JDEX Update

Last December we introduced our index for the New Economy in Japan. How's it performing so far?

December 29, 2000:	10,000
February 2, 2001:	10,949
Percent change:	+9.49%

Taking their cue from the Nasdaq's fall in the US, Japan's tech stocks in particular got hammered. With the R-word (recession is defined as three consecutive quarters of negative growth) entering market talk in the US, Japan investors in 2001 are likely to emphasize domestic-demand stocks and defensive stocks in sectors such as pharmaceuticals and utilities.

Of course, Japan still has economic and political problems of its own, which cannot be blamed on the flight of foreign investors.

The two new markets for venture companies, Mothers and Nasdaq Japan, have yet to fully earn the trust of investors amid lingering concerns of liquidity and quality of issues.

Mothers' reputation in particular has been tarnished by worries over the involvement of the Japanese yakuza (mafia) in its listed companies. The former president of Liquid Audio Japan, Masafumi Okanda, was arrested last year for kidnapping a former colleague who made moves to launch a competing online music business. Okanda is also suspected of being responsible for having hired yakuza cohorts to fire a couple of well-aimed rounds into the offices of competitor Digicube, which was also entering the online music turf. The exchange now conducts background checks on its candidates.

One of the biggest concerns this year for Japan investors is the effect that the unwinding of cross-holdings may have on stock prices toward the end of the fiscal year through March 2001. Aimed at improving financial transparency, new mark-to-market accounting rules from April 2001 will require Japanese companies to report financial holdings at market value rather than book value (purchase price). With greater pressure to explain unproductive equity holdings, many companies may unwind their cross-holdings, raising the supply of these stocks on offer to buyers.

Unlike their overseas counterparts, politicians in Japan, however inept they may be, are rarely made the butt of jokes by the mainstream media. But the Japanese news media did have a little fun at Prime Minister Mori's expense when it juxtaposed his IT revolution mantra with a televised scene of him using a computer for the first time. It took the PM some time to locate the two keys required to type the word "IT." And when faced with the mouse, Mr. Mori cradled it with both hands, unable to ascertain the precise function of the device. The lesson is perhaps that we should not rely too much on the government for guidance on technology matters.

Despite what the politicians say, will IT be the growth driver for Japan's economy? While we honestly do not expect the new JDEX to surge in 2001, we think it will be useful as an indicator of how New Economy stocks fare relative to Japan's broader economy.

Toy Story
While tracking of the JDEX did not commence until the start of 2001, of the 20 component stocks, Bandai was the sole gainer in 2000. Thanks to better-than-expected growth in sales of TV and animation character toys as well as the withdrawal from unprofitable businesses, Bandai forecasts a seven-fold jump in group net profit to ¥10 billion for the fiscal year ending March 2001.

Online Trading
On the one hand, the enormity of Japanese consumer savings is too large to ignore. On the other hand, Japanese individual investors, by and large, have not shifted their funds from postal savings into the stock markets. And in a bear market, we can expect them to remain ever more skittish.

Although many new retail brokerages have popped up within the past year and a half, fierce competition is forcing consolidation within the industry. Monex's planned acquisition of Saison Securities (a subsidiary of Credit Saison) this June is just one example. Monex founder Oki Matsumoto has also mentioned the possibility of a merger with DLJdirect. Matsumoto believes there may only be about five online brokers left standing in the end.

The key to survival is increasing the number of accounts, and brokers are devising creative ways to do so. In an effort to attract and educate first-time investors, Monex is selling a Tokimeki game fund, whose returns are linked to future sales of Konami's popular virtual girlfriend game software. This asset-backed security is the world's first content securitization product to be offered publicly to individual investors. A similar kind of security called David Bowie bonds, linked to earnings from music recordings, was available only to institutional investors via private placement.

Internet Stocks
Even die-hard tech investors have lost their Tokimeki (yearning palpitations) for pure Internet plays. This has not stopped believers such as Softbank's Masayoshi Son, who continues to invest in even more Internet companies. Last December, Forbes Global magazine named the Softbank founder Businessman of the Year. Forbes prefers to see him as a "visionary entrepreneur" who may help transform the world's second-largest economy rather than an example of "the worst excesses of the Internet bubble." Investors may not agree, as Softbank's share price has continued to slide despite a significant improvement in earnings on the back of restructuring an unprofitable US subsidiary.

WEEKLY PERFORMANCE

Note: Nikkei 225 figures adjusted to fix JDEX scale.

Speaking of wireless, we decided to drop MTI (Mobilephone Telecommunications International) in favor of Cybird in the JDEX. We originally suggested MTI when we previewed the JDEX in December since it represented the only mobile phone content play available to public investors. However, Cybird debuted on the Jasdaq OTC shortly before the JDEX commenced, and is a purer play in terms of mobile content. MTI is moving away from its low-margin mainstay cellphone sales business, but the content business still represents less than 20 percent of its revenues. Distributing over 60 content offerings to all the major Japanese wireless carriers, including all-important DoCoMo, Cybird is Japan's (and by extension the world's) first and foremost wireless Web content provider. Content site subscription fees account for 90 percent of Cybird's revenues, although the company is expanding into mobile e-commerce and solutions services.

While MTI says that its mobile content business is already profitable, Cybird is still bleeding red ink. Cybird's founder Kazutomo Robert Hori attributes deepening losses to its investment in development for upcoming Java-enabled cellphones. The company established a subsidiary, K Laboratory, last August to specialize in Java-based mobile content. For the fiscal year through March 2001, Cybird expects a 680 percent rise in revenues but group pretax and net losses of ¥1.13 billion. Hori hopes to move into the black the following fiscal year.

Trying to meld both the cellphone and TV with its Internet commerce site is online shopping mall operator Rakuten. Rakuten will have likely seen a group net loss in the fiscal year ending December 2000 due to a write-off of the ¥8.5 billion in goodwill (the difference between the purchase price and value of assets) it took on with the purchase of Infoseek Japan and three other Internet-related affiliates. But investors are unsure whether its aggressive plans to expand into all media will offset the slowdown in growth of its tenants, its main source of income.

Telecom
Round two of the wireless battle will be fought when NTT DoCoMo becomes the world's first operator to roll out 3G wireless phone services in May.

Although still Japan's largest stock in terms of market capitalization, NTT DoCoMo lost half of that over the Year 2000. DoCoMo is aiming to fund its overseas expansion, such as its trillion-yen, 16 percent stake in AT&T Wireless, with the issuance of new shares rather than through debt. At the time of writing, DoCoMo was contemplating a ¥1 trillion public offering of new shares on the Tokyo market in February 2001 and a listing on the New York market sometime later in the year. But concerns that the new issuance could cause a supply-demand imbalance have kept DoCoMo shares in sleep mode.

Shares of NTT rival Japan Telecom responded favorably to UK-based wireless carrier Vodafone's acquisition of West Japan Railway and Central Japan Railway's combined 18 percent stake in Japan Telecom. Vodafone already owns a 26 percent stake in Japan Telecom's mobile unit, J-Phone. There is also speculation that AT&T will sell its 15 percent stake in Japan Telecom, perhaps to either British Telecommunications or Vodafone, given DoCoMo's new stake in AT&T Wireless.

IT Manufacturers
Share prices of electrical machinery giants such as Fujitsu and NEC have been hampered by concerns over softening worldwide semiconductor demand. Attention has been turned toward manufacturers in areas such as specialized electronic components, WDM (wave division multiplexing), and glass and ceramics, mostly for the domestic market. In fact, NEC-affiliated Anritsu Corp. topped the list of gainers in 2000 with a 275-percent share price rise over the year, thanks to strong sales of WDM-related equipment.

NEC itself is in the midst of overhauling its manufacturing operations. Rather than trying to make everything by itself, it will sell off some of its overseas plants and outsource low value-added manufacturing. The company also plans to list its shares on the New York Stock Exchange sometime this year.

Fujitsu is reforming its business by concentrating resources on open computer systems like UNIX servers instead of IBM-compatible mainframe computers. As part of this restructuring at its wholly owned US computer unit, Amdahl Corp., Fujitsu is to book a special ¥55 billion loss in the fiscal year through March 2001. Fujitsu will focus in particular on the burgeoning file storage system business, selling its own SAN (storage area network) systems and OEM-supplied NAS (network attached storage) systems.

Slowing sales growth warnings by PC makers in the US contributed to the Nasdaq's decline at the end of last year, but sales growth in Japan remains healthy. Domestic shipments of PCs last April-September rose 28 percent from the year before. Sotec's first fiscal half pretax profits through September 2000 soared 210 percent from a year earlier to ¥2.29 billion, thanks to higher sales and the customer shift from sub-¥100,000 beginners' models to more expensive, higher-performance models.

The Japanese markets will see their first tracking stock this year, issued by Sony for its wholly-owned subsidiary SCN (Sony Communication Network), which operates Sony's ISP So-net. Sony decided to issue a tracking stock rather than take SCN public because it allows the parent to raise funds while retaining 100 percent control over the subsidiary. The price of tracking stocks are linked to the performance of the subsidiary. Holders of SCN tracking stocks will be given restricted voting rights, rights to receive dividends linked to those paid by SCN to the parent, and rights to convert them into ordinary Sony shares.

We may see more tracking stocks from Japanese companies who feel certain high-growth divisions or subsidiaries are hidden in the parent's shadow, as an alternative to spinning them off in IPOs.

All figures compiled by J@pan Inc editors, except weekly closing prices, which were provided courtesy Credit Suisse First Boston's Tokyo Research Office.