Tylerception

How I would think about investing in Japan today; Obvious disclaimer: this is not financial advice of any sort. The purpose of this post is not to provide a granular portfolio to buy, but rather a catalyst to get you thinking about Japan. Japan is unique in its tradition. There is a way to speak, to greet people, to conduct business, to live life. Understanding the distinctive way in which business is conducted in Japan is the ultimate alpha—the key that unlocks the gates to this multi-trillion dollar market. I've outlined below a few of the asset classes / strategies that I think are interesting. (equities, real estate, SMB rollups, VC) In all of them, I've provided both the beta approach, and the super saiyan alpha take. glhf Equities: - Beta: Invest in passive ETFs. There are two broad-market indices to choose from: TOPIX and Nikkei 225. The TOPIX is like the Russell 3000, and considered to be the best representation of the overall market. The Nikkei 225, like the Dow or S&P500, tracks a small subset (225) of Japan’s blue chip stocks. If you want lots of exposure to large multinationals, pick the Nikkei 225. If you want everything, pick the TOPIX. But the most important point when investing in Japan is hedging dollar-yen currency risk. If you bought the Nikkei 225 for 17,500 JPY in March 2020 and sold at 40,500 JPY this week, you will have made 23% p.a. yen-denominated return. But, with the yen depreciating against the dollar (USD/JPY from 110 to 151), your dollar-denominated returns are compressed to 14% p.a. Always consider currency forwards to hedge against this risk. - Alpha: Try to find deep value. Lots of publicly traded companies are FCF positive, and trade at a significant discount to book value or even below net cash. Due to the Tokyo Stock Exchange’s reforms and pressure from shareholders, many of these businesses are ramping up capex, expanding operations, or in the worst case: buying back shares and/or issuing dividends. However, due to high insider ownership, cross-shareholding, and a lack of catalysts, many of these stocks are value traps and trade sideways forever. Separating the wheat from the chaff is difficult, but possible. On the growth side, the BoJ’s ultra-low interest rate policy and a weak yen have created a golden opportunity for capital-efficient, export-heavy multinationals. Sectors that have benefited heavily from this are: sogo shosha (Buffett’s famous trade, which I’ll do another post about), precision manufacturing, semiconductors, robotics, and tourism. Real Estate: - Beta: Buy a REIT or residential property. The easiest way to get exposure is to invest in a REIT like iShares (1476.T). But even as a foreigner, it is easy to purchase real estate directly in Japan. There are two choices: rural or urban. A cheap vacation spot in the country-side will cost you in the low six-figures including renovation costs (see akiya). Keep in mind these almost never appreciate, but the cap rates from AirBnB/rental arbitrage can be very good (8~10% cap) if you choose the right locations. Alternatively, you can buy prime urban real estate in Tokyo. These have low rental yields (2~4% cap), but have capital appreciation potential, particularly in the neighborhoods within the Yamanote line (Shibuya, Minato, etc.) for Tokyo. - Alpha: Do the trade above with lots of leverage. Locals can get a 10yr mortgage at <1% interest at 90% LTV, but It can be difficult to access this credit market as an outsider. I’ve posted about this before, but the other way to do this trade looks like this: through an established RE broker, agree to put 5% of gross purchase price down on pre-construction developments in core high end areas from premier developers (Mitsubishi, Mitsui, etc.). Due to mass urban migration and a recent influx of expats, demand for high-end real estate in core areas of Tokyo and Osaka is increasing, and real estate prices reflect this demographic trend. With the right amount of hustle and network, you can structure highly asymmetric levered bets. SMB Rollups: - Beta: Buy shares in firms aggressively rolling up SMBs, or in the brokerages making fees off SMB M&A. Three factors make SMB M&A attractive: lots of business owners are nearing retirement without heirs; valuations are local (2~3x EBITDA) even for competitive, high-quality businesses; and debt for these acquisitions can be raised cheaply. Genda (9166.T) is rolling up arcade and entertainment assets, Yoshimura Foods (2844.T) is rolling up food-related assets, and SHIFT (3697.T) is rolling up software QA/testing assets. Zoning in on Genda: Genda paid an average multiple of 3.5x EBITDA for their first 12 acquisitions post-IPO with the majority of these deals funded by low-cost debt (<2%) at high LTV (~90%). Due to their focus on acquiring cash-flow generating businesses, they are able to pay down their debt quickly and maintain healthy leverage ratios. I expect more publicly traded firms to adopt a similar SMB M&A strategy, and with high IRRs on these acquisitions, they can make attractive equity longs. For a more pick-and-shovel play, look at the brokerages (Nihon M&A Center TYO:2127, M&A Capital Partners TYO:6080, Strike TYO:6196, M&A Research Institute TYO:9552, etc.). These firms handle 90%+ of deal flow and charge significant transaction fees (sometimes up to 10%)—making them good bets if you believe deal flow/activity will increase. (for you ct ppl, this is like buying Coinbase instead of btc) - Alpha: Do the rollups yourself. SMBs with $1~5MM of EBITDA are routinely sold to individual investors at 2~3x EBITDA. Permanent residents and foreigners with the right local networks can get 90% LTV financing for these deals. It doesn’t take a genius to see that these are amazing deals. But, execution is very difficult. Adverse selection is a real danger on the open market, as the brokerages circulate the deals to 10s~100s of buyers. A lot of the businesses are quite fragile (hence the low multiples), and the US approach of selling it for parts will put you on a black list. Japan is a society built on trust, and there is an unspoken agreement that you will protect the employees of the firms you buy. I often hear complaints of the way business is done in Japan; that its driven by non-economic and “irrational” factors, but everyone is looking at it wrong. Assimilating yourself into the business culture is the alpha, and if you prove yourself as a good steward you will begin to buy things at prices you won't believe. VC: - Beta: Be an LP in one of the Japanese VC funds. There are lots of Japan-native VC funds now, and also US funds with Japan exposure. Some notable names are: Eight Roads, One Capital, Digital Garage, Coral Capital DNX etc. You can pay normal fund economics (2 and 20) to get simple beta to the local vc market. - Alpha:  Write seed checks and help the founders scale their products abroad. Think about what Japan is great at: deep science, hard tech, robotics, hardware, manufacturing, nuclear, etc. Now think about how much larger the addressable market for these startups could be, if they effectively marketed their products abroad. I want everyone to experience the craftsmanship and dedication that goes into a Japanese product. Something as simple as a toilet is done leaps and bounds better by TOTO than any of its Western competitors, but it has taken them decades to sell volume in America, and they are insignificant in market share. If you are well-connected in the West, you can build a brand of being a reliable bridge and provide insane amounts of value to talented founders on western knowledge. With a robust talent pool, a world-class research ecosystem, and a rise in capital inflows to local VCs, the sector is poised for growth. Increasingly favorable immigration laws and the significantly lower cost of technical talent make Tokyo a very attractive place to found. Sakana ai is a great example of this, the backpack team moving to tokyo is another; i think this will continue to accelerate at a high rate. -Special Situations: Will keep this section short because I'll write about specific deals in the future, but just keep in mind that because of the baseline structure of Japan, things are highly highly inefficient. Keep an open mind, be respectful and get creative; there are tons of massively mis-priced opportunities from whisky to anime, to fashion, and ski resorts. I often say to my friends that a young Warren Buffett with $10MM would have probably move to Japan and dominated. He's the GOAT at investing but he's also incredible at branding; something as important in japan. And if you take away nothing else from this post, remember this: deploying capital in Japan is all about: 1) finding low-cost, fixed-rate leverage and using it to invest in high-quality assets, and 2) buying at local valuations (2~3x EBITDA) and selling at global valuations (>5x EBITDA) to price-insensitive counterparties. If you can figure out these two things, you will do extremely well. You may ask—why do I find Japan so exciting? The Japanese people take pride in the shokunin, or artisan, spirit—relentlessly striving towards perfection in their craft, taking pride in practicing even the most menial tasks day in and day out to improve. A sushi apprentice will clean, scrub, and prepare ingredients in the kitchen for years until they finally touch sushi rice for the first time. A Little Leaguer will practice eight to ten hours every Saturday and Sunday, dedicating hours to repeating the same movements and perfecting the same simple plays. Even Toyota’s Kaizen philosophy which propelled them to become the number one automaker in the world is rooted in this shokunin spirit. This tireless drive for perfection explains how Japan developed its world-class talent base; its unique coolness, and ubiquitous culture; and its reputation for producing the finest-quality products globally. I strongly believe that the next decade for Japan will be quite the opposite from the prior twenty.