GP profile: J-Star

Japan’s glacial economic progress and drawn-out, demographics-driven market evolutions have somehow inspired an aggressive ramp-up in private equity. But J-Star’s not getting carried away.

The Tokyo-based private equity firm has witnessed a multi-staged surge in investment interest in small to medium-sized enterprises (SMEs) since it was founded in 2006 despite there being only gradual shifts in prevailing macro factors and overall opportunity. As a result, the deliberate and disciplined J-Star brand appears something of a local anomaly, even though the market seems to be calling out for just such a strategy.

J-Star was founded by managing partners Greg Hara, Kenichi Harada, and Hideaki Sakurai, along with Tatsuya Yumoto, a partner, with a view to staying the course when perceptions around an SME boom resulted in an arguably overzealous PE industry. The four colleagues previously formed the small-cap buyout team at local VC stalwart Jafco but decided to set out on their own when swelling interest from global LPs prompted a nationwide trend in bigger and more ambitious PE programs.

This was a time when early movers in Japan that had established themselves through relatively small transactions were under pressure to take their operations to the next level, whether the market was ready or not. Advantage Partners and Unison Capital raised JPY215 billion and JPY140 billion, respectively, for their latest funds, a fourfold increase and a twofold increase on the previous vintage. Jafco was of the same mind with plans to double up to $500 million.

“The new direction our previous employer set did not make much sense to us. We were the core members of that team contributed to a nice track record by chasing smaller transactions.” says Hara, who also serves as J-Star’s CEO and chairman of the investment committee. “They wanted to change our style, and we were not comfortable with that. Also, at that point, we had a slight conflict of interests and we wanted to realign with our investors. But regardless, raising the first fund was super tough.”

Going solo

The biggest challenge was Jafco’s refusal to allow the team to claim its track record at the firm, leaving a limited amount of formal data to present to investors. Growing interest from global LPs did help, with 30% of the eventual JPY12.2 billion ($112 million) corpus coming from international institutions, but the process was otherwise limited largely to personal contacts. The plan was for the team of four to continue as they had at Jafco, buying control or co-control stakes at the smaller end of the SME space across a range of sectors.  

This core strategy has remained stable as J-Star has incrementally grown in firepower and general scope. The firm raised its JPY20.4 billion for its second fund in 2013 and added several investment professionals to the deal team. J-Star No. 3 followed with JPY32.5 million in commitments in 2017 amid another burst of enthusiasm for the Japanese middle market that saw at least seven PE funds close in a 12-month period. 

By this time, J-Star’s roster had grown to its current headcount of 16 investment professionals and three operational team members. Internal processes have not been significantly impacted as a result of the expansion, but a fundamental evolution is underway.

Decision making is still done by majority vote among the partners, with no senior figures having a veto. Non-partners are invited to participate in the investment committee, which includes the four founding partners, plus Satoru Arakawa, a partner who joined the firm in 2007, and Yuki Kashiyama, head of the operations team. The idea is that all information is shared, and all team members receive carried interest, including non-partners.

“The team is still small enough to maintain the investment style we started with, but the due diligence has become far more sophisticated,” says Hara. “It’s not just checking to see if the target company is okay but a process of finding the strengths and weaknesses that are most likely to be linked to post-buyout value creation activities.”

This was part of the thinking behind the introduction of the operations team in 2014, alongside observations that a steady increase in entry multiples necessitated more value-add. Furthermore, a general expansion of succession-driven M&A – currently around 70% of J-Star’s deal flow – was creating more situations where CEOs needed business partners rather than just capital. This trend has dovetailed with omnipresent concerns in Japan around aging and the declining workforce, creating more demand for operational support.

“Even the strategic buyers – where we want to exit our portfolio companies – are suffering a talent shortage,” says Kashiyama. “They don’t want to invest in a company just because it has a good business model or financial performance. They want self-sustaining companies because they can’t afford to deploy more management resources themselves. If we, as an operating team, can bridge that gap, it buys our firm time to understand the corporate culture of the portfolio companies and find the best candidates.”

Kashiyama joined J-Star as a principal in 2014 and was promoted to partner in 2016. He and each member of his team oversees a set of three separate investee companies. This means that nine companies, or about half of the current portfolio, are receiving direct operational support. All the companies are under some level of watch, however. The value creation team creates either weekly or monthly reports on each investment, confers with the relevant lead partner, and the group joint decides whether to deploy operational resources at ground level.

On the ground

These deployments can be fairly involved, with multiple instances involving J-Star value creation team members working as full-time employees of portfolio companies for 1.5 years. Kazumasa Ohara, a principal, did just such a stint by filling in as CEO for Alpha Corporation, following J-Star’s 100% acquisition of the education services business in 2017. At the time of the deal, a strong candidate for CEO had already been identified but he quickly became unavailable.

Ironically, the local talent shortage creating demand for this kind of operational team assistance is also limiting the operational team itself. Kashiyama hopes to add at least one more member in the near term but expects a challenging recruitment environment. C-level skillsets in the SME space are high on the wish list, but increasingly, the situation is calling for human resources capabilities. 

“Hiring and keeping the best talent, motivating people, and maintaining good morale is an escalating issue across Japan due to the population decline and aging,” says Kashiyama. “SMEs have suffered more than the bigger companies, so I believe that that kind of experience will really contribute to our portfolio companies.” 

Broader team expansion plans were mobilized last month when J-Star announced it would relocate to a larger headquarters in Tokyo’s Marunouchi financial district. The new office can accommodate a team of 30 and is expected to precipitate seven to eight hires in the next four years. At full capacity, J-Star – a team with $400 million in assets under management (AUM) – might claim to be larger than The Carlyle Group’s Japan operation. Carlyle, which lists 13 Tokyo-based investment professionals on its website, is reportedly seeking $1.8 billion for its fourth fund.

“We are committed to continuing to increase the size of the staff, not only in the investment team and the value creation team, but also in administration,” says Hara, noting that this is typically done with a view to diversification, including hiring investment-focused staff with non-financial backgrounds. “We have to deal with a larger number of LPs now, and the demands on reporting, compliance, and side letters are getting more complicated.”

J-Star is continuing to leverage rising global LP interest in Japan’s middle market at its own speed. A fourth fund is currently being raised – the target is said to be JPY42.5 billion (J-Star declined to comment) – with about 60% of commitments expected to come from international institutional investors. This would be in line with both J-Star No. 2 and No. 3.

“For us, performance is everything, not size. I don’t know how you can be successful just by accumulating AUM,” Hara adds. “Every time we raise a fund, it’s linked to team building activities because we spend about 3-6 months discussing how we can maintain discipline in our strategy with a larger fund. If we can build a larger team with decent quality, then we will be more comfortable increasing the fund size.”

Changing tides

Recent exit activity includes the sale in August of automotive supplier Tokai Trim. The deal was transacted on undisclosed terms, but during a six-year hold, Tokai paid down all its debt and grew EBITDA from $3 million to $5.5 million as J-Star reorganized operations across four countries. As with Alpha, a value creation team member – this time Kashiyama – was brought in for an extended residency before a CFO recruit was elevated to CEO.

Tokai Trim represents a declining area of interest for J-Star, however, as investment gravitate from manufacturing toward services, in line with the macro tides of Japan’s business sector. More recent forays have therefore focused on consolidation plays in fragmented, customer-facing categories such as hospice care, pet care and online media services. For the latter, a new platform called Periplus was set up earlier this month through a trio of small buyouts.  

“All traditional types of media and broadcasting business are declining, so a lot of marketing is shifting toward websites,” explains Arakawa. “We want to invest in ones that are dedicated to some niche market. There are so many small companies in digital media services that are essentially start-ups that cannot IPO. We can easily differentiate these companies by combining them and scaling them to be more competitive.”

Arakawa emphasizes that J-Star does not take a sectorial approach to investment, nor are deal team members brought in to specialize in certain segments. Such strategies have proven unnecessary in Japan’s bustling SME market, which is said to account for some 3.5 million companies and increasingly amenable to private equity.

The firm now reviews about 100 deal opportunities a year, taking face-to-face meetings with owners or management of 50. At the smaller end of the M&A space, succession is still seen as the dominant pipeline supplier, but corporate divestments are increasingly moving from large-cap inaccessibility into J-Star’s existing remit. As the GP solidifies its reputation, while simultaneously edging forward its value-add and investment capacity, this source of deal flow appears set to become more active. 

“Every member of the team is involved in deal sourcing, and I personally spend about half of my time investigating new deal opportunities. But now that we have a longer track record, people are approaching us, including a lot of boutique banks, either by direct mail or cold calling, and we look at every opportunity,” says Arakawa. “For the last five years, there have been a lot of succession situations, and now we’re seeing more of the carve-out type deals. We’re looking at several opportunities like that now.”

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• Topics
• North Asia
• GPs
• Japan
• J-Star