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Governance reforms turn Japan into Asia’s bright spot for private equity – AVCJ Forum

  • Pressure on listed companies, updated M&A code are driving deal flow
  • Activists are making a healthy and increasingly influential impact on the market
  • Competition among global and domestic private equity investors is rising

Corporate governance reforms will continue to drive private equity activity in Japan, having already taken the deal flow to record levels in 2023, according to Azusa Owa, a Tokyo-based partner at Bain & Company.

Speaking at last month’s AVCJ Private Equity Forum Japan 2024, Owa highlighted the impact of revisions to the country’s corporate governance code as well as more recent M&A guidelines from the Ministry of Economy, Trade, and Industry (METI) and pressure from the Tokyo Stock Exchange (TSE) on listed companies to improve performance.

“What the TSE is asking corporates is to focus on the cost of capital and then make sure you act on the improvement, and then report to the market with transparency,” said Owa, referring to a requirement that listed companies trading below book value issue plans to improve their valuations. Consequently, more companies are said to be talking to PE investors about take-private transactions.

Take-private and corporate carve-out opportunities coincide because listed subsidiaries of Japanese conglomerates are among the most likely assets to be divested, she added.

Japan became the largest private equity market in Asia Pacific last year, accounting for 30% of regional deal volume. The amount of capital put to work in the country in 2023 was nearly twice that seen in 2021 or 2022, said Jim Verbeeten, another partner at Bain & Company. He described Japan as a “bright spot in Asia” given the headroom for growth and weakening sentiment on China.

Elaborating on METI’s M&A guidelines – which focus on responses to takeover proposals – Verbeeten observed they not only encourage activist investors but also facilitate “market checks” by companies. “Before you just accept a friendly offer, can you, the board, go and check in the market what the company is worth?” he explained. “This creates opportunities for private equity.”

The role played by activists was described as healthy and increasingly influential, whether these investors are asking companies to solicit bids to ensure optimal value or taking direct action and bringing bids to companies. Owa noted that the 100-plus activist targets in Japan last year were based solely on publicly disclosed situations and the actual total could be higher.

“The market is excited, and we’re expecting an increase in shareholder value when activists engage on an asset,” she said, adding that companies with market capitalisations of JPY 50bn-JPY 300bn (USD 310m-USD 1.9bn) represent the sweet spot for activists.

Japan appeals to private equity investors because valuation multiples have been relatively attractive and there tend to be plentiful opportunities to improve EBITDA through value-creation initiatives. Despite the country’s solid deal flow, Verbeeten warned that competition for assets is intensifying as more international GPs enter the market and local PE players increase their fund sizes.

“If you’re a domestic GP and you have, say, a JPY 50bn fund and you invest in about seven assets, if you were only to look at listed assets, there are about 700 target companies,” he said. “If you double the fund size, that reduces to 400. Your universe of targets shrinks simply because the industrial structure in Japan, like in any market, is a bit of a pyramid.”

Local private equity firms must also take steps to ensure their top dealmakers don’t get poached by international GPs looking to build out in Japan. But recruitment isn’t the only challenge for large-cap market entrants, with Verbeeten emphasising they must articulate their differentiation and their “right to win in Japan.”

Investing in the country is a long-term game, he added, citing The Blackstone GroupApollo Global Management, and EQT as examples. In each case, about two years passed between the revelation of an intent to enter the market and that debut deal getting done.