Toshiba’s Continuing Struggle to Stave off Bankruptcy

Toshiba was one of Japan’s best-known electronics and machinery companies, with operations all over the world. But in addition to accounting irregularities that came to light two years ago, the company’s sudden December 2016 announcement of huge losses has left its reputation in tatters. The company is in danger of being delisted from the Tokyo Stock Exchange and its plunge into negative net worth puts it at risk of bankruptcy. Below I explore why Toshiba’s abnormal situation is continuing and what lies ahead for the company.

Improperly Posted Losses

Toshiba submitted its annual securities report for fiscal 2016 (April 2016–March 2017) to the Kantō Local Finance Bureau on August 10 and held a press conference the same day to announce its annual earnings results. The results should have been announced in May, but after being granted an extension the company submitted its annual securities report to the tax authorities six weeks past the usual end-of-June deadline. It is rare for a listed company—and exceedingly so for a giant concern like Toshiba—to be unable to announce its results and submit its report by the deadline.

The delay was due to auditor PricewaterhouseCoopers Aarata withholding its approval of the content of Toshiba’s annual securities report. What were the events that led to this?

On December 27, 2016, Toshiba announced that Westinghouse, its American nuclear power subsidiary, had suffered major losses in connection with nuclear power plant construction in the United States. Attributing the losses to construction delays and major cost overruns, Toshiba said that it would write down ¥652.2 billion on its books for April–December 2016. But PwC Aarata objected, finding it strange that such a substantial loss surfaced only in December 2016 and claiming that Toshiba and Westinghouse were likely to have known of the loss much earlier. The auditor maintained that the loss should have been taken in the 2015 fiscal year.

It is not unusual for companies to suddenly post losses. For example, many Japanese firms recorded huge losses after sales dropped sharply following the 2008 global economic downturn and again because their production facilities were damaged following the devastating March 11, 2011, Tōhoku earthquake and tsunami. However, it is unheard of for a company to suddenly put losses amounting to several hundred billion yen on its books for no justifiable reason.

When Westinghouse acquired nuclear plant builder Stone & Webster in December 2015, Toshiba requested a quote on construction costs from a different subcontractor and learned that due to increases in wage and materials costs, the costs of projects on the subsidiary’s books would be substantially higher. After spending a year examining the quote, Toshiba announced that it would have to write off ¥652.2 billion as a loss on its construction cost reserve.

But PwC Aarata maintained that Toshiba would have discovered the loss earlier had it obtained a provisional quote based on Stone & Webster’s figures, and refused to sign off on its audit. It ultimately offered qualified approval, meaning in essence that although it approved other parts of Toshiba’s financials, it rejected Toshiba’s assertion concerning when it had learned of the Westinghouse loss.

For its part, Toshiba put the qualified approval down to a difference of opinion and announced that its balance sheet had returned to normal. The fact remains, however, that PwC Aarata declared part of Toshiba’s accounting unacceptable, further damaging the manufacturer’s reputation.

Negotiations over the Toshiba Memory Sale Drag On

Westinghouse filed for bankruptcy in March 2017 and applied for reorganization under the US bankruptcy code. In addition to losses associated with nuclear power plant construction, Toshiba was forced to shoulder Westinghouse’s loan guarantees, putting it on the hook for losses of ¥1.24 trillion as a result of Westinghouse’s collapse. This left Toshiba with negative net worth of ¥550 billion at the end of March.

A company has negative net worth when liabilities exceed assets and even selling its assets will not generate enough money to cover its debts. Any major enterprise with massive liabilities of more than half a trillion yen would normally face bankruptcy, going into administration under the Corporate Reorganization Law or the Civil Rehabilitation Law.

But in Toshiba’s case, there are two reasons why this is unlikely to happen. First, Toshiba has decided to sell Toshiba Memory Corp., its highly profitable flash memory chip unit, enabling it to cover its losses with the roughly ¥2 trillion it expects from the sale. Second, working on the assumption that Toshiba will sell Toshiba Memory, bank lenders have formed a consortium to support the company. The banks are well aware that hounding Toshiba to repay its loans will cause it to fail, leaving the banks with soured loans on their books. Knowing this risk, they are prepared to wait for the sale of the chip unit, proceeds from which will be more than enough to cover Toshiba’s red ink.

Toshiba spun off its chip unit and decided to sell a majority or all of the company’s shares. After numerous efforts to attract lenders, on June 21 Toshiba decided to give preferred bidder status to a group led by the Innovation Network Corporation of Japan, a turnaround concern backed by the Japanese government, and also including the government-affiliated Development Bank of Japan, US investment fund Bain Capital, and Korean IT giant SK Hynix.

But although two months have elapsed since Toshiba gave this group preferred bidder status, no deal has been reached. Negotiations stalled because SK Hynix could not decide whether it would be an investor or a lender in the deal, which also needs to clear regulatory screenings in the countries involved after an agreement is signed. If Toshiba takes any longer to finalize the unit’s sale, it might not meet the deadline of getting its books in order by March 2018, since screening by each country’s authorities is expected to take six months or more.

If the sale is not concluded by that time, Toshiba, having recorded negative net worth for two years running, will be delisted from the TSE. It had already been demoted from the exchange’s first section to its second section in August because it recorded negative net worth for the first time at the end of fiscal 2016. Delisting would mean that Toshiba’s shares could not be traded on the market, making it difficult for investors to buy or sell. The company would also be unable to raise money on the market, a second major blow that it can ill afford.

Time Running Out

What lies in store for Toshiba now? In the best-case scenario, it sells its flash memory chip business, the deal is cleared by the antitrust authorities by the end of March 2018, and Toshiba resolves its negative net worth issue.

But things are not likely to go that smoothly. Even if a buyer for its memory chip business is found by the end of August, there is no guarantee that the regulatory authorities in each country will clear the deal by March next year. If that happens, Toshiba will have run out of time and will be delisted.

Does delisting mean that Toshiba will go bankrupt? Bank lenders hold the key to that answer. Right now, the bank consortium is continuing to support Toshiba. If the sale is concluded and the final step looks likely to gain regulatory approval in Japan and the other countries, Toshiba’s main banks will most likely continue supporting it even if it is delisted next March. A firm commitment from the consortium will likely keep Toshiba afloat for the time being.

But if the sale fails to go through and months go by with no solution in sight, the banks may change their tune. The prospect of bankruptcy will become real if Toshiba is delisted without having brought off the sale of its chip unit.