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Private Equity Goes Shopping


Japanese retailer The Daiei Inc. () (pronounced "die-ay") just couldn't stop expanding. It started out as a supermarket chain, then moved into credit cards, hotels, and Hawaiian shopping malls. It was also the proud owner of the Fukuoka Daiei Hawks, a winning professional baseball team. As with so many other Japanese companies, Daiei's management in the 1980s and early '90s seemed more interested in being big than being profitable. By 2001 it had accumulated an astonishing $20 billion in debt that it was having trouble servicing, and it became a symbol of Japan's "zombie" companies -- too big, with 96,000 employees in its group, to be allowed to die, but a walking corpse financially. Finally, last December the company was taken over by the state-run Industrial Revitalization Corp.

Daiei has now become a symbol for a new type of Japanese company: the buyout target. An investor consortium led by a Tokyo-based private-equity firm called Advantage Partners Inc., which was founded by two former Bain & Co. consultants, won a hotly contested bidding war in March for a 34% stake in Daiei, paying $564 million, along with an option to buy out the 34% still held by the IRCJ over the next three years. Rejected suitors included such big names as Cargill, Ripplewood Holdings, and Wal-Mart Stores (). And the Daiei deal was just one of dozens being contemplated by Japan's rapidly growing crew of international private-equity specialists. The Carlyle Group is busy in Japan, as is J.P. Morgan Partners () and Warburg Pincus. On Sept. 14, Kohlberg Kravis Roberts & Co. announced plans to open its first office in Tokyo. "There is a continuous trend of transactions becoming bigger and more deals being done," says Tamotsu Adachi, managing director for Carlyle in Japan.

Indeed, mergers, acquisitions, and buyouts have become a crucial part of the restructuring of Japan Inc., as giant conglomerates spin off low-margin units and unwind complex cross-shareholdings. Mergers-and-acquisitions work has been plentiful, with $127.3 billion in deals so far this year, according to Thomson Financial (). Private-equity-led buyouts are up from $1.89 billion five years ago to $8.7 billion last year. And money committed to Japan-focused buyout funds has grown from almost nothing in 1998 to more than $11 billion now. That reflects not only an urgent need for capital among cash-poor firms but also a corporate mindset that now embraces M&A instead of running from it. "There has been a huge macroeconomic shift toward better capital efficiency," says Richard L. Folsom, representative partner of Advantage, which put together the successful Daiei bid. "We see that change as irreversible -- there is no going back."

Case Study

Even so, whipping a laggard like Daiei into shape after years of lax management will not be easy. The transformation it has gone through in the last few years serves as a case study for investors eager to get into the business of corporate restructuring in Japan through private equity.

Daiei was founded in 1957 by charismatic business mogul Isao Nakauchi. In the late 1980s he began pursuing in earnest what turned out to be a misguided diversification drive. Within 10 years, Daiei's core grocery business had seriously deteriorated. Consumers abandoned the company's supermarkets for newer chains with a fresher look. Deflation and sluggish consumer spending delivered knockout blows. Once Japan's top superstore operator, Daiei fell to a distant No. 3 after the profitable Aeon Co. and Ito-Yokado Co. Yet local communities pressured Daiei to keep money-losing stores open -- and the company's banks, facing billions in losses, were reluctant to cut off its credit line.

Instead, the banks pushed Daiei to sell off subsidiaries it had acquired over the years. And that was a bonanza for post-bubble investors. Carlyle bought Daiei's in-house security company, Asahi Security Co., in 2002 and resold it to Toyota Industries Corp. earlier this year. Goldman Sachs Group Inc. () picked up four Daiei-owned hotels in 2003, while Morgan Stanley () grabbed another. That same year, Colony Capital bought a Daiei domed sports stadium and hotel complex. And Softbank Corp. took over the baseball team last year, ending the era of the Daiei Hawks -- now renamed the Fukuoka Softbank Hawks. Daiei's Ala Moana shopping center in Honolulu fetched $810 million from Chicago-based General Growth Properties Inc. ().

Now it's up to Advantage Partners to save the rest. The job is daunting. For the business year ended in February, Daiei posted a net loss of $4.65 billion on a 8% drop in sales to $16.4 billion. But Advantage's Folsom considers his investment a sure bet because of Daiei's prized store locations in central Osaka and Tokyo. "We see it as a unique opportunity," he says. Advantage bought a 24% stake, and Japanese trading house Marubeni Corp. () took another 10%.

When the Advantage-led group arrived in March, its first order of business was kicking out the remainder of Daiei's old board. (Nakauchi was dethroned in 2001.) It then hand-picked a management team headed by Yasuyuki Higuchi, 47, who had been president of Hewlett-Packard Co.'s () business in Japan. Fumiko Hayashi, a former president of BMW Tokyo Corp., serves as chairman, while a number of top officials at Advantage and Marubeni took other top positions. As part of the deal, Daiei's main banks agreed to waive about $3.64 billion in debt.

The tough love is about to begin. Under a restructuring plan hammered out with the IRCJ, Daiei will close 53 of its 263 stores -- mostly those outside city centers -- and slash at least 2,000 jobs. That will be a shock to rural communities that rely on Daiei as a central hub and employer. But the days of putting social responsibility ahead of shareholder interests are over. "Our No. 1 job is reviving Daiei," says Higuchi. "We realize that won't be welcomed by communities that lose Daiei stores."

Fresh Approach

Through write-offs and sell-offs, Daiei's debt load has been reduced to $5.0 billion. And it posted a first-quarter operating profit of $87 million. Morgan Stanley analyst Michinori Shimizu, however, says credit-card unit Daiei OMC Inc., not core operations, is the reason for the positive news.

The key to revitalizing Daiei is luring back customers, so Higuchi is busy upgrading stores and streamlining distribution channels. And he is emphasizing quality over low prices. "We need to be more of a Whole Foods () than a Wal-Mart," he says.

Daiei's revival is not a short term project. But investors seem to like what they see: Daiei stock is up 42% just in the past month. Meanwhile, Advantage's competitors are combing Japan for new deals. After all, corporate profits are rising, the stock market is at a five-year high and, after recent elections, the government is more committed to reform than ever. For dealmakers, there has never been a better time to invest in Japan.

By Chester Dawson, with Kenji Hall, in Tokyo


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