WealthBriefingAsia recently interviewed Kirk Shimizuishi (pictured), Japan private equity sector leader at , the global accountancy and consultancy group, about the state of the market and what the future holds.

Kirk Shimizuishi

WBA: Japan has been through a great deal of change in recent years: corporate governance reforms, the unlocking of cash on corporates’ balance sheets, improvements in return on equity, greater shareholder demands for change, etc. In broad terms, how have private equity firms been a force for these changes?
Over the years, private equity firms have become a supporting force in Japan, enabling companies, especially conglomerates, to divest their non-core businesses. This helps increase return on equity/return on invested capital and overall shareholder value, while also affording these non-core companies more operational autonomy. Additionally, private equity firms can help companies obtain the required management and financial resources needed to grow and capture their full business potential.  

We’re seeing more Japanese companies at ease with letting PE firms take over their businesses given the growing number of success stories of PE firms driving positive value creation in those acquired companies. We’re seeing win-win situations for all parties to the acquisition – seller, acquirer, and target company.  

WBA: Is there a particularly “Japanese” approach to private equity in terms of how buyouts, for example, are handled, structured, financed? 
From a financing perspective there is uniqueness to the way that buyout deals are financed in Japan.  Relative to Western markets, there is a greater use of leverage here: the debt multiples are significantly higher given an overall low-interest rate environment that allows for sufficient debt service coverage even with higher leverage levels.  Added to that, the tenors associated with the debt will be quite longer than what you see in Western markets – seven years is often seen in the senior debt offered in Japan, which is comparatively more difficult to obtain in other markets. 

Moreover, Japanese sellers tend to be quite selective in terms of who they sell to – it's not just about price. There is a significant “trust” factor that needs to be developed with the sellers, and many times this can take years to develop; hence the difficulty for new market entrants in the first couple of years.

WBA: What sort of returns are Japan-focused PE firms targeting? How realistic are these expectations in your view? What lessons do such PE firms learn from those in other countries, such as the US? 
Returns are no different than what is expected in other markets – typically 20 per cent is still the norm but for small-mid cap players there will be the expectation for higher returns given the ability to extract/generate more value at a quicker pace than with large cap deals.  Relative to Western markets, the greater use of low-cost financial leverage did help immensely in terms of return generation (exceeding hurdles).

However, as market competitiveness and deal entry valuations have increased, the ease at which GPs can generate the required returns has diminished.  That said, value creation is a fairly untapped area where GPs still have significant opportunities to capitalise on and drive returns.  

WBA  What PE models operate – is it mostly the classic closed-ended structure with capital calls, commitments, etc, or are you also seeing “evergreen,” perpetual structures taking shape? (Blackstone is in this space, for instance). 
PE models are the classic closed-ended structure. Some GPs will request extensions or seek quasi-exits through continuation funds, or GP's solutions offered by major LPs such as SWFs.

WBA What, typically, are the ways that returns are expressed in Japan – internal rates of return, or multiples? 
No different than other markets – usually IRR or cash multiple, but as holds become longer, there is a growing shift towards focus on cash multiples. Added to that, overseas LPs are highly focused on cash multiples, given that their allocation to local funds is not significant from an overall portfolio perspective.

Hence, there is a need to justify investments through high fund performance/multiple returns from these funds. Also, domestic LPs will tend to value/focus on IRR (whole yield mentality in a low-interest rate environment).

WBA: Have there been notable successes and a few problems? 
Global PE firms have seen success in Japan, standing out for the number, variety, size, and type of executed deal. Global firms have also developed strong reputations for closing on high-profile corporate carveouts and non-core real estate transactions. On the other hand, what distinguishes local firms are the existing capital relationships, which have allowed them to be successful in their deal structures, finding creative acquisition structures and value up angles. 

WBA: In your view, is Japan still relatively “virgin territory” for PE and is there a need for more expertise, infrastructure around the sector, understanding by banks of what PE firms do, etc?
The LBO financing market is still quite under-developed relative to Western markets. There is no proper secondary market and lenders concentrate on commercial banks. This means that the ability to do larger deals will eventually become constrained, so executing debt financing deals tends to take longer than elsewhere. Also, there is no high-yield market, so the mezzanine financing market will tend to be a limiting factor in deals. Japanese banks are rigid in their financing terms – amortising tranches continue to be a must in this market which can limit the type of deals that can be structured, and the flexibility offered to sponsors in the early years of their investments.

WBA: And on the wealth management side, what do you see private banks and wealth managers in Japan doing to make PE, as an asset class, more accessible to high net worth clients? Is there still a big job to be done in educating HNW advisors about the asset class, its quirks and characteristics?
While real estate continues to be a focus asset class for HNW investors, there is growing demand for private equity funds as the asset class becomes more familiar to HNW investors in Japan. Japan mid-small cap PE funds have generated high historical returns, which has attracted a significant amount of overseas LP money to them, a trend that will continue for the foreseeable future given the increasing deal flow in Japan (corporate carveouts, business succession, secondary buyouts, growth capital, etc.), thus demand from HNW investors to this area of the PE market can be expected to be high.