Guest contribution: Why not Hitachi?

Global value investor Andrew McDermott on the evolving fortunes of GE, Toshiba and Hitachi, and why Hitachi leads the way towards best-in-class corporate leadership & governance

Here a new initiative from Japan Optimist — a guest contribution. At Japan Optimist, I want to present the real forces shaping Japan, so I want to expand horizons and give real-world practitioners with “skin-in-the-game” a platform to present their case. Particularly when it comes to corporate governance issues, giving concrete corporate examples and case studies is often a much better way to gain insights into how Japan actually works than the standard general narrative offered by most. Japan excels in the particular….and yes, I start with Hitachi because here is one of Japan’s most powerful and proud conglomerates that certainly sets the tone for many Japanese CEOs and corporate leaders. The world has much to learn from Japan’s best-in-class corporate leadership.

The author is a friend and fellow investor/activist/strategist, Andrew McDermott. He has been involved with Japan since he joined NEC Logistics in Tokyo in 1992. After moving on to JP Morgan investment banking, Andrew set up his own investment management business, Mission Value Partners, in 2010 (see full bio below). He has been involved in more than 60 or so activist campaigns in the US, Europe and Japan. Although he has a global mandate for his fund, he is currently 100% invested in Japan. The opinions expressed here are his own and in no way are intended as investment advise. Also, I am not invested in his fund.

Enjoy and, as always, comments welcome. Many cheers from the sunny town of Karatsu (Kyushu) ;-j

Why Not Hitachi?

Nashville, March 27, 2023

Common knowledge maintains that Japanese managers are different.  Japanese individuals and products compete on a level playing field in areas as diverse as baseball, animation and automotives. However, the actual arts of corporate management are, by common consent, different in Japan.  This view suits financial experts in both Japan and abroad. What if it is incorrect? What if we were to judge all managements by a common yardstick?

Let’s dig in to an interesting case: the evolving fortunes of GE, Hitachi and Toshiba.  Toshiba and Hitachi had modeled themselves on GE in many important respects. All three firms competed and collaborated across a broad range of sectors, from consumer appliances to power plants. All three companies faced similar challenges as the new millennium dawned and their integrated business models came under attack from all directions.  All three faced the same basic challenge: restructure, refocus and execute.  To succeed, management needed a mix of strategic vision, adroit dealmaking and technical competence—the same skills needed today in the broader economy as de-globalization forces yet another reconfiguration of supply chains.

As of 2023, Hitachi stands head and shoulders above Toshiba and GE.  Hitachi continued to invest in nuclear energy as both GE and Toshiba backed away.  Hitachi exited its finance business years ago even as GE continued to pour resources into GE Capital.  Hitachi’s M&A strategy has been pitch-perfect: disposals of non-core semiconductor, chemical and medical businesses have funded the creation of a top-tier power business with deep expertise in grid upgrades that are critical for both national security and climate policies.  In addition, Hitachi has invested in systems integration skills that span the hardware/software interface for its own products as well as those of third-parties. These products range from rail systems to advanced manufacturing systems to auto parts. In short, Hitachi has much of what is needed as NATO-plus countries confront the need to reshore manufacturing in a changing energy and security environment.

Hitachi also has the financial strength to invest while Toshiba and GE lick wounds created by spending billions of dollars on share buybacks over the past decade at prices far above intrinsic value.  After reporting Japan’s largest loss in history in 2009, Hitachi raised capital and husbanded its strength for over a decade, often walking away from strategically attractive deals that were overpriced.  Because Hitachi did not overpay for its own shares or execute disastrous acquisitions like GE’s deals for Baker-Hughes and Alsthom or Toshiba’s purchase of Westinghouse, Hitachi was able to begin buying back shares just as GE and Toshiba had to stop.  Hitachi’s prudence allowed it to reward shareholders without short-changing its employees, pensioners or customers. It faced no major product difficulties the way GE has with its LEAP engines and various power products.  Hitachi dismissed no workers the way GE did when it laid off thousands of aviation employees, only to find itself short-staffed months later when post-COVID orders bounced back quicker than expected. Instead, Hitachi announced plans to hire 30,000 tech workers even as competitors around the world announced layoffs. Off the factory floor, Hitachi avoided the accounting scandals that plagued both Toshiba and GE.

Hitachi accomplished all this under the leadership of management drawn from its own ranks. These managers were trained as engineers. Not one held an MBA, but each had deep, practical experience in fixing the mistakes made by hubristic predecessors during the bubble market.  These managers were modestly compensated: the top 10 disclosed leaders earned a total of $24mm last year, a fraction of the $200mm (each) garnered by GE’s Larry Culp and and Jeffrey Immelt and only slightly more than the $17mm that Toshiba’s Danny Roderick earned for leading the Westinghouse deal that nearly bankrupted Toshiba.

Hitachi’s board set the tone for its management team. An international group of executives with experience in the products and markets in which Hitachi participated has supported Hitachi in often difficult negotiations with foreign governments and in its surprisingly successful efforts to attract international managers like Alaister Dormer.  The Board included several MBAs, but they were engineers first. Sir George Buckley, CEO of 3M and a noted critic of the “GE way” was joined by Cynthia Carroll, CEO of Anglo-American, and several other highly qualified and committed board members.  In contrast, both GE and Toshiba loaded their boards with financial engineers whose primary expertise was in breaking apart companies and/or managing money, not people or machines.

What separated Hitachi from GE and Toshiba? What do the similarities between GE and Toshiba and the differences between Hitachi and Toshiba say about the common knowledge view that “Japan Inc. doesn’t get it and needs private equity activism to shape up?”  These questions deserve much study. I don’t have all the answers, but I will hazard a few guesses. 

The simplest answer rings truest to me: Japanese managers and the companies they lead can, and should be, judged by the same standards applied everywhere else. Of course there are cultural differences, but these are far less important than commonly assumed.  More important are the similarities: in Japan during the bubble and in the US during the recent past, cheap capital enabled poor managers to misallocate capital. The same forces that allowed Japanese managers to overpay for everything from Rockefeller Center to Pebble Beach allowed US managers to enrich themselves while driving companies like GE and Boeing into the ground. Accepting or resisting these forces seems more an issue of character than ethnicity.

Though the leading players in the Toshiba drama were mostly Japanese nationals, they had far more in common with Team GE than Team Hitachi. Effissimo, the Singapore-based Japanese activist pulling the strings at Toshiba, knew as much about boardroom tactics and as little about actual engineering as Trian Capital Partners, the lead shareholder at GE. Both activists brought in CEOs with private equity connections and time horizons that stretched, at most, five years. Both counseled maximum leverage, maximum cost-cutting and immediate breakup into smaller pieces that could attract private equity auctions. Both skillfully skirted acting-in-concert rules (in Toshiba’s case with the unwitting help of Harvard) to obtain effective control without paying for actual control. Both managed the press adroitly, ensuring that any opposition to their plans was viewed as reactionary, even when delivered (in Japan) by experienced players such as John Roos, George Olcott, Osamu Nagayama or Mariko Watahiki.  And, of course, both focused almost exclusively on the boardroom, to the detriment of products, customers and employees.  

If we accept the premise that excellence is as likely to be found in Japan as elsewhere, then perhaps the solution to the “Toshiba problem” is not the adoption of the same techniques that ruined GE. Perhaps Hitachi (and Sony, and Toyota, and so many other Japanese companies who have quietly fixed themselves without “outside helpers”) might actually have a thing or two to teach American companies.  That, at least, seems to be the view of Larry Culp himself. In his master plan for fixing GE (before deciding to split it up), Culp claimed that the secret to his management success came not from Bain where he was an advisor or from Harvard where he’d received his MBA, but “from the best of the best…the Toyota Production system masters.”

I hope that Culp’s plan works, but I have my doubts.  My own view is that the reason for Hitachi’s progress and GE’s decline has much less to do with culture, academic pedigree or production systems and much more to do with ethics.  When Hiroaki Nakanishi took over as CEO of Hitachi after its record-breaking loss in 2009, the 40 year company veteran stated that Hitachi’s survival depended on radical change.  No one doubted that Mr. Nakanishi himself would rise or fall with the company.  His attitude was as common among Japanese managers of his generation as it has become uncommon among American managers of Larry Culp’s generation.  When Culp insisted upon the repricing of his stock options after GE’s share price had fallen by nearly half, he did so after firing thousands of line workers and cutting pensions for thousands more retirees.  In this, he followed firmly in the footsteps of his predecessors Jeffrey Immelt and John Flannery. All three men knew that highly remunerative positions at private equity firms awaited even the most abject failures at GE.  The concept of “skin in the game” has been so turned on its head by executive compensation practices at most US companies that the term has lost its meaning. 

Not so at Hitachi or, more broadly, in Japan. As Gillian Tett wrote for the Financial Times, “What was striking [about Japan when I lived there in the 90s] was the degree to which social norms spread that pain around…There was an idea of shared sacrifice.”  While this idea seems foreign today at companies like GE, it is not uniquely Japanese, just as financialized incentives are not uniquely American (look at Softbank or Carlos Ghosn for evidence).  What is consistent across time and culture is the link between effective leadership and shared sacrifice.  War correspondent Sebastian Junger has spent forty years studying leadership qualities across continents and cultures, from the Taliban to the US Army.  His most important observation: “If your leadership is not willing to suffer the same consequences as everyone else, your cause is going to fail.”  For many years, this was the prevailing attitude at US organizations, both military and civilian. That changed for reasons beyond the scope of this paper. As we begin yet another cycle of bailouts for financial companies whose executives have profited personally as their companies have failed, we could do worse than look hard at Japan’s sacrificial virtues, reminding ourselves that they can be, and have been in the past, our own.

The opinions expressed are my own. They are not intended as investment advice. I currently own and may in the future own positions in securities mentioned in this article.

Andrew McDermott - Nashville March 27, 2023

Added insights :

If you enjoyed this piece, here a link to a panel discussion between Jesper Koll, Andrew McDermott, and Leo Lewis (Financial Times, Tokyo) on Japan’s capitalism, hosted by the Asia Society Tokyo last month.

Jesper, Andrew & Leo - Asia Society Japan

About the author:

Andrew McDermott

After graduating from Princeton with a history degree, Andrew joined NECLogistics in 1992 in Tokyo. In 1994 he fell into a career in finance courtesy of JP Morgan, where he worked on deals ranging from Chinese infrastructure finance to venture capital to tech IPOs in Hong Kong, Singapore and San Francisco. He joined Southeastern Asset Management in 1998 and helped lead its international business until 2009. He founded Mission Value Partners in 2010. MVP manages a global equity portfolio that is currently 100% invested in Japan.

Over his career, Andrew and his partners have led over sixty “activist” events across the U.S., Japan and Europe. He was personally involved in several early Japanese cases, including Nippon Broadcasting, Tokyo Style, Nikko Cordial, Olympus and NipponKoa Sompo. More recent examples are Asatsu-DK, Megan Top, Sizably League, and Sapporo. He was also involved in non-Japan situations, including UBS, DeBeers, Waste Management, Nestle, Fairfax, Fiat, Renault, Aetna, and Hollinger. Involvement ranged from a cup of coffee with the CFO to discuss share buybacks to proxy fights.

Andrew recently moved MVP from California to Nashville, where he has been surprised by the relevance of Japan to the local economy.

Andrew McDermott