NGTG: Building The Danaher of Japan
Privately held NGTG is executing a buy-and-hold serial acquisition strategy focused on small to medium-sized manufacturing businesses. With a proven model & initial success, the future is bright
We are very excited today to share our conversation with Eiichi Arai, Founder & CEO of Next Generation Technology Group (“NGTG”). Arai-san & his colleagues at NGTG are in the beginning phases of building the Danaher of Japan. With a focus on acquiring cash generative small & medium-sized manufacturing businesses (“SMBs”), the group’s up-till-now success has been made possible by their detailed planning, methodical execution & consistent adherence to a set of deep rooted corporate values that permeates throughout the growing organization.
Left: Arai-san Right: product & factory pictures from NGTG’s initial portfolio company
JBI: It is so great to reconnect with you, Arai-san. Thank you so much for taking the time to share more about yourself & NGTG today.
EA: Of course. It is my pleasure.
JBI: Excellent. So, let’s dive right in. Before discussing NGTG, would you mind first sharing a bit about your professional background?
EA: Absolutely. While I am currently 37 years old, I began my career about 15 years ago after graduating from The University of Tokyo with a major in Economics (JBI note: U. of Tokyo is effectively Japan’s equivalent of Harvard). My first job was with Mizuho Securities where I worked within the Principal Investment division. I spent much of my time investing in & monitoring a $2Bn portfolio of mezzanine debt products, such as LBO, CMBS, RMBS, ABS & WBS. I was also instrumental in creating CDOs from various BB & BBB rated bonds.
Right after the Great Financial Crisis, I joined Innovation Network Corporation of Japan (“INCJ”) as a founding member in 2009. INCJ is a ~$20Bn government-linked investment fund focused on supporting the development of Japanese technology & industry. Notably, INCJ has two sides to its business, one focused on private equity & the other on venture capital. I was in the private equity group.
JBI note: to directly quote INCJ, their purpose is to “boost the competitiveness of Japanese firms by promoting a philosophy of 'open innovation' and creating next-generation businesses in promising new technologies by providing capital and managerial support, through private-public partnership.”
During my time at INCJ, I was responsible for investing in & supporting the growth of six companies, including UniCarriers (a forklift manufacturer), Nihon Inter Electronics Corporation (semiconductors), Transphorm (a U.S. semiconductor company), Zephyr (a small wind turbine manufacturer), Peach Aviation (a low-cost upstart Japanese airline) & Chaucer (a U.K. based freeze-dried food producer). We were fortunate to exit four of these companies during my tenure for multiples of our initial investment.
After seven years with INCJ, I decided to explore the world! I really wanted to see what people, cultures & businesses were like outside of Japan. I spent the next year and a half traveling to many different countries. It was an incredible experience. One of my biggest takeaways was that Japanese products & manufacturers are well respected globally.
JBI: What an experience! Travel is invaluable & it seems like it had a profound impact on you, as right after you returned, you founded NGTG, correct?
EA: Yes, exactly. I founded NGTG in July 2018. The team is now comprised of six members, each with a primary focus (i.e. deal sourcing, technology, finance, etc.). We aim to acquire SMB manufacturing companies where the owners do not have a viable successor - a very common reality in Japan. Unlike with a typical private equity firm, we do not sell our portfolio companies. Our ideal role model, if you will, is Danaher of the U.S. Their approach & strategy has inspired our own.
JBI: We’re very familiar with Danaher as well as with many other highly disciplined, serial SMB acquirers around the globe, such as Constellation Software, Indutrade & LIFCO, among others. Executing such a strategy in Japan seems to be incredibly attractive given the current market & other cultural realities. Would you mind elaborating on this?
EA: You’re exactly right. As most likely know, Japan’s population has been declining & will almost certainly continue to do so over the next few decades. To drive home this reality, the median age of SMB owners is 70 in 2020! Based on the latest government statistics, there are 3.6M SMBs in Japan today.
According to the same government report, approximately 50% of SMBs that go out of business each year are actually generating profits. Most such SMBs must close simply because they have no successor. This is an unfortunate reality for the owner as well as for his / her employees, customers & suppliers, however, it can be a very attractive opportunity for an astute investor-operator.
Naturally, acquisition multiples for these successor-less SMBs are meaningfully lower than more typical, larger deals. More specifically, NGTG’s target acquisition multiple falls between 3x to 5x EBITDA, depending on the situation & company quality. Something which is very unique in Japan is that most SMB owners highly value synergy, continuity, enthusiasm as well as the happiness of their employees and other stakeholders far more than maximizing their ultimate exit value. This benefits investors, of course, though also requires a very delicate, genuine & consistent approach to deal sourcing, negotiations & post-acquisition operations.
While it depends on the situation specifics, investors can often borrow very affordably from regional & government linked banks to finance such SMB acquisitions - sometimes even with zero or very little equity.
JBI: Interesting. Given our own research into this topic, we too have seen how the SMB succession crisis is a very significant & pressing dilemma for the Japanese economy. We’ve also come across government reports stating that 50% of Japanese SMBs with owners older than 60 years old are looking for, but are unable to find, a successor. Moreover, nearly 70% of SMB owners over the age of 70 are unable to identify a successor, all the while realizing that 2.4M SMBs (>60% total) will be run by managers aged 70 or older by 2025! While that creates a “target rich” environment for the likes of NGTG, we’d argue what is more important to appreciate is the very real economic & social value-add that you & your colleagues are providing to a growing number of communities across Japan. It’s easy to get lost in the numbers & get carried away by the potential investment upside, but it is critical to keep things in perspective. Acquiring quality, profitable SMBs that may otherwise have to close their doors is providing a true lifeline to the Japanese economy, however small.
With that said, if you don’t mind, we’d love to return to the idea of NGTG building the Danaher of Japan. How did you arrive at this vision? Why Danaher exactly?
EA: Let me answer that by starting from the beginning, if you will. When I think back, I knew I wanted to establish my own company during my university days. Realizing I lacked the many skills necessary for a quality CEO at that time, however, I decided to focus on beginning the early part of my career in the private equity industry. To get there, I first had to join an investment bank, which later allowed me to jump to INCJ, as mentioned earlier. While at INCJ, I first stumbled upon Danaher & immediately fell in love. Their deep focus on continuous growth & learning, always seeking to drive improvements in acquired businesses & maintaining an active acquisition mindset - it all resonated very deeply with me in how I began to think about business.
After having more deeply studied the “Danaher Business System” I attempted to execute a Danaher-esque investment & corporate improvement strategy in our efforts at INCJ. I’ll provide two examples of our efforts in this regard:
As touched on earlier, we invested in a company called UniCarriers (“UC”). UC was a new company formed via a combination of Nissan’s & Hitachi’s forklift businesses. Once acquired by INCJ, we supported the company in acquiring seven add-on acquisitions, which helped to significantly drive growth. The resulting cash flow was substantial. The principal strategy was quite simple: focus on a cash generative business model, leverage the cash flow to acquire similar cash-flowing businesses & rinse & repeat. Unfortunately, being a fund, we had to sell UC, though if we were able to hold the business for the long-term, I have no doubts that we could have further scaled the company’s size many times over using this strategy.
While not a deal I specifically worked on, my colleagues at INCJ invested in a now publicly listed company called Yoshimura Food Holdings (TSE: 2884). Quite simply, Yoshimura acquires small, usually sub-scale food manufacturers & looks to improve them & optimize costs by integrating them into their broader holding company. To date, I believe they have acquired around 20 companies. Their P/E ratio is ~50x & they are acquiring companies for a fraction of that, often with very affordable debt - it is a very value accretive acquisition strategy.
In seeing these strategies executed first-hand, I figured I could so the same in the manufacturing space. As mentioned, my travels abroad only reinforced my desire to build what is now NGTG after I saw how respected Japanese products & companies are around the world. To that end, I sought to start a company that is limitless in its ability to expand & could further its growth by acquiring companies not only in Japan, but also abroad in due time.
JBI: You’ve clearly put significant thought into how you want to build NGTG. To what extent is your approach & model different from other SMB acquirers in Japan? Are there many similarly focused investment firms or corporations?
EA: That is a good question & something we seek to emphasize when speaking with SMB owners. In Japan, and I would argue really anywhere, large corporations will acquire an SMB & quickly change its name, culture and brand - in a way, the SMB “disappears”. Many Japanese SMB owners are today very apprehensive about this path. Their life’s work is gone, for all intents & purposes, once acquired. I should add that for many large corporate acquirers, most SMBs are just too small to “move the needle”.
As for private equity, the industry’s reputation continues to slowly improve in Japan, but they will always need to sell portfolio companies. Conversely, we will never. This is a very powerful comparison we make when speaking with SMB owners.
As for competitors, we know of only a few today.
JBI: The buy-and-forever-hold approach is not only rare, but certainly quite powerful when speaking with SMB owners. You can really become a true “home” for these businesses, which, as you suggested earlier, is an important consideration for Japanese SMB owners.
To get a bit more into the weeds, can you share some details about how you went about initially setting up NGTG?
EA: Sure. Our first two hires were my close friend from high school, who has a CPA & a very strong background in finance, as well as a former colleague of mine from Mizuho Securities, who today leads our deal sourcing efforts. The other three members who round out our core leadership team at NGTG are also long-time friends of mine with complementary skill sets. Because of this, we work very well with one another through all of the inevitable ups & downs we encounter.
With regards to deal sourcing, we predominately use financial advisors & banks. Their success fees are not cheap, but we underwrite deals with this cost baked in. To date, we have met with more than 250 professionals at over 180 M&A & financial advisory groups to build out our deal pipeline. We generally, though not exclusively, focus on SMBs with $5M to $10M in sales. However, our first “platform” acquisition, Toshima, had $50M in revenue at the time of the deal across its two businesses in the auto parts & materials sectors. It was a unique opportunity that was too good to pass up!
Fortunately, we worked closely (& very hard!) with banks to acquire the business with mostly debt & very little equity - we put down <10% equity. For the equity portion, we raised a modest sum from high-net worth individuals.
JBI: To briefly dig a bit deeper into the topic of deal sourcing, do you find it relatively easy to convince SMB owners to speak with you?
EA: The short answer is yes. Our approach & model is unique & aligns well with the typical goals & desires of an older SMB owner seeking to hand off his hard-earned legacy. But again, we put in a lot of work to cultivate relationships with a very wide range of brokers & advisors - we do not have direct contact with SMB owners until we are well within the due diligence process. Over the course of the last two years, we have seen more than 300 information memorandums.
JBI: That is interesting to hear, as in the U.S., you’ll often have a more proprietary, “in-house” SMB owner outreach strategy. I imagine culture plays a role here to a meaningful degree when comparing deal sourcing strategies in the U.S. vs. Japan.
So, you brought up a bit earlier your target revenue range of $5M to $10M. Could you shed some additional light on your broader investing criteria & operating strategy?
EA: Just to recap a bit first, we only focus on manufacturing companies & we are a buy-and-hold investor. Beyond that, our target EBITDA range is currently $0.5M to $10M & we seek to acquire companies at a 3x to 5x EBITDA multiple.
To expand upon our operating approach post-acquisition, we are actively developing today what we are calling the “NGTG Way”, which is somewhat similar to the “Danaher Business System”. For our initial acquisition of Toshima, our entire corporate team at NGTG, a total of four of us, moved to the town in which Toshima is headquartered. We believe it is very important for us to “live & breath” the company, particularly as it is our first and thus most important portfolio company.
I am the day-to-day CEO of Toshima, which has a secondary benefit of increasing my credibility among other SMB owners. Instead of an “outsider”, I am now “one of them”.
To share a bit more, once we acquire a company, the NGTG leadership meets with every single employee one-on-one. We work hard to really understand the business & the existing culture as deeply as possible. After about three months of this in-depth company-wide engagement, we seek to optimize the corporate organizational chart & shuffle employees as needed, ensuring we keep active lines of communication with all team members. To help in that process, we have introduced Slack across our initial portfolio company as a means to more smoothly & casually communicate with everyone.
To touch on technology briefly, one team member at NGTG has prior experience at NTT Data, the largest system integrator in Japan. He leads our efforts to introduce production automation systems across our manufacturing processes. We also actively seek to upgrade our web presence & improve how we source & engage with customers on the internet.
In terms of cost savings, at Toshima we introduced a “one cent check system”, whereby employees need to initially receive clearance from the CFO before making corporate purchases - something that was not happening prior to our ownership. The CFO of Toshima is from NGTG. Upon implementing this system, we have saved ~30% in monthly production expenses. Ongoing analysis of production costs is essential.
JBI: So, you are building your own nuanced version of the “Danaher Business System” - very impressive! Can you speak to some of the bigger challenges you’ve faced thus far in building NGTG? Also, it would be interesting to hear how the COVID pandemic has affected Toshima & your ability to execute more generally.
EA: With regards to challenges, raising debt financing for our initial deal was extremely difficult. It took a lot of time, negotiations & ongoing effort. Our lack of a track record as a corporate group only made things harder. However, I was able to successfully lean on my experience & track record at INCJ coupled with our team’s overall experience to help us overcome this hurdle.
As for COVID, it has of course impacted our business. We’ve been fortunate in that Japan has not experienced the worst of COVID compared to other countries, so we have been able to continue production at our factory with the appropriate safety measures in place. As the leaders, the entire NGTG team has made a point to show up at our headquarters on a daily basis. On the investing side of things, we feel this is a great time to be a “contrarian” of sorts & have accelerated our efforts in pursuing new acquisitions. We are actively engaging with four specific opportunities as we speak.
JBI: As the saying goes, out of crisis comes opportunity.
Now, if we step back a bit, how do you think about NGTG over the next 1 to 2 years and also further out over the next 5 to 10 years?
EA: As I just mentioned, we should be able to acquire four additional SMBs by the end of 2020. In 2021, our aim is to acquire a subsequent six SMBs. Looking ahead to 2025, we will likely IPO on the Tokyo Stock Exchange with a 10 year goal of beginning to acquire SMBs outside of Japan.
JBI: Let me mark that down in our calendar here...I..P..O..in..2025...got it! I kid, but it certainly does seem that you & your colleagues have built a very strong foundation from which to achieve these stated goals. I know we’ll be watching closely!
To close things out here, we have two final, somewhat related questions. First, given your global travels, is there anything in particular you feel Japanese entrepreneurs & business leaders could better learn from those in other countries?
And second, what is one thing about Japan - and it can be anything at all - that you believe may not be very well known among those having never lived in or visited Japan, but that you feel is important, interesting or worth knowing about?
EA: I’ll highlight two things for now. In Japan, most things are in fact quite cheap in large part due to the stubbornly low inflation rate...or I should likely say, high deflation rate. Many non-Japanese believe Japan is an expensive country - in a lot of ways, it is not. In my opinion, we must further energize the Japanese economy to drive mild inflation. It is an ongoing dilemma, as most around the world know, but I am hopeful with more time we can succeed in this regard.
On a non-business note, I’d comment on how safe Japan is pretty much anywhere you go. You can walk the streets at midnight with just about no concern!
JBI: We can absolutely attest to that last comment, it is one of our favorite aspects about Japan!
Well, it has been a pleasure speaking with you, Arai-san. We thank you for your time & thoughts. What you are building in NGTG is very exciting & we look forward to following yours & your team’s ongoing success. How can those reading this also follow along?
JBI: Excellent. Thank you again!
JBI note: we are incredibly bullish on Arai-san’s & his team’s future with NGTG. We have spent significant time ourselves exploring SMB acquisitions globally, though particularly so in Japan. When thinking about NGTG’s current stage of development alongside its broader approach & model, we are immediately reminded of a very similar, publicly listed, small-cap U.S. based SMB serial acquirer, who itself is at a similar phase and trajectory. That company is Crawford United. We’ll let readers take a closer look at the business on their own, however, we will share below a few excerpts from an astute investor’s - Alluvial Capital - quarterly update letters, where he briefly shares his simple, yet powerful thesis on Crawford:
You can very easily replace Crawford with NGTG here & make two simple changes: increase the amount of deal leverage used - to upwards of 90% in some instances - and lower the cost of debt - to well below 6% (in considering the broader lending market realities in Japan today coupled with NGTG’s initial deal structure).
While both companies are executing very similar, attractive buy-and-hold acquisition strategies, we are most excited by the prospects before Arai-san & his team in Japan. Their opportunity set is immense with a very limited field of acquirer competitors, all the while executing in a core domestic market that offers a globally unparalleled opportunity to earn tremendous returns on (re-)invested capital in a highly capital-efficient manner over a multi-decade time horizon. We eagerly look forward to this future “compounder’s” hopeful 2025 IPO.
Disclosure: JBI is long CRAWA. The above is not investment advice. Complete your own research.