Japan outbound investment: Go local to go global

A British corporate buyer was in talks with a Japanese seller. The company, which had been the majority shareholder's hands for decades, was about to be sold for a handsome sum, and the only stickler was the exiting shareholder's attitude. "Why is this seller requiring me to guarantee certain employment levels for a period after the acquisition?" asked the buyer, frustrated. "Once I buy it, I should be able to do what I want with it."

The Japanese seller wouldn't budge, however, until he had ensured the care of his employees and the business' standing in the community would be maintained after the deal closed. He even insisted on having a clause promising that the relationships with the company's existing partners would be maintained.

It is not an isolated case. Attitudes such as this - the belief that financial exits should not be viewed as successful if they fail to take equal care of other stakeholders in the business - are prevalent among Japan's business owners. They are one of the reasons why local companies are traditionally difficult for outsiders such as foreign private equity firms to access.

One strategy which a number of Japan-focused PE firms are hoping may win them more favor, though, is the ability to help domestic businesses expand overseas. "Many Japanese companies historically aren't terribly receptive to financial investors," explains Paul Ford, a director in KPMG FAS' transaction services practice in Tokyo. "But if the financial investor can persuade a company that it has the competency to support overseas expansion in area where the company may not have a lot of skill or experience, it is seen as being able to bring something to the table."

Ford recalls how when he began working for KPMG FAS a decade ago, 80% of his work was for foreign funds doing deals in Japan as well as inbound work for foreign corporates. This has now been turned on its head, and a similar majority of his time is spent helping Japanese corporates buy overseas.

Crossing borders

Indeed, for many Japanese corporates, outbound investment is a strategy that is being pursued with or without private equity backing. The $50.9 billion of capital invested across 438 outbound deals so far this year is on track to break all previous records. Supported by low borrowing costs and a strong yen, large corporations and trading houses such as Toshiba and Marubeni have their fingers on the pulse of various industries and can easily identify targets by dint of having tracked their competitors so closely.

Those strategic buyers that are less sophisticated and have little or no global expertise rely heavily on domestic banks when putting together their outbound strategies. Japanese PE firms with international networks can play a role here as deal originators. Advantage Partners is one example of a local GP that has been upping its contact with Japanese corporates - on occasion even presenting them with outbound deals in which it hasn't participated.

"It's a great opportunity and we've found that oftentimes, even bigger companies may not be able to find a deal via an investment bank, since they may not have the international depth of management they need," says Emmett Thomas, the firm's head of Asia. "We have networks and are living in the transaction space more than some Japanese corporates who don't have business development teams on the ground."
As well as referring deals - no doubt in a bid to forge future co-investment relationships with corporates - Advantage is also one of a number of Japan-focused GPs that is attempting to grow its domestic portfolio companies in overseas markets.

Of the firm's 20 Japanese companies, up to 70% either have or plan to have operations elsewhere in Asia. Pokka is one firm that Advantage assisted to expand abroad, having acquired the company at a time when only 5% of its profits came from outside Japan. The GP initiated two bolt-on acquisitions in Southeast Asia - in Singapore and Malaysia - and designed an entry strategy into the Middle East. After six years, Pokka's overseas profits had risen to 30%.

The China imperative

Given that Advantage acquired Pokka in 2005, the firm's outward-looking strategy pre-dates an increasingly prevalent trend among more recent deals realized in Japan. In 2010, CITIC Capital - no stranger to outbound investment either, having established a Japan presence eight years ago to help companies expand to China - acquired Japanese logistics business Tri-Wall.

"We're helping Tri-Wall do business outside Japan, especially in China, in many ways," says Hironobu Nakano, senior managing director and head of Japan private equity at CITIC Capital. "We helped them with their issues with the local labor force, and with the many legal, accounting and finance issues they encountered when their factories relocated across China. We also introduced them to some of the companies CITIC Group owns which are potential customers."

CITIC Capital's efforts have seen Tri-Wall's China revenues increase to 60%, while 25% of sales now come from Southeast Asia.

Expansion into China, and other parts of Asia, particularly South Korea or Southeast Asia, also played a part in the deal rationale when CITIC Capital invested in coated film manufacturer Higashiyama Film last year, as well as Permira's secondary buyout of sushi restaurant chain Akindo Sushiro from Unison Capital last week. Permira sees strong demand for the Sushiro dining experience in China and Korea, and plans to help the firm hire more people to expand its presence in these markets.

When selling half of Jupiter Shop Channel to Bain Capital in a $1.3 billion deal in June, Sumitomo Corporation stressed that its choice of partner was in part based on the need to go overseas. The firm said Bain would use its "knowledge and worldwide network" to promote the expansion of the TV shopping company into Asia. Bain made a similar strategic offer to audiovisual equipment provider D&M, which it bought in 2008.

"Japan as a market is looking at fairly limited growth," says T.J. Kono, a director at Unison Capital, which also worked with Sushiro to put the firm in touch with a Korean management team. "We need to generate our returns in some way and obviously our primary focus continues to be investment into Japan, but one of the ways to create delta for our investments is to look at the overseas market."

There is more than one way to target the overseas market, however. While the bulk of activity takes the form of bolt-on acquisitions and organic growth by local portfolio companies, several Japanese PE firms have ventured into the realm of outbound primary investments.

The unifying theme for these deals is a connection with Japan: A foreign company might have a business alliance with a Japanese company, be leveraging technology from Japan or wanting to acquire domestic businesses. In this way Japanese GPs can have an advantage over foreign - and even global - competitors that lack extensive links back to the country.

Unison Capital's $104 million management buyout of South Korea's Nexcon Technology evidences the GP's superiority over a non-Japan investor. Prior to Unison's entry, the company had struggled to access Japanese customers, despite the huge potential for business with the likes of Sanyo, Panasonic and Sony. "Now we're introducing new management resources and advisers and a network in Japan who can put them in touch with these kinds of companies," says Unison's Kono. "It's a natural fit because we have the resources they can use to penetrate Japanese clients."

Another foreign acquisition for which Japan holds very strong business logic is Teleguam, the Guam-based telecoms services provider that Advantage Partners bought in 2010. Given that tourists from Japan represent 80% of the $1.35 billion tourism industry in Guam, Advantage has striven to increase the company's share of revenues generated by this visitor base, as well as helping it market its services in Japan.

Advantage has made six non-Japanese domiciled investments over the past decade, all of which purport to have strong Japan links. Hisense Broadband Multimedia Technologies, the China-based company Advantage acquired last year, for example, manufacturers fiber optics components. Chinese firms in this industry are heavily reliant on Japanese technology and so the GP provides assistance in terms of identifying potential partners and hiring talent in Japan.

Barrier to entry

One of the barriers to more widespread investment of this nature at present is the Japan-specific mandates under which most local GPs operate. Over time, KPMG's Ford suspects that funds will begin to widen in scope, as overseas markets compare ever more favorably to home. It appears this change in focus isn't a process that can be rushed, however, as LPs need to be appeased and the key to doing that is to build up a local presence in the target markets.

Unison Capital, for example, cut the size of its third fund by one quarter to JPY107 billion ($1.4 billion) due to limited dealflow earlier this year. A logical alternative to this would have been to commit the capital already raised to transactions in more buoyant markets, but this wasn't a move the GP considered due to its nascent state in most countries. "It's easy to say that you've got some capital and so you're going to allocate it to a different market and I'm sure some funds would definitely do that," says Kono. "But is it a justifiable investment decision based on the capabilities of the team? I'm not so sure."

Perhaps lessons are being learned from the last market peak, in 2000, when $32.2 billion was invested across 348 outbound transactions. Around that time, a large number of foreign GPs also entered Japan. Some were successful at sourcing deals; others weren't and have since left the market. "The ones that were successful seemed to share the characteristics of having either very good Japanese senior management or local partners, and spending a long time building meaningful relationships across industry, banking and government," says KPMG's Ford.

For Japanese funds trying to source acquisitions overseas, similar rules may hold true. Being able to finance acquisitions because of the strength of the yen isn't enough. Local presences need to be established and that means hiring local people, investing in them over the long-term and building connections with senior figures in industry and politics.

This is where global funds like Bain Capital, whichhave a footprint in Japan, and the likes of Advantage Partners and CITIC Capital, which have Hong Kong and China offices respectively, have a real advantage. As Ford says, there aren't any shortcuts.

PE exits: The lure of corporate Japan

The boom in Japanese outbound investment has provided a convenient exit route for an increasing number of international private equity firms. According to Thomson Reuters, Japan's strategic buyers have purchased $13.8 billion worth of companies from PE firms so far this year.

"This trend should continue," says Hideo Norikoshi, a Tokyo-based M&A partner at law firm Baker & McKenzie. "One reason is the strong yen. The other reason why companies are trying to invest overseas is the shrinking and aging population of Japan and the high cost of living."

Assets exited by PE firms to Japanese corporates, as with Japanese outbound M&A in general, cover a wide range of sectors. Businesses in the areas of manufacturing, engineering and electronics appear to have curried particular favor, though. One example is US-based air conditioner maker Goodman Global, which was sold by American PE firm Hellman & Friedman to Japan's Daikin for $3.7 billion last week. The CEO of Osaka-based Daikin, the world's second-largest air conditioner manufacturer, first claimed to be considering making a bid for the company more than 18 months ago.

"Because there's an enhanced risk profile when you're investing abroad - especially when every market in the region is unique - generally firms want to invest in area they're comfortable with and already have some experience with," Paul Ford, a director in KPMG FAS' transaction services practice in Tokyo, tells AVCJ. "That's why we see a lot of manufacturing and technology investment, because those are areas where many Japanese firms tend to have experience."

Riverstone Holdings' sale of British wind power engineering firm Seajacks International to Marubeni Corp and Innovation Network Corp of Japan (INCJ) for $850 million earlier this year is another prominent example of this tendency. Marubeni aims to use its expertise in manufacturing and renewable energy to help the company set up offshore wind farms in Japan and other parts of Asia.

Other recent private equity exits in this space include The Carlyle Group's sale of Talaris Topco, a UK-based cash handling machine maker, to ATM manufacturer Glory; the SkylakeIncuvest private equity fund's sale of its stake in SCD, a South Korea-based electronic components manufacturer, to Nidec Sankyo; and the exit by a consortium of venture firms including Mizuho Capital from Nistica, a US-based optical modules equipment maker, to Fujikura.

The inclination towards manufacturing and electronics deals is mirrored in the outbound private equity investment data too. "If you're going to be able to justify an outbound acquisition to your investment committee, you want to give a strong narrative about what your strategy is for the business," explains KPMG's Ford. "Having experience and knowledge of a particular industry is pretty critical when you're going into a new market."

It's no coincidence then that technology firms feature strongly in the handful of primary deals realized by Japanese GPs over the past year. These include DI Asian Industrial Fund's investment in Vietnamese medical equipment maker Japan Vietnam Medical Instrument and Unison Capital's buyout of Nexcon Technology, a South Korea-listed battery safety units maker.

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• Topics
• North Asia
• Investments
• Japan
• Innovation Network Corp. of Japan (INCJ)
• Bain Capital Asia
• Outbound investment
• Advantage Partners
• Unison Capital
• KPMG