Another Massive Loss at the Nuclear Subsidiary Derived from Negligence based on Irresponsible Idea of "National Policy". Who Pays the Bill?
January 20, 2017
On December 27, Toshiba announced on its U.S. nuclear power business that "several 100 billion yen worth of additional impairment charges would occur".
The share price nosedived the following day by 40 percent, with possibility of escape from the Tokyo Stock Exchange-imposed "special post requiring caution" getting remote, and access to new financing was fast closing. The core company of the Japan Inc., has started a meltdown at its core.
Toshiba, in its financial result of March 2016, fell into a massive red ink, impairing 260 billion yen of goodwill related to the nuclear power subsidiary Westinghouse ("WH"). The fake accounting led to the resignation of the past three presidents was proven to be an effort to eschew such an impairment charges. With the accounting shenanigan revealed, Toshiba's balance sheet got a deep hit, and to beef up equity, it was forced to sell the cash-generating medical equipment business to Cannon at 600 billion yen plus. That was supposedly the end of the past wrongdoings. Yet, Toshiba audaciously concealed another bruise.
The new earthquake was centered on CB&I Stone and Webster ("S&W"), an engineering firm that WH acquired in December 2015. Chicago Bridge and Iron ("CB&I"), the largest contractor in the U.S., was S&W's parent, and S&W being nuclear construction arm. Toshiba is to reassess the value of this company, and impair several 100 billion yen in the 4Q (Jan. to Mar.). NHK, Japan's national TV station reported the loss amount to be 500 billion yen.
Pitfall of Put Option
What kind of company S&W is? A nuclear generation power plant is not solely composed of nuclear reactors. Robust buildings are required to shut out radiation. S&W is a contractor specialized in construction and deconstruction of such buildings, and it works hand-in-hand with nuclear reactor maker such as WH. CB&I is less known in Japan, but some reader may remember that it acquired its rival and the biggest among peers, The Shaw Group, Inc,("Shaw"), in 2013.
Shaw was an irreplaceable partner of Toshiba and WH. In 2006, when Toshiba bought WH, Shaw chipped in 20% of WH along with Toshiba, eying expansion of nuclear business. In the WH's proposed 6 new reactors in U.S., including Vogle-3 and 4, and Virgil.C. Summer-2 and 3, Shaw was responsible for EPC (engineering, procurement and construction).
Toshiba acquired 77% of WH shares at $ 5.4 billion (660 billion yen at then prevailing forex rate) in October 2006. Mitsubishi Heavy Industries who made a bid at the auction anticipated the price tag of 200- 300 billion yen, but Toshiba won the bid at double that price.
Shaw joined the aggressive Toshiba team and invested 20% of WH. As a contractor, Shaw wished WH's revival, but it was cautious and inserted a put option in the agreement to sell its 20% stake to Toshiba at Shaw's discretion. In retrospect, Shaw must have felt uncertainty on WH's future at that juncture.
In fact, WH was on the verge of bankruptcy in 1990's. It was the U.S. blue chip heavy electric equipment maker suffering from the liberalized power market along with GE, but lacked good manager like Jack Welch, who revived GE with bold business portfolio reshuffling.
In 1993, WH invited Michael Jordan, an ex-consultant of McKinsey Inc., as Chairman, and he sold its power system division to Siemens of Germany, and nuclear division to British Nuclear Fuel Limited ("BNFL"). The remained WH bought CBS, one of the Big 3 TV network in 1995, name changing to CBS in 1997. It was as if Mitsubishi Heavy turning Fuji Television. The primary business, nuclear reactor manufacturing, was given Westinghouse Electric Company ("WEC") name, with 100% held by BNFL, but BNFL could not turn it around in 7 years, and announced a sale in 2005. Toshiba showed knee-jerk reaction to the opportunity.
A Screwball to Dodge Litigation from CB&I
Shaw's fear turned real. The world's nuclear business suffered a fatal blow after the Fukushima meltdown Incident of March 2011. States tightened safety regulations of nuclear plants and costs soared. Many projects were frozen, or entirely cancelled. Shaw quickly changed course, and withdrew from new construction of nuclear plants. Toshiba did not get true intention of Shaw's decision; when asked about possibility of Shaw exercising the put option in an interview by mass media in the aftermath of the 3.11, then President of Toshiba, Norio Sasaki asserted; "I am not worried", but Shaw exercised its right in a few months.
CB&I, who acquired Shaw in 2013, was more skeptical on the future of nuclear power than Shaw. As its acquisition closed, it promptly notified Toshiba to terminate a stack of agreements such as the EPC contract on South Texas Project ("STP") 3 and 4, and the construction management of advanced boiling water reactor ("ABWR") in third countries. CB&I abandoned its claims on STP and Nuclear Innovation North America ("NINA"), a development company of ABWR. Toshiba explained that "NINA's debt would be reduced and investment environment to STP would improve", but in short, CB&I wanted to get hell out of the nuclear business at any cost. CB&I asked WH to compensate other than STP and NINA, and litigations erupted. These suits were headaches for Toshiba after summer of 2015, when the world focused on WH with the outbreak of accounting scandal, as potential defeat in these lawsuits would have nullified Toshiba's hoax of "WH is doing well and there exists no sign of impairment". The beleaguered Toshiba threw a screwball. It acquired S&W from CB&I. Japanese saying tells; "If you eat poisonous food, eat plate as well", and Toshiba literally ate a plate called S&W.
WH and S&W have been working on projects to build 8 units of state-of-the art "AP1000 reactors" in the U.S. and China. Project costs after the Fukushima-1 incident soared with tighter standards, and S&W and Toshiba were in litigation of burden-sharing, and the existence of the lawsuits delayed projects and incurred further additional costs. Toshiba's purchase of S&W was to solve this negative chain reaction. With Toshiba and WH bear all the risk, retreating CB&I would have had no complaints. Toshiba's then news release exuded elation of removing the headache: "Alongside acquiring S&W, Westinghouse has reached agreements with Southern Co. and SCANA Corporation to resolve all outstanding claims and disputes including existing litigation with respect of the U.S. projects. The agreements also include price and schedule adjustments.
Yet, poison is poison even if you eat with plate. The Vogle project jointly promoted by WH and S&W delayed by nearly 3 years. The U.S. regulator Nuclear Regulatory Committee ("NRC") has tightened regulations after the Fukushima-1, and it turned very much meticulous. Rampant cost over-runs took toll of WH and S&W. The impairment this time reveals only a fraction of the hell.
How the Two War Criminals Take Responsibility?
Did the Ministry of Economy, Trade and Industry ("METI") of Japan recognize this poisonous plate? In fact, the official who encouraged Toshiba to jump into WH was Tadao Yanase, now Director-General of Economic and Industrial Policy Bureau., at that time was at the Agency for Natural Resources and Energy as the Director of Nuclear Energy Policy Planning Division. He championed nuclear energy as Japan's national strategy. After that, he sat as an aide of Prime Minister Shinzo Abe, and now being number 2 of the whole METI, but he remains silent now. According to a person familiar with the situation, METI in December 2015 was anxious to let Toshiba avoid negative equity in March 2016 fiscal year, and did not notice on the poisonous plate. After Toshiba Medical was to be sold to Cannon and Toshiba's equity would be held positive, then number 3 of METI, Takashi Shimada, and Deputy Vice Minister, sounded to Hitachi and Mitsubishi Heavy whether they were interested to buy WH. Hitachi, having heard the inside story of WH from its own partner GE, and Mitsubishi Heavy's president Shunichi Miyanaga who knows CB&I well from his stint at Chicago Business School, both felt something was wrong with WH to have bought S&W, and did not move.
In June 2016, when Taizo Takahashi who was number 2 at Agency for Natural Resources and Energy moved to the METI Deputy Vice Minister position, he again asked both Hitachi and Mitsubishi to buy WH. As Takahashi was the successor of Yanase as the Director of Nuclear Energy Policy Planning Division, he tried to let the flinching two companies to buy the stake indicating the matchmaking effort as a "will of METI as whole", but the two companies questioned WH's cost over-run at reactors in China and India. Takahashi also said that the first impairment in March cleaned up the nuclear division, and WH's financial numbers are fully reviewed by American auditors.
At last, Hitachi and Mitsubishi Heavy did not mess around with the impaired company, but Takahashi must be blamed had he knew the bruise at WH. If Toshiba falls into the second quagmire, the hidden war criminal, namely Yanase and Takahashi must be responsible. Knowing such process, Ikuro Sugawara, the Vice minister of METI is said to be whining that he gave up to sit on the current position for another term.
The Japanese government carries a big hurdle of renewing U.S.-Japan Nuclear Energy Agreement in 2018. If U.S. Government is discontent with Japan ill-treating WH who owns intellectual properties of nuclear reactors, a possible non-renewal of the agreement stops all the nuclear power plants in Japan. The new Trump Administration, claiming "America First", may take the renewal of the agreement as a hostage, may not allow WH going bust. Prime Ministerial Office might have been predicting the "Toshiba second round" at some point of time.
In the "Toshiba first round", Kenichi Sado, the head of Securities and Exchange Surveillance Commission, craved to indict the three past presidents of Toshiba, but Ministry of Justice and the Prosecutors Office blocked, as the Prime Ministerial Office intervened by hinting; "Toshiba still has gotten another big issue". Takaya Imai, the top secretary of Shinzo Abe, an old boy of METI, who once himself involved the scene clandestinely, slipped out from the case, sensing a danger. If these government officials all knew and did not make the bruise public, wasn't that a collaborated concealment by government and industry?
Businessmen in private sector cannot be immune as well. Yoshimitsu Kobayashi, Chairman of Mitsubishi Chemical and head of Keizai Doyukai, a business roundtable, is sitting as the chair of the nomination committee at Toshiba, asked by Toshiba former chairman Taizo Nishimuro. He was responsible on nomination of Satoshi Tsunakawa, president, and Shigenori Shiga, chairman, both of them anointed by Nishimuro. NHK and other media chased Kobayashi to get a comment in this New Year, but he escaped claiming "a rest at recluse".
Such a turmoil occurs similarly at AREVA, a French nuclear reactor maker. The construction of new reactors at countries like Finland got stuck with litigation against local power companies. Skyrocketing costs with tighter regulation derived a management crisis. The French Government underwrote €5 billion (650 billion yen) worth of new shares, and the nuclear reactor business of AREVA was bought by EDF, a national power at €2.5 billion . Mitsubishi Heavy, jointly developing new-generation reactors, will invest 60 billion yen to the new firm, along with Japan Nuclear Fuel, a semi-government entity.
Road to "Japan Nuclear"
The formula of AREVA case, seems impractical in Japan, as the biggest power company, Tokyo Electric Power is toiling with Fukushima reparation and has no fitness for further burden. Toshiba held a conference with banks in January 10th. It just said to speed up loss amount to be confirmed, and insisting "cash management in the March year end is not worrisome". Loan from banks add up to 800 billion yen, including 110 billion each from SMBC and Mizuho, but the bankers doubt sustainability of WH and barely complying with Toshiba's plea with only short-term bridge loan, and never agreeing equity injection or subordinated debt. That leaves government equity injection as the last option.
Jeffrey Inmelt, the GE Chairman, stated; "it is difficult to justify nuclear reactor business any longer", and retreating from it. German Siemens, complying the government direction of nuclear exiting, disbanded a joint venture with AREVA, achieved full withdrawal from nuclear business, quoting "lack of economic rational".
Yet, Japan Inc., still sticks to the nuclear power. Led by METI guidance, Toshiba, Hitachi, and Mitsubishi Heavy are negotiating an integration of nuclear fuel business. One step ahead of it lies a full integration of nuclear reactor business. If METI-sponsored Innovation Network Corporation of Japan ("INCJ"), a private equity sovereign fund invests into equity, one "Japan Nuclear" will be formed. But, motley bunch spoiled by taxpayers' money will not be a final solution. The dismal status quo of Japan Display Inc., a hodgepodge of losing small LCD businesses carved out from Hitachi, Toshiba, and SONY, which was capitalized by 200 billion yen from INCJ proves nothing but an outright failure of METI-led industrial policy. Toshiba, with back-to-back impairments, has no other option but to submit nuclear business to the government, and sell the semiconductor business in a spin-off IPO, leading to a disbandment of Toshiba Group, with 190,000 employees on board. It may be a consequence of the "America First".