Japan Inc. upgrades via M&A splurge

Japan’s marquee companies have signed a record-breaking run of transformational foreign acquisitions – and their financiers are shouldering the risk.
The changing face of Japanese marquee firms after transformational M&A surge
The changing face of Japanese marquee firms after transformational M&A surge

Canon chairman Fujio Mitarai took personal control of the Japanese printer and camera maker’s largest-ever overseas acquisition. The septuagenarian flew to Denmark in secret and then drove across the Øresund Bridge to Sweden and met the management of fast-growing video surveillance firm Axis.

The world’s biggest camera maker said on February 10 it would pay $2.82 billion in cash to seal the deal, representing a no-nonsense 70% premium to Axis’ share price a month prior. The acquisition could mark a turning point for the shrinking firm that Mitarai’s uncle Takeshi Mitarai helped found.

Fujio Mitarai is not alone in going to extraordinary lengths to secure the future growth of his company. Japan’s marquee companies have paid $37.2 billion so far this year, a record start to the year going back to at least 1995 and double the volume seen a year earlier, according to data provider Dealogic. Average deal sizes are also at all-time highs and premiums are soaring.

The yen’s fall against the dollar to its weakest level since the summer of 2007 in the wake of the Bank of Japan’s expansionary policies has magnified price tags for Japanese buyers but that has not daunted the country’s determined shoppers across industrial sectors. 

A week after Canon’s announcement, Japan Post stunned markets with a $6.42 billion bid for Melbourne-based logistics group Toll Holdings. The biggest ever offer for an Australian company from Japan came at a 49% premium to the previous day’s closing share price. A few months earlier, in December, Otsuka Pharmaceutical said it would pay $3.51 billion for the US’s Avanir Pharmaceutical at a whopping 226% premium to the average share price over the previous 90 days.

Japanese companies are winning auctions because they have more firepower than their global peers: after decades of austerity they are sitting on a record 87 trillion yen ($730 billion) in cash, and the country’s banks, which largely escaped the global financial crisis, are keen to provide acquisition financing.

Japanese shoppers have paid so far this year an average premium of 37.45% to the target’s share price in the month prior tp the bid, significantly above the global average of 29.36% for cross border deals, Dealogic data shows.

With the country’s Nikkei 225 benchmark stock market index trading back above 20,000 points for the first time in 15 years, equity financing is also on tap.

In addition to plenty of firepower, Japanese companies appear more determined to escape their moribund domestic market. The government’s economic stimulus package, or so-called Abenomics, is struggling to boost growth at home, meaning corporate sales will continue to stagnate unless boardrooms decide to take drastic action.

“Business leaders have realised that slow growth in Japan is complicated and difficult to turn around – so to survive they have to think big,” Shun Uchikawa, head of Citigroup’s M&A division in Japan, told FinanceAsia.

That change in mindset has resulted in a seismic shift in Japanese M&A strategy. Instead of targeting stakes in Southeast Asian companies worth $100 to $400  million, a popular tactic in recent years as a bet on future growth, the aim now is $1 billion-plus megadeals in developed    economies to buy mature businesses outright.

“Japanese companies are now targeting developed countries with an inevitable increase in the size of transactions,” said Yoshihiko Yano, head of M&A at Goldman Sachs in Tokyo.

Bite-sized deals and tentative steps are out. Bold action is in.

Japanese managers favour Europe and the US because they offer steady growth (compared to Japan), advanced technology, and experienced management teams in transparently regulated markets. 

“Axis is the bluest of the world’s blue-chips,” Mitarai said at a news conference called to announce Canon’s acquisition.

The pace in deal making is unlikely to let up as other Japanese executives come under pressure to follow suit. 

“The number of transformational deals will increase,” said Haruo Nakamura, deputy president of Mitsubishi UFJ Morgan Stanley Securities, a joint venture between MUFG and Morgan Stanley and the top M&A adviser in Japan by volume of deals .

Straight from the top
A sense of crisis within the upper ranks of Japanese industry is transforming how the country’s companies go about making acquisitions.

Traditionally, it was the business development departments of Japanese companies that instigated mergers. This reflected the esteem with which manufacturing skills were held in Japan: M&A was seen as a natural extension of what a company’s producers were already doing. They would propose a deal to the corporate office and seek the necessary budget. These departmental proposals would then slowly work their way up an organisation through committee meetings and consensus building in a process known in Japan as nemawashi.

M&A was also seen by middle management as a way to gain promotion. A sure-fire way of climbing the corporate ladder was to generate more sales from core products, and a small bolt-on acquisition often helped to achieve that goal more quickly. 

Now, Japanese senior managers fear their legacies are in danger as sales slow. So the corporate decision-making process in Japan is being rebooted and leaders like Canon’s Mitarai and Itochu’s Masahiro Okafuji are taking bold steps.

“The way decisions are made is gradually changing from bottom-up to top-down, more like the system in the US and UK,” Goldman’s Yano said.

Big bets
The risk in making super-sized acquisitions, clearly, is that they might not pay off. A study by consultancy McKinsey shows only 23% of mergers globally succeed in recovering the costs of a deal.

On top of that Japanese companies don’t have the best M&A track record historically. In recent years pharmaceuticals giant Daiichi Sankyo has been the poster child of how not to expand overseas. It bought a 63.4% stake in Ranbaxy Laboratories for $4.6 billion in 2008 but was shortly afterwards hit with sanctions from the US Food and Drug Administration and fined for poor product safety controls at the Indian company. It finally managed to extract itself in April this year from the ill-fated foray.

However, some Japanese managers now feel they have no choice but to take big risks.

Hence, Itochu’s chief executive officer Masahiro Okafuji drove the $10.37 billion joint bid announced in January with Thailand’s CP Group for a 19.73% stake in Chinese conglomerate Citic, despite opposition from other board members, two people familiar with the decision said.

Okafuji believes the Citic holding could be resold in a few years’ time at a higher value; in the meantime he hopes to form joint ventures with Citic’s businesses in China, the two sources said.

M&A advisers have been leery about the structure of the deal: “I would not recommend that transaction from an M&A practitioner’s point of view – it’s just 20% through the joint venture. It would be very hard to have their voice reflected in Chinese government-controlled Citic,” said one senior M&A banker in Tokyo.


Okafuji, the man behind the deal

“If Citic wants to damage Itochu’s investment there are very few things that Itochu can do,” he said. 

In another large deal that could yet be difficult to digest, Japanese logistics firm Kintetsu World Express is buying Singapore’s APL Logistics for ¥144 billion ($1.21 billion). At that price, APL was valued at 80% of Kintetsu’s market capitalisation. APL’s sales of around ¥186 billion are also just over 60% of Kintetsu’s. One analyst estimated it will take 15 years for Kintetsu to make the deal pay off.

Acquiring gaijin
To be sure, one way that Japanese companies are minimising the risk of failure as they expand internationally is by hiring foreigners. When Suntory Holdings bought distiller Beam for $16 billion it said the acquired company would be headquartered in Deerfield, Illinois and led by the incumbent CEO Matt Shattock.

The Japanese government has also encouraged companies to take on more outside directors as part of its efforts to boost growth. The thinking behind that is that outside directors might encourage greater risk taking, possibly including M&A, in order to boost the return on equity.

Japanese companies have in the past mostly fended off activist investors pushing for higher returns, but government prodding to be ‘good corporate citizens’ is harder to deny.

“Japanese companies are hiring outside directors to enhance their corporate governance and also increasingly hiring experienced foreigners, because they realise that is critical to being a successful global player,” said Mitsubishi UFJ Morgan Stanley Securities’ Nakamura.  

But the main upshot of corporate Japan’s growing global outlook has been the taking over of established, sizeable companies in developed markets. As such the Japanese have begun snapping up well-known brands such as Mizkan’s purchase of Unilever’s Ragu & Bertolli pasta sauces for $2.15 billion.

The average acquisition price tag hit $279 million in fiscal 2014, more than double the average in the previous four years, according to Dealogic data.

The US was the top target country for Japanese bidders with $28.8 billion spent on deals between April 1 2014 to March 31, (the Japanese fiscal year), followed by China and Australia with $11.5 billion and $7.1 billion, respectively, according to Dealogic.

So far this year Asahi Kasei has bought Polypore International for $3.16 billion and Mizuho Financial Group has bid $3 billion for Royal Bank of Scotland’s portfolio of US and Canadian loans. 

“Three or four years ago people were looking at greenfield acquisitions in Asia to lock in future growth; but the very recent trend is that Japanese managers are looking to spend several billion dollars on sizeable deals, often in the US,” one senior M&A banker in Tokyo said.

Price is no object
Taking control of brand names does not come cheap. Japan Post is forking out a hefty 49% premium over the pre-announcement closing share price for Toll. So it’s not surprising that Toll’s board called it a “compelling transaction” and stock analysts judged a competing bid unlikely. 

“Hefty premiums are evidence of how seriously many Japanese companies are taking M&A,” said Goldman’s Yano. 

Dai-ichi Life’s buyout of US insurance firm Protective Life was done at a 34% mark-up on its pre-announcement share price. It marked the highest price/earnings valuation paid for a North American life insurance company since 2001.

Japanese companies continue to pay top dollar even though the yen has fallen nearly 20% since April 2013, making overseas acquisitions more costly for them. 

“When they decide they want to own an asset they don’t really use the same valuation metrics as others – part of it is governance,” David Gross-Loh, a managing director at US private equity firm Bain Capital, said. “We couldn’t pay those prices.”

Financiers shoulder the risk
As Japanese companies set their sights on large, game-changing deals there is also an abundance of financing.

Japan’s relatively healthy banks are looking for ways to put money to work lucratively. Given Japan’s slow economic growth, corporate clients are not borrowing and the massive ¥80 trillion ($670 billion) in annual monetary easing by the Bank of Japan over the past two years means yields remain ultra-low.

Suntory’s purchase of Beam was financed by a $12.5 billion bridge loan from Bank of Tokyo-Mitsubishi UFJ. The size of the loan surprised the market because it is highly unusual for one bank to shoulder so much risk alone. 

The Japanese government is supportive of acquisitions. So JBIC, a policy bank, also helped to finance Suntory’s purchase of Beam. And when housing equipment firm Lixil acquired German bathroom fittings maker Grohe for $3.84 billion, it was DBJ that provided mezzanine and equity finance.

Acquisitive companies can also tap booming stock markets. When Dai-ichi Life acquired Protective Life for $5.71 billion it tapped equity markets for ¥277.1 billion ahead of closing the deal, the largest-ever equity follow-on offering by a Japanese insurance company.

Stock markets were so supportive that despite the 20% dilution impact the share price only fell 0.4% between news of the share sale and the offer’s launch. 

Historically low interest rates have meant borrowing from debt markets has never looked more attractive. Dai-ichi Life, for one, issued a $1 billion callable perpetual subordinated note in October.
“Cheap financing has been a tailwind for M&A,” said Goldman’s Yano. 

The trend in outbound acquisitions tends to be self-perpetuating in Japan.

After Japan Post and Kintetsu Express made big purchases, the normally quiet logistics sector is likely to be galvanised by more deals say bankers. 

Dai-ichi’s acquisition of Protective, meanwhile, has prodded Japan’s biggest life insurer, Nippon Life, to bulk up and maintain its position as number 1. Nippon Life said in March that it could use up to ¥1.5 trillion for investment and acquisitions in the coming decade.

“If the neighbours start doing something then everyone may want to follow suit,” said Yano. 


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