Profile: Phronesis Partners' Tomoya Shiraishi

After four years focusing on mega-transactions, Tomoya Shiraishi wanted to return to Japan's small and mid-cap buyout space. But the interlude between his departure from Permira and the establishment of Phronesis Partners - which pursues this strategy - lasted from 2009 until 2014.

Shiraishi put his plans on hold in the wake of the 2011 Great East Japan Earthquake, which triggered a major tsunami that in turn caused a meltdown at the Fukushima Daiichi Nuclear Power Plant. There were nearly 15,900 deaths and around 229,000 people were displaced from their homes. The World Bank put the total economic cost of the earthquake at $235 billion, making it the costliest natural disaster in history.

"I thought that as a private equity professional I could dedicate myself to supporting regional businesses in financial and managerial areas," Shiraishi explains.

I received on-the-job training as to how investments were made, the practical support side, and the value-add. My backbone as a private equity professional developed in the US

This resulted in the creation of Social Investment Partners (SIP) in conjunction with several other Japanese private equity executives. The organization targets businesses that are sustainable and have a social impact, with a particular emphasis on education, youth employment, childcare and female empowerment, and community development. It launched the JPY100 million ($1 million) Japan Venture Philanthropy Fund in 2013 with the support of the Nippon Foundation.

The fund's first commitment was to a non-profit that provides after-school care for primary school students. Programs are led by "citizen teachers," primarily retirees who organize activities that focus on local culture, for example. SIP agreed to provide JPY20 million in financing plus managerial assistance over a three-year period as the business looks to expand. The investment thesis has two strands: filling a gap in the market and encouraging more women to return to work after having children.

"Since we invested, revenues have grown five-fold," Shiraishi says. "As for the social impact, you can look at the increasing numbers of kids and citizen teachers, but the real beneficiaries are the mothers. The employment ratio for mothers is now increasing in those areas."

To the Valley

The notion of private equity as a source of strategic as well as financial support first became apparent to Shiraishi as a law student at Hitotsubashi University in the 1980s. His class examined case studies of venture capital investments in Silicon Valley, and it wasn't long before he got direct exposure to the asset class - as a member of the graduate intake at Jafco, he spent three years with the investment team in Japan before being dispatched to the Menlo Park office.

"I received on-the-job training as to how investments were made, the practical support side, and the value-add," Shiraishi observes. "My backbone as a private equity professional developed in the US."

It was the early 1990s, before the emergence of the dotcom era, and investors focused on high-tech manufacturing and software. Early Jafco portfolio companies included Novellus Systems, a semiconductor components producer that went public in 1988 and was acquired by Lam Research for $3.3 billion in 2011.

Four years in the US were followed by another six in Singapore, where Shiraishi was responsible for making direct investments in growth-stage companies based in Southeast Asia, Australia, Taiwan and China. Then, in 1998, came the call to return to Japan: Jafco was entering the buyout business and they wanted Shiraishi to serve as CIO of the new team.

Up until this point, Japanese private equity had been characterized by growth-stage deals, but the spate of bankruptcies that followed the Asian financial crisis created an opening for foreign turnaround investors. A Ripplewood Holdings-led consortium made the initial breakthrough, agreeing a $1.15 billion acquisition of collapsed Long Term Credit Bank of Japan in 1999. The likes of Lone Star Funds and Cerberus Capital Management soon followed with their own financial services investments.

Between 1995 and 1999, 13 buyout or turnaround deals were announced in Japan, according to AVCJ Research. Over the next four years the total rose to 146. Total capital committed across all private equity deals reached $15.3 billion during this period, a five-fold increase on the aggregate figure for 1995-1999.

Jafco was not operating at the scale of its foreign peers, and while there were a number of turnaround investments, the firm also participated in management buyouts, succession-planning deals, and carve-outs from publicly-traded conglomerates. These included metal coatings specialist Tocalo, the first privatization in Japan led by a financial sponsor. Working with company management, Jafco bought out majority owner Nippon Steel in 2001 and then launched a tender offer for the remaining shares.

"It was also one of the first cases of a re-listing of one of these companies," Shiraishi adds. "After four years we had increased revenue by about 1.4x and increased the EBITDA by about 4x. We listed the company on the First Section of the Tokyo Stock Exchange. Our return was around 10x."

The big buyout

Over the next few years, more global private equity firms established a presence in Japan and Shiraishi was recruited as Permira's country head in 2005. One of the attractions was the firm's international network, in terms of the resources it had at its disposal and the fact that Japanese companies were becoming more global and therefore required a different kind operational support.

Permira closed its fourth buyout fund at EUR9.6 billion a year after Shiraishi joined, and as part of a team responsible for investing a single global fund, he could only focus on the very largest of transactions. This often meant working on the Japanese element of deals led by other offices, but Shiraishi had the opportunity to take pole position on the acquisition of Tokyo-headquartered Arysta LifeScience.

At JPY250 billion (then $2.2 billion), it remains the fifth-largest corporate private equity buyout ever seen in Japan and the biggest undertaken by a single firm. Financing was required in US dollars and yen to digest the $1 billion-plus debt load, while Arysta itself was very international. The company was the number 10 player in global agrochemicals, generating $1 billion in annual revenue from a portfolio of more than 150 insecticides, weed killers and plant-nutrition products sold across 125 countries.

"The due diligence was quite international," says Shiraishi. "Permira had 15-20 professionals working on this one transaction from the beginning through to the closing. To lead this army was an education for me. I could not have got this with Jafco or with another Japanese private equity firm."

Three of Japan's five largest private equity buyouts, including Arysta, were announced in 2006 or 2007. That period saw more than 1,000 deals worth $29.2 billion, roughly equal to the previous five years combined. The other two of those three did not turn out as planned: investors in restaurant chain Skylark failed to make money on the deal, while Tokyo Star Bank defaulted on its debts and was acquired by creditors.

Shiraishi notes that Permira considered a number of other large investments in Japan but could not identify an investment thesis that justified the mooted valuations. "Financial liquidity was high, globally and in Japan," he says. "In the case of Arysta, we had been studying the company and the industry for two years ahead of the auction. We had done our homework and developed a good angle to increase the value post-investment."

Practical thought

As of 2013, Arysta's revenue had grown to $1.5 billion and the business was sold to US chemicals producer Platform Specialty Products for about $3.51 billion towards the end of the following year. By this point, Shiraishi was busy developing Phronesis alongside co-founder and co-CEO Takahisa Koitabashi, previously deputy head of I-Sigma Capital's corporate rehabilitation fund.

Phronesis reached a first close of JPY3 billion on its debut vehicle, New Paradigm Fund I, in July of this year. Half the capital came from the Organization for Small & Medium Enterprises and Regional Innovation (SMRJ), a government agency that supports many funds expected to contribute to economic growth. The private equity firm is targeting a final close of JPY10 billion over the next 12 months, with SMRJ accounting for no more than JPY2.5 billion.

Phronesis will buy companies with enterprise valuations of JPY2-6 billion and implement strategic and operational improvements. Shiraishi estimates there are more than 300 small-cap buyout funds in the US but only a handful in Japan. Meanwhile, domestic companies often lack the caliber of people required to professionalize systems and management, and maintain competitiveness in a changing commercial environment.

Over half of Phronesis' deals are likely to involve succession planning, with ageing founders turning to third-party buyers as they have no one within the family to assume control of their businesses. Many of these sit among Japan's more than 4,000 listed companies, so privatizations should be commonplace.

"Overall, the market is underserved, especially for small-cap companies, which make up three-quarters of the Japanese economy in terms of employment and GDP," Shiraishi adds. "If we can achieve sustainable growth for these businesses then our return multiple would be maximized. We also want private equity to be recognized in Japan as a value creator rather than a vulture or cost-cutter."

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