Understanding Japan’s outbound M&A boom

September 2019  |  COVER STORY  |  MERGERS & ACQUISITIONS

Financier Worldwide Magazine

September 2019 Issue

Japanese outbound M&A activity has risen in recent years. According to Thomson Reuters, outbound deals reached an all-time high of 777 in 2018, up nearly 16 percent on the year before, and setting a fifth straight record. Japanese companies spent roughly $175bn overseas last year, as they sought growth to offset a shrinking and tepid domestic market. In the final quarter of 2018 alone, there were outbound transactions totalling $171.8bn, according to Mergermarket, 25 of which were worth over $1bn, the highest such number recorded. And there are good reasons to believe that activity will remain robust for the foreseeable future.

Many factors are driving the increase. From a legislative perspective, the economic and fiscal reforms introduced by prime minister Shinzo Abe, known as ‘Abenomics’, have undoubtedly had an impact. The ‘three arrows’ of Abenomics – fiscal stimulus, monetary policy and longer-lasting structural reform – have produced positive results. Although Japan has, in some respects, fallen short of economic targets in recent years, particularly with regard to price dynamics and GDP growth, the national economy does appear to be on stronger footing.

A core tenet of Abenomics is encouraging companies to focus on returns and growth. To achieve this goal, Japanese firms are increasingly looking overseas. “The outbound M&A market continues to grow and is an important tool for Japanese companies to compete and expand globally,” says Hiroshi Watanabe, a partner at Ushijima & Partners. “Some driving factors include shrinking domestic markets and investment in emerging markets. Companies are often encouraged to acquire overseas companies because sustained growth is threatened simply by continuing domestic operations in Japan.”

Japanese companies in the technology, pharmaceuticals, electronics, automotive and transportation and renewable energy spaces have been particularly active of late. The $65bn takeover of Shire by Japanese pharmaceutical company Takeda was a landmark deal which signified the willingness of Japanese firms to look overseas for deals and growth. Mega-deals, typically valued at $10bn and over, have been an important factor driving outbound activity. Transactions valued at $1bn and above increased from 18 in 2017 to 30 in 2018, according to JP Morgan. A number of Japan’s other biggest companies, including Hitachi, Ricoh, Sumitomo Chemical and Fujifilm, have announced plans to strike $30bn worth of outbound deals over the next three years.

Demographic challenges

Japan’s aging population and declining birth rates are also encouraging companies to look for new opportunities for growth beyond their borders, especially in faster-growing regions. The native Japanese population fell by more than 430,000 last year, according to the Ministry of Internal Affairs. Unless the decline is reversed, one might expect Japanese companies to continue pursuing overseas targets in the coming decades. “Japanese companies see few growth opportunities in the Japanese market and feel the need to look elsewhere for growth opportunities,” says Hiroyuki Kano, a partner at Clayton Utz. “These opportunities are spread across a range of industries. Japanese investments had been heavily focused on the energy & resources sectors in jurisdictions such as Australia, but for the last few years they have been more diverse than ever before.”

According to Mark Davies, a partner at King & Spalding, Japanese companies of all sizes are grappling with relatively unfavourable domestic population demographics as they attempt to expand their businesses. “In the quest for market share growth at scale, it makes a lot of sense for Japanese companies to pursue that growth inorganically by way of M&A transactions involving foreign targets, especially in countries with expanding consumer bases,” he says.

“As research and development (R&D) costs rise, Japanese companies in innovative industries where R&D is capital-intensive may turn to acquisitions in order to complement their innovation strategies,” adds Mr Davies. “Further, given the country’s demographic situation, any industry that is particularly predicated on customer growth and ripe for consolidation, such as banking and financial services, will likely witness continued M&A activity for the foreseeable future.”

A recent change in Japan’s corporate governance code, conferring greater power on shareholders to push for high returns and growth strategies, is also fuelling cross-border M&A activity. Until recently, overseas deals were almost exclusively pursued by large, Tokyo-based companies; however a number of mid-sized, non-Tokyo based, traditionally domestic companies are now likewise pursuing outbound targets.

Financing the deal

The slow growth of the Japanese economy over the past two decades may also have an impact, as the Bank of Japan’s monetary policy has made it easier for Japanese companies to raise financing. “M&A usually relies on proceeds from financial institutions,” says Yuya Ito, a partner at Ushijima & Partners. “Domestic financial institutions’ lending has been increasing and the cause seems to be capital requirements for M&A. The Japan Bank for International Cooperation (JBIC), which is invested by the Japanese government and lends foreign currencies through three megabanks, renewed its loan capacity in 2018 to facilitate overseas M&A. Corporate bonds are another common method for financing Japanese M&A. For example, Takeda issued corporate bonds to reduce the total borrowing limit for bridging loans in 2018 when it acquired Shire in the biggest-ever buyout by a Japanese company.”

While some central banks have begun to raise interest rates, the Bank of Japan continues to maintain near-zero interest rates, giving Japanese corporations access to inexpensive capital with which to finance deals. “In most Japanese acquisitions of overseas targets, Japanese buyers pay in cash,” says Mr Kano. “With the Bank of Japan’s interest rate being in the negative territory, Japanese financial institutions are strongly incentivised to lend money and are generally keen to provide acquisition finance.”

This, along with encouragement from the Abe government, is driving strategic acquirers to look overseas. The government has highlighted the importance of capital efficiency in recent years, leading Japanese companies to take a more disciplined approach to capital allocation, divest non-essential businesses and pursue cross-border acquisitions. A number of large Japanese companies, including Sony, Hitachi and Panasonic, have begun to sell non-core assets, acknowledging the need to streamline their operations and use the proceeds to make more productive purchases.

Challenges pre- and post-closing

But it is not all plain sailing. Two of the biggest hurdles to completing cross-border transactions are the speed of the deal process and the availability of human resources. “Japanese companies take time to make big decisions due to their internal decision-making systems,” points out Mr Kano. “This is often difficult to overcome, particularly during the bid process, and this is a big issue for Japanese companies. From a resources perspective, Japanese companies tend to like organic growth as opposed to growth by acquisitions. Because of this fundamental culture, Japanese companies do not tend to have sufficient internal resources to deal with overseas acquisitions. There are also language barriers. Some Japanese companies have started to hire M&A experts to strengthen their internal resources to deal with M&A, but there is still a long way to go before this becomes the norm.”

For many companies, and particularly for Japanese acquirers pursuing cross-border deals, the post-merger integration period can also be challenging. “More than 80 percent of Japanese outbound acquisitions struggle to deal with post-merger integration issues,” says Mr Kano. “Japanese buyers must familiarise themselves with the culture of their targets and their management well in advance, through the due diligence and deal negotiation stages. It is too late to think about and deal with post-merger integration issues after the acquisition has completed. Though artificial intelligence (AI) and technology will become increasingly important for businesses in the coming years, this is still some way off. Currently, the vast majority of work in most businesses is done by people, so it is important that acquirers know the human aspect of the target, improve communications and strive to ensure that both parties understand each other. This is the simplest and yet most important element of any post-merger integration.”

Planning is critical. Outbound M&A deals are often more difficult to complete than domestic M&A due to differences in systems and cultures. Integration plans should be developed as soon as possible and incorporate the results of due diligence carried out on the target.

“Particularly important to successful post-merger integration is the appointment of senior management in the target company,” notes Mr Watanabe. “Furthermore, the person who will be responsible for managing the bought-out company should be actively involved in the transaction from an early stage,” he says. “Since communication in cross-border dealmaking is more difficult than in domestic M&A, it is up to senior management to disseminate growth strategies to the target. External directors should supervise the actions of senior management.”

Operational integration and cultural alignment are paramount if acquirers hope to unlock synergies and generate deal value. Japanese acquirers cannot underestimate the importance of careful integration planning involving a broad cross-section of functions, such as IT systems, human resources, legal, financial reporting, governance, operations and more. “Developing a sensible deal thesis, communicating that thesis to investors and other stakeholders, including employees, and outlining the process and measures necessary to implement that thesis, and the anticipated timetable to do so, is an effective way for Japanese management to demonstrate the accountability and credibility that today’s global investors expect,” adds Mr Davies.

And, as Japanese acquirers become more familiar with cross-border M&A processes and sophisticated deal techniques, such as the use of transaction insurance products, more Japanese companies will likely turn to the global M&A market to identify and exploit attractive growth opportunities, according to Mr Davies.

Looking ahead

Though the coming years may be hard to forecast, given the uncertainty gripping the global economy, Japanese outbound M&A is expected to endure, and even increase, provided companies implement successful deal processes. “What should be noted in the future is whether Japanese companies can enhance the quality of M&A,” says Mr Watanabe. “According to a METI report regarding cross-border M&A, Japanese companies should identify key points for each deal process, and create a framework for this process. This is also necessary for domestic M&A. We hope that Japanese companies will make effective use of M&A, which will lead to a revitalisation of the economy.”

According to EY, rising political and regulatory uncertainty, along with ongoing trade and tariff negotiations, may impact Japanese dealmaking. Those Japanese companies investing in US targets, for example, must be aware of the regulatory environment for transaction approvals under the Trump administration. “Transactions involving semiconductors, certain computer technologies, aerospace and defence and biotechnology will continue to be highly scrutinised,” says Mr Davies. “However, the increased focus of US regulators on blocking certain deals in the name of national security is not entirely a bad thing for Japan. Since most sensitivity is focused on Chinese buyers, for a number of reasons, and given the relatively higher degree of economic and political cooperation between the US and Japan, Japanese companies can position themselves to US targets as a favourable and viable alternative to Chinese buyers.”

In the coming years, the increasing risk of technological disruption and ever-changing consumer preferences could prompt Japanese executives to review their portfolios more frequently, which may lead to companies pursuing cross-border deals. Other objectives include securing market access and protecting supply chains.        

The global economic landscape is changing. The ebbing influence of Chinese acquirers in the global M&A market is also creating opportunities for Japanese companies, particularly in jurisdictions outside of Asia, such as the US and Europe, where return on investment tends to be higher.

Significant overseas opportunities await Japanese organisations in areas such as IT, pharmaceuticals and financial services. Newer industries such as autonomous vehicles and the Internet of Things are set to become sources of future dealmaking. Japanese companies have embraced globalisation and developed sophisticated strategies for operating and competing worldwide. With many sitting on healthy cash reserves – more than $890bn combined, according to Bloomberg – the funds are there for cross-border transactions. Pressure from activist investors, too, may prompt companies to utilise cash reserves for overseas expansion.

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Richard Summerfield