Hunting growth: Japanese outbound M&A on the rise

August 2012 Capital Agenda Insights Boardroom issues Are you considering a divestment in the short to medium term? Do you have Japanese suppliers or customers where a sale to them could make strategic sense? Do you have sufficient understanding of the Japanese buyer profile to make a successful deal? Do you know the motives of Japanese companies in order to attract their investment? Have you considered a partnership with a Japanese company as an alternative to an outright divestment? Hunting growth: Japanese outbound M&A on the rise Japanese companies are buying record levels of foreign assets. Companies looking to sell need to understand why if they want to reap the rewards The global M&A market is struggling to recover from the financial crisis, but one area is flourishing: Japanese companies are on a record-breaking international spending spree, buying foreign assets as never before. Outbound M&A deals by Japanese companies hit US$68b in 2011, an 81% increase on the previous year, according to data from Thomson Reuters. There were 644 deals in total, a rise of 20%. This upward trend is not a simple result of growing Japanese enthusiasm for M&A deals in general on the contrary, domestic deal-making has been falling since 2006. Rather, this trend stems from the opportunity for substantial growth which international expansion can bring. The rise of Japanese outbound activity will also bring change to the global M&A landscape, as we are likely to see new global companies coming to market. Activity will come from experienced deal-doers, including Japanese conglomerates, trading companies and large multinationals, as well as the M&A novices who have been domestically focused. Deal flows will be within the Asian region but also beyond. Companies looking to sell assets need to understand what is motivating Japanese buyers to look overseas, and why they are particularly keen to do so now. Japanese outbound M&A value (US$) and volume 35,000 Deal value ($m) 30,000 Number of deals 25,000 20,000 15,000 10,000 5,000 0 1Q,06 2Q,06 3Q,06 4Q,06 1Q,07 2Q,07 3Q,07 4Q,07 1Q,08 2Q,08 3Q,08 4Q,08 1Q,09 2Q,09 3Q,09 4Q,09 1Q,10 2Q,10 3Q,10 4Q,10 1Q,11 2Q,11 3Q,11 4Q,11 1Q,12 2Q,12 200 180 160 140 120 100 80 60 40 20 0 Source: ThomsonOne.com

What are the deal drivers? Problems at home One of the main reasons for Japanese companies to seek growth overseas is the lack of domestic demand. The local market for products and services are mature, with little scope for expansion. The country has suffered from a struggling economy since the boom and then bust years of the late 1980s. Growth was non-existent during the lost decade of the 1990s and has remained low and this is unlikely to change any time soon. The Japan Center for Economic Research (JCER) forecasts average growth will be less than 1% between 2011 and 2020. The country s population, meanwhile, is aging and falling. The JCER predicts it will reach 106.1 million by 2040, which is 20 million fewer people than in 2011. Moreover, the JCER forecasts that for every 100 people of working age (15 64), another 85 will be dependent, because they are either young (0 14) or elderly (65 or over). In response to these deep trends, Japanese companies have been moving overseas for growth. The number of businesses with an overseas affiliate has increased steadily for at least 20 years. Nearly three times as many Japanese companies have an overseas operation now compared to 1992, according to the Ministry of Economy, Trade and Industry. The trend is particularly clear for manufacturing companies and has fueled fears that Japan s economy is being hollowed out, with its prized industrial base and manufacturing skills being relocated overseas. But this development can be seen across sectors from consumer goods companies seeking younger, brandsavvy customers to insurance companies trying to offset the cost of paying out to elderly policyholders. Last year s devastating earthquake has also played a part. With the majority of Japan s 54 nuclear power plants shut down since March 2011, fossil fuel generators have been brought out of mothballs, and power costs have soared. The fear of supply rationing is imminent, encouraging companies that need a stable supply of energy to look for overseas locations. The impact of a strong yen Japan has sovereign debt problems of its own, but the global financial crisis has seen its currency strengthen as a relatively safe haven. Slowing growth in India and China, a struggling US economy and the continuing turmoil in the Eurozone have seen the yen appreciate to post-second World War highs against the US dollar. The rapid appreciation of the yen, which has been approximately 25% 50% over the past two years, has given companies with production facilities or service Number of Japanese overseas affiliates 20,000 18,000 Total Manufacturing 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Ministry of Economy, Trade and Industry 2

processes in Japan an even stronger incentive to relocate activities overseas. It also makes it cheaper for them to achieve this rebalancing via M&A transactions. The JCER forecasts that a future 10% appreciation of the yen against the US dollar would raise the ratio of foreign direct investment by 0.8%. Toyota, Asia s largest car maker, last year said it will spend Y26.3b building a production hub in Indonesia, as it aims to find half its sales in emerging markets by 2015. Businessweek reported that the company loses Y34b in operating income for every Y1 appreciation against the dollar. Emerging market focus The shift to an emerging market focus is another long-term factor influencing Japanese M&A plans. The grim European economy meant that in May this year, Japan recorded its first monthly trade deficit with the European Union since records started in 1979. Current troubles aside, Japanese companies with established activities in Europe or the US have been seeking high-growth potential elsewhere for some time. The number of Japanese companies with European and US subsidiaries has been shrinking since 2001. Their interest is increasingly shifting toward China, the wider Asia- Pacific region and, to a lesser extent, Latin America. While Japanese companies have placed substantial investment in the resources sector to secure a stable source of fuel for domestic use, a significant portion is aimed at penetrating the emerging market s consumer sector. USD/JPY 160 140 120 100 80 60 40 Source: IMF 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 3

The Japanese buyer profile Many companies involved in the current outbound M&A spree have been active international players for decades. They are household-name businesses in the automotive and consumer electronics industries and have been slowly moving overseas since the 1960s. The country s financial firms have also become more willing to re-enter the international scene. They have been cautious investors since having their fingers burned in Japan s 1980s bubble economy collapse. In general, their aversion to risk has helped them to avoid many of the problems that have hurt their counterparts in Europe and the US. The strong yen and the euro crisis have enabled Japan s financial firms to add new lines of business, fill gaps in their services portfolios and enter new territories. They have been particularly keen to buy the Asia-Pacific businesses of European institutions. M&A novices One notable factor of the recent outbound spree is that many of the companies involved are looking to complete M&A deals outside of Japan for the first time. The country has a rich seam of national market leaders both public and private companies that are almost entirely dependent on domestic sales. Faced with sharp falls in turnover, and armed with a strong yen, they are increasingly realizing that now is the right time to go overseas for growth. The window of opportunity for these businesses is directly linked to the yen s strength. Once the volatility in the Eurozone finally fades, there are indications that the next crisis brewing could be Japan, with its sky-high government debt Japan s borrowings, as a percentage of GDP, are twice those of the US and higher even than those of Greece. However, it must be noted that the debt situation in Japan is a little different from that of other countries. Many Japanese mega banks have been the primary investors of Japanese government bonds, which mean more internal reserves in Japan. Interest rates are still low, and Japan has enough financial assets to offset this debt for the time being. 4

What should sellers look out for? Japanese companies: 1) Are detail-oriented, so they may ask for quite a lot of information to be disclosed during diligence compared to other buyers 2) Are expected to be more disciplined around pricing than they have been in past 3) Tend to take quite a long time during the internal authorization process to make decisions, but once they make a decision, they move quickly 4) Typically do not make drastic people-related decisions, and tend to take good care of employees 5

Japanese targets and the motives behind them Consumer products Companies aim to gain market penetration in emerging markets mostly with fast-moving consumer goods players. Some Japanese companies are strategically using their own established brands. Japanese companies are using favorable exchange rates to buy well-known brands. Life insurance Companies hope to gain market penetration in emerging markets because of a declining domestic population. Their aim is to take advantage of the rising middle class in many of these markets. Automotive parts Initially, the goal was to support major Japanese automotive manufacturers going overseas. These companies are now looking for joint venture opportunities with local companies to gain access to non-japanese OEMs. They will bring technology and a global network to local firms, who have the domestic knowledge and experience. Japanese conglomerates (trading companies, locally called Shosha ) These companies are looking for natural resources, such as oil and gas, minerals, and commodities such as food and grain, among others. Japanese businesses are extremely sophisticated and in many different lines of business. More recently, they have been acquiring a larger percentage of the target versus the more traditional minority stake. Pharmaceutical The desire is for niche companies with good product pipelines, especially in Western countries, to fill gaps in their own product offerings. They also intend to build knowledge in generic products to then bring back to Japan. IT and media The goal is to expand beyond their domestic customer base and become global players. Telecommunication companies are expanding to emerging markets by taking minority stakes in operators, as well as looking at system and network integrators with a good local client base. 6

The following illustrates the top geographic destinations and target industries for Japanese investments since Q1 2006 to Q2 2012, both in terms of deal value and number of deals. Top target destinations for Japanese companies 1Q 2006 2Q 2012 Target nation Deal value (US$) United States 107,594 United Kingdom 31,172 Australia 23,618 Switzerland 18,548 Brazil 12,800 India 12,570 Chile 9,611 Singapore 7,829 Philippines 6,391 Top industry targets for Japanese companies 1Q 2006 2Q 2012 Deal value Target macro industry (US$m) Health care Consumer staples Financials Materials Energy and power High technology Industrials Telecommunications Media and entertainment Consumer products & services Retail Real estate 59,356 51,740 43,974 39,185 37,209 23,537 13,478 7,167 6,786 5,272 3,377 2,559 Number of deals 699 133 190 38 70 131 15 88 38 Number of deals 195 221 269 494 256 512 554 58 110 212 94 49 Conclusion Whether they are experienced overseas investors or are venturing outside Japan for the first time, the recent surge in outbound investment has made Japanese companies increasingly important players in the global M&A markets. It s more likely than ever that a business looking to sell an asset will find itself dealing with potential buyers from Japan. These sellers will secure better transaction terms if they understand why Japanese companies need to buy overseas, and why they are particularly keen to do a deal now. Source: ThomsonOne.com 7

Boardroom issues Are you considering a divestment in the short to medium term? Do you have Japanese suppliers or customers where a sale to them could make strategic sense? Do you have sufficient understanding of the Japanese buyer profile to make a successful deal? Do you know the motives of Japanese companies in order to attract their investment? Have you considered a partnership with a Japanese company as an alternative to an outright divestment? Contact Kenneth Smith Ernst & Young Transactions Advisory Services Japan Leader T: +81 3 4582 6663 E: kenneth.smith@jp.ey.com Ernst & Young Assurance Tax Transactions Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 152,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. About Ernst & Young s Transaction Advisory Services How organizations manage their capital agenda today will define their competitive position tomorrow. We work with our clients to help them make better and more informed decisions about how they strategically manage capital and transactions in a changing world. Whether you re preserving, optimizing, raising or investing capital, Ernst & Young s Transaction Advisory Services bring together a unique combination of skills, insight and experience to deliver tailored advice attuned to your needs helping you drive competitive advantage and increased shareholder returns through improved decision making across all aspects of your capital agenda. 2012 EYGM Limited. All Rights Reserved. EYG no. DE0355 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. ED None