Japan's niche businesses for changing times

Japan's economy has seen breakneck growth since the end of World War II, and despite the rise of China and India, has so far maintained its position as the No.1 largest economy in Asia, or No.2 in the world after the US. Japan has a population of around 120 million (the tenth largest worldwide), and has developed a vast variety of local businesses. However, Japan's consumer market is now shrinking – slowly but surely – as the birth rate declines and the aging population increases.

With consumption still declining in Japan and the worldwide recession exacerbating the impact, most companies are under pressure to sustain local market share. In this environment, many smaller companies are compelled into takeovers by larger rivals, or forced into bankruptcy, or to apply for the ADR (Alternative* Dispute Resolution) process. The number of collapsing companies peaked at about 1600 cases in February 2009, according to Tokyo Shoko Research Ltd.

Even giant companies, such as Japan's No.1 brewer Kirin Holdings and No.3 beverage company Suntory, are in merger talks – in this case to create a jumbo enterprise with ￥3.8 trillion ($42 billion) market cap by merging the two companies. Similar consolidation between two major electronics brands, Sanyo Electric Co., and Panasonic Co., was consummated to maintain their local market share while looking at opportunities for overseas expansion. 

Traditionally, these types of deals should attract mega-buyout funds such as Kohlberg Kravis Roberts & Co., the Carlyle Group, the Blackstone Group and RHJ International, who invest the billions required against the prospects of high returns. However, none of these have emerged as potential buyers recently, because leverage investment options are no longer available, due to current tighter lending policies.

Niche businesses – cheap but good?

While large buyout firms struggle to find new investment opportunities, Japan's mid-range GPs have positive views on deal sourcing. After conversations with numerous local firms, many said to AVCJ that there were plenty of investment opportunities in the mid-market, even in the current gloomy environment. 

With domestic consumption no longer growing, "cheap" and "convenience" are the current keywords to operate businesses that can support profit growth.

Japanese consumers used not to prefer to purchase second-hand items, except for vintage luxury goods and antiques, but now many prefer not to spend on new goods, opting to repair their possessions instead. This sector has produced some good examples of domestic private equity funds that have made good returns from investing in unique niche business.

In March 2008, Ant Corporate Advisory (ACA), a local private equity firm spun off from Nikko Antfactory (formerly owned by Citigroup), acquired 28.9% of BOOKOFF Corp., a secondhand book chain operator. ACA is a relatively new and small private equity firm, formed with the support of Sumitomo Corporation and with funds under management of approximately $450 million. About 14 months after the initial investment, ACA sold its entire stake in the company to major strategic partners from the publishing and book retailing industry, including Shogakukan Inc., Shueisha Inc. Kodansha Inc, bookstore chain operator Maruzen Co. book, distributor TRC Inc., and large printing company Dai Nippon Printing, for an IRR of approximately 50%. 

Daisuke Kawano, Partner at ACA, told AVCJ, "When we found that BOOKOFF was offloading the owner's shares, we thought that the business could achieve further growth. So, we presented a proposal to explain potential synergies with prospective investors from the publishing industry in the near term. At the time, BOOKOFF was already a well-known branded company, with many institutional investors wanting to take them, so the acquirer was decided via auction."

Second-hand first-rate deal

BOOKOFF started in 1991 with a single small outlet in Kanagawa prefecture, close to Tokyo, selling second-hand books and DVDs. Later, the company developed an online shopping site, while also retailing used and reconditioned products such as clothing, expanding its sales channels by franchising and reinvesting its own capital, until it eventually owned 1000 stores across Japan. The company also sells other used products, such as watches, toys, and home electric appliances, through shops under brand names including B-Life, B-Kids and B-Select.

"Japanese bookstores must operate consignment sales with distributors who represent Japanese publishers," Kawano continued. "Margins for bookshops are very low, so we thought that this system should be improved."

Now Maruzen, one of the strategic investors, can sell its stock with new prices as totally new second-hand books at BOOKOFF's outlets.

This deal was significant not only because of its performance during a difficult economic time for all fund managers, but also because it helped reshape the declining publishing industry in Japan, according to ACA. This is smart niche business investing that stems from a deep understanding of the local lifestyle and culture.

Living space in Japan is very restricted compared to most Western countries, with little storage space, particularly for people who live in studio-type flats. So, readers often sell books when they finish reading them, to make space for new books. Buyers also can purchase books at second-hand prices online through BOOKOFF, and can request home delivery. As for sellers, the company even offers free pick-up services.

BOOKOFF reported ￥60 billion ($666 million) of sales for the fiscal year ended March 2009, and it estimated fiscal year 2009 sales at ￥70 billion ($777 million)  Similar recycling outlet operators, including For You Co, Treasure Factory, and Watt-Mann Co., are all increasing their sales and their number of customers in Japan.

Buy and check on the internet

With household incomes frozen or contracting, Japanese consumers often check best prices through online sites before purchase. Kakaku.com is one of the popular sites for price comparison, with a wide range of product coverage. Since its formation in 1997, Kakaku.com has been consistently growing, and is now listed in Japan. The company is majority owned by Digital Garage Inc., a listed company involving in business solutions, media and venture incubation. In September this year it sold a 5% stake to Culture Convenience Club (CCC), a rental DVD and CD chain major, previously invested by MKS Partners, a local buyout leader, back in 2001.( MKS is no longer in operation.) According to the local media, access numbers for Kakaku.com in November this year were 59.2 million hits, up 32% from the same period a year ago.

Another unique business that attracted attention from a private equity firm was Aucnet, a local auction site operator. In 2008, Polaris Principal Finance Co., a Mizuho Bank-backed local buyout fund, invested in the company alongside its CEO and other investors, privatizing it. The Polaris-led investment consortium paid ￥5.7 billion ($63.3 million) together with ￥18.1 billion ($200 million) financed by Mizuho Bank, for 100% of Aucnet. Formed in 1984, Aucnet provides second-hand information services for cars, motorcycles, and PCs to support trade between business operators through its auctions business and other facilities. It also operates a flower auction site.

Iinuma Akira, a partner at Polaris, told AVCJ, "This company operates a very unique business, because the auction site is for commercial dealers. It also enables foreign buyers to purchase second-hand automobiles sold in Japan onsite. In fact, numerous dealers in China and Russia are key clients of the site." The company has about 7000 members in Japan who sell used automobiles.

"Before the start of this economic downturn, we thought this business could expand overseas. But we now need to make operational cutbacks of around 20% against slow sales', said Iinuma, adding that part of the reason for slow sales was Russian dealers who stopped purchasing. He said that Aucnet was even interviewed by foreign TV news to introduce its business model, proving its uniqueness.  

One other private equity investment has been made in a similar business. In October, the Carlyle Group executed an 100% takeover of Japanese auto after-market software provider Broadleaf Co., Ltd., in an MBO with the company's management team. Broadleaf operates a component inventory network which focuses primarily on used components for cars, and the CarPod.jp car-selling website, as well as other services.

Value add
With Japan's economy matured, people are no longer content with established business models. For instance, Advantage Partners in March 2008 took over Komeda Co., a Nagoya prefecture-based coffee salon, for ￥15 billion (167 million). Advantage then expanded the so-called Nagoya-style coffee shop outside the Nagoya region. As of February this year, the company has expanded to operate 335 outlets across Japan. What is the big difference between a standard coffee shop and a Nagoya coffee shop? Looking over Komeda's menu, customers not native to Nagoya may be surprised to see some free complimentary snacks served with a cup of coffee. In Nagoya, a first-tier city in the southeast of Japan's main island of Honshu, coffee shops will not succeed without offering free snacks to daily customers. Advantage apparently saw this is a value add to introduce the business across Japan, where people want to see something different.

Japan is facing serious issues created by an expanding elderly population and stagnant commercial sales. Local governments are trying to encourage people to have babies through government-subsidized funds for childbearing from 2010, as well as educating companies to consider favorable environments for pregnant women, but the birth rate has not yet improved in resonse. Japanese citizens over 65 years old will account for 22.5% of the total population in 2009. A fund manager told AVCJ that investment opportunities in healthcare businesses are continuously increasing. Even as Japan's taxi business shrinks, areas around hospitals are seeing increasing sales.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Save this article  
• Send to  

• Topics
• North Asia
• Industrials
• Investments
• The Blackstone Group
• KKR
• Polaris Principal Finance