How important is a strong CEO for a strong IPO?

Over the last couple of months, the Nikkei 225 stock index has been steadily recovering, passing the 16,000 mark at the end of September. Market sentiment is good and foreigners are busy buying stocks, being net buyers last week. As readers will know, we’re interested in freshly listed companies, particularly small cap firms that are more likely to be run by entrepreneurs.‘s Takashi Nishibori notes that the level of IPOs in Japan is still running at a healthy clip, with
15 IPOs in September and 17 planned for October. This will bring the total number of IPOs for the first 10 months of the year to 144, roughly the same as last year. Of the 127 IPOs done through to the end of September, the average opening price was almost 90% higher than the offering price. We think this is surprisingly high, considering that the market has been on this IPO binge for more than 5 years now.

However, it looks as if mid-2006 is marking a turning point for investors, who are just now starting to give the thumbs down on companies that don’t match expectations.

Just what those expectations are we are not sure. You’d think it would be on earnings. However, when we look at the continuing high-flying stock of Mixi, which even though the price is down from a high of JPY3.25m (US$27,500) a share to JPY1.85m (US$15,700) a share on Friday, it still has a market capitalization that represents an earnings per share
(PER) of 260 times! Clearly, glitter and potential are still big factors in the thinking of shareholders attracted to freshly public companies.

One company which doesn’t have the Mixi glitter and which because of its hard-core, hard-grind business model also doesn’t offer a quick near-term upside is Banctec Japan, an outsourcing company that went public on October 5th. Using optical character recognition technology and systems, Banctec outsources the boring bits of banks and insurance companies’ back office operations. After a mere 5 days of being public, the company is already feeling the “backlash”
of shareholder disinterest, with its share price plummeting from JPY126,000 (US$1,070) per share to just JPY74,000 (US$627), the price on Friday. That’s a 40% drop in just 25 hours of trading.

Market experts are saying that shareholders are moving away from the secondary markets, such as Mothers and JASDAQ, to focus on blue chip companies, which are raking in profits thanks to the continued economic boom and the weak yen. We don’t disagree with this, and certainly there are many other freshly listed companies falling below their IPO prices. However, a drop of 40% is precipitous and must surely tell the Banctec shareholders that this is more than just a market correction. Something deeper is wrong in the company.

Banctec originally came to prominence in the Japanese media in 2002, when a bunch of local private equity funds led by JAFCO decided to do a “Management buy-out” of the Japan and South Korean business from Banctec USA. We parenthesize the MBO status of the deal, since the CEO of the company only wound up with 1.9% of the shares, and is locked in along with other senior managers for 6 months before being able to sell any. So he wouldn’t be feeling much richer at present.

In fact, we think that this lack of senior management involvement in the IPO may be part of Banctec’s problem.
>From the IPO statement, we can see that the entire
management team were holding less than 7% of the company’s stock at IPO time, and thus the post-IPO performance may simply reflect their salaryman status in the business.

Instead, in our minds, a CEO who settles for a stake of less than 10% of the company in an MBO is probably thinking of his position as merely a job. There isn’t enough incentive in it for him to be thinking as a potentially rich owner. At best, and on paper only, he is worth JPY148m, not much of a return if you’ve just take a firm public.
…But at the same time, probably not bad for a salaryman.

Unfortunately, in a business with as little sex appeal as Banctec’s, the commitment of the CEO can make all the difference to both performance and public image. He needs to be motivated to show a strong, publicly visible face. And he needs to be coming up with a stream of fresh strategies to get customers and employees excited about the future. However, from what we can see, the company has produced very few press releases about any strategic activity. It’s almost as if they’ve been hiding in a hole.

To us, the structure of Banctec’s shareholdings and lack of senior management equity participation spells out that JAFCO and other Japanese private equity funds do not yet understand what is needed to step in and turn around a business. Economizing on the CEO stock allocation is not helping investor interests. If the CEO is not worth more than 1.9% of the company, then they need to get one who is. In essence, if they want Shinsei-style IPO results, then they have to put in extraordinary people, like Yashiro and his team.

If we were JAFCO right now, we’d be looking at some of our more recent deals (it may be too late to do anything with Banctec), and start looking to hire in a Masamoto Yashiro clone to set the business on fire again.

The incentive for JAFCO to do this is certainly there. From last week’s experience, it’s worth at least JPY4bn
(US$33.8m) in the week after the IPO, to get it right…