GP profile: Advantage Partners

Kaneko Hannosuke, a Japanese restaurant known for its tempura-on-rice dishes, is set to make its north China debut by the end of the year. The brand is owned by Oishii Promotion, a domestic operator keen to build on its expansion efforts in Hong Kong and Taiwan. Responsibility for execution of the China strategy falls on Zheng Yi Wei, a Beijing-based Korean restaurant chain that is looking for ways to scale.

The master franchisee deal that underpins this new alliance was brokered by Advantage Partners, which acquired both companies last year. While Oishii was backed by the private equity firm’s latest Japan fund – the latest in a string of restaurant deals that have proved reliable bankers over Advantage’s 26-year history – Zheng Yi Wei is one of the first four investments out of its new Asia ex-Japan vehicle. The partnership meets the needs of both strategies, and Advantage hopes similar arrangements can provide a competitive edge in other investments.

“Because of our track record in the industry in Japan, when we were bidding for the investment in China we were able to bring in not only Advantage team members with relevant experience but also consultants such as a design firm that specializes in restaurants,” says Emmett Thomas, the private equity firm’s head of Asia. “Capabilities like that that can convince a seller that we would be a better partner than someone who doesn’t have that sector expertise or doesn’t have it in Asia.”

Advantage’s drive to become more international in its outlook reflects a shift in the priorities of corporate Japan. Mid-market businesses recognize the importance of overseas expansion in the absence of strong growth prospects at home, and they may have brands and technologies that are a good fit for China or Southeast Asia. But these companies don’t necessarily possess the human or financial resources to pursue such an agenda. They need help and Advantage wants to provide it.

The private equity firm has 28 investment professionals in Japan and 17 in Shanghai, Hong Kong, and Singapore, but it endeavors to function as an integrated entity. Two-thirds of its Japanese deals have an Asia angle and every investment in the Asia fund must have a Japan-related value creation theme, so there is extensive cross-staffing between geographies. English is increasingly the default language for internal meetings, although the firm’s DNA is still very much Japanese.

On the rebound

Eighteen months ago, Advantage raised JPY60 billion ($535 million) for its fifth Japan fund. It was followed earlier this year by a final close of $380 million on the debut Asia vehicle. In between, the firm started investing its second Inflexion fund, which makes minority investments in public companies that don’t want to be privatized but are interested in working with Advantage based on its value creation proposals.

This endorsement from investors of existing and new strategies marks the completion of a decade-long return to form that, at its nadir in the years immediately after the global financial crisis, led some industry observers to question whether the GP had a future.

Advantage raised JPY215 billion for its fourth fund in 2007 and overcame stiff competition to acquire Tokyo Star Bank at a valuation of JPY252 billion the following year. However, the lender subsequently ran into difficulty and was surrendered to creditors in 2011 after debts tied to the deal went into technical default. It was a complete write-off for Advantage and its co-investors. The firm was left with a 40% hole in Fund IV and an uphill battle in seeking to minimize the damage.

“I know some people thought it was the end of Advantage Partners what with the difficulties around Tokyo Star and our struggles with some other portfolio companies after the crisis,” says Richard Folsom, who established the firm with Taisuke Sasanuma – they remain the representative partners – in 1992. “But internally we were all committed to do whatever it took to get through that. From 2011 to 2016, making Fund IV the best possible outcome for our investors was our single focus. It was a binding experience for people in the firm, and I think we came through much stronger.”

Some changes were made to how Advantage invests as well. The firm’s exposure to Tokyo Star was so large because it exceeded the 15% limit in expectation of syndicating the equity – only to see demand wither as the markets collapsed. Bridging provisions were removed from later funds. There is also an aversion to sectors such as financial services that can be subject to regulatory intervention, while steps were taken to improve deal underwriting.

These and other measures contributed to an operational approach that is much more systematic. “We have spent quite a lot of time building our own knowledge base,” Folsom says. “You don’t have to reinvent the wheel every time you buy a company. A lot of institutional knowledge can be built into scenario development in the underwriting process and the 100-day post-acquisition plan. The quality and consistency of our underwriting, as well as our capability to devise and execute operational plans has improved dramatically over the last 10 years.”

Almost every industry suffered because of the crisis and this resulted in prolonged holding periods for several investments, especially those in manufacturing companies. But they all came out the other side restored to full health. Fund IV, now nearly fully exited, is said to have delivered a gross multiple of around 1.9x. Exclude Tokyo Star and it rises to 3.4x. Katitas, which buys and refurbishes single-family residential homes, is a good example of a slow starter in Fund IV that came good. Advantage made a full exit through an IPO last December, generating a 5x return.

Laying down markers

During those early years of rebuilding, the private equity firm made several other exits on the back of value-add initiatives that have come to define its investment style. First up was the sale of non-alcoholic beverage business Pokka to Sapporo, following a concerted effort to revive the company’s flailing international business. When Advantage supported a management buyout in 2006, Pokka had a Singapore-listed subsidiary that had achieved reasonable scale but negligible profit.

“They were trying to do too much. We worked with international operations team to shore up the business, divesting the China operation and making three bolt-on acquisitions, two in Malaysia and one in Singapore,” says Thomas. “We recruited additional management and we took the company out of some of the bigger, more competitive markets and entered second-tier markets like parts of the Middle East, Bangladesh, and Sri Lanka.”

The international share of Pokka’s operating profit went from 8% to 33%. There was a perhaps equally meaningful shift in corporate culture. Hideo Nagatsuyu, a senior partner with Advantage in Tokyo, notes that Japanese companies often struggle overseas because of communication problems between headquarters and satellite offices. Pokka was encouraged to hold regular meetings, with senior executives in attendance, at which they gathered information and made decisions on the international business. “It helped them understand the global situation,” he says.

The success of Pokka helped vindicate Advantage’s decision to have an international presence. Thomas had joined the firm in 2007 and established a small team in Hong Kong that helped Japanese portfolio companies enter Asia through M&A, joint ventures, and greenfield expansion. They gradually came to realize that there were opportunities to apply Advantage’s mid-market buyout skills in Asia, targeting businesses that wanted to enter Japan or leverage Japanese expertise.

Between 2010 and 2012, Fund IV made three investments in China and one in Guam, all of which have since been exited, underpinning the argument for a dedicated Asia ex-Japan fund. They included ESG Holdings, a Chinese facilities management business that is now held up as a case study for how Advantage leverages a Japan angle in overseas markets.

“We did a major organizational restructuring, bringing in a new group CEO as well as introducing KPIs [key performance indicators], procedures and menus to make the business more efficient,” says Vivian Zheng, a Shanghai-based partner with the firm. “We also brought in a Japanese group – a trading house that has a facilities management business and a lot of real estate developments – as a minority investor. That helped us penetrate some of their shopping malls and other clients in China.”

Prior to Advantage’s involvement, ESG mainly provided cleaning services to shopping malls and office buildings. Over the next five years, airports, railway stations, hospitals, and Shanghai Disney Resort were added to the customer roster. Meanwhile, the product offering expanded to include higher-margin services that rely on technology and equipment as opposed to just labor.

Succession stories

The firm generated enough momentum to raise a JPY20 billion bridge fund in 2013 that gave it scope to make new investments during the rebuilding period. Earlier that year, another significant exit came with the sale of coffee shop chain Komeda Holdings for $482 million. The 7.2x gross multiple wasn’t Advantage’s highest even in 2013 – Community One, a condominium management business that scooped up several businesses from real estate developers caught up in the post-crisis chaos, generated 23.1x – but Komeda set a template for numerous succession deals that would follow.

“The founder wanted to roll out more stores nationwide but to do this he knew there was a need to strengthen the organization and management systems,” says Nagatsuyu. “It is the same for a lot of founder-owned companies. Product or store development is based on the founder’s intuition. We introduce scientific methods to analyze the market.”

Komeda had around 300 outlets when Advantage invested via its fourth fund in 2008. During the ownership period, it opened another 200 and doubled revenue. When Advantage bought massage chain Riraku in 2013, the founders retained a minority stake in the hope of a similar outcome. They got one: the number of outlets more than doubled and EBITDA tripled. The GP sold the business back to the founders – who saw the potential for further growth – last year for a 12.1x gross multiple, returning the entire bridge fund corpus from a single deal.

Komeda was one of several success stories, from a handful of mid-market GPs, that Japan’s private equity industry badly needed. The concept of a buyout didn’t exist when Advantage was established in 1992 because financial investors were forbidden from owning a majority stake in any business. This explains why the team had to wait five years before launching its first fund. Even then, deal-sourcing was complicated by negative perceptions of private equity.

Advantage’s first breakthrough was the carve-out of a premium baby formula producer from US pharmaceuticals giant American Home Products in 1999. Rebranded as Icreo, the business turned into a three-year growth story culminating in a trade sale. Other carve-outs followed as domestic companies began to divest assets in the wake of the Asian financial crisis. There are expectations of a steady increase in this kind of deal flow as corporate Japan come to terms with a new reality in which performance counts for more than scale, and resources are channeled into core operating areas.

But convincing a founder that private equity can be a responsible custodian of his business is contingent on presenting compelling evidence in support of such a proposal. Komeda appears to have contributed to this shift in mindset. The last two years have seen around 80 buyouts apiece, compared to an annual average of 46 for 2011-2015, according to AVCJ Research. Most fall into the small to mid-cap space, and anecdotal evidence suggests that succession is the primary driver.

About 70% of the deals in Advantage’s pipeline are succession transactions; corporate carve-outs account for 20% and the remaining 10% captures everything from turnaround to growth-oriented investments. Of the seven deals in Fund V, six are succession-related.

Differentiation factors

The challenge for the private equity firm is negotiating an investment landscape that has become more competitive and intermediated, even as the deal flow has increased. Advantage avoids full auctions, which are typically staged for transactions of $100 million or more, in favor of limited processes where a handful of mid-market GPs are invited to bid, and the winner proceeds to bilateral negotiations. However, these situations are becoming more contested as well.

“These days owners and advisors increasingly want to hear second opinions from other funds or strategic players,” says Shinichiro Kita, a senior partner with Advantage. “Therefore, we work closely with financial advisors, securities firms and other intermediaries – there are so many of them now – that know the companies well. We try to help them persuade the founders to work with private equity. Fortunately, we have a lot of experience in succession deals, so we can show many examples of how these companies can be successful with us after the founder retires.”

Moreover, if differentiation is the key to overcoming competition, Advantage can point to its presence in Shanghai, Hong Kong, and Singapore, and outline its track record in helping Japanese companies go global.

“We can visit founders in Japan and explain how we took these five other companies from having nothing overseas to it being a meaningful part of their business. It is a big part of the pitch we make,” adds Thomas. “A lot of these guys realize the domestic market is low growth and becoming more competitive. If they see a legitimate avenue to get some overseas exposure, it becomes compelling for them, especially if they plan to retain a stake in the business.” 

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• Topics
• North Asia
• GPs
• Buyout
• Advantage Partners