Struggling Sharp looks for help from—surprise!—the Japanese government

▶ A state-financed vehicle is likely to win control of Sharp ▶ “This is a test case for Abe, and he and his government will fail”

Japanese Prime Minister Shinzo Abe came into office on a pledge of resuscitating the economy with market reforms and stimulus programs. Now his government’s commitment to shareholder rights faces scrutiny in the case of troubled electronics giant Sharp.

Although the Osaka-based company is a household name because of its TVS, it’s long operated in the red. For the year ending in March, analysts estimate a loss of 82 billion yen ($694 million). Sharp is in talks with two possible saviors: Taiwan’s Foxconn Technology Group and a government-backed fund called Innovation Network Corp. of Japan (INCJ). Foxconn is offering $5.1 billion; INCJ plans to bid $2.6 billion.

It sounds like a win for Foxconn. But in Japan, floundering companies have long relied on the state. Sharp’s management is leaning toward the lower offer, according to two people familiar with the talks. Shareholders haven’t griped publicly, and Sharp’s banks seem to be onboard.

Critics see Sharp as proof that Abe doesn’t have the stomach for tough reforms. After vowing to liberalize labor markets and deregulate parts of industry, he has delivered few substantive changes. The economy has contracted three times since he took office. “This is a test case for Abe, and he and his government will fail,” says Michael Cucek, a political science professor at Temple University’s Japan campus. Foxconn Chairman Terry Gou has met with Sharp’s major lenders as well as government officials to press his case, according to a person familiar with the talks.

Bailout supporters say the Sharp rescue by INCJ is a strategic move to preserve jobs and domestic industries, from smartphone screens to refrigerators, and not a return to Japan’s bad old days of industrial planning. “Japan isn’t prepared to sell the technological crown jewels to competing nations,” says Nicholas Smith, a strategist at brokerage firm CLSA. “It’s hardly different from the rest of the world in that.”

Japan’s reputation for propping up corporate zombies goes back to early in the lost decades that followed the collapse of the asset bubble in the 1990s. The country’s bad debt exceeded its annual output; deflation became chronic. The Industrial Revitalization Corp. of Japan—incj’s predecessor— went beyond rescues of important companies to restructuring whole industries, from construction to tourism. INCJ was created in 2009 with 2 trillion yen, majority government ownership, and a mandate to promote the next generation of technologies and companies. Instead, its biggest investments have been in the struggling chip and display businesses of major electronics makers.

INCJ put money into Renesas Electronics, which was formed in 2010 from the hard-pressed semiconductor operations of Mitsubishi Electric, Hitachi, and NEC. Four years ago, INCJ created Japan Display from the troubled screenmaking units of Toshiba, Sony, and Hitachi with a 200 billion-yen infusion.

Letting Sharp go to a foreign investor would threaten Japan Display and perhaps the rest of the domestic screenmaking industry for mobile devices. Sharp’s IGZO technology, which offers better screen resolution, touch sensitivity, and battery life than rival products, could be used by Foxconn in its China factories.

Combining Sharp and Japan Display could create a panel maker capable of taking on market leader Samsung Display. The South Korean company shipped 24 percent of small and midsize screens in the first nine months of 2015, says market researcher IHS. Japan Display was second with 15 percent, followed by LG Display and Sharp with 13 percent and 9 percent, respectively. “Japan Display probably doesn’t want all that excess capacity from Sharp, but it’s better than the technology going to Foxconn,” says Alberto Moel, a tech analyst at Sanford C. Bernstein.

A bailout may send a discouraging message to local entrepreneurs and foreign investors. Startups will likely see the deal as one more example of the government protecting established companies at taxpayer expense. “It’s not good for governance reforms,” says Nicholas Benes, representative director of the Board Director Training Institute of Japan, which trains directors to be more aware of shareholder rights. “And it’s not a good example for the Japanese government to be setting for foreign investment.” - Pavel Alpeyev, Takashi Amano, and Tom Redmond

“Japan isn’t prepared to sell the technological crown jewels to competing nations. It’s hardly different from the rest of the world in that.” —— Nicholas Smith, CLSA

The fund is scheduled to be dissolved in 2024

The bottom line A takeover fight for TV maker Sharp shows the Japanese government is still ready and willing to intervene.