Japan Venture Capital Funds Facing Mergers as IPOs Disappear

By Patrick Rial and Kotaro Tsunetomi

April 6 (Bloomberg) -- Japanese funds that buy stakes in start-up companies are struggling to survive amid the worst market for initial offerings in 17 years, Kazuhiko Tokita, chairman of the Japan Venture Capital Association, said.

Only 49 companies went public last year, the fewest since 1992, depriving venture firms of the source of 45 percent of revenue and 90 percent of profits, based on data from 2007. The investors are likely to pool their holdings to create bigger stakes so they can pressure companies to merge or buy back stock, Tokita said.

“The industry needs to gather its power during this ice age, and that means combining,” said Tokita, a former director of Mitsubishi UFJ Financial Group Inc.’s venture capital unit. He predicts funds will lose money this year and possibly next. “When this is finished, what’s left standing will be the real venture capitalists.”

The country’s three biggest firms saw two years of profits wiped out since April 2008 as Japan’s economy shrank at a 12.1 percent rate in the fourth quarter, according to data compiled by the Venture Enterprise Center and Bloomberg. Japanese funds, which together manage 1.04 trillion yen ($10.6 billion), get more than twice as much revenue from IPOs as U.S. and European firms, according to Venture Enterprise.

Tokita’s group will hold a meeting for more than 100 members this month to facilitate merger negotiations and collaboration on investment stakes, he said.

Frozen Capital

The inability to take companies public is reducing new investments, starving start-up businesses of capital. Smaller companies, which employ about 70 percent of Japan’s workforce, said financing is the hardest to get in at least 23 years, according to a survey published by Shoko Chukin Bank on Feb. 25.

Of the 936 companies that went public in Japan from 2002 to 2008, 62 percent were backed by venture funds, data from the JVCA shows.

“The drain on available funds is a real concern,” Venture Enterprise wrote in a report. “Venture firms are Japan’s drivers of industrial competitiveness and economic activity.”

The venture units of Shinko Securities Co., Dai-Ichi Mutual Life Insurance Co. and asset manager Diam Co. merged in February 2008. Meiji Capital was acquired by Yasuda Enterprise Development on April 1.

“Funds that can’t break even in this environment will be forced to exit,” said Shinichi Fuki, executive managing director of Jafco Co., the largest venture investor. “There’s been talk that some players will be pushed into mergers, and I’ve got a strong feeling that’s what’s going to happen.”

IPO Profits

IPOs slumped as the deepening global recession dragged the Nikkei 225 Stock Average to the lowest level in 26 years.

The 49 IPOs last year was less than a third of 2006’s level, according to data compiled by Bloomberg. This year, no companies listed in January or February for the first time since at least 1999.

Profitability of IPOs is also declining. The first four companies that sold stock this year priced shares at an average of 7.9 times annual earnings, compared with 15 times in 2008.

The IPO “business model is dead,” said Hiroshi Matsumura, director of the VEC. “Those who can’t successfully diversify their exit strategies won’t survive.”

Jafco, Daiwa SMBC Capital Co. and Japan Asia Investment Co., the country’s three largest venture firms, reported combined losses of 25.6 billion yen ($260 million) for the first nine months of the fiscal year ended March, compared with total profit of 22.9 billion yen for 2006 and 2007.

Mounting Losses

Jafco lost 851 million yen in the period. Daiwa SMBC reported a 5.1 billion yen loss in the same period, while Japan Asia Investment suffered a 19.6 billion yen decline. Their shares slumped more than 10 percent this year, trailing the Topix index’s 3.2 percent decline.

Besides IPOs, venture funds make money when companies they invest in merge, repurchase stock, or sell units to other funds or companies. Management buybacks, where executives repurchase shares from venture capital firms, and liquidations made up 37 percent of Japanese venture fund revenue in 2007, VEC data showed.

Mergers accounted for 16 percent of revenue and 1.9 percent of profit, with other strategies making up the remainder, according to the VEC.

Stakes owned by Japanese funds are too small to force acquisitions, the JVCA’s Tokita said. Pooling holdings would give them new ways to profit, he said.

“Our industry is in a race for survival on a global level; we’ve been hit by a giant tsunami,” Fuki said. “VC firms that aren’t able to raise funds and continue investing when prices are low aren’t going to make it. The need for fund consolidation is not something I can deny.”

To contact the reporters for this story: Patrick Rial in Tokyo at prial@bloomberg.net; Kotaro Tsunetomi in Tokyo at ktsunetomi@bloomberg.net.