Update Letter from the Investment Adviser

RNS Number : 5886S

Nippon Active Value Fund PLC

09 July 2020

 

Rising Sun Management Limited

NAVF progress update: the potential use of SPVs to enhance returns

Where have we got to?

After five months of trading, NAVF has complete positions in six of its initial twenty target companies and over 75% of the desired allocation in another five. Overall, we have put to work over 67% of funds raised. The speed of investment has slowed in the last few months as the wide-scale and robust recovery in global stock prices from the March lows has consolidated and required several adjustments both to target quantities of individual stocks and the prices we are willing to pay for them. This is not bad news and we continue to benefit from the timing of our launch at the beginning of the Covid pandemic, as the fund's NAV on 30th June 2020 of 105.52 is testament.

The central tenet of NAVF's investment philosophy has always been to engage with interesting smaller Japanese companies holding what we deem to be excess amounts of cash on their balance sheets, thus providing considerable margins of safety, and which are managed by their 'salary man' executives well within established comfort zones. Our principal argument to add value to our portfolio is to persuade or, if necessary, cajole managements into aligning their interests with shareholders. We believe this is most easily done by encouraging companies to issue restricted shares to managers in amounts equivalent to multiples of their annual cash remuneration. We are not alone in this view: the originator of the idea is the Japanese government itself! We had expected to carry out this campaign in person with our feet on the ground in Tokyo. Nevertheless, we have now succeeded in completing the first eight virtual Zoom-based meetings with investee representatives.

What have we learned?

There are a number of common themes running through all our introductory meetings so far. The companies appear well-run, or, at least, their internal communications are impressive. Their spokespeople are uniformly aware of company strategy and direction, unfailingly courteous and patient, and, above all, prepared to respond to our largely anticipated arguments. Their reply to our suggestion that management, in its broadest sense (sometimes as many as forty executives), would benefit from the award of restricted stock to the tune of three to five times their annual salaries, is uniformly negative. Their counter-arguments are broadly similar: either they already have an older, less generous stock option plan in place, or they are considering creating one but not yet, or they are jealous of their enviable record in keeping senior pay in close relation to that of the rank and file. In short, they are not greedy Westerners but are concerned to maintain the long-term plan set out in the conservative corporate road map.

No surprises then…

Perhaps we might have enjoyed a slightly richer experience in these first meetings had we been able to travel to Tokyo, but, somehow, I doubt it. We are greatly indebted to our colleague Kazutaka Mizuochi, Rising Sun's President, for setting up our meetings and doing most of the heavy lifting and translation during them. We have been respectful but firm in our suggestions. By Western standards, we have been "talking softly." I believe we are where we expected to be. Japanese companies, even small ones, are now fully aware of the blandishments of activist investors and prepared to act to repel boarders, albeit with friendly smiles on their faces, for as long as possible.

With some of the companies with the smallest capital bases, NAVF may well be able to induce some change over time with comparatively modest shareholdings. It may even be possible to put one or two companies in play, should we fail to encourage more efficient deployment of capital via discussion, through greater visibility of the positions we already hold. Nevertheless, with other larger companies, we are going to need "a bigger stick."

Special Purpose Vehicles (SPVs)

During the marketing campaign for NAVF it was at one point hoped that even more than the very respectable £103 million actually raised might be forthcoming Yet, even had we secured larger sums, in preparing for activist approaches to other than the very smallest targets we have long recognised that additional external finance would need to be brought to bear. One of the mechanisms we envisage is the use of SPVs to provide additional firepower. We have now reached the point where Rising Sun Management is planning to raise funds for the first such vehicles and so I would like to explain how they should work and how we hope they will enhance NAVF's returns.

The intention is that a new company to be managed by Rising Sun will be set up with the single purpose of investing on a concert party basis in a selected target from NAVF's portfolio, once the Fund's own target position has been fully acquired. It is envisaged that US$ 15 -50 million will be carefully and discretely raised from one or a limited number of investors for each SPV.

Acting together, NAVF and the SPV will be able to purchase a larger percentage of an individual target's share capital and so provide additional leverage in our negotiations with management over the target company's future strategy including, possibly, threatening a take-over of the whole company. All necessary notifications to the Japanese regulators will be made by Japanese legal counsel to NAVF [and the relevant SPV]. Each SPV will be incorporated wherever makes most sense from the investors' point of view - the first entity is likely to be a Delaware limited liability company. NAVF and the SPV will be expected to exit each investment at the same time and on the same basis. NAVF's commercial security will be protected by an agreement being drawn up by the Fund's UK legal counsel. At the conclusion of operations, sale proceeds will be reflected in NAVF's value in due course and will be paid out to investors in the SPV before it is either wound up or re-purposed for another opportunity.

Our goal is to align the interests of NAVF and the individual SPV completely. The SPV will only purchase shares in the target company once NAVF has obtained a full position in the target, commensurate with the appropriate amount of risk for its portfolio. NAVF will not be competing with the SPV; rather the SPV will become an ally in the overall crusade, albeit with its aim completely on only one small part of the battlefield. The SPV, owning only one position, will obviously be a very different investment proposition from that of NAVF, which will continue to own a diversified portfolio. As a single-stock portfolio, the SPV will be much riskier and is not appropriate as a public entity.

Moving forward

It has always been the goal to fully invest NAVF's funds in the target portfolio within six months and we expect to be there or thereabouts.

Separately, the first objective for our SPV concert party strategy has already been identified. NAVF's position is close to being filled. Provided additional funds to empower the first SPV can be secured, it will then begin its own accumulation of stock. When a combined position of sufficient magnitude has been built, it will be time to help the target company's management with its aspirations.

Paul ffolkes Davis

30^th June 2020

 

END

 

 

PFURLMATMTIMBIM