Description

Summary

Pepabo is a consumer-internet firm with some super desirable assets, including:

• A leading domain registrar and hosting service (GoDaddy-esque)

• A leading online store hosting service for Japanese SMBs (Shopify-esque) with ~¥200bn GMV

• A leading “handmade” goods marketplace (Etsy-esque) with ~¥15bn GMV

• The leading Japanese marketplace for print-on-demand products (Redbubble-esque)

At (‘23E) ~4.5x EV/EBT, ~0.6x EV/sales, and ~13x PE (1), Pepabo trades at an extraordinary discount to comp firms (in-and-out of Japan). Pepabo’s “nano-cap” valuation of ~$110m (EV of ~$75m) also triggers some “sniff test” heuristics – those figures seem ultra-low considering their attractive, growing, and market leading digital assets for the world’s 3rd largest economy (where Japan frequently lags the U.S. in digital business-model adoption). 

I feel their net cash and website hosting business are likely worth substantially more than the current price, so an investor arguably pays less-than-nothing for i) one of Japan’s largest store-building-and-hosting platforms, ii) a leading handmade/bespoke product marketplace, and iii) the leading domestic print-on-demand marketplace for creative designs.

I’ve come to believe the CEO (founder-esque ~40 year old) has created an excellent company culture (top ~1% employer based on employee reviews) and is capable of “spawning” new consumer internet services over time. Additionally, GMO family companies have a deserved reputation for ambition, creativity, shareholder friendliness, and a history of incubating strong consumer-internet businesses. This has led to a number of their sister firms trading at double-digit sales multiples (numerous write ups on VIC).

Domain Registrar & Hosting: muumuu-domain.com & lolipop.jp

To buy a domain name, consumers visit a registrar (like GoDaddy) who mark up their registry COGS to something like $10/year. It’s a commoditized service, but once a customer chooses a registrar for their domains there is possible pain and negligible upside to switching providers – so churn is low, returns-on-capital are excellent, and it’s a pretty low-risk business.

But consumers can’t do anything with just a domain name. Like GoDaddy, Pepabo offers ancillary hosting services for ~420,000 sites which have ARPU upside from consumers naturally upgrading their plans or occasional price increases upon automated renewals. For simple website hosting – there isn’t a good call-to-action to switch providers (if it’s not broke don’t fix it). To quote a particularly strong tech analyst:

“You setup a website and you buy a domain name, and . . .  you’re going to pay for that website and that domain name basically until you die, right? Especially if you connect your email to it and all these sorts of things like ‘oh you’ve got your own custom domain - you’re very special’ . . . your lifetime value is actually huge.”     - Ben Thompson

I think web hosting is a great business and was already Pepabo’s cash-cow before they announced an automatic price increase upon renewals (for most plans) in November ’21 – which is likely to meaningfully improve future profitability.

https://lolipop.jp/info/news/7046/

With ~¥1,550m of ‘22E pretax income (before corporate overhead), I feel this division is arguably worth more than Pepabo’s current market cap. For perspective, at ~12x ‘22E pretax income (burdened with an admittedly debatable ~¥400m of corporate costs) the division is worth ~¥14bn (~1.5x current EV).

Additionally, this division has strategic value from its strong “top-of-funnel” position for prospective business-owners beginning to choose digital solutions (online-store-construction, payment processing, etc.) and from the contacts for a million domains (to cross-selling incremental digital services).

Color Me: shop-pro.jp

Color Me helps small-businesses design and host online stores, operating a platform of ~45,000 shops generating (GMV) of ~¥200bn (approx. doubled since 2015) with a “take-rate” around ~1%.

Management is explicitly prioritizing initiatives to increase stores, GMV, and take rate – most notably by launching a “free” plan to better compete with BASE (who has no monthly charge but an explicitly high take-rate) while simultaneously increasing the business functionality for existing stores.

There is a fair bit to like about this business: low-churn, positive-net-revenue-retention, growing end market, long-term tailwinds, etc. There are also real risks. Shopify in an incredible company and (after a poorly localized start) is now executing well in Japan. One local champion and (former) market-darling BASE has also experienced faster growth thanks to its “free” strategy and strong amateur-oriented brand.

But GMO Internet’s store platforms also have real strengths. Color Me (GMO Pepabo) and Make Shop (GMO Internet) both appear to be self-service market leaders by GMV (each near ~$2bn). Together they have attractive opportunities such as jointly attracting native language app developers or affiliated logistics solutions to better serve customers. It is worth noting again here that the GMO group generally has a super impressive legacy of creating market-leading digital services for the Japanese market.

To frame this division’s upside opportunity a little more succinctly: Pepabo’s EV is currently ~3-4% of this one divisions GMV. That GMV doubled over the past ~6 years. The Company has a logical roadmap to increasing the platform’s take rate, and just announced meaningfully increased prices for existing stores.

https://shop-pro.jp/?mode=product_pricing_updates

The largest threat to this division undoubtedly seems like Shopify executing extremely well in the Japanese market for an extended period. If that occurs to a winner-take-all degree, Pepabo’s upside would largely rely on the other divisions. 

Minne: minne.com

Minne is an Etsy-esque “handmade” marketplace where small merchants sell bespoke products to (overwhelmingly) younger-female customers looking for something unique. Today this market is evenly divided between Pepabo’s Minne and separately listed Creema – both of which allow sellers to access their marketplace’s aggregated consumer demand for a ~10% take-rate (plus any seller-services). Minne has a longer-tail of sellers on its platform (~800k sellers vs. ~220k) and received more orders, which arguably creates a stronger long-term position.  Ideally Minne & Creema could merge and cement a network effect in the category, both to guard against new players and realize highly synergistic economics. 

The entire category is currently very small in Japan (~¥30bn GMV for both marketplaces), and while Minne’s GMV growth was historically strong (up more than 6x since 2015), it recently slowed meaningfully (actually down YoY without mask-demand) causing legitimate concern. 

The important long-term question though is likely: will there be a cultural resonance with the model to create a multi-billion-dollar marketplace(s) for bespoke-products from small-merchants in the world’s 3rd largest economy?  If so, will Minne be (or co-own) a relevant player, or might an alternative marketplace (such as Mercari) capture that opportunity? I don’t know the answer, but options are valuable and if the category grows to some relevant size in Japan, Minne may offer Pepabo significant upside. 

If category GMV eventually grew to ~¥200bn (~$2bn), Minne captured ~30% of that, and achieved a blended take-rate (marketplace fee & seller services) of ~15%, division’s revenue would be ~¥9bn (above Pepabo’s EV).  Peer comps still trade at large sales multiples (for some good reasons).

So while that’s option-value upside, Minne represents meaningful potential vs. today’s valuation while contributing relatively little in the way of current income (on which basis Pepabo already seems attractive).

Suzuri: suzuri.jp

The model is similar to Redbubble or Society6, and Suzuri is apparently Japan’s category leader. Suzuri allows graphic designers to monetize their creativity via on-demand-printing of consumer products (shirts, hats, coffee cups, etc.). Simplistically, if a printed hat costs $10 - Suzuri offers the item for $20 plus whatever dollar margin the designer wants to tack on. I think this division also has some embedded optionality.

Conclusion

Considering Pepabo’s assets, I believe investment downside is reasonably protected in the long-term by i) the strategic importance of certain assets, ii) net cash, and, iii) stable and highly profitable domain hosting segment.  Their strong history of growth in important digital fields additionally makes current multiples of (‘23e) ~4-5x EBT, ~0.6x Sales, ~13x PE, and ~3-4% of EV/GMV (a figure excluding their most profitable segment) seem quite cheap.

Source: (Translated) Company Presentation Slides – Sales Growth

Additionally, I feel that major success in any single division could produce meaningful upside. Japanese markets have shown some propensity to become excited about fast-growing firms in the GMO family, which is understandable as they’ve built up a firm with leadership positions in digital payment, eSignature, SSL Certificates, domain registry, hosting, and FX trading. GMO’s founder is one of very few self-made billionaires in Japan and seems like an ultra-mission-driven guy, so in essence Pepabo’s ultimate controlling shareholder thinks big and has a history of treating outside shareholders well.

Stepping back though: this is a nicely profitable business in attractive categories, with the ability and willingness to raise prices, trading at attractive levels based on traditional value metrics (and has perhaps a ~3-4% forward dividend yield). That by itself seems to offer interesting upside, but if Pepabo ever gets one of these sales-multiples I (used to) keep hearing about – gee whiz this could have real upside! If Pepabo (in the future) sold for something like ~3x ‘25E sales, that may represent upside approaching ~4x. 

There are also some potential catalysts.  Pepabo just started publishing English presentations to engage with international investors (which may be more familiar with relevant comps) and, more importantly, just raised prices for website and store hosting services.

Shares could of course trade lower if efforts in other businesses are disappointing, if they’re “run over” by competitors, or if this knife just keeps falling.

With those considerations in mind, I believe shares offer a compelling risk-reward proposition.

Illustrative Valuation and Potential Upside:

Source: Author Analysis

Management Medium-Term Business Goals:

Source: Company Presentation (Translated)

Note: Select metrics based on my estimate of ‘23 pretax income and NPAT of ~¥1,550m, and ~¥1,000m, respectively. Translations from ¥ to $ use an exchange rate of ¥115 per $1

Risks: I don’t speak Japanese and I didn’t grow up around/am not the normal user for these businesses.  Color Me gets run-over by Shopify.  Etc.

Disclosure: Have ownership interest in GMO Pepabo at the time of this write-up that can change at any time without notice. There are no plans to provide future updates on the authors buying or selling activities for this or other stocks. The author may buy or sell shares of GMO Pepabo without notice for any reason at any time.

Catalyst

TBD if any...