Japan private equity sees a brighter future

Japan’s private equity story is beginning a new chapter.

Last year a total of 20 Japan-focused funds were on the fundraising trail, targeting a combined $6.2 billion, according to PEI data. CITIC Capital smashed its target for its Japan buyout fund on ¥30 billion ($266 million; €246 million) in February, drawing significant demand from new and existing investors.

Tokio Marine Capital, NSSK and Advantage Partners are targeting ¥50 billion, ¥63 billion and ¥60 billion, respectively, for their latest vehicles and seem sure to hit their targets, if not surpass them, according to multiple sources.

Funds including J-STAR and Polaris Capital are also raising capital and expected to close funds within the next few months.

Deal activity is likewise on the rise. Data from S&P Global Market Intelligence show that private equity and venture capital-backed deals in Japan totalled 423 in 2016, an increase of 16 percent compared with the previous year’s 364 deals.

Multi-billion buyout deals are still rare in Japan as domestic firms lean toward buying smaller companies and merging them with existing ones, but private equity giant KKR recently struck two notable transactions – the $4.5 billion purchase of Nissan Motors’ stake in Japanese automotive retailer Calsonic Kansei and the $1.3 billion acquisition of Hitachi’s power tools unit. Global firms The Carlyle Group and CVC Capital Partners have also scored chunky deals in Japan in 2016.

Indeed, confidence has returned to the market and the industry looks to be in much better shape to achieve growth.

Michael Taylor, Tokyo-based managing director at HarbourVest Partners, says: “One can definitely sense a change in interest towards alternatives. In particular, private equity has been top of mind as the largest Japanese institutional investors made public their intent to invest in alternative assets. That has had a knock-on effect for domestic GPs as it has been a more robust fundraising market, particularly for the mid-market firms.”

Yar-Ping Soo, partner and head of Asia at Adams Street Partners, says the firm has seen a shift in the last three to five years to a greater focus on returns. “The Japanese private equity market now is showing the best returns that we’ve seen in the country for a long time,” she adds.

While Soo did not provide specific numbers, data from Tokyo-based LP advisor Brightrust PE Japan reveals an average of 2.5x multiple and 45 percent gross IRR per deal.

SEEING MORE ACTION
The small to mid-cap space is where most deals occur. Small companies are the backbone of Japan’s economy, accounting for 99.7 percent of its 3.8 million companies and employing about 70 percent of the workforce, according to government figures. Japan’s lower mid-market has a wealth of companies looking for ownership transition, and while many have shut their businesses as owners age, the rest are turning to private equity for capital and expansion.

Jun Tsusaka, managing partner and founder of Tokyo-based mid-market firm NSSK, says he has never seen the Japanese private equity market this active in the past two decades. 

“It is a highly unusual environment, with strong deal activity generated from private companies being sold to carve-outs from large corporations,” he says.

“If you go back in the history of private equity, you see characteristics that are very similar to those of the US in the 1980s or Europe in the early 2000s – you find good companies, acquire them with attractive leverage, improve operations by addressing the proverbial ‘low-hanging fruit’, put in business processes to improve efficiency and add new people, and you end up having turbo-charged the business.

“It has taken the market a little longer to develop, but the fundamentals of being able to acquire quality companies with attractive leverage with potential upside appear to exist and should support a growing and attractive private equity market in Japan.” 

Taylor adds the “robustness” in local mid-market private equity fundraising is due to increasing investor interest in its equivalent in the US and Europe. “Big is not always better. It’s an extension of the same theme but now playing out in the number three economy in the world, which seems to be resonating with offshore capital now after many years of dormancy,” he says.

CHANGING SHAPE
Japanese LPs are also stumbling free from their internal bureaucracies and finally pushing ahead with their alternatives programmes.

Japan Post Bank, which has about $2 trillion of assets, launched its private equity unit in 2015 and has since assembled an all-star team including former senior executives from Goldman Sachs (chief investment officer Katsunori Sago), Nippon Life Insurance (head of private equity Hideya Sadanaga) and Government Pension Investment Fund (managing director Tokihiko Shimizu).

Sago says he wants to put “several trillion yen” into alternative assets over the next five to 10 years. And following in its sister company’s footsteps, the $800 billion Japan Post Insurance also set up an alternatives division in September.

Meanwhile, Japan’s $1.4 trillion GPIF (although not yet deploying capital in private equity) has been monitoring the industry closely.

GPIF has also been beefing up on PE 101. Last year it chaired a forum including global asset owners such as California Public Employees’ Retirement System, the Ontario Teachers’ Pension Plan and APG Asset Management to exchange ideas and best practices on ESG issues.

Asian private equity watchers are also following Japanese regional banks, which have taken important steps on the path to investing into alternatives. Not only is Japan’s regional banking community teaming up with domestic firms on deals, they are also getting seconded to enhance their know-how. These positive developments have raised expectations about the prospects of Japanese private equity, but investors like Soo are concerned that entry multiples are creeping up, and the challenge still lies in finding good and sizeable deals.

“There’s more capital flowing into the market and the stock market has done well, pushed up by the government’s quantitative easing. And globally speaking, private equity entry multiples in Japan are still lower than the rest of the world, but higher than what they were five years ago,” she says.

“Once again if you go back to the basics and look at the different drivers of returns (although Japan is generally not a high growth market), its advantage is that its valuations are much more reasonable compared to the rest of the world.

“In addition, there is a tailwind with where the market is moving, and if you buy smaller companies, they are less professionalised. The thing that you can do is to make those companies more palatable for buyers down the road, in which case you can increase your multiple expansion and make the market more attractive. Japan is playing the market quite differently, unlike China where growth is an important part as a driver of returns. In Japan that is a smaller part.” ?

BILLION-DOLLAR DEALS ARE BACK
Last year was notable for the return of the multi-billion-dollar deal to the Japanese market. KKR’s $4.5 billion acquisition of Japanese auto parts maker Calsonic Kansei Corporation from Nissan Motor and other shareholders was one of the biggest private equity deals in Japan in recent years.

Private equity firms Bain Capital and MBK Partners were also reported to have submitted second round bids for the business. Calsonic Kansei, which was founded in 1938, is one of the largest automotive parts manufacturers in Japan. The company currently has operations in the Americas, Europe, China and Asia across 78 production facilities in 16 countries. It counts Nissan, Renault, Isuzu, Daimler and General Motors as its customers.

The deal came just three months after Takaomi Tomioka, managing director and co-head of Carlyle’s Japan advisory team, told a media briefing that the firm could carry out two deals of up to $2 billion each from its Japan-focused fund, which presently invests in the mid-cap space.

“There could be about two large deals in Japan from our current fund focusing on Japan. With equity and debt combined, we could invest as much as ¥200 billion ($2 billion; €1.8 billion) in each deal,” he said.

Henry McVey, head of global macro and asset allocation at KKR, said in his Asia: Pivot Required report that Japan represented a major opportunity for corporate carve-outs, with EBITDA levels extremely favourable.