Shareholder Proposals for TEIKOKU SEN-I Co., Ltd. (3302)

※ If the diagram on the Web page is difficult to see, click above to see the PDF.

1. Executive Summary

■ Teikoku Sen-i Co., Ltd. (“Teikoku Sen-i” or “the Company”) operates an excellent business, but the Company's inefficient capital allocation is notably diminishing its equity value.

■ Specifically, the Company maintains excessive cash holdings that are not being used for investments or shareholder returns, as well as a large amount of cross-shareholdings that have little synergy with its main business. These factors continue to bring down the Company's capital efficiency while exposing its equity value to significant risks that the management team cannot control.

■ The SPARX Asset Management fund (“SPARX”), since becoming the shareholder in 2014, has continually engaged with the Company's management team in an effort to correct these corporate governance-related problems. However, the management team has not yet provided a rational explanation for its excessive cash holdings and large amount of cross-shareholdings.

■ Thus, with the aim of having Teikoku Sen-i implement sound, disciplined corporate governance policies, SPARX has made the following three shareholder proposals for the Teikoku Sen-i regular general shareholders' meeting scheduled for March 2019.

①.Election of directors

● Appoint Katsuya Natori as an outside director.

②.Dividends from Retained Earnings

● Set DPS at ¥95 for year-end FY12/18.
(At the time this presentation was published, the Company's guidance had DPS at ¥35.)

③.Partial modification of the articles of incorporation

● Shorten the term of office for board members from "up to two years from appointment" to "up to one year from appointment."

2. Overview of Teikoku Sen-i

Company Overview

■ Teikoku Sen-i manufactures and markets products related to disaster prevention.

■ It is a major manufacturer of fire hoses, with an estimated 50% share of the Japanese market.

■ Reflecting an increasing awareness of disaster prevention among local governments and private companies, the Company is currently importing cutting-edge disaster response vehicles, rescue equipment (chainsaws and hydraulic equipment), and counterterrorism equipment (such as explosives detectors), and marketing them in Japan

■ It also stocks nuclear energy disaster response equipment for energy companies.

Financial Statements (Summary)

■ The Company maintains its high profit ratio on sales due to its substantial customer base and the production and sales of its high value-added product line-up.

■ The Company demonstrates outstanding financial stability, with an equity ratio greater than 75%.

Irrational Capital Allocation

■ The balance sheet is loaded with cash that is not used for investments or shareholder returns, and with investment securities that have few synergies with the Company's core business.

■ This excessive cash balance and the investment securities continue to depress the Company‘s capital efficiency and harm its equity value.

Excessive Investment in Hulic

■ Of the investment securities Teikoku Sen-i holds, the majority are Hulic shares.

■ The Company's equity value significantly fluctuates based on Hulic's share price. This means that the Company's management team is exposing its equity value to excessive risks that they cannot control.

Unsound Corporate Governance

■ Individuals from certain corporate groups occupy many of the seats on Teikoku Sen-i's board of directors.

■ The auditor, Saburo Nishiura, is in a position in which he should audit all corporate affairs. However, because he also simultaneously serves as the Hulic chairman, he has a considerable interest in maintaining Hulic's share price and strong shareholders; there are certain risks for conflict of interest.

3. Shareholder Proposal Details

Proposal 1: Election of Directors

①.Election of directors

 Outline of proposal

 ● Appoint Katsuya Natori an outside director.

 Proposal rationale

 ● The two current outside directors are not adequately fulfilling their roles and responsibilities as independent outside directors, in contradiction to the intent of the Corporate Governance Code (“CG Code”).

 ● The CG code asks that independent outside directors serve in their roles by “appropriately representing the views of minority shareholders and other stakeholders in the boardroom from a standpoint independent of the management and controlling shareholders.” (From the CG Code General Principle 4-7, paragraph (iv))

 ● However, both outside directors continue to refuse SPARX's requests for meetings without providing any rational explanation. They are not doing their utmost to elicit the opinions of minority shareholders, and they invariably and unconditionally approve current management’s initiatives.

 ● This violates even the policy that the Company set forth to adhere to CG Code General Principles 5-1, which states, “...To the extent reasonable, the senior management and directors, including outside directors, should take a basic position of engaging in dialogue (management meetings) with shareholders.”
■ SPARX's recommended outside director, Katsuya Natori, not only has a long track record as a leading corporate attorney but also has served as a director, auditor, and executive officer for many corporations. SPARX expects that he will play a significant role in improving the corporate governance-related issues that Teikoku Sen-i is facing.

Proposal 2: Dividends from Retained Earnings

②.Dividends from Retained Earnings

 Outline of proposal

 ● Set DPS at ¥95 for year-end FY12/18.
 (At the time this presentation was published, the Company's guidance had DPS at ¥35.)

 Proposal rationale

 ● Roughly two-thirds of Teikoku Sen-i's assets consist of cross-shareholdings—investments (mainly in Hulic stock) in companies unrelated to the Company's main business—and cash equivalents. This is considerably lessening the Company's equity value while continuing to expose this equity value to excessive risks that the Company's management team cannot control.

 ● Through its continual efforts to engage with the Company over the past five years, SPARX has suggested that the Company (1) sell its Hulic shares in a reasonable amount of time and (2) set forth a clear policy related to growth investments and shareholder returns.

 ● Until the Company undertakes to sell its cross-shareholdings, make growth investments, and increase shareholder returns, SPARX asks that it distribute DPS of ¥95 for this fiscal year to prevent the Company’s further irrational capital allocation.

Proposal 2: Dividends from Retained Earnings

■ SPARX proposes that, to rein in the expansion of its financial portfolio, Teikoku Sen-i distribute dividends for the entire amount of its “pro forma free cash flow”(calculated from net profits plus depreciation costs, minus increases in operating capital and minus purchasing costs of tangible and intangible fixed assets).

■ Because a DPS of ¥95 is below the expected EPS of ¥114.38, the Company should be able to implement this proposal without decreasing its total equity and while continuing to maintain financial stability.

Proposal 3: Shortening the Term of Office for Board Members

③.Partial modification of the articles of incorporation

 Outline of proposal

 ● Shorten the term of office for board members from "up to two years from appointment" to "up to one year from appointment."

 Proposal rationale

 ● SPARX proposes reducing the term of office for board members so that, by increasing opportunities for shareholders’ approval, the Company can establish a structure for handling management issues—represented by the massive amount of its political cross-shareholdings. Such an arrangement would also allow for shareholder perspectives in managing these issues.

 ● Reflecting an increasing awareness of the need to improve corporate governance, the percentage of companies— among those companies with boards of company auditors listed on the TSE first section—stipulating a one-year term for board members continues to increase, reaching 73.2% as of July 2016.

4. Supplementary Materials

Shareholder Composition of Teikoku Sen-i

■ Because Teikoku Sen-i's shareholders include individuals from a set of related corporate groups, its outside directors and shareholders have become dysfunctional concerning governance. The Company's management is ignoring the interests of minority shareholders.

■ Furthermore, GPIF, which manages the national pension fund, holds more than 5% of Teikoku Sen-i's shares through trustee managing institutions (asset management firms). As a result, the entire population of Japan—not only to mention the minority shareholders who are directly investing in the Company—is forgoing profits due to Teikoku Sen-i's lack of corporate governance.

Last Year's General Shareholders' Meeting Proposals

■ Last year, SPARX submitted shareholder proposals regarding (1) dividends from retained earnings (DPS of ¥90) and (2) shortening the term of office of board members (with the same proposal as this year's).

■ Most institutional investors approved last year's shareholder proposals.

■ This year, to receive approval from even more shareholders, SPARX intends to amplify its explanation for the rationale behind these proposals.

The State of Conversations Thus Far

■ Since 2014, SPARX, as a responsible shareholder, has continued its efforts to engage with Teikoku Sen-i's management team.

■ After the Company's management team began engaging in dialogue with SPARX in 2015, we have had multiple discussions on improving capital efficiency.

■ The medium-term management plan announced in 2017 included no mention of capitalization strategy and the improvements that SPARX requested. As a result, SPARX submitted shareholder proposals at general shareholders' meetings in 2018, with the aim of having a public discussion about Teikoku Sen-i's implementation of sound, disciplined corporate governance.

This web-page has been prepared by SPARX Asset Management Co., Ltd. (“SPARX”) for informational purposes only, and is not intended to be a disclosure document pursuant to the Financial Instruments and Exchange Act, Japan. Under no circumstances is it to be used or considered as investment advice, a recommendation to buy, an offer to sell, or a solicitation of an offer to buy or sell securities. SPARX and its affiliates accept no liability whatsoever for any direct or consequential loss arising from any use of this web-page or its contents. The information is intended solely to report on investment strategies and opportunities identified by SPARX. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. SPARX and its affiliates do not warrant the accuracy or completeness of any of the information or data contained herein. References to specific securities and their issuers are for illustrative purpose only and are not intended to be, and should not be interpreted as investment advice or, a recommendation, offer or solicitation for the purchase or sale of any financial instrument. This web-page does not constitute tax advice and as such investors should be advised to consult their own tax advisers regarding the tax consequences of their investment activities. Investment return and principal will fluctuate, so that a client’s initial investment may increase or decrease. Investing in securities markets involve risks like those arising from stock and bond markets, currency exchanges rate and interest rate volatility. Past performance is not indicative of future performance. No part of this web-page may, without SPARX prior written consent, be copied, reproduced or published by any recipient for any purpose.

SPARX Asset Management Co., Ltd.

Page Top