The long goodbye: Japanese firms slowly sell assets

Japanese companies are finally willing to cut the cord and sell non-core assets to private equity firms. But supply is limited — and bidding looks likely to be ultra-competitive.

When Mark Chiba flew to Wendy’s headquarters in Columbus, Ohio in April for a meeting with the US firm’s top management to negotiate the combination of Wendy’s Japanese franchise with First Kitchen — a subsidiary of the conservative, family-controlled Japanese conglomerate Suntory Holdings — he knew it would be tough.

The relatively small and complicated deal, put together during secret meetings, required a sensitive balancing act. Chiba’s private equity firm, Longreach, needed to focus on bridging the gap between two very different corporate cultures. 

Unlike in the US, where funds are ubiquitous in high-profile auctions of multi-billion-dollar assets, private equity is only just starting to win acceptance among managers of Japanese blue chips.

These companies still regard non-core units as part of the family. They look at funds with suspicion.
The execution of Suntory’s first ever sale to a private equity firm took roughly six months to complete. But the deal was the culmination of years of talks with Suntory about its portfolio of businesses and required building trust with multiple layers of management, from the founding family through to the heads of operating divisions.

“The way we get those deals is through many, many years of strategic advisory dialogue with the senior management of the seller and other key decision-makers,” said Chiba, Longreach’s group chairman — and one of the few managers in Japan to secure such a deal on an exclusive basis. Just this week it signed another carve out, this time from Olympus

This long, winding process illustrates why private equity firms can’t count on a steady flow of exclusive Japanese corporate carve-outs to fall into their laps.

The low but rising number of such deals in the market will be fiercely contested and expensive. Far better for most yen-denominated funds is to focus on low-hanging fruit in Japan, such as smaller deals where elderly Japanese are looking to hand over the businesses that they founded to the next generation.

Carve-outs are in 
Private equity firms have long aspired to buy large, under-managed units of Japanese companies and some market participants are getting excited about a series of big 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 is calling for bids on its recall-struck airbag maker Takata. Private equity firms KKR, Carlyle and Bain are circling the assets, according to people familiar with the auction processes.  

“Large deals have been hard to come by historically, but this year there are a number of large, $500 million and over, opportunities in the market,” Jun Tsusaka, head of Tokyo-headquartered private equity firm Nippon Sangyo Suishin Kiko (NSSK), told FinanceAsia. “This is a good and important data point and, hopefully, a beginning of a trend.”

These deals follow a landmark acquisition by KKR in 2014. The firm bought an 80% stake in Panasonic Healthcare for an equity value of about ¥165 billion including net cash left on the balance sheet of about ¥10 billion. In a recent update for investors late September in Hong Kong, KKR said that its acquisition was tracking at a multiple-of-money invested of about three times. 

It was one of the few times a household name in Japan had sold a unit to a private equity firm, and helped lay the groundwork for other such deals in managers’ minds. KKR paid less than eight times pro-forma Ebitda of about $180 million for three profitable business owned by Panasonic Healthcare, based on the exchange rate at the time of the deal.

That may have been one of the most prominent deals in recent years. But it was far from an outlier.

“More Japanese companies are selling down non-core assets, which is positive for private equity,” said Shun Uchikawa, head of M&A for Citigroup in Japan.

This is partly because the Japanese government’s pressure on companies to focus more on pleasing shareholders is starting to have an effect. In June last year, the Japanese Corporate Governance Code took effect, encouraging firms to employ outside directors who regard non-core operations more dispassionately.

Foreign buyers have also been helped by the growing recognition among Japan’s executives that they need to move overseas for growth. This strategy is bringing them up against formidable and larger competitors, which is in turn pushing them to be leaner and more focused.

“Industries that are facing global competition, say in the TMT and healthcare sectors, need to focus on their core business and allocate their resources in terms of cash and human capital carefully in order to compete with global players,” said Kazuhiro Yamada, head of the Japan buyout advisory team at The Carlyle Group.

Astellas Pharma, for example, has been ruthlessly whittling down its product line. It bought US biotech firm Octa Therapeutics in November and the next day announced the sale of its dermatology business to Denmark’s LEO Pharma for €675 million, which it will plough into new drug development.

The offshore deals of Japanese companies are often so large that they still need to raise cash, pay down debt and bolster human resources for effective post-merger integration even after their banks provide them with jumbo loans. SoftBank, for example, sold $7.9 billion shares of China’s Alibaba and a majority stake in Finland’s Supercell to help relieve debt after the acquisition of US telecoms giant Sprint.

“We have some ongoing discussions about corporate divestitures with Japanese companies that own overseas assets, which they have identified as non-core,” said Carlyle’s Yamada.

However, Carlyle for one is not losing sight of the fact that carve-outs can’t sustain a franchise, which typically makes between eight and 10 investments per fund raised. 

“Our strategy has not changed at all … mid-cap and succession deals are the mainstream of deal opportunities for us,” said Yamada. “However, since corporate spin-offs are becoming more frequent, we are willing to look at those opportunities too.”

Healthy options
Private equity funds are being more discerning when it comes to carve-outs. 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.

“Some lessons have been learnt ... such as not to buy capital intensive, cyclical technology businesses which are over-leveraged and over-priced at the wrong time in the market. Private equity in Japan has also failed in the past to change management, so they couldn’t fully harvest the value creation of a change in ownership,” said Longreach’s Chiba.

To be sure, funds are looking at turning around Takata following the auto industry’s widest-ever defective airbag recall. But that could be counterbalanced by private equity’s interest in Nissan Motors’ auction of its 41% stake in Calsonic Kansei, which could fetch around ¥100 billion, based on the firm’s market capitalisation.

Fuji Heavy — run by CEO Yasuyuki Yoshinaga (pictured) — selling Takata

Calsonic had a net cash position in the fiscal year ending March 2015 and its shareholders’ equity ratio exceeded 50% in the fiscal year ending March 2016.

Private equity firms are competing for Calsonic with auto parts makers worldwide and have submitted offers in the second round of the auction, people familiar with the process said. 

Nissan is looking to reinvest the cash into electric vehicles and automated driving. “We see strategic merit in potential unwinding of cross-held shares between automakers and parts makers as it allows for more effective usage of cash,” said Goldman Sachs equity analyst Toshihide Kinoshita in a research note.

Private equity is also able to pick over carve-outs in a wider array of industrial sectors.

Wako Pure Chemical, which Takeda Pharmaceutical is auctioning, is engaged in the reagent, test drug and chemicals businesses. The firm’s sales have been comparatively stable over the past five years, ranging between ¥74.0 billion and ¥79.3 billion with recurring profits of between ¥7.3 billion and ¥8.7 billion.

Money doesn't always talk
One problem private equity does not have is leverage — Japanese banks are falling over themselves to offer loans given the difficulty of charging worthwhile spreads in a negative interest rate environment. But having the money was never really the problem for private equity in Japan; it was much more about sourcing deals and the cultural acceptance of private equity. A Japanese TV series in 2007 about funds was called Hagetaka: Road to Rebirth. Hagetaka means vulture in Japanese.

Japanese corporates generally don’t need private equity’s relatively expensive capital. After record high pretax earnings for the fiscal year ending March 2016, many large corporates have a lot of cash on their balance sheets. 

This is sparking doubts among some market participants that the recent uptick in carve-outs will lead to a flood of deals.

“Realistically, the deal-flow of corporate carve-outs is likely to be just as slim as it has been in the past,” said Shota Kuwaki, senior vice-president at Sunrise Capital, managed by CLSA Capital Partners. He warned against big carve-outs being considered part of the core strategy for buyout funds in Japan and said more lucrative deals could be found in the small-to-mid cap market.

Generally private equity can expect to pay double-digit Ebitda multiples for high profile carve-outs; for mid-cap succession-type deals, average Ebitda multiples of say five to seven times are common. Dealmakers agree you often see transactions generating over three times return in the smaller-end of the mid-cap space in Japan. Advantage Partners bought small property developer CommunityOne in 2008 and subsequently sold it for 23.1 times the money it invested. Twice the money invested is generally seen as a good investment for private equity firms.

“There were over 2,000 SMEs sold in Japan’s M&A market last year and this year is on a similar pace, primarily driven by succession issues at owner-operated companies. Hence NSSK’s focus on this segment of the market,” said NSSK’s Tsusaka.

Most private equity funds in Japan have only a handful of rainmakers. They do source deals from within their private networks but an additional angle comes from private banks in Japan, which already have a relationship with the founders.

“Many business owners in Japan do not have successors – they are a great opportunity for private equity funds,” said Koichi Ito, head of investment banking in Japan at Credit Suisse.

“We can help bring private banking clients together with private equity. We have already helped sell a few businesses to private equity firms and have more such deals in the pipeline.”

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