Description

Alphapolis is a high-margin publisher of novels and manga (Japanese comics) based on user-generated-content from their website.  The business model is extremely attractive as it has the positive features of publishing (one person’s work can be sold to millions of people) without the downside (publishers generally take a “spray and pray” approach to books because as William Goldman says, nobody knows anything).  

Alphapolis continues to grow its platform, which widens the funnel to create salable novels, which are then turned into comics. It is now pushing into anime, which opens up a whole new realm of potential revenue streams. 

The stock trades at a 5-year low and an EV/EBIT of 4.  There are some reasons for this that I will get into, but in a base case scenario a 2–3x return is possible on a 5-year horizon as profit continues to grow at double digits.

Valuation

Compared with both domestic and international peers, Alphapolis stands out significantly for its low EV/EBIT multiples, especially when contrasted against 5-year sales and profit growth CAGRs exceeding 20%.  International publishing companies are generally fully valued and not growing much. Japanese companies are all doing quite well with perhaps Starts Publishing the only one with similar attractiveness to Alphapolis (and following a similar UGC business model). Alphapolis’ low EV valuation is in part due to retaining all profit and distributing none to shareholders. As an asset-lite platform it has limited ways to reinvest profits.  

I estimate it will grow OP from 2.6b this year to ~5b in 5 years. At a 10x EBIT valuation, and with 20b in BS cash, the market cap could reach 70b, equivalent to 7,200 per share (+250% from the current share price level). 

Why Does This Opportunity Exist?

Being seriously underwater on this stock, I have a few thoughts on why it is doing so poorly.

1. Concerns Growth has Stalled: the company listed in 2014, at which time it was growing 30-40% annually, propelled by “light novels.”   One of their titles, "Gate," was turned into an anime in 2015, bumping sales and profit for that year, but in 2016 OP fell 80% as unsold books were returned by bookstores. From 2017 the company resumed its growth path, although at a lower rate. In 2021, another hit series, Moonlit Fantasy, was turned into an anime. The company used the occasion to spend heavily on advertising to promote their platform, so that OP only grew 2% even as sales rose 18%.  In 2022, sales only grew 2%, reflecting the giveback from Moonlit Fantasy sales bump.  Now in 2023, the company is expecting 8% sales growth, but a 5% decline in operating profit as they increase royalties paid to authors. 
   
   This is a long-winded way of saying, investors may be thinking the company is going ex-growth as the 3-year profit growth CAGR is forecast to be only 2% and sales growth has been volatile. I believe sales and OP, while lumpy, will continue to grow at double digit rates for the foreseeable future. This year OP is likely to grow, not shrink, in my view. 

2. Management Quality Questions: the company was founded by Mr. Kajimoto in 2000. He is a Tokyo University graduate and previously worked in advertising. He and his family control 70% of the shares. He has high confidence in his strategy and sees no need for outside views, in particular, from shareholders. He refuses to meet with investors, and feels no need to address the reasons his share price is off more than 50% from the peak. The reasons I see include cash-hoarding, vague plans for big M&A and low regard for shareholders.
   
   While he is market unfriendly, I think he is a capable entrepreneur.
   
   

3. Bias Against Publishing Industry: if you wanted a reliable way to lose money during the rise of the Internet, investing in publishing was a pretty good choice! Publishers were disrupted by the shift from print to online, which removed a lot of barriers to entry. The rise of smartphones and the Internet caused a decline in overall interest in reading, especially long-form work.
   
   However, the shift to digital is a tailwind, at least in Japan. Traditionally, when you had a new book to promote, you sent a ton of copies to the bookstores, hoping 100 books on a shelf would induce people to pick it up.  However, Japanese bookstores can return all unsold books to the publisher. In the past, return rates were around 40%, which publishers booked as losses (reversing earlier sales revenues.)
   
   With digital, there are no returns (and no printing costs). Additionally, because publishers are less reliant on bookstores, they are more cautious about sending too much inventory to them. So now return rates are down to 20% or lower for many publishers. Selling on Amazon is also a tailwind because publishers only need to supply an appropriate amount to the warehouses.
   
   These changes helped Japanese publishers grow OP sharply over the last 5 years, as noted in the valuation table above.
   
   People may consider publishing a dying industry, and that is reflected in current valuations. But they are well past the worst period, and many are generating record profits. 

How Traditional Publishing Works

First, a summary of the business models of traditional publishing houses. The key employees are the talented editors earning fancy salaries, but none of them have a reliable way to source future bestsellers.  Random House was named because they found the success or failure of books to be completely random. 

One rule of thumb for sales is that a famous person’s book will sell better than a non-famous person. So, editors sign fiction authors with past success, celebrities to write bios and well known scholars to write non-fiction (think Stephen King, Bruce Springsteen and Malcom Gladwell). However, you also have to pay these people more than non-famous writers, and so your profitability on these is not great.  Sometimes you lose money if you guarantee way more than the book actually sells, like paying $14mln for Hillary Clinton’s 2nd biography.  

When it comes to new, untested authors, your bias is to reject them. You pick out a few with potential and push those through to be published. But, nobody knows anything, and so you are basically just rolling the dice.  

For example, J.K. Rowling’s Harry Potter draft was rejected by 12 publishers. An editor at the 13th publisher accepted it, but was told by his colleagues that the book was doomed to failure. Now, Harry Potter is the best selling series of all time. E.L. James wrote the Fifty Shades series, which sold more than 150mln copies, but she self-published the first book due to a lack of interest.  

The traditional publishing industry does not have a reliable way of producing hit products. Instead, about 65% of titles lose money, 25% break even and nearly all your profits come from the 10% that are the top sellers - very much a Pareto Principle world.  So you end up with operating margins between 5 to 10% on average. 

How Alphapolis Works

Alphapolis flips the business model around. Instead of relying on smart and savvy editors to discover the next big hit - they let the readers do the work for them.  The result is that they have an industry leading OPM of around 26%. Their model wipes out the long tail of 65% of books that lose money and instead results in only releasing the 35% that will break even or better. 

Step 1: Web Site Posting 

Would-be authors post stories on Alphapolis’ site. Based on the comments, page views and voting, Alphapolis identifies stories resonating with readers. Posted content is available for free to readers. Authors are compensated with ad revenue from the site, but even a really popular work might only generate $100 per month. Authors are motivated by the chance for recognition and to see their name in print, not money. 

Content Categories

Alphapolis content falls into two main categories: “Isekai” or “Other World” fantasies and Cinderella stories. Isekai follow some common tropes: a loser guy dies and is transported into a parallel universe. Now he is bestowed with extraordinary abilities. Women flock to him as he easily defeats the baddies. This kind of story appeals to a niche demographic of underachieving males, but lacks broad market appeal. 

In Cinderella stories, the main character is sometimes like Cinderella,  oppressed by her family and society, while sometimes she is the evil stepmother archetype to comedic effect. These stories are read mainly by females, but have the potential for broader appeal, in my view. 

Alphapolis wants to branch out beyond such niche genres into stories with wide appeal that can turn into international hit IP. But they are at the mercy of what their authors and readers focus on.

One way the company encourages new story themes is by hosting various contests throughout the year and promising to make the winning submissions into published works. There are contests for horror, kids, fantasy, romance, character studies, historical fiction, manga and others.

Step 2: Novelization 

When Alphapolis determines a work has a good following, they will turn it into a published “light novel.” Light novels is a Japanese genre - there is no precise definition, but maybe you can say the stories are relatively simple and straightforward. Pulp fiction might be a close corollary. The job of the editor is to clean up the text and make the story flow, not to try and discover the next great author.

Alphapolis will publish print and digital versions, with 80% of sales coming from digital, a much higher rate than other publishers. They do not have a strong presence in bookstores. Digital sales are higher profit and don’t have the return risk of paper books. 

Profitability of the Novels

Almost all the light novels sell enough to be profitable. Alphapolis counts on fans who read it online to buy and for a few more people to find it. So an average title might sell 5,000 copies, generating revenue of about 5-6mln yen for the company. The author might get 300-500k yen for their effort, and the company gets the rest. After costs, they might make about a 10% margin on such a product.  However, they will have a certain number of novels that generate much higher sales, so that the overall sales average is closer to 8-9mn per novel and the margin is more like 20%. The important point is they do not have a long tail of loss-making books that need to be offset by big winners.  On the other hand, they do not have big fat tails of best-sellers due to the niche story genres. 

Step 3: Manga 

When they get a light novel that is in the top 10% or so of sales, it is now eligible to be turned into a manga. Manga are Japanese comics.  In contrast to DC and Marvel comics that are mainly superhero stories, Japanese manga can be about anything.  Manga are read by people of all ages in Japan, not just by children.

To make a manga is a much more labor intensive process compared to a novel. Alphapolis needs to find an artist to do the drawing and production takes about 6 months. However, the market for manga is much bigger than for light novels. As with light novels, the fan base is already established, so a manga will generally at least break even, with sales of maybe 10mn yen. However, some of these become popular series, selling millions of titles. As a result,  the average manga produced by Alphapolis generates 40-50mn in revenue, enough for a very healthy 30-40% margin. The company has been putting more and more effort into growing the Manga division, so that the number of titles published are increasing by more than 10% annually and manga now account for 75% of sales.

Step 4: Anime 

The very best-selling manga can be turned into anime - for which the audience is even larger than for manga. Anime itself is not expected to generate profit, but It is like a 12-week, 30-minute infomercial series for the manga and novels.

Alphapolis first made Gate into an anime in 2015. The boom and bust that this created in earnings scared them off for a number of years, but now they are back in force. 

Anime in Japan is created through a production committee system where various groups like a TV station, a game company, a toy company and others gather funds to pay an animation studio to make ~12 episodes at a cost of 800mn ~ 1bn yen. Anime also follows a Pareto Principle where 80% of anime lose money.

The publisher traditionally puts little or no money into the production budget and receives only upside through increased book sales when the anime airs. The publisher is in the best position when it comes to anime (and the anime production studio is usually in the worst position as they find it hard to meet the quality standards demanded on such a low budget.)

I estimate when Gate aired in 2015, it drove a 500mn increase in sales and 300mn in OP. Moonlit Fantasy in 2021 seems to have also added about 500mn and 300mn. 

The important thing about anime-driven sales is that these are not your first print runs of the books. That means there is none of the editing, drawing, and other related costs from the original production. Incremental margins are extremely high as you only have printing, shipping and author royalty costs, so that you probably make 70% or more on these sales. 
 

Alphapolis has 6 anime in production and more are expected to be announced over time. 

1. A Playthrough of a Certain Dude’s VRMMO Life - started airing in October. This looks to be a failure and I don’t expect any major impact (maybe 100mn to sales and 50mn to OP). 

2. Moonlit Fantasy Season 2 - will start airing in January and run for 2 quarters into May/June. The last time they aired this it had a significant impact, and was one of the most-watched anime on Netflix Japan. I have high expectations that the second season will be a catalyst as well. 

3. The New Gate - set to air sometime in 2024 - a different story from the previous anime, Gate. 

4. Re:Monster - airing set for April 2024. 

5. New Saga - originally set to air in summer 2023, but delayed due to quality issues and airing is currently undetermined. 

6. Isekai Yururi Kikou ~Raising Children While Being an Adventurer~ - announced in November and slated for release in 2024. 

In addition to these titles, I estimate Alphapolis has at least 5 other IP successful enough to turn into anime. Of course, they are developing new IP all the time as well, so the pipeline continues to be robust. 

Step 5: Monetization of IP 

A really successful anime opens up a whole new realm of possibilities in terms of revenue streams. There are toys, smartphone games, model figures, halloween costumes and tie-ups with consumer packaged goods. This is a one-in-a-hundred or one-in-a-thousand kind of situation, but my thinking is that if Alphapolis continues to put out anime content, something is likely to succeed, although estimating when that might happen is impossible.  

When this occurs, the income is royalty payments with 100% margins, so suddenly OP can increase by 1b, 2b, etc. in a discontinuous fashion.

Future Growth Prospects

Manga is the Future

Of course readers on VIC are highly intelligent devourers of books and longform journalism. But that is not the way the world is going. Attention spans are getting shorter. Manga fits well into this trend as it can be read cover to cover in 1 hour. If you find a manga you enjoy, you might buy the entire series of 10-20 books and devour them in a weekend. If you fall in love with Dan Brown books, it will probably take you at least a year to get through all of the adventures of Robert Langdon. So from a publisher’s point of view, manga is a more attractive genre. 

Anime is the Future

A season of anime (12 episodes) can be produced for $5-7mn given low wages for Japanese animators and a weak exchange rate. Compare that with Stranger Things or The Witcher where a season costs $150mn or more to produce.  The cost / benefit for anime makes a whole lot of sense compared to big live action dramas.  Netflix and other platforms are likely to continue pouring money into anime, which will be a tailwind for all Japanese publishers. 

According to the Association of Japanese Animations, the market size reached 2.7tn yen in 2021, an 8% CAGR over the last decade. 

Platform Growth + Anime

Alphapolis is a platform business.  They need more people to post on their site and more readers in order to create the broadest filtering mechanism to find good content.  In addition, they need to hire more editors every year.

On the platform side, the current situation is mixed. The number of submissions for the various contests is on a continuously rising trend, which is great. However, the number of site users is trending sideways. 

The number of employees, and editors in particular, continues to grow at around a 12% annual rate. I do not expect any problems in hiring going forward. 

The anime strategy is key to keeping the flywheel going.  A hit anime would drive recognition of the brand and bring new readers to the web site. In addition, it encourages would-be authors to post as they can see a path from posting to publication to anime. 

Royalties to Authors and Forecast Profit Decline

Alphapolis raised the royalty rate paid to authors to 10%, making it the industry leader. Previously it was a sliding scale with a minimum 7% level. 

I believe other publishers pay about 5% for a first printing by an unknown author. The royalty can reach 8-10% for reprints or known authors. 

I really like Alphapolis’ strategy - other publishers only have 5-8% OPMs, so they cannot easily raise royalty rates or they will destroy their business, while Alphapolis with 25-30% OPMs can afford to give away a few points to authors, and over time the effect should be to attract more and higher quality authors to their platform.  

This strategy will take time to pay off, while costs rise immediately, which is why the company has forecast a 5% decline in OP for this year. 

First half results released in November showed gross margins declined by 1.3%pt due to this royalty rate increase, but that was more than offset by a 17% increase in sales. Thus, gross profit increased 15% YoY and operating profit rose 4.4%.  I am relatively confident company guidance for a 5% drop in OP this year is overly conservative. 

Competition

The barriers to entry are virtually non-existent for a posting web site. However, the challenge is in getting the 2-sided platform of readers and authors to gather on the site. So once an ecosystem is established, it becomes hard for new entrants to displace the existing players.  In that sense, Alphapolis has a good position as one of the older players. 

Shosetsuka ni Narou - https://syosetu.com/  , which translates as “Let’s Become a Novelist,” is the oldest and most popular story posting site in Japan. It is one of the top 20 visited sites in Japan.  However, it is not a publishing company, but rather just a web business. Publishers like Kadokawa and Square Enix (and sometimes Alphapolis) use the site to find new authors and sign them to their labels. In that way, it is an attractive way for a new author to get noticed by the largest number of publishers. 

Kakuyomu - https://kakuyomu.jp/ , which translates as “Write / Read”, is operated by Kadokawa (one of the big 4 publishing houses) and launched in 2016.  It is the second-most popular posting site. Even though it is a late entrant to the posting site business, because it is owned by Kadokawa it has become quite popular as the path toward a published book is clear to authors. They were also quite fast in turning novels into anime, and so gained popularity with authors. 

Alphapolis fell behind relatively in recent years because of being slow to embrace anime, which is an important attractor of authors, but are now catching up. They are ranked third, but are the largest listed publisher with a pure UGC business model. Starts Publishing (7849) follows the same model, but focuses only on females. Their model is also extremely successful. 

Management

I am generally happy with management decisions on the business.  However, their overly conservative stance on the balance sheet is hurting the valuation.  The company pays no dividends and doesn’t buy back shares, so that cash is now approaching the same 10b level as sales.  

The founder has said various things as to why he refuses to distribute cash - he doesn’t personally have cash needs so why pay a dividend (ie no consideration of minority shareholders), he wants cash for M&A (never done a deal and no indication as to the size and financing structure that would be appropriate if they did buy something). 

President Kajimoto is a very successful entrepreneur by any standard, and I think it is safe to say he feels he knows what is right and feels no particular need to cater to shareholders. Since he and family members own 70% of the business, minority shareholders have no real redress for grievances. 

Estimates

I made a basic forecast of earnings for the next 10 years.  The number of titles published each year is set to increase, while I assume the revenue generated per manga title stays flat at 43mn yen. 

These estimates do not include the potential for discontinuous growth that would result from a hit anime.  I regard that as a free upside option. 

Risks

As with any platform, growth of the two sides (authors and readers) are self-reinforcing on both the upside and downside.  If competitors were to cause the relative attractiveness of posting on Alphapolis to decline, it could result in a death spiral. 

Catalyst

So far the anime announcements have not been catalysts at all for the stock price.  However, I would think that when an anime airs, if it is well received by the audience and drives book sales, that will drive the stock price higher. The key to watch will be Moonlit Fantasy starting in January, their biggest franchise.