Summary
1. A large, research-driven brokerage that has never fully adjusted to the realities of the post-90s Japan needed the deal-making and distribution muscle of SMFG.
2. Its tightening of the relationship over a year ago was based on recognizing that weakness.
3. The buy-out reflects a refusal of Daiwa leadership to try merging its culture with that of Nikko Cordial and the aggressive Sumitomo. A go-it alone strategy will be difficult - and lead to a new partner next year.
Analysis
The Japanese market seems to realize that Daiwa has decided to strike out in hope of finding a new strong-but-cooperative partner. It is pushing Daiwa shares down through the very-important (psychologically) floor value of JPY500, along which it has bounced for most of this year. It may go back toward its 340 bottom of this March, but its own network may be able to support it well above that price. Nonetheless, it remains a near-term short and a long-term buy. (We hold no position in that stock or its affiliates.)
The SMFG decision to drive through with the acquisition of the Nikko remnants in April did not register on Daiwa's stock price, but once SMFG struck out with an amazing 30% dilution of its common stock in order to finance a Nikko deal priced at just over 70% of that amount in Yen, it became clear that the pressure was on to consolidate or separate.
Thus, the 200-pt fall inside of 25 days in June-July was most of the shorting benefit (a 28% fall), but there may be another 10% from the current level. Most of the opportunity will lie in the volatility. While Daiwa struggles to rationalize some of its operations and decide on a clear non-Sumitomo strategy, it will have to look for a new partner. Unless it does the unlikely thing and reach overseas, that will be a tough struggle. During that time, market concerns globally and in Japan will put increasing pressure on share turnover, Daiwa's main revenue source. Its semi-annual report may confirm the cost of this independence and may show an even larger loss rate than March's -63.16 per share for the previous year.
Marshall Mays consults with leading institutions through GLG
Analyses are solely the work of the authors and have not been edited or endorsed by GLG.
