Deal focus: Japan sees more mid-cap carve-outs

J-Star, a private equity firm focused on Japan’s lower middle market, typically reviews about 100 potential deals a year. As recently as last year, only 5-10% of these opportunities were corporate carve-out situations. This year to date, that figure has doubled to 10-20%.

The GP, which closed its fourth fund last year at the hard cap of JPY48.5 billion ($460 million), has realized its first two carve-out transactions since inception in 2006 in the past month. The first of these was budget restaurant chain Pepper Lunch, acquired in July from Pepper Food Service, which is shifting its focus to a higher-end model. The second came this week with the purchase of waste management operator Sincere Corporation from IT and electronics giant NEC Corporation.

J-Star CEO Greg Hara declined to comment on the deal but recognizes it as a sign of increasing corporate divestment activity. The trend is part of a long-unfolding shift in Japanese business culture, punctuated periodically by shock events such as the global financial crisis and COVID-19.

“Many companies are doing okay from a liquidity standpoint due to a high level of cash holding and support from the banks, even with prolonged effects of the pandemic, but they’re showing negative P&L statements,” Hara says. “So, it’s been an easy decision for them to divest non-core subsidiaries. Also, the loss statement is a compelling event for the management and employees to be carved out.”  

NEC doesn’t quite fit the distress-tinged picture here since it is seen as leveraging the sedentary lifestyles of COVID-19 to do a booming trade in personal computers. Nevertheless, NEC has been responsible for a flurry of carve-outs in recent years, including four with private equity firm Japan Industrial Partners.

The sale of Sincere represents a significant extension of this activity, at least in terms of parting ways with a long-term asset. Sincere has provided waste management services for NEC since 1969 and continues to count its former parent as a primary customer.

Sincere operates two facilities in the Tokyo area, offering recycling and services such as waste power generation to corporate clients. Industrial waste is seen as more susceptible to economic volatility than public household waste, but it benefits from proprietary contracting. The urban footprint is a key advantage because it reduces transport costs for clients and raises barriers to entry for competitors.

J-Star is expected to pursue a buy-and-build strategy, bolting on individually owned recycling operations and potentially building new plants where good locations are available. Expanding the company’s headcount may prove difficult in Japan’s competitive job market, but therein lies much of the opportunity set for further carve-outs.

“Nowadays, talent is more liquid. Hiring and staffing a big business is not easy, and non-core subsidiaries are even more difficult,” Hara adds. “We have fewer people in Japan, the economy is not really growing, and even with COVID-19, the unemployment rate is still only 5%. The tight labor environment makes it harder for corporations to maintain a scale of non-core companies within a group.”

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• Topics
• North Asia
• Buyouts
• Support services
• Japan
• J-Star