An Economy Only a Dealmaker Could Love

Suddenly, Japan is the hot spot for mergers and acquisitions

For merger-and-acquisition specialists across the globe, 2002 was the annus horribilis they'd rather forget. The value of global deals shrank 27% from a year earlier, and thousands of investment bankers found themselves out of work. But one country bucked the trend. Surprisingly, that was Japan, where new deals soared 25%. Suddenly, the developed world's biggest economic basket case looks like the one bright spot on the horizon for mergers, acquisitions, and restructurings. True, the dollar amount of deals fell from $35 billion to $28.5 billion. But more important is that Japan is increasingly using restructuring to try to work through its problems.

That has investment bankers excited. Just ask Takeo Sumino, head of the global merchant banking and investment banking strategic planning departments at Nomura Securities. The dealmaker moved back to his native Japan in 2002 after 12 years in London. What he found was a massive opportunity. "Everyone knows Japan has 500,000 construction companies," quips Sumino--and far too many hotels, banks, auto-parts makers, and more. After a very slow start, the consolidation movement has picked up speed, in part because the government has been bearing down on banks, which in turn have shut off lending. Now, Japan Inc. has its back to the wall, and restructuring must accelerate. Sumino predicts deal flow--already up from 225 transactions in 1997 to 1,881 in 2002--could jump an additional 50% this year. "The need for industry consolidation," Sumino says, "is huge."

Both domestic and foreign outfits are taking advantage of the opportunities. In one recent deal, Ripplewood Holdings, the American private-equity firm that already owns Shinsei Bank and other properties, is backing a group in talks to buy the country's No. 3 fixed-line phone operator, Japan Telecom Holdings Co., from British cell-phone giant Vodafone Group PLC (VOD ). The deal, which excludes Japan Telecom's mobile-phone business, could top $2.5 billion, making it one of Japan's biggest foreign buyouts.

Last year's headline-grabbing cross-border deal came when Wal-Mart Stores Inc. (WMT ) bought a 37% stake in ailing supermarket retailer Seiyu Ltd. for $470 million. Seiyu also sold off its finance subsidiary to U.S. workout firm Lone Star (LSS ). The real action, however, came in the steady stream of local mergers, such as the $2.26 billion shotgun marriage of Sumitomo Construction Co. and Mitsui Construction Co. These domestic deals are essential to any solution of Japan's overcapacity problem.

This year, things could really heat up. Prime Minister Junichiro Koizumi has staked his political career on forcing the banks to speed up their write-offs of dud loans and on strong-arming weak corporate borrowers into selling off money-losing units. Thus some of the biggest deals so far are aimed at recapitalizing Japan's rickety money-center banks, which the government has targeted for cleanup. In December, Merrill Lynch & Co. (MER ) moved to create an $800 million debt-reducing joint venture with banking conglomerate UFJ Group. Hot on Merrill's heels was Goldman, Sachs & Co. (GS ), which bought $1.2 billion in preferred shares from Sumitomo Mitsui Financial Group Inc., for a 7% stake. Goldman will get a fat 4.5% dividend on those shares--and the Japanese bank will guarantee some $2.1 billion worth of loans that Goldman makes to blue-chip investment banking clients around the world. "It would be silly to say there is no risk involved," says a Goldman spokesman. But the firm concluded this was "the right time" to make a big bet on a Japanese bank.

Japanese investment banks are profiting, too. The top three banks in deal rankings for last year were Nomura, with $16 billion in deals, Daiwa Securities SMBC with $7.7 billion, and Mizuho Financial Group with $6.8 billion, according to Thompson Financial. Many of the deals in the works involve the overcrowded construction industry. In January, general contractor Hazama Corp. announced plans to merge with rivals Toa Corp. and Ando Corp. And the betting is that something will be done to bail out construction outfit Kumagai Gumi Co., which is groaning under some $4.3 billion worth of debt.

How long will the merger boom last? Given the overcapacity in construction and retailing, fragmented and inefficient sectors such as hotels and banks, and the sick balance sheets of a big chunk of Corporate Japan, it could roar ahead for five years or more. Japan is still a slowpoke economy, but for dealmakers, it's the hottest game going.

By Brian Bremner in Tokyo

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