The Barbarians Are At The Gate. Don’t Resist Them

The Barbarians Are At the Gate. Don’t Resist Them

(Bloomberg Opinion) -- One of the most storied global companies, Toshiba Corp., is set to get a serious makeover. Global hedge funds and private equity firms including the likes of Paul Singer's Elliott Management Corp. and Farallon Capital Management LLC are circling to, as activists like to call it, unlock value. Change is looking like a real possibility after months of chaos and uncertainty.

It stands in stark contrast to the company's recent past, which has been tainted by a series of crises and scandals — from accounting issues to a near brush with bankruptcy and a damning report that blew the cover on how Toshiba had effectively blocked shareholders' from exercising their rights.

A stream of progressive steps has boosted the stock price to multi year highs in recent weeks. Elliott and Farallon were nominated to the board, laying the ground for a much-needed shake-up. Toshiba also nominated as chair an executive of merger advisory and restructuring firm Houlihan Lokey K.K. Meanwhile, the company last week said it had eight offers for a buyout and two for capital and business alliances. It has signed confidentiality agreements with 10 potential investors as part of a process to work through its future plans. KKR & Co. and Blackstone Inc. are in the mix for a joint bid. The old guard seems to be moving out, making room for change.

That's set the stage for Toshiba's best option at this point: a leveraged buyout — one that could be the largest in the country. Enterprise value to earnings before interest, depreciation and amortization multiples aside, it's hard to say what the entire firm is really worth. Through the crises and issues, the company hasn't found it easy to fund its various segments and attract talent. The businesses may have “weakened beyond repair,” as Jefferies Holdings analysts recently put it. Its latest earnings didn't inspire much confidence, either.

Most industrial businesses that don't come close to the scale of Toshiba are valued at 10 times Ebitda, and the Japanese firm currently commands an enterprise value of over $20 billion. A big part of that is its more than 40% stake a Kioxia Holdings Corp., a highly valued business held by Bain Capital, which is preparing for an initial public offering. Taking the firm private at a reasonable takeover premium of, say, around 30%, levering it up and monetizing assets could help give Toshiba the overhaul it so desperately needs. The key question will be how much premium does the company deserve in the current context.

Having major shareholders Elliott and Farallon on the board makes this reform far more possible than any other option. Foreign investors have previously won big after helping Toshiba out when it needed it most. This time presents a similar opportunity.

On Friday, It noted one member was not in favor. That's unlikely to scuttle the overall nomination approval, but it indicates continuing dissonance between stakeholders, and raises questions around whether Toshiba insiders are indeed ready for a new look. Any attempt to build up unnecessary resistance will just look foolish.

There is no doubt that private equity style cost-cutting and hedge fund activism happening at the same time is a scary prospect. But without it, Toshiba's future — sans growth — is perhaps even scarier.