Company: Kao Corp (4452.T)
Business: Japan-based Kao Corp manufactures and sells consumer and chemical products. It operates in five business segments. The hygiene and living care segment provides fabric, kitchen, home, sanitary and pet care products. The health and beauty care segment offers 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. Finally, 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)
Activist Commentary: Oasis Management is a global hedge fund management firm headquartered in Hong Kong with additional offices in Tokyo, Austin and the Cayman Islands. Oasis was founded in 2002 by Seth Fischer, who leads the firm as its chief investment officer. Oasis is an authentic international activist investor, doing activism primarily in Asia (and occasionally Europe). The firm has an impressive track record of prolific and successful international activism. It has as many arrows in its quiver as any activist and has been successful in getting seats on boards, opposing strategic transactions, advocating for strategic actions, improving corporate governance and holding management accountable.
What’s happening
On April 8, Oasis Management announced that it owns over 3% of Kao Corp. Days earlier, the firm rolled out its “A Better Kao” presentation, proposing an overhaul at the company.
Behind the scenes
Kao Corp is a global fast-moving consumer goods company with a diversified portfolio of products spanning from hair and skin care to cosmetics and chemicals. The company operates across five segments, but hygiene and living care (33%), health and beauty (25%), cosmetics (15%) and chemicals (23%) are their four key segments generating nearly all of Kao’s 1.53 trillion yen in revenue in 2023. The company has a stable of brands (including Curél, freeplus, Jergens, Bioré, Oribe and Molton Brown) that has deeply underperformed its peers. As of the issuance of its campaign presentation, Oasis points out that Kao shares were down 22.9% since 2021 while peers were up between 1.7% to 100.4% during the same period. In addition, while peers have recovered their consumer products sales, Kao has failed to return to pre-pandemic levels and has some of the worst operating profit margins in the industry. Despite the push from the Tokyo Stock Exchange for companies to improve return on equity, Kao’s ROE has been on a steady decline to sub-5% in 2023 from approximately 20% in 2017. Operating margins are on a similar trajectory as well, declining to 4% in 2023 from 14% in 2019.
Oasis details what it thinks are the company’s issues in its “A Better Kao” campaign presentation. Oasis thinks the company: (i) is too reliant on Japan, generating 65% of revenue in its domestic market and 35% in the rest of the world, which is a distribution nearly inverse to their peers, (ii) is not in the optimal distribution channels, (iii) is not focused enough on marketing – while peers spend between 20% and 35% of its revenue on marketing and advertising, Kao has consistently only paid 10% to 11% of its consumer goods revenue. Oasis also said 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 does offer several solutions to the company to jumpstart growth such as: (i) reversing its opposition to international expansion and distribution in order to unleash the potential of its stable of globally beloved brands, which have been artificially constrained to domestic and regional markets; (ii) reviewing its brand portfolio, prioritizing focus and investment in high-growth areas, expand gross margins through product premiumization, streamline its bloated brand and SKU portfolio and focus particularly on rationalization in its cosmetics and health and beauty segments; and (iii) embracing marketing by onboarding a CMO with global experience as well as refreshing the board with similarly experienced directors. These are wholesale changes to Kao’s business, geographical footprint, distribution channels and product mix that would usually require an in-depth analysis of costs, demand, competitive landscape and chance of success. Oasis provides none of that.
Oasis does cite Beiersdorf’s turnaround as the analog for what is possible at Kao. Suffering many of the same problems, Beiersdorf had underperformed peers, poorly allocated marketing spend and lagged on premiumization. Investors had also lost confidence in management. The company refreshed its CEO overhauled its corporate culture and growth strategy and refocused on key brands and gross margin expansion. Since doing so, Beiersdorf’s share price has outperformed the rest of its European consumer goods peers. However, Oasis had absolutely nothing to do with that turnaround and is not recommending any of the executives from Beiersdorf for positions at Kao. It is hard to see what relevance Beiersdorf has here besides just being a peer.
Oasis states that the board has no directors with expertise in international consumer goods marketing or branding, and the firm makes good points regarding gender and demographics of the board. Oasis has proven to be a value-creating activist in many situations and would likely be a valuable board member here, but this is not a typical Oasis activist campaign. First, until 2023, the firm had never engaged a cosmetics company. Since then, this is Oasis’ third engagement of a Japanese company in the cosmetics, health and consumer goods category. The other two have not gone so well. Kusuri No Aoki and Tsuruha are both drugstore operators, engaged in the sale of pharmaceuticals, cosmetics and other consumer goods. At both companies, Oasis ran proxy fights and was defeated by management. Second, if Oasis is even remotely correct about the issues at Kao, fixing them would require a total reconstitution of the board and replacement of management. That is not something that is typically done at Japanese companies nor something Oasis has a lot of experience in. In Japan, Oasis and other activists have been successful in creating shareholder value just by engaging companies without getting their activist agenda implemented. That is something that can happen in Japan, but generally when the recommendations are minor such as capital allocation, selling down cross-shareholdings and corporate governance improvements. In this case, Oasis would have to implement its activist agenda and do some heavy lifting to create value at a company with the issues it claims this company has.
That does not seem to be part of the Oasis plan here. Oasis CIO Seth Fischer did not rule out submitting shareholder proposals to Kao, but even that seems like using a flyswatter on an elephant. Additionally, 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.
As of the date of its presentation, Oasis projected between 76% to 97% upside for the stock, or nearly 10,000 yen per share if their proposals are adopted. However, the investor has also been engaging privately with the company since June 2021 during which time growth has slowed, margins had declined, ROE has plummeted and the stock has slid. So, I would take the firm’s predictions and chances of success with a grain of salt.
Ken Squire is 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.