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Japan: Climbing On The M&A Train


Two months ago most Japanese had never heard of Lehman Brothers Inc. (LEH) Despite a presence in Tokyo dating from the early 1970s, the white-shoe investment bank had kept a low profile, with no history as a retail brokerage and only a few big mergers and acquisitions to its name. Not anymore. For the past few weeks, Lehman has been persistently in the headlines, although not in the way its public-relations staff would prefer.

What Lehman has done is finance an upstart entrepreneur's attempt to take over a major broadcaster through a backdoor maneuver in after-hours trading -- and there has been hell to pay ever since. Why? Because Lehman's involvement taps into deep-seated Japanese fears about foreigners buying out blue-chip companies. After taking a pounding from politicians and the local press, Lehman has denied it has any interest in owning a Japanese media outlet. But Lehman doesn't deny that it, like other Western investment banks, sees a lot of opportunity for dealmaking in Corporate Japan.

The main character in this business drama is 32-year-old Takafumi Horie, the flamboyant, Ferrari-driving head of an Internet conglomerate, Livedoor Co., that has been buying up small Japanese companies right and left. In early January, Horie set his sights on Nippon Broadcasting System Inc. (NBS), a Japanese radio broadcaster that owned a 14% stake in Fuji Television Network Inc., Japan's largest TV broadcaster. Fuji also owns a big stake in NBS, and the two had plans to merge. In after-hours trading before the stock market opened on Feb. 8, Horie raised his stake of NBS from less than 5% to 35%, tapping a $550 million credit line from Sunrise Finance, a lender affiliated with Lehman.

Later the same day, Livedoor announced the share purchase and said it would also issue $750 million in five-year, zero-coupon convertible bonds to Lehman Brothers Commercial Asia Corp. to pay back the Sunrise loan and finance its M&A activities. The transaction at one point could have given Lehman a 44% stake in Livedoor if it had converted all of the bonds into stock at the lowest possible share price. In fact, Lehman says it is gradually converting the bonds to stock and owning no more than a tiny stake in Livedoor. What's more, Lehman notes that this wasn't the first time it had provided a Japanese company with finance by buying convertible bonds. "This deal would be normal business in most countries," says C.J. Wilson, founder of Global Alliance Ltd., a Tokyo finance firm. "Horie made the rounds, and Lehman jumped at it."

But when the full extent of Lehman's involvement as Horie's mystery backer through Sunrise was disclosed in mid-February, a chorus of protest erupted from conservative politicians and commentators. They alleged that the U.S. bank, by bankrolling Horie's bid, was trying to muscle into Japan's media sector through the back door. The aftershocks of the row are still reverberating around Tokyo. Although Horie won't confirm it, many believe his real takeover target was Fuji television, and several Japanese celebrities have said they won't appear on NBS if Livedoor is involved. In Japan's Parliament, irate politicians have succeeded in delaying until 2007 a proposed set of new rules that would enable foreign companies to buy Japanese firms using their own stock. Horie now controls 50% of NBS, but it's unclear where that will get him because NBS, in a move to thwart Livedoor, loaned its entire stake in Fuji to Softbank Finance Corp. for five years on Mar. 24.

Despite the Fuji mess, Lehman has been bolstering its operations in Japan, and other outside investment banks, including Goldman Sachs (GS), Morgan Stanley (MWD), and Merrill Lynch (MER), have been doing the same. Lehman, in fact, has made Tokyo its Asian headquarters and has increased the headcount in its Japan office to over 800. That's up 50% in the past five years and up 20% just since last year. "The media have talked a lot about Lehman Brothers' role, but this is just a temporary issue," says Masaaki Kanno, chief economist at JP Morgan Securities (JPM) in Tokyo. "It won't be a big drag for the foreign firms with operations in Japan."

The lure of Japan is clear. Deregulation and reform, combined with an improving national economy, mean that opportunities for dealmaking have increased. And now that many companies have emerged from painful restructuring, they're in a far stronger position to make acquisitions. "It started with group restructuring, but M&A is now seen as a way to expand," says Jiro Nakano, an M&A research analyst in the investment banking group at Nomura Securities in Tokyo.

Lehman is in the process of expanding its strong Japan M&A team by one-third, having lured Masaru Shibata as head of M&A from Goldman, Sachs & Co. in October. That should prove a big asset, since Goldman has become the top-ranked foreign M&A adviser in Japan, and No. 2 overall. Lehman's goal is to become a top three player in Japan M&A. Last year it ranked eighth, according to Thomson Financial (TOC).

Some observers see the Fuji-Livedoor fight over NBS as a sign that Japan M&A is finally opening up, since in the past the country has seen few such hostile bids and takeover defenses play out to their logical conclusion. "This deal is a sign that Japan's capital markets are maturing," says Takeshi Tajima, an analyst at BNP Paribas in Tokyo.

LOOSENING UP

There are also signs that Japanese Prime Minster Junichiro Koizumi's government isn't about to cave in to the critics of hostile M&A activity. Although the decision to let foreigners use stock in M&A deals will be delayed until 2007, Koizumi's proposed revision in the corporate law, approved by the Cabinet on Mar. 18, is expected to go through. The bill will legitimize various other new M&A measures, such as lower thresholds for permitting mergers without formal shareholder approval. "Behind the noise and the fury, there's genuine progress under way in Japan," says Robert Feldman, head of research at Morgan Stanley in Tokyo.

Japan's courts also appear unwilling to erect barriers to coddle the Old Guard. On Mar. 23, the Tokyo High Court upheld a lower court decision two weeks earlier preventing NBS from issuing equity warrants to Fuji. The move would have watered down Livedoor's stake in NBS, thus derailing its takeover bid. The court ruled that such a move wouldn't be in the interests of shareholders -- an argument not heard too often in the past.

Of course, as the reaction to Lehman's involvement with Livedoor shows, foreign finance firms in Japan are not much loved. What's more, structural barriers such as a lack of independent boards mean Japan isn't going to resemble other markets overnight -- despite the government's commitment to reform. Nevertheless, for deals like this to happen at all shows that Japan is changing. "The direction is set -- the trend toward opening Japan's capital markets for foreigners remains unchanged," says JP Morgan's Kanno. Maybe, when it's time for the next deal, Lehman won't be tarred as a meddlesome gaijin.

By Ian Rowley, with Hiroko Tashiro, in Tokyo


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