After the period known as the Lost Decades, Japan finally saw some signs of ending deflation, returning economic growth and renewed business dynamism. Recent corporate-governance reform, low cost of capital, and political and social stability add to the interest among global equity investors. More importantly to us, the overall stock market valuation tends to get reasonable during the economic dawn. We got our boots on the ground in the land of the rising sun and spent days meeting with corporate executives and local money managers.
Our journey mainly touched upon a couple of niche markets across the total information-technology domain, where we happened to land on a few high-quality companies in the country. Below, we list our top two picks, both of which, in our opinion, have been part of the backbone of the modern Japanese economy.
Kakaku.com Inc.
The company’s namesake website, kakaku.com, provides price-comparison services for Japanese netizens across multiple categories such as electronics, consumables and services (e.g., internet, insurance). It claims to have gathered the most comprehensive product and category information (e.g., specifications, review) in Japan. However, owing to the rise of e-commerce behemoths such as Amazon, Rakuten, the online price-comparison leader has seen its services less and less relevant to consumers over time.
Fortunately, with its focus on innovation and mission to “become a part of people’s daily life,” the company has been exploring new verticals and successfully tapped into a couple of them. Tabelog, which used to be part of the price-comparison site, has now become a household name when it comes to restaurant discovery (think Yelp). It also pioneered the online reservation in Japan, the country with the highest density of restaurants per capita (far ahead of No. 2, the U.S.). Kyujin Box, as another example, is a comprehensive job-search site launched back in 2015 but still sees its revenue growing exponentially these days.
Platform is a high-margin, capital-light, cash-rich business model. Employing almost no debt, the management targets a high return on equity of 40 per cent, and a sustainable growth rate of 10 per cent – a rare but clearly value-generative formula for long-term shareholders.
Tobila Systems Inc.
If Kakaku.com Inc. is seen as an enabler to the Japanese consumer economy, then we can think of Tobila Systems as the protector. The Nagoya-based company is the only meaningful provider of anti-spam, anti-fraud filtering solutions for mobile and landline users in Japan, where nearly 90 per cent of frauds are conducted through telephone. It dominates around 80 per cent to 90 per cent of this niche market per our estimate, largely thanks to the extraordinarily high barrier to entry owing to huge amount of proprietary data needed (e.g., the larger the user base, the more accurate the filtering system), a wide distribution coverage through partner carriers (e.g., KDDI, SoftBank, NTT), and long-time relationships with the police department.
While its core business is maturing, Tobila has a decent track record of capturing adjacent opportunities. The business-phone segment, for example, now accounts for nearly 20 per cent of the total revenue and has been growing at between high-double-digit and triple-digit rates over recent years, albeit a lower profit margin. The management expects this segment to become the second pillar for the total group, after the mobile filtering business.
The management has a return-on-equity target of 20 per cent, which is more commonly seen (compared to Kakaku.com’s 40 per cent) across well-run Japanese companies. According to our calculation, the company retains roughly half of its profit to reinvest in the business (e.g., business-phone service) and to conduct bolt-on acquisitions and returns the other half to owners through dividends and share repurchases. Hence, purely based on math, a low-teens growth rate plus some yield should provide enterprising investors with some alpha at the right entry price.
Final Thought
It is worth noting that both companies were not only resilient but also profitably growing throughout at least a portion of the Lost Decades, implying only marginal relevance of macro factors to an investment thesis – as Peter Lynch always said, “if you spend 13 minutes a year on economics, you’ve wasted 10 minutes.”
Now, some general tips for investors (especially, Western ones) interested in Japan –
1. Capital allocation: don’t expect a strong sense of return-focused capital allocation, although we do find more companies and investors discuss about return on equity in Japan than we thought and probably anywhere else. Some issues include piling cash and sizable investment in financial securities on the balance sheet. We recommend investors examine both fronts with the management.
2. Philosophy: “making people happy” is a common slogan among Japanese business leaders and may indicate the society-first (probably shareholder-second or -third) kind of corporate philosophy. We are not saying there is anything wrong with this but would be mindful of it.
3. Circle of competence: “invert, always invert!” Admit the competitive disadvantage (vs. local money managers) when it comes to the language and culture. Hiring a translator to talk to the management and having boots on the ground may help fill the competitive gap.
Jason Del Vicario, CFA, is portfolio manager at HillsideWealth | iA Private Wealth Inc. Steven Chen, MBA, is global analytics associate at the firm.
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