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Why Japan Hasn't Caught Small Cap Fever


Special Report--ENTERPRISE: International: Japan

WHY JAPAN HASN'T CAUGHT SMALL-CAP FEVER

It's the sort of outfit that investment bankers love to take public. Tokyo's Impress Group has 10 computer and music magazines, including Japan's first Internet title, a flourishing CD-ROM business, and even a popular Godzilla screen-saver. Thanks to the current boom in personal-computer sales in Japan, Impress, with sales of $49.4 million, predicts its earnings will rise 54% this year, to $3.7 million.

So is founder and self-proclaimed computer nut Keiichiro "Ken" Tsukamoto, 38, tapping Japan's $4 trillion equity market to bankroll expansion plans into Internet home-shopping? Probably not. Tsukamoto launched his business in 1991 by using revolving bank credits and by dipping into the $150 million in stock he carried away from ASCII Corp., another computer-magazine publisher he helped found. "I was very lucky," he admits. But given Japan's stringent listing requirements--plus investor jitters about the country's economic prospects--all he can do right now is dream of selling new shares to the public. "We would like to go public," says Tsukamoto, "but it's unlikely, because publishers aren't really considered financially secure."

HIGH HURDLES. Indeed, Japanese growth companies such as Impress have to survive pretty much by their own wits--and often from their own pocketbooks. Only those with $2 million in equity and a year's worth of profits before listing have been able to come out on Japan's over-the-counter market. Rules are even tougher on the Tokyo Stock Exchange's second section, where midsize companies trade. Second-section issuers must have $10 million in equity and three straight years of profits to gain listings.

Few startups can make it past such formidable obstacles. That's why the average age of companies listing on the OTC market is 20 years, vs. 5 for America's NASDAQ. Worse, Japan's venture-capital market has declined as the economy has tanked, falling from $9 billion in 1992 to about $6 billion in '95.

The dearth of funds has sent some companies abroad in search of cash. Kobe's Muramoto Industry Co., a maker of chassis for videocassette recorders, went to the Thai stock market to raise $30 million for a plant near Bangkok. Other outfits such as Biomaterial Co., a high-tech specialist in cellulose-based materials, have even considered seeking a NASDAQ listing.

That small companies are largely shut out from raising capital in Japan is becoming a concern for policymakers trying to pull their country out of its long economic slump. With large manufacturers laying off workers at home and moving production offshore, any new jobs that Japan Inc. creates are likely to come from smaller fry. Yet they're starved for capital. "This is the first time I've seen the number of business failures exceed startups," laments Ryutaro Hashimoto of the Ministry of International Trade & Industry (MITI).

Still, there are signs that the capital squeeze may be easing. When an economic recovery looked as if it was beginning last year, Tokyo's second-section index vaulted 30% at one point. When the recovery fizzled, so did the index, which is currently about 40% of its 1995 peak. Now, with equities recovering, as interest rates fall and as the yen's strength ebbs, a slew of small-company funds is emerging. Daiwa Securities Co. and Yamaichi Securities Co. have raised about $300 million for their venture funds. Nomura Securities Co.'s Jafco unit has taken 20 companies public since April.

MOUNTING PRESSURE. Trouble is, companies that do gain listings are big and established by U.S. standards. And the economic signs point to even more pressure on small companies. Brutal cost-cutting campaigns by big Japanese companies mean they are dumping smaller suppliers at home for more affordable Asian counterparts. In addition, a flood of cheap imports--everything from European lager beers to Armani suits--has touched off widespread "price destruction" that's battering the lower end of the corporate chain. "Small and medium enterprises are where the brunt of the restructuring is taking place," says Morgan Stanley & Co. economist Mineko Sasaki-Smith.

To help out, MITI guaranteed more than $200 million in small-business loans in 1994, and plans to step up aid this year, particularly to promising high-technology companies. MITI also led a mission to the U.S. to study NASDAQ. And a new stock market--dubbed New Frontier--aimed at nourishing young companies with risk capital, will start trading in November.

MITI and the Ministry of Finance promoted the idea without first consulting Japanese brokers, who contend that most conservative Japanese investors won't go for the shares of unseasoned startups with no record of profits. Brokers are insisting that New Frontier companies come up with audited financial statements as the price of listing.

A more promising avenue for new listings might be a plan by the Tokyo Stock Exchange to start an offshoot of its second section--one with looser listing requirements. "A lot of companies could go right on that list," says Paul Heston, a venture-capital analyst at Deutsche Bank. The market won't get under way until 1996 at the earliest.

So it may be some time before Japan catches the kind of small-cap fever that has fired markets in the U.S. While the Nikkei stock average has recovered this year to the 18,000 level, that's only half its record level of 1989. And most Japanese investors, having been burned, are sticking to blue chips. "Japanese investors expect sure returns," says Shinji Ohki, president of Nippon LSI Card Inc., which is developing a digital camera that can take pictures, store them, and transmit them over a telephone line.

Of course, companies deemed strategically important by MITI are getting a helping hand. Take the Japan High-Tech Satellite Network, whose parent company, JTAS, is 60%-owned by MITI and other companies such as NEC Corp. and Matsushita Electric. MITI sees JTAS, a producer of scientific videos, as a promising entrant in the global multimedia boom. The official blessing helped JTAS raise $5 million in startup money in 1991. It will get an additional $2 million next month from the government agency to launch an ambitious project to download its videos by satellite to university and business users in Japan and elsewhere in Asia. But most of Japan's small companies, long on promise but short on profits, are pretty much on their own. Until Japan has something like a NASDAQ that rewards investors who bet correctly on the next Sony Corp., the nation's entrepreneurs face an uphill battle for cash.

The Struggle for Cash Among Startups

FRONTIER MARKET

Starting in November, small companies with no profit track record can list on this new market.

Downside: Disclosure requirements too skimpy to lure most investors.

TOKYO STOCK EXCHANGE

TSE may launch second section for small-cap stocks in 1996. Will attract some companies with proven earnings records, but other promising ones won't qualify.

VENTURE CAPITAL

A slew of funds has come online, but overall venture capital has declined since 1992. Commercial banks will lend only in small amounts to no-name entrepreneurs.

DATA: BUSINESS WEEKBy Brian Bremner in Tokyo


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