Finding the gems at the corporate fire sale

- by Noriko Takezaki -

When Renault and Nissan Motor were in final talks for Renault's recent acquisition of a major share of Nissan, a UK-based telecom carrier - Cable & Wireless (C&W) - began aggressively sparring with NTT regarding NTT's intention to acquire International Digital Communications (IDC), a Japanese international telecom. The M&A battle between the two has continued since April, with NTT the favored contestant. The IDC board of directors announced just before we went to press that they will ask their shareholders to sell their stocks to NTT, not C&W. Anywhere else in the world, this sort of pugilism wouldn't be news. But in Japan, itŐs not just news, - itŐs unheard of. The global M&A boom has finally reached these shores. But what do you have to do to succeed? Until a few years ago, many japanese thought that M&A deals only happened somewhere else. But now, facing the need for radical business restructuring to improve their stagnant cash flow, Japanese companies have decided to start cutting their losses and theyŐre jumping onto the M&A bandwagon - often with foreign companies. Telecom M&A In the telecom field, it seems that aggressive M&A deals are being announced every day. This is most likely due to the advanced state of liberalization and deregulation in this area in Japan, abetted by JapanŐs accession to the WTO (World Trade Organization) telecom agreement of 1997. For Japanese companies who lack global competitiveness, an M&A deal with a foreign company is now considered to be one of the most efficient methods to quickly improve their business. For foreign companies, meanwhile, itŐs a good chance to buy major Japanese companies, enhancing their local presence. JapanŐs telecom and information technology (IT) market as a whole is the world's second largest, after the US. Foreign players need to be here as never before. Shopping with PSINet The list of recent acquisitions is a veritable Who's Who of major foreign and domestic names: US-based PSINet established a bigger presence in Japan by acquiring a fistful of ISPs - including Tokyo Internet, Rimnet, and TWICS; Softbank has completely acquired E-trade and bought shares in Yahoo and GeoCities; British Telecom and AT&T bought shares in Japan Telecom - a long-distance telecom carrier; and the battle between C&W and NTT for IDC continues to heat up. In many cases, the scorekeepers for these M&As have been the large consulting companies, foreign investment banks, foreign LBO (leveraged buy-out) firms, Japanese trading companies, and in some cases, law firms. "All IT companies in Japan are hot targets for M&A deals," says Ryoji Itoh, director of Bain & Company Japan, a Japanese subsidiary of the global consulting firm. "We have many inquiries from foreign companies for potential M&A deals with major ITs in Japan, and for their part, Japanese companies are becoming more receptive to the idea. I think this M&A boom will continue for at least three to five more years." In addition to Itoh's company, consulting firms such as McKinsey & Co. Japan, Boston Consulting Group K.K., Booz Allen (Japan), A.T. Kearney K.K., Arthur D. Little (Japan), and Gemini Consulting Japan have been focusing on corporate strategy issues, and Ernst & Young Consulting Japan, Price Waterhouse International Assignment Consultants, Andersen Consulting, Deloitte Tohmatsu Consulting Japan, KPMG Global Solution have been mainly looking at the financing aspects of these corporate realignments. Itoh admits that the major factor contributing to the current M&A boom is the recent dismal business results of Japanese IT companies. In February, most of the major ITs announced revised estimates for fiscal 1998, projecting continued red ink due to the stagnant domestic economy and low market demand. Hitachi announced a negative net income of ´375 billion for fiscal 1998, while NEC will see a -´150 billion income and Toshiba predicts an overall income of zero (see figure). No doubt, Japanese ITs are desperate to restructure as a way to rebuild profitability, but unlike in the past, no options are being ruled out. Restructuring plans cover the full range, from divestiture of key operations and integration of long-time subsidiaries to a complete "separation" of deficit-ridden, non-core businesses from the parent company. As a way to successfully achieve this separation, many here think that the M&A route is an effective choice. Toshiba - an aggressive player Among Japanese IT companies, one of the most aggressive players in the restructuring game is Toshiba. The company has announced a restructuring plan that will see it transformed into a more compact organization focussing on core Toshiba businesses. Toshiba is reorganizing its 15 business groups into fewer than half that number, comprising eight in-house companies. The plan is to slice the deficit-ridden subsidiaries from Toshiba's core operations by forming joint ventures (JVs) with other companies. Foreign offers are welcome. In one case - Toshiba's air-conditioner manufacturing operation - the company established Toshiba Carrier Corp. together with the world's largest air-conditioning equipment manufacturer, Carrier (Toshiba will own a 60 percent share). For CPU chip development, Toshiba will establish a JV with Sony Computer Entertainment (SCE) Inc. to produce the 128bit CPU for the next generation SCE game machine, the PlayStation (Toshiba will take a 51 percent share). For power distribution and control products, the company took a 40 percent stake in the newly formed Toshiba Schneider Electric - a JV with Schneider Electric Japan, the Japanese subsidiary of France's Schneider Electric SA, a major manufacturer of electronic devices. In addition, Toshiba is working for the establishment of an additional JV with GE and Hitachi in the nuclear fuel business. Considering the pressing need for improvement in IT companies' financial situations, it seems highly likely that other IT companies will follow Toshiba's lead. Moreover, the objects of companies' restructuring efforts will include their once-protected family member companies - a radical departure from the Japan Inc. of old. The reason why? Starting next year, Japan's Big Bang financial reform program will drastically alter previously loose requirements for reporting financial statuses. Under the current system, companies and their shareholders focus mainly on firms' non-consolidated status, i.e. the status of the main company in each corporate group, or keiretsu. Under this long-standing system, the keiretsu member companies have relied heavily on their parent company for their businesses and the parent company protected its member companies in return for their cooperation. But under the new system, parent companies have to watch the financial status of all keiretsu group members closely, since shareholders will be able to evaluate the main company's financial status and those of the subsidiaries and affiliates. It will become increasingly difficult to hide losses incurred by non-competitive and bloated corporate group members, and if member companies do not perform satisfactorily, the main company will have no choice but to unload them on the first cash-rich buyer that comes along. Doing M&A in Japan Now that the death knell of the keiretsu - long acknowledged to be one of the main factors hindering free and fair competition in the Japanese market - has been sounded, the market here has started to open to foreign companies, and opportunities in many industries - not just IT and telecom - are waiting. However, M&A deals with Japanese companies are not an easy proposition. "Please keep in mind that there is still passive resistance and in some cases even hostility towards M&A in Japan," warns Ito of Bain & Company. "In Japan, acquisition is often perceived as a company jack, and people tend to feel guilty when they sell or buy companies. Therefore, when a foreign company approaches a Japanese candidate for a potential M&A deal, the prospective Japanese firm will usually be upset or offended at first. The process of starting negotiations with a Japanese company will require much time and patience." On the book, or off? Once the foreign company has gotten over the initial hurdle of approaching the target Japanese company to start negotiations for a potential M&A deal, the next thing the foreign company should do is to carry out a thorough due diligence check. At this point, foreign players should realize that if the Japanese company is on sale, it is probably already in a lot of financial trouble. Therefore, in making the due diligence assessment, the foreign company needs to be careful about the data that is analyzed. Under the current financial disclosure system in Japan, companies can hide certain high-risk information, such as contingent liabilities, unrealized losses, and unrecorded (off-book) liabilities. Furthermore, the foreign company should be patient in obtaining the required information, since some of it - especially segment profitability, value-added structure data, and activity-based economic accounting - does not even exist in Japanese corporations. Other data will be deemed highly confidential, and will not easily be released to outsiders no matter what the situation. During M&A negotiations with a Japanese company, Itoh warns, foreign companies should not give the target Japanese company the impression that they will make drastic changes in operation after the acquisition, since Japanese managers are extremely sensitive to drastic restructuring, staff reductions, and other measures commonly implemented outside Japan after an acquisition. Most managers expect the acquirer to leave the operation as it is and to offer autonomy to existing management. This of course can be a tough expectation to meet, since it was probably those same outdated organizations and poor business practices that got the target company in trouble in the first place. To give sufficient respect to the existing operation of the acquired company is, therefore, a tip for success post-M&A, according to Itoh. By keeping valuable staff from the acquired company as well as maintaining existing customers, the new company can smoothly start its business fully utilizing the established infrastructure. In addition, Itoh recommends making plans with a clear vision to demonstrate the new management's leadership and to establish smooth communications. As always, sufficient attention must be paid to cultural differences and possible language barriers. New businesses; new methods When it comes to newly developed businesses - like those involved with e-commerce - however, the situation will be different. "With Internet and e-commerce companies, you have much greater flexibility in building the new organization's business scheme since you don't have to stick to conventional means of distribution and communications," says Mie Teno, managing director at Deltapoint International, a Japanese consulting company. "Instead, establishing alliances with strategic partners will be key for success. [Detailed] research on Japan's unique market culture is necessary, including consumer preferences, household data, and population demographics. And doing these things quickly is crucial." Potential in Japan M&A opportunities are expected to increase as competition expands globally in the IT industry. Accordingly, many companies abroad will be interested in Japanese companies as a way to explore opportunities in this market, or in some cases to invest in the business potential and technology developed by Japanese firms. For example, Prudential Asset Management Asia - an American investment company - acquired a \3 billion equity interest in Japan Communications Inc. - a Japanese telecom startup focusing on the resale of mobile phone circuits. This was the first investment of this size in Japan by the investment company. In addition, H&A Asia Pacific - an affiliate of the US investment bank Hambrecht & Quist - has invested ´970 million in a Japanese software venture, Access, one of the leading developers of Internet appliances in Japan. These moves prove that there is great potential in Japan's IT and other markets. The door is open and the fire sale is on - are there any takers? Noriko Takezaki is senior editor at Computing Japan. Back to the table of contents