Giant maintenance: PE and corporate Japan

When KKR first moved to acquire Renesas Electronics in the summer of 2012, the ailing chipmaker was ripe for restructuring. Much like Japan as a whole, the company's finances had been a victim of both economic downturn and natural disaster. 

The 2011 earthquake and tsunami that devastated the Tohoko region also knocked out Renesas' chip-making factory. Even though Toyota Motors and other Renesas customers dispatched hundreds of workers to help get the plant back on its feet, the company still recorded losses in excess of JPY150 billion ($1.6 billion) for the 2012 fiscal year.

Before the disaster, Renesas - the world's leading manufacturer of microcontroller chips for cars - had already been losing ground to the likes Samsung Electronics as the strong yen sapped overseas profits and market share. By the time KKR put in its $1.3 billion bid, the company was implementing a restructuring plan that would lay off 12% of its workforce and sell or consolidate half of its domestic plants.

KKR was likely to push for an even more aggressive restructuring, and these fears prompted a consortium of Japanese manufacturers, led by the government-backed Innovation Network Corporation of Japan (INCJ), to swoop in with a $1.8 billion bailout. The move underscored the importance of Renesas chips to Japanese industry and the country's reluctance to give such technology to foreign players. It was tale of triumph for Japanese protectionism but one of abject frustration for KKR.

There is definitely a case for seeking buyouts amongst the debris of corporate Japan's restructuring efforts. The question is how GPs can tap into these opportunities and the extent to which they will have to compete with domestic players for the privilege.

"If you look at the history of Japan there has been a cycle to restructurings but large corporate divestments have been a stable source of deal flow over the last 15 years, with ebbs and flows," says Richard Folsom, CEO and co-founder of domestic buyout firm Advantage Partners. "In the current environment there is a bit of flow again."

The country's economic outlook in recent months has been dominated the reformist policies of Prime Minister Shinzo Abe - known as Abenomics - which comprise monetary, fiscal and structural measures. Whether these structural measures will precipitate a broader corporate restructuring drive on the part of the government remains to be seen. Indeed, a weaker yen means that Japan's legion of export-driven or multinational companies are actually enjoying the benefits from Abenomics.

"The internal exchange rate of yen to US dollar continues to be very conservative and so these companies continue to experience additional upside from internal and external rate differences improving their financial results until the end of the year," says Masahiko Fukasawa, managing director with turnaround specialist AlixPartners. He is of the opinion that, for many Japanese firms, this presents anopportunity to take action and start aggressively thinking about restructuring.

A different era 

The last time Japan witnessed a period corporate restructuring was in the years following in the Asian financial crisis. According to AVCJ Research, this period was characterized by a number of large-cap M&A deals involving Japanese companies, particularly in the financial sector, as corporations sought to consolidate or divest. In 1999, $174 billion was transacted across 219 deals - of which 76.4% was in financial services.

By comparison, last year $62.1 billion in committed in over 1,000 deals, with more than half of it focused on the utilities, electronics, heavy manufacturing and retail sectors.

The landmark private equity deals of the early 2000s included the $1.1 billion J.C. Flowers and Ripplewood Holdings-led investment in Long-Term Credit Bank of Japan (now Shinsei Bank) and Cerberus Capital Management' s similar-sized commitment to the equally debt-addled Nippon Credit Bank (now Aozora Bank).

However, restructuring wasn't limited to the financial sector. Unison Capital, for example, bought car parts manufacturer Kiriu, an affiliate of Nissan Motor, in 2001. It delisted the company, taking it out of the public spotlight, and proceeded to revitalize operations by reviewing product line-ups and business partners as well as consolidating production sites.

"Back then it is was more outright balance sheet restructuring," says Tatsuo Kawasaki, partner and co-founder of Unison Capital. "The issue for Nissan was to fundamentally change procurement. There was a very strong sense of financial, balance-sheet-driven restructuring needs - that was the situation then."

But not now. The current environment bears several distinctions from the post-Asian financial crisis restructuring period. First of all, the bulk of private equity deal flow is expected to come from carve-outs from corporates as opposed to takeovers of distressed corporates themselves. This naturally draws attention to the electronics and heavy industry sectors where many Japanese corporations s retain a large number of subsidiaries and divisions and there is considerable potential for overlap.

Panasonic, for example, has been in the process of shedding around JPY110 billion in assets for the past year in an attempt to boost cash flow. The ailing electronic giant cumulative loss of the past decade has amounted up to about $13 billion.

Advantage was one of the early movers in this recent spate of divestments, acquiring a digital camera unit from Sanyo Electric, a subsidiary of Panasonic. More recently, KKR is said to be among the suitors for Panasonic Healthcare, which manufactures products such as hearing aids and blood sugar level sensors. The unit reported an operating loss of JPY8.8 billion for the 2012 fiscal year with sales of JPY133.6 billion.

"Dealing with overcapacity and becoming more cost-competitive are all elements I think are behind restructuring," says Advantage Partners' Folsom. "In terms of global competition, Japanese companies have been lagging behind a little bit in their ability to take market share or maintain market share outside of Japan."

Like many large conglomerates, Panasonic's divestments are not just about boosting cash flow but also about shifting focus to its core operating areas. The company plans to spend JPY250 billion over the next two years on a fresh round of restructuring that will involve expanding automotive and housing development businesses as it pulls back from consumer electronics.

Global strategies

This expansion will frequently involve driving growth overseas because the sluggish domestic markets are unable to meet companies' ambitions. Here a regional or global private equity can really make its value count, offering access to international networks and expertise.

"I think the most important point for GPs is whether they can target companies with core services, brands and technologies that can be marketed overseas," says Satoshi Sekine, private equity leader and head of transaction support at Ernst & Young Japan.

The Carlyle Group made this play with Tsubaki Nakashima. The PE firm took a controlling interest in the ball-bearing manufacturer from Nomura Principal Finance in 2011 in a deal said to be worth around JPY70 billion including debt. Its strategy was to help the company expand into emerging markets.

"Carlyle is focusing on mid-cap companies that have good products and services but do not have the resources and the capability to grow overseas," Tamotsu Adachi, managing director and co-head of the private equity firm's Japan operation.

In this sense, the restructuring strategy involves shifting emphasis away from lower-end processes - combining parts or modules - that have a lower value add and can be outsourced to other manufacturers in the region. "Where there are key technologies is where Japanese companies have strength against foreign companies - they can still maintain competitiveness - so they will focus on that," Adachi adds.

Overseas expansion can also broaden exit opportunities for private equity investors in that strategic investors are more likely to pay a premium for a company that has growth prospects in emerging markets rather than just in Japan. In the same way, PE firms have prospered in selling portfolio companies in other countries to Japanese buyers.

Earlier this year, TPG Capital and Northstar Pacific Partners agreed to sell the bulk of their stake in Indonesia's Bank Tabungan Pensiunan Nasional (BTPN) to Sumitomo Mitsui Banking Corp. (SMBC) for $1.56 billion, pending regulatory approval. The implied money multiple is 6x. In 2011, Pacific Equity Partners and Unitas Capital sold New Zealand beverage firm Independent Liquor to Asahi Group for $1.27 billion.

Returning to private equity activity within Japan, to turn domestic companies into world beaters investors must first persuade incumbent owners to sell up. The primary obstacle, as KKR discovered in its pursuit of Renesas, is perception. Domestic companies are often conservative in their approach - arguably prioritizing employee stability over profitability - and they see PE as the polar opposite. Securing an alignment of interests would therefore be difficult.

Concerns over lay-offs are a particular flash point. A Japanese-led restructuring tends to see at most a modest decline in employee numbers. According to a study published by Colombia Business School's Center on Japanese Economics, of the 602 cases of corporate restructuring recorded between 1999 and 2007 only 2.31% involved any lay-offs at all.

An example of this reluctance to shed staff would be Sanyo. The electronics firm had been pursuing a restructuring program for almost 10 years when it was acquired by Panasonic in 2008. In 2003, it had 83,000 employees; by 2009 the number had swollen to 105,000, despite declining sales and a negative balance sheet dating back to 2004.

Unison's Kawasaki, adds that any private equity firm approaching a potential target must come equipped with an intimate understanding of its inner political workings, relying on internal and external networks to gauge the chances of a deal actually going through. This includes being aware that many large companies have former executive board members whose "retired" status belies a far-reaching influence on operations.

"It is multi-faceted approach, we need to make sure we are able to work with advisors so we can tap into whichever group we are interested in," says Kawasaki. "But more importantly having direct access to the influencers within both the spin-off and the selling organization can be crucial. It is important to have discussions with different levels of people below the CEO."

Agents of the state

Regardless of how deep a private equity firm might reach beneath the implacable surface of corporate Japan, the bottom line is that many companies would opt for capital from domestic sources - in the form of government-led support or a merger with a strategic player - over the uncertainty posed by a foreign financial investor.

Opinion is divided as to how much deal flow will be absorbed by government-backed funds but they have become a very real part of the private equity landscape. With a total investment capacity of JPY2 trillion, INCJ is by far the biggest of these, but it is not alone. Enterprise Turnaround Corporation of Japan and Development Bank of Japan, which launched a JPY150 billion fund in March, are among the other large players.

When INCJ was set up in the wake of the global financial crisis in 2009, it was given a remit to "to promote the creation of next-generation businesses." The fund has supported outbound acquisitions that domestic corporations wouldn't otherwise have been able to execute, such as Toshiba Corp's $680 million takeover of Swiss electronic-metering company Landis+Gyr and Marubeni Corp's acquisition of Aguas Nuevas, Chile's third-largest water business, in a deal reportedly worth $498 million. It has also made a string of VC-style investments within Japan.

What is unclear is how bailing out Renesas complies with INCJ's remit. Will the fund drive a comprehensive restructuring that creates a next-generation business or simply buy the company more time in its current form?

A statement issued in March by the Japanese Private Equity Association (JPEA) - whose members include KKR, Bain Capital and Carlyle - suggest some industry participants fear the latter. Without referring the Renesas deal by name, the association noted that government funding could allow companies to "push back problems" and "retain idle assets." It said that policy-driven finance should be used only to attract private sector funds, and invested with appropriate governance and accountability.

If these warnings prove prescient, the prospects for PE in the restructuring space will indeed be gloomy. Others, however, maintain that, despite competition from domestic players, attitudes will change as companies' grasp of private equity evolves.

"I have seen a lot of change, the mindset of Japanese management isgradually changing as they better understand what PE can offer, such as overseas expansion, job creation and appropriate levels of governance," says Ernst & Young's Sekine. He adds that private equity firms have demonstrated some strong exits in the last 6-12 months and this has not gone unnoticed by corporate Japan.

One view is that the way forward for GPs seeking restructuring deals is to work alongside domestic financial institutions - including government-backed funds - rather than competing against them. The rationale is that local institutions bring not only capital but also local connections and knowledge, opening up deals that would otherwise be out of bounds.

"For PE funds, having a majority alone is a great story but if you only chase the best story you are narrowing down the options," says AlixPartners' Fukasawa. "A PE firm has a unique capability for bringing in the kind of experienced management and valuable advice that is required for turning around these companies. Non-Japanese firms should consider the option of working with domestic players."

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• Topics
• North Asia
• Buyouts
• Japan
• KKR
• buyout
• Innovation Network Corp. of Japan (INCJ)
• The Carlyle Group
• Bain Capital Asia