Japan: Will Japan Inc Drive COVID-19 Induced M&A?

With the COVID-19 pandemic driving fire sales as well as industry and supply chain consolidation and financial investors having bulging war chests, the advisory industry is eagerly awaiting a wave of mergers & acquisitions - and may only be whistling in the dark. While Q3 has seen an uptick in deal numbers and values, it's anybody's guess whether M&A activity will be as low in the current downturn as it was after previous crises or whether this time it's really going to be different (which, in itself, is a recurring theme in advisors' publications in any crisis). Set against this background, the global M&A community is looking to Japan Inc to play a major part in post-COVID-19 M&A - largely due to the plethora of financially stable Japanese conglomerates with plenty of cash on their balance sheets. The question is: how will Japan Inc approach M&A in the (post) COVID times?

Take Europe. There are plenty of European businesses whose debt loads swelled in the early months of the pandemic through additional loans, repayable State aid and improved payment terms with customers, suppliers and landlords, etc. In the coming months, they will face a double whammy of these enlarged or extended debts becoming due and legislators reinstating the requirement to file for insolvency (which has been suspended in many jurisdictions). This will result in plenty of European companies desperately looking for fresh money. With a perceived cultural alignment and presumably safe standing when it comes to passing foreign investment control, Japanese corporates may well be the likeliest port of call, but is Japan Inc willing and able to live up to these expectations?

The answer is 'yes' - and 'no'. In the years before the outbreak of the virus, Japan Inc tentatively embarked on an overseas M&A spree. The government was encouraging international investments, and corporates seemed to heed the advice, not least because a shrinking and aging population at home had made international expansion a must. On top of that, a rise in shareholder activism saw corporates being urged to use their famous cash piles more efficiently, including by growth through acquisitions. Like anywhere else in the world, the pandemic caused most Japanese M&A efforts to come to a grinding halt. But the underlying conditions remain.

There are certain indications, and yet a lot of uncertainty, around Japanese M&A, both inbound and outbound. Warren Buffet just spent about US$6bn to acquire 5% stakes in each of Japan's five largest trading houses in what seems to be a bet on vibrant Japan M&A activity (which can be both sell-side and buy-side). Similarly, Carlyle Group plans to pour more than US$9.4 billion into Japanese businesses over the next three to five years. Adding in KKR supposedly planning a similar expansion of its operations in Japan, the indications are that private equity expects that Japan Inc will unbundle and put non-core assets up for grabs - any sponsor's dream M&A landscape where private equity can pick up and consolidate businesses that may have previously been a large conglomerate's Cinderella.

If Carlyle, KKR and other financial sponsors are betting on Japan seeing more divestitures than overseas investments, it would be hard to argue that they're wrong. While opportunities for Japan Inc to buy businesses in Europe and elsewhere at attractive post-pandemic valuations may be abundant, most Japanese companies will hesitate and watch the craze from the side-lines. This is because they tend to shy away from, and indeed have had disappointing experiences with, turnaround cases in Europe.

Even where it is a distressed parent company selling a business rather than the target itself being in distress, many Japanese companies' risk averse DNA will stand in the way of a deal. They may fear the anticipated velocity and perceived risk of such distressed transactions. Where fire sales require warp speed processes and offer limited due diligence of the target business, the "Ringi" decision-making in Japanese management systems (which seeks to achieve consensus on all management levels involved in the project) may indeed be too time-consuming to meet tight timelines and beat the competition in limited auction processes.

If possible, sellers seeking Japanese investments should therefore be able to demonstrate that the sales process will provide enough time and opportunity for due diligence and negotiations. Conversely, Japanese sellers will be well advised not to blanketly discard distressed M&A opportunities. If a business to be sold is attractive and fundamentally sound, the seller's creditors will agree standstills to allow enough time for an orderly sale process required to maximise proceeds. The risk of the acquisition will then be more of a function of the deal technology than risk appetite.

In spite of all of the above, there may be one more critical factor driving Japan Inc to be sellers rather than buyers: recent surveys (for instance by communications consultants Kekst CNC) have repeatedly revealed the Japanese population's utterly pessimistic view of the post-COVID-19 world, caused in no small part by a pronounced dissatisfaction with its government. The expectation that Shinzo Abe's successor Yoshihide Suga will widely continue in Abe's footsteps did little to improve morale. In this climate, overseas investments are unlikely to be popular, while the economic fall-out of the pandemic may provide a welcome excuse for divestitures that Japan Inc may have shied away from before the crisis for fear of unfavourable PR.

So while there is hope that Japan Inc will pick up some of the opportunities of distressed M&A in Europe and elsewhere, the increase in inbound M&A activity is likely to be more noticeable. Wherever the balance lies, Japan is on the brink of experiencing a meaningful increase in cross-border M&A.