Kobayashi Pharmaceutical can increase shareholder value with three steps suggested by Activist Oasis.

Company: Kobayashi Pharmaceutical (4967.T)

The company produces and sells both pharmaceuticals and consumer products in Japan and abroad. It operates in three different segments: the Domestic Business and International Business segments offer a range of products including health care, household, skin care, and others. Recently, the mail-order segment was merged with the domestic business segment, which now focuses on the mail-order sale of dietary supplements, skin care, and other products. The Other segment is involved 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)

Activist: Oasis Management Company

Percentage Ownership:  5.20%

Average Cost: n/a

Oasis Management is a global hedge fund management firm with offices in Hong Kong, Tokyo, Austin, Texas, 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 focuses on activism primarily in Asia (with occasional forays into Europe). The firm seeks to identify undervalued investment opportunities with great potential for value creation and has a prolific and successful track record of international activism. With a diverse range of tools at its disposal, 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

Oasis has suggested three paths for value creation for Kobayashi amid a scandal around its red koji-related products. These paths include (i) Kobayashi improving its operational performance on its own, (ii) Kobayashi going private via a management buyout, or (iii) Kobayashi working with Oasis to improve operational performance, corporate governance, and the constitution of its board.

Behind the scenes

Kobayashi Pharmaceutical is a Japanese pharmaceuticals and consumer products company with over 150 brands across various categories. In 2023, the company generated 173.45 billion yen in sales, with 75% coming from domestic sales, 24% from international sales, and less than 1% from other businesses. Despite posting record revenue in 2023, the business was coming off a declining base and only barely exceeded its 2018 revenue of 167 million yen. Additionally, since 2019, the company's 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 their peak in December 2020 to the end of 2023.

In early 2024, Kobayashi's red koji-related products were linked to health issues, causing the company to recall three products in March. The company formed a fact-finding committee to investigate the matter and assess the board's response. The committee concluded that the company did not engage in any malicious actions to conceal the matter but 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 red koji supplement scandal has caused the stock to drop nearly 20% since the end of 2023.

In May, Oasis Management emphasized the potential at Kobayashi. At that time, Oasis stated that this was not an exceptional or unpredictable crisis. At the time, Oasis said that they could intervene if there was no "self-improvement" and that the company would benefit if it implemented improved crisis management protocols and better corporate governance to hold management accountable and eliminate 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 composition of the board.

In July, Akihiro Kobayashi and Kazumasa Kobayashi resigned as president and CEO and chairman, respectively. Despite resigning, Akihiro Kobayashi remained on the board to handle compensation for victims. Kazumasa Kobayashi was appointed as a special advisor to the company. Both individuals announced they would return approximately half of their compensation from the past six months. Satoshi Yamane, an executive officer and head of sustainability management, took over as president and CEO.

Oasis has reported a 5.20% stake in the company, indicating that the activist is prepared to engage management more aggressively. It is clear that Kobayashi needs a reset, and Oasis is willing and able to assist in this process. However, it remains uncertain if the newly appointed CEO and shaken board will cooperate. The company's annual meeting took place in March 2024 before the fact-finding committee's results were released, so we must wait nearly a year before Oasis can submit any shareholder proposals, except for an Extraordinary Meeting. This board 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 indicative of how this board balances shareholder concerns with management interests.

Kobayashi should consider revamping its board and auditors, and at the very least, invite a representative from Oasis to join the board. This would give the company a sense of urgency to improve operational performance, corporate governance, and shareholder value maximization. Oasis has a track record of enhancing corporate governance at its Japanese portfolio companies, achieving an average return of 31.7% on its Japanese campaigns compared to 1.9% for the MSCI EAFE index. However, inviting an activist to a board is rare in Japanese companies today. If Oasis wants to create value for shareholders at a board level, it may have to resort to a proxy fight, which is a long shot, even at a company with governance issues. Recently, Oasis has faced challenges in campaigns that focused on poor corporate governance, resulting in losses at the 2024 annual general meetings of Hokuetsu and Ain Holdings. The loss at Ain was particularly concerning, as the pharmacy company displayed problematic governance, yet Oasis was unable to gain enough shareholder support to secure board representation.

Oasis is a renowned Japan shareholder activist and has a proven track record of obtaining board seats in the country. However, it is important to recognize that Japanese corporate governance has come a long way but still has much room for improvement. Despite the challenges, Oasis remains committed to its mission and continues to pursue its goals for the benefit of Kobayashi shareholders and the advancement of better corporate governance in Japan.

If Oasis receives a board seat, the firm could assist in evaluating strategic options, such as a management buyout at Kobayashi's current depressed share price or an acquisition by a strategic acquirer who could enhance quality assurance and integrate it into a more well-governed structure. Oasis has been active in Japanese pharmaceuticals and drug store companies in recent years, with a focus on consolidation as a major structural theme. The firm has advocated for change at Tsuruha Holdings, Kao Corp, Ain Holdings, and opposed management buyouts at Taisho Pharmaceutical Holdings.

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.