[Intl-tobacco] Japan Tobacco looks abroad

[Robert Weissman]

Smoke Alarm / The world's third-largest cigarette maker, Japan Tobacco,
now looks to Asian markets for future growth. But is its staid management
up to the challenge?

by Chester Dawson / TOKYO / Issue cover-dated June 22, 2000
Source: Far Eastern Economic Review, Thursday, 6/15/00

STARING OUT of a window on the 33rd floor of the Japan Tobacco building,
which towers over Tokyo's main government district, Masaru Mizuno surveys
the heavy clouds blocking the view of Mount Fuji southwest of the city.
"You can't see very far when it's overcast," says the company president,
who's soon to become chairman. "It's like the Japanese economy."

The same can be said of Japan Tobacco, which faces a hazy future despite
its commanding position in its home market and the purchase last year of
RJR Nabisco's international tobacco operations.

A slumping stock price shows the former state-run monopoly faces plenty of
problems. Chief among them: Profits have stagnated, forcing JT to trim its
payroll and close factories at home in order to streamline operations.  
Moreover, Japan's population of smokers is expected to peak by 2007, in
line with the overall population. More importantly, concerns about
antitrust violations prevent JT from expanding its dominant market share
in Japan.

These constraints have forced the staid company, a haven for
ex-bureaucrats that was established by government charter in 1898, to plot
a radical new course. "We don't have any choice but to go abroad," says
former tax-agency head Mizuno, 67, who began smoking in earnest only just
before his appointment as president in 1994. "Our new focus is on Asia and
other international markets."

For an inward-looking workhorse like JT, morphing into a global warhorse
presents a big challenge--but perhaps not an insurmountable one. That's
because the company is seeking its fortunes in other national markets in
Asia--the tobacco industry's most fertile region for growth and one where
JT already has a limited presence.

What's more, it has reinvented itself before. In 1985, the company was
privatized and forced to compete on its home turf after Japan's cigarette
market was opened to imports. Since then, it has ceded only about 25% of
the market to the likes of British American Tobacco and Philip Morris.
JT's marketing prowess and reputation for high quality enabled it to hold
its own at home and establish strategic toeholds in South Korea and
Taiwan, where it has intentionally grown slowly to avoid trade friction.

A huge war chest also helps. A year ago JT paid $7.8 billion in cash for
RJR Nabisco's tobacco business outside the United States--the biggest-ever
foreign acquisition by a Japanese firm. It made JT the world's
third-largest tobacco company with about 8% of the global market. The deal
secured three key brands:  Camel, Salem and Winston. Terrence Oliver, head
of the Tokyo office of international brand consultancy Interbrand, says
that was a smart move, because smokers are becoming more brand-conscious.
Indeed, annual sales of so-called global brands are increasing at about 5%
a year, compared to the average 1% growth in overall cigarette sales.

The deal also gave JT an established position in the former Soviet Union
and Eastern Europe. But the Pacific Rim is where Big Tobacco sees its
future. The region accounts for more than 40% of the $330 billion in
annual global cigarette sales and two of the world's largest cigarette
markets--China and Japan. Mizuno says JT is initially targeting Southeast
Asian nations such as Malaysia, Singapore and Thailand for a marketing
push to expand sales of its flagship Mild Seven brand. By far the biggest
market, however, is right next door in China, which consumes 1.7 trillion
cigarettes a year.

The Chinese government's tobacco monopoly severely limits inroads by
foreign cigarette makers, but that's expected to change once the country
joins the World Trade Organization. The state-run China Economic Times
reported in May that domestic cigarette brands "could lose 10% to 20% of
their market share within five years" of the country joining the WTO.

As a first step, JT reached a deal last year to consign production and
sales of Mild Seven in China to Shanghai Gaoyang International Tobacco.
Though company officials are reluctant to talk about China strategy, they
hint that JT may eventually invest in a joint venture--something that's
currently prohibited in China's tobacco industry. "If China becomes a
member of WTO it will create new opportunities for us," Mizuno says
cryptically.

Of course, major players like British American Tobacco and Philip Morris,
which each have roughly 15% of the world market, also want to expand in
China. And as it squares off against these rivals, JT must contend with
the vicissitudes of far-flung markets to a greater extent than ever
before. Mizuno says overseas operations, which in volume terms made up
about 5% of total cigarette sales before the purchase of RJR's
international business, now account for closer to 40%.

Oddly, though, Mizuno insists that "nothing has changed" in terms of
day-to-day management at the company's headquarters since the takeover.
That could pose a problem in future: Success abroad will depend on JT's
managerial moxie, which some observers say is in short supply, especially
when it comes to foreign markets. "They've done a very good job close to
home, but not so good further away," says James Sculley, president of
Philip Morris's unit in Japan. While Mild Seven has made inroads in Asia,
it has failed to sell well in Europe and America.

Managing JT's newly acquired empire will test the acumen of Katsuhiko
Honda, who takes over as president when Mizuno becomes chairman later this
month.  Honda, 58, won kudos within the company for spearheading the
negotiations with RJR Nabisco. He will be the first nonbureaucrat to rise
through the JT ranks to the top job since the company was privatized 15
years ago. But he has got his work cut out for him.

In fact, JT came under heavy criticism in the domestic media for paying
too much in the RJR deal, which was concluded just before sales tanked in
Eastern Europe and Russia. Company officials admit the transaction was
ill-timed and has weighed on earnings more than anticipated. In May, JT
posted a 32% drop in group net profit to Yen51 billion ($475 million) for
the year to March 31 on sales of Yen4.4 trillion. It projects profit will
fall to Yen35 billion in the current year. Even those numbers may prove
optimistic because of a downturn in European sales due to factors such as
higher cigarette taxes in Germany. "I'm sceptical about their forecast,"
says Keiko Sasaki, an analyst at UBS Warburg (formerly Warburg Dillon
Read), who rates the stock a "hold."

Still, JT enjoys some clear advantages at home over other big tobacco
companies that could cushion the blow from any missteps abroad. For one,
its majority shareholder has few complaints. That's because the company is
two-thirds owned by the Finance Ministry, which views it as something akin
to a sacred cow for tax revenue. The firm also has the support of
heavy-hitting politicians in Japan's ruling party; they recently gutted a
Health Ministry plan to halve the number of smokers in the country by
2010.

Then there's the Japanese legal system, which frowns upon class-action
suits.  JT officials say they are not interested in insuring the company
against legal action, citing a flawless record in court. That's one reason
why some investors consider JT a safe bet. Another is its projection for a
sharp profit upturn in the coming years. A business plan released in
February commits the cigarette maker to wringing out a profit of Yen140
billion from sales of Yen4.8 trillion by the year ending in March 2005.

Bullish analysts say those goals are achievable thanks to JT's stable of
world-class brands and the industry's high profit margin. "We believe they
can make it work," says Morgan Stanley Dean Witter analyst Taizo Demura.

For that to happen, though, JT will also need contributions from its
loss-making food and drug units. It is now pouring money into
biotechnology research to develop strains of genetically modified rice
and, not without irony, a drug for lung-cancer treatment. Yet JT's track
record for noncore investments is mixed. Previous forays in the 1990s
included such flops as mushroom cultivation and a sports-club venture.

JT officials admit that changing the company's corporate culture enough to
allow it to become a thriving global player won't be easy. As Mizuno
notes:  "Even changing our company's name would require an amendment of
law."