Why M&A Is Different in Japan

A byproduct of Japan’s sluggish economy has been an uptick in merger and acquisition activity.

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Although still relatively scarce by Western standards, M&A is alive and flourishing in Japan. “Twenty years of low growth have put corporations under pressure to change,” said Hidemi Moue, CEO of Japan Industrial Partners Inc., a private equity firm that buys and turns around company carve-outs. “Their investors cannot afford low returns on investment.”

Moue took part in a recent panel discussion sponsored by the Center on Japanese Economy and Business at Columbia Business School and the Center for Japanese Legal Studies at Columbia Law School titled “M&A in Japan: Reenergized.” Participants agreed that country’s environment is finally fertile enough to support an acquisitions spree.

To be sure, this is a fundamental rewriting of a patriarchal Japanese business culture where corporations historically built long-term, stable relationships with employees and grew organically to control all phases of a product's supply chain. Deeply ingrained biases linger, meaning non-Japanese buyers are still few and far between, and hostile takeovers remain mainly theoretical.

What's Driving M&A?

The panelists described two catalysts that have made the Japanese willing to sell nonessential parts of their companies and created eager buyers.

The first is a defensive play as companies strip activities down to core businesses and slough off the rest. Big Japanese companies have built numerous affiliated businesses in the postwar period. For example, Sony has more than 500 affiliated businesses, and Hitachi has 1,100, Moue noted.

In fact, whole Japanese industries have consolidated, with banking, steel, and pharmaceuticals leading the charge. Other sectors remain bloated by Western standards, said Moue.

Trimming their product rosters is a way for companies to focus and cut costs, added another panelist, Jonathan Rouner, managing director and head of international mergers and acquisitions for Nomura Securities International.

The second driving force is a mighty offense that corporations have undertaken to be competitive globally. Other than some notable purchases made in the 1980s, “outbound investment has taken off in the past decade, particularly the last five years,” said Rouner, who estimated about half of current Japanese investments are now for overseas businesses. Mega global acquisitions that made recent headlines include SoftBank’s $22 billion acquisition of Sprint in 2013, Suntory’s $16 billion purchase of bourbon maker Beam, and Daikin’s $3.7 billion purchase of Goodman, a US-based air conditioning company.

In a number of cases, the Japanese government has provided a backstop for foreign purchases. For example, building products company Lixil teamed with the Development Bank of Japan in 2013 in the $4.1 billion purchase of Grohe, a German bathroom fittings company. The approach created a two-tier A/B share structure and allowed the buyer to keep the acquisition debt off its balance sheets.

It’s Not the Same

Despite all the progress, Japanese M&A differs from Western deals in important ways. For one thing, deals are almost all acquisitions — mergers rarely occur. As the panelists explained, corporations want to divest businesses completely, and Japanese buyers are much more comfortable with majority control anyway.

Additionally, Japanese companies are rarely bought by overseas buyers. Any successful purchases are typically for companies teetering on the edge of dissolution. Rouner points to the 1999 acquisition of Nissan by French auto company Renault: “Nissan was distressed,” he said. Further, the alliance was technically a partnership as the two companies joined in a cross-shareholder agreement that allowed Nissan to remain listed in Japan and preserve its close ties with shareholders and suppliers.

Similarly, hostile takeovers are mainly theoretical. Although most legal hurdles to M&A have been lowered and transparency is much improved, the Japanese corporate governance norms still protect companies that balk at selling to international investors or hostile buyers, explained Curtis J. Milhaupt, a Columbia professor of comparative corporate law and director of the Center for Japanese Legal Studies at Columbia Law School. “It would be healthy if Japanese managers felt threatened by just a little hostile M&A,” he said, admitting, “I don't know when or if that will happen.”

Deals usually take a lot longer to complete than they do in the United States or Europe. “Japanese buyers can move more slowly than other buyers,” said Rouner. “The due diligence process is thorough and time consuming. And board approval commonly needs to wait till the next scheduled meeting, as opposed to a Western board that can be pulled together over a weekend to sign off on a deal.”

Valuations are typically higher, causing some Western bidders to suggest that the Japanese routinely overpay. In part, the high bids may be an inducement to patience. International sellers know that, although a Japanese bidder may take longer to bring an offer to the table, that offer is likely to be higher than those from non-Japanese interests. But Rouner suggests that higher prices are also a function of differences in valuation techniques and the use of discounted cash flow analysis to price deals. A willingness to look at return on investment over a longer time frame typically leads to higher valuations.

Modern Japanese acquisitions are likely to put in new management and follow new strategies. This is despite the tradition of growing talent from within. Moue’s firm follows this procedure as a matter of course. He explained that Japan Industrial Partners’ criteria for buying a business calls for finding rough gems that can be polished into profitable businesses, and such a complete change of course is nearly impossible with managers who have committed to a previous direction.

Where Do We Go From Here?

The panelists said a further growth spurt in M&A activity within Japan will likely occur only when shareholders demand it. Although institutional shareholders hold comparatively little sway in Japan, some pension funds are balking at the returns they can get from investing in government bonds. And should they enter equities in a bigger way, investors may become more vocal in demanding change — including acquisitions and divestitures. “Reshuffling of big portfolios means more M&A in the domestic market,” predicted Moue.

But, although Japanese corporations are certainly becoming more global, none of the panelists expected much more inbound investment from foreign buyers. Moue said one way foreigners have found to participate in Japanese M&A is through private equity firms such as his. Two-thirds of the fund's $700 million war chest is from overseas investors. “It’s a way for nondomestic investors to participate in the Japanese market indirectly,” he explained.

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