Description

oRo is an uncovered, $300m market cap Japanese SaaS ERP provider which has grown earnings at a 20% CAGR since listing in 2017. We believe the stock can continue to compound earnings at 20%+ via multiple growth levers including continued market penetration in Japan and an overseas expansion into Southeast Asia. The stock is attractively valued trading at 2024e 11x EV/EBIT and 21x P/E, which represents a 25-45% discount to Japanese peers and a 40% discount to its own average historical valuation since listing.

Background

oRo was founded in 1999 in Tokyo by two college friends who spent a few years as IT freelancers before founding the company. oRo initially focussed on building IT systems for advertising firms and selling third-party packaged software. In 2004, oRo expanded into website management and maintenance which sowed the seeds of the Marketing Services division, one of oRo's two divisions.

In 2006, the company developed and launched the initial version of ZAC, the company's flagship cloud-based ERP software system. ZAC is the core product in oRo's largest division, Cloud Services. oRo subsequently opened additional offices in Osaka, Fukuoka, Hokkaido, China, Taiwan, and Southeast Asia. The stock was listed in 2017 on the Tokyo Stock Exchange and is currently a member of the Tokyo Stock Exchange Prime Market.

Atsushi Kawata is the founder, Chairman, and President. Yasuhisa Hino is the co-founder, Senior Managing Executive Officer, Board Member, and de facto CFO. Both co-founders are actively engaged in managing the business and collectively own 55.6% of the company.

Cloud Solutions (CS)

CS is the most important of oRo's two divisions, and it accounted for 64% of consolidated sales and 79% of operating profit in 2023. The CS division offers two cloud-based SaaS ERP products, ZAC and Reforma PSA. Reforma PSA is a version of ZAC with more limited features which targets start-ups and companies with fewer than 50 employees. Reforma PSA only accounts for 3% of CS divisional sales so this write-up will focus on ZAC.

ZAC is a vertically-integrated, industry-specific cloud ERP designed for industries which manage business on a case, contract, or project basis. IT Services, Software, Advertising/PR, Content Production, Consulting, and other professional services are the most important end-markets for ZAC customers.

ZAC helps customers in these target industries with sales management, scheduling, expense management, workflow, and project management. ZAC is equipped with 2,000 parameters which fit most customers' operations without the need for customization. Version updates are automatically rolled out to existing customers as the product is continuously improved. The main target customer segment is SMEs in target industries with 50-500 employees.

ZAC Enterprise is a version of ZAC designed for larger organizations with more than 500 employees. The system is equipped with 13,000 parameters and typically requires add-on development work to customize for each large organization.

Prior to 2023, ZAC offered both one-time lump-sum purchase contracts and SaaS type contracts, but the one-time contracts were discontinued at the end of 2022. The below slide provides the fee structure for a typical 100 employee client under the two different contract types. Recurring revenue from monthly SaaS, maintenance, and data center usage fees accounted for 62% of revenue in Q1 2024 and the mix of recurring revenue is expected to continue increasing over time as the one-time license fees phase out.

Management estimates that the TAM for ERPs in ZAC's target industries is 44k enterprises in Japan , of which ZAC is currently capable of serving 30k-35k. ZAC has approximately 900 customers in the "volume" segment of the market of 11k enterprises, equating to a market share of approximately 8%. ZAC's customer concentration is very fragmented with the largest customer accounting for less than 2% of revenue.

Management is currently targeting larger sized enterprises with 500 to 3k employees right now.  Management believes that adding 130-140 new customers per year is a natural constraint for the organization, but adding increasingly larger customers will allow for continued strong growth. Eventually management plans to target large enterprises with 3k+ employees after the software platform is enhanced to be more scalable in terms of number of licenses per customer. Management is already receiving inquiries from prospective clients with more than 3k employees.

Sales of ZAC are made directly via in-house sales teams, sales agents, and partner SaaS accounting firms. ZAC's largest sales agents are Otsuka (4768) and Obic (4684). Freee (4478) and Money Forward (3994), which specialize in SaaS accounting software, also sometimes co-market ZAC as a complementary ERP system.

The KPIs for the Cloud Service business are growing steadily as highlighted in the company IR slides below. It is worth noting in the first slide that the Cloud recurring revenue (dark blue bar) has continued to grow sequentially every quarter when adjusting for the "migration demand" for ZAC Enterprise users who required one-time customization work in 2023 to meet requirements for a change in the Japanese legal system. ZAC clients received a free automatic upgrade to meet these requirements.

Cloud Solutions Competition

Obic Business Consultants (4733) offers a similar ERP system, Bugyo, which is the main competitor for ZAC in the domestic market for SME ERP systems. Pricing for ZAC and Bugyo are approximately the same. ZAC is very customized for the IT, Advertising, and Consulting industries and the system typically does not require customization for customers in these industries and version updates are automated and included in the subscription price. Bugyo typically requires significant customization and add-on features , and version upgrades are provided for an additional fee.

Simple management tools like Excel are another form of competition for very small, price-sensitive SMEs.

Oracle and SAP have high market share in large Japanese corporations, but typically are more focused on retail and manufacturing organizations. Oracle and SAP charge a minimum of JPY 100-200 million compared to approximately JPY 80 million for ZAC for an organization with 1k employees.

Management has not seen any major changes in the competitive landscape for ERP systems in ZAC's target industries in recent years.

Marketing Solutions (MS Division)

The MS Division provides one-stop digital marketing support to large Japanese corporations. Aeon and Nissan Motor are the division's two largest customers, both of which have been customers since 2004 and are ranked in the top 4 companies for domestic advertising spend. oRo provides customized marketing and website management for Aeon's network of malls and Nissan's network of auto dealers in Japan, China, Taiwan, and Southeast Asia. These two customers account for approximately 60% of divisional sales. 11% of divisional sales were from overseas markets in 2023.

The industry is highly competitive and management has historically focused on retaining its large customer relationships. The division has grown sales at a 5.4% CAGR over the past 5 years with an operating margin of c.20%.

Growth Opportunities

ZAC Overseas Expansion

Management is planning to launch ZAC in overseas markets in late 2025 or 2026. The potential target markets are countries where oRo already has a presence through its MS Division, namely Southeast Asia, Taiwan, and China. The market entry strategy is likely to involve partnering with local accounting software companies in each market who can offer ZAC as a complementary SaaS product. There are many Japanese companies with subsidiaries in these markets that could be ideal initial customers to target. Management is already in the process of localizing ZAC for target markets using in-house engineers with local language skills. Management has a medium-term plan to generate 20-30% of Cloud Services sales from overseas markets. While success is not guaranteed, the strategy and execution plan seem thoughtful and credible.

Marketing Solutions Division Turnaround

The MS division has been a relatively low growth cash cow but management is revamping its strategy to focus more on new customer acquisition. Two new senior executives were hired from Accenture in 2023. These executives have strong track-records in customer acquisition and they have revamped the way oRo communicates its organizational strengths to prospective clients. Additionally, oRo started a collaboration with Toppan (7911), a domestic leader in print marketing services, to generate business cross-selling opportunities. The Cloud Service division is likely to remain the primary earnings and stock price driver, but an acceleration in sales growth in the MS division could provide an additional boost to sales and earnings growth.

New Products

dxeco (https://www.dxeco.io/) is a recently launched SaaS management tool that oRo management has high hopes for. While it is only expected to generate around JPY 20m of revenue in 2024 (<1% of sales), a domestic competitor is generating JPY 100m of sales and growing rapidly. Management believes the potential market size is large and this could grow into a meaningful business over time.

Shareholder Return Policy

Management has steadily increased the dividend payout and absolute dividend amount since listing. In 2023, the dividend was hiked 50% and the payout ratio reached 26%. Management is also open to opportunistic share buybacks, and they did buyback and cancel 500k shares (3% of shares outstanding) in 2021. Management wants to avoid letting idle cash sit on the balance sheet, but also wants to maintain some cash for investing in R&D and the ZAC overseas growth opportunity. We think management's capital allocation and shareholder return policies are very sensible.

Valuation and Comp Analysis

oRo is trading at 2024e 11x EV/EBIT, 21x P/Em and 6.2% Free Cash Flow / EV. We believe this is a very reasonable valuation for a high-quality compounding business. It is also a significant 25-45% discount to peer companies in Japan and a nearly 40% discount to oRo's own historical average valuation. We expect the stock to perform at least in-line with its earnings growth with the additional possibility of a re-rating closer to peer company valuation multiples.

Catalyst

Earnings growth, overseas expansion, marketing services turnaround, new product launches