DB Schenker sale – storm clouds gathering
Don’t look into the rear-view mirror
Japanese firms rarely show financial discipline in mergers and acquisitions (M&A). When they have plenty of cash on their books, they tend to spend it; when they are short of cash, they can either borrow at dirt-cheap rates or raise equity to fund their plans.
Their methodical, almost scientific, approach to business, which provides the ethos for efficient supply chain management, makes up for the high equity premiums they usually pay in M&A.
Cheap debt and easy access to alternative kinds of capital were not the only reasons behind the deal that puts Japan’s Kintetsu World Express (KWE) on the verge of owning APL Logistics.
Once a valuable asset of Singapore’s NOL, APLL was sold to KWE for $1.2bn in February, since the seller needed funds to fix its debt-laden balance sheet. It’s tempting to argue that the economic merits should have played an important role in the KWE/APLL tie-up, but the air freight forwarder is no different from any other Japanese buyer seeking fortunes abroad.
“Economics” can become just a little detail in M&A when Japanese firms decide to pull the M&A trigger, which is nothing unusual for those familiar with Japanese management.
When KWE announced the purchase of APLL it said that it considered the “establishment of a management base that can compete on a par with European and US competitors in the global market” as part of its medium-term management plan. More action would likely ensue abroad, as domestic consolidation among the three largest players wouldn’t make much sense.
KWE is paying top dollar to grow abroad because its mature domestic market offers fewer opportunities – although it still represents almost 40% of revenue, prior to the consolidation of APLL.
“They are Japanese: they can borrow at nothing, they have an overseas earnings stream against a depreciating yen and a stagnant home market,” a senior consultant for a US hedge fund on its Japan book told me this week.
“They don’t care about cost of capital – trust me, virtually nobody in Japanese management pays much attention to that,” he added. “If they write the cost of capital down to zero, so what? They can go back and ask shareholders to bail them out.”
A second banker based in Tokyo pointed out: “Probably nobody would care about WACC [weighted average cost of capital] and net returns if they had lived in Japan over the last 30 years,” arguing in favour of “corporate management in a country where deflationary concerns have dominated since the 90s”.
On the face of it, KWE is a well-managed, solid entity, but its eagerness to pay up in deal-making, if anything, testifies to a great opportunity for sellers to ask for a premium valuation, just as NOL did with APLL.
In December, The Loadstar posted a possible valuation of APLL and pointed out that it was on track to deliver in all its core markets – Asia, the Middle East, Americas and Europe.
Steady operating margins to the end of the year meant annual trailing Ebitda of about $80m (up from $76m in 2013), which was in line with our expectations and implies a take-out multiple of 15x for APLL, assuming zero debts. That’s a 36% premium over KWE’s own valuation, based on KWE’s trailing Ebitda.
While focus is on outbound M&A in Japan, another question is whether Japan, after the depreciation of the yen, has become a more attractive location for inbound M&A, offering an opportunity for foreign investors to site production facilities.
“That’s attractive on paper, but doesn’t look feasible in reality and on a significant scale, and also hinges on the sector in question,” the Tokyo-based banker argued.
Some investors “have thought about it: the labour force is actually cheap, and employees work hard”, my first source noted, although the issue is “more red tape and cultural hurdles, both of which are substantial issues.”
That said, for “hi-tech precision manufacturers it probably makes some sense”, he concluded.
Japanese logistics companies have traditionally built their business on serving Japanese exporters, which has obviously meant stagnation in the last decade, excluding some rare cases such as the automotive industry, where the main players are trying to move with carmakers to break into new markets.
Risk will likely be contained – last year, some “¥2bn of payments for US antitrust matter was recorded in the fourth quarter”, KWE reported in its financial results, which is small change, really. Furthermore, consider that when the losses mount and capital structures are stretched, Japanese companies are pretty damn good at finding alternative solutions, which in some cases may jeopardise shareholder value.
It’s hard to say whether Japanese buyers will soon make another move, even though another such large deal such as Japan Post’s $5.1bn takeover of Australia’s Toll Group was also announced in February.
But if M&A is the path forward, South-east Asia and Africa may be their preferred destinations, my sources agreed, with one caveat called “PMI”, or post-merger integration – which is well known in Japanese boards.
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