Japan

In this briefing:

1. Japan: 2018 Sector Review – Down, Down, Deeper & Down
2. Japanese Banks:  These Lifeless Things (The Ozymandias Syndrome)
3. Jeans Mate Posts a Profit at Last
4. Global Semiconductor Sales Fall In November 2018. This Is Not A Good Sign.
5. THK (6481 JP): Downturn Discounted, Recovery Depends on New Orders

1. Japan: 2018 Sector Review – Down, Down, Deeper & Down

Source: Japan Analytics

DOWN, DOWN, DEEPER & DOWN – Japanese equities were as unfashionable as the venerable ‘Quo’ in 2018, although all of the year’s decline occurred in the fourth quarter. Our All-Market-Composite fell by 16.1%, only three sectors – REITs, Utilities and Telecoms – rose and four sectors – Metals, Building Materials, Technology Hardware and Machinery – fell by more than 30%. All of the sixteen outperforming sectors are domestically-orientated, and only two – Other Commercial Products and Other Consumer Products are manufacturing sectors. With no end in sight to the Bank of Japan’s accommodation, interest rates remained at historically-depressed levels and provided no respite to financial sectors. Construction and Building Materials declined as the pre-Olympic construction order cycle peaked out, although Real Estate outperformed as office vacancy rates and rents reached three-decade new lows and new highs, respectively. The largest fourth-quarter declines were in the Energy, Internet, Information Technology and Commercial Services sectors and now offer some attractive stock-specific opportunities.

2. Japanese Banks:  These Lifeless Things (The Ozymandias Syndrome)

Japanese bank stocks performed so poorly in 2018, with the Topix Bank Index falling 25.7% while the overall market declined by a lesser 16.4%, that some may be tempted to speculate that Japanese banks might be a key sector in leading a market recovery in 2019. We don’t think so. The fundamental outlook for banks’ profits remains clouded by a strengthening Yen against the US$, declining revenue growth, anaemic manufacturing sector loan demand, relentless downward pressure on net interest margins, weak fee business, rising valuation losses on both stocks and bonds, and ‘normalising’ credit costs. Simply put, there are no growth catalysts to drive the Japanese banking sector forward on a sustainable basis in terms of stock price appreciation. This all adds up to uninspiring valuations, even at current levels.  ‘Caveat emptor! (May the buyer beware!)’ remains our key recommendation to would-be investors in Japanese bank stocks for 2019.

3. Jeans Mate Posts a Profit at Last

While Rizap Group (2928 JP) has seen its share price crash and its CEO bow in apology after profit warnings and a plan to radically cut back on M&A, Jeans Mate Corp (7448 JP), which Rizap acquired last year, has quickly moved to modernise stores. It has just replaced its Shibuya store with a new concept called JEM that could mean the end of the Jeans Mate name altogether and posted its first operating profit in years. While many of Rizap’s acquisitions were dubious, Jeans Mate is one business that could be turned around into a modestly successful casual apparel retailer.

4. Global Semiconductor Sales Fall In November 2018. This Is Not A Good Sign.

The Semiconductor Industry Association (SIA) just announced that worldwide sales of semiconductors reached $41.4 billion for the month of November 2018, an increase of 9.8% YoY, but down 1.1% MoM, the first such decline since February 2018. While the decline is modest and total 2018 total semiconductor sales are on track to reach ~$470 billion for a YoY increase of 15.7%, any decline in what should be peak holiday season is not a good sign. 

Semiconductor sales historically track Wafer Fab Equipment (WFE) sales with a roughly six month time lag. North American WFE sales have been declining each month for the past six months meaning that this latest semiconductor MoM sales decline is right on schedule.  

Leveraging a decade’s worth of historical data, we analyse two key questions that are likely on every investors mind. Firstly,for how long should we expect semiconductor sales to continue their decline. Secondly, how steep should we expect that decline to be?    

5. THK (6481 JP): Downturn Discounted, Recovery Depends on New Orders

After dropping 60% from a high of ¥4,830 last February 27 to a 52-week low of ¥1,945 on December 26, THK closed at ¥2,062 on December 28, the last trading day of 2018.  

New orders peaked in the three months to Dec-17. The order backlog peaked in the three months to Mar-18, and so did the share price. Sales and operating profit peaked in the three months to Jun-18. Demand from the company’s top three user categories – electronics (semiconductor production equpment in particular), machine tools, and general industry – has been moving in parallel. By region, new orders from China have dropped most rapidly, followed by orders from Taiwan and Japan. 

After double-digit positive comparisons in the nine months to Sep-18, management is guiding for a 30% year-on-year decline in operating profit in 4Q of FY Dec-18. Judging from the orders trend and economic situation, substantial declines in sales and profits are likely in FY Dec-19. If demand from China picks up following a trade agreement with the U.S. sometime next year, there should be a moderate recovery going into FY Dec-20.

The shares are now selling at 7.7x management’s EPS guidance for FY Dec-18 and 0.9x book value at the end of Sep-18. Our forecast puts the shares on 11.9x earnings for FY Dec-19 and 10.4x earnings for FY Dec-20E. Valuations are at the bottom of their recent historical ranges. When orders recover, the stock price should, too.

In this briefing:

1. Forecasting the Semiconductor Market
2. Big Trouble in Little Stocks? Maybe TSE Mulls Changing TOPIX
3. Pasona Non-Grata
4. Korea M&A Spotlight: Nexon’s Founder Plans to Sell; Will Tencent Buy Nexon?
5. Jardine C&C (JCNC SP): Close the Stub Trade

1. Forecasting the Semiconductor Market

This is the time of year that Objective Analysis releases its semiconductor forecast.  This post is based upon a video posted on the WeSRCH website that explains the Objective Analysis 2019 semiconductor forecast.

Although accurate semiconductor forecasts are straightforward to produce, the consistently-accurate methodology spelled out in this Insight is rarely used.

The forecast predicts that the downturn that the industry is currently entering will be longer than most, with profits eluding chip companies until 2022.

2. Big Trouble in Little Stocks? Maybe TSE Mulls Changing TOPIX

A Nikkei Asian Review article on 21 December titled  Tokyo Stock Exchange’s big board about to get a lot smaller suggesting the TSE would boot up to 1500 stocks from TOPIX, which now boasts 2130+ members – far more than major indices in other developed markets. 

Since November, a dedicated internal panel (“Advisory Group to Review TSE Cash Equity Market Structure”) has been addressing the issues, trying to make Tokyo’s stock market more attractive for international investors. Some of the proposals raised include a market cap cutoff of ¥50 billion or ¥100 billion of which there were on that date 1,000 companies and 620 companies respectively. 

The same day, the TSE released a  Consultation Paper “Review of the TSE Cash Equity Market Structure”. There is the Paper and the Data presentation which accompanies it. And the Consultation Paper invites public comments through 31 January (contact the Listing Department at [email protected]).

The introduction makes clear the goal. The part below is underlined in the original document.

Taking into account the role the market structure plays, it is important that TSE reviews the market structure in order to further incentivize listed companies to proactively improve their overall value as corporation, in addition to further attracting diverse global and domestic investors by providing attractive investment opportunities. Conducting a review of the market structure, with the aim of supporting the se roles, will further contribute to the development of a sustainable capital market, and by extension, the wider Japanese economy.

That paragraph tells you all you need to know.

It Has Been Decided That Something Must Be Done So Something Will Be Done.

The Consultation Paper and the Data presentation accompanying it discuss the current market structure (with four “listing” markets including the TSE1, TSE2, MOTHERS, and JASDAQ (including sub markets), making it clear that…

• biotech companies which need R&D capital should be allowed to list in order to raise capital, but pointing out that small companies which are already in existence for many years which list just because they want to are not 
• the requirements for reassignment from JASDAQ, MOTHERS or TSE2 to the First Section (the “step-up market” to which all major companies should aspire) are too low, and many companies which should not be admitted to the top ranks because of weak internal management structure or corporate governance end up there anyway,
• delisting requirements and procedures may not function properly and should be reviewed,
• the ability for shareholders to trade the “pink sheets”, “green sheets”, or delisted stocks is insufficient.
• the requirements for listing and liquidity on JASDAQ are insufficient.

I would note that the Consultation Paper does not address the ¥50 billion or ¥100 billion question.  The fact that the Nikkei does so tells you where they want to go with this. 

• The TSE is not suggesting that small companies shouldn’t be allowed to list. 
• The TSE clearly defines three types of companies – 1) risky companies without profits but great need for capital to grow, 2) established companies where capital need is lower and market investment may be made by more risk-averse investors, and 3) the “step-up market” – the big leagues.
• The Paper asks investors what should be the listing criteria for each group and the treatment of those companies which no longer meet the listing criteria. Then it asks about delisting criteria. 
• Effectively, the goal of making such changes to minimum market cap would be to…
  • make TOPIX (which is an index consisting of all members of the TSE First Section) a “better” index which would look more like the S&P500. That would make TOPIX more like the indices commonly used by foreign investors – such as MSCI Japan and FTSE Japan.
  • provide two markets for smaller companies – one for growth companies without profits or track record and one for established companies with a track record. 

The “Call for Comment” questions in each section point you to the overall conclusions and destination and ask you, the investor, what limits should be placed to light the way there. Investors with an interest in market structure should think about how best to respond.

• Should parent-controlled subsidiaries be allowed to list when the parent owns more than 50%?
• Should all TSE1 companies be required to release extensive company data and documentation online? in English?
• Should companies which breach the public trust through scandal – such as Seibu Rail, Kanebo, and Olympus years ago or Toshiba more recently – be permitted to stay listed? (Seibu and Kanebo were delisted, Olympus and Toshiba stayed listed)
• What constitutes a situation where delisting should be mandatory?

The language of the Paper and the way the Call for Comment questions are framed tells me the “results” are already known and the results of the Public Comment period will simply be flavoring.

There will be a three-tier market – something akin to MOTHERS, something akin to TSE2 for “established companies”, and something like the TSE First Section which will be beefed up (stricter criteria) and slimmed down (fewer companies). 

Whether governance is improved through limits on subsidiary holdings by parent companies, or criteria for independent directors, or more extensive documentation (and in English) is up to investors. If they make enough noise, this could happen. 

Most important for traders and investors are the market impacts from potential changes to TSE First Section. If the TSE mandates that listing requires companies to have a market cap of  ¥100 billion, the change…

1. will have a profound effect on the supply/demand metrics for a large number of companies. THAT will create dislocations.
2. possibly prompt consolidation over time. The limited ability of small companies to access TSE1 listing because of insufficient size or dollar value of daily liquidity may cause mergers.
3. could have profound effects on the Nikkei 225 if done right. 

3. Pasona Non-Grata

PASONA NON-GRATA

Source: Japan Analytics

ROUND TRIP – Temporary staffing company Pasona (2168 JP)‘s shares have completed a year-long ’round trip’ after reaching Overbought territory one year ago following the launch of an ‘engagement campaign’ by the activist investor, Oasis. In May 2018, the company took advantage of its elevated share price to sell 2.3m shares (of which 2m were Treasury Shares), prompting a sharp correction in the share price. In recent months, the shares have languished as the company’s business performance has begun to deteriorate, reaching an 18-month low of 1,008 on 25th December, before rebounding 12% to close the year at ¥1,126.

HOLDCO DISCOUNT – According to the Smartkarma HoldCo Monitor, Pasona has the largest ‘ListCo as a % of Market Cap’ percentage at 365%, and the second-largest ‘Discount to Net Asset Value’ (78%) of the 77 companies that are tracked. With Pasona’s interim results due to be released on Friday 11th, January, the Insight will look at the company’s recent business performance, offer some guidelines for valuing the company and make two stock-specific recommendations. The format follows that of our recent Insight on GMO Internet. 

4. Korea M&A Spotlight: Nexon’s Founder Plans to Sell; Will Tencent Buy Nexon?

It was reported today that Nexon Co Ltd (3659 JP)’s founder Kim Jung-Joo plans to sell a controlling stake in Nexon’s holding company NXC Corp for at least 10 trillion won ($8.9 billion). Kim Jung-Joo and other related parties plan to sell their entire 98.64% stake in NXC Corp, which owns a 47.98% stake in Nexon. The 10 trillion won or more anticipated acquisition price for NXC Corp would include a significant management premium. Nexon Group’s shareholding structure is basically as follows: Kim Jung-Joo → Nexon (Japan) → Nexon Korea → About 10 affiliates. 

One of the reasons why the Nexon’s founder Kim Jung-Joo, who is only 50 years old, is trying to sell his entire stake in Nexon may have been due to the recent allegations about him giving about $380,000 worth of Nexon stock (prior to its listing) to his old high school classmate (who is now a senior public prosecutor) for free. Kim Jung-Joo has repeatedly faced allegations and attended numerous court hearings on this matter in the past two years. He may have gotten a bit tired from all these allegations. 

Given the enormous size of this acquisition, the two leading Korean game companies including NCsoft Corp (036570 KS) and Netmarble Games (251270 KS) are not likely to purchase Nexon. Rather, the leading contender to buy Nexon right now is likely to be Tencent Holdings (700 HK). The sheer huge size of this deal will represent one of the largest M&A deals in Asia in 2019. 

5. Jardine C&C (JCNC SP): Close the Stub Trade

In my original insight on October 17, 2018 TRADE IDEA – Jardine Cycle & Carriage (JCNC SP) Stub , I proposed setting up a stub trade to profit from volatility in the markets that caused the Jardine Cycle & Carriage (JCNC SP) stub to trade at a historically low discount to NAV. During the 78 calendar days that followed, Jardine Cycle & Carriage (JCNC SP) has gained 23% and the trade has made 5.03% on the gross notional. I now recommend closing the trade.

In this insight I will discuss:

• Performance of ALL my recommended stub trades
• a post-mortem trade analysis on the JCNC stub

In this briefing:

1. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?
2. Recruit Holdings Down 30% From October; Still Not Cheap
3. Japan: 2018 Market Review – Bear Market Rally Ahead
4. Last Week in Event SPACE: Harbin Electric, MYOB, TMB Bank, Halla Holdings
5. Are US Stocks A Buy Yet?

1. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?

Nintendo reported their 2QFY03/19 in October with results showing growth at both the top line and bottom line albeit not living up to consensus expectations. Top line grew by 4.0% YoY to JPY388.9bn in 1H03/19 while OP grew by 53.9% YoY to JPY61.4bn. OP in the last quarter (2QFY03/19) was the second highest the company has experienced over the last five years. This growth has been mainly driven by the sales of Nintendo Switch hardware which sold just over 5m units in 1HFY03/19. However, YoY growth remained at 3.4% compared to 4.9m units sold in 1HFY03/18. This has left investors worried about Nintendo’s aggressive target of selling 20m units of the Switch for FY03/19. Of this target, the company has managed to achieve only around 25.0% in 1H. Nintendo’s financial performance follows a seasonal trend with the December quarter showing stronger performance due to increased sales during Christmas. While the company’s current quarter is likely to show strong results, we remain skeptical about the company reaching the aforementioned target for FY03/19.

Switch Sales Have Caused an Improvement in Nintendo’s OP….

….Despite a Slowdown in the Growth of Units Sales

Nintendo’s Last Quarter Has Also Failed to Live Up To Consensus Expectations

2. Recruit Holdings Down 30% From October; Still Not Cheap

The share price of Recruit Holdings (6098 JP) has fallen by around 30% over the past three months from an all-time high of JPY3,826 (on 1^st October 2018) to JPY2,705 on 24^th December 2018. Prior to this, Recruit’s share price saw a strong upward rally during May-September following the company’s announcement that it would acquire Glassdoor Inc. (the company which operates the employment information website glassdoor.com).

We expect Recruit’s consolidated revenue to grow 7.7% and 6.5% YoY in FY03/19E and FY03/20E respectively, driven by the acquisition of Glassdoor and steady growth in Japanese staffing operations, partially offset by a likely slowdown in global labour market activity. We also expect Recruit’s consolidated EBITDA margin to improve by around 50bps due to higher margin from Glassdoor.

Despite the recent dip in share price and steady topline and bottom line growth over the forecast period, at a FY2 EV/EBITDA multiple of 14.0x, Recruit doesn’t look particularly attractive to us. Recruit’s internet advertising business and employment business peers, Yahoo Japan (4689 JP) and Persol Holdings (2181 JP) are trading at FY2 EV/EBITDAs of 7.7x and 9.6x respectively.

3. Japan: 2018 Market Review – Bear Market Rally Ahead

2018 MARKET REVIEW – In this Insight, we shall review the performance of the Japanese stock market, during 2018 and look forward to the coming year. We shall look back at the year from a Sectors, Peer Group and Company perspective in separate Insights to follow next week.

BEAR MARKET RALLY AHEAD – From the January 23rd peak to the December 25th low, the All Market Composite declined 24.5% in Yen terms and 24.9% in US$ terms placing Japan in a bear market for the seventh time since the bursting of the 1989 stock market ‘bubble’. The average stock is now 35% below its one-year high compared with just 10% below at the beginning of the year. Total Market Value is still ¥123t above the low of 12th February 2016, and the question remains – are we replaying March 2008 or February 2016? In both cases, there were bear market rallies (25% and 17%) before the final downward leg – which entailed further declines of 50% and 13%, respectively. In our recent Insight on 21st December – Ticking the Bear Market Boxes – we commented that it was too early for contrarians to start ‘nibbling’. The 1,000 point Nikkei 225 (NKY INDEX) decline the next trading day, and the rebound into the year-end suggests that a case can now be made for, at least, a short-term rally. In the charts in the DETAIL below, we shall explore the case for (✓) and against (✕), and attempt to answer the question of the 2008 or 2016 reprise.

4. Last Week in Event SPACE: Harbin Electric, MYOB, TMB Bank, Halla Holdings

Last Week in Event SPACE …

• Just how will Harbin Electric Co Ltd H (1133 HK)‘s independent directors justify recommending an Offer to shareholders at a price which gave cash less cavalier than cash?
• MYOB Group Ltd (MYO AU)‘s directors grudgingly yet understandably enter an agreed deal with KKR.
• A TMB Bank PCL (TMB TB) / Thanachart Capital (TCAP TB) courtship is a possibility after an earlier Krung Thai Bank Pub (KTB TB) /TMB alliance failed. 

(This insight covers specific insights & comments involving Stubs, Pairs, Arbitrage, share Classification and Events – or SPACE – in the past week)

As previously discussed in Harbin Electric Expected To Be Privatised, Harbin Electric (HE) has now announced a privatisation Offer from parent and 60.41%-shareholder Harbin Electric Corporation (“HEC”) by way of a merger by absorption. The Offer price of $4.56/share, an 82.4% premium to last close, is bang in line with that paid by HEC in January this year for new domestic shares. The Offer price has been declared final. 

• Of note, the Offer price is a 37% discount to HE’s net cash of $7.27/share as at 30 June 2018. Should the privatisation be successful, this Offer will cost HEC ~HK$3.08bn, following which it can pocket the remaining net cash of $9.3bn PLUS the power generation equipment manufacturer business thrown in for free.
• On pricing, “fair” to me would be something like the distribution of net cash to zero then taking over the company on a PER with respect to peers. That is not happening. It will be difficult to see how independent directors (and the IFA) can justify recommending an Offer to shareholders at any price below the net cash/share, especially when the underlying business is profit-generating.
• Dissension rights are available, however, there is no administrative guidance on the substantive as well as procedural rules as to how the “fair price” will be determined under PRC and HK Law.
• Trading at a gross/annualised spread of 15%/28% assuming end-July completion, based on the average timeline for merger by absorption precedents. As HEC is only waiting for approval from independent H-shareholders suggests this transaction may complete earlier than precedents. 

(link to my insight: Harbin Electric: The Price Is Not Right)  

KKR and MYOB entered into Scheme Implementation Agreement (SIA) at $3.40/share, valuing MYOB, on a market cap basis, at A$2bn. MYOB’s board unanimously recommends shareholders to vote in favour of the Offer, in the absence of a superior proposal. The Offer price assumes no full-year dividend is paid.

• On balance, MYOB’s board has made the right decision to accept KKR’s reduced Offer. The argument that MYOB is a “known turnaround story” is challenged as cloud-based accounting software providers Xero Ltd (XRO AU)  and Intuit Inc (INTU US) grab market share. This is also reflected in MYOB’s forecast 7% revenue growth in FY18 and follows a 10% decline in first-half profit, despite a 61% jump in online subscribers.
• And there is justification for KKR’s lowering the Offer price: the ASX is down 10% since KKR’s initial tilt, the ASX technology index is off by ~14%, a basket of listed Aussie peers are down 17%, while Xero, the most comparable peer, is down ~20%. The Scheme Offer is at a ~27% premium to the estimated adjusted (for the ASX index) downside price of $2.68/share.

• Bain was okay selling at $3.15/share to KKR and will be fine selling its remaining ~6.5% stake at $3.40. Presumably, MYOB sounded out the other major shareholders such as Fidelity, Yarra Funds Management, Vanguard etc as to their read on the revised $3.40 offer, before agreeing to the SIA with KKR.

• If the markets avoid further declines, this deal will probably get up. If the markets rebound, the outcome is less assured. This Tuesday marks the beginning of a new year and a renewed mandate for investors to take risk, especially an agreed deal; but the current 5.3% annualised spread is tight.

(link to my insight: MYOB Caves And Agrees To KKR’s Reduced Offer)

TMB Bank PCL (TMB TB) (Mkt Cap: $1.2bn; Liquidity: $7mn)

The Ministry of Finance, the major shareholder of TMB, confirmed that both Krung Thai Bank Pub (KTB TB) and Thanachart Capital (TCAP TB) had engaged in merger talks with TMB. Considering an earlier KTB/TMB courtship failed, it is more likely, but by no means guaranteed, that the deal with Thanachart will happen. Bloomberg is also reporting that Thanachart and TMB want to do a deal before the next elections, which is less than two months away.

• TMB is much bigger than Thanachart and therefore it may boil down to whether TMB wants to be the target or acquirer. In Athaporn Arayasantiparb, CFA‘s view, a deal with Thanachart would leave TMB as the acquirer rather than the target. But Thanachart’s management has a better track record than TMB.
• Both banks have undergone extensive deals before this one: 1) TMB acquired DBS Thai Danu and IFCT; and 2) Thanachart engineered an acquisition of the much bigger, but struggling, SCIB.
• A merger between the two would still leave them smaller than Bank Of Ayudhya (BAY TB) and would not change the bank rankings; but it would give TMB a bigger presence in asset management, hire-purchase finance and a re-entry into the securities business.

(link to Athaporn’s insight: Sathorn Series M: TMB-Thanachart Courtship)  

Halla Holdings (060980 KS) / Mando Corp (204320 KS)

Mando accounts for 45% of Halla’s NAV, which is currently trading at a 50% discount. Sanghyun Park believes the recent narrowing in the discount may be due to the hype attached to Mando-Hella Elec, which he believes is overdone; and recommends a short Holdco and long Mando. Using Sanghyun’s figures, I see the discount to NAV at 51%, 2STD above the 12-month average of ~47%.

(link to Sanghyun’s insight: Halla Holdings Stub Trade: Downwardly Mean Reversion in Favor of Mando)  

• LG Chem Ltd (051910 KS)‘s 1P is now at a 44.20% discount to Common. The dividend will be the same as last year of ₩6,000 despite lower earnings. The dividend yield for Common will be 1.68%, and 3.03% for 1P or a dividend yield difference of 1.35%, a four-year high. (link to Sanghyun’s insight: LG Chem Share Class: Another Pref to Watch as Div Yield Gap at 4Y High)  

• Glow Energy Pcl (GLOW TB). In a strange twist to the tale, the ERC agrees to approve Global Power Synergy Company Ltd (GPSC TB)‘s takeover of Glow under a revised plan in which they have to: 1) sell Glow SPP1, a power plant with 124MW capacity and 90 tons/hr of steam; and 2) allow clients such as Pa Daeng to change providers. This will reduce Glow’s market share within the MapTaPhut area, but Athaporn Arayasantiparb, CFA thinks the purchase price (Bt139bn according to Bangkok Post) will have to be revised downwards too.  For more on the original deal, see Deal Alert! GPSC Goes For the Jugular! and Anti-Trust Should Be A Non-Issue In The GPSC/Glow Deal.

• Unisem (M) (UNI MK). The Offer is now unconditional and will remain open to acceptances until the 7 January 2019.
• Stanmore Coal (SMR AU). The offer has been extended until the 22 January 2019.

Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.   

5. Are US Stocks A Buy Yet?

• 5%-like rallies on Wall Street are signs of a bear market not a bull market
• Bull markets require strong liquidity and low risk appetite, neither yet apply
• Risk appetite readings at minus 12.6 are still above the minus 40 criterion for an upturn
• Recent large fall in risk appetite consistent with upcoming economic recession

In this briefing:

1. Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019
2. Japan Pharma – Top Picks (28 Dec 2018)
3. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI
4. GMO Internet (9447 JP) – Grossly or Modestly Overrated?
5. Autonomous Driving. Waymo Leading The Charge With Ten Million Miles Driven And Counting

1. Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019

2. Japan Pharma – Top Picks (28 Dec 2018)

                                                                                                                                                                                                                                                                        `                        

3. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

As the colder winter weather is felt and the icy blast of industry tariff cuts continues to chill sentiment, we seek some respite (at least mentally) in the warmer climes of Okinawa. Okinawa Cellular is a unique company. It’s a small cap telecom network operator in Japan with a focus on the sub-tropical islands of Okinawa Prefecture. As part of the KDDI group, the company benefits from its parent’s economies of scale, but with its local presence, it also benefits from being the hometown hero. 

Because the stock is relatively small, from an investment perspective it runs into liquidity constraints that the other telcos do not have, so it’s a different type of investment but one that we think is worth looking at. Over the past 12 months Okinawa Cellular’s stock has fallen by 12.3%, but over the past year the stock has delivered a return in the middle of its peer group and has outperformed the broad TOPIX by about 5.5%. Like most telcos, Okinawa Cellular is also ramping its dividend payments, and the current yield is about 3.5%.

4. GMO Internet (9447 JP) – Grossly or Modestly Overrated?

Source: Japan Analytics

THE GMO INTERNET (9449 JP) STORY – GMO internet (GMO-i) has attracted much attention in the last eighteen months from an unusual trinity of value, activist and ‘cryptocurrency’ equity investors.

• VALUE– Many traditional, but mostly foreign, value investors have seen the persistent negative difference between GMO-i’s market capitalisation and the value of the company’s holdings in its eight listed consolidated subsidiaries as an opportunity to invest in GMO-i with a considerable ‘margin of safety’.
• ACTIVIST – Since July 2017, the activist investor, Oasis, has waged a so-far-unsuccessful campaign with the aim of improving GMO’s corporate governance, removing takeover defences, addressing a ‘secularly undervalued stock price we are not able to tolerate’ (sic), and redefining the role and influence of the company’s Chairman, President, Representative Director and largest shareholder, Masatoshi Kumagai.
• ‘CRYPTO!’ – In December 2017, GMO-i committed to spending more than ¥35b or 10% of non-current assets. The aim was threefold: to set up a bitcoin ‘mining’ headquarters in Switzerland (with the ‘mining’ operations being carried out at an undisclosed location in Scandinavia), to develop proprietary state-of-the-art 7nm-node ‘mining chips’, and, in due course, to sell GMO-branded and developed ‘mining’ machines. The move was hailed in the ‘crypto’ fraternity as GMO-i became the largest non-Chinese and the first well-established Internet conglomerate to make a major investment in ‘cryptocurrency’ infrastructure.

OUTSTANDING – Following the December 2017 announcement, trading volumes spiked into ‘Overtraded’ territory – as measured by our Volume Score. Many investors saw GMO-i shares as a safer way of gaining exposure to ‘cryptocurrencies’, even as the price of bitcoin began to subside. By early June 2018, GMO-i’s shares had reached a closing price of ¥3,020: up 157% from the low of the prior year and outperforming TOPIX by 135%. Whatever the primary driver of this outstanding performance, each of our trio of investor groups no doubt felt vindicated in their approach to the stock.

CRYPTO CLOSURE – On December 25th 2018, GMO-i’s shares reached a new 52-week low of ¥1,325, a decline of 56% from the June high. Year to date, GMO-i shares have now declined by 31%, underperforming TOPIX by nine percentage points. On the same day, GMO-i announced that the company would post an extraordinary ¥35.5b loss for the fourth quarter, incurring an impairment loss of ¥11.5b in relation to the closure of the Swiss ‘mining’ headquarters and a loss of ¥24b to cover the closure of the ‘mining chip’ and ‘mining machine’ development, manufacturing and sales businesses. GMO-i will continue to ‘mine’ bitcoin from its Tokyo headquarters and intends to relocate the ‘mining’ centre from Scandinavia to (sic) ‘a region that will allow us to secure cleaner and less expensive power supply, but we have not yet decided the details’. Unlisted subsidiary GMO Coin’s ‘cryptocurrency’ exchange will also continue to operate, and the previously-announced plans to launch a ¥-based ‘stablecoin’ in 2019 will proceed. In the two trading days following this announcement, the shares have recovered 13% to ¥1,505. 

RAIDING THE LISTCO PIGGY BANK – As we shall relate, this is the second time since listing that GMO-i has written off a significant new business venture which the company had commenced only a short time before. In both cases, the company was forced to sell stakes in its listed consolidated subsidiaries to offset the resulting losses. On this occasion, the sale of shares in GMO Financial (7177 JP) (GMO-F) on September 25 2018, and GMO Payment Gateway (3769 JP) (GMO-PG) on December 17 2018, raised a combined ¥55.6b and, after the deduction of the yet-to-be-determined tax on the realised gains, should more than offset the ‘crypto’ losses. According to CFO Yasuda, any surplus from this exercise will be used to pay down debt. Also discussed below and in keeping with this GMO-i ‘MO’, in 2015, the company twice sold shares in its listed subsidiaries to ‘smooth out’ less-than-desirable operating results.

5. Autonomous Driving. Waymo Leading The Charge With Ten Million Miles Driven And Counting

Waymo CEO John Krafcik made some bold decisions after taking the helm at Alphabet‘s self-driving project in September 2015. Chief among them was the fact that the company abandon its plans for Level 3 automated driving and focus exclusively on levels 4 & 5. Furthermore, he decreed that Waymo would no longer manufacture its own vehicles but would instead integrate their technology into those of other automakers. Three years later, those decisions would appear to be finally paying off.

On October 10 2018, Waymo reached a significant milestone having completed 10 million self-driving miles across 25 cities in the US. While their first million self-driving miles took 18 months to complete, Waymo now clocks up over a million self-driving miles per month.  The company also recently announced the launch of its robo taxi service in Phoenix, Arizona and looks set to quickly follow suit in California. Plans to extend its self-driving technology beyond robotaxis, most notably for trucks and last-mile transportation solutions are also in the works. Furthermore, the company has begun laying down a framework of innovative B2B revenue models which should help accelerate the speed with which they can eventually monetize their technology.

It hasn’t been smooth sailing all the way for Waymo however. Earlier this year, the company was derided for the driving style of its autonomous vehicles and faced the criticism that its driverless cars continue to have safety drivers. There was also an embarrassing incident where one of those very safety drivers caused the self-driving car he was monitoring to hit a motorcyclist when he attempted to take control of the vehicle. According to Waymo’s own analysis of the vehicle log files, the accident would not have happened had he not intervened. 

With ten million self-driving miles under their belt and a thoughtful, strategic approach to monetizing their technology beginning to emerge, Waymo remains firmly ahead of their peers in leading the autonomous driving charge.  

In this briefing:

1. 2019 Asia Selected Gaming Stock Outlook: Headwinds, Tailwinds and Our Top Picks for Entry Levels Now
2. SoftBank Corp (9434 JP) & Arteria Networks (4423 JP): A Tale of Two IPOs

1. 2019 Asia Selected Gaming Stock Outlook: Headwinds, Tailwinds and Our Top Picks for Entry Levels Now

Our review of ten Asian gaming companies forward prospects for 2019 yielded our top five picks. Two of those comprise this insight. Three more will follow in Part Two. There is, in our opinion, some disconnect between continuing macro headwinds in both the VIP and mass sectors and a more bullish tone based on a recent upside trend in Macau, strong results in the Philippines and Cambodia. Given the battering of the market in general, the already 8 month old bearish tone to the sector and the current pricing of the two stocks noted here, we see significant upside opportunity as we near the beginning of 2019.

2. SoftBank Corp (9434 JP) & Arteria Networks (4423 JP): A Tale of Two IPOs

During the second half of December 2018, Japan saw two telecom companies list on the Tokyo Stock Exchange: Softbank Corp (9434 JP) and ARTERIA Networks (4423 JP). After years of industry consolidation, which saw several stocks delist, this felt like a Christmas miracle (at least for those watching the sector’s stocks).

It would be hard to find two companies in the same industry that are so different – both in their business models as well as in how their IPOs were positioned to investors. One stock is 100 times larger than the other, but this is not a story of David and Goliath. It is two unique stories in parallel. 

While each company took a very different approach to selling its stock, both have suffered from the subsequent broader market weakness, irrespective of company specifics. We can’t say it has been the worst of times, but it certainly has been a tough time with SoftBank Corp down 13% and Arteria down 20% from their IPO prices.

In this Insight we explore how each company approached its IPO and how each has fared since. 

In this briefing:

1. Big Trouble in Little Stocks? Maybe TSE Mulls Changing TOPIX
2. Pasona Non-Grata
3. Korea M&A Spotlight: Nexon’s Founder Plans to Sell; Will Tencent Buy Nexon?
4. Jardine C&C (JCNC SP): Close the Stub Trade
5. Japan: 2018 Sector Review – Down, Down, Deeper & Down

1. Big Trouble in Little Stocks? Maybe TSE Mulls Changing TOPIX

A Nikkei Asian Review article on 21 December titled  Tokyo Stock Exchange’s big board about to get a lot smaller suggesting the TSE would boot up to 1500 stocks from TOPIX, which now boasts 2130+ members – far more than major indices in other developed markets. 

Since November, a dedicated internal panel (“Advisory Group to Review TSE Cash Equity Market Structure”) has been addressing the issues, trying to make Tokyo’s stock market more attractive for international investors. Some of the proposals raised include a market cap cutoff of ¥50 billion or ¥100 billion of which there were on that date 1,000 companies and 620 companies respectively. 

The same day, the TSE released a  Consultation Paper “Review of the TSE Cash Equity Market Structure”. There is the Paper and the Data presentation which accompanies it. And the Consultation Paper invites public comments through 31 January (contact the Listing Department at [email protected]).

The introduction makes clear the goal. The part below is underlined in the original document.

Taking into account the role the market structure plays, it is important that TSE reviews the market structure in order to further incentivize listed companies to proactively improve their overall value as corporation, in addition to further attracting diverse global and domestic investors by providing attractive investment opportunities. Conducting a review of the market structure, with the aim of supporting the se roles, will further contribute to the development of a sustainable capital market, and by extension, the wider Japanese economy.

That paragraph tells you all you need to know.

It Has Been Decided That Something Must Be Done So Something Will Be Done.

The Consultation Paper and the Data presentation accompanying it discuss the current market structure (with four “listing” markets including the TSE1, TSE2, MOTHERS, and JASDAQ (including sub markets), making it clear that…

• biotech companies which need R&D capital should be allowed to list in order to raise capital, but pointing out that small companies which are already in existence for many years which list just because they want to are not 
• the requirements for reassignment from JASDAQ, MOTHERS or TSE2 to the First Section (the “step-up market” to which all major companies should aspire) are too low, and many companies which should not be admitted to the top ranks because of weak internal management structure or corporate governance end up there anyway,
• delisting requirements and procedures may not function properly and should be reviewed,
• the ability for shareholders to trade the “pink sheets”, “green sheets”, or delisted stocks is insufficient.
• the requirements for listing and liquidity on JASDAQ are insufficient.

I would note that the Consultation Paper does not address the ¥50 billion or ¥100 billion question.  The fact that the Nikkei does so tells you where they want to go with this. 

• The TSE is not suggesting that small companies shouldn’t be allowed to list. 
• The TSE clearly defines three types of companies – 1) risky companies without profits but great need for capital to grow, 2) established companies where capital need is lower and market investment may be made by more risk-averse investors, and 3) the “step-up market” – the big leagues.
• The Paper asks investors what should be the listing criteria for each group and the treatment of those companies which no longer meet the listing criteria. Then it asks about delisting criteria. 
• Effectively, the goal of making such changes to minimum market cap would be to…
  • make TOPIX (which is an index consisting of all members of the TSE First Section) a “better” index which would look more like the S&P500. That would make TOPIX more like the indices commonly used by foreign investors – such as MSCI Japan and FTSE Japan.
  • provide two markets for smaller companies – one for growth companies without profits or track record and one for established companies with a track record. 

The “Call for Comment” questions in each section point you to the overall conclusions and destination and ask you, the investor, what limits should be placed to light the way there. Investors with an interest in market structure should think about how best to respond.

• Should parent-controlled subsidiaries be allowed to list when the parent owns more than 50%?
• Should all TSE1 companies be required to release extensive company data and documentation online? in English?
• Should companies which breach the public trust through scandal – such as Seibu Rail, Kanebo, and Olympus years ago or Toshiba more recently – be permitted to stay listed? (Seibu and Kanebo were delisted, Olympus and Toshiba stayed listed)
• What constitutes a situation where delisting should be mandatory?

The language of the Paper and the way the Call for Comment questions are framed tells me the “results” are already known and the results of the Public Comment period will simply be flavoring.

There will be a three-tier market – something akin to MOTHERS, something akin to TSE2 for “established companies”, and something like the TSE First Section which will be beefed up (stricter criteria) and slimmed down (fewer companies). 

Whether governance is improved through limits on subsidiary holdings by parent companies, or criteria for independent directors, or more extensive documentation (and in English) is up to investors. If they make enough noise, this could happen. 

Most important for traders and investors are the market impacts from potential changes to TSE First Section. If the TSE mandates that listing requires companies to have a market cap of  ¥100 billion, the change…

1. will have a profound effect on the supply/demand metrics for a large number of companies. THAT will create dislocations.
2. possibly prompt consolidation over time. The limited ability of small companies to access TSE1 listing because of insufficient size or dollar value of daily liquidity may cause mergers.
3. could have profound effects on the Nikkei 225 if done right. 

2. Pasona Non-Grata

PASONA NON-GRATA

Source: Japan Analytics

ROUND TRIP – Temporary staffing company Pasona (2168 JP)‘s shares have completed a year-long ’round trip’ after reaching Overbought territory one year ago following the launch of an ‘engagement campaign’ by the activist investor, Oasis. In May 2018, the company took advantage of its elevated share price to sell 2.3m shares (of which 2m were Treasury Shares), prompting a sharp correction in the share price. In recent months, the shares have languished as the company’s business performance has begun to deteriorate, reaching an 18-month low of 1,008 on 25th December, before rebounding 12% to close the year at ¥1,126.

HOLDCO DISCOUNT – According to the Smartkarma HoldCo Monitor, Pasona has the largest ‘ListCo as a % of Market Cap’ percentage at 365%, and the second-largest ‘Discount to Net Asset Value’ (78%) of the 77 companies that are tracked. With Pasona’s interim results due to be released on Friday 11th, January, the Insight will look at the company’s recent business performance, offer some guidelines for valuing the company and make two stock-specific recommendations. The format follows that of our recent Insight on GMO Internet. 

3. Korea M&A Spotlight: Nexon’s Founder Plans to Sell; Will Tencent Buy Nexon?

It was reported today that Nexon Co Ltd (3659 JP)’s founder Kim Jung-Joo plans to sell a controlling stake in Nexon’s holding company NXC Corp for at least 10 trillion won ($8.9 billion). Kim Jung-Joo and other related parties plan to sell their entire 98.64% stake in NXC Corp, which owns a 47.98% stake in Nexon. The 10 trillion won or more anticipated acquisition price for NXC Corp would include a significant management premium. Nexon Group’s shareholding structure is basically as follows: Kim Jung-Joo → Nexon (Japan) → Nexon Korea → About 10 affiliates. 

One of the reasons why the Nexon’s founder Kim Jung-Joo, who is only 50 years old, is trying to sell his entire stake in Nexon may have been due to the recent allegations about him giving about $380,000 worth of Nexon stock (prior to its listing) to his old high school classmate (who is now a senior public prosecutor) for free. Kim Jung-Joo has repeatedly faced allegations and attended numerous court hearings on this matter in the past two years. He may have gotten a bit tired from all these allegations. 

Given the enormous size of this acquisition, the two leading Korean game companies including NCsoft Corp (036570 KS) and Netmarble Games (251270 KS) are not likely to purchase Nexon. Rather, the leading contender to buy Nexon right now is likely to be Tencent Holdings (700 HK). The sheer huge size of this deal will represent one of the largest M&A deals in Asia in 2019. 

4. Jardine C&C (JCNC SP): Close the Stub Trade

In my original insight on October 17, 2018 TRADE IDEA – Jardine Cycle & Carriage (JCNC SP) Stub , I proposed setting up a stub trade to profit from volatility in the markets that caused the Jardine Cycle & Carriage (JCNC SP) stub to trade at a historically low discount to NAV. During the 78 calendar days that followed, Jardine Cycle & Carriage (JCNC SP) has gained 23% and the trade has made 5.03% on the gross notional. I now recommend closing the trade.

In this insight I will discuss:

• Performance of ALL my recommended stub trades
• a post-mortem trade analysis on the JCNC stub

5. Japan: 2018 Sector Review – Down, Down, Deeper & Down

Source: Japan Analytics

DOWN, DOWN, DEEPER & DOWN – Japanese equities were as unfashionable as the venerable ‘Quo’ in 2018, although all of the year’s decline occurred in the fourth quarter. Our All-Market-Composite fell by 16.1%, only three sectors – REITs, Utilities and Telecoms – rose and four sectors – Metals, Building Materials, Technology Hardware and Machinery – fell by more than 30%. All of the sixteen outperforming sectors are domestically-orientated, and only two – Other Commercial Products and Other Consumer Products are manufacturing sectors. With no end in sight to the Bank of Japan’s accommodation, interest rates remained at historically-depressed levels and provided no respite to financial sectors. Construction and Building Materials declined as the pre-Olympic construction order cycle peaked out, although Real Estate outperformed as office vacancy rates and rents reached three-decade new lows and new highs, respectively. The largest fourth-quarter declines were in the Energy, Internet, Information Technology and Commercial Services sectors and now offer some attractive stock-specific opportunities.

In this briefing:

1. Recruit Holdings Down 30% From October; Still Not Cheap
2. Japan: 2018 Market Review – Bear Market Rally Ahead
3. Last Week in Event SPACE: Harbin Electric, MYOB, TMB Bank, Halla Holdings
4. Are US Stocks A Buy Yet?
5. Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019

1. Recruit Holdings Down 30% From October; Still Not Cheap

The share price of Recruit Holdings (6098 JP) has fallen by around 30% over the past three months from an all-time high of JPY3,826 (on 1^st October 2018) to JPY2,705 on 24^th December 2018. Prior to this, Recruit’s share price saw a strong upward rally during May-September following the company’s announcement that it would acquire Glassdoor Inc. (the company which operates the employment information website glassdoor.com).

We expect Recruit’s consolidated revenue to grow 7.7% and 6.5% YoY in FY03/19E and FY03/20E respectively, driven by the acquisition of Glassdoor and steady growth in Japanese staffing operations, partially offset by a likely slowdown in global labour market activity. We also expect Recruit’s consolidated EBITDA margin to improve by around 50bps due to higher margin from Glassdoor.

Despite the recent dip in share price and steady topline and bottom line growth over the forecast period, at a FY2 EV/EBITDA multiple of 14.0x, Recruit doesn’t look particularly attractive to us. Recruit’s internet advertising business and employment business peers, Yahoo Japan (4689 JP) and Persol Holdings (2181 JP) are trading at FY2 EV/EBITDAs of 7.7x and 9.6x respectively.

2. Japan: 2018 Market Review – Bear Market Rally Ahead

2018 MARKET REVIEW – In this Insight, we shall review the performance of the Japanese stock market, during 2018 and look forward to the coming year. We shall look back at the year from a Sectors, Peer Group and Company perspective in separate Insights to follow next week.

BEAR MARKET RALLY AHEAD – From the January 23rd peak to the December 25th low, the All Market Composite declined 24.5% in Yen terms and 24.9% in US$ terms placing Japan in a bear market for the seventh time since the bursting of the 1989 stock market ‘bubble’. The average stock is now 35% below its one-year high compared with just 10% below at the beginning of the year. Total Market Value is still ¥123t above the low of 12th February 2016, and the question remains – are we replaying March 2008 or February 2016? In both cases, there were bear market rallies (25% and 17%) before the final downward leg – which entailed further declines of 50% and 13%, respectively. In our recent Insight on 21st December – Ticking the Bear Market Boxes – we commented that it was too early for contrarians to start ‘nibbling’. The 1,000 point Nikkei 225 (NKY INDEX) decline the next trading day, and the rebound into the year-end suggests that a case can now be made for, at least, a short-term rally. In the charts in the DETAIL below, we shall explore the case for (✓) and against (✕), and attempt to answer the question of the 2008 or 2016 reprise.

3. Last Week in Event SPACE: Harbin Electric, MYOB, TMB Bank, Halla Holdings

Last Week in Event SPACE …

• Just how will Harbin Electric Co Ltd H (1133 HK)‘s independent directors justify recommending an Offer to shareholders at a price which gave cash less cavalier than cash?
• MYOB Group Ltd (MYO AU)‘s directors grudgingly yet understandably enter an agreed deal with KKR.
• A TMB Bank PCL (TMB TB) / Thanachart Capital (TCAP TB) courtship is a possibility after an earlier Krung Thai Bank Pub (KTB TB) /TMB alliance failed. 

(This insight covers specific insights & comments involving Stubs, Pairs, Arbitrage, share Classification and Events – or SPACE – in the past week)

As previously discussed in Harbin Electric Expected To Be Privatised, Harbin Electric (HE) has now announced a privatisation Offer from parent and 60.41%-shareholder Harbin Electric Corporation (“HEC”) by way of a merger by absorption. The Offer price of $4.56/share, an 82.4% premium to last close, is bang in line with that paid by HEC in January this year for new domestic shares. The Offer price has been declared final. 

• Of note, the Offer price is a 37% discount to HE’s net cash of $7.27/share as at 30 June 2018. Should the privatisation be successful, this Offer will cost HEC ~HK$3.08bn, following which it can pocket the remaining net cash of $9.3bn PLUS the power generation equipment manufacturer business thrown in for free.
• On pricing, “fair” to me would be something like the distribution of net cash to zero then taking over the company on a PER with respect to peers. That is not happening. It will be difficult to see how independent directors (and the IFA) can justify recommending an Offer to shareholders at any price below the net cash/share, especially when the underlying business is profit-generating.
• Dissension rights are available, however, there is no administrative guidance on the substantive as well as procedural rules as to how the “fair price” will be determined under PRC and HK Law.
• Trading at a gross/annualised spread of 15%/28% assuming end-July completion, based on the average timeline for merger by absorption precedents. As HEC is only waiting for approval from independent H-shareholders suggests this transaction may complete earlier than precedents. 

(link to my insight: Harbin Electric: The Price Is Not Right)  

KKR and MYOB entered into Scheme Implementation Agreement (SIA) at $3.40/share, valuing MYOB, on a market cap basis, at A$2bn. MYOB’s board unanimously recommends shareholders to vote in favour of the Offer, in the absence of a superior proposal. The Offer price assumes no full-year dividend is paid.

• On balance, MYOB’s board has made the right decision to accept KKR’s reduced Offer. The argument that MYOB is a “known turnaround story” is challenged as cloud-based accounting software providers Xero Ltd (XRO AU)  and Intuit Inc (INTU US) grab market share. This is also reflected in MYOB’s forecast 7% revenue growth in FY18 and follows a 10% decline in first-half profit, despite a 61% jump in online subscribers.
• And there is justification for KKR’s lowering the Offer price: the ASX is down 10% since KKR’s initial tilt, the ASX technology index is off by ~14%, a basket of listed Aussie peers are down 17%, while Xero, the most comparable peer, is down ~20%. The Scheme Offer is at a ~27% premium to the estimated adjusted (for the ASX index) downside price of $2.68/share.

• Bain was okay selling at $3.15/share to KKR and will be fine selling its remaining ~6.5% stake at $3.40. Presumably, MYOB sounded out the other major shareholders such as Fidelity, Yarra Funds Management, Vanguard etc as to their read on the revised $3.40 offer, before agreeing to the SIA with KKR.

• If the markets avoid further declines, this deal will probably get up. If the markets rebound, the outcome is less assured. This Tuesday marks the beginning of a new year and a renewed mandate for investors to take risk, especially an agreed deal; but the current 5.3% annualised spread is tight.

(link to my insight: MYOB Caves And Agrees To KKR’s Reduced Offer)

TMB Bank PCL (TMB TB) (Mkt Cap: $1.2bn; Liquidity: $7mn)

The Ministry of Finance, the major shareholder of TMB, confirmed that both Krung Thai Bank Pub (KTB TB) and Thanachart Capital (TCAP TB) had engaged in merger talks with TMB. Considering an earlier KTB/TMB courtship failed, it is more likely, but by no means guaranteed, that the deal with Thanachart will happen. Bloomberg is also reporting that Thanachart and TMB want to do a deal before the next elections, which is less than two months away.

• TMB is much bigger than Thanachart and therefore it may boil down to whether TMB wants to be the target or acquirer. In Athaporn Arayasantiparb, CFA‘s view, a deal with Thanachart would leave TMB as the acquirer rather than the target. But Thanachart’s management has a better track record than TMB.
• Both banks have undergone extensive deals before this one: 1) TMB acquired DBS Thai Danu and IFCT; and 2) Thanachart engineered an acquisition of the much bigger, but struggling, SCIB.
• A merger between the two would still leave them smaller than Bank Of Ayudhya (BAY TB) and would not change the bank rankings; but it would give TMB a bigger presence in asset management, hire-purchase finance and a re-entry into the securities business.

(link to Athaporn’s insight: Sathorn Series M: TMB-Thanachart Courtship)  

Halla Holdings (060980 KS) / Mando Corp (204320 KS)

Mando accounts for 45% of Halla’s NAV, which is currently trading at a 50% discount. Sanghyun Park believes the recent narrowing in the discount may be due to the hype attached to Mando-Hella Elec, which he believes is overdone; and recommends a short Holdco and long Mando. Using Sanghyun’s figures, I see the discount to NAV at 51%, 2STD above the 12-month average of ~47%.

(link to Sanghyun’s insight: Halla Holdings Stub Trade: Downwardly Mean Reversion in Favor of Mando)  

• LG Chem Ltd (051910 KS)‘s 1P is now at a 44.20% discount to Common. The dividend will be the same as last year of ₩6,000 despite lower earnings. The dividend yield for Common will be 1.68%, and 3.03% for 1P or a dividend yield difference of 1.35%, a four-year high. (link to Sanghyun’s insight: LG Chem Share Class: Another Pref to Watch as Div Yield Gap at 4Y High)  

• Glow Energy Pcl (GLOW TB). In a strange twist to the tale, the ERC agrees to approve Global Power Synergy Company Ltd (GPSC TB)‘s takeover of Glow under a revised plan in which they have to: 1) sell Glow SPP1, a power plant with 124MW capacity and 90 tons/hr of steam; and 2) allow clients such as Pa Daeng to change providers. This will reduce Glow’s market share within the MapTaPhut area, but Athaporn Arayasantiparb, CFA thinks the purchase price (Bt139bn according to Bangkok Post) will have to be revised downwards too.  For more on the original deal, see Deal Alert! GPSC Goes For the Jugular! and Anti-Trust Should Be A Non-Issue In The GPSC/Glow Deal.

• Unisem (M) (UNI MK). The Offer is now unconditional and will remain open to acceptances until the 7 January 2019.
• Stanmore Coal (SMR AU). The offer has been extended until the 22 January 2019.

Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.   

4. Are US Stocks A Buy Yet?

• 5%-like rallies on Wall Street are signs of a bear market not a bull market
• Bull markets require strong liquidity and low risk appetite, neither yet apply
• Risk appetite readings at minus 12.6 are still above the minus 40 criterion for an upturn
• Recent large fall in risk appetite consistent with upcoming economic recession

5. Monthly Geopolitical Comment: Redrafting of Global Map of Political Alliances to Continue in 2019

In this briefing:

1. Japanese Banks:  These Lifeless Things (The Ozymandias Syndrome)
2. Jeans Mate Posts a Profit at Last
3. Global Semiconductor Sales Fall In November 2018. This Is Not A Good Sign.
4. THK (6481 JP): Downturn Discounted, Recovery Depends on New Orders
5. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?

1. Japanese Banks:  These Lifeless Things (The Ozymandias Syndrome)

Japanese bank stocks performed so poorly in 2018, with the Topix Bank Index falling 25.7% while the overall market declined by a lesser 16.4%, that some may be tempted to speculate that Japanese banks might be a key sector in leading a market recovery in 2019. We don’t think so. The fundamental outlook for banks’ profits remains clouded by a strengthening Yen against the US$, declining revenue growth, anaemic manufacturing sector loan demand, relentless downward pressure on net interest margins, weak fee business, rising valuation losses on both stocks and bonds, and ‘normalising’ credit costs. Simply put, there are no growth catalysts to drive the Japanese banking sector forward on a sustainable basis in terms of stock price appreciation. This all adds up to uninspiring valuations, even at current levels.  ‘Caveat emptor! (May the buyer beware!)’ remains our key recommendation to would-be investors in Japanese bank stocks for 2019.

2. Jeans Mate Posts a Profit at Last

While Rizap Group (2928 JP) has seen its share price crash and its CEO bow in apology after profit warnings and a plan to radically cut back on M&A, Jeans Mate Corp (7448 JP), which Rizap acquired last year, has quickly moved to modernise stores. It has just replaced its Shibuya store with a new concept called JEM that could mean the end of the Jeans Mate name altogether and posted its first operating profit in years. While many of Rizap’s acquisitions were dubious, Jeans Mate is one business that could be turned around into a modestly successful casual apparel retailer.

3. Global Semiconductor Sales Fall In November 2018. This Is Not A Good Sign.

The Semiconductor Industry Association (SIA) just announced that worldwide sales of semiconductors reached $41.4 billion for the month of November 2018, an increase of 9.8% YoY, but down 1.1% MoM, the first such decline since February 2018. While the decline is modest and total 2018 total semiconductor sales are on track to reach ~$470 billion for a YoY increase of 15.7%, any decline in what should be peak holiday season is not a good sign. 

Semiconductor sales historically track Wafer Fab Equipment (WFE) sales with a roughly six month time lag. North American WFE sales have been declining each month for the past six months meaning that this latest semiconductor MoM sales decline is right on schedule.  

Leveraging a decade’s worth of historical data, we analyse two key questions that are likely on every investors mind. Firstly,for how long should we expect semiconductor sales to continue their decline. Secondly, how steep should we expect that decline to be?    

4. THK (6481 JP): Downturn Discounted, Recovery Depends on New Orders

After dropping 60% from a high of ¥4,830 last February 27 to a 52-week low of ¥1,945 on December 26, THK closed at ¥2,062 on December 28, the last trading day of 2018.  

New orders peaked in the three months to Dec-17. The order backlog peaked in the three months to Mar-18, and so did the share price. Sales and operating profit peaked in the three months to Jun-18. Demand from the company’s top three user categories – electronics (semiconductor production equpment in particular), machine tools, and general industry – has been moving in parallel. By region, new orders from China have dropped most rapidly, followed by orders from Taiwan and Japan. 

After double-digit positive comparisons in the nine months to Sep-18, management is guiding for a 30% year-on-year decline in operating profit in 4Q of FY Dec-18. Judging from the orders trend and economic situation, substantial declines in sales and profits are likely in FY Dec-19. If demand from China picks up following a trade agreement with the U.S. sometime next year, there should be a moderate recovery going into FY Dec-20.

The shares are now selling at 7.7x management’s EPS guidance for FY Dec-18 and 0.9x book value at the end of Sep-18. Our forecast puts the shares on 11.9x earnings for FY Dec-19 and 10.4x earnings for FY Dec-20E. Valuations are at the bottom of their recent historical ranges. When orders recover, the stock price should, too.

5. Nintendo: Is the Hype Surrounding the Switch Slowly Dying Down?

Nintendo reported their 2QFY03/19 in October with results showing growth at both the top line and bottom line albeit not living up to consensus expectations. Top line grew by 4.0% YoY to JPY388.9bn in 1H03/19 while OP grew by 53.9% YoY to JPY61.4bn. OP in the last quarter (2QFY03/19) was the second highest the company has experienced over the last five years. This growth has been mainly driven by the sales of Nintendo Switch hardware which sold just over 5m units in 1HFY03/19. However, YoY growth remained at 3.4% compared to 4.9m units sold in 1HFY03/18. This has left investors worried about Nintendo’s aggressive target of selling 20m units of the Switch for FY03/19. Of this target, the company has managed to achieve only around 25.0% in 1H. Nintendo’s financial performance follows a seasonal trend with the December quarter showing stronger performance due to increased sales during Christmas. While the company’s current quarter is likely to show strong results, we remain skeptical about the company reaching the aforementioned target for FY03/19.

Switch Sales Have Caused an Improvement in Nintendo’s OP….

….Despite a Slowdown in the Growth of Units Sales

Nintendo’s Last Quarter Has Also Failed to Live Up To Consensus Expectations

In this briefing:

1. Japan Pharma – Top Picks (28 Dec 2018)
2. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI
3. GMO Internet (9447 JP) – Grossly or Modestly Overrated?
4. Autonomous Driving. Waymo Leading The Charge With Ten Million Miles Driven And Counting
5. 2019 Asia Selected Gaming Stock Outlook: Headwinds, Tailwinds and Our Top Picks for Entry Levels Now

1. Japan Pharma – Top Picks (28 Dec 2018)

                                                                                                                                                                                                                                                                        `                        

2. Okinawa Cellular (9436 JP): Warm Tropical Breezes with KDDI

As the colder winter weather is felt and the icy blast of industry tariff cuts continues to chill sentiment, we seek some respite (at least mentally) in the warmer climes of Okinawa. Okinawa Cellular is a unique company. It’s a small cap telecom network operator in Japan with a focus on the sub-tropical islands of Okinawa Prefecture. As part of the KDDI group, the company benefits from its parent’s economies of scale, but with its local presence, it also benefits from being the hometown hero. 

Because the stock is relatively small, from an investment perspective it runs into liquidity constraints that the other telcos do not have, so it’s a different type of investment but one that we think is worth looking at. Over the past 12 months Okinawa Cellular’s stock has fallen by 12.3%, but over the past year the stock has delivered a return in the middle of its peer group and has outperformed the broad TOPIX by about 5.5%. Like most telcos, Okinawa Cellular is also ramping its dividend payments, and the current yield is about 3.5%.

3. GMO Internet (9447 JP) – Grossly or Modestly Overrated?

Source: Japan Analytics

THE GMO INTERNET (9449 JP) STORY – GMO internet (GMO-i) has attracted much attention in the last eighteen months from an unusual trinity of value, activist and ‘cryptocurrency’ equity investors.

• VALUE– Many traditional, but mostly foreign, value investors have seen the persistent negative difference between GMO-i’s market capitalisation and the value of the company’s holdings in its eight listed consolidated subsidiaries as an opportunity to invest in GMO-i with a considerable ‘margin of safety’.
• ACTIVIST – Since July 2017, the activist investor, Oasis, has waged a so-far-unsuccessful campaign with the aim of improving GMO’s corporate governance, removing takeover defences, addressing a ‘secularly undervalued stock price we are not able to tolerate’ (sic), and redefining the role and influence of the company’s Chairman, President, Representative Director and largest shareholder, Masatoshi Kumagai.
• ‘CRYPTO!’ – In December 2017, GMO-i committed to spending more than ¥35b or 10% of non-current assets. The aim was threefold: to set up a bitcoin ‘mining’ headquarters in Switzerland (with the ‘mining’ operations being carried out at an undisclosed location in Scandinavia), to develop proprietary state-of-the-art 7nm-node ‘mining chips’, and, in due course, to sell GMO-branded and developed ‘mining’ machines. The move was hailed in the ‘crypto’ fraternity as GMO-i became the largest non-Chinese and the first well-established Internet conglomerate to make a major investment in ‘cryptocurrency’ infrastructure.

OUTSTANDING – Following the December 2017 announcement, trading volumes spiked into ‘Overtraded’ territory – as measured by our Volume Score. Many investors saw GMO-i shares as a safer way of gaining exposure to ‘cryptocurrencies’, even as the price of bitcoin began to subside. By early June 2018, GMO-i’s shares had reached a closing price of ¥3,020: up 157% from the low of the prior year and outperforming TOPIX by 135%. Whatever the primary driver of this outstanding performance, each of our trio of investor groups no doubt felt vindicated in their approach to the stock.

CRYPTO CLOSURE – On December 25th 2018, GMO-i’s shares reached a new 52-week low of ¥1,325, a decline of 56% from the June high. Year to date, GMO-i shares have now declined by 31%, underperforming TOPIX by nine percentage points. On the same day, GMO-i announced that the company would post an extraordinary ¥35.5b loss for the fourth quarter, incurring an impairment loss of ¥11.5b in relation to the closure of the Swiss ‘mining’ headquarters and a loss of ¥24b to cover the closure of the ‘mining chip’ and ‘mining machine’ development, manufacturing and sales businesses. GMO-i will continue to ‘mine’ bitcoin from its Tokyo headquarters and intends to relocate the ‘mining’ centre from Scandinavia to (sic) ‘a region that will allow us to secure cleaner and less expensive power supply, but we have not yet decided the details’. Unlisted subsidiary GMO Coin’s ‘cryptocurrency’ exchange will also continue to operate, and the previously-announced plans to launch a ¥-based ‘stablecoin’ in 2019 will proceed. In the two trading days following this announcement, the shares have recovered 13% to ¥1,505. 

RAIDING THE LISTCO PIGGY BANK – As we shall relate, this is the second time since listing that GMO-i has written off a significant new business venture which the company had commenced only a short time before. In both cases, the company was forced to sell stakes in its listed consolidated subsidiaries to offset the resulting losses. On this occasion, the sale of shares in GMO Financial (7177 JP) (GMO-F) on September 25 2018, and GMO Payment Gateway (3769 JP) (GMO-PG) on December 17 2018, raised a combined ¥55.6b and, after the deduction of the yet-to-be-determined tax on the realised gains, should more than offset the ‘crypto’ losses. According to CFO Yasuda, any surplus from this exercise will be used to pay down debt. Also discussed below and in keeping with this GMO-i ‘MO’, in 2015, the company twice sold shares in its listed subsidiaries to ‘smooth out’ less-than-desirable operating results.

4. Autonomous Driving. Waymo Leading The Charge With Ten Million Miles Driven And Counting

Waymo CEO John Krafcik made some bold decisions after taking the helm at Alphabet‘s self-driving project in September 2015. Chief among them was the fact that the company abandon its plans for Level 3 automated driving and focus exclusively on levels 4 & 5. Furthermore, he decreed that Waymo would no longer manufacture its own vehicles but would instead integrate their technology into those of other automakers. Three years later, those decisions would appear to be finally paying off.

On October 10 2018, Waymo reached a significant milestone having completed 10 million self-driving miles across 25 cities in the US. While their first million self-driving miles took 18 months to complete, Waymo now clocks up over a million self-driving miles per month.  The company also recently announced the launch of its robo taxi service in Phoenix, Arizona and looks set to quickly follow suit in California. Plans to extend its self-driving technology beyond robotaxis, most notably for trucks and last-mile transportation solutions are also in the works. Furthermore, the company has begun laying down a framework of innovative B2B revenue models which should help accelerate the speed with which they can eventually monetize their technology.

It hasn’t been smooth sailing all the way for Waymo however. Earlier this year, the company was derided for the driving style of its autonomous vehicles and faced the criticism that its driverless cars continue to have safety drivers. There was also an embarrassing incident where one of those very safety drivers caused the self-driving car he was monitoring to hit a motorcyclist when he attempted to take control of the vehicle. According to Waymo’s own analysis of the vehicle log files, the accident would not have happened had he not intervened. 

With ten million self-driving miles under their belt and a thoughtful, strategic approach to monetizing their technology beginning to emerge, Waymo remains firmly ahead of their peers in leading the autonomous driving charge.  

5. 2019 Asia Selected Gaming Stock Outlook: Headwinds, Tailwinds and Our Top Picks for Entry Levels Now

Our review of ten Asian gaming companies forward prospects for 2019 yielded our top five picks. Two of those comprise this insight. Three more will follow in Part Two. There is, in our opinion, some disconnect between continuing macro headwinds in both the VIP and mass sectors and a more bullish tone based on a recent upside trend in Macau, strong results in the Philippines and Cambodia. Given the battering of the market in general, the already 8 month old bearish tone to the sector and the current pricing of the two stocks noted here, we see significant upside opportunity as we near the beginning of 2019.

In this briefing:

1. SoftBank Corp (9434 JP) & Arteria Networks (4423 JP): A Tale of Two IPOs
2. Are US Stocks Still Expensive?

1. SoftBank Corp (9434 JP) & Arteria Networks (4423 JP): A Tale of Two IPOs

During the second half of December 2018, Japan saw two telecom companies list on the Tokyo Stock Exchange: Softbank Corp (9434 JP) and ARTERIA Networks (4423 JP). After years of industry consolidation, which saw several stocks delist, this felt like a Christmas miracle (at least for those watching the sector’s stocks).

It would be hard to find two companies in the same industry that are so different – both in their business models as well as in how their IPOs were positioned to investors. One stock is 100 times larger than the other, but this is not a story of David and Goliath. It is two unique stories in parallel. 

While each company took a very different approach to selling its stock, both have suffered from the subsequent broader market weakness, irrespective of company specifics. We can’t say it has been the worst of times, but it certainly has been a tough time with SoftBank Corp down 13% and Arteria down 20% from their IPO prices.

In this Insight we explore how each company approached its IPO and how each has fared since. 

2. Are US Stocks Still Expensive?

There are striking parallels between 1929 and 2018.  

The 1929 crash put a halt to a nine-year bull run on the market.

Up until October 1929, same as this year, market consensus was that asset prices could only go up from their current level.

As we mentioned in When the Tide Goes Out, Dominoes Fall, a decade of building up excesses meant a painful burst, back 79 years ago: between October of 1929 and September of 1932, eighty-nine percent of the value of stocks was erased and the market didn’t recover to its former peak until 25 years later.

Are we in a similar situation right now?