Activist Oasis proposes three steps to increase Kobayashi’s shareholder value

work: Kobayashi Pharmaceutical manufactures and sells pharmaceuticals and consumer goods in Japan and overseas. The company operates in three business divisions. The domestic and overseas business divisions offer products such as healthcare, household goods, and skincare. The company recently integrated the mail order division into the domestic business division, which sells nutritional supplements, skincare, and other products by mail order. Other divisions include transportation, plastic container manufacturing, real estate management, and advertising planning and production.

Market capitalization: Approximately 440 billion yen (5,635 yen per share)

Ownership percentage: 5.20%

Average cost: None

Activist Statement: Oasis Management is a global hedge fund manager headquartered in Hong Kong with offices in Tokyo, Austin, Texas, and the Cayman Islands. Oasis was founded in 2002 by Seth Fisher, who leads the firm as its Chief Investment Officer. Oasis is a bona fide international activist investor, primarily operating in Asia (and occasionally Europe). The firm seeks to identify investment opportunities that are undervalued but have significant potential for value creation. The firm has an impressive track record of prolific and successful international activism. Oasis has as many arrows in its quiver as any activist, successfully participating in board meetings, opposing strategic transactions, advocating for strategic actions, improving corporate governance, and holding management accountable.

Oasis recently announced that it holds a 5.20% stake in Kobayashi Pharmaceutical. As the scandal surrounding Kobayashi Pharmaceutical’s red koji-related products continues, Oasis said it may negotiate with the company if it does not improve on its own and proposed three paths to value creation: (i) Kobayashi Pharmaceutical improving its operational performance on its own, (ii) going private via a management buyout, or (iii) working with Oasis to improve its operational performance, corporate governance and board composition.

Kobayashi Pharmaceutical is a pharmaceutical and consumer goods manufacturer based in Japan. It owns over 150 brands, including pharmaceuticals, oral care, food, skincare, fragrances, and mail order. The company generated sales of JPY 173.45 billion in 2023, with 75% from domestic sales, 24% from overseas sales, and less than 1% from other businesses. The company achieved its highest revenue ever in 2023, but it has been on a downward trend, only slightly exceeding the 2018 revenue of JPY 167 million. In addition, since 2019, return on assets has declined from 12% to 10.4%, return on equity from 11.3% to 10.1%, and operating profit margin from 16.2% to 14.9%. As a result, the company’s stock price fell by more than 45% from its peak in December 2020 to the end of 2023.

Things only got worse in early 2024 with a series of reports of health problems believed to be linked to Kobayashi Pharmaceutical’s red koji-related products. In March, the company recalled three products. Kobayashi Pharmaceutical then began investigating the issue and set up a fact-finding committee to evaluate the situation and the board’s response. Last month, the company announced the results of its investigation. While the committee concluded that the company had not engaged in any malicious acts to conceal the problem, it also found that Kobayashi Pharmaceutical lacked awareness of the safety of health foods and had not timely reported or consulted with the board of directors, auditors, the government, or consumers. The committee also found that the company lacked preparedness for health hazards and did not devote sufficient resources to quality control. The scandal over the red koji supplement has caused the company’s shares to fall nearly 20% since the end of 2023.

In May, Oasis Management highlighted Kobayashi’s opportunity. At the time, Oasis emphasized that this was not an unusual or unimaginable crisis. At the time, Oasis said it could step in if there was no “self-improvement” and that the company would benefit if it implemented improved crisis management protocols and improved corporate governance to hold management more accountable and eradicate nepotism. Oasis proposed three paths for value creation: (i) improve operational performance on its own, (ii) be taken private via a management buyout, or (iii) work with Oasis to improve operational performance, corporate governance, and board composition.

In July, Representative Director and President Akihiro Kobayashi and Chairman Kazumasa Kobayashi stepped down. However, Akihiro Kobayashi remained on the board to continue working on compensation for victims, and Kazumasa Kobayashi became a special advisor to the company. Both men announced that they would give up about half of their compensation for the past six months. Satoshi Yamane, Executive Officer and Chief Sustainability Officer, was appointed Representative Director and President.

Oasis now reports a 5.20% stake in the company, perhaps a sign that the activist is ready to begin more active negotiations with management. It is clear that Kobayashi needs a reset, and that Oasis is willing and able to be that partner, but it remains to be seen whether the newly appointed CEO and the shaken board will work together. The company’s annual general meeting was passed in March 2024, before the results of the fact-finding committee were released, so Oasis will likely have to wait almost a year before it can submit a shareholder proposal unless an extraordinary general meeting is requested. This board has overseen several product recalls and has been found not to have effectively fulfilled its oversight role in quality assurance and crisis management. Accepting the resignations of Akihiro Kobayashi and Kazumasa Kobayashi is a step in the right direction, but keeping them involved in the company is a better indication of how this board is weighing shareholder concerns with management’s interests.

Kobayashi would be wise to refresh the board and much of the auditors and at least invite Oasis representatives to the board. This would instill in the company a sense of urgency to improve operational performance, corporate governance, and maximizing shareholder value. In addition, Oasis has long been committed to improving corporate governance in its Japanese portfolio companies, and its corporate governance-themed campaigns in Japan have achieved an average return of 31.7% compared to 1.9% for the MSCI EAFE index. Nevertheless, inviting activists to the board is rare in Japanese companies today. If Oasis wants to create value for shareholders at the board level, it will need to do so through a proxy fight. But that is difficult to achieve, even for a company with corporate governance issues like ours. Oasis has recently faced difficulties in campaigns over weak corporate governance, suffering losses at Hokuetsu and Ain Holdings’ 2024 annual general meetings. Ain’s recent losses were particularly disconcerting. That’s because Oasis was unable to garner enough shareholder support to elect a board of directors, despite the pharmaceutical company’s problems with corporate governance.

This is not a criticism of Oasis; they are one of the top shareholder activists in Japan and are the only ones able to secure board seats in Japan. Rather, this is the reality of corporate governance in Japan, which has made great strides in recent years but still has room for improvement. Oasis is not the type of activist to be discouraged by one or two defeats; activists in Japan are accustomed to losing proxy fights. We hope they pursue this course for the sake of Kobayashi shareholders and to continue the upward trend towards improved corporate governance in Japan.

If Oasis were to join the company’s board, it could assist in evaluating strategic options, including a management buyout at Kobayashi Pharmaceutical’s currently struggling share price or an acquisition by a strategic acquirer that could improve quality assurance and consolidate the company into a more disciplined organization. Oasis has been very active in Japanese pharmaceutical and drugstore companies in recent years. The firm has cited consolidation as a key structural theme, advocating for change at Tsuruha Holdings, Kao and Ain Holdings, and opposing a management buyout at Taisho Pharmaceutical Holdings.

Ken Squire is founder and president of 13D Monitor, an institutional research service on shareholder activism, and founder and portfolio manager of 13D Activist Fund, a mutual fund that invests in the activist 13D investment portfolio.