Activist Oasis suggests 3 steps to build shareholder value at Kobayashi

Business: Kobayashi Pharmaceutical manufactures and sells pharmaceuticals and consumer products in Japan and internationally. The company operates in three segments: The Domestic Business and International Business segments offer health care, household, skin care and other products. The Company recently merged its mail-order segment into its domestic business segment, which is engaged in the mail-order sale of dietary supplements, skin care and other products. The Other segment is engaged in transportation, plastic container manufacturing, real estate management and advertising planning and production.

Stock Market Value: ~440 billion Japanese yen (5,635 yen per share)

Percentage Ownership:  5.20%

Average Cost: n/a

Activist Commentary: Oasis Management is a global hedge fund management firm headquartered in Hong Kong with additional offices in Tokyo and Austin, Texas, as well as the Cayman Islands. Oasis was founded in 2002 by Seth Fischer, who leads the firm as its chief investment officer. Oasis is an authentic international activist investor, doing activism primarily in Asia (and occasionally Europe). The firm seeks to identify investment opportunities that are undervalued and have great potential for value creation. The firm has an impressive track record of prolific and successful international activism. Oasis has as many arrows in its quiver as any activist and has been successful in getting seats on boards, opposing strategic transactions, advocating for strategic actions, improving corporate governance and holding management accountable.

Oasis recently reported a 5.20% position in Kobayashi. Amid a scandal around Kobayashi’s red koji-related products, Oasis said that it could engage the company if there was no self-improvement and suggested three paths for value creation: (i) Kobayashi could improve operational performance on its own; (ii) go private via a management buyout; or (iii) work with Oasis to improve operational performance, corporate governance and the constitution of the board.

Kobayashi Pharmaceutical is a Japan-based pharmaceuticals and consumer products company. It owns a stable of over 150 brands in categories across pharmaceuticals, oral care, food, skin care, air fresheners, mail order and more. The company generated 173.45 billion yen of sales in 2023 with 75% coming from domestic sales, 24% from international sales, and less than 1% from its other businesses. While the business posted record revenue in 2023, it was coming off of a declining base and only narrowly exceeded its 2018 revenue of 167 million yen. Moreover, since 2019, return on assets declined from 12% to 10.4%, return on equity from 11.3% to 10.1% and operating margins from 16.2% to 14.9%. As a result, the company’s shares declined over 45% from its peak in December 2020 to the end of 2023.

Matters went from bad to worse in early 2024 amid reports of health issues that appeared to be linked to Kobayashi’s red koji-related products. In March, the company recalled three products. Subsequently, Kobayashi began an investigation into the matter and formed a fact-finding committee to assess the situation and the board’s response. Last month, the company released the results of the investigation. While the committee concluded that the company did not engage in any malicious actions to conceal the matter, it also found that Kobayashi lacked awareness of the safety of health foods and failed to make timely reports and consultation to the board, auditors, government and consumers. The committee also found that the company lacked preparation for health damages and failed to invest sufficient resources into quality control. The scandal around the red koji supplement has sent the stock down nearly 20% since the end of 2023.

In May, Oasis Management highlighted the opportunity at Kobayashi. At that time, Oasis highlighted that this was not a case of an extraordinary or unimaginable crisis. At the time, Oasis said that they could step in if there was no “self-improvement” and that the company would stand to gain if it implemented improved crisis management protocols and improved corporate governance to better hold management accountable and root out nepotism. Oasis suggested three paths for value creation: (i) improve operational performance on its own; (ii) go private via a management buyout; or (iii) work with Oasis to improve operational performance, corporate governance, and the constitution of the board.

In July, president and CEO Akihiro Kobayashi and Chairman Kazumasa Kobayashi resigned from their roles. However, Akihiro Kobayashi remained on the board to continue handling compensation for victims, and Kazumasa Kobayashi was made a special advisor to the company. Both individuals announced they would return approximately half of their compensation from the past six months. Executive officer and head of sustainability management Satoshi Yamane took over as president and CEO.

Now, Oasis reported a 5.20% stake in the company, likely a sign that the activist is ready to begin engaging management more aggressively. It is clear to us that Kobayashi needs a reset and that Oasis is a willing and able partner to do so, but it is yet to be seen if the newly appointed CEO and shaken board will play ball. The company’s annual meeting passed in March 2024 before the results of the fact-finding committee were released, so we will have to wait nearly a year before Oasis could submit any shareholder proposals barring the requisition of an Extraordinary Meeting. This is a board which has overseen several product recalls and has been found to be ineffective in its oversight role of quality assurance and crisis management. While accepting the resignations of Akihiro and Kazumasa Kobayashi is a step in the right direction, keeping them involved with the company is more telling as to how this board weighs shareholder concerns versus management interests.

Kobayashi would be wise to overhaul much of its board and auditors, and at minimum invite a representative of Oasis onto the board. It would imbue the company with a sense of urgency to improve operational performance, corporate governance and shareholder value maximization. Moreover, Oasis has an extensive history of working to improve corporate governance at its Japanese portfolio companies, delivering an average 31.7% return on its Japanese campaigns with a corporate governance thesis versus 1.9% for the MSCI EAFE index. Despite this, a board invitation to an activist is something that rarely happens in Japanese companies today. If Oasis wants to create value for shareholders from a board level, it is something that would probably have to happen through a proxy fight. But that is also a long shot, even at a company with corporate governance issues as we have here. Oasis has encountered difficulties recently in campaigns which have centered around poor corporate governance, being delivered losses at the 2024 annual general meetings of Hokuetsu and Ain Holdings. The recent loss at Ain was especially disconcerting, as the pharmacy company had displayed problematic corporate governance, yet Oasis was unable to achieve enough shareholder support to gain board representation.

This is not a criticism of Oasis. The firm is a top-tier Japan shareholder activist and if anyone can get board seats in Japan, it is Oasis. Rather, it is more of a reality of Japanese corporate governance, which has come a long way over the past several years but has much further to go. Oasis is not the type of activist to be deterred from one or two losses: Japanese activists are used to losing proxy fights. We would hope the firm pursues this for the sake of Kobayashi shareholders and to continue the upward momentum toward better corporate governance in Japan.

If the firm receives a board seat, Oasis could assist in assessing strategic alternatives, including a management buyout at Kobayashi’s currently depressed share price or an acquisition by a strategic acquirer who could improve quality assurance and integrate it into a more well-governed structure. Oasis has been very active in Japanese pharmaceuticals and drug store companies in recent years. The firm has cited consolidation as a major structural theme, campaigning for change at Tsuruha Holdings, Kao Corp, Ain Holdings and management buyout opposition at Taisho Pharmaceutical Holdings.

Ken Squire is the founder and president of 13D Monitor, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that invests in a portfolio of activist 13D investments.