Japan carve-outs: Slow burn story

The pursuit of Toshiba Corporation’s Nand flash memory division has featured enough twists and turns to satisfy the most ambitious of Hollywood screenwriters. Now, though, the story appears to be nearing a close. A consortium comprising Bain Capital and an assortment of Japanese and strategic investors has agreed a JPY2 trillion ($17.8 billion) deal; Western Digital – the classic spurned partner nursing a grievance – may make a dramatic intervention but has yet to show its hand.

Should the transaction go through, it would certainly represent a landmark. Strip out the infrastructure investments and Chinese government-linked deals, and Toshiba Memory Corporation (TMC) is by some distance the largest buyout in Asia. But is the deal a watershed for private equity? At first glance, the argument is persuasive: after years of frustration spent trying to persuade corporate Japan to divest its most prized assets, the industry has finally made a breakthrough. That said, Toshiba is also an outlier – in terms of speed of execution, process, and size.

First, the parent company is essentially a distressed seller. Toshiba is in dire straits following the bankruptcy of its Westinghouse nuclear division and related write-downs. In order to avoid two consecutive financial years with liabilities that exceed assets – grounds for delisting from the Tokyo Stock Exchange – the company needs cash. Selling TMC is the quickest way of getting it.

Second, corporate Japan did not stage a rescue effort for Toshiba, perhaps put off by the size of the hole that needs filling or the corporate governance concerns that might be raised by such an effort. The situation is very different from Renesas Technologies five years ago. KKR seemed set to invest in the ailing chipmaker until Innovation Network Corporation of Japan (INCJ) rallied a group of local conglomerates to support a bailout. This time around, INCJ is part of the Bain consortium, alongside Development Bank of Japan and assorted US strategic players.

Third, the TMC deal is unusually large; the Japan Airlines turnaround in 2010, for example, was only half the size, including the cash injection and waiving of debts. Toshiba is selling a large and lucrative business because it has no option, not because it sees strategic value in doing so, as is the case with most other divestments.

This is not to challenge the notion that corporate carve-outs are a viable strategy for private equity investors in Japan. Mid-market GPs have been picking up these assets for a number of years and now it appears that larger deals are becoming available for global buyout firms.

PE investment in the country, based on announced deals, came to $11.1 billion in 2016, a post-global financial crisis high, and $7.2 billion has been transacted so far this year (excluding Toshiba). This includes three divestments of $1 billion or more. Calsonic Kansei Corporation and Hitachi Koki were controlled by Nissan Motor and Hitachi, respectively, before KKR bought out the parent and completed a tender offer. A similar deal, involving Hitachi Kokusai Electric, KKR and Japan Industrial Partners, has been delayed due to stock price volatility but is expected to proceed in due course.

Several factors have contributed to this increase in deal flow. Governance has become more of a priority in Japan, following the introduction of various pieces of regulatory guidance. Greater emphasis is also being placed on return on equity (ROE), which is forcing companies to think about how they can remain competitive in increasingly crowded markets. The upshot is that selling assets in order to focus on several key industry verticals makes strategic sense – and as others adopt this approach, the negative stigma eases.

Private equity investors’ hopes that additional assets will become available are well-founded, but they should be realistic in their outlook. In the absence of an economic collapse, TMC might be a one-off and anything smaller – though still in big-ticket territory – will be fiercely contested. The Japan carve-out opportunity is real, but realizing it is going to be a protracted process.

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• Topics
• North Asia
• Buyouts
• Japan
• Bain Capital Asia
• KKR