Description

The correction in US and European growth stocks has dominated recent headlines, but many investors are unaware that the Mothers Index (a rough proxy for the Japanese equivalent), is down 35% over the past twelve month and is now trading around its 2013 levels.

There are as a result a multitude of interesting opportunities currently available in the Japanese Internet Services sector.

While Japanese Internet Services businesses tend to be growing less rapidly than their US-based contemporaries, share prices tend to trade at much more reasonable valuations to actual (and not reported) profits. Contrary to some preconceptions, disclosure can be very good with quarterly presentations available in English and access to engaged management teams. The annual and mid-term guidance provided is a godsend for investors who value predictability and can get an clear view on the  management’s reliability and track record of delivery.

The write-up on GMO Pepabo (posted by VI4Life in February 2022) clearly demonstrated a number of the characteristics that make the sector attractive, and we believe i-Mobile also falls into this bucket.

i-Mobile is valued at 2.4x EV/EBIT and 9x PE based on its latest twelve month financials.This does not seem demanding when taking into account the 10% earnings CAGR over the past 5 years and the track record of positive capital allocation by the two founders. The company regularly buys back and cancels shares, while also paying a special dividend in 2021, a rare occurrence in Japan. The company’s own mid-term plan foresees EBIT to grow from Y3.75 billion in current FY2022 (the company’s fiscal year ends in July) to Y4.50B in F2024. This implies management think that they will be able to keep increasing earnings to match the pace over the past 5 years.

i-Mobile consists of two business units. The first is a legacy media operations and advertising network which generates stable cash-flow sbut operates in a competitive market. The second is  a very profitable and growing Home Town Tax Donation (HTTD) venture which has a clear competitive positioning and benefits from positive network-effect characteristics.

The Ad Network unit represent 60% of revenues but only 30% of EBIT. A good introduction of their service with a useful video in English can be found here: https://www2.i-mobile.co.jp/en/index.aspx

In recent years the online market has been consolidated by large advertising agencies and internet platforms, leaving i-Mobile to focus on aggregating digital output between smaller advertisers and sites. The company also works as a reseller of Google ad inventories. In September 2019, management made the clever acquisition of a gamified rewards point system, Ohte, which has proven to be synergistic addition to the existing ad placement activities. The new division posted strong results in F2021 but guidance indicates that the business unit operating margins should revert back to 10%. That being said, the unit should keep generating consistent cash flows going forward and could provide some upside optionality.

In 2015, the company entered the then nascent Home Town Tax Donation (HTTD) market. The scheme allows tax payers to reclaim up to 20% of  both their local and income taxes, in the form of coupons and products, by sponsoring rural municipalities across Japan. The scheme is a clever way for the government to inject tax revenues into poorer regions and is growing rapidly (the market has increased at 35% CAGR over past 5 years).

Four players have emerged to serve as portals where tax payers can select chosen municipalities for their denotations. The market leader, Furusato, is a subsidiary of Change Inc. (3962 JP), while the second and third largest firms are subsidiaries of Softbank and Rakuten respectively. i-Mobile operates Furunavi which is the smaller portal with a 15% market share, but it intends to grow further. Interestingly, Furunavi is able to charge the highest take-rate thanks to a wider choice of rewards and a strong supply of municipalities connected to its platform. It is also the only provider offering electronic goods.

Furunavi produces 70% of company EBIT and is growing quickly. Projections for that business included in its mid-term plan, which can be found in its comprehensive quarterly English disclosure:

https://www.i-mobile.co.jp/ir/library/english_disclosure.html

Management has beaten its own annual guidance for the past 5 years, except in 2018. In the past two years, actual EBIT was 75% higher than guidance in 2019 and 217% in 2020. This conservative stance should inspire some confidence in these medium term projections!

The company has reduced headcount from 280 to 200 employees when it divested an online gaming business. Thanks to strong results and a focus on costs, free cash flow has surged to $37 million over the last 12 months. The company paid a 6% special dividend in June 2021, in addition to their usual 3% dividend and has bought back and cancelled 19% of its shares in the past 4 years. Despite this, excess cash has accumulated on the balance sheet and now stands at 57% of market cap. Therefore, management intends to make additional acquisitions in loyalty-linked businesses over the next couple of years. We usually heavily discount this optionality in Japan, but would give i-Mobile some credit based on previous success with Ohte and the wealth of opportunities clearly available in this space.

We think the two founders are well aligned with minority investors. They have proven to be agile with new internal initiatives such as Furunavi and opportunistic with small acquisitions such as Ohte.

The daily liquidity is about US$1 million, which we feel is acceptable when taking into account the 40% free float.

Risks:

-          Adverse regulatory changes in the Home Town Tax Donation (HTTD) market

-          Broader negative market changes in the Online Advertising business

Disclaimer:

This is not investment advice

Catalyst

-          No need for a catalyst here: the valuation is so low for the quality of this growing business that a steady double digit return could be achieved through a simple rerating to its 5-year average of 14 x PE supported by a steady continuation of earnings growth and stable 20% ROE.

-          Downside seems to be limited with 57% of the market cap in cash and strong free cash flow generation.