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Warren Buffett Is Sage of Tokyo as Well as Omaha: William Pesek

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Commentary by William Pesek

Jan. 14 (Bloomberg) -- I find very few wonderful businesses in

Japan at present.

Thats how Warren Buffett explained his lack of interest in the

second-biggest economy to students at the University of Florida.
Buffetts gripes include very low returns on equity and a
corporate culture thats unresponsive to shareholders.

Japans markets have been battered of late by the global crisis,

and the Nikkei 225 Stock Average fell more than the Dow
Jones Industrial Average in 2008. Stocks in the U.S., the epicenter
of the credit crunch, fell 34 percent, while Japans dropped 42
percent.

Buffetts concerns explain much of the difference. And yet, the billionaire investors views are hardly a
revelation. They are certainly not news to anyone who suffered from the Nikkeis plunge in 2008 and
11 percent slide in 2007. Whats intriguing about Buffetts comments is that he didnt make them
yesterday, or last month, but in October 1998.

A lot has changed in Japan. Banks rid themselves of the bad loans behind the forgettable 1990s.
Companies woke up to the pressures of globalization, cutting some costs and trimming bloated
workforces. Key industries, particularly automakers, have increased market share in the past 10 years.

Or have things changed very little since Buffetts 1998 speech? Analyst John Mihaljevic, writing on the
Web site Seeking Alpha, looked at corporate Japans evolution since then, and its not pretty.

Five Issues

We approached our study of Japanese stocks with the hypothesis that we should be able to find some
compelling investments given the cheap valuations of a large subset of Japanese public companies,
wrote Mihaljevic, managing editor of the Manual of Ideas in New York. So far, however, we have
remained unimpressed.

Five specific issues are explored: a lack of business focus, murky corporate governance, little regard for
returns on investment, the high cost of production, and clubby boardrooms.

Many big companies still look more like conglomerates of old than Western-style enterprises. Yes, many
Western economies and companies are taking their lumps these days. Yet the lack of focus is apparent
in names such as Sony Corp., which oddly has both a bank and an insurance arm.

Governance Concerns

On corporate governance, there have been modest successes. Nipponkoa Insurance Co., Japans

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fourth-largest casualty insurer, recently raised its profit target and vowed to cut costs and increase sales
in response to pressure from one of its biggest shareholders: Southeastern Asset Management Inc.

Marked improvements are still few and far between. The increasing prevalence of takeover defenses and
poison pills to avert mergers that may benefit shareholders is a big concern.

Companies in Japan, Mihaljevic says, routinely spend as much as 10 percent of annual revenue on
capital expenditures even though they are in businesses with pretax profit margins of less than that
amount.

Japan also is a high-cost center. While companies have embraced global outsourcing, many prefer to
produce goods at home. That increases costs and leaves companies vulnerable to the strengthening yen.
Buffett has long said high costs thwart his desire to buy an entire company in Japan.

Finally, the lack of gender diversity in boardrooms speaks to a continued unwillingness to open up the
corporate culture. If there is any developed economy that needs to adopt new ways of doing business,
its Japan.

Superior Technology

Japan is home to a highly skilled and hardworking labor force. Companies benefit from access to
superior technology and manufacturing techniques. Japan also has some of the most environmentally
friendly business practices anywhere.

Buffetts Berkshire Hathaway Inc., its worth noting, has invested in Japanese shares here and there
since 1998. In September, for example, Berkshires Iscar Metalworking Cos. agreed to buy a 71.5
percent stake in Tungaloy Corp., a manufacturer of tools for cars and planes.

But, Mihaljevic says, assuming constant multiples, investors are likely to be disappointed, as theyll be
earning returns similar to the companies returns on equity. The latter generally range in the low- to
mid-single digits and appear unlikely to rise anytime soon.

Politics are worth considering, too. Its hard to remember a time in the last 15 years when Japan
existed in the kind of leadership vacuum that pervades the nation today. With a public support rate
below 20 percent, it wont be easy for Prime Minister Taro Aso to enact legislation to support the
economy.

Theres no doubt the U.S. precipitated the global crisis. Yet Japans economy stopped on a dime because
the government did nothing to create growth from within. Once U.S. demand dried up, Japan lost all
steam.

Japans longest postwar expansion did little to fatten the paychecks of average households. A decade
after pledging to boost domestic demand, Japans remains largely a one-trick economy: exports. That
recognition is now reflected in stock prices.

The Nikkei was at 12,995 points on the day of Buffetts 1998 speech. Today its at about 8,400. It may
be time to start calling the Sage of Omaha the Sage of Tokyo, too.

(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net

Last Updated: January 13, 2009 16:01 EST

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