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INCJ finds venture-capital business difficult

Japan's state-backed fund struggles with poor investment performance

INCJ 's headquarters in Tokyo

TOKYO Innovation Network Corp. of Japan has incurred losses in more than 80% of the cases where it has cashed out on investments, underscoring the difficulty that the public-private partnership is having with one of its core tasks: nurturing new businesses.

The setbacks for INCJ are happening as the fund finds itself in the spotlight for its role in the effort to buy Toshiba's flash memory unit, something the government is keen on as it tries to keep the chipmaker's technology in domestic hands.

INCJ is a partnership set up by the Japanese government and big companies, aiming to "create new businesses to play a key role in [producing] next-generation national wealth." In pursuit of that goal, INCJ offers risk financing that the private sector is reluctant to provide.

TOUGH TIMES One of its early bets was on All Nippon Entertainment Works, or ANEW, which was funded by INCJ in the autumn of 2011 to turn Japanese manga and video games into Hollywood films. The company was later sold to Future Venture Capital, an independent venture capital company based in Kyoto.

INCJ spent 2.2 billion yen ($19.87 million) on ANEW, which has yet to make a single movie. In the end, INCJ unloaded the company to FVC for just 34 million yen, resulting in a near total loss.

ANEW's management was in disarray from the start. The Japanese executives recruited to run the business were repeatedly replaced. Although ANEW hired a highly paid top executive from the U.S., "operating costs soared in the absence of collaboration between the Japanese and U.S. sides," said Shinya Tominaga, an executive officer at FVC.

ANEW's annual losses were running from 300 million yen to 400 million yen. The red ink swelled as INCJ twice pumped additional cash into ANEW despite the lack of movies on the horizon.

LONG ODDS As of the end of July, INCJ had made 118 investments totaling nearly 1 trillion yen. As of the end of fiscal 2016, INCJ logged a return of more than 100 billion yen. Most of that came from "restructuring investments," such as money raised from the listing of a liquid crystal panel maker created from a merger of the LCD businesses of three companies.

INCJ does not provide data on the financial performance of individual investments. Thus, information on its investments in 92 venture businesses is unavailable. But a Nikkei survey found INCJ broke even in four instances, or 17% of the 23 cases where it unloaded all shareholdings. The survey also revealed that losses grew in around 10 cases after additional cash was pumped in.

INCJ sold part of its equity stake in Peach Aviation, a discount airline, for a 12 billion yen profit, but that gain was not enough to offset losses elsewhere. "We were inexperienced when we were founded and regret that losses increased on investments at that time," said Toshiyuki Shiga, who took over as chairman and CEO of INCJ two years ago, in an interview with The Nikkei. INCJ was short on staff members well-versed in investment in venture businesses, he said.

One out of three to four businesses invested in by major venture-capital companies in Japan eventually lists on the stock market. While a success rate of 17% appears low, INCJ takes greater risks than private venture capitalists do to support new businesses.

Japanese companies and financial institutions tend to avoid risk despite extremely low interest rates on safer investments.

Investment in venture businesses in Japan totaled 130 billion yen in fiscal 2015, a fraction of the roughly 7 trillion yen of such investment in the U.S. The presence of public money can help encourage private investment to flow, but this assumes the companies chosen to receive the cash are well-run.

"Their actions often differed from what they said they were going to do," said Soichiro Imoto, president of Sphelar Power, of the Kyoto-based solar cell maker's four-year alliance with INCJ. Imoto accused an outside director from INCJ of pretending that he had not given his informal consent to an investment. "We even received an email implicitly calling for the meeting minutes to be doctored."

The outside director from INCJ, who is no longer with Sphelar Power, said that the case in question had presupposed the meeting of many of the fund's investment conditions. Whatever the truth of the matter, trust between Sphelar and INCJ completely collapsed and the company eventually bought back its shares for roughly a tenth as much as the fund paid for them.

Another startup was asked by INCJ to "set ambitious targets, as public funds will be used."

"Considerable returns can be expected on investments made after 2013," Shiga said. That bullish view follows the creation of a special team of venture capital experts within INCJ. The fund invested in a total of 22 startups between fiscal 2009 and 2012, but the number reached 24 in fiscal 2013 alone.

In contrast with private venture capitalists, which make nothing if the companies they invest in fail to perform, INCJ is funded by taxpayers, meaning it "tends to indulge in increasing the number of investments," said one former senior official.

LET THE SUNSHINE IN "Because it has been entrusted with public funds, [INCJ] should openly disclose the profit and loss of each investment," said Atsushi Saito, who headed the now defunct Industrial Revitalization Corp. of Japan and is now chairman of private equity specialist KKR Japan.

"Accountability and transparency are needed" to make investment discipline work, Saito said.

INCJ has disclosed information in every case where it has cashed out. But Shiga opposes applying this policy across the board, arguing that compulsory disclosure will cause risk financing to dry up because only the failures will draw attention.

One such failure was the Japan Key Technology Center, set up in 1985. The center poured a total of 290 billion yen into more than 100 companies to support basic research, but 95% of the money was lost.

INCJ and 13 other public-private funds in Japan receive money from taxpayers through the fiscal investment and loan program. To improve the effectiveness of that capital, the funds need to become more transparent. Shunning outside scrutiny is likely to result in throwing more good money after bad.

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