Mid-market firm J-STAR has made eight investments in Japanese healthcare since taking a majority stake in care provider HCM Corporation in 2011. J-STAR partner Satoru Arakawa and manager Masayoshi Nakajima explain the characteristics of healthcare investing in the country in the last seven years, and how Japan’s ageing population and expanding demand for quality services spur investment opportunities.

How has Japan’s ageing demographic opened up opportunities for private equity?
Satoru Arakawa: Japan’s population is divided into three segments: seniors who are 65 years and older who make up about 30 percent of the population; the 15-64 years working age group who account for 60 percent; and the 0-14 group who make up about 10 percent of the demographic, according to census data. Of these three groups, the growing segment is clearly the seniors. We need to create an economy that’s more efficient in addressing their needs, spanning healthcare services, end-of-life care, robotics and pharmaceuticals.

We also see an opportunity to boost opportunities in the professionals, managers, executives and technicians, or PMET, sector, as well as providing jobs for housewives and senior people re-entering the workplace. There are many service providers now focused on this space, who provide education, training and re-skilling. Another opportunity for private equity is to tap the foreign talent pool, via Japanese language schools to encourage non-Japanese to study and work in Japan. The government was previously not open to immigration, but that is changing.

What are the challenges facing Japan’s healthcare system?
SA: While the country has a National Health Insurance programme, which provides universal access to healthcare, demand for elderly care keeps rising and the system’s funding mechanisms cannot cope. The healthcare sector is also highly fragmented especially the hospital network. This definitely needs a boost in terms of efficiency and management.

With funding constraints and ballooning medical costs reducing the standard of public health services, Japan’s increasingly wealthy population is seeking more high-quality care from private healthcare providers. For example, end-of-life care services are increasing as the population ages. About 80 percent of patients die in hospital beds, but the government cannot increase the healthcare budget, and so has stopped increasing the number of hospital beds and shortened the average hospital stay.

In addition, many elderly patients go home after surgery or treatment but do not receive the appropriate care because family size is shrinking. Fifty years ago, the extended family meant that three generations lived together, but that is not the case anymore. The younger generation can no longer support the elderly at home, so we need to provide care homes to accommodate old people and their post-treatment recovery. We see this as an opportunity for investors like us to develop and improve healthcare facilities through partnerships with experienced operators and service providers.

Masayoshi Nakajima: As a percentage of GDP, the Japanese government’s total health spending amounts to $3,801 per capita, trailing the US ($5,032) and Switzerland ($5,038), according to the OECD health statistics for 2016. While we have free access to healthcare and medical services are affordable for most people, quality service is limited and only available for wealthy people. The government also does not allow a mixed healthcare service, so citizens end up receiving only “adequate and necessary” care. Public healthcare comes before private for Japanese citizens, but boosting the efficiency of private healthcare facilities and reducing the cost would help a lot.

Which healthcare sub-sectors offer the best opportunities?
SA: Aside from expanding investments in life sciences and healthcare services, we think the market for professional services needs consolidating. For example, end-of-life care needs more skilled nurses and healthcare workers and the opening up of the economy to foreign talent will boost the need for Japanese language education. We also see the same opportunities in the pharmacy sector, as the government limits the number of prescriptions dispensed per pharmacist, pushing up demand for licenced pharmacists.

Currently many venture capital firms are looking closely at robotics or personal healthcare data management. However, we don’t see many opportunities from a private equity standpoint because these companies are not yet stable and cashflow positive. What might be a viable opportunity in the next five to 10 years could be medical tourism, as more foreigners seek anti-ageing therapies and cancer screening in Japan.

What are some significant legal and regulatory developments for the healthcare industry?
MN: Led by Abenomics, the country has implemented widespread changes in health-related policies such as deregulating the life sciences sector as well as emphasising treatment and care for Alzheimer’s patients. There are also National Strategic Special Zones that offer eased regulation and benefits. In pharmaceuticals, Japan has incentivised the use of generic drugs. The government has an 80 percent target for generic drugs by 2020, up from 65.8 percent in September 2017. Foreign players are also partnering with domestic firms to enter the market but there are many restrictions.

The Ministry of Health, Labor and Welfare reviews the prices for all medical procedures and drugs available in Japan every two years. The government also reviews the nursing care prices in Japan every three years. As a response, we are carefully analysing which areas are supported and those whose costs are reduced. For example, funding for dementia care is now favoured. By 2025, 4.7 million Japanese over 65 will have dementia, a sharp increase from 2.8 million in 2010, the health ministry estimates.

How has J-STAR responded to these changes?
SA: In the last decade many Japanese companies entered the healthcare sector to create residences for seniors. We also saw the opportunity to create more hospice services in Japan with our investments in HCM Corporation, Nurse Call and Kairos & Company.

One of the merits of coming early into the healthcare sector is building our network. We invested in 2010 and when we were considering an exit, many bankers and companies were interested in buying the company. In addition to this, we have built up relationships with our partners and healthcare managers across the country, thus increasing the firm’s expertise in the sector. One of the key factors of investing successfully in the healthcare sector is to select good and experienced operators and managers carefully, as there are relatively high compliance and reputational risks associated with operational incidents. To date we have made eight healthcare investments including bolt-on acquisitions.

How did the deal with HCM Corporation come about?
SA: HCM Corporation provides home care services to seniors in Japan. It also offers private duty home care services; and operates an assisted living facility in Chiba. The company was backed by a few venture capital firms. They tried to list the company within their investment periods but decided instead to seek a financial sponsor. Some large-cap GPs looked at the deal but declined because it was too small. One of the GPs recommended J-STAR to HCM’s owners and that’s how the discussion started.

We offered the management the chance to invest more, and that is why their shareholding increased. The equity size was less than $20 million; J-STAR held about 60 percent and the remaining shares were held by HCM management.

What improvements have you made with HCM?
SA: At the time of investment in 2011, HCM was only providing home visits. We added residential services, where revenue can be more stable and diversified. It was a bit risky because there are upfront fixed costs to hire new employees and rent a facility. We also had to pick the right spots to attract customers. Initially the management also hesitated from providing facility type services because of the risks. HCM’s management is a very experienced team and has excellent operational know-how and reputation based on their long-time involvements in at-home care services, which helped them create competitive facility-based care services.

Since investing, we opened four facilities in the Tokyo area and acquired a nursing care operator in the Osaka area, helping boost earnings almost 1.7 times over three years. We also hired a new CFO to support management.

J-STAR invested in Platia, a nursing care facility focused on patients with dementia, in 2016. What was attractive about the company?
SA: The group home segment is highly fragmented and there aren’t that many players in this market. We saw the opportunity to invest in Osaka-based Platia in 2015 but found at that time the company was too small for us to acquire. We decided the best strategy was to actively seek bolt-on acquisitions to boost the company’s growth. Two months after investing in Platia in 2016, we acquired Katsura Shoji, which operates four group homes close to where Platia’s facilities are located. In 2017, we completed another investment in a group home service provider called Luminous.

As the company grows, we can afford to hire more people – management, IT and human resources – to work together and share best practices and resources across the group.

Currently we are seeking two more opportunities in the group home business in Osaka and Nagoya area because many small business owners are seriously considering consolidation to stay attractive and competitive.

And what about Aisei Pharmacy?
MN: Aisei Pharmacy operates about 340 pharmacy stores in the high-density metropolitan area of Tokyo, Nagoya, and Osaka. The company was planning to delist from the Tokyo Stock Exchange and they found a partner in us.  We started the conversation in 2015 and the transaction was completed in March 2016. The company’s performance at acquisition was strong. Aisei was one of the top 10 companies of the dispensing pharmacy industry in Japan in terms of revenue. In addition, what was attractive about Aisei is that they operate through medical complexes that house both pharmacies and clinics.

What has J-STAR done with AISEI during its one-and-a-half-year ownership?
spoJ-STAR became the sole owner following the de-listing. We introduced prospective M&A candidates to them and helped them to find good locations for new pharmacies. We’ve also helped them set up a new type of recruitment business that outsources to other small companies. Our primary objective is to hire the best people for Aisei. Professional service-oriented jobs are really scarce in Japan now. It’s win-win situation for the market and for Aisei because we can retain staff – this is a value add service from our side.

In December 2017, we fully exited Aisei to its company management, generating a more than 3x return for J-STAR’s investors over a relatively short hold period.

This article is sponsored by J-STAR and was first published in the Japan supplement that accompanied the April issue of Private Equity International.