The ¥2 trillion ($15 billion; €14 billion) bid that a Japan Industrial Partners-led consortium submitted in February to take Toshiba private is a live example of many of the trends currently playing out in Japan. The take-private has been trailed for months following shareholder discontent, which led to the appointment of two activist investors to the board last year.
Others believed to have previously expressed interest in the deal include a range of names, such as Japan Investment Corporation, KKR, Baring Private Equity Asia, Blackstone, Bain Capital, Brookfield Asset Management, MBK Partners, Apollo Global Management and CVC Capital Partners. Yet while reports emerged of the Japan Industrial Partners consortium reaching preferred bidder status back in October 2022, securing finance commitments for the bid appeared to take several months.
“Corporate Japan is at a tipping point in embracing private equity as a means to help it with strategic decisions”
If the deal goes ahead, it would be among the largest deals seen in Japan, a market where international firms in particular have been increasingly jostling for position over recent years. Bain Capital, for example, has been in Japan for many years but has stepped up its activity recently. In 2022, its acquisition activity included Hitachi Metals, microscope manufacturer Evident Corporation and Mash Holdings, a clothing retailer. In January this year, it won board support to take field marketing business Impact HD private.
Meanwhile, Partners Group, which has been in Japan since 2007, has made two senior Tokyo hires in the past year, and Investcorp opened its first office in Japan earlier this year. Another relative newcomer to Japan, EQT, merged with Baring Private Equity Asia in 2022 to boost its capacity for Japanese dealmaking in particular. “Japan is a key part of our Asian expansion plans,” explains Tetsuro Onitsuka, a partner in the BPEA EQT team. “The market has generated some good returns, it is relatively low risk because it is stable and developed, and it has grown steadily over the past 15 years – a trend we expect will continue.”
Japan has long offered promise to private equity players – both international and local – but it is only recently that deal activity has started to pick up meaningfully. After a record-breaking 2021, when Japanese private equity deal value reached $28 billion, according to Bain & Co – which is well over the previous average of around $12 billion annually quoted by the Japan Private Equity Association – the figures for 2022 are expected to be similar when they are available. Indeed, the consultancy recently said that “unlike other countries, Japan’s private equity market remains hot”.
So what has unlocked the market? At the larger end, it’s a confluence of factors, including corporate governance reforms from 2014 onwards gradually taking effect and the devaluation of the yen in the past year (pertinent to dollar or euro-denominated investors), as well as a greater recognition among Japanese boards of what private equity can achieve.
“There are a lot of businesses in Japan that have previously been under-managed, that are non-core and have lacked investment”
Some suggest that certain past deals have acted as door-openers for what we see today. Among these is a Bain Capital-led consortium’s ¥2 trillion acquisition of Toshiba’s memory chip division, which ran into regulatory issues in China and the US before eventually getting over the line in 2018. “Deals have risen significantly in size over the past two to three years,” says Tsuyoshi Imai, a partner at Ropes & Gray. “The market has seen that private equity is able to transact at scale and often under challenging conditions.”
This is shaping the types of deals coming on to the market, adds Imai. “Corporate carve-outs are now starting even to include some of the parent’s more essential businesses,” he says. “That’s because there is growing recognition among boards that they need to re-invest the proceeds into the most profitable parts of their business. It’s also because private equity is now recognised as a potential buyer, where previously there may not have been buyers able to take on these assets.”
Yet, as in the case of Toshiba, it’s also down to growing activism in Japan. “Corporate Japan is at a tipping point in embracing private equity as a means to help it with strategic decisions,” says Takanobu Hara, a partner at BPEA EQT. “But overall, corporate Japan is really changing, as we see a high level of shareholder activism and a lot more discipline in capital markets here than 10 years ago. That is acting as a catalyst for strategic decision-making.”
This is creating opportunity for those willing to do the heavy lifting required to whip carve-outs in particular into shape. “There are a lot of businesses in Japan that have previously been under-managed, that are non-core and have lacked investment,” says Tatsuya Ochi, who leads Partners Group’s private equity direct investment business in Japan. “That means there are plenty of hidden gems in corporate portfolios.”
Yet with so much interest from some domestic and plenty of international players, these deals do not come cheap. Kazuhiro Yamada has been with Carlyle in Japan since 2001 and is now managing director and head of the Carlyle Japan advisory team, so has seen the market develop from its infancy. He points to competitive pressures at the top end of the market, where auctions often don’t allow much time or access for due diligence. “For transactions with an EV of $1 billion or more, there is a lot of competition,” he says. “You might be bidding with up to 10 others. We are seeing some of the newcomers bid quite aggressively, likely because they are under pressure to do deals in Japan.”
It’s a development that Kazushige Kobayashi, a managing director at MCP Asset Management and head of the team managing a Tokyo local government-backed SME fund of funds, also notes. “Carve-out deals often have a global component and so there is scope for international growth,” he says. “But there are many new entrants to this space in Japan that are trying to get deals done. This is resulting in some high prices and competitive transactions.”
Success in succession
This is why many firms remain focused on succession-related deals, which have long been the mainstay of Japanese private equity. Larger transactions may be capturing global attention, but the wealth of family businesses, most of them established during Japan’s economic transformation following the second world war and with founders now reaching retirement age, continue to attract capital from some international firms and the bulk of domestic firms. Vitally, these tend not to be subject to wider auctions. “With as many as 60 percent of family-owned businesses in Japan today without a successor, private equity has become known as a solution to the issue,” explains Yamada. “Our view is that private equity is now seen as a good option and far preferable in many instances to selling to a strategic player because these are often competitors.”
It’s a trend that J-STAR has also been capitalising on, with a focus on succession, shareholder restructuring, M&A support and business restructuring, among other areas. “An ageing demographic, the need for industry consolidation and the improved perception of M&A and private equity are making founder-owners receptive to private equity as a means to solve succession issues and drive growth,” says J-STAR partner Satoru Arakawa. “In many of these situations, sellers prioritise the solution offered over price.”
Yet in deals large and small, private equity firms operating in Japan can experience some challenges. One of these – especially for those used to the pace of US and European transactions – is the length of time it can take from initial deal scoping to completion. The fact that many larger Japanese deals are in technology or industrial sectors can snarl up processes, particularly given the current backdrop. “The geopolitical situation can impact deal timelines, and regulatory issues can affect whether a deal closes or not,” says Saeko Inaba, a partner at Ropes & Gray.
“For transactions with an EV of $1 billion or more, there is a lot of competition”
However, many say that it is Japan’s business culture that can slow dealmaking the most. “A unique feature of the Japanese dealmaking market is the consensus-driven approach,” says Onitsuka at BPEA EQT. “This can be a challenge because the probability of a deal getting done is lower than in other markets unless we have a really strong proposal. However, it can be a good thing because it means we have to sharpen our pencil and create compelling plans around value creation and support.”
Another key challenge in a market that may have been around for some time, but that has only really taken off in the past six or seven years, is access to experienced private equity professionals who understand the nuances of the Japanese market. “Retaining professionals is one of the biggest challenges in Japan, as Japan is pretty unique in terms of culture, business practices and the way networks are built,” says Carlyle’s Yamada. “You also need people who speak both Japanese and English.”
Finally, potential storms ahead may lead to a shake-out in what has been a suddenly active market. “There is likely to be a global downturn or recession coming up,” says Ropes & Gray’s Imai. “We have seen a high volume of deal activity over the past five to 10 years, and many of those have not yet exited. The deal professionals that worked on those transactions have never experienced a downturn, and many assumptions or agreements may not have been sufficiently pressure tested. When the downturn comes, we could be looking at quite a few folks in trouble.”
A way forward
Despite these issues, it looks likely that Japanese private equity will continue to attract a lot of interest both internationally and domestically. LPs with Asian exposure, for example, are increasingly eyeing Japan as they shift allocations in light of geopolitical tensions and regulatory reform in China. They may well find new opportunities as the market develops further. “The secondary buy-out market is picking up in Japan,” says Partners Group’s Ochi. “That’s a sign of the market’s maturity. There are more than 300 companies in private equity portfolios in Japan and, especially in an environment where IPOs are challenging, secondary buyouts are becoming an attractive exit route for firms.”
It may have been a long time coming, but Japan’s private equity scene looks set for an interesting few years. “It feels as though private equity has finally caught up in Japan – and I don’t see that diminishing any time soon,” says Imai.
Deal financing in Japan
Arranging financing for larger deals can take considerable time. This is partly because Japanese banks are the main source of capital.
There are few international banks, and private debt funds are far less in evidence here than in many other markets.
Yet, unlike in other international markets, banks remain keen to finance private equity deals. “We are not seeing new banks enter Japan,” says Ben Morris, a partner in the finance group at Ropes & Gray. “It’s a highly domestic bank-dominated market. Some are going into new areas, such as mezzanine financing, and they have been supportive of private equity. The lack of new market entrants does limit syndication options, but it means that banks stay invested in deals as opposed to selling them down.”
BPEA EQT’s Tetsuro Onitsuka agrees. “The Japanese financing market is quite different from others,” he says. “The banks here are much more relationship-driven and less transactional. It means they tend to stay the course as opposed to dipping in and out of the leveraged finance market. That really helps with dealmaking because it means the banks are supportive.”
Also in Japan’s favour are low interest rates. With base rates still negative, the country is something of an outlier globally, while regulations limiting the amount of interest that can be charged on loans – the cap is currently around 15-20 percent – mean financing costs remain low. Yet these are clearly constraining factors for the development of a private debt market and therefore limit the opportunity to increase financing capacity in Japanese deals. “Deal sizes are increasing,” says Ropes & Gray’s Tsuyoshi Imai. “However, bank capacity is not quite keeping up, so the larger deals can knock on the ceiling of what markets can provide.”
There are some signs, however, that interest rates may rise somewhat. A new governor is set to take the helm at the Bank of Japan in April this year, with many expecting a directional shift. “There may be some change to monetary policy,” says Kazushige Kobayashi at MCP Asset Management. “Interest rates may rise a little in a bid to stabilise the yen and to dampen down inflation, which is low, but rising.”