Thinking Points

  • Japan’s Keiretsu structure has shaped business culture long time, even getting Mitsubishi employees drinking a certain brand of beer.
  • The structure hasn’t favored foreign investors seeking important positions thus far, but the environment is changing.
  • Investors ought to be aware of Keiretsu to avoid the same mistake T. Boone Pickens made several decades ago.

Do you know which beer Mitsubishi employees drink?

I’m guessing not. And I’m fairly certain many native Japanese folks wouldn’t know either (including myself, until recently).

Today, we will talk about Keiretsu, or Japanese business conglomerates. I’ve written related articles in the past, like this one about Mitsubishi Heavy (TSE: 7011), but haven’t taken the time to explain what a Keiretsu actually is.

What is a Keiretsu?

According to Wikipedia, a keiretsu is a set of companies with interlocking business relationships and shareholdings.

The keiretsu structure can be traced back 400 years. Before World War II, Japan had 3 major business conglomerates (called Zaibatsu in Japanese) – Mitsui, Mitsubishi, and Sumitomo – all of which had heavy family influence. Mitsui and Sumitomo can be traced back to the 1600s. Mitsubishi started more recently in the 1800s. After World War II, the General Headquarters of the Allied Powers (GHQ) worked to dissolve all major and many of the second-tier zaibatsus.

Source: Old Tokyo – Mitsui Bank in 1935

The dissolution effort faded as the Japanese political climate resisted the efforts and the United States figured zaibatsus would play an important role in reindustrializing Japan. As a result, the big 3 zaibatsus survived. The key difference is that the families are no longer in control. This is what we call horizontal keiretsu today.

And then we have the vertical keiretsu, which is probably more familiar internationally. The most famous example being Toyota and its network of suppliers. The close ties allow for careful coordination, which is most visible in supply chain concepts like just-in-time inventory systems. Flip this upside down and we have cartel-like operations. My favorite read so far is this gem by T. Boone Pickens from 1992.

Why do Keiretsus matter today?

For one, a lot of the grievance over Japanese corporate governance (or the lack of it) stems from keiretsu practices. Long-time Japan investors ought to be familiar with cross shareholdings and board seats filled with important people from keiretsu member companies. These groups are tightly knit.

Much of what T. Boone Pickens experienced is still real today, though more open to foreigners recently. In case you didn’t get a chance to read the article, T. Boone Pickens became the #2 shareholder with a 26% stake in Koito Manufacturing (TSE: 7276), a Toyota Keiretsu company. Since Toyota Motors (TSE: 7203) had 3 board seats with a 19% stake, Mr. Pickens figured he’d get a seat at the table. Despite a 2.5 year effort, he never got that seat.

More recently, scandals around Mitsubishi Automotive (TSE: 7211) come to mind. Long-time Mitsubishi Corporation (TSE: 8058) shareholders are probably tired of the continued fumbles of Mitsubishi Automotive, from recall cover-up scandals in 2000 and 2004 to the fuel scandal in 2016. Mitsubishi Corporation recently completed its 120 billion yen ($1.1 billion USD) tender offer which increased its stake in Mitsubishi Motors from 9.24% to 20%. Yes, 120 billion yen. T. Boone Pickens is probably shaking his head in disbelief.

Source: Mainichi Shimbun

It goes without saying that change is difficult. Mitsui, Mitsubishi, and Sumitomo, along with the mid-tier keiretsu companies, have a rich history often extending beyond 100 years. Moreover, the Mitsubishi Keiretsu revenues combined is enormous. According to Diamond JP, Mitsubishi Keiretsu revenues was 58 trillion yen ($532 billion USD), or about 10% of Japan’s GDP in 2016. That’s only one keiretsu. Combine the big 3 and we have a system with a rich history that is hard to ignore, avoid, or change.

The Japanese government is tackling this issue with the implementation of the Stewardship Code. However, even with the Stewardship Code, which calls for companies to disclose the rationale for cross-shareholdings, the keiretsu practice of cross shareholdings continue. Toyota Motors, for example, acquired a 5.05% stake in Mazda as a part of a partnership agreement in October 2017. Mazda (TSE: 7261), in exchange, is now 0.25% owner of Toyota Motors. Total investment amounts to roughly 50 billion yen ($460 million USD) each for Toyota and Mazda.

The bottom line

In short form, investors ought to pay attention to whether their investments belong to keiretsus and whether the keiretsu has a good track record. You may end up investing in a company like Mitsubishi Corporation, only to watch the company allocate some of its resources to the problem child (i.e., Mitsubishi Automotive). On the other hand, the Stewardship Code working against Japan’s keiretsu and some of its common practices may mean opportunities are on the horizon. One example is Seth Fischer of Oasis Capital betting on Kyocera (TSE: 6971) to unload its 12.95% stake in KDDI (TSE: 9433).

If you guessed that Mitsubishi employees drink Kirin Beer, you guessed right! Kirin Holdings (TSE: 2503) is part of the Mitsubishi group.

Kenkyo Investing
Kenkyo Investing

Kenkyo Investing applies a value investing approach to Japanese equities, providing insights that are often unavailable to non-Japanese speakers.