Described as “the most closed investment market in the developed world” by European Union trade commissioner Peter Mandelson, and ranked last by the Organization for Economic Co-operation and Development (OECD) as a target for foreign direct investment among major economies, Japan has developed a reputation for being resistant to foreign investment and extremely hostile to the practices of foreign financial investors.
But contrary to Japan’s reputed aversion to foreign capital and Western investment practices, Japan’s volume of M&A transactions grew at a compound annual growth rate of 13.9% between 1996 and 2006, foreign ownership in companies listed on the Tokyo Stock Exchange rose to 28.0% of market value, and, after years of lackluster economic performance, polls of the Japanese population now indicate a belief that foreign investment can help the moribund Japanese economy. This article will examine the general environment for foreign investment into Japan, recent high profile investments that have encountered resistance, and specific strategies Western investors have employed to successfully avoid or ameliorate resistance to foreign investment.
Investment rates into Japan trail those of other major economies. Despite its rank as the world’s second largest economy, Japan’s inward FDI rate is surpassed several times over by those of individual European countries. However, keeping with successive government administrations’ goals of doubling the level of foreign direct investment in Japan at five-year intervals or faster, Japan has been narrowing “the FDI gap.”
Gross capital inflows to Japan increased to their highest level in 2006, and foreign capital invested in Japan reached $107.6 billion that same year. M&A volume and value have also shown a long-term upward trend, and domestic and foreign private equity firm buyout activity has increased disproportionately quickly compared to overall M&A, demonstrating an increased openness to Western forms of financing. M&A activity is expected to increase further still with new legislation allowing triangular mergers with foreign entities, which has been characterized by the Japan External Trade Organization as “a systemic change that will very likely promote M&As of Japanese companies by overseas companies.”
Continuing reforms to bring down the firewalls between retail and investment banking, and relaxing regulations for acquisitions within the pharmaceutical industry, among others, make a compelling case that the government is genuinely trying to facilitate both domestic and foreign M&A activity.
Despite the support shown by elected officials for increasing FDI in Japan, foreign investors still face a substantial amount of bureaucratic red tape, particularly with respect to protected industries. DI is principally governed by the Foreign Exchange and Foreign Trade Control Law, which specifically prevents foreign investors from acquiring a majority stake in Japanese companies within industry sectors classified as closely related to national security and public safety. This includes industries as diverse as aeronautics, defense, nuclear power generation, energy, telecom, broadcasting, railways, tourist transportation, petroleum and leather processing.
Foreign investors intending to make direct investments in certain industries must file with the Japanese Ministry of Finance as well as the respective ministry governing the specific industry of the investment target. If issues are found in relation to the investment, either the Ministry of Finance or the industry-specific ministry has the authority to issue an official recommendation to revise the investment plan or to put a complete stop to the acquisition. Industry-specific regulations that, for example, limit foreign ownership to one-third for airline and telecom companies, further constrain foreign investors.
Blocked Investments
Steel Partners and TCI provide two examples of take-over bids for Japanese companies meeting with intense resistance on multiple fronts. Steel Partners is a U.S.-based buyout/activist fund and the largest shareholder of several sizeable Japanese corporations. Steel Partners has imported its U.S. activist investment model to Japan and has shown a willingness to question publicly the strategy of current management at its investment targets and to litigate disagreements.
As a result of Steel Partners’ posture, the firm’s take-over bid for household-brand Bulldog Sauce met with resistance from the media and Japan’s legal system. The court to which Steel Partners appealed a failed injunction to prevent Bulldog’s poison-pill strategy stated: “[Steel Partners] pursues its own interests exclusively and seeks only to secure profits by selling companies’ shares back to the company or to third parties in the short term, in some cases with an eye to disposing of company assets…. As such, it is proper to consider the plaintiff an abusive acquirer.”
The battle between London-based TCI fund and Japanese power provider J-Power has also become a test of Japan’s eagerness for foreign direct investment. TCI began attracting media attention in Japan by acquiring shares of J-Power in 2005. After applying for approval to increase shareholdings to 20%, TCI met a wall of resistance: J-Power management cautioned that TCI could cut maintenance and investment costs in nuclear plants, and the Japanese media relayed sensationalist warnings about the potential for “blackouts.” The result: The Japanese government blocked the investment.
As evinced by the prior examples of Steel Partners and TCI, loud public investor agitation has not produced a track record of success for foreign investors. However, there are numerous counter-examples of smoother direct investment involving foreign and Japanese companies — including Renault’s investment and subsequent turnaround of Nissan, and Citigroup’s January 2008 purchase of Nikko Cordial, Japan’s third largest brokerage. The Nikko Cordial acquisition, born from a seven-year joint venture, was carried out quietly with a minimum of public attention and, according to Citigroup executives, has thus far been beneficial to both parties.
A number of influential business leaders interviewed for this research contributed their views on Japanese resistance to foreign investment and how it can be avoided or overcome. Several themes consistently recurred:
Select acquisition targets that won’t elicit resistance: Leaders of foreign funds making investments in Japan consistently counseled that it was important to avoid conducting business in a confrontational manner. But more importantly, they said, investors would be wise to select investment targets that will not elicit opposition. The management team of real estate investment group Merchant Capital partially attributed both its and Merrill Lynch’s successful avoidance of resistance to the fact that they invested in an asset class that lacks the emotional or regulatory resistance of private equity or activist-shareholder investment. Masanori Mochida, president and representative director of Goldman Sachs Japan, went further and cautioned against Westerners making any type of active investment in Japan.
Show sensitivity to the local culture: Among both Japanese and Western investors interviewed, the foreign fund most consistently mentioned was Steel Partners. The activist-shareholder role Steel Partners adopts is entirely practical from a shareholder-value centric view, but their non-collaborative approach (not disclosing their post-investment plans or objectives to the management teams of target companies) and confrontational style (seeking injunctions against their targets) have been perceived as tone deafness by other investors in Japan. Far more savvy is Citigroup’s approach, which has been so delicate in its integration of Nikko Cordial that employees at the branch level are largely unaware of any change of control, according to Brian McCappin, head of Fixed Income and member of the Executive Committee at Nikko Citigroup.
Negotiate as equals: A large number of investors targeting Japan, as well as Ray Yamamoto of GCA (Japan’s largest independent M&A advisory firm), emphasized the necessity of dealing with potential acquisition targets and investment targets as equals. This extends from the lip service of sometimes describing acquisitions as “mergers” to the culturally specific and highly formalized Japanese convention of having only counterparts of the same title and responsibility level meet with each other.
Avoid headcount reductions to the highest degree possible: Several issues lie at the root of Japanese resistance to foreign investment. But for the general public, raised on the ideal of lifetime employment, perhaps nothing is more central to opposition to foreign investment than the fear of American-style cost-saving through headcount reduction. Indeed, in our poll of Japanese attitudes towards foreign investment, this was what Japanese citizens feared the most about foreign ownership of Japanese companies. Manabu Yamamoto, a managing director at Cerberus Japan, echoed the words of other interviewees when he stated that they do not view headcounts as a variable cost when examining Japanese companies. In his seven years at Cerberus Japan, Yamamoto has never seen his firm implement layoffs. Takeshi Kamiya and Ryosuke Kawashima, consultants in Bain’s private equity advisory practice, caution that any fund that seeks to cut costs through a headcount reduction strategy would find it difficult or impossible to consummate future deals.
Keep out of the public eye: Interviewees noted that the level of sensationalism in the Japanese press towards foreign investment has died down over the past decade. But investors also uniformly agreed that keeping investments and transactions out of the media should be a priority. GCA’s Ray Yamamoto largely credits his eight successful takeover defenses against the Murakami fund (a Western-style, Japanese activist fund) to the attention he was able to generate in the media.
Make a commitment to this specific geography: According toRichard Folsom, cofounder of Advantage Partners (the PE firm which has completed the most deals in Japan), the only firms that have succeeded in making direct investment in Japan are those demonstrating a complete commitment to the country. Folsom suggested that localizing to Japan, creating a deal-sourcing network and acquiring processing capabilities in Japan required such a large investment of resources that funds only partially focused on Japan (e.g., pan-Asia funds) would inevitably begin looking at other geographies that are more welcoming to FDI and provide faster consummation of deals.
The satirist Peter Finley Dunne’s oft-repeated criticism of Japan after Commodore Perry’s military/trade mission, which opened Japan to the West, has rung true for almost 200 years: “Th’ trouble is whin the gallant Commodore kicked opn th’ door, we didn’t go in. They come out.” However, there is clear cause to be optimistic that, as foreign investors’ capital and investment practice more fully adjust to Japan, and as Japanese attitudes and policies become more accepting of foreign investment, foreign capital will increasingly “go in.”
This article was written by Stephen Hibbard, Forest Shultz, Lilian Wouters and Jan Zelezny, members of the Lauder Class of 2010.
