Financial sponsors in Japan require patience

"We identified a big æpaperÆ opportunity in Japan in 2004, the only Asian market which met our criteria for size of deals and provides traditional leveraged buyout type opportunities.ö This is how Guido Paolo, chairman of Permira in Asia, explains the private equity firmÆs decision to establish its first Asia office in Tokyo in early 2005. He talks about paper because, at the time, the opportunity was theoretical and Permira had yet to prove it could be translated into reality.

Permira announced its first investment in the country, which is also JapanÆs largest buyout to date, in October 2007.

But PermiraÆs Paolo suggests the two-and-a-half years it has taken to close its first deal is typical of the market. Indeed, his mantra for success in Japan is: ôBe creative and patient. Japan does not have a well-defined deal flow and taking an idea from conception to maturity can take two years û or more.ö

And for Permira, EuropeÆs largest buyout fund, patience has paid off. On October 23, it announced it will pay Ñ250 billion ($2.2 billion) to acquire Japanese agro-chemicals firm, Arysta LifeSciences.

The deal also represents a blockbuster exit for Arysta owner, Olympus Capital Holdings. Olympus acquired the first tranche of its Arysta stake in 2002 and, over time, increased this to full equity ownership.

David Shen from Olympus echoes the views of PermiraÆs on thinking out of the box commenting: ôcreativity in how we approach investment targets contributes significantly to our investment track record in Japanö.

Permira emerged winner in what specialists term a ôhard-fought auctionö. The seller was represented by Lehman Brothers and Goldman Sachs. Both strategic buyers and other financial sponsors were in the final round. The outcome was surprising to some sources as strategic buyers typically have a longer forecast horizon on targets than financial sponsors, which can enable them to out-bid the competition.

But Permira had a few aces up its own sleeve. As part of its focus on opportunities in the chemicals sector, Permira had already identified the asset, which proved to be an advantage for the private equity firm.

When describing reasons for PermiraÆs success in winning Arysta Paolo cites deliverability, timing and the ôability to raise competitive financing û when leverage is available private equity can be more competitive then trade buyersö.

Japanese banks, awash with liquidity, have certainly been stepping up to the plate to provide the leverage. For the Arysta acquisition, Permira will contribute Ñ100 billion of equity from its funds and the acquisition vehicle will raise Ñ150 billion of debt, from a combination of local and global banks.

ôThe willingness and ability of Japanese banks to lend balance sheet to support the (Arysta) deal has been a factor enabling us to bid aggressively,ö agrees PermiraÆs Paolo.

The deal follows on the heels of the acquisition of accounting software firm, Yayoi for Ñ71 billion by Seoul-based private equity firm MBK Partners. Merrill Lynch advised MBK on the deal.

Sources say MBK will raise about 60% of the outlay through debt from Japanese banks. UBS advised Livedoor on the sale and also helped MBK Partners arrange leverage for the deal. ôNo small feat at the height of the subprime crisis,ö says a specialist.

Private equity is knocking on some doors at a propitious time. For restructuring situations or where the company is loss-making private equity is often the best û or even only û option. This was the case in August when private equity investors Longreach Group and Phoenix Capital put together a Ñ20 billion package to bail out NIWS Co. The target, which offers customised software, hardware and consulting services, had accumulated losses of Ñ30 billion at the time the deal was announced. Not surprisingly, the entire investment from the financial sponsors went into NIWS to recapitalise the firm.

ôPrivate equity investment in Japan has shifted from returns being made predominantly on the æbuyÆ to requiring a clear programme for adding value,ö explains the CEO of Colony CapitalÆs Asia operations, Grant Kelley. ôInvestors are doing larger, more complex deals where they need to effect a turnaround or value-added strategy.ö

Colony CapitalÆs $737 million investment in Fukuoka Hawks Town in 2004 is one such deal. Colony Capital repositioned and restructured the assets and brought in new investors; for example it sold the baseball team to SoftBank. Specialists estimate Colony achieved an internal rate of return of more than 75% on the investment, which it exited in March 2007.

The take of Kelley from Colony Capital on Japan: ôThe ingredients for success are the same as anywhere û have a clear investment thesis and execute against it, with one major difference, which is that relationship management and generating a win-win at each stage of the investment is crucial.ö

Resistance to private equity in Japan was also driven by the reluctance of management to induct investors who will demand accountability. It is widely acknowledged that management of companies oftentimes represents the interests of stakeholders such as suppliers, customers and employees better then it does those of shareholders. Historically, this was possible due to tangled webs of cross-holdings that made takeovers nearly impossible. Further, local institutional shareholders, who were frequently the largest external shareholders, were known to not demand the rights that came with their investments.

ôCorporate governance and low levels of attention paid to shareholder value are probably the weakest links of the current Japan Inc situation,ö observes PermiraÆs Paolo.

But specialists agree that this is changing. The unwinding of cross-holdings has benefited both institutional and retail investors. For their part, local institutional shareholders are becoming more vocal as they seek to maximise returns from their investments. And private equity firms are becoming more sensitive to the need to think and act local rather than charge in assuming they are white knights.

ôFirms have sometimes paid insufficient attention to ælocalisingÆ their operation,ö agrees Colony CapitalÆs Kelley of one reason Japan has hitherto proven a difficult market for some sponsors. ôLocal presence and credibility is critical to every aspect of the deal chain û sourcing, closing, asset managing and exiting.ö

Some of the reasons corporate Japan is becoming more open to private equity have nothing to do with the investors. Concerns are rising that raising equity in public markets could lead to hostile takeover situations. There are also apprehensions that activist shareholders could hold management to ransom. Indeed, 2006 and 2007 have heralded an increase in these situations.

Management is now re-assessing the funding sources available to them to finance their capital requirements. Debt is still the obvious first choice but is not suitable for all types of situations and companies.

Despite all the reasons why private equity is becoming a more acceptable funding source specialists donÆt expect a flood of deals. What is generally agreed is that the product is on a growth trajectory in the country and that is set to continue.

ôJapan accounts for a very small percentage of global private equity deals currently as is still a challenge for financial sponsors to source and close deals in the country,ö agrees Shunichiro Tsunokawa from Morgan StanleyÆs M&A division. ôBut there is a strong likelihood that the market will see an increased pace of private equity investing.ö


This is an abridged version of a story which first appeared in the Japan supplement that was published with FinanceAsia's November issue.