The firm’s newly installed managing partner traces a relationship with Japan that runs from lost decade through landmark deals like Toshiba Memory to the country’s emergence as Asia’s buyout hotspot

Olympus Corporation has divested various assets to intensify its focus on medical technology, but the sale of scientific solutions division Evident Corporation to Bain Capital for JPY 428bn (USD 2.7bn) in early 2023 pointed to an evolution in thinking. Evident was not the typical unloved and operationally inefficient unit. The business was performing – the kind of asset corporate Japan is loath to sell.

Scientific solutions, which mainly comprises microscopes and videoscopes, accounted for 14% of Olympus’ revenue in 2022 with an operating margin of 14.7%. But the endoscopic solutions business was bigger and arguably better, delivering four times as much revenue at twice the operating margin.

“They decided to divest because scientific solutions didn’t have as high a return on capital as the other business. Previously, few Japanese companies would have made that decision willingly – even if there was just one dollar of profit, they would hold on,” said David Gross, a co-managing partner at Bain who was a founding member of the firm’s Asia business and launched the Tokyo office in 2006.

“This was an intentional portfolio management strategy, and it shows how Japanese governance has evolved to a higher echelon.”

Gross’ 24-year career at Bain has taken him from Boston to Tokyo and back to Boston, where he recently replaced Jonathan Lavine as global head, a role shared with John Connaughton. His journey – and that of the firm in Asia – is entwined with the evolution of corporate Japan and how private equity has overcome initial scepticism to be seen as a responsible custodian of divested assets.

Kioxia, a prized flash memory business acquired from Toshiba for JPY 2trn in 2017, features prominently in the deal rundown as Japan’s biggest corporate carve-out. But it sits alongside the likes of MEI Conlux, Jupiter Shop Channel, and Proterial, each of which contributes to a narrative punctuated by multi-year sourcing efforts, careful stakeholder engagement, and operational heavy lifting.

Bain remained committed to Japan even through the late 2010s when other global sponsors were pulling back, and it has made 30 investments to date – not only carve-outs but also founder-succession deals and take-privates. A local team of over 50 investment professionals deploys a significant share of a pan-Asian fund that has increased in size with each vintage as well as a dedicated Japan mid-cap vehicle.

End of the miracle

In presiding over this expansion, Gross has at times been given cause to reflect on his personal narrative, not least with Bain’s acquisition of NEC Biglobe in 2014. He was sitting across from the company that gave him his first job out of college in 1992, nurturing an interest in Japan – and a familiarity with its corporate culture – that has proved invaluable.

This interest was piqued a few years earlier on visiting the country for the first time. Resolving to move to Tokyo after graduation, Gross was recruited by NEC as part of an initiative to attract young professionals who could be trained up to run the company’s myriad overseas subsidiaries. It was the tail-end of the Japanese economic miracle and cracks were beginning to show.

“I got there when the party was starting to end,” Gross recalled. “The bubble burst in 1990 and the lost decade began a few years after that. Companies were big and fairly bureaucratic, with a lot of layers and lifetime employment. That’s great when you want an unlimited number of employees. But when businesses stopped growing, or started shrinking, that became a problem.”

In his view, Japan’s challenges were rooted in the commodification of technology hardware and a failure to pivot on the emergence of lower-cost competition in South Korea and Greater China. The country made its name through heavy capital investment-oriented manufacturing, exporting high volumes at high quality. It didn’t adjust well when the opportunity set shifted from hardware to software.

By then, Gross had returned to the US for business school and then a consulting job at Bain & Company. He joined Bain Capital in 2000. A Ripplewood Holdings-led consortium made headlines around that time with the acquisition of Long-Term Credit Bank of Japan – which was subsequently turned around and relisted as Shinsei Bank – but Gross did not envisage relocating to Asia.

“Japan wasn’t on the radar for private equity,” he said. “There was no growth and the model was unclear. I went to a couple of conferences in New York about Japan private equity. Wilbur Ross [who bought another distressed Japanese bank] presented at one of them. It was interesting, but I ended up thinking, ‘This is never going to happen. There will never be a US-style PE industry in Japan.’”

Nevertheless, Bain picked him to help set up its Asia business in 2006. A debut fund closed the following year on USD 1bn – the firm closed its fifth Asia fund in late 2023 on USD 7.1bn – by which point a couple of Japan deals had closed. The first, MEI Conlux, was a payment systems provider owned by Mars. Bain and Advantage Partners acquired it for USD 570m, leveraging the US-Japan cross-border element.

Gradual transformation

Eight years later, Bain secured Biglobe, described by Gross as the inaugural pure carve-out from a Japanese corporate. In the interim, several deals closed that didn’t quite fit the profile.

For example, by the time Bain acquired call centre business Bellsystem24, its parent, Nikko Cordial, was already part of Citi. Meanwhile, Jupiter Shop Channel was deliberately structured as a 50-50 joint venture with Sumitomo Corporation rather than a carve-out, though the private equity firm was said to have retained governance control and a mandate to drive value.

These transactions coincided with a low point in Japan private equity. Nearly USD 40bn was invested between 2005 and 2007, but multiple large-ticket buyouts struggled in the wake of the global financial crisis and GPs became cautious. Annual average deployment for 2008 through 2015 was USD 6.9bn. Unlike some of its peers, there was no internal pressure at Bain to withdraw from the market.

“It seemed like we hadn’t had enough time to test the thesis. They knew it was a significant down cycle, and we should give this more of a chance. The economy wasn’t doing anything, but no one was under the illusion that we would experience a lot of growth in Japan,” said Gross.

“It was always first about profit improvement. If you could take these undermanaged businesses, bring in best practices and fix the cost structure, you might be able to get things going. You did the deal based on the profit improvement you thought you could generate. The upside was getting some growth.”

Skylark represented a turning point. Bain acquired the restaurant chain – a nationally recognised brand – for JPY 160bn in 2011 after a previous private equity buyout resulted in a restructuring, turned it around, and took it public three years later. Aside from the earlier distressed bank deals, Gross points to it as one of the first end-to-end private equity success stories in Japan at scale.

By 2016, Japan was a market transformed. PE investment hit USD 11.5bn and rose to USD 25.1bn the following year, largely on the back of Kioxia. Since then, annual average deployment has been USD 22.3bn. Corporate governance reforms pushing corporates to prioritize performance over size – thereby facilitating divestments – are often cited as a key driver of deal flow, but Gross is more circumspect.

“They are a contributing factor, but not because of any single reform making an immediate difference. Rather, Japanese executives who were more progressively minded and thinking about doing things got air cover,” he noted. “And at the same time, there was finally a successful vintage of deals in Japan. People recognized you could make good investments in the country.”

Toshiba and beyond

While private equity’s status as an acceptable solution was underlined by Kioxia, the deal was unusual. Toshiba’s flash memory business was the second-largest of its kind globally and the mainstay of a storage and electronic devices solutions unit that accounted for 28% of the company’s revenue in 2016. It was only put up for sale to alleviate stress caused by the nuclear power unit filing for bankruptcy.

“We had been talking to Toshiba for years. They had a lot of businesses, some of which were sold. The division you never asked about was Toshiba Memory because it was the crown jewel. It took a dire set of circumstances for them to consider selling it,” said Gross.

Bain had to put together a consortium that was large enough to cover the equity cheque and in line with requirements that Japanese investors – including Toshiba, which rolled over a portion of its stake – held at least 50%. Meanwhile, there was resistance from Western Digital, which claimed power of veto via a joint venture with Toshiba, and a tortuous, multi-jurisdiction antitrust approval process.

Seven months passed between Toshiba shareholders voting for the deal and Chinese regulators signing off in May 2018. The process was slowed by the US imposing tariffs on imports from China, prompting Gross to describe it as one of the first victims of the breakdown in global free trade. He declined to be drawn on whether such a deal would be possible today following the escalation in US-China tensions.

There have been other notable carve-outs, from Evident with its insights into the evolution of strategic thinking to Proterial, Japan’s second-largest closed PE buyout after Kioxia at JPY 817bn and another long-slog approval process. Succession and take-privates are more conspicuous in Bain’s recent deal flow, but Gross believes more can be extracted from corporate Japan as market dynamics shift.

“We are still working through the backlog, there’s a lot of room left for those same theses. We are also seeing businesses that have a lot of real estate. You need to be able to evaluate that and maybe you find a way to sell it or do a sale and leaseback,” he explained.

“Then we see activist situations here and there. Activists will buy small stakes, enough to agitate and make recommendations. Sometimes the resolution is us paying a premium to take it private, and we wind up doing a lot of the things they suggested, but in a more holistic manner. Rather than taking the excess cash as a dividend payment, we are presenting a strategic vision for the business.”

Japan picture to big picture

Japan’s buoyant public markets have proved an obstacle to securing certain assets in the past year or so as seller expectations have risen. At the same time, competition has intensified with more global and pan-regional private equity firms targeting the country and a clutch of local GPs increasing their fund sizes to the point where they are edging into territory typically occupied by Bain and its peers.

Gross plays down the notion of too much capital chasing too few deals. First, most buyouts of meaningful size must be financed by a combination of three domestic banks and they will not support an unlimited number of competing bids. Second, capital is just one aspect of a complex deal sourcing and execution matrix reliant on proprietary relationships and finding the right stakeholder balance.

“This has never been a market where you just go out and buy a company. You need the right political-corporate-human dynamics coming together, and it’s a dark art, figuring out what is required for that,” he said. “Having more qualified private equity professionals in Japan engaging in those dialogues would stimulate the market, but those are hard to find, as ourselves and others have discovered.”

Gross has been splitting his time between Tokyo and Boston for a while, increasingly skewing towards the latter and getting involved in firm-wide initiatives. Bain’s approach to succession is, in his view, systematic and planned, with an emphasis on smooth transitions and retention of talent. Lavine, for example, went from head of credit to managing partner in 2016 and has now become group chair.

Moving from an Asia-centric to a global role brings certain big-picture themes into focus, not least how large-cap private equity firms think about expansion across asset classes and the impact of a sustained period of higher interest rates on investment. The interest rate adjustment is described as a not unwelcome return to more of a fundamentals-based reality, but it puts pressure on other competencies.

“We must be thoughtful about capital structure and concentrate on driving the operating value of businesses because we can’t rely on leverage and maybe not on multiple expansion either,” Gross said. “It plays into our model, but we must continue to move up the curve in how we add value – leveraging technology, global angles, and specialists in our portfolio group that are deep in certain disciplines.”