Japan's brave new world of M&A

  • 02 Dec 2005
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In the brave new world of corporate Japan, M&A is a dynamic growth business. The banks might have forged the biggest deals but upstart Livedoor earned the biggest headlines for its audacious hostile bid for Fuji TV. Between the sublime and the previously considered ridiculous, there is a reshaping of middle market Japan, as domestic mergers abound, as Japan's finest buy offshore and as MBOs and LBOs gain momentum. EuroWeek has chosen the subject of M&A for its 2005 investment bank roundtable. A panel of experts from the leading investment banks give their views on the major developments and their implications.

Corporate Japan was earlier this year shaken by the audacious hostile bid launched by upstart Livedoor for establishment favourite Fuji TV. Although not successful, the deal has sparked a vigorous debate on the regulatory and cultural implications of hostile bids in Japan.

Japan's post-war success was built largely on the Japanese version of capitalism in which the corporate was seen as an instrument of national welfare. Cross-shareholdings and lifetime employment were seen as more important to the nation than competitiveness and shareholder returns.

But the past seven to eight years has seen an unwinding of the old cross-shareholding ties and a sharp increase — from about 55% in 1998 to nearly 26% today — in foreign ownership in the stock market.

When internet company Livedoor launched its bid for Fuji TV, the deal was funded by Livedoor issuing to Lehman Brothers a sizeable, private multi-strike convertible bond. That caused a reflex assumption from some quarters that corporate Japan was now in the firing line of the foreign raiders.

The audacious Mr Horie

Livedoor's chief executive officer Takafumi Horie, a casually dressed 32 year old, is as Japanese as any middle aged board director in the country. He had struck at the local heart of the enormously conservative Japanese media industry, and establishment Japan was visibly shaken.

Livedoor announced on February 8 that it had acquired a 35% stake in Nippon Broadcasting Systems, a radio broadcaster. The goal was evidently television company Fuji TV, in which NBS held 22.5%. Causing revulsion among some parties, he had built up his stake secretly in after-hours trading, both exploiting and exposing a loophole in Japan's patently deficient regulatory system and aiming his weaponry at the cosy, old cross-shareholding ties that have weakened but not entirely died.

While some in Japan's corporate establishment were aghast, Horie enjoyed popular support. Japan's people are ready, willing and able to embrace change, a trend reinforced so publicly by the re-election of Prime Minister Koizumi earlier this year in what was effectively a national referendum on financial and corporate reform.

After an intense and public takeover drama that lasted several months, both parties eventually gave in. Livedoor sold its slightly more than 50% stake in NBS to Fuji TV, which then acquired a 13% stake in Livedoor and entered an ostensibly friendly business alliance.

Shutting the stable door?

Possibly as a direct result of the hostile bid, the introduction of cross-border share swaps (the Commercial Code amendment) have been delayed a year until at least April 2007. That means foreign companies remain uncertain as to when they will be able to issue their stock in exchange for shares in their Japanese takeover or merger targets.

This was seen as a regrettable move by many forward-looking observers — after all share swaps are mostly for friendly deals and the Livedoor bid, while largely funded by Lehman, was in fact one local company preying on another.

Aside from the share swap deferral, Japan's Ministry of the Economy, Trade and Industry (Meti) introduced measures to allow corporate Japan to install more Anglo-Saxon style takeover defences, such as poison pills, or chewable pills that can be swallowed if a takeover is later deemed acceptable.

The changes were explained by Meti as necessary measures implemented after long consideration and designed to reflect the underlying structural change in cross-shareholdings, the rise of foreign money in the stock market and the increasing demands for more open and accountable management by leading institutions.

However, while the Meti proposals called for third party checks by independent directors or auditors and for shareholder approval of defensive measures, the timing and substance of the Meti proposals meant many interpreted them as regressive and reactionary.

A national debate

The changes would, the argument went, further open the door for anti-takeover measures by management teams interested more in entrenching themselves than in corporate performance, shareholders' rights and shareholders' returns.

Some anxious companies since the Livedoor bid are issuing shares to friendly investors, sparking fears that a new variety of cosy cross-shareholdings might proliferate.

The Livedoor bid has spawned a fascinating debate as to what type of corporate world there will be in a restructured Japan. Can both hostile and friendly M&A really create shareholder value and at the same time improve national wealth? Are hostile bidders such as Horie upstarts out for a quick profit to the possible detriment of the country at large, or visionary harbingers of a better future?

Megabanks and megachanges

Whatever the implications of the Livedoor bid, the attempt was made possible by the wholesale corporate restructuring of the past five years as well as the changes at the banks.

The merger of MTFG with UFJ comes after those five years of tough restructuring during which cross-shareholdings and non-performing loans have been slashed. At year end at the end of March the leading banks reported that non-performing loans (NPLs) had been cut down to less than 5% from more than 10% only three years ago.

Optimists interpret the MTFG/UFJ deal as heralding an era of renewed vitality at the banks. With only three megabanks left — there were nearly five times that number of bank groups in the late 1980s — the worries over systemic stability are nearly over. The focus is now on the banks becoming leaders in what is virtually the whole range of wholesale and retail financial services, from asset management and trust banking, to consumer finance and structured finance.

MUFG, for example, the newly formed entity out of MTFG and UFJ, will be a vast financial conglomerate, with a substantial stake also in Acom, a leading consumer finance company.

As the banks have become ever more focused on returns and on efficiency, as cross-shareholding ties have weakened or disappeared, mid-market corporate Japan is now increasingly turning its attention to mergers, at home at first but overseas as well.

The Koizumi administration is also keen to increase the flow of foreign money directly into corporate life in Japan. Foreign direct investment (FDI) is a paltry 2% of GDP whereas in the US it stands at 22% and in the UK at 37%.

Catalysts for change

It is of course not money that is needed — Japan has a vast amount of capital surplus — but by reference to those two Anglo-Saxon economies there are plenty of experts who argue that foreign direct investment (FDI) will greatly enhance competition and innovation in the domestic corporate scene.

The reshaping of corporate Japan will also involve ever more private equity, MBOs, LBOs and the full gamut of M&A activity. The megabanks are increasingly willing to finance such deals, whether through bank loans, bridge loans or through the multi-strike convertible bonds that Nomura has pioneered since 2003 and which almost every investment bank is now offering clients. Where the banks won't yet go, other lenders or mezzanine financiers are massing their ranks.

The big banks and the leading local investment banks also want to win a big share of the rich fee income from the fast-growing  M&A market. Daiwa SMBC, Mizuho Securities, Mitsubishi Securities and Nomura are hoping to challenge the skills and success of the leading global investment banks such as Lehman Brothers, Goldman Sachs, Merrill Lynch, Morgan Stanley and UBS.

Whatever its manifestation, the brave new world of Japanese M&A is exciting, challenging and for most parties involved, highly rewarding.

Was the Livedoor bid to take over Nippon Broadcasting System/Fuji TV — financed as it was by Lehman Brothers — a one-off or a sign of things to come?

Damian Chunilal, Merrill Lynch: We see this deal as a sign that larger mergers and acquisitions are to come in Japan. In particular, the Livedoor bid demonstrated the fact that companies now have a variety of financing channels available to them to allow them to raise substantial amounts of money in one go. We are now in an environment where, given the right conditions, some smaller companies may be able to acquire larger organisations. This is a sea change in Japan that brings with it enormous ramifications — and opportunity.

Keiji Miyakawa, Deutsche Bank: Livedoor's move on Fuji TV is a signal that there are hostile transactions to come but a hostile approach will be only one of the types of transactions we will see. We are already seeing companies preparing for potentially hostile transactions. Though it failed, Yumeshin Holdings's attempt to acquire Japan Engineering Consultants was considered one of these.

A major misconception in Japan is that hostile bids are always made by foreigners. The reality is that the only hostile bids are normally by Japanese firms. Foreign firms are either inhibited by the due diligence involved, by the risk to their reputations, or they are simply interested in buying some shares low and selling high.

Yumeshin Holdings and Livedoor are two examples of the potential aggression of Japanese firms. But, in general, hostile bids do not happen in Japan without a friendly approach first. Only if that does not succeed do potential acquirors move to talk to shareholders directly and go hostile if they have to. I believe Livedoor's action earlier this year has opened the possibilities of the hostile approach in the minds of many of Japan's corporate executives.

Akira Kondo, Mitsubishi UFJ Securities: The techniques used in this instance — from the use of out-of-market trades to get around the provisions of the regulations, to the financing via high interest bridge loans and through a moving strike CB — generated legal, financial, and reputation risks. This was possible in the case of Livedoor itself, with its risk-embracing management team, from CEO Takafumi Horie on down.

However, I do not foresee major corporations flocking to take on transactions with this same level of risk anytime soon.

That said, there has been increased recognition that when a company's market value is allowed to drop lower than its intrinsic value, the management has effectively disqualified itself.

Moreover, players in the Japanese market are beginning to show strong interest in the capitalist principle of maximisation of shareholder value. In the future, we may be seeing more hostile acquisitions as well as acquisitions with unconventional capital links between the parent company and the subsidiary.

Taiji Okusu, CSFB: We believe that it was a sign of things to come, although it ended as a green-mailer transaction after all. It awoke the management minds in Japanese companies which took for granted that hostile takeovers were very remote phenomena in Japan.

Japanese management used to think that the other stakeholders are as equally important as the shareholder, but the Livedoor situation forced them to re-evaluate that view.

That takeover bid also created pressure from the corporate powers that be that led to the postponement of the Commercial Code amendment which would have allowed a foreign company to acquire a Japanese company by using its own shares for a share-for-share exchange. It also prompted many Japanese listed companies to introduce or be prepared to introduce a poison pill. All these provide clear evidence of just how much Japanese management teams fear a hostile bid.

Livedoor in the end sold the stake it had built up to Fuji TV, which seems to me that Livedoor was not seriously looking for control of Nippon Broadcasting. That, combined with the extreme financing put in place for Livedoor, seems to have created a tarnished image for any aggressive move, whether by a foreign or domestic company, as negative and demoralising.

Takamitsu Araki, Shinsei Bank: The transaction has mostly symbolic value — it clearly demonstrates that we are entering a more dynamic M&A environment with more options to secure control. As a practical matter, hostile acquisitions are rare, and successful ones are rarer still, no matter where you are in the world.

I would not expect the Livedoor deal to set off a wave of similar deals. If Livedoor had presented a convincing business plan, the result may have been different. The method of financing, however, can and has been replicated and put to use as a means of corporate finance in Japan.

In light of the increased number of hostile bids for public companies is the Japanese regulatory environment sufficiently comprehensive and tight?

Miyakawa, Deutsche: The question presumably arises from Livedoor's acquisition of 34% of Fuji TV before launching a formal tender offer but this was understood to be permitted under current legislation and regulations, and both Meti and the Tokyo Stock Exchange have said as much.

Nevertheless, there were other ways open that might also have been effective. Currently, Japan permits takeover bids up to only a certain percentage of a target company's shares, an option not available in the US or the UK, either for legal or practical reasons. If such a bid is successful, then the acquiror only needs a 51% holding of the target firm to control it.

However, such a situation leaves ambiguities for the remaining shareholders who have no choice but to stay as they can tender only a pro rata portion of their shares.

If there is any situation that requires the attention of regulators and legislators then surely it must be this, for the protection of minority shareholders.

The poison pill is another area that needs clarification. While in the US and UK one could expect considerable litigation against moves to install poison pill defences which would ultimately provide clarity on their structure and application, in Japan there is almost no such litigation to provide clarity. This again threatens the position of shareholders. A US-style approach to instituting a special committee at the board level to oversee the best interests of shareholders could be one way forward.

Okusu, CSFB: They were not well prepared for the various tactics seen in hostile bid situations, for example the loophole of using TOST-Net trading (off exchange) to acquire over 33.3% of a certain company.

The Livedoor transaction also created another loophole which should be remedied, namely the sale of a special purpose company (SPC) which held more than 33.3% of Nippon Broadcasting shares and which was not subject to current regulation as that SPC is not a listed entity. It is, in my opinion, clearly against the regulations, but the authorities (the FSA) did not interfere with such a sale and therefore this tactic could be used in other takeover attempts.

Kondo, Mitsubishi UFJ: As a result of the Livedoor bid, takeover regulations have been made more stringent, but regulatory oversight in Japan is still inadequate and there are still many ambiguities and grey areas which need to be re-evaluated.

In the area of hostile acquisitions, only generally applicable rules are in force, meaning that in many cases the specifics of the transaction require that the case be left to the discretion of the judicial authorities. Yet there have been few similar cases to date and legal precedents are also slim.  Furthermore, there are instances in which the ruling of the judicial authorities takes a substantial amount of time. In that regard, quite considerable grey areas remain, and there is a lot of room for future legislation in this area.

Chunilal, Merrill: Hostile bids have only just begun in Japan and it will take some time to determine whether or not this is the beginning of a long term trend. Having said that, hostile bids did indeed expose grey areas in the initial regulations, and there have already been moves toward greater clarity and transparency.

For example, purchases of a third or more of a company's stock, even if conducted outside trading hours as in the case of Livedoor's purchase of Nippon Broadcasting shares, now have to be governed by rules that ensure full and fair notification to all holders.

Other changes that have occurred recently include several court decisions and Meti opinions that keep companies from defending themselves excessively against hostile takeovers. All in all, we expect these trends toward clarity and transparency to continue.

Are the boards of directors of Japanese corporations generally reacting positively or negatively to the arrival of the hostile bid in Japan?

Okusu, CSFB: No, they are not reacting positively. Because in most cases, the board of directors are appointed by the CEO, therefore they are not independent when they make a decision regarding the hostile bid. As demonstrated in the Livedoor case, even the independent directors supported the CEO's decisions despite the fact they might have been damaging to shareholders other than Fuji TV.

Miyakawa, Deutsche: The boards of most Japanese firms are almost always negative towards any unsolicited proposals, mostly as a result of being staffed by officers who have built their careers in the same firm. This concern is reflected in the results of the IMD Business School's world competitiveness survey which placed Japan close to the bottom in terms of corporate governance. Without an independent board, there is little room for independent thought.

Kondo, Mitsubishi UFJ: In Japan, there seems limited awareness of the fact that directors are chosen by shareholders, or that the greatest responsibility of directors is to maximise shareholder profits. Generally speaking, it is commonplace for the directors of Japanese companies to take a negative view of hostile acquirors, seeing them as adversaries that threaten their position.

Chunilal, Merrill: We are aware that some Japanese boards view the arrival of hostile bids as positive because they can help to realise the hidden value of companies in the form of share price appreciation. But I think it is fair to say this view is not yet widespread — there is still a great deal of apprehension among boards about the tactic and the perspectives or rights of minority shareholders.

Stefan Green, Goldman Sachs: Boards are very concerned about the possibility of hostile takeover attempts but it is important to note that there has not recently been a significant successful hostile takeover in Japan. Boards are clearly strengthening their structural defences in order to be better able to deal with potential raiders. For example, companies are limiting the number of directors on boards and implementing various types of shareholder rights plans.

The impact of these developments on shareholder value will depend on how the structural defences are used. In this regard, the recent shareholder activism from both foreign and domestic parties is important. While many people may only point to foreign activists, domestic investors are clearly increasing their focus on good governance and are more willing to be vocal in expressing their views.

Is the growing number of domestic mergers aimed at creating companies large enough to compete and acquire globally?

Green, Goldman Sachs: There are multiple motivations for the recent rise in domestic merger activity. Some domestic consolidation has had offensive objectives — to build scale and global reach in order to access new growth opportunities and improve margins. Other recent moves have had a defensive motivation aimed at making takeovers from potential outside buyers more difficult. 

Miyakawa, Deutsche: In the case of pharmaceuticals, yes, the industry is consolidating. But there are many sectors where firms have to get bigger and tougher if they are to dominate and survive. Even among financial institutions which I thought were the most conservative, there has been considerable consolidation in the last 10 years, whereas some other industries have not even begun to consolidate. A key factor to consolidation is a reluctance on the part of many companies to be the first mover. When there is a first mover, however, nobody then wants to be the last and thus once begun, consolidation will happen quickly I believe.

Kondo, Mitsubishi UFJ: Companies in the pharmaceutical sector are now forced to extend their business scale to cover enormous R&D costs and their competition is inevitably on a global scale. It is very clear that their motivation for M&A is to strengthen their competitive and defensive positions in the global market.

However, in Japan, most mergers currently are aimed at business expansion and cost reduction in order to strengthen competitive power domestically. There have also been some transactions which are a product of natural selection in keeping with decreasing market size and this trend seems likely to remain unchanged this year.

Chunilal, Merrill: Yes. As an example, as the domestic pharmaceutical market becomes more saturated, Japanese pharmaceutical companies are realising that they need scale and financial strength to compete globally. The 2005 Daiichi-Sankyo merger, in which Merrill Lynch acted as a financial advisor for Daiichi Pharmaceutical, was entirely aimed at growing scale in the face of increased global competition. The combined company needs to bulk up in order to cover growing R&D expenses driven by international pressures.

Are Japanese corporations already a serious force in the global M&A market?

Chunilal, Merrill: To be honest, we think there is still a long way to go before Japanese companies become a true force in global M&A. While the number of deals involving Japanese corporations merging with or acquiring foreign companies is increasing, many major domestic players have yet to develop their international strategies and mindsets to really leverage these sorts of transactions. We continue to work with Japanese companies of course on these issues and progress is being made, but we would not predict a strong surge in previously inactive Japanese names conducting transactions abroad.

Green, Goldman Sachs: Yes, they are serious contenders as can be seen by a number of recent cases in which Japanese firms have beaten out global competitors to buy assets. For a number of companies, global growth is critical and domestic equity and debt capital has been very supportive.

Miyakawa, Deutsche: Yes, Japanese firms will be a serious force in global M&A. In fact, Japanese firms have already started on cross-border acquisitions. Purchases by top corporations, such as Fuji Photo Film that acquired Sericol Group of the UK earlier this year, are indicative of how 'In-Out' transactions are coming through as globally minded Japanese firms are developing strategies in the face of competition and economic realities.

Bhattal, Lehman: The volume of Japanese M&A transactions is still significantly smaller than in the US and in Europe because many Japanese companies do not want to be sellers in global consolidation. If Japanese companies become more receptive to becoming takeover targets of foreign competitors or private equity funds, the volume of Japanese M&A will significantly increase.

Consolidation in the financial sector is an exception. M&A activity among megabanks and large insurance companies accounts for a large part of Japan's M&A volume. Looking forward, we believe that M&A activity will pick up in other sectors and beyond Japan's borders.

Kondo, Mitsubishi UFJ: At present, only a few Japanese corporations are active in the global M&A market, and these have a limited impact in the market, insofar as they are often still protected by stability-enhancing cross-shareholding and their overall market value is relatively small.

However, we expect substantial upgrading of corporate performance resulting from improvements in financial strength. We anticipate M&A transactions no longer being viewed by Japanese management as an extraordinary activity. And we also foresee amendments to the regulatory framework, such as the Corporate Law reform taking place next year. Therefore, my hunch is that Japanese corporations will become more active as both sellers and acquirors in the global M&A market, so long as the economic recovery of Japan continues.

Okusu, CSFB: We believe that they will become a serious force, because otherwise they will be left behind the global competition. The total M&A annual volume in the country is still low and therefore has great potential to grow.

The Japanese population is 125m and on a sharp declining trend, so no Japanese company can rely on a domestic economic growth. They need to consolidate domestically or expand the overseas business to tap into global markets. They will tend to focus on the Asian market first, and secondly the US market.

Where are Japanese companies looking overseas?

Miyakawa, Deutsche: Japanese firms are active in almost every sector but, most interestingly, those that are thinking most about this are the top players in each industry sector. Second ranked players or below in each sector cannot afford such moves, a position which is in turn driving their moves towards domestic consolidation.

Kondo, Mitsubishi UFJ: Asian markets, especially the huge potential market in China, are attracting the interest of Japanese companies. They have particular interest in trends in China with regard to the automobile, machinery and equipment, heavy industry, construction, and distribution and logistics sectors.  However, as a result of country risk, the likelihood of any big M&A transactions taking place will be low, staying at the level of business tie-ups, or perhaps joint ventures at best.

Chunilal, Merrill: It is difficult to narrow this down, but the pharmaceutical and technology industries in Japan are probably the most active at this point. Recent deals in technology include TDK's purchase of Densei Lambda from Invensys of the UK, and Rakuten's purchase of Linkshare, a US online marketing affiliate.

What we can say as a generalisation is that Japanese management is increasingly coming to the realisation that the domestic market is moving toward saturation. Add to that the widespread consolidation among their global peers and the resulting increase in competition, and it is clear that in any industry sector today's Japanese leader needs to begin looking at overseas opportunities.

What role has private equity played as Japanese companies spin off non-core assets?

Chunilal, Merrill: 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 in the future.

As the Japanese economy recovers and the country's non-performing loan problems have improved, companies have shifted their attention toward becoming more globally competitive. The pharmaceutical industry is an ideal example: as international competition heats up, many of these manufacturers have realised the pressing need to reorganise their structures and private equity can play a critical role in helping to fund these changes. Other listed companies are also 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, management buy-outs or delistings are good options, and again private equity is a key facilitator.

Opportunities for private equity will continue to grow in Japan as the market and its players evolve.

Okusu, CSFB: It has played an important role in providing liquidity for distressed/non-core assets in Japan. It also helped introduce concepts new to Japan, such as the MBO and LBO. However, not many management teams of Japanese companies see the merit of the MBO, tending to focus on the risks rather than the opportunity to become wealthy. As is typical in Japan, it will take time for the management to realise how appealing the MBO can be but once that hurdle is overcome, I believe there will be a great wave of deals.

Bhattal, Lehman: Private equity is expected to grow further in Japan. In the past several years, most work-out funds were active in acquiring businesses or assets in distressed situations. Japanese companies had to spin-off non-core assets and businesses in an effort to improve the condition of their balance sheet. As private equity funds bought and restructured those assets, Japanese corporate officers and directors became more familiar with the activities and objectives of those funds, and are now more open to using private equity funds as a source of capital for restructuring and growth.

Kondo, Mitsubishi UFJ: Private equity has increased the number of selling options during the divesting of companies' non-core businesses. In particular, private equity investors have served as heavy-hitting buyers in cases in which a company has the technical capacity for R&D but lacks the financial capacity to cover those R&D costs because the business in question is non-core, or in which a company falls under a particular keiretsu industrial grouping but is unable to expand its markets. That is because these private equity buyers enjoy financial muscle as well as an unaffiliated, and therefore neutral, position.

We can expect the scope of private equity's activities to expand, such as to the role of financier for the delisting of publicly traded companies. Yet if private equity does not stick to businesses within its area of expertise, retain capable managers well versed in corporate management, or select its timing carefully, it will be difficult for it to attain stable returns.

Is there a genuine management/leveraged buy-out market in Japan and will MBOs/LBOs become more popular?

Bhattal, Lehman: Corporate Japan's interest in the management buy-out will likely increase for two main reasons. Companies, especially those with strong management, may become more cautious about potential hostile takeover bids. And also because there is capital available to finance those management buy-outs, either from private equity or through debt financing.

Chunilal, Merrill: More listed companies will be taking a look at this we believe. They will consider the costs and complexities of remaining listed, and for those that determine they have little or no need to raise capital they could elect to go private through an LBO or MBO structure.

Having said that, we do not expect a great surge — particularly among larger cap companies — because they may consider their listings prestigious, they might still wish to raise capital for acquisitions, or maintain employee incentive plans based around stock options. Instead, delisting is likely to remain a consideration primarily for mid to small cap companies without high future capital raising needs or for which growth is not a primary mission.

Kondo, Mitsubishi UFJ: The risks and costs associated with going public are significant for management, since management has to meet investors' requirements while handling the risk of hostile bids and shareholder interference.

To reduce these risks and costs and increase the degree of managerial flexibility, the market looks poised to see an increase in LBOs and MBOs aimed at delisting publicly-listed companies. Full-scale attempts, for example at World Co and Pokka Corporation, have already occurred, and a conservative commercial bank is expected to develop LBO-related activities as a new source of business.

Okusu, CSFB: We reviewed the MBO market potentiality back in 2000, and our conclusion at the time was positive, largely because corporations had so diversified themselves in a whole variety of business areas in the 1980s and 1990s, much of which was a failure. We concluded that the Japanese banks which supported that diversification could no longer afford to continue to support loss-making operations. We continue to believe that MBOs/LBOs will become popular, but the problem is that there are too many financial sponsors for too few transactions.

Miyakawa, Deutsche: Yes, I expect that use of MBOs will become more common, and I see them as one of the potential growth areas for private equity firms. There will be many more of them to come, driven mainly by succession issues, such as was the case with World Co, Ltd. To a lesser extent, MBOs might also be driven by management teams of companies in difficulty.

We have already seen two MBOs this year. One was World Co, which launched a highly leveraged MBO that placed control back in the hands of the company's founders. The other was Pokka, in which the private equity fund Advantage Partners played a role. These companies satisfied the traditional requirements for a successful MBO: stable cashflows, reasonable enough stock prices to justify a premium, a strong commitment by the founders, and limited interloper risk.

What are the new methods being employed for acquisition financing in Japan

Green, Goldman Sachs: In recent situations we have seen acquisitions being funded with bridge loans, mezzanine financing and private convertible bond placements. These methods of financing have been increasing in popularity because they provide their acquirer with rapid access to significant funding to complete acquisitions in addition to the traditional route of bank debt. These techniques will continue to evolve to enhance acquirers' ability to rapidly fund deals.

Bhattal, Lehman: Japanese companies have an array of financial instruments they may use to finance acquisitions. The use of private [moving strike] convertible bonds has become popular among certain IT ventures and growth companies, particularly among those with shares trading below book value. Those companies may continue to use such acquisition finance structures going forward. Private convertible bonds have the benefit of being an effective way to expand growing companies' shareholder base, and are also an efficient and cost-effective way for them to raise funding.

Miyakawa, Deutsche: The World Co MBO is an important case in point of the introduction of new methods. This approximately $1.7bn MBO is being achieved with only about $100m of capital from management and the rest from external investors.

With so many external investors available and happy to provide funds at almost no cost whether as senior lenders or junior investors, the management at World has shown how a very heavily leveraged MBO of almost 100% can be achieved without giving up any control of the company. With the cost of financing in Japan so cheap, the use of junior or mezzanine financing is very attractive for an acquiror.

Chunilal, Merrill: The mezzanine financing provided in the World Co case was quite unique given the limited say in governance/voting rights it offered the financing company, particularly considering the somewhat lower level of return. We do, however, believe mezzanine strategies could expand further along with growth of the LBO/MBO market. Japan could also see more stapled finance offerings by sell-side investment banks — this has become quite common in the US and Europe and may well become more prevalent here as well.

Okusu, CSFB: We are trying to establish a high yield market in Japan. We transferred a high yield market specialist from New York to Tokyo this year. The first high yield transaction, Dividend Recapitalisation, was completed this year, valued at $1bn. We would like to apply this technique for the acquisition finance in more MBOs and LBOs. 

  • 02 Dec 2005

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