With fierce competition in the U.S. and Europe driving up prices, many of the larger buyout shops and M&A houses have set sail for Japan, hoping to capitalize on its downtrodden economic situation. And while some of its early champions have since packed up and left town, there remains a select group of buyout giants still hoping to make a go of it.
“Japan is the biggest untapped opportunity in the world, but tapping into it is extremely difficult,” says John Breckenridge, a managing director in the Tokyo offices of JPMorgan Partners. “In Japan, you have some world-class companies that are 40 to 50 years old and have yet to see any best practices improvements. But the only way things happen in Japan is when the target or parent is in absolute crisis.”
Breckenridge has been with JPMP Japan since 2001, and since his arrival the firm has made one purchase. It bought Rhythm Corp., an auto parts subsidiary of Nissan Motor Co., in August 2002 for approximately $85 million. JPMP Japan has a second deal in the works that will likely close this year, a source close to the firm says.
While Breckenridge and other pros point to the low cost of debt and low valuations as major draws to Japan, there are significant barriers to entry. Probably the biggest difference for LBO shops, as well as capitalists in general, is that Japanese sellers aren’t motivated strictly by economics. For example, Japanese companies place a large emphasis on how well the target and its employees will be treated after the acquisition.
“In the U.S., if a company wants to be sold, they simply hire an investment bank and send the book to anyone and everyone with the resources needed to buy [the target],” says Wilbur Ross, chairman and CEO of WL Ross & Co. “In Japan, a buyer has to negotiate his way onto a bidding list, and it can take a while to build relationships up to a point where a foreign private equity firm would be offered the chance to buy a Japanese company.”
“The Japanese seller wants to know how [a buyer] can help the business -that’s way more important than the price,” agreed Breckenridge. “It’s a beauty pageant that has nothing to do with the actual price.”
Moreover, while it’s normal for any country to have concerns about foreign companies snapping up resources, nowhere is this wariness more prevalent than in Japan. However, Breckenridge says that’s slowly changing to benefit U.S. private equity players.
“The trick is to inculcate change,” says Ross. “If you can get over the hurdles that exist, there are wonderful opportunities. But you can’t function properly over there without people on the ground, and you have to stock your office with Japanese [pros]. You can’t force the Japanese to become more American. Their culture is well established and mature, therefore culturally resistant to change. Any dealing with them can only be accepted if you address these social issues.”
As if the vast cultural differences aren’t enough to scare off buyout pros, the startup costs are enormous. “Unless you have an abundance of cash to play with, it’s just not economical to operate there,” says a buyout pro at a mid-size, U.S. based buyout shop. “The leases are expensive and staffing costs are enormous.”
And while that can be countered in other countries by quickly nailing down a few deals, everyone agrees it takes at least a year just to get the ball rolling in Japan. “Patience is key,” says JPMP’s Breckenridge.
Not only does it take an extraordinary amount of time to find the right deal, but once the sides agree to explore the option of an LBO, the process really begins to drag out. “Transactions take much longer over there,” adds Ross. “The Japanese negotiate every single word [in] a contract, because they intend to live up to what they sign.”
To western firms that place returns at the top of their priority list, that sounds as foreign as sitting on the floor to eat dinner. But Breckenridge points to a shift that, if continued, will be beneficial to private equity firms looking to pluck undervalued Japanese companies off the selling block.
But while the barriers for U.S. firms are obvious, just as obvious are the seeds being sewn by pioneer firms planting their respective flags on the island.
“There has been no watershed event, and there probably won’t be, but buyouts such as the Ripplewood and Carlyle deals are setting the table for an influx of business for us,” a private equity pro says.
Ripplewood Holdings, after ruffling more than a few Japanese feathers following its $1 billion takeover of Japan’s Long-Term Credit Bank in 1999, may finally be changing the minds of locals who saw them as merely capitalistic foreigners taking advantage of a debt-riddled bank. Just last month, Ripplewood inked the largest LBO in Japan’s history, buying Vodafone Group’s Japanese fixed-line assets from Japan Telecom in a $2.2 billion transaction. In a country where debt-heavy buyouts are rare, the fact that the debt-to-equity ratio was an astounding 75%-to-25% is evidence of how desperately in need of a helping hand some Japanese companies are today.
The Ripplewood deal, which was agreed upon in August, was followed up just one week later by Carlyle Group’s $118 million public-to-private deal to acquire Kito Corp., a maker of cranes and hoists. While each may not constitute a watershed event on its own, the deals are shaping the future for U.S. LBO action in Japan. “These are big deals, and that’s an important phenomenon-it’s rare to see deals this [size] over there,” says Ross.
Ross, whose company has foreign offices in Japan and South Korea, points to the Japan telecom deal as something all of Japan will be watching-and using-as a barometer to measure the future viability of U.S. LBO shops doing business in Japan. “This deal is indeed a flag-carrying effort…telecom deals affect not only the company but have a direct impact on so many citizens,” he says.
Carlyle, with its enviable list of globally savvy senior advisors such as George H.W. Bush, James A. Baker III and John Major, may be best positioned to take advantage of the slew of distressed opportunities in Japan. Since 2001, the firm has invested $30 million in eAccess, a DSL provider and has made three purchases: Asahi Security, a Brinks-like cash-security business, Fab Solutions, a developer of inspection and evaluation tools for the semiconductor industry, and Kito Corp.
“Our senior advisory board makes a big difference…they open doors,” says Ken Albolote, a Carlyle Japan-based vice president focused on the telecom, media and technology sectors. Carlyle not only has an Asian fund to draw from, but is on the verge of closing its first Japan-centric fund, a vehicle with a target of $400 million. “It’s a great place to put money into, not just for private equity firms, but for LPs [too],” he says.
Not all limiteds agree, however. “I’ve seen Carlyle’s Asia returns, and they’re not good,” says an East Coast LP. “We’re struggling to understand what benefit being over there will do for us. We’ve heard the same pitch from buyout shops for 10 years, Now is the time, get in before the rush,’ but we’d rather miss out on one good fund than enter three horrible ones looking for that one gem.”
Moreover, many buyout shops are carrying out that wait-and-see approach and have yet to enter Japan’s market, even if they have the means to do so. “There are a lot of firms on the sidelines, waiting to see how everything plays out,” says Albolote. “What they’re really waiting for are a few successful exits, and there’s a good chance we’ll see returns in the 25% to 30% range.”
“One or two good deals does not a fund make,” another limited partner counters. “We’re content to see how things unfold.”
However, with valuations of Japanese targets at an all-time low, and, in what many see as the trough in the Japanese market, reticent LPs may be missing a great opportunity for large returns. “You only get one chance to get in on the ground floor,” says one buyout player based in Japan.