BATTLE LINES DRAWN

Private equity appears to be gaining a strong foothold in Japan, as pioneering investors continue to mark out the tracks for others to follow. The audacious buyout and subsequent sale earlier this year of Shinsei Bank by Ripplewood Holdings was a deal that showcased the enormous rewards on offer for those able to blend canny negotiating skills with a compelling turnaround strategy.

Rival US-based funds have not been slow to seize the opportunity: witness, for example, The Carlyle Group's $2 billion acquisition of wireless data provider DDI Pocket earlier this year.

But there has also been an example of how an opportunity can slip through private equity's net: recent developments at $10 billion consumer finance business Takefuji Corporation suggest that private equity firms expecting open season in Japan may find things are not quite as straightforward as they'd imagined.

Tokyo-based Takefuji, founded in 1966, is one of Japan's biggest consumer loans companies. On the back of Takefuji's success, 74 year-old founder and 58 percent shareholder Yasuo Takei has built up a $6 billion fortune. Then came the fall from grace: in 2004, he was convicted in the Japanese courts of ordering employees to tap the phones of journalists who had been critical of the company.

Takei was given a three-year jail sentence suspended for four years. In addition, Japanese law stipulates that any company owner found guilty of having broken the law must reduce their holding in the company to less than 25 percent.

This propelled Takefuji onto the radar of private equity firms looking for a controlling stake in the business. However, the opportunity was not a particularly straightforward one: Takei was, after all, not the most willing of sellers.

Reluctantly, he opened discussions with buyout houses – first Newbridge Capital and then Goldman Sachs Capital Partners. But talks with both parties soon got bogged down when the bidders insisted on acquiring majority stakes and making changes to the management team, according to reports.

When it became clear that an impasse had been reached with both parties, Takei cast his eye around for alternatives. And when he did so, he saw three white knights galloping towards him in the form of US hedge funds DKR Capital, Sage Capital and Lakewood. For Takei, the hedge funds' willingness to take minority stakes was a godsend. It wasn't long before a deal was wrapped up, with the hedge funds taking a combined 17 percent, a trust over which Takei had no control acquiring 12 percent, and 5.5 percent being sold to the stock market. This allowed Takei to remain the largest shareholder with 24.8 percent and retain effective control.

One may take the view that to draw any broad conclusion from Takefuji would be misleading because of that deal's very particular set of circumstances. Nonetheless, in its aftermath, questions have been asked in Japan about the extent to which hedge funds are capable of encroaching onto private equity territory.

Hedge funds certainly appear to have the muscle to make an impact, even though private equity is a significantly bigger player. According to Asian industry data provider AsiaHedge, hedge funds in Asia had $47 billion of capital under management at the end of June this year compared with around $100 billion of capital held by private equity firms.

But market observers say the argument goes beyond mere numbers. They point to a blurring of the traditional line separating private equity investor from hedge fund professional. Generally speaking, hedge funds are seeking to change tactics as a way of bolstering returns. In order to do this, some have been asking investors for permission to buy parts of companies and sell later for a significant profit, thus mimicking the approach of their private equity cousins.

But there is a degree of scepticism regarding hedge funds' ability to set aside their short-term investment techniques in favour of playing the long game. “These firms (hedge funds) don't know how to deal with illiquid assets, not only from a capital perspective but also from a mental perspective,” JP Morgan Partners' chief investment officer Arnold Chavkin told Reuters recently.

Others posit a scenario in which hedge funds will struggle to compensate for their lack of operational experience when investee companies encounter difficult trading. If this were to happen at Takefuji, for example, investor demands for change may become louder and Takei may eventually feel it incumbent on him to re-open the door to private equity bidders.

Buyout houses would then breathe a sigh of relief. If company owners keen to retain a controlling stake while achieving a liquidity event come to see hedge funds as the means to do just that, private equity needs to counter with the argument that to ensure longterm prosperity, there's no substitute for operational experience.