Stronger stock market performance bodes well for exit conditions in Japan’s rapidly maturing PE spac

Interested observers have long anticipated the “arrival” of Japan’s private equity market. As the world’s fourth-largest economy after the US, China and Germany, the country has no shortage of companies. Almost 4,000 businesses are currently listed on the Tokyo Stock Exchange—for comparison, the New York Stock Exchange carries around 2,400—not to mention the millions of privately owned businesses that dot Japan.

Add to that prolonged deflation, which the government is only now considering ending, after more than two decades of economic stagnation. Falling prices have held back Japanese growth and innovation, making its companies prime targets for sponsors capable of helping them realize their full potential.

And so Japan’s PE market seems finally to be having its moment. In 2023, the country logged 860 PE deals—including buyouts, secondary buyouts and exits—down slightly from the record-high 948 recorded the year before, but broadly in line with the market’s performance in 2021, when 874 deals were recorded as part of a global, post-pandemic bounce-back. Indeed, the Japanese PE market has been trending up fairly consistently since 2010, with aggregate PE deal value reaching an all-time high of US$50.8 billion in 2023, a year-on-year increase of 63 percent.

Private equity activity by volume 2010 – 2023
Target location: Japan Bidder location: Global Sectors: All Sectors
Private equity deal type(s): Exit, Buyout and Secondary Buyout

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Effective July 1, 2023, the underlying Mergermarket data supporting the M&A Explorer was consolidated with Dealogic data to produce an even more complete picture of the M&A marketplace. M&A Explorer commentary published before July 1, 2023 may reference data that does not reflect this consolidation.

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Slow start

This year has gotten off to a slower start, with only 194 PE deals through Q1, a fall of 11 percent on the previous quarter. The aggregate value of those transactions is US$2.1 billion, down 84 percent from Q4 2023, and the lowest quarterly total since the end of 2018.

Nonetheless, the longer-term trend suggests Japan is embracing PE like never before. With a rapidly aging population, prospects for handing down family businesses are becoming less and less viable, making selling to PE an attractive and workable remedy. For sponsors, the opportunity is clear. A recent report from Bain & Company notes that investors are drawn by the “deep pool of target companies with significant potential for performance improvement.”

The underperformance of companies and the mounting pressure on leadership teams to divest non-core assets is another factor stimulating buy-side interest. Japan’s Corporate Governance Code, last updated in 2021 and reviewed every three years, emphasizes the importance of reviewing strategic shareholdings and encourages companies to provide a clear rationale for the assets they own. As global competition intensifies and profitability pressures mount, conglomerates are now viewing carve-outs to PE as a natural solution for streamlining their portfolios.

US sponsors

Overseas sponsors are paying close attention. KKR sees Japan as the centerpiece of its Asia-Pacific strategy and considers the entire region central to the firm’s goal of doubling its assets under management to more than US$1 trillion within the next five years.

The firm’s most recent classic PE buyout, which closed last year, saw it carve out Hitachi’s third-party logistics unit for US$5.2 billion, while earlier this year Industrial & Infrastructure Fund Investment Corporation, a Japanese real estate investment trust managed by KKR, expanded its portfolio with the acquisition of warehouses totaling nearly 400,000 square meters from KKR-owned Logisteed.

Other US PE firms taking an interest in the country include Bain Capital and Carlyle Group. Notably, Bain and North Asia-focused sponsor MBK Partners were part of a rival bidding group led by Japan Investment Corp that attempted to acquire Toshiba. Ultimately, domestic turnaround firm Japan Industrial Partners outbid the consortium with a US$14 billion offer, in what was one of the largest-ever PE buyouts in the country.

Exit market

Japan’s PE success story, however, still does not include a significant number of exits. While PE exits enjoyed a 23 percent year-on-year increase to a record 96 last year, and tripled in value to US$8.3 billion, that sum represents an exit-to-buyout value ratio of just 1 to 5.1, versus a global ratio of 1 to 1.8.

Compared to more mature PE markets in North America and Europe, the number of large exits remains extremely low in Japan. For example, McKinsey notes that there were only nine Japanese deals with an exit value exceeding US$1 billion between 2010 and 2023, while in the US there were 464.

The need to achieve liquidity from current investments is not unique to Japan—Bain & Company estimates there are 28,000 unsold companies forming “a ballooning exit backlog” in PE portfolios globally—but the challenge feels especially acute here.

Secondaries

The dearth of traditional exit opportunities has seen continuation funds take off in the US and Europe over the past three years. Rather than exit to their peers or strategic buyers, fund managers are increasingly turning to the GP-led secondaries market. Bringing in new follow-on capital to further grow high-potential portfolio companies before exiting them prematurely, below desired valuations, has become a widely accepted strategy.

The trend is also emerging in Asia. Preqin data shows that five continuation funds were raised there last year, the most in over a decade, and interest continues to grow. China has been the primary market so far, but GP-led deals could become more popular in Japan as a way of returning cash to investors.

As for traditional exit routes, KKR successfully listed former Hitachi unit Kokusai Electric in October 2023 in a rare IPO that valued the company at US$3.6 billion, with shares surging by 28 percent on its first day of trading. Meanwhile, in March 2024 the Nikkei 225, Japan’s leading index, set a new high as the stock market enters a period of expected growth. Exits may have lagged to date, but for PE this equity market performance augurs well for the future.

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