The drive to be No. 1 came at a price. As with many other Japanese companies its size, Daiei’s rise was fueled by easy credit from friendly banks. In the mid-1990s, as the bubble burst, the banks feared widespread default on these loans. So they dispensed more cash, desperately trying to keep big borrowers afloat. In one recent tally, the Oriental Economist, a monthly newsletter, identified 66 Japanese companies with debts greater than $1 billion and share prices below ¥200 ($1.60). Together they owe a staggering $260 billion, or about double Argentina’s national debt. Daiei alone accounts for $17 billion, putting it near the bottom of this class, which the Japanese know as the zombiegaisha, or “zombie companies.”
They are the sick soul of Japan’s economic slump. The postwar culture of reckless lending nurtured staggering inefficiencies. Today global export brands like Toyota and Sony are the exception in Japan, where 90 percent of the population works for companies that sell mostly to the domestic market. These firms are one third less productive on average than companies in the United States, says the McKinsey Global Institute. They also carry twice as much debt, says the Bank of Japan. Japan itself is graded an increasingly dangerous risk by credit trackers like Moody’s and Standard and Poor’s, and now falls in the same debtor category as Slovakia. Some analysts are beginning to warn that Japan could be headed for a debt crisis similar to Argentina’s, but with far more frightening implications for Asia and the world (following story).
Japan is still afloat despite its incompetent domestic economy, but just barely. Its stellar multinationals are sputtering as well. The crisis could come to a head on March 31, when as part of its “big bang” financial reforms Japan will stop insuring large bank deposits. The plan was to encourage Japanese to move money out of savings and into the economy. The fear is that ordinary people have lost confidence in their own country, and will clear out accounts and send the money abroad. Bank runs and capital flight are all too likely. Credible reform might lower the risk, but will probably result in the collapse of many of Japan’s largest companies, forcing tens of thousands of layoffs and a political crisis for Prime Minister Junichiro Koizumi. “If Japan continues to delay, debts will reach an uncontrollable magnitude,” warns Takashi Watanabe, a banking specialist at Bunkyo University. “There is a possibility not just of the bankruptcy of major industries, but of the Japanese economy as a whole.”
Daiei stores are vivid testimony to the decay inside Japan. At the Daiei in Akabane, a popular Tokyo bedroom community, everything from the mannequins to the costume jewelry is a generation out of date. The music is by the Carpenters, piped in from the 1970s. The food courts are grimy. Rows of rolling apparel racks are bathed in naked fluorescent light. Signs promise sale, discount and half price, but customers rarely bite. On one recent evening they included several homeless people resting beside the escalator. A young couple traded whispers at the nearly empty snack bar. One of the few real shoppers, a woman with her teenage son in tow, flipped through denim skirts. “These are to wear at home,” she stressed. “If I want anything fashionable I try the stores at the other side of the station.”
Daiei is now emerging as a high-profile test of how far the government will go to fix the rot. In coming months, according to senior politicians and bureaucrats in Japan, the watchdog Financial Services Agency (FSA) will order banks to cut off dozens of the most indebted businesses. Most are in construction, real estate, retail and finance–the crumbling pillars of the domestic economy. In November the FSA included Daiei in an unprecedented audit aimed, according to the FSA, at exposing bad loans to shaky corporate borrowers. The likely outcome: pressure on Daiei’s four main banks to abandon the ailing giant. “My sense, at this point, is that 70 percent of Daiei will be cut off,” perhaps as early as this month, a senior government official told NEWSWEEK. That would result in the liquidation of most of Daiei’s assets–a fire sale unprecedented in postwar Japanese history.
The ironic side of the Daiei story is that Nakauchi started out as a rebel attacking entrenched interests before he became one. After the war Nakauchi entered Japan’s booming black markets, according to biographer Shinichi Sano, author of “Charisma: The Postwar Era of Isao Nakauchi and Daiei.” “He traded everything but drugs and women,” says Sano. In the late 1950s, Nakauchi took over the family drugstore in Kobe and soon bought another. He defied Japan’s pervasive sales cartels by selling beef for ¥39 per gram–about half the “fixed” retail price. Over the years he undercut cartel pricing on everything from soap to consumer electronics in his expanding chain of modern grocery stores.
Nakauchi hungered to be Japan’s biggest retailer. Like many business leaders of his generation, he valued volume over profitability, and expanded relentlessly. He built an empire by acquiring or starting companies, often in leveraged deals with chummy banks. By the late 1960s he was Japan’s retail king, no longer a rebel but a symbol of the system.
In some ways, Nakauchi was less a retailer than a real-estate tycoon. Skyrocketing property prices were the main inflater of the 1980s bubble economy, and Nakauchi built his empire on them. He bought land in suburbs and small towns to build his huge grocery stores, both reshaping the countryside and earning huge paper profits on the land. He then used the property as collateral to secure more loans to buy rival chains or more land to build more stores. Thinking property values would rise forever, lenders played along. They bankrolled Daiei’s expansion into hotels, convenience stores, restaurants, pachinko parlors and–in 1988–professional baseball.
No outsider knew enough about Daiei to question these moves in detail. Until very recently Nakauchi kept an iron grip on the group and made all the key decisions. He shuffled store managers frequently to prevent the emergence of local fiefdoms. On several occasions he sidelined assertive executives in favor of yes men. In 1969 he sacked his own brother for advocating steady growth over pell-mell expansion. The trend continued through late 2000, when Nakauchi forced the resignation of group president Tadasu Toba, allegedly for suggesting that Daiei shed its noncore assets and contemplate merging with a foreign partner. “Toba tried to implement hard solutions,” says Takayuki Suzuki, retail-industry analyst at Merrill Lynch Japan. “The family said no.”
An old saying conveys one of the cardinal rules of banking: size matters. “If you owe the bank $10,000 you have a problem,” it goes, “but owe $10 million and you have a partner.” Nowhere is that more true than in Japan. Most of the biggest debtor companies are virtual wards of their banks. They have seats on their boards and wield veto power over management. The bank’s goal is always to keep the company afloat. Called credit monitoring, the system is Japan Inc.’s alternative to the shareholder monitoring popular in the West.
Japan’s ways of managing corporate failure were once considered more efficient than the U.S. tradition of bankruptcy, hostile takeovers and shareholder revolts. In the 1970s, for example, Mazda was rescued from the brink of financial collapse by its main lender and the government. Sumitomo Bank injected new credit and a crisis-management team. The government urged rivals not to undermine Mazda in its time of trouble. A 1983 American study of “The Mazda Turnaround” praised the rescue as evidence of “an implicit social policy of protecting the inner circles” of corporate Japan.
The strategy proved disastrous following the collapse of Japan’s asset bubble in 1990. Unwilling to write off or even reveal the growing volume of bad loans on their books, banks turned to a practice called “evergreening”: covering old loans with new ones, so the dead leaves would never drop. Dai-Ichi Kangyo Bank, for example, funded retailer Mycal until the eve of its collapse last September under $8 billion in debt. Aoki Construction had received almost $2 billion in debt forgiveness from its main banks since 1999, but shut its doors last month anyway. Delay only magnified the losses. “A quick resolution lets markets operate, providing fuel for increases in economic activity,” said the head of the U.S. Council of Economic Advisers, R. Glenn Hubbard, during a recent visit to Japan. “A slow resolution leads to paralysis and stagnation.”
Daiei is a textbook case. It lost billions in paper wealth when Japan’s bubble burst, but kept expanding anyway. In his autobiography, “The Distribution Revolution Never Ends,” Nakauchi hailed the 1994 acquisition of three competing retailers for completing his 37-year march to create “a national chain from Hokkaido to Okinawa.” The mergers gave Daiei a total of 356 outlets, with sales of ¥2.6 trillion. Counting on Japanese recovery, Daiei kept borrowing and spending. It bought Hawaii’s biggest shopping mall and built a $1 billion stadium for its baseball team.
But Japan stagnated. By 1996 Daiei’s operating profit had plunged 93 percent. In response the company split in two, creating the Daiei Group and Daiei Holding Corp. The idea was for the holding company to sell stocks in gems of the empire, as a fund-raising alternative to more loans. But unlike Sony or Toyota, Daiei found few buyers. Japanese analysts and media warned of huge hidden losses in undisclosed family businesses.
Like Japan itself, Daiei was lurching toward a crisis. By mid-2000 the company was $30 billion in debt (a sum that has since fallen, due mainly to the weakening yen). The strain triggered a power struggle between Nakauchi and Toba, then Daiei’s president. In November that year both men resigned, reportedly battling over Toba’s plans to save Daiei by breaking it up. Toba refuses to discuss his ouster. “I’m from a generation that believes that generals should not talk about lost wars,” he told NEWSWEEK.
The casualty count is not yet complete. According to Daiei spokeswoman Kikue Inoue, top management had hoped to hold on only to solid businesses and allow distressed operations to fail. It was the bankers, she says, who insisted that Daiei be kept whole. “Logically it made sense to divide them,” says Minoru Nakano of Teikoku Databank in Tokyo, “but the trouble with Daiei is that the banks know that if it goes under, they may go under too.”
That’s a real risk. Koizumi is trying to weed out the worst debtors without provoking a full-scale bank crisis. Last month the Parliament strengthened the Resolution and Collection Corp., the agency charged with cleaning up the loan debacle, making it easier for the institution to buy bad debt. Separately, the government has issued new rules intended to allow banks to fix bad companies while preventing messy disruptions for suppliers and employees. “Many reporters have asked me if these rules were tailored for Daiei,” says lawyer Shinjiro Takagi, principal author of the workout scheme. “They weren’t, of course, but sometimes I imagined it.”
It will be impossible, however, to clean up this mess without pain. Stephen Church of Analytica Financial figures bad corporate debt now amounts to a whopping $19 trillion, or 44 percent of Japan’s GDP. Officially, Japan’s position has been that foreign analysts were grossly exaggerating the problem, but that may be changing. Last week Daiei confirmed that it is negotiating with its four main banks, meaning one of two things: another stopgap rescue or Daiei’s breakup. Investors, betting that the company will survive, drove its share price up more than 20 percent last week. “The banks can’t just say no and cut off ties,” says Shigeharu Shiraishi of SG Yamaichi Asset Management Co. in Tokyo. “Under these circumstances, it is very difficult for Japan to escape the [bad loan] crisis.”
There is a clear example for Japanese politicians to follow right next door in South Korea, which was forced to seek a humiliating IMF bailout in 1997. As in Japan, family-run conglomerates dominated the economy. Their distress swallowed bank reserves and froze many of Korea’s prime assets. To revive the economy, President Kim Dae Jung nationalized more than 40 failed banks and empowered a special agency to shut down or sell off the heaviest debtors. The Korean Asset Management Company, or KAMCO, has since disposed of some $44 billion in distressed assets, most to foreign buyers, in deals that revitalized South Korea. The problem, says Chung Jae-Ryong, KAMCO chairman and CEO, is that “Japan is scared of going through this, so they’re pushing the debt crisis forward to the next generation.”
Recent history shows that restructuring can work in Japan. The freshest example: Renault’s successful turnaround of ailing automaker Nissan, which under foreign management has battled back from near bankruptcy through cost-cutting and better design. Yet Nissan is an exception to the rule. Mergers and acquisitions remain both rare and risky. The main players are foreign investment banks, which still get overwhelmingly bad press in Japan for doing their jobs. Ripplewood Holdings of New Jersey has been a whipping boy since it acquired the failed Long-Term Credit Bank in 2000. In October the FSA scolded the bank for doing exactly what all smart lenders do: denying credit to weak companies.
Can Koizumi transform this bad-debt culture? Breaking up Daiei would send a strong message, and there are signs an endgame is near. In December Sentaku magazine reported that “like rats fleeing a sinking ship, [suppliers] have begun to leave Daiei.” Last week Japan’s financial pages brimmed with speculation that Daiei might be forced to sell major assets, including its baseball team and stadium. One analyst told NEWSWEEK that banks will be forced to forgive more than $10 billion of Daiei debt, a staggering loss. “Even that is no solution,” he says, since Daiei would be left with barely enough money to “clean the entrances and toilets” at its faded retail stores.
At 81, Daiei’s legendary founder is fighting to stave off an ignominious unraveling of his empire. Though Nakauchi officially retired in 2000, he still appears at critical junctures. Most recently, in October, he lobbied banks to continue supporting the company after Moody’s lowered its credit rating to junk status. In his autobiography, Nakauchi pledged to follow the path of a mythological samurai from Kobe who was killed in battle but reborn seven times: “I’ll stay in active service as long as I live.”
Daiei may not have long. Most analysts believe Nakauchi’s multibillion-dollar shop is running out of loans and lives. The end, when and if it comes, would hit hardest in the small towns that are the heartland of Japan’s domestic economy and the favored location of Daiei stores. “I don’t think there is a single housewife in Japan who hasn’t bought a radish from Daiei,” says biographer Shinichi Sano. “When it collapses, all of the Japanese people will have to face the fact that we really must do something about this economy.” For all its prowess on the global stage, Japan can no longer afford to subsidize incompetence at home. That’s one bitter lesson that can come none too soon.
