Toshiba is embarking on a firesale of its businesses $6.3 billion writedown of its US nuclear operation that has thrown it into financial turmoil. Loizos Heracleous, Professor of Strategy, argues poor strategy is at the heart of the Japanese conglomerate's problems.
Toshiba’s latest troubles stem from lax corporate strategy capabilities rather than ineffective corporate governance.
In late December 2016, Toshiba announced potential impairment losses of “several billion dollars” from its US nuclear operations, in a dispute over the value of the assets of an acquisition by Toshiba’s subsidiary, Westinghouse Electric.
More recently this figure was estimated by analysts to be as high as $7 billion, while the writedown announced by Toshiba in February 2017 was $6.3 billion.
Given Toshiba’s already weakened financial situation after a 2015 accounting scandal where the company admitted to overstating its revenues by $1.3 billion over seven years, this is unwelcome news for investors.
Toshiba already has a total debt to equity ratio of 324 per cent compared to the industry’s 120 per cent, sliding revenues, and negative profit margins.
In February the company announced a net loss of $3.4 billion during the year to March 2017 and its chairman stepped down to take responsibility. In mid-March Toshiba asked for a second extension in reporting its earnings, sending its share price to around 45 per cent of what it was at the end of 2016.
Ironically, Toshiba has taken steps to improve its corporate governance after the 2015 scandal. It has reduced the size of its board from 16 directors to currently 10, six of whom are reported to be outside directors. It has also committed to staffing its audit and nomination committees “in principle” solely by external directors.
However, the current problems do not stem from lax corporate governance but from debatable strategic capabilities. Particularly, capabilities in corporate-level strategy, where a key function of the strategist is to manage the corporation’s portfolio of businesses to maximize returns.
This means that overly complex corporate portfolios, particularly if synergies across businesses are hard to detect - such as Toshiba’s diversified stable of businesses - are unlikely to deliver high returns.
Should the CEO take responsibility for Toshiba's financial crisis?
A key part of corporate-level strategy is evaluation of acquisitions. While it is easy to critique transactions post-hoc, it is nevertheless fair to ask what capabilities Toshiba already had in the nuclear business before it decided to acquire nuclear operations based in the US? And why it believed this business would be one of its key growth engines.
It is also fair to ask why the due diligence prior to the acquisition could not identify the operational, legal, client, and asset valuation issues that now threaten to sink Toshiba.
While the board certainly has a strategy supervision function, it is the CEO and senior executives that are primarily responsible for a company’s strategy.
The board should of course question the premises and assumptions that are made in strategic plans and initiatives. However, especially when plans put forward appear credible, the board rarely has the time or inclination to go into the fine details, and operates on a presumption of trust towards the capabilities of management.
That is why often debatable and ultimately disastrous strategic initiatives get approved by the board. The tendency to expand in whatever area looks like it could be profitable, especially within a diversified corporate setting, is a prevalent approach by conglomerates in Asia - particularly in large emerging economies.
Toshiba’s fate now depends in the short term on whether banks or the Government will be willing to offer a lifeline. In the medium to long term, it depends on whether decisive action can be taken in terms of managing its portfolio of businesses.
Will the Japanese banks bale out Toshiba?
Banks in Japan have historically assisted corporations in trouble. Given that banks are often shareholders in troubled corporations, they don’t want their share holding to amount to nothing (or very little, depending on how much can be recovered) if the corporation enters bankruptcy.
They also don’t want to increase their bad debts, given that corporations already have large loans from banks. Finally, they don’t want to forego the ongoing revenues and cash flow from interest paid on these loans.
Japanese business culture is not used to large scale lay-offs and bankruptcies. For all these reasons, it is likely that banks will offer a lifeline to Toshiba. If that fails, the state may step in.
What should happen next is a hard-nosed evaluation and decisive management of the portfolio of Toshiba’s businesses.