January saw two major departures from Western buyout firms that have been trying to break into the notoriously elusive Japanese buyout market.
Kohlberg Kravis Roberts (KKR) Asia and Permira Advisers each lost a senior investment professional from their respective Tokyo offices in the same month.
Naohiko Kitsuta, a managing director at KKR, resigned after less than two years at the firm. Kitsuta had joined KKR from MKS Partners, one of Japan's most prominent buyout firms, in 2007. He was a partner at MKS and led buyouts in the consumer services and retail sectors. MKS Partners itself is now reportedly winding down operations and trying to sell its stakes in its existing portfolio by the end of this year.
Tomayo Shiraishi, a co-head at Permira's Tokyo office, left the firm in the same month. He had joined Permira in 2005 from Japanese private equity firm JAFCO's buyout division.
Both KKR and Permira opened their Tokyo offices in 2005. To date, both firms have done one deal each. In 2007, KKR took a ¥20 billion ($223 million) stake in credit card firm Orient as part of a consortium led by Mizuho Financial Group. In the same year, Permira acquired Japanese agrochemical company Arysta LifeScience, for $2.2 billion in a secondary buyout from private equity firm Olympus Capital Holdings Asia.
Besides its distinct language and cultural differences, Japan is a famously tough market to penetrate due to the prevalence of close-knit business relationships that in many cases go back generations. Japanese banks also tend to have ties with each other, making it difficult for private equity firms to get a foothold.
“There has always been a need to develop links with both financial institutions, themselves a source of deals, or with potential target companies,” says Chris Hodgens, a partner at law firm Baker & McKenzie in Tokyo.
In recent years, Western private equity firms have aimed for large deals in the $2 billion to $3 billion range. In such deals, people connections are very important, especially among the management of For tune 500c ompanies, comments a local limited partner.
A key tactic for Western firms trying to break in has been to recruit high profile local private equity names. In the cases of the departing Kitsuta and Shiraishi, however, the extent to which this paid off is not clear. One domestic institutional investor told
“Both firms are fairly new entrants into the Japanese market and one big issue is sourcing the kind of deals they like to do, which are deals at the billion plus mark, historically judging. And Japan has not had a huge appetite for such deals,” says Hodgens.
PERMIRA ON TRACK
Alex Emery, a managing director and now sole head of Permira's Tokyo office, remains unfazed by the firm's experience in Japan so far.
“When we opened our office in Japan, we were prepared to go for up to five years without investment. So having made one investment after three years is, I find, a good track record,” he says.
Emery asserts that Permira would “much rather fund one high quality company than three or four smaller ones” and says what counts is the amount of equity put to work. He points out the firm put about $1 billion of equity into Arysta.
“In being very selective, there is, in that sense, enough deal flow for us to participate in. Permira is very disciplined when looking at attractive deals. The firm passes on many deals that don't fit its criteria. It intends to play at the top end of the market, in terms of size,” says Emery.
But in a country that currently sees only between 50 and 80 buyout deals annually, there are slim pickings at the top end of the market. For M&A activity to increase markedly in Japan, a fundamental change in business culture would be necessary.
“In the US, management has to achieve a certain return on equity. In order to match that expectation, management has to add value to the company. In Japan, the required return on equity is relatively low. So as long as the division makes a profit, it is considered a core asset and not for sale,” says a limited partner in the country.
Emery maintains that the nationality of the would-be buyer has no bearing in the face of this traditional reluctance to divest of subsidiaries and engage in M&A.
“Fundamentally, the big corporates don't have a history of doing M&A especially in terms of selling subsidiaries. It is not related to whether the buyers are foreign or local,” he says.
Private equity's cause in Japan has not been helped by the media, which has painted GPs as ruthless asset strippers. In a country where the expectation is still that jobs are for life, private equity firms have been portrayed as anathema to the traditional business culture.
“Private equity is a relatively new phenomenon in Japan and Asia. Uncertainty, as well as some negative press in Japan, have tarnished people's view of it,” agrees James DeGraw, a partner at law firm Ropes & Gray based in Tokyo.
STILL PLUGGING AWAY
Despite the difficulties, neither KKR nor Permira are showing signs of fatigue in their long-lasting bid to put down roots in Japan. As part of this, the leveraging of local expertise continues.
KKR has increased its Tokyo staff from six to 10 over the past year and a half, and both KKR and Permira made key appointments at a senior level last year, this time choosing well known figures with long and distinguished careers outside the private equity industry.
In October 2008 Permira appointed Hiroaki Yoshihari as a senior adviser to focus on the country's technology, media and telecoms sectors. Yoshihara, who retired from KPMG in 2007, was the audit and consulting firm's international vice chairman and a global managing partner.
A month earlier, KKR appointed Yoshiharu Fukuhara as a senior adviser to its Japan activities. Fukuhara has been the honorary chairman of Shiseido, a luxury cosmetics and fragrances manufacturer, since 2001. The grandson of Shiseido's founder, Fukuhara joined the company in 1953. In 1987, he was appointed president and chief executive officer and in 1997, became chairman of its board.
“KKR did publicly indicate that it would get closer to Japanese financial institutions to improve deal sourcing. I suspect the moves are aimed at furthering that strategy. It seems like they are looking at links at a much more senior level in hopes of improving deal sourcing capability,” says Hodgens.
“Japan is an inexorably unfolding, highly attractive opportunity for private equity,” comments Mark Chiba, group chairman and partner of Tokyo-based private equity firm The Longreach Group. “But you have to be patient, as the best investment flow is proprietary and comes from harvesting many years of relationship building.”
Western private equity firms can take heart from the example of the US investment banks that came before them. According to Chiba, it took them 10 to 15 years of sustained effort to establish “really meaningful and highly profitable platforms” in Japan. They got there eventually.