Japanese outbound M&A
January 2013 | COVER STORY | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
Japanese outbound M&A has followed a sharp upward trajectory in recent years and 2012 proved particularly successful – by the third quarter, Japanese companies had spent over $66bn in 559 overseas acquisitions. The ability of Japanese companies to run overseas operations has, however, been called into question. Differences in business and management culture have made past transactions difficult, and impacted on post-acquisition operations. What issues exist for Japanese companies eyeing international targets, and what steps can be taken to ensure that transactions succeed in the pre- and post-acquisition phases?
Japanese firms have been making use of overseas growth opportunities for at least the past 20 years. According to Japan’s Ministry of Economy, Trade and Industry, close to three times the number of Japanese firms now have overseas operations compared to 1992. Outbound M&A has surged since late 2009, with 2012 witnessing a record breaking acquisition spree.
January 2012 saw Sumitomo Mitsui Financial Group’s purchase of Royal Bank of Scotland’s aircraft leasing arm for around $7.3bn. This was followed by Mitsubishi Corp’s 40 percent purchase of Encana Corp’s Canadian shale gas assets for approximately $2.9bn in February. Three months later, Marbeni Corp acquired US grain giant Gavilon LLC for $3.6bn. All of these bumper deals, however, were eclipsed by Softbank’s $20bn acquisition of Sprint Nextel in October.
Behind this international expansion are numerous factors, both demographic and economic. “Generally speaking, a shrinking population and market is the biggest driver for Japanese companies to look overseas for new opportunities to grow or survive,” says Hiroyuki Kano, a partner at Clayton Utz. “M&A is the typical way that Japanese firms expand into foreign countries.”
Japan’s economy has certainly struggled since the boom and bust years of the 1980s. With growth expected to be less than 1 percent between 2011 and 2020, according to the Japan Center for Economic Research, the domestic market is unlikely to see significant expansion any time soon. This lack of domestic demand drives Japanese companies to seek growth opportunities abroad. The country’s domestic market is further impacted by its aging and declining population. Japan’s Ministry of Health, Labor and Welfare’s most recent 50-year demographic forecast made for uncomfortable reading. The report suggests that the elderly, who currently make up 23 percent of the population will, by 2060, account for 39.9 percent, with an average life expectancy of 90.93 years for women and 84.19 years for men. Birth rates, meanwhile, are expected to continue their downward spiral.
While this slow decline and aging population is driving many firms to look elsewhere while there is time to act, other factors are also at play. “High costs in Japan have also pushed Japanese companies to shift production and resources out of Japan, which in some cases has spurred outbound M&A,” explains David Sneider, a partner at Simpson Thacher & Bartlett LLP. “The Great East Japan Earthquake in March 2011 further impelled Japanese companies to seek to diversify their production and markets outside of Japan. In addition, the strength of the Japanese yen has enhanced the buying power of Japanese companies, enabling them to bid very competitively for foreign assets as they have become available.” The global financial crisis has seen the yen appreciate to post-Second World War highs against the US dollar.
This appreciation – ranging between 25 and 50 percent in the past two years – has provided companies, especially those with production facilities or service processes, with an incentive to relocate overseas. Toyota reportedly loses ¥34bn in operating income for every ¥1 appreciation against the dollar. In 2011, the firm announced it would spend ¥26.3bn constructing a production hub in Indonesia, aiming to tap into emerging markets. The strength of the currency also makes the move to overseas territories cheaper to achieve via M&A transactions.
Historically, the energy and resources sector has been of particular interest for Japanese acquirers. Japan is a country low on natural resources, relying on imports from overseas. This situation has been compounded by the 2011 earthquake and the shutdown of Japan’s nuclear reactors. With most nuclear generation stopped, base electric power output has shifted to hydrocarbons again. Trading companies have reaped great benefit from buying assets ranging from coal to LNG to oil-bearing tar sands. The past several years have seen a number of significant outbound investments in energy-related industries, such as Toshiba’s acquisition of Landis+Gyr, as well as in natural resource companies and assets. A further impact of Japan’s retreat from nuclear has been an uncertain electric power situation which has served to dampen domestic investment in new or upgraded manufacturing facilities – bolstering outbound M&A.
The pharmaceutical sector is also a particularly active one, says Mr Sneider. “Many Japanese pharmaceutical companies facing low growth prospects in the domestic market, expiring patents, and limited prospects for in-house product development, see outbound M&A as a strategic imperative for their business. The acquisition of an established foreign pharmaceutical company may provide easier market entry into a highly regulated industry, an established regional market recognition and distribution networks or an important new product or pipeline for drug development.” Food security is an additional issue and an increasing number of food companies are going overseas to secure food supply chains upstream.
In regional terms, North America received the greatest attention of Japanese firms in 2012, according to mergermarket data. Japanese acquisitions in North America during the first three quarters of the year added up to $25.2bn – a 234.7 percent increase on the same period in 2011.
Deals in this region accounted for 44.2 percent of the total value of Japanese outbound deals. The energy, mining & utilities sector was the most active for Japanese companies in North America, accounting for $6.6bn worth of deals in the period. Business services was the second-most attractive industry, making up 22 percent of deals in the region.
European firms are the second-most alluring targets, accounting for $21.6bn in the first three-quarters of 2012. The industrial and chemical sector was the most active in the region by volume, where 21 such deals were struck. The focus is, however, beginning to gradually slip away from both the US and Europe, toward China, the wider Asia-Pacific region and Latin America. A significant effort is underway to penetrate the consumer sector in these emerging markets.
Many Japanese companies involved in the current overseas spending spree have been active M&A players for some time. Most are household name automotive and electronic companies, though financial firms have recently become more eager to enter the scene. Since the 1980s bubble collapsed, financial firms have been cautious investors. However, this prudence paid off, and they avoided much of the fallout of the 2008 recession. Such firms have been particularly keen to buy up Asia-Pacific businesses from their European counterparts. Another feature of the current M&A surge is that a large number of the firms involved are those looking to complete their first transaction outside of Japan. This may explain the hurdles that commonly arise when dealing with Japanese firms.
Studies have revealed that international executives find Japanese firms to be more risk averse and detail-oriented than buyers from other developed countries. This can lead to long delays as boards decide key issues. “Typically, the decision making process is very slow due to the layers of approval required within a large Japanese corporation,” stresses Mr Kano. “In particular, there seems to be little flexibility in terms of the timing of board approval or executive committee approval – these approvals can often only be obtained once a month, on a particular date of the month, for example.” Once decisions are finally made, deals tend to progress quickly; however, such delays are not conducive to the M&A process, which requires parties to be flexible and quick to respond – especially in auctions with competing bidders. Japanese companies that prepare well in advance, consider a range of options, and enable their deal teams to act with authority and respond quickly in fast-paced negotiations, tend to meet with success.
The language barrier can provide a further challenge. Customarily, Japanese firms have been relatively more insular and less aggressive than their global counterparts. As a result, many firms lack employees experienced in M&A, who are also appropriately fluent in English. This issue more commonly affects traditionally domestically-focused companies that lack the global presence of more expansive companies but, as these firms begin to pursue an international growth strategy, the problem may become more apparent.
Language issues can become more troublesome once the deal is complete. Indeed, in addition to the challenges that beset all acquirers, Japanese firms face an extra set of post-acquisition hurdles. In the past, Japanese companies have met failure when attempting to integrate foreign firms, largely the result of a disparity of business and management culture. “The main challenges include how to manage the local – overseas – operations and issues, such as employment issues,” says Mr Kano. “Employment culture is quite unique in Japan, which has a reputation for loyalty to your employer and a so called ‘lifetime’ employment system. Things are changing now, but this thinking remains deeply engraved in Japanese corporation culture. Japanese companies cannot simply replicate this same culture in their overseas operations. They have to adjust themselves to cater for local employees and optimise operations.”
The processes involved in a successful outbound M&A deal do not sit particularly well with Japanese business culture. An ‘insider-outsider’ mindset can leave Japanese managers unwilling to acquire full control of the acquired business, challenge the management of the target or impose the philosophy of the parent firm upon it. Both the acquirer and the acquired can therefore be left organisationally and culturally distinct, with potential synergies and common goals unmet. Additionally, many Japanese executives expect that foreign firms will appreciate a hands-off approach when it comes to the running of the business, but this is frequently not the case. Subsidiary firms often welcome the benefits and capabilities of an acquiring firm, and executives crave engagement with their new management.
Many non-Japanese executives can also be left baffled by the power structure of Japanese firms. Target firms can build relationships with individuals during the acquisition process only to discover they have little influence within the firm. Similarly, the power of middle-managers within Japanese parent companies is sometimes a cause for concern, as is the distance put between the executives of the target and the CEO of the acquirer.
In light of this clash of corporate cultures, it is unsurprising that retaining foreign talent is a critical problem for Japanese acquirers of overseas firms. “Foreign executives often express frustration over not having a clear understanding of the Japanese parent’s deal logic, not being able to leverage the capabilities of both parties and create synergy, and not having a functional communication line to jointly discuss issues that may arise,” Mr Sneider explains. “In order to avoid frustrated foreign executives from leaving, Japanese companies should, at the outset of the post-merger integration period, discuss and clarify these issues with the foreign executives and actively involve them in the decision-making process.” Japanese firms may also consider implementing mentorship programs, pairing managers from the acquired firm with an executive from the parent, to allow for greater alignment of corporate values and tighter communication.
Bringing foreign employees to Japan for training sessions, and as a means of gaining valuable insights into the operation of the acquired entity, can motivate staff on both sides and help to reconcile the business philosophies of both firms.
Japanese firms should find that there are a number of post-acquisition management approaches available to them, though the best strategy may only arise as a result of trial and error. Establishing a blueprint for management prior to the deal, and ensuring it is tailored to the strengths and weaknesses of the target firm, will aid in maximising value once the deal is completed.
With significant cash on their balance sheets available for investment, and with access to low-cost financing from the country’s leading banks, Japanese firms are likely to continue cross-border transactions for the foreseeable future. Indeed, 2013 could see stronger outbound deal flow. “I think there will be an increasing number of M&A deals in 2013, but the size of the deals will be more diverse – there will be many smaller size deals going forward,” says Mr Kano. “This is because more and more small to medium sized companies will look overseas for opportunities, in addition to the larger-scale acquisitions typically done by larger trading houses and the like.”
All of this, however, is dependent on the continuation of factors that have driven the current surge. Dramatic changes in immigration policy and patterns, though unlikely, could diminish the appetite for outbound deals. A turbulent political landscape, however, would present the greatest risk to dealflow. “If the completion of key elections in the United States, Japan, China and a number of other important countries brings greater certainty to the political environment, there is the potential for an added boost to activity,” declares Mr Sneider. “Of course, some uncertainties may continue to cloud the outlook, including the ongoing European economic crisis and the fiscal deadlock in the United States, to the extent it remains unresolved.”
Businesses looking to sell assets are more likely than ever to find themselves dealing with Japanese firms – whether experienced overseas investors or those that have only recently broken free of the domestic market. It is imperative that both sellers and acquirers understand the drivers behind the deal, and the corporate culture of their opposite number, if they are to agree on sound transaction terms and make the deal work in the long run.
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