AVI Japan Opportunity Trust Plc · LSE:AJOT
AVI Japan Opportunity Trust — Fujitec — Proxy Contest (March 2023)
73 slides from AVI Japan Opportunity Trust's proxy contest presentation, March 2023
Slide 1: Taking Fujitec to the Next Level
TAK I N G FU J I TE C TO TH E N EXT LEVEL — Asset Value Investors 25 Bury Street London SW1Y 6AL
Slide 2: Introduction to AVI
Introduction to AVI Specialised international equity boutique – founded in London in 1985 – long-term shareholder working with management to improve corporate value in a sustainable manner Experience in Japan – investing in Japan for over two decades – ¥54bn invested in Japanese companies – public c
Slide 3: AVI's History with Fujitec
AVI’s History with Fujitec • AVI, on behalf of its clients, owns 3.4%1 of Fujitec’s outstanding shares • We have been shareholders since July 2018 and have sought to work constructively with Fujitec’s management • We have had open discussions and sent three letters to the Board seeking an improvemen
Slide 4: Executive Summary
E X E C U T I V E S U M M A RY 4
Slide 5: Fujitec's Three Key Failings
Taking Fujitec to the Next Level - Summary o Fujitec can be a best-in-class services and technology company focused on Asia… o …but it currently lags its global competitors in the elevator/escalator (“E&E”) market in all relevant performance metrics; operating margins, ROE and stock valuation o That
Slide 6: Solutions to Address Failings
Taking Fujitec to the Next Level - Summary o AVI is proposing an integrated set of concrete measures to solve Fujitec’s weaknesses. AVI’s proposed solutions are not narrowly focused on capital efficiency, but address strategy and governance as a whole SOLUTIONS TO ADDRESS FAILINGS 1) Comprehensive S
Slide 7: Agenda
Agenda 1. Overview of Fujitec, its Failings and our Solutions – Company Overview – Attractive Industry – Fujitec’s low valuation – Explaining Fujitec’s undervaluation – AVI’s recommendations 2. Addressing Fujitec’s Undervaluation – Operational Inefficiencies • Lack of scale • Inefficient manufacturi
Slide 8: Overview of Fujitec, its Failings and our Solutions
O V E RV I E W O F F U J I T E C , I T S FA I L I N G S AND OUR SOLUTIONS 8
Slide 9: Fujitec – Company Overview
Fujitec – Company Overview o Founded in Japan in 1948 it first expanded overseas into Hong Kong in 1964 o Fujitec manufactures, installs and maintains elevators and escalators (“E&E”) o While having a global presence, 87% of sales and 90% of profits are derived from Asia where it has its highest mar
Slide 10: Fujitec Overview – Sales Split and Regional Presence
Fujitec Overview – Sales Split and Regional Presence JAPAN (40% of sales) EUROPE (0% of sales) Head Office Egypt Shiga (factory) NORTH AMERICA (13% of sales) Saudi Arabia Canada UK USA, Ohio (factory) SOUTH ASIA (9% of sales) EAST ASIA (38% of sales) China (3 factories) India (factory) Hong Kong (fa
Slide 11: E&E Industry Overview
E&E Industry Overview o The industry is split into three areas: new installation (47%), modernisation (13%) and maintenance (40%) o 90% of the market is elevators and 10% escalators o The majority of new installations are in China with a mature and largely saturated industry elsewhere o The maturing
Slide 12: Attractive Business Model
Attractive Business Model o The risk of unsafe equipment, heavy regulation and customer trust restricts new entrants, with the top 8 players being on average 111 years old, allowing incumbents to earn high returns on capital o Increasing use of outsourcing has driven efficiencies and shifted E&E com
Slide 13: Fujitec Overview – Competitive Positioning
Fujitec Overview – Competitive Positioning o Fujitec is the 8th largest E&E company in the world by sales o Like all the main players Fujitec has a deep history – essential for customer trust o The industry has undergone heavy consolidation over the past two decades with the largest five players com
Slide 14: Undervalued Despite Attractive Business Model
Undervalued Despite Attractive Business Model Despite Fujitec’s attractive business model … which is not a recent or one-off and deep history, it trades on a low multiple occurrence and at a significant discount to peers… Fujitec’s relative EV/EBIT Fujitec’s Relative EV/EBIT for the past five years
Slide 15: Explaining Fujitec's Low Valuation
Explaining Fujitec’s Low Valuation We attribute Fujitec’s low …and one valuation to three key failings… secondary OPERATIONAL INEFFICIENCIES POOR CAPITAL DISCIPLINE WEAK GOVERNANCE SHAREHOLDER COMMS Poor strategy and An excess of equity, with High presence of Vague mid-term plan implementation have
Slide 16: Explaining Fujitec's Low Valuation cont'd: Operational Inefficiencies
Explaining Fujitec’s Low Valuation cont’d Operational Inefficiencies o Fujitec has the lowest operating margin of any pure-play E&E peer and less than half industry leader, Otis o A lack of scale, low outsourcing of manufacturing, centralised decision making, OPERATIONAL INEFFICIENCIES and scattered
Slide 17: Explaining Fujitec's Low Valuation cont'd: Poor Capital Discipline
Explaining Fujitec’s Low Valuation cont’d Poor Capital Discipline o Fujitec has 32% of balance sheet assets allocated to cash and ‘strategic investments’ which is excessive considering that its assets are funded with 62% equity compared to 37% for peers (12% including Otis) POOR CAPITAL DISCIPLINE o
Slide 18: Explaining Fujitec's Low Valuation cont'd: Weak Governance
Explaining Fujitec’s Low Valuation cont’d Weak Governance o Fujitec has the weakest governance of all global elevator companies o Weak governance is a risk for shareholders which along with poor decision making contributes to Fujitec’s lower valuation WEAK GOVERNANCE Separation of % Compensation/ An
Slide 19: Explaining Fujitec's Low Valuation cont'd: Shareholder Communications
Explaining Fujitec’s Low Valuation cont’d Shareholder Communications o Fujitec’s disclosure and transparency to shareholders is suboptimal o Peers have dedicated IR functions and devote considerable resources to shareholder communications SHAREHOLDER COMMS o Lack of information and awareness is hamp
Slide 20: AVI's Recommendations
AVI’s Recommendations How Fujitec can improve its situation OPERATIONAL INEFFICIENCIES POOR CAPITAL DISCIPLINE WEAK GOVERNANCE SHAREHOLDER COMMS Undertake strategic review Increase board independence Increase transparency on Reduce reliance on with help of outside operations through more shareholder
Slide 21: Taking Fujitec to the Next Level – Potential Upside
Taking Fujitec to the Next Level – Potential Upside We urge the Board to recognise Fujitec’s potential upside and conduct an objective strategic review of the business with the help of outside professionals – considering all options including a merger with a competitor Upsides can be enhanced throug
Slide 22: Addressing Fujitec's Undervaluation: Operational Inefficiencies
A D D R E S S I N G F U J I T E C ’ S U N D E R VA L U AT I O N O P E R AT I O N A L I N E F F I C I E N C I E S 22
Slide 23: Fujitec's Operational Underperformance
Fujitec’s Operational Underperformance o Fujitec’s 6% operating margin is the lowest amongst its pure-play global E&E competitors o Over the past 10 years its margin has trailed peers by an average of 6.9 percentage points o Fujitec’s underperformance is not a recent or one-off occurrence, its persi
Slide 24: Fujitec's Operational Underperformance by Region
Fujitec’s Operational Underperformance by Region o Fujitec’s highest margins are achieved in South Asia and Japan, although still below peers. Japan margins are driven by a respectable 10% market share and high exposure to profitable after-sales business. Margins could be boosted further from more e
Slide 25: Explaining Fujitec's Operational Inefficiencies
Explaining Fujitec’s Operational Inefficiencies Our research and discussions with management, customers, suppliers, distributors, and industry experts indicate Fujitec’s low margins come from the following factors: i) Lack of Scale ii) Inefficient Manufacturing Process iii) Mismanagement of China Bu
Slide 26: i) Lack of Scale
i) Lack of Scale o • Fujitec Fujitecisfailed one ofto utilize inorganicE&E the smallest scale-up OEMs while competitors in the havejust world with capitalize on it…. market a 2% global • share, Xx someway behind its nearest competitors Revenue Fujitec’s Low Relative Market share (US$bn) Fujitec 13.0
Slide 27: i) Lack of Scale – Widening Gap
i) Lack of Scale – Widening Gap o The difference in scale between Fujitec and other OEMs has been widening o Fujitec has achieved a lower revenue CAGR since 2000 than 2 of the 3 major OEMs despite starting from a smaller base Historical Revenue Expansion (US$bn) 2000 2019 +4.8% CAGR 13.1 +1.6% CAGR
Slide 28: i) Lack of Scale – The Cause
i) Lack of Scale – The Cause …while competitors have capitalized on M&A, particularly Kone which has achieved Fujitec has unsuccessfully relied the strongest growth. on costly organic growth to pursue market share… As a % of revenue Otis has spent more on M&A in just 3 years than Fujitec has in 10 2
Slide 29: i) Lack of Scale – Summary
i) Lack of Scale – Summary o Economies of scale play a significant part in driving lower costs and higher margins especially for maintenance services and procurement o Fujitec should explore all M&A options in its transformation plan Procurement • Larger material purchases give stronger bargaining p
Slide 30: ii) Inefficient Manufacturing Processes
ii) Inefficient Manufacturing Processes o Fujitec largely relies on a vertically-integrated manufacturing process, where it produces componentry in-house o There are significant cost savings to be made by streamlining this process and relying on outsourced manufacturing Planning & Order Receipt Sour
Slide 31: ii) Inefficient Manufacturing Processes – Outsourcing
ii) Inefficient Manufacturing Processes – Outsourcing o Continued outsourcing trend has allowed OEMs to focus on installing and maintaining elevators o Like the automotive industry some decades ago, E&E players are recognising the benefits of outsourced manufacturing o Controllers are still the prim
Slide 32: ii) Inefficient Manufacturing Processes – Outsourcing cont'd
ii) Inefficient Manufacturing Processes – Outsourcing cont’d o Outsourcing is a good way to leverage suppliers’ scale economies and expertise o Thanks to outsourcing, elevator OEMs can focus on core competencies – software, technology and servicing – rather than spending resources on manufacturing o
Slide 33: ii) Inefficient Manufacturing Processes – Outsourcing cont'd
ii) Inefficient Manufacturing Processes – Outsourcing cont’d o Multiple discussions with Fujitec management and competitors/suppliers suggest there is huge room for Fujitec to ramp up outsourcing This should be the key focus in the strategic review. Component Western E&E Peers Fujitec Point to addre
Slide 34: ii) Value is in Service and Technology not Manufacturing
ii) Inefficient Manufacturing Processes – Value is in Service and Technology not Manufacturing o Fujitec’s strategy of investing heavily in vertical manufacturing and avoiding active M&A has been unsuccessful o The greatest driver of shareholder value for an E&E company is not manufacturing, but tec
Slide 35: iii) Mismanagement of China Business
iii) Mismanagement of China Business o Established in 1995 through a JV with Chinatex, Fujitec has a long history in China o Today Fujitec holds a 60% stake in Huasheng Fujitec with Cofco (merged with Chinatex in 2016) o Fujitec has a unique exposure to China in terms of profit as well as elevator p
Slide 36: iii) Mismanagement of China Business – Market Share
iii) Mismanagement of China Business – Market Share o Fujitec has been suffering from lack of scale in China for years o While local small players have been squeezed out by major OEMs over the past decade, Fujitec has failed to take market share o Despite its smaller size it has achieved slower grow
Slide 37: iii) Mismanagement of China Business – Underperforming Margins
iii) Mismanagement of China Business – Underperforming Margins o Fujitec China has been underperforming competitors margin-wise o Its margins suffered greatly during the market downturn in 2016-2018 due to inefficiencies and high costs Operating Margin Fujitec Operating Margin (JPYmn) in China-relat
Slide 38: iii) Mismanagement of China Business – Recommendations
iii) Mismanagement of China Business – Recommendations o Fujitec must address issues in its manufacturing, sales and maintenance network in China to take advantage of the huge potential, increase its scale, and reduce costs o A transformation plan should be led by a new head of China, with local exp
Slide 39: iv) Non-core Country Exposure – North America
iv) Non-core Country Exposure – North America o Established in 1977, Fujitec has failed to get a foothold in the North American market due to a lack of M&A and centralised decision making by Tokyo o With North America accounting for just 3% of global new installations and being heavily focused on th
Slide 40: iv) Non-core Country Exposure – Europe
iv) Non-core Country Exposure – Europe o Fujitec first expanded in Europe with the establishment of Fujitec UK in 1982 o Despite almost 40 years of history it has failed to establish a successful business o Fujitec’s presence today contributes little to earnings and is a distraction for management E
Slide 41: iv) Non-core Country Exposure
iv) Non-core Country Exposure o Fujitec’s strategy for North America and Europe is unclear given its under-investment and resistance to exploring strategic options o Fujitec needs to set clear milestones and take effective measures to overcome difficulties in North America and Europe, including poss
Slide 42: iv) Centralised Decision Making
iv) Centralised Decision Making o Discussions with Fujitec management and industry experts reveal a centralised decision making structure that does NOT allow Fujitec to leverage local experts’ experience o Too much centralised control reduces flexibility and leads to bureaucratic, inefficient decisi
Slide 43: iv) Centralised Decision Making
iv) Centralised Decision Making o Centralised decision making is frustrating for local management and employees who have on-the- ground expertise and are better placed to guide strategy o Public reviews by Fujitec employees highlights their frustrations: “ Communications with the head office is very
Slide 44: Addressing Fujitec's Undervaluation: Poor Capital Discipline
A D D R E S S I N G F U J I T E C ’ S U N D E R VA L U AT I O N P O O R C A P I TA L D I S C I P L I N E 44
Slide 45: Poor Capital Discipline
Poor Capital Discipline o A resilient, strong financial foundation is paramount for any corporation o However, Fujitec is depressing corporate value with its inefficient balance sheet; 32% of balance sheet assets are allocated to cash and equity investments, excessive given its assets are funded wit
Slide 46: Poor Capital Discipline cont'd – Excess Equity
Poor Capital Discipline cont’d – Excess Equity o Finding the balance between maximising returns on capital and financial security is difficult o However, Fujitec’s lack of focus on capital efficiency has led to a bloated balance sheet that has been, and is, mismanaged o 62% of assets are funded with
Slide 47: Excess Equity Driven by Low Shareholder Returns
Poor Capital Discipline cont’d – Excess Equity Driven by Low Shareholder Returns o Fujitec has returned less cash to shareholders than its peers o Over the past 10 years Fujitec has allocated only 29% of cash flow from operations to shareholder returns, compared to 70% and 56% for Kone and Schindler
Slide 48: Excess Equity Driven By Poor Working Capital Management
Poor Capital Discipline cont’d – Excess Equity Driven By Poor Working Capital Management o Fujitec is the only global peer with a net positive working capital position o Low manufacturing outsourcing and inefficient terms with customers and suppliers absorbs excess capital, particularly inventory Ne
Slide 49: Too Much Equity Driven by Strategic Investments
Poor Capital Discipline cont’d – Too Much Equity Driven by Strategic Investments o Fujitec holds stakes in 39 listed companies with a value of Y5.8bn or 5% of Fujitec’s market cap and 4% of balance sheet assets o 25 of these holdings are part of a cross-shareholding structure, an archaic approach to
Slide 50: Historical Buybacks and Overhang of Treasury Shares
Poor Capital Discipline cont’d – Historical Buybacks and Overhang of Treasury Shares o Fujitec has only ever conducted two share buybacks, in February 2015 and April 2015, for 6.4% and 7.4% of shares outstanding respectively o Both purchases were conducted through ToSNeT-3 where a seller is usually
Slide 51: Lack of Capital Policy
Poor Capital Discipline cont’d – Lack of Capital Policy o Fujitec does not disclose a capital policy and simply states they have a policy which considers cost of capital1 o Capital efficiency is an important driver of corporate value. It must be rigorously analysed by the Board and a policy disclose
Slide 52: Inefficient Balance Sheet Harming ROE and Corporate Value
Poor Capital Discipline cont’d – Inefficient Balance Sheet Harming ROE and Corporate Value o ROE is a primary driver of corporate value which is driven by both “R” and “E” - either increasing profits or reducing equity o Fujitec’s relatively low margins offers an opportunity for improvement but alon
Slide 53: Inefficient Balance Sheet Harming ROE and Corporate Value
Poor Capital Discipline cont’d – Inefficient Balance Sheet Harming ROE and Corporate Value o Kone’s and Schindler’s balance sheet structure presents a target for Fujitec to work towards o Both companies have family roots and management have successfully achieved a healthy balance between prudent con
Slide 54: Recommendations to Improve Capital Efficiency
Poor Capital Discipline– Recommendations to Improve Capital Efficiency o Fujitec has too much equity, harming ROE and corporate value: - Fujitec has the lowest ROE amongst peers, 8.8% vs Kone and Schindler’s 30.1% and 24.4% - While partly attributable to lower margins, Fujitec’s low ROE is also driv
Slide 55: Addressing Fujitec's Undervaluation: Weak Governance
A D D R E S S I N G F U J I T E C ’ S U N D E R VA L U AT I O N WEAK GOVERN AN C E 55
Slide 56: Weak Governance
Weak Governance o Fujitec has the weakest governance of all global elevator companies o Poor governance is a risk for shareholders and contributes to Fujitec’s lower valuation o These issues are easily rectifiable Separation of % Compensation/ Anti- % Board Chairman and Board Structure Executives No
Slide 57: Weak Governance cont'd – Low Relative Independence
Weak Governance cont’d – Low Relative Independence o 56% of Fujitec’s Board directors are independent vs a peer average of 67%, with Toshiba-best-in class at 83% o While additional independent contribution of Endo Kunio and Yamahira Keiko from June 2019 is welcome, more independence - particularly w
Slide 58: Weak Governance cont'd – Suboptimal Board Structure
Weak Governance cont’d – Suboptimal Board Structure o Fujitec adopts the conventional statutory auditor-style board structure o This was the only board structure available in Japan until 2003 o An audit & supervisory committee board structure has two separate boards: a board of directors and a board
Slide 59: Weak Governance cont'd – No Compensation or Nomination Committee
Weak Governance cont’d – No Compensation or Nomination Committee o Fujitec is the only global elevator company not to have a compensation or nomination committee o Decision making surrounding compensation and nomination is vague and unclear o Fujitec needs dedicated committees, composed and chaired
Slide 60: Weak Governance cont'd – Combined Chairman and President/CEO Role
Weak Governance cont’d – Combined Chairman and President/CEO Role o Fujitec has no separate Chairman role, with Takakazu Uchiyama holding the role of President, CEO, and Chairman o METI in its Practical Guidelines for Corporate Governance Systems, encourages companies to examine whether the powers a
Slide 61: Weak Governance cont'd – Anti-takeover Measure
Weak Governance cont’d – Anti-takeover Measure o Fujitec implemented an anti-takeover measure/poison pill in 2007 following a takeover attempt o The measure is voted on by shareholders every three years and was passed with 64% approval 2019 o After instruction by the board and approval at a sharehol
Slide 62: Recommendations to Improve Fujitec's Governance
Weak Governance – Recommendations to Improve Fujitec’s Governance o Appoint additional independent directors such that 2/3 of the board are independent: Increase - In order to ensure diversity of opinion Fujitec should seek a board that has 2/3 independent members, inline with peers Independence - N
Slide 63: Addressing Fujitec's Undervaluation: Poor Shareholder Communications
A D D R E S S I N G F U J I T E C ’ S U N D E R VA L U AT I O N Poor Shareholder Communications 63
Slide 64: Poor Shareholder Communications
Poor Shareholder Communications o Fujitec’s disclosure and transparency in both Japanese and English is suboptimal o Peers have dedicated IR functions and devote considerable resources to shareholder communications o Lack of information and awareness is hampering Fujitec’s valuation Capital Markets
Slide 65: Poor Shareholder Communications – Lack of Strategy and Vague Mid-Term Plan
Poor Shareholder Communications – Lack of Strategy and Vague Mid-Term Plan o Fujitec’s 15 page mid-term plan is vague and covers very little strategy o It’s clear that little thought or effort went into the plan, with little importance placed on communicating to shareholders o Management presented g
Slide 66: Poor Shareholder Communications – Sell-Side Coverage
Poor Shareholder Communications – Sell-Side Coverage o Fujitec has no sell-side coverage, limiting the market’s awareness of Fujitec o Fujitec’s coverage is dramatically lower than peers o Considering Fujitec’s market cap, attractive business model and high foreign ownership it is surprising Fujitec
Slide 67: Lack of Detail and Transparency, no Dedicated IR
Poor Shareholder Communications – Lack of Detail and Transparency, no Dedicated IR o No dedicated IR function shows in quality of shareholder materials. The current management who oversee IR are overworked and cannot focus solely on shareholders o Fujitec’s two page English interim and quarterly rep
Slide 68: Recommendations to Improve Shareholder Dialogue
Poor Shareholder Communications – Recommendations to Improve Shareholder Dialogue o Improve information disclosure in reporting documents and mid-term plan: - Fujitec’s transparency and information disclosure is subpar relative to peers Enhance - A vague mid-term plan with a poorly presented strateg
Slide 69: Appendix: Debunking Management's Arguments
Ap p e n d i x D e b u n k i n g M a n a g e m e n t ’s Arg u m e n t s 69
Slide 70: Appendix: Debunking Management's Arguments
Appendix: Debunking Management’s Arguments Fujitec management have defended Fujitec’s low operating margins due to the following factors: 1. We are more exposed to NEW INSTALLATION, which generates lower margin 2. We are more exposed to DEVELOPING MARKETS, which generate lower margin BUT, the above
Slide 71: Debunk: Fujitec is More Exposed to New Installation
Debunk Management’s Arguments – 1. “Fujitec is More Exposed to New Installation” o Fujitec’s exposure to high-margin after-service work is inline with peers, accounting for 50% of total sales Business Mix New Installation vs Maintenance / Modernisation 47% 50% 57% 52% 52% 53% 50% 43% 48% 48% Otis Sc
Slide 72: Debunk: More Exposed to New Installation cont'd
Debunk Management’s Arguments – 1. “Fujitec is More Exposed to New Installation cont’d o Otis discloses its margins for new installation and maintenance respectively o Even Otis’ new installation business achieves a higher margin than Fujitec’s total business o Otis’ maintenance margins highlight th
Slide 73: Debunk: Higher Exposure to Developing Markets
Debunk Management’s Arguments – 2. “Higher Exposure to Developing Markets” o Although difficult to compare with peers, Fujitec derives 40% of its sales from Japan, a developed market with high reliance on maintenance and modernisation o Coupled with North America at least 53% of Fujitec’s sales come