Description

A sum of the parts thesis in Japan? Where do I sign up? But really, we think shares of UNITED are undervalued based on underlying net assets. We think those assets are of high quality with long runways for growth. Most importantly, management is taking proactive and pro-shareholder steps to unlock this value by simplifying the corporate structure and returning cash to shareholders. With shares trading well below cash and investments, we see minimal downside, substantial upside, and multi-bagger potential if management executes while their assets continue to grow. 

Japan 

Before we dive into the specifics of the company, it is worth discussing what we are seeing in Japan more broadly. Most investors are not particularly interested in Japanese stocks, and for good reason. The Nikkei 225 Index (a broad measure of the Japanese stock market) peaked in 1989 and has yet to regain those highs more than 30-years later. Japan is home to the oldest companies in the world, including an enterprise called Kongo Gumi which specializes in the construction of Buddhist temples and has been in continuous operation since the year 578. For those in the back without your calculators handy, that is 1,443 years and counting. While we appreciate a focus on the long-term as much as anyone, a corporate culture that prioritizes survival at the expense of all else is hardly what gets the capitalistic juices flowing. This often manifests as cash hoarding, an unwillingness to take any sort of risk, and a general lack of dynamism and entrepreneurialism. As a result, Japanese stocks tend to trade for very low valuations which are largely deserved. 

But what is true in the aggregate can miss important nuances beneath the surface. The Tokyo Stock Exchange has a section called “Mothers”, which is a loose acronym for “market of the high-growth and emerging stocks”, and consists of startups and generally more entrepreneurial enterprises. They operate in high-growth fields like e-commerce, software, artificial intelligence, FinTech, and other cutting-edge industries. What we’ve found is that in contrast with the general perception of Japanese companies, many of the Mothers constituents are dynamic, entrepreneurial, and shareholder-minded and appear to have largely gone unnoticed by western investors. 

UNITED Inc. 

With that preamble out of the way, let’s get to the specifics. UNITED is a collection of both passive minority investments and wholly-owned operating businesses. Investments are spread between publicly listed companies in Japan, direct venture investments in earlier-stage companies, and LP interests in venture and private equity funds. The most notable investment by a mile is a 4.7 million share stake in Mercari, a used-goods marketplace listed in Japan that has been extraordinarily successful. UNITED has monetized a portion of their Mercari holding, but their original shares are up more than 200x since their 2013 investment.  

On the operating side, UNITED’s most important business is KiRAMEX, which operates the online technology school Tech Academy. There is a growing shortage of IT personnel in Japan, driven by a skills gap between an aging workforce and the increasingly digital demands of modern employment. Since 2017, KiRAMEX has grown its student count almost 8x from 3,880 to 30,173, and is now the largest online programming school in Japan (according to a Macromill survey). 

KiRAMEX operates a unique model that brings “mentors” from industry to teach the courses and is highly selective; only 10% of applicants are selected as mentors. Students benefit from mentors with real-world experience and even have a chance to work on live projects while they learn. As the business scales, they have the opportunity to create a virtuous feedback loop. KiRAMEX gets the best mentors, which attracts the most students, which gives KiRAMEX further firepower to hire more of the best mentors. 

The Opportunity

In the past, UNITED’s attention has been divided among various business lines including digital advertising, game and app development, and even cryptocurrency with mixed results. In 2020, the Company restructured to focus on KiRAMEX as the core operating business along with the group’s investment efforts. The reorganization was a dramatic change, and entailed shutting down loss-making businesses and reallocating resources to the most promising opportunities. Thus, the historical consolidated financials bear little relevance to the Company as it exists today. 

Today, UNITED is leaner, more agile, focused, and shareholder oriented. And this is not at all reflected in the share price. At ¥1,674 per share and 21.8 million shares outstanding, that is an implied value for the whole company of ¥36.5 billion or $330 million. What do we get for our money? As mentioned, the largest single investment is a 4.7 million share stake in Mercari worth $262 million at today’s market price, and more at our estimate of fair value. They also have cash of $151 million on the balance sheet. Between Mercari and the cash, that is already $413 million of value, well in excess of the market cap. Outside of Mercari, UNITED also holds various other investments worth an estimated $50 million. That is $463 million before we get to the operating businesses. 

UNITED’s KiRAMEX business is housed within its “DX” (Digital Transformation) segment and comprises a major portion of the total. While KiRAMEX financials are not separately disclosed, the DX segment grew 34% last year in total, including 67% growth at KiRAMEX. Similar businesses in Japan today trade for 5-10x sales. If we value the DX segment at the low end of this range, that is worth ~$140 million. Over time, if UNITED’s new focus on KiRAMEX drives continued growth, this estimate could prove particularly conservative. 

With cash and investments far exceeding the share price, there is a large margin of safety in UNITED that protects against fundamental downside risk. Rather, the risk is that the upside we see will remain unrealized which is far too common in Japan. In these cases, we want to see management taking tangible, proactive steps to unlock embedded value and drive the shares higher and that is exactly what we see at UNITED. President and Executive Officer Tomonori Hayakawa studied business in the United States, and has fully embraced change and dynamism as a core operating principle. He has been aggressive with culling the business portfolio where there is no path to sustained profitability, and perhaps most encouragingly has begun a large capital return program which combines dividends and share repurchases. UNITED has committed to pay out 20% of earnings as dividends, and recently announced plans to retire 13.5% of shares outstanding through share repurchases and treasury share cancellation. Once that repurchase is complete in March 2022, UNITED is likely to engage in ongoing share repurchases with excess cash. In management’s own words, the purpose is clear: “we plan to retire our treasury shares in two separate transactions to boost the value of shares”. We cannot emphasize enough how different this is from what people typically expect from Japanese companies. 

Also worth mentioning is that the Mothers index (and Japanese small caps more broadly) is not filled exclusively with low-multiple stocks and countless examples of “value” left unrealized. What we’ve noticed is that the market has tended to reward simple growth stories and abhors complexity (sound familiar?). We see fast-growing software companies with clean financials and straightforward reporting trading for >40x sales. But with fewer eyes pouring over these companies, we suspect that there is less effort to untangle the financials of more messy situations like UNITED. As management continues to simplify the corporate structure down to just KiRAMEX and the investment portfolio, we expect the stock to more accurately reflect underlying value.

Mercari

Mercari has been written up twice on VIC and I recommend that you read those to get a more detailed overview of the business. We agree with those theses and are very optimistic about UNITED’s largest asset. To summarize, Mercari operates the dominant used-goods marketplace in Japan, having leveraged a user-friendly model that streamlines the buying and selling process with high engagement. The business in Japan is growing fast, with fat profit margins north of 30% that could be headed to 40% or even 50%. With an enterprise value of ~$6.9 billion, Mercari shares appear to reflect a reasonable valuation for their Japanese marketplace business (about 26x pretax) but miss valuable optionality that the Company is building. Mercari has a fast-growing U.S. business that has recently begun to overtake rivals, allowing them to raise prices to improve profitability. Historically the U.S. business has run losses, masking the Japanese profitability, but going forward we think the U.S. will be profitable. If they can get real traction in the U.S., the upside is enormous given the size of the market. Mercari also has a promising payments offering called Merpay that facilitates payments on and off the Mercari platform and is beginning to explore other financial services like asset management. Further, we think it is likely that once the U.S. shows sustained profitability, Mercari may expand their model to other markets such as Taiwan where they are already experimenting with cross-border selling. 

I’m happy to discuss our views on Mercari further in the comments. 

Conclusion

Ultimately we see UNITED as a collection of good businesses trading at a large discount to intrinsic value, run by a capable management team who is doing all the right things to unlock value for shareholders. 

Risks

Capital allocation - UNITED is asset rich and appears to be following a rational capital allocation framework. But if management changes course from the focused strategy and decides to redeploy capital into more diverse activities, share value could be impaired if those ventures are unsuccessful.

KiRAMEX - On the operating side, management is focused on KiRAMEX as their primary operating business. Results have been strong to date, but if the growth runway or margin structure prove less favorable than anticipated, our value estimate could be too high. 

Catalyst

Corporate simplification

Share repurchases

Growth at Mercari and KiRAMEX