Private equity firms often fret that it is hard to source deals in Japan because companies there loathe making big restructuring moves.
Maybe they are not looking in the right places, as the experience of Ant Capital, a Tokyo-based buyout firm previously owned by Citigroup Inc, suggests. In Japan, for private equity, it pays to think small.
"We are very busy now despite this (market) situation," Kazunori Ozaki, chief executive officer at Ant Capital, said at the annual SuperReturn private equity conference in Hong Kong last month.
Ant Capital, which manages $1.3 billion, targets companies with less than $200 million in enterprise value.
It has sold five of its portfolio companies since last year, including Aunt Stella Inc, which runs a cookie store chain, Japanese confectionery maker Morinaga & Co, and BBMF KK, the operator of a mobile phone comic book Website, and major Japanese publisher Shogakukan.
And last month it completed the purchase of almost 100 percent stake in VarioSecure Networks, a provider of computer security, for $5.7 million.
"Basically small cap is undervalued because of its non-profile. To be small caps means they are discounted already," Ozaki said at the Hong Kong conference.
Ryosuke Iinuma, managing partner of Ant Capital, told Reuters in an interview the firm's portfolio companies are a fit with some of Japan's large companies which want to fill gaps in their businesses by buying smaller firms.
"Some Japanese companies have a good appetite for acquisitions. They want to add product line-up to their business to boost competitiveness," he said.
The market for private equity in Japan has indeed looked unappetising.
The value of acquisitions in Japan by private equity firms fell to $8.8 billion last year from $21.2 billion in 2007, according to Thomson Reuters data. That is just $1.7 billion so far this year.
But targeting smaller transactions may indeed be the right strategy, as 94 percent of Japan's roughly 3,000 M&A transactions were worth less than $100 million last year, according to Thomson Reuters.
The Hong Kong-based Centre for Asia Private Equity Research Ltd says smaller deals have generated higher returns for private equity firms in Japan.
Some 33 deals completed from 2004 through the end of June this year have showed transactions for companies with market value between $100 million and $500 million had an internal rate of return of 19.6 percent. That compared with an 8.7 percent internal return on companies with more than $1 billion market value.
"Mega deals provide much more challenges to secure those types of returns because they are already really big, you don't have a growth play," said Bradley Edmister, a lawyer specialising in mergers and acquisitions at Ropes & Grey in Tokyo.
"Small and medium companies are fundamentally good companies with good technologies but they simply don't have ambition for growth. Private equity firms can help those companies achieve greater organic growth, including overseas expansion."
Citigroup, which has offloaded assets globally to bolster its capital, is now in the process of selling telemarketer Bellsystem24 in Japan.
The sale of Bellsystem24 is expected to fetch more than $1 billion, making it the largest acquisition involving foreign private equity firms in Japan in about a year-and-a-half.
Permira, CVC Capital, which teamed up with Blackstone, and Bain Capital were shortlisted for the second round of bidding.
This would be the biggest private equity firm deal since March last year when Permira completed a buyout of agrichemical company Arysta LifeScience Corp and Advantage Partners bought Tokyo Star Bank from Lone Star. Each deal was about $2.2 billion.
Permira has not made any investments in Japan since then, while Kohlberg Kravis Roberts & Co has not made any significant investments in Japan since it opened an office in Tokyo in 2006.
"Japan's big companies are still not ready for drastic restructuring and they keep non-core business units even though they don't need them," said a Tokyo-based fund manager for a life insurer in charge of private equity fund investments.
"That is still slowing down private equity transactions," said the manager, who did not want to be named because of company policy restrictions.
Ant Capital's Iinuma said smaller companies tend to have more potential for growth than large corporations.
"There are a lot of opportunities to improve EBITDA by just cutting inefficiencies, without top line growth," Iinuma said.
EBITDA is short for earnings before interest, taxes, depreciation and amortisation -- a cash-flow measure often used to value investment targets.