Lawyers Still See Obstacles to Foreign M&A in Japan
Following last month's $1.67 billion acquisition of Panasonic Corp.'s health care unit by KKR & Co., some are wondering if Japan Inc. is starting to cast off a longtime aversion to private equity.
“Many Japanese corporations have recognized that if they don’t sell noncore businesses, they will likely not survive," says Ropes & Gray Tokyo partner Scott Jalowayski. "Foreign private equity can take the asset off of the books, add value, and ideally turn the businesses around. They are coming in to help.”
That certainly seems to have been the case for Panasonic. Once a symbol of Japan's economic and technological prowess, it and other Japanese electronics giants have since been outpaced by the likes of Samsung Electronics Co. Ltd. and Apple Inc. In each of the past two years, Panasonic has reported a $7.5 billion loss, and its management has decided to pare the number of its business units from almost 90 to 49.
Other struggling Japanese companies may follow suit. But cultural norms die hard, which is why many lawyers in the market aren't holding their breath for a boom in foreign acquisitions in Japan, least of all by private equity groups. Though outbound investment by Japanee companies has boomed in recent years, inbound investment to Japan, though rising, remains low compared to other countries in Asia. The country’s inbound foreign investment accounts for 4 percent of its GDP, lower than North Korea’s 12.5 percent. In the first half of 2013, foreign M&A deals in Japan were valued at $3.6 billion; that compares to almost $16 billion in China.
Jobs are at the core of Japanese resistance to foreign investment. Though the country's famous tradition of lifetime employment has been on the wane, it is still considered an important part of the culture at many large conglomerates. Shearman & Sterling Tokyo partner Kenneth Lebrun says that's a major reason why they have so many relatively unproductive business units in the first place.
“When the core business is unable to support a company’s employees, instead of laying people off, they create subsidiaries and move people there so they will still have a job, ” he says. “It may be good for the society, but not very healthy for a business. ”
Yoshinobu Fujimoto, a partner with Tokyo's Nishimura & Asahi, agrees, noting that selling an asset is an emotionally difficult decision for Japanese management to make. “They believe that business continues forever and see the continuity of employment as a high priority even in the event of a financial crisis,” he says.
Selling to foreign private equity, with its reputation for reorganizing companies and orchestrating mass layoffs of employees, is often seen as the worst possible outcome, short of liquidation.
“Historically, companies are often less willing to sell to private equity than a strategic buyer because of the perception that private equity tends to do more major restructuring and to break up the business into little pieces,” says Edward Johnson, a partner at Orrick, Herrington & Sutcliffe in Tokyo.
But for such perceptions, notes Jones Day Tokyo partner Steven DeCosse, foreign private equity firms would be logical buyers for many struggling subsidiaries of large Japanese conglomerates. They are often able to pay higher prices than other potential acquirors, and they also have experience with complex deals, such as extracting a business unit from larger group.
But other aspects of Japanese business culture further hamper potential foreign buyers, such as the lack of independent directors who might focus more on shareholder returns and actively push for divestitures.
“Most of the boards of directors in Japan have either none or just one or two outside directors, ” says Lebrun. “Almost every other director is a lifetime employee, who is attached to the company and its employees at a more personal level.”
Bingham McCutchen Tokyo partner Christopher Wells says there is very little job mobility at management level, meaning that few employees have experiences in other organizations. “This ‘group identity’ tends to keep out ‘outsiders’ and can make it very difficult to replace senior management after a merger,” he says.
Fujimoto says the Tokyo Stock Exchange currently doesn’t require listed companies to appoint any independent directors, only recommends that they do. “Unless the Corporate Act or the Tokyo Stock Exchange decided to mandatorily require independent directors for the companies, not much change will happen,” he says.
Moreover, the prospect of government assistance for many troubled companies means that foreign buyers can be kept at bay.
Less than a year before the Panasonic deal, KKR was outbid by Innovation Network Corporation of Japan, a Japanese government-backed fund, in a $1.8 billion investment in chipmaker Renesas Electronics Corp.
“Even if the KKR bid was economically much better, it would have lost out to a bid where more consideration was given to employees of the target over the long run, ” says Wells. “The government fund did not ‘win’ because it had a ‘special advantage.’ Rather, it better understood what would be needed to win the bid in terms of intangible offer terms. ”
But Simpson Thacher & Bartlett Tokyo partner David Sneider, who advised KKR on its bid, thinks Renesas was a particular case in the industry the government regards as especially important. “I don’t think there was any significant bias against foreign private equity,” he says.
In any case, Sneider says, current trends may be working to the favor of private equity. For instance, there is talk of the government reducing the role of government in these deals. “If the government reduces their support for troubled companies, they may have to turn to private sources of capital,” he says.
Wells thinks some will do so if they are in such trouble that they have no choice. “I think very little Japanese M&A is based on synergies, ” he says. “Distressed conditions are much more relevant.”
But Johnson says the KKR–Panasonic deal might help make private equity more socially acceptable to other Japanese companies. “Each deal that occurs facilitates the next deal’s occurring, ” he says, “and each sale to a private equity fund makes the next such sale easier.”
Linklaters Tokyo partner Hiroya Yamazaki says many Japanese companies aren’t waiting for private equity to step in to begin restructuring themselves. “Companies like NEC and Fujitsu have already gone through downsizing, ” he says “Panasonic, for example, has been doing internal reorganization among groups; salaries of some employees were reduced by as much as 30 percent.”
The private equity business itself seems to be of two minds about Japan. KKR cofounder Henry Kravis said in a recent speech in Hong Kong that he saw increasing opportunity in Japan. The Carlyle Group has likewise raised a $2 billion fund exclusively for Japan investments.
But a number of big names like Advent International and Ripplewood Holdings, a private equity pioneer in Japan, have exited the market. Earlier this year, TPG Capital founder David Bonderman said in an interview on CNBC that Japan was one of the most challenged markets on the globe, citing its aging population and what he saw as the lack of a culture of corporate responsibility.
"Over time, I hate the place," he said.
Yamazaki says there’s no doubt Japan is a tough market. “The population is getting smaller and the market is shrinking, ” he says. “As a profitable asset, Panasonic’s health care unit is attractive to private equities, but not all the assets are attractive. Private equity firms are unlikely to buy unprofitable assets.”