Toby Rodes - Unlocking Value in Japan (EP.407)

Episode Summary

Executive Summary: Toby Rhodes argues Japan is at a rare inflection point where corporate governance, rising cost of capital, and a developing market for control are finally forcing capital allocation discipline. Drawing on decades in Japan, he explains why value investing works there, how Konami Capital screens for high-quality cheap companies, and why activism, buyouts, and private equity can now unlock significant value.

Main Topics: Rhodes’ lifelong connection to Japan (Priority: 5/5): He traces his fascination with Japan to his grandfather’s business ties there, then to language, culture, and years of study and work that gave him a deep understanding of Japanese society and markets. Japan’s distinct capitalism and market inefficiency (Priority: 5/5): Rhodes argues Japanese capitalism is designed for insiders, with historically strong barriers to foreign capital and foreign competition, making it structurally different from U.S. markets and often mispriced. Why today is different for governance reform (Priority: 5/5): He says prior reform waves failed because they arrived during market distress or lacked enforcement, but current reforms are being backed by stewardship codes, regulatory pressure, and a real market for control. Konami Capital’s value-quality investment process (Priority: 5/5): The firm combines quantitative screening, DCF ranking, deep fundamental research, and engagement to find cheap but high-quality Japanese small and mid-cap companies that can re-rate or be acquired. Risks, catalysts, and the role of activism (Priority: 4/5): Rhodes discusses false starts in activism, the impact of a stronger yen and rising rates, and the possibility that private equity or unsolicited bids will become more common as Japan normalizes. Portfolio construction and engagement-based returns (Priority: 4/5): He explains how the portfolio evolved from an equally weighted approach to a concentrated, high-conviction book focused on names where engagement can unlock value or trigger takeout bids. Personal leadership and habits (Priority: 2/5): The conversation closes with Rhodes’ hobby, values, mentors, and lessons about time, discipline, and calculated control, reinforcing the personal philosophy behind his investing approach.

Key Arguments: Japan offers a large pool of high-quality businesses trading at low multiples, akin to a private equity opportunity in public markets. Japanese markets historically failed to price capital properly because the system was built to protect insiders and suppress outside influence. Earlier governance reforms failed because they came during weak market conditions and were associated with feared asset stripping rather than constructive capital allocation. Current reform is more durable because regulators, stewardship codes, domestic institutions, and foreign managers now reinforce one another. A functioning market for control is the key missing ingredient; unsolicited bids and takeovers create accountability and unlock value. Konami avoids value traps by screening for durable quality, productive balance sheets, and strong incremental returns before engaging management. The firm’s engagement can be positive or adversarial, but both modes are principle-based and aim to improve capital efficiency and shareholder returns. Rising rates and a stronger yen are not fatal to the thesis because the portfolio is built from companies that have survived multiple macro regimes and because higher capital costs improve discipline. Japanese disclosure may appear weak in English, but useful information is often available in Japanese-language documents and local context. Private equity and strategic bidders may increasingly be able to finance and execute acquisitions in Japan, validating public-market activism and shortening holding periods for successful names.

Data Points: Listed companies in Japan: 4,000 - Rhodes says Japan still has roughly 4,000 listed companies, similar to the U.S. today, but reached that level from a different starting point. Listed companies in the U.S.: 4,000 - Used for comparison with Japan to show the U.S. has consolidated more aggressively over time. Japan listed companies 20 years ago: 2,000 - Illustrates how Japanese listed company count doubled over two decades despite weak governance and low equity discipline. U.S. listed companies 20 years ago: 8,000 - Shows the U.S. market shrank from 8,000 to 4,000 through takeovers and exits. Japanese firms below 1x price-to-book: About half of listed Japan - Rhodes uses this to argue that much of the market still trades as if defaulting on its cost of equity. Uncovered Japanese companies: Roughly 60-70% / about 3,000 companies - He says much of listed Japan remains uncovered by the sell side, creating informational inefficiency. Companies in Konami’s screen: About 300 - After applying quality and valuation filters, this is the pool of investable candidates. Portfolio holdings: About 15 names - Konami is now highly concentrated after years of refinement. Top positions weight: Top 5-6 names = 50% of portfolio - Shows increasing conviction and concentration around highest-confidence engagements. Portfolio valuation: About 3.5x EBITDA on 50% of weight; sub-4x EBITDA overall - Indicates significant discount to Japanese market multiples. Portfolio earnings multiple: About 9x earnings - Part of the valuation summary supporting the cheapness thesis. Portfolio dividend yield: About 3% - Shows cash yield embedded in the portfolio. Market multiples: About 7-8x EBITDA, maybe 12x depending on market cap adjustments - Used as comparison to show portfolio trades at roughly half to a third of market valuation. Portfolio free cash flow yield: 40-50% higher than the market - Rhodes presents this as evidence of superior cash generation at lower price. Portfolio ROE: 30-40% higher than the market - Shows that quality is elevated despite the value orientation. Historic sales meetings in Japan: About 450 meetings a year in Boston - Rhodes describes his intensive engagement with Japanese companies while at GMO. Docomo IPO valuation model: First published discounted free cash flow model in 1998 - Marks an early example of bringing valuation discipline to Japan. Nikkei/Topix level at governance turning point: Around 7,000 - Rhodes recalls this as the depressed starting point of earlier governance reform. Nikkei/Topix level today: Just under 40,000 - Used to show how much the market has recovered since the early 2000s. Japan banking system share of GDP: 20% of GDP - He cites the scale of the 1997-2003 banking cleanup. TSE compliance/monitoring: Companies published cost of capital - Referenced as a regulatory push to make capital discipline more explicit; no numeric count given. Yen move in 2023: 107 to 161 per USD - Rhodes cites this as a major currency swing affecting forecasts and sentiment.

Pivotal Quotes: "Japan finally understands that this system in its three lost decades is proof that capital doesn't flow from low return ideas to high return ideas in Japan." — Toby Rhodes: Explaining why the old insider-focused system no longer works in a mature economy. "If you want the rain that waters your crops, you got to have thunder and lightning too." — Toby Rhodes: Describing why real governance change requires the friction of unsolicited takeover bids and market-for-control discipline. "Japan was a museum. You could come. You could look. You could examine. You could read about. You could be interested in. But you couldn't buy anything." — Toby Rhodes: Summarizing why he believes Japan has shifted from a passive market into a real investable opportunity.

Implications: Listeners should view Japan as a potentially durable re-rating story driven by governance reform, active engagement, and takeover activity. The opportunity is sizable, but success depends on deep local knowledge, selectivity, and patience.