Japan roundtable: A certain future

As the country's private equity market continues to evolve and thrive, five leading investors discuss why the mid-market is primed to be more competitive in the next decade.

Post-global financial crisis, Japan was not high on most investors’ list of desirable investment destinations. Ten years on, Japan private equity is booming – fundraising surged in 2017 and deal values were at their highest since 2008.

JOHN CHEUCK is managing partner at Ant Capital Partners, a leading lower mid-market fund that specialises in Japanese SME buyouts. He has over 25 years of experience in private equity investment and cross-cultural management in the Asian region, including Japan. Prior to joining Ant Capital Partners in 2010, he was a partner of pan-Asian private equity fund GEMS in Hong Kong and a venture partner with Apax Partners in their joint venture fund in Tokyo.

MARK CHIBA is the group chairman and partner of North Asia-focused The Longreach Group. He is responsible for senior relationship-driven deal sourcing across Longreach’s sector and geographic focus, with a special focus on financial services sector investments, and on building the firm’s general partner capabilities, capital base and global networks. Before Longreach, Mark served as chief executive and president of UBS Securities Japan, co-head of UBS Investment Banking Japan, and a member of the global UBS Investment Bank Board.

GREGORY HARA is the chief executive and managing partner of J-STAR. He has been responsible for the investment activity of the firm since its inception in 2006. Previously Hara was a senior manager of Tokyo-based private equity firm JAFCO. Earlier in his career he was vice-president of Lehman Brothers and vice-president of the Long-Term Credit Bank of Japan.

MEGUMI KIYOZUKA is the managing director (head of Japan) of CLSA Capital Partners Japan. Before joining the firm in 2006, he was a director at The Carlyle Group in Tokyo, where he led buyouts in the consumer, healthcare and industrial sectors. Before Carlyle, he worked with the Bank of Tokyo-Mitsubishi UFJ where he gained over 10 years of experience in M&A and syndicate lending across various countries in Asia-Pacific.

YASUYUKI TOMITA is the managing director of DBJ Asset Management in charge of managing mandates of private equity funds from the Development Bank of Japan as well as other Japanese institutional investors. Prior to this, he was vice-president at DBJ, where he developed policy-based private equity fund businesses in the Japanese market, overseas investment programme initiatives and strategic partnerships with global financial institutions.

Private Equity International arrived at the Palace Hotel in Tokyo on a crisp and sunny March afternoon to meet with five of Japan’s most illustrious private equity specialists to talk about the country’s oft-noted business succession opportunities, increased investor appetite and the mid-market environment.

Why is Japan’s mid-market humming?

Mark Chiba: There are three things that are very interesting that have happened in the last 10 years in the mid-market.

On the dealflow side what we find after many years of working strategically and quietly with many conglomerates in Japan is that they are selling – not just large assets in the big-cap space but also a relatively long agenda of very interesting globally positioned, fairly sophisticated businesses in the mid-cap space.

I think the ability of them to run quieter sales of those assets is very interesting for us. For us the sweet spot equity cheque is between $100 million and $120 million. The dealflow is there and the entry valuation is also more reflective of a long-term trust relationship between a buyer and a seller, with a private equity firm being a trusted, credible owner for that asset. There’s a lot of that dealflow.

Second is value creation. I think there are obvious relatively low-hanging fruit value-creation opportunities in those assets. We jump on those pretty hard with global benchmarking, with operating partners, cash efficiency, increasing margins and profitability, and of course, growth. We take these platforms and grow them here in Japan, as well as into Asia. The mid-market is letting private equity firms like us do those things.

Finally, exits. There are so many strategic buyers that would love to buy a good Japanese business, that has been renovated with good management, gotten efficient and is well positioned. The good things about the assets in the mid-market in Japan is that these are not big, regulated, politically-sensitive assets. Why is it humming? There’s a long-term sale agenda that’s happening at very interesting valuations, there are a lot of value-creation opportunities and it’s a relatively clean exit path for the assets.

John Cheuck: I don’t think the mid-market here in Japan has changed so much in the last 10-15 years. It’s just that it has been overlooked by prominent investors and less covered by the media.

If you look at the statistics on where the public market is and where the private equity deal companies have come from, the huge number is from the small and medium enterprise sector, of which there are 3.8 million companies, according to government data. If you look at the companies traded, a very small portion are large-cap companies and a vast majority are under $200 million in enterprise value. And if you look at M&A activity, investment from public and private equity has always been in the mid-cap sector, it’s just that the tail-end of a global upswing has finally reached Japan and that investment in mid-cap companies there is finally receiving the benefit of global attention.

Has the competitor set changed?

Megumi Kiyozuka: Due to a very successful fundraising year last year, dry powder in Japan private equity has increased and relatively speaking, the competition is getting fierce. For us as a mid-market player we need to have a very unique, proprietary deal origination strategy, otherwise we have to pay a very expensive price for assets.

Another important point is that we are finally starting to see new names, such as Bain Capital’s recent spin-out, which has started to be active as well.

Yasuyuki Tomita: DBJ historically focused on the mid-market and occasionally invested in large-cap because the mid-market earned higher returns than the large-cap space. I believe many Japanese investors also prefer Japan’s mid-market and look at it closely now. Our challenge is that many managers are easily raising funds, so I think the definition of mid-cap is wider than before. With this in mind we try to ask our managers to keep the discipline. However, many of them want to increase their fund sizes.

Also, we are interested in the new managers in Japan and could support them in their new fund. Insurance companies and pension funds are reluctant to invest in first-time funds but financial institutions like DBJ, regional banks and mega-banks are open to invest.

Gregory Hara: I don’t see it now as an intense and competitive landscape. There are new entrants but I feel stronger market demand from the seller-owners not only in succession-led deals but also in growth capital. Competition is there but opportunities abound.

Why are LPs bullish on Japan?

JC: When we were out fundraising in 2010-11, people asked two questions: ‘Why Japan? And why Japan?’ They told us at that time: ‘We’ve got in excess of 3x and 30 percent plus IRR in China; India has numbers close to China too, so why should we look at Japan?’. Fast forward 10 years from then and the statistics show if you had $10 going into China and India, the cash that has come out is not impressive; $10 into America or Europe, $14 plus has come out; $10 into Japan and $12 has come out. And if you ask around the table, the average holding period for any one of our investments is between three and five years. So if you are diligent and you work very hard on value creation, your distributed to paid in is already up over 1.0x in that period of time. It’s a very positive statement of what LPs are looking for at this point in time.


Roundtable: A certain future

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Ardian’s Tokyo adventure

GH: Japan is seeing a robust exit environment dominated by trade sales. Abenomics’s spotlight on big companies, the pressure of the government and the Stewardship Code have resulted in companies looking to spend their money in the M&A market to purchase good assets and increase their return on equity. Therefore, trade sales have been the path to exits. The IPO market is also more robust than three years ago. Secondaries, trade sales, IPOs – liquidity is pretty ample in this market as long as we do our homework of creating decent value in our portfolio companies and bring good returns to our investors.

How are private equity firms achieving returns in a high-valuation environment?

JC: Every time we have the investment committee meeting I remember one of my mentors telling me: ‘The biggest returns made in private equity have always been from larger, highly valued and priced assets. You always pay more to make more.’ I still haven’t been able to exercise that very well with the SMEs we look at, but I am sure that that type and class of assets in Japan is coming to the market very soon.

But I think we have to be disciplined, focused on what we know and what we can do with our companies, choosing correctly in terms of the people, sector and products and services we back. We had a very lucky investment recently, a company we have been working on for five years but was too small for us to invest in when they came to us. We volunteered to work with their management, gave them advice over the last five years. Early last year, the founder passed away and that threw the company into turmoil. But at the end of the day, the family said they wanted to work with us because we supported them in the last few years and helped them double in size. That was a very special relationship.

MC: For us it’s about finding fundamentally good businesses that need management or capital scale in new markets. We take that business and transform it into a company which a strategic is interested in buying.

When we have got a company and turn it into a shareholder-focused, globally successful business that’s well-run, the strategic buyer can pay a premium because it’s a rare asset. Instead of buying it at the multiple we bought it at, we get multiple expansion. It’s a bit like a house with great foundations that’s run down. We renovate it and somebody’s paying a fair premium for that finished product. And it’s not an arbitrage, it’s not a flip. It’s a genuine value creation but you get multiple expansion because of what you create, particularly with these small companies.

MK: Generally speaking, we focus on two things – improving performance of the company by EBITDA expansion and improving the quality of the management, which is not just about transparency but attracting more willing buyers. Once we acquire the business, we help the management team and founder improve the company so it becomes attractive to potential stragetic buyers or to be listed in the public markets. Multiple expansion may sound like an opportunistic “gambler type of approach” but it’s not. It’s a day-to-day effort in enhancing the portfolio company.

GH: In the last 12 years we have been focused on providing “solution capital”– solving problems not just operationally but also in succession, liquidity, scarcity of human resources – we work on everything. We are dealing with these “imperfections” which should be reflected in the multiples. It’s multiple expansion rather than multiple arbitrage because we work hard on creating value for the company.

What are LPs seeking now in Japan?

MC: LPs ask: what are the drivers of exit returns. They are a bit worried about – as seen in the early 2000s and what you have seen since 2012 with Abenomics –  market reflation.

“Insurance companies and pension funds are reluctant to invest in first-time funds but financial institutions like DBJ, regional banks and mega-banks are open to invest”
Yasuyuki Tomita

Are GPs actually not generating absolute value because they are just bidding exits that are driven principally by multiple expansion, which is driven principally by the macro environment? That’s a big concern. How much of the revenue growth is margin expansion? Have you changed this business into a different business? Are you really accessing growth? Have you created value and paid down debt? And if you do have multiple expansion how much of that is how much you’ve done to the business versus getting lucky with the macro?

I think LPs are looking at underwriting GPs who have gotten strong and are really honing their value-creation skills over time. They are also looking for GPs that are institutionally stable and will be around. There’s so much pressure on LPs around the world to pare down their relationships, so many GPs coming at them. If they think this is a great GP and a great fund but will only be around for five years, they won’t invest. They want to see a long-term platform that can justify their investment and precious time.

Where is private equity finding opportunity?

MK: We have been applying a flexible and opportunistic approach on sector selection. But based on our track record I think we are most excited about these three areas: business process outsourcing, retail (especially e-commerce), and consumer goods and services. For this last sector I mean goods and services that provide more value for money because unfortunately Japanese people’s income is declining. The median income is shrinking therefore the value-for-money type of goods and services have become more appealing.

GH: Healthcare because Japan’s ageing society itself requires a new style of services to match the increasing demand. A healthcare service provider needs to be more sophisticated whereas historically the industry has been more fragmented, which creates some hurdles for smaller players to see the next stage of business growth. For J-STAR we employ a buy-and-build strategy in the healthcare space to achieve growth. With healthcare, however, you need to be very careful with the operations. Mismanagement could create a huge reputational damage to the business.

JC: Labour shortage is a key theme. I live in Hong Kong, a stone’s throw from Macau where there are a lot of gaming companies looking for opportunities in Japan. The law has been passed and locations have been selected. If Japan embraces gaming, one global operator coming here to Japan in just one location is equivalent to 30 hotels. That’s 30 hotels multiplied by the number of housekeepers, porters, room attendants needed. It’s a huge number and a huge headache for these gaming companies, how to staff up. We have looked at opportunities in these supporting industries but have been scratching our heads where this shortfall can be covered.

YT: With regard to private equity dealflow, manufacturing and consumer/retail are still dominant sectors, reflecting the Japanese industrial structure. You might think manufacturing seems to be cyclical but nowadays private equity managers are resonant and very selective to invest in companies that expect EBITDA growth and/or cashflow stability from strong customer relationships. And they structure downside protection well in many cases. I think Japanese GPs are getting more sophisticated and this has proven successful in their manufacturing investments.


In Japan it takes years of trust and relationship building to seal a deal. An important part of the ecosystem unique to Japan is the M&A centres and boutique advisory firms. Examples are the Nihon M&A Center and M&A Capital Partners, that have established businesses that advise the soon-to-retire presidents on the types of deals GPs can offer.

According to John Cheuck: “The source of deals is always more important than people like to give credit to. A lot of companies we look at in the lower mid-market that don’t have any debt on their books, no major relationship with banks, are shown to us by tax advisors, accountants, sometimes consultants, as well as ex-private equity professionals who had a change of heart during the GFC. These are all very important to bring interesting opportunities to us.”

Megumi Kiyozuka adds: “We have 50 relationships with those independent M&A boutique firms and we call them ‘ninja’. And we call our approach ‘ninja intermediary’ because we can’t cover the entire targeted investment opportunity, but they do. And therefore, we always communicate with them as to the kinds of companies we are looking for and how we can help. These intermediaries frequently bring in investment opportunities and their role has always been important to our dealflow.”

What are Japanese sellers looking for in private equity buyers?

JC: The owners we deal with in the lower mid-market are looking for operational skills. They are also looking for opportunities to work with management, train and upgrade them. They are also looking for our track record and references with other companies to give them that ease of mind.

MK: From our experience we find that sellers want on-site portfolio support capability because they are always facing a shortage of management teams. It takes time to hire a professional COO or CFO, so for us we always second our junior professional to the portfolio. We call it “body-on” because it’s more than just a hands-on approach. This kind of approach is always appreciated by the founders as on-site professional management consulting is not easily accessible for many founders at small to mid-cap enterprises.

MC: What sellers are looking for in the large-cap space, like Toshiba Memory or Panasonic Healthcare, it’s always cross-border. But finding management teams and GPs that can do cross-border in the mid-cap space is trickier.

For example, if we are buying a manufacturing company from a conglomerate or doing a Wendy’s deal with a US to Japan angle, we need to have the confidence to operate cross-border as well. And I think that’s important because globalising some of these mid-cap businesses and using Japan as a laboratory is necessary. That means hiring a chief executive who could work 100 percent effectively in Japan but also deal with an American partner, for example, or a Chinese expansion strategy. That’s a very important consideration.

What are you most looking forward to in the next 12 months?

JC: We’re most looking forward to the middle-aged folks looking for partners and peers to work with while they sell a minority share of their company and work with us as we build the legacy they have started. I think that’s been a growing theme in our pipeline and that’s what is exciting for me, personally. On top of that is the cross-border element, not just cross-border growth but also cross-border supply chain refinement. We continue to look forward to making those refinements and efficiencies in our portfolio companies.

MC: We have an unusually busy year. We are in the process of finishing up our current fundraising and expect a lot of new investments as well as exits. It’s also an exciting time in terms of institutionalising and solidifying the firm. We’re also proud of having a high-quality LP base, both in Japan and overseas, with lots of intellectual capital. It’s a fantastic assist for our business and keeps us performing even better.

MK: Our investment team has been growing and it’s been enjoyable to watch. Another thing is that private equity firms are finally accepted by the business community. I’m really looking forward to seeing many more aggressive business owners approaching us and having a conversation with us this year.

YT: Japanese LPs’ demand for private equity investments is dramatically increasing. It’s good to see them doing domestic investments directly, but because of the language and resource issues many of them cannot invest overseas by themselves. In this regard, we want to be the liaison for these LPs as they start to make their overseas investments. We are busy as well and face some resource issues, but we plan to increase our team to address LPs’ demand for new investments.

GH: In the last 12 months, we’ve made 10 deals and three add-on deals, thus our capital deployment ratio is now close to 40 percent. We started to manage the latest fund in April 2017, towards the end of the year we might plan another fund. But the important thing to highlight is that DPI ratio for J-STAR No. 2 is close to 1.0x, due to three exits recorded in 2017. Lastly, we are looking forward to a long-awaited IPO exit for one of our portfolio companies by late this year.

This roundtable was sponsored by Ant Capital Partners, CLSA Capital Partners, J-Star and The Longreach Group, and first appeared in the Japan supplement which accompanied the April 2018 issue of Private Equity International.