Description

BASE (4477:JP) has emerged from a crowded field as a leader in the Japanese e-commerce cloud software market, with a differentiated business model that enables individuals to open an online shop for free. I believe BASE’s positioning avoids direct competition for new users with industry behemoth Shopify and other subscription-based models, which should lead to them capturing a dominant share of Japanese long-tail e-commerce GMV in the long run. This model also holds potential for a successful global expansion. 2020 financial results following the coronavirus state of emergency declaration in Japan displayed the exceptional operating leverage embedded in their business and suggest that the shares are still attractively priced for long-term appreciation.

This may have come across your radar already as “the Shopify of Japan,” but it’s important to recognize that Shopify has well-established operations in Japan. However, Shopify did not enter the Japanese market with a (partially) translated and localized offering until 2015, giving local players an eleven-year head start to carve out their slice of the storefront e-commerce software market. While Shopify dragged their feet and local incumbents found various ways to trip over themselves, BASE surged to the top of the heap in terms of new shop openings, where it has held a significant lead for the past three years. The service has the best reputation in the industry for its mobile-first design and ease of use for beginners. According to a recent Macromill survey, a majority of online retail shop creators used BASE last year, with no other service accounting for more than 10%:

They are elephants or capybaras, but we are mere ants, in contrast. For ants, even if you join forces with capybaras, there’s no way you can defeat elephants. Therefore, you must dig up the ground so that you might trip up the elephants. Understand? – CEO Yuta Tsuruoka

BASE has several key advantages over the plethora of competing services, which vary by pricing model, features, and user experience. First, unlike Shopify or MakeShop, a subsidiary of GMO that is the current Japanese market leader by revenue, BASE does not charge a subscription fee, which lowers the barrier for physical store owners or entrepreneurs to try out new ideas. Compared to other free services, BASE provides a high level of customization (html edit), unique features (made-to-order, lottery and reservation sales), and value-added services (data analysis, sales promotions, inventory financing) to help its customers succeed with less required capital outlay. Once a shop begins to generate sales, the Company collects settlement and service fees on each transaction. The company mediates transactions by holding payment in escrow until a package is confirmed to be delivered, similar to former shareholder Mercari(4385.T). This enables BASE to allow new shops to receive credit card payments immediately, without the typical 2 to 3-week credit examination period required when using other free services, such as STORES (#2 free competitor). In the Q32020 results commentary, management highlighted the importance of this:

“Payment and support for opening online shops are usually separated in different tools. However, in BASE, in one product we offer both payment service and creation of ecommerce shops. When account is created under BASE, instantaneously payment support is available and support for opening of online shops is available. That is why many individuals and SMBs are using our service.”

BASE also has a much faster deposit cycle than other free services, meaning shop owners can receive their money more than a month quicker than they could at STORES without paying an additional fee. BASE charges higher transaction fees than STORES (6.6% + 40 yen vs. 5%), but STORES is less customizable, does not allow users to host shops on their own domains, and does not include made-to-order sales or free access to data analysis tools.

In comparison to Shopify, BASE works out to be cheaper than Shopify Basic until monthly GMV crosses ~US$900:

Base vs. Shopify (Basic) Monthly Fees

It stands to reason that store owners would be switching to Shopify or MakeShop as they comfortably surpass $1000 in monthly sales to save costs, but in FY20Q1, FY20Q2, and FY20Q3 average monthly GMV per shop was JPY136k ($1,276), JPY208k ($1,950), and JPY167k (1,565) respectively. The mean is likely skewed higher than the median, as management noted in their FY20Q2 results presentation commentary that some shops generate monthly GMV of over JPY8m(~$80k). While the majority of revenue-generating shops (~50k) likely save money using BASE over Shopify, the outlier shops that could theoretically save up to US$25k/yr by switching to Shopify but have continued to use BASE instead. Furthermore, BASE was able to increase commission rates by an additional 2% of GMV in September 2017 with minimal impact on GMV, as most shops chose to stay on the platform. While management has commented that transaction fees are reduced for larger customers to retain business, there are several other factors that increase switching costs over time and lock in customers for the long run.

First, there are some notable features that BASE has that Shopify is missing, namely make-to-order and lottery sales. Make-to-order sales is an API extension powered by Canvath that allows the seller to manufacture and sell T-shirts, mugs, key chains, tote bags, and other items designed on the Internet, without any working capital requirements. Lottery sales are used to sell rare items (like my favorite Japanese whiskey) by lottery instead of a first-come-first-served basis. These two features are important for long-tail e-commerce, which is basically sellers using social networks to market a customized product or service to a small but highly engaged and passionate target market.

Second, as a store grows, the store manager may use more extensions, or APIs, to manage that growth. BASE Apps provides a wide range of free and freemium APIs for store administration, sales support, social media management, and so on. As users integrate more APIs into their BASE store, the switching cost increases as more additional labor is required to ensure a seamless transition to a new platform. While Shopify offers more APIs than BASE, many are still not localized for the Japanese market. This is the biggest source of Shopify’s moat in North America, so it can cut both ways, but we can see how important it is to acquire users at the inception of a store.

Third, BASE stores increasingly benefit from network effects in payments as the platform attracts more stores and customers. BASE stores are required to use PAY.JP, which has several advantages over competing services. One, it covers all major credit cards and five other payment methods (Shopify does not yet support JCB, which has 40% retail and 20% EC market share in Japan). Two, whereas customer credit card data has to be managed by stores independently with other services, PAY.JP manages customer data centrally and monitors transaction data in real-time, enhancing data security and consumer convenience. Three, PAY.JP is also made available to third-party merchants through a payment API, and consumers are able to transact with any merchant in the network without re-entering their credit card data with PAY ID.

Lastly, BASE stores benefit from the Company’s sales promotion activities and financing efforts. While stores manage much of their traffic to their own sites independently through social networks, BASE offers a number of services to assist in generating traffic for new stores. For instance, BASE lists customer products on a shopping app with 5 million users. The Company plans to distribute JPY60m worth of coupons in the second half of 2020, although that amount could be increased due to record profitability, and it regularly runs television commercial campaigns to raise awareness of the platform for both store owners and shoppers. Stores can win a lottery to have their products featured in physical BASE shops. The Company also introduced a new financial service, Yell Bank, in 2018 that uses past customer sales data to offer risk-free growth financing to stores. Therefore, leaving the BASE ecosystem could mean a reduction in traffic, sales, and financial support.

Given its strengths in new user acquisition and a purely transaction-based model, BASE has been one of the biggest beneficiaries of the COVID-19 pandemic. GMV increased 196% yoy in FY20Q2 and 125% in FY20Q3, driven both by sales increases at existing shops and a surge in new shop openings:

BASE FY20Q3 Presentation

The number of revenue-generating stores increased by 90% yoy in FY20Q2 and 81% in FY20Q3, while the average GMV per shop increased 55% and 24% yoy respectively:

BASE FY20Q3 Presentation

Net sales and gross profit increased about 210% and 136% yoy in FY20Q2 and FY20Q3 as take rates were fairly stable:

BASE FY20Q3 Presentation

As the employee count only rose by one person in FY20Q2 and four people in FY20Q3, and promotional costs were in line with past campaigns, the Company displayed impressive operating leverage for the last two quarters:

Following an IPO in late 2019 and a secondary offering of JPY12.4B in October 2020, BASE is now flush with cash and cash flow to reaccelerate investment in product R&D and user acquisition, including a new TV commercial advertising campaign which began in November. The CEO has stated that they do not intend to target large enterprise accounts on competing platforms that require relatively high acquisition costs, as these accounts could be easily lost to competitors in the same fashion. The Company will continue to focus on acquiring first-time users and building out more services to accommodate growing customers. Historically, the payback period for new user acquisition has been around 12-13 months, but in these exceptional times, it has fallen to an astounding 3 months.

While some reversion to the mean was to be expected following the cancellation of Japan’s COVID-19 state of emergency at the end of May, a lasting shift in the economic climate continued to drive new shop openings in Q3. BASE is providing physical shops a lifeline as many consumers are still working from home and foot traffic has fallen at physical stores. Results for the second half of the year have thus far met the top end of management’s updated guidance, as strong growth in shop openings continues. Management had the following to say about the monthly GMV trend after FY20Q2:

“For the BASE Business, GMV growth rate YoY accelerated in April and May. From May 235.2% is the number you see here, but at the end of May with the lifting of the state of emergency, we saw a slowdown in June. But in July and August, we have seen a higher than expected level. I think it’s fair to say that we are plateauing at a high level.”

FY20Q3 results tracked the upper range of these expectations:

If the Company is setting a new revenue base now at roughly JPY100B (~$1.05B) annual GMV, and the PAY business is generating an additional ~JPY40B annual GMV, the stock today with a JPY235B market cap is trading at about 1.7x annualized GMV. Shopify, in comparison, generated $30B GMV in Q2 and $30.9B in Q3, so at a $135B market cap is now trading at about 1.1x GMV. However, BASE enjoys significantly higher take rates than Shopify in its core business, which means it is valued at roughly 24x annualized sales based on the last two quarters of results, far lower than Shopify which trades at 45x annualized sales. BASE also has higher overall gross margins (60.2% vs. 52.8%), comparable yoy overall GMV growth (98% vs 109%), and higher 3-yr cumulative GMV growth (+414% vs. +382%). Clearly these are both incredible companies and valuations are much higher than the market averages, but they seem to be mispriced relative to one another. I think the primary reason for this is size and investor awareness, as many interested in the space are just now taking a look at BASE, a ~$2 billion company, while most investors would know about Shopify by now.

BASE has a long runway for rapid growth, given its small size and positioning as a champion of the long-tail economy, which has seemingly limitless potential for growth. The theory here is that products and services with low demand or low sales volume can collectively make up market share that rivals or exceeds the mainstream economy if the distribution channel is large enough.

Source: Emma’s Blog

The Japanese EC market is about JPY20 trillion today (less than 10% penetration), management estimates the EC storefront creation market is growing faster at about JPY1 trillion, and BASE is growing significantly faster within that market at about 10% share of GMV. Based on current growth rates, the Japanese EC could double again in 5 years or so. Assuming storefront share grows to 10%, and BASE share grows to 25% of storefront GMV, BASE GMV could grow another ~10x in this timeframe. Taking this out further, let’s say Japan EC reaches JPY100 trillion in ~15 years, storefront EC grows to 25% as the long-tail thesis plays out, and BASE market share trends towards its current share of 50%+ of new store openings. In such a scenario, BASE GMV could grow 100x in Japan alone, without any further expansion in take rate (which management also believes can go higher). At such a scale, operating margins should significantly exceed the 25% level achieved in FY20Q2 and approach

The beauty of the long-tail is that a tool like BASE enables very niche supply and demand to find each other in a way that was never before possible. In the long-run, the acceleration of the long-tail economy may actually spur overall growth in the Japanese retail economy, contrary to many observers’ expectations. The BASE CEO does not see a ceiling on the domestic growth opportunity any time soon:

“There are 1.6 million retailers nationwide in Japan. If you consider the number of stores dealing with daily use items, I think we can target around 300,000 or 400,000 merchants on our platform. But if we consider independent creators as potential merchants, I think there’s no limit to our future growth.”

Source: BASE FY20Q2 Presentation

The other obvious avenue for growth is expansion abroad, both through cross-border e-commerce and by making the service available for international merchants. The Company is actively working on building out services and adding new partners to facilitate easier cross-border transactions. As for making the service available internationally, management notes that there is probably no equivalent service available, as Shopify and recently listed BigCommerce focus on larger customers. Management thinks that BASE has “a lot of opportunities” on a global basis, and says they “are looking forward to providing services to non-Japanese people as well.” In terms of execution, BASE is already integrated with some foreign players for certain services and functions, but there is likely a lot more to be done to export an equivalent ecosystem to the world. If they are successful, the opportunity is huge; Shopify’s global GMV is already 100x larger than BASE’s today, but a large portion of the potential market is probably unserved due to Shopify’s relatively expensive monthly subscription fee for its basic service.

Interestingly, BASE’s former strategic investor, Mercari, has gained traction in the US market with it’s C2C business with a similar approach to facilitating transactions and a mobile-first strategy. Mercari US GMV grew 165% yoy last quarter, with over 4 million MAUs, up 71%.

I think it will be difficult for existing competitors to match BASE within Japan. Subscription models like GMO and Shopify will be wary of offering a free tier at the risk of cannibalizing their existing business, and they will continue to focus sales efforts on winning larger accounts. Other free transaction-based models may simply not have the developer talent needed to provide a highly customizable offering with seamless transaction facilitation to rival BASE. I have heard that STORES is also running an aggressive advertising campaign now, but if interested customers do online research and still come to the conclusion that BASE is a superior product, then this is actually just free advertising for BASE. Any new entrant starting with inferior scale would certainly face an uphill battle competing with a free service with superior brand recognition and extensive functionality.

Absent any radical changes in the competitive environment, BASE is positioned to grow at a rapid rate well into the future. I don’t have a specific price target in mind, and there will undoubtedly be volatility along the way. Ultimately, I think the addressable market and BASE’s share will be large enough for them to earn their market cap, in say 10 to 15 years. Any reasonable multiple on that should get you to a very satisfactory IRR over the long run.

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