Carlyle Japan: Looking Past Public Perception for Buyout Opportunities in Japan

May 15, 2008

Speaker
Takeshi Isayama, Chairman, Carlyle Japan

Presider
Alicia Ogawa, Director of the Program on Alternative Investments; Associate Director for Program Development, Center on Japanese Economy and Business, Columbia Business School

Takeshi Isayama, Chairman of Carlyle Japan, shared his outlook on the buyout market in Japan and the conditions for its growth in the years ahead.

Japan and the U.S. are the two largest economies, and although "some say that China is now the larger economic power in terms of purchasing power parity, and that the BRICs, Brazil, India and China, are growing more rapidly, yet no one will doubt that the capital markets of the U.S. and Japan, which are noted for their rule of law, stability and good order, will remain on top for some time to come," said Mr. Isayama.

The conventional wisdom has been that "this relationship was about Japan conceding to U.S. demands," but "in my personal experience" during 33 years at MITI, the Ministry of International Trade and Industry, "it was not that simple," he commented. Discussions on trade and other economic frictions "were usually candid and forthright," and the results benefited both countries. Thus, for example, when the U.S. asked Japanese automakers with plants in the U.S. to buy more American parts, the Japanese firms were concerned about the high prices charged by U.S. suppliers. "However, it turned out that nurturing U.S. parts suppliers produced greater efficiencies not only for Japanese individual companies, but the industry as a whole," and "many of the local practices were translated into global best practices."

Mr. Isayama was invited to become a member of Carlyle a year ago, and initially "I was not sure if I should take my place among the people who allegedly lend you an umbrella on a sunny day, but take it away when it starts raining," he said. As he got to know the buyout business, however, he realized that the turnaround of Nissan Motor, where he worked before joining Carlyle, illustrated the very benefits that buyout firms are designed to provide.

Renault's 1999 purchase of a controlling interest in Nissan brought both financial support and new leadership to the troubled Japanese automaker. By rationalizing parts purchasing, CEO Carlos Ghosn cut total manufacturing costs at Nissan by some 20 to 30 percent; and "on the demand side, he made sure that Nissan lived up to its engineering capabilities and focused on consistent product development and marketing in order to offer value-priced products that meet customers' expectations." Two years later, a year ahead of schedule, Nissan reached its turnaround goals, and within three years it had cut its debt by over $10 billion; Nissan's annual operating profit is currently around $8 billion.

In sum, Mr. Isayama said, "the general role of a buyout fund is to force the changes that revived Nissan."

For many years, support for distressed companies in Japan was largely in the hands of government, with major banks providing indirect financing, he noted. "However, with globalization, this method restricted companies from gaining quick funding and resulted in Japanese companies lagging behind in R&D investment and capital reinvestment. Companies in Japan lost their global competitiveness, and many collapsed" as the bubbles in Japanese equities and real estate burst.

"Since then, as private corporations have grown and become more powerful, the private sector has taken on a greater role," he continued, "especially true since Japan's financial big bang in the late 1990s, which spurred competition among the private sector financial institutions to provide corporate bailouts." The first buyout fund in Japan was set up in 1996, and by the end of 2007, there were 125 buyout funds in Japan representing commitments of $24 billion.

Of all the funds under the Carlyle Group umbrella, Carlyle Japan Partners' 2001 fund "is recognized as the fund with the best performance," Mr. Isayama said. "Yet the total number and amount of funds in Japan is still less than one-tenth of the U.S. This underlines that the Japanese buyout business is still in its infancy."

Despite an easing of legal restrictions on buyout funds, it's still unclear whether the Japanese government will give a warm welcome to foreign capital, he observed. "It seems evident, though, that the financial, fiscal and economic authorities that guide and oversee the buyout market do not necessarily have sufficient global expertise and experience. Meanwhile, in the private sector, Japanese corporate management is highly concerned about the possibility of a takeover by a foreign fund and will generally take preventive measures against mergers and acquisitions by activist funds."

"We need to be equipped with strong management that breaks this psychological war. Once this challenge is solved, M&A and buyout funds will begin working effectively and Japan will transform into an extremely compelling market for investors," Mr. Isayama declared. "Particularly at this time when buyouts in the U.S. and Europe are slowing due to the subprime crisis, Japan is blessed with an opportunity to capitalize on external resources. Increasing numbers of American and European investors are interested in the Japanese market where Japanese corporations, especially those with strong engineering capabilities, are losing significant market value."

"Looking ahead, the establishment of a basic international framework is necessary for the further growth of buyout funds," he reflected. At over $150 trillion, the financial economy is more than three times the size of the actual economy, and "on top of this, the financial economy is behaving as if the actual economy did not exist. You can see the impact it has had on resources and other commodities, and particularly the price hikes in oil and gas and minerals"; and "even more disturbing is the rise in the price of agricultural products such as grain, which could lead to famine in Asia and Africa."

"Meanwhile securitization is creating extraordinary value, but this value may drop to a de facto zero price depending on how circumstances play out. As we are seeing with the subprime crisis, financial products without transparency might cause financial institutions to fail, which would have a devastating effect on the real world economy. We shouldn't think that this will never happen."

"As one who is intimately familiar with the state of U.S.-Japan relations, I imagine that the two governments could start by sharing common policies in areas where it is possible to do so, such as news pertaining to information disclosure and risk management, and then foster global collaboration," he said, citing as "one small step" along these lines the Plaza Agreement of September 1985, whereby the G-5 nations agreed to economic reforms that led to the revaluation of the yen by about 10 percent initially and by more than 50 percent thereafter. "I sincerely hope that the first step in the search for a global vision of sustainable financial capitalism will be taken by Japan and the U.S.," Mr. Isayama concluded.

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Ms. Ogawa asked the first questions:

Buyout firms in Japan have done a very good job, better than American firms have in the U.S., about promising managers that they are not necessarily going to be deprived of their jobs. There is a big effort to keep the management in place and work with them. Given this, why are managers so afraid of working with buyout firms now?

"Unfortunately very few Japanese top executives really understand what buyout funds do," and there's a stereotype that the funds are aggressive and won't necessarily do what benefits everyone, Mr. Isayama replied. "But as I begin to repeat what actually we do in Japan, not many, but an increasing number of Japanese top executives are beginning to be very attentive to what we have done. Very fortunately in the past six or seven years we have had fairly remarkable performance. That could be good enough to convince them."

Carlyle has had some nine or 10 portfolio investments in Japan; the most recent and most famous maybe is Toshiba Ceramics. What kind of facts about the case do you use to try to convince CEOs that working with buyout companies is in their best interest?

It depends on the type of company, Mr. Isayama said.

With subsidiaries that have lost out on opportunities for growth because they've been sheltered from competition by the parent company, Toshiba Ceramics is indeed an example that he cites, he said. But "it will take time. One case is not enough."

With mid-size and small companies "it is much easier," he commented, because typically there's been a management error, a purchase of real estate or unnecessary equipment, that's obvious to everyone, and the problem is that because of a relationship with suppliers the company is finding it hard to change direction. "They need some good excuse to abandon a portion of their businesses," and a buyout firm can provide this.

Is the Nissan experience a model for that? And how does that play out for you personally?

"These experiences helped me a lot to explain what we are now trying to do," he answered. Nissan's corporate culture changed completely in a period of three or four years. Only 2.5 percent of managers were women, for example, and when Mr. Ghosn set a target of doubling that ratio in three years, there weren't enough women within the company who'd been trained for these roles, and so the company had to recruit from outside, which brought in people who "are very capable and have completely different experiences."

Questions from the audience followed:

How many of your investors are domestic, and how would that help you in the long term in making your case for returns that will flow back to those investors as well?

Carlyle Japan is currently about $2 billion, 53 percent of which comes from Japanese investors, mostly financial institutions, Mr. Isayama replied. "If these numbers become more visible, perhaps I do believe that Japanese investors will try to take advantage of that in competing with foreign investors and vice versa."

Do you have any comments on attitudes towards shareholders in Japan?

"We have to pay respect to shareholders," and at the same time, people in Japan value return not just in terms of money, but also "in terms of other values, social values," he replied. "Taking this into consideration, you can perhaps employ a much better, wise corporate strategy to extract more profits from the Japanese market."

As I look at the Carlyle Japan website I notice that everybody from chairman to associates is Japanese. Is that a strategic choice?

This is a basic principle in other Carlyle funds around the world, in Italy and Spain, for example, responded Mr. Isayama. In day-to-day operations Carlyle Japan makes its own decisions, though in terms of financial decision-making "we rely on U.S. headquarters, getting their advice based upon their experiences."

Do you think that METI in its current incarnation has a responsibility or a role in encouraging Japanese management to be more open minded when it comes to foreign capital investment, vis-à-vis a buyout fund or even just equity investors?

Historically, when Japan has faced situations where different values have come from outside, in "most cases Japan accepted that, absorbed that. So, it may take time, but it's just a matter of timing," Mr. Isayama answered. "Many people begin to recognize that. They look around. Asian countries once were so depressed, but are now growing rapidly. They are beginning to feel that unless we, ourselves, are completely in accordance with global standards, perhaps we will be left behind... Only after conquering those differences we could grow and we could change" and take on the status of a leader.

--Katherine Hyde