J-STAR: Driving value through consolidation

This article is sponsored by J-STAR.

The Japanese private equity industry has enjoyed sustained growth in recent years, even as the wider economy has remained largely stagnant. Hideaki Sakurai, co-founder and managing partner at J-STAR, says Japanese private equity firms can play a key role in revitalising the economy by supporting consolidation across multiple sectors and providing capital for companies to grow.

Meanwhile, investment manager Takashi Fukui and principal Kazumasa Ohara explain how J-STAR has pursued special situation investments and what its value-creation strategy entails. Investing in restaurants at the peak of the pandemic may seem counter-intuitive – but J-STAR is now reaping the rewards as the quick service restaurant business it acquired in 2020 recovers and prepares for expansion into new international markets.

How has the market for private equity firms operating in Japan changed in recent years?

Hideaki Sakurai: We started J-STAR in 2006. The size of our first fund series was ¥12 billion ($88 million; €83 million) and, at the time, our main investors were Japanese financial institutions. Since then, we’ve launched fund series two, three and four; then, last December, we started our fifth fund series, which has a size of ¥76.8 billion. In this latest fund, about 70 percent of our investors come from overseas.

We have seen the weight of overseas investors gradually increase. The biggest reason why Japan has become attractive to foreign investors is that the Japanese private equity market is still not mature. There is a lot of room for the market to grow.

We are seeing a lot of opportunities with carve-out deals or owner succession deals, where management is looking for support for their further growth, which they cannot achieve by themselves. For J-STAR, the most successful game plan is to promote industry consolidation through bolt-on acquisitions. This is key to our success.

J-STAR has also been making special situation investments. What attracted you to this strategy?

Takashi Fukui: We made an investment in a quick service restaurant brand called Pepper Lunch in August 2020. Pepper Lunch is the original Japanese DIY teppan restaurant chain, with 500 outlets globally in 16 countries. The key concept behind the business is ‘do it yourself’. The store staff will assemble the fresh raw meat with vegetables and/or rice on a patented hot metal plate that is heated to 260C by an electromagnetic cooker in 70 seconds, and it remains hot at 80C for up to 20 minutes. Then the customer will stir the ingredients on the sizzling plate, experiencing the fun of cooking by themselves.

Although the uniqueness of this brand was obvious, this was quite a tough time to invest because it was during the height of the covid-19 pandemic. Still, we knew that basic human needs will not change, and that the food and beverage sector will always be an inevitable part of our lives.

Our investment in Pepper Lunch was a carve-out deal. The deal only covered the restaurants themselves, along with the employees operating the restaurants. We only had four people in the headquarters, including the newly hired CEO. I spent two years with Kazumasa Ohara, my colleague from the value-creation team at J-STAR, working directly with the Pepper Lunch business to ‘start up’ the company and support decision making. We also worked in the restaurants to understand how the business actually operates on site.

How did you assess the risks and opportunities around this investment?

TF: The deal process started in April 2020, when lockdowns were severe in Japan and Pepper Lunch’s other markets. At that time, all the stores were closed, and nobody knew what the world would look like after the pandemic. When we were conducting due diligence, we were not able to visit the outlets until the last week of the process.

As soon as restrictions were eased in Japan, we were able to visit some of the restaurants and check the daily and hourly sales data from the restaurants that had partially re-opened. We could see that sales were quite strong, and the business was already making a recovery.

One of the major factors that attracted us was the potential for Pepper Lunch to grow globally. Of Pepper Lunch’s 500 outlets, around 200 are in Japan. The rest are mainly in Asia, along with 13 restaurants in Australia, six in the US and two in Canada. The Western market is still not yet fully developed – and we expect to achieve growth there in the future.

What is the future outlook for Pepper Lunch?

TF: Pepper Lunch’s operation is quite simple, and we don’t need chefs in the restaurant, which fits pretty well with the franchise model. Also, its manpower-saving operations stand out in today’s world of labour shortages and inflation, which pose a headache for most food and beverage brands. This means that our unique and well-established business model has a high chance of expanding the business globally.

For the first two years of our investment period, the restaurants still had to operate under certain restrictions. Even so, we were able to hire 60 experienced head office staff and stabilise the business. Finally, we were able to fully re-open from July 2022.

In Japan, Pepper Lunch’s sales have recovered to around 90-95 percent of pre-covid levels. In most of our other markets outside of Japan, the business has recovered beyond pre-covid levels. Overall, the business is doing very well.

What value-creation strategies are you pursuing across your portfolio?

Kazumasa Ohara: We have a dedicated value-creation team, in addition to the investment team. Our value-creation team, which includes members experienced in a management position or as business consultants before joining the team, is in charge of increasing value throughout our portfolio following our investment. The team shares knowledge, experience and best practice with portfolio company management to improve their performance, in addition to executing improvement measures in each company, such as enhancing IT systems to help portfolio companies achieve digital transformation in their operations.

Also, led by this team, we are actively working to develop the perspectives on ESG among the management teams of our portfolio companies. It might not have a large direct impact on EBITDA, but we believe that making our businesses more sustainable and strengthening ESG practices in our portfolio companies helps to improve our potential exit paths.

In Japan, mid-market companies – which is the type of company we typically invest in – tend to lag behind on ESG, compared with blue chip companies. But awareness of ESG is certainly increasing in Japan and the importance of ESG is getting stronger every day. We are encouraging the management teams of the portfolio companies to think more about ESG and we are educating them on the need to focus on improving their performance in relation to ESG standards.

More foreign private equity firms are investing in Japan – how can local firms like J-STAR compete?

HS: The Japanese economy is definitely a mature economy, although there are many opportunities for private equity to expand its role. Interest rates in Japan are still very low, so borrowing costs are very attractive compared to other markets in Europe and North America. That is a major factor encouraging foreign private equity houses to focus on deploying capital in Japan.

“We are seeing a lot of opportunities with carve-out deals or owner succession deals”

Hideaki Sakurai

Global PE firms and local PE firms currently tend to co-exist in different-sized markets in Japan. While foreign private equity firms entering Japan could bring more competition in some cases, it does mean that large-cap companies are moving to carve out non-core segments of their business. So, there are many chances to acquire assets.

Also, there can be opportunities for companies such as J-STAR to grow mid-market businesses and ultimately sell them to companies controlled by large, foreign private equity firms. For example, last year, one of our nursing care businesses was acquired by Nichiigakkan, which is owned by Bain Capital.

Local private equity firms also have advantages over foreign competitors in terms of building business relationships. Older family business owners have often been hesitant to sell their business to foreign private equity firms. That is typically a chance for us to make an investment.

What role will private equity play in modernising the Japanese economy?

HS: To improve growth rates in Japan, we clearly need to improve the business environment. Local PE firms should work harder on solving bigger social problems in Japan. To tackle those, local firms need to build trust with their own investors.

Private equity firms like J-STAR have a very important role and a strong business opportunity in this respect. One of our roles in society is to assist in making industries in Japan more efficient through consolidation, succession and revitalisation of companies through our capital and know-how.

I strongly believe that we are a catalyst for industries to consolidate and we are playing a key role in supporting companies in Japan as a solutions capital provider. Our consistent support of our portfolio companies in this way helps us to maximise returns for our firm’s investors.

What will you focus on at Pepper Lunch in terms of value creation? And what are your plans for exit?

Takashi Fukui: We have recently made an add-on acquisition of our master franchise in the Asian markets. They have significant experience and knowledge of expanding franchise businesses in multiple countries. On top of that, they operate direct outlets in Singapore, Hong Kong and Shanghai, which will be a source of talented people who speak both English and Chinese.

Currently, our Pepper Lunch restaurants in Japan have a different supply chain to the overseas restaurants, even though they use the same type of beef. We will revolutionise our supply chain into one with global scale to supply high-quality meat at an even more reasonable price to our global customers. We believe this acquisition will be our growth engine to expand our brand presence in North America and to enter the European market.

In terms of the exit route, for now our main plan is to go public at the end of our hold period. But we are not limiting ourselves to the public route. Of course, if a good potential buyer were to come in, we would be willing to talk to them. Because of our plan to expand in the US and Europe, we believe the business will be an attractive target for international investors.