Blackstone May Not Be So Lucky Next Time

Blackstone Group Inc. got lucky in Japan. It may not have the same outcome this time, and that’s a lesson for private-equity houses circling the country.

Last year, the U.S. buyout giant lost out to Lone Star Group in a high-profile, take-private battle for Japanese real-estate developer and hotel operator Unizo Holdings Co. The company is now on the brink, reeling from the impact of Covid-19. The investors who beat out Blackstone are dealing with the aftermath.

Hong Kong-based hedge fund Asia Research and Capital Management Ltd., an investor in Unizo’s bonds, is getting ready to file a petition for bankruptcy and believes the Japanese company is insolvent, according to Moody’s Investors Service. The hotel operator had to sell assets last year to pay interest and dividends to Lone Star. Regional banks are now sitting on 147 billion yen ($1.34 billion) of unsecured loans to the Japanese real estate developer — that's about 18% of their 2019 pretax income.

For Blackstone, it seems like a moment to breathe a sigh of relief. However, last month, seemingly unfazed by Unizo’s fate, the U.S. buyout firm went in again and picked up a package of eight hotels from Japan’s Kintetsu Group Holdings Co., a railway operator. The company will continue to run the properties, which have a book value of 42 billion yen.

Deals have to go on, no doubt. With record levels of dry powder sitting around, someone’s got to deploy money. Here’s the thing, though: Exit deal values were down 24% last year because managers were waiting to ride out the pandemic before selling. In Japan, they fell 58%, according to Bain & Co. 

This would seem like the right time to reassess how Japan’s low valuations relative to the rest of the world stack up against the many unknown risks that the pandemic continues to throw up for businesses and investors. As I’ve written before, the conditions may have looked ripe for the picking but exiting at an opportune time, with justifiable internal rates of return, is proving much harder than anticipated. 

The small and medium-size firms that private-equity investors love are clearly struggling. As Covid-19 has dragged on, such companies – large contributors to employment and productivity growth in Japan – have been hit hard as their assets shrink. They’ve been propped up by the government and lenders. Direct public transfers to companies were worth around 13.5 trillion yen, or 2.5% of gross domestic product in the fiscal year ended March, Capital Economics notes. Tax deferrals have added to the support.

It isn’t clear how these firms will emerge as the helping hand is withdrawn over the course of this year. Larger companies have held up slightly better but with much higher levels of debt.

Investment decisions are being premised on the optimism that the pandemic will abate and vaccinations will pick up. That's a flimsy baseline. Let’s be honest, no one really knows anything about timing at this point.

Just look at where we are: Japan is near a record number of cases with severe symptoms and many prefectures are under a second state of emergency. Meanwhile, vaccination rates are low and the country has only used a fifth of the doses it has imported. Like other countries, it is well behind its inoculation plans. Harder still is the practicality of doing all the on-the-ground diligence on target companies to understand why they’re undervalued or downright cheap. Those are factors private-equity managers cannot control or quantify. At this point, pricing in a recovery becomes more art than science.

As Japan Inc. grapples with holding its businesses together, it’s worth wondering how much private equity-backed governance reform and restructuring they’ll be open to. For now, companies are just trying to preserve value. Focusing on performance targets, long-term growth and value-creation aren’t really top-of-mind.

Blackstone and other private-equity houses continue to eye Japan, ready to swoop in. But buying assets is only half the equation, as Unizo’s investors have found. Running these businesses successfully and making timely exits is what drives returns. That’s a lot tougher than it looks.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia. She previously worked for the Wall Street Journal.

©2021 Bloomberg L.P.

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