Canon's main business faltering in face of shrinking sales

Updated : 14.02.2017 / Category Corporate Investigations

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As the countdown echoing around the Uchinoura Space Center in Kagoshima Prefecture in southern Japan reached "zero" at 8:33 a.m. on January 15, a rocket blasted off straight and true into the brilliantly clear sky. The takeoff went without a hitch, but just 20 seconds later, success instantly turned into failure.

The telemetry data—including data on such factors as position, altitude and speed—sent from the rocket to the space center suddenly cut out. Ignition of the rocket's second-stage engine was intended to be triggered by transmissions sent from the space center. But with the telemetry disrupted, ground controllers were unable to confirm the condition of the rocket, and pushing ahead with the ignition carried the risk of sending the craft into an unexpected flight path. The ignition was aborted and the entire rocket plunged into the sea where the first stage had been expected to come down.

The Japan Aerospace Exploration Agency's project to launch the SS-520 No. 4 small rocket and send a microsatellite into space had quickly ended in failure. The rocket is just 9.5 meters long, less than one-fifth the size of JAXA's main H-IIA launch vehicles. The SS-520 had been produced on a shoe-string budget by incorporating commercially mass-produced electronic devices, the first time such a public-private partnership had been implemented in Japan's rocket program. If the SS-520 had succeeded, it would have been the world's smallest rocket to launch a satellite and been a sparkling opportunity to expand Japan's space business. Those expectations appear to have been dashed.

Pride comes before a fall
The rocket failure stung Canon Inc., which had been heavily involved in this project. The Tokyo-based company had dispatched engineers and been a major driver of efforts to keep costs down. Subsidiary Canon Electronics Inc., a manufacturer of precision components for laser scanners and camera shutters, had played a central role by developing and making the avionics equipment fitted to the rocket to control its trajectory. Canon had combined the design and production methods honed in its digital camera and multifunction printers with its expertise in parts procurement to bring down the cost of the avionics equipment. It managed to make this computer small and light enough to fit on this small rocket.

In autumn 2016, Canon finished its self-designed miniature satellite. The 65-kilogram CE-SAT-1 is an Earth observation satellite measuring 50 centimeters long and wide, and 85 centimeters high. Loaded with photographic equipment harnessing Canon's digital camera technology, the satellite's development and production cost under ¥1 billion—less than one-tenth of similar satellites made by other companies. Canon has inked a deal with the Indian Space Research Organisation, which has been involved in rockets for commercial satellite launches. A launch date of March this year has been booked at the space center in southeast India. Canon plans to test the accuracy of the photography equipment for its first two years in space and also start looking for future clients. The company has a blueprint to have its satellite-related business earn ¥50 billion annually by around 2020 and ¥100 billion in 2030.

However, not everyone shares Canon's positive outlook. "Using commercial products for rocket avionics should require technological development sparked by new ideas. Just adapting digital camera technologies and the like won't be enough," said one aerospace industry insider, pointing to Canon's overconfidence and superficial understanding on this issue. Avionics for a rocket and for a satellite "are completely different," the insider added. Indeed, since the turn of this century, the use of commercial products has rapidly expanded in satellites, but there have been "almost no examples" of this in rockets, a source at NEC Corp. explained.

Rockets fly at incredible speeds. Just because a company has the skill to make satellite avionics, that is no guarantee this system can be quickly transferred to rocket avionics.

Fear of being left behind
So why has Canon, which holds more than 50 percent of the global market for single-lens reflex cameras and also has major slices of the global pie for cameras and office equipment, turned its hand to the unfamiliar space industry? The overriding reason is an intense sense of urgency that Canon is being swamped by changes in the structure of its existing primary businesses due to the spread and increasing capabilities of smartphones and other devices.

On January 31, Canon announced its results for the fiscal year ending in December 2016. Though the yen depreciated near the end of the year following the election victory of U.S. President Donald Trump, which helped Canon's bottom line, the company had revised its business forecasts downward in April, July and October last year.

Consolidated group sales were originally forecast to be up 1.3 percent year-on-year to ¥3.85 trillion, but this was gradually reduced to ¥3.6 trillion (a year-on year decrease of 5.3 percent) in April; to ¥3.52 trillion (a drop of 7.4 percent) in July; and to ¥3.36 trillion (a drop of 11.6 percent) in October.

The rapid strengthening of the yen during this period certainly had a significant impact on Canon. About 80 percent of Canon's sales are made abroad. For every yen the currency loses against the value of the dollar, Canon's operating profit drops about ¥5 billion annually. For every yen it loses against the euro, operating profit falls about ¥3 billion.

However, the shrinking sales volume of Canon products such as compact digital cameras and office printers also has had a major impact. In particular, the decline in the number of digital cameras still shows little sign of being turned around.

If Canon does not boldly restructure its business and establish new operations while its main businesses stubbornly hang on to their existence and the company has the financial wherewithal to make such changes, it likely will eventually wither.

Questions over Toshiba subsidiary purchase
At the end of June 2016, Japan's Fair Trade Commission took the unusual step of issuing a written warning to Canon regarding its proposed acquisition of shares of medical equipment maker Toshiba Medical Systems Corporation (TMSC). In March that year, Canon had announced it was purchasing the Toshiba subsidiary. The commission stated there were suspicions Canon's purchase scheme had legal flaws, and in addition to issuing the warning took the unprecedented step of publicly announcing its warning.

The deal was structured so voting rights of TMSC were temporarily transferred to MS Holdings, a paper company set up by a third party and capitalized at just ¥30,000. Canon would pay ¥665.5 billion for one "class share" and share warrants that could exercise voting rights only after the deal had cleared reviews to ensure it did not violate competition laws, including Japan's Antimonopoly Law.

Under the Antimonopoly Law, a company that notifies the purchase of shares to the authorities cannot acquire the shares for 30 days. However, MS Holdings, which had zero sales, was not obligated to provide this notification. Canon could transfer and acquire the TMSC shares without waiting for the deal to be checked by the competition watchdog.

At the time, Toshiba was mired in red ink due to huge losses following an accounting scandal, and was at risk of falling into insolvency. To prevent this, Toshiba desperately needed to book proceeds from the sale of TMSC shares before the end of March 2016. If Toshiba had waited for the commission to review the deal, it would not have been completed in time.

The commission eventually approved the acquisition, although it stated the series of actions was "likely to give rise to the formation of a certain joint relationship between Canon and TMSC," although it "could not find sufficient evidence to support the existence of illegal conduct." The commission found the deal was in a "gray area." The acquisition cleared regulatory approvals in all countries where Toshiba and Canon operate, and procedures for the deal were completed by December.

No longer debt-free
It remains uncertain how Canon will use TMSC to spur its own growth, or how it will draw out synergistic effects that justify the ¥665.5 billion purchase.

TMSC is Japan's leading maker of diagnostic medical imaging devices, and is in the world's top three for computed tomography scanners. Its consolidated net sales in the period ending in March 2016 were about ¥417 billion, and its operating profit was ¥18 billion. "Its profit ratio isn't that high, but it has the ability to consistently churn out profits of more than ¥10 billion," a Canon source said.

Though TMSC is "strong" domestically, the number of hospitals in Japan continues to fall. The number of clients who purchase TMSC's products will inevitably decline. Consequently, the only way to secure continued growth is to seek out overseas markets, but an industry source indicated TMSC's sales networks in developed countries such as the United States and European nations were "weak." Furthermore, TMSC's main business revolves around selling medical devices. Its major rivals, such as Germany's Siemens, already go beyond selling medical equipment; they are growing their markets by offering total support packages that include consulting services for hospital management, and service industries that harness information technology. On this point, TMSC lags far behind.

Canon financed more than ¥600 billion of its TMSC purchase through short-term borrowing, ending its status as a debt-free company. Its free cash flow also tumbled into the red to the tune of more than ¥400 billion in the period ending in December 2016. The cracks in Toshiba's once-robust foundation are faint, but they are starting to widen.

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This is a translation of an article from the February 2017 issue of Sentaku. The original article can be found here.