M&A activity in Japan soared to a record high $150 billion in 1999, up from $18 billion in 1998. Seventy-five transactions (valued at $77 billion) that quickly consolidated the banking sector accounted for half of the boom. Another hot area was telecommunications, with 52 deals, valued at $30 billion. The automotive sector too has been going through a transformation, including the sale of stakes in Nissan Motor (Renault), Mitsubishi Motors (DaimlerChrysler), and Subaru (General Motors).

Moreover, in 1999 cross-border deal activity rose sharply, tripling in value from the previous year—to $27 billion on nearly 150 deals. This increase signaled an important trend for foreign companies in the world’s second-largest market. While many of the deals involved distressed businesses, and the level of activity pales in comparison to the 12,000 mergers and acquisitions in the United States in 1999, global companies are no longer ignoring deals in Japan. Yet in the country’s unique social and business culture, mergers and acquisitions are unusual even between home-grown partners, so a knowledge of how to do deals in Japan is becoming a required skill for the world’s most sophisticated companies.

Japanese corporate boards are packed with insiders who have remained in place for decades

Many considerations that deter outsiders from embarking on M&A deals in Japan are well known. Japanese companies have an old-world, even feudal character. Corporate boards are packed with insiders who have been in place for decades. And business arrangements and investments are often maintained not for economic or strategic reasons but because of family ties, long-standing relationships with suppliers and distributors, and loyalty to employees. Balance sheets can throw up surprises: a shipping company might turn out to own a bar run by a relative of the president, or an appliance manufacturer may have a few "love hotels" or golf courses. With transparent accounting guidelines only now being implemented and no tradition of forthright disclosure or shareholder activism, many such oddities remain buried in the accounts, where only those with intimate knowledge of the company concerned would spot them.

Despite such differences in style and practice, global companies can make acquisitions in Japan—especially if they explicitly address these differences in the course of negotiating and structuring deals. Moreover, the increasing awareness among Japanese business owners, managers, and shareholders of the need to rationalize their companies means that many are now more open to the prospect of a partner or buyer.

First, face the obstacles

Outsiders wishing to make deals in Japan face three main difficulties: the lack of an M&A infrastructure, a scarcity of financial skills, and opposition—from corporate boards, from vested interests outside them, and from executives.

A lack of infrastructure

The forces that propel M&A deals in the West—shareholders, analysts, and the market—can’t be relied upon to fuel deals in Japan. They are also difficult to influence. Shares of most publicly held companies are cross-held by each company’s main suppliers, banks, and customers. These shareholders, who exert little pressure for higher earnings or share values, may actively discourage deals. Dividends are set and are usually unrelated to earnings. This state of affairs is beginning to change; one hostile deal has already been completed: the February 2000 takeover of the pharmaceutical company SSP by the German company Boehringer Ingelheim. But Japan has a long way to go before the level of deals there approaches that in the West.

Given the minimal extent of M&A activity in Japan over the past decade, it is hardly surprising that the country lacks an M&A infrastructure. A shortage of consultants and investment bankers with experience in the field presents a real handicap. (Japanese executives tend to handle inquiries from potential suitors on their own.) When a US consumer packaged-goods company was sizing up a Japanese bottling company, the US company found many unrelated assets. Local investment banks could tell it what the target owned but couldn’t suggest how it might structure a deal to get the parts of the business it wanted and dispose of the rest. The result was several changes of investment bankers and long delays in completing the negotiations.

It is important to be prepared for such limitations. Non-Japanese advisers are often surprised by what they find after careful digging through financial statements. Japanese advisers, on the other hand, might be prepared for what they find but incapable of coming up with a creative solution for disposing of Uncle Fuji’s business. They don’t necessarily realize that global companies expect them to propose ways of getting the desired parts of a business at a reasonable price.

A scarcity of financial skills

Japanese accounting practices present further difficulties. Despite recent moves by leading companies to embrace economic value-added thinking and adopt discounted-cash-flow valuation methods, few Japanese executives have experience in these areas. For decades, asset-based valuation has been the method of choice for valuing companies in Japan. Consolidated operating profits or profit per unit of sales, rather than detailed financial analysis of business areas, continues to be a common way for executives to understand the performance of a business.

It is thus often impossible to form a clear picture of a company’s financial value. The introduction of fully consolidated accounting laws in Japan in April 2000 has improved transparency up to a point because this legislation forces companies to report the performance of subsidiaries over which they have effective control rather than simply issuing a single consolidated financial report. Even so, real insights into financial value can still be elusive.

Establishing the costs and profitability of a given business within a conglomerate can be extremely difficult. Take the case of a Canadian industrial-equipment company that looked at a business unit of a major Japanese electronics manufacturer. Most of the target’s subsystems were sourced from facilities wholly owned by the parent company and shared by all of its divisions. It was impossible to relate costs to specific products. Such a situation is not unusual; even the accountants of many target companies can’t sort out the revenues and costs or expenses of individual business units. For this reason, a good knowledge of the industry and of benchmark levels of business functions will help a buyer "create" a plausible economic scenario for a particular business.

It is important to remember that the main aim of deals in Japan should be strategic advantage. Short-term cost savings are unlikely to be on offer—though, with the proper approach, global levels of efficiency probably are.

Opposition from the board

In the West, deal making is typically the domain of the chief executive officer, the chief financial officer, executives charged with developing new businesses, and bankers. In Japan, a different and far wider web of decision makers is involved. Besides the board of directors, merger decisions are influenced by prominent corporate or family shareholders, past chairpersons, and regulators. No single person, such as the CEO or CFO, controls the entire decision-making process.

This reality can have various repercussions. One is the fact that a board might be reluctant to engage in conclusive discussions on the sale and subsequent restructuring of a company. Board members, promoted largely on the basis of seniority and strongly loyal to the company, can find the prospect of a sale overwhelming and put off the decision, even when the business is in serious distress. To overcome their reluctance takes patience and persistence.

Consider one example. A non-Japanese multinational proposed a joint venture to a Japanese pharmaceutical company known for its strong R&D, product development, and sales force. The Japanese company countered with an offer for a simple licensing deal that would have done nothing to save money on field sales costs and would have made marketing strategies for specific drug-therapy areas more complex. After several rounds of discussions, the underlying issues in the Japanese company surfaced: the powerful heads of sales and R&D were concerned for their people and for their own roles and relative power within the new company, and the board wasn’t clearly committed to a more aggressive growth strategy.

Eventually, a compromise was proposed. The two sides agreed that at first the Japanese would control the new company but that, gradually, control would be transferred to the multinational as its pipeline of products came to account for a majority of sales. In another, similar situation a compromise allowed the seller to remain listed on the Japanese stock exchange for a period after the company’s acquisition.

Opposition from outside the board

Even when the CEO of a target company supports a deal, opposition can come from regulators, senior family members, or corporate shareholders. To diffuse the tension, the buyer must often mobilize "back-channel" support for the CEO by arranging meetings between the chairpersons of the two sides or by involving senior directors of the target company’s main shareholders.

Consider the experience of a multinational beverage company that wanted to buy and combine two Japanese beverage bottlers with which it was affiliated. To try to obtain agreement, the buyer’s chief executive had to negotiate with the chief executives of the Japanese industrial conglomerates that were the leading investors in the bottling companies. The deal was eventually clinched thanks to the participation in the talks of an outside party with a vested interest in the deal: 7-Eleven Japan and its largest shareholder, Ito-Yokado, a Japanese real-estate company. Because 7-Eleven preferred to buy from one bottler rather than several, 7-Eleven prevailed upon the bottling companies and their investors to consolidate.

Opposition from the executive ranks

Senior executives on the boards of their companies have little incentive to champion any merger deal that could threaten their position

Senior executives who sit on the boards of their companies have little if any incentive to champion a merger deal that might threaten their position. Few top managers in Japan have stock options or employment contracts offering golden-parachute protection if their companies are sold. Housing, cars, club memberships, and vacation facilities—the source of much personal self-esteem and standing in the Japanese business community—can all disappear along with the job. What is more, because a labor market for senior executives barely exists, Japanese business executives have little opportunity to launch new corporate careers.

To counter opposition from these threatened executives, a foreign suitor must address their specific personal needs. One approach might be to guarantee that the executives will be retained after the deal is consummated or to offer them consulting and advisory positions in the newly merged entity. Attractive retirement packages—two years’ severance pay for early retirement, for example—can be useful.

Many Japanese companies still operate with bloated sales, R&D, and administrative staffs as well as excess manufacturing capacity

Second-tier managers, though often overlooked by global companies pursuing mergers, must also be won over. These managers, who might run manufacturing facilities or sales functions, fear the impact a merger might have on their jobs, their personal power, and the people in their organizations. Since many Japanese companies have not yet restructured and still operate with bloated sales, R&D, and administrative staffs, as well as excess manufacturing capacity, the managers of these areas in particular feel threatened by any proposal that involves cost cuts.

To help put these managers (who may be board members) at ease, a foreign suitor would be well advised to solicit their input and then directly address the issues that concern them most. To persuade them to accept a deal, it might be necessary to define what will happen to specific manufacturing or R&D facilities or functions, to draw up global forecasts for product sales or development plans for new businesses, and to estimate the timing and magnitude of job cuts.

Telling reluctant managers a compelling story is important here. The suitor might talk about new competitive advantages or business opportunities that the managers could use to explain their position to family, friends, and employees. Taking this approach doesn’t mean that cutting jobs and costs will be impossible—only that the rationale for doing so must be explained in the context of a larger and more attractive goal.

Of course, the more distressed an acquired company may be, the more latitude a buyer has in proposing terms. One good example is the recent restructuring of Japan’s Long-Term Credit Bank (LTCB), a distressed institution that was nationalized by the Japanese government and then sold to the US-based private equity firm Ripplewood.¹ As a condition for acquiring the bank, Ripplewood negotiated a put option that allowed LTCB (renamed Shinsei Bank) to sell back to the government any loans that had lost 20 percent of their value. The power of this option became clear in July 2000, when Shinsei sold the government roughly $2 billion worth of loans to the department store chain Sogo Ltd. This action triggered a chain of events that forced Sogo to file for court protection from its creditors two weeks later. But all was not smooth for Ripplewood, which was accused by angry Opposition politicians of getting a good deal at the expense of Japanese taxpayers.

What suitors must do

For some global companies, the obstacles to a deal rule out the possibility altogether. But other companies have overcome the barriers and concluded mergers successfully.

Invariably, such companies rely on a specialized, experienced M&A team to make the deal a reality. This team usually includes a senior executive who is a Japanese national as well as a skilled finance or new-business executive. Support comes from full-time consultants, advisers, analysts, and—vitally—from the most senior level of management. A typical team will remain in place for up to a year, as in the cases of the Renault-Nissan deal and the global beverage company mentioned previously. The team’s task is to analyze opportunities for deals, to build relationships with executives in potential target companies, and to communicate the foreign suitor’s strategy and long-term commitment to Japan. Above all, the team must make the deal attractive to key executives and to the board and show creativity and flexibility in seeking mutually acceptable solutions.

A carefully crafted communications plan covering "whom to see when," how to describe the benefits of the merger, and ways of keeping the board fully up-to-date on important issues must be developed. In addition, all details specifying exactly how value will be enhanced by the merger are best negotiated before the memorandum of understanding so that no surprises pop up to derail the agreement. Indeed, a consensus on the details of postmerger integration and restructuring is almost always required before a deal can be closed.

Although these practices would be recommended anywhere in the world, in Japan agreement will not be reached without them. But buyers with the patience to craft a deal so painstakingly are likely to find that it works to their advantage because the leaders of the acquired company will feel committed to making the partnership work.