What Warren Buffett sees in Japan Inc

In late September, Warren Buffett’s Berkshire Hathaway invested $6.5bn in five Japanese trading houses that are well over a century old. “Berkshire’s investment in 5% each of Itochu, Marubeni, Mitsubishi, Mitsui and Sumitomo, though small relative to his investment firm’s $140bn mound of cash, was its biggest outside America. It said its stakes could increase to as much as 9.9% over time. “Berkshire’s investment in 5% each of Itochu, Marubeni, Mitsubishi, Mitsui and Sumitomo, though small relative to his investment firm’s $140bn mound of cash, was its biggest outside America. It said its stakes could increase to as much as 9.9% over time.”
This investment is interesting because in the late 90s, Buffett seemed to have ruled out investing in Japanese value stocks when he said: “You walk down the street and you look around for a cigar butt someplace. Finally you see one and it is soggy and kind of repulsive, but there is one puff left in it. So you pick it up and the puff is free.”
So what has changed? Why is Buffett now drawn to Japanese trading houses? Firstly, each of these trading houses has collected valuable assets over the past 50 years: “From the 1950s to the 1980s they acted as go-betweens, scouring the world for energy, metals and minerals, helping to underpin Japan’s economic miracle. Then they invested in mines and hydrocarbons to feed the China-led commodities boom before shifting “downstream”, buying everything from convenience stores to cable companies. In the process they accumulated assets faster than they sold them. The results are unwieldy. Mitsubishi peddles everything from coking coal to Kentucky Fried Chicken. Itochu, the most profitable, calls its consumer division the 8th Company, implying it has run out of names after seven other units.”
Secondly, they are cheap because they are complex investment vehicles: “the trading companies are cheap. Of the five, only Itochu trades at a market price higher than the book value of the net assets on its balance-sheet. That is not to say they are a bargain, though. Kikkawa Tatsuya of JPMorgan Chase, a bank, says their low-return legacy assets, which sometimes suffer big write-downs, increase investors’ perception of risk. Their complexity raises their cost of equity, which is higher than for more focused commodities producers, such as ExxonMobil or Rio Tinto.”
Thirdly, the trading houses have energy-heavy portfolios and talented executives, two things that Buffett is fond of: “He likes energy firms, and all the trading houses, particularly Mitsui and Mitsubishi, have big energy businesses. They stand to benefit from a post-pandemic economic rebound that boosts demand for power. The companies are also wellsprings of talent. Jeremy White of Baker McKenzie, a law firm, says they maintain a tradition of recruiting from the best Japanese universities, and rival investment banks and tech firms as the most prestigious companies to work for.”