There was a time when Sharp could charge $1,000 for a calculator. That was in 1966, however, and recent results show the company once leading in consumer electronics cannot keep up with technology and costs.
“Sharp is in circumstances in which material doubt about its assumed going concern is found,” the company said in a statement to the Tokyo Stock Exchange Nov. 1. In business, the assumption of “going concern” means that the company will operate at least the next 12 months without the threat of liquidation. Investors and employees of Sharp surely hoped for a more optimistic outlook after the firm celebrated its 100th anniversary in September.
The net loss of $4.8 billion it reported for the first half of the fiscal year, which ends in March 2013, is much higher than its anticipated shortfall of $2.6 billion.
The company took higher charges to inventory and deferred tax assets, an accounting position that would have allowed it to save on taxes for future profits. Given that the regulator forced it to reduce that position, future profits are unlikely for the maker of LCD televisions, mobile phones, printers, and solar panels.
This report continues the volatile series of minor profits and major losses. Unfortunately, time to return to profitability is running out for Sharp. Moody’s and S&P downgraded the company’s rating on its $4.2 billion in long-term debt to junk. The company can only keep operating thanks to a $4.5 billion bank credit line it secured, but that will run out in June 2013.
The poor financial figures are the consequence of several factors that are working against the Japanese consumer electronics industry, which once dominated the world.
Internal Factors: High Costs and Low Innovation
“Corporate Japan, along with much of the rest of Asia, is guilty of paying too many redundant quasi state employees anything at all. It is a ruinous policy, symptomatic of a failure to face tough decisions, and it is slowly but surely eliminating all of the residual equity value in far too many businesses,” writes hedge fund manager Hugh Hendry in a letter to investors.
Sharp provides a good example of this policy. From March 2008 to March 2012, the company’s revenues decreased by 28 percent. Yet its workforce increased by 5.7 percent to 56,756 employees.
The company plans to tackle this problem by introducing voluntary retirement plans and otherwise reduce labor costs by cutting back on wages and bonuses. Should it decide to fire workers—the company did not mention it explicitly—it would not be cheap. In a recent restructuring, Sony had to pay $75,000 to $100,000 per redundancy.
The company also announced it would reduce its fixed cost base by selling off unproductive assets and reducing its inventory. Declaring a large part of its freshly produced inventory worthless highlights the lack of demand for its products. Japanese products are not keeping up with technological developments elsewhere.
“Household names such as Sharp, NEC, and Sony produce earnings reports that numerically illustrate just how they have been left high and dry by a devastating combination of American technology, Korean ingenuity, an ongoing failure to tackle costs and the [high] Yen,” says Hendry.
External Factors: High Japanese Yen, Chinese Slowdown
Japanese exports are cheaper when the U.S. dollar buys more yen. At the end of Japan’s export driven “miracle” in 1990, the dollar bought as many as 159 yen. In 2008, when the last crisis hit, the average rate throughout the year was 103 yen per dollar.
In 2012, the average has been 79, a depreciation of the dollar of 23 percent. In other words, Japanese products on average are now 23 percent more expensive than in 2008, an external force working against these companies on top of the internal problems.
The impossible is happening today in Japan. Some of the largest Japanese corporates are on the verge of bankruptcy.
—Hedge fund manager Hugh Hendry
Hendry does not think this trend is about to reverse. “The impossible is happening today in Japan. Some of the largest Japanese corporates are on the verge of bankruptcy. Sharp would be an example of that. And I am saying if we move very rapidly into an environment of the ’60s and God forbid the high 50s, then you would see revolution in Japan,” he said at The Economist Buttonwood conference in October 2012.
Hendry also believes that Japan was a beneficiary to the expansion of the Chinese economy in the past decade. Geographical and cultural proximity have helped Japanese companies export to China. Capital goods used for production and construction were in particular demand, as investments in infrastructure and factories make up almost half of Chinese GDP.
With the recent slowdown in Chinese GDP growth, demand for Japanese products has faltered. “Japan is the most industrially exposed economy there is to a Chinese slowdown,” says Hendry. Consequently, he has made financial bets that rise in value when the fortunes of Japanese companies decline.
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