Carlyle Learns a Hard Lesson About Private Equity in Japan

Private equity firm Carlyle Group, which manages $87.9 billion in assets, has spent more than a decade building a global platform. The firm has a team of 450 investment pros that operate in offices in 19 countries. And one of its biggest efforts has been in Japan.That market has been tough to crack and also risky. For example, late last week, one of Carlyle's investments -- mobile-phone company Willcom -- filed for bankruptcy and as a result, the equity holding is now worthless. Despite this, Japan remains a promising market for private equity, and Carlyle certainly isn't going away.

A Long and Winding Road

The Willcom transaction is a classic case study of private equity deals in Japan. First of all, it took Carlyle roughly two years to get it done. Next, the firm had to bring along a Japanese partner, Kyocera. The upshot was that Carlyle wound up with 60% of the equity.

Willcom was also part of the KDDI conglomerate, which made it difficult to grow because of the bureaucracy. For example, Willcom's wireless technology, called the personal handy service (PHS), was somewhat dated.

So then why do the deal? Well, PHS was actually a low-cost approach to providing mobile service. Carlyle saw it as a way to make inroads in the market.

No Choice but to Restructure

And yes, after Carlyle made its investment in 2004 (which came to $330 million), Willcom was able to post strong growth, as the customer base grew from 2.9 million to 4.6 million at its peak.

However, by 2007, the company hit a brick wall as NTT DoCoMo, Softbank, Emobile and even KDDI made gains in the low-cost market. At the same time, Willcom was unable to keep up with new mobile technologies, which worsened as the credit crunch hit.

With $2.3 billion in debt and lagging revenue growth, Willcom had no choice but to restructure. Now it appears that Softbank and Advantage Partners (a Japanese private equity firm) may ultimately purchase the company.

In It for the Long Term

As the world's second-largest economy, Japan is potentially lucrative for private equity firms. In fact, the country has a variety of massive conglomerates that could benefit from spin-offs. And many privately held firms could also use more financial discipline.

Besides Carlyle, a few other private equity firms have been trying to capitalize on the opportunities in Japan. A notable player is Bain Capital. Over the past year, it has paid $1.1 billion for BELLSYSTEM24, a call center in Japan, and it purchased the master franchisee of Domino's Pizza in Japan.

Yet, plenty of skepticism abounds in Japan about big American private equity firms that aggressively pile on debt, cut jobs and costs. No doubt, the Willcom bankruptcy will definitely be a tell-tale sign of this -- and could be an impediment to further deals.

But Carlyle and Bain realize that a long-term perspective is required and that the payoff should be strong, despite the risks. After all, it looks like Carlyle will still double its return on Japanese investments (according to a report in The Wall Street Journal). Just imagine if Willcom had been a home run.

Tom Taulli advises on
business tax preparation and is also the author of a variety of books, including the including The Complete M&A Handbook. His website is at
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