So we see every day why Japan has so much trouble getting out of it's long slump. There was an article recently talking about how the lost decade in Japan is actually a myth, and that the reality is that Japan has done better than we all think since the bubble popped in 1990. Yes, Japan has low unemployment, earnings are up and the economy avoided a depression, but that was done pretty much by government debt spending.
I wouldn't be too proud of that.
Anyway, recent headlines further highlight the disfunction of corporate Japan. We painfully realized how incompetent the government was in handling the earthquake and nuclear crisis last year and corporate Japan continues to shock us observers with truly bizarre developments.
Olympus sued current and former executives and directors for failing to deal with the fraud but strangely kept them on board. Apparently, there is no support in Japan from shareholders to fire the board or replace the senior management. How can this be? It doesn't make any sense at all. Woodford just gave up completely. I don't know if he is the right guy or not, but the fact that there was no support for him in Japan and full support for current board and management is mind-boggling.
Nomura today also lost Jasjit Bhattal, the head of Nomura's global business apparently because Tokyo resisted Bhattal's call for deeper cuts in global operations (shutting unprofitable businesses, getting out of unprofitable countries etc...). This is really bizarre too because I would think that more often, a head of a business would want to expand more than headquarters feels comfortable with and they leave. Most bosses are empire-builders; they want to expand their empires, cost and risk be damned. And Bhattal wanted to *shrink* and Tokyo said no, lol. Only in a Japanese company can this happen (?).
I have no idea if Bhattal is any good or not, but I get the sense that this is typical Japanese corporate mentality to resist change and resist firing people. Also, Japanese are notoriously bad at cutting losses and admitting defeat (look at Olympus!). They are also more concerned with market share and status than profitability (statements to the contrary notwithstanding). You can be sure there are turf war issues too; intense lobbying by heads of unprofitable businesses to keep them going.
I don't know if this means that the Lehman purchase was a complete failure, but I bet that deep cuts would have been interpreted as such which probably scare the heck out of senior management in Tokyo.
Anyway, this is not a good development, I don't think.
Nomura's legacy of failing internationally seems to be continuing and this might just be the latest iteration of it.
I still think for Nomura to realize value, they should focus on the domestic business and then eventually team up with a strong international bank. Of course, this will never happen for the reasons I stated before.
Similar to this was the Sony comments that they will never exit the TV business because the engineers are very proud of their work.
I truly wish Japanese companies would really stop thinking this way and focus on profitability, returns on capital and things like that. As Jack Welch says, firing people might be unpleasant and short term bad for the fired, but over the long haul it is good for everyone; the company (as they can cut cost and reduce the odds of bankruptcy which would be bad for everybody and reallocate resources to productive areas) , the fired employee (that can go out and find something that they can do productively instead of becoming corporate zombie employees like so many salarymen in Japan) and even the economy (as the newly unemployed find productive things to do including starting ventures. Also more frequent firings would by necessity increase labor mobility).
Japan has a long, long way to go...
*sigh*
Showing posts with label Olympus. Show all posts
Showing posts with label Olympus. Show all posts
Wednesday, January 11, 2012
Friday, November 18, 2011
Olympus Continued
So the story continues to unfold and it doens't sound too good. In my earlier post, I said that on the face of it there might be 459 billion yen or 1,700/yen per share in value at Olympus just by valuing the medical equipment business at 8.0x EBITDA, adding up the cash and securities and deducting long term debt (see here).
I also did say, though, that financial statements are in question with such a fraud of massive scale. Who knows what is going on there? Since the scandal broke, they said that financial statements will have to be restated going back 20 years.
Still, if the loss was a billion dollars or so and if the phony payments and recent writedowns were related to the earlier losses and that was all there is, there was a chance that Olympus may have plenty of equity value for shareholders.
However, today's New York Times article about an investigator's memo raises questions about that.
From the article today (read here: NYT Olympus article, November 18, 2011)
"Olympus paid a total of 481 billion yen, or $6.25 billion, through questionable acquisition payments, investments and advisory fees from 2000 to 2009, according to the memo, but only 105 billion yen has been written down or otherwise accounted for in its financial statements. That leaves 376 billion yen, or $4.9 billion, unaccounted for, according to the memo"
Well, if this is true, there goes the 459 billion in equity value that might have existed at Olympus. Also, this memo only mentions the period 2000 to 2009. If the losses occured in the early 1990s, there may be more from 1990 - 1999.
Anyway, I guess this is a speculation that certain types of investors like, but with such a potential black hole, the wise thing to do might be to stay away.
Wow.
Again, the scary thing is that I find it hard to believe that Olympus is a single, rogue company. I think this is a systemic problem with many large corporations in Japan. Of course it's silly to think this is going on at all Japanese corporations, but I find it hard to believe that this is the only company that has done this.
I also did say, though, that financial statements are in question with such a fraud of massive scale. Who knows what is going on there? Since the scandal broke, they said that financial statements will have to be restated going back 20 years.
Still, if the loss was a billion dollars or so and if the phony payments and recent writedowns were related to the earlier losses and that was all there is, there was a chance that Olympus may have plenty of equity value for shareholders.
However, today's New York Times article about an investigator's memo raises questions about that.
From the article today (read here: NYT Olympus article, November 18, 2011)
"Olympus paid a total of 481 billion yen, or $6.25 billion, through questionable acquisition payments, investments and advisory fees from 2000 to 2009, according to the memo, but only 105 billion yen has been written down or otherwise accounted for in its financial statements. That leaves 376 billion yen, or $4.9 billion, unaccounted for, according to the memo"
Well, if this is true, there goes the 459 billion in equity value that might have existed at Olympus. Also, this memo only mentions the period 2000 to 2009. If the losses occured in the early 1990s, there may be more from 1990 - 1999.
Anyway, I guess this is a speculation that certain types of investors like, but with such a potential black hole, the wise thing to do might be to stay away.
Wow.
Again, the scary thing is that I find it hard to believe that Olympus is a single, rogue company. I think this is a systemic problem with many large corporations in Japan. Of course it's silly to think this is going on at all Japanese corporations, but I find it hard to believe that this is the only company that has done this.
Thursday, November 10, 2011
Olympus Kills Japanese Stock Market?
Olympus was down again the limit and I don't think any shares traded, having been offered down the limit all day at 484 yen/share.
Olympus, on it's own is not a big problem. These things do happen. The U.S. had it's Enron, Worldcom and others.
But the problem is that Olympus is an old, stodgy blue-chip company, not some aggressive, MBA-led startup. If you can't trust Olympus, who can you trust in Japan? What other companies have similar problems? If this sort of cover-up is culturally acceptable are any of the income statements and balance sheets in Japan reliable? Is there something wrong with the auditing system in Japan? The scary part is not what happened to Olympus itself, but the suspicion that this is not uncommon (as I said, sadly, I was not surprised by what happened).
This is a scary thought for investors. This is especially true now with sentiment so fragile after the big, global financial blowup.
My fear is that this will turn people off to stocks in Japan for many years. This is not like the financial crisis in the U.S. where the collapse is easy to understand. It was a standard bubble and collapse. People now trust banks quite a bit less and are afraid of leveraged balance sheets and risk-taking financial institutions. But nobody is worried about Coca-Cola, Starbucks or Google. Yes, stocks aren't that popular after such a long period of subpar performance.
But that's different than what is going to happen in Japan going forward post-Olympus. Olympus was not a subprime lender or bank. What happened is not industry specific, so people won't just be able to avoid certain risky industries, they will have to avoid Japan overall.
The Japanese handling of the Fukushima crisis also doesn't inspire confidence. If they can't tell the truth about that, how can we trust the regulators of Japanese corporations? Would they not also lie and help cover things up for the sake of a bigger, social good?
Back in 2006 there was a Livedoor/Murakami scandal that rocked the Japanese financial markets and that really killed the Japanese OTC market, I think.
You will see that the market peaked in early 2006 just as the Livedoor scandal broke. This really turned people off to the OTC market (even though Livedoor was Tokyo Stock Exchange listed). I think it changed the perception of the market as a rigged thing with no chance for outside investors.
Why is this important? You will say that lower valuations will be good for investors and they can make good returns. This is true, but in the case of the Japanese OTC market, I think the problem is that with a bad market, low valuations and no liquidity, companies can't raise capital. If companies can't raise capital at reasonable prices, the market won't develop. I think the Japanese OTC market is stuck in the vicious cycle and can't get out of it, and it seems to me it is largely due to the Livedoor/ Murakami scandal. At least it seems like that to me.
You can see that the JASDAQ market did top out earlier than the Nikkei 225 Index. The Nikkei didn't top out until the financial crisis began to unfold.
The problem here is that any chance of people coming back to stocks in Japan may be set back for years due to this Olympus problem. Who is next? As for foreign investors, they will realize that they have no mechanism to resolve these Olympus-type problems as they do in the U.S. This means that at the margin, foreign investors will be less likely to invest in Japan.
Of course, value investors need not worry about what other people do and whether stocks are popular or not. But what it does tell you is that Japanese stocks will probably have to get a lot cheaper on a valuation basis before people get interested.
With this lack of transparency, shakey accounting/auditing, no recourse when trouble occurs, rational investors will demand a discount to invest in such a place.
For many years, Japanese stocks traded at a premium to U.S. and other global stocks. This really made no sense to me as returns on capital, margins and other productivity measures were usually far lower than Western counterparts.
The premium has disappeared in the past couple of years making people bullish on Japan again, but Olympus, I think, will change that somewhat. Parity valuation will not be a reason to go to Japan anymore (unless there are other factors that make a specific investment interesting. All of these things have to be evaluated on a case-by-case basis).
Couple that with the incompetence of the Japanese government in dealing with the economic situation and government finances, this is a recipe for a long, extended bear market far longer than has already occurred.
This is very unfortunate as I have been interested in Japan for many, many years and have been waiting for some sort of bottoming out over there.
It now looks like there won't be a true bottom for a long time.
I will continue to look for interesting situations over there, but things are not looking too good at all.
I do also understand that I may be putting in a low in the Japanese stock market by making such a negative post!
Olympus, on it's own is not a big problem. These things do happen. The U.S. had it's Enron, Worldcom and others.
But the problem is that Olympus is an old, stodgy blue-chip company, not some aggressive, MBA-led startup. If you can't trust Olympus, who can you trust in Japan? What other companies have similar problems? If this sort of cover-up is culturally acceptable are any of the income statements and balance sheets in Japan reliable? Is there something wrong with the auditing system in Japan? The scary part is not what happened to Olympus itself, but the suspicion that this is not uncommon (as I said, sadly, I was not surprised by what happened).
This is a scary thought for investors. This is especially true now with sentiment so fragile after the big, global financial blowup.
My fear is that this will turn people off to stocks in Japan for many years. This is not like the financial crisis in the U.S. where the collapse is easy to understand. It was a standard bubble and collapse. People now trust banks quite a bit less and are afraid of leveraged balance sheets and risk-taking financial institutions. But nobody is worried about Coca-Cola, Starbucks or Google. Yes, stocks aren't that popular after such a long period of subpar performance.
But that's different than what is going to happen in Japan going forward post-Olympus. Olympus was not a subprime lender or bank. What happened is not industry specific, so people won't just be able to avoid certain risky industries, they will have to avoid Japan overall.
The Japanese handling of the Fukushima crisis also doesn't inspire confidence. If they can't tell the truth about that, how can we trust the regulators of Japanese corporations? Would they not also lie and help cover things up for the sake of a bigger, social good?
Back in 2006 there was a Livedoor/Murakami scandal that rocked the Japanese financial markets and that really killed the Japanese OTC market, I think.
You will see that the market peaked in early 2006 just as the Livedoor scandal broke. This really turned people off to the OTC market (even though Livedoor was Tokyo Stock Exchange listed). I think it changed the perception of the market as a rigged thing with no chance for outside investors.
Why is this important? You will say that lower valuations will be good for investors and they can make good returns. This is true, but in the case of the Japanese OTC market, I think the problem is that with a bad market, low valuations and no liquidity, companies can't raise capital. If companies can't raise capital at reasonable prices, the market won't develop. I think the Japanese OTC market is stuck in the vicious cycle and can't get out of it, and it seems to me it is largely due to the Livedoor/ Murakami scandal. At least it seems like that to me.
You can see that the JASDAQ market did top out earlier than the Nikkei 225 Index. The Nikkei didn't top out until the financial crisis began to unfold.
The problem here is that any chance of people coming back to stocks in Japan may be set back for years due to this Olympus problem. Who is next? As for foreign investors, they will realize that they have no mechanism to resolve these Olympus-type problems as they do in the U.S. This means that at the margin, foreign investors will be less likely to invest in Japan.
Of course, value investors need not worry about what other people do and whether stocks are popular or not. But what it does tell you is that Japanese stocks will probably have to get a lot cheaper on a valuation basis before people get interested.
With this lack of transparency, shakey accounting/auditing, no recourse when trouble occurs, rational investors will demand a discount to invest in such a place.
For many years, Japanese stocks traded at a premium to U.S. and other global stocks. This really made no sense to me as returns on capital, margins and other productivity measures were usually far lower than Western counterparts.
The premium has disappeared in the past couple of years making people bullish on Japan again, but Olympus, I think, will change that somewhat. Parity valuation will not be a reason to go to Japan anymore (unless there are other factors that make a specific investment interesting. All of these things have to be evaluated on a case-by-case basis).
Couple that with the incompetence of the Japanese government in dealing with the economic situation and government finances, this is a recipe for a long, extended bear market far longer than has already occurred.
This is very unfortunate as I have been interested in Japan for many, many years and have been waiting for some sort of bottoming out over there.
It now looks like there won't be a true bottom for a long time.
I will continue to look for interesting situations over there, but things are not looking too good at all.
I do also understand that I may be putting in a low in the Japanese stock market by making such a negative post!
Wednesday, November 9, 2011
Olympus
What is happening at Olympus is really sad. The worst part of it is that I'm not even that surprised. I have been looking to invest in Japan for a long, long time and have only found 'trades' to do there; buying stocks when they are very cheap due to short term worries about this or that.
But I haven't been able to find good, solid blue chips to invest in or interesting vehicles like Berkshire Hathaway, Leucadia or Loews type thing where you don't really care about the industry but trust the capital allocation skills of management.
This really illustrates one of the biggest problems in Japan; lack of transparency, total disregard for shareholders, outright dishonesty at the very top (which is not unusual in the U.S. either) which just seems culturally acceptable over there. I guess part of it is due to the lack of due legal process. In the U.S., people lie too, but they get sued or go to jail (OK, OK, I hear the protests about how few bankers have gone to jail... Yes, yes, Fuld was a liar as were a bunch of others and they remain on the loose. But still...). I don't think that happens very often in Japan.
Anyway, let's take a quick look at this thing. What is shocking to me is that despite the stock price being down 90% from their highs, the stock is not even super cheap. It's cheap to be sure, but not ridiculously so. Again, this goes to show how overvalued Japan has been even recently despite a 20 year bear market.
As the chart shows, as recently as 2007, the stock traded at 5,000 yen per share. Peak EPS was 214.44 in the year ended March 2008, which comes to a p/e ratio of 23x. That might not be ridiculously expensive, but before that going back to 2001, Olympus never earned EPS of over 200 yen/share.
The EPS history goes like this:
year-end
March of: EPS
2001 44.57
2002 38.87
2003 91.88
2004 126.96
2005 -44.98
2006 105.99
2007 176.79
2008 214.44
2009 -428.43
2010 177.22
2011 27.47
I haven't looked at the reports in 2007, 2008, but these were years at the height of the bubble so these earnings may or may not be repeatable.
Here is a close-up look at Olympus. The stock crashed over the past few days from over 2,000 yen/share to the current 584 yen per share.
Is that cheap? Since so many people talk about book value per share with respect to Japanese stocks, let's take a look at that. According to the quarterly filing (in Japan), Olympus had 151 billion yen in shareholders' equity and 266.9 million shares outstanding (net of treasury stock), so that comes to a book value per share of 565 yen per share. So even after this stunning drop in stock price, Olympus is now trading at only a slight discount to BPS.
Here are some fundamental figures for Olympus:
If Olympus earned decent returns on equity (ROE) over time, BPS would be a great buy. But it looks like over time, the ROE of Olympus has been around 5.12%, not so exciting. This does include the -44.4% loss in 2009, but since that is a real loss from a writedown, I would not exclude that. The 25.8% ROE in 2010 is mostly due to a gain booked as a result of transferring a business so it's not operational.
Otherwise, Olympus only earned an ROE above 10% in five of the last twelve years. A decent looking 15-16% ROE was only achieved at the height of the bubble back in 2007 and 2008.
I should point out that much of this book value is goodwill. Even though there is 151 billion yen in shareholders' equity, there is goodwill of 168 billion yen. So in the current world where tangible book value is popular, Olympus has a negative tangible book value.
Sales has been declining every year since 2008 and margins haven't been that exciting looking.
It is interesting to note that while Olympus is known for their cameras, the Imaging business accounts for only 15% of sales and hasn't made money recently at all. The Medical Products business (70% market share of endoscopes etc...) has been the money earner here, accounting for more than 100% of the operating income at Olympus last year.
Since this is the crown jewel of Olympus, let's take a quick look at it:
Sales have been flattish over the past couple of years and operating margins seem to be trending down. I don't have a lot of understanding of this industry and the outlook for this segment, but it does look like a decent business with decent margins, although it is trending down.
Growth? Management says that growth will come from Asia, and that may be so. Who knows. Many Japanese companies have been talking about Asia as their engine of growth for many years without too much to show for it so we'll see.
If Olympus does get back to historical earnings that it earned back in 2007, 2008, then Olympus stock is certainly cheap. Peak EPS was 214 yen and the stock is now trading at 584 yen/share so that's only 2.7x peak earnings. I am a bit skeptical that earnings can get back up there.
So let's take a look at the balance sheet. As of the end of June, 2011 there was 151 billion yen in shareholders' equity and 59 billion yen in investment securities, much of it in equities. Yet another problem with Japanese business is their continuing of cross-holding of stocks. Twenty years later, a lot of corporate balance sheets are still stuffed with stocks. This is very annoying, but is another topic altogether.
There is also 267 billion yen in cash and cash equivalents. So one is tempted to add this up, the 267 billion in cash and 59 billion yen in stock and call that non-operating assets, deduct it from enterprise value and get a cheap valuation on the operating business.
Let's look at it that way, then. Long term debt as of the end of June, 2011 was 631 billion yen.
With 267 million shares outstanding and a stock price of 584 yen/share, that's a market cap of 156 billion yen, plus 631 billion yen is total capitalization of 787 billion yen.
Deduct cash and cash equivalents from that and you get 520 billion yen enterprise value for Olympus. If you consider the 59 billion yen as not operating assets and more like cash, then deduct that and you get 461 billion yen in enterprise value.
EBITDA of Olympus in the last three years were 108 billion, 130 billion and 96 billion yen for an average of 111 billion yen or so.
Using the enterprise value with cash and cash equivalents excluded would give a valuation of around 4.7x EV/EBITDA and excluding stockholdings, it would come to 4.2x EV/EBITDA. Out of conservatism and the reality that these corporations may never sell their crossholdings, it's better to use 4.7x EV/EBITDA.
Is that cheap?
I don't know much about the medical systems business, but here's a quick look at some comparables (which admittedly don't look too comparable, actually).
Just as a quick sanity check, I picked some medical device-like companies:
Operating
EV/EBITDA margin ROE
Johnson and Johnson 8.6x 25.4% 18%
Medtronic 8.2x 28.5% 20%
Covidien 8.6x 21.8% 19%
Becton Dickinson 7.5x 22.5% 23.6%
All of these are for the last 12 months and are pulled from Yahoo Finance.
Yes, 4.7x EV/EBITDA seems cheap. But the ROE and operating margins are not even close. Olympus earns nowhere near 20% ROE or 20% operating margins over time as a whole.
Maybe one should only look at the medical systems segment and see what it is worth since it does earn a 20-23% operating margin. If that can be valued at 8.0x EV/EBITDA, then maybe we have a good sum-of-the-parts story here (even though betting on a corporate action in Japan is a loser's game; a value realizing transaction will never happen over there!!).
This is a really simplistic sum-of-the-parts, but here goes.
Let's put a 8.0x EV/EBITDA multiple on the medical systems segment of Olympus, add the cash and stockholdings value, deduct the long term debt for the 'equity' value and divide by the number of shares to see what this thing is worth assuming the rest of the businesses are worth exactly ZERO.
In the year-ended March, 2011, the medical systems segment had the following EBITDA:
Sales: 355.5 billion
Operating income: 69.3 billion
D&A: 16.9 billion
Amortization of goodwill: 9.3 billion
Total EBITDA: 95.5 billion
The operating margin of this segment was a slightly less than 20%, so let's use an EV/EBITDA ratio of 8.0x to value this business and then add the rest of the stuff and deduct the long term debt:
Medical systems segment value: 764 billion (95.5 billion x 8.0)
Cash and cash equivalents: 267 billion
Investments: 59 billion
Total: 1,090 billion
less long term debt: - 631 billion
Equity value: 459 billion
Number of shares outstanding: 267 million
Equity value per share: 1,719 per share
With the above assumptions, Olympus shares are worth at least 1,719 yen per share.
However, this valuation may not necessarily be reached. My opinion is that if the firm as a whole does not start to earn reasonable operating margins and returns on equity, then this hypothetical valuation may never happen (even though Olympus stock did seem to trade above this level for most of the recent past).
In order for this valuation to be forcibly realized, the medical systems group would have to be sold at this level of 8x EV/EBITDA or something like that, and as I said, in Japan these value realization events rarely happen as many foreign investors in Japan has learned over the past twenty years.
Also, it is not clear what the future of the other segments are. Japanese companies tend to pump money into even losing segments out of inertia or pride. This can be a very serious value destroying thing to do. Japanese companies do tend to overemphasize market share and sales growth more than return on capital.
Of course, the biggest problem here is the big question mark of the current scandal. What actually is going on? Are the earnings/balance sheet figures even reliable? What do they mean? What is the future of Olympus?
These are very hard questions to be sure.
I don't own any Olympus and don't plan on buying any in the near future as I am skeptical that things will be 'righted' soon, but I will keep an eye on it and may post some updates if I see anything interesting.
Having said all that, this is not to say that the stock can't go up. It is certainly possible that value investors see value here and jump in, pushing the price back up dramatically. Just because I am not interested doesn't mean it won't go up (in fact, the fact that I'm not interested means it will probably go up).
But although I see some value on a look-through or sum-of-the-parts basis as described above, my experience watching Japanese companies makes me worry that future management will continue to destroy shareholder value, even with a nice, profitable jewel of a business. I fear that instead of realizing value for shareholders via a spin-off or sale, or by shutting down unprofitable or low profit segments, they will continue to take money from the good business and dump it into the bad to preserve or increase sales, and more importantly, I think, maintain employment.
Dumping good money into bad businesses seems to be at least partially motivated by Japanese management's aversion to right-sizing/layoffs. They would rather spend money on a low profit factory to update it with subpar returns on investment rather than close it down and have to lay off workers.
Anyway, I don't know that this is what Olympus has been doing in the past, but their capital management in the past hasn't been very encouraging either way. Also, even though there seems to be a lot of cash on the balance sheet, this may not go back to shareholders any time soon (it's not net cash anyway). Just skimming the annual reports going back a few years, they seem to be hell bent on growth.
And one way they want to grow is through acquisitions. And keep following that thought, Japanese corporations have historically been horrible in acquisitions. That's partly because of their reputation to pay too high a price (which is no surprise given the history of managements' obsession with sales and disregard of returns on capital), and their reputation for not being able to manage the businesses they buy.
In any case, that's just a quick look at this thing for now. I will keep thinking about this for a little bit.
But I haven't been able to find good, solid blue chips to invest in or interesting vehicles like Berkshire Hathaway, Leucadia or Loews type thing where you don't really care about the industry but trust the capital allocation skills of management.
This really illustrates one of the biggest problems in Japan; lack of transparency, total disregard for shareholders, outright dishonesty at the very top (which is not unusual in the U.S. either) which just seems culturally acceptable over there. I guess part of it is due to the lack of due legal process. In the U.S., people lie too, but they get sued or go to jail (OK, OK, I hear the protests about how few bankers have gone to jail... Yes, yes, Fuld was a liar as were a bunch of others and they remain on the loose. But still...). I don't think that happens very often in Japan.
Anyway, let's take a quick look at this thing. What is shocking to me is that despite the stock price being down 90% from their highs, the stock is not even super cheap. It's cheap to be sure, but not ridiculously so. Again, this goes to show how overvalued Japan has been even recently despite a 20 year bear market.
The EPS history goes like this:
year-end
March of: EPS
2001 44.57
2002 38.87
2003 91.88
2004 126.96
2005 -44.98
2006 105.99
2007 176.79
2008 214.44
2009 -428.43
2010 177.22
2011 27.47
I haven't looked at the reports in 2007, 2008, but these were years at the height of the bubble so these earnings may or may not be repeatable.
Here is a close-up look at Olympus. The stock crashed over the past few days from over 2,000 yen/share to the current 584 yen per share.
Is that cheap? Since so many people talk about book value per share with respect to Japanese stocks, let's take a look at that. According to the quarterly filing (in Japan), Olympus had 151 billion yen in shareholders' equity and 266.9 million shares outstanding (net of treasury stock), so that comes to a book value per share of 565 yen per share. So even after this stunning drop in stock price, Olympus is now trading at only a slight discount to BPS.
Here are some fundamental figures for Olympus:
Otherwise, Olympus only earned an ROE above 10% in five of the last twelve years. A decent looking 15-16% ROE was only achieved at the height of the bubble back in 2007 and 2008.
I should point out that much of this book value is goodwill. Even though there is 151 billion yen in shareholders' equity, there is goodwill of 168 billion yen. So in the current world where tangible book value is popular, Olympus has a negative tangible book value.
Sales has been declining every year since 2008 and margins haven't been that exciting looking.
It is interesting to note that while Olympus is known for their cameras, the Imaging business accounts for only 15% of sales and hasn't made money recently at all. The Medical Products business (70% market share of endoscopes etc...) has been the money earner here, accounting for more than 100% of the operating income at Olympus last year.
Since this is the crown jewel of Olympus, let's take a quick look at it:
Sales have been flattish over the past couple of years and operating margins seem to be trending down. I don't have a lot of understanding of this industry and the outlook for this segment, but it does look like a decent business with decent margins, although it is trending down.
Growth? Management says that growth will come from Asia, and that may be so. Who knows. Many Japanese companies have been talking about Asia as their engine of growth for many years without too much to show for it so we'll see.
If Olympus does get back to historical earnings that it earned back in 2007, 2008, then Olympus stock is certainly cheap. Peak EPS was 214 yen and the stock is now trading at 584 yen/share so that's only 2.7x peak earnings. I am a bit skeptical that earnings can get back up there.
So let's take a look at the balance sheet. As of the end of June, 2011 there was 151 billion yen in shareholders' equity and 59 billion yen in investment securities, much of it in equities. Yet another problem with Japanese business is their continuing of cross-holding of stocks. Twenty years later, a lot of corporate balance sheets are still stuffed with stocks. This is very annoying, but is another topic altogether.
There is also 267 billion yen in cash and cash equivalents. So one is tempted to add this up, the 267 billion in cash and 59 billion yen in stock and call that non-operating assets, deduct it from enterprise value and get a cheap valuation on the operating business.
Let's look at it that way, then. Long term debt as of the end of June, 2011 was 631 billion yen.
With 267 million shares outstanding and a stock price of 584 yen/share, that's a market cap of 156 billion yen, plus 631 billion yen is total capitalization of 787 billion yen.
Deduct cash and cash equivalents from that and you get 520 billion yen enterprise value for Olympus. If you consider the 59 billion yen as not operating assets and more like cash, then deduct that and you get 461 billion yen in enterprise value.
EBITDA of Olympus in the last three years were 108 billion, 130 billion and 96 billion yen for an average of 111 billion yen or so.
Using the enterprise value with cash and cash equivalents excluded would give a valuation of around 4.7x EV/EBITDA and excluding stockholdings, it would come to 4.2x EV/EBITDA. Out of conservatism and the reality that these corporations may never sell their crossholdings, it's better to use 4.7x EV/EBITDA.
Is that cheap?
I don't know much about the medical systems business, but here's a quick look at some comparables (which admittedly don't look too comparable, actually).
Just as a quick sanity check, I picked some medical device-like companies:
Operating
EV/EBITDA margin ROE
Johnson and Johnson 8.6x 25.4% 18%
Medtronic 8.2x 28.5% 20%
Covidien 8.6x 21.8% 19%
Becton Dickinson 7.5x 22.5% 23.6%
All of these are for the last 12 months and are pulled from Yahoo Finance.
Yes, 4.7x EV/EBITDA seems cheap. But the ROE and operating margins are not even close. Olympus earns nowhere near 20% ROE or 20% operating margins over time as a whole.
Maybe one should only look at the medical systems segment and see what it is worth since it does earn a 20-23% operating margin. If that can be valued at 8.0x EV/EBITDA, then maybe we have a good sum-of-the-parts story here (even though betting on a corporate action in Japan is a loser's game; a value realizing transaction will never happen over there!!).
This is a really simplistic sum-of-the-parts, but here goes.
Let's put a 8.0x EV/EBITDA multiple on the medical systems segment of Olympus, add the cash and stockholdings value, deduct the long term debt for the 'equity' value and divide by the number of shares to see what this thing is worth assuming the rest of the businesses are worth exactly ZERO.
In the year-ended March, 2011, the medical systems segment had the following EBITDA:
Sales: 355.5 billion
Operating income: 69.3 billion
D&A: 16.9 billion
Amortization of goodwill: 9.3 billion
Total EBITDA: 95.5 billion
The operating margin of this segment was a slightly less than 20%, so let's use an EV/EBITDA ratio of 8.0x to value this business and then add the rest of the stuff and deduct the long term debt:
Medical systems segment value: 764 billion (95.5 billion x 8.0)
Cash and cash equivalents: 267 billion
Investments: 59 billion
Total: 1,090 billion
less long term debt: - 631 billion
Equity value: 459 billion
Number of shares outstanding: 267 million
Equity value per share: 1,719 per share
With the above assumptions, Olympus shares are worth at least 1,719 yen per share.
However, this valuation may not necessarily be reached. My opinion is that if the firm as a whole does not start to earn reasonable operating margins and returns on equity, then this hypothetical valuation may never happen (even though Olympus stock did seem to trade above this level for most of the recent past).
In order for this valuation to be forcibly realized, the medical systems group would have to be sold at this level of 8x EV/EBITDA or something like that, and as I said, in Japan these value realization events rarely happen as many foreign investors in Japan has learned over the past twenty years.
Also, it is not clear what the future of the other segments are. Japanese companies tend to pump money into even losing segments out of inertia or pride. This can be a very serious value destroying thing to do. Japanese companies do tend to overemphasize market share and sales growth more than return on capital.
Of course, the biggest problem here is the big question mark of the current scandal. What actually is going on? Are the earnings/balance sheet figures even reliable? What do they mean? What is the future of Olympus?
These are very hard questions to be sure.
I don't own any Olympus and don't plan on buying any in the near future as I am skeptical that things will be 'righted' soon, but I will keep an eye on it and may post some updates if I see anything interesting.
Having said all that, this is not to say that the stock can't go up. It is certainly possible that value investors see value here and jump in, pushing the price back up dramatically. Just because I am not interested doesn't mean it won't go up (in fact, the fact that I'm not interested means it will probably go up).
But although I see some value on a look-through or sum-of-the-parts basis as described above, my experience watching Japanese companies makes me worry that future management will continue to destroy shareholder value, even with a nice, profitable jewel of a business. I fear that instead of realizing value for shareholders via a spin-off or sale, or by shutting down unprofitable or low profit segments, they will continue to take money from the good business and dump it into the bad to preserve or increase sales, and more importantly, I think, maintain employment.
Dumping good money into bad businesses seems to be at least partially motivated by Japanese management's aversion to right-sizing/layoffs. They would rather spend money on a low profit factory to update it with subpar returns on investment rather than close it down and have to lay off workers.
Anyway, I don't know that this is what Olympus has been doing in the past, but their capital management in the past hasn't been very encouraging either way. Also, even though there seems to be a lot of cash on the balance sheet, this may not go back to shareholders any time soon (it's not net cash anyway). Just skimming the annual reports going back a few years, they seem to be hell bent on growth.
And one way they want to grow is through acquisitions. And keep following that thought, Japanese corporations have historically been horrible in acquisitions. That's partly because of their reputation to pay too high a price (which is no surprise given the history of managements' obsession with sales and disregard of returns on capital), and their reputation for not being able to manage the businesses they buy.
In any case, that's just a quick look at this thing for now. I will keep thinking about this for a little bit.
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