Those who fail to learn from history are doomed to repeat it. This phrase unfortunately rings true for the Toshiba Corporation (“Toshiba”) as it faces yet another accounting crisis. On February 14, Toshiba delayed the announcement of its third-quarter financial results for fiscal year 2017 due to alleged inadequate internal controls related to the acquisition of CB&I Stone & Webster (“S&W”) by Toshiba’s US-based nuclear power subsidiary, Westinghouse Electric Company (“WEC”). As we foresaw in our 2016 season review, “What Happens Three Times Will Happen Four Times,” it has happened again. After nearly two years of embarrassing announcements and poor crisis management, the latest allegations raise questions over the continued reign of the multinational Toshiba Empire.
There seems to be no end in sight for Toshiba’s problems. The initial discovery of accounting fraud in 2015 led to revelations of concealed impairments at WEC in late 2015 and further discovery of accounting fraud in early 2016. Consequently, at the 2016 AGM, Toshiba completed a total overhaul of its board of directors, including the appointment of a new chair and CEO, and a pledge for greater transparency in order to reform the company’s governance structure. But given recent events, these promises appear to have been empty.
The delay of the third-quarter financial results was due to alleged inadequate internal controls over the Purchase Price Allocation process for the acquisition of S&W by WEC. While the full effect to the financial statement is still unknown, Toshiba expects to book a ¥712.5 billion writedown in the nuclear power business in the United States, which will lead to a ¥499.9 billion net loss for the first nine months of fiscal year 2017. Further, Toshiba is facing possible asset deficiency at the fiscal year end, which may result in their downgrading from the Tokyo Stock Exchange’s first section to second section.
So what happened this time? On February 14, following the notice of the one-month postponement of its quarterly report, Toshiba held a press conference to announce the unaudited financial results of the first through third quarters of fiscal year 2017 along with some troubling news:
- Losses due to impairment of goodwill in the nuclear power business in the United States totaled ¥712.5 billion;
- Toshiba’s equity at the end of December 2016 is negative ¥191.2 billion, meaning its debts exceed its assets;
- At this rate, Toshiba will have a net capital deficiency of ¥150.0 billion at the end of the fiscal year;
- Multiple internal reports from January suggested inadequate internal control over the acquisition of S&W by WEC;
- Submission of the quarterly report was postponed in order to conduct an extended investigation on the possible corporate scandal before finalizing the financial results;
- Shigenori Shiga, the chair of Toshiba, would resign from the board effective February 15, 2017, and Mr. Danny Roderick, president and CEO of Energy System Solutions Company of Toshiba and chair of WEC, was dismissed from his positions at Toshiba effective February 14, 2017; and
- Toshiba may sell a majority stake when spinning off its memory business, including its core business of NAND flash memory, as opposed to its previous plan to sell less than 20% to raise more than ¥200 billion.
The current financial and corporate woes stem from the acquisition of S&W, which originally cost WEC $229 million (approximately ¥27.5 billion) and took place at the end of December 2015, in the midst of Toshiba’s accounting scandals. Prior to the acquisition, S&W was a partner of WEC and engaged in several joint nuclear plant projects in the United States. However, the joint projects were fraught with problems. As such, in 2015, WEC decided to consolidate the development projects under one umbrella in order to facilitate construction. The management of Toshiba, who had enough problems on their plate, judged it to be “more advantageous than risk.” However, after the acquisition additional costs were discovered, and it turned out that the consolidation would not bring about efficiency improvements as initially envisioned. At least that is the explanation provided for the huge impairments booked in the year since the acquisition.
In September 2012, Mr. Shiga, who was the chair and president of WEC at the time, brought Mr. Roderick on as the president of WEC from a joint nuclear power company between General Electric and Hitachi. This move coincides with the start of the concealing of losses at the subsidiary.
Reviewing these ongoing problems, it appears that Toshiba’s failure is rooted in its overly proud corporate culture: the company does not accept failure. Reports of undesirable financial results were rejected, even if they reflected the true realities of the company. Senior management would demand better figures and would not settle for anything less. With the truth unacceptable, employees at Toshiba apparently sought ways to cook the books. To say the least, such conduct is far from the transparency that shareholders expect from a listed company.
What is truly shocking is that despite its pledge to bring about reform, the new revelations provide clear evidence that the same problems have been allowed to persist.
According to the recent news coverage, Mr. Roderick and other WEC executives are alleged to have placed inappropriate pressures on subordinates to fabricate the impairment loss amount reported as a result of the asset assessment at S&W. This means Toshiba, a company which has already been designated as a “security on alert” by the Tokyo Stock Exchange, was still conducting the very acts they have been reprimanded for.
Toshiba shareholders have been through a lot over recent years, and their patience may have reached its limits. If true, the current allegations suggest egregious mismanagement and negligence on the part of the board, particularly Mr. Shiga (whose area of specialty is the nuclear power business), the CFO, and members of the audit and nomination committees; moreover, they undermine the credibility of the company’s pledge to improve governance and transparency. Countdown for Toshiba Empire’s destruction has begun. Whether or not a stay can be achieved will be solely up to Toshiba.