The Rebound in Japanese M&A Volume in 2021

Since the outbreak of COVID-19 in late 2019, M&A activities across the globe have been affected. Nevertheless, 2021 saw a rebound in M&A volume in Japan. Statistics show that 4,000 M&A transactions took place in Japan, with an aggregate deal value exceeding USD140 billion. However, the figures on deal volume and value do not reveal the intricacies and multi-faceted trends underlying M&A activity in Japan. As will be explained below, the statistics of 2021 indicate a continuation of the trends underlying M&A activity in Japan in recent years.

There has been a recent trend among Japanese conglomerates of divesting their non-core businesses and exiting non-essential business sectors that are no longer in line with their future business strategies, and this has continued throughout the pandemic. Such divestments have provided the catalyst for the sustained level of activity among private equity (PE) funds as they continue to seek investment opportunities among traditional Japanese companies. At the same time, many Japanese conglomerates are in the process of restructuring their businesses by venturing into complementary business sectors or acquiring new technologies to achieve the digital transformation that has proven so crucial in these uncertain times. In particular, the pandemic has provided several Japanese conglomerates with the impetus to sell their non-core subsidiaries on the one hand, and on the other hand to consolidate their businesses by delisting core subsidiaries to make them wholly-owned or by acquiring companies with complementary businesses or new technologies.

A representative example of the above-described trends is the series of carve-out transactions undertaken recently by Hitachi, Ltd., a traditional Japanese manufacturer of electrical equipment. In addition to its other acquisitions in 2021, Hitachi acquired GlobalLogic Inc. in a deal valued at USD8.9 billion. The acquisition was intended to expand Hitachi's digital solutions business and promote its social innovation through digital technology, and is expected to accelerate the digital transformation of Hitachi's social infrastructure on a global scale.

At the same time, Hitachi has been consistently divesting its non-core businesses in recent years. These businesses have mainly been sold to large private equity (PE) funds. For example, it was announced earlier this year that Hitachi had sold its shares in Hitachi Construction Machinery Co. Ltd, a manufacturer of construction machinery, to a consortium led by Japan Industrial Partners Inc., a Japan private equity firm, and Itochu Corp, a global general trading firm.

Industry-watchers view these series of carve-out transactions by Hitachi to let go of non-core businesses as part of a corporate restructuring and major shift in business strategy.

Businesses in Japan and elsewhere are expected to continue adopting a cautious approach to M&A due to continuing uncertainties resulting from the pandemic and the possible emergence of new variants of COVID-19. Nevertheless, the rising trend of global PE investments in Japan is expected to continue in 2022, fostered by the significant volume of divestitures by Japanese conglomerates and the investment opportunities they create. Japanese conglomerates are also expected to continue their pursuit of renewal through acquisitions at home and abroad, while assessing the need to relinquish non-core businesses.

One of the most significant global economic trends in recent years is the sharpening focus on environmental, social and governance (ESG) issues in the conduct of business. Across the globe, governments have been steadily introducing regulatory initiatives to address ESG concerns. These initiatives include, for example, the European Commission's proposal for a Corporate Sustainability Reporting Directive (CSRD). The high-profile ESG-related shareholder activism involving ExxonMobil is emblematic of increasing shareholder interest in ESG issues. Conforming to this global tide, the Financial Services Agency of Japan and the Japan Exchange Group are also proposing mandatory ESG disclosures by companies in Japan, particularly listed companies. In line with these developments, a growing number of investors are factoring ESG issues into M&A transactions, by assessing the potential ESG-related synergies on offer and evaluating the potential of ESG-conformant practices to unlock medium-to-long-term corporate value.

There have been important Japanese M&A transactions where ESG-related issues, such as sustainability, have been major considerations. It should be noted, however, that the development of ESG investing in the Japanese market is progressing on a bottom-up basis.

More specifically, unlike in certain jurisdictions where ESG considerations are mandated by laws and regulations, thereby entailing the conduct of due diligence that specifically target ESG compliance (in addition to other compliance matters) in M&A transactions, no ESG-specific law has been passed in Japan thus far. As a result, ESG-specific contractual protections (such as ESG-related representations and warranties, indemnities, covenants and/or closing conditions) are rarely seen in Japanese M&A documentation. With that said, foreign institutional investors - particularly global PE funds with highly-developed global compliance programmes and policies that place importance on the impact of ESG on the medium-to-long-term value of a business - sometimes conduct ESG-focused due diligence in the course of acquiring Japanese targets. Occasionally, such investors also insist on ESG-specific contractual terms. Such grassroots movements are now taking the lead in the development of ESG-focused M&A practices in Japan.

Consistent with this trend, Japanese target companies are increasingly subject to comprehensive and detailed ESG-related scrutiny from potential buyers at a level comparable to the M&A practices in the USA and certain European jurisdictions. As global PE funds are expected to remain active in the Japanese M&A market for the foreseeable future, it is anticipated that Japanese companies will pay increasing attention to ESG issues to attract better offers from potential buyers and investors.

In view of the uptrend in the level of inbound investments into Japan, more and more Japanese companies can be expected to develop or accelerate their ESG initiatives and strategies to augment their medium-to-long-term corporate values, not only in conformance with global regulatory trends, but also to broaden their investor base and open the door to more M&A opportunities. This, in turn, would further enhance the ESG imperative in Japanese M&A practice.