Warren Buffett Is Sage of Tokyo as Well as Omaha: William Pesek

Commentary by William Pesek

Jan. 14 (Bloomberg) -- “I find very few wonderful businesses in Japan at present.”

That’s how Warren Buffett explained his lack of interest in the second-biggest economy to students at the University of Florida. Buffett’s gripes include “very low returns on equity” and a corporate culture that’s unresponsive to shareholders.

Japan’s markets have been battered of late by the global crisis, and the Nikkei 225 Stock Average fell more than the Dow Jones Industrial Average in 2008. Stocks in the U.S., the epicenter of the credit crunch, fell 34 percent, while Japan’s dropped 42 percent.

Buffett’s concerns explain much of the difference. And yet, the billionaire investor’s views are hardly a revelation. They are certainly not news to anyone who suffered from the Nikkei’s plunge in 2008 and 11 percent slide in 2007. What’s intriguing about Buffett’s comments is that he didn’t make them yesterday, or last month, but in October 1998.

A lot has changed in Japan. Banks rid themselves of the bad loans behind the forgettable 1990s. Companies woke up to the pressures of globalization, cutting some costs and trimming bloated workforces. Key industries, particularly automakers, have increased market share in the past 10 years.

Or have things changed very little since Buffett’s 1998 speech? Analyst John Mihaljevic, writing on the Web site Seeking Alpha, looked at corporate Japan’s evolution since then, and it’s not pretty.

Five Issues

“We approached our study of Japanese stocks with the hypothesis that we should be able to find some compelling investments given the cheap valuations of a large subset of Japanese public companies,” wrote Mihaljevic, managing editor of the Manual of Ideas in New York. “So far, however, we have remained unimpressed.”

Five specific issues are explored: a lack of business focus, murky corporate governance, little regard for returns on investment, the high cost of production, and clubby boardrooms.

Many big companies still look more like conglomerates of old than Western-style enterprises. Yes, many Western economies and companies are taking their lumps these days. Yet the lack of focus is apparent in names such as Sony Corp., which oddly has both a bank and an insurance arm.

Governance Concerns

On corporate governance, there have been modest successes. Nipponkoa Insurance Co., Japan’s fourth-largest casualty insurer, recently raised its profit target and vowed to cut costs and increase sales in response to pressure from one of its biggest shareholders: Southeastern Asset Management Inc.

Marked improvements are still few and far between. The increasing prevalence of takeover defenses and poison pills to avert mergers that may benefit shareholders is a big concern.

Companies in Japan, Mihaljevic says, routinely spend as much as 10 percent of annual revenue on capital expenditures even though they are in businesses with pretax profit margins of less than that amount.

Japan also is a high-cost center. While companies have embraced global outsourcing, many prefer to produce goods at home. That increases costs and leaves companies vulnerable to the strengthening yen. Buffett has long said high costs thwart his desire to buy an entire company in Japan.

Finally, the lack of gender diversity in boardrooms speaks to a continued unwillingness to open up the corporate culture. If there is any developed economy that needs to adopt new ways of doing business, it’s Japan.

Superior Technology

Japan is home to a highly skilled and hardworking labor force. Companies benefit from access to superior technology and manufacturing techniques. Japan also has some of the most environmentally friendly business practices anywhere.

Buffett’s Berkshire Hathaway Inc., it’s worth noting, has invested in Japanese shares here and there since 1998. In September, for example, Berkshire’s Iscar Metalworking Cos. agreed to buy a 71.5 percent stake in Tungaloy Corp., a manufacturer of tools for cars and planes.

But, Mihaljevic says, “assuming constant multiples, investors are likely to be disappointed, as they’ll be earning returns similar to the companies’ returns on equity. The latter generally range in the low- to mid-single digits and appear unlikely to rise anytime soon.”

Politics are worth considering, too. It’s hard to remember a time in the last 15 years when Japan existed in the kind of leadership vacuum that pervades the nation today. With a public support rate below 20 percent, it won’t be easy for Prime Minister Taro Aso to enact legislation to support the economy.

There’s no doubt the U.S. precipitated the global crisis. Yet Japan’s economy stopped on a dime because the government did nothing to create growth from within. Once U.S. demand dried up, Japan lost all steam.

Japan’s longest postwar expansion did little to fatten the paychecks of average households. A decade after pledging to boost domestic demand, Japan’s remains largely a one-trick economy: exports. That recognition is now reflected in stock prices.

The Nikkei was at 12,995 points on the day of Buffett’s 1998 speech. Today it’s at about 8,400. It may be time to start calling the Sage of Omaha the Sage of Tokyo, too.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net