7&i

News that one of Japan’s leading retailers and owner of 7/11 had received an approach from its leading convenience store competitor Couche Tard (ACT) was a big boost to the market for corporate control in Japan. 7&i has long been two businesses - a world class global CVS chain and its struggling domestic supermarket, department store and other retail assets - which traded at a large conglomerate discount. Deeply entrenched management and a weak board have allowed this situation to persist over any years.

We have previously owned the stock as prospects for unlocking this value seemed brighter with the engagement of a US activist fund. Management did reform the board and had agreed in principle to separate the group into pieces however the glacial pace of change fuelled by fierce internal opposition to change and challenging trading encouraged us to exit. The value was present but the positive catalyst that we require was not. ACT took advantage of the weak share price and has proposed a takeover. Whilst details are few we would expect that they will sell off non CVS assets to help fund the deal, along with new equity and a hefty slug of debt. This proposal is not that different from what so many investors have been asking management to do for 15 years… at this stage the company risks lowing control of the pace of change.

Our sense is that the price is not high enough; that management can probably promise enough self help and there are enough anti trust obstacles that cast doubt on the deal to maintain 7&i’s independence. However, the management team is now ‘on notice’ and their flexibility is gone. Sympathy is not in order as they have had at least a decade - two! - to address their operational challenges, group structure and low valuation. That they have failed to do so despite frequent, strong requests for change means that they have only themselves to blame. We often say to firms that if they do not act voluntarily there is a good chance that other prospective owners will force their hand. I’m sure that 7&i management now wish that they had listened to shareholders more closely and moved faster in response.

Despite the higher share price in recent days selling 7&i was the right decision. The weak operational execution and lacklustre commitment to reform have led the shares to underperform the broad market over not just the last year but also over many years. The big risk in investing in such a value situation is the length of time it takes to play out. The opportunity cost of owning structurally underperforming shares is very high in a market where so many others are taking proactive steps to improve returns and look after shareholders.

20.08.2024/155