After being in business for more than a decade, Tokyo-based fashion retailer Mark Styler hit a crossroads familiar to many Japanese consumer goods companies. Hindered by slow growth in a mature economy, the company was not reaching its full potential at home. Meanwhile, across the East China Sea, millions of potential customers hungry for Japanese brands were waiting. The company knew it had to go overseas but lacked the resources to do so effectively.
Enter CITIC Capital Partners, the investment arm of Hong Kong-headquartered CITIC Capital Holdings. Specialising in investments tapping into the China growth story, the GP proved to be the perfect partner for Mark Styler. In 2015, it invested an undisclosed amount in return for a majority stake in the retailer. The strategy was simple: leverage CITIC’s bulging China network and draw on the GP’s regional expertise to expand Mark Stylers’ online and retail store business – including brands like Laguna, Marua and Dazzlin – to China.
“The Chinese economy is becoming more consumer driven and there is a rising middle class,” explains Hironobu Nakano, senior managing director and head of Japan for CITIC Capital. “These people come to Japan very often and there is a huge number of Chinese tourists arriving every year who have the opportunity to buy Japanese products.”
The investment was the first to come from CITIC’s third Japan-focused fund which closed on a hard-cap of ¥30 billion ($266 million; €246 million) in February, exceeding its initial ¥25 billion target. The fund’s success not only demonstrates a healthy dealflow for Japanese companies pursuing an overseas strategy but also reveals LPs’ appetite for Japan-focused funds that are able to effectively deploy a cross-border strategy.
Foreign – or at least, foreign-owned – GPs are playing a larger role in Japan’s private equity market. This is a note-worthy trend in a market often perceived as difficult, or even hostile, to foreign buyers. But does this image still ring true?
The past few years have seen several foreign GP-led deals make headlines in Japan. Most involve the biggest global GPs. Recent deals include Bain Capital’s $421 million purchase of hot spring resort chain Oedo Onsen, KKR’s $550 million carve-out of Pioneer DJ Corporation, and Carlyle’s $263 million purchase of building materials firm Senqcia Corporation.
More big deals are on the way. In January, KKR launched a tender offer to buy the power tool and life science equipment unit of Hitachi in a deal valuing the business at $1.28 billion. This comes on the heels of a $4.5 billion bid for auto parts maker Calsonic Kansei Corporation from Nissan Motor, though it is worth noting big deals do not define a market which is predominantly driven by mid-market activity.
Looking at S&P Global Market Data, deals by “foreign private equity buyers” hit a peak in 2014 with 39 deals worth $5.5 billion, the number dropped to 20 deals in 2016, with just $59 million worth of investment disclosed. This is unlikely to offer a full and accurate picture, however, as many deal figures go undisclosed. Furthermore, there is no single clear definition of what constitutes a foreign GP when many global platforms have a fully localised team and strategy.
CLSA Capital Partners, the private equity arm of the eponymous Hong-Kong based brokerage, is a veteran of Japan’s mid-market space and has been targeting mid-market opportunities through its Sunrise Japan fund since 2006. The fund is now in its second iteration having reached a final close on Sunrise Capital Fund II in late 2014 at $210 million.
Shota Kuwaki, senior vice-president at CLSA’s Sunrise Capital Fund, says founder-owners are more receptive than ever when it comes to working with private equity investors – foreign or otherwise. So-called succession deals – where founders seek to cash out all, or part, of their ownership and retire – are a particularly prevalent theme.
“Many of these founder-owners have become more receptive to private equity funds helping out as a sponsor,” says Kuwaki. “They partner with private equity funds to pursue either further domestic growth or, given the Japanese market as a whole is not a high-growth market, actively expand overseas.”
This was the solution CITIC Capital was looking to provide for fashion label Mark Styler – though the deal was not a succession play but a turnaround focused on expanding the firm’s 170-store footprint beyond Japan. But cross-border strategies also work both ways.
Having a global network not only offers a way to take Japanese goods and services abroad, but it is also a way to bring in global brands and tap regional consumer trends within Japan. This is precisely what happened with a recent investment in the Wendy’s Japan franchise by Longreach, a Japan-focused GP with offices in Hong Kong and Tokyo that could leverage its Greater China links and cross-border capabilities (see panel).
Taking advantage of a global footprint is not limited to taking companies overseas. CLSA’s Kuwaki stresses that, contrary to the fact the Sunrise Capital fund is part of both an Asian and global platform, most of the value-add that occurs within the portfolio is carried out by the firm’s Tokyo team.
“If the company we acquire wants to pursue overseas expansion we will help to the best of our ability to expand overseas, utilising CLSA’s broad Asian network, but this will always be an upside and not part of the base case scenario,” he says.
“The big benefit of being part of the CLSA platform is that it brings credibility. I think a lot of the Japanese founder-owners take comfort from being part of a large organisation.”
Having international credibility, and a track record to go with it, has helped CLSA break some important barriers in Japan. The most recent example is CLSA’s May 2016 acquisition of KK BC Holdings, a company that operates 68 cram schools under the brand Tanaka Gakushukai.
“This was obviously a landmark deal,” says Kuwaki. “The education system in Japan is considered a sacred industry and no private equity firm in the past has been able to tap a pure education play such as a cram school and we were the first ones to be able to do it.”
Kuwaki adds that one of the benefits of completing such a landmark deal is the scrutiny it receives from other Japanese business owners. Provided the deal goes well, this can add to the investor reputation and contribute to the GP’s deal pipeline in future.
The sentiment is echoed by CITIC Capital’s Nakano who notes that growing activity among cross-border focused GPs in Japan is less to do with a market more open to foreign private equity and more about the ability of existing GPs to build trust in the market.
As the Japanese private equity market matures and GPs build their track record, cross-border transactions are becoming increasingly routine. Successful deals like Mark Styler depend on a GP demonstrating that its commitment to the country – unlike fashion – is not a passing fad.
“In terms of the perception of the owner or CEO, I don’t think there is much difference between a foreign firm or a local firm,” says Nakano. “It is more about what kinds of deals you have done, how long you have been investing in Japan, and how much you are committed to Japan.” ?
A LICENCE TO GRILL
Japan-focused GP Longreach found its cross-border capabilities essential when it took over the Wendy’s Japan franchise
When Japanese fast-food tycoon Ernie Higa first announced a joint venture with US burger chain Wendy’s in 2011, he had hoped to rapidly expand the chain throughout Japan. The serial entrepreneur had already made a success of the Dominos Japan franchise before exiting the business, and its 180 stores, to Bain Capital in 2010. But Wendy’s proved to be more of a challenge, and four years later the franchise had made little headway.
Higa’s solution was to team up with Suntory-owned chain First Kitchen in 2015, an idea that eventually led to Longreach leveraging its relationship with both Higa and Suntory to acquire both the franchise and First Kitchen. The two businesses complemented each other perfectly, with First Kitchen’s more Japanese approach to casual dining – with menu items like pasta and salads – complementing Wendy’s American-style menu of burgers, fries and chilli. For Mark Chiba, co-founder of Longreach, part of the deal’s success was down to his firm’s cross-border capabilities.
“The deal had two simultaneous elements,” says Chiba. “First, we had to negotiate the carve-out from Suntory, a relatively conservative Japanese institution, which required very high level trust relationships and strategic discussions. At the same time, we had to negotiate the franchise agreement with Wendy’s in the US that would enable us to take those 136 stores from Suntory and convert them to a tailored new growth concept called Wendy’s First Kitchen.”
Longreach was also tapping into another important cross-border trend: the growth in demand for premium fast-food offerings across Asian market as more middle-class, aspirational consumers look for upmarket concepts.
“Japan is in a sense a bit of a laboratory for middle-class Asia,” says Chiba. “When Korean, Chinese and other affluent but value-focused Asian tourists come to Japan, we can make Wendy’s First Kitchen a destination for them. One of the huge themes in Japan is the growth of tourism from Asia and we are looking for ways to tap into that in the consumer and services sectors.”