Japan middle market: Going local

The Carlyle Group and Nomura Principal Investment journeyed all the way to Okinawa, an island 2,000 kilometers southwest of Tokyo, for Orion Breweries. The JPY52.1 billion ($477 million) transaction wasn’t without its complexities: there was some succession planning, but it was part of a broader private tender offer to around 600 small shareholders. 

Establishing credibility with a range of parties – the founding family, the management team, the local community in Okinawa, and strategic partner Asahi Brewery – was essential. However, arguably the most eye-catching aspect of the deal wasn’t the far-flung location of the target, but the fact that a well-known brand like Orion was available in the first place. “Nobody thought a sale was feasible, so nobody contacted them,” says a source close to the deal.

As competition rises in Japan’s middle market, PE firms must become more creative in their deal sourcing if they are to secure quality assets at acceptable valuations. This may involve increases in fund size, greater investment or emphasis on operational capabilities, or a cultivation of formal and informal advisory networks to explore corners of Japan’s economy – by industry or geography – that often get overlooked.

Buyout deal flow has grown substantially in recent years, with an annual average of 71 transactions between 2015 and 2018, up from 42 for the preceding four years, according to AVCJ Research. The bulk of activity is concentrated in the sub-$50 million equity check space, which is dominated by succession situations.

The inbetweeners

Virtually every deal features an intermediary, typically a tax advisor, consultant, or professional broker. They put together shortlists of suitable buyers – conscious that the company owner prioritizes discretion and responsibility in counterparties above ability to pay the highest price – and a limited auction ensues. The number of PE firms in the market hasn’t necessarily grown, but several industry participants observe that owners are more willing to engage financial advisors and soliciting a wider variety of participants to join auctions.

Covering the advisory community has therefore become standard practice for most GPs. Advantage Partners tracks 130 intermediaries and divides them into four tiers, with approximately 25 currently in the first tier. While Richard Folsom, the firm’s co-founder and representative partner, sees this as an important task, it serves as a means for Advantage to demonstrate its differentiation rather than being in itself a differentiator. “It’s more about the companies we have worked with, how they have fared, how they have transitioned into independent management,” he explains.

Much of the deal flow handled by lower-tier intermediaries doesn’t qualify for Advantage’s $20-100 million equity check range. M&A Capital Partners and Nihon M&A Center between them handle more than 900 transactions a year, but their business models are based on capturing a critical mass of small-scale opportunities. What this does give them is a geographical reach that extends beyond the Kanto-Chubu-Kansai axis anchored by Tokyo, Nagoya and Osaka. Between January and March, Nihon’s M&A coverage also took in Kyushu and Okinawa to the south as well as Hokkaido and Tohoku to the north.

Nihon relies on an in-house team of more than 350 consultants across eight domestic offices, tie-ups with accountants organized into a network of 865 regional M&A centers, and alliances with over 300 regional and shinkin banks. Some middle-market private equity firms have replicated elements of this coverage through their LP bases as regional banks have become more active investors in recent years.

In Tokio Marine Capital’s fifth fund, which closed at JPY51.7 billion in 2017, 17 regional banks – out of 34 investors in total – accounted for one third of the corpus. “LPs ask us to focus on Nagoya and the surrounding Chukyo metropolitan area,” says Koji Sasaki, a partner at Tokio Marine. “There are lots of manufacturing companies, many of them family-owned. Once a deal gets into a local newspaper, the family becomes famous and so other families might think about succession and approach us.”

Multiple touchpoints

NSSK also has opportunities referred to it by a collection of 25 regional banks that are either invested in its funds or lend to its portfolio companies. In addition, the firm doubled down on Nagoya, augmenting its coverage through a strategic partnership with a middle market securities house and launching a $60 million fund that focuses on Nagoya and the nine Chubu prefectures. Having more local touchpoints facilitates deal sourcing for the firm’s flagship funds as well, the second of which closed in 2017 with JPY60 billion in commitments. 

“The Tokyo metropolitan area represents about 40% of Japanese GDP and 47% of our deals come from that area. Chubu’s share of GDP is about 14% but it is responsible for 40% of our deals. We’ve seen more activity in that area because we raised the dedicated fund,” says Jun Tsusaka, who led TPG Capital’s Japan business before establishing NSSK in 2014. “We’ve received inquiries from other regional governments for these funds. They like our type of investing, which is operationally additive. And when you get the government seal of approval, it is easier to get Japanese banks to invest as well.”

NSSK now plans to take the initiative a step further with a nationwide business succession fund that is intended to strengthen the firm’s coverage of Kansai, Tohuku and Kyushu as well as Chubu. The target is $100 million.

While deeper regional penetration – sometimes supplemented by seminars on succession planning run in association with intermediaries – enables private equity firms to establish a footprint that eases their reliance on opportunities that emanate from the Tokyo financial community, getting access is only half the battle. A GP must then convince a company founder that it can take the business to the next level. Track record and operational expertise are often the clinching factors.

“When a founder sells a company, they want it to do well after they sell, so they look for people who can add value – for example, productivity measures that help the bottom line,” Tsusaka adds. “If they like what they see, they might keep 10% of the company and enjoy the upside with you.”    

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• Topics
• North Asia
• GPs
• Buyouts
• Japan
• Tokio Marine Capital
• NSSK
• Advantage Partners
• M&A