Japan's state-backed funds take risks, but what are the rewards?

TOKYO Fri Apr 26, 2013 4:31am IST

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TOKYO (Reuters) - As part of Japan's economic revival plan, the new government has added $3.2 billion to the spending power of state-linked funds investing in Japanese companies, effectively acting as venture capitalists much to the chagrin of private equity firms.

Critics argue the government largesse - the state funds spending power has now gone up to some $34 billion - will crowd out private equity in a country that desperately needs risk-taking investors to revitalise a corporate sector struggling to maintain its global competitive edge.

"What's happening now is that state-backed funds are investing in companies, which private funds are also willing to invest in," said Tomonori Ito, professor at graduate school of international corporate strategy at Hitotsubashi University.

Last year, U.S. private equity firm KKR & Co (KKR.N) was edged out from taking control of struggling chipmaker Renesas Electronics Corp (6723.T) by a group led by the state's Innovation Network Corporation of Japan (INCJ).

Adding credence to the concerns, Thomson Reuters data shows that private equity investment in Japan of $94.85 million so far this year is just one-sixth of the year-earlier amount and is at the lowest level since 2006.

If the investment continued at the same pace for the rest of 2013, the year's total would be just over $300 million, the lowest by far in at least a decade. Last year's total was $3.2 billion.

Scarcity of risk-taking investors has long been seen as a weakness in Japan that explains why it has failed to produce a Japanese Google or Facebook and the likes of electronics giant Sony Corp (6758.T) are being overtaken by nimbler rivals such as Apple Inc (AAPL.O) and Samsung Electronics (005930.KS).

Still, the government faces a dilemma. While it wants more venture capitalists, few have come knocking on Japan's door. So successive governments have felt compelled to fill the gap with state-backed funds.

GRAPHIC: Private equity slows link.reuters.

Since sweeping to power in December, Prime Minister Shinzo Abe has pumped more money than ever into existing state-linked funds while setting up new ones. Government-owned lender, Development Bank of Japan, has created a 150 billion yen fund and a 60-billion-yen "Cool Japan Fund" is under consideration to invest in the clothing and animation sectors.

The risk in using public funds to invest in companies is that they are less demanding than private equity, critics say. They may be reluctant to make hard business decisions and so could delay corporate restructuring, helping troubled firms stay afloat at the expense of healthier rivals and ultimately delaying the economic revival policymakers desire.

"I agree that risk money is not widely available in Japan, so someone needs to inject cash into Japanese companies," said Shusaku Minoda, head of Japan Private Equity Association and chairman of KKR Japan, the Japanese entity of KKR. "But if whoever forms a fund to do it, it should be disciplined as private funds are."

CROWDING OUT

The association urged the government last month to set up a monitoring system on the returns on government funds and to limit the amount they invest and the period of their investment.

Without such discipline, these funds will be no more than another channel for fiscal pump-priming, critics say.

"These are projects that have sprung up because fiscal discipline was relaxed, under the mantra of economic stimulus," said Hideaki Tanaka, professor at Meiji University's graduate school of governance studies.

The Japanese public, who are ultimately on the hook if state investments go bad, get little or no information on performance targets, returns or how companies are selected.

In one example, the INCJ spent 200 billion yen to form Japan Display, the world's No.1 maker of small and medium-sized LCD panels, out of struggling units of Sony, Toshiba Corp (6502.T) and Hitachi Ltd (6501.T).

Launched last year, the company is 70-percent owned by the state and unlisted, so the public has no way of judging how the investment is paying off.

INCJ, which under Abe received an injection of 124 billion yen to boost its capital to 280 billion yen, has provided no information about its performance.

An INCJ spokesman said it was "generally difficult to answer" queries about the profit outlook for companies in its portfolio, criteria on which investment decisions are based, growth targets, capital costs and governance.

A notable exception to the information void was the 2010 bailout and last year's flotation of Japan Airlines Co (9201.T) by Enterprise Turnaround Initiative Corporation of Japan, which last month was renamed the Regional Economy Vitalization Corporation of Japan.

The entity cashed in 313 billion yen on the airline's turnaround. In most cases though, there is no clarity whether the state is making or losing money.

Possible risks to Japanese taxpayers were on full display last year when Elpida Memory Inc, a maker of DRAM chips, failed only three years after it was saved with a 30 billion yen investment from the DBJ and 110 billion yen in loans from DBJ and other banks.

Yukio Noguchi, honorary professor at Hitotsubashi University, who specialises in Japan's economy and finance, said it was not clear what purpose multiple state funds served besides creating jobs for retiring officials.

"If the government keeps creating these funds, then there is no hope," he said. (Editing by Tomasz Janowski and Neil Fullick)

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