Private equity is big business in Japan. US funds, such as those controlled by Ripplewood, Lone Star and Goldman Sachs, have achieved remarkable results. But nowadays home-grown funds are also competing for deals, from pre-IPO financings to the de-listing of public companies through management and leveraged buy-outs.
Financing extended by the three leading bank groups for management and leveraged buy-outs reached ¥1.4tr ($12.3bn) in 2005, up 14% on the year and marking a record high, according to the Nikkei newspaper in an article on January 26. That might seem small when set against the vast LBO/MBO markets of the US and Europe, but Japan is a late starter.
According to statistics quoted by the Nikkei from M&A research and brokerage firm Recof Corp, a record 67 management or leveraged buy-outs took place in 2005, up from 43 deals in the previous year.
The participation of the three megabanks — Mizuho, SMFG and MUFG — provided the platform for a range of buy-outs, including the headline deals to take apparel firm World Co and soft drinks maker Pokka Corp private.
Breaking with old ties
Japan's post-war success was until the 1998 financial crisis built largely on the Japanese version of capitalism in which the corporate was effectively an instrument of national welfare. The ability to provide lifetime employment was more important to the board of directors of corporate Japan than return on capital. A corporate spider's web of cross-shareholdings insulated management teams from reproach.
But the 1998 financial crisis marked the beginning of the end of Japan's old corporate model. The years since then have seen a near-complete unwinding of the old cross-shareholding ties, intense corporate restructuring, a sharp consolidation in the bank sector and a big increase — from about 5% in 1998 to approaching 30% today — in foreign ownership in the stock market. The result is a collective focus like never before on shareholder returns and on corporate efficiency.
M&A reshaping Japan
Merger and acquisition activity has made spectacular strides forward in a land now extraordinarily fertile for growth. Moreover, the reshaping of corporate Japan involves increasing volumes of private equity, from pre-IPO financing to MBOs, LBOs and the full gamut of M&A activity.
In the autumn last year, EuroWeek published a special feature on M&A in Japan. Damian Chunilal, head of Pacific Rim investment banking at Merrill Lynch, explained at the time: "Private equity has played a critical role in helping the Japanese economy to accelerate its recovery. It has brought risk capital to not only distressed companies, but also to organisations that need to focus and streamline their businesses better. And, we think that private equity will play an even greater role in Japan going forward."
He also noted that some listed companies are coming under increasing scrutiny by corporate governance funds whose interests may not always be in line with management's mid to long term growth strategies. "For some of these," he noted, "management buy-outs or de-listings are good options, and again private equity is a key facilitator."
Specialist funds emerge
In keeping with the principles of its Ripplewood founders, Shinsei Bank has been fast to react to the opportunities afforded by the world of private equity and buy-outs. The bank began its private equity operations about four years ago, not long after Ripplewood took over the defunct Long Term Credit Bank of Japan from the government.
"LTCB did not have such a business unit, although it did have an incredible depth of relationships across the landscape of corporate Japan," explains Daniel Fujii, general manager of the private equity team within the principal transaction group at Shinsei.
"We early on identified the need to add to our product base and private equity fulfilled a distinct need at a time when so many larger companies were over-leveraged and so many of the smaller and mid-size companies were actually starved of the leverage they needed to help their businesses."
The arrival around that time of wave after wave of new private equity houses in Japan not only helped to restore balance sheet ratios, but also freed up the companies to restore relationships with the lending community.
"We were looking for companies in which to invest that we could help with the broadest range of banking and capital market products," says Fujii. "We aimed to provide expertise in venture capital at the earliest stage in pre-IPO financing, in LBO/MBO funding and in bankruptcy refinancing, which of course at that time was a big business."
Fujii says that the world of Japanese private equity has made rapid strides forward since Shinsei began its initiatives. "One interesting theme we identify nowadays is the transition from the post-World War II founder-owners and their families to new ownership."
In this area, Shinsei aims to provide comprehensive solutions to the problems these now often disparate family members face, such as inheritance planning, succession issues and the appropriate financial and corporate structures for divesting assets and businesses.
"In short," explains Fujii, "we are helping to fill the gap between the founders and their second or third in line. The Pokka deal is in some ways an example of this, the transition from founder entrepreneur to professional management owners."
Pokka's MBO case study
The buy-out of soft drinks company Pokka to which Fujii refers was an MBO and de-listing from the Tokyo Stock Exchange that was concluded last autumn. Citic Japan Partners, a ¥20bn fund Shinsei formed with Citic Capital Markets, Marubeni Corp and Sumitomo Trust & Banking, was a core investor in the buy-out.
Shinsei owns 25% of Citic Japan, the principal objective of which is to invest in and act as a catalyst for additional capital for Japanese companies that have strong expansion potential in China, especially in auto parts, electronics, industrial machinery, chemicals and pharmaceuticals.
Brian Doyle is managing director of Citic Capital's private equity group in Tokyo. "Our mission is to locate and invest in middle market companies that need both capital and additional support and expertise to help them expand in China." Greater China by 2003 already accounted for more than a quarter of Japan's exports, making it the nation's single largest market.
Local private equity and advisory group Advantage Partners was the lead investor in the Pokka buy-out. But Citic Japan's presence was valuable not only for its funding participation but also because China has the fastest growing soft drinks market in the world.
Doyle explains: "Pokka was successful, profitable and growing as a public company, but the management recognised that it needed to make a strategic shift in its emphasis and the exigencies of the public market did not suit what they thought they needed to do to achieve that."
Matching funding to focus
The Pokka management saw that the greatest opportunity to increase the scale of the business rapidly lay in China. But to grow there the company needed to form manufacturing and distribution partnerships and therefore allocate capital and resources to projects that might not produce returns in the short to near term.
Pokka's distribution model was for many years based on vending machines, once the main outlet for beverages in Japan. However, convenience stores have now become a big sales channel and beverage producers are spending vast sums of money on sales promotion to secure shelf space in these stores.
"It was all about a vision for the future, rather than making decisions as a public company constrained by quarterly reporting considerations," Doyle explains.
Pokka went private supported by a high quality group of financiers. SMBC provided the senior debt, parent Sumitomo Mitsui Financial Group having earlier cut its teeth providing more than ¥133bn of senior funding for the country's largest buy-out to that date, the de-listing of apparel firm World Co.
Tokio Marine Capital put up the mezzanine funding for the Pokka deals and the equity came from Advantage Partners, Citic Japan Partners and management.
Two of Pokka's major shareholders, including Otsuka Beverage Co and Nestlé Japan Holding Ltd, supported the buy-out, which took place at a near 24% premium over the average share price for one month before the company announced the buy-out plan.
Aside from its involvement in Citic Japan, Shinsei has also established several sector focused funds, all of roughly $100m-$220m in size. The sectors covered include biotechnology, retail, China focus (through the Citic Japan Fund) and a media/entertainment industry fund.
"Our target market here is companies from very small up to about $1bn in sales," says Fujii. "We are looking for opportunities where we can help the company grow from a financial solutions perspective and also by adding to their sectoral expertise with our specialists who manage each of the funds. It is all about leveraging the resources of the bank and of our partners."
A trademark transaction in which Shinsei was involved was the buy-out and de-listing of Shinwa, the electronics company (see box on page 31). The founder had died and his wife wanted to cash out, while their son was president of the company but with no equity stake.
The mission was to buy-out the company, give the son and the management a meaningful shareholding and to create an employee stock ownership plan through which the employees could share in the company's fortunes. The company later moved its headquarters to Hong Kong to exploit the Chinese market.
Shinsei was one of the core arrangers and financiers of the original buy-out and then sold on its stake in the new company to the later established Citic Japan Fund.
Citic Japan itself has recently been trying to close a new transaction, a roughly ¥12bn buy-out deal that Doyle described as a "signature transaction". "This was sourced through the Shinsei network, without which we would find it tough to locate this sort of opportunity," he says. "It is the spin-off of an affiliate from a larger group and ideally fits our criteria."
From de-listing to pre-IPO
Shinsei's initiatives in the private equity arena also focus on companies that are heading towards, rather than exiting, listing status. The bank, for example, made a successful investment in FinTech Global Inc, valued at about $0.4m, before its listing debut on the Mothers section of the Tokyo Stock Exchange last June.
The financing was small, but important for Shinsei and positive for FinTech — a structured finance boutique — which has since gone from strength to strength as a public company.
"Shinsei is a late stage pre-IPO investor, not a venture capital player," says Manabu Nakamura, deputy general manager of the pre-IPO investment team within the bank's private equity and principal transaction group. "Our objective is of course a positive financial return, but we see the equity relationship also as a major building block for the creation or cementing of banking and capital markets relationships with the company. In FinTech Global's case, the company was pleased to count Shinsei as a shareholder and partner in the company's future."
That is borne out by FinTech's executive director Takeshi Sugimoto, who told EuroWeek in April that it was important to count Shinsei as a shareholder before listing "not only for arranging securitisation but also for expanding principal investment — the pre-IPO funding was effective to reinforce the relationship with one of the major financial institutions."
Subsequent to the IPO and after the lock-up period ended in December 2005, Shinsei sold the shares and registered a gain of over 40 times the original investment. By April 28, the company boasted a market capitalisation equivalent to $1.44bn, having listed with a valuation of roughly $390m.
FinTech's rapid growth
FinTech's share price in late 2005 and early 2006 was buoyant and the stock was trading in high volumes, allowing Shinsei to comfortably trade out of its investment through the market.
Shinsei was comfortable in analysing FinTech's prospects. FinTech is a Tokyo-based company that arranges the securitisation of real estate and other monetary claims. It listed on the Mothers section of the Tokyo Stock Exchange on June 8 following an IPO managed by Nikko Citigroup.
At the time of the IPO, the company's core business was the design of liquidation schemes for assets, and also the securitisation of high-risk claims and the selling of them after obtaining guarantees from insurance companies. FinTech also arranges securitisation schemes that use as collateral the future value of real estate under development.
Although the securitisation market has seen intensified competition from securities firms and banks, FinTech continues to grow under the banner of operating as a boutique investment bank specialising in securitisation.
FinTech used the nearly ¥2bn in proceeds from the IPO to expand its investment and loan business and set up a brokerage subsidiary.
Company founder and president Nobumitsu Tamai said last September that FinTech should produce growth in pre-tax profits of more than 180% to ¥4.4bn for the year to September 30 2006, due to a surge in securitisation activity and an increase in the property development business to 50 individual projects.
Pre-IPO market competition stiffens
Aside from FinTech, Shinsei is busy hunting for other pre-IPO investments, although the market is crowded. The bank's target companies are high growth enterprises seeking a listing within two years from the investment. The bank invests directly, not through any affiliated venture capital entity.
The improvement of the banking relationship is vital for so many small to medium sized companies with which Shinsei deals. "The consolidation of the Japanese bank sector has meant that the number of City banks has fallen from more than 15 to just three megabanks," says Nakamura.
This means that many companies are seeking to diversify their bank relationships away from these giant lenders. "Very obviously," he observes, "Shinsei has built a reputation in the past five years as a creator and provider of sophisticated and imaginative financial solutions for this type of enterprise."
The prospects for the pre-IPO market are good, but competition for deals has intensified. The Nikkei newspaper estimated in early January that about 200 companies would list in 2006, nearly at the level of the record of 203 during the telecom/media/technology bubble in 2000. The paper said that the main engine behind the strong IPO activity is the emergence of a third generation of entrepreneurs in the IT/internet market.
"With many new sources of funds looking for opportunities, the market is concerned that this money and other funds hunting for deals will push prices up. "This will inevitably happen anyway, as the IPO and equity new issue markets in general are much healthier than in recent years and the market indices are much higher," says Nakamura.
When, for example, listed private equity and venture capital company Jafco in January raised ¥98.5bn for a new venture capital fund to invest in unlisted start-up firms aiming to go public, the presence of some 20 or so Japanese pension fund investors in the new vehicle said much about the country's burgeoning venture capital industry. When Jafco established its first fund in 2004, only one pension fund stepped up to the plate.
Shinsei takes about 10% of the deals it looks at, and Nakamura admits the bank has turned down some investments in companies that have subsequently made successful listed companies. "For us it is not just about the investment, but about the total relationship we can build with the company, not just through Shinsei but also through our affiliates such as Showa Leasing and Aplus."
|Shinwa heads to Hong Kong|
EuroWeek discussed the Shinwa buy-out and post de-listing strategy with Yoshifumi Naito, president and chief executive officer of Shinwa International Holdings Ltd, the new name of the company since moving its headquarters to Hong Kong in April 2004.
EuroWeek: What were the main reasons behind your decision to take Shinwa private through a management buy-out and de-listing?
Naito: The difficulties we face in our operating environment are severe. We are seeing an increase in the competitive strength of Chinese companies, which have an immense cost advantage and are rapidly improving their production technologies. At the same time, Japanese companies are no longer able to set their prices higher than others. Japan's tax system, costly social infrastructure, high wages and other structural items are holding back Japanese companies.
EuroWeek: Can you describe life as a private company compared to life as a public entity?
Naito: It requires enormous time and expense to comply with the listing rules and the obligations of a public company, as the interests of public shareholders always need to be considered. There are more restrictions on the actions of management compared to a private entity.
EuroWeek: Has the buy-out been successful?
Naito: The buyout has been successful. The private equity division of Shinsei Bank took a major stake in Shinwa and other prominent investors have joined as well, including Citic. We have implemented a number of initiatives at Shinwa since the buy-out, for example, we have relocated our global headquarters from Tokyo to Hong Kong in order to create better global efficiencies and drive strategic growth, particularly in China. We have consolidated offices in Japan to bolster our ability to continue the development of sophisticated and unique mechanical designs and to raise efficiency. Most dramatically, we are changing the management style. Whereas before, 14 of our entities across the globe have operated independently, we now have a strategic business unit strategy to drive our strategic focus on customers and to improve profitability.
EuroWeek: What are your plans for the future?
Naito: It is one of our short-term milestones to achieve a listing in Hong Kong. We see Hong Kong as a much more lucrative market compared to Japan. It offers great flexibility to raise additional capital for business expansion and attracts international partners and/or strategic investors.