Sanwa becomes a target of ValueAct's investment.

Company: Sanwa Holdings Corp. (5929.T)

A Japan-based company primarily focuses on manufacturing and selling building and commercial facility construction materials, as well as offering maintenance and renovation services. The company operates in three regions: Japan, North America, and Europe. Its product offerings include shutters, doors for buildings and housing, partitions, stainless products, front-desk products, and windows and exterior products.

Stock Market Value: 874.8 billion Japanese yen (3,820.00 yen per share)

Activist: ValueAct Capital

Percentage Ownership:  5.94%

Average Cost: n/a

ValueAct has been a leading corporate governance investor for over 20 years, with principals typically holding board seats in half of their core portfolio positions. The firm has a history of U.S.-led international activism, primarily in Japan, and has had an average return of 48.15% on their international investments compared to 7.60% for the MSCI EAFE Index over the same periods. Two of their best international investments have been Japanese companies where one of their co-CEOs, Rob Hale, is on the board: Olympus (177.82% versus 19.68% for the MSCI EAFE) and JSR Corp (135.77% versus 44.35% for the MSCI EAFE).

What's happening

On Sept. 25, ValueAct Capital reported holding 5.94% of Sanwa Holdings.

Behind the scenes

Sanwa is a leading manufacturer of shutters, garage doors, and other related products for residential and commercial applications worldwide. The company holds a dominant position in its industry, with a 50% to 60% market share in Japan, a 30% market share in the U.S., and a 37% market share in Europe. In the last fiscal year, Sanwa generated 43% of its revenue in Japan, 37% in North America, 18% in Europe, and 2% in the rest of Asia. Despite being an activist target in Japan, Sanwa is a high-quality and growing business that is not plagued by many of the issues typically present at such targets.

ValueAct Capital has disclosed in a shareholding report that they have acquired a 5.94% stake in the company with the purpose of providing advice to management or making important proposals. This makes them one of the top five shareholders of Sanwa, according to the company's most recent disclosure of its principal shareholders in June 2024. This is a typical activist position for ValueAct, as they have a history of working with strong management teams to maximize shareholder value. There are three value creation opportunities for the firm: (i) expanding margins in the U.S. market, (ii) expanding margins in the Japanese market, and (iii) improving capital allocation and balance sheet efficiency.

Nearly 37% of Sanwa's revenue and 50% of its EBIT come from its U.S. business, which was built through many acquisitions that were not efficiently integrated. As a result, Sanwa operates over 15 factories across the U.S. (versus two to four for peers), and there remain duplicative corporate functions and regional management teams. U.S. EBIT margins are in the mid-teens, versus 30%+ for peers Clopay and C.H.I. Overhead Doors. There is a tremendous opportunity to centralize, consolidate, and professionalize its U.S. operations, which could lead to margins that are at least in the low-to mid-twenties over the next few years.

In Japan, Sanwa's business has a margin opportunity. Currently, the company's EBIT margins are around 11%, but they could potentially improve by a few hundred basis points in the next few years. Although margins are lower in Japan compared to other countries, demand remains strong from urban redevelopment, and the first inflationary environment in a while should make it easier to pass on price increases. As the market leader in Japan, Sanwa could leverage its position to increase pricing power in the future.

Sanwa currently holds about 10% of its market capitalization in cash, which is excessive compared to peers. It is common in Japan for companies to unnecessarily accumulate cash and investment securities without reason. ValueAct will likely prioritize capital allocation and optimizing the balance sheet of Sanwa, and may call for increased shareholder returns in the form of buybacks to capitalize on the company's relatively low valuation.

Increasing margins at both businesses and repurchasing shares should result in a continuous re-evaluation of the company's worth from its current 8.5-times EV/EBITDA ratio to the low-teens of its peers.

Sanwa has been consistently growing sales, profits, return on equity, return on assets, earnings per share, and dividends for several years, especially post-Covid. Since the beginning of 2020, the company has delivered a share price return of +180% and a total shareholder return of +225%, outperforming the S&P 500 and Nikkei 225. ValueAct and Sanwa are likely aligned on what needs to be done and are confident that management can accomplish it. With ValueAct in the picture, there should be more urgency in accomplishing it much quicker. Historically, the firm has taken board seats in approximately half of its portfolio positions, but it only does so when it and management are aligned on the value creation potential from the firm's presence in the boardroom. Neither seem to be the case here, so ValueAct is likely to continue as an active shareholder while Sanwa continues to do what it's been doing, just on a faster timetable.

The U.S. and Japanese businesses are separate entities. If the U.S. business were sold for the 13-times EBITDA that KKR sold the C.H.I. Overhead Doors business, it would equal almost the entire enterprise value of both the U.S. and Japanese businesses, effectively obtaining the strong Japanese business for almost nothing. This is not something that ValueAct has traditionally supported. However, as fiduciaries and economic creatures, ValueAct would ensure that management weighed the unsolicited offer against the long-term value of a standalone business and made the decision that was best for shareholders.

As an engaged investor, ValueAct has historically closed the gap between "good" and "great" by supporting management in executing its plan.

Dalton Investments had previously exceeded the 5% filing threshold at Sanwa on June 30, 2023. The firm reported that it had submitted three shareholder proposals, but quickly withdrew those proposals due to the company proactively disclosing measures regarding improvements to capital allocation and corporate governance. Now, ValueAct will pick up where Dalton left off, but we are sure that ValueAct comes in with a much longer-term mind frame.

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.