Excitement, Tinged With Concern, Should Meet Nasdaq Japan Debut - TheStreet

TOKYO -- When

Sugi Pharmacy

, a regional drug-store operator, goes public on

Nasdaq Japan

Monday, the hoopla over the start of Japan's latest venture market, and the potential it creates for 24-hour, global equity trading, will likely be an afterthought.

Sugi's management, which declined to comment ahead of the offering, will likely focus on how to spend the 7.7 billion yen (roughly $72 million) it expects to raise, but expectations are the company will expand its 89-store chain in central Japan into a nationwide retailer. Given the company is anticipating a 36% jump in pretax profits for the current fiscal year and sports a relatively affordable offering price of 7,000 yen (about $66) a share, analysts say Sugi's offering will be successful and it will have the funds to expand in no time.

Sugi is one of the eight Japanese companies that debut along with the exchange, a joint venture founded by Internet conglomerate


and the U.S.'

National Association of Securities Dealers

. When the joint venture was first announced in June, Internet and tech shares were all the rage and Japan promised to be a lucrative market. With global tech shares now convulsing, however, the fledging exchange, which declined to comment, has traded its cutting-edge image for a considerably frumpier wear.

Only companies currently posting profits have been approved to list, at least in the initial phase of the launch. Even though this is a distinct difference from its American parent, which routinely lists companies that haven't made a dime, the reasons behind the decision are no great mystery. If Sugi and its fellow debutantes stumble, the exchange, which competes with the

Tokyo Stock Exchange's Mothers

board, may suffer an irreversible embarrassment.

"This selection by Nasdaq Japan is to distance itself from the Mothers market, which started at the peak of Japan's Internet and venture fever," says Hisashi Koizumi, an equity strategist at

Kankaku Securities

. "With investors shying away from Internet companies right now, Nasdaq Japan will have to start here and slowly build up its roster of venture firms."

That, of course, doesn't mean the companies are cheap. As with shares trading on the Mothers board, which launched last December, price-to-earnings ratios on Nasdaq Japan are relatively high. Computer equipment provider

X Net

sports a P/E of 100, based on the expected offering price, while software developer

Digital Design

has a P/E of 580 and digital media agent

Creek & River

has a P/E of 850. By comparison, the average P/E on the

Nikkei 225

is around 150, while on the

Nasdaq Composite

it's about 151.

If the stocks' debuts are successful, those valuations will probably get stretched on the first day of trading. Because of Japan's Commercial Code, most of the firms will issue under 1,000 shares, creating a liquidity shortage. The code dictates that companies can only issue stocks to the extent that they can maintain at least 50,000 yen (about $470) in net assets per outstanding share. Until this law is changed or abolished, something Japanese regulators are currently mulling, there is little anyone can do.

Another peculiarity is the new electronic trading system the exchange wants to adopt once it links up with member U.S. and European bourses as early as next year. Market makers like

Nomura Securities


Daiwa SB Capital Markets

, which promise to make a market in shares and earn money on the spread between the bid and offer price, don't like the proposed system. The main reason for the aversion is it will allow brokers who aren't market makers to execute orders if the trade falls within the quoted range. The firms contend the involvement of other brokers isn't fair when they should shoulder the risk to create a market for shares that may not otherwise attract buyers. This will drive up administrative costs, they add.

But they also have a fair amount of self-interest at stake. Market making, which was only introduced in the over-the-counter, or OTC, market in December 1998, is a small but booming business. Almost 25% of all monthly OTC trades are now executed through market makers, and the

Japan Securities Dealers Association

, the organization which overseas the OTC, expects that figure to rise by 10 percentage points for the next two years. Nomura and Daiwa are currently the top two market makers in Japan, and they figure profits will dwindle if other brokers are allowed in.

Nasdaq Japan may need to compromise. It is unlikely to succeed without the two brokerage giants. Shares of small companies that are listing on Nasdaq Japan are expected to be bought up by a select group of wealthy Japanese individuals, which Nomura and Daiwa have handled for decades. Until the exchange is mature enough to attract Grade A firms that a wider range of investors and fund managers can comfortably buy, Nasdaq Japan will need the attention the big guys can bring to it.

The biggest snag, however, is the role of Softbank. Many players are afraid the exchange, which aims to have about 70 companies trading by the end of the year, will be deluged by the conglomerate's affiliates. Even though exchange officials say otherwise, many are concerned the performance of Nasdaq Japan will be linked to the performance of Softbank shares, which are down almost 70% from its high this year.

Softbank, which declined to comment for this story, holds a stake in



though a U.S. unit.

"We definitely want to reduce the color of

Softbank President Masayoshi Son," Nasdaq Japan president

Tatsuyuki Saeki

told reporters back in February. Although he acknowledged the exchange wouldn't have come to life had it not been for Son, Saeki added he wanted to see Son's contribution wane over the next few years.

Already the conglomerate appears ready to make its mark.

Morningstar Japan

, the unit of the Chicago-based mutual fund tracker and Softbank, is scheduled to debut on the exchange on June 23.