Moment of truth for Japan’s relationship with private equity

Pandemic poses challenge, and opportunity, for buyout groups such as KKR and Carlyle

A year ago, when US private equity group Carlyle began its search for investors in its fourth Japan fund, demand was buoyant.

Sales of non-core businesses by Hitachi, Toshiba and other conglomerates, as well as Japan’s problems with finding successors for its ageing business bosses, presented attractive opportunities for buyout funds. Around that time, rival KKR also declared the country its “highest priority” market outside the US.

Within six months, Carlyle had lined up most of its investors then, last week, came the announcement that it had raised $2.3bn, more than twice the size of its previous fund. In a video interview Kazuhiro Yamada, head of Carlyle Japan, expressed relief that the fund had closed early, before the effects of coronavirus hit financial markets, raising fears that dealmaking and fundraising would grind to a halt.

The question now is how the pandemic will affect the mindset of the Japanese chief executives on the other side of the negotiating table.

In the years after the financial crisis of 2008, consolidation accelerated in certain sectors, creating national champions such as screen maker Japan Display. At the same time, the strong yen drove large overseas acquisitions by companies from Shiseido to Suntory and NTT.

This time, as the outbreak causes a general shutdown of economic activity, companies are scrambling to maintain liquidity. Even Toyota, one of the world’s most financially robust carmakers, is exploring a new credit line with banks to boost its balance sheet. Protecting jobs is another top priority.

But according to Mr Yamada, there will also be an increased appetite for asset sales, with rapidly deteriorating profits and revenues forcing companies to focus on the strongest parts of their business.

So far, deal activity has not fallen off sharply. Japanese companies spent $24bn in the first three months of the year in 138 overseas deals, although Seven & i Holdings pulled out of talks to buy Marathon Petroleum’s Speedway petrol station chain for about $22bn after failing to agree a valuation. That compared with $107bn on 177 deals in 2019 — heavily boosted by pharma group Takeda’s completion of its £46bn acquisition of Ireland’s Shire — and $24bn on 152 deals in 2018, according to Dealogic.

Data from research group Recof also show domestic M&A is humming along nicely. More than 700 deals have been announced so far this year — roughly the same level as last year, when a record was set.

Even with the impact of Covid-19, consultancy PwC estimated Japan-focused investment funds will raise more than $5bn this year, which would be the highest amount since 2006.

Still, the M&A fallout from this pandemic should not be underestimated. While discussions between sellers and buyers may continue via video link, it will become increasingly difficult to close deals with face-to-face meetings off limits and factory and office visits cancelled. The volatility in the markets will also complicate negotiations on valuations.

“With public market values falling so much, a buyer needs to determine whether the valuation represents the new normal or whether there is going to be a V-shaped recovery in terms of earnings or valuation,” said Jun Tsusaka, a former Japan head of TPG who is now chief executive of Tokyo-based private equity firm Nippon Sangyo Suishin Kiko.

From past experience, Mr Tsusaka estimated more than 80 per cent of deals under discussion will be held up.
Bankers and lawyers who had been talking in January about Japanese outbound megadeals in the pipeline have toned down their enthusiasm significantly. “There will be no megadeal this year,” one Tokyo-based M&A banker warned.

For buyout funds though, the response of Japanese corporations to the crisis will provide some indication of whether private equity is becoming a mainstream feature of the corporate landscape, rather than a last resort.

In the wake of the Lehman crisis, struggling companies such as Renesas turned to an all-Japan consortium for financial rescue rather than be taken over by a foreign private equity fund.

But in the years before this outbreak, Japan Inc has no longer been the reliable backstop in times of stress, while funds such as Carlyle and KKR now have a history and record in the market that should make it easier for them to compete with domestic strategic buyers.

The speed of deterioration in corporate balance sheets as everyday life has shut down means Japanese companies, big and small, will be forced to make dramatic choices in order to survive. Private equity could become an acceptable part of the mix for managing the way through.

Source: Financial Times

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