It's bad enough the U.S. subprime loan market is inflicting pain on lenders as far away as Japan. But lately the pain has spread beyond the banking sector into Japan's high-tech sector. The most prominent example: Sanyo Electric (6764.T). On Oct. 17, when news broke that the company has decided not to sell its semiconductor business to a private equity firm, there was the whiff of a potentially bigger problem. Neither Sanyo nor Advantage Partners, which had been planning to buy the division, would say why the deal fell through, but many people who follow the industry say the Tokyo-based private equity firm couldn't raise the money to pay for the acquisition.
The deal's collapse shows how a global credit crunch might slow the transformation of Japan's consumer electronics industry. Recently, the country's tech makers have turned to private equity money for help in reducing the bloat in their operations. Both Toshiba (6502.T) and Matsushita Electric Industrial (MC) successfully tapped private equity firms to revive neglected and chronically underfunded divisions in the recent past. That reliance on nontraditional credit sources has become essential for Japan's once-dominant tech titans as they try to improve profitability while keeping rivals at bay and lowering costs of products that must compete against those of ambitious rivals from Korea and low-cost upstarts from China.
So far this year, three of Japan's 10 largest bids from private equity firms have targeted tech companies, including Sparx's pursuit of Matsushita-owned Victor of Japan and Perry Capital's bid for NEC Electronics (6701.T). However, overall private equity spending, at $9.2 billion, is less than half the total from the first nine months of 2006, according to market tracker Thomson Financial (TOC).
Advantage's failed attempt to buy Sanyo Semiconductor wasn't entirely unexpected. Several months earlier, Advantage had won negotiating rights to buy the wholly owned subsidiary of Sanyo, which makes chips used in TVs and cell phones to sell to customers and for use in Sanyo's own electronics. Advantage outbid other suitors with its $850 million offer.
But even before Advantage's Oct. 15 deadline to have the money in hand, many creditors it had approached were reporting losses from subprime lending. The deadline coincided with the announcement that the quarterly profits at one such lender, Citigroup (C), were down 57% due partly to subprime loan trouble. Others, including Merrill Lynch (MER), also had to write off billions in bad loans.
Even so, investors reacted as if they had been handed a nasty surprise. At the close of trading Oct. 17, Sanyo's shares had dropped more than 6%, though a Tokyo bourse benchmark, the electrical machinery index, was down just 0.5%. A day later Sanyo's shares shed another 1.6%. By Friday, they had rebounded slightly.
A Setback for Many
Sanyo's misfortunes are a setback for a consortium of investors led by Goldman Sachs (GS), Daiwa Securities (8601.T), and Sumitomo Mitsui Banking Group. They ponied up billions to save Sanyo in January, 2006, and have since worked hard to restore the company's verve by guiding its efforts to find buyers for its noncore businesses.
In May, General Electric's (GE) Japan-based arm STV Partners bought Sanyo's finance unit, Sanyo Electric Credit, for more than $1 billion. Telepark, a subsidiary of trading company Mitsui & Co. (MITSY), said in August that it would absorb Sanyo's cell-phone retail arm for an estimated $40 million. And just last week, Sanyo announced a basic agreement to sell its cell-phone division to Kyocera (KYO), a deal Credit Suisse (CS) estimated at $430 million. The semiconductor unit's sale would have gotten rid of a capital-intensive and volatile business while raising an estimated $855 million for Sanyo to repair a tattered balance sheet.
But the fact is, even without the extra cash, Sanyo's outlook is brighter. Morgan Stanley (MS) figures Sanyo will report net profits of $183 million this fiscal year through March, 2008—its first net profit in four years. Operating profit could fall by 5% to $409 million but sales are expected to rise 1.3% to $20 billion. More important, cash flow should improve.
Controversy Despite Signs of Progress
Even the semiconductor unit, which accounts for around 8% of the company's overall sales and operating income, appears to be doing better. Credit Suisse reckons that the unit's operating profits will grow by 25% to $44 million this fiscal year through March, 2008, and nearly double the following year. Only two years ago, the unit had reported an operating loss of $305 million. "We believe the semiconductor unit is already turning to a profit," says Credit Suisse analyst Koya Tabata. "Sanyo is no longer a company near bankruptcy."
Yet for all the signs of progress, controversy has dogged the company. A month after Chairwoman Tomoyo Nonaka resigned in March, her likely successor—and heir to Sanyo's founders—Toshimasa Iue, quit (BusinessWeek.com, 3/19/07). And in May, the company said it would release revised earnings for the past six years to fix accounting mistakes.
Investors' high expectations might explain why they punished Sanyo for not selling. The company had made semiconductors a wholly owned subsidiary in mid-2006 to give the unit's management freedom to carry out reforms. Many observers interpreted the move as a sign that the unit, which does only 5% of its business with Sanyo, wasn't a good fit and was being prepared for a spin-off.
New Strategic Plan
The division's sale would have signaled to investors that Sanyo was making more progress in focusing on areas with the best prospects for growth, such as solar panels and batteries for laptops and cars. That would be in line with what others are doing. For instance, Sony (SNE), a company once fiercely protective of its semiconductor division, said on Oct. 18 that it would sell to Toshiba the production lines for its high-powered Cell chip, used in the PlayStation 3 video game console.
Sanyo could convince investors that holding onto the chip unit isn't so bad. It's slated to unveil a new strategic plan by late November. "We decided not to sell the semiconductor business, and instead we will nurture it as one of the core businesses in our components division," Sanyo said in a statement. For now, investors clearly prefer a clean break over nurturing.