Why Japan Is Wary of Foreign Cash

As Chinese and Arab investors weigh big stakes in Japanese companies, concerns grow over corporate raiding and sharing tech knowhow

It's been a grim year for Japan's stock market. The Nikkei 225 index of leading stocks has slumped 18% from its 2007 peak as foreign investors, who control about 30% of trading on the Tokyo Stock Exchange, have pulled money out of the market following the U.S. subprime mortgage mess. But could a new class of overseas investors fill the void in Japan?

It briefly looked that way on Nov. 26. Despite sharp declines in recent weeks, the Nikkei rose as much as 400 points before ending the day a modest 1.7% higher, at 15,135. The trigger for the gains: rumors that China Investment Corp., a body set up by the Chinese government to better manage an estimated $1.4 trillion in currency reserves, was planning to invest in Japanese stocks.

According to Japan's largest business daily, the Nikkei, the CIC is considering putting some $200 billion into riskier overseas assets and it has Japan, the world's second-biggest economy, in its sights. As further evidence of its expansion the CIC's Web site has been advertising two dozen new job openings for specialists in North American, European, and emerging-market securities, as well as Japanese stocks and bonds.

A Testy History Between China and Japan

You would think Japan Inc. would be cheering an infusion of money for Tokyo's ailing stock market. After all, it could eventually counter the outflow of money from overseas investors. Hedge funds, for example, have pruned their investments in Japan and reallocated cash to other parts of Asia since the beginning of this year, according to Singapore fund tracker Eurekahedge.

Many fund managers have bailed after being disappointed by Japan's low returns and poor company profitability. Goldman Sachs (GS) figures that average return on equity for companies listed on the Tokyo Stock Exchange's main section will be around 10.2% in the current fiscal year through March, 2008, compared to 20% in the U.S. and 15.7% in the rest of Asia.

But not everybody in Japan will welcome investment from their next-door neighbor. That's partly because Japan and China have a long history of testy diplomatic relations. Beijing's assertion of its growing political and economic might and its efforts to find a home for its huge currency reserves are likely to fan suspicions in Tokyo that the Chinese are trying to buy up Japan's high-tech know-how. "Japanese managers will welcome the boost to share prices, but there may be kind of phobia if the Chinese become major shareholders," says Yasuhiro Matsumoto, an analyst at Shinsei Securities in Tokyo.

Tightening Up the Rulebook

Don't be surprised if Japanese regulators decide to toughen rules on investments and takeovers involving overseas firms, analysts say. But while Japan will want to protect industries that are vital to national security, there are no legal provisions it can call on to ban potential commercial deals, says Kazuyoshi Komiya, who heads Komiya Consultants, a Tokyo management consulting firm. Lawyers add, however, that regulators interpret the rulebook more strictly if the national interest is deemed to be at risk.

Some companies already have taken matters into their own hands. One example: In June, shareholders in Toshiba Machine, which specializes in machine tools and industrial robots, approved new anti-takeover measures designed as protection against Chinese buyers. The decision came four years after Toshiba Machine, based in the central Japanese city of Numazu, resorted to laws that ban the transfer of sensitive technologies to fend off a bid from a Chinese firm.

Concerns over China play into larger fears in Japan about corporate raiders and hedge funds buying up companies to bust them up and sell off the parts to the highest bidders. Earlier this year, Japanese media applauded condiment maker Bulldog Sauce for successfully staving off a takeover bid (BusinessWeek.com, 6/18/07) from U.S. investment fund Steel Partners.

Arab Companies Getting Into the Act

The cash isn't only flowing from China. On Nov. 26, Dubai International Capital, an investment company based in the United Arab Emirates, announced it had bought shares in Sony (SNE). The Middle Eastern investor, which said in July that it might spend up to $1.5 billion in one or two listed Japanese companies, said the stake was "substantial" but didn't disclose specifics. And United Arab Emirates state-run investment company International Petroleum Investment paid $775 million to acquire a 20% stake in Cosmo Oil in September, becoming its largest shareholder. Formerly known as Maurzen Oil (where Japanese Prime Minister Yasuo Fukuda worked until 1976), Cosmo actively courted IPI to help it fund expansion plans.

For now, though, it's unclear how regulators, corporate bosses, and the Japanese public will respond to the wave of cash entering Japan. Much will depend on the motives of overseas investors; parking cash in Japan as a passive investor probably wouldn't rouse Japanese authorities to act as much as launching a takeover bid. As for CIC's plans, Japan Inc. will just have to wait and see. Eiichi Sekine, a financial industry analyst at Nomura Institute of Capital Markets Research in Tokyo, says CIC won't begin buying stocks in Japan until the first half of next year at the earliest.

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