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New rules were introduced in Japan in May that will allow so-called sankaku gappei, or triangular mergers. A foreign firm with a Japanese subsidiary can now acquire a Japanese company by having it merge with its Japanese sub. Formerly, a foreign firm could use as consideration only shares of the subsidiary, which was impractical because the sub's stock was rarely traded publicly. Now acquirers can use other assets, including shares of the foreign parent.

The new rules are intended to raise foreign direct investment in Japan. According to the EU, the value of cross-border mergers (sales) in Japan was $2,512MM in 2005, versus $429,146MM in the EU and $105,560MM in the US. The value of cross-border mergers in the EU is thus 170 times higher, and in the US 42 times higher, than in Japan. The government wants to raise the proportion of foreign investment in Japan GDP to 5% in 2010 from 2.2% in 2005.

But the new rules have met opposition from Japan's business community. Originally intended to be introduced in 2006 following passage of a revised Company Law in 2005, implementation was postponed for a year. The Japan Business Federation (the Keidanren) continues to resist and has been working to adopt rules making triangular mergers more difficult. In contrast, both the American Chamber of Commerce and the Delegation of the European Commission to Japan have welcomed the new rules. Although some Japanese business leaders have suggested that triangular mergers will lead to more hostile takeovers, the general consensus seems to be that they will be used almost exclusively for friendly acquisitions. For the merger to be tax-free, the foreign subsidiary must have an actual, physical presence in Japan, including office and staff. Although the minimum degree of activity required is not known, this requirement should not be a huge roadblock for acquirers. Foreign acquirers will also need to insure that their stock is liquid in Japan; otherwise, shareholders of the target company won’t want it.

Some observers point out that Japanese firms have much smaller market capitalizations than their US and European counterparts, which is why company managements are so afraid of being gobbled up by them. Because of the new rules and previous law changes, some 450 to 500 Japanese companies have or plan to introduce poison pill defenses. Overall, many observers believe the new law won't have that much direct impact. Rather, it will be one more factor in an environment that is trending toward increased M&A activity in Japan. Instead of encouraging foreign takeovers, the new rules may spur consolidation in domestic industries, like steel and paper, that demand restructuring. One indication of this trend is that cross shareholdings that had recently been unwound are now being rebuilt.

Source: The Impact of Triangular Mergers on Japan M&A