Kao Corp faces a challenging battle with Oasis' campaign launch.

Company: Kao Corp (4452.T)

Kao Corp, a Japanese company, produces and sells consumer and chemical products across five business segments. The hygiene and living care segment offers fabric, kitchen, home, sanitary, and pet care products. The health and beauty care segment provides facial, body, hair, oral care, hair styling, and color products, as well as salon, in-bathroom health care, and warming products. The life care business offers health drinks and hygiene products for commercial use. The cosmetics business provides counseling and self-selection cosmetic products. Lastly, the chemical business segment features oleo chemicals, fat and oil derivatives, surfactants, fragrances, and other specialty chemical products.

Stock Market Value: 2.92 trillion Japanese yen (6,273 yen per share)

Oasis Management is a global hedge fund management firm with offices in Hong Kong, Tokyo, Austin, and the Cayman Islands. Founded in 2002 by Seth Fischer, who serves as the firm's chief investment officer, Oasis is an authentic international activist investor that primarily focuses on activism in Asia (with occasional forays into Europe). The firm boasts an impressive track record of successful international activism, with a diverse range of strategies and tactics at its disposal. Through its efforts, Oasis has been successful in obtaining board seats, opposing strategic transactions, advocating for strategic actions, improving corporate governance, and holding management accountable.

What's happening

Kao Corp. was presented with an overhaul proposal by Oasis Management on April 8, which was announced after the firm revealed that it owns over 3% of the company.

Behind the scenes

Kao Corp is a multinational corporation with a diverse product portfolio ranging from hair and skin care to cosmetics and chemicals. The company operates in five segments, with hygiene and living care, health and beauty, cosmetics, and chemicals being its four key segments that account for nearly all of its 1.53 trillion yen in revenue in 2023. Despite having a strong brand portfolio, including Curél, freeplus, Jergens, Bioré, Oribe, and Molton Brown, Kao's shares have underperformed its peers, with a 22.9% decline since 2021 compared to a recovery in consumer products sales among peers. Additionally, Kao's operating profit margins are among the worst in the industry, with a decline to 4% in 2023 from 14% in 2019, despite the Tokyo Stock Exchange's push for companies to improve return on equity. Kao's ROE has also been on a steady decline to sub-5% in 2023 from approximately 20% in 2017.

Oasis highlights the company's issues in its "A Better Kao" campaign presentation. According to Oasis, the company is overly dependent on Japan, generating 65% of revenue domestically and 35% abroad, which is a distribution that is almost the opposite of its peers. Additionally, the company is not optimally distributed through its channels, and it is not focused enough on marketing, with peers spending between 20% and 35% on marketing and advertising, while Kao has consistently only spent 10% to 11% of its consumer goods revenue. Furthermore, Oasis notes that Kao has a bloated brand portfolio with too many subscale domestic brands; the company has nearly 80 brands, but generates the same revenue as peers with 10 to 30.

Oasis offers several solutions to Kao to boost growth, including: (i) reversing its opposition to international expansion and distribution to tap into the potential of its globally popular brands, which have been limited to domestic and regional markets; (ii) reviewing its brand portfolio, prioritizing focus and investment in high-growth areas, increasing gross margins through product premiumization, simplifying its complex brand and SKU portfolio, and particularly focusing on rationalization in its cosmetics and health and beauty segments; and (iii) bringing on a CMO with global experience and refreshing the board with similarly experienced directors. These changes to Kao's business, geographical footprint, distribution channels, and product mix would typically require a comprehensive analysis of costs, demand, competitive landscape, and chances of success. However, Oasis does not provide any of that.

Beiersdorf's successful turnaround serves as an example for Kao, as both companies face similar challenges such as underperforming peers, poor marketing allocation, and lack of premiumization. However, Oasis clarifies that they have no involvement in Beiersdorf's turnaround and are not recommending any of its executives for positions at Kao. The relevance of Beiersdorf in this context is unclear.

Oasis argues that the board lacks expertise in international consumer goods marketing and branding, and raises concerns about gender and demographic diversity. Despite its track record as a value-creating activist, Oasis acknowledges that this is not a typical campaign. The firm has never engaged a cosmetics company before and its previous engagements with Japanese companies in the cosmetics, health, and consumer goods category have not been successful. Oasis ran proxy fights at Kusuri No Aoki and Tsuruha, both drugstore operators that sell pharmaceuticals, cosmetics, and other consumer goods, and was defeated by management. If Oasis is correct about the issues at Kao, fixing them would require a complete reconstitution of the board and replacement of management, which is not typical in Japanese companies or something Oasis has much experience in. In Japan, activists have been successful in creating shareholder value by engaging companies without implementing their activist agenda. However, in this case, Oasis would have to implement its agenda and do significant work to create value at a company with the issues it claims.

Oasis CIO Seth Fischer did not rule out submitting shareholder proposals to Kao, but even that seems like using a flyswatter on an elephant. Moreover, a settlement here is very unlikely. Oasis had been privately meeting with management since 2021, so if management was inclined to work with them, it would have happened already, and Oasis would not have had to go public with its campaign. On the contrary, the day after Oasis launched its campaign, Kao stated that the firm lacked sufficient understanding of its portfolio management and restructuring plans.

The investor has been privately engaging with the company since June 2021 and has observed a slowdown in growth, decline in margins, and a plummet in ROE, despite Oasis projecting between 76% to 97% upside for the stock, or nearly 10,000 yen per share if their proposals are adopted. Therefore, I would take the firm's predictions and chances of success with a grain of salt.

Ken Squire is both 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.