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Business trends

Private equity bets big on Japan: 5 things to know

US-China tensions and corporate reform drive buyout boom

The rise of megafunds specializing in Asia is driving private equity investments in Japan. (Source photo by Arisa Moriyama) 

TOKYO -- CVC Capital Partners is preparing a $20 billion bid for Toshiba, while a consortium led by Bain Capital has offered to buy Hitachi Metals in a deal that Nikkei reports could be worth $7.3 billion.

The two moves highlight the growing appetite of private equity investors for Japanese deals.

Here are five things to know about Japan's private equity boom.

What is driving private equity investors into Japan?

The rise of megafunds specializing in Asia is the biggest factor. KKR recently raised $15 billion for its fourth Asia fund -- larger than its last North America fund, which raised $13.9 billion in 2017. Overall, dry powder -- capital that has been raised but not yet spent -- of Asia-Pacific focused funds hit $477 billion in 2020, a 71% increase from 2017, according to Bain & Company.

The huge market in China was the driving force behind the rise of megafunds. But with growing political tension between China and the U.S. and Europe, "there is now a risk in shifting Asia funds towards China," said an executive at a major Asian asset manager.

That backdrop, combined with a growing urgency among industrial conglomerates to restructure their business portfolios, is fueling a mergers and acquisitions boom in Japan. The country's ultralow interest rates also enable private equity investors to make bold bets, which are usually partly financed with debt.

Who are the major players?

The players leading the latest string of deals are no strangers to Japan's M&A scene. Luxembourg-based CVC Capital Partners, the company behind the Toshiba deal, is one of the biggest private equity firms in Europe. Its past investments in Japan include restaurant chain Skylark in 2006 and a recent $1.5 billion acquisition of Shiseido's personal care business.

Bain Capital, which is said to be leading the bid for Hitachi Metals, has also been on a shopping spree in Japan. It was part of the consortium that bought Toshiba's chipmaking unit for $18 billion in 2018, and it took nursing home operator Nichii Gakkan private last year.

A less high-profile but important group of investors are institutional investors, including government-linked funds. These players not only invest in private equity funds but are increasingly putting money directly into companies as co-investors, helping boost the size of deals. Nikkei has reported that state-backed funds Japan Investment Corp. and the Development Bank of Japan are expected to participate in CVC's acquisition of Toshiba.

What kind of deals are attracting capital?

Japan is unique for its large portion of buyouts, which typically involve a buyout fund or a company's management taking a controlling stake in the company. Growth deals, by contrast, involve the acquisition of minority stakes. In India and Southeast Asia, growth deals made up more than 80% of the total in 2020, while more than 70% of the deals in Japan were buyouts, according to Bain.

Buyouts typically involve major changes in the target company to increase its profitability, such as installing a professional CEO and shutting down loss-making divisions. Foreign private equity investors are generally considered a good fit for Japanese manufacturing companies because they can help the company find new customers overseas.

Recent deals also tend to involve a conglomerate combining a sale with an acquisition, a sign that they are aggressively restructuring their business portfolios. Hitachi, for example, announced a $9.6 billion acquisition of U.S. software company GlobalLogic. Pharmaceutical company Takeda, which bought Irish drugmaker Shire for $62 billion in 2019, sold its consumer health care business to Blackstone for about $2.3 billion last year.

What does this mean for investors?

Advocates hope the growing acceptance of private equity will help revitalize conglomerates in Japan, which once drove the Japanese economy but have recently become a symbol of how the country has fallen behind in the digital era. Japanese banks and pension funds struggling with low interest rates are also hoping private equity funds can boost their returns -- a successful fund is generally expected to at least double the money it raises from investors.

But whether the funds can deliver a handsome profit also depends on external factors, such as stock market valuations. Kioxia, the Toshiba chip unit, planned to go public last year but canceled the offering at the last minute. More recently, Applied Materials terminated a $3.5 billion deal to buy Japanese peer Kokusai Electric from KKR, saying that it could not obtain approval from Chinese regulators. An executive at a Japanese financial institution said the recent boom in special-purpose acquisition companies indicates that the "stock market is showing signs of overheating."

Is there any pushback?

A revised foreign exchange and trade law that requires foreign investors to notify the government if they buy a stake of 1% or more in strategic companies does not appear to have dented investor appetite.

But some politicians have voiced concern over foreign capital buying into Toshiba, which operates domestic nuclear power plants. Fumio Kishida, Japan's former foreign minister, recently tweeted that unlike the U.S., Japan does not have a framework for preventing inbound investment for national security reasons.

"Freedom of investment remains important. But in the future, it is necessary to consider a framework that can avoid adverse effects on management and sensitive information for core security industries," he added.

Some investors have also raised concerns over the lack of protection for minority shareholders, who may be forced to accept unfavorable terms if approval for the deal reaches a certain threshold. Conflicts tend to arise when a private equity fund and large shareholders, such as family owners of a company who also sit on the board, team up to take the company private. During Bain's takeover bid for health care company Nichii Gakkan last year, Hong Kong hedge fund Lim Advisors criticized Nichii Gakkan's management for failing to protect the interests of minority investors.

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