Description

Thesis

Quality 20-30% growing tech company without the tech headaches (has high cash margins instead of cash burn and does not have egregious stock comp) available at a cheap price on the basis of fwd profit.  Recurring revenue web analytics and social media analytics SaaS business with abundant cash flow and low 40s OPM wielding an already successful yet underappreciated and potentially transformative chatbot catalyst.  Trading at 14x 2023E EV/EBIT is an undemanding entry multiple given the quality and growth. Potentially transformative chatbot business is muddled by lack of disclosure -- the company only published its first English document in Feb 2021.

Having a CEO call and studying their track record supports my view that management’s operational prowess is special -- they are 3 for 3 on pillars.  Their website analytics business UserInsights launched in Dec 2008 and reached ~800m in rev in 2021 (took 13 years).  Their next pillar of social network analytics (called SocialInsights) launched in Jan 2012 and is already ~800m in rev in 2021 (took 9 years).  Their chatbot business launched in Feb 2017 is already ~20% of revenues and I forecast it will eclipse 800m by 2023 at the latest (would be 7 years) with a long runway because chatbot  TAM > web analytics TAM.  Moreover, the unit economics are fantastic as low 40s OPM is extremely impressive for a 20-30% grower still scaling up its third pillar. I attribute these impressive results to this management team’s combination of technological prowess, disciplined resource allocation into promising growth markets, and incorporating customer feedback into product improvements (i.e. delighting the customer).  Finally, their two most important growth drivers:  SocialInsights and Chatbot are protected by a narrow moat from foreign competition because User Local’s proficiency in Japanese language, colloquialism, and slang helps User Local differentiate – and the local VC scene is underwhelming.  

Business Description

This is a group driven mainly by good technology delivered to customers at a cheap price in 3 areas as outlined below. Distribution is mainly direct: “direct sales account for most of our sales” and “there is no main distribution partner.”  Lead gen for direct sales is augmented by online marketing, particularly listing advertisements.

UserInights (~40% of rev)

User insights business provides website analytics service to clients who are largely working in an online marketing capacity.  Heat map analysis shows marketers where on a webpage that users are engaging the most.  SEO analysis helps with search engine page ranking and Google adword purchases.  Subscribers to UserInsights also get automatic report generations to help organize all the data for consumption both by the active user and internal teams at the user’s employer.  User Insights also provides clients with analysis of advertising effectiveness and user attributes.  Comps are SimilarWeb and SEMrush (both listed).  The tools are used to analyze viewership via PC browser, mobile, and tablet. More details:

Subscriptions entail a modest upfront fee (usually equiv to 1 or 2 monthly fees) to cover onboarding/training/demos/slight customizations and a monthly fee of JPY 50k (smaller sites), or JPY 100k (larger sites). 

Social Insights (~40% of rev)

This is their “UserInsights” for social media -- for use by online marketers’ management and analytics of social media accounts and campaigns.  Similar to UserInsights, pricing is JPY 50k/mth with 10 staff able to access the account. Google translated table below further outlines the Social Insights functionality:

Here is the Search awareness of User Local in Japan as compared to Global competitors like SimilarWeb, SEMrush and Ahrefs over the past 5 years.

Chatbot (~20% of rev and growing)

Automating support tasks previously handled by phone or email. Pricing is JPY 100k/mth.  Conversation log data is accumulated by repeating chatbot conversations and the accuracy of the answers can be improved using machine learning, although technological differentiation is not far in excess of peers. Industry data is sparse for Japan, but CEO believes they are taking market share -- driven by easy implementation at a low cost of $500, which is lower than “good competitors” at $3000 and “average competitors'' at $10,000.  The CEO attributes their implementation efficiency to the first mover advantage of knowing what designs are the most easily applied to a wide variety of customers (i.e. low customization needed). They look at typical SaaS metrics, but don’t disclose LTV/CAC, only saying “CAC is low and payback is fast.”  CEO said they have over 30 clients, which implies to me that we need to monitor customer concentration risk. Below is a moderately helpful Google translated chart showing the breadth of their chatbot solutions.

Why I accept the risks associated with disclosure

The vast majority of revenues are recurring, which reduces my risk of forecasting error, as does the consistent 20-25% historical growth cadence (will exceed this year) and OPM seemingly pegged around 40%.  The modest entry multiple does not require heroic growth either in magnitude or runway.  The financial results are incredible, which eliminates pressure to verify unit economics that they do not disclose.  Disclosure is a common shortfall with Japanese companies, so I’m a bit numb to it by now – so I should also mention that.  Also, I value this conservatively assuming the consistent delivery of 20-30% growth slows to 15% by my outyear and consistent advertising productivity decelerates materially with no justification other than me wanting to have conservative forecasts. These forecasts are likely to be exceeded if I’m right on management quality – but it’s still quite cheap on these conservative assumptions. Finally, I like the management, spoke with the CEO for 60 mins, and want to invest with them, so I’m willing to give them the benefit of the doubt.

Why I am willing to give management benefit of the doubt

How often do you see a tech business launch three pillars organically each one more impressive than its predecessor, CAGR at 20-25% while holding steady at 40% OPM for years with ROIC averaging 20% on TIKR’s calc and #NAN on my calculation because of the negative working capital?  I consider this financial performance to be top 1% globally. The CEO is proud of his company’s 3 for 3 performance “we have had no unsuccessful product launches” and describes the drivers as a “resource allocation diligence…that will continue”  Basically, they know how to identify a solution that has commercial promise while diverting away from proofs of concepts that don’t show promise, fund the development of promising projects responsibly, iterate designs based on customer feedback, while avoiding cash burning albatross programs and avoiding over-hiring (only 76 employees) – i.e. they are able to sidestep mishaps that are endemic at most tech companies. Big data capability enables them to collect logs on user behavior, identify areas of dissatisfaction, make improvements, and accurately reflect the needs of users and into product development.  CEO described this as a “feedback loop” impacting the design of a product that really cares about delighting the customer.  Their process struck me as the antithesis of engineers running amok doing non-commercial pet projects that interest them intellectually.  They also put a lot of emphasis on ease of implementation. Anecdotally, I was impressed by their answer to my GPT-3 chatbot question, that GPT-3’s latency is too long to build a commercially viable chatbot – I agree with this statement and it gave me the impression that they are intelligently studying next gen natural language processing. Management also owns 56% of the shares (see table below).  I spoke with Founder/CEO Masao Ito, which gave me confidence.

Valuation

I have growth decelerating to 15-20% in 2023-2025 despite them being on-track for ~30% growth in 2022.  I have OPM progression ~flat at 41.5% as per history of consistent delivery of low 40s OPM and management’s stated desire for that to continue.  On my terminal EBIT forecast of 2.2bn in 2025, I’m using a terminal multiple of 20x EBIT to reflect business quality and likely double-digit growth prospects beyond 2025.  2500/sh fair value (in PV terms). Expected 3 yr IRR 28%.

Risks in order of what worries me most

1. Churn and concentration risk in chatbot where they only have 30+ clients

2. Lack of disclosure means I can’t track rev or OPM by activity, I don’t know churn trends, # customer adds, market share, LTV/CAC etc etc

3. The financials are so good that I expect competition, but this is mitigated by the poor VC infra in Japan. Engineers are not highly valued in their business culture (low wage/low prestige) – so they get to compete under that umbrella

4. Management ownership limits the float and makes this trade more like a micro-cap

5. The CEO’s top candidate for fourth pillar sounded underwhelming to me (image recognition AI to prevent cheating at physical testing centers), but who am I to criticize these guys.  Even if I’m correct that this isn’t enough to be a 4th pillar, they are “exploring many” fourth pillars and chatbot’s growth runway permits them 1-2 more years of tinkering.  Even if new business initiatives come up empty for the first time in the company’s history, this stock still has upside due to the growth prospects of the first 3 pillars -- i.e. favorable risk/reward.

6. Yen continues to weaken, but this is lower on the list because USD/JPY hedging options are available

Catalyst

• Chatbot growth
• SocialInsights growth
• Management continues its track record of developing new businesses