September 9, 2020
【Column】Demystifying the coronavirus – impacted Japanese M&A Market – Part 1 –
Demystifying the coronavirus
impacted Japanese M&A Market
Why have domestic deals increased amid the pandemic, and where to from here?
*The first part focuses on the pre-coronavirus M&A market in Japan. Namely, despite the general downward trend of global M&As, the number of Japanese domestic M&A deals increased in June and July 2020, compared with the same time in 2019. In this part, we examine why the pandemic has not slowed domestic M&A deals in Japan. The second part discusses the record-breaking M&A figures in June and July 2020, and what lies ahead. We believe that the M&A market in Japan will continue to see an upward trend for the remainder of the year.
Part 1: The Pre-Coronavirus Booming Japanese M&A Market
COVID-19’s impact on businesses worldwide is a well-known narrative. We are painfully familiar with soaring unemployment rates, dramatic damage to GDP, and figures that indicate a global economy in ill health. The M&A market is no exception. While some countries and industries have been harder hit than others, deals have decreased significantly during the first half of 2020 compared with the same period last year. Many deals have faced completion uncertainty, delays, and some have even been cancelled. Indeed, in March 2020, Xerox abandoned its takeover bid of HP, citing the coronavirus. Kobe Steel also announced that it would delay plans from March until June to transfer parts of its copper tube business to an investment fund, citing COVID-19 concerns.
The Japanese M&A market seems to be performing better than the U.S. and European markets. Multiple economic and social factors have softened the blow. Japan’s corporate cash-hoarding culture no doubt provided Japanese companies with more cash than those in other countries to continue deal activity or to buy out smaller, struggling market players. The market’s resilience may also be an after effect of a record-breaking 2019. This boom was partially caused when retiring bubble-era entrepreneurs faced with succession issues sold their businesses to bigger corporations. Another factor was a spike in conglomerates divesting their non-core businesses in response to increasing shareholder scrutiny. These trends do not seem to be slowing during the pandemic. In this article, we explore some of those factors contributing to Japan’s growing M&A market.
Factors Contributing to Japan’s Growing M&A Market
The Japanese M&A market has been on a record-breaking streak. In 2019, Japanese companies completed roughly 4,000 deals of which 2,840 were domestic. The previous record was 2,814 domestic deals in 2018. This was a near doubling from the beginning of Abenomics in 2012. As discussed below, some of the factors fueling this boom include restructuring, management succession-related issues, and shareholder activism.
Before COVID-19, these historic highs suggested that this trend likely would continue in 2020. However, COVID-19 brought this upward climb to a sudden halt. As will be discussed in Part 2, the first half of 2020 saw a 13% dip in the number of domestic and cross-border M&A deals involving Japanese companies, and 60% dip in the combined value of deals, compared with the same period from last year. We are now seeing a slow recovery from the initial shock to the market.
- Restructuring and divestments
Even before COVID-19, companies were cutting inefficient or redundant businesses. For example, Hitachi reduced the number of its subsidiaries listed on the Tokyo Stock Exchange from 22 in 2008, to 3 by 2019. In 2019, Hitachi sold its chemicals and diagnostic imaging business to a domestic rival. This was unthinkable considering it was a core part of the company’s business. Similarly, Toshiba sold its memory chip business to Bain Capital and other U.S. tech groups in 2018. As companies face increasing scrutiny from shareholders and external directors, and attitudes towards divestments change and become normalized in corporate Japan, this trend is likely to continue.
- Small and Medium Enterprises (SME) sell-out
Many Japanese bubble era scholars believed that the lifespan of a company is 30 years. That could be a convenient explanation of why so many bubble-era entrepreneurs, who established their business 30 years ago, and who now are perhaps facing succession challenges, have turned to M&A to exit.
As noted in our previous articles, SMEs make up 99.7% of companies in Japan and employ around 60% of the Japanese workforce. (While there are many definitions of ‘SME’, the term generally refers to businesses that hire less than 100 employees, with a capital not exceeding 1 million yen.) More strikingly, of the companies that went into liquidation in 2018, the CEO’s average age was 70. When these factors are considered in totality – an economy built on SMEs, a generation of aging leadership, struggles in saturated and competitive markets – it exposes the breadth of the succession issue in Japan. As a result, we have seen a steep proliferation of succession related M&As in the past decade.
- Industry consolidations
In 2019, Japanese businesses spent $56bn on buying domestic rivals. This is not surprising given how saturated and competitive some markets have become. Earlier this year for instance, long-time rivals Mitsui Sugar and Dai-Nippon Meiji Sugar announced that they will be consolidating their business: bringing in a smaller company Nippon Beet Sugar Manufacturing as well.
Other factors that have resulted in increasing consolidations include push by shareholders for higher returns and for overall corporate growth. Japan’s strategic and aggressive focus on outbound M&A in the past few years – as the domestic market became stagnant and competitive – is another byproduct of these pressures.
As with SME owners selling their businesses to larger corporations, smaller players in these overcrowded markets will continue to be acquisition targets for cash-rich larger rivals.
- Land of the Rising Activists
In other jurisdictions, shareholder activism is entrenched in the corporate landscape. In comparison, as discussed in our prior articles, the environment in Japan has been slow to change. There are several reasons, such as the traditional view that companies are run for all stakeholders and not just shareholders, and the prevalence of cross-shareholdings among Japanese conglomerates.
Since governance reforms were implemented almost 10 years ago, we have seen a slow but steady decline in cross-shareholding among public companies, and thus a decrease in entrenched and management friendly shareholders. Indeed, given this changing of the guard, more shareholders are actively engaging with their investee companies through dialog with management or proxy voting.
The Japanese market has become a fertile ground for domestic and foreign investors. We have seen an increasing number of foreign private equity firms entering the market. As a result, the doors for hostile takeover attempts have opened: previously uncommon, almost taboo, in Japan. For instance, Takeda Pharmaceuticals, in response to activist shareholders, disposed its cross-shareholdings in 12 companies in 2018. Likewise, in 2019, Sony sold its entire stake in Olympus, under pressure from the activist fund Third Point. This trend has diversified the M&A market in Japan, and the roll of foreign shareholders, especially for listed companies, has and will continue to increase.
*This Newsletter is provided for educational and informational purposes only and is not intended and should not be construed as legal advice.
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