2023-08-10 18:02:29 ET
Summary
- Japanese SME owners are getting older and struggling to find successors, leading to an increase in mergers and acquisitions as a solution.
- Nihon M&A Center, M&A Capital Partners, Strike, and M&A Research are four listed Japanese companies specializing in M&A brokerage services.
- These companies have massively outgrown the wider Japanese M&A brokerage market by focusing on SMEs and taking market share away from banks and securities firms.
- M&A Capital arguably distinguishes itself in our peer group review, both in terms of corporate strategy as well as operating and financial ratios.
- The company strikes us as the most interesting investment opportunity to consider at present.
'Small & medium enterprises (SMEs) are the backbone of the economy' is a phrase that everyone is likely to have heard before, especially during times of electoral campaigns. To varying extents for different countries, this remains very much true as of today, despite an accelerating trend of consolidation across nearly all industry verticals over the past four decades.
It is especially true for Japan, in which SME accounted for over 99% of all businesses, over 65% of private sector employment, and over 50% of gross domestic product ((GDP)), according to various estimates.
So why are we introducing this article on the Japanese mergers & acquisitions (M&A) brokerage market by highlighting the importance of SMEs in the economy? Well, because Japanese SME owners are getting older, and they are struggling to find successors. In this context, merging or being acquired by another company becomes an increasingly probable solution for many SMEs.
We'll be focusing our analysis on four listed Japanese companies today, that specialize in M&A brokerage services:
Nihon M&A Center Inc: ( OTCPK:NHMAF ) Founded in 1991 by a team of CPAs and tax accountants, Nihon is the largest independent M&A broker in Japan. The company focuses mostly on unlisted companies in Japan, but also has a small international presence in other South East Asian countries. The company is notable for having a strong network of alliances with accounting firms and regional financial institutions, through which it receives referrals to broker deals.
M&A Capital Partners Co. Ltd: Established in 2005 by its current CEO, M&A Capital is a boutique M&A broker predominantly focused on business succession for Japanese unlisted companies. In 2006, the company acquired Recof Corporation (seemingly Japan's first-ever M&A specialist) and its subsidiary Recof Data Corporation. M&A Capital is slightly different to Nihon and Strike with regards to its fee structure, its strategic focus on larger deals, as well as a more proactive approach to make M&A proposals to business owners directly.
Strike Co Ltd: Founded in 1997 by its current CEO, Strike is a boutique M&A broker that mainly focuses on unlisted companies. One of the main differentiating characteristic of the company is its high percentage of M&A introductions received via its website, launched in 1999, which features a database of selling and buying information and enables counterparty search.
M&A Research Institute Holdings Inc: Founded in 2018 by its current CEO, M&A Research is a boutique M&A broker that has only recently entered the market. The company has successfully differentiated itself by offering a different fee structure to clients, with no start-up or interim fees, and only success fees for closing M&A deals.
The table below provides some basic descriptive information for each of these companies:
Industry background
Companies involved in mergers & acquisitions typically engage advisors for support throughout such a process. This can take the form of advisory services to a single party, and/or brokerage services between buyers and sellers.
M&A advisors are mainly banks and investment banks, securities firms, and independent M&A advisory firms. M&A brokers - like Nihon, M&A Capital, Strike, and M&A Research - are more common for smaller M&A deals, predominately between unlisted Japanese companies, as well as acquisitions of private firms by public companies. In addition to independent M&A brokers, regional banks and accounting firms also broker deals as intermediaries.
According to estimates by Recof Data in M&A Capital's latest investor presentation , the number of M&A deals closed has been growing at a compounded annual growth rate ((CAGR)) in the mid- to high-single digit over the long term. Between 2014 and 2022, the number of M&A deals closed grew at a CAGR of about 8.4% , and reached approx. 4,250 last year.
As can be expected, there is some level of overall market cyclicality, as shown by the decline in the number of deals closed in the early 1990s, during the global financial crisis of 2008, and due to the 9.0-magnitude earthquake of 2011. The market has since recovered strongly, barring the more temporary decline experienced during the COVID-19 pandemic. Having said that, the underlying structure of the market has been changing more recently, with a lower number of deals, but of a larger size on average.
Structural growth drivers
As we mentioned in the introduction, the main growth driver is that SMEs business owners are getting older, and they are struggling to find successors. This results from the declining number of births and fertility rate in Japan, and the fact that the children of business owners are increasingly choosing other careers for themselves.
Thus, according to various estimates, the average age of SME owners has steadily increased, from 54 years in 1990 to nearly 63 years in 2021. In other words, the age distribution curve is rapidly shifting right, as shown below:
According to estimates by M&A Capital, the number of profitable companies in Japan with owners aged 60+ and without a successor in place is around 240,000. It is projected that over 25% of these companies, or over 60,000, will engage M&A advisory and/or brokerage services in the coming decade. This would represent a CAGR in the overall number of deals closed in the mid- to high-single digit.
Additional growth drivers include a fairly large number of yearly bankruptcies amongst small Japanese companies, which often leads their assets to be bought off, as well as demand for 'transformative' M&A in a very low growth domestic economy.
Comparative analysis
Let's now take a deep dive into how Nihon, M&A Capital, Striker, and M&A Research have performed over time. Please note that this analysis is somewhat complicated by the fact that not all have the same fiscal year ending. As a result, Nihon can be said to be 'behind' by six months in this analysis, compared to the other three companies that will all soon report FY23 results (fiscal year ending in September).
The graphs below display the number of deals closed, total sales, and estimated market share for our peer group of companies over the past decade.
The first point we'd like to highlight is that clearly, all four companies being looked at have massively outgrown the wider Japanese M&A brokerage market. It would appear that they've done so by taking market share away from banks and securities firms, that have historically done most of the M&A advisory & brokerage business. That, in turn, has been achieved by focusing heavily on SMEs, and coming up with a more attractive offer for SME owners looking to sell/buy in terms of fee structure (more on that later).
The numbers speak for themselves. Overall, the cumulative number of deals closed by these four companies increased at a CAGR of over 22% between 2014 and 2023e, more than twice as fast as the broader market.
Nihon has grown sales at a 10y CAGR of 16%, M&A Capital at 34%, and Strike at 44%. M&A Research, the new kid on the block, has grown sales at a 5y CAGR of 152%.
All in all, their combined market share increased from less than 10% in 2014 to about 25% of the total market in 2023e. Nihon increased its market share from 6% to 12%, M&A Capital from 2% to 5%, and Strike from 1% to nearly 6%. M&A Research has reached a 3% market share in just a few short years.
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Before resuming our analysis of business fundamentals, let us briefly turn to efficiency ratios, which will give us a chance to talk more about what differentiates these four companies from one another, and especially M&A Capital.
The graphs below display the number of deals closed per consultant, the revenue per deal closed, and the revenue per consultant between 2014 and 2023:
We can see that Nihon has had an overall stable profile this past decade, although there has been a deterioration in revenue per consultant over recent years. M&A Capital stands out as the top performer in this analysis, with all metrics trending positively and a sizable gap emerging relative to peers, especially in terms of revenue per consultant. Strike's efficiency ratios are also generally stable to positive, but are average relative to peers. Last, M&A Research appears less focused on efficiency metrics in pursuing a very fast-growth strategy.
So let's talk a little bit about what differentiates these companies from one another:
- Sourcing deals
One of the first aspects to consider is the manner in which these companies source the M&A deals they broker, as well as their capabilities to do so. Here, Nihon is notable for having a strong network of alliances with accounting firms and regional financial institutions, through which it receives referrals to broker deals. We estimate that for both Nihon and Strike, over 50% of the deals closed came from referrals, and M&A Research also aims to promote growth through referrals. M&A Capital, on the other hand, focuses largely on sourcing deals itself. In doing so, it aims to source larger and more complex deals, which are more value-adding. In addition, sourcing deals directly implies a higher level of profitability, as M&A Capital does not have to pay a referral fee to a bank or an accounting firm.
- Fee structures
Another very important consideration that seems to be at the root of why independent M&A boutiques have been able to gain market share over time is the manner in which they structure their fees. Here, the overall tendency is clear: make M&A cheaper for SME owners, and make fees increasingly contingent on the successful closing of a deal.
As shown above, M&A Capital and then Strike first paved the way in scarping initiation fees (when the M&A brokerage agreement is concluded), relying instead on fees when a memorandum of understanding (MoU) is signed, and when deals are finally closed. M&A Research then took it one step further, dispensing of interim fees altogether and relying solely on success fees.
It is also crucial to highlight the difference in the application of the success fee. Here, M&A Capital is the only firm to apply the Lehman formula to the equity value of the transaction only, rather than the value of total assets, as all other three companies do. According to M&A Capital, this leads to a total intermediary commission rate of 2.7% on average, which it claims to be as much as 3x lower than peers. That is quite remarkable, and when you consider that despite this, the company has achieved a leading level of average revenue per deal closed, it really lends gravitas to the notion that it is focused on larger, more value-adding deals ('large deals' with a commission of JPY 100m or more represent about 20% of total, according to the company).
- Talent & matching capabilities
These companies' ability to grow depends in large part on the talent of their consultants as well as their overall matching capabilities. We've already highlighted some idiosyncratic characteristics, such as Nihon's unparalleled network of alliances with referring partners, and Strike's website which features an advanced counterparty search. Here, M&A Capital claims to have a compensation structure that attracts the best talent in Japan, by having the highest average wages in the industry for eight consecutive years. According to estimates by Tokyo Shoko Research cited in the last IR presentation, M&A Capital's average annual income is over 40% higher than the peer group average. In their view, this has enabled them to assemble the best M&A brokerage team in the country, which in turn enables it to handle bigger and more difficult deals.
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Let's now come back to business fundamentals and complete our analysis. We've already talked about the growth profile of these companies over the past decade. Let's now have a look at profitability levels, returns on invested capital ((ROIC)), and free cash flow generation.
All four companies operate very profitably, with operating profit margins in the 40-50% range on average. Nihon has had a declining trend in profitability, with operating margins falling from 50% to below 40% last fiscal year. M&A Capital has had a slightly more stable profitability profile, with margins in the high 40s. Strike has gradually caught up to the pack, with operating profit margins now close to the peer group average. M&A Research has yet to establish a consistent track record of profitability, despite margins having improved substantially over the past couple of years.
ROIC levels are typically in the 20-30% range, with the exception of M&A Research that is posting much higher figures, likely due to the fact that it is still such a young company which hasn't yet built up much assets on its balance sheet.
Free cash flow generation is also very attractive, with a FCF to net income ratio of about 100% on average. Once again, here, M&A Capital stands out of the pack with a high FCF conversion rate of close to 120% on average. M&A Research also catches the eye, but once again we prefer to wait until they establish a more lengthy track record before drawing any conclusions.
Financial health
As can be expected from highly profitable and asset-light companies, they typically employ very little debt, because they simply don't need to. All four companies are in excellent financial health. As of the end of their last respective fiscal years:
- Nihon has a net debt to equity of -0.8x, and a net debt to EBITDA of -2.9x. Cash represents 20% of current market capitalization.
- M&A Capital has a net debt to equity of -1.1x, and a net debt to EBITDA of -3.6x. Cash represents 40% of current market capitalization.
- Strike has a net debt to equity of -0.7x, and a net debt to EBITDA of -2.0x. Cash represents 15% of current market capitalization.
- M&A Research has a net debt to equity of -0.9x, and a net debt to EBITDA of -1.8x. Cash represents 2% of current market capitalization.
Dividend policy
Part of what we see when looking at these companies' balance sheets can be explained by their different dividend policies. While Nihon and Strike pay out dividends, M&A Capital and M&A Research don't. Nihon has typically paid out about 40% of earnings, and recently the payout ratio has increased to nearly 80%. Strike has rapidly increased its dividend to a payout ratio of about 30% of earnings. With cash building on M&A Capital's balance sheet, it seems probable that the company will also start paying out a dividend eventually. For M&A Research, the focus on supercharged growth is likely to prevent the company from initiating a dividend in the immediate future.
Ownership
A few words on the ownership structure of the four companies in our peer group:
Nihon still has a little bit of insider ownership, with the founder holding about 6% of the shares according to Eikon. Baillie Gifford, a Scottish investment management firm focused on quality growth, has recently been building a position, increasing their stake to nearly 9%. Nomura Asset Management also owns nearly 7% of the company.
M&A Capital still has about 55% of the shares held by insiders, 44% by the Founder & CEO, and nearly 7% by one of the executive Directors. Grandeur Peak Global Advisors, a US hedge fund focused on small caps, also owns 6% of the company.
Strike is also 44% owned by its Founder & CEO, while other executes also own a small amount of shares. The free float is about 45% of total.
Finally, M&A Research is 64% owned by its Founder & CEO.
Despite the limited free-float, all of these companies have meaningful liquidity in their shares traded on the Tokyo Stock Exchange. The average 3-months daily turnover ranged from over USD 2m for Strike to over USD 35m for Nihon and M&A Research.
Valuation multiples
The next couple of charts display valuation multiples, including 12-months forward PE ratio, based on consensus estimates, as well as historical P/FCF and P/B ratios:
As can be seen by looking at the first graph, Nihon - which has the longest trading history - has historically traded at very high multiples, often above 30x 12-months forward PE, and as high as 80x recently! It's now come back down to more reasonable levels, likely due to some deteriorating trends in growth and operating metrics over recent years, and also because of a small accounting irregularity they experienced in 2021. M&A Capital and Strike have followed a similar downward trend in multiple, often trading above 20x historically but now in the low teens. M&A Research still has the high multiple associated with rapid expected growth.
A similar picture emerges when looking at P/FCF and P/B (both based on last fiscal year) ratios. Note that we've had to put M&A Research's P/B ratio on a secondary axis not to completely distort the chart, that's how fast it has expanded over the past two years!
Valuation models
The following table summarizes our main assumptions for our discounted cash flow models, versus historical values:
We model growth over the next 10 years to be well below the prior decade, and well short of these companies' mid-term targets. We forecast a CAGR in sales ranging from 8-11% for the established players, with Nihon at the bottom end, Strike at the top end, and M&A Capital somewhere in the middle. M&A Research, if it does anything close to its targets, will continue to grow at a much faster rate.
Profitability levels are also expected to be below historical averages for both Nihon and M&A Capital. We expect operating income margins to range from 36-40%, with M&A Research and M&A Capital leading the pack, and Strike trailing.
We forecast FCF conversion rates of 80-100% for the established players, once again with M&A Capital and Strike leading and trailing the pack respectively. It remains to be seen what level of FCF conversion M&A Research can achieve on a consistent basis.
Using a WACC of 9% for Nihon, which is the largest and most established of peers, and 10% for the other three companies, we derive fair values as indicated in the table above. It seems to us that M&A Capital is showing meaningful upside potential, while M&A Research is priced for a successful implementation of its very ambitious growth objectives.
Risks
- Competitive landscape: by far the biggest risk and uncertainty relates to the manner in which the competitive landscape will evolve going forward. As evidenced by the successful emergence of new entrants, there are little to no barriers to entry to the M&A brokerage business. Increasing competition should, in principle, fade the rate of growth, and pressure profitability and return levels over time.
- Cyclicality: we've already outlined the manner in which M&A advisory and brokerage services are subject to cyclicality related to the broader economic environment.
- FX risks: all four companies derive nearly all of their revenues in JPY, and their costs are nearly all in JPY as well. As non-Japanese investors, there is a risk of a continuing depreciation of the JPY relative to the USD or other foreign currencies.
- Accounting risks: revenue recognition for M&A advisory & brokerage firms is subject to certain guidelines and formulas, which may lead to some accounting irregularities. Nihon has recently experienced such issues, albeit for a fairly small percentage of revenues.
- Going regional & global: all four firms eventually aim to become regional and then global players in the M&A brokerage market. This implies risks related to expanding operations in countries other than Japan.
- Liquidity of U.S. listings: investors that consider making an investment in any of these companies should focus on their primary listing in Tokyo rather than their very illiquid U.S. listings.
Initial conclusions
This article has aimed to provide an overview of the Japanese M&A brokerage space, as well as Nihon, M&A Capital, Strike, and M&A Research. There is much to like about this particular niche of financial services, including a number of structural growth drivers that should lead the broader market to expand in the mid- to high-single digits over the coming decade. Additionally, the industry structure seems poised to continue to consolidate gradually, with all four companies expected to gain further market share and grow well above market, and possibly in the double digits.
All companies being analyzed operate very profitable businesses, that generate strong returns on invested capital and generate ample free cash flows. All maintain exceptionally strong balance sheets. For the most part, all remain owner-operated, or at least retain some level of insider ownership.
On balance, this introductory investigation into the Japanese M&A brokerage market has left us most impressed with M&A Capital. It is the second-largest independent M&A boutique, and generally ranks first in our peer group review in terms of operating metrics and financial ratios. In our view, there are a number of interesting differences in corporate strategy which make M&A Capital fundamentally stronger than peers, including a more attractive fee structure, a more proactive approach to sourcing deals rather than relying on referrals, and more focus on handling larger and more complex deals by having the most competent and best-remunerated human capital available.
Moreover, we can't help but be somewhat at a loss to find adequate reasons that would justify the gap in valuation multiples between M&A Capital and its peers, as well as relative to historical averages. Overall, M&A Capital's valuation levels appear both low relative to peers, and attractive in absolute terms: with a 12-13x PE, a 7-8% FCF yield, and an EV/EBIT of 6-7x according to our own estimates for fiscal 2023 (ending next month). Just looking at mean reversion on multiples, and you're contemplating a double bagger or more. The existence of meaningful upside is also implied by our DCF model.
In conclusion, for us at Oyat, we'd be remiss if we didn't have a proper discussion about M&A Capital, when presented with the opportunity to acquire a participation in such a company at the current valuation level. And that is precisely what we'll do when the whole team is back from summer break. M&A Capital really does tick all of the boxes on our checklist, and some quite spectacularly. Apart from one important one. It clearly rates poorly - as do all of its peers - in one key category: competitive 'moat' and barriers to entry. This will be firmly in our minds as we consider the merits of initiating a position in M&A Capital, and will likely limit its role to a 'supporting' rather than a 'core' position in our portfolio. Such 'core' positions currently being occupied in our portfolio by the like of Berkshire Hathaway, Roche, Kone, Alphabet, Novo Nordisk, amongst others.
We hope you've enjoyed reading about this rather niche market that is the Japanese M&A brokerage space. Feel free to post us a word below if you have any comments or questions.
For further details see:
Introduction To Nihon M&A Center And The Japanese M&A Brokerage Sector