US-based Ripplewood hunts down Japan Telecom

25 Feb 2003

US-based private equity group Ripplewood’s plans to purchase the fixed line assets of Japan Telecom via a leveraged buyout deal could, if successful, be the largest in Japan’s history, but sceptics are already warning that the company will have to ramp up its efforts in the data services segment to counteract the long-term trend of declining revenues from voice telephony. Ripplewood is reputedly in talks with Mizuho, Sumitomo Mitsui Bank and Bank of Tokyo Mitsubishi and other leading financial institutions over securing more than JPY200 billion (USD1.7 billion) in financing to pay 80% of the asking price with bank loans secured against its assets. With formal due diligence on Vodafone-controlled Japan Telecom’s fixed line operations set to begin soon, Ripplewood is understood to be keen to limit its exposure on a deal which has a potential value of between JPY300 billion and JPY350 billion.

Foreign private equity firms have historically been unwelcome in Japan, viewed as they are as preying on weak companies. Ripplewood’s bid has attracted a degree of curiosity, however, as analysts speculate as to how it will realise a return on its investment given the commoditisation of the traditional voice telephony market and attendant reduced margins in the industry. Some suggest the company could look to repay the debt within six years by utilising Japan Telecom’s operating cash flow – JPY90 billion in 2003 – but given the poor outlook for the fixed line business, where cash flow is expected to dip to JPY50 billion per annum over the next couple of years, it could struggle to meet its target unless it dramatically grows the data side of its business. To date, Japan Telecom’s corporate strategy has emphasised improving performance through the continued implementation of Project V. The programme is designed to realise cost efficiencies and enhance revenue growth of profitable areas as well as developing fresh revenue streams including the expansion of its broadband portfolio. But with the arrival of new players to the fixed line market continuing apace in Japan it is still difficult to see how the telco will make sufficient inroads. As at 30 September 2002 Japan’s fixed line market consisted of the original Type I carriers (NTT and KDDI ), 380 new Type I (NCC) carriers, 113 Special and 10,263 General Type II carriers. The figures marked a general rise from the same period in 2001 at which time there were 360 new Type I (NCC) carriers, 115 Special and 9,691 General Type II carriers.

Moreover, despite 17 years of market liberalisation the fixed line market remains by and large in thrall to former local monopoly operator NTT. Although government legislation saw the introduction of the MYLINE carrier selection service in May 2001, by 31 March 2002 an MPHPT report concluded that NTT still controlled 74% of the local MYLINE market, as well as 67%, 57% and 53% of the intra-prefecture, inter-prefecture and international markets respectively. By the end of September NTT’s regional units NTT East and NTT West had 25.045 million and 25.559 million local subscribers respectively – the lion’s share of the market. Therefore, given the proliferation of companies starting up in Japan, Ripplewood could look to use Japan Telecom as a base from which to launch further audacious merger or acquisition bids, leading to much needed consolidation within the industry. Another option for the US company could be to float the business or sell it in the future, thereby raising up to JPY350 billion – a significant return on its JPY70 billion of equity.

CIT’s Yearbook of Asia-Pacific Telecommunications 2003