How ValueAct can help elevate Sanwa from a good company to a great one – MASHAHER

Business: Sanwa Holdings is a Japan-based company mainly engaged in the manufacture and sale of building and commercial facility construction materials, as well as the provision of maintenance and renovation services. It operates in three geographic segments: Japan, North America and Europe. Its offerings include shutters, doors for buildings and housing, partitions, stainless products, front-desk products, windows and exterior products.

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

Percentage Ownership:  5.94%

Average Cost: n/a

Activist Commentary: ValueAct has been a premier corporate governance investor for over 20 years. The firm’s principals are generally on the boards of half of ValueAct’s core portfolio positions and have had 56 public company board seats over 23 years. ValueAct has been a pioneer of U.S.-led international activism, primarily in Japan. A significant amount of their portfolio is invested internationally. Rob Hale, co-CEO of ValueAct and co-portfolio manager of ValueAct’s Japan fund, is on the boards of Japanese companies. This is somewhat of an unprecedented and industry-leading action for U.S. activist funds. ValueAct has had 27 prior international activist investments and has had an average return of 48.15% versus an average of 7.60% for the MSCI EAFE Index over the same periods. Moreover, two of the firm’s best international investments have been two Japanese companies where 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).

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

Sanwa is a manufacturer of shutters, garage doors and other related products for residential and commercial applications globally. The company commands a compelling position in its industry as the No. 1 player in Japan (50% to 60% market share), and is a top-two player in the U.S. (30%) and 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. This is a high-quality and growing business and a company that is not plagued by many of the issues typically present at activist targets in Japan.

ValueAct Capital has disclosed, in a large shareholding report, that it has accumulated a 5.94% position in the company with an investment purpose of providing advice to management or making important proposals. This makes them one of the top five shareholders of Sanwa based on the company’s most recent disclosure of its principal shareholders in June 2024. This is a typical activist position for ValueAct in that it is a good company with a strong management team where there is an opportunity for the firm to work with management to maximize shareholder value. There are three value creation opportunities here: (i) U.S. margin expansion; (ii) Japan margin expansion; and (iii) capital allocation and balance sheet efficiency.

The U.S. business accounts for nearly 37% of the company’s revenue and 50% of its earnings before interest and taxes (“EBIT”). This business was built through many good 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.  Accordingly, U.S. EBIT margins are in the mid-teens, versus 30%+ for peers Clopay (owned by Griffon Corp) and C.H.I. Overhead Doors (which KKR sold to Nucor in 2022). 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, there is also a margin opportunity. Currently, Sanwa’s Japanese business has EBIT margins of about 11%, which can likely be improved a few hundred basis points in the next few years. Margins are much lower in Japan for a variety of reasons: An important one is that the company is vertically integrated in Japan, doing installation in addition to manufacturing, which is more labor intensive and expensive given recent wage inflation. However, in Japan, demand remains strong from urban redevelopment, and the first inflationary environment in quite a while should make passing on price increases more palatable. As the main player in Japan by market share, Sanwa could likely exercise additional pricing power down the road.

Lastly, ValueAct will likely focus on capital allocation and optimizing the balance sheet of Sanwa, which has been a major component of the firm’s theses at other investments in Japan. The company currently holds about 10% of its market capitalization in cash. Compared to peers, this is clearly excessive, and it is quite typical in Japan for companies to unnecessarily accumulate cash and investment securities without reason and far beyond their working capital requirements. Ahead of any shareholder value creation, ValueAct will likely call for increased shareholder returns in the form of buybacks to capitalize on the Sanwa’s relatively low valuation.

Continuing to increase margins at both businesses and buying back shares should lead to a continuous re-rating of the company’s value from the 8.5-times enterprise value/earnings before interest, taxes, depreciation and amortization (“EV/EBITDA”) it currently trades at to the low-teens of peers.

ValueAct has an earned reputation as a collaborative and amicable activist, and there is no reason why this situation should be any different, particularly since Sanwa has been doing a lot of the right things for a long time. For several years, and especially post-Covid, the company has consistently grown sales, profits, return on equity, return on assets, earnings per share and dividends with a target payout ratio of 40% of consolidated profits. Since the beginning of 2020, the company has delivered a share price return of +180% and a total shareholder return of +225%, healthily outperforming the S&P 500 and Nikkei 225 over this period. ValueAct and Sanwa are likely on the same page as to what needs to be done and are both 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 ValueAct does not take board seats just for the sake of it, but rather when it and management are aligned on the value creation potential from the firm’s presence in the boardroom. Moreover, the firm only needs to take a board seat if it does not feel that management is pursuing or realizing value creation opportunities or if it does not feel it could be effective as an active shareholder. Neither seem to be the case here. ValueAct is likely to continue as an active shareholder while Sanwa continues to do what it’s been doing, just on a faster timetable.

There is also a potential strategic opportunity here. The U.S. and Japan businesses are run independently of each other. If the U.S. business were sold for the 13-times EBITDA at which that KKR sold the C.H.I. Overhead Doors business, it would equal almost the entire enterprise value of both the U.S. and Japan businesses, effectively getting the strong Japanese business almost for free. This is not something that ValueAct has historically advocated for. It’s also not something that the firm is advocating for here, but if an unsolicited offer came in, as fiduciaries and economic animals, ValueAct would make sure management weighed it versus the long-term value of a standalone business and took the course that was best for shareholders. 

In closing, this is a good company. There’s the stock price, the key financial metrics – things are moving in the right direction. But sometimes good companies tend to enjoy the status quo, particularly in Japan, and they do not feel incentivized to take the steps to become great companies. As an engaged investor, ValueAct has historically closed the gap between “good” and “great” by supporting management in executing its plan. 

One final note: This company is no stranger to activists. 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. Less than a year later, Dalton started selling down this position. 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 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.