October 5, 2023
I’m delighted to sit down with Eiichi Arai, who plans to take the Next Generation Technology Group (NGTG) public on the Tokyo Stock Exchange next year.
Eiichi and his team have acquired nine Japanese industrial manufacturing SMEs in the last five years. With consolidated revenues of over USD 70m, NGTG is now gearing up for acceleration.
Gustaf: Eiichi, after a fruitful seven-year stint in the government-linked INCJ’s private equity team, you embarked on a 1.5-year trip around the world. Before departing Japan, had you anticipated founding NGTG upon your return in the summer of 2018?
Eiichi Arai: Gustaf, I had the idea of starting NGTG before going on my round-the-world trip. I observed limitations in the private equity model during my time at INCJ and saw a massive business succession gap in Japan.
With Japan's ageing population, the median age of SME owners now stands at 70. Many businesses are forced to shut down due to a lack of successors as these owners retire. However, if you look closely, about half of these shut-down businesses have healthy financials with positive EBIT!
Japanese SME owners often value long-term growth and the happiness of employees over valuation. While private equity firms have gained certain credibility these days, many owners still hesitate to sell their companies to them. Their fears stem from potential resale and a lack of long-term incentive alignment.
And based on my knowledge of Danaher, I was certain that a similar serial acquirer model would be successful in Japan. Given the cultural backdrop and immense need for business succession, a model providing a perpetual home, ensuring the continuity of the business and its employees, would be welcome.
Also, seeing INCJ make a successful investment in a serial acquirer within the food industry, the now publicly listed Yoshimura Food Holdings (TSE: 2884), reinforced my hopes for this model.
In addition to this hunch, the trip strengthened my mission to start NGTG. It helped me understand how the rest of the world views Japan, particularly the respect Japanese companies command in product design and manufacturing.
While many manufacturing businesses in Japan have great technologies unique in the global market, the lack of successors, the low quality of marketing and sales, and the slow adoption of digital tools prevent them from realizing their full potential. I believed that they could become much stronger businesses with the right support!
Additionally, as many B2B manufacturing businesses in Japan actually have relatively high margins (7-9% EBIT), I was assured that building a serial acquirer in the manufacturing space would be the right path to pursue.
Gustaf: Could you share any more details on why you chose manufacturing?
Eiichi: The three main reasons why we focused on the Japanese manufacturing industry for our serial acquisition model were:
1. The existence of many high-margin businesses in the space.
2. Less competition.
3. The potential for global expansion.
We ran with these hypotheses, and have confirmed that the first two reasons are true.
Our concept is well-regarded by owners, and we're likely to be “chosen” by them. Their complex operations and the difficulty in valuing their technology keep other buyers away, enabling us to acquire them at reasonable valuations.
We screen for targets using relatively strict benchmarks, specifically EBITDA margins above 10% and EV/EBITDA between 2.0x and 5.0x. And we’ve still been able to acquire nine great companies during the past five years.
The third reason is still to be tested, but Toshima’s chemical business is rapidly increasing sales from international clients. We’re hopeful that this positive cycle will continue to help us realize our vision.
Gustaf: Which company has been your main business inspiration?
Eiichi: Danaher has always been a benchmark and inspiration for me. I learned about the business while at INCJ and have been fascinated by their growth through M&A and their strong commitment to improving portfolio companies.
In fact, we designed our own value-creation playbook called NGTG Growth Program or “NGP” after the renowned Danaher Business System, Danaher's value-enhancement playbook.
I’ve continued to learn about other serial acquisition business models around the world since then. Of course, your serial acquirer primer and the articles of other examples on your website have kept me highly motivated!
Gustaf: I’m happy to hear that; thank you! I stumbled upon your old blog and noticed your ambition to become a 150-year-old. That’s quite the goal, but it’s still shy of NGTG’s unlimited ownership time horizon. Did your visit to a cryonics facility during your US travels sway you to take the chance of being able to check in on NGTG beyond your 150th birthday?
Eiichi: You’ve got a keen eye, Gustaf! I’m amazed you saw that I visited a cryonics facility in Arizona. Of course, I sure do hope that NGTG continues beyond my 150 years!
Gustaf: That’s great! And how does NGTG stand apart from other potential acquirers to ensure the firm thrives long-term?
Eiichi: Jokes aside, I do think NGTG has three unique characteristics that help us stand out from other acquirers.
First, by valuing each firm’s culture and not forcing unwanted exits or integrations, our unique model supports each individual business to live on.
The perpetual holding strategy that allows for the continuity of individual businesses is rare in Japan, so this is highly valued among SME owners.
Usually, large enterprise buyers change the name, culture, brand, and other aspects, causing the SME to effectively “disappear”. On the other hand, a PE buyer would typically need to resell the acquired business at some point.
Second, we have our own value-creation playbook, NGP. It supports our portfolio companies to improve their performance, both through assistance from the NGTG team and knowledge sharing among themselves.
And lastly, our diverse team of professionals and strong connections with brokers and financial institutions provide us unparalleled M&A execution capability.
These characteristics have led to NGTG being “chosen” as the acquirer and allowed us to acquire high-performing companies that meet our high bar in terms of EBITDA margins and valuation.
Gustaf: Could you talk a bit more about your M&A execution capabilities?
Eiichi: Our diverse team of professionals helps us differentiate ourselves from other acquirers, allowing us to assess the businesses and technologies of target companies from various angles and close deals efficiently.
Not only is our value-creation playbook standardized, but we also standardize the M&A execution process to make the knowledge and operation scalable.
In addition, we have built trusting relationships with financial institutions and brokers. They value our execution capabilities highly. And we now receive countless introductions to potential deals; more than 350 deals were added to our pipeline in the past year through this channel!
Furthermore, these relationships, combined with the Bank of Japan's monetary easing policy and the challenges regional banks face in effectively managing accumulated deposits, enable us to obtain favorable financial packages for new acquisitions.
Therefore, we can secure cost-effective, high-leverage debt packages for our acquisitions, sometimes reducing our equity portion to near zero!
Gustaf: Take us back to the initial days of NGTG. What did they look like?
Eiichi: I originally started NGTG with former classmates and colleagues. Their backgrounds included accounting, manufacturing, and tech, which were complementary skill sets that helped overcome an early-stage venture's ups and downs.
The early days were a never-ending series of cold calls to various brokers… And our first investment into Toshima Manufacturing is especially memorable. Raising acquisition financing was challenging as NGTG didn’t have a track record yet. However, we were able to draw on my background in PE and the team’s complementary expertise in negotiations with banks.
Following the acquisition, I became the CEO, and the other three NGTG members rented a house nearby so we could visit the company every single day.
We were careful to avoid any top-down initiatives; trust was slowly built by sitting down with every single employee to have deep discussions and rolling up our sleeves alongside them.
And as the Toshima team gradually opened up, we explored various improvement initiatives together, which helped build the foundation of our current NGP.
Two years after the acquisition, I handed over the Toshima CEO role to one of its employees, Mr. Saito, so that they could continue to build on their success in a self-sustainable manner.
Likewise, while we do provide hands-on support to our portfolio companies, we ensure they can become self-sustaining after the initial value-creation period.
A positive side effect of this early experience as CEO of Toshima was that it became much easier for me to break the ice with SME business owners in the sourcing process!
They feel much more comfortable selling to someone who has shared the same experience than to pure investors who may be alien to them.
Gustaf: Talk about immersing oneself in the operations. How has the NGTG growth program evolved?
Eiichi: We started by combining the initial members’ experiences and created a list of post-acquisition action items as a preliminary NGP.
And as I mentioned, our first platform was Toshima, a company with two businesses: cold forging for automobile parts and spattering target (a chemical substance that can be used for superconductors, batteries, etc.).
We did everything from back-office reinforcement, such as hiring support, to operational improvements, such as installing an IoT on-site monitoring system and developing in-house AI-based inspection equipment. We also established digitization initiatives such as online chat tools to promote open communication and production management systems.
To make this all happen, it certainly helped that one of our initial members had a strong tech background while another had experience at a large manufacturing enterprise. My experience from investing in six companies at INCJ also provided us with many ideas.
The biggest challenge was experiencing the COVID outbreak three months after closing Toshima. We felt like we were pushed off a cliff after the joy of our first success!
Due to factory shutdown and supply chain disruptions, the revenue for that period decreased significantly. It was tough.
But COVID also had a positive impact. Being in crisis mode brought the NGTG team and portfolio companies closer together. We were all desperate to overcome the obstacles, so the employees became even more cooperative to try various new ideas.
Our value-creation process has successfully led to significant growth of Toshima’s operating profit, which has increased from around USD 1-3M before acquisition to be on its way to achieving a record-breaking USD 6M this year.
Drawing from the Toshima experience, we applied similar initiatives to our second portfolio company, Toyo Mark. As a result, their margins also improved by more than five percentage points, giving us confidence in the reproducibility of the playbook.
We continue to improve NGP through trial and error. The NGTG team meets weekly to share how NGP functions at each site, continuously updating the playbook and facilitating the sharing of best practices between the subsidiaries.
Over the years, NGP has evolved into our secret sauce to success. Its initiatives improve each company’s cash flow, allowing us to repeatedly acquire companies by utilizing the accumulated cash of existing portfolio companies.
Gustaf: After the IPO, does NGTG plan to explore opportunities outside Japan? How do you see your growth trajectory in the next five years?
Eiichi: Global expansion is certainly top of mind for us. We chose manufacturing because it is Japan’s well-respected strength in the global market, and we hope to become Japan’s first global serial acquirer.
However, our short-term focus post-IPO will remain on the domestic market. I believe there are more low-hanging fruits in the Japanese market with an ongoing need for business succession, and we plan to capitalize on this opportunity.
Our strategic objective is to acquire four to five companies annually over the next five years. We believe this is a feasible goal, given that we anticipate receiving 400 to 500 deal proposals each year and expect to close about 1% of them.
To provide some context, we successfully acquired three companies from a pool of 350+ potential deals presented to us this past year. That momentum, combined with the favorable macro trends in Japan, underpins our confidence in sustaining robust growth.
Additionally, following our IPO next year, we plan to opportunistically target larger companies, potentially leading to an upward trajectory for our growth target.
Gustaf: For readers who wish to connect, how can they reach you?
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