UBS interview

Fumitaka Eshima Fumitaka Eshima is a managing director of UBS Investment Bank in Japan and heads the legal department. He began his professional career at Anderson Mori, from where he moved to Freshfields in London and Lee & Lee in Singapore before returning to Tokyo in 1996 as a director of SBC Warburg. After some time as managing director of CSFB's legal department in Tokyo, he then joined UBS (SBC Warburg's successor) in 2003. His experience includes capital markets, M&A and other corporate finance transactions. He is a graduate of Tokyo University and holds a masters degree in law from London University.

IFLR: What opportunities exist for restructurings and buyouts in Japan?

Fumitaka Eshima: Large distressed companies are available for sale. Also, Japanese companies are more willing to spin-off their non-core businesses than before.

These developments are providing financial and strategic buyers with an increasing number of acquisition targets. At the same time, there are more opportunities for debt providers, both in relation to leveraged buyouts (LBOs) and securitizations.

What market conditions have created this trend?

One important factor has been that Japanese companies now place a greater emphasis on earnings per share. To enhance that, they need to dispose of low profit, non-core businesses and they have become more open minded to this. A good example is Toshiba's sale of Toshiba Tungaloy to Nomura Principal Finance in 2004.

Another important factor has been the improved perception of private equity activities. These funds have sometimes been seen as distressed vultures, but now they are seen more as legitimate buyers.

Which LBO structures are most common?

There have recently been some large LBOs in Japan, particularly by foreign funds. The largest was Ripplewood's $2.2 billion purchase of Japan Telecom in 2003. As in other jurisdictions, an LBO in Japan typically requires an acquisition vehicle to be set up to then acquire the target company with non-recourse funding secured on cash-flows from the target. Large Japanese banks are willing to lend money to LBOs for higher yields and also for up-front commitment fees.

Compared with their foreign competitors, however, Japanese buyout funds seem to be less active in this area and sometimes buy companies without commitments from debt-providers. Some of those acquirers then seek financing after execution. This two-tier approach has the benefit of speedy negotiation at the time of acquisition, although the acquirer runs the risk of being unable to find suitable debt financing after all.

How have changes to legislation and regulatory policy stimulated the market?

Various efforts by legislators and policymakers have helped to create a more active buyout market in Japan. In particular, a series of key changes to the Commercial Code, for example, the introduction of share swaps (kabushiki kokan) and company splits (kaisha bunkatsu), have made it much easier to reorganize and acquire a company and its assets.

In terms of bankruptcy reforms, the introduction of the Civil Rehabilitation Law in 2000 and the amendment of the Corporate Rehabilitation Law in 2003 have speeded up the court-sponsored restructuring of a distressed company, as well as making it possible for a purchaser to buy such a company subject to court approval before creditors approve a rehabilitation plan (which tends to take time). The birth of the Industrial Revitalization Corporation of Japan in 2003 has also provided a framework for the out-of-court rehabilitation of some distressed companies.

What challenges do investors still face?

While an increasing number of companies are available for sale, the number of buyout funds is also increasing. Because of this increased competition, it remains difficult, particularly for new private equity firms, to win auctions and source attractive deals.

Another challenge is that investments by buyout funds will be affected if the interest rate goes up; highly leveraged transactions could in particular be seriously affected by higher rates. LBOs are still new to Japan and we are yet to see the full business and economic cycle of an LBO.

What are the main legal stumbling blocks?

Lawyers need to address various structuring issues for LBOs. For example, the Commercial Code requires a court to appoint an appraiser for certain asset purchase transactions by a company that has been incorporated for less than two years. This requirement applies to newly established acquisition vehicles.

Another typical issue is how to create a security interest effectively over cashflows from the target company. Japanese laws governing security interests are less flexible and do not have an equivalent to the floating charge under English law.

Japanese law is also yet to introduce compulsory acquisition, so an acquirer seeking 100% ownership of the target needs to go through a series of transactions to squeeze out minority shareholders for cash.

How likely are these shareholders to challenge this?

While the Commercial Code does not have an established scheme for minority squeeze-outs, bankers and lawyers have developed schemes to achieve a squeeze-out through a series of transactions. In a typical deal, the acquirer sets up a holding company above the target and then sells the target to another subsidiary of the acquirer. As a result, the minority shareholders receive cash proceeds for their shares.

However, this type of minority squeeze-out potentially exposes the deal itself or the target's directors to litigation. For example, minority shareholders might seek to rescind a shareholder resolution by arguing it is unfair. They might also want to sue the board members of the target for a breach of their fiduciary duties.

There is no direct case law on these issues but the risks are not immaterial, particularly given that a minority squeeze-out could potentially constitute an abuse of rights by majority shareholders.

Is there a way to mitigate the risks?

The key to avoiding legal disputes is to make sure the price paid to minority shareholders is fair. That is the most important factor for them.

From a practical perspective, however, it is not easy to determine whether a particular price is fair. Therefore it is important to have a range of objective factors to support the fairness of the price being paid. Assuming the typical situation where the acquirer first launches a tender offer bid (TOB) before it attempts to squeeze out remaining minority shareholders by offering the same price, a particularly important factor seems to be the shareholding ratio that the acquirer achieves through the TOB. If the ratio is sufficiently high, for example 90% or more, there is a strong argument to support that the price is fair. It is important, therefore, to offer a sufficiently high price so the acquirer can reach such a high shareholding ratio.

The objectiveness and transparency of the procedure is also important. A fairness opinion from an investment bank should help.

In which other areas are more legal clarity and flexibility needed?

There are still various outstanding issues that require clarification or regulatory changes. For example, a tax-free merger is not possible where there is a cash-out. This limits the flexibility of a merger structure. Also, the precise extent of the Japanese mandatory TOB rules is not clear in relation to pre-agreed cross transactions executed on a stock exchange.

Meanwhile, some of the Japan Securities Dealers Association's rules limit the ability of securities houses to solicit transactions in non-listed securities. While the rules are thought to be targeted primarily at brokerage transactions, they can be interpreted in such a way as to prevent a securities house from talking to sellers in the acquisition of non-listed stocks in a restructuring transaction.

Are there reforms in the pipeline that will benefit the market?

Extensive reforms to Japanese company law are being discussed and are likely to go through the parliament in 2005 and become effective in 2006. These include a wide range of changes that are going to have an impact on the structuring of acquisitions.

For example, the introduction of a merger structure where shareholders in the merged company receive assets other than shares in the surviving entity (for instance, cash or shares in the parent of the surviving entity) is expected. This will make it much easier to structure a minority squeeze-out.

Greater flexibility in structuring acquisitions will also be possible after the introduction of a simplified merger process without shareholders approval at the target (or at the acquirer), and after the abolishment of the requirement that there is a court-appointed appraiser for significant asset purchases by newly established companies.