Japanese outbound M&A: Strategic imperative

It was generally acknowledged that the successful bidder would pay a high earnings multiple and over the weeks that followed sources suggested to AVCJ that the valuation was so large it would kill the deal. In mid-July, Suntory announced that it would set up a joint venture with GarudaFood to produce non-alcoholic beverages and take a large minority stake in the Indonesian company's distribution arm.

The GarudaFood situation serves a reminder of the financial clout of Japan's consumer players. Driven by a need to diversify their business - and buoyed by a low cost of capital and a strong yen - these companies are on a buying spree, snapping up assets everywhere from Australia to Brazil. If Carlyle did indeed push its offer beyond what was financially sustainable, it just goes to show how even the most aggressive private equity deals can flounder in the face of determined strategic investors.

"When a corporate is willing and able to pay in the region of 13-15x EBTIDA it is extremely difficult for PE firms to compete," says Simon Pillar, managing director at Pacific Equity Partners (PEP). "Whenever you are up against a corporate investor you have to consider their cost of capital and strategic intent. These can be formidable challenges in the bidding process."

Recent acquisitions by Japanese beverage firms fall on the cusp of this valuation danger zone. Kirin's A$3.3 billion buyout of Australia's Lion Nathan in 2009 came in at 12.5x EBITDA, preceding its $970 million acquisition of Singapore-based Fraser & Neave a year later, also valued at 12.5x. It took a majority stake in Brazil's Schincariol in August at 15.7x.

In July, Asahi agreed to buy Permanis, Malaysia's second-biggest soft drink maker, for $273 million, which equates to an EBITDA of 15.4x. The purchase of New Zealand-based Independent Liquor one month later for NZ$1.525 billion ($1.27 billion) valued the company at 13x.

As one of the parties that sold Independent Liquor - the other was Unitas Capital - PEP has benefited from this Japanese largesse. The PE firms were originally looking for a partner to come in for 20-25% of the company and help deleverage the balance sheet and support business growth. But the asset generated interest from a number of bidders and it became clear that Asahi wanted to buy the company outright.

PEP and Unitas secured a 1.5x return on their original NZ$1.2 billion investment made in 2006. Each firm owned 43.9% of Independent Liquor while a further 11.75% was held by Lynne Erceg, widow of the company's founder, who stands to make NZ$179 million from the sale. Pillar says that Independent Liquor represents an attractive growth platform for Asahi in Australia and New Zealand, as well as offering inroads into North America and Asia.

An Asahi spokesperson adds a glimpse of the stark reality facing Japanese consumer firms: "We doubt there is any space for us to grow in the domestic market so it's important for us to seek overseas expansion."

Retraction mode

The factors contributing to the decline in domestic markets - beer shipment volumes have fallen 15% in the last decade - are clear. Japan's population growth has been negative for four of the last five years, according to the World Bank, and the proportion of over-65s has risen in the last 10 years as the working population has fallen. GDP growth is largely stagnant, price deflation is a longstanding problem and the Ministry of Economy, Trade and Industry expects consumer spending to retract by 0.2% this year.

The government is actively encouraging companies to enter new markets and the beverage companies have proved particularly aggressive in their planning and execution.

Asahi has earmarked $10 billion for M&A as it chases a goal of having overseas sales account for 20-30% of total sales by 2015. Suntory said in January that it had JPY300 billion ($6.5 billion) available for acquisitions over the next few years. Its target for 2011 is for overseas beverage sales worth JPY318.1 billion, just under half the target for domestic beverage sales. Kirin's foreign business accounted for 25% of total sales last year, up from 18% in 2006, and the plan is to push this past 30% by 2012.

Borrowing costs are low, with average interest rates on bank loans having stayed below 2% for the last decade. A real game changer is the value of the yen. The currency has gained about 6% on the US dollar since the start of the year and more than 25% since January 2008. The currency reached a post-war high of JPY75.95 to the dollar on August 19 even as the government staged its biggest market intervention in seven years to try and rein in growth.

"I have seen private equity exits in Europe to Japanese companies, particularly in auctions at very high multiples. This is offset by the stronger yen," says Satoshi Sekine, private equity Leader and head of transaction support for Ernst & Young in Japan. "As long as the currency is strong and Japanese companies get bank financing this trend will continue."

Outbound investment by Japanese corporations reached a record JPY3.4 trillion in 2010, up 86.5% year-on-year. The number of transactions hit 520, another record, with over half taking place in the Asia Pacific region. Between January and August 2011, 308 deals were completed, 27% more than for the same period of last year, with the total value transacted rising 65%.

Clear objectives

In terms of geography, there is a strong preference for emerging markets or, in the case of Australasia, markets that are significant in Asia and currently underpenetrated by Japanese brands. Although there have been acquisitions in Europe, Hiroshi Nonomiya, managing director at RHJ International Japan, notes that Asia is primary focus while South America is becoming more important, particularly Brazil which is also home to a relatively large number of second- or third-generation Japanese immigrants.

The beverage firms are uniformly clear in what they are looking for - to the point that the press releases might as well be cribbed from the same template. To pick one example, Suntory said it was looking to combine GarudaFood's local expertise and distribution networks with its technologies and experience in product development.

"They are looking for opportunities to generate earnings to improve the growth profile of corporations and this often leads to synergistic transactions in offshore markets," says Andrew Thompson, national head of private equity at KPMG Australia. "The Independent Liquor deal is about getting a business that will help distribution of Asahi products in Australia and also improve exposure to a faster growing market than Japan."

With this in mind, the Japanese firms are also generally consistent in their desire to retain existing management teams. PEP's Pillar notes that Asahi were keen for Independent Liquor's present CEO and his executive team to keep their jobs, adding that the Japanese company has been thoughtful in its approach to integrating the two corporate cultures.

While most market participants are complimentary about Japanese firms' strategic approach and execution of deals, some say that companies can be overly cautious and this may cost them in auction situations as well as in terms of efficient post-deal integration. Ichiro Katagiri, a Japan-based director at global professional services firm Towers Watson, which helps companies resolve staffing integration issues, believes this approach is rooted in lessons learned from the often flawed Japanese M&A boom of the late 1980s.

"Back then they didn't understand how Western companies should be managed and integrated and so now they spend more time on due diligence and are generally more cautious in their approach," Katagiri says. He adds that Japanese beverage companies still face integration issues but on a more nuanced level: Their success is based on successful local marketing strategies but, post-acquisition, the onus is on creating regional and local teams that are able to interact.

As long as Japan's domestic markets continue to be sluggish, there is every reason to believe that Japanese food and beverage companies will maintain their buying spree. For private equity firms in possession of assets that appeal to Japanese - and Chinese - companies, weakness in the public markets does not mean exits must be postponed.

"This is a good time to sell to strategic investors," says RHJ International's Nonomiya.

 

PE and corporates: Problem partnerships

Private equity firms are keen to support Japanese corporations on the overseas M&A trail. The potential synergies to be gained from pairing strategic interests with the deal-making acumen and international knowledge of financial sponsors receive much attention. But industry participants are dubious about the prospects for such partnerships.

"A lot of PE firms want to partner with these companies. It's what the big Japanese trading firms have done in the past - fund the acquisition and help manage it until it reaches certain benchmarks," says Arthur Mitchell, Tokyo-based senior counselor at White & Case. "But Japanese companies are low risk, low return, while private equity is high risk, high return."

In August, CITIC Capital Partners announced that its Japan buyout fund had purchased stakes in Higashiyama Film, a coated film manufacturer, and Tri-Wall KK, which produces corrugated fiberboard packaging. Yichen Zhang, CEO of CITIC Capital, made it clear that the private equity firm's mandate for these and other deals was to "assist outstanding Japanese companies in their international expansion, particularly to China."

CITIC Capital Partners is entering territory where few others have been successful. Advantage Partners, working with CITIC Capital Partners, is credited with helping beverage company Pokka Corp. expand its footprint in Southeast Asia before securing a lucrative partial exit to Sapporo in 2009. Hiroshi Nonomiya, managing director at RHJ International Japan, cites his firm's work with electronics manufacturer Denon, which it bought in 2001 and guided through the acquisition of US firm Marantz.

"They could only do it with help from us in terms of financing and management capabilities," Nonomiya says, stressing that such opportunities really only lie with mid-size companies because the largest players are able to act alone.

Bob Partridge, Greater China leader for transaction advisory services at Ernst & Young, blames the general tensions between corporations and private equity firms on their different objectives: operational synergies versus high returns. "Asian corporations are not comfortable with the preferential rights granted to private equity firms," he adds. "They see it as a partnership yet the private equity firm could make a call and walk away."

 

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• Topics
• North Asia
• Australasia
• Consumer
• Exits
• Buyouts
• Pacific Equity Partners
• Unitas Capital
• The Carlyle Group
• Ripplewood Holdings
• CITIC Capital Partners
• Advantage Partners