The Rise of Eizo Kobayashi

Back to Contents of Issue: January 2005

The Rise of Eizo Kobayashi And how investing is becoming Itochu's new business line

by Jessie Wilson

December 14, 1999, is a date that Eizo Kobayashi will not easily forget. It was the day that one of the world's largest trading companies, Itochu Corporation, pinned its hopes on an entirely new form of financing, the listing of a technology crown jewel called CTC -- or Itochu Techno-Science as it was called then.

The listing was handled by newly formed securities house Nikko Salomon Smith Barney, and it turned out to be the largest IPO of 1999, raising around 110 billion yen (approximately $1 billion). On the day it was listed, CTC had a higher market cap than its parent. It was a feather in the cap for Kobayashi, who as COO for the IT and telecom division of the massive trading firm had fathered the IPO. It was also a welcome injection of funds and assets to the balance sheet of Itochu at a time when the company was undergoing massive restructuring.

Perhaps typical of Kobayashi's style, after the many intensive months of preparation and herding CTC's management towards rapid growth with profits, instead of having a wild party in a swank restaurant in Aoyama after the stock markets closed, he finished off at the office as usual and took a group of employees to a local restaurant for an evening pep session. For Kobayashi it was business as usual, and another step in an extraordinary career that has seen him rise from an ordinary Bucho to CEO in just ten short years.

The CTC listing marked the beginning of ascendancy for Kobayashi. Not only did it prove him in the eyes of the senior management of the trading firm, but it also provided a key event for the President of Itochu in 1999, Uichiro Niwa, to pull the talented Kobayashi in closer (eventually making him a Managing Director in 2002) and take him on as his right-hand man to execute some difficult strategies for 2000 and beyond. The two became very close and indeed, Niwa became a mentor to Kobayashi. He not only coached him in the rough and tumble of the boardroom politics of a $100-billion company, but also inculcated him in the art of radical shake-ups, starting with Itochu itself.

Niwa: the Mentor.........................................
To understand Kobayashi, you need to look at his boss, whom he still speaks of in reverential tones. Niwa was a bit of a maverick, installed as president of an ailing Itochu in April of 1998, in order to bring about change. He didn't waste any time, appearing in frequent interviews and speeches with his signature message of pushing Itochu full steam ahead while the rest of Japan was mired in a deep funk. Remember, this was a time when Japan had lost the plot and was wallowing in self-recrimination and spiraling deficits. His message wasn't always well received. At Itochu headquarters, Niwa reportedly spent many weekend management sessions berating his colleagues for their meek acceptance of the status quo and their lack of resolve to fix things. "Where is your sense of crisis?!" he would ask them.

Well, if there wasn't a sense of crisis in 1998, there certainly was one the following year, when Niwa announced in October of 1999 that the company would write off over JPY400 billion of bad assets from the company's books. This was a major shock both to the company and to the stock market--Itochu's stock fell almost 12% on the day of the announcement--and at one point Niwa was accused of betting the farm on his risky strategy. It was during this time that Niwa tasked his CFO Sumitaka Fujita to find a way to bring some urgently needed funds into the company. They would need the money to overcome an anticipated FY1999 deficit that eventually did hit JPY88 billion ($800 million).

Kobayashi was tasked along with a group of other managers to bring about the listings of CTC and broadcasting subsidiary J-SAT, while others worked on a scheme created with Mizuho (then Daichi Kangyo Bank) to securitize the billions of yen of promissory notes the company was holding, and general corporate streamlining and cost-cutting. These actions, coupled with Niwa's determination to slice away over 350 money-losing subsidiaries between 1998 and 2001, meant that Itochu enjoyed several billion dollars of extra cash and securities at a critical time in the restructuring process. The real cash cow was of course CTC, and between December 14th 1999 and March 2001, Itochu was able to sell on 50% of CTC in five different discrete transactions for a massive JPY200bn ($1.8 billion) in capital gains.

As luck would have it, the strategy coincided with a peaking of the technology markets, and in FY2000, ending March 31, 2001, the company declared a massive JPY70 billion profit. Although the following three years' results were rather more tame as the remaining bad assets were worked out, nevertheless the Niwa legend had been established, and Kobayashi was along for the ride.

The Handover....................................................................................
While Niwa capitalized on his cachet as the man who did in fact save the farm, by going on a public relations campaign in 2002 and 2003, he left the competent Kobayashi and other managers to look after daily operations. In July of 2003, Niwa, in characteristic style, published an article in the monthly Bungei-Shunju, a magazine widely read by business executives. The article very directly criticized PM Koizumi's economic policy--possibly a first in the current generation of Japanese business leaders. He asserted that Koizumi was doing the exact opposite of what was needed to achieve a recovery in the economy, and that rather than claw back funds in the form of taxes and pushing the banks to the edge, consumer spending was the key to recovery and that this would only come about with at least a temporary tax reduction.

While the article didn't hurt the 64-year-old Niwa, it did show his frustration with the system, and signaled the possibility that there was a leadership change in the wind. Niwa had already announced in 1998 that he would only stay on as the CEO for six years, so the market was watching for signs. Sure enough, succession rumors started later that year, and on March 5th, 2004, Kobayashi was announced the next president of the world's 18th largest company (Forbes Global, 2000, 2004).

There was a general excitement in the company at the prospect of Kobayashi taking the reigns, particularly among the younger employees. For a start, at 55 he's relatively young; Niwa was 59 when he took over, and the previous president was in his sixties. Kobayashi is also up-to-date with technology and knows how to communicate with the rank and file. While Niwa had the unenviable task of confronting and pushing his staff, Kobayashi is much more congenial. Even while working on major refinancing and IPO deals, Kobayashi somehow found time to take members of his old IT and telecomms division to a local Italian restaurant not far from the head office. This established a feeling amongst employees that Kobayashi represents the future, rather than a severance with the past. It doesn't hurt, either, that on his watch, the company has recovered from a JPY31.9 billion net loss in FY2003, and that FY2004 is looking to be very strong indeed.

Now, freed from the adverse effects from its latent losses, the stage is set for Kobayashi to leave his mark on Itochu. Whereas Niwa in his own words was destined to become "the clean-up guy," Kobayashi will probably be known as the "ultimate trader." Promising to turn around the company by fostering an environment in which it is "better to fight and lose than to not fight and win," he has vowed to stay focused on aggressive, forward-looking management strategies, aiming for a real profit growth of JPY75 billion ($680 million) for the current fiscal year.

But just how exactly does he plan to realize what many analysts perceive as an overly ambitious forecast? Especially as the windfall profits of raw materials consumption by China start to recede with a likely slowing of the global economy? One key strategy appears to be investing.

The business of investing for profit..................................................
Investing by trading companies is nothing new, but historically investments were made as strategic positions to enhance the parent company's competitiveness and it was taken for granted that the investees would be both grateful and cover their own costs--little thought was given to how these investments might yield useful profits in the near term. Instead the emphasis was on reliable control of resources and market share. As a result, most trading companies until the beginning of the eighties were vertically integrated, with interests ranging from iron ore mines and oil fields all the way through to auto production, financing, and distribution. A convoy system like this is hard to break, and by 1997, Itochu had more than one thousand subsidiaries--some of which were multi-billion dollar companies such as CTC, but most of whom were bleeding the parent company dry. Today, after the reforms of the "Niwa Jidai" (Niwa period), the company has 459 subsidiaries and 202 affiliates.

One important innovation that Niwa introduced, and which Kobayashi was tasked to implement, was the concept that investments could be made for profit, so long as they had a finite life and would contribute to the firm's bottom line trading activities. Niwa believed that technology would be a major leveraging point, and since his background was in food, he tapped his Information Technology Division Manager, Eizo Kobayashi, in 1999 to become his right-hand man for implementing the investing strategy. Since joining Itochu in 1972, Kobayashi had worked almost exclusively in high-tech, beginning with the import of such venerable brands as Control Data and Cray Research. In the 1980's Kobayashi was posted for four years to Hong Kong to help Epson set up a printer factory there, followed by eight years in Los Angeles, managing IT and electronics trading between Japan and the USA. So clearly, with both a technology background, an excellent understanding of global trading, and excellent command of English, Kobayashi was the right guy for the role.

In Japan in particular, Niwa was a strong believer in the power of the nation's small to medium-sized companies. He rationalized that as Japan moved from manufacturing to tertiary industries, need would force these smaller companies to adapt first and that they needed capital to create innovations. This strong belief in leveraging private equity is also a reason why the company decided in the late nineties to stick to trading rather than become a manufacturer as some of its competitors have done.

Thus in 2000, Niwa established a separate corporate department that he and Kobayashi could access directly, thus avoiding company politics, and which is now called the Innovative Technology Development Office (ITDO). This department, staffed by 14 people, is largely responsible for the company's new business development, particularly in biotech and nanotech, as well as, through the various business units both in Japan and overseas, actual investments. The strategy is to leverage Itochu's broad business base and resources. As General Manager of the ITDO, Yoshio Matsumi comments, "We can take advantage of Itochu's unique, complex and integrated operations as a sogo-shosha. Since we are involved in pretty much all industries, we are in an ideal position to act as matchmaker between the market needs and technology seeds, and hence to apply science-driven technologies to the real economy."

Distributing risk.....................................................................................
The ITDO is rather unique in its strategic value to the company. The operation is busy establishing relationships with both investment groups and primary research organizations all over the world. Matsumi is justifiably proud of his strategic alliances with the Los Alamos and Lawrence Livermore Labs in the USA, Institut Pasteur in France, Tsinghua University in China and the CSIRO in Australia -- amongst many others. The group helps the company to develop new technology and invest in promising ventures. "One of our most important partners is Los Alamos National Laboratory in the US, the world's largest laboratory," says Matsumi. "We are working together with them, and also with Columbia University, on such developments as composite materials, new food safety methods and non-destructive evaluation techniques, and hope to apply their technologies and intellectual properties to a variety of industries, depending on the market needs." The ITDO is particularly involved in biotechnology and nanotechnology, seeking to make them part of Itochu's core operations in four to five years. Such activity is not without risk, as Matsumi remarks, "We are not passive investors nor are we investment bankers or venture capitalists. Itochu is an investor and business partner, with specific business interests in our investees."

Of course biotechnology and nanotechnology represent a great unknown for any investor, since that is the nature of the opportunity. Unlike IT, which these days usually depends on incremental and predictable improvements, natural science discoveries are often breakthroughs which open up huge possibilities--and often huge problems, as testing begins. Thus Itochu has decided to take on partners to both share the risk and to increase deal flow. One particularly strategic alliance has been a $20-million investment in a $900-million biotech venture capital fund with MPM Capital, the world's largest biotech venture capital group. Itochu is the fund's sole Special Limited Partner.

The fund's Medical and Scientific Advisory Board consists of world-class recognized leaders in the healthcare field, including a Nobel laureate, the former Commissioner of the Food and Drug Administration (FDA), and the Distinguished Jackson Professor of Clinical Medicine at Harvard Medical School. As might be expected, with such luminaries on tap, the focus of the fund is to invest 80% in biotechnology/biopharmaceutical companies and 20% in medical device opportunities. Geographically, 80% of the investment is in the US and 20% in Europe and Japan/Asia.

Bringing investments to market.......................................................
Although CEO of a $100-billion company, Eizo Kobayashi still stays very much in touch with the investment side of the business. "In 2000, Uichiro Niwa appointed me as the so-called ?Master of Net Valley,' and together we promoted a large number of net-related businesses. Of course, many of them have now disappeared, but others are now successful businesses," Kobayashi said in a recent interview. As examples, he pointed to a typical pre-IPO company doing well: e-commerce and stock trading site The Nikkei, a respected financial daily, recently reported that is to go public, although Itochu declines to say when, and considering that its contemporary E*Trade is pricing itself for a November end IPO at JPY123bn ($1.17bn) valuation, hopes are high that will fetch a similar amount. Indeed the IPOs are coming thick and fast in the second half of 2004. In October, Itochu took another of its subsidiaries, Excite Japan, an Internet portal site, public. The company now has a valuation of JPY35.75 billion ($304 million), netting Itochu JPY1.833 billion ($17 million) in "uridashi" share sales, and it still owns 65% of the company! Primarily targeting urban residents in their 20s and 30s, Excite Japan is only the second company to be listed in Japan which earns most of its revenue from being a portal-- the other is Yahoo Japan Corp., which went public in 1997.

Yet, as many analysts have been quick to point out, not all Itochu's ventures have been so successful, with most typically having been in companies from a seed level, which is always a risky approach. Indeed, as venture capitalists are fond of saying, out of every ten investments, five or six will go bad, three or four will pay back a modest return, and one will be a "ten-bagger." Thus to make money on a professional level, it seems that Itochu needs to improve the amount of capital it is applying to such investments, letting them move further up the value chain and closer to the IPO, where there is much less risk. Kobayashi says himself, "Of the 100 or so Internet companies we invested in, a number have fallen by the wayside. This is the nature of risk involved in early-stage investing. However, our business is all about risk and how to manage it, and as the recent IPOs show, the returns can be worthwhile."

Analysts remain skeptical about just what Kobayashi's strategy is--one of aggressive growth, risk taking, or just business as normal? "Clearly Kobayashi has just been appointed, but as such, has yet to make a clear corporate strategy. We feel that their forecasted net earnings of JPY100 billion is very optimistic and we have no clear idea of how they will reach such a goal," says analyst Tomoyasu Kato of Nomura Securities, who notes that the biggest challenge facing trading companies today is how to change a mixed background in strategic investment into a history of success.

For the time being, however, the future looks promising, with Itochu having posted record profits in all seven of its business areas in the first half alone. This bodes well for the remainder of fiscal year 2004, particularly since many businesses in their portfolio typically perform better in the second half of the year.

More in the pipe................................................................................
Right now, Itochu has a number of seed funds at work. In Japan, the Gambare Nippon Fund, known in English as Challenge Japan Investment, has about JPY4 billion which it is putting into IT, Biotech, Nanotech, and MEMs. The fund has already invested in five companies and plans another 15-20 over the next two years (so it really is seed-round funding). With the Gambare Fund, Itochu started a model of cooperative investment, and has brought in such luminary partners as the NTT Group. The objective of the fund is of course to help Japan rejuvenate herself and wean the country away from raw manufacturing.

One star investment for Itochu has been MeshNetworks, a wireless networking firm funded last year. As part of the deal, Itochu set up a 100% self-owned Japanese operation for the company, and under a licensing agreement MeshNetworks Japan has already started in Tokyo with a variety of proposals to the public sector. The investment was facilitated by Itochu Cororation. Interestingly, and probably not by accident, the Itochu Technology CEO is Kazuhiko "Bob" Sunada, whose last posting was in the same IT and telecomms division that Kobayashi was running. Clearly the Kobayashi investment DNA runs deep.

Toshiyuki Awai, Manager, Business Solution Section, Business Solution Department, Information Technology & Telecomunication Division Aerospace, Electronics & Multimedia Company, is particularly excited about the prospects for MeshNetworks, saying, "MeshNetworks' mobile ad-hoc technology differs from other systems in that you can still connect while traveling at 400 km per hour, without the need for a base station, up to a range of 5km." He adds that they have identified many uses for this technology in ITS and other areas. "So, even if in Japan we are confined to civilian uses, there will still be strong demand for the technology."

Fukuwauchi Technologies.......................................................................
Another company in which Itochu has invested heavily in recent months is Fukuwauchi Technologies, a company specializing in the manufacture of Diamond-Like Carbon (DLC) coatings. These are surface coatings which can be applied on plastic, glass, ceramic and metal at close to room temperature with properties rivaling those of natural diamond, but at a fraction of the cost. "DLC is a very useful technique that has wide applications," said Tomio Uchi , CEO of Fukuwauchi Technologies, explaining its versatility. "DLC thin films have unique properties such as extreme hardness, chemical inertness, and high-corrosion resistance. Therefore, DLC technologies are increasingly gaining importance in many forms of industrial applications, including wear-resistant coatings for artificial teeth." With strategic funding from Itochu to the tune of JPY60 million ($5.4 million), Fukuwauchi is working on improving coating techniques and processes for diversified industrial applications, as well as developing their own ready-to-market products. Confident that demand for DLC coatings can only increase, Uchi told us that he has plans to take the company public within four years.

Ishimori Entertainment..........................................................................
In September 2004, Itochu agreed to invest in a content publishing joint venture with Ishimori Shotaro Pro Inc., a major manga publisher and closely held firm representing the interests of famed manga artist Shotaro Ishinomori. The new company is called Ishimori Entertainment Inc., an entity created to produce and distribute movies, TV shows, print and online publications, and various merchandising based on the Shotaro Ishinomori titles. The more than 300 titles include such classics as the "Masked Rider," "Cyborg009," "Hotel," "Kikaider," and "Gorenger." The partners believe sales will be around JPY1.5~2.0 billion ($14.3~$19 million) annually. Itochu regards this alliance as a key step in their efforts to produce and distribute entertainment contents in both the Japanese and overseas markets. "They initially just asked us to sell their content," explained Masayasu Takigawa, manager of Content Business, Network & Content Business Dept. Aerospace, Electronics & Multimedia Company. "But we were reluctant to do that, and suggested forming a joint venture, with all the sales rights going to the new company. That way, if they grow, so do we." Given the recent worldwide boom in manga and Japanese animation, one can only assume that grow they will.

Staying the Course............................................................................
Kobayashi has made it clear to staff and partners that unlike some of its rivals, Itochu will continue to focus on its core competence as a trading company and is not interested in becoming a manufacturer. "Since there are very few sogo-shosha style companies outside of Japan, there are a lot of unique capabilities and functions that we can take advantage of as a trading company, not least of which, our extensive global networks," says Kobayashi. However, he is also quick to point out that Itochu is so much more than just a middleman, adding that it is their aim to create joint businesses with their investees, creating not just transactional revenue, but also capital gains upon an IPO.

Whether or not any of these companies go public remains to be seen, but what does remain clear is that Kobayashi's success in turning CTC, a subsidiary of Itochu, into a multi-billion dollar company offers but a glimpse of what lies ahead for the Itochu Corporation. "Just wait and see!" joked one Itochu executive in a Wall Street Journal article. "CTC may grow bigger and bigger, and Itochu will end up as its trading division." Well, probably that is overstating the early demise of an increasingly profitable parent, but still proof indeed that even the old heavyweights are still capable of spawning nimble offspring and they are willing to change with the times. The question now is whether Eizo Kobayashi can build a sustainable business for Itochu out of his new investment strategies, ready for the next global downturn lurking just over the horizon.

As for Kobayashi the man? The impression we received is of a man who has the leadership skills and commitment to lead the $100-billion Itochu forward. A search for background on him on the Internet reveals surprisingly little about him, and yet, talking to both Itochu employees and CEOs of other companies, we heard repeatedly a message of a well-developed business acumen, great people skills, and an element of luck--all key virtues for the CEO of such a massive company in the cut-throat business of international trading.

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