Japan, a Catch-22?

When investors look at the economic growth pitch, investing in Japan certainly appears far less attractive. This is reflected in fundraising numbers as well as investments (see chart), as LPs look to ride the China growth wave. Even domestic institutional investors are taking their money out of the country, following well-trodden paths to China and India. One Japanese LP told AVCJ that only 10-20% of the group's total commitments are allocated in the local market.

However, as AVCJ has reported, PE investment opportunities have begun to open up in the land of the rising sun, with targets ranging from SMEs to large-scale assets. Particularly under tighter lending conditions by local lenders, some companies have had to seek alternative financing – sometimes in the form of PE money – in order to expand their business and inject new ideas and best practice. As Japan enters what is hopefully a new economic cycle, deal flow appears to be re-emerging.

Cases in Point

Mid-cap focused local buyout firm Valiant Partners recently purchased a  controlling 76.67% stake in Fuji Food, a Tokyo-based cooked foods operator for JPY6.89 billion ($75.8 million). In another SME succession deal for The Riverside Company, the firm acquired a 100% stake in Naka & Co., Ltd., a Japanese manufacturer and distributor of crystal oscillators, a component of almost all electronic equipment. Japan's Mizuho Capital Partners, the MBO-focused buyout firm 50:50 owned by Mizuho Corporate Bank and its managing principals paid JPY5.3 billion ($58 million) for Medical Tribune, which publishes weekly medical newspapers, formerly owned by listed Japanese company Impress HD.

Two notable deals broke the $100 million mark, including the JPY32.5 billion ($358 million) acquisition of Intelligence Ltd., the recruitment services subsidiary of Tokyo-based cable broadcaster and media content provider Usen, by Kohlberg Kravis Roberts & Co.; and The Longreach Group's recent bid for Sanyo Logistics Co. for JPY10.3 billion (c.$113 million).

Although deals might be slow(er) to present, LPs have not forgotten about Japan as an important destination within Asia for stable returns in a stable environment with clear legal and regulatory landscapes and a transparent (if revolving) government.

Growth of the buyout firm

Japan's private equity industry emerged in late 1990s with only a few buyout establishments, like Unison Capital, MKS Partners and Advantage Partners. The local PE market developed, opening the door for buyout firms to become involved in TOB and MBO transactions. In 2006, notable buyouts of significant scale began to ramp up, including Toshiba Ceramics by Unison Capital and Carlyle Asia (2006), Skylark by CVC Asia Pacific (2006), Yayoi by MBK Partners (2007), Tokyo Star Bank by Advantage Partners (2007) and Atysta Life Science by Permira (2008).

Interestingly, before 2007, local buyout firms had no foreign investors in their operating funds, but with such headline-grabbing deals on the radar, several domestic PE firms were able to raise money from international LPs. Today, foreign participation has not grown to the extent that funds may have hoped.

The outsider's opinion

Asian-focused f-o-f managers have reported that almost no new commitment was made to private equity funds in Japan this year. About 50 LPs were active at the peak period of Japan's PE industry, and only around five LPs are still investing in Japan.

One European fund-of-funds manager said, "Based on my calculation of fund operations, a $50 million fund size is not suitable for capital allocation; a fund size of at least more than $100 million would make [more sense in terms of investment] with a reasonable number of fund managers."

In terms of the outlook for change on the horizon, most of AVCJ's sources noted that Japan has a limited number of funds and at present, not enough deal flow for the returns they are seeking. One PE player said that unless Japanese companies are pushed to open up to investments, there may not be an immediate change.

With an aging population and a birthrate of just 1.37% p.a., more local companies will face succession issues as owners get closer to retirement. In addition, many companies will need to start considering a move outside Japan for expansion, which will require new skillsets and management.

However, a deep-rooted corporate culture is still a concern – and one that keeps LPs from becoming comfortable with Japan as a PE investment environment. One of the previous hurdles was taxation laws, but the Ministry of Trade and Industry (METI) in Japan have been working to change this. Under the new law, eligible foreign LPs are no longer required to pay up to 20% of the income earned from deals. It is a step in the right direction, but LPs still feel that uncertainty within the government dictates that they watch and wait for the moment.

METI has – to its credit – realized that industrial restructuring is an important catalyst for deal flow in Japan's commercial industry. Therefore, the government arm is putting forward the Industrial Structure Revision Proposal, covering facilitation of industrial restructuring and consolidation conducive to profitability. These would be core issues for enhancing private equity's role in Japan. AVCJ will outline these plans in future editions.

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• Topics
• North Asia
• Performance
• GPs
• Buyout
• Fundraising
• Regulation
• The Longreach Group Limited
• Unison Capital
• Advantage Partners
• CVC Capital Partners
• MBK Partners
• Permira Advisers
• The Carlyle Group
• KKR