Japanese M&A has pushed way into record territory lately, but the picture is decidedly one-sided. Rather than activity centering on domestic transactions or foreign buyers seeking a foothold in the Japanese market, it is outbound M&A that has continued to eclipse all other deal types by value.
Japan-based bidders spent a total of US$216.18 billion on 754 deals last year, of which US$175.5 billion, or 81%, is attributable to outbound activity. This is by far the highest value ever, dwarfing 2012's US$115.6 billion, the second-highest annual deal activity amount on record. It also represents a 120% annual gain. So, what's behind this lopsided market boom—and why now?
For starters, Takeda Pharmaceutical's US$78.2 billion (including net debt) takeover of Shire, the largest acquisition of a foreign company in Japan's history, represents more than 44% of all outward M&A in 2018. Stripping this single deal out of the figures makes the trend far less pronounced; nevertheless, a confluence of drivers appears to have contributed to the continued high demand for overseas deals.
Prime Minister Shinzo Abe's reforms may have played a significant role. As a pillar of his wider ‘Abenomics’ agenda, the country's premier sought to improve investor relations with the introduction of the Stewardship Code in 2014, followed by amendments in 2017 and 2018, modernizing corporate governance.
To attract investors to Japanese companies and elevate the stock market, the reforms promoted capital efficiency and emphasis on return on equity in particular. With Japanese companies now armed with capital surpluses, two trends are playing out: Share buybacks are at an all-time high, reaching US$55.6 billion in 2018, and Japanese companies have become more acquisitive overseas than ever before.
R&D versus M&A
Another contributing factor is the hunt for research and development (R&D) capabilities. Japan is the third biggest spender on R&D, with around US$186.5 billion invested in 2018, behind only the US and China. It has the highest spend per capita of the three, with R&D accounting for 3.5% of its GDP. In a bid to keep pace with an ascendant and increasingly innovative China and the US, Japanese businesses are plowing more money into R&D programs and, by extension, M&A.
Rather than developing goods themselves, companies can opt to fast-track their research programs by acquiring target companies with attractive innovation capabilities. As a case in point, Takeda's Shire acquisition was reportedly motivated by its expiring drug patents, a ‘patent cliff’. The company itself said the deal gave Takeda a “more global, robust and modality-diverse pipeline” and a “focus on breakthrough innovation.”
This theme is especially evident in the technology sector, which claimed three of the five largest deals, including Hitachi’s buying a majority stake in the power grid business of Swiss electronics and engineering group ABB for US$9.4 billion, and semiconductor company Renesas Electronics purchasing its US counterpart Integrated Device Technology for US$7 billion.
This trend can also be seen in the automotive industry, which continues to converge with the tech sector as cars become more digitally sophisticated. In the fourth-largest deal of 2018, Japanese car parts maker Calsonic Kansei, owned by US private equity firm KKR, bought Fiat Chrysler’s high-tech parts unit Magneti Marelli for US$7.1 billion.
Don’t count out domestic & inbound dealmaking
While record breaking outbound traffic has commanded the lion’s share of the attention, the domestic and inbound markets in Japan are by no means soft. Domestic activity is expected to remain high for the next few years, especially for private equity (PE) investors, bolstered by the increased discipline imposed on public companies by the stewardship code and the shareholder activists who have applied increased pressure1 based in part on the corporate governance code and stewardship code. These trends appear to be moving Japanese listed corporations to become more transparent and shareholder-value driven.
The changes to market dynamism since the reforms, as well as rising pressure from shareholder engagement, have driven Japanese corporations to restructure and optimize their business portfolios, engaging in ‘asset recycling’. However, the market sentiment remains that many Japanese-listed corporations have only begun to make the financial improvements these reforms call for, and significant carve-outs and portfolio restructurings are available for those PE funds able to forge close relationships with Japan’s large corporate groups.
Along with strong reserves of dry powder at these funds and favorable rates for Japanese bank financing of leveraged buyouts, these opportunities for private equity investors are attracting a great deal of attention from global PE funds keen to invest in Japan for the first time, as well as their peers who have been investing in the market for many years.
To see materially increased aggregate deal value, some say these global funds will be the key activity drivers given their scale compared with domestic PE funds that mainly tend to be smaller and focused on middle market or smaller deals, below US$1 billion. Big-ticket carve out/portfolio restructuring transactions by major players such as Hitachi have been generating opportunities for larger investments over US$1 billion dollars per deal, including listed subsidiaries like Hitachi Kokusai in recent years.
1 See White & Case Alert, “Japan's 2019 Proxy Season Results Announced (Shareholder Activism Update)”, September 12, 2019.