Japan is a relatively small equity player on the global stage, yet it has more listed companies than any other exchange in the world. There are 3,957 companies on the Tokyo Stock Exchange (TSE), while the largest market by capitalisation, the New York Stock Exchange, contains half as many stocks at 2,272, despite being over four times larger at $28.3trn.
Even Japanese equity investors themselves such as AVI Japan Opportunity trust manager Joe Bauernfreund say there are “far too many” public companies.
Many business owners in Japan believe being listed gives their firm elevated status – even if it does not make financial sense for their company. This preference for going public reverses the trend seen elsewhere in the world, as more and more companies opt to hold off listing and remain private.
Bauernfreund says: “Japan has an aversion to private companies because there’s a sense that being listed gives you a quality stamp. That shift towards private businesses we’ve seen in other parts of the developed markets hasn’t played out yet in Japan. “We’re only now beginning to see greater interest in companies going private in takeover bids or management buyouts, because it is such a fantastic opportunity for the private equity industry to exploit.”
Going public in Japan does have its benefits because of this perceived legitimacy, but it can have a detrimental effect on a company if the motives are purely for reputational gain, according to Junichi Takayama, Japan equity investment director at Nikko Asset Management. The result is a market swamped with low-growth companies.
“Ideally, you would want to list your company to raise capital for investing in profitable projects, but many are just using the stockmarket as a means to cash out, not necessarily because they want to grow their company further,” Takayama explains.
“And being listed on the Tokyo Stock Exchange also has reputational purposes to really gain trust. You’re basically saying to the whole world that you have no ties with the Japanese mafia.”
Dropping the dead weight
It is well known that the TSE has become inundated with companies that should not be listed. In an effort to remedy this, its market structure was revamped in 2022 and tougher requirements demanded from its constituents. Companies listed on the TSE’s prime market – the main group intended for global investors – must now meet higher capitalisation, liquidity and governance thresholds, to distinguish which companies are listing for the right reasons.
Takayama says: “It’s harder now for companies to be listed on the prime market, and even if they make it to the top, they run the risk of being demoted or delisted if they don’t continue to satisfy those requirements. The biggest rationale behind the reform was to remove corporate complacency by ensuring companies were motivated to keep improving their business operations or risk being delisted.”
The TSE has not been shy in pressing those deemed to be dragging their feet. Last year, it instructed all companies on the prime and standard markets to disclose how they were improving their cost of capital and stock prices. In an even more brazen move in January 2024, a list of those not taking adequate action was published.
This certainly had the desired effect. Only 40% of companies were engaging with the TSE’s requests last year, but that has risen to 74% after its intervention. The half (51%) of Japanese companies not complying in 2023 has now shrunk to a fifth (19%).
As a result, management buyouts in Japan hit an all-time high last year as public companies spent ¥1.4trn (£7.9bn) moving their businesses back into private ownership.
‘Acquisition without consent’
There may be a mass exodus of listed companies taking themselves private, but the TSE has gone a step further in encouraging consolidation between companies. It published a set of guidelines last year detailing how companies should respond to acquisition offers. They must now give “sincere consideration” to potential acquirers, meaning they can no longer shrug off offers that may benefit shareholders.
With such a large pool of stocks to choose from – many of which are trading at low valuations – the opportunities on offer to potential buyers is abundant, according to Daniel Haydon, manager research analyst at Morningstar.
“For a long time, people just assumed these companies were unacquirable, but that sentiment has really changed,” he says. “I think that’s going to be a good thing for the Japanese small-cap segment because it’s a really deep capital market in terms of the number stocks. It’s definitely an area of active interest for us at the moment.”
This article first appeared in our sister publication, Portfolio Adviser and the November issue of Portfolio Adviser magazine.
