NSSK: Coming into its own

Japanese private equity may have had a few false dawns in the past, but the market today is very different from that of just 10 years ago, says NSSK founding partner Jun Tsusaka

This story is sponsored by NSSK

With support from domestic and some international limited partners, the Japanese private equity market has been particularly active over the past few years – there were 686 Japan-focused private equity deals in 2018, up from 548 in 2017, according to S&P Global Market Intelligence figures. Some of this activity has been driven by international firms, such as Bain Capital’s $18 billion purchase of Toshiba’s memory chip business and KKR’s $4.3 billion acquisition of Calsonic Kansei, an automotive components supplier, but the real transformation has been taking place on the ground.

A growing number of local firms, boosted by a more developed private equity ecosystem, are targeting smaller and mid-market businesses, using their knowledge of the unique characteristics of the Japanese market to source deals and create value – indeed, 646 of the deals done in 2018 were completed by domestic houses.

We spoke to Jun Tsusaka, founding partner of Nippon Sangyo Suishin Kiko (NSSK), a house that won the Firm of the Year Japan in the 2018 PEI Awards, to find out what is driving private equity activity and why the market will only grow.

We’re seeing record levels of deal volume in the Japanese market. Could this just be a blip?
No, this is clearly a long-term trend. The Japanese private equity industry is now reaching a point where it has a developed ecosystem. Just as in the US in the 1980s and in Europe a decade later, you are now seeing private equity players with scale operating in Japan – there are now around 174 local, pan-regional and international firms active in the market. A lending community for leveraged transactions has developed, with over 20 banks able to provide senior debt and a handful of mezzanine lenders that can lead deals. You also have a public market and underwriters that understand the private equity portfolio equity story and the M&A market is buoyant.

Overall, we now have experienced GPs that have some scale, a sophisticated and deepening lending market, a strong exit market and – most importantly – willing sellers.

Who are those willing sellers?
Much of the dealflow in Japan is driven by succession issues and/or family businesses being sold, as well as the carve-out of non-core businesses by major corporations. This is against the backdrop of a very healthy M&A market – there were 3,132 M&A deals in Japan last year, making it the third-most active market globally after the US and China. That may surprise some, but most of the deals are smaller transactions – less than $100 million – that do not get press coverage.

Family business deals are happening now because the average age of these owners is around 60, and around two-thirds of these companies have no successor. Owners are often burdened by personal guarantees on loans and they potentially face 55 percent inheritance tax. What is interesting about these deals is that owners often do not want to be seen selling their business and so a shift in terminology has changed perceptions of the market and legitimised the process – the transactions are often badged as “a succession deal in the interest of the company, employees, customers and all stakeholders” rather than a business sale.

Given the sensitivities of family owners, how are the deal processes managed?
This is where the Japanese market demonstrates some of its unique characteristics. These owners, of which there are around 3.8 million, according to the Ministry of Economy, Trade and Industry, do not want to sell through auctions because of confidentiality concerns, or they are often not interested in selling to the highest bidder. They are primarily concerned with their status following the sale, protecting employees and their salaries and the future of their business.

These factors mean there is strong potential to negotiate genuinely proprietary investments. This gives a big advantage to domestic private equity players with strong operational capability and local relationships. Nowadays, private equity is the preferred exit for the majority of these sellers because they can stay with the businesses through the transition and ensure their legacy is protected and enhanced.

What about carve-outs? What are we seeing there?
Dealflow from corporates is set for a substantial further increase as they adhere more strictly to corporate governance measures and focus on maximising shareholder value.

There is a staggering number of subsidiaries within corporate portfolios in Japan; the top 10 Japanese companies on the Nikkei 225 alone have 5,140 subsidiaries between them. We have seen this trend start to play out over the past few years as conglomerates such as Hitachi and Fujitsu have begun selling non-core businesses.

To what extent does Japan offer domestic expansion opportunities?
This is one of the most interesting facets of Japanese private equity. Many firms tend to develop growth strategies around international expansion, yet Japan has a large domestic market relative to the size of investment, a diversified opportunity set and an economy that is less correlated to other major markets.

Japan’s GDP is the third-largest in the world, at over $5 trillion, and domestic consumption accounts for over half of this. That means the domestic market represents a huge growth opportunity for small and medium-sized businesses, which tend to be quite regionally focused. If you take a Tokyo-focused business (a city that has a market size of $2 trillion, comparable to the economies of Brazil or India), you can expand it into regions such as the Osaka area which is a sizeable economy.

Domestic growth can be achieved by providing growth capital, establishing new business processes and providing human capital support, and this can happen in shorter timeframes and at lower risk than international expansion.

How do you capture these opportunities at NSSK?
We have built our organisation to provide portfolio companies with geographic access and new customer access. We can hire people in specific markets in Japan. We have relationships on the ground with local governments, regional financial institutions and local tax, accounting, legal and M&A advisers.

This is supported by the way we approach business. We were established in 2014 and have therefore been able to integrate environmental, social and governance management into the way we operate. We recently hired Yoshihito Ohta, formerly managing director at Kyocera Corporation, as a special advisor for operations and he has a focus on corporate philosophy. This is important for nurturing happy employees and “doing the right thing” and we believe these are vital as they drive positive outcomes for the short and long term. This is highly attractive to sellers – we believe our philosophy of being responsible and accountable investors has enabled us to gain a disproportionate number of proprietary deals.

Can you give us an example of how this works in practice?
Vati is a great example of domestic expansion and our responsible approach to investment. It operates nursing home facilities and is differentiated by the high patient satisfaction rates and low cost relative to competitors. Since our investment in 2016, Vati has opened up 18 new care facilities, improved occupancy rates to an average of over 92 percent, introduced best practice safety and compliance measures and increased accounting and finance transparency. We expect revenues to increase by over 50 percent from 2016 to 2020 and EBITDA to rise by more than 150 percent.

You mentioned earlier that Japan offers diversified opportunities that are less correlated to other markets. Can you explain further?
Japan’s unique history of zaibatsu and keiretsu has created a vast and diverse industrial and service base. Beyond sheer size, the Japanese market offers private equity the chance to build a highly diverse portfolio – much more so than in other markets, where there is significantly more industry concentration. Even the largest sector in terms of GDP – manufacturing – only accounted for around 20 percent in 2017, government figures show. Private equity firms therefore have a broad spread of opportunities to invest in across uncorrelated industries.

In addition, unlike many other growth economies, gross exports were just 16 percent and net exports -0.3 percent of GDP, which means that the Japanese market is far less dependent on global trade and politics.

Operational improvement is now a staple for generating private equity returns. How do you view this at your firm?
Operational value-add has always been a key pillar for NSSK. Our investment strategy is based on differentiated deal sourcing, investment discipline focused on taking control positions, and on industries where we have expertise and a unique angle and an operational perspective that assists our risk assessment and builds value creation opportunities. You have to take a systematic approach to this – we call our programme “NSSK Value-Up Programme”.

Our investment in Bunkasha in 2017 demonstrates this approach. Established in 1948, this is a Tokyo-headquartered analogue and digital publisher of manga titles focused on female readers over the age of 20. In an increasingly digitised market, we saw tremendous opportunity in this distinctive brand, which has over 6,000 titles in its library. We have helped the business hire an experienced digital manager and invested in a new IT system to enable digitisation and support Bunkasha’s new promotion and sales strategy. This structured and considered approach has led to a 34 percent CAGR in digital revenues at the business between 2014 and 2018 – far higher than the wider comic industry’s 25 percent CAGR over a similar period.

How do you see the market developing over the coming years?
Private equity in Japan will grow in stature and importance. The activity we are seeing now is the direct result of a more developed ecosystem. The fact is Japanese private equity players are now more experienced and business owners are more receptive to private equity investment. In the post-2000 period, you had a lot of distressed deals taking place as banks were cleaning up their balance sheets and many traditional private equity houses were established – they were early pioneers of the market. But you still had a prevailing attitude among sellers that private equity investors were vultures. Returns were also inconsistent, and the public market was shut for much of this period.

However, from 2012, when Shinzo Abe became prime minister, we have seen market reforms and economic policies that have favoured growth. Unemployment fell from 4.3 percent to 2.5 percent between 2012 and 2018 and the Nikkei has increased by 120 percent. More domestic private equity firms have been established and their LP base has deepened considerably. We still need to see how returns post-2012 pan out, but these vintages appear to be on solid ground. This all points to an active and sustainable private equity market that is capable of delivering good results to investors.