Rescuing a Giant: Sharp’s Future in Foxconn’s Hands

Mori Kazuo [Profile]

[2016.04.20] Read in: 日本語 | 简体字 | 繁體字 | FRANÇAIS | ESPAÑOL |

In early April Taiwan’s Foxconn concluded its bid to acquire Sharp, placing the future of the debt-ridden manufacturer firmly in the hands of the group’s chair, Terry Gou. The question going forward is whether the charismatic business leader can right the fortunes of the struggling Japanese company.

A Decision Fitting the Global Era

On April 2, Hon Hai Precision Industry and Sharp signed a deal giving the Taiwanese contract manufacturer, which trades under the name Foxconn, a majority share of the beleaguered Japanese electronics giant. With Sharp financially on the ropes, Japan’s Ministry of Economy, Trade, and Industry threw its weight behind a rival restructuring offer from the Innovation Network Corporation of Japan, a domestic fund combining public and private assets. In the end, however, the one-time industry leader Sharp chose Foxconn as the key to rebuilding its operations.

The agreement between Sharp and Foxconn is largely significant in two ways: One, it is the first foreign takeover of a major Japanese electronics manufacturer; and two, Sharp’s rejection of a public bailout demonstrates that Japan’s private sector is reaching the understanding that it must be self-sufficient.

The deal is equally significant for demonstrating the extent of decline of the domestic electronics industry, a former pillar of the Japanese economy. The implications of a foreign buyout of Sharp, once the world leader in liquid crystal technology, was not lost on the Japanese business world, which brooded over the possibility of hard-won technology flowing overseas.

The global economy, however, increasingly forces companies to make rational fiscal decisions that fall in line with market principles. This can also be said for national economies, which are subject to the same comprehensive forces, and countries can no longer bank on long-term growth without opening their markets to oversea capital. Prime Minister Abe Shinzō has made foreign direct investment a pillar of his long-term growth strategy, and Sharp accepting Foxconn’s offer makes it appear that the once firmly bolted doors of Japan’s economy are creaking open.

Foxconn’s investment of over ¥388 billion in Sharp is a boon for Japan as the funds for the bailout are coming from a foreign entity, meaning INCJ can now direct the ¥300 billion it had on the table toward other investments. The concerns over the outflow of Japanese technology, meanwhile, are largely unwarranted.

South Korean and Taiwanese makers have long surpassed Sharp in manufacturing large liquid crystal display panels. Companies including Samsung Electronics are now at the forefront of developing organic electroluminescence displays, which many believe to be the next generation of screens. In this sense, Sharp’s earlier attempts to safeguard its technical advantage were largely for naught, as the free flow of technology is a matter of course in an open economy.

A Change in Direction

There is, of course, no denying that Sharp’s technological prowess was a major motivating factor in Foxconn and INCJ reaching out to the struggling company. The Sharp name, once synonymous with leading technology and innovative breakthroughs, still holds a glint of its former luster, and it now falls to company executives to keep that shine from dimming completely.

Foxconn is not only providing Sharp with a needed injection of capital. As the company found itself in need of a financial suitor largely due to a dearth of capable management, the buyout is significant for bringing change to the boardroom. Sharp’s current president, Takahashi Kōzō, is expected to step down to make way for new leadership. New executives will be finalized in late June at the stockholders meeting, which will also see Foxconn receive a third-party allotment of shares. But even if Takahashi stays at the helm, the chief decision maker for Sharp will now be Foxconn Chairman Terry Gou.

In Gou, Sharp gains a capable leader and, for the first time, the opportunity to rebuild under a new business model. Gou’s charismatic management style and fleet-footed business acumen has enabled him to build Foxconn into the world’s largest electronic manufacturing service company, boasting annual sales of around ¥15 trillion and employing approximately 1 million people. During the joint announcement on April 2, Takahashi said he was impressed with the speed and tenacity with which Gou carried out meetings, demonstrating how the Foxconn head led the way at every level of the negotiation process.

Negotiating from the Shadows

Banks also played a chief role in the deal, serving almost as shadow negotiators in accepting Foxconn’s bid for Sharp and directing the course of talks between the two entities. Without access to capital, Sharp was at the mercy of its lenders. Gou realized that the banks would have the last word on any deal, and from the start of the year he made the rounds at major lenders Mizuho Corporate Bank and Bank of Tokyo-Mitsubishi UFJ to secure support for the buyout.

While Takahashi made a valiant effort in keeping Sharp from folding, in reality the company for some time has been firmly under bank management. In the twentieth century lenders would have taken an all-out approach by sending a top official to oversee restructuring, but in the present day risk management specifies less obviously intrusive methods.

Each bank has placed a representative on Sharp’s board, UFJ doing so in 2013 and Mizuho in 2014. They serve as advisors to Takahashi and other executives and monitor the company’s operations. They do not, however, have a direct say in how business is run.

Sharp saw its earnings nosedive in the second half of 2014, and in March 2015 it tumbled into the red on a nonconsolidated basis, where it has floundered ever since. Aside from financial backing, Sharp’s two main lenders have written off ¥200 billion in loans in exchange for preferred shares. The investment fund Japan Industrial Solutions, to which Mizuho and UFJ provide funding, also purchased ¥25 billion of preferred shares, and JIS’s chair and president provide oversight as outside directors.

Credit protection has been a top priority for the banks. But while lenders from the start of the 2015 fiscal period called on Sharp executives to put forward a medium-term management plan and introduce restructuring measures, such steps failed to staunch the flow of red ink at the company’s LCD business. Running short of options, the banks wanted to avoid the looming specter of bankruptcy at all costs, as it could force them to write off the full amount of loans to Sharp.

An Unsavory Domestic Offer

With Sharp in a tailspin, METI stepped forward to back the INCJ plan, which aimed to restructure Japan’s LCD industry. Under the proposal, INCJ would split off Sharp’s LCD business and make it a subsidiary of Japan Display Inc., a company formed in 2012 from a merger of Sony, Toshiba, and Hitachi’s LCD divisions.

The INCJ bid looked to boost the competitiveness of Japan’s LCD operations by merging it under a single, national banner. The plan also proposed integrating Sharp’s and Toshiba’s white goods divisions.

INCJ, in exchange for a ¥300 billion infusion, also sought up to ¥350 billion in support from lenders through cancellation of ¥200 billion in premium shares and ¥150 billion in debt-equity swaps. For the banks, which viewed credit protection as top priority, INCJ’s bid lacked appeal.

In contrast, Gou’s plan freed lenders from the financial burden of Sharp’s bailout.

Determined Pursuit

In 2012 Foxconn agreed on a potential capital and business tie-up with Sharp but never finalized the deal, citing a plunge in the Japanese manufacture’s shares. The only product from the failed alliance was Gou’s investment company buying a stake in Sharp’s LCD plant in Sakai, Osaka—a factory responsible for Sharp’s financial woes—which Foxconn then jointly operated.

Gou, however, remained steadfast in his pursuit of Sharp. Determined not to squander a second chance of adding the brand to the Foxconn Group, he put forward a bid trumping the INCJ offer and then made the rounds at METI and offices of other stakeholders to explain the details of the proposal. His determination paid off on February 25, when Sharp’s board of directors voted to accept Foxconn’s offer.

Just as everything seemed sewn up, though, that same day Foxconn announced it was putting the deal on hold as it looked over a list of ¥350 billion in contingent liabilities that had come to light a day earlier. Foxconn, seeking to sort out potential debt obligations, returned to the negotiating table with a revised plan.

In the end, Foxconn reduced its bid for Sharp by ¥100 billion to ¥388.8 billion and added conditions that included an option to buy Sharp’s LCD business if the maker failed to implement third-party share allotments. Negotiations came down to the wire, but both parties reached an agreement and inked the deal on April 2.

A Perilous Road Ahead

To outside observers, Sharp and its lenders appear to have been at the mercy of Foxconn. In reality, though, with INCJ already out of the running there were no other options available.

Foxconn is aware of the inherent risk in buying Sharp. At a press conference following signing the deal, Gou refrained from going into details of his plan to turn Sharp around, but somberly asserted, “I have a clear roadmap in my heart.” Sitting next to Takahashi, Gou appeared to choose his words carefully throughout the event. With regard to the difference in business cultures, he emphasized that the deal “is not an acquisition, but an investment” and maintained that Foxconn and Sharp will retain their separate group identities as they move forward.

Sharp intends to use ¥200 billion from its deal with Foxconn to further develop its OLED technology and bring it to market. Gou has highly praised the company’s cutting-edge IGZO technology—high-definition, ultrathin, and energy efficient LCD screens using indium gallium zinc oxide as a semiconductor—and has expressed his intention to keep displays as a central part of Sharp’s business. To do so, however, requires surpassing Samsung and other leaders in OLED technology, which will be no easy task. Nor does Foxconn face smooth sailing, with economic uncertainty and rising wages in China, where it has the majority of its production facilities, presenting very real risks.

In the end, there is no certainty that Foxconn will succeed in turning Sharp around. But as Gou has accepted the risk, it now falls on his business savvy to forge the deal into a success story.

(Banner photo: Foxconn Chairman Terry Gou, center, Foxconn Vice President Tai Jengwu, left, and Sharp President Takahashi Kōzō at a joint press conference following signing a takeover agreement in Sakai, Osaka, on April 2, 2016. © Jiji.)

  • [2016.04.20]

Journalist. Born in Tokyo in 1950. Graduated from Waseda University, where he majored in economics. Has been deputy chief editorial writer at Nihon Keizai Shimbun (Nikkei) and visiting researcher at the Weatherhead East Asian Institute and Center on Japanese Economy and Business, Columbia University. Works include Nihon no keiei (Japanese Management) and Keiei ni karisuma wa iranai (Managers Don’t Need Charisma).

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