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Japan has witnessed keen growth in 2023, and the year ahead looks as bright as ever for investors, especially with a stable market, favourable policy conditions, and weaker yen, writes Freny Patel.

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apan will continue to be a hotbed for investors in 2024. Although investment growth may not be as high as in 2023, there will still be strong demand for mergers and acquisitions, private equity, and real estate, say experts.

Japan has garnered significant investment interest due to its unique set of qualities that differentiate it from other global economies. The distinguishing factors include its stable political system, advanced technological infrastructure, highly skilled workforce, and strong commitment to innovation. These characteristics have made Japan a preferred destination for investors seeking long-term opportunities that offer stability, growth and profitability.

Further, Japan’s strategic location in the Asia-Pacific region provides access to a vast and diverse market, home to some of the world’s fastest-growing economies. The nation thus presents an attractive proposition for investors seeking to diversify their portfolios and tap into the region’s vast potential.

“The two biggest reasons driving investor interest are the weakened yen that is encouraging offshore investors to buy Japanese assets at a significant discount and the marginal cost of debt supported by Bank of Japan’s ultra-low interest rate policy, which can provide positive leveraged yield on all investments,” says Koji Naito, research director, capital markets, Japan at JLL. He adds it is a phenomenon that can be seen only in Japan at this moment.

The weakening yen compared to major currencies like the Euro and the US dollar has made Japanese assets more attractive to foreign investors, Michael Mroczek, president of the European Business Council in Japan and foreign law partner at Nozomi Sogo, agrees.

“Foreigners can invest in Japan with a view that they can get returns not only from the actual business but also from future changes in forex rates,” says Kengo Nishigaki, founder and partner at GI&T Law Office. The Japanese yen is weak against almost all global currencies and currently trading at 144 to the US dollar.

From a legal perspective, Takeshi Iitani, partner at southgate, identifies three government policies that have had a positive impact on investment in Japan. First, the Ministry of Economy, Trade and Industry (METI) has encouraged Japanese companies to carve out M&A transactions to reorganise their business portfolios and to attract investment from foreign investors for innovation and economic growth, he points out.

“The Tokyo Stock Exchange has been urging TSE-listed companies to enhance their capital efficiency and improve ROE [return on equity] or PBR [price to book ratio]. These moves have provided more investment opportunities for foreign investors,” Iitani says.

Lastly, though, Japan like many other countries, has tightened its regulations on inbound investments, “they are much less onerous, in our view, than those of other leading economies, especially CFIUS in the US”, says Iitani.Jacky Scanlan

Jacky Scanlan-Dyas, a Hogan Lovells partner, corporate & finance and regional lead for corporate in Japan, cites Japan Prime Minister Fumio Kishida’s “new capitalism” initiative of June 2023, aimed at establishing a more concrete strategy to increase wages, improve productivity, and improve growth.

The covid-19 pandemic equally had a role to play in boosting Japan’s investment climate, Mroczek points out. “During the pandemic, Japan’s stringent border controls significantly limited foreign business travel, [thereby] indirectly fostering a conducive environment for domestic business consolidation and foreign investment via remote channels,” he explains.

Further, Japan’s stability from a geopolitical perspective means that investors do not have to apply a high discount rate, Nishigaki points out. “Japan’s high ethical and compliant culture also means that investors can safely invest in the country trusting its financial records,” he adds.

The increase in geopolitical risks – in particular, the tension between the US and China, two of the most prominent trading partners – has a significant effect on Japanese companies, says Nishimura & Asahi’s managing partner, Ryutaro Nakayama.

Ryutaro NakayamaMroczek agrees that the geopolitical and economic situations in neighbouring countries have played a role, as investors seek stable and potentially lucrative opportunities within Japan’s relatively stable market.

Driving M&A

Many factors drive M&A in Japan. Its persistent low-interest rate environment is one of the key reasons the country stands out and spearheads the M&A market.

Japan is the only major global market that recorded growth in 2023 and this trend is likely to continue into 2024, Scanlan-Dyas reiterates. “We are continuing to see several carve-out transactions as well as corporate restructurings,” she adds.

According to data released by S&P Global Market Intelligence, Japan witnessed 1,425 M&A deals in the first 11 months of 2023 against a worldwide decline given the prevalence of higher interest rates in most other global markets, resulting in “tepid dealmaking”.

Favourable government policies will further boost the growth momentum in 2024, as potential buyers take advantage of the recently revised M&A guidelines. The new rules – announced by the METI in August this year – allow unsolicited takeover bids and aim to prevent credible hostile offers from being turned down without serious consideration.

The new rules aim to prevent some of the “unfair defence strategies” used by Japanese companies to avoid being taken over and to simplify M&A transactions. These rules expedited Nidec Corp’s unsolicited takeover bid for Takisawa Machine Tool Co in November of this year.

Japanese corporate reorganisations, which often also involve sales of non-core or underperforming businesses, are equally on the rise. Faced with rising material costs, a weakening yen, and labour shortages, many Japanese companies are considering selling their non-core assets or even selling themselves.

Anticipating interest from overseas clients to continue into 2024, Nels Hansen, White & Case Tokyo-based partner corporate/M&A practice group says: “The historical challenge remains that many Japanese companies do not generally seek to sell businesses or assets absent a compelling need to do so. We thus expect that the sectors of interest will be ‘any that are willing to sell’ to overseas investors such as our PE sponsor clients, who can offer the opportunity of a future relisting and management equity and expertise, which may be attractive to Japanese strategy [at companies].”

Japan’s aging and declining population has also prompted companies to consider divestments. Various industries may see an increase in M&A transactions due to this demographic shift.

Scanlan-Dyas says: “The divestiture of non-core businesses and deglobalisation generally is an increasing strategy we are seeing amongst Japanese businesses and, interestingly, also a change in how Japanese businesses operate as they are becoming more comfortable with the culture of selling businesses.” Similarly, succession issues have become more acute in smaller businesses and could prompt M&A deals in the need to find a successor or new management.

There is also the China link. With the geopolitical tensions during the past few years, many Japanese companies have recognised that they may need to consider supply chain risks when it comes to dealing with their largest trading partner, China. Japan may also benefit from other companies pivoting away from China – not necessarily building factories in Japan but maybe relying on its factory automation companies to help them build elsewhere, says Scanlan-Dyas.

Flourishing PE

Along with M&A deals, the private equity (PE) market has also flourished in Japan with a significant increase in interest from both local and international private equity firms.

“Over the past decade, we have observed a shift in the attitude of Japanese companies towards private equity,” says Gavin Raftery, co-managing partner at Baker McKenzie’s Tokyo office. Previously there were very few deals as companies were hesitant and cautious of PE funding.

Gavin RafteryJapanese companies are more open and trusting towards PE funding, which is now recognised as a means to deal with succession problems, where the next generation is unwilling to take over the business, Raftery says. Partnering with PE can be a stable and positive option with most recent exits in Japan having been to other PE funds or strategic buyers, he adds.

“We anticipate increased inbound investment from PE funds, which are exploring regional opportunities outside of China, particularly given the recent changes in policy regarding foreign investors in combination with low interest rates and a favourable USD/yen exchange rate,” says Charlie Wilson, head of M&A and the private equity group in Asia and co-managing partner of Sidley Austin in Singapore.

Raftery agrees that the flourishing PE market has seen a significant rise in interest from local and international PE funds engaged in business deals in Japan. Many new PE players have entered the market, with several announcing their plans to open an office in Tokyo and invest in the Japanese market.

Such investments are not just one-time transactions in Japanese companies; instead, private equity funds are exploring how the domestic market can generate capital, says Raftery.

“Several major private equity firms have recently expanded their investment strategies in Japan … now [they] include real estate and infrastructure as part of their investment strategy for the first time,” he says, expecting more deals in the infrastructure space.

Evergreen

“The technology sector has been and should continue to be one of the primary investment areas for foreign investors,” says Iitani. Japanese technology has long been valued by foreign investors as a means to bolster their technological offerings globally.

“The Japanese population is expected to continue to decrease, thereby dimming the allure of Japan as a market, but acquiring Japanese tech companies can allow foreign investors to expand their business in the global market,” says Iitani.

Raftery, however, feels differently and opines that though 2024 will witness a high level of activity in the digital sector, there might not be as many attractive deals as in the case of other sectors. “Given the limited pool of digital assets in terms of innovation and technology, investment and deal flow in this area will start slowing down as the level of frantic innovation pace settles,” Raftery explains.

Nakayama sees growth in restructuring, renewable energyand sustainability.

Japan’s sustainability goal will further drive investment in 2024.

The government’s push to become carbon neutral by 2050 will provide an impetus for economic growth, says Scanlan-Dyas. “With sustainability initiatives often come innovation, which in turn attracts investments – we expect to see more investment by Japanese companies in overseas companies that are focused in greener areas,” she anticipates.

There has been a rise of transformative M&A in outbound deals as Japanese companies have begun focusing on acquisitions geared towards sustainable growth, points out Scanlan-Dyas.

The energy sector has seen substantial growth and investment interest in Japan, points out Mroczek. “This surge is likely driven by the global push towards renewable energy sources and Japan’s strategic initiatives in diversifying its energy portfolio,” he explains.

Growth in this sector is not only pivotal for Japan’s energy security but also offers lucrative opportunities for investors, given the country’s commitment to sustainable energy solutions and technology advancements in this field. Mroczek says.

Driven by key sectors such as energy and sustainability, Mroczek expects the Japanese legal market to flourish in 2024.

“The increasing complexity of transactions in these sectors, coupled with Japan’s commitment to environmental goals, will require sophisticated legal expertise, thereby boosting demand for legal services,” Mroczek explains.

Scanlan-Dyas agrees. “Almost all the transactions we work on now require some form of regulatory approval … so we work very closely with our regulatory specialists on all our deals,” she says.

There has been an increase in the number of small and mid-sized enterprises filing for bankruptcy as the financial support measures provided to Japanese companies during the pandemic have expired, says Nakayama.

“We are expecting to see more transactions to acquire such distressed assets … [and] more M&A deals involving industry reorganisations, which could consolidate and/or reallocate business resources currently dispersed in the market,” he adds.

Another evergreen sector that will continue to see investment appetite is real estate.

The real estate industry has been thriving for a considerable period and is expected to continue doing so, with the entry of new players in the market, Raftery says.

The hospitality sector is getting close to hitting the peak in terms of deals, opines Raftery given the sizeable activity in the hotel sector during the past 18 months as Japan came out of the pandemic and there has been a huge increase in tourism.

The contribution of real estate is substantial, says Naito, adding that the current active market conditions are expected to continue.

While Japan will remain a hotbed for investors, some sectors may not continue to be as attractive as they were this year.

Outbound thrust

“Outbound M&A is also likely to continue to grow as the US and Europe M&A activity increases and larger Japanese companies seek international growth,” Wilson tells Asia Business Law Journal.

Charlie WilsonJapan witnessed a significant increase in outbound investment, which accounted for the third largest source of capital within Asia in the third quarter of this year, Gordon Marsden, head of Capital Markets, Asia-Pacific, at Cushman & Wakefield, said.

Raftery expects to see an increase in outbound deals as Japan refocuses on opportunities overseas given its aging population. “It’s just a matter of time before this happens, not a question of whether it will happen,” he says. Japan Inc has not invested much in foreign markets during the past few years but may do so once the yen strengthens against the dollar, he adds.

Several Japanese companies recently announced their plans to invest overseas during the next three to five years, and some have adjusted their budgets for overseas M&A deals, Raftery says.

“Historically, European and US markets have been highly attractive for Japanese investors due to their maturity and depth. However, Southeast Asia has been gaining more traction in recent years, especially in areas such as energy transition,” Raftery adds.

What happens around the world could drive some of the outbound investment activity once the outcomes are known, such as the Indonesia and the US presidential elections next year, Raftery adds.

Naito concurs that while offshore investors’ appetite is expected to remain strong, domestic investors are also showing aggressive investment behaviour.

Challenges

Japan is considered a “safe haven” in contrast to challenges faced in other jurisdictions. However, several external factors could pose challenges to the investment climate, including the strengthening of the yen against the US dollar, the implementation of the global tax framework known as “Pillar Two” and an increase in domestic interest rates.

“Japan’s current inflation rate of a little over 2% is still considered healthy, and much lower than inflation rates seen in other countries worldwide,” Raftery says. Nonetheless, any alterations to these external factors could potentially affect deal flows in 2024, he adds.

“M&A deals and private equity funding will require a greater degree of due diligence, as valuations may be impacted by Pillar Two,” Raftery anticipates. Pillar Two, a global tax reform that will introduce a minimum tax rate, will impact companies operating across multiple jurisdictions.

Pillar Two could disincentivise companies setting up operations in such low tax jurisdictions and drive growth in corporate reorganisations, Raftery says. Though Japan has a high tax rate, the Japanese authorities could impose a top-up tax on companies operating in low-tax jurisdictions such as the Cayman Islands, he explains.

This could slow down investment growth in 2024, as it may have a direct impact on cash flows, he adds.

The strengthening of the yen against the dollar could equally reduce the attractiveness of the Japanese market, Raftery says.

“While an increase in interest rates is expected in 2024, it is anticipated to be gradual and minimal, maintaining the attractiveness of investment in Japan,” Mroczek says.

“Any increase in Japan’s interest rates will have a direct impact on the cost of doing deals,” Raftery points out.

Naito tells ABLJ that the central bank has “no reasons to raise interest rates steeply” and that at best they could go up “marginally”.

“Raising interest rates would have far-reaching disruptions on the domestic economy and as a result, there is a consensus that even if interest rates rise in Japan, the rise will be slight compared to neighbouring economies,” Iitani says.

Japan’s interest rate policy has always been a key concern in terms of how sustainable it is given the longer-term impact on its effectiveness and stimulating the economy, says Scanlan-Dyas. She agrees with the consensus that Japan’s gross domestic product will slow down and that the central bank will tighten its monetary policy.

But Scanlan-Dyas ends on a positive note, saying: “While domestic consumption has dropped, the market seems positive that exports will increase and tourism will return to help balance post-covid recovery.”

Mroczek concurs that, in contrast to the predictions of economists regarding the challenges that Japan may face, several factors are likely to sustain and stimulate investment interest in the country in 2024.

“Factors that could spur investment include advancements in digital technology and artificial intelligence, increasing emphasis on sustainable practices across various industries, and Japan’s robust legal and regulatory framework that ensures a secure investment environment,” Mroczek explains.

Investors will need to closely monitor and assess the potential challenges, and take appropriate measures to mitigate any negative impacts on their investment portfolios.

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