i Overview of M&A Activity
M&A transactions are an active and consistent presence in the Japanese market. The aggregate number of M&A transactions in which Japanese companies were involved, whether domestic, inbound or outbound, was 3,850 in 2018, according to Recof's analysis, representing an increase of approximately 26 per cent from 2017.
i Domestic transactions
In 2018 the number of domestic M&A transactions in the Japanese market was approximately 2,800, a record high. Most Japanese companies regard M&A as one of the most important business strategies to achieve growth and operating efficiency. In addition, many traditional Japanese large-scale (involving conglomerates) companies, such as Hitachi and Toshiba, are actively divesting non-core businesses (whether in subsidiaries or affiliates), and aiming at emphasising their core businesses, in the hope that their return on equity (ROE) can increase. In the past, most Japanese companies were severely criticised by, particularly, foreign investors for their low ROEs as compared with those of US and European companies; however, this has been much improved by the increasing number of Japanese companies divesting non-core businesses, and a focus on corporate ROE has been one of the objectives of the economic strategy under the Abe administration (Abenomics). As a result, private equity (PE) funds have been prominently featured as key buyers of divested businesses and operations, having access to low financing costs through the Bank of Japan's ongoing quantitative and qualitative easing monetary policies and investors' appetite for better returns in the low interest rate environment. It was reported that the number of domestic M&A deals involving PE funds, whether Japanese domestic or global, was approximately 750 in 2018, which also was a record high.
ii Inbound transactions
Although the number of inbound transactions in Japan where foreign buyers, whether strategic or financial, acquire Japanese target companies is not as numerous as either purely domestic or outbound transactions, because many traditional Japanese companies are having difficulties increasing their ROE and others are facing challenges to their survival without injections of capital or other support, the number of inbound transactions has grown steadily in recent times. Approximately 260 transactions were reported in 2018, which represented an approximately 30 per cent increase from 2017. Among notable inbound transactions were:
- the acquisition of Toshiba Memory, Toshiba's subsidiary, by Bain Capital, an active US PE fund, and its consortium (which comprised international investors, including a Korean competitor) for approximately US$18 billion;
- the acquisitions of Hitachi Kokusai Electric and Hitachi Koki, subsidiaries of Hitachi, by KKR, for approximately US$2.2 billion (inclusive of dividends, US$2.8 billion); and
- the acquisition of Asatsu-DK (ADK), the third-largest and a traditional advertising agency company in Japan, also by Bain Capital, for approximately US$1.35 billion.
iii Outbound transactions
Because of the shrinking of the Japanese market caused by the aging society and declining population, Japanese (particularly, listed) companies are obliged to seek to expand their businesses overseas, as domestic organic growth can no longer be expected. Many Japanese companies have expressly announced that they intend to seek to engage in outbound M&A transactions and to increase their investment into foreign markets. In 2018, the number of outbound M&A transactions was reported to reach a record high. Among others, the acquisition of Shire plc (see Section V.i) by Takeda Pharmaceutical is the largest acquisition by a Japanese company in market history in terms of purchase price (approximately £46 billion). As a result of this and other transactions, the aggregate transaction value of outbound deals significantly rose in 2018, reflecting an approximate 150 per cent increase from the previous year.
On the other hand, the acquisition of a foreign company can be operationally and culturally challenging for any purchaser, whether Japanese, US or European. Consequently, it has been reported that many Japanese companies that closed acquisitions in outbound M&A transactions have struggled during the period following post-merger integration (PMI), and several companies have had to write off significant amounts of goodwill in their acquisitions under the International Financial Reporting Standards. In response, the Ministry of Economy, Trade and Industry (METI) established a study group of Japanese companies' M&A transactions overseas, and released a report in March 2018 reflecting various issues and providing suggestions and also some guidelines for Japanese companies in conducting outbound M&A deals. Nevertheless, despite these operational and other issues, the increasing trend of outbound M&A transactions is expected to continue as Japanese companies (are obliged to) seek to increase their growth and future prospects.
II General Introduction to the Legal Framework for M&A
It is generally stated in Japan that an M&A transaction is defined as a transaction where control of a target company is transferred in any manner. In this regard, M&A transactions can generally be grouped into three categories: stock transfers, business transfers, and statutory mergers and other corporate restructuring transactions.
i Stock transfers
This structure is the most frequently utilised in Japanese M&A deals and the best known. A stock transfer agreement, or stock sale and purchase agreement (SPA), is based on an agreement regarding the transfer of the stock in a target company between a seller and a buyer and is basically governed by the Civil Code of Japan. While no formality including a stock transfer form is required for an SPA to be effective in Japan, recent transactions in Japan using a SPA have been negotiated with reference to deal styles employed in the US market; provided, however, that the perfection of the transfer of the stock in the target company requires a change of the stockholder's name in the records of the target company from the seller to the buyer, which is not subject to the payment of or submission of an exemption from stamp duty as is the case in the United Kingdom. Although stock acquisitions in the US can include a feature where the target company newly issues shares that give the buyer (who subscribes for these newly issued shares pursuant to a share subscription agreement) a control right with respect to the target company, in Japan the use of a share subscription agreement is generally regarded as being a different category from SPA transactions, as share subscriptions are governed by the Companies Act of Japan.
For a buyer to obtain control of a target, it is generally thought in Japan that the buyer only has to purchase a (simple) majority of the target's outstanding shares. However, as the Companies Act provides that a two-thirds vote is required for certain major corporate actions to be adopted as a resolution at a general shareholders' meeting of the target company (as a special resolution), it is sometimes said that the purchase of the majority of outstanding shares of a target is not sufficient, but rather two-thirds is required. In this regard, generally speaking, for a buyer to acquire one-third or more of the outstanding shares of a listed target company, the buyer is obligated to make a tender offer or use takeover bid procedures provided in the Financial Instruments and Exchange Act of Japan, known as a 'mandatory TOB procedure' and based on the UK and European regulatory approach. Furthermore, if a buyer intends to purchase two-thirds or more of the outstanding shares of a listed target company through the TOB procedure, the buyer is obligated to purchase all shares tendered and offered by the shareholders of the listed company, even if the buyer expressly announces an upper limit of the number of shares that the buyer intends to purchase (referred to as the 'mandatory obligation to purchase all of the offered shares in the TOB procedure'), as is also the case with UK and European regulations. Except for these two mandatory points, the TOB procedure in Japan is similar to the tender offer process in the US market.
ii Business transfers
A business transfer agreement (which is governed by the Companies Act) was often utilised in Japan so that a buyer succeeds to a transferred business of a seller. However, for the business transfer to be perfected, any and all registrations, licences, permissions, etcetera, have to be perfected in light of any and all assets (including real estate, intellectual property rights, licences, permissions), and the process for the closing of a business transfer was therefore very tedious and time-consuming.
Accordingly, a company split agreement, which was adopted in the Companies Act relatively recently, is now often used instead of the business transfer structure. In a company split, the process generally entails a transferring company (namely, the seller) splitting a portion of its business following a resolution adopted at a shareholders' meeting, and the split business is automatically transferred to a succeeding company (namely, the buyer), that is, an effect of universal succession. As a practical matter, a company split is much more convenient and efficient as compared to the business transfer structure, and this form is therefore often used these days.
iii Statutory mergers and other corporate restructuring transactions
A statutory merger in Japan is almost equivalent to that seen in the United States and European countries. In a statutory merger, generally speaking, the disappearing company is merged into the surviving company, as a result of which those two companies will be integrated into one merged company. Tax and accounting impacts usually determine which company (namely, the buyer or the seller) is the disappearing company and which is the surviving company.
A stock exchange agreement is a very efficient and straightforward transaction so that a target company automatically becomes a 100 per cent subsidiary of a buyer if both the target and the buyer obtain a special resolution (i.e., two-thirds approval) at a general shareholders' meeting. In this process, no mandatory requirements relating to the TOB procedure are necessary even if the target is a listed company.
A stock transfer is a unique process under the Companies Act, and is not a simple transfer of stock (or shares) of a target company. The process was originally introduced in order for a company to newly incorporate a 100 per cent parent company (i.e., for a holding company of one or more existing companies to be created). However, in the context of M&A transactions, a stock transfer is utilised in a situation where two companies intend to integrate their businesses in an umbrella structure of one holding company; namely, if shareholders of the two companies adopt a resolution at a general shareholders' meeting approving the joint-stock transfer agreement, a joint holding company will be newly established, and the two existing companies will be 100 per cent subsidiaries of the joint holding company. As it may not be clear which company from among such two companies is the buyer (or the target) and this ambiguity is suitable to mores in Japanese business society, this structure has been used in various deals in the Japanese market where the transaction was intended to act as an integration of equals rather than being considered a takeover of one company by another (such as the Isetan/Mitsukoshi and Dwango/Kadokawa combinations, and recent business integrations of regional banks, including the Concordia group).
However, this approach may minimise successful PMI and lead to entrenched redundancies rather than increased efficiencies if the two operational subsidiaries remain as sister companies after closing. Stock transfers have been recently criticised on the basis that unless and until the actual integration of the two subsidiaries is conducted, the effect of the transaction as a successful M&A transaction is questionable.
III Developments in Corporate and Takeover Law and
i Significant recent statutory amendments and proposals
First, while cash-out mergers have been legally possible in Japan, this transaction type requires numerous technical procedures, including special approval at a general shareholders' meeting and court procedures, for such a merger to be effective. The Companies Act was amended relatively recently so that a shareholder holding 90 per cent or more of a target company can force the other shareholders to sell their shares in the target to the acquirer with the approval of the target's board of directors. As a result, in many cash-out transactions of publicly held companies where bidders seek to obtain all of the outstanding shares of the target, bidders have stated in their TOB announcement that they would seek to exercise this right if they were able to acquire 90 per cent or more of the target's outstanding shares through the tender offer.
Secondly, although bidders are allowed to use shares as consideration in tender offers in Japan, in practice, only cash has been so far utilised as the offered consideration because of certain procedural obstacles in the Companies Act and the resultant tax treatment (namely, a capital gains tax is imposed on the selling shareholders, and carrying-over is not permitted). An amendment has been proposed, however, which if adopted would eliminate this procedural process and enable a Japanese stock company to more easily use its own shares as consideration in a tender offer to acquire more than 50 per cent of a target company's (including a foreign target company's) voting shares. The proposed amendment would also affect the tax characterisation so that any capital gain arising from the sale of shares can be carried over if certain requirements are satisfied. (This tax law change would apply more generally and not just in tender offers.) This is in addition to the already adopted amendments to the Industrial Competitiveness Enhancement Act and the relevant tax law (they became effective in 2018) that aim to facilitate transactions utilising own shares as consideration.
Thirdly, although still at the proposal stage, it is also planned that the Companies Act is to be amended to further promote corporate governance reforms. In this regard, the proposals include, among other things, requiring listed companies to appoint outside directors, determine and publicly disclose their remuneration policies, and electronically provide their business and other reports as well as the agenda of shareholders' meetings online. The bill to amend the Companies Act containing these proposals is expected to be presented to the Diet in the latter half of 2019 or thereafter. While it is uncertain whether and how those amendments may affect M&A transaction activities involving listed companies, more input from and discussion with outside directors and shareholders are expected to stimulate the companies' consideration of appropriate potential transactions.
IV Recent Legal and Commercial Developments Involving Listed Companies that Affect M&A Transactions
i Soft law impacts
The Tokyo Stock Exchange adopted Japan's Corporate Governance Code (CGC) in 2015, with an amendment thereto in 2018 in response to the increasing globalisation of the world economy and growing expectations for established rules of conduct for directors of Japanese listed companies. The CGC takes a comply or explain approach: namely, listed companies are not required to comply with each principle set out in the CGC, but they are required to explain the reason if they do not comply with any of the CGCs principles. Although the CGC is just soft law and is not legally required to be complied with, and nor is it enforceable by the courts, listed companies are obligated to comply with the CGC to continue their listing on the Exchange; as a result, adherence to the CGC has become an established custom by listed companies, and it is expected that the courts will recognise the CGC principles as appropriate rules of conduct applicable to directors of all Japanese listed companies.
In addition, the Council of Experts on the Stewardship Code, a council body set up by the Financial Services Agency of Japan (FSA), provided Japan's Stewardship Code (JSC) in February 2014 and updated it in May 2017. The underlying philosophy of the JSC is to promote awareness of the fiduciary responsibilities that institutional investors owe to their investor clients, and to seek to encourage those institutional investors to engage in dialogue with their investee-listed companies to enhance the mid and long-term return on their investments. In Japan, similar to most other markets, institutional investors are major players in the stock market. The JSC also adopts a comply or explain approach, and expects institutional investors to voluntarily adopt principles and follow its suggested guidelines.
Increasing pressure from the market and clients have caused traditional institutional investors to more keenly recognise their responsibilities and accountability to clients, and this enhanced awareness has gradually changed the voting practices of investors, including votes concerning proposed M&A transactions. Although the JSC is addressed to institutional investors and does not bind investee-listed companies directly, it has played a substantial role in promoting enhancement of listed companies' corporate governance through the improvement of the monitoring of corporate activities and results by institutional investor shareholders.
In March 2018, the FSA published a draft guideline for investor and company engagement, which became final and effective in June 2018. This guideline is intended to supplement the CGC and the JSC and encourages institutional investors and listed companies to particularly focus on their dialogue with each other. As a result, it was recently said in Japan that although directors of Japanese companies (including listed companies) do not legally owe any fiduciary or other duties directly to each shareholder, but only an indirect duty to shareholders through their direct statutorily prescribed duty of care of a prudent manager to the company, directors of listed companies now have become obliged to make business judgements as if they directly owed a fiduciary duty to their companies' shareholders as result of the impact of the CGC and the JSC. Japan has been a very difficult market for a long time, particularly, for hostile takeovers and activists, and these developments may signal changes in this area.
There have been only very limited cases where shareholders have brought actions against directors who have rejected hostile takeovers, or put pressure on boards to obtain favourable acquisition prices or proposals from activists or other third parties seeking to increase a company's return on equity, or sought to engage management seeking to increase the efficiencies of businesses. However, now that listed companies and their major shareholders (namely, institutional investors) are adopting the principles set forth in the CGC and the JSC, directors of listed companies face difficulty in rejecting hostile takeovers out of hand or without a reasonably justifiable basis that is in the best interests of the company and that of its shareholders. At the same time, institutional investors find it difficult to support a target management's attitude without reasonable analysis and considering whether the management's attitude promotes the best interests of the company and shareholders.
In this regard, although it is a controversy involving listed Japanese real estate investment trusts (J-REITs), as of the end of May 2019, Star Asia Group, through Star Asia Investment Corporation, a J-REIT, is trying to take over Sakura General REIT Investment Corporation, another J-REIT, in a hostile transaction by seeking to convene a unitholders' meeting of the target so as to consider resolutions that would effect the takeover. Specifically, Star Asia Group has asked investors in Sakura General REIT Investment Corporation to call a unitholders' meeting at which the cancellation of the existing asset management contract and the approval of a new asset management contract will be on the agenda: if these actions are taken, then management control of the target would change. Sakura General REIT Investment Corporation, however, has shown strong willingness to oppose this, and has called on investors to oppose Star Asia Group's proposals. This has attracted much attention because, if successful, it would be the first hostile takeover of a J-REIT.
ii Change of circumstances involving listed companies in Japan
Traditionally, shares in Japanese listed companies were cross-held by their business partners, including their main banks, who acted as stable and management-supportive shareholders. It has been said that this system of cross-shareholding weakened the market discipline that should have been applied to listed companies and caused inefficiencies in the use of companies' financial resources. Almost a decade ago, the law and regulations were amended to require listed companies to explicitly disclose, in their annual securities reports, the amount of shares held in other listed companies and the purpose of such share ownership. In addition, the CGC requests listed companies to disclose their policies with respect to cross-shareholdings. The updated CGC further requests listed companies to disclose various matters relating to their cross-shareholdings. With the strengthened emphasis on disclosure of cross-shareholding and increasing pressure from the market, many listed companies gradually have decreased the amount of their cross-shareholding, and now, listed companies have fewer passive and management-friendly or supportive shareholders, and increasingly face the discipline of and pressure from the stock market to improve their financial performance.
Moreover, with the growing global trend of shareholder activism and changes in the Japanese market environment, including enhanced corporate governance measures, activist funds are expected to increase their presence and seek to target more and more listed Japanese companies. Indeed, there have been several, albeit still not many, large-scale or notable cases indicating the success, or at least the significant impact, of shareholder activism in the past few years. This trend will lead to increased market discipline being put on listed companies to improve their ROE.
In November 2018, the METI launched a new study group, the Fair M&A Study Group, so that best practices in handling conflicts of interest that can arise in M&A transactions can be followed in Japan. The Group is looking at, among other things, management buyouts and squeeze-outs by controlling shareholders and considering what changes, given the current environment surrounding Japanese listed companies, should be implemented. It is expected that the Guidelines for Management Buyout published in 2007 would be updated as a result of the Fair M&A Study Group's report. This update is expected to reflect the accumulation of legal and practical discussions and the progress of corporate governance reform over the past few years.
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
As noted earlier in Section 1, given Japan's ageing society and declining population, which has put a strain on domestic organic growth, as a result of which the Japanese domestic markets are expected to continue to shrink, more and more Japanese companies intend to make or increase significant investments overseas. To do so, many will seek to engage in M&A transactions. A typical example is the unprecedented large-scale (i.e., the largest in history) acquisition of Shire plc, an Irish-headquartered corporation, by Takeda Pharmaceutical, a leading Japanese pharmaceutical company, with a purchase price of approximately £46 billion. As is often stated, the pharmaceutical and generics industries in Japan have to, and therefore are eager to, lay greater emphasis on expanding their business overseas to grow and expand their portfolios. It is generally said that the chemical and electric components (excluding semiconductors) manufacturing industries also are active in outbound M&A transactions.
While the Japanese economy has had stable growth for several years now because of Abenomics and the length of its favourable business climate has reached a record high (as in the United States), on the other hand, not all sectors of Japan's economy has been favourably affected. For example, Japan's regional banks are struggling due to the Bank of Japan's continuous quantitative and qualitative easing policy (zero or negative-interest policy), and the FSA has pressured a number of these regional banks, generally those that have declared losses in their recent business years, to consider a business integration with other strong or creditworthy regional banks. As a result, there have been several prominent transactions in this sector, such as the establishment in 2016 of Concordia Financial Group, currently the second-biggest regional bank in Japan, by means of a merger between Yokohama Bank and Higashi Nihon Bank, and the formation in 2017 of Kansai Mirai (Future) Financial Group, Inc, the biggest regional bank group in the Osaka area, through the business integration of Kinki Osaka Bank, an affiliate of Resona Bank, and Kansai Urban Bank and Minato Bank, affiliates of Sumitomo Mitsui Banking Corporation. In addition to these notable integrations, there also have been various other recent business integration and M&A transactions involving regional banks. This trend is expected to continue given the severe environment surrounding Japanese regional banks.
In addition, as already referred in Section 1 as well, traditional and large-scale Japanese conglomerates that aim to focus more on their core businesses and to increase their ROE and efficiency have been actively divesting their non-core businesses, whether conducted directly or through subsidiaries and affiliates. Given this seller-side demand, supported by low funding costs and investors' strong appetite for better returns in the extreme low interest rate environment, PE funds have played an important role as the key acquirers of those divested businesses.
In this regard, not only domestic PE funds but also foreign PE funds are very active in these divestiture M&A transactions. Some of these transactions have been very large in scale, such as the acquisition of Toshiba Memory by Bain Capital, a US PE fund, and its consortium, the acquisition of Asatsu-DK by Bain Capital, and acquisitions of Hitachi Kokusai Electric and Hitachi Koki by KKR, another US PE fund.
Vi Outlook AND CONCLUSIONS
Despite the unstable global economy, particularly given the trade war between the United States and the People's Republic of China, and the existence of various geopolitical risks, it is expected that the M&A market in Japan will continue to be active, and most likely will expand even more. The trends of Japan's ageing society and declining population will be challenging to change despite government policies seeking to do just that. The strong demands of shareholders and investors toward listed companies for higher ROE and return on investment are putting continuous pressure on those listed companies to continue to grow and to operate at higher and higher levels of efficiency.
Even if the Bank of Japan's unprecedented easing policy were to be abolished and even if the strong stock market were to be weakened, there is no factor currently foreseen that will lessen Japanese companies from being involved in M&A transactions.
1 Masakazu Iwakura is a senior partner and Gyo Toda and Makiko Yamamoto are partners at
TMI Associates. They would like to thank Vincent Tritto, a foreign attorney at TMI Associates,
for his valuable assistance.