By Craig Mellow

Toyota Motor just forecast a 21% drop in operating profit for the coming fiscal year, citing U.S. tariffs on auto imports. That's the bad news for Japan's largest listed company and the export-intensive No. 4 economy.

Toyota may have countered with some good news, leaking plans to acquire its Toyota Industries subsidiary for north of $40 billion. That would be Japan Inc.'s biggest move by far toward unwinding its hated (by investors) cross-shareholdings, depending on how it is structured.

"This would be the deal of the century," says Drew Edwards, head of Japan value equities at GMO. "It could be governance-positive or governance-negative."

Japan's dominant conglomerates grew up on a Venn diagram pattern, different arms owning stock in one another. Toyota Motor, for instance, controls nearly a quarter of Toyota Industries. Toyota Industries owns 9% of Toyota Motor.

Markets abhor these arrangements because they muddy what should be arm's-length dealings with suppliers, immobilize capital, and protect founding families from restive investors, among other reasons.

Most independent Toyota Motor shareholders voted against Akio Toyoda, grandson of the founder and current chairman, at the last annual meeting, Edwards says.

A straightforward consolidation, Motor acquiring Industries, would be a governance leap forward. But Toyoda seems to be eyeing a special purpose vehicle that would include some of his own capital and some of Toyota Motors', and leave Industries' stake in the mother ship. That would only cement Toyoda's control without clear operational benefits.

"If the main focus is just to privatize Toyota Industries, investors will question whether this is positive," says Masahiro Akita, Japanese auto analyst at Bernstein.

Toyoda's megadeal could still benefit Japan by infecting others with the consolidation bug. "This should definitely be a source of encouragement to other companies," says Grace Su, a global value portfolio manager at ClearBridge Investments.

Cross-shareholdings account for some 30% of Japan's market cap, she estimates, one reason that the iShares MSCI Japan exchange-traded fund $(EWJ)$ trades at 16 times earnings, compared with 26 for the S&P 500 index. On May 8, Nippon Telegraph & Telephone offered 2.37 trillion yen ($16.4 billion) for shares it doesn't own in subsidiary NTT Data, a 35% premium to the listed price.

Share buybacks, a mainstay of U.S. capitalism but a relative novelty in Japan, are meanwhile running at triple last year's rate, pleasing investors who see excess idle cash in corporate coffers.

"Toyota's move sends a message to all the other companies that have sound fundamentals but lack sound capital allocation strategies," says Shuntaro Takeuchi, portfolio manager for Matthews Asia's Japan Fund.

Japan's industrial titans will struggle in the short term against headwinds: President Donald Trump's tariffs, a global economic slowdown, and a rising yen that makes exports less competitive. "Japan is an export-driven market with not much room for fiscal stimulus," Su says. "We're favoring Europe right now."

A yen that has soared 8% against the dollar this year, and a possible end to decades of deflation, could on the other hand boost domestic-facing stocks. "I currently see a lot of value in balance sheet financials like banks and life insurers," says Julian McManus, equities portfolio manager at Janus Henderson's Overseas Fund.

Longer term, Japan could be "the U.S. circa 1982," with shareholder barbarians at the gate of "overcapitalized conglomerates run by self-interested managements," says GMO's Edwards. Watch Toyota's deal of the century first.

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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May 09, 2025 10:22 ET (14:22 GMT)

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