This Japan Ad Agency Has More Juice

(Bloomberg Gadfly) -- Even before the divorce, WPP Plc is squeezing for more alimony. 

Shares in Japan's third biggest advertising agency Asatsu-DK Inc. soared as much as 20.5 percent Tuesday, the most on record, after Bain Capital LP offered to buy out the company for $1.3 billion.

Asatsu-DK is trading at 3,810 yen ($33.68) per share, higher than Bain's 3,660 yen bid price. In other words, the market believes Bain will sweeten its offer. Asatsu-DK's largest shareholder, London-based WPP, the world's biggest advertising firm, has indicated Bain's offer is too low, according to people familiar with the matter.

Traders in Tokyo are making the right bet. Currently, WPP owns 24.7 percent of Asatsu-DK. U.K.-based value fund Silchester International Investors LLP holds 17.2 percent, while Northern Trust Corp. and Franklin Resources Inc. have 9.2 percent and 7.1 percent respectively. So long as WPP has two of the three money managers in its camp, it has the majority vote and power to block any deal.

Asatsu-DK's major shareholders will probably be on WPP's side, at first. They're no fans of President and CEO Shinichi Ueno. Ueno's support rating among investors slumped by 30 percentage points to 59.5 percent in the latest fiscal year, the most among companies in the Topix Index, according to CLSA Japan strategist Nicholas Smith. Since Ueno took office

Asatsu-DK is "going nowhere," writes Nicholas Tanner of Pearl Hill Advisors. With a 5 percent market share, the ad agency lacks buying power and its gross margins of 15 percent are and will probably remain lower than market leaders Dentsu Inc. and Hakuhodo DY Holdings Inc., which command market shares of 22 percent and 17 percent. Not surprisingly, Asatsu-DK's return on equity is also below those of competitors.

WPP hasn't been a happy partner since it bought a quarter of Asatsu-DK in 1998 for 30 billion yen. Almost twenty years after its original purchase, WPP's stake is worth only about 39 billion yen. Meanwhile, Asatsu-DK has been trying to placate WPP with special dividends. But since its business operations are sinking, so are the cash payouts. In conjunction with Bain's offer, Asatsu-DK said it has changed its year-end forecast to "no dividend,'' and intends to end its tie-up with WPP and sell its 31.3 million shares in the advertising giant.

Given Asatsu-DK's ownership structure, Bain has probably recognized it needs to raise its offer. The private equity firm will likely want to increase its price gradually, and alienate the other key shareholders from WPP along the way.

Japan's Prime Minister Shinzo Abe has been pushing Japan Inc. to unwind cross-shareholdings. He has a point. In this case, the 2.4 percent stake in WPP that Asatsu-DK owns is worth 63.4 billion yen. This and the company's 20 billion yen cash pile constitute more than half of Asatsu-DK's market value.

Viewed this way, Bain's offer looks cheap. At the current market price, Asatsu-DK's enterprise value is just over 74 billion yen, or 10 times historical Ebitda -- broadly in line with Dentsu and Hakuhodo.

Seems shareholders haven't priced in enough of a buyout premium after all.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

To contact the author of this story: Shuli Ren in Hong Kong at sren38@bloomberg.net.

To contact the editor responsible for this story: Katrina Nicholas at knicholas2@bloomberg.net.