Why Japan is entering a golden era for PE

NSSK managing partner Jun Tsusaka describes how the Japanese PE market is gaining lasting momentum.

When Tokyo-based Nippon Sangyo Suishin Kiko (NSSK) closed its second vehicle on 60 billion yen ($566 million; €453 million) in September last year, it did so in a flurry of domestic capital raising. Unusually for a Japanese mid-market vehicle (and first time institutional raise) NSSK II drew commitments from not only local investors but also large foreign institutions. NSSK managing partner and founder Jun Tsusaka explains why the Japanese market, which he concedes has “had had its fits and starts”, is poised to shine on a sustainable basis.

Jun Tsusaka

How would you describe the market?
The first golden era of Japanese private equity is about to begin. If you go back to the 1980s in the US and 1990s in Europe, you’ll see a similar period where every year there was an increase in the number of transactions and exits and a rise in participants, as well as the generation of steady returns over time. The industry is building in a systematic and sustainable fashion, which hasn’t happened before. As we look back at the post-Abe period, we’ll see this decade or two as a very attractive period of Japanese private equity investment. Early investments and returns already suggest the 2012-2018 vintages as being quite attractive from a deal entry and performance perspective.

Did Abenomics set the scene?
There is no doubt that the PE market has done well after Abenomics, but even before then, during a very complex period – there was the financial crisis, the tsunami, the earthquake, and the stock market was flat – private equity did well. The Nikkei 225 generated returns of 1.0x from 2006-2016, while we generated returns of 2.0x, and 3.6x for deals under $55 million. For LPs looking for markets that are not correlated with public equity markets, Japan is a very good example of non-correlation and a market that can generate solid returns when there are global public market issues.

What has whetted LP appetite?
One of the biggest factors is realisations – both in number and performance. A lot of sophisticated foreign investors have started to turn their attention back to Japan with solid returns on capital and the ability to deploy capital on a steady basis. Many US institutional investors appear to be wary of overexposure to the US market and deploying capital there because entry multiples are anywhere between 10-14x and in Europe they are 10-12x. In Japan entry multiples are higher than they were five years ago but are still on average in the range of 8-10x. For the middle market, entry multiples are still in the 7-9x range. There is the general perception that you are able to buy equivalent companies at lower valuations in Japan. Plus, the inefficiencies associated with these businesses provide for larger potential upside from cost reduction and revenue enhancement initiatives.

Is too much money now chasing too few deals?
My contention is still absolutely not. There has been about $10 billion of dry powder raised in the past 12-18 months. Although that’s a lot of money, the big dollars are tied to larger pan-Asian funds. And it is still very small relative to the size of the economy. There are around 4 million SMEs in Japan. The large-cap players are not going after smaller deals and there are plenty of them (over 3,000 middle market M&A transactions last year) to go around for the 50-75 or so GPs in that space. It’s not congested and the quality of the dealflow today is better than what I’ve seen in the past decade.

What kinds of investments do you typically look at?

We have completed seven deals in the past 36 months and all have been proprietary (where we are able to secure a minimum of two months of exclusivity prior to making any financial commitments).

US Mart is a good example. In 2015 we acquired the indoor playground operator business in a succession deal where the founder/owner didn’t have any children to take it over. The owner had about 70 amusement facilities in malls throughout Japan. He wanted to continue to grow the business and needed a partner to manage a large organisation. To increase the number of locations, we made a commitment to expansion given the need in the market and the short cash break-evens, took a systematic approach to site selection, revised lease contracts entered into with landlords, as well as implemented overall cost management. The business has about 140 facilities today with over 14 percent operating margins.

We brought in a senior district manager from McDonald’s to standardise best practice across all stores. The second big hire was a CFO who came to us from ANA Hotels Group. At the mid-level we’ve also hired 20-30 people. Since we bought the business, we’ve seen continuous revenue and earnings increases every quarter. With the excess cashflow we have received a dividend equivalent to over 10 percent of investment capital in the first year.

NSSK II bought elderly care provider SC Holdings for a reported $230 million. What attracted you?
The business provided low cost nursing services to the largest segment of the elderly care market – the middle class – in suburban Tokyo and the Greater Kanto area. It was struggling with how to enter its next phase of growth and constrained in terms of people and business processes. The owner, who had no successor, wanted to double the number of facilities to 200. The complexity of doing that was high. They needed a partner that could bring people and processes to the table.

What improvements have you made?
For each investment we implement our NSSK Value-up Programme, which looks first at introducing management systems, improving sales and marketing, and revamping HR policies and incentives. In the case of SC Holdings, there have been two big changes. First, we forecast improving 85 percent occupancy levels to 89-90 percent during our investment. We have raised that to 92-93 percent and are deriving more earnings per facility than we thought. We are three years ahead of schedule.

Second, we worked with a consultant to create an algorithm to determine optimum locations based on population size and age, number of hospitals and occupancy levels. Over the next 12 months we anticipate building a dozen or so new facilities using capital we provided to drive shorter cash break-evens on new facilities. We have also worked on accounting and finance transparency and improving safety and compliance procedures and upgrading internal control systems. These don’t directly contribute to revenues but are very valuable. The market is willing to pay a premium price for these elements.

Did you change management?
No. Our slogan is ‘In Partnership with Management’. We kept the existing team and brought on board staff where needed. Through our HR initiatives, the company has hired 20-25 mid-level people and we are continuously looking for talent to assist the CFO and back office management.

What are your thoughts on exiting?
For all of our investments we look at a three-to-five year horizon. For SC Holdings, we will probably see a full realisation earlier than anticipated. The cashflow improved materially in year one, so we’ve already returned 10 percent of invested capital in year one and will look at IPO and strategic sale alternatives in due course.

What’s next for NSSK?
We are always looking for talented, motivated and curious people. We have a very high impact senior advisor hire in April that has both large cap and SME expertise. A new senior associate and a director will also start in April. And while we are very concerned about the back office quality and control systems of our portfolio companies, we also endeavour to make sure that our internal systems meet global best practice. We want to practice what we preach.

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