Seven & I seeking govt protection tests Japan's appetite for reform

By Reed Stevenson
 

Seven & i Holdings Co.’s desire for government protection against Alimentation Couche-Tard Inc.’s buyout proposal suggests Japan may not be ready yet for big cross-border mergers. How the state reacts will tell the world whether the country is ready for change.
 

The Japanese operator of 7-Eleven stores is seeking designation as a “core” company under the Foreign Exchange and Foreign Trade Act, an upgrade that would require prior notification to the government of any purchase of its shares above 10 per cent, Bloomberg reported on Tuesday.

With the ball effectively in the government’s court, Couche-Tard’s approach has become a high-profile test of whether corporate Japan, long considered impenetrable for inbound mergers and acquisitions, will be forced to evolve. If granted, the “core” designation could make the biggest-ever takeover of a Japanese company essentially dead on arrival. 

 

“The consensus view is that a takeover would be difficult, but taking this step means that the possibility of a takeover has receded even further,” said Ikuo Mitsui, a fund manager at Aizawa Securities Co. “For shareholders, there’s growing concern about the lack of speed and focus on the convenience-store business, as well as its growth potential.” 

Couche-Tard hasn’t disclosed terms or a price for its proposed buyout of Seven & i, which currently has a market value of ¥5.47 trillion after declining 1on Wednesday on news of the effort to seek government protection. The stock has climbed 19since Couche-Tard’s buyout proposal was made public on Aug. 19, rebounding from 30-month lows.

It’s not clear when Japan’s Ministry of Finance, along with other agencies, will determine whether to change Seven & i’s status to a core industry. That category is reserved for companies in sectors such as aerospace, nuclear energy and rare earths. The law was designed to protect the country from security risks, such as the outflow of military technology.

Although Seven & i submitted the application after Couche-Tard’s takeover approach went public, it was made in response to a routine ministry query in June that was sent to listed companies via the Tokyo Stock Exchange, according to one person with knowledge of the proceedings.

The retailer filed paperwork to change its designation in time for an Aug. 23 deadline, the person said, asking not to be identified because the information isn’t public. The routine query from the ministry was sent out because it is revising its list of core and non-core companies after its disclosure in April 2023. 

Although Japan’s government has shown protectionist tendencies in the past and corporate boards have long prioritized stability over shareholder value, policymakers also recognized that this has held back the economy, as well as much-needed restructuring. New corporate guidelines were released last year to remove some of the barriers, adding to efforts to improve governance.

“An active market for desirable M&A transactions will optimize resource allocation, accelerate industry restructuring, and promote healthy economic metabolism of Japan’s capital markets where many participating companies currently have low capital efficiency,” the government said in the guidelines.

So far, there have been few success stories at meaningful scale. KKR & Co., CVC Capital Partners and Blackstone Inc. walked away from a buyout of Toshiba Corp. in 2022 after meeting stiff resistance from management. Three years ago, Chinese home appliance maker Guangdong Galanz Enterprise Co. became the single biggest shareholder in rice-cooker maker Zojirushi Corp. and sought to appoint new directors, but was rejected. 

The foreign exchange act is also almost certainly a deal-killer. In 2008, concerns over power supply and nuclear energy led Japan to block the London-based Children’s Investment Fund from buying shares in Electric Power Development Co., known as J-Power.

That makes Seven & i a high-profile test case. 

Institutional resistance wouldn’t be the only hurdle. While Couche-Tard is confident that it can secure enough debt financing to acquire the entirety of Seven & i, according to people familiar with the company’s plans, any acquisition would probably cost close to $80 billion. That assumes a premium of 40to Seven & i’s current value and factoring in existing liabilities, according to Nicholas Smith, strategist at CLSA Securities Japan Co.

“It’s an absolutely enormous deal” were it to happen, Smith said. “This is how cross border deals fall apart. The sheer complexity of the company makes it difficult. This is a business that will have regulators all over the deal.”

Seven & i has more than 85,000 stores, including Speedway and Sunoco gas stations in North America. By comparison, Couche-Tard has roughly 16,700 outlets. 

While best known for its 7-Eleven shops, the company’s operations also include Denny’s Corp.’s Japan restaurants and its own bank. The retailer has finalized plans to close 33 Ito-Yokado stores in Japan, the Nikkei newspaper reported Wednesday. 

The Japanese retailer’s sprawling operations are a key reason why it has been under pressure for a while from shareholders to restructure and boost value. Activist fund ValueAct Capital Management LP has asserted that the 7-Eleven stores could be worth more as a standalone enterprise. Although Seven & i has taken restructuring measures and initiated a buyback after fending off efforts to oust Chief Executive Officer Ryuichi Isaka, it’s still facing investor criticism. 

“Couche-Tard sees exactly what we see — an undervalued, mismanaged, world-class asset,” Ben Herrick, associate portfolio manager of Artisan Partner International Value’s team, which owns a stake in Seven & i, wrote in an email last week. “Should the board determine the offer is inadequate, management and the board must be held accountable to expedite difficult decisions to deliver the same or better share price on behalf of shareholders.”

Any designation change could also be seen as a vote of confidence in Seven & i to face investor pressure on its own. For now, Seven & I’s official stance is that no decisions have been made while “a special committee of independent outside directors is currently reviewing the proposal.” 

Whatever happens, the pressure on the retailer to unlock greater value will likely only grow. Couche-Tard’s bold takeover approach is also a sure sign that corporate Japan is evolving, whether it likes it or not, said CLSA’s Smith.

“There’s momentum behind the companies trying to do the right thing,” Smith said. “And the whole corporate reform movement very much has government support behind it.”