Terrie's Take: Nine New Trends for Japan in 2014, Record Deficits, LNG, Nationalizing Islands, and Tune Hotels
Terrie’s Take is a selection of Japanese-centric news collected and collated by long-time resident and media business professional Terrie Lloyd. AkihabaraNews is pleased to present Terrie’s learned perspective; we all could use another take on the news - here’s Terrie’s:
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Terrie’s Take on January 20, 2014
- Nine New Trends for 2014
- Record Current Account deficit in November
- JGC co-wins big Canadian LNG project
- Gathering 280 chickens (islands) to mother hen
- Budget operator Tune Hotels looks at 20 new hotels for Japan
Nine New Trends for 2014
Welcome to the first edition of Terrie's Take for 2014. As is our custom, we take a peek into the future and ask ourselves what trends or macro developments might happen and what impact they will have on doing business in Japan. While fortune telling is an art best practiced by monkeys throwing darts, we nonetheless enjoy the speculative process and here share it with our readers.
1. Conflict with China over the Senkaku Islands
One wonders what is really going on behind the sabre rattling by Japan and China over the Senkaku/Diaoyu islands. On the surface it's about oil reserves and national pride, and maybe that is all there is to it. On a deeper level, though, maybe there is a dimension of global politics that is yet to express itself clearly -- one in which Japan is just a pawn. If the conflict is about oil and pride, then the path to escalation could be short and swift. Patriotism, the most deadly form of pride, is readily found in the armed forces of both countries (how else do you get people to sign up during peace time?), and given that the initial source of conflict is likely to be a showdown between the Japanese and Chinese airforces or navies, we can be reasonably sure that a miscalculation is not far away. The question, though, is not whether there will be an escalation but how far will it go?
Until recently the Japanese were reasonably confident that their territorial claims would be backed up by the international community, while their military objectives would be backed up specifically by the USA. However, an annual Japanese government poll (http://www.mofa.go.jp/files/000022801.pdf) found last year that U.S. public opinion has swung towards the feeling there that Japan should take care of its own security. This result was apparently a bit shocking for the Japanese, who see the U.S. as a Big Brother in terms of its security relationship, but it has also provided the impetus the Abe government has needed to commit itself to rebuilding the military and to have Japan play a more assertive role internationally.
If there is an escalation, we don't see it developing into a full-scale war. Instead, we believe that the Chinese would quickly occupy the Senkakus and set up facilities there, forcing the Japanese into a humiliating retreat. Even if Japan put soldiers on the Senkakus before such an escalation, the Chinese would still invade the islands, capturing the Japanese forces emplaced there and trying them in a military court back in Beijing -- echoes of what happened when the Chinese fishing boat skipper was tried in Japan several years ago. Also, by "invasion" we don't mean just militarily. We think the Chinese will be more imaginative, for example, causing a flotilla of private protestors to try to land on the islands, looking to provoke a Japanese response -- after which the Chinese could act militarily to "rescue" their citizens.
If there was such a showdown, we suspect that the rest of the world would vigorously condemn China's actions but do little else because of their collective dependence on China's factories and investment. This will further emphasize to Japan the new reality that it's on its own. What's the probability of a conflict happening? We'd like to say "low", but logic would dictate that if China was to take the risk and make a move, it should do so this year, while Japan is still militarily vulnerable and not yet politically organized enough to respond effectively to an annexation of the Senkakus. The longer China waits, the more likely it is that Japan will fight back, causing a polarization of the developed world and an increased likelihood of trade bans and other retaliatory actions.
2. Bigger than expected drop in consumer spending
It doesn't take a rocket scientist to imagine that the increase of the nation's consumption tax from 5% to 8% in April will cause consumers to think twice about buying more stuff for a while. Abe's big gamble is that there will be sufficient public optimism that within a couple of months of the increase, people be sufficiently buoyed by "animal spirits" to forget the extra costs, and resume consumption and investment locally. The unfortunate problem is that with 31% of Japanese households having no savings, any increase in the cost of living is going to go straight to their bottom line, with no upside that inflation usually brings -- such as increased interest on your bank account or increased prices for your shares. This will create more suffering, despite some meager handouts the government is making so that it can say it is doing something for the poor.
Furthermore, among the 40m people with regular jobs, less than 20% work for the companies most benefitting from Abenomics, the exporters. Of the rest, pay raises will be small or not happen at all in 2014, and they will also experience a perceptible drop in living standards as the economy in their segment of the market tightens. It's probably fair to say that the brunt of Abenomics will be borne by younger families and the elderly. With older people, the pressure will be on them to sell up their assets, which is the harsh reality not having enough of the working generation to support them. However, for young families there is no real escape. So instead, they will do without. If you have shares in companies making kids clothing or cram schools, it might be a good time to sell.
3. LDP scandals to re-emerge?
As a result of the consumer spending hit, Abe's honeymoon with most citizens will likely end in Summer-Fall 2014, and his political fortunes will become more polarized. The media will pick up on the changing public mood and will start digging for dirt. Based on the theory that old habits die hard, we wouldn't be surprised if the LDP finds itself caught up in various hands-in-the-cookie-jar scandals by the end of this year and in 2015, just as they used to in the good old days. Where will theses scandals come from? As always, look to where the money is going, and you will find greed and power-grabbing not far behind. In the case of Abenomics, this will be in the use of BOJ, DBJ, and other government-controlled banking and funds, the nuclear power industry, the construction industry and particularly the Tohoku relief efforts and shortly the Olympics, and military spending. Lots of nice big dark corners in all those sectors.
The problem, of course, is that now there is a secrecy law in place, and so the details of some of the best scams will be placed under lock and key, allowing the politicians to control which tidbits (opposition peccadillos) go to the media and which get kept secret until such time as the perpetrator has long-since deceased. That said, we wonder if the Japanese secrecy law can be enforced abroad? Probably not. So we will add another mini prediction -- that "deep-dive" Japanese journalists will start passing their most juicy leads to western colleagues, so as to ensure that their stories get heard.
4. Scandal over child cancers in Fukushima
Apart from monetary scandals, we believe another source of negative PR for the government will be in health and particularly the kids in Fukushima. Already, early health checks are finding abnormally high instances -- "several times to several tens of times higher" (59 kids and teens out of 239,000 tested) -- of thyroid cancer in Fukushima prefecture. It defies belief that government and local prefectural authorities are saying that it is too early for such cancers to be manifesting themselves, so this must just be a statistical blip.
Or, and no one is saying it, but maybe those kids were affected by the Daiichi plant years before the disaster? Either way, families with children who decided to trust the government and stay in the prefecture after the Fukushima power plant blew up must be regretting their decisions now. Over time, as it becomes clear whether or not there is another Minamata-type wave of victims, the decision-makers will no doubt duck responsibility and leave it to the families affected to drag their cases to the courts -- something guaranteed to take years or decades to happen. Maybe someone will say sorry in 2061 -- this is how long it took (50 years) for the nation's PM, Junichiro Koizumi in 2006, to issue the first formal Prime Ministerial apology to the Minamata victims.
5. Continuing improvement in tourism sector
Lose China and gain an alternative market. The "China-plus One" strategy was originally conceived for Japanese manufacturers trying to diversify away from overdependence on China, but now is being applied to other sectors as well, such as consumer product exports, food imports, and tourism. So while Chinese tourist arrival numbers are still being affected (although increasingly less so) by the Senkaku Islands row, the government has decided that they will turn on the taps for South East Asian travellers, by removing unpleasant visa restrictions that applied up until now. The government has obviously decided that the threat of a couple of thousand potential overstayers each year is vastly outweighed by tourist spending and independence from the Chinese. As of July last year, easy entry was offered to Thais and Malays, with the result that Thais started arriving in Japan at the rate of about 50,000-60,000 per month (61,300 in October 2013), significantly more than previously and vaulting Thailand into the position of being the fifth largest source of tourists, just behind Hong Kong.
This year, the chances are that Vietnam and Indonesia tourists will also be offered freer access, and in the case of Indonesia this will unlock a market population of 247m people, bigger than all the other SEA markets combined. Given that Thailand will probably field about half a million tourists to Japan in the full year (since the visa easing) through to June, then Indonesia could wind up contributing 4-5 times this number. With this simple but effective move, the government appears to have been able to build inbound tourism by a surprising 20% per year. While the numbers are still small potatoes compared to other industries, the incoming spending will still be very welcome news to government financial planners.
The soaring numbers will stimulate more hotel building, and more importantly help build the presence of more foreign firms. We think this is important, because as the ski resorts of Niseko and Hakuba show, the presence of foreigner operators completely changes the attractiveness of those destinations to foreign tourists. It makes the destinations far more accessible and less intimidating. The presence of more hotels will also support more activities operators, who will diversify the experiences a tourist can have when coming to Japan, thus increasing the likelihood of repeaters. Think of trailblazers like Canyons (white water rafting) in Gunma, other guided adventure tours, cycling, unique traditional accommodation, and other experiences.
6. More large M&As, stimulated by low interest rates
Since the Lehman Shock, those Japanese companies that got in on the M&A track prior to December 2012 found themselves with a 30% price saving compared to 2013, by virtue of the temporarily high yen. Coincident with Abe's reset of the yen in 2013, M&A activity for 2013 also fell, by about 50% by value. However, we don't think it was necessarily the falling yen that caused the reduction in deals, and instead it has been more a matter of market timing and the inevitable gap between the early adopters and the rank-and-file. We need to remember that Japanese companies are not particularly opportunistic and are not buying up companies overseas just because the yen is favorable.
Instead, what they are looking for is future earnings. Why? Because earnings are likely to decrease back in Japan mid- and long-term, and because money is still cheap. For this reason, the Japanese like to buy profitable, not distressed firms, and the premium being paid is justified by simple accounting math. The average profitable foreign company yields 2-3 times the earnings on capital that a similar Japanese businesses in their local market does, largely because foreign firms are more efficient and because of their focus on returning profits. In Japan, company politics and the ethos of the "company being the family" mean that a lot more cash gets spent on overheads that wouldn't be considered necessary in other business cultures. Let's not forget, either, that Japanese companies get their funds for 1% or less per annum, and that buy-out loans can 10 years or longer. So if your M&A target company is making 10% or so in EBIT profits annually, then buying it for 1% interest on the new cashflow is a no brainer. Instead, your deal frequency is going to be more a gauge of your bank's confidence in you and your confidence in managing a bunch of foreigners.
7. Foreign M&A as government policy
A related prediction this year is that we think it will emerge that some Japanese corporate M&As are being done in close concert with the government, rather than as solo efforts by the acquiring company themselves. In much the same way as Japan has operated a convoy system for chosen industries domestically in the past, we believe that a similar line of thinking will emerge in international M&A, whereby the government will pick companies that can ONLY survive by overseas M&A, and provide the expertise and financial means for them to do so. Strategically the thinking will be that this prevents a foreign, especially a Chinese, player from snapping up desirable international competitors. The government already buys public stocks, so why not extend the mandate by providing research, management support, and of course easy loans to continue the M&A march?
While we know of no western government taking such a deliberate and calculated market domination approach, sovereign wealth funds clearly show that countries believe they have a role in making markets. Still, Japan will have to be careful that it is not seen as a monopolistic threat by its allies, else it may have to endure a repeat of the Japan-bashing it received in the 1980's. Where will the next big deals come from? We expect substantial ongoing M&A in all the major export sectors (autos, retail, food) as well as the service sectors most benefiting from Abenomics, such as banking, construction, real estate, and science.
8. TPP passes but is gutted
One of the predictions we got wrong last year was that Japan would not join the TPP discussions. We took things at face value and imagined that Japan would fail to gain traction on its own. We didn't think about the fact that the USA might want Japan in the talks, nor that PM Abe would be able to keep his own farming constituency quiet. Our guess is that several secret "grand deals" were done to get Japan into the TPP discussions. Now, as with many deals, the resulting compromises may mean that TPP will be significantly watered down and will be a disappointment to most of the other member countries. But bread crumbs better than nothing.
TPP will, however, be a political gift to PM Abe, since he will be able to push through various unpopular agricultural and other market sector reforms, all the while pointing a finger saying, "The foreigners made me do it." It does help that with China's saber rattling, the conservative Japanese farming lobby is probably now torn between preserving their lifestyles and in the future possibly just preserving their lives. Japan needs the USA militarily for the time being and no one denies that, so if the USA wants or is willing to give certain concessions on the trade side of things, then that's the way it's gonna be.
9. Commercialization of stem cells
Imagine being able to grow back your eyesight when you're in your 50's and beyond, and your doctor has diagnosed that you will go blind in the next 4-6 months? What would you, an older person probably with substantial personal assets (typically, in Japan at least), be willing to pay to have your eyesight restored? US$100,000? More? OK, another question: what about those patients who don't have a lot of wealth? Will they be given government subsidies to get regenerative medicine? Or will regenerative procedures for non-life-threatening ailments be classified as non-essential and thus effectively for the rich only?
These are the type of difficult questions that are going to be confronting the Japanese in the next ten years, as the research into adult stem cells accelerates. Late last year, the government gave the go-ahead for Riken to undertake clinical trials using stem cell therapy to repair macular degeneration. The consensus is that the techniques are now well established and predictable, and that fears of failed surgeries and unexpected tumors are receding. We forecast that not only regeneration of eyes, but also of a number of other organs will be announced over the next 12 months. Coupled with these scientific breakthroughs, we believe that there will also be network of commercial ventures announced, which will explain why PM Abe said last year his government was willing to pump potentially over US$1bn into the field. Basically the Japanese are on the verge of creating a whole new industrial sector, where science and technology, not just labor costs, provide the nation with a new competitive advantage.
Record Current Account deficit in November
One important measure of the health of the Japanese economy, the current-account deficit, increased to a record JPY592.8bn in November 2013, mostly due to the weaker yen and the ongoing record import of hydrocarbon fuels to drive Japan's electrical utilities while a decision is made as to whether to restart the nation's remaining 50+ nuclear reactors. Experts say that the deficit is sustainable for some time to come, because of the surplus of income from overseas, but if it continues, it is likely to undermine the faith of investors of Japan's public credit-worthiness. (Source: TT commentary from bloomberg.com, Jan 14, 2014)
[TT: Investopedia.com: 'Current Account Deficit' is a measurement of a country's trade in which the value of goods and services it imports exceeds the value of goods and services it exports.]
JGC co-wins big Canadian LNG project
Engineering company JGC has announced that it has co-won a major contract with U.S. Fluor, to build an LNG gas plant in Canada. The deal is reportedly worth around US$9.4bn and is for Chevron Canada at the company's Kitimat site in British Columbia. Once the plant is up and running, it is expected to produce about 11m tons of LNG annually. Kitimat is expected to become yet another major feed point for fuel for Japan, the world's largest consumer of LNG. (Source: TT commentary from hurriyetdailynews.com, Jan 14, 2014)
Gathering 280 chickens (islands) to mother hen
In for a penny, in for a pound. Japan has decided that it will nationalize about 280 islands whose ownership is unknown and which it believes determine the country's territorial waters claims. While some of the targeted islands are inhabited, most are not, and therefore, the historical owners in many cases are unknown. Apparently about 500 islands serve as the anchor points for Japan's territorial claims. Only about 160 of the 280 islands in question have names, and so the government plans a naming program as well. ***Ed: No word on just where these islands are or what effect they will have on diplomatic relations with China, Taiwan, South Korea, and Russia. However, we would rank this action as being equivalent to Abe visiting the Yasukuni Shrine ten times in a row, in terms of international stimulative value, if the islands are in contentious territory. With 280 of them, chances are that some are... Stay tuned!** (Source: TT commentary from the-japan-news.com, Jan 9, 2014)
Budget operator Tune Hotels looks at 20 new hotels for Japan
The owner of the budget brand Tune Hotels, Tim Hansing CEO of Red Planet Hotels, has said that his company intends to open up to 20 new budget hotels in Japan by 2020. Hansing said in Hong Kong after a recent research visit that his firm is planning to capitalize on the expected surge in younger travelers to Japan, competing with the nation's traditional operators, whom he labels "very boring, poor value for money, and very tired." Hansing's visit came as foreign operators try to figure out whether Japan needs more hotels or not. ***Ed: Some experts such as Capital Economics in London reckon that Japan has limited capacity for increased demand for hotel rooms, and if this is true, then for those companies willing to make the investment, the opportunity to carve out a new segment in the market seems to be attractive. For example, we are unaware at the present time of any well-known international (foreign) budget operator active in Tokyo. There are of course many local budget operators, but Hansing seems to suggest that they may not understand the foreign target market.**(Source: TT commentary from cnbc.com, Jan 14, 2014)
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Images: Terrie's Take; AkihabaraNews