The Rise of Private Equity Activity in Japan

By Ory Ratoviz (Cal Poly SLO) and Jonathan Vu (UC Berkeley)



Synopsis 


Japan has become a target in recent years for private equity activity, seeing consistent growth in deal volumes before COVID-19. There’s no surprise that Japan is receiving interest from major international private equity firms, especially considering that it is the third largest global economy. However, Japanese business culture has been proven to be a sticking point in previous acquisitions, according to consultancy PWC. In their survey of business leaders, PWC found that 57% of respondents cited “incompatible cultures” as the leading  reason for failed M&A deals. Therefore, there must be other reasons why an increase in outside involvement has occurred. 


Graph: GDPs of Global Economies (World Bank)



Table of Contents 


Section 1: Globalization and International Relationships

  • Japan’s government agencies have been working diligently to incentivize investors to choose Japanese capital markets.

  • Increasing international relationships have also fostered the explosive growth of foreign direct investment.

Section 2: Operational Shifts

  • PE firms are reshifting their objectives so that improvement of their acquired businesses through a sustainable long-term growth strategy is a top priority.

  • Traditional PE practices are on the decline as they are no longer a match for long-lasting, authentic growth of acquired companies.

Section 3: Increasing Consolidation Efforts

  • Japanese conglomerates have been divesting components of their company, creating opportunities for private equity firms to enter different markets or diversify their portfolios.

  • Blackstone’s recent acquisition of Takeda’s generic drug division illustrates the consolidation landscape in Japan.

Section 4: Tax and Regulatory Incentives

  • Japan’s tax incentives and tax scheme are exceedingly conducive to growth of PE activity.

  • Deductions and capital gains tax exemptions incentivize foreign investors to pursue organic growth and hold their investments for an extended period.

Section 5: FEFTA Amendment

  • A key change in Japan’s regulation of the financial services industry occurred with the amendment to the Foreign Exchange and Foreign Trade Act (FEFTA) in November of last year.

  • The Japanese government made clear that it wants safe, transparent, and sustainable growth of its financial services industry. 



Globalisation and International Relationships


Japan is promoting globalization in their financial services sector as foreign investment is becoming a more crucial factor for success. According to The Japanese Times, the Japan Financial Services Agency (FSA) is aiming to “boost the profile of Japanese financial and capital markets… [and to] allow applications for approval and registration to be submitted in English [to] speed up the processing time, among other things.” It is important to note that COVID-19 has necessitated and accelerated the prioritization of foreign investment. Japan’s government agencies have been working diligently to incentivize investors to choose Japanese capital markets through lower taxes, streamlined business regulation, and special treatment. Increasing international relationships have also fostered the explosive growth of forign direct investment. The emphasis on globalization and its corresponding effects have directly resulted in increasing PE activity within Japan. The Bank of Japan found that by the end of March, “the balance of overseas credit by Japanese banks rose to ¥4.7 trillion ($44 billion).” It has also affected the method by which PE firms function. 


Graph: Global Buyout Deal Value (Bain)



Operational Shifts


Private equity firms are changing the way they operate within businesses they acquire. In the past, the focus was on maximizing gains for PE firms through quick flips, debt financings, or multiples arbitrage. In recent days, however, the focus has shifted to the target businesses themselves. According to BCG, PE firms are determined, and sometimes forced, to improve their acquired businesses through a sustainable long-term growth strategy. This is achieved through creation of the right teams and objectives that will drive large-scale operational changes. In Japan, PE firms have completely altered the way they manage in order to maximize value for the investor -- traditional PE practices are no longer a match for long-lasting, authentic growth of acquired companies. In addition to a change in PE practices, there has also been a fundamental shift in the mindsets of major Japanese conglomerates.


Graph: APAC Funds Assets Under Management Growth (BCG)



Increasing Consolidation Efforts


Consolidation efforts by major Japanese conglomerates have driven private equity activity in Japan. These firms have been divesting components of their company, which have helped prompt this consistent growth in PE activity over the last few years. With more companies divesting product groups or divisions, consolidation efforts create more opportunities for private equity firms to enter different markets or diversify their portfolios. This trend driver is best illustrated by Blackstone’s recent acquisition of Takeda’s generic drug division. Takeda recently said that they wanted to place more of a focus on their prescription drug business, and were planning on divesting nearly $10 billion in assets. Clearly, generic drugs have not been a product group that is important to Takeda any longer, which brought them to sell their over the counter division to Blackstone. This is only one example of how consolidation efforts by major Japanese conglomerates will help continue to spur growth in Japanese PE. Further, in comparison to the other major economies, Japan’s regulatory system is more conducive to private equity activity.



Tax and Regulatory Incentives


One of the most significant regulatory differences is Japan’s tax incentives and tax scheme. The specific tax exception that is most geared towards private equity is the Tax Incentives to Promote Open Innovation. As long as the portfolio company fits the criteria passed in the bill, such as the age of the company must be less than ten years old, then the private equity fund is able to deduct 25% of the amount invested. Furthermore, Japan has a tax code that will continue to spur private investment, specifically with regards to capital gains tax. A foreign investor will not have to pay a capital gains tax unless they fulfill both of the following criteria: foreign investor owns more than a 25% stake in the Japanese company and sells 5% or more of their stake in the company in the same tax period. The fact that both conditions have to be met in order for capital gains tax to be imposed is geared toward promoting private equity activities. This specific provision further incentives private equity firms to promote organic growth in their investments and to hold them for an extended period.



FEFTA Amendment


A key change in Japan’s regulation of the financial services industry occurred with the amendment to the Foreign Exchange and Foreign Trade Act (FEFTA) in November of last year. 

In short, according to K&L Gates, the amendment hopes to strengthen Japanese national security, increase government oversight, expand regulatory powers, improve transparency of public companies, and allow sharing of information with certain foreign governments. While this amendment has raised skepticism from Japanese firms, who want to ensure that there are as little roadblocks as possible to foreign investment, the amendment has largely not impacted foreign investment. In fact, international investments have only increased in recent times -- government oversight and registration requirements have not deterred the stunning volume of direct foreign investment. In implementing this amendment, the Japanese government made clear that it wants safe, transparent, and sustainable growth of its financial services industry. 



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