April 2007

LONG ONLY JAPANESE EQUITIES

Polo Ralph Lauren made a tender offer for the 80% of the shares it did not own in Impact 21, its Japanese licensee and distributor, at a price 35% below our estimate of full intrinsic value. .

Unfortunately, the offer is likely to succeed as Polo Ralph Lauren already has 61% of acceptances. We will reluctantly sell or tender our shares. The business had performed badly in the last year and, as a result, the shares had fallen, recording one of the worst performances of the companies we held during 2006. Thus, for some the offer 25% above last month’s closing price looked attractive, even if we think the Polo Ralph Lauren brand in Japan is underexploited and has much more potential. Unfortunately the fruits of any redress of the situation will now accrue to Polo Ralph Lauren itself. Once again, our ownership of a business dominated by one large shareholder, in this case a licensor, has yielded less than optimal returns. It is a lesson for the future.

Ono Pharmaceutical is a second ranking ethical pharmaceutical company with limited growth prospects but an alluring valuation from a break-up perspective. 50% of its current market capitalisation is accounted for by net financial assets. We visited the company last year and decided not to buy it at the then prevailing price, resolving instead to concentrate on our investments in Takeda Chemical, Astellas, and Taisho Pharmaceutical. Just recently, a 7% shareholder of Ono has demanded that the company pay a ¥700 dividend, up from the ¥100 proposed this year, in order to return some of its idle cash back to shareholders. In justification for the request the shareholder stated: ‘Most of the firm’s financial assets are unrelated to pharmaceutical operations and the ratio of its financial assets to total assets is much higher than the level considered necessary for routine operations (including research & development) and a growth strategy. We understand that the management may consider the acquisition of firms and operations in the future, but it should be able to raise the necessary funds from the capital market (in such a case). Holding excess financial assets in preparation for future acquisitions thus runs counter to the best interests of shareholders. Excess capital should be returned to shareholders.’ The company is yet to respond but we will watch developments closely as our investments in Taisho, Takeda and Astellas are similarly loaded with excess capital (net financial assets are 59%, 32% and 28% of market capitalisation respectively) with Astellas the only one with a plan to disperse some to shareholders.

Fuji Photo announced some good results, with restructuring provisions down materially from last year. Next year should be another one of continued recovery as the investment into new business areas such as LCD components reap rewards. However, as we have stated before, the predictability of this business is much less than selling silver halide film and our enthusiasm for the company has waned as a result. It still has some other good niche businesses in medical imaging and copying but, as a result of the decline in the overall predictability of its cash flows, we have already applied a higher discount rate to them than we did before.

Other news last month included: Earth Chemical raised its stake in Fumikilla from 5 to 6% increasing its ‘investment’ further in a strategic competitor; Bandai Namco announced a higher dividend, 16% higher than the original forecast and a share buyback; Kao announced better than expected results and a greater than expected reduction in net debt but disappointing profit expectations for next year; Aderans reported worse than expected results but a massive 70% hike in the dividend with a further rise expected next year; Osaka Securities Exchange raised its dividend by 39%; and Rohm felt pressured to raise its by 11% and to commit itself to a higher payout ratio from next year. Nintendo, our largest holding, announced profits streaks ahead of market expectations and raised its dividend by 77%, well above its earlier projections. We remain hopeful that the extraordinary success experienced in Japan for its latest products, Nintendo DS and Wii, will be repeated in the larger overseas markets of Europe and the USA. There are good signs that European sales are doing well and also tentative signs of an acceleration in the USA. If our hopes prove correct, investors and the company will be too cautious in their expectations for sales profits and dividends this year, like they were last.

These latest increases in dividends, announced after companies’ fiscal year ends with the annual results, have already increased the overall weighted average dividend growth rate of our companies from 6% in May last year (see the May 2006 monthly report) to 23% now. We expect a little more before all the results are out, making FY 2006 almost as good for dividend growth as FY 2005.

Michael Lindsell
May 2007

16 Apr 2007 LTL 000-048-5