Toshiba, unplug and restart

On Monday November the 9th, Toshiba Corp. shares shrank by 7.5% (Chart 1) after the Japanese company reported unexpectedly scanty financial results and sued former executives in connection with an accounting scandal, thus raising the presumption of lengthy legal uncertainties.

Its stock has now decreased by 40% since the beginning of the year. The manufacturing and electronics giant surprised the market by announcing a dramatic operating loss* of ¥ 90.5 billion ($733 million) for the latest six months-period on Saturday November 7th , in comparison to an operating profit* of ¥137.9 billion for the same semester (April-September) of the last year. The unusual weekend announcement was likely thought to cushion market shock, after the conglomerate* had missed two deadlines to report results, delaying its earnings release for the second time.

Moreover, Toshiba is launching legal action against five former executives for financial mismanagement in the wake of an accounting fraud earlier this year. The Japanese colossus declared it is seeking damages for $1 billion with them, including its preceding CEO Hisao Tanaka, who resigned in July following a probe into accounting procedures. In the previous months, other company executives have also stepped down. However, actually, what does this accounting scandal consist of? The former top management has been accused of having artificially inflated net profits by $1.9 billion over the latest seven years. Hence, one of the most voluminous corporate scandals of the Japanese history. The whole issue started in April, when Toshiba itself started investigating accounting procedures in its energy division. Subsequently, the situation worsened in May, when the company designated an independent committee to undertake the review. The multidivisional firm even cancelled its year-ended dividend and postponed earnings, prompting analysts to downgrade its investment rating* and earnings forecasts. The accounting scandal does not seem to represent the unique problem for the Japanese giant. First, there is a technical reason for the already cited poor financial results, too. This may be partially linked to a significant write-down* of much of the amount spent on a retail store point-of-sale recently bought from IBM: from a balance sheet perspective, this has been particularly painful. A second cause for the scanty financial performance of the group might derive from its excessive level of diversification. Indeed the Tokyobased conglomerate offers a huge variety of products varying from small electronic circuits to nuclear reactors. In particular, the unique Toshiba’s division with a substantial profit in the aforementioned semester has been the devices and components Business Unit. Contrastingly, the other divisions seem to have suffered more from the corporate crisis. Indeed Masachi Muromachi, who became president in July, affirmed the company should reconsider that targets it had set for delicate and relative recent industries such as healthcare. In addition, he underlined many times that regaining trust from customers, investors and the institutional environment will result in better economic performances only if accompanied by a necessary restructure of the organizational structure.

Hence, the explanation why the firm has started a process of sales of stakes in noncore investments like in Finnish elevator-producer Kone. This may show the path towards the recovery for the company: focus on what still works, in Toshiba’s case, most notably chips and components rather than televisions and laptops. Without the profits assured by the chip business, earnings would have been even more negative.

Interestingly, the electronic devices and components business, which includes memory chips, obtained positive performance, despite the fluctuating demand for smartphones and PCs high pricing and margins. However, the situation may not improve immediately since in October average prices for NAND flash memory chips (used in common smartphones) continued to fall. Moreover, the challenging environmental conditions are going to become harsher during the fundamental transition to the next technological frontier for the industry: the so-called 3D NAND. That is going to happen, not because of the complexity and variety of knowledge required, which Toshiba owns, but on the contrary, because of competitors: Samsung Electronics and Tsinghua Unigroup. In this regard, the Chinese group has announced that it will raise $12 billion to strengthen its position into memory chips manufacture. In such a turbulent context, the danger is that Toshiba’s  unprofitable divisions will dissipate resources and management attention. Televisions and laptops continue to represent a considerable burden, posting a ¥42.5 billion operating loss during the six-month period. Considering the low margins of such commoditized* products and the sales confined only in Japan, most analysts think that the company would be better shutting down or selling the TV and PCs divisions entirely.

In conclusion, the goal of this article is not only underlying the central importance of a Toshiba’s policy aimed at regaining credibility (which is nonetheless crucial, according to the authors), but also emphasizing the need for a more responsible corporate conduct combined with a deep organizational change.

Relevant definitions:

• Operating profit (loss): The profit earned from a firm’s normal core business operations. This value does not include any profit earned from the firm’s investments and the effects of interest and taxes. Also known as “earnings before interest and taxes” (EBIT) or “operating income”
• Conglomerate: a corporation that is made up of a number of different, seemingly unrelated businesses. In a conglomerate, one company owns a controlling stake in a number of smaller companies, which conduct business separately.
• Rating: an evaluation of a corporate or municipal bond’s relative safety from an investment standpoint. It scrutinizes the issuer’s ability to repay principal and make interest payments.
• Write-down: reducing the book value of an asset because it is overvalued compared to the market value. A write-down typically occurs on a company’s financial statement, when the carrying value of the asset can no longer be justified as fair value and the likelihood of receiving the cost (book value) is questionable at best.
• Commoditized: a good or a service becomes commoditized when one offering is nearly indistinguishable from another.

Source: Investopedia.com