Private equity houses target Japan as Covid shadow extends

By late evening on Monday, the first day of Japan’s long-awaited vaccine rollout for the elderly, the nation had inoculated just 1,139 people over the age of 65 who were not involved in healthcare.

To optimists, that extremely low vaccination rate is the foothill of a programme that, while belated, will soar to majestic heights of speed and efficiency in coming months. To sceptics, it evinces a serious failure of willpower and execution. To global private equity funds, particularly those interested in property deals, it represents potential opportunity.

For obvious reasons no one is keen to state it out loud, but the economic effects of the Covid-19 pandemic are starting to work out very favourably for private equity in Japan. Last month, Blackstone paid $550m for eight hotels owned by the Osaka-based Kintetsu railway group in a sale that might otherwise have taken years to emerge. 

The logic may feel contorted, says the senior executive of another fund, but the longer it takes the world’s third-biggest economy to bounce back to something close to normal, the faster will be the flood of deals for which the largest funds globally have long been camped-out in expectation.

Their need to do deals, the executive adds, is becoming more pressing. According to Bain & Co, private equity collectively held a record $477bn “dry powder” of unspent capital focused on the Asia-Pacific region at the end of 2020. “We need to use it, and in the Asian region, Covid is making Japan look like the best prospect out there,” the private equity executive adds.

The argument that the opportunities for deals will rise centres on the impact of the pandemic on industries such as rail transport and the way that the Japanese banking sector is likely to respond.

Last year, in the initial phase of coronavirus, the banks were encouraged by the government to be generous lenders to a corporate world in shock. These were top-down pressures that seemed entirely appropriate to the crisis in hand but also assumed it would take about a year for Japan and the world to be entering a post-pandemic state. The problem, a year later, is that any such assumption remains premature.

The issue, say analysts, is how rapidly the banks toughen their stance as the emergency generosity they were called upon to provide becomes a more permanent need. The banks were not particularly happy companies even before Covid-19 struck. Their profitability took a significant hit in 2016 when the Bank of Japan introduced a negative interest rate policy. Their subsequent chase for alternative sources of revenues has had to become increasingly inventive or, in the case of the kind of financing that MUFG and Mizuho provided to the collapsed Archegos Capital Management, more risky.

But Covid has dealt a heavy blow to the models of domestic businesses that never for a moment felt risky to the banks — railway companies with rock-solid cash flow supplied by millions of commuters and by the retailers and hotels that leased the space in the giant real estate portfolios they own around the country’s stations.

For years, investors have eyed these large property portfolios and decided that in many instances they could be managed far more effectively and profitably than by their current owners. Private equity has made that same case to many of Japan’s private rail companies, a group that comprises 16 major operators, and more than 50 regional groups, but until now, few have been under particular pressure to sell.

Over the next few weeks, says Jefferies analyst Hideyasu Ban, Japanese banks will start to make their presentations for the new financial year and those will include potential reclassification of loans according to sector. They might reflect the fact that Covid-19 continues to maul commuter rail traffic and the associated businesses beyond what the banks had bargained for.

Private equity houses believe that increasingly nervous Japanese banks are about to get tougher with these companies and call on them to look for ways to recapitalise. The easiest way for this to happen, as Blackstone’s recent deal shows, is to sell off the property portfolio to a group of buyers circling precisely this opportunity.

The code to look out for in coming months, says Ban, is Japanese banks talking about increasing their emphasis on “financial consultancy” services to corporate clients. These are the routes through which the banks will raise pressure on companies to restructure with asset sales.

leo.lewis@ft.com