Corporate Japan doing the right thing - Buying Back its Shares

In the first half of 2013 japanese corporations engaged in share repurchases totalling an amount of 1,78 Trillion Yen. The highest amount since 2005.

In Japan share repurchases are a rather new phenomenon to deploy free cash flow. Altough not explicitly forbidden to repurchase shares, it was never done before 1995. The reason was to be found in the tax treatment of share repurchases. Since it was not possible to tax shareholders individually, when dividends would have been paid via stock repurchases, all shareholders would have had to pay income tax in proportion of their equity fraction. That made share repurchases infeasible for japanese companies. The tax treatment was amended in 1995 and made share repurchases feasible for japanese firms.

The first company to repurchase own shares was Asahi Breweries in November 1995.

Another change concerning share repurchases happened with the 1997's revision of Comercial Law. Since than it is possible to execute share repurchases without the approval at the shareholder's meeting. Before, decisions by the board of directors to alter the articles of association and to execute a repurchase had (in contrast to the US) to be approved at the shareholder's meeting. Furthermore, another revision took place in 1998. Before 1998, Share buy back programs were limited to an amount of 10% of outstanding shares. If the company intended to buyback more approval was necessary at the shareholders' meeting. In addition, the total amount of funds used for share buybacks was limited to the profit available for dividends.The 1998 revision relaxed the 10% rule and also allowed to use capital reserves for stock repurchases.

Only after those revisions of the Commercial Law did share repurchases became significant in amount in the corporate landscape of Japan.

Two repurchase methods are available for a firm; (1) open market repurchase (2) tender-offer repurchase

Goldman Sachs predicts share repurchases to double to 3,8 trillion yen in FY 2013 ending March 2014. If Goldman Sachs is right this amount would surpass the amount spend in 2005 (3,06 trillion Yen) on share repurchases.

When executed at favourable stock prices, e.g shares trading below book value or even better below NCAV, I regard share repurchases as the single best option for deploying free cash flow. Even better than only buying back the shares and holding them in the treasury account is the cancellation of those shares. While buybacks lower the amount of shares circulating in the markets a cancellation of shares goes further by increasing each stock's share of profits.

As mentioned before, high aggregate amounts of share buybacks are not a new phenomenon in Japan (see 2005). But there is a qualitative difference between the share buybacks that have been executed in recent years compared to 2005 and before. In 2005 many share repurchase programs were forced upon the japanese management by acitivist funds like Steel Partners. In recent years management has been implementing those programs on their own free choice.

This could very well be a signal of a significant change in corporate Japan's mindset. It is especially important in Japan, which has been blamed for hoarding cash and neglecting shareholder's interests.


Source:

In Abe We Trust as Japan Buybacks Reach Eight-Year High  (Bloomberg)

Japan in share buy-back spree    (Financial Times)

Firms Look to Buy Back Interest in Their Shares   (Wall Street Journal)

Hatakeda, Takashi/ Isagawa, Nobuyuki: Stock price behavior surrounding stock repurchase announcement: Evidence from Japan; Pacific-Basin Financial Journal, 12(3): 271-290; 2004-06