Homegrown

You get the feeling that Nobuo Matsuki never expected to find himself in the sock business. He started his career as a corporate planner at Toyota, went on to get an American business-school degree, then found himself, in the 1980s, a member of that rare breed known as the Japanese venture capitalist. When the asset-price bubble popped at the beginning of the 1990s, though, Matsuki began to see big opportunities on another front--companies that had fallen on hard times.

That's how he found himself snooping around Fukusuke Corp., a 123-year-old apparel maker on the verge of bankruptcy. At first the idea seemed like a nonstarter: how could a Japanese clothing manufacturer possibly hold its own against low-wage China? Still, something about the company caught Matsuki's interest. Socks and underwear, he learned, are the biggest-selling clothing items in Japan, and Fukusuke manufactured high-quality socks and underwear. "You can make mass-market products in China," Matsuki, 57, argues, "but when it comes to high-margin, low-volume production, you want to be close to the market." In 2003 Matsuki's investment fund, MKS Consulting, acquired the notoriously ill-managed Fukusuke and immediately installed a new team of experienced retail executives who completely overhauled the way the company does business. The move has started to pay off: according to Teikoku Databank, Fukusuke earned a $7 million profit in the year ending in January 2005 after losing $43 million the two years before.

Not that long ago only foreign buyout firms made headlines in Japan. During the recession, overseas players such as Ripplewood and Goldman Sachs roamed the corporate landscape, snapping up everything from banks to golf courses. The Japanese press fretted about "vulture funds" and worried about assets falling into the hands of Anglo-Saxon "invaders." Small wonder: domestic buyout companies were virtually nonexistent. Under the traditional postwar-business sys-tem in Japan, the banks--intimately allied with the companies whose shares they held--tended to sort out management messes, not outside investment funds. "In the so-called good old days the megabanks not only lent money but took care of corporate governance on behalf of stable shareholders," says Motoya Kitamura, an analyst at Alternative Investment Capital. All that changed fundamentally, he says, when a series of 1997 banking reforms undercut the traditional system of cross-shareholdings. "And that's when people began to recognize the importance of direct financing--such as buyout funds."

It's taken some time, but now homegrown buyout firms are pushing to the fore in the latest striking transformation of Japanese capitalism. The failed supermarket chain Daiei, famous during the bubble years for its frantic expansion into countless lines of noncore businesses, is undergoing a thoroughgoing workout at the hands of Advantage Players, one of the most prominent domestic-private-equity players. Advantage won the deal over a host of competitors, including Wal-Mart and the U.S. agribusiness giant Cargill. (The $416 million Advantage invested in Daiei this year counts as the biggest private-equity deal so far.) U.S. private-equity group Cerberus finds itself vying with a Japanese competitor, Nikko Principal Investment, for control of the distressed railway and real-estate conglomerate Seibu. Privee Zurich Turnaround, run by several Japanese alumni of the famously in-your-face U.S. investment bank Salomon Smith Barney, recently acquired a leading securities house, which, its executives hint, could be used to support future hostile-takeover bids when the time is right.

The buyout market in Japan is modest compared to those of the United States and Europe, but growing steadily. While America and the EU might see buyouts totaling $140 billion or more in a year, the Japanese figure in 2004 was $5 billion--up from $800 million two years earlier. Depending on whom you ask, there are now somewhere between 50 and 70 private-equity firms, foreign and domestic, in Japan--up from 1 in 1997. According to Simon Chadwick of Chikusei Partners in London, about 30 could be classified as Japanese, but "many have no track record or funding." Chadwick says that the small- and midmarket buyout business is dominated by Japanese firms, while the big deals are almost exclusively handled by big foreign companies.

The distinction between domestic and foreign players isn't always apparent. Kitamura points out that Japanese institutional investors have been putting money into the big Western private-equity companies for many years. Meanwhile, several of the "Japanese" firms are heavily financed by foreign capital--especially those that pursue larger, midmarket deals. (Advantage Partners says its financing ratio is 70 percent domestic, 30 percent foreign.) The Japanese branch of the Carlyle Group, for example, is regarded by most of its rivals as a domestic player thanks to its almost exclusively Japanese management team. That may be one reason why the company has earned high marks from rivals for its dealmaking acumen. Kitamura notes that, rightly or wrongly, "managers tend to have an impression that Japanese buyout funds are friendlier than non-Japanese buyout funds. The Japanese buyout funds tend to have easier access to Japanese managers."

Why are Japanese firms becoming active in the industry? The main reason, presumably, is simply natural evolution. Many of the Japanese who now run private-equity companies of their own cut their teeth working for the Americans, and they combine that know-how with the predictable home-team advantages. The domestic buyout firms, say industry observers, tend to pursue their deals more discreetly--important in a country where hostile takeovers are virtually unknown and buyouts rarely result in large-scale layoffs. "This is a market where the deals don't pop up on everyone's radar screen," notes Richard Folsom of Advantage Partners. (An American who's been living in Japan for 25 years, he's the only foreigner in his company.) He says that he and his partners have been known to spend years quietly cultivating company managers and intermediaries in the hopes of bringing deals to fruition. He says that many of the foreigners who arrived in the late-1990s and after--some of whom have since left the market in frustration--were hurt by the perception that they weren't in it for the long term. "That kind of short-term commitment isn't really what's going to get you plugged in."

Folsom should know. He's famous within the business for spending days in small-group negotiations with the recalcitrant workers of a salt-manufacturing company that Advantage bought in 2003. In the end, says Folsom, he and his colleagues persuaded almost all of them to stay, and today the company is said to be thriving--with sales rising from $120 million at the time of purchase to $220 million this year.

In the early years of this century, a lot of analysts said that Japan would become the world's hottest buyout market. That hasn't been the case, as deals have proved harder to pull off than a lot of outside companies anticipated, and many foreign funds have since left. What's more, with the economy improving, there are fewer potential targets. Yet the locals argue that conditions are ripe for those who know the market. Parent companies are still focusing on core businesses and divesting themselves of irrelevant subsidiaries. Debt remains cheap. Perhaps most important, the idea of buyouts, still a relatively new concept, has finally gained widespread acceptance. "I feel this is the kind of opportunity that comes once in 50 years," declares Matsuki. "It's the beginning of the real market."

At Fukusuke, the sock maker, MKS managers have been hard at work whipping the company into shape. They've even brought in Toyota-trained consultants to reduce the high defect rates on production lines. "If we can reduce the defect rate by 2 percent, we've got 2 percent more profits," argues Matsuki, who claims his fund has generated a 25 percent net return to investors as of September 2005. Those kind of numbers need no translation.

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