Japanese cross-border M&A takes off

In a time of global economic and political uncertainty, Japan’s relative stability stands out. After more than two decades of slow growth, the country continues to face many challenges. But Abenomics, the fiscal stimulus, monetary easing and structural reform plan enacted by Prime Minister Shinzo Abe, may be setting Japan on the road to recovery.

The hope is that mounting confidence will filter through to retail investors who will move from bank deposits to the stock market in the expectation of rising inflation. Corporate sentiment towards merger and acquisition (M&A) activity could follow a similar trajectory – and Japanese companies’ targets are increasingly likely to be overseas. What’s driving outward bound investment? One important element of Abenomics and its goal of kick-starting the economy is to encourage companies to focus on returns and growth. This edict is prompting companies to look overseas, given the maturity of Japan’s economy and its ageing population. Moreover, Japanese companies have been consolidating for decades so there are often limited opportunities domestically that would gain anti-trust approval.

Japanese corporates considering international M&A enjoy a fortuitous backdrop.

Firstly, China, which has dominated M&A volumes in recent years, is scaling back activity in order to protect its currency, the renminbi. At the same time, the US is becoming more inward-looking and there is a risk of protectionist measures being introduced that would hamper corporates’ ability to invest internationally. Japanese companies may, therefore, face less intense competition for targets than in the recent past and are likely to be welcomed as a source of capital and stability. In short, Japanese firms may become the standard bearer for global investment.

Secondly, Japanese companies have the necessary financial firepower for M&A. Given the slow growth of the domestic economy over the past two decades, many have high levels of cash – even by the elevated post-crisis levels of most corporates around the world – and are under pressure from investors to spend it. Moreover, recent changes to the corporate governance code require companies to meet return-on-equity (RoE) standards or explain their failure to do so to shareholders. Keeping cash on the balance sheet makes it difficult to meet these new expectations: buying an M&A asset is an easier route to compliance.

This imperative is also changing the target countries of Japanese companies. Many have focused on Asia in recent years. However, many of the opportunities in growth economies, such as China, are long-term in nature and may initially generate a low return. They are therefore unappealing from an RoE perspective. Consequently, many Japanese companies are seeking well-established firms that are cash generative and have strong market positions. These are most likely to be in the US and EMEA.

Finally, when Japanese companies need to access additional funds for M&A activity, the domestic banking market is extremely attractive. It is currently easy and cheap to borrow money as Japanese banks have large deposits, relatively small loan books and healthy capital positions. Banks seeking to invest the deposits they receive can either put them in Japanese bonds, which offer low returns and carry exposure to interest rate risk, or can lend them on for M&A transactions at a much higher rate. As a result, any company seeking funds for an M&A can borrow at low cost.

Continuing strong growth

Figures from Mergermarket show that Japan’s outbound activity in 2016 enjoyed its fourth consecutive year-on-year increase in deal value, with 309 announced outbound deals worth $92.1 billion – the second-highest annual value on record. Outward bound M&A comprises an ever-increasing proportion of overall M&A activity for Japanese companies, accounting for 49% of the total in 2016 compared to just 15% in 2009, according to Thomson Reuters.

Europe was the most attractive destination for outbound investment in 2016, attracting $52.2 billion from 107 transactions, notes Mergermarket. In terms of sectors, technology dominated, largely as a result of SoftBank Group’s $30.2 billion takeover of UK semiconductor company ARM Holdings. While SoftBank’s acquisition of ARM was fortuitously timed, coming in the month after the Brexit referendum when uncertainty was at its highest and sterling was weak, the rationale for the deal with more straightforward: SoftBank wanted to buy into the next generation of technology and broaden its geographical footprint.

A second trend evident in 2016 was the ambition by Japanese manufacturers, especially in the food and consumer products sectors, to acquire companies that enable them to access new export markets. For example, in November Japanese food company Ajinomoto agreed to buy 33% of African food group Promasidor for $532 million. The deal, which had Nomura as the sole financial adviser for the target, generated significant competition with many of the world biggest food groups vying for the asset. For Ajinomoto, Promasidor offered access not only to rapidly growing economies but also a route to market for its existing products.

Within EMEA, the UK is likely to remain a natural starting point for many Japanese companies looking for M&A opportunities for cultural and linguistic reasons: English is by far the most common foreign language and there is familiarity with many British customs. However, uncertainty about the UK’s impending departure from the European Union and its future trade access to it could prompt caution in the coming year.

Germany will play a larger role in Japanese companies’ M&A strategies given its strength in the automotive, manufacturing and engineering sectors where Japan also has a significant presence. Already, there is already growing Japanese appetite for German assets. In June 2016, Nomura acted as sole financial advisor to auto components company Musashi Seimitsu Industry for the acquisition of Hay Group, a producer of high precision forged and machined steel automotive parts in Europe.

Support at home and abroad

Japanese companies contemplating international M&A activity need to carefully consider the capabilities of the bank they select for an M&A transaction. Unlike US companies, which typically have clearly defined targets in advance of appointing a bank to act as an advisor, Japanese companies may have a number of potential targets in mind. They, therefore, need an advisor with detailed, comprehensive sector expertise. The advisor may play a pivotal role in helping the client to ascertain the merits of each potential target and determine which would best fit their strategic objectives.

While Japanese companies have become increasingly international in nature, M&A activity in continental Europe, for example, can bring linguistic and cultural challenges given the region’s diversity. Clients may, therefore, need a bank with an on-the-ground presence to help them navigate differences in how business is conducted, manage their expectations and ensure they understand each step of the process.

Finally, for Japanese companies engaging in international M&A activity, it can be important to choose a bank with a significant presence in their home county. A deep understanding of the needs of Japanese companies and how they operate can be helpful to ensure that information is relayed to the client in the most appropriate way and guidance and reassurance are provided in a familiar manner.