Description

Next operates the leading online real estate in Japan. It trades at an attractive absolute multiple and a huge relative discount to other leading RE portals worldwide. The shares have been impacted over the last year by the changes in Japanese tax rates and an increase in advertising expenses. Both these issues are temporary and should fade over time.

Next was founded by Takashi Inoue. He worked at Recruit, the Japanese classifieds conglomerate and the leader in real estate listings offline, prior to founding Next. He is a founder/operator CEO and still holds 36% of Next's shares.

Next operates Homes.jp, the leading RE portal in Japan. Next has several competitors including:

• Suumo
  • Division of Recruit
  • Online and offline assets
  • Suumo has roughly Y74bn in revenues, 40% of which they attribute to online
  • Suumo is Next's main competitor
• Yahoo Japan
  • YJ has a RE portal
  • RE is not material nor an area of focus for YJ
•  Rakuten
  • Next powers Rakuten's RE portal
  • Rakuten owns 16% of Next
• At Home
  • Player but smaller traffic and listings base

To compare the scale, Next has had around 4.3-4.5mm listings while Suumo (owned by Recruit) has 2-2.2mm, Yahoo Japan 1.8-1.9mm, and At Home has around 1.5mm. From a traffic standpoint, Next and Suumo have similar levels of traffic although Next is larger when you include its Rakuten traffic.

Next has grown rapidly over the last few years (LTM revenues of Y15bn vs. Y10bn in FY13). While there have been a number of reasons for Next's growth, the biggest one is the change in business model. Next changed its business model from the traditional listings fee model employed by most industry players to a per inquiry fee. For example, Suumo charges a set amount for a listing to be uploaded and then charges feature fees to highlight or upsell the listing. By contrast, Next now charges a flat fee to the agent after which they can post as many listings as they like but they are also charged each time that a consumer makes a request to the listing agent about a property. This new business model caused agents to post all their listings to Next.

Suumo is unlikely to follow because they have a large base of revenues to protect and their classifieds model across many verticals relies on listings fees. This setup reminds me of Ebay vs. Amazon marketplace -- Ebay's reliance on large listings fees made them vulnerable to a success-based business model that relied on final value fees (Amazon maketplace).

Next shares have been weak over the last six months because the top line growth has slowed from 21% y/y in 3QFY14 to 13.4% in 1QFY15 while operating margins have also contracted, resulting in operating profit down -54% and -18% y/y in the last two quarters and OP margin guidance of 13.5% vs. 17.4% in FY14.

The slowdown in revenues is mainly attributable to a hard comparison and changes in the Japanese consumption taxes. Like everywhere else in the world, Japanese consumers are increasingly searching for real estate online first. Ad dollars are following the shift in behavior and that should help Next grow at a mid-double digits pace as listings grow, inquiries grow, and Next gradually takes pricing. The most obvious example of Next's TAM is the Y74bn currently earned off and online by Suumo (5x Next's LTM revenues)

The decline in margins is mostly due to higher advertising spending. Next has historically limited advertising spending to just under 30% of revenues. However, this year Next decided to invest more heavily in order to improve its brand awareness and capitalize on consumer's shift to mobile apps. As a result, advertising will be 4-5% more as a % of revenues than a year ago and the gap between Suumo's ad budget and Next' will have closed from to ~1.5x (from 3-4x a few years ago). Going forward, Next expects to reduce advertising as a % of revenues by about 1pt per year. Overall, the decision to invest a few incremental pts of margin into advertising seems like a reasonable bet given the mobile transition and the size of the potential market. Management has been more prudent than, for instance, Zillow which has been spending 40-70% of revenues on advertising in recent quarters for similar reasons.

So the Japanese macro and the decision to invest in marketing have hurt results and the share price. However, this is still a company that can grow its top-line 15-20% annually over the next 3-5 years while expanding operating margins towards the LT goal of 25%. I assume that revenues exceed Y22bn in CY16, a 18% CAGR from CY13 and that Next is able to expand operating margins to 20%, 250bps higher than CY13 levels.

Price target: Y980 (+44% upside).  Next would then be trading at 10x EBIT and 20x EPS...reasonable levels for a leading online vertical site. These multiples are far below the levels that other leading online RE companies currently trade for [see chart below] and are attractive on an absolute basis.

Risk: Y470 (-30% downside). Assuming margins remain compressed due to competition and the multiple contracts to 15x FY15 EPS (vs. 21.5x today). Longer term, permanent impairment here seems less likely as Inoue would have several willing buyers (including Rakuten) if he were interested in selling.

from CapIQ, EBIT is unadjusted for SBC, etc.

Catalyst

• Next cycles through its heaviest period of advertising spending
• Japanese housing market improves post consumption tax
• Investors realize the price disparity between Next and other leading online RE companies