Capital Market Reforms Widening Opportunities for M&A Expansion in Japan

May 2023

Market reforms are helping to accelerate corporate Japan’s mindset shift––and boost the business sector’s appeal for foreign investors. In 2021, Japan revised its Corporate Governance Code (CGC) to encourage publicly listed companies to diversify their ranks as a means of enhancing value. The revamped CGC called for the appointment of more independent, outside directors (especially for companies listed on the Tokyo Stock Exchange Prime Market), including those with executive-level experience; for directors’ compensation to include mid-term and long-term incentives linked with sustainable growth; for the disclosure of targets to hire more women, non-Japanese and mid-career employees for key positions; and for guidelines about human resources that would codify these efforts.

The CGC revisions also put sustainability on the agenda. As Japan attempts to reach net-zero emissions goal by 2050, it’s mandating that companies disclose how their business practices align with the United Nations’ Sustainable Development Goals (SDGs). Previous changes to the CGC, introduced in 2015, prodded Japanese companies to focus on cost of capital and return on capital and attempted to reduce companies’ cross-shareholdings––a practice that had insulated executives from shareholder demands and takeovers and acquisitions.

Other initiatives have had a positive impact, too. Japan’s Stewardship Code for institutional investors, introduced in 2014 and revised twice since then, has increased domestic pension funds, trust banks and asset managers’ engagement and dialogue with companies they own shares in. Japanese companies are now held more accountable for their decisions, and more openly discuss the effects of takeovers on management control and investors’ equity holdings. (At last count, in 2020, more than 280 institutional investors had committed to the Stewardship Code, according to Japan’s Financial Services Agency.) The Tokyo Stock Exchange’s market segmentation review and tighter delisting criteria have prompted companies to adopt more measures that can boost their corporate value. In 2019, Japan’s Ministry of Economy, Trade and Industry (METI) devised guidelines that led Japanese companies to take a closer look at structural conflicts of interest, such as those between themselves and their subsidiaries’ shareholders. The following year, METI published “Practical Guidelines for Business Transformations - Toward Changes to Business Portfolios and Organizations-,” to prompt Japanese companies to assess business portfolios for sustainable growth at three layers: management, board of directors (especially independent, outside directors), and investors. The guidelines also outlined approaches to the smooth divestment of business units. The result: many companies had to choose between pouring more capital into their subsidiaries or selling their shares and agreeing to a spinoff.

These days, it’s not hard to find success stories among the corporate mergers and acquisitions (M&A) in Japan. One example: Panasonic Healthcare, currently PHC Holdings. In 2014, New York-based private equity firm KKR scooped up the non-core business unit of Japanese hi-tech conglomerate Panasonic that specialized in blood glucose monitoring system, research/medical support equipment, and electric medical record system and other healthcare technologies.

With KKR’s support, the company, renamed PHC Holdings (PHC), went on a spending spree. PHC acquired the diabetes-care business of Bayer AG for around 140 billion yen (1.08 billion dollars*). KKR assisted PHC throughout the acquisition process – from due diligence to negotiation, valuation and post-merger integration. Later, PHC added Thermo Fisher Scientific’s anatomical pathology business to its portfolio.

By the time PHC launched its initial public offering, listing on the Tokyo Stock Exchange in 2021, the company had transformed itself into one of the world’s top healthcare companies. It wasn’t just a triumphant comeback for a former subsidiary of a struggling hi-tech. It was also a ringing endorsement of how cross-border M&A is having an empowering effect on Japanese industries.

Japan’s M&A market has been on an upward trajectory lately. In 2022, there were 4,304 deals involving Japanese companies, a 37-year high. The figure––which included KKR’s 671.4-billion yen (5.2-billion dollars*) acquisition of Hitachi Transport System Ltd. and Takeda Pharmaceutical Co.'s 546.7-billion yen (4.2-billion dollars*) purchase of a unit of U.S. pharmaceutical startup Nimbus Therapeutics––capped a nearly continuous expansion of M&As that goes back to 2011.

* Converted at 130 yen to the US dollar

The surge of tie-ups, takeovers and buyouts reflects Japanese companies’ more aggressive pursuit of growth in overseas markets. As deals with foreign companies rise and as more upbeat stories emerge, the old perception of these transactions as a restructuring last-gasp for Japanese firms is being put to rest.

When it comes to cross-border M&A in Japan, Japanese pharmaceutical company Chugai is often cited as a model case. Tokyo-based Chugai started a strategic alliance with Roche, one of the global industry’s biggest names, in 2002. Chugai retained its management independence and remained a publicly listed company. Among the biggest benefits: Chugai gained exclusive right to develop and market Roche’s product in Japan, access to worldwide sales channels and R&D know-how. A stable revenue base from Roche’s product enables Chugai to concentrate investments on unique and highly innovative drug discovery.

Compared with pre-alliance figures, Chugai achieved about 17-fold increase in operating profit and has outsold its rivals in cancer treatments in Japan. The stellar performance fueled a renewed sense of purpose and confidence throughout the company. For executives in many Japanese industries, the Chugai-Roche deal reinforced the merits of cross-border arrangements and offered a strong rebuttal to businesses that remain heavily focused and overly dependent on the domestic market.

To encourage Japanese companies to consider the use of inbound M&A transactions, Japan’s Ministry of Economy, Trade and Industry (METI) has compiled a research of “Case Studies Relating to the use of Inbound M&A Transactions,” with details on background information and post-deal integration as well as the significance and merits of each example.

The emphasis on improving corporate value and capital efficiency, and prioritizing sustainability and the heightened awareness of corporate chieftains is beginning to spread beyond Japan’s publicly listed companies to the broader business community across the archipelago. The hope is that these changes will entice more foreign companies to explore M&A in Japan as an expansion opportunity.