Asia Access Quarterly: Corporate disposals fuel the rise of Japanese private equity

Private equity in Japan

Historically, listed corporates have dominated the Japanese M&A landscape, be they corporate mergers or internal corporate reorganisations, acted upon by familiar names such as Hitachi or Panasonic. Pioneering domestic PE firms operating alongside locally based, larger-cap Western funds have struggled to compete, with their levels of ‘take-private’ and secondary ‘PE-to-PE’ deal activity in the Japanese market almost negligible. This said, the changes implemented by the Financial Services Agency (FSA) to the Securities and Exchange Law of Japan in 2007[1] was a turning point that was initially crafted to encourage Western style corporate governance and use of Western M&A tools (such as use of shares in cross-border deals), ultimately inviting an influx of Western capital into the region.

In the decade that followed, however, such Tsunami of inbound cross-border deals never came. Realising this, we saw many Western PEs shift their Asian headquarters from Tokyo to Hong Kong and Singapore. Long-standing cultural resistance stood in the way of corporate disposals in Japan; disposing of non-core or under-performing assets was previously seen as - we believe - ‘dishonourable’, and in many boardrooms, maintaining domestic employment across a very diverse portfolio of businesses was more important than enhancing shareholder value.

Over the last two decades, we have witnessed slow but seismic, internally driven shifts across the market. We believe this has included a call for shareholder activism, stronger governance - after a series of high-profile corporate scandals - and an effort to remedy structural inefficiencies across several key industries, which likely had been too slow to horizontalize and outsource to remain lean. We also saw the pandemic play a significant role in encouraging efficiencies, forcing Japanese corporates to re-evaluate and streamline their non-performing assets lacking in critical mass, growth prospects or profitability. To escape potential domestic scrutiny, Japanese corporates initially turned to performing disposals abroad, resulting in regions such as Europe experiencing a nearly five-fold increase in Japanese disposal activities in the past 10 years (as demonstrated below – see Chart 1).

Japanese corporate disposals in Europe[2]

	2011	2012	2013	2014	2015	2016	2017	2018	2019	2020	2021
Total	8	14	22	19	25	20	26	22	15	29	38
Volume of total by auction	(5)	(5)	(3)	(6)	(12)	(5)	(8)	(7)	(6)	(12)	(21)

Unwinding of cross shareholdings in Japan Inc.

The structural shifts outlined above were likely driven by the breakdown of traditional conglomerates across Japan. We have seen it become increasingly difficult for the large, vertically integrated giants - supported by family groups of banks and ‘keiretsu’ suppliers (a network of businesses with shared historic roots) - to operate economically or remain competitive.

The last decade has seen the unwinding of legacy cross-shareholdings by banks and commercial partners - including customers and suppliers - which once stabilised Japanese corporates[3]. We saw this stability allow them to make bold investment decisions during the Japanese expansionist era, but it now acts as deterrent to inbound M&A activity[4].

Cultural shifts in the Japanese employment market have also driven changes. Today, Japan’s employee turnover is still considered low, but in many of new and highly specialised sectors such as tech, pharmaceuticals, and services, the notion of ‘job loyalty’ is an outdated one.[5] We have witnessed this shift has destabilised the previously seen competitive strength of large corporates in the market, creating more opportunities for PE-backed and independent businesses and resulting in improved scope for M&A activity.

Finally, for those western PEs who remained in Japan, we believe their patience has paid off. Western PEs have finally been able to win over the Japanese shareholder sentiment and public opinion by successfully delivering large buyouts (as seen below in Chart 2) – at times outperforming competitive bids from the Japanese establishment.

Japanese buyout PE deals[6][7]

Japanese M&A deals with EV > USD 1bn[8]

Private Equity in Japan – Outlook

Overcome by the market shifts in Japan, we have seen US and European PEs have in some cases returned, after nearly a decade, to re-establish a presence in the local market.

The likely short-term expectation is that Japan will continue to rationalise corporate portfolios and we believe domestic buyout activities will continue to grow. Equally, the increasing dissolution of cross-shareholding, coupled with the introduction of the new top-tier section of the Tokyo Stock Exchange for globally competitive companies, is expected to continue to generate opportunities for the Western PEs in Japan[9].

We therefore expect the Japanese market to mature over coming years to bridge the ~25x gap in PE investment volumes (adjusted on a per GDP basis) between itself and Europe or the US[10].