Description

Hosiden Corporation is a developer, manufacturer, and assembler of electrical appliances and automobile parts.  The company was established in Japan over 70 years ago.  

Hosiden specializes in connectors, switches, and various electo-magnetic components.  The electro-magnetic component segment comprises 85-90% of the business, with the remaining 10-15% split among acoustic components, display components, and applied equipment.  The operating profit split is, in general, similar to the revenue split.  Nintendo is the major, long-term customer of Hosiden and has been a driver of the business over time.  

Hosiden has an exceedingly strong balance sheet with >65% of the market cap covered by cash and equivalents, as of 12/31.  This balance sheet, and a change in capital allocation policy, formed the starting points of our interest in Hosiden.  

 Japan

This is likely well understood at this point, but Japan had tried – for years – to improve corporate governance and increase stock valuations. By the end of 2022, ~50% of companies’ shares were trading below book value.  To combat this, the Japan Exchange Group (JPX) requested capital improvement plans from all companies listed on its markets while simultaneously launching their version of a large-cap “quality” index – the JPX Prime 150.  

The JPX Prime 150 chooses among the largest listed Japanese equities and narrows it down to companies whose return on equity is above its cost of capital, and whose price-to-book ratio is greater than 1.0x.  The importance of this index was demonstrated when JPX snubbed Japan’s largest listed company, Toyota, due to its not meeting the inclusion requirements. In addition, JPX publishes the list of companies who have successfully submitted capital improvement business plans, in what is seen as a method to promote those that follow through in their effort to improve their stock price, while silently shaming those that have not.  

Japan has made a visible effort to specifically decrease the number of companies who trade at less than 1x book value and thus you see many references to “PBR” in Japanese financial press releases – the goal here is simply to drive up valuations through very simple corporate governance changes.  

Hosiden, which was trading around 60-70% of book value in early 2023, submitted a list of initiatives to drive P/B to 1x.  While it has begun to work (P/B has increased since the initiatives were introduced), we believe their P/B will continue to trade higher and likely trade >1x at some point in the near future, while the company continues to compound book value.  

Capital Allocation and Stock Performance

Hosiden’s four solutions to improve its price to book were – 

1. Selling excess real estate owned – this will likely be a small benefit to the cash balance but not material.

2. Increasing the amount if IR information for investors, and specifically increasing the amount of English information available.  The English portion of the initiative is a broad positive as foreign investors continue to pour assets into Japan and search for bargains, and Hosiden is extremely cheap.  

3. Sell various cross-shareholdings – like many Japanese companies, Hosiden owns stakes in various business partners as a form of “relationship maintenance.”  In many cases, it just seems to tie up capital that could otherwise be used for more productive uses, especially for a company trying to improve its own stock price.  Shareholding sales likely won’t be a major driver of cash towards dividends or buybacks, but it will hopefully contribute towards a return of capital over time.

4. Dividends and buybacks – this was management’s biggest commitment.  From 2023 to 2026, Hosiden committed to buy back ~10% of stock, while at the same time paying out 30% of profit in dividends.  The net effect of this was a mid to high single digit return of capital every year, over the next three years.  

In addition to this, the company committed to retiring all new shares bought back.  Hosiden is a somewhat typical Japanese company in that it holds an enormous amount of treasury shares that it could retire, but instead refrains from doing so, in case the shares are used for M&A or rewarding workers.  Over time, the number of their treasury shares has risen, and as of today, comprises about 15% of issued shares (~10mm treasury shares versus ~60mm shares issued).  

I believe that over time two things will happen – buybacks will increase beyond the stated goals, as the company seeks to increase its valuation, while also increasing share cancellation in excess of new shares acquired.  The timing for the increase is hard to pinpoint, but my sense is that if this happens, it is likely to happen within the 2024/2025 period, as their main customer, Nintendo, provides a big catalyst for profit and balance sheet growth. 

Business Prospects

I believe Nintendo accounts for 60-70% of the business in any given year.  Hosiden can experience large swings in revenue depending on the sales of Nintendo’s console (the Switch) while the rest of the business is relatively steady and growing.  

The 30-40% of sales not related to Nintendo are dominated by mobile, automotive, and healthcare component sales.  While the mobile market has reached a level of saturation and is now a slow growth business, their sales in automotive (coming off a low base due to auto production issues post COVID), healthcare, and other areas, are growing at a brisk pace.  I think between 2023 and 2026 the non-Nintendo sales can compound at 7-10%/year, which leads to total company sales growth of 4-7%/year.  

On the Nintendo front, Hosiden is one of Nintendo’s main assemblers of the Switch (Foxconn being the other).  The cadence of Switch sales largely determines Hosiden’s Nintendo-related sales, and I think the introduction of the Switch 2 will be a catalyst for both revenue growth and the stock.  

The successor to the Switch (which I’ll refer to as the Switch 2) has been rumored for years.  The rumor mill really began to heat up last year as multiple sources reported Nintendo was targeting a Christmas 2024 launch, but details proved elusive.  The news flow around Christmas 2024 seemed to change in a big way last week, as almost every source in the video game or business news industry seemed to agree on a Q1 2025 launch for the Switch 2.  While Christmas makes more sense intuitively, a Q1 launch for a Nintendo console is not unheard of, as the original Switch was also launched in a Q1 period.  

By the time the new Switch is launched it will have been 8 years since Nintendo launched a flagship console – the Switch still sells well, but the graphics have fallen behind other consoles, which has hurt third party sales and limits the ultimate market for the console.  If the Switch 2 can produce graphics better than the PS4, which is the current consensus related to its hardware specs, I believe Nintendo has a much better argument for their console as the “main” console in the house and will lead to better sales of both the console itself and 3p releases.  In addition, I think the Switch 2 could have enormous sales in the first couple of years as Nintendo has a very sparse set of game releases over the next year leading up to the console release, suggesting Nintendo’s  desire for the launch to be a major success.  It’s been years since we’ve seen a new flagship 3D Mario game, a new Mario Kart, a new Smash Brothers, etc.  All these will likely be released with significantly better graphics and technical capabilities, which should be enough to drive significant console sales.  

Hosiden has been a core Nintendo partner for decades and will reap the benefits of this new launch.  As the non-Chinese assembler, Hosiden potentially holds more importance than in the past as well – depending on US elections and tariff issues, Hosiden may be handling more volume than they’ve seen in prior years.  Management has told me that they are currently holding excess cash as a prerequisite to retain new contracts with some of their larger customers and are ready to expand manufacturing and grow inventory if one of their customers needed that to happen.  I think the odds are high that Hosiden will see a large step up in growth as we go forward and retain their partnership with Nintendo in the future.  

Valuation 

As mentioned earlier, Hosiden currently trades below 1x book - it currently trades at ~0.8x outstanding shares - and is focused on improving the P/B as time goes on.  So even if growth never materializes, I expect the stock to move upwards as they close the P/B gap, while growing book value and paying dividends.  Given the level of earnings today and the pace of capital returned to investors, they should be able to grow book value at a mid single digit pace while maintining a mid single digit capital return policy.  

On an EV/EBITDA basis, it is extremely cheap.  Hosiden’s EBITDA was roughly 19b yen in the 22/23 period (a great year for Nintendo sales) and will be roughly 15b yen in the 23/24 period that ends 3/31/24 – Hosiden trades around 3-4x EBITDA today.  Given the prospects of a big Switch 2 console cycle that lasts for a few years, and ongoing growth at the other divisions, I believe Hosiden is likely to trade close to 3x EV/EBITDA as we move into next year, with that valuation falling further as cash continues to pile up on the balance sheet.  While there is some variance in revenue due to Nintendo, and there will be variance this year as we transition from one Switch to the next, operating profit has been north of 11b yen every year since the original Switch launch, so I expect the 23/24 EBITDA level of 15b to be a rough estimate of current normalized EBITDA before we start seeing further gains from the Switch 2 and growth from the other businesses.  

From a stock perspective, Hosiden typically performs very well around periods of Nintendo console hype.  I believe management knows this and given the low valuation and continuous cash generation above and beyond the buyback and dividend outflows, I think there is a good chance management will try to increase their P/B valuation sooner rather than later.  Given Nintendo hype and a stated desire to increase book value, I think the next few years will be very good for Hosiden, and believe a re-rating will happen as various catalysts occur at the same time.    

Disclaimer: The information contained herein reflects the views of the author as of the date of publication. These views are subject to change without notice at any time subsequent to the date of issue. The author has an economic interest in the price movement of the securities discussed in this presentation, but the author’s economic interest is subject to change without notice. All information provided in this presentation is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. In addition, there can be no guarantee that any projection, forecast or opinion in this presentation will be realized. All trade names, trademarks, service marks, and logos herein are the property of their respective owners who retain all proprietary rights over their use. This presentation is confidential and may not be reproduced without prior written permission from the author.

Catalyst

Switch 2

Return of Capital