Significantly, debt financing remains firm. Debt capital market volumes come in at $160 billion year to date (YTD), compared to $150 billion for the same period last year, according to Dealogic. Admittedly, raising debt is an obvious strategy in a country of quasi-zero interest rates. But observers suspect that the true answer is more profound û debt does not require the ceding of ownership rights. And losing ownership is a clear and present danger to Japanese companies these days; precisely because of the M&A boom. So oddly enough, the M&A boom could be causing the ECM markets to dry up.
Why?
Observers estimate Japanese executives are concluding that M&A in Japan, however hyped by Wall StreetÆs best and brightest, can have some unpleasant consequences. They are realising that itÆs a lot better not to be taken over. (There may also be a reaction against KoizumiÆs market-friendly policies, now that the man himself has stepped down from the post of prime minister. That chimes with the slowdown of right-wing policies under his successor Shinzo Abe.)
Part of the corporate response is therefore to stop increasing their freefloat by relying on other forms of capital û thus preventing an ownership leak from their own company to potential acquirers via share issuance. That issuance constipation is whatÆs holding back ECM volume, they say. ItÆs probably an accurate reflection of just how gloomy sentiment in Japan is that so many firms should see themselves as potential victims.
The crucial question, then, is whether M&A is going to continue, or whether shrewd Japanese managers will learn more ways of reversing the current boom. Certainly, itÆs the defence that seems to be currently favoured by the law. Thus, the authorities appeared to be recently encouraging poison pill defences when they threw out the case by Steel Capital Partners against the actions of the target, Bulldog Sauce, in June.
But so far at least, M&A is having a good year, certainly by JapanÆs low standards. According to boutique adviser Recof Corp, M&A involving Japanese companies totalled Ñ4.7 trillion ($402 billion) in the six months from April through September, up 10% from one year earlier û and incomparably higher than 10 years ago. However, this is from a low base, and Japan is still a small market by the standards of the US, the UK or Europe. The 10 largest completed deals reported by Dealogic year-to-date amount to just over $24 billion. Last year, the top 10 deals amounted to $27.6 billion û excluding the mammoth $17 billion takeover of Vodafone Japan by SoftBank.
This year, the biggest deal was the $8 billion acquisition of Nikko Cordial by Citi. In terms of volume, the year-to-date total of completed deals comes in at $173 billion compared to $174 billion last year. (Nomura tops the leader-board as advisor for announced deals, followed by GCA and Citi, and also tops the leader board for completed deals, followed by Merrill and Goldman). So in contrast to the moribund ECM market, M&A is strong and growing. The market is certainly attractive: ôIn Japan, our sense is there are still mis-pricings of corporate assets, and opportunities still exist,ö Grant Kelley, CEO of private equity fund Colony Capital, recently told FinanceAsia.
Yet some issues are still hurting the M&A market. The Japanese donÆt take kindly to the mass firings which are an important attraction of M&A in the West, in pursuance of back office efficiencies. In addition, Japanese M&A is often cast in terms of predator and prey (or winner and loser). In Japan, management is still not inured to being identified as prey û however beneficial a payout would be to shareholders. That reflects different perceptions about the pecking order of corporate stakeholders. Many Japanese executives simply feel that M&A is not good for management and staff, however good for shareholders. Richard Koo, chief economist at Nomura, also speaks of the æextremely distinctive DNAÆ in Japanese firms, which dooms many mergers to failure.
On the international front, in particular, the Japanese have reason to feel they are more likely to be the target than the aggressor. JapanÆs capital markets are open, yet Japanese companies have small market capitalisations relative to their Western peers. Unlike in the West, there is less of an obsession with pushing up the share price to benefit shareholders (the mindset which brought down Enron, incidentally). So even the biggest Japanese firms in many sectors are frequently relative pygmies in terms of market cap. That makes them vulnerable to a takeover if the acquirer is using his shares as currency.
In addition, the government seems keen to imitate the West. Regulations about triangular mergers (which became active in May this year) are making it easier for foreign subsidiaries in Japan to buy local targets using their parentÆs shares. (However, the board of the target company has to vote and agree on an approach by a suitor, meaning the legislation doesn't encourage hostile deals.)The biggest deal this year, the takeover of Nikko Cordial by Citi, was just such a deal. But, points out, Bob Grondine, a partner at White & Case in Japan, the triangular merger measures are far less convenient than the code regulating domestic M&A. In particular, they only permit for tax deferral under special circumstances. In fact, Grondine believes the strict criteria for obtaining tax deferral made the triangular mergers a dead letter - at least, until the Nikko Cordial deal with Citi.
Shareholder activities are also becoming more common in Japan, and have won some successes over local managers. The passage of the Japanese version of the Sarbanes-Oxley act next year will further pressure Japanese managers to pay more attention to shareholder returns.
So all is by no means lost. A recent study by the Economist Intelligence Unit (EIU) suggests that low-key M&A will carry on. It wonÆt be giant deals, it will be successful Japanese companies offloading their subsidiaries or buying profitable new ones (ôDomestic, friendly, inter-and-intra groupö as the EIU puts it). Despite the high-profile international deals, then, itÆs likely that highly asymmetrical deals will be the real driver of M&A û for example, a giant company offloading some unprofitable subsidiary. Nor will that be a new development. One-third of all M&A transactions in Japan are in the mid-market range of $500 million, while fully 80% of all deals by number have involved an unlisted target firms, according to the EIU.
Some observers suggest private equity investors could be beneficiaries. These, as long as they take a minority stake and pay due respect to local sensibilities, are more likely to be seen as working in the interest of existing management. Financial sponsors could, for example, incentivise management with stock, thus aligning private equity and management interests. Indeed, a privatisation with the right partner would prevent a takeover by the wrong partner. But ultimately, Japanese managers are not keen to look as if they need to be rescued by private equity firms in the worst case, or to be seen to be selling out the company for private profit in the best case. It may seem somewhat emotional to Western financiers but selflessness, loyalty and reputation are still taken seriously in corporate Japan.
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