February 26, 2019 / 4:17 AM / a month ago

Breakingviews - Nintendo plays winning Japanese buyback game

Banners of Nintendo's new game console Switch are pictured at its experience venue in Tokyo, Japan January 13, 2017. REUTERS/Kim Kyung-Hoon

HONG KONG (Reuters Breakingviews) - Stock buybacks are often a silly financial engineering game, but in Japan they warrant serious consideration. Nintendo shows how they can be played to winning effect.

The Super Mario maker will repurchase shares for the first time since 2014, and is simultaneously cancelling a big slug of mostly useless treasury stock sitting in limbo. Although the acquisition accounts for less than 1 percent of the Kyoto-based company’s $33 billion market value, the reasons behind the decision are significant for Japan Inc.

Nintendo is essentially backstopping a secondary sale by five Japanese banks that want to offload shares because of greater regulatory attention on cross-holdings. Companies must now provide financial rationales for stakes they own.

Bank of Kyoto, for one, may struggle to justify the 277 different Japanese stocks – Nintendo being the largest holding – it was sitting on as of last March. At $9 billion, they were worth more than twice as much as the bank’s own market capitalisation. Travis Lundy, an analyst who publishes on SmartKarma, notes how hard it is for companies to generate a decent return on equity simply by collecting dividends from cross-holdings with one hand and paying them out with the other. The Nintendo transaction is a welcome sign that the new corporate governance code could be gaining traction.

Cash is abundant to help unwind these value-destructive arrangements. Japanese enterprises were holding so-called “internal reserves” worth $4 trillion at the end of the latest fiscal year. More than half of non-financial companies in Tokyo’s benchmark index are net cash, according to CLSA. Nintendo is one. And valuations across Japan, at just 12.5 times expected earnings, are low. As for treasury shares, they can artificially inflate market values and be misused as piggy banks for M&A.

Buybacks help address all these issues, and momentum is gathering. The Nintendo deal sent Bank of Kyoto shares up 8 percent, with investors potentially hoping it will pare more holdings. Share repurchases in Japan have surpassed a record 6.5 trillion yen ($58.7 billion) since April 1, and Goldman Sachs forecasts the figure will grow another 20 percent this coming fiscal year. SoftBank Group, Sony and others recently joined the buyback party. Many, like Nintendo, are also cancelling hoarded shares. For Japan, buy and hold is no longer the name of the game. 

Breakingviews

Reuters Breakingviews is the world's leading source of agenda-setting financial insight. As the Reuters brand for financial commentary, we dissect the big business and economic stories as they break around the world every day. A global team of about 30 correspondents in New York, London, Hong Kong and other major cities provides expert analysis in real time.


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