Breaking Up Is Never Easy

The Saga of Toshiba

The story of the rise and now very dramatic fall of Toshiba is a soap opera. The Japanese company is an enormous conglomerate, an industrial titan with its fingers in everything from computers to home appliances to involvement in nuclear plants. Unfortunately, Toshiba’s foray into nuclear power plants, via their subsidiary Westinghouse, has experienced significant cost overruns, forcing it to sell assets to avoid bankruptcy.

To stave off creditors and stay afloat, Toshiba decided to sell their microchip assets, setting a minimum bid price of $18 billion – a hefty price tag, to be sure, but as the world’s number 2 producer, a premium they can command. Many bids were placed, including one by their joint venture partner, Western Digital (WD), but eventually, the company decided to accept the bid from a consortium led by Private Equity investors Bain Capital and the Japanese Government via a publicly run investment fund.

As a partner in the semiconductor sector with Toshiba, Western Digital claims this sale violates their joint venture contracts, which state that any relevant asset sale by Toshiba must get the approval and consent of WD before it can be completed. As they made a bid for the assets themselves, they obviously did not approve nor consent to the sale to the Bain consortium, and promptly launched a lawsuit against Toshiba for breach of contract.

Toshiba’s reaction has been somewhat mixed – the CEO, at a shareholder meeting, openly reprimanded Western Digital shareholders for interfering with the sale of Toshiba’s assets in a time of crisis, while the head of the microchip unit has publicly stated the company is willing to make concessions to their partner in order to ensure a smooth and quick transfer. While all this drama was playing out, WD submitted a new bid for the assets, but was once again rebuffed.

Recently, Toshiba’s self-imposed deadline for the asset sale came and went, without any resolution or sale, for which they launched their own lawsuit against Western Digital, claiming $1 billion in damages for what they see as improper interference in the microchip asset sale. Convoluting things even further, Toshiba is now back at the negotiating table, as SK Hynix, a rival company from Korea, that is a member of the Bain consortium, would be providing financing via convertible debt, thus raising concerns that they would get a sizable ownership stake should they convert their debt into equity. Of course, again, one of the main parties they’re negotiating with is Western Digital.

Mergers and Protectionism

While propping up domestically favored industries has a long and varied history, with protectionist sentiments growing amongst voters, governments are increasingly feeling pressured to step in in cases of distress, and the Toshiba deal is no exception – the whole ordeal smacks of government intervention.

Bain’s decision to include a known rival in its bidding consortium was something of a misstep, for example. While bringing expertise into the buying party is advisable to ensure a smooth transition and minimize execution risk, the group should have been cognizant of the fact that the idea of a foreign rival taking a potential stake in the company wouldn’t be politically palatable for the Japanese government, thus leading to their “preferred buyer” status falling through when that information became public.

It can also be easy to be blind to domestic favoritism when substantial opportunities arise, as protectionist measures often serve to make the protected industries less efficient than foreign-owned, more “Darwinian” competitors. When a crisis hits, these large, inefficient organizations get hit hard and become juicy targets for corporate takeovers, often possessing valuable intellectual property and favorable market positions.

Buyers Beware?

As buyers look at the potential for a deal, they sometimes fail to see all the potential problems, including possible interventionist measures. For example, as these favored companies are also often large employers in the country and sources of national pride, governments then step in to protect these distressed local champions, potentially stifling leaner, more efficient take-over offers in a well-intended, if possibly misguided, bid to protect the hometown hero.

Navigating the waters of a different country is never easy, and this is only compounded when the takeover target is a member of a domestically sensitive industry. Roadblocks can be thrown up in every conceivable way, shape, and form, and deals often fall through because of them. However, for the savvy dealmaker, the payoffs can be huge.

Kevan Hartford

Kevan Hartford is a Toronto-based finance professional working in asset management.