World View: The International M&A Podcast

Andrew Clare

Welcome to Our TLT podcast series on International M&A.  I'm Andrew Clare, a corporate legal director at TLT with a specialism in international M&A transactions. Today we're looking at the Japanese M&A market, specifically key themes which have impacted that market over the past two years, emerging trends and anticipated changes.  I'm delighted to welcome today as our guest speaker, Haruka Murata, who is a corporate partner at the Tokyo Office of Miura and Partners law firm as a specialist in M&A with an international angle, Haruka will provide her expertise and experience to this podcast.  Many thanks for joining us today, Haruka.

Haruka Murata 

Thank you very much for inviting me to this podcast.  I'm very happy to be here.

Andrew Clare

So over the past few years, the UK M&A market has been volatile and shifting due to many factors, not least the interest rate and inflation rises, the ongoing war in Ukraine, the COVID-19 pandemic, supply chain uncertainty and geopolitical change, including of course Brexit.  We would like to talk about any similar challenges in Japan.

Haruka Murata 

As to the eminent market situation, one item to be noted is exchange rate, due to weak Yen outbound transaction from Japan, which has been majority of Japanese and many deals is not active as before.  Rather I see more appetite from foreign companies on inbound deals.

Andrew Clare

Yeah, I think that's right.  I guess that reflects the relative weakness of the Yen right now, doesn't it, which gives foreign investors greater purchasing power.  I think this morning when I looked at the exchange rates, it was ¥181.00 to the pound and ¥148 to the dollar, which obviously gives foreign buyers a lot of purchasing power.

Haruka Murata 

And the second thing to be noted is appetite for sales side transaction.  Japanese companies are generally buying entity for past decades, as you know.  But nowadays those acquired assets is often on sale and not a good chance for foreign investors to acquire these Japanese assets and as I said, weak Yen may be beneficial for foreign investors as well.

Andrew Clare

I think that's a fairly recent phenomena.  I also read somewhere recently that many Japanese small business owners have difficulty in finding successors and that the owners children sometimes don't want to inherit their parents business.  If that's correct, then I would imagine that this combined with the weak Yen might result in further acquisition opportunities for foreign buyers even in respect of smaller family owned businesses.  Is that something you've seen?

Haruka Murata 

Yeah, I share with you too and it sometimes happens.

Andrew Clare

So I think that's another opportunity for foreign buyers, not just the sort of mid-level enterprises, but smaller family owned businesses are also becoming attractive acquisition targets.

Haruka Murata 

And as to eminent market practice, one item to be noted is increase of insurance transactions.  Warranty and indemnity insurance has not been popular in Japan ten years ago but Japanese insurance companies have started to advertise this insurance product for the last few years, and it is getting more and more popular.  Partly because Japanese companies, especially traditional companies, prefer to use their growth insurance company, which they normally use  The brand and insurance is dramatically getting attention these days, and now it is often used for cross-border ideals, but started to be even used for domestic transactions in Japan.  Different from before, it is worth proposing insurance when negotiating with Japanese companies and also in some transactions insurance code is shared between sellers and buyers.  Depending on the situation, you could negotiate on cost sharing as well.

Andrew Clare

That's very interesting.  So you're saying that generally a Japanese company would choose an insurance company it's familiar with.

Haruka Murata 

Yes, which is a Japanese insurance company.  So the next item to be noted is impact of COVID-19 pandemic.  Traditionally, client signature or online meeting have not been openly used in Japan but it dramatically increased during COVID-19 and now Japanese companies are not reluctant to use them.  So I think it is good for cross-border transactions.

Andrew Clare

Yeah, thanks, I'd agree entirely I think, well, I mean COVID-19 it seems something like that happened in the distant past now but I think most business people around the world would agree that this has been one definite benefit coming out of COVID-19 and it certainly makes it easier to organise a deal closing in terms of availability of signatures.  So yes, I'd agree with your comments there, Haruka.

Haruka Murata 

Yes, yes and I think before COVID-19, Japan is quite delayed compared to UK practice, but now it's almost the same I think.

Andrew Clare

So moving on to my next question, question two, thinking about transaction time scales.  How long on average are M&A deals in Japan taking to close and what would you say often impacts or delays the timeline of deals in Japan?

Haruka Murata 

Yes, it totally depends on transactions, but domestic transaction in Japan normally takes one month to a few months and I think cross border transaction takes a bit more depending on which country and the other party is.  And my impression is that Asian transaction takes a bit more than European or US transaction.  And I will also talk about items to be noticed specifically for Japanese companies.  One thing is the internal procedure, which is quite unfamous I think, and traditionally many Japanese companies need to complete time consuming procedure called Ringi to make business decision and it makes the decision making very slow.  Now some companies are changing, but some are not, and here are some tips to negotiate with such companies. Consider negotiation strategy accordingly.  Like after things are agreed at lower level negotiation, if such agreed items are not approved internally, additional negotiation is required, which delays timeline of the deal.  You should fully aware of decision making process, including player lobbying activities in the company.  The second thing is that please invite decision making person on negotiation is necessary and for that purpose, getting to know who has authority to decide and to what extent is very important.  And lastly, it may be useful to involve adviser for where no local system makes a decision. We can advise how to organise negotiation strategy to help Japanese counterparts move quickly.

Andrew Clare

Yeah, I think some very good points there Haruka.  This is really interesting for me, having spent several years working in Japan, I guess this consensus based decision making process is a business custom quite unique to Japan and I understand that traditionally a paper based Ringi show would be used.  Do you find these days that companies are using on electronic format to speed this process up?

Haruka Murata 

Yes, it sometimes helps and the more you often used compared to be poor, but it still need to be circulated internally, so it takes some time.

Andrew Clare

OK, so Haruka with the Ringi approach to decision making in Japan, are there some occasions sometimes where a decision has to be made very quickly and if that's the case, can they bypass the Ringi approach to decision making?

Haruka Murata 

Sometimes it's difficult to totally bypass the process, but Japanese corporation getting to be aware that on this long throw decision making is troublesome.  So nowadays, especially in cases of cross border transaction, they will make efforts to speed up, so it's worth negotiating, I think and the other thing is regulatory approval.  At same as other countries, some transactions are subject to flyer approval on FDI regulations.  In 2019, due to cyber security importance, information processing and communication area is added to those subject to prior approval.  And in 2020, investment threshold on listed company was amended from 10% to 1%.  So now very minority investments may be subject to prior notification.  And certain exemption arrangement was introduced.  However, this is only utilised for minority investors because if you send director to the target, this exemption cannot be used and normally in case of majority acquisition, few directors will be sent to the target, so this cannot be used for such transaction.  And waiting periods is 30 days but nobody shorten in easy case.  On current tendencies, it seems the authority is getting severe these days compared to before and just for your information, So in case you consider investing in this industry, FDA regulation is especially noted.

Andrew Clare

So in most cases, is prior approval simply a formality and the investor just has to wait 30 days.

Haruka Murata 

It depends. in the past it was not very strict, but these days compared to before, as I said it also is like getting more and more severe.

Andrew Clare

So the message seems to be that a foreign buyer will need to factor in to the timetable a minimum 30 day wait, and even after that period the transaction structure may need to be revised.  Can you tell me what is the most common mechanism used for bridging the enterprise value?

Haruka Murata 

So as to cross border transaction, no big difference at the method of valuation.  So mainly DCF discount cash flow is used with support of other methods.  And in case Japanese company is a buyer to acquire foreign company.  Due to compliance, many companies get independent valuation report.  In this case, valuation report is normally insufficient.  And in that case, serial side cooperation is required, such as providing information.  And both price adjustment, which is completion account used and lock box mechanism is used for cross-border transactions.  Regarding purely domestic transactions, locked box is more used.  And in case of smaller deal, which is domestic, even just fixed price with a locked box mechanism could be.  However, Japanese companies sometimes change its attitude on domestic deal and cross-border transactions and they may be more flexible in case of cross-border transactions.  So it is false negotiating based on international standard, I think.

Andrew Clare

So on the whole, there are no material differences to the way enterprise value is determined in many other countries, which is, which is good.  And regarding your comments about obtaining an independent valuation report, I think a foreign target company would be expecting this and wouldn't have a particular problem disclosing the required financial information.  Provided of course a binding non-disclosure letter has been signed, that's pretty much the norm.  So just a related question, how is enterprise value to equity value bridge achieved in Japan?

Haruka Murata 

Yes so enterprise value and equity value breach.  It is achieved by normal net and net debt working capital adjustment.  As of closing for completion, account deal and lock box date for lock box deal.  And if the question is in case buyer and the seller has different view on equity value, how final purchase prices are agreed or not mechanism is often used.  Although is not often used in domestic transactions, it is pretty common in international transactions.  And this is good mechanism to agree on purchase price in case seller and the buyer has different view on business plan and cannot agree on equity value.  Well, however, there is demerit as well.  On such amount, additional purchase price is often paid if certain thresholds such as achievement of certain level EBITDA is satisfied.  However, it is often the case that the dispute arises regarding whether such stressful, dissatisfied or not, because calculation and normalisation method is complicated.  It is good option but not perfect too for a situation where buyer and seller has different view on equity barrier.

Andrew Clare

So as you noted just now, it sounds like the purchase price adjustment mechanisms are pretty much the same as they would be in the UK, which will be comforting for any UK investors going into the Japanese market.  Can I ask in the event of a dispute regarding earn outs, is it common practice in Japan to refer the dispute to an independent third party expert such as an accountant?

Haruka Murata 

Yes, yes, it is pretty common.

Andrew Clare

OK.  And is the experts decision final and binding on the parties, do they have to comply?

Haruka Murata 

If it is agreed as such in the agreement, and it is pretty common to stipulate such growth in the SPA.

Andrew Clare

Yeah.  So that’s the same as in the UK and generally who would pay the experts costs is that 50/50 or does it depend on the direction of the expert?

Haruka Murata 

Both cases are common.  I think Japanese corporations tend to prepare share equally but both arrangement is, yes.

Andrew Clare

So if a foreign buyer makes a breach of warranty claim against a Japanese seller, is it possible to allow the buyer to set off the amount of the claim against any earn out consideration it owes to that seller?

Haruka Murata 

Yeah it is possible.

Andrew Clare

So it depends what's written in the in the agreements I guess.  You made a comment about the buyer and seller having a different view on enterprise value.  I guess it would be really important to agree on the stock purchase agreement, the accounting policies and principles to be applied to the calculation of EBITDA.  I haven't personally seen many disputes, but I suspect that most disputes concerning completion accounts and earn outs arise from a basic misunderstanding about accounting policies and principles.  In other words, whether the buyers policies or those of the target company should take precedence.  So in conclusion, I think it's really important that the parties reach complete agreements on the accounting bases to be applied, I've also experienced in the past where even though the policies are agreed, if you have, say, an American and English party, there's a difference in opinion over the terminology, what the actual terminology means, the interpretation and nuance of the terminology itself.  So I think it's vitally important in the SPA that both parties agree fully on the methodology.  For your clients who are expanding and investing into the UK markets, how are you seeing them approach this and are there any elements of UK M&A which you have seen creating unexpected hurdles?

Haruka Murata 

Regarding investment into UK market, it seemed Brexit has not materially impacted appetite of Japanese corporation to make acquisition in UK, rather weak and is it seems weak and is hurdle.  And the other note is compared to be poor clients including large companies are more and more interested in investing in start ups as well.  And I am aware that FDA regulations are booming in European legal world, however, compared to you with issues.  Since not many Japanese companies have experienced big issues so far, I don't think it being a big hurdle at this moment.

Andrew Clare

I agree that Brexit hasn't materially impacted Japanese corporations appetite to invest in the UK, from what I've seen.  In fact, there seems to me to be a new a new third phase of Japanese investment taking shape in the UK.  I saw some figures recently showing that there were nearly 900 Japanese subsidiaries in the UK in 2016 pre-Brexit, compared to approximately 1150 in 2022.  Now obviously those figures don't tell the whole story, but it's still a pretty significant increase.  That said, I think the type of investment has changed over that period and moved away from the traditional manufacturing, automotive and consumer electronics sectors towards more strategic investments in sectors like energy, transportation, telecoms, infrastructure and also R&D in biotech, pharmaceuticals and semiconductors.  So I think in essence the paradigm has shifted and the pattern has changed.  There have also been some pretty big acquisitions in the UK by Japanese companies since Brexit.  For example, Takeda Pharmaceuticals, acquisition of the former company Shire, which I think was somewhere in the region of 60 billion U.S. dollars in 2019 and in 2021, Renaissance acquired the UK Semiconductor Company Dialogue for approximately $6 billion and of course there have been a whole range of smaller but still important strategic acquisitions.  So as far as I can see, that's a good sign of renewed market confidence in the UK economy.  So would you say that Brexit has negatively impacted where Japanese companies are looking to expand, perhaps not choosing the UK as a hub for expansion as a result?

Haruka Murata 

So I as stated, not for acquisition transactions.  However, having UK as a hub may be impacted.  Some clients prefer to use Netherlands, Germany or other countries as a headquarter of EU subsidiaries due to regulatory.  Using EU law generally for internal matters for European subsidiaries is sometimes easier to manage entire EU subsidiary, so this also may be point to decide whether you have.

Andrew Clare

That's very interesting, that certainly supports the data I've seen from UK analysts, which suggests that since Brexit, a lot of Japanese companies have moved their logistics, warehousing and coordination functions to the EU, particularly Germany and Switzerland.  Looking to the future, are there any new laws or anticipated market changes we can be thinking about in the Japanese M&A market?

Haruka Murata 

Yes, and I understand that you are interested in recent development generally so I will talk about few recent developments from a regulatory perspective.  One is the Japanese government in August 2023 issued new guidelines on acquisition of listed companies in Japan.  It is sometimes said that Japanese among their practice such as TOB, is not transparent enough and despite one is to ensure fairness, transparency was the other things of public deal.  For example, it is recommended to duly consider the acquisition proposal in good faith or to fully negotiate respecting shareholders benefit.  One of the things noted by foreign investors who is considering investment to Japanese listed company is that where the proposal is specific enough or what is buyers credibility and track record are recommended to be considered when the company considers their proposal.

Andrew Clare

So is it fair to say that the new guidelines are designed to prevent shareholders from unfairly or unreasonably blocking a takeover?  Or is it more about being fair to the minority shareholders?

Haruka Murata 

I think as a background, their purpose is to invite investment by showing that the Japanese listed company is fair and transparent towards the transaction.  The other thing is that in 2022 and 2023, Japanese government and the Ministry of Trade, Economy and Industry, which is merely cosmetic it should guideline and delete the materials on respecting of human right.  And nowadays, in addition to business, legal and financial due diligence, human rights due diligence attracts attention of companies engaging in among their activities in Japan.  However, this practice is not common in Japan still.  And thus as a buyer requesting human rights DD is sometimes difficult.  However, internal arrangement on human rights such as supplier arrangement is often different between European based companies and Japanese domestic companies, so it may be useful to at least confirm if there is any internal arrangement on that point, and if so, confirmed its high level outline to have image on how much effort is required for PMI post merger integration.

Andrew Clare

Certainly ESG issues are high on the list of priorities for UK investors and it seems from what you're saying Haruka that this will be an increasingly important factor in Japan as well.  So Haruka, in your experience, do many companies in Japan adopt some form of ESG policy?

Haruka Murata 

Yes, it is getting more and more popular, but if you consider investing in smaller companies or like, smaller companies.  Sometimes they don't not have these kind of things, so you need to arrange something after acquisition.

Andrew Clare

Certainly many UK companies have supplier codes of conduct which include requirements for suppliers to comply with mandatory legislation, such as the Modern Slavery Act and the Bribery Act.  So I guess if a UK company is looking to acquire a Japanese business as you say, this might be a post-merger integration matter to consider after the acquisition.  I also get the sense that human rights, due diligence on an M&A deal in Japan would be important from a reputational risk points of view.  I think that goes for any jurisdiction actually.  Just picking up on your point about post-merger integration generally, do you find that many foreign buyers spend time before the acquisition planning their PMI strategy or is this something they tend to think about later?

Haruka Murata 

I recommend to consider well in advance because sometimes internal procedure internal practice in Japan, is different from foreign practice.

Andrew Clare

I certainly remember that in the past, PMI was one of those areas that was considered to be a nice to do a nice to have something which the buyer would consider only after completion of the acquisition because it costs money to do that.  But I think these days most companies recognise the value of planning PMI before the acquisition takes place and that this approach can actually save money in the long term.  OK, thanks for your input there Haruka.  So Haruka finally, if there's one key takeaway we can offer listeners, what would that be?

Haruka Murata 

It could be flagged for FDI regulations because it has not been strictly applied so far in Japan, but recently it becomes practical issue for foreign companies investing in Japan.  Especially information related industries.  So this may be a recent trend to be noted.

Andrew Clare

Yeah, OK, that sounds like a very important point and I think this relates to the point you made about earlier making prior notification and the clearance process, especially in sensitive industry sectors.  My sense is that this really is important and it reinforces the need for foreign buyers to work with their own advisers and also Japanese Counsel to carry out careful and thorough due diligence on the sector in which they are proposing to invest before they submit a notification.  OK, many thanks Haruka.  Well, that brings this podcast to an end that just leaves me to offer huge thanks to our special guest, Haruka Murata at Muira and Partners for such an interesting insight into the Japanese M&A market.  Thanks for listening to this TLT podcast, and please visit tlt.com to listen to our other podcasts in this international M&A series discussing the US and German M&A markets.  If you found this podcast interesting, please like and subscribe on your usual podcast provider.  Thank you very much.