Japan outbound investment: Playing away

When Meiji Seika Pharma - the pharmaceuticals arm of Meiji Group - acquired Indian drug maker Medreich earlier this month it was an ideal solution to an issue that has often plagues Japanese companies. Meiji was keen to expand into the generic drugs market but like so many conglomerates found the domestic market did not offer the growth it needed.

The Japanese drugs market is by no means small, commanding annual sales of approximately JPY 6.45 trillion ($64.5 billion) it is second largest pharmaceutical market in the world, according to Thompson Reuters. However, only 6.6% of this market - $3.8 billion - comprises generic drugs. In India, however, generic drugs are worth a staggering $26 billion. Factor in the large, growing population and expanding middle class and it is clear why Meiji wanted to go there.

The deal - which provided an exit for Temasek Holdings, which invested INR1.09 billion (then $22 million) in Medreich in 2005 - not only demonstrates the continuing hunger among Japanese strategics for overseas assets but also shows how private capital can participate. There are plenty of opportunities to partner with Japanese corporates and exit assets to them, but these companies also represent a competitive threat on the investment side.

According to Thompson Reuters, Japanese outbound M&A stands at $33 billion dollars across 239 deals so far this year, compared to $47 billion over 614 deals in 2013. While the numbers do not match the previous peak of 2012 - when M&A reached $83.2 billion - they are impressive in context of a weaker yen. At the same time, many expect investment to increase further.

"If anything the story is that is getting bigger and better," says Hiroshi Kondo, head of M&A advisory and partner at law firm Baker & McKenzie in Tokyo. "For many of the Japanese firms doing outbound deals today the reason is growth. The prospects for demographic growth in Japan mean there is little else they can do other than go offshore to take new markets."

In addition to sluggish demand caused by ageing population, many firms venture overseas to counter the impact of fierce competition from domestic rivals industries. And they are backed in these endeavors by Japanese banks keen to provide M&A financing.

Fabled shores

Two themes have emerged when it comes to the jurisdictions in which Japanese firms are looking to invest. The US accounts for the most M&A transactions for any single country, with 46 so far this year. However, Southeast Asia features prominently as a region with 54 deals. While US companies are seen as mature and a source of advanced technology and expertise, Southeast Asia has come to the fore for different reasons.

"China and Thailand used to be popular destinations, but they have been joined by, among others, Indonesia, the Philippines, Vietnam and even Myanmar where it is possible to hire relatively cheap skilled labor," Satoshi Sekine, Japan private equity leader at EY. "Also, because of the close proximity to Japan, Japanese companies are more familiar and comfortable with Southeast Asia than other emerging markets."

Politics also plays a role, with Southeast Asia regarded as an attractive alternative to China, given the recent tensions between Tokyo and Beijing. "While there is still a strong trade relationship between Japan and China, the political tensions have encouraged some Japanese companies to diversify their overseas manufacturing locations and reduce reliance on China," says Paul Ford, a director at KPMG FAS.

Some of the most significant deals to take place this year have involved Indonesian companies. The first of these facilitated a partial exit for Northstar Group and TPG Capital when they sold another portion of Bank Tabungan Pensiunan Nasional (BTPN) to Sumitomo Mitsui Banking Corp. for $528 million. The Japanese group now owns 40% of the bank, having first invested in 2013. The second deal saw Nippon Life Insurance acquiring a 20% stake in Asuransi Jiwa Sequis Life for around $424 million.

Partly thanks to these transactions, financial services accounted for one quarter of all Japanese outbound M&A in the first of this year and in 2013. However, the lion's share of capital goes into consumer staples, which are responsible for 56% of M&A so far this year and 42% last year.

Southeast Asia is where Japanese strategics frequently come into contact with private equity, and for the latter it can be a double-edged sword. Cash-rich Japanese companies factor long-term synergies into their pricing, which means they can get comfortable with high valuations. For example, BTPN was priced at 4.5x book value, making it one of the most expensive bank transactions ever seen in Asia.

This is great for Northstar and TPG but not for PE firms bidding against Japanese strategics for assets. There are plenty of cases in which private equity has lost out, notably in 2011 when Indonesia's Garuda Food spurned selling an equity stake to The Carlyle Group in favor of a joint venture with Suntory. More recently, Japanese insurer Meiji Yasuda overcame competition from Carlyle, KKR and CVC Capital Partners to acquire a piece of Thai Life.

On the flipside, ties between Japanese strategics and private equity can be mutually beneficial. Aside from providing a potential exit route, the Japanese party can bring strong industry knowledge and regional sales channels to a venture.

"From the Japanese corporate perspective, a private equity investor can help de-risk an investment," adds KPMG's Ford. "It provides capital to reduce the up-front investment, and also helps the corporate avoid consolidating the target business, which may be desirable in the case of a highly leveraged acquisition."

Alignment issues

However, even when there is a strong alignment of interest between PE fund and Japanese strategic investor, deals often do not come to fruition. One Asian GP making investments in Southeast Asia claims to have entered into six memoranda of understanding with Japanese investors, none of which resulted in a transaction being executed.

"The reality is that a lot of these strategics are not used to doing deals outside of Japan and they are very cautious," says the GP. "The low interest rate environment means they can preserve status quo and that means they are under no pressure to do something quickly."

Baker&McKenzie's Kendo says various upsets experienced by Japanese strategic investors in emerging market in the recent past have also contributed to a climate of extreme caution. He cites the case of Ranbaxy - another Indian pharmaceuticals asset - which was acquired by Daiichi Sankyo in 2008, but ran into trouble with US regulators over allegations of doctored test results and was fined $500 million.

"Many Japanese companies are going to be cautious, especially in Southeast Asia since due diligence and compliance issues are big headaches for them. Many of our clients are beginning to ask us to conduct very careful compliance due diligence," he says. "The current trend of Japanese companies is to try and seek synergies at a very high level."

But there are organizations trying to smooth the way for better alignment of interested between Japanese investors and private equity, including the government-backed Japan Bank for International Cooperation (JBIC).

In the last couple of years it has provided equity financing for overseas acquisitions by Marubeni Corporation and Mitsubishi Heavy Industries. Now JBIC is an LP in CVC Capital Partners' latest pan-Asian fund, with a view to improving communication between private equity and corporate Japan.

There will be no shortage of opportunities to realize this ambition, provided strategic and private equity investors recognize the capabilities each brings to a deal and are able to work together in a way that is mutually beneficial.

"I don't believe the weaker yen in itself will cause long-term outbound M&A to decline," one GP tells AVCJ. "The primary drivers are the strategic need to diversify and optimize supply chains, and to grow the top line outside of a challenged domestic market. These drivers don't go away, especially on the revenue side."

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• Topics
• GPs
• North Asia
• Southeast Asia
• Buyouts
• M&A
• Japan
• Outbound investment
• buyout
• JBIC