Tailwinds build for private equity deals in Japan

Japan is drawing more attention from private equity investors attracted by low interest rates and an array of investment opportunities in fragmented industries and family-owned businesses.

The announced value of private equity- and venture capital-backed investments in Japan in 2022 and 2023 totaled $45.61 billion, a greater than 52% increase over the previous two-year period, according to S&P Global Market Intelligence data.

Large global buyout firms remain bullish on Japan even with slower private equity-backed dealmaking in the first half of 2024.

KKR & Co. Inc. co-CEO Joseph Bae, speaking at an industry conference in May, said the combination of low corporate valuations, relatively cheap financing, less competition for deals and "massive" opportunities to build business value through operational improvements made Japan the firm's best-performing market for buyouts since 2010.

"That cocktail of things leads to really extraordinary private equity opportunities," Bae said.

Shifting attitudes

A more open attitude toward private equity among Japanese business owners is another tailwind to dealmaking.

Kenta Shima, partner at Toyko-based lower-middle-market firm J-Star Co. Ltd., said that around the time of his firm's debut in 2006, "negative impressions" of private equity limited deal flow in Japan. Most deals at the time rose from special situations, like a bankruptcy or a business owner who lacked a successor but refused to sell to a competitor in the same industry.

That began to change as M&A activity in the country picked up between 2010 and 2020, with private equity firms participating in more take-private deals and carve-outs.

One deal from that period was KKR's 2017 acquisition of semiconductor equipment business Kokusai Electric Corp. from Hitachi Ltd. and Japan Industrial Partners Inc. The deal resulted in Japan's largest IPO in about five years when KKR exited its investment in 2023.

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Opportunities for private equity in Japan expanded further as the country emerged from the COVID-19 pandemic, with business owners increasingly open to partnering with private equity on operational improvements and industry consolidation plays.

Leveraging private equity support to expand into non-domestic markets is a key strategy for getting around the limits on growth in a country with a shrinking economy and aging population, Shima said.

"This is a country in which it is almost impossible to have organic growth," Shima said.

Investment opportunities

For private equity funds targeting listed Japanese companies, corporate reform promoted by the Tokyo Stock Exchange Inc. (TSE) to improve capital efficiency is a major driver, said Hajime Koyanagi, general manager of the investment strategy department at Nihon M&A Center, a Japanese advisory firm.

The TSE in 2023 required Japanese companies with a price-to-book value ratio below 1.0 — signifying a market capitalization below the net value of the business' assets — to take action to raise it above that level. That created an opening for private equity to invest in struggling businesses and improve their capital efficiency, Koyanagi said.

J-Star's Shima said Japan's business succession challenge, linked to an aging population and high proportion of family-owned businesses, remains a key source of private equity deal flow. So do sector consolidation plays.

"The big picture is, this is a country that is very inefficient. A very fragmented market," Shima said.

Fundraising momentum

The $10.47 billion raised by Japan-focused funds in 2023 was the second-highest annual total since at least 2015, according to Preqin.

This year, as of June 6, 176 Japan-focused funds in the market were targeting $8.4 billion in aggregate capital, according to Preqin. If successful, that would be the third-highest fundraising total for Japan-focused funds in a decade.

Bain & Co. reported in May that Japan private equity fundraising benefited from limited partners' desire to pivot away from China, which is facing slowing economic growth.

Largest deals

The take-private deal for Toshiba Corp. by domestic private equity firm Japan Industrial Partners Inc., which was announced in 2022 and completed in 2023 at $12.20 billion, was Japan's largest private equity-backed transaction in seven years, according to Market Intelligence data.

But firms based outside of Japan backed eight of the 10 largest private equity or venture capital investments targeting Japanese companies since 2023.

Kazumasa Kodaira, investor relations manager for J-Star, said his firm did not view them as competitors but as potential acquirers for their middle- and lower-middle-market portfolio companies.

"And we are seeing some good potential buying interest from foreign GPs," Kodaira added.