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Japanese corporate deals -- work on the sell side

After warming to foreign acquisitions, could groups now be more positive about disposals?

| Japan
     © Reuters

Even though there are still two months to go, 2018 looks set to become a record year for Japanese companies targeting overseas acquisitions, with over $150 billion of deals already announced.

Few dispute the overarching logic driving deal activity. Faced with a rapidly aging and shrinking population, and a mature home market where product differentiation is challenging, many Japanese companies judge that they have scant choice but to look beyond the country's shores for new growth.

But as M&A volumes rise, buoyed by increasingly ambitious deals, so have the voices that question the wisdom of Japanese corporates' overseas ventures. If the critics are worried about a revival of the bubble era buying spree that cost Japan Inc.'s shareholders so dearly, these concerns might be understandable. But more often than not, they veil deeper misgivings: They seem to be insinuating that Japanese companies are somehow uniquely ill-suited to the role of overseas acquirer. However, this view is flawed and misses the point.

Japanese companies have only really embraced M&A as a strategic option over the last five to 10 years. An earlier generation of corporate leaders tended to view such transactions as something akin to weddings or funerals -- special events that might happen once, or maybe twice in the lifetime of their company.

From around the mid-2000s, however, the structural challenges facing Japan became more acute. The speed at which China has risen to become a formidable regional and global rival has shocked Japan Inc., even as the growth of a wealthy middle class in populous Southeast Asia has presented a new and lucrative market on its doorstep. More recently, the rise of fintech and advances in technologies such as artificial intelligence and autonomous driving have spawned a new breed of competitors that look set to cause widespread disruption. The fact that Japan is playing catch-up in these technologies is a further source of concern.

Spurred on by these challenges and opportunities, and supported by a benign funding environment, a number of Japan's blue-chips have evolved to become highly strategic deal-makers. The biggest companies have recruited sizable in-house M&A teams and enlist support from multiple financial advisers to execute increasingly sophisticated transactions.

Die-hard skeptics may point to an oft-cited tendency for Japanese acquirers to "overpay" in cross-border transactions. However, "overpaying" is a subjective term and not necessarily indicative of naivety. Companies are not commodities; each is unique. If there is a sound rationale behind a purchase -- if, for example, the target in question is the missing piece in a strategic jigsaw puzzle -- the value unlocked over the long-term may well outweigh the initial expense.

In addition, Japanese acquirers tend to look at return on investment over a longer horizon, making them more comfortable with a valuation that might seem high by U.S. or European standards. Aggressive offers are often a reflection of management's conviction -- admittedly sometimes misplaced -- that a purchase is the right fit for the long term.

In fact, if anything, it is this long-termism that at times proves to be an Achilles' heel. For no matter how thorough the due diligence or detailed the business plan, there will always be deals that do not pan out as anticipated.

Having become more confident acquirers, Japanese corporations would now do well to focus on becoming more strategic sellers.

Too often, a reluctance to confront the reality that an acquisition is not living up to expectations has unnecessarily damaged corporate value. Clinging to a problem asset in the hopes of a breakthrough has pushed some companies to the brink of bankruptcy. Instead of selling up and reinvesting the funds recouped, they have been forced to sell the proverbial family jewels simply to survive.

Encouragingly, there are signs of change. As Japan's shrinking population forces a reassessment of old practices such as lifetime employment, the mental barriers against selling assets -- whether foreign or domestic -- are falling. In the electronics sector we have witnessed major players such as Hitachi, Panasonic and Sony reinvent themselves. By selling businesses facing margin pressures from lower-priced overseas competitors, embarking on acquisitions and divestitures, these companies have transitioned into higher-margin businesses with greater growth potential.

Some notable successes -- for both seller and sold -- have highlighted the potential rewards to be reaped from noncore asset divestitures. PHC Holdings Corp. -- formerly Panasonic Healthcare and part of the Panasonic group -- is a good case in point. PHC Holdings has continued to grow since it was carved out in a $1.6 billion transaction, with the support of new owners (KKR and Mitsui & Co.) fully focused on its success. Meanwhile, the core remaining Panasonic group used the funds raised from the spinoff to sharpen its focus on B2B businesses, earning plaudits from investors in the process.

In the first half of this year, 109 companies announced plans to exit or scale back from established businesses -- a pace that suggests that 2018 may exceed a record set in 1999. Gradual but growing acceptance of the role private equity can play in corporate realignments in Japan is likely to add more impetus to this trend.

However, while these are positive developments, they largely reflect the streamlining of domestic operations.

It will always be difficult to judge whether a deal is fundamentally flawed, or just needs more time to blossom. But clinging on to ill-fated purchases may lead to greater troubles down the line.

Let us hope that in the years to come, Japanese companies will be as bold in their overseas divestitures as they have become in the acquisitions.

Yoshihiko Yano is head of Mergers and Acquisitions in Japan at Goldman Sachs. He previously worked as an attorney-at-law in Japanese and U.S. law firms.

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