Brief Japan: Nexon Valuation Analysis and more

In this briefing:

1. Nexon Valuation Analysis
2. Topcon (7732 JP): Weak 3Q, Likely to Fall Short of FY Mar-19 Guidance

1. Nexon Valuation Analysis

In this report, we provide a valuation analysis of Nexon Co Ltd (3659 JP). A key question is “How much are investors willing to pay for Nexon which would drive higher EV/EBIT multiples and inversely reduce the earnings yield (measured by EBIT/EV)?” 

In our view, we believe that investors would be comfortable with earnings yield (measured by EBIT/EV) of about 7-9% given the risks of operating a global game franchise such as Nexon. This would suggest EV/EBIT of about 11x to 14x, using 2019 estimates. Our sensitivity analysis suggests that at the top end of the EV/EBIT valuation range of 14x, this would imply market cap of 1,905 billion yen, which would be 21% higher than current market cap. As such, despite Nexon’s share price rising 25% YTD, we think there could be further upside in the months ahead. 

Having digested plethora of public information on this deal (but not privy to all the bankers’ discussions) in the past several days, we believe that the US based companies including Amazon and Comcast are better positioned to acquire NXC Corp/Nexon, rather than the consortium led by Tencent. 

We believe there is an intense Chinese government pressure on Tencent to not do this deal. (This is just our guess based on public information). The game industry is not strategically important to China, unlike other industries such as semiconductors, energy, or financial. Depending on how much controlling stake Tencent wants to take, it is likely to involve several billions of dollars ($4 billion to $7 billion for Tencent, for example). This is a lot of money. Plus, China Inc’s balance sheet is not as strong as pre-GFC of 2008. Forking over $4 to $7 billion out of China into Japan/Korea would be meaningful. In short, although Tencent would like to do this deal, we think that behind the scenes, the Chinese government appears to be putting intense pressure on Tencent to not do this deal. 

2. Topcon (7732 JP): Weak 3Q, Likely to Fall Short of FY Mar-19 Guidance

Topcon’s FY Mar-19 guidance looks over-optimistic. Operating profit was up 8.5% year-on-year on a 1.4% increase in sales in the nine months to December, but down 10.1% on a 2.3% decrease in sales in 3Q. To make management’s full-year targets, it would have to increase by 41.0% on a 6.8% increase in sales in 4Q. The sales of all three major product segments – Smart Infrastructure, Positioning and Eye Care – have been slow. Intra-company eliminations have undercut segment profits.

At ¥1,561 (Friday, March 1, close), the shares are selling at 23.6x our EPS estimate for this fiscal year and 9.8x projected EV/EBITDA. These multiples compare with 5-year historical lows of 16.1x and 6.8x. Japan Analytics’ calculation of Annual No-Growth Valuation shows further downside risk (see chart below).