The Changing Shifts of Outbound M&A in Japan
Tomohiro Terada speaks to us this month about M&A activity in Japan. He expands on outbound M&A and how and why it has risen in popularity over the past few years, as well as discussing why cross border transactions may fail and how to avoid that from occurring.
Outbound M&A from Japan has been more popular over the past five years; from your experience, what accounts towards this shift?
According to this chart issued by Recof, one of the most famous M&A advisers in Japan (Recof: https://www.recof.co.jp/crossborder/en/company/), the number of outbound M&A is growing but are still outnumbered by domestic transactions. But, the point here is IN-OUT (outbound) transactions: they have been growing as they are often used to expand Japanese companies because there is less market room available for existing companies to expand in Japan. This is mainly due to the population decline and the labour market in Japan not being open to foreign workers to the same extent that other countries open themselves to foreign workers.
In my sense, the reasons why Japanese companies have been exploring foreign markets by IN-OUT M&A are that: (i) Japan does not have any potential market left, and (ii), under ‘Abenomics’ where long term interest rate is kept very low, it is easier for Japanese companies to borrow funds from banks in Japan (but, this situation did not start from Abenomics, that monetary measure was taken by the previous prime minister). In fact, there are some adverse effects created by Abenomics (see the answers to Q2 below) so this is not the main driver for Japanese companies to explore new markets in foreign countries via IN-OUT M&A.
The recent trend behind IN-OUT M&A in Europe or the US is: (i) to acquire technology (IP) unique to target companies or (ii) to get into the market which is restricted in the relevant jurisdictions against foreign (Japanese) companies, such as staffing companies or alcohol beverage companies. IN-OUT M&A targeted in Asia is often to acquire companies which have huge potential for growth in the regional market. This explains why in 2019, the IN-OUT M&A in the US was outnumbered by those in Asia.
In fact, Abenomics did not and does not have so much impact on the increasing trend of IN-OUT M&As.
From a legislative perspective, the economic and fiscal reforms introduced by prime minister Shinzo Abe, known as ‘Abenomics’, had an impact on the rise of outbound deals. What reforms took place here and, in your opinion, what more needs to be done?
The main monetary policies taken under Abenomics are quantitative easing and low interest rate policy. In terms of IN-OUT M&As, the former one is not so relevant. The latter is relevant to some extent, which is mentioned below. Overall, these policies are not intended to motivate Japanese companies to IN-OUT M&As.
In fact, Abenomics did not and does not have so much impact on the increasing trend of IN-OUT M&As. Indeed, “keeping the long-term interest rate extremely low” policy has worked well in terms of Japanese companies easily borrowing funds used for IN-OUT M&As from banks in Japan. However, in light of financial accounting matters, it is not a better financial strategy to change the company’s debt/equity ratio towards only increasing debt portion. Thus, that policy does have some impact on companies considering IN-OUT M&As, but is not the definitive factor behind it.
One of the reasons why Japanese companies are aggressive to outbound M&As is that they are cash-rich. Their overall dividends amounts are not as large as European/US companies. They tend to reserve excess cash for emergency use or company business expansion. In addition to the extremely low long-term interest rate in Japan which helps Japanese companies to borrow funds from banks, under Abenomics, the Japanese YEN has been kept weak, which means the currency exchange rate remains in favour of Japanese exporting companies. (If the Japanese YEN is weak, the price of products produced by Japanese manufacturers are kept low in foreign countries, which is good for exporting Japanese companies but not good for Japanese companies which intend to do IN-OUT M&A transactions, because foreign currency is used for those transactions).
So, if the Government would like to incentivise Japanese companies to engage with IN-OUT M&As, the additional measure to be taken thereby is to keep the Japanese currency strong. In fact, in Q3 of 2016, following the Brexit referendum, Japanese YEN became the strongest in the last three years, which accelerated IN-OUT M&A transactions. But, from a wider point of view, most companies engaging in IN-OUT M&A will not expatriate earned money in the foreign countries back to Japan because of taxes and bank wire charges imposed by Japanese banks, unless Japan has a special tax regime endorsing Japanese companies to get the money back from overseas – such as GILTI introduced in the U.S. by Trump administration at the end of 2017. Furthermore, most Japanese companies have been earning profit by exporting goods or services to foreign countries instead of engaging in IN-OUT M&A transactions. (Strong Japanese YEN would hurt the majority of those Japanese companies). So, the Japanese Government would not introduce a policy that will work towards a stronger Japanese YEN.
Some countries have very unique laws and regulations applicable to M&A transactions whether it is domestic or cross-border.
Japanese companies are pursuing more targets in the developed countries of Europe; what should companies be prepared for?
With respect to business perspectives, the purpose of Japanese companies acquiring European companies is to acquire a particular technology or IP held by a target company or expand their business in a foreign country where a target is located. I have experienced the case where a Japanese company acquires a German company to create a business hub in Europe or to explore a highly regulated industry such as a staff dispatching business.
From the legal perspective, we need to take care of two particular issues in M&A transactions in Europe: (a) local laws and regulations and (b) merger control filings. Each country in Europe sometimes has specific regulations, some of which are described below.
In case of an acquisition of a company in Europe, if certain requirements are met, the acquirer and the seller shall make a filing to the European Commission, which would generally save filing to other relevant member states.
Local laws and regulations
Some countries have very unique laws and regulations applicable to M&A transactions whether it is domestic or cross-border.
In France, under the relevant laws, in the context of acquisitions totalling more than 50% of the share capital of a French company, the acquirer may not execute the M&A agreement (e.g., share purchase agreement) until the works council process has been completed. This adds another uncertainty to cross-border M&A transactions where a French company is a target. That works council process means that the provision of the required information to a works council of a target company and the submission by a works council of its opinion about the transaction is needed. It is not recommendable that this process is put into a condition precedent of the closing of an M&A transaction. In many cases, this process is set as a prerequisite of signing an M&A agreement because, if a works council provides a negative opinion as to some terms and conditions of that M&A transaction, that opinion should be reflected on the terms and conditions before signing.
Since the end of 2013, French law provides for a fixed one-month consultation period starting from the date the employer (the French target) has provided the works council with the necessary information. The works council may request additional information and/or request an expert or an accountant for helping a works council assess the information provided by the employer. If an expert is appointed, the consultation period is set to two months. There are two possible, but not definitive, solutions: (i) executing an exclusivity agreement with a sufficiently long duration between the seller and the acquirer or (ii) granting a put option to the seller on their French target shares.
In the UK (and Australia and Hong Kong as well), there is a particular way to squeeze out minority shareholders which is called “scheme of arrangement”. Under the scheme of arrangement, the majority shareholders can squeeze out the majority shareholders under a court’s involvement if the majority shareholder can acquire over a certain amount of shareholdings (threshold). The threshold amount and procedures taken varies among jurisdictions so that we need to be careful about the requirements of them.
Recently, I happened to see a case where the article of association of the UK company states to the effect that any shareholder is granted a drag-along right in order to collect majority shares of that company. It seems that the minority shareholder can exercise this right to collect 100% of shares of that company. However, under UK case law, it is highly likely that the minority shareholder can not squeeze out the majority shareholders by exercising that drag-along right in order to become a majority shareholder. It is worth being aware that, in the UK in the past, there was a tax favourable scheme for investment funds to invest in a UK company in the past. Then, if such a fund is dissolved, a large number of shareholders in a private company is lawfully created. If a Japanese company tries to obtain a minority shareholding of that target at the first stage and then pursues to obtain 100% shares at the later stage, we need to amend the articles of association of the target company in a proper way or resort to the scheme of arrangement if a Japanese company can go beyond a certain threshold at the initial stage.
It is not the laws and regulations which would need to be overcome in the case of IN-OUT M&As in Germany. But, in case of acquisition of shares of a private company in Germany, all the clauses of a share purchase agreement must be read by both parties in front of the notary public in Germany word-by-word. This process itself usually takes a whole day, which would affect the timing of public disclosure if a Japanese acquirer is a listed company.
Merger control filing in Europe
In case of an acquisition of a company in Europe, if certain requirements are met, the acquirer and the seller shall make a filing to the European Commission, which would generally save filing to other relevant member states. This is called the “one-stop shop system”. However, in some cases, the member states require the parties of an M&A to make a filing to such member states as well even though that one-stop shop system is applicable to that transaction. In some other cases, even if the requirements for that one-stop shop system is not met, the European Commission may require parties to make a filing to them. The important thing is for a Japanese company to retain a lawyers’ team as a control hub in order to control such filings filed worldwide, in addition to a local counsel in each jurisdiction in Europe. My law firm is often retained as a control hub to give proper instruction to a European local legal counsel.
In the case of an auction process, a negotiation process, or a PMI, the quick and substantive decision is requested from the seller’s side.
It has been reported that more Japanese companies are looking for majority interest. Why is this the case and how should investors/companies react to the added appeal of majority interest?
Most Japanese companies are looking for majority interest because they are business companies and aim to expand their own businesses into unexplored countries where targets are located. In order to get synergy from the contemplated M&A, a Japanese business company (acquirer) needs to get a majority of shares of a target company. By controlling the target company’s business, the Japanese company’s business model penetrates into the target country.
How should investors/companies react to the added appeal of majority interest? If that is the acquisition of a public company, the investors will decide upon whether they accept an offer from a Japanese company (acquirer) by looking at prospectus or similar documents disclosed by the said company.
If that is the acquisition of a private company, the sellers (in many cases, the sellers are owners and officers of a target company) will see the proposed price tag, the retention plan (if the sellers are officers of a target company), and other proposed business plans in order to assess synergy after the M&A transaction. If that is the acquisition of a public company, the officers or the directors of the target company must perform their fiduciary duties, which means they need to assess the future impact which will be generated from the M&A transaction; whether putting the target company under the control of a Japanese company is beneficial for the company and its shareholders.
What are the reasons why Japanese companies fail in outbound deals and how can these be avoided?
- The decision making process of a Japanese company is slow compared to that of a foreign company
In the case of an auction process, a negotiation process, or a PMI, the quick and substantive decision is requested from the seller’s side. If the person who is granted an authority to move the transaction forward (usually C-level officer, in the case of a Japanese company) is kept informed by the deal team of the Japanese company, that person is able to make a substantive decision quickly. However, usually, that is not the case and it takes a while for them to make a decision at every stage, because they need to have an official internal meeting at each phase. While taking those steps, the seller side has a feeling that the Japanese acquirer gets disinterested in that transaction (which turns out not true!). As a result, the Japanese company tends to lose an opportunity in the middle of an M&A transaction.
- Members involved in the M&A transactions are not experienced
In most cases, it is quite rare that a Japanese acquirer has a team specialised in cross-border M&A. On the other hand, most foreign companies have their own M&A transaction teams composed of M&A legal experts, IP experts, accounting experts, IT experts, and labour experts, all of whom are employees of that company (they also retain outside advisors as well). In addition, once the M&A project has begun, a Japanese acquirer teams up employees for that M&A transaction. However, most of them are not exclusive to that project, nor are they experienced with M&A, especially cross-border M&A. Their day-to-day responsibilities, even after the launch of the M&A project, see them being engaged in ordinary works as well as project works. Please note that, generally, the legal team of a Japanese company is much smaller than that of a foreign company in terms of numbers. According to the research conducted by METI (Ministry of Economy, Trade, and Industry) in Japan in 2018, the average number of a legal division in a Japanese company is 18.9 which is obviously much smaller in terms of global standard. The employees in a legal division in Japan who are qualified as attorneys at law is 17.4%, which is, again, much smaller than the level you’d see at multinational companies around the world.
Japanese companies, especially traditional companies, do not have good impressions of foreign acquirers, simply because, unfortunately, they are foreigners.
What are the current trends of OUT-IN M&A and what are your key takeaways for a foreign company that wishes to be engaged in an OUT-IN M&A in terms of due diligence and negotiation of M&A agreement?
After the COVID-19 outbreak, most Japanese companies are trying to sell or carve-out non profitable divisions or businesses. But, some Japanese companies were trying to keep the lucrative portion in the non profitable business at their hands during those transactions. As a result, those projects ended up being unsold, leaving them to be unsuccessful.
Japanese companies, especially traditional companies, do not have good impressions of foreign acquirers, simply because, unfortunately, they are foreigners. So, giving them a good impression at an early stage of the project is one of the keys. During the DD phase, it is often seen that a foreign acquirer is so frustrated because a Japanese target company is unresponsive and answers are provided by them after a prolonged time and are sometimes not accurate to the questions. It is important to keep in mind that, as I mentioned in question 5(2) above, a Japanese target company often has fewer employees involved in an M&A transaction (even if it is cross-border!) when responding to questions made by a foreign acquirer. In a recent IN-OUT M&A case where I represented a foreign acquirer, only four to five of the employees of the Japanese target (a listed company in Tokyo Stock Exchange) were responding to the questions, as topics varied from commercial, IP, environment, to tax matters, which were not known by those employees. As a lawyer, if you notice that the target’s manpower is very small, an effective way is to set up a face-to-face interview session at the beginning of the DD process. In the age of COVID-19, an online meeting via Zoom or Teams is a good substitute. If a foreign acquirer can show generosity or sincerity in that interview, the transaction is likely to go smoothly. Moreover, if there are some concerns about legal matters that have not been cleared in the DD phase, proposing a confirmatory DD which is usually conducted post signing to the sellers is a better option, but not as common these days. In the course of the negotiation of an M&A agreement, a Japanese seller individual or the management of a Japanese target tends to get emotional if harsh terms are provided to them. Sometimes, the seller may say, “It has to be done” or “No more negotiations, let’s walk away”. But, if those things happen, the key is to try to reach out to the seller side through a financial adviser, not by yourselves, with some intervals between these contacts. This may result in a negotiation being prolonged up to a couple of months but it would still resume. A negotiation process in M&As are like a roller coaster and, in many cases, so many unpredictable things occur. But, the key is to show your sincerity and honesty to a Japanese seller/target in order to establish a good business relationship; this is one of the keys of a successful OUT-IN M&A transaction.
Tomohiro (Tom) Terada | Associate, Attorney-at-law
Admitted in Japan and California
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Hibiya-Nakata is a new type of law firm founded by Nobuo Nakata in 2012 to respond to the new market trend and demands. Hibiya-Nakata is a small M&A boutique law firm with a global network and international standard of practice and quality.
Hibiya-Nakata specialises in advising Japanese companies on their Japanese outbound M&A transactions and international companies on their Japanese inbound M&A transactions with close cooperation with affiliated foreign local firms in global networks (such as that of Allen & Overy), which cover more than 100 countries worldwide. Our selected small number of Japanese Bengoshi team manages the overall transaction by effectively collaborating with excellent teams fully in accordance with the client’s strategic plan and intention. As a result, our clients enjoy the most efficient and smooth execution of the transaction.