Japan Special: Roundtable

Five industry veterans pass their verdict on the Japanese corporate landscape, its challenges and the rewards of investing in the country.

Doubts may linger over the success of Prime Minister Shinzo Abe’s economic growth programme, but the Japanese private equity industry is finding reasons to be optimistic.

The latest data from Japan’s Cabinet Office show that the country’s economy is shrinking less quickly than previously thought. Figures for the last quarter of 2015 show it contracted at an annualised pace of 1.1 percent from October to December 2015, down from 1.4 percent in the previous quarter. The numbers also presented a slight upward revision for domestic demand.

Among the five private equity practitioners that gathered for Private Equity International’s Japan roundtable discussion, expectations for 2016 ran high. There are signs that corporate divestitures are starting to drive increased dealflow, entry valuations are looking increasingly attractive and the corporate culture is slowly warming to private equity ownership. Furthermore, the world’s largest pension fund, the Government Pension Investment Fund, is sitting on a vast undeployed alternatives allocation that could find its way into private equity.

PEI: What is the Japanese private equity story to date?
Yasufumi Hirao:
Private equity investments account for only 2-3 percent of total M&A transactions in Japan. In terms of size, more than half are below ¥10 billion ($87 million; €79 million), which would be considered small-cap transactions. In addition, more than half of transactions nowadays are business succession and corporate carve-out deals, compared to the early 2000s when turnaround transactions were a large portion of total deals.

Megumi Kiyozuka: I agree with Hirao-san that the private equity market in Japan is heavily skewed to small to mid-cap companies. According to data from the Japan Buyout Research Institute, about 60 percent of deals in Japanese private equity history were $50 million or less in terms of enterprise value; the next 30 percent were between $50 million-$300 million; and 10 percent or less were over $300 million.

Ryosuke Iinuma: Through our almost 20-year history we have recognised that the sweet spot of Japanese private equity is in the small to mid-cap market. It’s not a coincidence that all of us here focus on that space.

Taisuke Sasanuma: I don’t feel Japanese private equity is getting to be more competitive; I think the situation has remained the same for the last 10 years. But I would say that the quality of the deals has been getting better. Many of them are really bankable; management group capabilities are quite strong; and most of the deals are in the attractive sectors of the market. It’s a qualitative change.

Which sectors are providing the most interesting opportunities for private equity and why?
Koji Sasaki:
The most interesting opportunities today come from family business successions. There are two types: one is traditional business succession where ageing founders do not have any successor and contact us directly for a sale; another is partnership investment alongside family members, where sons and daughters who inherit the business ask us to recapitalise the company to further its growth. In Japan, this kind of deal happens more often because founders are generally more reluctant to sell the company due to a strong sense of attachment.

MK: Japan’s maturing consumer market has generated some trends which we are very interested in. A good example is e-commerce. Sales numbers alone are not growing, but there has been a real shift from store sales to e-commerce. If there is a good company riding on this trend, we would be very interested. Another example is manufacturing, such as for speciality store retailers of private brand apparel for [the likes of] Gap, Uniqlo, H&M and Zara.

TS: I have observed that the expected function of private equity and venture capital seems to be getting closer. We have seen several deals which size-wise and growth-wise seem to be in the infancy stages, but the founder is interested to sell and give up ownership in order to get operational or strategic help from us. What happens is that we take a majority stake, work together to grow the company and let them absorb the know-how from a private equity firm.

Has volatility leading to deflation had an impact on the operating environment?
Stock prices falling sharply may affect exit opportunities. We haven’t exited a business since last year, but looking ahead our strategy of exiting through initial public offering may be somewhat affected if market volatility continues.

MK: I think the leveraged buyout market in Japan is probably the best in the world now. Some figures we are seeing include five years tenor, 5x EBITDA and less than 150 basis points. It’s a very positive environment for investing and I haven’t observed any negative impact so far.

Are there opportunities for GPs from corporate carve-outs?
I have been talking to some foreign LPs recently and I noticed high hopes among them that recent reforms in Japan’s corporate governance code would increase the opportunity for carve-out transactions. That may be true, but we have yet to see it. I think the more realistic and immediate driver for corporate disposals is semi-distressed situations. Toshiba Corporation – while it is not in a distressed situation – had been under a lot of pressure to divest its crown jewel Toshiba Medical; that’s an example that gives a more realistic view of corporate carve-outs in Japan.

YH: As Kiyozuka-san mentioned, we have high hopes and high expectations for the increasing number of corporate carve-outs. But while the number of transactions is increasing, it is still very limited. Another important thing to note is these corporate carve-outs still seem largely driven by events – and not by a strategic focus on core assets – as in recent cases with electronics companies. Looking back at the number of private equity deals, there are at most about ¥400 billon-¥500 billion worth of transactions per year, which is less than 10 basis points of Japan’s total gross domestic product. If you look at the US and Europe, private equity transactions equate to around 1-2 percent of the total economy. I wouldn’t be surprised to see deal sizes in Japan increasing 10 or 20 times in the near future, but this will only happen if corporate carve-outs become the norm.

Is there a better understanding and acceptance of private equity by company owners than previously?
The situation is improving, and I give credit to those people who act as intermediaries like investment banks. I think the level of information given to the seller has improved a lot. Sellers are better informed of the advantages and disadvantages of each potential buyer, and can therefore make rational decisions. Previously they hated seeing us private equity firms, but that negative perception is decreasing. Nowadays, private equity firms have a better chance of at least meeting the sellers and presenting our proposals.

KS: Yes, absolutely. We find it very interesting that business successions or partnership investments with family members are increasing. One of the reasons behind this is that company owners have a better understanding of private equity and see our role as integral to the growth of their companies. Word-of-mouth is also very important; our most recent acquisition, gift catalogue business Yamato, was sourced directly from the president of our other portfolio company, furniture and kitchenware retailer Asplund.

RI: We actually do not hear about any hesitation or allergic reaction to buyout funds from the business owners we deal with. They acknowledge private equity firms as “good friends” because we improve management and apply KPI-based management. A positive reputation is a form of deal sourcing for us. For example, we invested in cookie company Aunt Stella in 2005 and this led us to Muginoho Holdings in 2006, which also sells sweets and owns the cream puff chain Beard Papa.

TS: It used to be that large enterprises and top management feared that their employees would be unhappy if they sell to private equity firms. In my experience, the opposite is true: they are much happier when they are not held captive by weak enterprises. Once a private equity firm comes in, we really maximise the potential of those subsidiaries, work together to pursue maximum growth opportunities and improve profitability.

How is the fundraising environment in Japan today?
The fundraising environment is much improved compared to the previous cycle. As far as the domestic situation is concerned, commercial banks (which were negatively affected by the Volcker rule in the previous cycle), are coming back. Regional banks are becoming more interested in private equity and on top of that, corporate pensions have started allocating to alternatives, meaning domestic LPs are now much more aggressive.
Foreign LPs – who had very high hopes in the 2000s and subsequently left Japan disappointed – have started to come back. One reason is that, relative to China and India, and in the context of current global volatility, Japan is more stable and attractive. A second reason is political leadership under Prime Minister Abe’s administration. Lastly, GPs have shown strong track records through the years and have generated good returns.

RI: Every time I visited foreign LPs during our fundraising period in 2011 to 2012, they only had three words for the Japanese private equity market. “No.” “Why?” “Disappointed.” I don’t hear those three words anymore.

TS: Foreign investors might be concerned about foreign exchange. They’re becoming a little bit more sceptical about the real effect of the third arrow [structural reforms] of Abenomics; this is the impression I’m getting from them. It has changed quite a bit in the past years. The first and second arrows – fiscal stimulus and monetary easing – worked well, so at that time global investors had high expectations for Japan’s economy.

How is the GP-LP relationship in Japan?
Banks and financial institutions are the second largest group of LPs in Japan after corporate investors. I have observed that Japanese banks are committing more capital to private equity firms, not only for treasury purposes but also for business development. In Japan, ageing business owners who face succession issues often consult local banks for solutions. When banks do not have sufficient solutions internally, they approach GPs to provide buyout solutions. From our viewpoint, this is a unique route for deal sourcing. I think this GP-LP co-operation is mutually beneficial.

RI: My impression is that the number of foreign LPs who have started to study the Japanese private equity market is gradually increasing. Last week we had foreign LPs visiting us and they said they would allocate some budget to invest into Japanese GPs; this would be a first time for them and they required some assistance understanding the Japanese private equity market.

TS: The Institutional Limited Partners Association and even the United Nations are providing [reporting] requirements that are widely shared among LPs. In one sense this is a cost for us, but it is also a benefit. We know these guidelines can really improve the quality of our operations, our own brand, as well as that of our portfolio companies. We are in a dynamic era; previously both GPs and LPs have been pulling against each other, but this next phase will be about real partnership.

What advice would you give to new managers or entrants to the Japanese private equity market?
I would recommend new entrants to be patient. Sourcing high quality investments in Japan requires a long-term commitment to the country, including building deep relationships and leveraging networks developed through past transactions. After building these networks and generating a track record, dealflow can become more consistent, leading to strong returns even in a slower deal environment.

MK: First is the origination capability and constant deployment of capital; second is stable performance; third is overall attractive returns; and lastly, a stable team; these are what LPs most frequently ask for.

YH: LPs are looking for both uncorrelated and absolute returns from their private equity investment.
Aside from executing alpha-generating strategies, it is important that GPs can identify underlying issues in portfolio companies, propose ideas to fix them, and deliver solutions. Do the funds have the track record and resources to do that? A successful investment cycle starts with this very basic value-adding activity. That, to me, is key.

serves as the president and chief executive officer of fund of funds manager Alternative Investment Capital. He has nearly 20 years of global private equity experience in direct investments and fund investments. Hirao previously managed the private equity portfolio of Mitsubishi Corporation, which owns around half of AIC. He was a former director of investments at MC Capital Europe.

RYOSUKE IINUMA is the representative director and president of Ant Capital Partners. He joined the firm in 2001 and has played a key role in the organisation’s development. Iinuma leads a team of about 10 investment professionals and focuses on corporate management and business strategy. He has served on the board of several companies, including Checker Motors, Golf Partner, Willplus Holdings, VarioSecure and Apple World.

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 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 the region.

KOJI SASAKI is the president and managing partner of Tokio Marine Capital and leads its buyout team. He has been with the firm for almost two decades and was promoted to president in July 2015. Sasaki previously worked with the Long-Term Credit Bank of Japan where he was involved with M&A advisory. He also serves as a director in several Japanese corporations such as Miki Shoko Co., Ltd., Bushu Pharmaceuticals and Showa Yakuhin.

TAISUKE SASANUMA is one of the founders of private equity firm Advantage Partners, one of the earliest buyout funds in Japan that has raised more than four funds and made more than 40 acquisitions. Sasanuma has significant management consulting experience, having previously worked with Bain & Company, Sekisui Chemical Corporation and several major US and Japanese corporations. He is the chairman of the Japan Private Equity Association.