TOKYO/SYDNEY In February 2015, bankers working on Japan's biggest IPO in three decades woke to news that left them shaken. Their client had just closed a multi-billion dollar deal - but had kept them firmly out of the loop.
Just months ahead of its listing, state-owned Japan Post Holdings Co (6178.T) was buying Australian logistics firm Toll Holdings for A$6.5 billion ($4.9 billion), leaving underwriters scrambling to understand the impact on the selldown.
"My heart skipped a beat when I read the Nikkei (newspaper) that morning," one banker who worked on the deal told Reuters. "Clients have to be honest and at least tell us before making the deal, since it would impact the sale price and business forecasts."
They were right to worry. Barely two years after trumpeting the deal, Japan Post last week said a 400 billion yen ($3.6 billion) writedown on Toll would push it to an annual loss in its first year as a listed company.
The massive impairment charge has drawn into focus the deal's rich premium, speed and timing, raising questions over Japan Post's due diligence and its plan to integrate Toll's sprawling business into a global conglomerate spanning postal delivery, banking and insurance.
Japan Post acknowledged concerns over the due diligence process and its management of the company, but blamed the writedown on worse-than-expected economic pressures.
"During the acquisition, due diligence was implemented taking into account the opinion of accounting, taxation, legal and financial experts," said Hideo Murata, a spokesman for Japan Post. "Commodity prices fell faster than we had thought, and we couldn't imagine the direct impact on Toll's earnings."
The saga may further undermine Japanese efforts to persuade investors to believe in its corporate governance reforms which have been shaken by high-profile failures of foreign takeovers by companies including Toshiba Corp (6502.T) and Kirin Holdings Co Ltd (2503.T).
For Tokyo, it also comes as the government prepares a second offering of shares in Japan Post. In total, it plans to raise around 4 trillion yen through the privatization.
Japan's Ministry of Finance declined to comment on whether it would investigate the Toll deal.
An official overseeing the second offering told Reuters: "As for the timing and the size of the next tranche of Japan Post IPO, we will deal with it appropriately while continuing to monitor market developments,"
Investment banks coordinating the 2015 and upcoming share sales declined to comment.
Then-Chief Executive Taizo Nishimuro saw the Toll deal as the crucible in which Japan Post would transform itself into a global logistics powerhouse and lend stardust to its IPO.
Toll had excellent growth potential and a balanced portfolio of business, Japan Post said.
Under the ambitious Nishimuro - a former chairman of Toshiba and the Tokyo Stock Exchange - Japan Post hired Mizuho Financial Group (8411.T) and Australian boutique firm Gresham Partners as financial advisers. Sydney-based Clayton Utz came on as legal adviser.
Mizuho, Gresham and Clayton Utz all declined to comment.
The final offer - at a hefty 49 percent premium to Toll's share price a day earlier - was unanimously accepted by Toll's board.
Though criticized as high by some analysts, a person with direct knowledge of the deal said the premium was in line with other deals in the global logistics industry. The roots of the writedown were in the management of Toll after the takeover, not in the terms of the deal, the person added.
Last year, rail-based Australian freight firm Asciano Ltd, bowed to a A$6.8 billion buyout at a 39 percent premium to its pre-bid price after a six-month bidding war, while UK Mail accepted a 242.7 million pound offer by Germany's Deutsche Post (DPWGn.DE) at a 43.1 percent premium.
Still, the divide between the offer and Toll's challenges became apparent on Feb. 18, just a day after the parties announced the deal, when Toll unveiled a 22 percent fall in half-yearly net profit.
"Had (Japan Post) actually delayed that announcement of the acquisition, they probably would have saved themselves 10, maybe 20 percent," said an analyst who in 2015 rated the uncontested offer as well above Toll's valuation.
The economic keystones of Toll's business had shifted.
A sharp slowdown in Australia's mining and steelmaking industries had cut freight demand, while the hollowing out of the country's manufacturing base was also hitting margins and demand for haulage.
"It's been tough the last two or three years," said Paul Sarant, chief executive of No. 3 Australian trucking firm K&S Corp Ltd (KSC.AX).
"We're all focused in terms of reducing cost, improving our performance and through the whole freight network trying to optimize the efficiencies."
Toll was also facing internal issues, brought about by its ambitious growth strategy.
Between 2001 and 2013 Toll had bought over 20 companies from Southeast Asia to Africa, leaving it wrestling with duplication of technology, staff and, in the case of couriers, entire lines of business.
"These units effectively go out to market separately from each other and they're actually in the market against each other for work," said Transport Workers Union assistant secretary Michael Kaine.
Jeffrey Luckins, an audit director and due diligence specialist at Australian accounting firm William Buck, said it appeared Japan Post had missed the big picture.
"Did they have the right experts on hand? Did they ask the right questions? Did they bring economists in? If they've written off (almost) the entire value of the investment, one assumes that the assumptions that have been made ... were incorrect."
Japan Post had warned investors in its IPO prospectus that managing Toll's web of acquisitions could be difficult. But despite its awareness of potential risks, Toll's high fixed costs eroded profits as economic factors began to bite, Japan Post's Murata said.
"We were aware of the drop in Toll's earnings between the takeover and the writedown, and took steps to address it. It was not the case that we did nothing and watched," he said.
Decisions by Toll's management, 80 of whom were made millionaires when their share options vested after the takeover, continued to face scrutiny.
In September, for example, the company announced it was paying A$170 million for two new ships to link the island state of Tasmania with the Australian mainland.
But at 210 meters, the ships were too long for Toll's dock at the Tasmanian port.
A Toll spokesperson declined to comment on the Tasmanian situation except to say: "We are working closely with port authorities to finalize the details."
Top Toll managers including chairman Ray Horsburgh and chief executive Brian Kruger left the company in December. Kruger did not respond to requests for comment while Horsburgh declined to comment.
Paul Little, who ran Toll for two decades until 2010 and was the architect of its aggressive growth strategy, also declined to comment for this report.
But after last week's announcement of the writedown and the loss of 1,700 Toll jobs, Little told The Australian newspaper the company's "legacy has been trashed" and said he stood by his contribution.
"There is not much I can do about the fact that Japan Post overpaid for the company and I had a reasonable shareholding," said Little, who made A$320 million on the sale of his 5 percent stake.
(Refiles to add dropped word in paragraph 7.)
(Additional reporting by Emi Emoto and Tetsushi Kajimoto in TOKYO; Editing by Lincoln Feast)