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Rising sum

8 October 2013 By Peter Thal Larsen

Japan Inc is breaking some deep-rooted taboos. The country’s corporate establishment has long frowned on companies that succumb to foreign takeovers, offload non-core businesses, or leverage up for acquisitions. Three recent M&A deals suggest these strictures are no longer so tight. A freer form of capitalism may be taking hold in the land of the rising sun. 

Start with cross-border takeovers. For decades, foreign companies could only hope to buy a Japanese counterpart if it was in financial distress. That is why the merger of Tokyo Electron with U.S. rival Applied Materials came as a shock. Though the Japanese semiconductor equipment maker is hardly on its knees, it emerged as the junior partner in an all-share deal.

Applied Materials did its utmost to sugar-coat the takeover pill. The combined company will keep a Japanese stock market listing, and both sides will nominate five directors to the combined group’s board, which Tokyo Electron’s current CEO will chair. Even so, a large Japanese company has done the previously unthinkable and voluntarily surrendered its economic independence to a foreign rival.

Panasonic’s sale of its healthcare business to Kohlberg Kravis Roberts for around $1.7 billion is smaller, but equally significant. That’s because large Japanese companies almost never sell non-core units: indeed, the very concept of a business being non-core is anathema in Japan. Selling to a foreign private equity firm is even more controversial. It’s only a year since KKR was rebuffed by the establishment in its attempt to acquire Renesas, a troubled Japanese chipmaker. 

Yet despite being Japan’s largest corporate employer, Panasonic is under pressure. Its electronics business is wobbling; last year it cancelled its dividend for the first time in sixty years. Panasonic is keeping a 20 percent stake in the healthcare arm, presumably as insurance in case KKR walks off with a big profit. Other big Japanese groups thinking about how best to allocate capital must now be considering similar moves.

On the face of it, Lixil’s $4 billion takeover of German bathroom group Grohe looks less surprising. After all, Japanese companies have been buying overseas for years as they seek sources of growth to counteract the declining population at home. Moreover Lixil, whose CEO Yoshiaki Fujimori previously worked at General Electric, has made many acquisitions.

What’s novel about the Grohe takeover, however, is its use of leverage. Lixil is swallowing a company with an enterprise value half its own without issuing any new equity. It has pulled off this trick by drafting in the Development Bank of Japan, a state-owned lender, as an equity partner. By parking half of Grohe with DBJ, Lixil keeps the target’s debt off its balance sheet. It also avoids consolidating the goodwill on the deal, which Japanese accounting rules would require it to amortise, thereby reducing its earnings.

Such aggressive financial engineering may be questionable, especially with the support of a state-owned institution with super-low hurdle rates of return. Nevertheless, it’s a sign that Japanese companies can hold their heads high when it comes to devising creative corporate structures.

Whether Japan’s taboo-busting deals will work out for shareholders – the ultimate key to their success – is hard to say. Cross-border mergers are tricky, and Tokyo Electron and Applied Materials have offered little detail about how and when they will actually integrate their businesses. KKR’s private equity rivals will be watching closely to see whether the buyout firm has the freedom it needs to restructure the hodge-podge of unrelated business that comprise Panasonic’s healthcare division. And Lixil’s bet will only be declared a victory when it pays down some of Grohe’s debt and fully absorbs the group on its balance sheet.

Moreover, some of Japan Inc’s bigger seemingly inviolable rules also remain in force. Even though the domestic market continues to shrink, Japanese companies still seem unwilling to merge with each other. That is why Japan, despite having just 40 percent of the population of the United States, still has many more carmakers, brewers, and electronics manufacturers.

Nevertheless, the recent breaking of corporate taboos in three novel deals suggests that Japanese executives are beginning to follow the animal spirits unleashed by Prime Minister Shinzo Abe’s economic policies. After years of excessive caution, a shift away from some shibboleths of the past is good news for Japanese capitalism.


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