When Toyota Motor Corp.'s (TM ) top brass met with financial analysts at New York's exclusive Metropolitan Club on Sept. 6, they pulled out all the stops. The event began on the sidewalk, where Toyota's flashy new Formula One race car was parked next to the cutting-edge Prius electric-gasoline hybrid. Inside, President Fujio Cho talked up Toyota's $3.1 billion annual cash flow, record dividends, and 10% share of the global auto market.
But Cho & Co. couldn't gloss over one disturbing trend: Despite record earnings and a pledge to buy back $5 billion in stock this year, Toyota's shares are down 9.6% since January. Indeed, although Toyota has spent $8.3 billion on share repurchases in the past five years, and although it has outperformed the benchmark Nikkei 225 stock index, its stock trades lower today than it did in 1997. A primary culprit: the selling of shares by Japan's troubled big banks, which held 16% of Toyota a year ago but which now hold only 12%.
It's not just Toyota's problem, either. Plenty of other Japanese blue chips, from Honda to Tokyo Electric Power, are also suffering through a bank-induced slide in their share prices. The result is a situation that exposes just how dysfunctional Japan's financial system is--and how Tokyo's economic turmoil could inflict a lot more damage on investors before its slow-motion crisis is resolved. Granted, sales by banks are not the only factor depressing prices, but they're a key reason even blue chips aren't immune to Tokyo's market woes. "Bank unwinding will continue to be a drag on the market," says Garry Evans, an equity strategist at HSBC Securities.
Here's how the best companies Japan Inc. has to offer are getting hammered. Japan's banks, as everyone now knows, are in terrible straits, sitting on bad debts exceeding $600 billion. The banks also hold stock portfolios worth some $237 billion. They need to raise cash to shore up their reserves and offset the bad loans. And they must meet a 2004 regulatory deadline to reduce drastically the amount of capital they hold in stocks: Policymakers at the watchdog Financial Services Agency have been prodding the banks to seek a better return on assets, reduce exposure to stock market swings, and end those unholy alliances in which Japan's banks would often hold shares in a company and extend loans to the same company.
Over the long run, the program is sound policy. Japan's banks need to be free and clear of the cross-shareholdings that have clouded their judgment in making loans. But it's the short run that's scaring the socks off investors and pounding Japan's blue chips. As the banks have steadily unloaded their shares, they have helped sink the Nikkei 225 to its lowest level in nearly two decades. In the process, the banks have found it far easier to sell blue-chip shares like Toyota, rather than the dog stocks they hold in near-dead construction companies or property developers. The result: Toyota shares take a hit. "Investors need to have an understanding of the banking situation," says Toyota's Ryuji Araki, executive vice-president and finance chief.
Banks are, in effect, punishing the most competitive companies for their own sins in lending to uncompetitive ones. Of course, the banks are trying to sell stock in distressed companies--but these shares don't raise nearly as much money as the blue chips do. What's more, the banks have a reason not to dump the shares of the market laggards wholesale: They're also big borrowers, many of them barely able to service their loans. If the banks dumped their shares and prices plummeted, many of those zombie companies could slide into bankruptcy--compounding the bad debt problem at the banks.
It all adds up to a vicious cycle: The more the banks dump shares of blue-chip stocks, the lower their prices go, which further saps confidence in Japan's markets and the country's broader economy. "It's a concern," says Yukio Shohtoku, a managing director at Matsushita Electric Industrial Co. (MC ), which owns the Panasonic brand. Despite growing sales and a return to profitability this year, Matsushita's shares are down by 17% since January. But, he says, "the only option is really to improve our corporate performance in terms of profits."
The market swoon is also bad news for Japanese Prime Minister Junichiro Koizumi. He plans to announce an economic stimulus package later this month, and one of its goals is to boost stock prices. The package will likely include a hodgepodge of corporate tax cuts and government pledges to speed up purchases of bad loans from banks. That, Koizumi hopes, will shore up the stock market and help banks improve their balance sheets prior to the end of September, when they must report the market value of their shareholdings.
The government will probably patch together enough support for the markets to prevent a complete meltdown, a trick it has managed to pull off before. But the downward pressure on shares will then resume, as the banks continue to sell. As of March, leading banks owned 9.8% of Nintendo Co. (NTDOY ), down from 18.9% a year earlier. Banks reduced their stake in Honda Motor Co. (HMC ) to 9.7% from 10.7% over the same period, according to HSBC Securities Inc.
Foreign investors are part of the casualty list in this struggle. Foreigners--who in buying Toyota thought they were investing in a Japanese icon that would prosper despite the country's economic troubles--now own 16% of the company, up from 10% in 1999. They shouldn't expect Toyota's buybacks--the biggest in Japanese corporate history--to do much for the stock. Few recent buybacks have been enough to offset the downward pull on Japan's blue chips.
There's plenty of potential downside still to come. To meet the Financial Services Agency's guidelines, major banks such as Mizuho Bank, UFJ, and Sumitomo Mitsui Financial Banking still need to dispose of some $62 billion in shares by March, 2004. That's on top of the $39 billion they sold last year, estimates HSBC. That more than offsets the $17 billion in expected corporate buybacks this year.
Another worry is the equity holdings of major life insurers. They control about $177 billion in shares, according to Goldman, Sachs & Co. economist Kathy Matsui. And they're under enormous pressure to raise money, as policyholders who lose their jobs or see their wages fall cash out annuities. Furthermore, as shares continue to slide, many insurance companies are paying out more to policyholders--who are guaranteed a return--than they're getting from their investments. If the Nikkei stock index doesn't rise significantly by the end of September, nine out of the top 10 life insurers will face losses on their portfolios, Mitsui says. They will then be tempted to sell even more shares to meet their solvency margin requirements. Japan still has some great companies. But there are plenty of reasons why it won't have great stocks for years to come.
By Chester Dawson in New York and Brian Bremner in Tokyo, with Irene M. Kunii in Tokyo