In the booming global M&A market, few areas have been as hot as Japan. Mergers involving Japanese companies have more than quadrupled in the past four years as the corporate sector moved aggressively to restructure after the country’s lost decade of economic stagnation, and foreign buyers arrived to pick up Japanese assets on the cheap.
Now, in a twist that demonstrates the renewed vigor and confidence of Japan Inc., the biggest growth in merger activity is taking place overseas. Japanese companies are venturing abroad in search of deals, looking to capitalize on their newfound health and open fresh avenues for growth. And the country’s big banks, themselves products of mergers in recent years, are flush with funds and only too happy to finance the takeover wave.
“Japanese firms realize the importance of restructuring, and now that the economy is in good shape, they are eager to search for new opportunities,” says Isao Kubota, a professor of economics at Teikyo University in Tokyo and former chairman of Lone Star Japan Acquisitions, an arm of the U.S. buyout firm.
That view is echoed by Seiji Sato, a senior M&A banker at Daiwa Securities SMBC Co. in Tokyo. “Opportunities for growth are limited in Japan, given the decreasing population,” he explains. “The domestic market is saturated, so companies are looking overseas for further growth.”
Sato should know. His bank advised Nippon Sheet Glass Co. on its recent £3 billion ($5.5 billion) acquisition of the British glassmaker Pilkington Group, a company approximately twice its size. The deal, which was completed in June, puts NSG at rough parity in terms of sales with the industry leaders, Japan’s Asahi Glass Co. and France’s Saint-Gobain, and gives the Japanese company a big presence in the European and U.S. markets, as well as a foothold in fast-growing emerging markets like China and India.
“We cannot look only at Japan for expanding our operations,” company president Katsuji Fujimoto said at a recent symposium in Tokyo, explaining the rationale for the deal.
Japanese companies announced 162 acquisitions of non-Japanese entities worth a total of $20.8 billion between January and mid-August, according to capital markets data provider Dealogic. That is more than the $15.9 billion worth of overseas acquisitions announced in 2005 and five times 2003’s total, when Japan Inc. was still struggling with deflation and stagnant growth at home. The outward-bound M&A compared with $105.4 billion of deals for Japanese targets announced in the first seven months of this year.
Japanese companies have gone on overseas buying binges before, of course, notably in the heyday of the country’s late 1980s bubble economy, when Sony Corp. snapped up Columbia Pictures Corp. and Mitsubishi Estate Co. bought New York’s Rockefeller Center. Most of those high-priced purchases turned out badly, however. Mitsubishi Estate ceded control of Rockefeller Center to a real estate investment trust in 1995, when the partnership it used to control the property went bankrupt. Columbia, although still in the Sony fold, has been a drain on its parent’s earnings and management time for much of the past 17 years.
This time the surge in overseas acquisitions looks more sustainable. Unlike the bubble-era deals, when massive domestic liquidity prompted Japanese entities to overpay for trophy properties, today’s purchases are mostly strategic, says one senior U.S. investment banker in Tokyo. Having fixed their problems at home, Japanese companies are looking overseas to grow their product range and extend their geographic reach.
“You have to be a global player to survive in the competitive international environment,” sums up Hiromi Yamaji, executive managing director for investment banking at Nomura Securities Co. in Tokyo.
Such global considerations drove Toshiba Corp. to agree to buy Pennsylvania-based Westinghouse Electric Co. from its U.K. parent, British Nuclear Fuels, for $5.4 billion in February. The deal, which is pending U.S. regulatory approval, will make Toshiba the world’s largest supplier of nuclear power plants and give it a strong U.S. and international presence to go with its domestic dominance. President Atsutoshi Nishida says he hopes the acquisition of Westinghouse - and its pressurized water reactor technology, which Toshiba had licensed - will help his company win the lion’s share of any new orders in the U.S., where utilities are mulling the construction of some two dozen reactors after a near 30-year hiatus in orders, as well as a third of the ten to 15 plants that are planned in China.
Toshiba trumped competing bids from Mitsubishi Heavy Industries of Japan and General Electric Co. to win Westinghouse. It is negotiating to sell as much as 49 percent of the business to three partners - Japanese trading company Marubeni Corp., engineering firm Ishikawajima-Harima Heavy Industries Co. and U.S. engineering outfit Shaw Group.
The upsurge of merger activity is a welcome sign of the Japanese industry’s renewed vibrancy after the retrenchment of the ‘90s. The collapse of the economy left the corporate sector deeply in debt and awash with surplus capacity. Many Japanese companies were forced to abandon their ambitions of global dominance and focus instead on paying down their borrowings and reorganizing their domestic operations.
The need to restructure sparked an upturn of domestic merger activity in the late ‘90s and early part of this decade, a trend enhanced by legislative reforms that included the lifting of a ban on holding companies in 1997 and the creation of a divestiture system in 2001 that enables companies to swap assets. When it came to cross-border transactions, however, the most notable deals involved foreign purchases of distressed Japanese assets, so-called out-in transactions. These included French automaker Renault Corp.'s 1999 purchase of a controlling 44 percent stake in Nissan Motor Co. and private equity firm Ripplewood Holdings’ acquisition the same year of the former Long Term Credit Bank of Japan, since renamed Shinsei Bank.
“In the 1980s, 90 percent of cross-border transactions in Japan were in-out, but after that the majority were out-in,” says Nomura’s Yamaji. “Now the traffic is both ways.”
Stronger balance sheets and resurgent profits - corporate earnings have grown at a double-digit pace for the past three years - have put Japan Inc. in a more expansive mood. Acquisitions of foreign companies have been on the rebound since 2004, when Sony led a consortium that bought U.S. film studio Metro-Goldwyn-Mayer.
“Japanese companies were becoming much more confident about the outlook for their companies and what they could do,” says Stefan Green, managing director for investment banking at Goldman Sachs Group in Japan. “They had done a lot of work in preceding years to cut costs, improve cash flow and start paying back banks. Corporate management found they had cash on hand, they had stabilized their businesses, improved margins, and now they wanted to start growing rapidly.”
Japanese companies initially targeted Asia for acquisitions, but in the past two years, they have turned their sights on the U.S. and Europe. Companies announced $8.6 billion worth of U.S. acquisitions between January and early August and $5.0 billion worth of European deals, compared with $5.2 billion in Asia. “What Japanese companies started to realize, especially larger ones, was that they needed to push into the U.S. and Europe to generate substantial top-line growth,” Green says.
The ready availability of cheap finance is fueling companies’ appetite for foreign acquisitions. Although the Bank of Japan just raised interest rates for the first time in almost six years, they remain extraordinarily low by international standards, with many companies able to borrow at rates of about 3 percent or slightly higher.
Just as important, the restructuring of Japan’s banking sector has produced a handful of megabanks with ample lending capacity. That financial clout has helped the banks climb the ranks of M&A advisers. Through early August, Daiwa Securities SMBC had risen to second place among merger advisers in Japan from seventh a year earlier, thanks in part to the firepower of its 40 percent owner, Sumitomo Mitsui Financial Group, the country’s No. 2 bank by assets. Daiwa SMBC worked on 57 deals worth $24.6 billion, just behind top-ranked UBS, which advised on $24.8 billion worth of deals, according to Dealogic. Daiwa SMBC advised Nippon Sheet Glass on the Pilkington deal, along with UBS and Lazard. The bank also helped finance the transaction by arranging a ´45 billion ($390 million) bank loan and leading a ´110 billion convertible bond issue for NSG.
Foreign banks dominated Japan’s merger business several years ago but “these days the situation has changed,” says Yoshikazu Fukushima, general manager of M&A at Daiwa SMBC. “As transactions involve a lot of financial structuring, as well as strategic simulations in Japan or in overseas business, they also need assistance from Japanese professionals.”
Mizuho Financial Group, the country’s third-largest bank by assets, rose to fourth place, behind Citigroup, in the M&A league tables, advising on 40 deals worth $18.9 billion, while Nomura Securities ranked fifth, according to Dealogic.
Companies are loath to use equity as an acquisition currency because such transactions require shareholder approval and because many foreign investors sell shares received as part of a takeover, which tends to depress the acquirer’s share price, bankers say. Toshiba financed the Westinghouse purchase with two syndicated credit lines of ´200 billion each, led by Sumitomo Mitsui Banking Corp. and Mizuho.
Another factor driving the merger wave is the growing presence of foreign shareholders in Japan’s equity market. The proportion of Japanese stocks held by foreigners rose to 24 percent last year from 6 percent in 1991. These investors are more outspoken than their Japanese counterparts in demanding growth, prodding managements to do more deals, bankers say. By contrast, the proportion of cross-shareholdings among Japanese companies and closely linked financial institutions - a web that has tended to discourage M&A in the past - has fallen to 20 percent in 2005 from 46 percent in 1991.
The increase in foreign takeovers looks set to continue, bankers say. For one thing, a much wider variety of Japanese companies are now seeking acquisition targets.
“Big Japanese companies that already have global operations have not been very aggressive in using M&A as a tool, but you will see it becoming more and more important for them,” contends Goldman Sachs’ Green. Japanese trading companies are eager to acquire energy and commodity assets that they can link to their global networks. In December 2004, for example, Mitsui & Co. teamed with International Power, a U.K.-based electric utility, to buy 13 power plants in Europe, Asia and Puerto Rico from Edison International, a U.S. utility, for $2.3 billion.
Small and medium-size Japanese companies also are increasingly looking at mergers as a way of expanding into overseas markets, bankers suggest. Last year Toppan Printing Co. paid $650 million to acquire Texas-based Dupont Photomasks, a maker of semiconductor manufacturing components; engineering group TDK Corp. bought the Lambda power supply business of the U.K.'s Invensys for £235 million ($410 million); For-side.com, a provider of mobile phone content, acquired the British mobile information and entertainment provider iTouch for £67 million; and cosmetics group Kao Corp. bought U.K. skin-care products maker Molton Brown for £170 million.
“You are going to see medium-size Japanese companies, the majority of whose operations have historically been domestic, starting to use cross-border M&A as a tool,” says Green.
The big challenge facing Japanese companies is to prove they can run their new overseas acquisitions effectively. Early signs are encouraging because businesses are showing more flexibility and sensitivity in managing overseas operations than previously, bankers say.
In the past most Japanese companies would appoint Japanese managers to overseas acquisitions and seek to impose their management practices lock, stock and barrel, often with negative effects. But some of today’s acquirers are looking to retain the management expertise of their new purchases.
At Pilkington, for example, Nippon Sheet Glass raised its offer after an initial bid was rejected and won management’s support for a friendly deal. The two sides know each other well, as Nippon Sheet Glass had acquired a 20 percent stake in the British company in the 1990s. Pilkington CEO Stuart Chambers will continue to run the business and has joined the board of his Japanese parent.
“The background against which Japan’s latest thrust into M&A overseas is taking place is very different from that of the 1980s,” says Nomura’s Yamaji. Back then, he explains, “people did not have a sense of global markets, but the way of thinking is totally different now. Also, maybe Japanese companies were a little bit too confident. Now, they see the world in a more humble way.”
Goldman Sachs’ Green says that today’s Japanese managers are more cosmopolitan and skilled than the older generation’s, which augurs well for the new surge of deal making.
“I believe very strongly that this could mean the wave of overseas acquisitions will be very different from previous ones,” he says. “Managers who are being sent to run the overseas operations in the acquired entity tend to be the stars coming through the system, and they tend to be very well regarded in Japan.”
