Bidding War for Kakaku.com Escalates - EQT vs Bain

Multiple new salvos have been fired in this battle of the titans over the last month.

EQT is in a bidding war with a consortium of Bain Capital & LY Corp (owner of messaging app Line + Yahoo Japan) to take Kakaku.com private. Kakaku.com is the owner of leading restaurant reviews platform Tabelog. With the latest round of bidding, Kakaku.com’s market cap has reached US$4.8bn – so this is a significant deal even by global standards.

The deal is complicated by the presence on Kakaku’s register of telecom operator KDDI (~18%), payments processor Digital Garage (~21%), and activist Oasis (~20%).

Rather than laboriously recap the to & fro, I am going to shamelessly copy and paste a great summary of the multiple rounds of bidding, from the only broker in Japan I am aware of who covers activism in a dedicated fashion – CLSA’s John Seagrim:

What is particularly interesting about this deal is that the price shareholders will receive hinges on KDDI agreeing to sell its stock back to Kakaku.com at a discount. The rationale is that KDDI will be tax exempt on a buy back once other shareholders are squeezed out, due to the size of its shareholding. This would compare with paying the full tax rate on a sale to Bain. Kakaku needs to consent to receiving a lower pre-tax price that is equivalent to the post-tax price received by other shareholders. This would result in a sharing of the tax benefit with all selling shareholders.

Bain’s announcement of two different offer prices appears to be aimed at both pressuring KDDI to do the right thing by other shareholders, and highlighting Kakaku.com’s Board’s responsibility to shareholders (note, the Board does not have such a duty) to ask KDDI to offer the same treatment to Bain as it did to EQT in order to achieve the best price for shareholders.

Complicating matters significantly, Digital Garage had agreed to sell its stake back to Kakaku as part of EQT’s bid, but then reinvest with EQT post-privatisation. Digital Garage sees Tabelog and its restaurant relationships as a key growth area for its payments processing business. Bain’s partner LY Corp owns payment wallet PayPay, and major LY Corp (indirect) shareholder Softbank owns SB Payment Service – a direct competitor to Digital Garage.

Oasis will almost certainly be telling Kakaku’s board to sell to the highest bidder. The Chairman of that Board is the Founder and CEO of Digital Garage. Oasis not so long ago bought a large stake in Digital Garage and waged a very vocal public campaign, before selling its stake to Resona Bank. To say they are unlikely to be on good terms is almost certainly an understatement.

Now, the Board is supposed to (but not required to) follow the recommendations of the special committee of external directors that was established to evaluate the deal. Somewhat hilariously, three of the six external directors were excluded from participation on the committee due to conflicts. One is the CEO of a company backed by EQT, another is the CEO of a company backed by a fund affiliated with Digital Garage, and the third is an executive officer at KDDI! One of these external directors has since stepped down and has not been replaced, leaving the board 50% internal, 50% external directors, whereas previously external directors were the majority.

Of the three “non-conflicted” external directors that comprise the special committee, the Chairman is the most “Japan Inc.” establishment of all the external directors, having spent his entire career at storied ex-zaibatsu trading company Mitsui & Co. A public takeover battle with an activist making demands is likely anathema to his entire raison d’être. Another member is a lawyer, but with a career in Public Prosecutions rather than corporate law, and the third member is an accountant. An outside observer might be forgiven for taking an educated guess that this committee may not view achieving the best price for shareholders as their key priority.

Bain can succeed provided KDDI agrees to the buyback, but may still struggle to reach the 2/3 threshold for squeezing out minorities without Digital Garage’s agreement. Realistically, KDDI is unlikely to agree to Bain’s bid without the special committee’s support. Oasis will tender to whomever pays the most provided it thinks the deal will go through. Digital Garage is unlikely to agree to back Bain’s bid, but potentially could be backed into a corner by the special committee.

The special committee, despite the potential misgivings an educated dispassionate outside observer might possess, has actually behaved reasonably well to date. Withdrawing their recommendation that shareholders should tender to EQT when they have received Bain’s higher bids. However, this is only part of the story, as corporate lawyers in Japan in these situations have split the nature of the committees’ recommendations in two.

The first part is “does the special committee support the bid?” the second part is “does the special committee recommend that shareholders should tender into the bid?”. While the legal and mental gymnastics required to view these two concepts as being distinct are not uniquely Japanese in nature (the US and UK both allow this in some circumstances), the regularity of their exhibition in these situations certainly is.

So theoretically the special committee still supports EQT’s bid, and EQT now has the highest bid provided KDDI does not agree to work with Bain. This would seem like an easy out for the special committee to end the process and go with EQT, but they still need to get the deal through. EQT has met Oasis’ publicly announced minimum price of ¥3,640 per share, so the question is whether that is enough to make Oasis tender in the face of a 1.1% higher bid from Bain. If all three major shareholders support the deal, it is highly likely to go through. 1.1% does not sound like much, but it represents the better part of an additional $10m for Oasis’ investors, and almost $2m in performance fees for Oasis (assuming a 20% fee). Kakaku.com is currently trading above even Bain’s higher price.

Regardless of the outcome, Digital Garage is set to receive a huge windfall relative to its market capitalisation. DG is currently valued at a market cap of US$720m. Its stake in Kakaku is currently valued at US$997m. Even assuming the entirety of that is profit and they pay full tax, it almost covers DG’s market cap. If EQT wins, and DG reinvests into Kakaku post privatisation at what will be a very full price, much of those proceeds will disappear into Kakaku equity (there will be debt in the capital structure, so it will not be all the proceeds).

Should one buy DG then?

Potentially. The value opportunity is clear on an asset basis, and DG is also the (distant) second player in online payments behind GMO Payment Gateway. This is a valuable business. The digital marketing business is less interesting, but has some value.

The issue is the company is run by management that has not done a good job of allocating capital and has been unwilling to reform the business operations even in the face of heavy outside pressure from Oasis. With Oasis selling its DG stake to Resona Bank, a key partner of Digital Garage’s for offline payments, there is even less incentive for management to look after shareholders even if DG receives a huge windfall from selling its Kakaku.com stake as shareholders aligned with management control the register. A key unknown is what Resona Bank, which now owns 30% of Digital Garage, thinks of all this.

These hurdles have not stopped Hong Kong hedge fund Old Peak, which has increasingly become activist in Japan, from building a 7% stake in Digital Garage, and the stock price is certainly not reflecting the bidding war, being little changed from its level prior to the first announcement of the EQT deal for Kakaku.

In any event, Bain is at the centre of yet another major takeover battle in Japan that will create yet more interesting and highly relevant corporate governance precedents, and looks likely to deliver a fantastic result for minority shareholders.