|Shares Out. (in M):||35||P/E||0||0|
|Market Cap (in $M):||450||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
Katakura Industries (“3001 JP”) has a market value of ¥48.8 billion despite a growing real estate portfolio worth ¥117.5 billion, or 141.2% more than 3001 JP’s current market value. This valuation attributes zero value to 3001 JP’s net cash and securities of ¥32.7 billion, as well as its other businesses. In total, we believe 3001 JP is worth ¥150.2 billion, or 207.6% more than the current market value. Downside is protected as 3001 JP’s proportional net cash and securities portfolio covers 67.0% of the current market value and 3001 JP generates positive free cash flow. As of December 2017, an activist is the company’s largest shareholder and is making progress towards unlocking 3001 JP’s value.
|3001 JP Valuation:|
|Real Estate Value||¥117,490|
|Non-RE Businesses||¥0||<< assuming no value for non-RE businesses as earnings from them roughly cover corporate costs|
|Fair Value Per Sh||¥4,272.79|
|Net Cash & Inv||¥32,707|
|Net Cash & Inv Per Sh||¥930.45|
This opportunity exists because:
1. 3001 JP’s most valuable real estate sits on land the company has owned for more than 60 years and is recorded on the balance sheet at historical cost.
2. 3001 JP has several operating businesses, not just real estate, and therefore, it does not regularly provide net asset value estimates.
3. 3001 JP does not provide granular detail about its most valuable real estate assets.
4. There is no analyst coverage given the small market capitalization (~US$450mm).
Real Estate Business:
3001 JP began operations as a textile company in 1873 and over time the company gradually expanded into other businesses including its growing real estate development business. 3001 JP has done the opposite of the many Japanese publicly traded companies with trapped real estate value (i.e., sit on land under their HQ’s worth more than market valuation) and proactively moved their headquarters away from valuable land to develop the land into income generating commercial properties. Today, the company’s real estate business mainly consists of leasing out retail properties that generated ¥5.5 billion of EBITDA in 2017 and has experienced 11% organic operating profit CAGR in the last five years. 3001 JP has conservatively guided to 3% operating profit CAGR for the real estate business over the next 4 years in its long-term plan (3001 JP’s real estate business has beat its annual operating profit forecast each year in the last 7 years and outperformed its prior 2016 long-term plan EBIT target by 49%). Summary stats for the real estate business are laid out in the table below:
|Real Estate Stats:||2010||2011||2012||2013||2014||2015||2016||2017||2018E||2021 Plan|
|EBITDA - CX||-¥4,970||¥2,189||¥1,292||-¥436||-¥1,370||-¥6,557||¥4,214||¥4,632||¥4,650|
While 3001 JP does not provide much individual property information, they do provide a third-party appraisal valuation of ¥117.5 billion for its real estate portfolio as of year-end 2017 in a small section on pg. 73 of their annual report (http://www.katakura.co.jp/ir/news/pdf/2018/109_shihanki_4.pdf). Of that ¥117.5 billion in real estate, we believe two successful commercial properties account for 90% of the value:
1. Cocoon City: this is a retail shopping center that was 3001 JP’s textile factory in Omiya Ward, Saitama City. Omiya Ward is the commercial and business center of Saitama City (located in the Greater Tokyo Area) and it has 5-year and 10-year population CAGR of 0.9%, as opposed to the overall declining population trend in Japan. Cocoon City is very attractively located just 200 meters outside of the Saitama Shintoshin Station (in Japan, an essential indicator of real estate value is proximity to a popular train station). The Saitama Shintoshin Station is the second busiest train station in Omiya, and it has seen healthy passenger growth over the years – 6 year passenger CAGR of 4.2% and 11 year passenger CAGR of 3.1% (https://en.wikipedia.org/wiki/Saitama-Shintoshin_Station). Given 3001 JP owned the land next to the station for over 60 years, book value of the land is close to zero. The total book value of Cocoon City is ¥16.6 billion (mostly construction costs to develop the property), but we believe the market value for Cocoon City and nearby land is closer to ¥81 billion. This prices the property at ¥551k per sqm, which we think is fair and perhaps conservative given there are three nearby commercial buildings that Ministry of Land, Infrastructure, Transport and Tourism recently appraised between ¥551k per sqm to ¥1.36 million per sqm (https://tochidai.info/area/saitama/ - the first three buildings underneath the map). We’re taking the lowest value to be conservative.
|Land Value||Land Area||Land Value||Saitama Shintoshin|
|Property||per sqm||(sqm)||(in million yen)||Station (in meters)|
|4 Chome-262-16 Kishikicho, Omiya-ku, Saitama-shi, Saitama-ken||¥1,360,000||1,247||¥1,696||160|
|4-1 Shintoshin, Chuo-ku, Saitama-shi, Saitama-ken||¥777,000||778||¥605||300|
|4 Chome-13-2 Kishikicho, Omiya-ku, Saitama-shi, Saitama-ken||¥551,000||419||¥231||600|
|Saitama Shintoshin company-owned land (mostly Cocoon City)||¥551,000||147,000||¥80,997||200-300|
1. Tokyo Square Garden: this is a multi-purpose commercial building that was 3001 JP’s headquarters. In 2010, 3001 JP contributed their land to a JV with The Dai-ichi Life Insurance Company for the development of the property and retained an 11.2% ownership of the finished Tokyo Square Garden building. The property is also attractively located – just 500 meters outside of Tokyo Station. It’s 100% occupied, and is managed by Dai-ichi Building, a private property management company in Japan that manages 308 commercial buildings. In January 2017, Japan Prime Realty (a publicly traded Japanese REIT) bought 8.2% of Tokyo Square Garden for ¥18.4 billion, implying 3001 JP’s stake is worth ¥25 billion (you can find more info on the Japan Prime Realty transaction on pg.14 of their investor deck http://www.jpr-reit.co.jp/ir/library/uploads/170309-6957fe8c3c.pdf).
|JPR Acquisition Price||¥18,400|
|% of TSG Purchased||8.22%|
|Implied TSG Value||¥223,844|
|% Owned by 3001 JP||11.18%|
|Value of 3001 JP's Stake||¥25,026|
Put together, we believe Cocoon City and Tokyo Square Garden account for ¥106 billion of the ¥117.5 billion of total appraised rental real estate value. The rest of the rental real estate portfolio is mostly shopping centers and a few hotels, and excludes the actual real estate owned where 3001 JP operates its other businesses – that is an additional ¥3.6 billion of value (if valued at book). We feel comfortable with the ¥117.5 billion appraisal valuation as it implies 21.5x EBITDA, which is in line with valuation of other Japanese retail REITs.
|Japanese Retail REITs||Ticker||LTM EBITDA|
|Mitsui Fudosan Co., Ltd.||8801 JP||19.3x|
|Japan Retail Fund Investment Corporation||8953 JP||23.1x|
|AEON REIT Investment Corporation||3292 JP||16.7x|
|Frontier Real Estate Investment Corporation||8964 JP||20.3x|
|Fukuoka REIT Corporation||8968 JP||22.7x|
|Kenedix Retail REIT Corporation||3453 JP||25.3x|
3001 JP has ¥35.3 billion of long term investment securities, most of which are common stocks of other publicly traded Japanese companies. It is a well-diversified portfolio consisting of more than 50 publicly traded stocks. The biggest holding is Hulic (3003 JP), a ¥780.4 billion real estate development and management company – 3001 JP’s stake as of year-end 2017 was worth ¥6.7 billion, or 19% of its investment portfolio. No other stock accounts for more than 6% of the portfolio. These cross-shareholdings are a common practice in Japan with the intent to maintain business relationships by investing directly in business partners. As part of Japan’s recent corporate governance reform, these cross-shareholdings have been under scrutiny. The government has been using Japan’s $1.3 trillion Government Pension Investment Fund (GPIF) as a vehicle to lead the industry towards adopting the country’s new Stewardship Code and Corporate Governance Code (http://www.gpif.go.jp/en/topics/pdf/20170623_stewardship_principles_proxy_voting_principles.pdf, https://www.robeco.com/en/insights/2017/12/has-stewardship-improved-things-for-japanese-equity-investors.html). The GPIF started publishing its holdings in 2016 and revealed it owned 1.65 million shares of 3001 JP as of 3/31/2016. Its holding remained unchanged as of 3/31/2017 and we believe it continues to be a top shareholder of 3001 JP. The Japanese government is set to revise its 2015 Corporate Governance Code in June 2018 and changes will be focused on unwinding cross-shareholdings (https://asia.nikkei.com/Opinion/Investors-stand-to-gain-from-Japan-s-corporate-governance-reforms2). It’s likely that GPIF will implement measures to enforce the new code; therefore, we believe GPIF’s involvement will create pressure for 3001 JP to start divesting some of these cross-shareholdings in the next few years. Ongoing activist pressure discussed below will also help push for value realization of this investment portfolio.
While 3001 JP has ¥26.9 billion of cash on its consolidated balance sheet, only ¥3 billion of that is actually held at the corporate level, and the remaining ¥23.9 billion is held at 3001 JP’s 57.8% owned pharmaceutical subsidiary. Therefore, when we value 3001 JP’s proportional cash, we only take the 57.8% of the ¥23.9 billion cash at the subsidiary level. Our bridge to the proportional cash balance:
|Cash at Pharma Sub||¥23,893|
|3001 JP's Share of Cash||¥13,810|
|Cash at Corp Level||¥3,000|
We’re also excluding minority interest in our enterprise valuation because practically all of 3001 JP’s minority interest comes from its pharmaceutical subsidiary, and our valuation framework includes only 3001 JP’s share of cash at the subsidiary, not the consolidated value of the pharmaceutical business.
Non-Real Estates Businesses:
We did not devote a lot of time in the writeup to 3001 JP’s other businesses outside of the real estate business because they are less material and basically generate enough EBITDA to offset corporate. But in addition to the real estate business, 3001 JP has four business segments:
1. Textile (20% sales, EBITDA breakeven): mainly manufactures and sells underwear-related garments.
2. Pharmaceutical (31% sales, 23% consolidated EBITDA): this is the 57.8% owned subsidiary called Toa Eiyo, which manufactures and sells heart medication drugs, vitamins, and hypertension treatment patches called Bisono Tape.
3. Machinery (21% sales, EBITDA breakeven): makes three-valve manifold related products, fire engines, firefighting related equipment, and agricultural equipment.
4. Other (6% sales, loss-making): houses all the new businesses being tested out by the company.
Real estate makes up for the remaining 76% of consolidated EBITDA. Summary financials for each segment by year are below:
What makes 3001 JP especially interesting today is Oasis Management’s ongoing activist campaign which could potentially help unlock significant value. Oasis has had some recent success in Japan pushing for corporate governance improvements and shareholder value creation. For example, Oasis engaged Nintendo for years in an effort to push the company into mobile gaming and this ultimately paid off with the enormously successful launch of Pokemon Go. Oasis was publicly against Panasonic’s recent takeover offer for Panahome, and forced Panasonic to raise its tender price by ~20%. Oasis also won a court case against Toshiba Plant Systems & Services forcing the company to terminate a deposit agreement with it parent Toshiba that had locked up significant capital. Additional situations we’ve followed suggests that Oasis plays the long-game.
Oasis first reported owning 3% of 3001 JP as of year-end 2015. They made several shareholder proposals in the company’s 2017 AGM that were rejected. In December 2017, Oasis more than doubled their stake in 3001 JP to 6.9%, becoming the company’s largest shareholder. Oasis recently made the following shareholder proposals at the 2018 AGM: (i) removing the current CEO from the board; (ii) nominating two outside directors (one real estate expert and one textile expert); (iii) a special dividend of ¥127 per share; and (iv) setting and announcing specific ROE goals for each business segment every year and withdraw businesses that fail to meet at least a 5% ROE. These proposals were rejected, but we believe Oasis’ continued campaign has helped raise awareness to the mediocrity of 3001 JP’s other non-real estate related businesses and is pressuring management to improve results. Recently, 3001 JP announced restructuring/exiting some non-core businesses and the resignation of two directors. So positive changes are being made, even if at a slow, Japanese pace!
Given 207.6% upside to the fair value of it’s real estate and net cash and an activist shareholder pushing for value realization, we believe an investment in 3001 JP is a compelling and asymmetric risk-reward.
Continued RE profit growth
Shift to a more strict ROE focus