Secondaries in Japan: A new wave?

What is the best way to divest portfolio companies in face of sluggish global markets? A growing number of private equity investors in Japan are looking back at the way they came in - passing their portfolio companies to their peers. After only 3-4 secondary buyouts per year between 2007 and 2010, there were nine in 2011. The trend has continued this year, with seven deals in eight months.

Unison Capital has recently been the most active private equity player in this space. In May, it partnered with GC Corp. to acquire Showa YakuhinKako, a Japan-based pharmaceutical company, from Tokio Marine Capital, Polaris Capital and PineBridge Investments for a reported JPY50 billion ($650 million). The investors had held the asset since 2008.

Last December, Unison bought auto industry supplier Asahi Tec for JPY23.9 billion from RHJ International, which first invested in the company in 2003. One month earlier, it acquired shoe repair company Minit for $128 million, bringing to an end CVC Capital Partners' six-year tenure.

More recently Unison has been on the other side of the table, selling its entire stake in AkindoSushiro, a leading Japanese sushi restaurant chain, to UK-based Permira for $1 billion, marking the largest secondary buyout of the year so far. Unison invested in the company in 2007 via Unison Capital Partners II.

"Our second buyout vehicle was raised in 2004 and is now reaching the end of its fund life in two years unless we extend it, with some portfolio companies still staying with the fund," Tatsuo Kawasaki, a partner at Unison, tells AVCJ. "In Japan, a good number of transactions are likely to be sold to other private equity players or strategic investors, given the slow IPO market."

A time to exit

The transactions mentioned above represent a handful of the slew of Japanese buyout deals that took place in the years leading up to the global financial crisis. According to AVCJ Research, the country saw just $2 billion transacted across 27 buyouts in 2005. A year later deal volume had doubled but cumulative value grew fourfold to $8 billion, followed by $11 billion in 2007, despite only a small increase in transactions.

Since then, deal value has passed $4 billion on only one occasion, in 2011, but Bain Capital's $2 billion acquisition of restaurant chain Skylark - also a secondary buyout - accounted for nearly half the total. This transaction, said to be around $3.4 billion including debt, brought to a close one of the most infamous of the 2006-2007 megadeals. Nomura and CVC paid around JPY380 billion (then $3.19 billion) for Skylark, supported by JPY220 billion in loans from Mizuho.

One of the megadeals that has yet to see an exit is financial software developer Yayoi, which was purchased by MBK Partners for JPY71 billion in 2007. According to reports in January, Orix dropped out of the bidding, leaving Advantage Partners and Bain Capital, but nothing has been heard since.

"Many funds were very active in 2006-2007 and it's time to exit from these investments," says Kazushige Kobayashi, managing director of Capital Dynamics. "Also many of them are in the market trying to raise new funds and so they have to show some returns to investors."

According to a research published by Tokyo-based advisory firm Brightrust in April, private equity players have significantly lengthened their investment holding periods over the last few years. While there were 94 exits with an average holding period of 3.2 years in 2007, the duration had extended to 4.8 years and 4.6 years in 2010 and 2011, respectively.

For example, Bain and Skylark's owners - Nomura and Mitsui, which replaced CVC in 2009 - started negotiations as early as March 2011 but progress stalled as banks temporarily withdrew funding following the earthquake and ensuing tsunami and nuclear crisis. The deal eventually went through in October.

Brightrust added that exit pressure would likely rise in 2012 as several investments of seven-years or more pushed the average holding period to 5.6 years. As of April, approximately one-third of portfolio companies held by Japanese buyouts funds were ready for exit, with another third heading there: 75 deals were older than five years, and 85 were in the 3-5 years range.

The expiry of financing packages is also pushing private equity players to seek exits for heavily leveraged investments. With local banks still willing to lend at attractive rates, Japan remains one of the world's most liquid debt markets. According to the World Bank, Japan's benchmark lending rate has been below 2% since 2001, compared to 7-9% in Australia, Asia's only other sizeable leveraged buyout market.

"Everything we have done in Japan involves leverage," Jonathan Zhu, managing director of Bain Capital Asia, told AVCJ last November. "The average leverage multiples were never very high, probably 3-4x supporting a deal valuation of 6-7x EBITDA."

With a typical maturity of 6-7 years for Japanese loans, leveraged deals completed in 2006-2007 must be exited or refinanced in the next couple of years. Private equity firms generally prefer the former - fund life extensions often require permission from LPs while the longer an investment is held the more likely IRR will suffer.

Tsuyoshi Imai, a Japan-based partner at Ropes &Gray, adds that currency gains are another major reason for foreign funds to exit. "In 2007, the yen was about 120 to the US dollar; now it's below 80," he says. "If a financial sponsor [that does not call capital in yen] made an investment in 2007, it could realize a 40% return based on currency appreciation alone."

Limited options

The rise in secondary buyouts should be seen in the context of other exit routes. Ernst & Young surveyed 100 industry participants between July and August last year on their expectations for secondary exits, trade sales and IPOs in Asia Pacific over 2012 and beyond. Only 13% of respondents saw promise in the public markets, the lowest score in the region, with China and India managing a relatively bullish 67% and 55%.

Japan saw 17 private equity-backed IPOs last year - compared to only three and four in 2009 and 2010, respectively, but public investors remain very cautious due to market volatility prompted by global economic uncertainty. The Nikkei 225 Index, for example, closed at 8,783 points on Monday, lower still than in the weeks following the tsunami in March 2011.

"Because of the relatively weak performance of the domestic capital markets and the long lead time required to take a company public, a sale to secondary or strategic buyers presents a more attractive option in Japan compared to many other markets," says Imai.

When the IPO market is likely to remain sluggish over the foreseeable future, cash-rich Japanese corporations could be another way out for private equity investments.
According to the Ernst & Young survey, 47% of the respondents see trades sales as the most viable exit strategy in Japan this year. However, Satoshi Sekine, head of private equity at Ernst & Young Japan, notes that PE is often considered preferable to a strategic investor in situations where entrepreneurs want to retain a degree of autonomy.

Darren Massara, managing partner at NewQuest Capital Partners, adds that strategic players like to keep relatively large cash reserves in times of uncertainty, which can be a disincentive to deploying large sums. "While strategic investors are sitting on a lot of cash today, they remain quite cautious," he says. "Given the global economic climate, financial investors with committed capital to spend may have a higher appetite for acquiring these secondary stakes."

Pass the parcel?

Furthermore, given that the Japanese market is relatively small, it cannot be relied upon to deliver consistent deal flow for large buyout firms. The secondary space therefore offers rich pickings for global or pan-Asian funds.

According to some industry participants, large PE firms are merely passing portfolios amongst themselves. A less cynical way of looking at recent secondary deals is that the target companies have the capacity for overseas expansion and global private equity firms are well equipped to support these endeavors.

Osaka-based Sushiro, for example, is regarded as a prime asset: revenues reached JPY99.8 billion for the year ended September 2011, up 69% from JPY59 billion in 2007 when Unison first invested, and outlets have been opened abroad. Sources familiar with the situation say that Permira was one of several private equity players involved in the bidding process.

While Permira remains an occasional investor in Japan, Alex Emery, partner and co-head of Asia at the firm, tells AVCJ that the aim is to develop a balanced portfolio with different dynamics, and so Japan will not go ignored.
"Japan is a mature market and with that comes a certain level of investor confidence, unlike China and India," he says. "Deals are large and offer control stakes, leverage pricing is attractive, and business is equipped with good governance and low risk."

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• Topics
• North Asia
• Secondaries
• Buyouts
• Japan
• buyout
• Secondaries
• NewQuest Capital Partners
• Bain Capital Asia
• Unison Capital
• Permira Advisers