Japan: An Activist Hedge Fund Helps Light up an Old Gasper

Source from:  The Economist  03/01/2013

THERE is an almost quaint—if you can stand it—old-world aura about smoking in Japan, like watching a 1950s film noir. Smoke billows out of bars. The government holds down cigarette prices. In some cities, you can puff away indoors, but not on the pavement.

A very modern battle has been waged over Japan's tobacco industry, however. It has pitted an activist hedge fund from London, The Children's Investment Fund (TCI), against the state-backed cigarette company, Japan Tobacco (JT), the seller of Camel and Winston brands outside America. On February 25th the fight reached a denouement when the government said it would sell shares worth 967 billion yen ($10.3 billion), reducing its 50% stake to 33%. It said the money would be used to help cover reconstruction costs after the 2011 earthquake and tsunami. TCI claimed it as a bounty to shareholders, too.

The battle started in June 2011, when TCI, with a 1% stake worth $400m, wrote to the finance ministry spelling out why Japan Tobacco should return more money to shareholders, saying the shares were seriously undervalued. Since then shares, which had underperformed global rivals, have soared (see chart). TCI claims credit for much of the increase. "The Japanese people are very conflict-averse. I don't mind being the bad guy who stirs things up," says TCI's Oscar Veldhuijzen.
 
Japan Tobacco says TCI is claiming credit for something the firm would have done anyway. Its dividend payout ratio (as a share of earnings) has risen from 19% in 2008 to 30% last year and will rise to 50% in 2016, an increase that is even bigger than it looks because of new accounting rules. "They [TCI] want to claim the trophy on everything, including perhaps causing the earthquake itself," one insider sniffs.

Erik Bloomquist, a global tobacco analyst at Germany's Berenberg Bank in London, says TCI's main contribution was to remind Japan Tobacco that it should be run for the benefit of shareholders and set expectations for higher returns. "It did hold JT's feet to the fire in a way that hadn't happened before," he says. But he reckons that Mitsuomi Koizumi, chief executive since last year, may be more shareholder-friendly anyway. It may have helped that the government has benefited as a shareholder. TCI was pushing an unlocked door.
 
The battle is not yet over, though. Shareholders still worry that JT may waste money on investing in low-growth businesses, such as Bristol-based Imperial Tobacco, instead of boosting returns further. The company worries that TCI just wants a short-term pop in the share price, rather than long-term growth in the business.
 
One oddity is why a hedge fund ostensibly funding a children's charity is betting so heavily on tobacco. Mr Veldhuijzen says the charity has no investment in JT; the stake is held on behalf of partners and outside investors. "We've doubled our money," he boasts. Try not to choke. Enditem