M&A in Japan has remained steady since the outlier spike in activity in Q4 2021, with that momentum continuing in the first months of this year. In Q1 2023, there were 196 deals, almost exactly matching the 192 total in the prior quarter.
The quarter also posted the highest deal value since Q3 2020, reaching US$33.4 billion.
A major restructuring
Based on public reports, carve-out and restructuring specialist Japan Industrial Partners (JIP) agreed to make a tender offer for Toshiba. If the deal is consummated, this would be the first time a company of Toshiba’s size has been taken private in the country. Although not an unsolicited takeover—to which Japanese boards are especially resistant—several US-headquartered private equity (PE) firms including Bain Capital, CVC Capital Partners and KKR had already showed interest in the company.
While JIP ultimately outbid these parties, keeping Toshiba under Japanese control is widely reported to be the preferred outcome for its management and board. Activist investors had recently built positions in the conglomerate, which owns strategic nuclear and defense assets, and sought to effect change.
Despite its large economy, Japan does not compete at the same level as the US, India or China in software development. Once one of the greatest innovators in the world, the country has lagged in this field for several reasons. One is a lack of entrepreneurial culture and an underdeveloped venture capital ecosystem compared with similarly sized economies.
Another key differentiator between the US and Japan’s software development is in each country’s approach. The Japanese government took a more involved, protectionist role in incubating fledgling software and tech companies during the Japanese Economic Miracle by awarding contracts with state-run enterprises. While this provided stability and supported employment, it blunted the steel-sharpening effects of competition and, over time, the industry lost its competitive edge.
Policy and attitude changes could augur long awaited change and stimulate more M&A in the sector. Japanese stock markets trade at lower multiples than their US and European counterparts. In addition, shareholder pressure to produce higher returns coupled with the difficulty startups face in securing bank loans create an environment potentially conducive to M&A, though startups have historically favored IPOs over other exits.
Perhaps the most important development happened in April 2023 when the government introduced attractive incentives that allow companies to deduct 25% of the acquisition price of domestic startups from their taxable income up to a value of approximately US$40 million per deal and up to US$100 million in aggregate per year. This set the stage for corporate acquisitions of young companies.
In January, the US special purpose acquisition company (SPAC) Pono Capital Two wholly bought out SBC Medical Group, giving the cosmetics surgery group an equity valuation of US$1.2 billion and putting it on course to float on the NASDAQ. Cosmetic surgery is big business in Japan, which by some estimates ranks among the top five countries globally along with the US, Brazil, Germany and China for both the number of plastic surgeons and the number of procedures performed. An aging and wealthy population is a major driver in this market, with affordable eyelid surgery being especially popular.
Meanwhile, Hitachi and Honda Motor changed the ownership of their automotive component joint venture, Hitachi Astemo, and brought in JIC Capital in a deal valued at just under US$1.2 billion. Hitachi’s stake was reduced from 66% and Honda’s increased by 7%, with JIC taking the remaining 20%. The plan is to float Hitachi Astemo, which supplies components such as powertrains and chassis systems for both traditional vehicles and the booming electric vehicle market.
M&A in Japan typically reflects the country’s industrial strengths as well as the demographics that are shaping its society and demand within its economy. More than anything, corporate reforms and a fresh focus on shareholder value are likely to drive deal activity going forward. These ongoing reforms have been underway for several years. The most recent focus has been on book value (many companies trade below 1x book value, which has not been scrutinized but will be going forward), board diversity, enhanced disclosures, and increased scrutiny of decisions to remain public in the face of a takeover proposal, to the extent such proposals can be made public (regulators take a harsh view of public bear hugs, subject to limited exceptions).
But the promotion of shareholder value will ultimately underpin deal activity. METI’s Practical Guidelines for Business Transformations, published in 2021, expressly called on companies to review their portfolios and pursue carve-outs where necessary to achieve more sustainable growth. In a country renowned for its legitimization of deliberate action to shore up friendly corporate cross-shareholdings to mitigate shareholder pressure, and where growth is stunted, a greater priority on shareholder returns and the increasing participation of activist investors may bring companies to the negotiating table to restructure their businesses. Ultimately, management incentives to sell assets remain extremely limited in Japan with a vanishingly small portion of compensation being tied to share price or performance. Consequently, shareholder pressure is one of the few possible drivers of an active market for corporate control in Japan.