Goodbye to the Glory Days

Back to Contents of Issue: February 2003

Trading houses are trying to shift from being all-around elites to focused middlemen.

by Sumie Kawakami

"LIKE DOCTORS AND LAWYERS, becoming a shosha-man was one of the most honorable careers that a young university graduate could dream of back in the 1980s," says a 39-year-old Nissho Iwai employee who wishes to remain anonymous. He never dreamed that he could become one of the 4,000 soon-to-be-restructured; but now he watches as his debt-swamped employer tries to join forces with another trading house bleeding red ink, Nichimen. The two have agreed to integrate under a new holding company in April.

At a joint press conference held in Tokyo on December 11, Toru Hanbayashi, Nichimen's president, said, "Judging from the recent economic situation, we thought that the timing (of the integration) must be now." Hidetoshi Nishimura, Nissho Iwai's president, added that the integration of Nichimen -- which is strong in textile and raw materials -- and Nissho Iwai -- whose strength lies in airplanes and energies -- is unlikely to bring conflict, and that the restructuring would be faster with the two firms cooperating with each other.

Nissho Iwai is currently the sixth largest trading house in Japan, while Nichimen is the eighth largest in terms of sales.

Glory days
Sogo shosha translates literally to "all-around trading company." As its name suggests, these companies handle everything that has to do with overseas markets -- from trade, marketing and information to financial matters. With vast networks across the globe, Japanese trading houses used to represent Japan even in regions where Japanese government ties were insignificant. "Whatever the government officials don't know, find it out from the shosha-men" was a common phrase in the Eastern Bloc before the Berlin Wall came down in 1989.

The anatomy of Japanese trading houses was a favorite topic among Japanologists during the 1980s. Western scholars argued that their invisible ties with the government go back to the days of the Meiji restoration. In The Invisible Link: Japan's Sogo Shosha and the Organization of Trade, M.Y. Yoshino and Thomas Lifson argued, for example, that the Mitsui family, which had been a vital financial patron of the restoration movement, used its powerful political connections to be granted the opportunity to enter into banking, mining and trade. The company was expected to export overseas surplus products of the Imperial land and to import products needed at home, and thereby to engage in intercourse with the 10,000 countries of the universe, the book says.

Postwar economic growth also made the existence of general trading houses necessary. It's no exaggeration to say trading houses once dominated Japan's imports and exports. According to the Japan Foreign Trade Council, the value of exports handled by Japanese trading companies was JPY22.2 trillion, or 42.6 percent of total exports, in 1991. At JPY33.4 trillion, the proportion of imports handled by trading companies was even higher, at 79.0 percent. The nine top shosha were especially prominent in the postwar economy.

Streamlining operations
But those glory days are gone. With the spread of the Internet, purchasing foreign goods is becoming much easier, cutting the margins of these middlemen. Also, like many other firms in Japan, they too blew a large portion of their assets on bad investments during the bubble economy. And now they are finally realizing that they have stretched their businesses too thin.

Banks also need the trading houses to restructure. Pressured by economic and fiscal policy minister Heizo Takenaka's plans to accelerate disposal of bad loans, banks are also trying to encourage trading firms to get rid of their nonperforming assets, to partner with other firms and to cut costs. Over the past two years, a number of trading firms have gone through drastic streamlining.

So far, Nissho Iwai has been one of the more aggressive streamliners. The company spun off its information business division in 2000 under new firm ITX, while its LNG business was integrated under a 50-50 joint venture with Sumitomo in October 2001. Nissho Iwai and Japan's largest trading house, Mitsubishi, were scheduled to integrate their steel businesses in January 2003.

Nissho Iwai isn't the only one that is trying to find allies: Itochu and Marubeni established the 50-50 joint venture Itochu- Marubeni Steel in October 2001, while Sumitomo and Mitsui & Co. also integrated their home building material businesses last February.

In the meantime, the gap between the strong and the weak is widening. While the top four firms -- Mitsubishi, Mitsui & Co., Itochu and Sumitomo -- still wield a lot of power, the trading houses ranked lower down the list, including Nichimen and Nissho Iwai, are having harder times adjusting to the advancing deflation, weak stock markets and concerns over a global economic slowdown.

Osaka-based Tomen has already been granted debt forgiveness by its main financial institutions. The company announced in December that it had agreed with Toyota Tsusho, a trading firm under the Toyota Group, on a business integration starting in March. Kanematsu has asked for debt forgiveness from its main bank, Tokyo Mitsubishi Bank. The whole industry is in a state of flux.

Fumihito Gotoh, a senior analyst at Merrill Lynch, points out that trading houses in the lower ranking group have reduced debt by disposing of healthy, highly liquid assets instead of disposing of high-risk assets as they are supposed to be doing. They are doing this, he says, on the fear that getting rid of high-risk assets may damage their equity capital.

"When this happens, the positive factor of debt reduction is canceled out by the negative factor of a reduction in liquid and disposable assets, which would serve as a future source of funds for repaying debt, resulting in almost no improvement in credit," says Gotoh. "At the same time, high-risk assets continue to deteriorate as deflation progresses."

Limited effects?
The Nissho Iwai-Nichimen integration may motivate others to follow suit. But they first have to prove that their integration plans bring about the "synergy effects" both presidents talked about. Analysts are skeptical.

The two companies agreed to cut their combined group work force to 17,000 from the current 21,000, the number of subsidiaries to 300 from the current 430, and operating expenses by JPY80 billion by April 2004. They will also seek to post pretax profits of JPY100 billion and to cut their interest-bearing debt to less than JPY2 trillion within five years.

Furthermore, the two firms announced that the new holding firm is scheduled to raise JPY200 billion worth of equity capital. In addition to asking for funds from their main bank, UFJ Bank, they are also asking US investment bank Lehman Brothers to play a central role. The two trading houses announced that they will not ask for financial institutions to forgive debts.

Together, the two firms already have JPY162.4 trillion in equity capital (Nissho Iwai had JPY85.3 billion in equity at the end of September 2002, and Nichimen had JPY77.1 billion). With an additional JPY200 billion, the new holding company will have JPY362.4 billion, which would make it the fifth largest in equity capital, surpassing Marubeni. The combined sales would come to around JPY7.5 trillion, which would also threaten Marubeni.

"While Nichimen has taken a strategy to select and concentrate, Nissho Iwai has an attachment to the ideal shosha style of business."

But Nichimen and Nissho Iwai also have significantly high levels of debts compared to the top five firms. Nissho Iwai's interest-bearing debt stands at over 21 times more than its equity capital; Nichimen's is over 11 times. These are significantly higher than the top level trading houses. In the case of Mitsubishi, Mitsui and Sumitomo, their ratio of interest-bearing debt to equity capital is somewhere between 4.0 and 5.0. The combined interest-bearing debt of Nichimen and Nissho Iwai is over JPY2.75 trillion. Even if the two firms were able to raise the planned JPY200 billion, the debt would still be over 7.5 times higher than equity capital.

Shiroh Sakawaki, an analyst at Daiwa Institute of Research, says the two firms have strategies that are almost at opposite poles, and finding ways to compromise will be key to their future together. "Nichimen has taken a strategy to select and concentrate," he says. "The strategy reflects the fact that the company has secured relatively good positions in textile and chemical goods. On the other hand, Nissho Iwai has an attachment to the ideal shosha style of business. For example, ITX, which was spun out from the company's IT division, still has a sort of strategic alliance with Nissho Iwai." The old model of "all-around trading company" no longer works, Sakawaki says, and this alliance will work only if Nissho Iwai can come closer to Nichmen's strategy.

Gotoh of Merrill Lynch also is skeptical about the integration. He poses two questions. The first is, is it rational for an investor like Lehman Brothers to invest capital without the two firms seeking debt forgiveness from their main banks? Lehman is reportedly planning to put up JPY50 billion, but nothing had been announced by the company as this magazine went to print. Gotoh also questions whether even a capital increase of more than JPY200 billion, if it's achieved, will be enough to cover potential losses that may arise.

"Considering that there may be losses related to bad-asset disposal and restructuring, it will not be easy to achieve the target" of a net debt to equity ratio of 500 percent.

The larger picture
Whatever comes out of the deal, concludes Gotoh, it won't have a major impact on the giants. "The size of the businesses is totally different," he says. Marubeni is already struggling to improve its balance sheet on its own, while Tomen, having been granted debt relief from its banks, is now seeking assistance from Toyota Tsusho, according to the Japanese media. The game seems to be easier for the financially sound top four, but they, too, have more weight to lose.

The trading houses have certainly entered a new chapter in their history. Yesterday's all-around elites now have to face the fact that streamlining and focusing on what you are good at is what being a shosha-man in the 21st century is all about. @

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