Going-Private Transactions of Listed Subsidiaries are Driving M&A Activity in Japan

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Summary

• M&A activity is picking up in Japan in 2020.
• The increase in deal value of M&A in Japan has been driven largely by going-private transactions of listed subsidiaries.
• Unlike Europe and the United States, there are many parent-subsidiary listings in Japan.
• Institutional investors have questioned the independence of such listed subsidiaries from a corporate governance point of view.
• Potential issues in going-private transactions of listed subsidiaries include structural conflicts of interest and information asymmetries that are harmful to minority shareholders in the listed subsidiary.
• While Japanese market practice has improved significantly in addressing structural conflicts of interest and information asymmetries, minority shareholders will need to examine carefully the measures taken in any particular transaction.

The COVID-19 pandemic has negatively impacted M&A activity around the world. However, in Japan, M&A activity is on the rise in the second half of 2020, after slumping in Q2. Total M&A deal value has increased remarkably. Total M&A value in Q1-Q3 of 2020 has reached US$212bn, compared to US$136bn for the same period in 2019, an increase of 56%. Deal volume also increased, with 3,035 transactions, a 12% increase from 2,706 transactions for the same period in 2019.[1]

This increase in deal value has been largely driven by going-private transactions of listed subsidiaries— acquisitions or divestments of listed subsidiaries by their parent companies. Such transactions account for one third or more of total deal value of all transactions in Japan for 2020 YTD. In the largest deal for 2020 so far, telecoms giant Nippon Telegraph and Telephone Corporation (NTT) announced plans of a tender offer to acquire all shares it does not own in mobile carrier NTT Docomo for about USD 40.3bn. More generally, the telecom sector may gain momentum in terms of deal flow as newly appointed Prime Minister Suga has reaffirmed former Prime Minister Abe’s pledge to reduce mobile telephone fees.

Hitachi has announced both an acquisition and a divestment of a listed subsidiary this year. For its acquisition of Hitachi High-Tech Corporation, Hitachi wants to merge the businesses together to enhance its Internet of Things platform. Sony Corporation has bought out the 35% stake it did not own in Sony Financial Holdings (SFHD) in a US$3.7bn transaction. SFHD offers a wide range of banking, insurance and credit card services and by acquiring the company outright Sony would have the opportunity to strengthen its position in the fintech market and pivot away from relying on consumer electronics.

Major Going-Private Transactions of Listed Subsidiaries 2020 Q1-Q3 Japan

Unlike in the United States or Europe, there are many cases in Japan where the shares of parent companies and subsidiaries are listed on the same stock exchange (Parent-subsidiary listings). As of the end of 2019, 259 companies—or about 7% of all listed companies—were listed subsidiaries. According to research by the Ministry of Economy, Trade and Industry of Japan (METI), the ratio is 0.5% and 0.0% in the United States and United Kingdom, respectively. Parent-subsidiary listings have often been justified as resolving conglomerate discount—the value of the sum-of-the-parts tends to be greater than the value of the single listed conglomerate. Moreover, as listed companies, both the parent company and the subsidiary have various options for raising funds and can pursue faster growth as a corporate group. Furthermore, listed subsidiaries can more easily recruit talented employees than wholly-owned subsidiaries since listed companies are perceived as more prestigious and stable for workers in the Japanese job market.

On the other hand, some institutional investors have questioned the independence of listed subsidiaries from a corporate governance point of view. If a subsidiary is forced by a parent company to do business on unfavorable terms, the rights of minority shareholders in the subsidiary can be compromised. This issue was pointed out in a new guideline regarding group governance systems formulated by METI, the Practical Guidelines on Group Governance Systems (GGS Guidelines), published June 28, 2019. In addition, parent-subsidiary listings may contravene the principle of fairness of shareholder rights as set out in the Tokyo Stock Exchange (TSE)’s corporate governance guidelines. The TSE carefully examines subsidiary listing applications to ensure whether operations are established in a manner that enables management independence from the parent companies. Increased awareness of the requirements of sound corporate governance has highlighted disadvantages in parent-subsidiary listings and may have encouraged these going-private transactions. The drawbacks of parent-subsidiary listings sometimes outweigh the benefits. Either conversion of a listed subsidiary into a wholly-owned subsidiary or divestment of a listed subsidiary can be an effective method to resolve the tension between the goals of optimization of the group as a whole and partial optimization of the listed subsidiary.

In such transactions, there are bound to be potential issues such as structural conflicts of interest and information asymmetries. First, there may exist a structural conflict of interest between subsidiary directors affiliated with the parent company (the acquirer) and minority shareholders (the sellers). More specifically, such directors may have an interest in lowering the acquisition cost and may prioritize the interests of the parent company over the interests of minority shareholders. Also, huge information asymmetries exist in such transactions. The parent company inevitably has a massive amount of information about the target subsidiary compared to minority shareholders selling the shares. Moreover, it cannot be expected that the parent company will voluntarily disclose such information. For example, there is concern regarding timing of such M&A transactions because directors of the parent company may have particular information on the target subsidiary and take it private at a time when the market share price is temporarily undervalued compared to its intrinsic value and longer term profitability.

At the same time as its group governance guidelines, METI also completed its Fair M&A Guidelines,^[2] a significant update and extension to its 2007 guidelines for dealing with conflicts of interests in going private transactions. The Fair M&A Guidelines reflect and incorporate major changes in Japanese corporate governance over the past decade—most obviously the addition of outside directors on Japanese listed company boards—and bring Japanese going private transaction practice more in line with that in the United States and Europe. Also, while the 2007 guidelines addressed only MBOs—defined as transactions where management was acquiring a stake in the company from its public shareholders—the 2019 version extends to acquisition of a listed subsidiary by its parent.

The Fair M&A Guidelines, while non-binding in nature, are already having a significant impact and provide a valuable roadmap for going private transactions in Japan. For example, Sony’s transaction mentioned above is a typical case. According to the Fair M&A Guidelines (3.2.3), “A Special Committee that operates properly will help to address issues with respect to structural conflicts of interest and information asymmetries, and be a highly effective Fairness Ensuring Measure while ensuring fairness in M&A”. SFHD established the Special Committee after receiving acquisition offer from Sony. Also, the Fair M&A Guidelines advise that “the Special Committee to be substantially involved in negotiations between the target company and the acquiring party with respect to the transaction terms, including the acquisition consideration” (3.2.4.4) and “the Board of Directors can decide in advance that it will not agree to an M&A transaction if the Special Committee determines that the transaction terms are not appropriate” (3.2.4.5). The board of directors of SFHD delegated authority to negotiate with Sony to the Special Committee and declared that they would not approve the transaction if the Special Committee regarded the transaction terms as unreasonable. Of course, these types of structural measures are familiar to those involved with going private transactions in the United States and Europe, but they go well beyond historical practice in Japan and represent a shift toward protecting the interests of minority shareholders. It remains to be seen whether the Fair M&A Guidelines will be influential in Japanese courts’ analysis of buyout transactions, for example in response to an appraisal action by a dissenting minority shareholder.

The trend of going private transactions involving listed subsidiaries should continue for some considerable time, as approximately 245 listed subsidiaries will remain at the end of 2020. Pressures from investors for additional going private transactions should only strengthen, especially if listed subsidiaries’ share prices are temporarily depressed due to the influence of the pandemic. For future transactions, the practices stipulated in the guidelines of METI and the TSE will be followed in order to solve the issues mentioned above. Of course, in any specific transaction, minority investors will need to carefully examine whether sufficient measures are taken in connection with the M&A process and adequate information is provided to them.

[1] Source: Refinitiv

[2] METI, Fair M&A Guidelines, June 28, 2019. Available here in English

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This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Yoji Maeda, an O'Melveny partner licensed to practice law in Japan and New York, Scott Sugino, an O'Melveny partner licensed to practice law in California and a registered foreign lawyer in Japan, David G. Litt, an O'Melveny of counsel licensed to practice law in California, District of Columbia, and a registered foreign lawyer in Japan, and Shinji Kusuda, an O'Melveny counsel licensed to practice law in Japan, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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