Japanese Government Looms in the Background for Tortured Toshiba Sale

 | Jul 13, 2017 | 10:00 AM EDT
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You knew it wasn't going to be easy. Nothing is with Toshiba (TOSYY) .

Just when it seemed the Japanese electronics giant had reached a deal to sell its crown jewel, its chip-making unit, to a bidder backed by the Japanese government, it appears to have botched that $18 billion sale.

It desperately needs the cash from selling its prize money spinner to offset an estimated $9 billion loss from its nuclear unit. It also wants to avoid the indignity of being delisted from the Tokyo Stock Exchange.

And the company appeared to have got what it wanted. Although the deal wasn't necessarily the best in terms of price, Toshiba identified an offer by a state-backed consortium that includes the Korean chipmaker SK Hynix (HXSCL) and the Boston-based private-equity group Bain Capital as its preferred bid.

But try as it might, it can't complete the deal. A deadline to reach final agreement on that sale by the time of its shareholder general meeting on June 28 has come, and blown by. Now its bankers say it has reopened talks with its legal opponent Western Digital (WDC) and with Hon Hai Precision Industry (HNHPF) , better known as the Apple component supplier Foxconn, which have both offered competing deals.

It's an all-too-familiar scenario for a company in a perpetual muddle. A company that was forced to delay the release of its financial results twice, and then put them out in April without the sign-off from its auditor, is back to square one.

I asked back in April whether credibility-challenged Toshiba was the worst-run company in "Japan Inc." Toshiba's problems are company-specific, but they are also symptomatic of a much broader problem. They are the product of a corporate culture that for far too long let the "C-suite" operate unchecked, with no questions asked.

Toshiba has some pretty fierce competition in the "worst-managed" category from the likes of bankrupt airbag maker Takata (TKTDY) , linked to 16 deaths for inflators that burst and send shrapnel flying through the air. Despite that, Takata took its sweet time in recalling its products.

And it has competition from Mitsubishi Motors T:7211, which has plainly made up fuel-efficiency data on its cars. That compounded its earlier, decades-long cover-up of defects on its cars. 

There are numerous other contenders -- the inept response to the nuclear disaster at Fukushima by Tepco (TKECY) also springs to mind -- but Toshiba's current muddle pretty much pushes it to the top. 

What happens with Toshiba will be a yardstick by which to judge the corporate state of play in Japan. Its banks are, unusually, pressuring Toshiba to push through the chip-unit sale.

Sumitomo Mitsui Financial  (SMFG) , Mizuho Financial Group (MFG)  and five other major lenders met with Toshiba top management on Tuesday to assess the sale. The banks then said publicly that Toshiba was taking another look at other offers, with Toshiba agreeing to hold yet another extraordinary shareholder meeting by the end of October.

That the banks are being so outspoken is a sea change from Japan Inc.'s previous pattern. Deals were sorted out between bankers and their clients, companies that generally held stock in each other, to prop up "zombie companies" stumbling along and barely making a living, let alone a profit.

That worked remarkably well during Japan's startling rebuilding of its economy in the aftermath of World War II. It has failed miserably in the decades since Japan's economic bubble burst in the late 1980s.

The administration of Prime Minister Shinzo Abe recognizes the issue and is pushing for deep-rooted changes in the way Japanese companies are run. Those changes include the selection of outside directors on corporate boards and a push for better returns on equity. The government is also demanding a reduction in cross-holdings between companies and their clients. 

Activist investors are eking out small gains that bolster the influence of minority shareholders. And Japanese companies that have sat for far too long on huge piles of cash are returning some of it to investors via higher dividends, or buying back their own shares.

Investors should note the formation of the JPX-Nikkei 400 index, which includes good corporate governance among its criteria for selection. U.S. investors can play that through the iShares JPX-Nikkei 400 ETF (JPXN) and the Deutsche Trackers Japan JPX-Nikkei 400 Equity ETF (JPN) .

Investors say the changes so far are only an inch in a miles-long change. Toshiba is a yardstick to measure how far things have come.

Toshiba became the first major Japanese company to issue unaudited results when it put out its latest figures in April. PricewaterhouseCoopers Aarata said it was unable to form an opinion about Toshiba's figures, increasing the risk that the Tokyo Stock Exchange will de-list Toshiba's shares. Toshiba even said there were questions about whether it was able to function as a going concern.

The stock exchange still hasn't decided what to make of Toshiba's unaudited results -- its rules required a delisting if it missed the third deadline to file. If Toshiba posts two years of negative shareholder equity, as it will for the year ending March 2018 without a chip-unit sale, it will also be delisted according to TSE rules -- a terrible loss of face in an Asian culture that prizes reputation so much.

Its investors are losing patience, and are increasingly vocal, literally, in their criticism. "Toshiba has become a laughingstock around the world. You have no clue what's going on," one shareholder shouted at management during a shareholder meeting in March.

It's hard to see how Toshiba will resist an offer of bailout help from the Japanese government. Its preferred bid includes not only Hynix and Bain but also the state-backed Development Bank of Japan, as well as the public-private Innovation Network Corp. of Japan.

With that team at risk of collapse, Toshiba's banks have forced it to reconsider. In its new look at other bids, it will reconsider Foxconn's deal that reportedly offered as much as $27 billion for the business -- almost $10 billion above Toshiba's own estimate. 

At the back of all the bidding is the Japanese government, which is wary about allowing chip-making technology to sell to foreign rivals. That raises questions about the presence of Korean Hynix in the preferred bid. Foxconn, although Taiwan-based, has extensive operations in China and close relations with the government there.

San Jose, Calif.-based Western Digital has now reportedly also offered a deal that includes the Development Bank of Japan, and the Innovation Network Corp. of Japan, the Japanese government apparently covering its bases.

To complicate matters, Western Digital and Toshiba are both partners and fierce legal adversaries. Western Digital and its subsidiary SanDisk on Tuesday won a temporary court order forcing Toshiba to open up its databases and continue sending chip samples as part of their joint venture together.

Jim Cramer explains why he views the court victory as a "huge victory for Western Digital." If the courts continue to find in Western Digital's favor, any sale to the original preferred bidder "is finished," Cramer says. "There are lawyers involved in this deal." Western Digital is a holding in the Action Alerts PLUS charitable trust. 

Toshiba plans to appeal the ruling, which it says only gives Western Digital access to technical information until July 28, anyway. It says Western Digital has "improperly obtained and used" Toshiba's data. 

Besides the temporary restraining order on the databases, Western Digital has also filed an injunction that would allow it to block any chip-unit sale at all, thanks to its existing partnership with Toshiba. The court is due to rule on Friday. 

And whatever happens then, there will be another hearing on July 28, followed by the shareholder meeting within three months. It's highly unlikely that Toshiba is going to unravel the mess that it has created for itself by then -- if it ever does.

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