Global Private Equity – Japan

A country analysis of Private Equity

2/1/2009

Submitted by:
Group no. 7
Abhishek Shah IB084
Ashish Mishra IB088
Sourabh Verma IB107
Vini Sanghavi IB111
Table of Contents

Introduction..........................................................................................................................................................................................2

Evolution and Growth of Financial System in Japan .......................................................................................................2

1. Commercial Banks .............................................................................................................................................................3

2. Government Financial Institutions ...........................................................................................................................3

3. Securities Institutions ......................................................................................................................................................3

4. Capital Markets ....................................................................................................................................................................4

5. Money Markets ....................................................................................................................................................................4

Private Equity in Japan ...................................................................................................................................................................5

Private Equity as an Asset Class .................................................................................................................................................6

Market Risk ...........................................................................................................................................................................................7

Private Equity Players & their Investment in Japan ........................................................................................................8

International ...................................................................................................................................................................................8

Japanese .............................................................................................................................................................................................9

Exit Routes..........................................................................................................................................................................................10

Performance of Private Equity in Japan ..............................................................................................................................12

Sources of Deal Flow .....................................................................................................................................................................13

The Future ..........................................................................................................................................................................................14

References ..........................................................................................................................................................................................15

1
Introduction

Japanese economy was the only eastern hemisphere country which was a part of league of the
developed industrialized countries in the 1970s and 1980s. Largely on the backing of its strong
mechanical and electronic prowess, it was giving the developed nations of the west a run for their
money. Some of the world’s most prominent technological contributions in the field of automobiles,
electronics, machinery, robotics and semiconductors have come from Japan. Some of the world’s
best brands from Japan have been Sony, Toyota, Nissan, Mitsubishi, Honda, Nintendo and many
others.

The 60s to 80s era has been termed as ‘Japanese Miracle’ with average 10% growth in economy in
60s, 5% average growth in 70s and 4% average growth in 80s. Despite the slowdown in the 1990s
after the Japanese asset price bubble, Japan still remains to be the second largest economy in the
world, next only to the US. Year 2000 was the year of global slowdown, which brought the economy
to slow down further. However, from 2005, it has been doing reasonably well.

Evolution and Growth of Financial System in Japan

The 1980s saw that United States was increasingly becoming more and more reliant on debt from
outside; on the other hand, Japan was rather finding opportunities to park its funds. Tokyo had
become a major international financial centre. It was in during that time, that Japan had world’s
some of the biggest banks and the largest stock exchange then. It was in 1980s that the financial
services and banking industries took off in Japan.

Commmercial
Banks

Government
Money
Financial
Markets
Institutions

Financial System in Japan

Capital Securities
Markets Institutions

2
1. Commercial Banks
During 80s Japan had 13 major and 64 regional banks,
The commercial banks in the Japan were involved in
7 long term credit banks, 69 mutual loans and savings
traditional banking business that of accepting bank and various dedicated financial services
deposits, lending loans, dealing in foreign exchanges, providers.
retail operations like credit card, leasing and financing Source: www.photius.com
real estate. In early 90s, five biggest banks in the world
were Japanese Banks.

2. Government Financial Institutions

These were the specialized institutions which got their funds from postal saving systems and the
funds were utilized by these institutions in the areas such as export-import related financing,
housing, etc. The post saving systems used instruments like saving deposits, annuities, etc. to
channelize savings by providing high rates of interest.

3. Securities Institutions

The securities companies in Japan were the typical investment firms which invested in the
securities and also provided the various services such as the brokerage, underwriting of private and
public securities. The biggest four players of this industry were:

 Nomura
 Daiwa
 Nikko
 Yamaichi

All these firms were members of the NYSE. Other then these there were another 10 midsize firms
and countless small firms. Nomura in 1986 had capital in excess of $10 billion and was one of the
biggest investment firms in the world. Nomura was also a member of the LSE. These firms’ were
majorly earning their revenues from fees earned from broking, underwriting and trading and
dealing in shares and bonds. In late 80s a number of foreign firms also entered the Japanese market.

The insurance companies of Japan also became important leaders in their sector in the world.
Japanese used insurance as the saving instruments and the industry grew at a rate of more than

3
20% in the late 1980s. These companies went on to become some of the largest players in the
international money markets.

4. Capital Markets

Two of the three biggest stock markets in 1988 were in Tokyo and Osaka, with the Tokyo Stock
Exchange (TSE) being the largest in the world. TSE was founded in 1878 and as on December, 2007
had 2412 listings. While the combined market cap of all companies listed on TSE was around 484
trillion Yen. There are three main indexes which track the performance of TSE: Nikkei 225, TOPIX
and J30. Currently it is second largest in the world. TSE has tied up with London Stock Exchange in
June-2008 to develop a market based on LSE’s Alternative Investment Market. Osaka Stock
Exchange (OSE) is the largest derivatives exchange in Japan. In early 1990s it was the largest
futures market in the world. It has 477 companies listed.

Before 1980s most companies relied on financing their business operations by way of debt.
However, after 1980s most companies started to be more reliant on capital markets for their
funding and hence the growth of the capital markets in Japan came. The stock markets transactions
blew up with Nikkei growing from nearly 6000 in 1982 to 39000 in 1990s.

5. Money Markets

The money market instruments in Japan are mainly used by the players like banks and huge
corporations in order to take care of their liquidity positions. While as discussed earlier, the
insurance companies of Japan were huge investors in the international money markets. For
instance, they had huge funds parked in the US treasury. The Bank of Japan has taken initiatives
which have helped Japan to be on the lower side of inflations most times. Especially after the 1990s
asset bubble, the economy though was in downturn all these years, the economy has still been solid
and in recent global slowdown, the Japanese economy is not so badly hit as many other developed
nations.

4
Private Equity in Japan

Japanese Private Equity (PE) Market is very nascent. Japanese become interested in Private Equity
market only in late 1990s or early 2000s. The country possesses immense potential to grow in this
field. This is evident by the fact that there are numerous sprawling conglomerates in Japan, which
could easily hive off their non-core businesses to raise capital.

Another cultural hitch that might be averting International Private Equity players from entering
Japanese market is that traditionally Japanese businesses avoid foreign intervention. Also, the
shareholders do not push these companies to improve their performance which worsens the
matter. With this background, small local companies have been hesitant in accepting Private Equity.

Talking about Japan, one of the partner of KKR, the leading international private equity firm, quoted
that – “The change should come from inside”. The foreigners cannot cause a change in Private
Equity space of Japan as long as the local people or management is not willing to accept it.

One cultural aspect that discourages Private Equity in this part of the world is – Fear of cost cutting
through layoffs by PE players. Layoff in Japan is almost a curse. However with the increasing global
competition and stress on the companies to reduce cost, local company’s management will have to
embrace these changes. This presents an opportunity for the international private equity funds for
sourcing small deals in Japan.

Being a budding market, Japan does not have many successful Private Equity stories to advertise
PE. There is not much knowledge and expertise about this asset class. This is another reason for
less popularity of PE in Japan.

A major hindrance is lack of local talent specializing in turnaround skill, deal experience and other
skills required for PE. So the executives are to be groomed first before they can start earning for the
fund. One way to overcome this is formation of teams. PE funds have formed teams of people with
complementary skills - deal sourcing and financial skills. They are usually a combination of foreign
experts with Local talent. This has in a way, helped the PE funds to surmount the problem of lack of
local PE expertise in this region.

5
Private Equity as an Asset Class

Japanese have been modest contributors to Private Equity as an Asset Class. Banks and Insurance
companies have been investing in PE since the late 1980’s. They have been investing in US &
Europe both through funds of funds and directly from their offices in London and New York. But
during the recession of 1990s these activities saw a steep decline. Lately, the PE activities are
picking up again in the country.

Japan has a very low interest rates and hence generating high returns using fixed income securities
like government bonds is not possible. The domestic equity markets also do not yield high returns.
Thus the fund managers or investors have to look at other asset classes in order to get high returns.
Traditionally Japanese investors prefer liquidity but due to lack of asset classes yielding high
returns, they are ready to invest in long term assets like PE. Given the high return nature of Private
Equity, investors are ready to increase their contribution to PE and also set up Private Equity
Program.

In early 21st century, many private pension schemes, for the first time, diverted a part of their
portfolio towards private Equity. However the contribution has been small and they are not a major
Limited Partners. One major Japanese regulation which hinders this says that pension funds cannot
directly be the Limited partner in a Private Equity fund. They have to investing using Trust banks as
Trustees. The trustees have the same fiduciary duty as the pensioners. Hence the decision involved
should have the consent of both the trustees and the pensioners.

Investing in Private Equity Funds who invest abroad exposes the investor to currency risk. Japan’s
exchange rates have been very sensitive. Thus the fear of losing out because of exchange rate risk
also thwarted the growth of this asset class in Japan.

Japanese regulations and banking system are also not tuned to this asset class. This discourages
returns and hence many potential General Partners to set up Private Equity fund in the country.
However things are changing now, under the financial Services Minister, Mr. Yuji Yamamoto,
adoption of foreign financial models is being encouraged. They have encouraged participation of
foreign Private equity and hedge funds in the country’s financial system.

6
Foreign banks and funds are attracted to Japan as the cost of borrowing is very low. Also the
restriction on foreign bond issues and listing are being relaxed now. This is overall provided foreign
investor with a hospitable environment to set up funds in Japan.

Some Private Equity investment companies are Daiwa, Nippon, Yasuda and Tokyo Marine. A few
banks having investment in this asset classes like Norinchukin and Mizuho banks. In September
2007, Nomura Holdings, Norinchukin Bank and Development Bank of Japan established a company
called Private Equity Funds Research and Investment Co. Ltd. It aims at assessing and analyzing PE
funds and offer investment advice & investment management services in PE funds globally.
Formation of this company was a step towards bringing transparency and structure to the system.

The Japanese government is holding up talks to ease regulations that will make environment for
private equity more inviting in Japan. They are talking about reducing capital gain tax, lifting some
of the restrictions on foreign investments. Also relaxation in policies which will enable pension
funds and insurance companies to invest directly in Private Equity funds.

Market Risk

The market risks perceived by Limited Partners in Japanese Markets are as mentioned below

 Increased Competition has caused to reduce profits from this asset class. This is the
biggest threat as perceived by the LPs in this country.
 Almost 66% of the Limited Partners believe that there is a dearth of PE talent in
Japan.
 Other risks are related to the policies and regulatory framework of the country like
taxation, legal restriction on Limited Liability Partners.
 Around 40% of the LPs believe that any increase in interest rate will also be a
potential risk for private equity investment.

These risks are represented pictorially in the following graph.

7
 Source: Coller Capital Barometer on Japan

Private Equity Players & their Investment in Japan

Japan’s local General Partners were set up their Private Equity funds as late as 1999s. Since then
Japan has seen a boom in the private investment Activities. There have been more and more local
firms being set up. Institutions like pension funds, insurance started recognizing Private Equity as a
high return asset class and worth being invested into.

Lately, big International Private Equity houses like KKR, Carlyle, Cerberus and TPG have opened
offices in Tokyo, Japan. They are yet to start their full fledged operations here. One of the primary
concerns of these huge PE funds is lack of mega deals in this market. The Private Equity investment
made in Japan is very small as compared to other markets. There have been a few large deals like
Cerberus acquiring 29.9% stake in Seibu Holdings for 88.7 billion Yen, CVC Asia pacific invested 94
billion yen in Skylark which is the biggest Japanese family restaurant chain. KKR, who opened its
office in Japan in 2005, earmarked $4 billion USD for PE investment in Asia out of which it is yet to
invest $3billion USD. It is waiting for the right investment opportunity.
Other Private Equity Players in Japan are –

International
 Blackstone Group LP – set up office in 2007
 Kohlberg Kravis Roberts &Co. (KKR) – moved to Japan in 2005
 Carlyle Group – opened their office in Japan in 2000

8
  HarbourVest Partners – A Boston based PE fund
 Cerberus Capital Management
 Texas Pacific Group Newbridge – Asian arm of TPG.
 Ripplewood Holdings – An American private Equity Firm
 Permira – Entered Japan in 2005, an International European PE Fund
 Lone Star Funds – A Dallas based fund, set up by John Grayken
 Basic Capital Management – Dallas based PE Fund

Japanese
 Advantage Partners , Tokyo 1992 - Leading PE fund of Japan
 BNP Paribas Japan - Affiliated to BNP Paribas
 MSK – buyout fund, investment in Xymax, Benex, Fukusuke
 Nomura Holdings – A part of Nomura Groups, Tokyo
 Unison Capital – Invest around 700 billion Yen in Japan
 Phoenix Capital – Affiliated to Tokyo Mitsubishi Financial Group
 Nippon Mirai Capital – Corporate restructuring & turnaround Fund
 Tokio Marine Capital – Buyouts and Venture Fund since 1990s
 NIF Ventures – Buyout fund headquartered at Tokyo
 AC Capital – Set up in 2003, Turnaround fund

Following table presents few major deals in Japan.

Fund Acquisition/Investment
Cerberus Capital Management Acquired 29.9% stake in Seibu Holdings for 88.7
billion Yen. Also owns Aozora Bank.
CVC Asia Pacific Invested 94 billion yen in Skylark which is the biggest
Japanese family restaurant chain
TPG Newbridge Investment in Ashikaga bank

Lone Star Group Bought Tokyo Star bank and turned it around and sold
a third of it to reap huge profits, almost sevenfold.
Ripplewood Holdings Made gain of 3.5 billion by investing in Long term

9
 Credit Bank of Japan ( Shinsei Bank) in 2004
Advantage Partners Acquired Tokyo Star bank Ltd in March 2008. They
have 340 billion Yen Assets in Japan. It has invested in
more than 20 Japanese companies

The various types of Funds present in Japan include local as well Asian & Global Funds. The
distribution of these funds is presented in the graph below –

Source: Coller Capital

KKR have called Japan a fertile territory for Venture Capital and private Equity activities. Till now
the shareholders never pushed the management to increase productivity. Managements of the
companies are facing pressure from various activist firms of institutional investors to perform
better. This has made things favorable for Private equity funds.

Exit Routes

The most popular exit routes in Japan are Secondary buyouts, Trade Sales, Recaps and IPOs.

 Secondary buyouts: This involves buying of stakes from existing PE fund by

another PE fund.

10
  Trade Sales: Trade buyers from the same industry as the company buy equity from
the PE fund. This is profitable for the company as such a deal realizes synergies for
both the companies participating in the deal.
 Recapitalization: Recapitalization is an exit strategy wherein the company or
management takes debt to buy stakes back from the existing Private Equity Firm
that wants to exit. This happens usually when the management wants to take back
the control and do not want any external firm to have substantial stake in the
business.
 Initial Public Offerings: When the market conditions are favorable, taking the
company public through an Initial Public Offering can earn a good deal for
management.

According to majority of existing Limited Partners in Japan, the popularity of the Secondary
buyouts and Trade Sales is going to increase in coming days. Recapitalization is likely to become
less common according to the opinion of a few Limited partners. Majority of them think that IPOs
would remain a preferable exit route as a result of strong capital markets in Japan. Following graph
captures the view of various LPs on the contribution of these strategies.

Source: Survey by Coller Capital

11
Performance of Private Equity in Japan

Japanese Private Equity has its own Strengths and Weaknesses. Following graph shows the relative
strength of this market. Macro economic climate is most favorable, banks debt is easily available
and capital markets are also very developed. This is also a result of low cost of borrowing in the
country. This makes cost of fund very low and thus attractive. Legal & Regulatory Framework, IPO
Markets and Availability of deals flows are at acceptable levels for most of the Limited partners.

However, 37% of the Limited Partners think that tax climate is unfavorable for private Equity in
Japan. However, Japanese officials are planning to relax tax rules and regulations to make Private
Equity activities and foreign investment favorable in the country. This change is still under
discussion in Diet. If passed, it will totally change the picture of private equity in Japan.

Source: Coller Capital Private Equity Barometer

Before the Global Crisis, Limited Partners were able to realize a net return of as good as 16%.
According to a report by Coller Capital, 72% of Limited Partners accounted a net return of 16% by
investing in Local buyout funds. This is commendable as compared to LPs in Europe & North
America, where only 50% of LPs are able to achieve such type of returns. The following bar chart
shows a comparison of returns of LPs in different parts of the world. Buyouts reap maximum
returns, out of which Japanese buyouts beat other Asia – Pacific, European and North American
buyouts. However returns from the Japanese venture are lowest of all other venture funds.

12
Source: Coller Capital Barometer on Japan

Sources of Deal Flow

The Private Equity deals are made in either in startups or distressed companies or for corporate
restructuring. It might also be in publically quoted companies or through secondary buyouts. These
are the major sources of deals in Japan. According to a survey conducted by Coller Capital, majority
of Limited Partners expect the contribution of Secondary buyouts and publically quoted companies
in sourcing a Private Equity deal will increase in coming days. Also 40% of the LPs, who have taken
this survey, are of the view that Private Equity deals in distressed or turnaround situation will come
down in near future. According to the majority, the number of deals sourcing due to startups would
almost remain the same. A graphical representation of the result of this survey is as shown below.

Source: Survey by Coller Capital

13
The Future

The prospects of Japanese markets in this downturn are brighter than most of the developed
markets in the world. Despite the downturn, Japan is amongst the very few developed economy
which is doing well. The economic activities are not reduced to a large extent. This is an inviting
signal for private equity activities.

Private Equity market in Japan is its initial stage and is all set to grow in the coming days. The main
reason for this is less competition in the space of Private Equity. Following the crisis, the world is
going to see lot of consolidation in the industries. Japan’s market is positioned the best in the World
to emerge as a leader in this.

Japanese government is increasingly adopting measure to make Japan’s financial environment

welcoming for foreign investors. It is relaxing its regulation to make investment in Private Equity
more viable. They aim at changing the traditional nature of financial space to include the best
practices of the foreign countries in their systems. These changes have driven international PE
funds to Japan in early 21st century. Their annual earmarking of funds in Japan is increasing every
year. There have been a few big deals in terms of monetary size and they are expected to grow.
International PE funds are optimistic on Japan’s role in Private Equity arena in the future.

Japan’s government is considering nixing the Capital Gain Tax by 40%. Currently this is one area
where foreign investors lose out. Japan’s capital Gain tax is the one of highest in the World. If this
regulation is passed that Japanese market would be flooded with foreign Investment. This change is
expected around April 2009. Currently only 4% of the private equity funds comes from foreigners.
This is negligible in contrast to the figure for UK and European Union where around 60 to 70% of
the Funds come from outside the country. If taxation is made favorable then one can expect a boom
in private equity market in Japan.

After the crisis, the cost of funding has increased tremendously. This factor will not affect Japan as
much because the deal size here is small in comparison to the deals happening in US, UK or Europe.

Overall, from a bird’s eye view Japan’s Private Equity Market is set to grow to harness its true
potential which is immense.

14
References

http://www.nochubank.or.jp/pdf_news/19-41_Establish_Joint_Venture.pdf
http://www.iht.com/articles/2006/10/03/bloomberg/sxtpg.php
http://www.mvision.com/PDFs/5.pdf
http://www.collercapital.com/assets/html/pressrelease.html?ID=81
http://www.heidrick.com/NR/rdonlyres/8A1DC824-7847-4279-820B-
C6FE67991BD1/0/HS_PrivateEquityinJapan.pdf
http://www.japanconsult.com/Japan_private_equity.htm
http://www.altassets.com/casefor/countries/lists/casefor_japan.php
http://www.privateequity.com/alpha_search.cfm?letter=j
http://www.mckinseyquarterly.com/Private_equity_heads_for_Japan_848

15