Here are three interesting facts about Japan: First, it has one of the largest number of publicly listed companies in the world; at over 3,700 in 2020 only India, the US, China and Canada have more, according to World Bank figures. Second, the market capitalization of these companies amounts to more than 130% of GDP; again an unusually high share, beaten principally by the US with its trillion dollar tech companies and international financial centers like Hong Kong and Switzerland. The third, and rather inconvenient, fact is that Japan has been significantly outpaced by the US and China in terms of the growth of total market capitalization. The total market capitalization of Japanese listed companies increased by 75% from 2010 to 2020, which is exactly the same rate as the global market as a whole; however in the same period market capitalization in the US and China grew by 130% and 200%, respectively.
There are many different debates and opinions that arise when reflecting on these three facts, but the financiers at ORIX have drawn their own conclusive viewpoint: that Japan’s corporate scene is full of big conglomerates that are ripe for ‘carve-outs’.
The idea of carve-outs - the sale of non-core divisions - is not new in Japan, though it has been slower to adopt the laser-like focus on a single core business that is common in the US and increasingly so in Europe. However, the growing power of shareholders and investors, including activist investors, demanding more focus on core businesses and capital efficiency, is starting to be felt in Tokyo too.
The corporate governance reforms promulgated by late prime minister Shinzo Abe are also prompting large companies to shed “Cinderella” businesses which do not fit with core activities, in which they have stopped investing, and which are often underperforming as a result.
A three-pronged strategy
This is meat and drink for ORIX’s Private Equity Investment unit in Japan, which together with the separate Concessions operation forms one of the group’s 10 business divisions. Started in 1983, the unit returned to PE investments from 2012 after restructuring itself following the global financial crisis. In the decade since, it has completed nearly 30 investments, usually buying 100% of the target company, and about half of these have been successfully exited.
Headed by ORIX main board member and Senior Managing Executive Officer Shuji Irie and Executive Officer Seiichi Miyake, the PE Investment business has approximately JPY370 billion ($2.7 billion) in assets, or 3% of the group total and contributed 2% to overall profits in 1Q FY2022. The goal is to raise the assets invested to JPY1 trillion, or 10% of the total – making this one of ORIX’s three strategic growth pillars alongside Asset Management and Environment & Energy.
Most of the unit’s transactions in the past have come from purchasing private small - and medium - sized businesses direct from founders and owners who have no natural successors. Business succession for small and middle sized companies is another critical issue for Japan, and ORIX plans to continue this successful approach.
This strategy will be reinforced as the recent market restructuring of Tokyo Stock Exchange is likely to force many small and middle sized listed companies to either downgrade or go private, since they will no longer meet specific criteria such as free float, market capitalization of free float and others. With no alternative sources for raising fresh equity and potential concerns of shareholder activism, such firms, which are in many cases founder/owner led, may consider selling out to a group like ORIX that has a large balance sheet.
But the third leg in the PE Investment division’s strategy will be carve-outs, an area it expects to see increased growth and importance as Japanese companies start improving corporate governance and hence focus profitability, capital efficiency and shareholder returns. Still, it will take work on the part of ORIX to persuade Japanese conglomerates to think of it as a potential partner for their orphan businesses.
Adding both operational and financial value
For that reason, the PE Investment group has recently hired Akikazu Ida, a seasoned investment banker with more than two decades of M&A experience, as a deputy head of the division. Described as one of its ‘pioneers’ when it comes to carve-outs, Ida will not only be receiving proposals from his extensive M&A network; he will be proactively approaching large companies that his team has analyzed, with a view to triggering discussions about potential disposals.
One of the things he brought to the table as an example story was Hitachi in the 1990s when the industrial conglomerate had more than 40 business segments, many of them separately listed, that it decided to sell off to focus on businesses such as digital, IoT and smart manufacturing where it had the potential to achieve global leadership. Other large cap companies followed suit, and he actually joined as the financial advisor to Fujitsu on three of their carve-out divestitures.
For the business on the block, a sale to ORIX, with its hands-on approach to improving all aspects of corporate value, can herald a transformation. The ORIX team in Japan will not only improve administrative functions to save costs but also support front-line sales and even product development. Synergies can come from using ORIX’s existing distribution channels to develop new customers and making use of ORIX products and services.
Indeed, ORIX is rather special, as one of the very few companies active in Japanese private equity that are not PE “funds”. As a company that operates solar farms, resorts, airports and much more, its people approach problems with a genuine business mindset and focus on operations rather than just financial metrics.
Then there is the power of the group balance sheet. Many of the companies ORIX acquires have been starved of investment; and often there is an inability to refinance their borrowings to reduce the cost of capital. Since ORIX is injecting purely its own money, rather than that of third-party investors raised via a fund (as traditional PE firms do), it can be extremely flexible and take a long-term view: while most acquired businesses are eventually sold, some may end up as permanent ORIX companies.
But the PE Investment business has ambitions beyond improving individual investments. “There is a lack of true risk capital in Japan and this stops whole industries from restructuring or consolidating,” explains Ida. “If we can supply that, we could have a positive impact on an entire sector and therefore on society generally.”
