Local lenders keen on deals

In 2005, the management of World, a Tokyo-listed clothing company, completed a buyout of the business in a landmark deal with a transaction value of ¥230 billion ($2.15 billion). Unusually for an MBO, the deal was financed almost entirely with debt. Reportedly undertaken to thwart a potential hostile takeover, it involved only $10 million worth of equity, which management funded with their own money. Chou Mitsui Trust and Banking provided $500 million of mezzanine finance, while Sumitomo Mitsui Banking Corporation, Aozora and Sumitomo Trust supplied approximately $1.7 billion in senior debt.

According to data from the Japan Buy-out Institute, a research body, the transaction helped lift the value of sponsorless buyouts in 2005 to a level not seen before or indeed since, even though 2007 delivered a record nine such transactions in total (see table p. 25). It is no wonder then that people still talk about the World MBO two years on, crediting Nobuo Sayama at GCA, a local M&A advisory boutique, for his role in bringing the deal to completion.

At the time, World prompted speculation as to whether equity-less buyouts might be a factor in limiting the scope for growth of private equity-led investments in Japan. For private equity funds still struggling to deploy significant amounts of capital in the country, a rise to prominence of sponsorless buyouts would obviously not have been helpful. However, despite base interest rates still significantly below 1 percent and the cost of debt funding correspondingly cheap, sponsorless buyouts have not taken off. Instead, locals consider prospects for private equity-led transactions in the world's second-largest economy to be promising.

“Japan did not suffer the bad effects of the subprime crisis, and so lending appetite among local banks especially continues to be strong.”

Indeed, Sayama, who prior to joining GCA as a managing partner helped establish Unison Capital, one of Japan's leading local private equity groups, says he is expecting Japan's buyout market to grow. He says sponsorless buyouts á la World will remain the exception, because a number of conditions need to be met for banks to get comfortable and lend enough senior and subordinated debt to eliminate the institutional equity tranche.

Typically, he explains, a listed company aspiring to an MBO without surrendering equity to a buyout fund will need surplus cash, a growing business that supplies strong and stable cash flows as well as competent management. If and when such a company is trading at a lower-than-desired valuation, buyout aspirations tend to arise, Sayama explains. But such constellations tend to be “very rare”.

To illustrate the point, Sayama says his firm GCA has been talking to an unnamed potential client about pursuing a sponsorless buyout for over two years, and only recently has the client been willing to seriously consider the prospect.

SUPPORTIVE LENDERS
Regardless of whether a buyout proposition materialises with or without the involvement of an institutionally funded equity provider, the Japanese debt market is likely to show interest. According to local bankers, leveraged finance is still readily available to finance buyouts because Japan has not experienced much of a knock-on effect of the fallout from the US subprime crisis.

Says a Tokyo-based banker: “Japan did not suffer the bad effects of the subprime crisis, and so lending appetite among local banks especially continues to be strong.” He also says that in addition, the Japanese operations of most international investment banks still ‘claim’ to be keen to lend.

To be sure, the onslaught of the global credit crunch did have the effect of pushing pricing up by 25 to 50 basis points since October 2007, as loan syndication has become more difficult than before, the banker notes. But this is of course an increase from such a low base rate that overall funding costs remain modest.

Those banks that are open for business are typically impartial as to whether they are lending to back a financial sponsor in an acquisition or a corporate borrower seeking to delist, he explains. For private equity funds active in Japan, this is promising – as is the fact that the stock market's recent volatility is putting corporations under pressure to improve performance. Therein lies opportunity for private equity to enter the picture and help management effect change – as opposed to management teams trying to take ownership of the business by themselves.

Hideya Sadanaga, deputy general manager of the credit and alternative investment department of Nippon Life, questions the motivation behind sponsorless buyouts. “After all, buyouts purport to add value to a business. I don't see why the management of a listed company can't achieve that while being a public company,” he says, comparing sponsorless buyouts to share buybacks that are driven by cheap stock prices rather than boosting shareholder value at large.

The participation of a buyout fund in a public-to-private, on the other hand, represents an “attempt” to shake up a company with the ultimate aim of achieving results that management may not be able to achieve without external help, Sadanaga insists.

WITH OR WITHOUT YOUIn 2007, approximately 10 percent of Japanese PTPs were completed without private equity sponsorship.