Q&A: Carlyle sees rise in Japanese carve-outs

Kazuhiro Yamada, head of Carlyle's Japan buyout group, talks about why Japanese companies are more willing to say goodbye to non-core units.

The Carlyle Group sees a rise in Japanese companies willing to say goodbye to non-core businesses in order to boost their return on equity and compete more effectively on the global stage. 

Private equity firms have long aspired to buy large, under-managed units of marquee Japanese companies, and there is an unusually large crop of carve-outs this year.

Japan’s biggest drugmaker Takeda Pharmaceutical is spinning out Wako Pure Chemicals; Nissan Motors is auctioning autoparts maker Calsonic Kansei; Fuji Heavy Industries' adviser Lazard is calling for bids on its the recall-struck airbag maker Takata, according to market sources.

The Washington-headquartered private equity firm has placed a bid for Wako Pure Chemicals, according to two of the market sources. Carlyle declined to comment.

A wider array of targets in terms of sectors is also healthier for buyout firms. The industry’s returns in Japan were hit badly in the aftermath of the global financial crisis as many funds had invested in cyclical industrial sectors and financial institutions. Carlyle’s purchase of lossmaking chipmaker Covalent from Toshiba was one example that struggled.

However, Carlyle is not losing sight of the fact that the still sporadic number of carve-outs can’t sustain a franchise alone. The firm's mainstay is a steady flow of smaller, privately negotiated deals, often instigated by elderly Japanese businessmen wishing to pass on the companies they founded to the next generation, expand overseas or monetise their equity holding.

Carlyle is putting its new fund, Carlyle Japan Partners III, to work at a brisk pace and it is generally performing well, investors in private equity -- known as limited partners -- told FinanceAsia

Kazuhiro Yamada head of its Japan buyout group talks to FinanceAsia about the trend of rising carve-out opportunities:

The following transcript has been condensed and edited for clarity.

Are corporate carve-outs gaining traction in Japan?

Finally, corporate carve outs have emerged. When we established our second fund, spin-off opportunities were much talked about but nothing happened.

There are two main reasons why spin-offs are happening now:  the top management of Japanese listed companies are now required to communicate with institutional investors and explain their strategy. They also need to demonstrate a certain level of profitability – so they are seriously thinking about how they can maximise profits or cash to the investor – this is an incentive to managers to think about carve outs. 

Secondly: globalisation. Industries that are facing global competition, say in the TMT [technology, media and telecommunications] and healthcare sectors, need to focus on their core business, allocate their resources in terms of cash and human capital carefully in order to compete with global players. 

Does this trend represent an opportunity for private equity? Are you seeing more traction in your own discussions with corporate management?

The number of discussions has definitely increased over the past five years, although the discussion may take a long time. Nowadays a large number of top executives in Japan are European- and US-educated with MBA degrees; so their management style has shifted to the global standard.

We generally see more under-managed companies in the mid-cap area, partly because in Japan the most capable people have chosen to work in the largest companies. However, even though Japanese blue-chips have good resources, they can still be slow at making decisions and a low-growth domestic market means large companies may suffer low profitability.

Our investment pace is good.

Is it culturally more acceptable to sell units to foreigners now in Japan?

There used to be an allergy, or mental hurdle, to selling their company to overseas investors, but no more. 

Large companies do have their own culture, which becomes apparent in areas such as decision-making. But if we put in the right management or promote younger, talented people maybe we can change the culture. It’s not easy but we have effective options.

Are Japanese companies also considering selling non-core overseas assets?

A Yes I think so. We have some ongoing discussions about corporate divestitures with Japanese companies that own overseas assets, which they have identified as non-core. 

Has Carlyle changed strategy now that corporate spin-offs are more available?

Our strategy has not changed at all. Mid-cap and succession opportunities are still very attractive and we are strong in that area. We have 19 professionals here, one of the largest investment teams among private equity firms in Japan. They are all Japanese with local connections. Carlyle has 16 years of experience here in Japan.

This experience creates a huge opportunity for succession deals – without a wide network it is impossible to generate such deals. We think this is a differentiating factor for Carlyle Japan compared with other Japanese private equity players. That is why mid-cap and succession deals are the mainstream of deal opportunities for us.

However, since corporate spin-offs are becoming more frequent – we are willing to look at those opportunities too.

In the past Japanese companies tended to sell only distressed units – is that still the case?

A It used to be that the only available deals were low-profitability assets, sold when the parent company was in trouble and needed cash.

Kazuhiro Yamada

Recently, the management of blue-chip companies has changed a bit. Now they need to allocate more cash to core businesses, otherwise they cannot compete with global players.

Japanese companies are making very large acquisitions overseas and even though the Japanese megabanks are keen to finance these purchases, the Japanese companies still need to raise cash and strengthen human resources for effective post-merger integration. 

In the past, it was mainly financially troubled companies that thought about corporate divestiture. Today corporates like Hitachi are also selling assets.  When we sat down with Hitachi people I was impressed with their board, which includes North American and European senior executives. They came across as professional and clear that business unit leaders need to show action in their pursuit of the group strategy and financial returns. 

How does the performance of private equity firms in Japan stack up against other markets?

Japanese private equity funds are looking more attractive to investors due to negative interest rates and the return on leverage. 

Secondly there are under-managed situations in Japan that create opportunities for private equity and although the yen is appreciating now, in the long term it may depreciate again. 

The challenge is the aging population and mature market. 

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