TOKYO, April 27 : London-based activist fund Palliser Capital has made a "significant" investment in Japanese factory automation firm SMC Corp and has proposed it make a $3.8 billion share buyback, according to a letter sent to the company.Palliser believes SMC, which makes machinery used in chipmaking, has shown foresight in investing in production capacity but said the company is undervalued and should focus on improving utilisation and margins, the letter, reviewed by Reuters, showed.SMC has capacity to conduct a 600 billion yen ($3.8 billion) share buyback over the next two years and maintain a consistent dividend payout ratio of at least 40 per cent, the activist fund said in the letter.As investment in artificial intelligence boosts the chipmaking sector, Japanese firms with strengths in niche areas of the supply chain have become a particular focus for investors.Show MoreShow Less"With strengthening semiconductor demand and recovery in non-semiconductor industries, SMC is well positioned to optimise capacity utilisation," Palliser said in the letter.Shares in SMC, which was founded in 1959 and whose products include valves, actuators and chillers, have underperformed its peers over the last five years, the letter said.SMC shares extended gains and were up 7.5 per cent in Monday morning trading in Tokyo.There is "a significant disconnect between SMC's current market valuation and the quality of its underlying business fundamentals," according to the letter.The letter did not provide further details on the stake. Palliser declined to comment. SMC said it had received the letter and would announce earnings on May 14.Surging activist activity in Japan is putting continued pressure on companies as corporate governance reforms push firms to unwind cross-holdings, sell non-core assets and buy back shares.Revisions to the corporate governance code stressing the need to ensure efficient use of cash are raising expectations that more companies may deploy their cash reserves."SMC would demonstrate leadership in disciplined excess cash deployment ahead of the anticipated revisions to Japan's corporate governance code later this year," according to the letter.Palliser has previously taken stakes in MSG maker Ajinomoto, which produces film used in package substrates for chips, and toilet manufacturer Toto, which makes electrostatic chucks used to hold wafers during chipmaking.Its other Japan investments have included Keisei Electric Railway and Japan Post Holdings.($1 = 159.6800 yen)