September 15, 2020
【Column】Demystifying the coronavirus – impacted Japanese M&A Market – Part 2 –
Demystifying the coronavirus
impacted Japanese M&A Market
Why have domestic deals increased amid the pandemic, and where to from here?
*In part 1, we examined why the pandemic has not slowed domestic M&A deals in Japan. Here we discuss the record-breaking M&A figures in June and July 2020, and predict what lies ahead. Our belief is that the M&A market in Japan will continue to experience an upward trend for the remainder of the year.
Part 2: The Market in the Middle of a Pandemic - 2020 and Beyond
1. The initial shock
First half of 2020 saw a 60% shrinking in value of domestic and cross-border M&A deals involving Japanese firms to around 2.9 trillion yen. Cross-border deals were especially hard-hit, with overseas acquisitions declining 76% in value from the same period the previous year. In contrast, domestic deals only shrank by 30% in value.
This initial halting of deals was a by-product of a working culture that believes “remote work is not real work”. In a country that values face-time, businesses were ill-prepared to conduct deals remotely – many thinking it was not possible. Coronavirus has challenged the Japanese economy, and in particular M&A market by making due diligence, face-to-face negotiations, and everyday execution of deal tasks difficult. Rigid administrative procedures, such as corporate seal requirements, strict internal procedures, difficulty in changing preset board meeting agendas and obtaining M&A approvals at these board meetings, all played a part.
As a result, the first half of the year saw companies initially go into a shock cash-saving mode: more so than their usual cash-saving habits.
2. The June and July figures
In June, domestic M&A cases were up by 7% compared with June last year. Further, in July, there were 70 domestic M&A cases, making it the third consecutive month that figures were higher than the equivalent month in the previous year. Some factors that may have maintained the 2019 upward trajectory are discussed below.
- The new masked, digital age
The factors that halted both cross-border and domestic M&A activity from March to May appear to have been addressed. Some deals are now moving forward with parties having never met. Negotiations and kick-off meetings among sellers, buyers and multiple advisors can be done over Zoom or its equivalent. In the domestic context, companies have resumed face-to-face negotiations with new precautionary measures. (Wearing a mask during negotiations is no issue in a country so accustomed to mask-wearing during winter months to prevent the spread of influenza.)
Japanese companies are showing a willingness, or at least “shikatanai” (or “there is no other way”) attitude towards this new masked, digital world. While this may have seen deal activity resumed domestically, how this digitalization of deals will impact the quality, length and the various M&A procedures is yet to be understood. While starting negotiations online and conducting parts of due diligence is feasible, there is still skepticism and resistance towards closing a deal with an unfamiliar party: more so if the party is foreign and is not from the same cultural background.
- Cash is King
In Part 1, we discussed Japan’s infamous corporate cash-hoarding culture: the long-time anathema of the activist shareholder. While this usually gets the stick from the international business community, the practice may have paid off in this crisis. Once the market overcame the initial shock, from March to May, companies with enough cash resumed deal activity. Notable domestic deals included Pepper Food Service, a holding company of several restaurant chains, sold its star business – Pepper Lunch – to an investment fund J-STAR for 85 billion yen.
While the value of the transactions during this period had decreased compared with the same time last year, the increase in terms of the number of deals is a promising trend for the market.
- Earlier than planned successions
We discussed the succession issues faced by a generation of bubble-era entrepreneurs, looking to M&A as their exit strategy. See Part 1. Cash flow issues and other sobering trajectories caused by coronavirus have forced cash-strapped entrepreneurs to retire earlier than anticipated. While the total amount of deals from January to June decreased compared to first half of last year, succession related deals increased compared to the same period as last year. Succession cases made up many of the June and July figures (for example in July, out of the 252 domestic cases, 47 were succession related cases). We anticipate that we will see more domestic succession driven cases in the second half of 2020 with big corporations snapping up their smaller rivals in saturated markets.
3. 2020 and beyond
In the domestic context, the trends described above will likely continue. Succession issues will continue to cripple SMEs for the foreseeable future. Companies will continue to make divestments and downsize in response to shareholder pressure. This may lead to an increase, or at least the maintenance, of current activity levels.
For cross-border deals involving Japanese companies, it is unlikely we will see any complex mega-deals this year. As remote work and virtual meetings become the norm, a certain level of due diligence and negotiations can be conducted remotely. This trend will likely continue even post-corona. Yet for Japanese companies, a sensitive, high-stake decision to purchase a foreign company cannot be all achieved over Zoom. The inability to “shake hands on it” will hinder cross-border mega deals closing in the foreseeable future. As well, valuations remain challenging in corona times: with most companies’ 2020 financial statements not being a fair representation of how a company may perform in the future.
Japanese businesses have experienced an IT bubble, the Lehman shock, and the 2011 Tohoku disaster. They are accustomed to conducting M&As during such downturns. Each crisis has had a lasting impact on the market, and the coronavirus’ long-term market effects are already being felt.
Notably, Mitsubishi implemented an unprecedented policy in response to the pandemic. It announced that it will implement a one-in, one-out policy: breaking taboo of Japanese companies that were reluctant to make divestments in the past. If other corporations follow this powerhouse’s strategic move, it could cause a seismic shift in the way the Japanese M&A market operates. With conglomerates slimming down, we may see foreign private equity firms rushing in to make attractive bids.
In any case, one thing is certain: while the road back to pre-coronavirus levels of activity internationally will be a long and rough one, the Japanese M&A market seems to be re-gaining its momentum.
*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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