Toyota buyout capitalises on insiders’ control

MELBOURNE, June 16 (Reuters Breakingviews) – The $33 billion offer to buy out Toyota Industries  rests on shareholders acquiescing in effectively financing a large slug of the deal. As a shocking example of how to engineer around Japan’s shareholder value push, it’s hard to beat.

The proposal was unveiled earlier this month by the world’s largest carmaker, Toyota Motor, its Chair Akio Toyoda, and the wider group’s real estate firm, Toyota Fudosan. If successful, it would unravel one of the $4 trillion economy’s most complex series of value-destructive cross-shareholdings.

These ownership arrangements have long protected Japanese companies from outside interference – whether from activist investors or unwanted potential buyers. But they also engender conflicts of interest and inefficient deployment of capital that hinder GDP growth. Not helpful given the population is shrinking.

That’s why the government and bourse operator Japan Exchange want cross-shareholdings unwound. The take-private offer for one of its own from key members of the Toyota Group – an association of multiple interconnected companies – aligns with that goal, while enjoying one last hurrah of the benefits for insiders.

Between them, the three buyers own just over 30% of Industries, the firm that started the Toyota empire more than a century ago as the maker of the world’s first automatic looms. Include the stakes held by other Toyota Group companies Denso  Aisin (7259.T),  and Toyota Tsusho which are not directly participating in the buyers’ consortium, and that ownership tally jumps to 42%.

Factor in Nippon Life and other Japanese companies holding strategic stakes that tend to vote with management and the bidders may hold sway over as much as 55% of the shares, reckons Travis Lundy, an analyst who publishes on Smartkarma. That means independent shareholders probably can’t block the deal. But it is egregious enough to merit close examination.

Start with the transaction’s structure. The three partners are stumping up about $6 billion of equity and borrowing almost $20 billion from banks to buy out the world’s largest maker of forklift trucks. That’s a punchy amount of leverage: equity represents just 24% of the deal.

Moreover, that sum doesn’t cover all of the target’s stock: Toyota Motor is helping itself and its buyout partners in several ways. First, it is agreeing to hold on to its almost 25% stake in Industries until after the tender offer for all other shareholders closes. This reduces the funds the buyers need to secure upfront.

Second, when Toyota Motor does sell its shares back to the target, it’ll be for about $7 billion, an 18% discount to what’s being offered to other shareholders. Finally, the carmaker is also putting in the most cash, almost $5 billion, but downgrading its holdings from straight-up equity to non-voting preferred shares.

There are more wrinkles too. For all their talk of investing in the take-private deal, Toyota Motor, Toyota Fudosan and Toyoda are really just ploughing back in the after-tax proceeds from selling their existing Industries stakes.

In Toyoda’s case, it’s even less: he’d get $16 million before tax from tendering his current 0.05% stake in Industries and has pledged to put in just $7 million to finance the same company’s buyout. That would give him 0.5% of the new entity created to hold Industries; Fudosan would own 99.5%, a more than 18-fold increase on its present holding.

Then there’s the price. Expectations of a deal, first reported on April 25, pushed Industries’ shares as high as 18,400 yen ($127.70) apiece by early June, roughly 40% above the undisturbed price. The buyout consortium’s actual offer on June 3 squelched those hopes: all shareholders except Toyota Motor would get 16,300 yen a share, a 23% premium.

Even getting there took some negotiating, with the special committee set up by Industries’ board to consider the proposal succeeding in getting the consortium to put more money on the table. It then twice, on rejected the 16,300 yen proposal, arguing that “it was difficult to consider that the price secured the interests of the target company’s minority shareholders to the maximum extent in light of the target company’s intrinsic value and other factors”.

Yet it was finally accepted, even though the price was only in the middle of the range of the fairness opinions, locally referred to as share valuation reports, from SMBC Nikko Securities and Mitsubishi UFJ Morgan Stanley Securities that valued the company at as much as almost 20,000 yen a share.

According to a Breakingviews analysis, it could be worth even more, meaning the deal undervalues Industries by as much as 38%. Here’s how: the target’s core business is worth 12,000 yen a share, or $25 billion, applying the same 13.5 times multiple carried by German rival Kion (KGX.DE), onto this year’s estimated earnings collated by LSEG. Then its listed stakes in Toyota Motor, Denso, Toyota Tsusho and Aisin are worth almost $28 billion, with another $2 billion or so coming from its holdings in other Toyota Group entities.

The four big publicly traded companies have announced they are repurchasing their own shares from the buyout target at a 10% discount as part of the deal. Assume the others do, too, and factor in what, estimates Lundy, would be an almost $5 billion tax bill, and the sales would bring in $22 billion, or 10,500 yen a share. That brings Industries’ total value to 22,500 yen a share.

Ideally, those buybacks would take place before the tender offer begins in December, with the proceeds returned to shareholders. Executing those deals first would make it harder for any buyer to undervalue Industries. Instead, the buybacks are slated to happen only once the tender process successfully concludes.

Some of the proceeds would then fund the delayed almost 1 trillion yen, roughly $7 billion, repurchase of Toyota Motor’s shares in Industries. That would leave the new owners flush with as much as $15 billion, enough to pay off three-quarters of what they borrowed.

It’s a deal crying out for an activist investor to put pressure on the buyers to improve their offer. Hong Kong-based hedge fund Oasis Management intends to do so, Reuters reported earlier this month. Trouble is, Industries’ shareholder register is packed with friends, so it’s a hard fight to win.

Japan’s government and regulators can easily make things friendlier for independent shareholders if they want, including by tightening rules around related-party transactions. The Toyota deal is an example of how Tokyo is giving its biggest groups sufficient room to create new protective ownership structures even as they are forced to dismantle old ones.

Follow Antony Currie on Bluesky.