When news broke last month that Canon had won the bidding war for Toshiba’s medical unit, close watchers of Japan’s private equity industry pointed to the challenges foreign private equity firms face when looking to acquire companies in the country.
The sale of Toshiba Medical Systems Corporation, the world’s second largest maker of medical imaging equipment, highlights some of the frustrations the likes of KKR and Permira, who lost out in the deal, have when bidding for large Japanese assets: namely, competing against local trade buyers awash in cash and potential protectionist issues.
With a price tag of around $6.2 billion, the Toshiba deal is more than double the total value of all private equity transactions completed in Japan in 2015. Just $2.6 billion-worth of deals closed last year, according to Bain and Company, a significant drop from the $5.6 billion the year before.
The biggest private equity deal in the country during 2015 was Bain Capital’s ¥50 billion ($440 million; €396 million) purchase of Ooedo Onsen Holdings, a hot springs and hotel chain. Such deals are a drop in the ocean when compared with the multi-billion-dollar deals completed by private equity firms in western markets.
SIGNS OF CHANGE
Every year, Japan watchers say the private equity landscape will improve. Whether 2016 will be that year remains to be seen, but signs are pointing to a market surge.
Japan’s corporate governance code, which is part of Prime Minister Shinzo Abe’s 2013 Japan Revitalisation Strategy, has been in force since last July and experts believe this will finally help open up more deals for private equity buyers. The reforms put pressure on Japanese listed companies to target higher returns on equity (ROE) and sustainable growth, and this is expected to generate more carve-out deals of non-core assets.
Another exciting space to watch is Japan’s almost four million small and medium-sized enterprises (SMEs), often praised as the backbone of the world’s third largest economy. About half of these often family-run businesses are led by chief executives aged 65 years or older and a lack of succession planning is providing private equity buyers huge potential dealflow.
Japan’s SMEs are also hungry for investment firms with foreign know-how to help them expand internationally, something private equity firms are well-placed to provide, according to Tamotsu Adachi, managing director and co-head of the Carlyle Group’s Japan buyout advising group. He cites Carlyle’s recent investment in GGC Group, owner of the Meisui Bijin bean sprout brand, as an example.
“We were happy to meet the owner who was thinking of growing the company by partnering with a global private equity firm,” says Adachi. “We discussed how we could help him and how the business should be in the coming years. They have a vision and hope to expand the business outside of Japan, and that’s the sort of value we can supply to them.”
Over the last year, Japan watchers have seen a few significant developments that point to an increase in capital flowing into private equity from Japanese institutional investors. The industry’s eyes are on the Government Pension Investment Fund (GPIF), the world’s largest pension fund with assets of $1.2 trillion. It has an as yet untouched allocation of up to 5 percent to alternatives: equivalent to around $60 billion.
Japan Post Bank, which had $1.8 trillion in assets as of 30 September 2015, is also touted as a huge source of capital. So is 2016 the year that alternatives managers will finally see Japanese institutional money start to flow?
“I think the signs are better this year than ever,” says Alexander Wellsteed, who advises the Japan Bank for International Co-operation on private equity fund investments.
Wellsteed, speaking in a personal capacity, noted that the low returns that fixed income and public equities will return to large Japanese institutional investors will force them to look at alternatives this year.
“The beauty of alternatives is that – at its best – it can be counter-cyclical; it can be relatively uncorrelated with equity markets; it is relatively uncorrelated with other investment classes,” Wellsteed says. “Alternatives and private equity is something that is desperately needed in Japan at this time.”
While the short to medium-term future for the private equity industry in Japan may seem positive, particular issues remain. Corporate divestitures should provide ample dealflow to private equity buyers, but making these deals work can be tough.
“Divested companies from large corporations usually have very strong corporate cultures from their parent company,” Adachi says. “How to deal with this culture, how to change the culture of these companies, is a big issue for private equity firms.”
Another challenge is the lack of internationally experienced private equity professionals in Tokyo. Compared with centres like London and New York, the Japanese capital has only a handful of private equity experts with relevant experience, and this is restraining potential growth, according to sources.
On top of that, private equity is still suffering from a poor public image.
“Domestically, private equity still has an unfortunate association with asset stripping, laying people off in smaller family owned businesses in the countryside,” says Wellsteed. “The industry as a whole needs to communicate better about the benefits of transformational and growth focused private equity, both in a domestic and in an international context.”
Despite this, attractive deals can be found. Healthcare, retail and mobile technology are some sectors providing attractive opportunities, according to Megumi Kiyozuka, a managing director at CLSA Capital Partners in Tokyo.
Businesses that cater to social trends, such as value-for-money apparel retailers which benefit from higher levels of low income earners in Japan, are particularly attractive, he says.
Appetite for exposure to Japan remains lukewarm. Japan-focused funds raised just $2.6 billion last year, according to PEI Research & Analytics. Sources say LPs’ concerns include yen-dollar fluctuations, whether Abenomics will succeed in revitalising the economy, and Japan’s declining population.
“A lot of international LPs are not very excited about Japanese private equity, but this bitter taste comes from a few concentrated experiences and isn’t representative of all the funds on the market,” says Charles Wan, a vice-president who focuses on fundraising at Atlantic Pacific in Hong Kong.
“If you take a broad-based index approach to the returns, you’d find that Japanese private equity has delivered reasonable returns quite consistently, but it does take time.”
Takuya Sato, secretary-general of the Japan Private Equity Association, agrees.
“It might take more time and more good successful examples of private equity buyout divestitures before we have the same deal frequencies in Japan as in the US or European markets,” Sato says.
And with just $2.6 billion in private equity deals last year, it seems the only direction deal volume in Japan can go this year is up.