Japanese GPs prepare for a smaller future

Advantage Partners and Tokyo Star Bank, Unison Capital and Toshiba Ceramics, RHJ and Asashi Tech, Permira and Arista Life Science, The Carlyle Group and Willcom. Between 2006 and 2008, buyout deals abounded in Japan, with PE firms committing several hundred billion yen.

But the days of high prices and high leverage are long gone. A number of high profile failures - Willcom filed for bankruptcy protection last year while Advantage Partners had to hand over Tokyo Star Bank to creditors after failing to meet debt repayments - have led investors to rethink their approach. Last year, European buyout fund Advent International went so far as to scrap its $550 million Japan-focused fund.

"Advent refunded all the commitments so we only lost the management fee we paid to them," one global LP tells AVCJ. "It was the worst situation for us - not seeing single investment but the money was sitting there in the fund. It was so frustrating."

Not everyone has been put off, however. Private equity firms with long track records in Japan and deep industry knowledge still see opportunities. Bain Capital recently said that Japan will be the primary focus of its second Asia fund, which has raised over $1 billion. Shintaro Hori, chairman of Bain Capital Japan, says the firm is particularly interested in working with Japanese corporations seeking to expand into foreign markets.

AVCJ has also been told that sovereign wealth fund Korean Investment Corporation was in Japan recently looking for investment opportunities that create economic synergies between South Korea and Japan.

Some positive signs

For all the bad headlines about Tokyo Star, there have been some strong exits in the market. Advantage Partners sold Pokka, a local beverage firm, to Sapporo this year, realizing a 7x return on its original investment of JPY250 billion ($3 billion) three years ago. Unfortunately no foreign LPs participated in AP's funds before 2008.

Other notable exits include Valiant Partners making a 3.9x return on Hanshin Dispensary following a sale to the company's founder and industry peers for JPY7 billion ($84.2 million) and Next Capital's trade sale of golf equipment manufacturer Kasco for JPY2.1 billion ($25.9 million), generating a 4x return. Both deals are notable in that they were executed by mid-cap specialist funds for sensible prices.

"It is important that we should not grab investees by paying higher prices during the good economic environment, but make deals that fit to our investment strategy and add value without rushing," says Masao Nakagawa, a Senior Director at Nippon Mirai Capital.

It is generally acknowledged that mid-cap deals are the key to stable returns in Japan nowadays and there are plenty to go around, with small- to medium-sized enterprises accounting for 99% of local industry.

"In recent years, M&A has become more accepted as part of management strategy for developing mid-cap companies and we see this as a great opportunity," says Yasushi Ando, CEO and COO at New Horizon Capital. He adds that 70% of potential target companies could be bought for under JPY10 billion ($124 million), an ideal buyout size.

In many cases, these companies are looking to counterbalance shrinking domestic sales by striking out into new markets. A wave of consolidation is expected, leaving a bulwark of companies with the capacity and compete globally, and this transition should create opportunities for private equity firms with global networks and skills.

Private equity investment can be a good fit for entrepreneurs who don't want to resort to merging with a rival and the industry is no longer seen in a negative light. "Even the authorities now regard private equity as means of bringing out industrial revival," a government source tells AVCJ.

Fundraising problems

Various mid-size funds that were set up around 2006 have now invested at least half of their capital and are trying to raise new funds. The likes of J-Star, New Horizon Capital, Valiant Partners, Nippon Mirai Capital are all said to be targeting funds of JPY15-30 billion ($185-370 million).

Traditionally, these local funds have relied on banks for financing but with lending restrictions tightening, they are turning to foreign LPs, many of which are wary of Japan. Industry participants expect there to be a fine balance between capital demand and supply in the next couple of years, with good funds attracting LPs at the expense of the rest.

"I am calling the current environment ‘Death Valley' because funds with poor track records won't be able to raise capital and they will be eliminated, reducing the number of private equity funds in Japan," says Megumi Kiyozuka, managing director of CLSA Capital Partners.

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• Topics
• North Asia
• GPs
• Fundraising
• Buyouts
• Advantage Partners
• Unison Capital
• The Carlyle Group
• Permira Advisers
• New Horizon Investment Advisors