Mitsui Fudosan may create value in 3 ways, as suggested by activist Elliott.

Company: Mitsui Fudosan Co Ltd (8801.T)

Mitsui Fudosan is a Japanese real estate company with five business segments. Its leasing unit leases office buildings and commercial facilities, while the allotment sale segment sells condos, houses, rental housing, and office buildings to individual customers and investors. The management segment includes property, brokerage, and asset management. Mitsui Home focuses on new construction, reform, and renewal businesses. Lastly, the "others" segment operates hotels, golf courses, and resort facilities, as well as the loan guarantee business.

The stock market value is 3.869 trillion yen, equivalent to 4,144.00 yen per share. Additionally, the stock is traded in the U.S. as an American depositary receipt under the ticker MTSFY.

Activist: Elliott Management

Percentage Ownership:  2.5%

Average Cost: n/a

Elliott is a highly skilled and successful activist investor who leads a team of experts from top tech private equity firms, engineers, and former technology CEOs and COOs. When evaluating an investment, Elliott hires a range of consultants, including specialty and general management consultants, expert cost analysts, and industry specialists. The firm has a long history of focusing on strategic activism in the technology sector and has been highly successful with that approach. However, in recent years, its activism group has expanded and evolved, and the firm has been doing more long-term activism and creating value from a board level at a broader range of companies.

What's happening

Mitsui Fudosan is being urged by Elliott to implement a 1-trillion-yen share buyback plan and reduce its ownership in Oriental Land.

Behind the scenes

Elliott seeks three essential factors in an activist investment: a top-notch business, undervalued by the market, and with a plan to drive change and increase shareholder value.

Mitsui Fudosan is undoubtedly a top-notch business. As Japan's leading real estate company, its buildings are exceptional in terms of location and rental rates. Despite being a commercial real estate company, Mitsui Fudosan boasts significant brand power, which translates to premium pricing power. Its reputation for quality is so strong that tenants are willing to pay a premium to lease space in its buildings.

Mitsui Fudosan's stock price has remained stagnant since January 2014, despite the Nikkei's significant increase of over 120%. The company's net asset value has tripled over the same period. Historically, Mitsui Fudosan has traded at a premium to its real estate value. However, its current post-tax discount is 33%, with the value of its real estate, post-tax, at 5,700 yen per share, compared to the stock trading at 3,850 yen. Additionally, Mitsui Fudosan has an 800-billion-yen stock portfolio, which includes a 550-billion-yen position in Oriental Land Company, or OLC, and successful fee-based real estate businesses, bringing its net asset value to 7,103 yen per share, implying an 84% discount in the price of the stock.

Mitsui Fudosan is facing challenges with low valuation and return on equity in absolute terms and relative to peers. Its governance practices further hinder shareholder confidence. The company's 800-billion-yen stock portfolio accounts for about a fifth of its market cap, but generates only 7 billion yen per year in dividend income. OLC, which accounts for about 70% of the portfolio, is a risky and inefficient allocation of capital as it is a single publicly traded company that is one of the most expensive stocks in the TOPIX 100 on both a price-earnings basis and an enterprise value to earnings before interest, taxes, depreciation and amortization basis. The Tokyo Stock Exchange has been encouraging companies to improve ROE and get above a one times book value valuation. Currently, Mitsui Fudosan has 0.65 times price to adjusted book value (for real estate companies) and the lowest ROE among its peers.

To create value for shareholders, Mitsui Fudosan can take immediate action in three ways. First, it can accelerate the sale of its stake in OLC, which it has already begun, but has not been successful due to Elliott's engagement. This is similar to Palliser Capital's call for a reduction of Keisei Rail's 22% stake in OLC. Second, Mitsui Fudosan can sell 500 billion yen of non-core real estate holdings. Third, the company can use the proceeds to buy back shares and invest in new real estate developments, which will create the most value by redeveloping rather than holding onto these assets. This will result in a higher return on equity, lower cost of capital, and a higher price to book value.

Dai Nippon Printing, another Japanese company, followed a similar path as Elliott's engagement at this company. The firm called for share repurchases to boost ROE and the disposal of certain real estate holdings and cross-shareholdings. After announcing their engagement, Dai Nippon made the largest share repurchase in its history, worth 300 billion yen or 30% of the company's market cap.

Although Mitsui Fudosan's corporate governance is not ideal, with low governance scores from Institutional Shareholder Services, a board with only one-third independent directors, and a strange two-year term structure, there is some optimism to be found. There is no dominant shareholder, low cross-shareholdings (around 8%), and current president and CEO Takashi Ueda has expressed a commitment to increasing shareholder returns and improving capital efficiency, as well as divesting real estate assets.

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.