M&A in Japan: Interview with Arthur Mitchell by Dr Gerhard Fasol
M&A in Japan: Many see the current financial crisis as a period of unique opportunities. Several foreign companies are currently entering or seeking to expand business in Japan. At the same time, there is a wave of Japanese acquisitions abroad. Arthur Mitchell is a lawyer who has worked on a very large number of M&A deals and financial transactions involving Japan, and shares some of his 40 years of experience with Japan below.
Arthur Mitchell is Senior Counselor at the law firm White & Case in Tokyo, and registered as foreign lawyer in Japan.
Arthur has worked on a large number of private equity investments and many other joint ventures and financial transactions involving Japan.
He was General Counsel of the Asian Development Bank (ADB) where he managed 42 attorneys from 18 countries. Previously he headed the Japan practice for Coudert Brothers and the Pacific Practice Group for Chadbourne & Parke.
Arthur also was founder and CEO of a New York based consulting firm, which launched the first ever hedge fund offered in Japan!
Arthur was educated at the Harvard Law School (JD), UC Berkeley (BS) and Kyoto University, Faculty of Law.
M&A in Japan – Megatrends:
1 Question (Dr. Gerhard Fasol):
Arthur, you have been involved with Japan for 40 years now. What are the mega-trends you see for M&A over these years? What has changed over these years?
Of course, the biggest change during that period was the mind-set of Japanese management. In the 70’s and early 80’s, M&A was virtually a dirty word. That was because of what we might call the “village-mentality” of managers. The idea was that you look after your group and minimize outside influences on business decisions. More recently, certain types of M&A have come to be seen as a practical way of achieving corporate objectives. For a period of time following the bursting of the economic bubble, the cross-shareholding levels of listed companies went down but in recent years, the trend has reversed and these holdings are on the rise again. While friendly acquisitions are now readily accepted among the Japanese themselves as well as with foreigners, hostile acquisitions are still less well received in Japan.
On the subprime crisis and Lehman Shock
2 Question (Dr. Gerhard Fasol):
I think one of the most interesting manifestations of this change in thinking is the potential acquisition of Sanyo by Panasonic, but there are many more.- What is your take on the current crisis? Doesn’t our crisis now create opportunities as well?
The current crisis is not a natural disaster. It’s a man-made debacle that originated with the sub-prime loan and securitization process in the United States and is properly understood as a major market, policy and regulatory failure. Japan suffered a long recession due to the failure of its “bank-centric” financial system and the U.S. has now aptly demonstrated that capital-market-centric frameworks can produce unacceptable systematic risk. As recently as a few months ago, it looked like Japan would not suffer too much because Japanese companies and banks were on the sidelines when it came to investment in sub-prime and exotic securitized products. Now it is apparent that Japan can not remain as a tranquil island in a sea of financial trouble. The Japanese stock and commercial real estate markets were heavily dependent on foreign investors who are either hesitant about investing in Japan at this time or have too many problems back home, which prevents them from focusing on Japan. On the other hand, Japanese companies are relatively cash-rich and are keenly interested in making overseas acquisitions in order to make up for the time lost during the last 15 years. Depressed asset prices in other countries, as well as a strong yen, make these acquisitions particularly attractive. The question is whether Japanese managers will be able to transform these opportunities into a strategic advantage.
Preparations, finding deals:
3 Question (Dr. Gerhard Fasol):
As long as I have been working with Japan – on one ear I hear foreign fund managers complaining (in English) “that there are no deals”, but on my other ear, when I talk with my Japanese business friends (in Japanese) I hear about so many deals happening all the time – one of my friends, a Japanese private equity investment manager, has done tens of deals up to US$ 1.5 billion in size within Japan. What advice do you have for these fund managers complaining that there are “no deals in Japan”?
As I just mentioned, the number of M&A deals among Japanese parties has increased dramatically in the last 10 years. Acquisitions in Japan by non-Japanese have also increased over that period but over-all foreign direct investment in Japan by comparison with international standards is still relatively small. FDI in Japan has been consistently between 2-3% of GDP, far below the level for other OECD countries. As a general rule, Japanese managers are still rather reluctant to sell divisions or the company itself unless there is a compelling strategic logic to the combination or the firm is under financial stress. The chief motivation for doing these deals is rarely related to purely financial concerns as more focus is placed on market share and company standing in the marketplace. The key to accessing deals is to have the relationships with important decision-makers at companies that are likely to be interested in M&A for strategic reasons. This is why it is important for funds to be represented in Japan by senior Japanese executives and advisors with long-standing ties.
4 Question (Dr. Gerhard Fasol):
Same with companies – I know some foreign companies who have to tried to make acquisitions in Japan for 10 years without success. What’s your advice? Look harder? Put more resources into searching and preparing?
As just mentioned, relationships are of paramount importance even today. Among the Japanese themselves, these relationships originated with school, social or company ties. Given this reality, it is very hard for foreigners to duplicate this process. Some foreign private equity funds have tried to address this by hiring rather young Japanese bankers who literally and figuratively “speak their language” but the unfortunate reality is that many of these individuals do not have credibility with the decision-makers. Some years ago, foreign firms also had difficulty hiring senior Japanese to work in these firms. That is less of a problem these days but finding the right ones still presents challenges. For example, if they have a background in the financial services industry, they may not know the business of the manufacturers. If they come from a manufacturing background, they may have contacts only in a narrow industry. One way to bridge this gap is to form an advisory board of senior people-both Japanese and foreigners-who can serve as the bridge.
M&A in Japan: The Transaction:
5 Question (Dr. Gerhard Fasol):
When a foreign company acquires a Japanese company, which are the points critical for a successful transaction?
From a legal perspective, the initial question is always whether there are any governmental regulations that would restrict or prevent the investment. Prior to 1980, investment in numerous industries was highly regulated but following reforms in that year, with the exception of a very short negative list, legal barriers were relaxed. Until recently, no foreign acquisition was blocked on “national security” grounds. For the first time this year, the Japanese government blocked an increase in the shareholding by the Children’s Fund, a U.K. private equity fund, in J-Power, an electric power company, on the dubious grounds that foreign ownership above 20% would be harmful to “social order”. The Japanese legislature is now debating whether Japan will restrict ownership of a single shareholder to 20% in Narita and Kansai airports when they are privatized in the near future. In the context of Macquarie’s ownership of 19.9% of the facilities at Haneda airport, this move has obvious anti-foreign overtones. As economies around the world deteriorate, it would not be usual to see even more protectionist measures in Japan as well but, for the moment, I do not think that we can say that there is a discernable trend. Therefore, overall, adequate planning is the most critical step that needs to be taken to ensure a successful transaction.
On activist investors
6 Question (Dr. Gerhard Fasol):
I have discussed both the Children’s fund and the Macquarie issues with senior Japanese leaders, and found that their opinion is quite devided, some are for, some are against. So I guess its a question of doing enough ground work and preparations, and finding the right allies. Can you tell us some points to watch out for, which could become a problem down the road?
As just mentioned, planning is key. Understanding the Japanese counterparties and what motivates them and the lay of the land is imperative. Foreign investors should not assume that their usual company practices can be imported on a wholesale basis to Japan. Many aspects of law and regulation are very similar to those of other countries but labor relations is one area that can be quite different. For example, most Japanese employees, including senior managers, do not have written contracts but virtually all companies have company policies and rules that govern the employment relationship. Problems can arise if the foreign investor seeks to impose employment contracts which are at variance from the existing rules or practices. The law provides that employees generally cannot be dismissed except for cause. In the case of tech-companies, it is normal in many foreign countries to expect that any intellectual property created by the employee on the job belongs to the company. In Japan, the employee has the rights to an invention made on company time but the company will have non-exclusive license. If the company considers that the invention is critical or important for its business, the company should purchase the intellectual property for a fair price. Accordingly, it is important to observe local practices in these areas.
7 Question (Dr. Gerhard Fasol):
What is your experience with joint-ventures to enter Japan’s markets? Lots of people will advise to avoid joint-ventures at all cost. What is your advice?
Foreign companies seeking to enter the Japanese market have a number of options now. In almost every industry I can think of, it is now legally possible for a foreign firm to set up “greenfield” operations (Fasol: recent examples of “greenfield” start-ups in Japan are IKEA and H&M, and also GOOGLE). Of course there are costs and risks associated with that method but it should not be automatically dismissed. Short of an acquisition, it is also possible to have joint ventures or strategic alliances with Japanese counterparties that may be mutually beneficial and can reduce costs and risk (Fasol: a dramatically successful case is YAHOO in Japan, however in this case it was not YAHOO Inc seeking a joint-venture entry in Japan, but it was Masayoshi Son with Softbank investing in YAHOO Inc and building YAHOO-Japan, which is now arguably far more successful than the original company). If this is coupled with the introduction of off-shore business opportunities, this may lead to a mutually beneficial working relationship that might mature into an acquisition in the future. In order to be successful, foreign companies need to nurture relationships with Japanese companies in their industry and think of ways in which they can “add value” to each other. An interesting example of this is what the Kirin Beer Company is doing with the San Miguel Corporation of the Philippines. Kirin owns about 20% of San Miguel. In the future, they plan to make a number of joint ventures for beverage production in Asian countries. This is a strategic relationship where the parties add value through exchanges of technology, marketing and manufacturing techniques and finance. This model can be used in Japan and can lead to even closer business integration.
The devil is in the details….
8 Question (Dr. Gerhard Fasol):
The devil is in the details…. which details should you watch out for in an M&A transaction?
Yes, the devil is in the details—and there are thousands of devils that have to be dealt with. But in this regard, there is nothing unusual about Japan. I think that the most important thing is to build a common understanding about how the venture will be managed and what the goals are going to be post-acquisition. I do think that the Japanese generally have a somewhat longer term perspective on business. When foreign investors acquire an interest in a Japanese company, they tend to expect better financial performance over a shorter period of time. This can cause tensions in the relationship. For example, if the foreign investor intends to make staff reductions or spin-off divisions after the acquisition in order to improve over-all performance, these matters should be thoroughly discussed and agreed upon well in advance of the closing.
Post-merger phase, integration
9 Question (Dr. Gerhard Fasol):
In my experience, the M&A transaction is the easy part – the really difficult part is to make it work post-merger. There are plenty of gigantic ship wrecks lining the M&A road into Japan. What are the most critical mistakes to avoid to crash into one of the many cultural and other rocks and icebergs? What is your advice?
While failures certainly make the headlines, there are numerous foreign companies that have been very successful in Japan over a long period of time (Fasol: and numerous successful acquisitions as well, the prime example is Renault’s investment in Nissan). These include IBM, Coca Cola and Microsoft and many others. To my mind, successful ones have a long-term perspective, good Japanese managers and a home office that truly understands the local environment. As there have not been a tremendous amount of large-scale foreign M&A deals yet, it is hard to say at this time if this will prove to be the most successful way to enter the market. What we can say is that, with the exception of hostile deals, M&A is a viable route that has yet to be tested in larger deals. As the Japanese market for most products is fairly saturated, and the population is shrinking, Japanese companies (both large and medium-sized) are now looking for major opportunities abroad. With the exception of those who can introduce new products and technologies in Japan, it probably makes sense for foreign strategic investors to look at their Japanese counterparts as partners who can help them pursue global strategies. Financial investors are likely to find more opportunities in Japan as the economy weakens in the next few quarters.
10 Question (Dr. Gerhard Fasol):
In my work I often see that foreign managers make huge mistakes in Japan which they would never make at home. An outstanding example is the fraud case, where Lehman Brothers seems to have been defrauded of US$ 350 million by someone who seems to have pretended to be an employee of a huge trading company which he was not (its unclear what really happened, and we might never know).
No, I am not sure that I agree. I think that fraud happens everywhere. You may have read recently about the former Chairman of NASDAQ who perpetrated a $50 billion fraud on his fund investors. I think that what happened to Lehman Brothers in the case you mentioned is that someone forgot to do the normal due diligence that accompanies transactions of that nature. Actually, it’s emblematic of the new “Gilded Age” which has just ended with the collapse of many of the pillars of the U.S. financial system, including Lehman Brothers. In some very serious ways, America has gone off the rails and has taken most of the world with it. I think that in the aftermath of the financial debacle, we will see a return to basics-less leverage, fewer complex financial products and lower appetites for risk. This is now a global trend which will affect deals in the U.S. Japan and throughout the world.
Avoiding the well known traps…
11 Question (Dr. Gerhard Fasol):
What is your advice to foreign companies in Japan to avoid such dramatic traps.
I do not think that there is anything particular or peculiar about Japan even though some things may be done differently. What is important is to understand attitudes and why people think the way they do. As an example, Japanese shareholders do not always vote in favor of things that many Westerners might think are in their economic interest. We might call that irrational behavior. An example might be the vote that the Sapporo Beer shareholders took when they voted down a generous offer by Steel Partners, an American activist fund. I think it shows that values other than “pure economics” are at work. But this is not unique to the Japanese. German shareholders have similar views. For that matter, I don’t think that “Joe the Plumber” in the recent American election really voted in accordance with his own economic interest. What is important to understand is that people often have multiple motives which are influenced by history, culture and their views of the world. It’s imperative to understand the context in which they are making decisions. That is the only thing that will help a foreign investor avoid “local traps”.
12 Question (Dr. Gerhard Fasol):
Which is your greatest success story working with Japan or Asia over all these years and why?
I have been a lawyer for over 35 years so I have seen a lot of deals. What I like most is finding a unique solution to a problem, creating a new financial product or adding value by helping a client to visualize a new business opportunity. Perhaps one of the most unique things I have done was to help create a strategic alliance between a major Japanese bank and a U.S. real estate firm to assist Japanese investors crack the U.S. market. This led to a front page feature article in the Wall Street Journal. But that was a long time ago. More recently, when I was General Counsel of the Asian Development Bank, I played a significant role in the response to the tsunami that affected a number of Asian countries. We had to deal with a new situation, when there was no road map and very little time. I had to conceptualize the framework that led to the final response and negotiate with numerous stakeholders both within and outside of the bank. And real lives were at stake. I think that that is what lawyers should do and I was glad to have the opportunity to help.
13 Question (Dr. Gerhard Fasol):
Lots of EU-Japan and US-Japan complain that Japan is still closed today, and they make recommendations for changes in Japan to encourage more inward investments into Japan. Which changes in Japan would help most to increase foreign investments in Japan?
I think that there are very few formal barriers, other than some tax disadvantages, which might discourage foreigners from acquiring Japanese companies. The real issue is one of mind-set. It’s fair to say that the attitudes of Japanese managers have changed over time. For example, attitudes toward shareholder value have evolved. Japanese managers are not just giving “lip service” to the idea that they need to balance the interests of customers, employees and shareholders because key players among the bureaucracy and politicians as well as leaders in the press and academia are calling for focus on shareholder value as a means of making Japanese companies more global and more competitive. But in order to be competitive, companies need to properly motivate and compensate their employees to create the desired results. It’s unclear that Japanese managers will be able to manage non-Japanese employees or will recruit senior foreign managers to work within their companies. The recent take-over of Lehman’s operations in Asia by Nomura will be an interesting test case.
14 Question (Dr. Gerhard Fasol):
In your view, what is the greatest challenge faced by Japan?
Japan faces a major demographic problem in its low birth rate and rapidly aging population. Despite the obvious risk to its standard of living, there is really very little public debate concerning what to do about this problem. Japanese companies have tremendous technologies and manufacturing experience. Clean tech is a notable advantage. But Japan’s technological edge probably will not be a sufficient engine of growth. And it seems unlikely that the birth rate will increase dramatically. This means that Japan will have to find creative ways to use women and seniors more productively in the economy. Immigration will present another challenge and an opportunity. If Japan can make the social accommodations that are required by this demographic situation-and companies open the doors to the best managers they can attract from all parts of the world, Japan can become a leading country in the 21st century.
Thank you – and Merry Christmas!
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