HMV Shibuya and Tsutaya

Following the disappearance of Tower Records, Virgin Records and other titans of the music industry around the globe, it was inevitable for a similar act to happen in Japan. That Japanese music retailers could last so long is a testament to the propensity of the local population to continue buying music and not download illegally, and to a lesser degree, to the lack of music discounting by retailers (by law). Even Japanese dinosaurs cannot survive beyond their age, and HMV announced the closing of its flagship Shibuya store and several others. The Shibuya store was HMV's first of 66 to be opened in Japan (HMV's Japan website).

(It is appropriate to note that Tower Records Japan continues to fight the good fight, following an MBO of the Japanese unit in 2002 which sidestepped the bankruptcy and liquidation of Tower Records in the U.S. Tower Records Japan did have the foresight to understand CD's do not sell themselves in the internet age and lead marketing campaigns in collaboration with producers. Tower's successful "No Music No Life" ad campaign launched the firm's brand recognition similarly to MTV in the U.S.)

The fall of music in Japan is a topic for another column; there are several factors that play a role, and I will only point them out quickly - antiquated legal code prohibiting the discount of new music albums, written novels and other consumable media, lack of innovation and production of saleable music, and changing demographics.

I would rather take this opportunity to highlight what comes next - from the ashes of HMV Japan rises Tsutaya, the brand driven by the awkwardly-named Culture Convenience Club Co., Ltd. ("CCC"). Its main platform, Tsutaya, grew to market dominancy originally through video rentals (a Japanese version of Blockbuster in the U.S.) and then music CD rentals (which helped the quick drop in CD sales) before further expanding to rent comic books in addition to retail sales of the same consumables.

What is CCC's growth strategy going forward?

Sankei Biz (in Japanese) writes that CCC is currently in negotiations to buy HMV Japan's business from current owner Daiwa SMBC Principal Investments. Allegedly, this will include the absorption of HMV's stores, although it is unknown whether the HMV brand will be kept or jettisoned in favor of Tsutaya. This also neglects the fact that many of HMV's locations in prime retails areas are within close proximity to Tsutaya's own; HMV Shibuya lies within 50 meters of Tsutaya at Q-Front Shibuya.

CCC also looks to expand its retail operations in new directions, including online video rentals a la Netflix (Tsutaya Discas) and an online travel agent (T-Travel). More interesting is an adult-geared entertainment complex with retail, restaurants and parking in fashionable Daikanyama adjacent to Hillside Terrace (CCC's press release), which follows a strategy initiated by Tsutaya in Roppongi Hills and Tokyo Midtown.

->This strategy has also been recognized and favored by other retailers in this age of austerity. While the young are more prone to downloading music and movies and shopping for second-hand items, and the older remain a generation of savers (opening their wallets for vacations rather than CDs), the key spending demographic is the 30-49 year-old slice. This has been widely acknowledged over the past couple years, and the Japanese advertising community continues to zero in. One current example is the successful TV drama Dousoukai by TV Asahi, which tells the stories of families breaking under pressure, love affairs and difficulties in parenting that arise during the 30th year reunion of junior high school friends. As a further press for viewers, the drama resurrects teen idols of the 80's and early 90's for the main character roles. <-

One potential future engine of growth is Tsutaya's Point Card System. CCC's 2009 Q2 investor report shows the rapid increase not only in T-Point members and accepting retails partners, but also in number of transactions. What CCC does not break out is revenue attributable to the T-Point system, both in retail partner fees and in credit card issuance.

Of course, as CCC's approx. 6% interest (indirectly held by Tsutaya Co., Ltd.) in second-hand retailer Book-Off suggests mass retailing of affordable goods, both sales and rentals of new and used items, will continue to be the core business strategy. I imagine that CCC will negotiate down rents for its retail sites to take advantage of falling real estate rents and counter-act revenue decreases, which will hopefully boost operating profits.

JAL Hotels

Although no official announcement has been made by either company, the Japanese continues to widely report that Okura Hotels has agreed to take over JAL Hotels. Okura Hotels even explicitly notes there is no existing agreement to purchase JAL Hotels on its website (Japanese only). The decision for Japan Airlines to sell its hotel operations, branded under Nikko Hotels and Hotel JAL City, has long been expected by the investment community. That this decision took half a year FOLLOWING bankruptcy to be made highlights the political opposition within JAL and the government. Nonetheless, as a business decision this is a no-brainer.

Through the two brands, JAL Hotels currently operates 58 hotels, 41 domestic and 17 overseas. Its 2009 financials show JPY 13.8 billion in sales and JPY 0.2 billion in operating profit (Mainichi Shimbum in Japanese only). For any business manager, this is an unexceptable profit margin and the business should be jettisoned. This also stands in high contrast with Okura Hotels financials, which state JPY 55.1 billion in sales with JPY 2.1 billion operating profit for 21 hotels. Of course, from a Western perspective, Okura Hotels' operating margin is also nothing to boast of...

There are two points to make in this transaction. First, this transaction is to buy the JAL Hotels operating company and assume its 1,000 employees. Okura Hotels is only gaining two hotels - the rest were sold over the past several years to reduce its balance sheet and to free capital. This makes JAL Hotels' poor financial results look even worse. It also calls into question Okura Hotels' purchase price of JPY 6 billion (Asahi Shimbum in Japanese only). As a sale, this is undoubtedly a great price - and understandably, other potential buyers (private equity firms and domestic and international hotel operators) could not make this bid. But how does Okura Hotels justify this price?

This leads me to the second point - this is a transformational deal for Okura Hotels, adding 400% more hotels to its operations in one swoop. What is Okura Hotels motivation? Do they have the operational ability to increase profitability at JAL Hotels? Will they continue to operate the overseas hotels? Will they maintain the Nikko and JAL City brands?

Regardless of these answers, Okura Hotels will need to turn around this ship quickly; JAL Hotels already has forward commitments for two hotels in Suzhou, China.

Uichiro Niwa

New Japanese Prime Minister Naoto Kan appointed lifetime Itochu salaryman Uichiro Niwa as the next ambassador to China. China has accepted this appointment. Although stodgier elements in the Japanese sphere, such as the Foreign Ministry, may not be pleased - as pointed out by the Mainichi Shimbum - but this is indeed a good move. The Foreign Ministry, like its counterparts in the civil service, typically boast that only their staff can serve these posts to to intelligence, training and experience, but this creates a stiff and inflexible team, which can have the opposite effect of not dealing effectively in a dynamic environment.

Already, the Chinese government has been caught off-guard by the announcement of Uichiro Niwa. But more importantly, Uichiro Niwa's background as a career businessman and ultimately president of Itochu, a major trading company, is highly suitable for the role of ambassador to China. Mutual trade between Japan-China is at an ever-growing level, and the trade vital to Japan Inc.'s future. While the migration of manufacturing from high-cost Japan to low-cost China has enabled Japanese players to remain competitive, this has not been without problems. Contamination of food products with chemicals and other substances has caused waves over the years. Over the past month many have followed employee strikes at Honda factories in China. These are issues for a businessman to tackle. Military expansion by China and accompanying effects such as the promotion of national patriotism at the expense of Japan and its role in World War II are serious concerns. Perhaps a businessman is not naturally suited to undertaking these challenges. On the other hand, the Foreign Ministry has shown no skill in handling them over the years, either.

It is also helpful to look at a model for the businessman-as-ambassador; the U.S. typically sends political appointees as its ambassadors to large and influential countries. While these appointees do not always get along with the foreign service officers, this model allows a President to understand and direct foreign policy more clearly and in line with his platform, and chooses from the best and the brightest (usually someone who has distinguished oneself in the private sector) to represent the country at the highest levels.

Renown

Following sales of struggling firms Laox and Honma Golf to Chinese companies, 40% of Japanese-based Renown, a textile and apparel company, was sold to Shandong Ruyi. This was widely reported, as per the Daily Yomiuri, as a result of poor financial performance by the Japanese firm for several years and the interest in a Chinese textiles-maker in expanding existing Japanese brands in China. The Financial Times shares that Shandong's president, Qiu Yafu, had expressed interest in Renown's brands, distribution network and management expertise. This is in spite of a number of dispositions Renown has made in recent years, including real estate assets and brands such as Aquascutum. The motivations of buyer and seller are also listed and explained in Renown's Investor Relations release (although less accessible since it is only in Japanese).

Of course, this trend of Japanese companies selling themselves to overseas firms (and in particular, to Chinese firms) makes complete sense; many Japanese firms continue 1) to be poorly-capitalized, and 2) need to expand sales - preferably in a high-growth market such as China. Also, for a Chinese buyer, the transaction highlights an M&A play that will increase over the next several years - the purchase of technology and other intellectual property, brands, manufacturing and management expertise, which enables 1) sales of said product/services domestically in China, and 2) moving manufacturing and other functions on-shore to China to lower operation costs and maintain global competitiveness.

Also of interest is the sales price. Shandong Ruyi is purchasing 40% of Renown through new third-party allocated shares. Why 40% instead of a majority-enabling 50%+, or 100% of shares to make a wholly-owned subsidiary? Perhaps it is to maintain a buffer for its public status under Tokyo Stock Exchange listing requirements. Perhaps this allows Renown full control without linking future potential losses to parent company. Or perhaps the buyer believes this is the right value for brands, technology, distribution network and other expertise under a liquidation scenario, and intends to move the aforementioned strengths to China and liquidate the Japanese entity. This is probably too negative a scenario, as Renown's stock continues to surge following the share purchase announcement on May 24th.