Advantage Partners: ‘There is more appetite to deploy capital here’

Taisuke Sasanuma and Richard Folsom, Advantage Partners’ representative partners, talk us through three decades of investing in Japan

This article is sponsored by Advantage Partners

In the late eighties, when Taisuke Sasanuma and Richard Folsom first put their heads together to explore the potential for buyout investing in Japan, a domestic private equity industry did not exist. Anticipating that the two key regulations holding the industry back – one prohibited financial investors from owning a majority stake in a business and the second banned funds from nominating board directors – would change, the two entrepreneurs launched Advantage Partners in late 1992. Back then, they positioned the firm as a principal owner operator investing off its balance sheet. Since then a lot has changed for the industry and the firm, which raised its first fund in 1997, when indeed those regulatory restrictions were lifted.

Now investing their fifth flagship Japanese buyout fund, we caught up with Sasanuma and Folsom, Advantage Partners’ representative partners, to ask why Japan remains an attractive investment destination.

In the three decades you’ve been investing, what’s changed in the Japanese market?

Taisuke Sasanuma

Taisuke Sasanuma: The most notable is the perception of private equity and the recognition that GPs buying and selling companies is a meaningful economic activity. Back in 97, 98 and 99, after we raised our first vehicle, you often heard funds described as locusts and vultures. Private equity was seen as taking advantage of companies in difficult situations by restructuring the balance sheet to the GP’s advantage and laying-off people. Around that time, there were some global players that arrived in the local market and executed some early deals that appeared to confirm that view. It was a challenge to persuade companies to get comfortable with the idea of working with us. It was hard to get an audience with founder-owners – who still make up a significant proportion of the investment opportunity – and corporate parents to work on carve-outs.

Over our 20-year plus history, the market has come a long way. There are now dozens of successful investment examples, where GPs have acted as very responsible business stewards putting companies on a more competitive and sustainable growth trajectory and adding value not only to the businesses but to the economy more generally.

Richard Folsum

Richard Folsom: In the early days, the view was that funds were all the same. Today it’s clearer that funds take very different approaches toward creating value and generating returns. One that has worked well in Japan – the one we take – is being very collaborative, hands-on and supportive of long-term growth. Private equity is now seen as the go-to solution for founder-owners in a succession situation looking to monetise and professionalise their business. Private equity also gives founder-owners the opportunity to participate in the economics of value creation. Most of our founder-owners reinvest 20 percent of their sale proceeds back into the company. They are not only a seller, but also a buyer into the next growth phase.

Has it become easier to source deals?

RF: Most definitely. At the smaller end of the mid-market where we invest, succession deals constitute the majority of transactions, and the number continues to grow due to Japan’s demographic trends. More than two thirds of our deals have been succession cases. Founder-owners are generally positively disposed to invite GPs to pitch to them. And corporate parents also recognise that managers are helpful to work with.

TS: Both founder-owners and corporate parents are often reluctant to sell to a direct competitor, ie, a strategic buyer. They recognise that a GP may ultimately exit to a strategic, but when that happens they will be one step removed. Over the past five years or so, the number of deals executed by GPs has more than doubled. Last year marked a historical high for private equity deals in Japan.

So is the market more competitive; are more GPs looking for deals?

TS: There are two distinct private equity markets in Japan that display different competitive dynamics. At our end, where enterprise values are sub-$500 million, the number of deals has doubled, but not the number of GPs. We are building a Japan-focused portfolio and need to make three to four investments a year. However, private equity penetration is still low in this segment at around 10 percent of transactions and the presence of GPs is creating more dealflow.

RF: At the larger end, where transactions have an enterprise value of $1 billion or more, dealflow is intermittent. This is where the global and pan-Asian funds play. They have an allocation toward Japan within a broader portfolio and don’t need to execute a transaction every year. However, when a deal arises, it’s very competitive. And more global funds are setting up in anticipation of more future deals – there’s momentum.

Are there any macro factors, very low interest rates for example, which are impacting the deal environment?

RF: The cost of debt is low and banks are happy to lend to private equity transactions. That’s very supportive. Deal opportunities continue to grow, and the proportion of deals accessible to private equity is expanding. In turn, the investor base recognises the opportunity and there is more appetite to deploy capital here. That’s a tailwind for us, and our peers.

As the market has matured, have there been more secondary transactions between private equity firms?

TS: In general, yes. The market for secondary transactions is becoming more active as GPs build up their portfolios. We have sold to other GPs a handful of times, but we haven’t been a buyer yet.

Have you seen a significant lift in asset pricing?

TS: If you look at valuation averages at our end of the market, prices have been going up. But it’s more than a reflection of competition. In our own portfolio we’re finding – and I think you can say this in general – that the quality of the companies has dramatically improved over the last decade, meaning companies demonstrate greater growth and profitability potential.

Therefore paying a fair price means paying a higher multiple than you would have for companies that were more challenged, stressed or weaker in their markets, which is where private equity first began 20-odd years ago. Back then many of the deals were special situation type transactions, or involved the disposal of troubled corporate units.

Once you’ve invested, how do you go about growing a business?

TS: Our approach is very consulting-focused. We look at not just the company’s financial structure and the balance sheet, but what we can do to help address key operational and strategic initiatives to boost EBITDA, make the company more competitive to grab market share, and to position it on a stronger growth trajectory, all to increase its value. Digital transformation is something we try to address at all companies in our portfolio.

RF: Another lever is geographic expansion. Many of our companies have the potential to be a market leader. These are businesses where the founder-owner has grown it to a certain level but cannot take it to the next phase, whether that’s expanding from a regional to a national business or going overseas. We’ve helped multiple companies, especially those in retail and consumer services, roll-out stores nationally. We assist them to create a model to identify the best locations and the appropriate number of stores to open there.

In sourcing deals, how important are intermediaries?

RF: We take a two-strand approach to sourcing: we look at sectors where we’ve been successful in the past to identify a list of possible targets where we could deploy some clear value enhancement levers. These sectors include lifestyle products and services, which encompasses food and consumer services; healthcare; and industrial manufacturing, where we like companies with the potential to expand, including internationally, but haven’t had the resources. We try to meet these businesses and pitch to them.

TS: We also ensure good advisor coverage. Founder-owners typically consult with a financial advisor first about their succession plans and potentially finding a sponsor to invest their business. These are local financial institutions and boutique firms, not global investment banks. We have a list of more than 130 advisors that we cover; which means we meet with them and share case studies demonstrating our success, so when they do receive a sell-side mandate from a founder-owner client we are top of mind. Typically, a sale is a closed process where only a handful of people get an opportunity to pitch to the owner and we want to make sure that we’re on that list.

Explain your ‘private solutions for public companies’ strategy to us.

RF: To date we’ve raised five Japan-focused funds and acquired more than 100 companies, including buyouts and add-ons. In 2016, we launched our first Asia fund, with the goal to expand the same buyout approach to investments in China and South-East Asia. Our third strategy is Private Solutions. This evolved out of the interactions we had with Japanese listed company management teams as we investigated the potential for a public-to-private transaction. We’ve done a number of these deals over the years, but for each one we’ve managed to complete, there have been literally dozens of management teams we’ve had productive discussions with, who’ve been excited by our strategic and operational input and the chance to work with us, but haven’t seen any benefit to going private.

In general, over the past five to 10 years the volume of public-to-privates has declined. Public companies have been fairing better and there’s less motivation to de-list. We recognised an opportunity to provide them with the same level of strategic and operational support, while the company remains listed and we take a minority stake.

TS: At the same time, our investors, particularly international LPs, were trying to get access to what they viewed as “undervalued” listed Japanese companies. For a while, they had been taking passive equity positions and waiting for values to rise and were getting frustrated. Although locally listed companies may appear undervalued on paper, unless there is some kind of external catalyst, the share price tends not to change much. These investors realised they needed someone like us to work proactively with management to add value. Investing through a fund, we take the same approach to listed companies as we do to our buyout investments, pulling the same value creation levers and actively engaging with management.

Today, how much of your business is focused on Japan versus the rest of Asia?

RF: The private solutions for public companies strategy is focused solely on Japan. We’ve invested in about a dozen listed companies through this fund. On the buyout side, right now, our current portfolio is about 2:1, Japan: Asia (ex Japan). We have 15-20 companies in our Japan buyout vehicles and six or seven companies in the Asia Fund portfolio. We are still quite weighted toward Japan.

In sourcing deals, how important are intermediaries?

RF: We take a two-strand approach to sourcing: we look at sectors where we’ve been successful in the past to identify a list of possible targets where we could deploy some clear value enhancement levers. These sectors include lifestyle products and services, which encompasses food and consumer services; healthcare; and industrial manufacturing, where we like companies with the potential to expand, including internationally, but haven’t had the resources. We try to meet these businesses and pitch to them.

TS: We also ensure good advisor coverage. Founder-owners typically consult with a financial advisor first about their succession plans and potentially finding a sponsor to invest their business. These are local financial institutions and boutique firms, not global investment banks. We have a list of more than 130 advisors that we cover; which means we meet with them and share case studies demonstrating our success, so when they do receive a sell-side mandate from a founder-owner client we are top of mind. Typically, a sale is a closed process where only a handful of people get an opportunity to pitch to the owner and we want to make sure that we’re on that list.