Steel Partners Decries Sapporo’s Unwillingness to Negotiate, Deteriorating Performance
Steel Partners Japan Strategic Fund (Offshore), L.P. (“Steel Partners”) today delivered to Sapporo Holdings Limited (2501.JP) (the “Company”) a letter criticizing the Board of Directors’ (the “Board”) continuing unwillingness to engage in meaningful negotiations and failure to stem an ongoing deterioration of value of the Company. In light of the Board’s intransigence and management’s poor performance, Steel Partners recommended that the Company engage an internationally recognized investment banker to explore strategic alternatives, including a possible sale of the company or certain business lines, as well as management and operational consultants to help prepare and execute a feasible plan to improve operational results and margins.
Steel Partners’ recommendation is in response to a June 9th letter from Sapporo in which the Board opposed Steel Partners’ request to increase its stake in the Company, while providing no new additional information on how it intends to improve the performance of the Company. The Board’s position was reiterated in a subsequent meeting with representatives of Steel Partners.
“The Board’s unwillingness to emerge from behind defensive measures and its increasingly indefensible reluctance to enter into meaningful negotiations is a progressively noticeable sign that the Board is misusing defensive measures to entrench management,” Warren Lichtenstein of Steel Partners wrote in the letter. “It is unfortunate that the Board has chosen this route, as we believe that if you had negotiated an acquisition structure with Steel Partners, with appropriate standstill provisions, many of your concerns and those alleged concerns of other stakeholders would have been alleviated.”
Steel Partners noted that the Board’s actions are counter to recommendations by the Ministry of Economy, Trade and Industry’s Corporate Value Study Group, which stated in a recent report: “(the) use of takeover defense measures for the purpose of entrenching management…cannot in any way be condoned, and the Corporate Value Study Group cannot support such defense measures.”
Steel Partners has worked for seventeen months to comply with the Company’s Rules for Large Scale Acquisition of Shares or Advance Warning System, answered more than 65 questions presented by the Board, the vast majority of which were either irrelevant or pertained to management’s role going forward, engaged third party consultants to examine the Company’s beer business and its real estate holdings and drafted and submitted a comprehensive “Value Enhancement Plan” to the Company and other shareholders.
“Notwithstanding our good faith efforts to negotiate with the Board, not once during this tedious and expensive seventeen-month process has the Board been willing to discuss an offer price, or even the general range of an offer price, that it felt reflected the value of the Company and that would be fair to the Company’s shareholders,” Mr. Lichtenstein wrote.
Steel Partners said the Board’s unwillingness to negotiate or take other meaningful steps to enhance value was unacceptable in light of Sapporo’s increasingly poor performance. Over the last five years, the Company’s Alcoholic Beverages segment operating margin has averaged only 2.4% compared to 7.3% and 7.7%, achieved by rivals Kirin and Asahi, respectively. Management has missed its recurring profit target in five of the last six years while return on shareholders’ equity has been less than 8%, the minimum required by the Japan Pension Fund Association in order to receive support for a company’s board of directors.
“Based on these results, and management’s collective disregard of its fiduciary duty, it is clear that management is neither fit nor capable and should no longer be empowered to, or have the privilege of, running a world-class beer company such as Sapporo,” Mr. Lichtenstein wrote.
On March 10, 2008, Steel Partners sent the Company a revised proposal whereby SPJSF would seek an ownership position of 33.3% of the Company’s outstanding voting rights, at an increased offer price of Yen 875 per common share. On February 15, 2007, Steel Partners submitted a proposal to purchase 66.6% of the stock of the company for Yen 825 per common share.
Steel Partners has been a long-term, supportive shareholder of Sapporo Holdings since 2004 and is currently the largest single shareholder holding, together with its related parties, 73,400,000 shares, or 18.63% of the Company’s outstanding shares.
Full text of the letter:
July 8, 2008 Sapporo Holdings Limited 20-1, Ebisu 4-chome, Shibuya-ku, Tokyo 150-8522 Attention: Mr. Takao Murakami, Representative Director and President Steel Partners Japan Strategic Fund (Offshore), L.P. P.O. Box 2681 GT, Century Yard, 4th Floor Cricket Square, Hutchins Drive George Town, Grand Cayman
Dear Mr. Murakami:
Steel Partners Japan Strategic Fund (Offshore), L.P. and related parties (“Steel Partners” or “we”) own approximately 18.6% of the outstanding shares of Sapporo Holdings Limited (“Sapporo” or the “Company”) and is the Company’s largest shareholder. As you well know, Steel Partners made a proposal in February 2007 to acquire up to 66.6% of the outstanding voting rights of the Company at Yen 825 per share. At the time, our offer represented a premium of 4.56% to the previous closing price, 13.32% to the 30-day average preceding our offer and 19.22% to the 90-day average preceding our proposal. Our proposal was meant to increase our ownership in the Company while at the same time providing liquidity at a premium to other shareholders who wished to sell their shares.
To address the Board’s concern regarding Steel Partners owning a majority of the Company’s shares, we amended our proposal in March 2008, to reduce our proposed acquisition to only 33.3% of the outstanding voting rights at Yen 875 per share, an increase of over 6% over our previous offer. We also offered to negotiate a voting agreement and other standstill provisions in order to provide the Sapporo Board of Directors (the “Board”) and Special Committee with assurances that we would continue to be dedicated and constructive long-term shareholders. We met with you and certain members of the Board to discuss our revised proposal and asked that you negotiate terms and price for a transaction that would benefit all shareholders. However, the Board rejected this revised proposal as well without any negotiations between us despite our repeated requests; it instead requested in its June 9, 2008 letter that we maintain our ownership below 20% of the Company’s shares.
We spent a significant amount of time and effort over the past seventeen months complying with the Company’s Rules for Large Scale Acquisition of Shares or Advance Warning System (“AWS”). We answered more than 65 questions, the vast majority of which were either irrelevant or pertained to management’s role going forward. Additionally, we engaged third party consultants to examine the Company’s beer business and its real estate holdings. We even submitted a comprehensive “Value Enhancement Plan” on November 8, 2007, which we provided to management and disclosed to the public so that all constituents could better understand our ideas for maximizing corporate and shareholder value.
Our efforts to comply with the AWS cannot be overstated, particularly in light of the METI Corporate Value Study Group’s recent report, entitled “The Proper Role of Defense Measures in Light of Recent Changes in Various Environments” (the “Corporate Value Report”). The Corporate Value Report provides, in footnote 10, that “…it should be unacceptable to demand that an acquirer disclose information that exceeds the standards of information necessary in order for shareholders to make appropriate decisions on the pros and cons of the acquisition and to invoke defense measures because such demands have not been complied with.” The Corporate Value Report provides further that there are limits to what prospective acquirers are able to provide regarding post-acquisition business plans or targets. Specifically, the Corporate Value Report states in footnote 16 that “(i) demanding specific, exhaustive disclosure of the formula used for calculating the acquisition price such as the facts and hypotheses assumed, the calculation method, the figures used in the calculation . . . or (ii) demanding specific, exhaustive disclosure of post-acquisition management policies such as business plans, financial plans, capital policy, dividend policy, and asset utilisation policy; then invoking defensive measures because some of this information has not been provided is inappropriate when compared with the amount of disclosure made by a target company.”
Furthermore, notwithstanding our good faith efforts to negotiate with the Board, not once during this tedious and expensive seventeen-month process has the Board been willing to discuss an offer price, or even the general range of an offer price, that it felt reflected the value of the Company and that would be fair to the Company’s shareholders. Instead, the Board rejected our proposals claiming that our acquisition of a majority of the outstanding voting rights would likely harm corporate value and created excuses for not allowing us to increase our ownership position. The Board has even refused to negotiate provisions aimed at addressing concerns regarding our revised target ownership stake (now 33.3%) and the possible impact a larger Steel Partners stake may have on the Company’s relations with various stakeholders, including vendors and customers.
Despite the Board’s duty to consider the best interests of its shareholders, the Board stated in its June 9, 2008 letter that it considered the feedback of the Company’s creditors, banks, suppliers and employees when reaching its conclusion to reject our proposals. The directors should understand that collectively they have an obligation to manage the Company for the benefit of shareholders. This view is re-affirmed in the Corporate Value Report, which states (1) in Section 3.1.1 thereof, that “(a) board must not misrepresent the interests they are trying to protect with defense measures by referring to the interests of interested parties other than shareholders even in situations that will not serve to secure and enhance shareholders’ common interests, nor may they interpret conditions for invocation widely in order to protect their own interests” and (2) in Section 3.1.5 thereof, that “(i)f the acquisition proposal may prove to be conducive to shareholders’ common interests through an improvement in the acquisition terms, a board must carry out sincere negotiations with the acquirer to improve the terms of the acquisition.” By any measure it is clear that the primary responsibility of a board of directors is to its shareholders as a whole.
The Corporate Value Report provides further in Section 1 thereof that “(the) use of takeover defense measures for the purpose of entrenching management…cannot in any way be condoned, and the Corporate Value Study Group cannot support such defense measures.” The Board’s unwillingness to emerge from behind defensive measures and its increasingly indefensible reluctance to enter into meaningful negotiations is a progressively noticeable sign that the Board is misusing defensive measures to entrench management. It is unfortunate that the Board has chosen this route, as we believe that if you had negotiated an acquisition structure with Steel Partners, with appropriate standstill provisions, many of your concerns and those alleged concerns of other stakeholders would have been alleviated.
While you stated in your letter dated June 9, 2008, that you considered feedback from stakeholders including some shareholders, we do not believe you consulted the vast majority of your shareholders. We strongly believe the only way to gauge the opinion of ALL shareholders is to allow them to respond to a TOB and allow them to decide whether to tender their shares. And in so deciding, we refer to Section 3.1.7 of the Corporate Value Report, which states that “(a) board must give clear explanations that are based as much as possible on facts to shareholders on matters such as their evaluation of the acquisition proposal so that shareholders may decide on the appropriateness of the acquisition.” We believe this is particularly important as the Board is not allowing any shareholders to receive Yen 875 per share, a 19.2% premium over the current market price of Yen 734 per share.
During this tedious seventeen-month process, operating performance at the Company has continued to deteriorate. Nikkei recently reported that the Company is in danger of dropping out of the top three of Japanese beer producers, likely losing its number three position in the market to Suntory. Even the Company’s flagship Yebisu brand has lost market share to Suntory’s Premium Malts. Meanwhile, management has done little, if anything, to take advantage of the tremendous brand appeal of Sapporo. This is not a short-term trend – over the last five years, Sapporo’s Alcoholic Beverages segment operating margin has averaged a paltry 2.4% compared to 7.3% and 7.7%, achieved by Kirin and Asahi, respectively, during the same period. Firm wide, management has missed its recurring profit target in five of the last six years.
Additionally, return on shareholders’ equity (“ROE”) has been less than 8%, the minimum required by the Japan Pension Fund Association (“PFA”) in order to receive support for a company’s board of directors. The chart below highlights ROE since 2002.
Sapporo's Return on Equity PFA Minimum = 8% 2002 1.1% 2003 2.5% 2004 5.2% 2005 3.6% 2006 2.1% 2007 4.6% 2008E 4.3% 2009E 3.6%
The only reason the Company’s ROE is projected to exceed 8% in 2008 is due to a partial sale of its Yebisu Garden Place. If this one-time gain were excluded, our analysis indicates normalized ROE for 2008 would be 4.3%. As further evidence of this analysis, ROE drops to 3.6% in 2009, even less than that in 2007! Such low returns are bad for Sapporo and its shareholders, which include many employees and pensioners who rely on management to deliver returns to fund their retirement. Your shareholders need a management team with the competence and desire to revive Sapporo’s business, not one focused on preserving its position without regard to its own inability to implement the necessary financial reforms or to grow market share and profitability. We all deserve better.
For some peculiar reason, management published a forecast of corporate results through 2016! Given that management has performed so poorly under your leadership, we, and likely the vast majority of your constituents, have no confidence in this forecast.
Based on these results, and management’s collective disregard of its fiduciary duty, it is clear that management is neither fit nor capable and should no longer be empowered to, or have the privilege of, running a world-class beer company such as Sapporo or its vast real estate holdings such as Yebisu Garden Place, the Ginza properties and other world-class properties.
Sapporo and the Japanese Beer Industry
As you know, the Japanese beer market is a no-growth market due to the changing demographics of Japan and the growing appeal of other alcoholic beverages in the Japanese market. Further, the Japanese beer market is plagued by overcapacity. Over the past few months, we have visited three of the five domestic beer factories and none was at greater than 65% capacity utilization. To counter these challenges, we asked the Company to pursue a more focused strategy to emphasize the strength of the Yebisu brand, both in Japan and abroad which would help grow the Sapporo brand. Unfortunately, none of this has happened, and the Company’s performance has continued to deteriorate.
Similar conditions in other markets have contributed to consolidation throughout the beer industry, a trend that has mostly been avoided in Japan. In the past two years, we have seen large scale acquisitions and transactions including the merger of Molson and Coors, the joint acquisition of Scottish & Newcastle by Carlsberg and Heineken and the recent proposed bid by InBev (the second largest beer company by market capitalization in the world) to purchase Anheuser-Busch (the third largest beer company by market capitalization in the world).
With more challenging market conditions on the horizon, it is becoming increasingly apparent that the Board’s actions demonstrate management’s lack of interest in improving corporate and shareholder value. As we said above, our proposed bid of Yen 875 per share represents a premium of 19.2% to the closing price of Yen 734 on July 7, 2008, yet the Board denies shareholders the ability to sell their shares at a premium. Clearly, the Board is out of touch with current market conditions, PFA requirements, and Tokyo Stock Exchange and METI regulations and guidance as to the use and appropriateness of anti-takeover defenses.
To be clear, our preference is to sit down to negotiate and to agree on terms that would allow Steel Partners to increase its ownership in the Company while management makes necessary changes to grow Sapporo’s business. However, as management does not want to listen or entertain discussions with us and has not taken any meaningful steps to stop the continuing deterioration in shareholder value, we recommend that the Board engage (1) an internationally recognized investment banker to explore strategic alternatives, which may include a sale of the company or certain business lines, and (2) management and operational consultants to help the Company prepare and execute a feasible plan to improve operational results and margins, in order to maximize shareholder value and stop the damage to corporate value that has resulted from management’s business plans.
Should you wish to discuss any of these items addressed in this letter, please contact me.
Warren G. Lichtenstein
Full text of SPJSF’s letter can be found at www.spjsf.jp.
Steel Partners Japan Strategic Fund (Offshore), L.P. is a long-term relationship/active value investor that seeks to work with the management of its portfolio companies to increase corporate value for all stakeholders and shareholders.