Japan

In this briefing:

1. Zozo: At First the Fit Was Bad but Now the Threads Are Unravelling

1. Zozo: At First the Fit Was Bad but Now the Threads Are Unravelling

Just a day after a pledge from CEO Maekawa to stop tweeting sent ZOZO Inc (3092 JP)‘s stock up 8% intraday, the Nikkei reported that United Arrows (7606 JP) would be parting ways with Zozotown and bringing their e-commerce business in-house from October. This comes just days after United Arrows affirmed their desire to continue working with Zozo casting doubt on the positive noises coming from Zozo itself.

As we have pointed out previously, this is the big risk for Zozo and with arguably the company that granted Zozo credibility when it was a startup leaving, a dark cloud has settled over the company’s mid-term future.

In this briefing:

1. Itochu and Descente: Gloves Off
2. The Downward Revision in FY03/19 Guidance Places Panasonic in Our Worst-Case Scenario
3. Murata Up 12.8% Following 3QFY03/19 Earnings Release
4. Sony Revises FY03/19 Guidance Downwards; Management Announces a Surprise Buyback
5. Meiji Holdings 3QFY2019 Results On Track to Meet Guidance, Dark Clouds Loom Over Its Mid Term Target

1. Itochu and Descente: Gloves Off

Descente Ltd (8114 JP) issued a 13-page statement yesterday in response to Itochu Corp’s (8001 JP) tender offer to raise its stake in the sports firm from 30.44% to 40%.

In brief: its gloves off and Descente is limbering up for a fight for its independence – an independence it has not had since the 1990s.

Itochu insists it is the answer to Descente’s weaknesses but Descente is having none of it, arguing that it is already implementing the strategies proposed by Itochu.

Descente’s statement of intent was followed by Descente’s labour union, All Descente, supporting Descente, saying Itochu’s bid was contrary to Descente’s long-term interests.

Descente may well hope for an MBO as a way out, and Itochu may want a third party to acquire Descente as Travis Lundy suggests. Either way, a quick resolution is needed if Descente is to take advantage of the upcoming sports boom in Japan.

The question remains as to whether Descente would benefit from independence or control by Itochu. To date, it is arguable that the very tension between Itochu’s demand for faster growth and higher profits and, on the other hand, Descente’s reining in of this demand in favour of long-term brand cultivation that has led to Descente’s recent growth path. Without this delicate balance of tensions, the whole edifice may sag.

2. The Downward Revision in FY03/19 Guidance Places Panasonic in Our Worst-Case Scenario

• Panasonic Corp (6752 JP)’s 3Q earnings were quite weak, failing to meet both consensus and our estimates. Panasonic reported revenue of JPY2,074.8bn and OP of JPY97.5bn resulting in an OPM of 4.7% compared to 5.8% in the third quarter of last year
• The majority of revenue growth came from the Automotive & Industrial Solution (A&IS) segment which saw the strongest growth in revenue at nearly 8% YoY followed by the Eco Solutions Segment. Despite the steady growth in the A&IS revenue, the segment continued to display a decline in profits by almost 13% YoY.
• A downward revision in targets was made following the weak earnings this quarter. Nine-months cumulative figures weren’t particularly attractive in the OP front as well (Revenue up 3% YoY and OP down -8% YoY as of 3QFY03/19). Panasonic is nearing our modest case scenario, although its downward revised earnings target places it in our worst-case scenario, where we expect Panasonic to be exposed to a high degree of risk, increasing its lookout for other customers. Panasonic has only tied up with Toyota Motor (7203 JP) thus far and may have to diversify its customer base further to bring earnings to a sustainable level.
• After the earnings release and news about Chinese competitor, CATL (A) (300750 CH), collaborating with Honda Motor (7267 JP) ( Honda Chooses CATL as Battery Partner for Their EVs; Panasonic Has Lost the Chance), Tesla Motors (TSLA US) announced that it was acquiring battery company Maxwell Technologies for production of its EV batteries. Panasonic fell almost -5% on Monday’s open.

3. Murata Up 12.8% Following 3QFY03/19 Earnings Release

• Murata reported 3.4% YoY revenue growth to JPY427.6bn and 89.9% YoY OP growth to JPY85.6bn in its third quarter earnings.
• Despite the strong third quarter performance, we, along with consensus, expect the company to underperform its revenue guidance. This is mainly due to the slowdown in the smartphone market, which is expected to persist in the current quarter as well.
• Based on our estimates, Murata is currently trading at a FY1 PE multiple of 17.5x, lower than its historical median of 20.5x.

4. Sony Revises FY03/19 Guidance Downwards; Management Announces a Surprise Buyback

• Sony’s revenue for the quarter fell by 10.1% YoY to JPY2,401.8bn while company’s OP saw a 7.5% YoY growth in 3QFY03/19. 
• Sony downgraded its FY03/19 revenue guidance following the third quarter’s earnings results. The company expects to make revenue worth JPY8,500bn for FY03/19, a 2.3% decrease from the October forecast. Sony’s OP forecast for the year still remains at JPY870.0bn.
• Following the 3QFY03/19 earnings release, the company announced that it would buyback JPY100bn worth of its own stock starting Tuesday and lasting until the 22nd of March. 
• As per consensus expectations, Sony is currently trading at a FY1 PE multiple of 7.6x, significantly lower than its historical median of 19.7x.

5. Meiji Holdings 3QFY2019 Results On Track to Meet Guidance, Dark Clouds Loom Over Its Mid Term Target

Meiji Holdings (2269 JP) recorded revenue growth of 4.1% in 3QFY2019. The food segment which produces yoghurt, drinking milk, cheese, ice cream, chocolate, nutritional products and sports nutrients came short of the expectations as it recorded a 1.1% drop in revenue. The pharmaceutical segment grew by 35.9% during the quarter allowing Meiji to maintain overall revenue growth in line with FY2019E guidance.

In contrast, EBIT turned out better than expected as it grew 32.6% in 3QFY2019. Both the food and pharmaceutical segments reported significant margin gains, thus the overall EBIT margin of Meiji improved by 227bps cf. 3Q2018.

In this briefing:

1. Japan Stock Weekly
2. Zozo: At First the Fit Was Bad but Now the Threads Are Unravelling
3. ND Software (3794 JP) TOB for an MBO – Fireworks a Possibility
4. Yahoo Japan 3Q Update: Consumer Business Drives Mid-Term Growth; Plans to Diversify in the Long Run

1. Japan Stock Weekly

Yaskawa (6506) 

The shares have corrected significantly, as have most in this sector, but given that it would appear orders are bottoming out, and that there are certainly some encouraging signs for the future we would start to look and this name, and others in this space, on a 12 month view.

Hino (7205)

Cheap and shares have underperformed but the domestic market is mature and overseas is showing signs of slowing. There are better bets elsewhere.

Katitas (8919)

A great growth story in the domestic housing sector. 

2. Zozo: At First the Fit Was Bad but Now the Threads Are Unravelling

Just a day after a pledge from CEO Maekawa to stop tweeting sent ZOZO Inc (3092 JP)‘s stock up 8% intraday, the Nikkei reported that United Arrows (7606 JP) would be parting ways with Zozotown and bringing their e-commerce business in-house from October. This comes just days after United Arrows affirmed their desire to continue working with Zozo casting doubt on the positive noises coming from Zozo itself.

As we have pointed out previously, this is the big risk for Zozo and with arguably the company that granted Zozo credibility when it was a startup leaving, a dark cloud has settled over the company’s mid-term future.

3. ND Software (3794 JP) TOB for an MBO – Fireworks a Possibility

Today, ND Software (3794 JP) announced a Management Buy Out (MBO) sponsored by both the existing president, who owns 20%, and J-Will Partners to take the company private at ¥1700/share, which is a 28.7% premium to last trade and comes out to be roughly 7.2x trailing 12-month EV/EBITDA.

The deal comes with a 66.7% minimum threshold for completion, after which there will be a two-step squeeze-out, as is the norm in deals like this.

J-Will Partners was founded about 15 years ago and has since done 170 deals for more than ¥350 billion. The fund manager specializes in “small-mid-sized companies” (which means small companies like this one) in 2nd-4th tier cities in Japan. The specialty is helping revive or grow small regional Japanese companies to better serve a larger customer base, compete with their urban and overseas rivals, and grow their local economy. For that, the deals are often funded by regional financial institutions and businesses.

Terms & Schedule

With irrevocables of 31% and shareholders I would deem friendly to management holding another 20+% at a minimum, on the surface this looks like it shouldn’t be overly difficult to get done…

BUT…

4. Yahoo Japan 3Q Update: Consumer Business Drives Mid-Term Growth; Plans to Diversify in the Long Run

Yahoo Japan (4689 JP)  reported 3Q FY03/19 financial results last Monday (04th February). Revenue and OP were on par with consensus. YJ revised the lower range of its FY03/19E OP guidance upwards by JPY7bn to JPY140bn mainly due to lower than expected growth related expenses (expenses for new challenges as per the management). Meanwhile, the upper limit of the FY03/19E OP guidance of JPY143bn remains unchanged. The revised OP guidance for FY03/19E is JPY140-143bn.

In this briefing:

1. Zozo: At First the Fit Was Bad but Now the Threads Are Unravelling
2. ND Software (3794 JP) TOB for an MBO – Fireworks a Possibility
3. Yahoo Japan 3Q Update: Consumer Business Drives Mid-Term Growth; Plans to Diversify in the Long Run
4. Screening the Silkroad: Small-Mid Cap – Possible High-Risk Names: Q1 2019

1. Zozo: At First the Fit Was Bad but Now the Threads Are Unravelling

Just a day after a pledge from CEO Maekawa to stop tweeting sent ZOZO Inc (3092 JP)‘s stock up 8% intraday, the Nikkei reported that United Arrows (7606 JP) would be parting ways with Zozotown and bringing their e-commerce business in-house from October. This comes just days after United Arrows affirmed their desire to continue working with Zozo casting doubt on the positive noises coming from Zozo itself.

As we have pointed out previously, this is the big risk for Zozo and with arguably the company that granted Zozo credibility when it was a startup leaving, a dark cloud has settled over the company’s mid-term future.

2. ND Software (3794 JP) TOB for an MBO – Fireworks a Possibility

Today, ND Software (3794 JP) announced a Management Buy Out (MBO) sponsored by both the existing president, who owns 20%, and J-Will Partners to take the company private at ¥1700/share, which is a 28.7% premium to last trade and comes out to be roughly 7.2x trailing 12-month EV/EBITDA.

The deal comes with a 66.7% minimum threshold for completion, after which there will be a two-step squeeze-out, as is the norm in deals like this.

J-Will Partners was founded about 15 years ago and has since done 170 deals for more than ¥350 billion. The fund manager specializes in “small-mid-sized companies” (which means small companies like this one) in 2nd-4th tier cities in Japan. The specialty is helping revive or grow small regional Japanese companies to better serve a larger customer base, compete with their urban and overseas rivals, and grow their local economy. For that, the deals are often funded by regional financial institutions and businesses.

Terms & Schedule

With irrevocables of 31% and shareholders I would deem friendly to management holding another 20+% at a minimum, on the surface this looks like it shouldn’t be overly difficult to get done…

BUT…

3. Yahoo Japan 3Q Update: Consumer Business Drives Mid-Term Growth; Plans to Diversify in the Long Run

Yahoo Japan (4689 JP)  reported 3Q FY03/19 financial results last Monday (04th February). Revenue and OP were on par with consensus. YJ revised the lower range of its FY03/19E OP guidance upwards by JPY7bn to JPY140bn mainly due to lower than expected growth related expenses (expenses for new challenges as per the management). Meanwhile, the upper limit of the FY03/19E OP guidance of JPY143bn remains unchanged. The revised OP guidance for FY03/19E is JPY140-143bn.

4. Screening the Silkroad: Small-Mid Cap – Possible High-Risk Names: Q1 2019

Increasing risk apparent

• Q4-2018 Small-Mid Cap High-Risk screen ( Screening the Silkroad: Small-Mid Cap – High-Risk Names To Avoid Q4 2018 ) delivered a market cap average share price decline of 4.5%. This compares with the MSCI Asia Pacific Index appreciating 4.2% over the same period. 
• Our screen looks for high valuation multiples presented by candidates, with significant earnings growth forecasts, as well as financial indicators that suggest balance sheet distress. 
• The Risk to this screen: The Financial and Utility sectors are not covered in this screen. Moreover, “risk is not a number, it is a concept or notion”, as James Mortiner cited during his time at Société Genéralé. Hence, some stocks due to their business model being realigned to a more profitable approach may appear on this screen, whilst also be a member of more positive value or quality screens.
• 26-stocks appear in our Q1 2019 screen. Eight (8) of which are new, namely from Korea, Japan and Taiwan. Singapore remains absent from the screen for the third quarter running, whilst New Zealand has only presented one candidate in Q4 2018.

• Our screen suggests that risk is increasing amongst the small-mid cap universe, as the Alman Z average score slips to 1.14 in Q1 2019 from 1.16 in Q4 2018 and 1.38 in Q3 2018. Moreover, our average stock in the list has a ranking of 42.3, compared to 54.9 in Q4 2019. 

Our screening styles

For those that follow us, you will know our Stock Ranking system from our Notes from the Silk Road: Setting Out Our Small-Mid Cap Lemonade Stand  For newcomers to our notes, it is merely a tool for identifying favourable and unfavourable stocks. In addition, to add more depth to our selection process we also monitor a series of “style categories” namely:

■ Growth, 
■ Value, 
■ Quality,
■ Momentum, 
■ Deep Value, 
■ Income,
■ Underperformance.

Within these style categories, we drill down further through a series of alpha momentum screens allowing us to differentiate and identify stock picks. 

In this briefing:

1. The Downward Revision in FY03/19 Guidance Places Panasonic in Our Worst-Case Scenario
2. Murata Up 12.8% Following 3QFY03/19 Earnings Release
3. Sony Revises FY03/19 Guidance Downwards; Management Announces a Surprise Buyback
4. Meiji Holdings 3QFY2019 Results On Track to Meet Guidance, Dark Clouds Loom Over Its Mid Term Target
5. Japan Stock Weekly

1. The Downward Revision in FY03/19 Guidance Places Panasonic in Our Worst-Case Scenario

• Panasonic Corp (6752 JP)’s 3Q earnings were quite weak, failing to meet both consensus and our estimates. Panasonic reported revenue of JPY2,074.8bn and OP of JPY97.5bn resulting in an OPM of 4.7% compared to 5.8% in the third quarter of last year
• The majority of revenue growth came from the Automotive & Industrial Solution (A&IS) segment which saw the strongest growth in revenue at nearly 8% YoY followed by the Eco Solutions Segment. Despite the steady growth in the A&IS revenue, the segment continued to display a decline in profits by almost 13% YoY.
• A downward revision in targets was made following the weak earnings this quarter. Nine-months cumulative figures weren’t particularly attractive in the OP front as well (Revenue up 3% YoY and OP down -8% YoY as of 3QFY03/19). Panasonic is nearing our modest case scenario, although its downward revised earnings target places it in our worst-case scenario, where we expect Panasonic to be exposed to a high degree of risk, increasing its lookout for other customers. Panasonic has only tied up with Toyota Motor (7203 JP) thus far and may have to diversify its customer base further to bring earnings to a sustainable level.
• After the earnings release and news about Chinese competitor, CATL (A) (300750 CH), collaborating with Honda Motor (7267 JP) ( Honda Chooses CATL as Battery Partner for Their EVs; Panasonic Has Lost the Chance), Tesla Motors (TSLA US) announced that it was acquiring battery company Maxwell Technologies for production of its EV batteries. Panasonic fell almost -5% on Monday’s open.

2. Murata Up 12.8% Following 3QFY03/19 Earnings Release

• Murata reported 3.4% YoY revenue growth to JPY427.6bn and 89.9% YoY OP growth to JPY85.6bn in its third quarter earnings.
• Despite the strong third quarter performance, we, along with consensus, expect the company to underperform its revenue guidance. This is mainly due to the slowdown in the smartphone market, which is expected to persist in the current quarter as well.
• Based on our estimates, Murata is currently trading at a FY1 PE multiple of 17.5x, lower than its historical median of 20.5x.

3. Sony Revises FY03/19 Guidance Downwards; Management Announces a Surprise Buyback

• Sony’s revenue for the quarter fell by 10.1% YoY to JPY2,401.8bn while company’s OP saw a 7.5% YoY growth in 3QFY03/19. 
• Sony downgraded its FY03/19 revenue guidance following the third quarter’s earnings results. The company expects to make revenue worth JPY8,500bn for FY03/19, a 2.3% decrease from the October forecast. Sony’s OP forecast for the year still remains at JPY870.0bn.
• Following the 3QFY03/19 earnings release, the company announced that it would buyback JPY100bn worth of its own stock starting Tuesday and lasting until the 22nd of March. 
• As per consensus expectations, Sony is currently trading at a FY1 PE multiple of 7.6x, significantly lower than its historical median of 19.7x.

4. Meiji Holdings 3QFY2019 Results On Track to Meet Guidance, Dark Clouds Loom Over Its Mid Term Target

Meiji Holdings (2269 JP) recorded revenue growth of 4.1% in 3QFY2019. The food segment which produces yoghurt, drinking milk, cheese, ice cream, chocolate, nutritional products and sports nutrients came short of the expectations as it recorded a 1.1% drop in revenue. The pharmaceutical segment grew by 35.9% during the quarter allowing Meiji to maintain overall revenue growth in line with FY2019E guidance.

In contrast, EBIT turned out better than expected as it grew 32.6% in 3QFY2019. Both the food and pharmaceutical segments reported significant margin gains, thus the overall EBIT margin of Meiji improved by 227bps cf. 3Q2018.

5. Japan Stock Weekly

Yaskawa (6506) 

The shares have corrected significantly, as have most in this sector, but given that it would appear orders are bottoming out, and that there are certainly some encouraging signs for the future we would start to look and this name, and others in this space, on a 12 month view.

Hino (7205)

Cheap and shares have underperformed but the domestic market is mature and overseas is showing signs of slowing. There are better bets elsewhere.

Katitas (8919)

A great growth story in the domestic housing sector. 

In this briefing:

1. Yahoo Japan 3Q Update: Consumer Business Drives Mid-Term Growth; Plans to Diversify in the Long Run
2. Screening the Silkroad: Small-Mid Cap – Possible High-Risk Names: Q1 2019
3. Auto Earnings: Positive Toyota/Mazda, Negative Subaru/Suzuki
4. Kosaido: Activism Drives Price 30+% Through Terms

1. Yahoo Japan 3Q Update: Consumer Business Drives Mid-Term Growth; Plans to Diversify in the Long Run

Yahoo Japan (4689 JP)  reported 3Q FY03/19 financial results last Monday (04th February). Revenue and OP were on par with consensus. YJ revised the lower range of its FY03/19E OP guidance upwards by JPY7bn to JPY140bn mainly due to lower than expected growth related expenses (expenses for new challenges as per the management). Meanwhile, the upper limit of the FY03/19E OP guidance of JPY143bn remains unchanged. The revised OP guidance for FY03/19E is JPY140-143bn.

2. Screening the Silkroad: Small-Mid Cap – Possible High-Risk Names: Q1 2019

Increasing risk apparent

• Q4-2018 Small-Mid Cap High-Risk screen ( Screening the Silkroad: Small-Mid Cap – High-Risk Names To Avoid Q4 2018 ) delivered a market cap average share price decline of 4.5%. This compares with the MSCI Asia Pacific Index appreciating 4.2% over the same period. 
• Our screen looks for high valuation multiples presented by candidates, with significant earnings growth forecasts, as well as financial indicators that suggest balance sheet distress. 
• The Risk to this screen: The Financial and Utility sectors are not covered in this screen. Moreover, “risk is not a number, it is a concept or notion”, as James Mortiner cited during his time at Société Genéralé. Hence, some stocks due to their business model being realigned to a more profitable approach may appear on this screen, whilst also be a member of more positive value or quality screens.
• 26-stocks appear in our Q1 2019 screen. Eight (8) of which are new, namely from Korea, Japan and Taiwan. Singapore remains absent from the screen for the third quarter running, whilst New Zealand has only presented one candidate in Q4 2018.

• Our screen suggests that risk is increasing amongst the small-mid cap universe, as the Alman Z average score slips to 1.14 in Q1 2019 from 1.16 in Q4 2018 and 1.38 in Q3 2018. Moreover, our average stock in the list has a ranking of 42.3, compared to 54.9 in Q4 2019. 

Our screening styles

For those that follow us, you will know our Stock Ranking system from our Notes from the Silk Road: Setting Out Our Small-Mid Cap Lemonade Stand  For newcomers to our notes, it is merely a tool for identifying favourable and unfavourable stocks. In addition, to add more depth to our selection process we also monitor a series of “style categories” namely:

■ Growth, 
■ Value, 
■ Quality,
■ Momentum, 
■ Deep Value, 
■ Income,
■ Underperformance.

Within these style categories, we drill down further through a series of alpha momentum screens allowing us to differentiate and identify stock picks. 

3. Auto Earnings: Positive Toyota/Mazda, Negative Subaru/Suzuki

On a relative basis we have been positive on Toyota Motor (7203 JP)  and negative on Subaru Corp (7270 JP)  since early 2017 as we consider Toyota’s underlying earnings strength to be superior to the majority of its peers and consider hybrids to be moving towards the mass adoption stage while we also feel that Subaru, after a purple patch when it led the automotive industry in terms of margins, is now falling back to Earth and the sell side remains behind the curve on the depth of issues and underspend that needs to be addressed at the company. The ratio between the two returned about 40% in 2018 but is down about 12% so far this year.

In the case of Mazda Motor (7261 JP) and Suzuki Motor (7269 JP), in Mar 2018 we took the contrarian view of preferring Mazda over Suzuki despite earnings momentum being significantly stronger for Suzuki than for Mazda. This proved to be “early” as the ratio declined 16% during the year and at one point fell as much as 30%, but we continue to feel that our thesis has merit and would note that the ratio is now up 2% relative to its value at our initial recommendation. Our thesis is simply that Mazda’s earnings are under pressure due to forward investments in technology (extremely high efficiency gasoline and diesel engines) and distribution and after sales which have traditionally been a Mazda weakness and are in our opinion the main difference between Mazda and a much stronger company like Honda. In the case of Suzuki, while the long-term growth outlook due to the India exposure remains bright, we felt that momentum was likely to decelerate and that Suzuki could face headwinds in the short-term as consumer upgraded from mini-vehicles in which it is dominant, to compact and mid-size cars where Suzuki is strong in India, but not the force of nature that it is in the mini-vehicle segment. While it has taken time, recent results suggest this thesis is starting to play out.

4. Kosaido: Activism Drives Price 30+% Through Terms

In my piece Smallcap Kosaido (7868 JP) Tender Offer: Wrong Price But Whaddya Gonna Do? discussing the Kosaido Co Ltd (7868 JP) MBO by Bain, even the title suggested it was a lowball bid with the wrong price.

The deal was announced at ¥610/share which was a 40+% premium to last, but it was still being done at a 44% discount to Tangible Book Value Per Share. I mentioned in the conclusions the following four points…

• This is a virtual asset strip in progress. It is the kind of thing which gives activist hedge funds a bad name, but when cloaked in the finery of “Private Equity”, it looks like renewal of a business.

• This company is an example of why investors should be spending more time on their stewardship and the governance of their portfolio companies.

• It is also why investors should be taking a very close look at the METI request for public comment on what constitutes “Fair M&A.”

• If deals like this start to not get done, that would be a bullish sign. Investors will finally be taking the blinders off to unfair M&A practices.

The share price jumped from the 400s to just under the Tender Offer Price, traded there for several days, then a week after it started trading at or near arb terms, the share price suddenly jumped through terms and headed higher. As of today’s close, the stock is 28% through terms.

Yesterday the shares briefly traded almost 40% through terms.

Something is up.

In this briefing:

1. Sony Revises FY03/19 Guidance Downwards; Management Announces a Surprise Buyback
2. Meiji Holdings 3QFY2019 Results On Track to Meet Guidance, Dark Clouds Loom Over Its Mid Term Target
3. Japan Stock Weekly
4. Zozo: At First the Fit Was Bad but Now the Threads Are Unravelling
5. ND Software (3794 JP) TOB for an MBO – Fireworks a Possibility

1. Sony Revises FY03/19 Guidance Downwards; Management Announces a Surprise Buyback

• Sony’s revenue for the quarter fell by 10.1% YoY to JPY2,401.8bn while company’s OP saw a 7.5% YoY growth in 3QFY03/19. 
• Sony downgraded its FY03/19 revenue guidance following the third quarter’s earnings results. The company expects to make revenue worth JPY8,500bn for FY03/19, a 2.3% decrease from the October forecast. Sony’s OP forecast for the year still remains at JPY870.0bn.
• Following the 3QFY03/19 earnings release, the company announced that it would buyback JPY100bn worth of its own stock starting Tuesday and lasting until the 22nd of March. 
• As per consensus expectations, Sony is currently trading at a FY1 PE multiple of 7.6x, significantly lower than its historical median of 19.7x.

2. Meiji Holdings 3QFY2019 Results On Track to Meet Guidance, Dark Clouds Loom Over Its Mid Term Target

Meiji Holdings (2269 JP) recorded revenue growth of 4.1% in 3QFY2019. The food segment which produces yoghurt, drinking milk, cheese, ice cream, chocolate, nutritional products and sports nutrients came short of the expectations as it recorded a 1.1% drop in revenue. The pharmaceutical segment grew by 35.9% during the quarter allowing Meiji to maintain overall revenue growth in line with FY2019E guidance.

In contrast, EBIT turned out better than expected as it grew 32.6% in 3QFY2019. Both the food and pharmaceutical segments reported significant margin gains, thus the overall EBIT margin of Meiji improved by 227bps cf. 3Q2018.

3. Japan Stock Weekly

Yaskawa (6506) 

The shares have corrected significantly, as have most in this sector, but given that it would appear orders are bottoming out, and that there are certainly some encouraging signs for the future we would start to look and this name, and others in this space, on a 12 month view.

Hino (7205)

Cheap and shares have underperformed but the domestic market is mature and overseas is showing signs of slowing. There are better bets elsewhere.

Katitas (8919)

A great growth story in the domestic housing sector. 

4. Zozo: At First the Fit Was Bad but Now the Threads Are Unravelling

Just a day after a pledge from CEO Maekawa to stop tweeting sent ZOZO Inc (3092 JP)‘s stock up 8% intraday, the Nikkei reported that United Arrows (7606 JP) would be parting ways with Zozotown and bringing their e-commerce business in-house from October. This comes just days after United Arrows affirmed their desire to continue working with Zozo casting doubt on the positive noises coming from Zozo itself.

As we have pointed out previously, this is the big risk for Zozo and with arguably the company that granted Zozo credibility when it was a startup leaving, a dark cloud has settled over the company’s mid-term future.

5. ND Software (3794 JP) TOB for an MBO – Fireworks a Possibility

Today, ND Software (3794 JP) announced a Management Buy Out (MBO) sponsored by both the existing president, who owns 20%, and J-Will Partners to take the company private at ¥1700/share, which is a 28.7% premium to last trade and comes out to be roughly 7.2x trailing 12-month EV/EBITDA.

The deal comes with a 66.7% minimum threshold for completion, after which there will be a two-step squeeze-out, as is the norm in deals like this.

J-Will Partners was founded about 15 years ago and has since done 170 deals for more than ¥350 billion. The fund manager specializes in “small-mid-sized companies” (which means small companies like this one) in 2nd-4th tier cities in Japan. The specialty is helping revive or grow small regional Japanese companies to better serve a larger customer base, compete with their urban and overseas rivals, and grow their local economy. For that, the deals are often funded by regional financial institutions and businesses.

Terms & Schedule

With irrevocables of 31% and shareholders I would deem friendly to management holding another 20+% at a minimum, on the surface this looks like it shouldn’t be overly difficult to get done…

BUT…

In this briefing:

1. Kosaido: Activism Drives Price 30+% Through Terms
2. Honda Chooses CATL as Battery Partner for Their EVs; Panasonic Has Lost the Chance

1. Kosaido: Activism Drives Price 30+% Through Terms

In my piece Smallcap Kosaido (7868 JP) Tender Offer: Wrong Price But Whaddya Gonna Do? discussing the Kosaido Co Ltd (7868 JP) MBO by Bain, even the title suggested it was a lowball bid with the wrong price.

The deal was announced at ¥610/share which was a 40+% premium to last, but it was still being done at a 44% discount to Tangible Book Value Per Share. I mentioned in the conclusions the following four points…

• This is a virtual asset strip in progress. It is the kind of thing which gives activist hedge funds a bad name, but when cloaked in the finery of “Private Equity”, it looks like renewal of a business.

• This company is an example of why investors should be spending more time on their stewardship and the governance of their portfolio companies.

• It is also why investors should be taking a very close look at the METI request for public comment on what constitutes “Fair M&A.”

• If deals like this start to not get done, that would be a bullish sign. Investors will finally be taking the blinders off to unfair M&A practices.

The share price jumped from the 400s to just under the Tender Offer Price, traded there for several days, then a week after it started trading at or near arb terms, the share price suddenly jumped through terms and headed higher. As of today’s close, the stock is 28% through terms.

Yesterday the shares briefly traded almost 40% through terms.

Something is up.

2. Honda Chooses CATL as Battery Partner for Their EVs; Panasonic Has Lost the Chance

CATL (A) (300750 CH) announced on Monday that it has signed a deal with Honda Motor (7267 JP) for jointly developing Li-ion batteries. This news comes to us as no surprise, given CATL’s effort in expanding market share globally by tying with leading automakers such as Nissan Motor (7201 JP), Daimler AG (DAI GR), and Bayerische Motoren Werke Ag (BMW GR). It seems that the Chinese battery leader is now targeting leading Japanese automakers alongside their focus on luxury automakers in Europe ( BMW to Invest in CATL: Chinese Battery Maker to Gain Exposure in Europe?).  Following Panasonic Corp (6752 JP)’s news about forming a Joint Venture with Toyota, we were under the impression that Panasonic would hit a deal with Honda as well. However, it seems that CATL has emerged as a first mover and secured a steady business by partnering with Honda, one of the leading automakers in Japan. Although Panasonic and Honda joined hands for developing a swappable battery system in Indonesia, the team hasn’t really gone ahead in developing Li-ion batteries. Honda’s battery sales are now for CATL, while Panasonic has lost a steady business deal unless the latter makes plans with Honda to develop new battery technologies such as solid-state batteries. In our opinion, Honda and CATL, being leaders in their respective industries, when joined together via this agreement should capture a strong position in the auto sector which is striding towards electrification. The effect of this news on CATL share price cannot be really seen as the markets are closed for ongoing holidays in China. Panasonic, however, opened -5.1% low on February 5th, mainly due to its disappointing 3QFY03/19 earnings and could be partly due to this news.

In this briefing:

1. Zozo: At First the Fit Was Bad but Now the Threads Are Unravelling
2. ND Software (3794 JP) TOB for an MBO – Fireworks a Possibility
3. Yahoo Japan 3Q Update: Consumer Business Drives Mid-Term Growth; Plans to Diversify in the Long Run
4. Screening the Silkroad: Small-Mid Cap – Possible High-Risk Names: Q1 2019
5. Auto Earnings: Positive Toyota/Mazda, Negative Subaru/Suzuki

1. Zozo: At First the Fit Was Bad but Now the Threads Are Unravelling

Just a day after a pledge from CEO Maekawa to stop tweeting sent ZOZO Inc (3092 JP)‘s stock up 8% intraday, the Nikkei reported that United Arrows (7606 JP) would be parting ways with Zozotown and bringing their e-commerce business in-house from October. This comes just days after United Arrows affirmed their desire to continue working with Zozo casting doubt on the positive noises coming from Zozo itself.

As we have pointed out previously, this is the big risk for Zozo and with arguably the company that granted Zozo credibility when it was a startup leaving, a dark cloud has settled over the company’s mid-term future.

2. ND Software (3794 JP) TOB for an MBO – Fireworks a Possibility

Today, ND Software (3794 JP) announced a Management Buy Out (MBO) sponsored by both the existing president, who owns 20%, and J-Will Partners to take the company private at ¥1700/share, which is a 28.7% premium to last trade and comes out to be roughly 7.2x trailing 12-month EV/EBITDA.

The deal comes with a 66.7% minimum threshold for completion, after which there will be a two-step squeeze-out, as is the norm in deals like this.

J-Will Partners was founded about 15 years ago and has since done 170 deals for more than ¥350 billion. The fund manager specializes in “small-mid-sized companies” (which means small companies like this one) in 2nd-4th tier cities in Japan. The specialty is helping revive or grow small regional Japanese companies to better serve a larger customer base, compete with their urban and overseas rivals, and grow their local economy. For that, the deals are often funded by regional financial institutions and businesses.

Terms & Schedule

With irrevocables of 31% and shareholders I would deem friendly to management holding another 20+% at a minimum, on the surface this looks like it shouldn’t be overly difficult to get done…

BUT…

3. Yahoo Japan 3Q Update: Consumer Business Drives Mid-Term Growth; Plans to Diversify in the Long Run

Yahoo Japan (4689 JP)  reported 3Q FY03/19 financial results last Monday (04th February). Revenue and OP were on par with consensus. YJ revised the lower range of its FY03/19E OP guidance upwards by JPY7bn to JPY140bn mainly due to lower than expected growth related expenses (expenses for new challenges as per the management). Meanwhile, the upper limit of the FY03/19E OP guidance of JPY143bn remains unchanged. The revised OP guidance for FY03/19E is JPY140-143bn.

4. Screening the Silkroad: Small-Mid Cap – Possible High-Risk Names: Q1 2019

Increasing risk apparent

• Q4-2018 Small-Mid Cap High-Risk screen ( Screening the Silkroad: Small-Mid Cap – High-Risk Names To Avoid Q4 2018 ) delivered a market cap average share price decline of 4.5%. This compares with the MSCI Asia Pacific Index appreciating 4.2% over the same period. 
• Our screen looks for high valuation multiples presented by candidates, with significant earnings growth forecasts, as well as financial indicators that suggest balance sheet distress. 
• The Risk to this screen: The Financial and Utility sectors are not covered in this screen. Moreover, “risk is not a number, it is a concept or notion”, as James Mortiner cited during his time at Société Genéralé. Hence, some stocks due to their business model being realigned to a more profitable approach may appear on this screen, whilst also be a member of more positive value or quality screens.
• 26-stocks appear in our Q1 2019 screen. Eight (8) of which are new, namely from Korea, Japan and Taiwan. Singapore remains absent from the screen for the third quarter running, whilst New Zealand has only presented one candidate in Q4 2018.

• Our screen suggests that risk is increasing amongst the small-mid cap universe, as the Alman Z average score slips to 1.14 in Q1 2019 from 1.16 in Q4 2018 and 1.38 in Q3 2018. Moreover, our average stock in the list has a ranking of 42.3, compared to 54.9 in Q4 2019. 

Our screening styles

For those that follow us, you will know our Stock Ranking system from our Notes from the Silk Road: Setting Out Our Small-Mid Cap Lemonade Stand  For newcomers to our notes, it is merely a tool for identifying favourable and unfavourable stocks. In addition, to add more depth to our selection process we also monitor a series of “style categories” namely:

■ Growth, 
■ Value, 
■ Quality,
■ Momentum, 
■ Deep Value, 
■ Income,
■ Underperformance.

Within these style categories, we drill down further through a series of alpha momentum screens allowing us to differentiate and identify stock picks. 

5. Auto Earnings: Positive Toyota/Mazda, Negative Subaru/Suzuki

On a relative basis we have been positive on Toyota Motor (7203 JP)  and negative on Subaru Corp (7270 JP)  since early 2017 as we consider Toyota’s underlying earnings strength to be superior to the majority of its peers and consider hybrids to be moving towards the mass adoption stage while we also feel that Subaru, after a purple patch when it led the automotive industry in terms of margins, is now falling back to Earth and the sell side remains behind the curve on the depth of issues and underspend that needs to be addressed at the company. The ratio between the two returned about 40% in 2018 but is down about 12% so far this year.

In the case of Mazda Motor (7261 JP) and Suzuki Motor (7269 JP), in Mar 2018 we took the contrarian view of preferring Mazda over Suzuki despite earnings momentum being significantly stronger for Suzuki than for Mazda. This proved to be “early” as the ratio declined 16% during the year and at one point fell as much as 30%, but we continue to feel that our thesis has merit and would note that the ratio is now up 2% relative to its value at our initial recommendation. Our thesis is simply that Mazda’s earnings are under pressure due to forward investments in technology (extremely high efficiency gasoline and diesel engines) and distribution and after sales which have traditionally been a Mazda weakness and are in our opinion the main difference between Mazda and a much stronger company like Honda. In the case of Suzuki, while the long-term growth outlook due to the India exposure remains bright, we felt that momentum was likely to decelerate and that Suzuki could face headwinds in the short-term as consumer upgraded from mini-vehicles in which it is dominant, to compact and mid-size cars where Suzuki is strong in India, but not the force of nature that it is in the mini-vehicle segment. While it has taken time, recent results suggest this thesis is starting to play out.

In this briefing:

1. Honda Chooses CATL as Battery Partner for Their EVs; Panasonic Has Lost the Chance
2. Sumco Reports Solid Growth in Revenue and Operating Profit; Stock Is Still Trading at a Discount
3. MODEC: 17% Price Jump as Results Beat, Guidance Is Lowballed
4. Pan Pacific International: UNY Acquisition the Bright Spot as SSS and Inbound Decelerate
5. Nintendo Downgrades Switch Unit Sales Forecast for FY03/19 Despite Strong 3Q Financial Performance

1. Honda Chooses CATL as Battery Partner for Their EVs; Panasonic Has Lost the Chance

CATL (A) (300750 CH) announced on Monday that it has signed a deal with Honda Motor (7267 JP) for jointly developing Li-ion batteries. This news comes to us as no surprise, given CATL’s effort in expanding market share globally by tying with leading automakers such as Nissan Motor (7201 JP), Daimler AG (DAI GR), and Bayerische Motoren Werke Ag (BMW GR). It seems that the Chinese battery leader is now targeting leading Japanese automakers alongside their focus on luxury automakers in Europe ( BMW to Invest in CATL: Chinese Battery Maker to Gain Exposure in Europe?).  Following Panasonic Corp (6752 JP)’s news about forming a Joint Venture with Toyota, we were under the impression that Panasonic would hit a deal with Honda as well. However, it seems that CATL has emerged as a first mover and secured a steady business by partnering with Honda, one of the leading automakers in Japan. Although Panasonic and Honda joined hands for developing a swappable battery system in Indonesia, the team hasn’t really gone ahead in developing Li-ion batteries. Honda’s battery sales are now for CATL, while Panasonic has lost a steady business deal unless the latter makes plans with Honda to develop new battery technologies such as solid-state batteries. In our opinion, Honda and CATL, being leaders in their respective industries, when joined together via this agreement should capture a strong position in the auto sector which is striding towards electrification. The effect of this news on CATL share price cannot be really seen as the markets are closed for ongoing holidays in China. Panasonic, however, opened -5.1% low on February 5th, mainly due to its disappointing 3QFY03/19 earnings and could be partly due to this news.

2. Sumco Reports Solid Growth in Revenue and Operating Profit; Stock Is Still Trading at a Discount

Sumco (3436 JP) reported its 4QFY12/18 and Full-year FY12/18 results yesterday (5th February). The company reported double-digit growth in revenue and operating profit for 4QFY12/18 driven by strong demand for semiconductor silicon wafers across all sizes alongside a favourable trend in wafer prices. Revenue grew 17.7% YoY in the 4^th quarter, in spite of missing its own top-line estimate by 1.7% and falling a touch below consensus and our estimates. Operating profit increased 57.1% YoY to JPY20.9bn, yet again falling below guidance, consensus and our estimates. The strong growth in operating profit resulted in a 640-bps expansion in the operating profit margin to 25.3% compared to the 18.9% reported in 4QFY12/17.

3. MODEC: 17% Price Jump as Results Beat, Guidance Is Lowballed

Modec Inc (6269 JP) reported strong 2018 results as operations for the year went smoothly and gross margin recovered to double digits in the fourth quarter with the company also releasing its contingency reserves resulting in a large uptick in SPC related earnings below the operating line.

Like last year however, guidance disappointed as the company released what we consider to be lowball estimates. Nevertheless, the stock reacted positively as the strong results offset some of the recent negativity from the large fall in crude prices. We examine the degree of conservatism we see in guidance below.

4. Pan Pacific International: UNY Acquisition the Bright Spot as SSS and Inbound Decelerate

Newly and somewhat boringly renamed  Pan Pacific International Holdings (7532 JP; PPI) (formerly the much more evocative Don Quijote or Donki) announced results yesterday after the close, seeing 11% YoY sales growth for the first half and 14% YoY current profit growth. With the inclusion of the expected contribution from a consolidated Uny Holdings, the company also boosted its FY outlook by 46% at the revenue line and 32% at the NP line.

Results at the 6 converted Uny stores continue to trend well and the company announced its intention to convert a further 19 stores by the end of the calendar year. Familymart Uny Holdings (8028 JP) had been projecting about ¥25bn in OP for Uny and its subsidiary UCS, which combined with PPI’s previous forecast for FY06/19 of ¥53bn would sum to about ¥78bn in OP, in line with consensus for PPI’s FY06/20 OP. Given the store conversions, growth overseas and some modest growth domestically for the mainline Donki stores, the prospects for a significant beat of consensus next year seem good.

5. Nintendo Downgrades Switch Unit Sales Forecast for FY03/19 Despite Strong 3Q Financial Performance

• Nintendo recorded strong revenue and OP performance in 3QFY03/19. Revenue for the quarter amounted to JPY608.4bn (+25.9% YoY) and OP amounted to JPY158.6bn (+36.1% YoY).
• Albeit strong performance across topline and bottomline, the company downgraded the sales units forecast for the Switch from 20m to 17m for FY03/19. Switch unit sales continue to be heavily driven by software releases. The company has only two hit software releases planned for 4QFY03/19. As such, the company has not made any changes to guidance. 
• The company continues to broaden its reach in the mobile gaming market with two releases set for summer 2019. While this may help the company reduce its reliance on gaming consoles over the long run, currently, mobile games make up less than 10% of the company’s topline.
• Based on our estimates, Nintendo is currently trading at a FY1 EV/EBIT multiple of 11.4x, lower than its historical median of 13.4x.