Structural changes in Japanese society are driving private equity dealflow among founder-owned businesses and corporate carve-outs, say Atsushi Akaike and Daisuke Takasuki at CVC Japan.

Partner and Co-Head of Japan Atsushi Akaike and Principal Daisuke Takatsuki were recently interviewed for Private Equity International's keynote interview.

Read Atsushi and Daisuke's interview below and find the full report on PEI's website.

Why is the time to be investing in Japanese private equity?

Atsushi Akaike: CVC Japan was launched 20 years ago, in 2002, and people have been saying that this market is poised for growth for the last two decades. However, I really do feel that now is the time that Japanese private equity is going to take off. The country’s economy has been very stable for the past decade. Japan is also facing a lot of structural changes, largely due to an ageing population and very low birth rate. Some industries, therefore, require consolidation, as demand is decreasing.

At the same time, technology is creating new business opportunities, just as it is in other parts of the world. In addition, we are seeing a growing acceptance for private equity among the Japanese business community. Corporates are increasingly prepared to consider selling their non-core assets to firms like us, and family owners are more and more likely to partner with us. With all these factors coming together, I think this might be the moment where the Japanese private equity market opens up, and I expect to see gradual but consistent growth in the years to come.

What types of opportunities are you starting to see as a result of these structural changes?

AA: Japan is the third largest economy in the world by GDP, and its industrial base is very similar to Germany. There are many manufacturing businesses, for example, that other private equity houses are focused on. CVC, however, tends to focus on services and consumer-facing businesses. We are looking for opportunities in sectors such as healthcare, where demand is being driven by an ageing population, or technology-enabled service companies and consumer product businesses, where we can often help build a brand outside of Japan and drive internal efficiencies in order to capture its full potential. One example of a recent bilateral transaction that reflects some of these structural changes is our investment alongside the founding family in TRY Group, the largest home and private tutoring company in Japan.

The Japanese tutoring market has been growing even though the number of children in the country has been declining. This is due to increases in per head spend, driven by growth in the number of double income households reflecting the increasing number of women in full-time employment. Another recent example is our bilateral investment in FineToday Shiseido, a skincare and haircare company carved out from Shiseido, the leading prestige cosmetics company in Japan. Fine Today Shiseido generates around 45 percent of its revenues in Japan and 55 percent elsewhere in Asia. Growth in those non-Japanese markets is predicted to increase by more than 5 percent per year, and this is a growth area we are looking to target – within five years we expect to have a truly pan-Asian business.

How would you describe competitive dynamics in the Japanese market?

AA: A number of international private equity firms have recently set up shop in Japan and, of course, there are many domestic firms as well. The Japanese market has always been competitive and we expect competition to increase further, as more and more firms recognise the region’s growth prospects. However, a new entrant cannot build a senior and experienced team overnight, it takes time to establish a reputation and gain the trust of the corporate community. CVC invested in TRY Group as Japan’s tutoring market grows. It takes time to gain traction in the Japanese market – I have been involved in transactions where it has taken more than five years to complete the deal after talks initially began with the CEO.

Where do your deals tend to come from?

AA: Typically, there are two categories. One is a founder succession situation, and the other is a corporate carve-out. Many of the older founders are now reaching their later years and, due to the very low birth rate, they do not necessarily have succession options within their own families. These types of opportunities are growing in both size and number. What is interesting is that while these founders care about valuations, they also very much care about who is going to look after their companies after they sell. These businesses are like children to them, and they want them to continue to flourish and for the culture they have built up throughout their entire careers to be maintained. Meanwhile, most large Japanese corporates are extremely diverse and have too many operations that are non-core within the group.

Historically, Japanese business leaders have tended to prioritise size – revenue and number of employees – over performance. Yet that is starting to change. With the increase in global competition, focus on corporate governance and dialogue with active shareholders, non-core divestitures are now more seen as part of the solution. Not all these non-core assets will be sold at once. There is still a lot of internal politics to navigate, including pressure from employees and unions. It can easily take three to five years to bring one of these deals to fruition. But there is now an acceptance that non-core divestitures make sense. With both succession-driven and corporate carve-out opportunities, we primarily transact on a bilateral basis. That is partly down to CVC’s culture, but it is also helped by the fact that in the Japanese market people really care about who they sell to, as well as the price.

What is your approach to value creation once you have completed a deal?

Daisuke Takatsuki: At CVC we want to create sustainable value by building better businesses, and the concept of partnership is fundamental to our approach – that includes both partnership with management teams and partnership with potential co-investors. For example, following our carve-out of Fine Today Shiseido, which Atsushi mentioned earlier, Shiseido has remained an important co-investor and collaborative value-creation partner. Another important aspect of CVC’s approach to value creation involves adding resources. Many companies require additional talent, for example, and we will often look to strengthen the management team with complementary talent from outside. We also work with specialist experts to support management teams on specific projects. In addition, there are instances when we need to help a company evolve its culture following a change in ownership, while preserving its integrity. Management teams and employees that have come out of large corporations tend to be used to a more hierarchical environment. It can also be important to incentivise teams to take decisive action, which means that alignment with our management teams is critical too. We try to instil the mindset of a challenger business in order to help portfolio companies grow to their full potential. The Japanese economy is flat and so we work closely with management teams to really foster a culture of growth.

How is this approach different from that of your competitors?

DT: Even among the large global private equity houses there are significant differences in approach to value creation. As I have mentioned, our approach at CVC is one of partnership. We never bring in our own people to do the job of management. We do, however, spend significant time with a company's management team to identify where CVC can add value and the resources that we can procure from outside to help make that happen.

Do you consider ESG to be part of your value-creation process?

DT: Absolutely. ESG is ingrained throughout the investment process: from origination, through value creation to exit. We firmly believe that investment in ESG is a critical part of ensuring the long-term success of any business. We have a very structured approach to non-financial reporting, and we work with external partners to help companies track their carbon footprint, for example. We also work with one of the top ESG ratings agencies in the world, EcoVadis, and it is mandatory for all the businesses that we invest in to participate. Finally, we have the CVC Foundation, a philanthropic organisation that works with portfolio companies as well.

AA: One example where a proactive approach to ESG added value involves our former portfolio company, elderly care business Hitowa Holdings, which we acquired from its founder in 2016. It was losing 40 percent of its staff every year and so, with management, we focused heavily on non-financial key performance indicators around employee satisfaction. This resulted in the staff attrition rate falling to below 25 percent. While we invested a significant amount in creating a positive working environment at the business, we saw a return on that investment in the form of lower hiring costs.

DT: Those efforts resulted in a very attractive valuation for Hitowa Holdings at exit. In a nutshell, if you take the right actions at portfolio companies then you can create better businesses that can continue to grow after the period of your ownership, so will be more desirable to future owners and can command higher prices.

How would you describe the exit environment in Japan?

AA: Buyers will pay high multiples for good businesses. That does not only refer to good financials, but also strong operations, management teams and sustainable growth. We sold one portfolio company at a 16x multiple having acquired it at 10x, for example. Of course, we helped drive growth at that company, but we also helped put an excellent management team and operational systems in place, which gave the new buyer confidence in future projections. While Japan is not a particularly heated market, buyers will pay for quality.

This article first appeared in Private Equity International on 01 Jun 2022