Description

Summary:

IFIS Japan https://www-en.ifis.co.jp/, founded in 1995 by Mr. Kazuharu Osawa (previously the #2 ranked employee at Thomson Japan), is a sticky and highly profitable subscription-based niche financial information/news business – a microscopic version of Thomson before the merger with Reuters, with some similarities to Factset/Dealogic – obscured by a boring legacy financial document preparation business.[1] 

Since A) the company’s free float market cap is tiny (Mr. Osawa controls 47% of the shares), and B) the boring non-data businesses historically generated up to half of total segment profits (before unallocated headquarters expenses, more on this below), it appears to us that other investors may have overlooked the resilience, growth, and rarity of the financial information segment.  For example, IFIS Japan’s foreign shareholding percentage as recently as late 2014 was only 0.9% despite the fact that its financial information segment generates nearly JPY 34 million of revenue per employee – less than McGraw-Hill Financial (JPY 36 million) but still more than Thomson Reuters (JPY 29 million), Factset (JPY 16 million), and newly acquired SNL (JPY 9 million).  

We conducted many meetings, calls, and emails with Mr. Osawa and his top managers (all are fluent in English with work experience at blue chip companies like Thomson Financial, Goldman Sachs, Yahoo Japan, etc.), and everything we learned suggests that the financial information/news segment alone, plus the company’s existing cash pile worth 42% of its current market capitalization, is worth more than the entire company.  At the very least, we believe IFIS is worth more than the 4x EV/EBITDA and 6x EV/FCF multiples it sells for today.  

We believe buyers of IFIS Japan at today’s prices have good reason to be excited because history shows that the best niche providers of mission-critical data to professionals can thrive for many years and make a case for regularly raising prices by integrating themselves into the workflows of their subscribers to the point where users can’t live without the data.  For example, the shipping industry bible Lloyds List (owned by Informa Plc) was started in 1734 and is still heavily relied upon by industry practitioners in 2015.  Our impression is that many of the companies in the market data industry have A) historical data sets that took many years to build, B) subscriber bases that took many years to acquire, C) ingrained subscriber usage habits that take years to change, if they can be changed at all, and D) revenues, growth rates, market sizes that are so tiny they deter new most new entrants.  As a result, it seems many niche data companies wind up being acquired instead of competed away.  For instance, Thomson Financial – before it merged with Reuters – was actually just a roll-up of 41 different niche data companies ranging in size from a few million to hundreds of millions of US dollars in revenue, each with their own separate CEO and customer lists until the group was streamlined in the early 2000’s.[2] 

The market data industry faces risks and challenges, but a friend employed by a successful market data company has been willing to chat with us about his experiences.  Through us, this friend met the management of IFIS Japan and concluded that the company definitely deserves to exist. 

Consolidated (JPY bil):          Revenue / EBIT / Equity / Net cash / ROE-ex cash / Dividend per share

2015 (co est.):                        4.30 / 0.55 / 2.40 / 1.84 / 64% / 7.50

2014 (actual):                         3.71 / 0.38 / 2.11 / 1.73 / 70% / 5.00

2013 (actual):                         3.45 / 0.32 / 1.93 / 1.51 / 53% / 4.50

2012 (actual):                         3.16 / 0.21 / 1.74 / 1.41 / 48% / 3.50

2011 (actual):                         2.45 / 0.18 / 1.60 / 1.35 / 50% / 3.00

2010 (actual):                         2.70 / 0.11 / 1.55 / 1.20 / 24% / 2.50

The crown jewel and profit center: financial information segment  

Segment P&L (JPY bil): revenue / EBIT

2015 (co. est): 0.75 / 0.39

2014:               0.71 / 0.32

2013:               0.62 / 0.27

2012:               0.57 / 0.22

2011:               0.60 / 0.25

2010:               0.50 / 0.17

Core product revenue history (JPY mil):

Research manager 2013, 2014, 2015 (1Hx2) revenue: 107m, 106m, 106m

Consensus service 2013, 2014, 2015 (1Hx2) revenue:  215m, 235m, 256m

Capital Eye 2013, 2014, 2015 (1Hx2) revenue: 176m, 183m, 206m

·       Research Manager

o   IFIS Japan started out as one of Japan’s first distributors of sell-side equity research reports to retail/institutional investors.  Initially, the equity research reports were printed then delivered by mail and fax, but by 1998 the company developed the first online platform for accessing sell-side equity research reports.  That platform, now called Research Manager https://www-en.ifis.co.jp/service/research.htm, evolved into a business model where most domestic sell-side equity research houses upload their latest equity research reports for free, while hundreds of buy-side institutional investment firms subscribe to the platform for hundreds of US dollars per login ID per month.  Buy-side investment managers have been happy to pay for this since the content is more localized and the subscription price is significantly cheaper than competitors like Bloomberg.[3]  Likewise, sell-side brokers like Goldman Sachs have been happy to supply their research reports to Research Manager for free since it provides them a way to track exactly who among the hundreds of buy-side subscribers are downloading the reports.[4]  Research Manager now has a diversified base of a few thousand actual end-users spread across some 800 login ID’s from 147 corporate clients (by revenue the top 1-10 clients only account for 6-34% of total), with subscription renewal rates well over 95%, and steady pricing (in fact there is probably scope to raise prices but the company has been very conservative on that front). 

·       Consensus service (consensus manager and consensus bulk data)

o   After Research Manager reached critical mass (today its estimated domestic market share is over 60%), IFIS Japan realized that a unique opportunity existed to combine two separate streams of corporate earnings estimates – the free earnings estimates provided by publicly listed companies, and the free earnings estimates provided by sell-side brokerage analysts to the Research Manager platform.  The combination of those two data sources formed the foundation of a superior “consensus” earnings estimate platform called Consensus Manager https://www-en.ifis.co.jp/service/consensus.htm.  Consensus Manager provides a valuable service to many stock market participants, especially institutional fund managers that care a lot about A) whether their internal earnings estimates are similar/different to both the “street consensus” earnings estimates and actual corporate earnings, and B) whether the companies they own have a stable/volatile record of earnings estimate revisions.  Today the consensus earnings estimates provided via the Consensus Manager, generated by 100% in-house data collection/processing, have become an industrywide standard.  For example, third party studies have been published demonstrating the superior accuracy of Consensus Manager estimates over competing services, and we know for a fact that the domestic subsidiaries of Deutsche Bank, Credit Suisse, Bank of America Merrill Lynch, and many other sell-side equity firms rely upon these estimates as a measuring stick they publish with most equity research reports they issue to clients.  The IFIS consensus service platform now has many hundreds of end-users users from at least 67 corporate entity clients (30 that subscribe to the cheaper online-only version and 37 that subscribe to the pricier bulk-data feeds) that pay a few hundred to a few thousand US dollars per month with over 90% subscription renewal rates (top 1-10 clients: 12-58% of revenue).[5] 

In recent years, Consensus Manager has also become the sole provider of earnings estimates to the leading online stock brokerages in Japan (i.e. Monex, SBI, Rakuten, GMO Click, etc.).  IFIS Japan’s joint website with Yahoo Finance Japan, http://kabuyoho.ifis.co.jp/, is also supplied with Consensus Manager data and has become so popular to online retail investors that Yahoo has agreed to share 60% of online advertising revenues from this site with IFIS Japan.        

·       Capital Eye

o   We believe Capital Eye https://c-eye.ne.jp/ is the crown jewel of IFIS Japan’s financial information portfolio.  In July 2007, IFIS Japan acquired the intellectual property and management team of a company called Capital Eye for just over USD 100,000.  Capital Eye, originally a Thomson-owned company, was trying to create a Japan-focused capital markets subscription information/news service to sell to investment banks, especially their capital markets teams focused on arranging debt financing for domestic companies.  But Capital Eye’s business plan was never successfully commercialized under Thomson’s ownership.[6]  After IFIS acquired the company, however, Capital Eye’s subscription service gained traction by putting together a constant stream of useful niche information – including rumors – about specific corporate debt issuance deals, the precise terms of which (indicated pricing, covenants, etc.) are often only semi-public when announced and often remain hidden after deal completion.  Today Capital Eye is known for having the “details behind the details,” and its killer applications include a real-time indicated deal pipeline that lists when domestic corporate debt issuers are coming to market (and for how much money).[7]  This information is important to the corporate debt issuer because if they originally intended to go to market with a bond issuance next week but a much larger, more profitable competitor was also planning to go to market on the same week with more attractive terms to lenders, then it would be much harder for the smaller issuer to complete their deal.  Today Capital Eye has many hundreds of users from at least 63 corporate entity clients that pay thousands of US dollars per month with over 99% subscription renewal rates (top 1-10 clients: 11-59% of revenue).[8]  

Overall, we believe the financial information segment occupies a genuine and verifiable niche in Japan.  Since Mr. Osawa was previously at Thomson (now Thomson Reuters), we spent time studying their key competitive advantages as listed out in a 2014 investor presentation (see below or http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MjI1MDM0fENoaWxkSUQ9LTF8VHlwZT0z&t=1).  Aside from the phrase “global,” we think IFIS’ market data business has every single one of these advantages too, just on a smaller scale. 

Proprietary news, data, and analytics

Critical in mass markets that matter

DNA of innovation

Global technology capabilities

Highly integrated into customer workflows

Globally renowned brands

Long-term customer relationships

Global presence

Talented, motivated, and committed employees

For example, we have no doubt that IFIS products are highly integrated into certain niche customer workflows.  It’s become routine among equity analysts at Japanese brokerages to benchmark their own earnings estimates against IFIS consensus estimates, which are acknowledged to be the best in Japan.[9]  Below are some highlighted instances of that from analysts at Deutsche Bank, SMBC Nikko, JP Morgan, Daiwa, and Bank of America Merrill Lynch. 

https://www.dropbox.com/s/k8t6e3ygj68b6bf/Consensus%20manager%20examples.pdf?dl=0

            Other IFIS products like Capital Eye, a data platform for capital markets bankers, are so integrated into customer work flows that even large market data competitors like Bloomberg have agreed to distribute it on their terminals (see below).  A close friend that is an equity capital markets banker in Asia confirmed that his peers do subscribe to Capital Eye for access to Japanese deal-related news, rumors, and pipelines that aren’t available anywhere else.

https://www.dropbox.com/s/obp82h1qp9vj37p/Capital%20Eye%20Bloomberg%20example.pdf?dl=0

Management: talent/experience worth more than current EV of just JPY 2.7 billion

We’ve had many meetings with IFIS Japan in Tokyo and Manila.  The atmosphere of these meetings was more international than any other Japanese company of this size we’ve ever met.  Most of our conversations were in English, and the managers we interacted with all had experience working in blue-chip domestic and international companies.  Founder/President Kazuharu Osawa worked at KDDI and Thomson Financial, while managing director Mr. Shogo Noguchi worked at Goldman Sachs and Softbank/Yahoo Japan.  Likewise, Ms. Kazuko Takada, CEO of subsidiary Capital Eye (a capital markets news/data platform), spent many years with Thomson Financial in Tokyo and London. 

All of these managers have been very transparent and welcoming.  Not only did they provide us with free trial login ID’s to experiment with their products, in the case of Ms. Takada at Capital Eye, she even personally guided us through a two-hour product demonstration in her office.  Likewise, Mr. Noguchi has personally responded to dozens of emails from us (in English) over the last year and arranged for us to visit their data entry office in Manila.

This interaction led us to conclude that IFIS managers understand their business and, just as importantly, shareholder value.  Mr. Noguchi, who was an equity analyst at Goldman Sachs (you can still find his old analyst reports on Bloomberg), is fluent in the language of shareholder expectations.  Likewise, there’s no IFIS shareholder with more value at risk than President Osawa.[10]  In our first meeting with President Osawa, an energetic 65-year-old, said something to the effect of “I am so asset light, I don’t even own a car” as a way of saying he likes doing business without hard assets.

Unsurprisingly, none of IFIS’ businesses require much capital: return on equity could exceed 70% this year excluding cash, or 16% including cash.  IFIS’ cash pile has been earmarked for growth initiatives, a big priority for President Osawa, who has repeatedly said he hopes revenues to hit JPY 10 billion by 2020, more than double today’s levels.  There is always the risk that the cash could be wasted as the company tries to get bigger, but we take comfort in IFIS’ track record of dividends (up 200% since 2010) and acquisition track record (all tiny tuck-in deals completed at very low multiples of revenue/profit). 

Major risk: the non-financial information businesses

We think the biggest risk to IFIS shareholders is the possible deterioration of the non-financial information businesses that contributed a third of total profit in 2014.  By far the largest of these non-data businesses is the “fund disclosure” business https://www-en.ifis.co.jp/service/fund.htm, an asset-light outsourced document preparation service (think formatting/editing prospectuses, marketing brochures, regulatory documents, etc.) for Japanese REITs, investment trusts / mutual funds, and insurance products.[11]  The key to this business is speed/automation, accuracy, price, and most importantly, client trust – so only a few major competitors exist in this space, the biggest of which is Pronexus (7893 JP).  The good news is the fund disclosure business is sticky: 60-70% of the revenue is related to preparing recurring documents from existing funds.  The bad news is A) 30-40% of revenue is related to preparing documents for newly launched funds, business that could decline in a bear market, and B) price competition is heating up. 

            We don’t expect the fund disclosure business to collapse when the next bear market arrives – in fact, it held up well during the global financial crisis (segment profit margins were 18% in 2009 versus 23% last year thanks to a highly variable outsourced cost structure).  Year-to-date, issuance of Japanese REITs and investment trusts has maintained positive momentum despite the recent stock market turbulence.[12]  Long-term, the growth in net assets of all publicly offered investment trusts in Japan has been on a steady uptrend aside from a few setback years (see page 20-25 http://www.toushin.or.jp/english/).  As you can see on pages 28-30 of the latest Morningstar Japan results presentation, there is much scope for the Japanese fund management industry to grow relative to where the United States is on an apples to apples basis.[13]

We have had some casual discussions with management about whether it makes sense for IFIS Japan to separate the stable data businesses from the less stable non-data businesses.  After all, IFIS employees are already internally separated along those lines.  Given that established market data businesses with predictable revenues and high profit margins typically trade for very high multiples, spinning off the data business in-specie to IFIS shareholders might create a significant valuation uplift to IFIS shares.  Will management follow-through with a spin-off suggestion at some point?  We have no idea, but they acknowledged that the stock market has historically undervalued IFIS; any spin-off would need the blessing of President Osawa, whose immediate priority has been growing the company. 

Growth?

In our opinion, IFIS Japan is cheap enough that dramatic growth isn’t necessary to make it a worthwhile investment at today’s prices.  Still, if you meet the management you will hear that the company has ambitions to reach JPY 10 billion in revenue by 2020 (organically and from potential acquisitions).  We’ll see if they get there.

At the very least, 2015 is looking like a good year for growth: management estimates consolidated revenue and operating profit will increase 16% and 45%, respectively.  This forecast even looks conservative given that consolidated revenue and operating profit increased 17% and 87%, respectively, in the nine months ending 2015 September 30.  41% of the profit growth in the year ending December 2015 will come from the financial information segment (thanks to growing revenues from all data products, especially Capital Eye, which according to the grapevine has taken some share from Bloomberg), while 34% of the growth will come from the fund disclosure segment (thanks increased document preparation from new fund launches and a larger base of old funds).    

Can growth in the financial information segment continue beyond 2015?  Yes, according to research from Burton Taylor, a consultancy focused on the market data industry.  Their research indicates that annual Asian market data spending (USD 4.7 billion) has a long way to catch up to Europe (USD 9.6 billion) and North America (USD 12.8 billion).  According to Burton Taylor’s demand survey, spending across all geographies will grow in the next few years, even in Japan (estimate: +0.7% per year).[14]  

We think IFIS Japan has a decent chance to capture at least some of the above expected demand growth even if they have to compete against giants like Bloomberg.  Why?  Because there are many Japan-specific quirks to earnings and earnings forecasts that are not being captured well by global players like Bloomberg.  As a long-time Bloomberg user, we can speak from experience when we say that it is not possible to screen for Japanese stocks based on revised company forecasts (at the revenue, EBIT, and NPAT levels).  If you wanted to use Bloomberg to, say, pull up a list of Japanese public companies ranked by the percentage increase of the one-year forward EBIT forecast (in Japanese, that would be phrased as営業利益修正(来期)(最新-期初)(％)), you couldn’t do it – you would need to have localized data services like IFIS Japan, Shikiho Online, etc. 

Also, since IFIS Japan already generates lots of cheap ancillary data from their previous generation platforms like research manager (where they receive daily sell-side reports for free), they have ample opportunity to repackage aspects of that into new/useful niche products that Japanese users would gladly pay for but global peers would find too tiny/local of an opportunity to waste time on.  We know for a fact that IFIS Japan often receives requests from existing clients on other platforms to create new products.

Fair value > market cap today, even if you ignore all but one segment:

Excluding treasury shares that account for 6% of total shares outstanding, at today’s stock price of JPY 480 per share IFIS Japan has a market cap of only JPY 4.64 billion, or JPY 2.71 billion excluding cash.  That JPY 2.71 billion not only looks cheap versus the company’s forecasted 2015 revenue and EBIT of JPY 4.30 billion and JPY 550 million, it looks cheap versus level of talent in the company. 

We believe the true profit contribution of the financial information segment – a segment that, were it to be separately traded, would deserve a much higher valuation multiple – is obscured by IFIS Japan’s segment breakdowns, which have a relatively high amount of staff expenses not allocated to any segment.  Since only ~20 of IFIS’ ~140 total employees work in the financial information segment, if we allocated the unallocated staff expenses proportionally across the company on a staff-count basis, we would find that the financial information segment already actually contributes up to ~2/3 of consolidated profit.

Conservatively assuming the financial information segment actually generates just under 60%, or JPY 320m, of 2015 EBIT (including unallocated HQ expenses), that means all other segments combined will generate JPY 230m of EBIT.  A 10x EBIT multiple (~15x NPAT or way below what peers sell for) would still give the financial information segment a fair value of at least JPY 3.2 billion.  This JPY 3.2 billion, plus cash of JPY 1.9 billion, would give us a fair value for the entire company of over JPY 5 billion, at least 10% higher than the current market cap today, without giving any credit to the other profit-generating segments in the company or further growth beyond 2015.

            In our opinion, the closest listed peer in Asia with a boring print business attached to a niche market data business that generates most of consolidated profit would he the Hong Kong Economic Times (423 HK) or HKET.  HKET today is essentially a traditional newspaper attached to a niche market data/news segment that owns ETNet (a real-time news/data platform for Hong Kong’s retail stock brokers/investors) and EPRC (a data platform for Hong Kong property agents).  We have met with HKET management and subscribed to both ETNet / EPRC; while ETNet also scoops/sells unique stock market rumors, we think IFIS Japan’s management and products (especially Capital Eye) are more sophisticated.[15]  Strangely, even though HKET A) trades in Hong Kong (arguably the most bombed out market in Asia), B) has less net cash as a % of market cap, and C) has a far worse record of profitability/growth/ROE (instead of expanding the market data business they spent heavily build a free newspaper), it still trades at higher P/E (15x) and EV/EBIT (9x) multiples to IFIS Japan.  Granted, there is some latent value in HKET’s own-use properties, but they don’t generate income and might not be sold for a long time, if ever.

Catalyst

Continued growth and market recognition of the financial information segment.  Possible (but low probability) separation/spin-off of financial information segment.