By Makiko Yamazaki and Kane Wu

TOKYO/HONG KONG Japan's M&A market is standing out against a worldwide decline this year, thanks to surging domestic deals as rising costs, stricter governance rules and shareholder pressure force companies to explore strategic options.

Total value of M&A transactions involving Japanese companies grew 14% year-on-year to $111 billion for the first nine months of 2023, making the country the only major market in the world that recorded growth, according to data compiled by LSEG.

The momentum is expected to continue in the near-term as prospects of more corporate restructuring, carve-outs and management buyouts make it a favoured hunting ground for global private equity.

"The Japanese stock market is performing quite well and this type of favourable environment encourages the founders, and those with concentrated ownership to consider selling," said Bain Capital Asia managing partner David Gross-Loh.

"In the next 6-12 months, there are easily several billion dollars worth of deal opportunities that are in our pipeline," including a couple of billion-dollar-plus take-private situations, he said.

Domestic deals, including private equity buyouts of Toshiba and JSR that totalled over $20 billion, surged 67% to be the major driver, reversing the traditional outbound acquisition model for growth, LSEG data showed.

Bankers said pressure for listed firms has been higher than ever since the Tokyo bourse made a rare call to show plans for better capital efficiency, in an effective vote of confidence for activist shareholders agitating for changes.

The top two deals this year, Toshiba Corp and JSR Corp, had activists on their rosters.

"If your stock is underperforming relative to your book value, you are more likely to start thinking proactively what to do before an activist shows up," Jim Verbeeten, partner at consulting firm Bain & Company in Tokyo, said.

Shinsuke Tsunoda, senior managing director and veteran M&A banker at Nomura Securities, said the tougher business environment with rising inflation and pressure on profit margins is also making companies more open to drastic action including mergers with rivals.

"Faced with higher wages and rising materials and energy costs, companies are more serious about a restructuring of their lacklustre domestic businesses, a step long overdue," he said.

SURGING M&A

A cheap yen, which earlier this week slid below the psychologically important 150 per dollar mark to its weakest level in a year, and low interest rates in Japan are also "a pretty significant driver of the ability to do deals," Bain Capital's Gross-Loh said.

Bankers said terms for loans from Japanese banks have tightened since Marelli Holdings, an auto parts supplier bought by KKR in a leveraged deal, requested a massive debt waiver last year. Ultra-low interest rates are also widely seen to end in the foreseeable future.

But the terms are still attractive compared to other markets, the bankers said.

The strong M&A market comes as two long-standing obstacles to Japanese dealmaking - reluctance towards unsolicited takeovers and difficulties in cutting overlapping jobs in post merger integrations - may be fading.

The Japanese government in August released new M&A guidelines aimed at cracking down on excessive defence tactics, removing a long-held stigma around unsolicited bids and spurring corporate takeovers.

The guidelines already prompted Nidec Corp, the world's top maker of electric motors, to launch an unsolicited tender offer for Takisawa Machine Tool which was later accepted by the Takisawa board.

Nicholas Smith, CLSA Japan strategist, wrote in a recent report to clients that shrinking demographics can make M&A work as tightened labour markets make restructuring and cost-saving easier.

"Previously, excess employment issues held back M&A, because cutting overlapping headcount is the primary way M&A cuts costs and raises returns," Smith said.

"As the labour shortage bites, expect M&A to surge as companies start being targeted as labour reservoirs."

(Reporting by Makiko Yamazaki and Kane Wu; Editing by Sumeet Chatterjee and Stephen Coates)