Firms targeting assets divested by conglomerates still face obstacles, though barriers to PE investment in Japan are gradually falling.

By Stuart Beraha, Noah Carr, Tom Evans, Hiroki Kobayashi, Ivan Smallwood, David Walker, and Catherine Campbell 

Many hurdles that traditionally challenged private equity firms looking to invest in Japan have been lowered in recent years. The Japanese government is increasingly supportive of overseas buyers, addressing legal, structural, and cultural obstacles and creating renewed interest in the country’s conglomerates, many of which house non-core assets ripe for acquisition. While the environment for foreign private equity buyers has improved considerably, deal teams should be aware that significant general and target-specific challenges remain.

Decreased Barriers Bring Increased Opportunities for PE Investment

Many of the barriers to deals are falling, with traditional cross-shareholder arrangements (where Japan’s large corporate groups held significant stakes in each other’s shares) being substantially unwound, and the adoption and incremental improvement of statutory squeeze-out and tax-free spin-off mechanisms. 2017 revisions to the Financial Services Agency-sponsored Stewardship Code, a set of principles voluntarily adopted by institutional investors, actively encouraged the divestiture of non-core assets by expressly citing the need to enhance medium- to long-term corporate value and encouraging institutional investors to collaborate as needed. Further, the government’s drive toward enhanced corporate governance and shareholder returns includes an increasingly open attitude towards foreign capital.

Much More Than a TSA — Be Prepared for Deal Complexities

Although Japan’s conglomerates are encouraged to divest non-core assets, deals remain challenging.

Often the business being sold will simply be a division of the seller that needs first to be carved out. Even if the target is held in a subsidiary, the parent will often hold key assets such as intellectual property. Beyond key assets, substantial dependencies will typically exist between the seller and the business, in both directions, and disentangling those businesses will require attention — more so than European deal teams will be accustomed to. Many Japanese conglomerates are not structured to facilitate selling entities or groups of assets, posing significant difficulties for deal teams.

Even if the business being sold is a listed subsidiary, some of the same dependencies may still exist and, where the target’s management is involved, the target’s board likely will seek to comply with the Ministry of Economy, Trade, and Industry’s new Fair M&A Guidelines, using a special committee of independent directors, which may seek to assert its independence by imposing its own pricing or other requirements to approve the sale.

Market Challenges Remain

Despite an increasingly open attitude from the government and the market, in an era of growing protectionism and enhanced focus on national security concerns, some sectors still present obstacles for overseas buyers. Japan’s Foreign Exchange and Foreign Trade Act, equivalent to the Committee on Foreign Investment in the US, applies to a broad range of sensitive sectors, including transport, energy, broadcasting, telecommunications, and software. Acquisitions in these areas are subject to substantial government involvement, as seen in Bain’s Toshiba Memory acquisition. Special attention must be paid to the composition of consortia bidding for such assets.

The cultural issues that have traditionally arisen in cross-border M&A transactions for Japanese assets also continue to test private equity buyers. Firms should prepare for atypical requests — such as a seller’s desire that the buyer protect employees of the sold business going forward — that can be challenging for buyout firms to accommodate.

Open for Business

Japan is now more accessible to foreign private equity buyers than ever before, but while the trend continues in the right direction, many challenges remain. In our view, successful execution still requires a long-term investment in understanding the local business culture. An advisory team with experience in Japanese cross-border private equity and M&A transactions — that includes international IP and technology expertise on the ground — is critical to navigating the remaining obstacles in a market that offers many opportunities.