Formerly a popular destination for large buyout deals in Asia, Japan was the focus of an anticipated PE revival with the onset of Abenomics.

But though the right elements are in place – liquid markets, availability of deal leveraging and attractive PE exits – limited partners (LPs) have become circumspect and adopted a wait-and-see stance.

For its third Japan-focused buyout fund, Carlyle Group targets a peer-beating ¥100 billion, half of what some investors had been expecting. The predecessor Fund II closed at ¥165.6 billion in 2006. And Unison Capital’s fourth mid-market PE fund’s target of ¥60 billion is the second largest, but much lower than Unison Capital Partners III’s ¥140 billion target.

The market is populated by 10 Japan-focused PE funds, which raised a collective $3.7 billion, according to data provider Preqin.

Lagging indicator
While investor interest in Japan PE has picked up over the past year, “small, local PE firms are struggling to raise funds”, says Satoshi Sekine, Japan private equity leader at EY.  

Deal volume has trailed behind China, the US and Europe, notes Joseph Chang, head of the Hong Kong office at SCM Strategic Capital Management, a Swiss-based institutional investment adviser.

Company valuations could be a factor. Because private businesses are valued against a benchmark of publicly listed peers, and the yen fell 21% against the dollar in 2013, while the Nikkei 225 rose 57%, deal valuations are more pricey, says Chang.

On the other hand, higher company valuations resulted in a few highly priced PE exits last year. “Close to $6 billion of exit proceeds went back to limited partners last year, which was second only to China in the Asia region,” says Chang.

However, until institutions grow more confident in the potential value and volume of Japan’s PE deals, they will be more inclined to gain exposure to the market through regional funds, which are able to deploy capital elsewhere, says Sekine.

Institutions are also wary because of varied returns as some private equity firms paid high prices for Japanese companies before the financial crisis.

For example, as of September 2013, Carlyle Japan Partners I had a net internal rate of return of 34%, but Fund II’s net IRR was -4.1%, according to CalPERS data.

Deals on the horizon
Despite LP concerns on the longer-term prospects of Japan’s PE market, there are some bright spots.

Domestic banks have been keen to provide PE deal leveraging, which provides PE firms with relatively cheap financing, says Chang.

KKR’s $2.8 billion buyout of Panasonic Healthcare last year was reportedly backed by $1.3 billion in financing from Mizuho Bank and Sumitomo Mitsui Banking Corporation.

Sekine says more Japanese company owners understand what PE firms can offer, “such as overseas expansion, governance and the creation of jobs”.

Attractive deals are therefore expected to materialise in the coming years.

*The full-length version of this article appears in the May edition of AsianInvestor magazine.