Japan Global M&A Brings Risks as Funds Sell Lixil Convertibles

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Lixil Showroom
Samples of interior wall tiles, left, are displayed at the Lixil Group Corp.'s showroom in Tokyo. Photographer: Kiyoshi Ota/Bloomberg

Lixil Group Corp. is being punished in the convertible bond market after becoming the latest Japanese company to stumble seeking growth with overseas acquisitions.

Aviva Plc is among investors selling the housing material company’s 2020 equity-linked notes, which slumped 5.4 percent from a peak in March after it reported accounting irregularities at its German unit. Tokyo-based Lixil said Thursday its subsidiary, Joyou AG, which mainly operates in China, is considering whether to file for bankruptcy.

“Part of the reason for us to reduce and move to a more neutral weight on Lixil was the uncertainty in M&A execution and the expansion into China,” said Justin Craib-Cox, who manages $2.5 billion of global convertibles in London at Aviva Investors Global Services, a unit of the U.K. insurer. “There isn’t a strong edge from outside Japan in knowing whether they have what it takes to expand into new regions.”

Japanese companies have announced $42.7 billion of overseas acquisitions so far this year, the most for the period since at least 1990, according to Bloomberg-compiled data. The results to date have been mixed. Sprint Corp., the U.S. carrier that Japan’s SoftBank Corp. bought for $22 billion in 2013, saw its net loss widen in the three months ended March. Daiichi Sankyo Co. sold its controlling stake in India’s Ranbaxy Laboratories Ltd. in April last year after struggling to turn around the business it acquired for about $4.6 billion in 2008.

Failed M&As

“In most cases, Japanese M&As of foreign companies in the past five years failed because of weaknesses in providing clear direction and the inability to integrate the target business,” said Cosmo Takamatsu, the managing director in Tokyo at AlixPartners, the global business advisory firm, without referring to any specific company. “Part of the problem is also their slow decision-making process, which typically is based on consensus-oriented decisions at the headquarters.”

Lixil said Joyou may have lost half of its shareholder equity because an audit at a Joyou unit showed there were “substantial deviations” between reported sales, debt and cash figures and the actual amounts, according to a statement. Lixil expects a charge of as much as 16 billion yen ($132 million) if Joyou files for bankruptcy. The Japanese company said on May 1 it’s delaying releasing group earnings because it has to review the accounting at Joyou.

Zurich-based Fisch Asset Management also sold Lixil’s convertible bonds because the stock’s decline has made it harder for investors to profit from holding the debt that pays no interest.

Shares Drop

Lixil’s shares have dropped 11 percent this year to 2,273 yen in Tokyo on Thursday. The company’s 2020 and 2022 notes are convertible into its stock at 3,880 yen and 3,800 yen, respectively. The shares closed at 2,713 yen on Feb. 16 when the equity-linked notes’ details were announced.

“The revenue related to the German subsidiary operating in China is relatively small,” said Stephanie Zwick, a fund manager at Fisch, which oversees about $8.7 billion of assets. “It’s a minor thing for the group if they change the auditing method. We are quite comfortable with the credit quality of Lixil.”

A consortium led by Lixil purchased Grohe Group, a German bathroom-fixtures maker and parent of Joyou, in January 2014 for 2.94 billion euros ($3.27 billion), according to data compiled by Bloomberg. Lixil has also acquired American Standard Brands, another maker of bathroom fixtures, and Permasteelisa SpA, which made walls for the Guggenheim Museum and the Sydney Opera House.

Commitment Sought

“We would ask for clarity around Joyou and the audit process, clear business targets in terms of merger activity, and how the business looks afterwards,” Aviva’s Craib-Cox said in the May 15 interview. “In short, commitment.”

Shizuka Fukushima, a spokeswoman for Lixil, declined to comment.

As Japanese manufacturers expand abroad, accounting irregularities at overseas units have been rising, according to a report last month by Tokyo Shoko Research Ltd., a corporate research firm. Cases related to globalizing of business increased to 15 in the year ended March 31 compared with six in the previous 12 months, it said.

Shigeru Matsumoto, a Tokyo-based senior managing director at SCS Global Consulting K.K., which advises on M&A, said his research shows that about half of overseas acquisitions by Japanese companies end up failing in ten years.

Housing Slump

A slump in Japan’s home building market after a sales tax increase in April 2014 is also weighing on Lixil’s convertible notes, according to Masahiro Mochizuki, an analyst at Credit Suisse Group AG in Tokyo.

The company’s core domestic earnings dropped 17 percent in the year ended March 31 to 74.1 billion yen, as sales decreased 4 percent. Housing starts in Japan fell from a year earlier for 12 straight months through February, before rebounding in March, according to government data.

“The company has been affected too much by the drop in new construction,” said Credit Suisse’s Mochizuki. “They aren’t winning the competition against their rivals.”

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