The private equity invasion of Japan: Ripplewood and others are shaking up a traditionally closed market.

Politicians, bankers and even ice cream-licking punksters on the streets of trendy Shibuya were quietly outraged this past winter when Ripplewood Holdings made a breezy $2.3 billion through the initial public offering of Shinsei Bank . That was twice what the New York-based private equity firm had invested in the bank, and it didn't pay a single yen in Japanese taxes. The visceral fear, dating back to Commodore Matthew Perry and his "black ships" that forcibly opened Japan 150 years ago, was that the gaijin, or foreigners, were gobbling up precious Japanese assets.

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But Ripplewood's tax-free bonanza was not only quickly forgotten--it has actually encouraged more U.S., European and even Japanese turnaround funds to join the fray. As they prowl for acquisition targets, this year shapes up as the dawn of private equity in Japan. That comes as quite a surprise to some Japan-watchers. After all, powerful government ministries have traditionally barred foreigners like Boone Pickens from snapping up Japanese assets.

Clearly, something has changed. Elite bureaucrats have decided that some foreign role is helpful in cleaning up bad assets and injecting liquidity into a system that has been deprived of lending from Japan's own troubled banks. And there are other factors: an economic recovery, better investor knowledge about private equity, louder shareholder calls for higher returns, and the unwinding of cross-shareholding relationships among members of the big keiretsu, or industrial groups.

The world view of Japan as a closed market has been wrong, says Guy Hands, chief executive of buyout fund Terra Firma Capital Partners. He says the country is now "an extraordinary investment." The Japanese government will probably no longer allow huge Shinsei-like windfalls, but Hands believes Japan remains flush with potential deals. There are still some limits, to be sure. Imposing drastic management changes, such as job cuts, are still a taboo, as Wal-Mart learned when it tried to sack more than 1,000 employees of the Seiyu retail chain in which it had acquired a controlling interest.

Preying on Divestitures

But there now are more than a dozen foreign private equity funds in Japan. Their deals include Cerberus' acquisition of Aozora Bank , Lone Star's stake in Tokyo Star Bank, The Carlyle Group's position in e-Access, and Ripplewood's purchase of Japan Telecom. (See table, page 22.) Goldman Sachs, meanwhile, has purchased three dozen country clubs, and Lone Star has acquired a cluster of prestigious clubs as well.

Look closer at the players and deals and there is no common strategy except that they all are focused on the arbitrage of target companies' hidden values. Some, like Ripplewood and Lone Star, get involved operationally and go for long-term returns while others act more like venture capitalists, merely looking for a rate of return.

Of all the players, Ripplewood is seen as the most aggressive. Except for Shinsei and a huge southern Japan resort called the Seagaia that Ripplewood bought in 2001, all the other deals scaled by CEO Tim Collins have involved corporate divestitures. He bought Niles Parts from Nissan Motor, auto parts maker Asahi Tee from NGK Insulators, and Nippon Telecom from Vodafone, to name a few deals. "Corporate divestitures have become acceptable modus operandi at an increasing number of Japanese companies," says Hiroshi Nonomiya, Ripplewood's managing director in Japan. Adds Collins in a rare interview: "I think we have a significant profit in each and every one of our investments."

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Ripplewood is now sitting on an estimated $10 billion to $12 billion in assets. There's a great deal of speculation about what Collins, a 47-year-old native of Kentucky, is planning next. Without tipping his hand, Collins says his goal is "to focus on industries where Japan has the potential to be the leader of increasing globalization." Those sectors include auto parts, chemicals, consumer electronics, electrical equipment, household appliances and petroleum. "There is both a consolidation opportunity in the Japanese market and the potential to create tremendous competitive advantage by becoming more and more global," he adds.

By going global, Collins is referring primarily to the booming markets of East Asia. "Shinsei is going to China, Niles is going to China, and Asahi Tec is expanding in Thailand," he says. "That is the opportunity for us, taking these companies and helping them grow their businesses in those markets."

At the same time, it's clear that Collins wants to do more takeovers in Japan. "My sense is that the best opportunity for my capital is in companies that we buy, rather than investing in passive investments like stocks and mutual funds," he says. "I'm not a good passive investor. My personal investment strategy is cash for companies in which we have a substantial control. I don't know very much about the stock market."

As to why the government has allowed him such latitude, Collins believes that most ministries want to promote structural change in the industries they oversee. "There's been a recognition that creating profits and healthier businesses is really important for the overall well-being of Japanese society," he argues. "That is what made a big difference for us."

Who Wants My Company?

It does seem that the trend lines support his case. For one thing, demographic changes are going to be a driving force that will prompt more Japanese companies to spin off operations to the private equity market, now believed to be more than $19 billion. By 2025, as much as a quarter of Japan's population will be 65 and older, making it the world's oldest society and the nation with the lowest birth rate. Already, CEOs of privately owned companies are complaining that their siblings or children are not interested in inheriting their businesses or that they cannot find capable candidates among their employees. About half of the $190 billion that is expected to be inherited in the next few years is related to businesses. CEOs who fail to find someone to carry on are expected to sell.

Just as important is the power of regulatory change. During what is known as "the lost decade" following the bursting of the bubble in 1990, Japan chucked much of its Commercial Code, the red tape that stood in the way of mergers and acquisitions, transfers and divestitures. In October 2003, legislation was enacted to allow cross-border stock swaps between foreign-capitalized companies and Japanese firms.

Prime Minister Junichiro Koizumi is undertaking a program to increase inward foreign direct investment to Japan to 15 trillion yen, or $140 billion at current exchange rates, by 2008, as he promised President George W. Bush. In April, the U.S. Embassy in Tokyo organized investment seminars in Kyoto and in the southwestern city of Fukuoka to find investment opportunities for U.S. medical, environmental, financial, computer and educational businesses. "Regulatory and administrative support, coupled with the unwinding of cross-share-holding and low stock prices, is contributing to the increased number of M & As and hostile bids," says Masaji Toshino, a Daiwa Institute of Research pension analyst.

After having refused to allow foreigners into their inner sanctums for centuries, the Japanese appear to be concluding that their economy can benefit from operating know-how and outside capital. The foreigners, it seems, are able to rethink old-fashioned business models and deploy the right kind of professional talent to fix chronic problems. "We are more willing than ever before to accept foreign things, capital and people," says a senior Ministry of Finance official. Good news, indeed, for Collins and the world's private equity investors.

WHO'S WHO IN JAPAN'S PRIVATE EQUITY BUSINESS

Aside from Ripplewood, there are many other private equity firms. Here
is a sampling:

Headquarters  Company               Acquisitions

U.S.          Cerberus              Purchased Aozora Bank, formerly the
                                    Nippon Credit Bank, in April 2003
                                    for nearly $1 billion
U.S.          Lone Star             Bought Tokyo Star Bank from the
                                    government for $339 million in 2001
U.S.          The Carlyle Group     Led by former top U.S. political
                                    leaders, acquired a $26 million
                                    stake in e-Access, an Internet-based
                                    telecom line wholesaler, then exited
                                    in March 2004
Japan         Unison Capital        Bought Orient Shinpan, an
                                    installment credit provider; Mine
                                    Mart, Japan's largest liquor store
                                    chain; and Kiriu, an auto brake
                                    manufacturer
Japan         MKS Partners          Acquired Culture Convenience Club,
                                    the largest Japanese rental software
                                    chain; Sazaby, a fashion and
                                    accessory store chain; and Fukusuke,
                                    a 122-year-old kimono and footwear
                                    maker
Japan         Phoenix Capital       Took over Ichida, a kimono
                                    distributor that carries Ralph
                                    Lauren products; Tsumura, the
                                    largest Japanese maker of Oriental
                                    herbal medicine; and Tokyu
                                    Construction
Japan         Tokio Marine Capital  Invested in WeatherNews, an
                                    information service and Broad System
                                    Create, a software developer
U.K.          Terra Firma Capital   Affiliated with Nomura Holdings; has
              Partners              done about a dozen deals
U.K.          Steel Partners        Has bought large chunks of nearly a
                                    dozen companies while engaging in
                                    hostile bids for small textile firm
                                    Sotoh and chemical maker Yushiro
                                    Chemical