Shogun diplomacy: Corporate management in Japan

The bailout of Japn's Seibu had got off to a rocky start. Back in November, 2005, New York buyout firm Cerberus Capital Management made public its intention to invest JPY160 billion (then $1.4 billion) to save the ailing Japanese railway and resort business, taking 30% stake. 

No sooner had the ink dried on the deal, a legal challenge was mounted by Yuji and Seiji Tsutsumi, sons of Seibu's late founder, who claimed Cerberus had undervalued the group's railway unit. In a rare and public feud, the brothers sought a Tokyo court order against Cerberus and Seibu management to essentially block the deal. The injunction eventually came to nothing but it was a sample of things to come.

Eight years on and Cerberus is embroiled in yet another furor as it tries to gain control of Seibu, having fallen out with management back in 2011 over the timing of the company's purported IPO. Where did it all go wrong?

Reluctant partners

According to AVCJ Research, Japanese inbound M&A last year was worth $10.7 billion last year, the most since the global financial crisis. Anecdotal evidence suggests even more buyout and restructurings opportunities are on the horizon. As such, many GPs are eager to woo management.

Much of the reluctance among Japanese managers to entertain outside investors stems from the traditional structures that exist at board level. Many if not all directors spend their entire careers with a firm, working their way up through the ranks. They don't like outsiders, even though a fresh pair of eyes might be beneficial.

In addition, liquidity of Japanese management can be lacking. While there can be exceptions, capable managers from outside are rarely invited in and structures can be rigid, As such, managers often do not see the real problems within the company.

The Cerberus-Seibu affair is not the only an example of a deal turned sour. Few takeover bids in Japan are successful and shareholder activism in the country has a poor track record. Intervention from outsiders can often be blocked by big Japanese investors while smaller shareholders typically side with managers locked in battle with hostile funds, under the assumption that acquirers prioritize making money over the interests of target companies.

One well-documented case is that of US hedge fund Steel Partners, which in 2007 found the management of condiment maker Bulldog Sauce staunchly opposed to its attempts to acquire the 90% of the company it didn't already own. The deal was blocked by a "poison pill" or shareholder rights plan, the definitive anti-takeover defense. Steel Partners challenged the move only for Tokyo District Court back Bulldog.

This difficulty is exacerbated by the fact that that the public' perception of PE, especially coming from overseas, is generally one of mistrust. "It can be discouraging," one Japan-based GP tells AVCJ. "The Cerberus affair has got a lot of coverage in the Japanese press over the last few months and the tone is still disappointingly biased and presumptive that a foreign shareholder is not a good thing."

However, the same GP stresses that this is not necessarily the prevailing view among the broader group of Japanese executives.

Ensuring alignment of interest with Japanese management can be much easier in the mid-market space. Domestic buyout firm J-Star benefits from both its local presence and the different style of management encountered at smaller companies. Rather than having to deal with layers of entrenched senior executives, most negotiations involve a single owner-founder who has greater decision making powers.

"In my experience with small to medium-sized companies people are really cooperative," says Gregory Hara, CEO and founder, J-Star.

Carlyle's Adachi expresses a similar sentiment, pointing out the mid-cap companies are more likely to be led by decision makers who appreciate the sense of urgency when bringing in much needed changes. "We don't go for old-fashioned companies, with an old fashioned governance structure because it is just so difficult to change those companies," says Adachi.

This does not mean common ground cannot be found with old-style management. Jupiter Shop Channel was every bit the traditional model when Bain Capital took a 50% stake in the company last June - around 90% of the board had spent their entire careers with the firm.

"A lot of it is having a clear operational plan around what the strategic focus is going to be, making sure there is sufficient consensus before you make the investment," says David Gross- Loh, managing director with Bain Capital in Tokyo. "We do a lot to build a relationship with the management up front and make clear what our plans are. It is a longer and more involved process but out of that we know whether or not interests are aligned."

Coalition of all the talents

Another integral component to a successful investment is the "hybridmanagement model" - bringing in valuable industry expertise from oversea to work alongside existing management. This not only ensures the Japanese management continues to be integral part of the leadership structure, but also offers target companies that might not be offered by domestic suitors. 

For example, when Bain acquired Japanese restaurant chain Skylark in 2011 for $2.1 billion, it brought in Ralph Alvarez, former president of McDonald's, as executive chairman. Creating the executive chairman position was a unique way of retaining the valuable knowledge of a Japanese CEO but also having input from someone from outside in a senior role, Gross-Loh explains.

But perhaps an even a better way of ensuring investors and management are on the same page is though compensation. J-Star's Hara notes that offering stock options and other incentives can be a real motivator. "We come up with target measures, access the amount that can be used as a bonus and then management can have autonomy to distribute that pool to certain individuals," he says. "It's key to making sure interests are completely in line."

 

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• Topics
• North Asia
• Investments
• Buyout
• Japan
• Bain Capital Asia
• The Carlyle Group
• J-Star
• Unison Capital