After a stellar 2005 in which over ¥6trn of deals were completed, Japanese ECM activity is set to tear up the record books this year. With the banking and REIT sectors leading the charge, the torrent of equity issuance continues to find eager investors. And although not everything has been perfect, few are forecasting that the primary market will founder any time soon. Brad Frischkorn reports.
It is a good time to be an ECM banker in Japan, according to Gareth Lake, managing director of equity capital markets at Nikko Citigroup in Tokyo. And in many ways, the market does indeed have a pleasing feel to it. By August 2006, the volume of Japanese ECM deals had already equalled the ¥6trn recorded in 2005 with four months to go, and the year looks certain to top the all-time high of ¥7trn set in 2004. The surge is being felt all over – on both the public and private sides, on IPOs and CBs, capital increases and secondary sales.
The proliferation of banking sector deals has distinguished 2006 from previous years, as many recipients of government fund injections begun in the late 1990s have now cleaned up the worst of their bad loans and are striving to make their balance sheets whole again. Mizuho, Sumitomo-Mitsui, Mitsubishi UFJ, and Mitsui Trust have been the first large lenders to come to market: over the last 12 months, this group has been behind a staggering US$15bn worth of stock deals.
Mitsubishi UFJ’s transactions this year include a series of bold moves, including a ¥418bn (US$3.7bn) secondary sale, co-ordinated with a simultaneous buyback of up to 189,000 prefs issued to the Deposit Insurance Corporation worth ¥315bn. Separately, the bank also raised US$5bn in international debt with a three currency global perpetual bond. For the megabanks, the race to rid themselves of government control has driven the market. Mizuho also covets a ADR listing on the NYSE, much like rival Mitsubishi already has.
With some ¥6.6trn in public funds dispensed in exchange for preferred convertible shares in 1998 and 1999 alone, and dozens of banks subsequently on the receiving end, the pipeline for more transactions of this type could take years to exhaust. Much will depend on the conditions for conversion, however.
"Unless there is a trigger point – a reset date, conversion date, or specific request by the bank – these kinds of deals are highly unlikely,” said Nikko Citi’s Lake. “Extensive discussions (with the government) are done well ahead of time."
In the case of Mitsui Trust, which gave the go-ahead for the government to liquidate all of its Class 1 prefs set to convert this year, the ¥98bn deal represented only about 10% of its government assistance. Its Class 2 and 3 prefs will convert in 2009. Resona Bank is another big bailout recipient waiting to be heard from.
REITs still rolling
The J-REIT market, still fewer than five years old, has enjoyed almost storybook growth from its beginning – and is still exploding. Over three dozen trusts are now publicly traded, and their asset portfolios span office buildings, commercial facilities, warehouses, single-family dwellings, hospitals and hotels, both in and away from Tokyo.
With over ¥700bn REIT deals having come to market so far in 2006, and another half-dozen in the pipe for the rest of the year, this year’s volume should easily surpass the ¥840bn seen in 2005. However, the uptick in overall volumes is such that REITs’ share of the total ECM pie is currently running at about 11%, down from last year’s 16%.
J-REIT M&A activity has been self-reinforcing for asset valuation, and has help to drive up land prices in urban areas. By end-2005, publicly held REITs, together with private property funds, saw their aggregate assets increase 80% year-on-year to nearly ¥8trn, with listed REITs comprising 44% of that total.
But while big-ticket bank deals have drawn almost universal investor support, the J-REIT market is clearly displaying growth pains. Some of these were illustrated in August when MID REIT's ¥96bn domestic IPO – the largest J-REIT flotation – priced to lukewarm support. Two months earlier, Japan Ecology REIT's ¥21.5bn IPO had been pulled due to pricing concerns.
The termination of the central bank’s quantitative easing and zero interest rate policies has not hurt most equity dealmaking, mainly on the back of more favourable cost-of-capital comparisons. But J-REITs, with their paltry 3.4%–3.6% average dividend yields, have suffered as bond yields have risen. Industry competition is also intensifying, and investors are now scrutinising portfolios far more diligently.
REIT operators must also contend with increased regulatory scrutiny over asset quality, paperwork and accounting methods. Newsflow- and regulatory-driven sentiment means that precipitous post-listing price falls are no longer uncommon for the sector: in 2005, half of the year’s 13 J-REIT IPOs fell in price after going public.
“With so many REITs to choose from, we’re seeing the inevitable separation between winners and losers based on portfolio quality, sponsor name, and cap rate weakness,” said one banker. “It’s hard to reconcile all of that by simply raising the (dividend) yield.”
Surge of primary deals
In terms of this year's challenging offers, however, more commotion has been spawned by jumbo capital increases from the likes of Mitsui & Co (¥198.6bn), Elpida Memory (¥137bn), All Nippon Airways (¥107bn) and Japan Airlines (¥158bn).
Soaring crude and commodity prices helped to make Mitsui’s capital increase offer as a proxy play on those markets, and to wild success, especially overseas. Elpida’s aggressive offer generated over US$5bn in demand, and resulted in a clear affirmation of international confidence in Japan’s D-RAM manufacturing capability.
The ANA and JAL offers, which came to market in that order but four months apart, unfolded very differently and provided a rare contrast in execution between industry arch-rivals. Both offers were huge, but ANA’s deal – its first trip to the equity markets in 22 years – appeared to resonate better with investors, who were undaunted by its high P/E and were convinced by its fleet restructuring and expansion plans. Books were well-covered, and share dilution was held to a tolerable level.
In contrast, JAL’s capital increase was hounded from the start by scrutiny over the firm’s falling passenger numbers, weakening revenues, safety mishaps, a well-publicised managerial coup, and even the planned use of proceeds from the transaction. The shares lost over a third of their value over the course of the deal, on strong hedge fund involvement, resulting in the deal shrinking and leading many to wonder why the firm had not simply turned to a more indirect or private funding arrangement for restructuring help.
Bankers involved in the transaction were strident in its defence, however.
"To raise ¥158bn and fundamentally recapitalise the company was a great accomplishment, made all the more impressive by the challenges it had to overcome such as record high oil prices and global equity market turmoil – not to mention North Korea firing missiles,” said Dan Dees, head of financing group at Goldman Sachs in Japan, which led the deal as joint global co-ordinator with Mizuho.
Increasingly widespread stock ownership and foreign participation – ongoing themes for the last few years – have helped bring Japan’s major bourses in line with global standards for liquidity. It has also made them much more stable, a quality which, when combined with the broader Japan Inc recovery story, has led to a better acceptance of most kinds of Japan equity deals than before. Retail investors have played a major part in this story, helping foreign pubic offer without listing (POWL) tranches to do well almost universally.
The public and private convertible bond (CB) markets remain robust, but after a blizzard of unfavourable press in 2005, regulatory authorities are set to crack down on the latter with new rules requiring more disclosure and shareholder approval. Such requirements are unlikely to benefit the public CB market, due to the higher credit necessary for marketed deals.
Still, underlying secondary market volatility and resilience is seen playing into the hands of public issuers again. So far in 2006, convertible bond issue volume is already running at ¥800bn, three times the level for all of 2005. Now with higher bond yields, CBs with coupons may also return, as was seen with CSK's July ¥35bn domestic convert (0.25% coupon).