Thinking Points

  • Septeni Holdings (TSE: 4293) is one of the largest internet advertising agencies in Japan. Additionally, the company has a growing but still unprofitable Media business focused around a smartphone Manga (Japanese comics) app.
  • The company is led by CEO Koki Sato, a young and assertive manager well known in the Japanese IT startup community. He started the Internet Advertising operations 18 years ago, when Septeni had 20 employees. Today, the company employs nearly 1,500 employees.
  • With a share price of 163 yen (October 19, 2018 closing), investors can expect to gain a five year investment CAGR of between -0.5% and 20%, with the most likely case being 11.2%.

Septeni Holdings (TSE: 4293) is a large and established internet advertising agency. In addition to internet advertising, the company has a growing (but still unprofitable) Media business focused on Manga (Japanese comics) smartphone app with original content.

Fiscal 2017 segment revenues are broken down as follows:

Source: Company filings

 

What’s most interesting about the company is its growth story. CEO Koki Sato is a celebrity of sorts among the IT startup community, known for building Septeni into an internet advertising powerhouse from nothing over the last 18 years.

 

The business

Overview

Septeni got its start as a human resources consulting company in 1990. Shortly after in 1993, the company expanded into direct mail marketing. In fact, CEO Koki Sato only discovered Septeni (then called Sub And Liminal) after receiving a piece of mail that read “transportation expenses provided”. It was a solicitation for students to attend Septeni’s company introduction event, a common first step in recruitment. And Koki attended for the transportation allowance.

After starting with Septeni in 1997, Koki spent his time working for the weekend. At the time, Septeni was a 20 person company that came with the exciting new business venture environment. Still, playing music was Koki’s higher priority at the time. Over the course of two years, however, he started getting his creative juices flowing through business instead of music.

In 2000, Koki sat down with the then CEO Mamoru Nanamura (now chairman, and and asked for permission to start a new business. The CEO told him to go ahead, and that was the birth of Septeni’s internet advertising business. Today, internet advertising is Septeni’s core operation, and the Media business is Koki’s new venture.

 

Internet Advertising

Internet Advertising is Septeni’s bread and butter, which accounted for 92% of fiscal 2017 revenues. Led by Koki, Septeni is recognized as one of the pioneers in Japanese internet advertising. The company started off with PC-based internet advertising, then like many others, made the shift to mobile. More recently, the company has grown its video advertising business, which now accounts for almost 20% of Internet Advertising segment billing volume.

Source: Fiscal 2018 Q3 earnings presentation

 

In addition to video advertising, Septeni is focused on business expansion outside of Japan. In fact, Septeni is one of the 179 Tokyo Stock Exchange listed companies that has adopted IFRS accounting. As a reference, the exchange has 3,640 listed companies as of October 19, 2018, most using Japanese GAAP.

The company switched from JGAAP to IFRS in fiscal 2016, noting that it intends to continue business expansion globally, and decided to adopt the global standard IFRS accounting rules. If you take a look at the financials, it looks like Septeni revenues took a nosedive after the switch. However, this is due to a change in revenue recognition in the Internet Advertising segment. Here’s a revenue chart that better compares recent revenues with historical revenues:

Source: Company filings, fiscal 2015/2016/2017 revenues above aren’t IFRS, but provided for reference by Septeni management in filings.

 

Back to global business expansion. The way Septeni defines foreign revenues is: foreign clients advertising in Japan and foreign clients advertising in foreign countries. Outside of Japan, Septeni has offices in China, Korea, Taiwan, Hong Kong, Vietnam, Singapore, Malaysia, Indonesia, and the US. Currently, foreign revenues accounts for ~15% of total revenues. More recently, the company announced its acquisition plans for eMFORCE (Korea based digital marketing agency) from competitor Opto Holdings (TSE: 2389). The acquisition was set to take place on October 1st, 2018, but was later rescheduled to October 31st, 2018. Acquisition price is estimated between 1.5 to 1.9 billion yen ($13.4 – $16.9 million USD). Management projects foreign revenues will account for 25 to 30% post acquisition.

Here are a few basic metrics on eMFORCE:

Source: Press release (in Japanese), table created by author. Conversion used: 1 KRW to 0.00088 USD.

 

Recent revenue growth and operating performance has lagged. Management attributes this to several major projects not contributing as much as expected and several clients facing industry-wide advertising restrictions. As for operating performance, the company increased wages for its employees in fiscal 2017 and hired 125 new employees in April 2018. Total employee count is 1,497 people as of June 2018, 1,215 of which are full time employees. Additionally, Septeni implemented flex time schedules, remote work, and now allows employees to engage in side businesses (not yet common in Japan).

 

Media

The Media business mainly consists of Ganma, Septeni’s smartphone app for reading manga (Japanese comics). The Ganma business was setup in 2013. Though it hasn’t turned a profit, the app boasts just over a million users as of February 2017, according to Nielsen Digital (Japanese). From fiscal 2016 to 2017, the segment has nearly doubled its revenues and its operating losses. Fiscal 2017 revenues came in at 1,163 million yen ($10.4 million USD) and operating losses at 1,420 million yen ($12.6 million USD).

Source: Ganma website (operated by Septeni subsidiary)

 

The app is in a highly competitive environment. In order of user scale, companies like Line (TSE: 3938), NHN Entertainment (KRX: 181710, related to Line Corp) subsidiary NHN Japan, Shogakukan (private, major publisher), DeNA (TSE: 2432), and Shueisha (private, major publisher, related to Shogakukan) all offer competing apps:

Source: Nielsen Digital (in Japanese), company affiliations added by author.

 

Interestingly, at a September 2017 event in Tokyo, Ryota Yasue (chief editor of DeNA’s Mangabox) described Mangabox’s road to profitability in 5 steps:

  1. Ice age: Forget about monetization.
    1. Start posting content and attract readers.
  2. Caveman: Basic monetization.
    1. Make book available for sale for manga readers. (Mangas are released in short chapters, often on a weekly basis, and readers can read the book if they want to get ahead).
    2. Allow readers to gain access to manga chapters a week in advance if they shared it on social media.
  3. Civil War: Advertising.
    1. Created own ad platform. Tied up with video game and books to advertise inside manga series.
  4. Modernization: Revisiting monetization strategy.
    1. Started selling books in online store, even for those that weren’t made into manga.
  5. Today: Multimedia expansion.
    1. Making manga series into anime series. Development of IP in other media.

 

Mangabox started in 2013, the same year as Ganma, and the user scale is at similar levels. Mangabox hit 10 million downloads in 2016 while Ganma hit that mark in mid 2018. Ganma is starting to move toward multimedia expansion, with several mangas made available on Kindle and a couple made into anime. The company is largely focused on self-created content (through individual artists) and protecting/developing intellectual property (IP).

What’s more encouraging is that 9 out of 30 top non-game app earnings in Japan for 2017 were manga apps:

Source: AppAnnie (Japanese), highlights added by author.

 

Management hasn’t commented about when they think Ganma would reach profitability.

 

Overall

Besides the near term revenue decline in Internet Advertising and profitability for Ganma, many of the factors that affected operating performance, particularly from a cost perspective for Internet Advertising, seem self directed (i.e., increasing pay of employees, hiring). In the fiscal 2018 Q3 presentation, management lowered full year guidance:

Source: Q3 2018 earnings presentation (Japanese), table created by author.

 

Shareholders

As of June 30, 2018, Septeni had 138,856,500 issued shares, 12,463,355 of which were in treasury. This puts outstanding shares at 126,393,145 shares.

Here are the major shareholders as of March 31, 2018:

Source: Q2 2018 filing

 

Village seven Co, Ltd (Japanese) is the chairman/founder Mamoru Nanamura’s family fund. In case you’re wondering why the company is called Village seven, “Nana” means seven and “mura” means village in Japanese, hence Village seven. Mamoru sold 100,000 shares on February 14, 2018 for 420 yen per share and 500,000 shares on February 15, 2018 for 408 yen per share.

CEO Koki Sato owns 402,500 shares, or 0.32% of outstanding shares, according to fiscal 2017 filings.

Henderson Global Investors also submitted a filing disclosing ownership of 7,009,000 shares (5.05% of issued shares) on April 5, 2018.  

Septeni has issued stock options on more than a few occasions. The fiscal 2017 filing shows the following unexercised options:

Source: 2017 filing, translation by author

Financials & valuation

Key points to keep in mind when looking at Septeni financials and valuation are:

  • Koki (CEO) is an assertive business manager with a proven track record in ventures.
  • The Ganma business is still in an early startup phase and content IP is building.
  • If DeNA’s Mangabox is any indication, the Ganma model is moving in the right direction.
  • A healthy Internet Advertising business is necessary to support continued investment in Ganma and overseas expansion.
  • Recent underperformance in Internet Advertising appears self-directed. Best to look at Internet Advertising as an established business and Media as a binary bet.

Septeni carries no debt, but much of its liabilities are in the form of accounts payable, putting equity-to-asset ratio at 0.49. Not the typical Japanese cash heavy balance sheet. The company has more or less maintained this level of balance sheet health over the past decade. Dividend payout ratio has remained between 15~30% over the last 8 years. The company bought back a considerable amount of shares in fiscal 2017. Of the 3,539,200 shares repurchased, 1,739,200 shares were for the Board Incentive Plan. Price paid was 341 yen per share combined for a total cost of 1,206 million yen ($10.7 million USD). Besides that, there hasn’t been a material repurchase.

Even with guidance adjusted down, Septeni is expecting a non-GAAP operating income of 3,898 million yen ($34.7 million USD) for the Internet Advertising segment. With a significant increase in Septeni’s employee count in April 2018, it wouldn’t be surprising to see an increase in revenues for fiscal 2019 when the new employees start contributing to business performance meaningfully. Assuming operating income at 3,600 million yen ($32 million USD) or so is likely conservative. 4,200 million yen ($37.4 million USD) is about normal, and 5,000 million yen ($44.5 million USD) is optimistic.

The real question surrounds Ganma. In the fiscal 2017 presentation Q&A, Koki was blunt about not knowing when exactly Ganma would reach a breakeven point. So long as the Internet Advertising business is healthy, it’s safe to assume Septeni will continue investing in Ganma. For valuation purposes, however, it’s best to layout several scenarios and see how Ganma would affect Septeni business performance. While an oversimplification, a bad case would be continued ~1,000 million yen ($8.9 million USD) level of operating losses indefinitely. Reasonable case would be breakeven, and good case would be, say ~1,000 million yen ($8.9 million USD) of operating income in 5 years (fiscal 2023).

Corporate adjustments at ~2,000 million yen ($17.8 million USD) per year and we’re looking at worst case operating income level of 600 million yen ($5.3 million USD), reasonable case at 2,200 million yen ($19.6 million USD), and best case at 4,000 million yen ($35.6 million USD) at the end of fiscal 2023.

With share price of 163 yen (October 19, 2018 closing price) as cost basis, investors can expect a five year investment CAGR of anywhere between -0.5% (worst) and 20% (best), with the most likely case being 11.2%. This assumes all current unexercised stock options are exercised and EV/EBIT at 8x.

 

The bottom line

Septeni went from being a 20 person direct mail company to one of Japan’s leading internet advertising powerhouses with nearly 1,500 employees in less than two decades. Now Koki, who started Septeni’s internet advertising business, is leading the company into global expansion of its internet advertising business and its new manga app venture. Investors looking for exposure to Japanese startups should consider investing in Septeni. Over a five year investment period, investors can expect to make between -0.5% and 20% investment CAGR, with the most likely case being 11.2%


Kenkyo Investing
Kenkyo Investing

Kenkyo Investing applies a value investing approach to Japanese equities, providing insights that are often unavailable to non-Japanese speakers.