Deal focus: NSSK builds out drugstore empire

Jun Tsusaka, CEO of NSSK, observes that the best returns in the 30-year history of private equity in Japan have come out of special situations. He expects the current market to provide another harvest.

“You need to be tied into the bankruptcy community here and you need to have operational capability. Both are must-haves,” Tsusaka said of the recipe required for special situations success. But even then, openings can be elusive.

NSSK’s latest special situations investment has come courtesy of Japan’s snowballing business succession space.

Looking to tap broader healthcare sector momentum, pharmacy chain operator Kraft had embarked on a debt-driven M&A spree but failed to integrate the new assets and make them economically accretive to enlarged business. The cashflow mismatch turned the company into special situations target just as its founder, who had 100% control, was grappling with the lack of an heir apparent.

Most opportunities in this vein are not usually of such scale. Kraft is considered the third largest player in its space, having built up an empire of 900 locations under the Sakura brand since its inception in 1982. Annual revenue currently tops JPY 170bn (USD 1.1bn).

NSSK has acquired 100% of Kraft for around JPY 100bn, according to a source close to the situation, marking its largest investment to date. Tsusaka declined to comment on deal details but described the company’s financial pain as inconsequential to its lenders.

“Unlike in a typical bankruptcy situation, where the banks take a major hit, in this instance, the resiliency of the business came through. Their cash flows are now back to levels where we’re able to finance a deal without hurting the banks at all,” he said.

The plan is to build out the store footprint to about 1,200 locations within five years, mostly sticking to the metro Tokyo, Kansai, and Tokai regions. NSSK is a believer in an area dominance approach to expansion, whereby a tighter geographic focus reveals advantages in supervision and moving around staff.

Longer term, there is potential to monetise a relatively robust but still fledgling data component. Kraft recently teamed with IBM Japan to develop an artificial intelligence system that tracks operations around the filling of prescriptions and pharmacist consultations. But the core value-add will be in more fundamental fixes.

Despite solid sales, Kraft is considered middle-of-the-road in terms of profitability. It has not installed best practices in terms of store operations, procurement, and optimising the product mix. This includes a failure to achieve promising economies of scale in moving non-drug goods.

“While they have upgraded well, we think, from a productivity and EBITDA enhancement perspective, there are quite a few low-hanging fruit items,” Tsusaka said. “Over time, we’ll do more sophisticated productivity improvement measures.”

NSSK has substantial experience in building out medical brick-and-mortar chains, having backed nursing home operators Welfare Suzuran and Vati. A partial exit from the latter in 2020 yielded a 3x multiple and a 40% IRR. The secret sauce in these rollouts is data-driven location selection.

Significant consolidation potential is also seen in the fragmented nature of Japan’s pharmacy space. Tsusaka describes an industry where the top nine players are all household names but only represent 17% of national sales. In terms of physical outlets, operators with fewer than 20 locations account for 60% of all pharmacies in the country.

The expansion outlook is further enhanced by a rapid disintegration in the hospital space. Large university-connected general hospitals are ceding market share to small, specialized clinics, with some 7,000 new clinics estimated to open every year. Pharmacies are expected to piggyback the trend.

“It’s a perfect industry for private equity because our expertise is buying, evaluating, and due diligencing businesses, and integrating those businesses into an existing core,” Tsusaka added. “The mergers and integration piece is quite critical – and that’s what a firm like NSSK brings to the table.”

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• Topics
• North Asia
• Buyouts
• Healthcare
• Japan
• NSSK