Cool Investor Response to Japan Tobacco Inc. Threatens Privatization : Markets: Even before cigarette maker is listed on Tokyo Stock Exchange, the issue has already failed.

TOKYO —  Japan’s rocky efforts at selling off government assets are lurching forward with preparations to offer shares in Japan Tobacco Inc. on Thursday.

But even before Japan Tobacco--the only company allowed to make cigarettes in this nation of heavy smokers--is officially listed on the Tokyo Stock Exchange, the issue, in effect, has already failed. It follows several similar privatization efforts in which stocks initially surged and then crashed. The poor reception last year for the listing of the government’s East Japan Railway Co. (JR East) was widely blamed for triggering a prolonged 21% drop in the market.

Prior to the Japan Tobacco public listing, the government conducted a lottery to give certain investors the right to buy the shares in the former government monopoly that still enjoys broad regulatory protection. However, two-thirds of the lottery winners have declined to buy shares.

Their lack of enthusiasm makes it highly likely that Japan Tobacco’s price--now pegged at $14,600 (1.43 million yen) per share--will fall on Thursday.

“Probably it will be a disaster,” said Takefumi Suzuki, senior analyst at Baring Securities Ltd. “Many people, including individuals, are quite pessimistic, and institutional investors won’t buy at that level. The price will go down below the 1-million (about $10,500) level eventually.”

Partly because the market is already pessimistic about Japan Tobacco’s prospects, there is little chance that the new listing will trigger a broad market plunge, similar to the drop that followed last year’s JR East issue.

The Japan Tobacco listing “won’t have such an effect on the market because it’s already discounted,” Suzuki said. “It’s clear that it’s already failed.”

The overall impact will also be lessened, analysts say, because investors are not as pessimistic about the economy as they were last year when JR East made its market debut.

The Ministry of Finance, which is in charge of the privatization, has also pledged to limit the fallout from a decline in Japan Tobacco’s price by withdrawing shares from the market if the price falls immediately after the listing.

The ministry can also provide broad support for Japan Tobacco shares, and the general market, by instructing government pension funds and the postal savings system to increase their purchases of shares.

But if the government has to resort to such measures, analysts say, it would be a setback for the overall privatization effort.

The government initially planned to sell 666,666 (a third) of Japan’s Tobacco’s 2 million shares. Sales of shares to the public have so far been conducted in three stages.

First, large-lot investors, either institutions or individuals, submitted sealed bids for 230,000 shares. The weighted average of winning bids came out to $14,600.

An additional 436,666 shares were then offered at that price to lottery winners. When most declined to buy, the same offer was made to lottery runners-up. Securities analysts say that in this second round, the purchase rate appears to have fallen to about 20%. That means that more than 200,000 shares are likely to remain unsold before Thursday’s listing.

Japan Tobacco also faces other liabilities. The anti-smoking movement is much weaker in Japan than in the United States (38% of Japanese smoke compared to 25% of Americans), but concern about the health hazards of cigarettes is growing here.

A national coalition of 70 groups campaigning against smoking sent a letter in August to institutional investors asking them not to participate in the Japan Tobacco auction. The letter warned that tobacco is a declining industry and therefore not a good investment.

Japan Tobacco has started efforts to diversify into other fields, including real estate and pharmaceuticals. But sales of tobacco and cigarettes still make up nearly 99% of its total revenues.

The key interest of the Finance Ministry appears to be to make as much money as possible from the sale.

The Ministry of Finance needs to raise money from privatizations “because they are facing an extreme shortage of funds because of the tax revenue shortfall,” said Jesper Koll, head of market and economic research at J.P. Morgan.

Before the government made its final decision to move forward with the Japan Tobacco sale, institutional investors and brokerage firms “warned the Ministry of Finance repeatedly, asking them to postpone the issue and wait for better market conditions,” Koll added. “You’ve seen a decline in stock volumes in Tokyo over the past 12 months. The stock market clearly is not very strong. An increase in new issues is likely to be a dampener.”

Now, with so many investors declining their rights to purchase shares, “the big loser is the Ministry of Finance,” Koll said.

If the ministry is forced to hold back shares, it will make nearly $3 billion less than it expected to gain from the sale.

Another big loser may be the government-held JR West, another spinoff company from the former Japan National Railways system, which expects to go public early next year.