Research Report: Japan private equity: A new era of opportunities
Now is a good time to be a local General Partner (GP) in Japan. Contrary to the global picture of slowing deal activity, exits and fundraising, Japan is experiencing strong private equity dealmaking with an abundance of target companies with decent growth potential, and a buoyant fundraising environment. It was the only Asia-Pacific private equity market that grew in 2023, according to Bain[1].
Many international investors have pulled back from China, which has long taken the lion’s share of LPs’ Asian private equity allocations. Global private equity and venture capital investment in mainland China fell to $68.8 billion in 2023, a five-year low, amid US-China political tensions, escalated by regulatory actions by both countries, and concerns about slowing economic growth. This has spared significant budget for alternative Asian destinations such as Japan, Australia, and South Korea. Japan is an increasingly attractive option for a plethora of reasons.
Drivers of growth
Stability is what Japan has come to be known for. A stable regulatory environment and weakened yen, which has come down by around a third against the dollar over the last several years, are among factors enhancing the appeal of Japanese assets to foreign investors. Japan has proven itself a resilient market in the face of macroeconomic uncertainty.
However, the Bank of Japan’s move in March to raise rates for the first time in 17 years begs the question: Is this the beginning of the end of the era of low-cost financing? Though there is no indication of further policy tightening, two-thirds of economists surveyed by Reuters predict another hike this year[2]. Still, any hikes are expected to be minimal and Japan is an attractive destination for yield spread against borrowing costs – particularly in the middle market – so “the relative attractiveness of cash-on-cash returns, considering leverage and other factors, is unlikely to significantly decline as long as interest rate hikes remain gradual”, according to a CBRE report[3].
Improved corporate governance has been an important driver of Japan’s resilience. In recent years, the Japanese government has launched a series of measures to boost domestic productivity and global competitiveness, including revisions of the Stewardship Code and Corporate Governance Code. Meanwhile, the Tokyo Stock Exchange has been urging all companies listed on its Prime and Standard Markets to take “action to implement management that is conscious of cost of capital and stock price”. With the spotlight on the nearly half of TSE-listed companies trading below book value, leadership teams have been under pressure to enhance corporate value. And investors are increasingly holding directors to account for perceived shortcomings.
According to the latest information from the TSE, nearly half of companies on the bourse’s Prime Market have provided a business plan to improve capital efficiency.[4]
A shift in mindset
Looking to escape the growing burden of tightened listing requirements and shareholder activism, Japanese listed companies are more seriously considering private equity bids than ever before.
Selling off to the private sector is no longer a taboo carrying fears of high leverage and reduced valuations. There has been an awakening to the notion that actually, the right GP can invest in the business to boost operational efficiency, uncover hidden pockets of value, improve margins and future proof the business.
In 2023, private equity deal value in Japan was up 183% compared to the prior five-year average, according to Bain data. Key streams of deal flow include:
Public-to-private management buyouts (MBOs)
The realisation that public markets may not be the right home, especially for a lot of family-owned businesses, has spurred the growth of MBOs, both in terms of frequency and value. In 2023, there were 26 MBO announcements in Japan – the highest number since 2010 – with a combined value of $2.4 billion, according to data from LSEG[5].
By selling to a private equity fund, the members of the founding families who typically lead the MBO can cash out a part of their assets in the assurance that their business will be led by a professional management team who can improve governance and more efficiently execute the strategy for the long term.
Business succession deals
In a population that is both aging and shrinking from its 2010 peak[6] and a cultural context in which many businesses are held by families, the average CEO in Japan is over 60 years and – in many cases – has no suitable successor.
It is no surprise that business succession deals make up over 60% of private equity deals in Japan, according to an analysis by Deloitte Asia Pacific’s Satoshi Sekine[7]. As business owners become more receptive to private equity as a solution to their succession dilemma, this trend is expected to continue.
Corporate carve-outs
Corporate carve-outs, spin-offs and divestitures have been on the rise amid growing corporate governance pressure on leadership teams to dispose of underperforming or undermanaged non-core assets and double down on their core business units.
According to a McKinsey report, six of the 10 closed private equity deals worth more than ¥100 billion ($670 million) since 2020 were carve-outs[8]. As governance reform pushes more companies to restructure and streamline their operations, GPs should see more opportunities to snap up and breathe new value into these businesses.
Foreign investors get in on the action
While challenges remain – such as the recruitment and retention of local private equity talent and uncertainties surrounding a potentially stronger yen – overseas investors have been paying attention to the favourable forces at play. Private equity is taking on a more prominent role in Japan’s financial landscape and both domestic and international players are looking to get in on the action: the attractive risk-return profile, the significant potential for performance improvement, and of course, the returns – Japanese buyout funds launched between 2010 and 2023 had delivered a 1.01x median Distributed to Paid-In Capital (DPI) as of January, versus 0.42x in Australasia and 0.13x in India, according to CEPRES data[9].
Some Limited Partners (LPs) are even making exceptions to their minimum commitment size to invest in a local GP. Endowments and other institutional investors are used to committing at least $100 million, but most local managers in Japan remain relatively small, with a fund size of under $1 billion . With conviction in the returns potential of Japanese businesses and the high-quality homegrown managers that they are backing, LPs are in some cases lowering their investment thresholds to $30 million. They understand that down the line ticket sizes are likely to increase, and that getting in early and fast to gain a foothold in this market will pay off.
Against a backdrop of challenging global markets, it is no wonder that Japan has emerged as a hotspot for private equity. We expect the market to expand rapidly over the next few years and will be watching with keen interest as it develops.
[1] https://www.bain.com/insights/asia-pacific-private-equity-report-2024/
[2] https://www.reuters.com/markets/asia/boj-will-raise-rates-again-this-year-say-two-thirds-economists-2024-04-19/
[3] https://mktgdocs.cbre.com/2299/81810afe-0fbe-4d8d-9969-5d076fc0c0bb-520610414.pdf
[4] https://www.pzena.com/japanese-corporate-governance-reform-1q24/#footnotes
[5] https://www.ft.com/content/a2ff9efc-0c4e-4dbe-ae41-cf373cde66a9
[6] https://www.preqin.com/insights/research/reports/private-equity-and-venture-capital-in-japan-2023-preqin-territory-guide
[7] https://www.deloitte.com/global/en/services/financial-advisory/perspectives/breaking-new-ground.html
[8] https://www.mckinsey.com/industries/private-capital/our-insights/a-force-for-good-japans-private-equity-opportunity
[9] https://www.privateequityinternational.com/integrals-1-2bn-close-points-to-heady-year-for-japanese-fundraising/#:~:text=Japan%20has%20typically%20performed%20fairly,benefit%20from%20several%20other%20tailwinds.
