Doctor in the House

Back to Contents of Issue: June 2002

Buyout funds have charged into Japan, looking to shape up sick companies. But do these 'vulture' capitalists have the right medicine?

by Sumie Kawakami

AN ADVERTISEMENT FOR POPULAR writer Ryo Takasugi's recent work of fiction, Shosetsu: Za Gaishi (A Novel: Foreign Capital), contains a warning: "Foreign capital is sucking the blood of Japanese taxpayers." Takasugi's take on buyout funds captures the Japanese sentiment over the past few years. But so far the funds have sparked more fear than deals. More than JPY1 trillion sits and waits as these so-called corporate revitalizers search through the scorched economic landscape for good buys. Where will their search take them next and will it be good for Japan?

Crises trigger action. Lately, the Japanese economy has seen plenty of crises and not much action.n Buyout funds -- which buy entire companies or portions of companies, turn them around, then try to sell them at a profit -- have been slowly setting up in Japan to change all that. These funds, usually a small group of people with a lot of money, specialize in streamlining or restructuring companies forced to sell cheap to survive. Their names are not household ones -- Carlyle, Cerberus, Lone Star -- but frankly, they don't care about name recognition. Their game is sizing up a good buy, whipping it into shape, then making a profit on the resell. And Japan's combination of a prolonged recession, low stock prices, rising bad loans, historically low interest rates and poor profitability makes it the perfect playing field for these funds. Or so it would seem.

Potential buyout opportunities aren't limited to ailing companies. Some financially sound companies have been looking to spin off non-core businesses to boost efficiency and profitability. Nissan Motor is a case in point. After the carmaker was taken over by Renault of France in 1999, it sold many of its subsidiaries or non-core business operations. US-based private equities fund Ripplewood Japan bought Nissan's auto-parts maker Niles Part for JPY10 billion in 2001; British fund 3i bought Nissan's logistics service providers Vantec for JPY15 billion last year as well; and Japanese investment firm Unison Capital bought auto-parts manufacturer Kiriu.

Investors at foreign buyout funds say they tend to be more interested in these healthy non-core assets. "The basic idea is to redo a living company with stronger potential," says Hiroshi Nonomiya, managing director at Ripplewood Japan. But buyout funds suffer from a negative image in Japan, says Lee Daniels, managing director at Asian buyout fund NewBridge Capital. "Healthy companies traditionally don't like private equities to come in and assist them," he says.

In a country that has developed procrastination into a high art form and where the selling of one's company is still considered one of the lower forms of betrayal, buyout funds are slowly making their presence felt. It all began with the dramatic entry into the market of Ripplewood Holdings in 1999. The company led a consortium that purchased the Long-Term Credit Bank (LTCB), reinstalled a management team and reorganized the institution as Shinsei (literally 'reborn') Bank.

The hype around Ripplewood's purchase of LTCB and a few other high profile cases -- Lone Star's JPY40 billion buyout of Tokyo Sowa Bank and the government forgiveness of a JPY197 billion bad loan to Sogo held by Shinsei Bank, for example -- is still largely responsible for the image the Japanese have of buyout funds. These deals were controversial, even scandalous, as the nation expected the companies to be stripped of their value and employees to be dumped on the side of the road while the foreign bandits made off with the loot.

Buyout funds emerged during the 1980s in the US as conglomerates tried to sell off non-core businesses as a way to focus business and increase profitability. A number of funds have entered the Japanese market in the expectation that a similar trend is about to start here. Although they are normally viewed as being of the same ilk, each fund has its own characteristics, strategies and goals. 

Ripplewood Japan
Previous Deals in Japan: The former LTCB, now Shinsei Bank Nissan's electronic auto-parts unit Niles Parts (JPY10 billion)
Audio manufacturer Nippon Columbia Co. (JPY10 billion)
Resort hotel Seagaia (JPY18 billion)
Photo: Hiroshi Nonomiya, managing director, former executive from Mitsubishi Corporation
Amount of Fund: JPY120 billion Areas of Interest: Manufacturing, electronics, chemistry, hotels, food industry

Ripplewood Holdings has made its presence known in Japan by a series of huge deals over the past three years. It plans to buy two or three companies a year and acquire assets worth JPY500 billion to JPY1 trillion over the next few years. The LTCB buyout created an image that the company buys failed companies, but out of 50 investments Ripplewood has made over the past five years, few involved failed companies. It is known as a typical management buy-in player, in which the firm replaces an entire management team, but Nonomiya denies this, saying it all depends on the case.

Meanwhile, the Japanese government has been giving conflicting signals: Some parts of it seem bullish on buyouts and others seem downright xenophobic. "In order for corporations to restructure, somebody needs to buy their assets," says Michihiro Kishimoto, deputy chief in the trade, finance and economic cooperation division of the Ministry of Economy, Trade and Industry (METI). "The buyer can be either domestic or foreign, but we cannot put too much hope on domestic buyers. That leaves us with foreign capital." Fair enough. But what to make of comments by an agriculture ministry official earlier this year who said that he would prefer to have Japanese companies buy failed dairy-products maker Snow Brand?

One thing is certain: The market for buyouts in Japan is growing. During 2001, there were 22 deals with a total transaction value of JPY116.4 billion, up from nine deals worth JPY5.1 billion in 1988, according to Mitsubishi Research Institute.

In reality, the buyout curtain rose here in 1997, even before Ripplewood's entry. As Japanese banks started getting rid of their nonperforming loans, major firms such as Goldman Sachs, Morgan Stanley, GE Capital, Cerberus and Lone Star focused in on the distressed debts market. Initially, their main target was distressed-assets in the form of real estate kept as collateral by Japanese banks. As Japanese institutions were unable to dispose of their own bad debts, the distressed debts market was wide open for these foreign players. The Nikkei Shimbun, a major business daily, estimated in September that distressed assets bought with foreign capital over the past few years was worth more than JPY30 trillion at face value.

Buyout opportunities with these real-estate-related bad debts -- a legacy of the bubble economy -- have peaked, says Tomoo Tasaku, partner at PricewaterhouseCoopers Financial Advisory Services. What's rising instead is what Tasaku calls "recession-related bad debts." While the bad debts tied to real estate were caused by too much bank lending and a bubble in real estate investment across the country, recession related debts are rising because of deterioration of business operations.

Foreign funds see the deterioration as a sign of opportunity. Several major players specializing in turnaround investments -- Ripplewood, Carlyle and 3i, to name a few -- entered the new market, as did some distressed-assets players. Major distressed-assets player Lone Star bought a majority of shares of ailing Tokyo Sowa Bank and revamped it under the name Tokyo Star Bank in 2001. Cerberus invested in retailer Nagasakiya, but it exited without making a profit.



Origin: US
Previous Deals in Japan: 
A number of golf courses, buildings and land.
Invested in failed supermarket Nagasakiya, but later exited.
Amount of fund: 200 billion yen (estimate)
Areas of Interest: Distressed assets

One of the most secretive funds in Japan, Cerberus was one of the early arrivals and has been a key player in the distressed debts markets. It may have some interest in turnaround buyout opportunities, but could lack the skills to turn Japanese businesses around, according to Motoya Kitamura of the Mitsubishi Research Institute.
Lone Star Japan
Previous Deals in Japan:
Failed regional bank Tokyo Sowa, now called Tokyo Star Bank. Consumer finance company, Minebea, now Star Finance. Various high-profile golf courses.
Amount of Fund: 800 billion yen -- 70% earmarked for Asia.
Areas of Interest: Golf courses, buildings, land, banks.

A golf course gobbler. One of the early comers to Japan, Lone Star has bought a number of golf courses across the country, while investing in bubble era condos. More recently, it is looking at real estate investment trusts (REITs). Also active in picking up financial institutions. Tokyo Star Bank started operations last year, aimed at grabbing Tokyo's niche market of small and medium-sized corporations as well as individuals. Also seems to have deep political connections Ñ the chairman is Yoshio Terasawa, ex vice president of Nomura Securities and former minister for economic planning.

Initially, these funds seemed to be more focused on buying out an entire corporation as there were ready-made deals offered by the government. At the peak of Japan's financial crisis, the government was in a hurry to get rid of sick banks such as LTCB, Tokyo Sowa and Kofuku Bank; they even offered dowries via public money injections. In the case of LTCB, the government removed a significant portion of debts before Ripplewood came in; it has also given Shinsei the right to nullify a certain portion of loans that go bad in the future. But, these ready-made deals are rare nowadays and buyout deals have been slow in materializing as corporate restructuring and industry streamlining -- both of which were supposed to boost buyout opportunities -- failed to take off as fast as they were expected to. Economic reforms that prime minister Junichiro Koizumi pledged have been slow to come.

Turnaround investments normally take three to five years before they become profitable, so there's more at stake than there is with the quick selloff of real-estate-related debts. In the case of Japanese corporations, which take longer to make decisions and go through the due diligence process than Western companies, turning a company around can take even longer. In addition, a lack of corporate governance or pressure from shareholders often works as a drag on the company, and changes come slowly. The fact that very few managers in Japanese corporations have stock options also makes them reluctant to act responsibly and quickly in times of trouble, sources say. Also, as Japanese corporations are often run by owners themselves, they tend to stay on until the very end, trying to make last ditch efforts to survive. "When we were raising our fund targeted for Japan, we told investors, 'please make sure you know the (the whole process) will take longer in Japan than in the US, perhaps as long as five to seven years,'" says Ripplewood's Nonomiya.

Buyout activities recently have been more focused on non-core businesses of ailing corporations, which are spun off and pushed toward an IPO or used as a platform for building a bigger, healthier corporation. For example, Carlyle Group purchased ASS, a cash-transport and security subsidiary of troubled supermarket giant Daiei, for JPY10 billion in January. "The firm was No. 1 in that industry," says Haruyasu Asakura, managing director at Carlyle Group. "There are a number of smaller corporations in the industry; some of them are subsidiaries of larger corporations, others independent. We've decided that ASS will be a platform and our scenario is that ASS will acquire these players.  

The Carlyle Group  (Japan)
Origin: US
Previous Deals in Japan: Invested in ASDL operator eAccess 
(JPY3 billion)
Daiei's security subsidiary ASS (JPY10 billion)
Photo: managing director Haruyasu Asakura, an experienced buyout professional formerly with Apax Globis Partners, former executive at Mitsubishi Corporation
Amount of Fund: JPY75 billion in Asia
Areas of Interest: Telecommunications, media, technology, manufacturing, consumer goods and corporate outsourcing services.

Carlyle is one of the world's biggest private equity groups, with more than JPY1.7 trillion under management globally. Asakura describes its investment style as similar to Ripplewood, but probably closer to European style management-led buyouts. He says that the firm retains a strong sense of independence: "Any alliance may cause a conflict of interest and I personally think it's better to be independent."

"If we look at the Japanese industrial structure as a whole, we see huge conglomerates in-source everything within the keiretsu system," Asakura continues. "Daiei is a retailer, but it had this security company. Generally, Japan's economy is changing in a direction where these companies (spin off) their non-core businesses, or in other words, outsource them. We find this category attractive." Ripplewood Japan also has a similar strategy. "We first select an industry in which structural changes are about to come," Nonomiya says. "The basic idea is that we buy a company that can be a platform."

The basic idea for Ripplewood is the same in Japan as it is in the US: The company makes a key purchase in an industry, then brings in 'industrial partners' as well as investment professionals to jointly do some screening to select a particular target and sketch out a scenario for making it profitable, Nonomiya says.

But no matter how straightforward the explanation is, buyout funds still raise eyebrows in Japan. Asakura says, "Although all of us are Japanese who have worked in traditional Japanese corporations for a number of years and have personal credibility, new clients give us a suspicious look, saying, 'You are foreign capital after all, aren't you?' or 'Foreign funds do quite brutal things.' Our first job is to make people trust us."

How 'foreign' are these foreign funds? Let's take a closer look at the most high profile one in Japan -- Ripplewood. It has established two funds in Japan: one is a so-called 'special occasion fund' specifically designed for Shinsei Bank's buyouts and the other is a JPY120 billion fund for the Japanese market in general. Around 40 percent of the latter fund comes from Japanese investors, including Mitsubishi, according to Nonomiya. How about Unison Capital? It has a JPY38 billion fund specifically targeted on Japan and is generally considered a Japanese fund as it is run by Japanese experts. But a huge amount of this JPY38 billion comes from foreign capital by way of a Cayman Island-based fund.

Tasaku of PricewaterhouseCoopers has been in the distressed-asset business in the US and Japan for 20 years. He says the idea that helpless Japanese companies are being preyed on by high-flying foreign vultures is absurd. Some Japanese buyout players make profits "disguising themselves as foreign," he says. "If you say foreign capital is buying up Japan at beaten-down prices, then the owners shouldn't sell in the first place. Those who sell do so because they see some merit." Besides, he says, none of these funds specializing in turnaround investments have really made much profit yet.

In this day of global investments, trying to figure out whether a certain deal is domestic or foreign is becoming increasingly pointless. For example, the record-setting JPY27.5 billion leveraged buyout of sporting goods retailer Victoria last year was led by a three-pronged group -- Japanese investment bank Jafco, Deutsche Bank and US buyout fund Lone Star. Distressed-assets expert Lone Star bought 12 Victoria stores and the land they stood on for around JPY10 billion. It then leased them back to a new company called Jafco Sports Holding. Deutsche Bank put up JPY9.5 billion in financing. The rest of the money came from Jafco, which owns 100 percent of the new company.

"What was interesting in this deal was that it was Deutsche Bank, not the Japanese, that financed the deal and they put a premium on the interest because they were dealing with risky distressed assets," says Motoya Kitamura, a buyout researcher at Mitsubishi Research Institute. "That was something Japanese banks couldn't have done then."

Japanese banks normally finance loans to companies with distressed assets at the same interest rate as they would for healthy companies, if both are in the same keiretsu, or corporate grouping, Kitamura explains. But things are slowly starting to change. More and more Japanese players have come into the distressed-assets market, Kitamura says. They accept new ways of dealing with debt and corporate rehabilitation.

There is no figure showing just how many private equities funds are here and how much money has been pooled specifically for Japan, but industry sources say major players plan to invest well over a total of JPY1 trillion over the next three to five years. "It is easy to say we will invest X billion yen, but there aren't really that many deals around," Tasaku says. "Foreign funds initially came on the idea that there must be plenty of undervalued corporations, but when they come, they don't see that many. Or there may be many, but they just cannot find these deals so easily. The reality is that there aren't as many opportunities as they had hoped."

Buyout funds here are normally worth tens of billions of yen, which is significantly lower than the amount most Western-based funds control. Major funds in the US are often 10 or more times bigger than funds here. These funds are still waiting to see whether investments made in Japan over the past few years have actually become profitable, says Kitamura. "What they care the most about is the quality of management teams and whether the management teams can rebuild the company hand in hand with them."

Newbridge Capital
Previous Deals in Japan: None
Photo: Lee Daniels, managing director, former AT&T Japan president and CEO, former Jupiter Telecom president
Amount of fund:
$1.6 billion (JPY213 billion) in Asia. Although Newbridge raises funds for investment in Asia without specific targets per country, "I believe and I think most of our partners believe that Japan ultimately will be our largest presence; it's just a question of when," says Daniels.
Areas of Interest: Consumer products, financial services, manufacturing, technologies and telecommunications.

NewBridge Capital is an Asia joint venture with two US powerhouses --- TPG and BLUM. Together with its parent companies it manages $12 billion (JPY1.5 trillion) globally. Although Daniels refrains from talking about specific deals, "we are still interested in the Japanese financial banking area. There are rumors about KDDI selling DDI Pocket or Tu-Ka. Those would be worth looking at. If Japan Telecom decides to spin off any assets, we would be interested in looking at that."

Daniels of NewBridge says private equity funds need a success story -- like Nissan -- to change their image. Then "people can say, 'look at these private equities. They came in and they purchased these companies, and within a short period of time these companies' profit increased. It was a win-win for everybody involved,'" Daniels says. "So far, there is no bona fide success story that would make people more open to considering that as an option."

Some argue that fast-changing South Korea may be a better place for buyout funds, but Ripplewood's Nonomiya shrugs off the argument: "There is no country that compares to Japan in terms of the size of enterprises with a solid manufacturing industry. We only looked at Japan, nothing else."@

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