High Water Mark For The Nikkei?

As foreign investors bolt, the Tokyo market may have peaked

For the first half of 1996, it looked as if the days of fast money had returned to the Tokyo Stock Exchange. Ever since the Nikkei stock average finally snapped out of its five-year funk last summer, a stampede of big Japanese companies has issued new shares to raise much-needed cash. At the same time, smaller companies have rushed to market with public offerings. Snapping up the new shares was a seemingly endless stream of foreign investors. Betting on Japan's economic rebound, they helped boost the Nikkei to 21,275 on Aug. 21, from last year's low of 14,485.

But now, the dash for cash by Japan Inc. may be about to create a massive share glut just as the foreign money has started leaving town. After pouring $65 billion into Japanese stocks since last fall, foreigners have turned net sellers in the last 12 weeks or so. That is one reason the Nikkei has tumbled 6% since June 26 (chart).

Nobody is forecasting a meltdown on the Nikkei. But if foreign money heads for the exits in a big way, predictions earlier this year that the benchmark index could reach 25,000 by yearend will look fanciful. Overseas investors now own an all-time high 10% of Japanese outstanding shares. And "there has been a huge reliance on foreign investors" during the rally, says UBS Securities Inc. equity strategist Neil Rogers. Should more of them bolt, "there will be a very nasty supplydemand relationship," he warns.

What's driving the foreigners out? Although most economists believe Japan's economy will expand by 2.7% or so in 1996, the outlook for 1997 and beyond looks dicey. Last September's $131 billion government spending package will lose its stimulative punch later this year, and an expected boost in the sales tax next April, from 3% to 5%, is likely to put a damper on consumer spending.

The exodus couldn't come at a worse time--right in the middle of an equity financing boom. During the first half of 1996, Japanese companies raised $24 billion via share offerings and convertible bond issues that eventually will morph into additional shares. That's already more than in all of 1995, and UBS's Rogers figures that an additional $22 billion will be raised by yearend.

FEW TAKERS. The problem is partly pent-up demand. With the Nikkei's long slide since 1989, few cash-hungry companies were allowed by the Finance Ministry to go to market with more shares until recently. So they're making up for lost time. Also contributing to supply is the fraying of Japan's cross-shareholding system, in which companies take equity stakes in one another to ward off raiders and cement business ties. A new study by Daiwa Institute of Research noted that cross-holding networks accounted for 49% of all outstanding shares last year. It was the first time the amount had fallen below 50% since the early 1970s.

Trouble is, besides Japanese trust banks and life insurers, there have been few takers at home to soak up all of these shares. Major brokerages are using wild gimmicks to lure back individual investors, who fueled the late-1980s bull market, bailed out when it imploded, and never returned en masse. Nomura Securities Co., for instance, has started offering customers a chance to win $300 certificates just for showing up at a branch office and filling out a questionnaire on their financial needs.

The buyers had better materialize soon. Big money-center banks such as Sakura Bank Ltd. and Nippon Credit Bank Ltd. also have announced major preferred-share offerings--perhaps $46 billion over the next two years--to shore up their capital bases and pay off post-bubble bad debts.

Even the Japanese government, which has a ballooning budget deficit, is dipping into the stock market. Come October, the government will take its first step toward selling off Osaka-based West Japan Railway Co., or JR West, one of six rail companies spun off from the bust-up of Japanese National Railways (JNR) in 1987.

In one of the highest-value stock offerings of the year, some 1.7 million shares will be sold at major exchanges. The plan was to cash in on the rally to help pare the debt of JNR Settlement Corp., a holding company formed to assume the debts of the six railways that once formed Japanese National Railways. The company inherited a staggering $255 billion in debt from the six railroads. But with so many shares competing for fewer investors, analysts figure the government may need to price them at a 20% discount compared with a similar JR East offering in 1993.

The story is the same in Japan's booming over-the-counter market. Roughly $3.1 billion in small-company public offerings hit the market from April to June alone--just shy of the full-year total for 1995, $3.2 billion. Why the rush? Companies fear that the Bank of Japan will raise the nation's near-zero interest rates later this year, which would probably shake up the market.

Some such issues are heavily speculative. Take the heralded Aug. 30 initial public offering of Takefuji Corp., Japan's biggest consumer-finance lender. It extends a maximum of $5,000 in unsecured loans--at interest rates of up to 27%--primarily to young middle- and low-income salarymen short on yen. By procuring funds cheaply and charging borrowers dearly, Takefuji has made a killing. Pretax earnings last year were up 56%, to $1.03 billion, on a par with blue-chip Nintendo Co. profits.

So Tokyo fund managers are betting that the $50-a-share stock price in Takefuji's 5 million-share offering could rise as much as 40% when trading begins. Yet the lender is heavily exposed to Japan's still-sinking real estate market. Some 9.2%, or $1.1 billion, of its assets are tied up in a Kyoto site that developers won't touch.

The fate of such IPOs depends in part on whether the foreign-money exodus continues. For now, overseas investors are jittery about the earnings outlook. Japan's flagship semiconductor giants probably will suffer from this year's 60% drop in memory-chip prices. And if the economy grows by only 1.7% in 1997, as Salomon Brothers Inc. predicts, then an earnings rebound by manufacturers that lifted share prices earlier this year could be cut short.

Foreign investors might be lured back if Prime Minister Ryutaro Hashimoto's coalition government delivers an expected $30 billion-plus supplementary budget this fall to stoke Japan's economic engine. That, plus a modest pickup in corporate investment and consumer demand, could strengthen the recovery.

Yet with companies of every stripe issuing new shares, foreign investors departing, and domestic players still wary, something has to give eventually. A tsunami of new shares with not enough buyers is hardly the recipe for a return to the good old days on the Tokyo bourse.

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