Analysis of Japan's Economic Woes; HP-Compaq Deal (Sep 11, 2001)

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TiM GW Bulletin 2001/9-1

Sep. 6, 2001

Analysis of Japan's Economic Woes

From Piety to Pity

Huge Write-offs Cripple Fujitsu's Earnings; Japan's Unemployment Soars; Also, HP-Compaq Deal: Two Losers Don't Make a Winner; Echoes from Euro Press

PHOENIX, Aug. 16 - Anybody still remember quality circles, consensus management, lifetime employment, fifth generation computers…? They were the hallmarks of the daunting “industrial miracle” that the Land of the Rising Sun once represented.

The feared Japanese takeover of the American business became such an obsession in the early 1980s, that certain U.S. congressmen unabashedly bashed Japanese products on the Capitol steps with hammers, symbolizing the Japan-bashing climate that pervaded the American psyche at the time.

Today, admiration and fear of the former Japanese industry titans has been replaced in America with pity and indifference. And for a good reason… Those who ride the crest of one economic wave are the first to crash when the next one comes along.

The Japanese economy contracted slightly in the first quarter as originally announced, and it shrank by 3.2% in the second. The epithet “recession” was avoided for now only on a technicality (two consecutive contracting quarters are deemed to constitute a recession). The first quarter GDP has just been revised upward to slight growth.

But that did not deter the Japanese economy, trade and industry minister, Takeo Hiranuma, from being uncharacteristically frank about how bad things really are. “The economy’s footing has become very week,” he said, according to a Sep. 8 New York Times story. “Whether the economy will attain zero growth this fiscal year is doubtful.”

“Zero growth” is an oxymoron, of course, just like the “negative growth” was in the old IBM Speak (see “Big Blue Now Also Singing the Blues,” Annex Bulletin 85-34, June 18, 1985). But that’s splitting hairs at a time of a splitting economic headache.

Richard Katz, an author of books on Japanese economic woes, put it even more bluntly. “Japan is going into a new recession before it ever recovered from the last recession,” Katz told the Times. “As soon as it lifts its head from the mat, it plops right down again.”

A trip from a vaunting and daunting position, to feelings of piety and pity, also applies to the leader of the Japanese IT industry - Fujitsu. In fact, it would be fair to say that Fujitsu spent much of the last decade or so spinning its wheels. With several “red ink” bottom lines in some years, and meager profits in the rest, Japan’s No. 1 computer maker eked out only a 0.4% net margin on revenues of $444 million! (see the chart).

In order to feel good about such results, Fujitsu shareholders would have to look at the bottom lines of some Japanese banks. They will certainly find no comfort by comparing themselves to IBM, the company that back in the “Golden Era” of the 1980s, Fujitsu both admired and feared, and then promised to defeat in the marketplace.

It didn’t happen, of course. Because Fujitsu had lost its compass - the Big Blue. As IBM stumbled so did Fujitsu, along with several other Japanese companies used to copying IBM successes instead of creating their own. In the end, both of these once omnipotent industrial giants resemble two tired dinosaurs at the start of the Third Millennium.

In fact, one might say that Fujitsu has added to its own problems. Serving as a part of the country’s social net like many other Japanese establishment corporations, Fujitsu more than doubled its payroll (hiring over 102,000 employees since 1985!), despite its business woes. And while its revenues and profits stagnated in the last decade, and as IBM cut at one point nearly as many employees as Fujitsu employed at its peak, the Japanese vendor nevertheless increased its workforce by 28% (since 1990).

Even last year, as its net earnings plummeted by 82% compared to the FY00 profits, and coming on the heels of a loss in FY99, the Fujitsu employment remained virtually unchanged at about 188,000 in the last three years (it was 187,400 as of March 31, 2001).

Well, everything has its price, and so does a social net. Looks like the days of full employment are over in Japan. The latest unemployment statistics show a jump to 5%, the highest level in nearly half a century (i.e., since right after the end of WW II). And the actual unemployment would be closer to 11%, experts say, if “a more inclusive” sampling method were used, according to the Times.

Japan’s auto industry alone is expected to shed some 143,000 workers by 2005, a Japanese union group study showed. Overall, between three and four million jobs “at a minimum” may be lost if the country is to “clean up the bad loan problem,” says Katz.

Add to it that the cost of corporate borrowing is going up in Japan, and you can see why the days of “full employment” may be over even at the erstwhile industry leaders, such as Fujitsu.

In short, it’s a mess worse than that we are facing here in the U.S., or Europe is within its own beleaguered markets.

What is worthy of note, however, is that Fujitsu’s overall FY01 operating profit was at a record level - $2 billion. That’s up 42% over FY00 (in U.S. dollars, or 67% in yen). This yielded an operating margin of 4.4%; up 1.5 points since FY00. Yet the bottom nearly fell out of the company’s bottom line, which declined by 82% since FY00!?

How’s that possible? Because of write-offs... bad investments... Obviously lots of them ($826 million total).

First, there was a $450 million write-off related to Amdahl, which also caused higher income taxes (for a detailed explanation, see Fujitsu’s 2001 Annual Report). Then there was a $211 million charge to “reorganize Fujitsu’s operations,” presumably in Japan, and mostly in IT. And then there was a $74 million “restructuring” write-off related to ICL, a U.K.-based subsidiary. Finally, there were several sundry charges related to investments and retirement benefits.

But if the Fujitsu shareholders can look at the Japanese banks when they need to be consoled about their company’s meager bottom line, they can also feel heartened in comparison to an Australian bank when it comes to bad investments. And not just any old bank… the largest one in Australia!

In a story datelined out of Sydney, the New York Times reported on Sep. 8 that National Australia Bank will have to write off more than $2 billion on account of a computer error at its Florida-based U.S. mortgage subsidiary, HomeSide.

Now, “this is an ERROR!” (playing off Paul Hogan’s “That’s a knife? THIS is a KNIFE!”-line from the first “Crocodile Dundee” movie).

Analysts and investors told the Times that National Australia got over its head in a market it did not fully understand. The Melbourne-based bank’s chairman, Frank Cicutto, called the losses “a disaster,” and “a strategic disappointment.”

But a Wall Street analyst (from J.P. Morgan) put it less kindly. “They didn’t understand what they bought” (when National acquired HomeSide in 1998 for about $1.2 billion).

Sound familiar? (Fujitsu acquired remaining shares of Amdahl in 1997 for about $1.5 billion in total value - see Annex Bulletin 97-32, 7/31/97).

In other words, the hardware-driven Japanese companies which are now struggling in the “new world” of services and software may feel some empathy for the National Australia’s management. And lucky that they made their errors on a smaller scale.

On the other hand, they can’t blame “a computer error” for them, can they?

PHOENIX, Sep. 4 - "Two wrongs don't make a right," goes an old saw. "Two losers don't make a winner," would be an analogous headline describing today's $25 billion-Hewlett-Packard acquisition of Compaq.

If in doubt (re. the "two losers" term), just check the HP and Compaq stock charts. Both look like downhill ski slopes. HP stock dropped from $60-something to $20-something in the last 12 months. Compaq's shares plummeted from about $33 to $12 in the same time frame. And that's before the "ski jump" that we can expect after today.

The two computer companies' performance make even the IBM stock look like a relative winner, even though the Big Blue has basically treaded water for most of the last 12 months. Which is why some of the reporters' questions we fielded this morning - comparing the new $87 billion-HP to IBM, were off the mark.

IBM stock has been in the doldrums because the company is carrying too much of its old hardware baggage around the waste. And here was HP now adding some new hardware baggage to its waistline. And that's a "winning strategy?" The folks at Armonk must be laughing for joy.

Nor should one expect any respite for HP and Compaq after today's announcement. We do not see any uphill slopes for the HP stock in the near future. The only question in our minds is if today's deal may mark the end of a solid ground downhill slope, and the beginning of a ski jump? (i.e., meaning a free fall?). Time will tell...

P.S. Today's (Sep. 4) closing numbers may well mark the start of a "ski jump" for HP and Compaq. HP's shares plunged by 19%, while Compaq's plummeted by 10%, despite a surging stockmarket for most of the day.

PHOENIX, Sep. 10 - Echoes of the HP-Compaq "megadeal" are now also reverberating in Europe. Here's, for example, a link to The Sunday Business Post, a leading Irish (Dublin) newspaper, which ran a story in its Sunday edition on that topic under the headline, "HP-Compaq far from a done deal:":