This article is sponsored by J-STAR
For some deal teams, investing in industrial enterprises has fallen far out of favour, their sights set purely on new sectors driven by advances in technology: fin-tech, med-tech, energy-tech and e-commerce.
However, Japanese veteran investor J-STAR is balancing both. The firm, which has been investing since 2006, is still finding ways to generate returns by revamping businesses in industrial niches. J-STAR managing partner Kenichi Harada and principal Hiroaki Kiriseko explain how.
What is your approach to growing an industrial business in an increasingly high-tech marketplace?
Kenichi Harada: We have owned 30-plus companies over the years. There are various circumstances to consider – bringing in younger management, introducing new technology, revitalising processes, and, at the same time, some owners would like to keep a 35 percent holding.
Supporting young entrepreneurs by re-energising the management team is key. While the majority of our portfolio companies have faced the challenge of generational transition, approximately one-third of the portfolio companies have entrepreneurial young owner CEOs who keep investing in the business with us. Business succession is not just about buying a business from an old man and selling to someone else and that is it. Our approach has been to help them retain younger talent and upgrade their systems to keep up with the changing business environment.
Why is younger management important?
Hiroaki Kiriseko: Succession is a feature of most buyouts in Japan. Yokoi Manufacturing is a good example of transitioning between generations. The company produces fire extinguisher products such as hoses and hydrants. It is a mature and stable market with high barriers to entry and only three major players, of which Yokoi is one with 40 percent market share. But it needed help. The president, Ryo Yokoi, was 37 years old when we started discussions with him in 2017 – he was a third-generation owner of a business founded in 1958 built by his father and grandfather. Our first conversations with him were about generational change.
Our first priority post-acquisition in December 2017 was to revitalise the management team. While its president was young, the Yokoi management team were all about 70 years old, including the CFO. We wanted to bring in younger talent. As a first step, we hired a new CFO. The previous one retired just after our investment. We selected the new one out of a pool of two-dozen candidates. He had no experience in the fire hydrant and extinguisher industry – he used to work at a larger scale electrical appliance manufacturer – but he came with fresh eyes.
We also made use of internal talents. We encouraged the business to promote younger talent and to introduce educational programmes and training. One J-STAR staff member is deployed on secondment to the company to oversee the training of younger management staff. He also assists the CFO.
And the results from refreshing the team?
HK: It has changed the management style. Prior to J-STAR’s acquisition, Yokoi had various divisions and units that worked in silos, where the respective person in charge guarded their patch. The business was encouraged to bridge these walls and drop the silo mentality so the leadership could manage the whole group as one company. Before we invested, the president had already invited younger members of the team to attend board meetings. But it tended to be one-way, top-down reporting. They did not make a full contribution. Post-investment, younger team members who showed promise were invited to lead dialogue sessions.
KH: The business was run in a hierarchical, militaristic style. We changed that culture quite a bit. The intention was to run the business in a livelier and more interactive way. The business is benefiting from new blood and ideas that the previous board may never have come up with.
What challenges did this transition throw up?
KH: It is tough for a 37-year-old president to manage a board of older members. Even his father wanted to bring in younger talent. But given they had granted certain autonomy to each individual board member over separate functions, revitalising the board membership itself was pretty difficult. Even though the president had a plan to do so, he realised he could not do it by himself. He felt stuck. He realised he needed outside help.
Our initial discussions encompassed the family’s involvement with the business, and how much longer they should stick with it. We observed that many board members paid their loyalty to the family itself, not necessarily the business. It became apparent to us that we needed to change the focus of their loyalty to the business.
By changing the board composition, a trade-off was that the president lost a couple of reliable elder executives who he used to consult. So now we need to fill that gap; we are now the consultants. We hold a bi-monthly meeting of the president, the CFO and a J-STAR team member, which takes place away from the regular board meeting. These are sessions in which we want the president to feel comfortable sharing his immediate concerns or any challenges. We listen and consider how these may impact our plans for the business.
What other changes have you made at Yokoi?
KH: In terms of cost efficiencies, Yokoi is a very labour-intensive business, so the quality of labour is a key determinant of growth. How to secure the labour force, where to do it, and how to do it are things we are working on. We are beginning to outsource certain tasks. We are also exploring new business areas. Fire extinguisher equipment is such a niche market that you cannot expect double-digit growth going forward focused on this single business line, so we are helping Yokoi to develop new, more widely applicable business lines. One is to add new fire prevention systems to waste pits and dump sites for waste management and recycling businesses, which automatically extinguish a blaze. These are the kinds of themes we have been thinking about, inspired by our ownership of Harita Metal, which recycles scrap.
SHOWING YOUR METAL
When you invested in Harita Metal in December 2017, what were your goals for the metal recycling business?
HK: Three things. First was renewal of capex. When we acquired a majority stake, the business had an enterprise value of several billion yen. Its 49-year-old owner and president knew it needed better access to capital markets. That prompted our initial conversations. The business operates shredders, rollers and other machines that process heavy-duty materials. They depreciate and need constant renewal and technical upgrades. New capital was immediately necessary.
The president had the vision that metal recycling should be essential infrastructure serving the entire economy. But we realised there was a gap between his vision and the reality of the business operation and that there was a lack of short to medium term business planning. We also realised Harita needed to upgrade itself from family business to more of an institutionalised firm that can utilise external capital. We asked management to formulate a plan, which is closely linked to the capex schedule.
The third priority addressed its weak sales strategy. A recycling business cannot earn revenue by just existing. They needed to push sales initiatives. In a business like this, sales people need to be really good at analysis and know which client is really contributing to the top and bottom line. The sales team needed to configure the best client mix that will support the growth of the business, not simply send individuals out on the road to pitch. We hired a new person to formulate the sales strategy, as well as new resources within the sales team.
KH: The business is well located in Toyama Prefecture close to the Sea of Japan with 6,000 clients ranging from small to large, and including domestic, Chinese and Korean businesses. A key piece of background to the business’s growth is China’s decision to stop taking industrial waste from other countries. That door has closed. This has created a headache for Japanese businesses and the government, providing an opportunity for Harita and Yokoi. Waste needs to be recycled in Japan. Waste that cannot currently be recycled needs to be stored. That presents a fire risk to which Yokoi offers the solution.
How will this initiative boost EBITDA?
KH: Installation of a fire prevention system at Harita is taking place this summer. For Harita, it is risk mitigation and beneficial over the long run. For Yokoi, it is revenue positive. We are also exploring new client bases for Yokoi, such as biomass power generation businesses that store flammable waste. However, Yokoi products are already in high demand and production is at capacity, so the business might need to hire more people. But this is a pure B2B play and the margins are really lucrative. It is a growth engine from Fund III’s point of view.
The bigger picture is to revive old economy businesses with newer technology like artificial intelligence or robotics. AI is not just for IT companies. At Harita, they are introducing better efficiencies in the scrapyard using AI. One idea is to use image sensors that can determine the composition of materials and segregate them. These initiatives also apply to automated document handling of regulatory permits for sign-off, filing or submission. AI-aided scanning for classification and sorting of numerous pieces of regulatory paperwork specific to the recycling business would substantially enhance business management efficiency.