Thinking Points

  • i-Mobile (TSE: 6535) operates an internet advertising platform and a growing local government tax donation website (which is largely dependent on a government tax program).
  • While the core internet advertising business faces headwinds, the local government tax donation website doubled revenues and tripled operating income in the past year.
  • Outstanding shares increased 13.6% in August 2018 when two directors exercised stock options, with considerable unexercised options remaining.
  • Though there is no clear catalyst for a positive shift in investor sentiment, patient investors can expect an investment CAGR of between 7.8% and 11.7% over the next three years, purchasing at the current share price of 725 yen.

Introduction

i-Mobile (TSE: 6535) is primarily an internet advertising platform operator. Secondarily, the company has a consumer segment, which includes a growing local government tax/donation website called “Furunavi”, restaurant promotion, staffing, and entertainment businesses. The company started segment reporting in Q2 of fiscal 2018.

Key services offered are:

Source: i-Mobile 2018 earnings presentation, translation by author

 

Founded in 2007, the company can still be considered a late stage startup. It’s also relatively new to the public equity markets, making its IPO on October 27, 2016 to the Mothers section of the Tokyo Stock Exchange. The company has since transferred over to Section 1 as of May 2018.

 

The business

Internet Advertising

i-Mobile’s internet advertising network, on the company website, is listed as one of Japan’s largest. According to the Advertising Expenditure Report, published by Dentsu (TSE: 4324), internet advertising expenditures for 2017 amounted to 1,509.4 billion yen ($13.4 billion USD), or 23.6% of total advertising expenditures in Japan for 2017. In comparison, i-Mobile’s internet advertising related revenues came in at 15,846 million yen ($140 million USD) for fiscal 2018. This equates to about a 1% share in internet advertising in Japan. The industry appears fragmented and highly competitive, with a long list of big players.

The company offers various internet advertising services from the standard targeted and video advertisements to affiliate marketing, smartphone app engagement, digital signage and more.

Source: i-Mobile website

 

For fiscal 2018, the segment recorded 15,846 yen ($140 million USD) in revenues and 1,395 million yen ($12.3 million USD) in operating income, or a year-over-year change of +6% and -34.5%, respectively.

 

Consumer

The Consumer segment is mainly driven by the local government tax donation website “Furunavi”. Additionally, there are about a half a dozen other services within this segment. The most notable thing about this segment is that revenues doubled and operating income tripled in the last year.

So a little bit about how local government tax donation works in Japan.

In 2008, the Japanese government introduced the hometown tax donation system. Originally, the idea was to help local governments by providing tax deductions to individuals donating money to their hometown governments. Soon after, local governments started offering gifts in return for donations.

Now, it took a while before this hometown tax donation system gained traction, but it exploded over the past few years:

Source: Ministry of Internal Affairs and Communications (Japanese), chart created by author

 

Specifics aside, the way this works is that an individual donates money to local government(s) of the individual’s choice. Subtract 2,000 yen ($18 USD) from the total amount donated in a year and that’s the amount of tax deduction the individual or household gets from residential tax (paid to municipality of residence) and income tax (paid to national government). And now, the local governments send gifts in return for the donations.

The gifts are now seen as a problem. According to a September 2018 Nikkei article (Japanese), 1,156 of the 1,718 local governments had given away gifts which amounted to more than 30% of donations in 2016. During the spring of 2017, the Ministry of Foreign Affairs and Communications sent out a letter telling the local governments to keep gifts under 30% of donation amounts and to only give away local goods. Then again, a similar letter was sent out in the spring of 2018. Still, 246 local governments are above the 30% threshold and 190 local governments were giving away non-local products.

Going back to Furunavi.

Furunavi is one of six major websites that facilitates the donation-gift exchange between local governments and individuals. The other five are:

  • Furusato Choice (Trustbank, private)
  • Satofuru (Softbank Group [TSE: 9984])
  • Rakuten Furusato Nouzei (Rakuten Group [TSE: 4755])
  • Furupo (JTB Corp, private)
  • ANA no Furusato Nouzei (ANA Group [TSE: 9202])

 

Here are some of the popular gifts on Furunavi’s website:

Source: Furunavi

 

The key concern, from a business operations perspective, is that the entire business of Furunavi is dependent on a tax program. Moreover, the national government sees the current state of excessive gift giving by local governments as a problem, and are working towards rectifying the program for 2019. There is no mention of this in i-Mobile’s 2018 earnings presentation.

For fiscal 2018, the segment recorded 2,412 million yen ($21.3 million USD) in revenues and 681 million yen ($6 million USD) in operating income, or a year-over-year change of +120.8% and +204.9%, respectively.

 

Overall

For fiscal 2018, i-Mobile recorded a total of 17,981 million yen ($159 million USD) in revenues and 2,119 million yen ($18.8 million USD) in operating income, or a change of +14.6% and -10.2%, respectively. The company beat revenue target by 2.4% and missed operating income target by 11.8%.

For fiscal 2019, management is guiding for 19,073 million yen ($169 million USD) in revenues and 1,802 million yen ($16 million USD) in operating income, or a projected change of +6.1% and -14.9%, respectively.

Management didn’t give out segment-specific guidance, however, judging by the 3 slides spent on consumer segment vs. 1 on internet advertising in the fiscal 2018 earnings presentation, it’s clear that there is a heavier focus on the consumer segment.

The main concern for i-Mobile is the focus on consumer segment, particularly Furunavi, paired together with declining operating performance for the internet advertising segment.

 

Shareholders

The first thing to note about i-Mobile shares is that it is complicated. After the IPO in October 2016, the company has bought back shares, issued new shares, issued stock options, and made a section transfer from the Mothers section to Section 1 of the Tokyo Exchange.

Interestingly, in a Toyo Keizai article published one day after IPO (Japanese), the CEO mentioned using the roughly 5 billion yen ($44 million USD) raised to pursue M&A deals. So far, the company has done two acquisitions (TAGGY [76.1%], Netch [46.2%]) and one capital alliance (Looop [4.14%]), using about 1,335 million yen ($11.8 million USD) in the process.

** Looop disclosure didn’t actually disclose any operating business info other than sales.

Note – TAGGY was operating at a loss, with falling revenues (halved in one year)

 

It’s not immediately obvious whether these deals were value accretive or not. TAGGY was quickly dwindling while Netch was quickly growing. As for Looop, there simply isn’t any useful information available.

Without getting caught up in the details, the focal point for share ownership should be on the topic of stock options. As of fiscal 2018 short form financials (unaudited, July 31, 2018 year end), total issued & outstanding shares stood at 21,174,800 shares. According to the filing, exercisable options amounted to 3,344,560 shares, or 15.8% of outstanding shares.

Now, i-Mobile issued stock options on three different occasions: August 2008, July 2015, and December 2015. The first round was for 5,400,000 shares (split adjusted) and offered to two people: Tetsuya Noguchi (CEO) and Toshihiko Tanaka (Chairman). Prior to the October IPO, on January 1, 2016, Tetsuya cancelled 1,230,000 shares and Toshihiko cancelled 1,290,000 shares (total of 2,520,000 shares). This left Tetsuya with 1,410,000 and Toshihiko with 1,470,000 exercisable options (total of 2,880,000 shares). The shares were exercisable at a split adjusted 4 yen per share. The exercise period end was on August 10, 2018. The only requirement for both people to keep the options is to remain employed with i-Mobile/affiliate, retire, or have more than half the board accept the retention of options.

On August 6, 2018, both Tetsuya and Toshihiko exercised the options.

Here is the history of buying and selling for Tetsuya and Toshihiko:

Source: EDINET filings compiled by author

 

This leaves us with 24,054,800 issued shares. Since i-mobile cancelled bought back shares in February 2018 (and hasn’t repurcahsed any since), Tetsuya and Toshihiko own 68.8% of outstanding shares.

One thing worth noting here is that, besides the IPO transaction, all selling was done off market. And off market transactions are fairly common for Mothers listed companies planning to transfer to Section 1. Normally, this is done to meet the Section 1 shareholder count requirement of 2,200. With that said, i-Mobile already had 7,000+ shareholders as of fiscal year end 2017.

The next two rounds of stock options were given to directors, employees, and others. The long form financials (Yuho) filed in 2016 showed the following information:

Source: Fiscal 2016 filings

 

This was updated to the following in the 2017 long form financials:

Source: Fiscal 2017 filings

 

Also, IPO date is October 27, 2016. One-third of both options can be exercised after a year has passed, another third after two years, and the last third after 3 years. All options must be exercised by July 31, 2024.

The fiscal 2018 filings aren’t released yet as of this writing (October 12, 2018). The unaudited short form financials shows 3,344,560 of unexercised options. Subtract the 2,880,000 shares exercised and we’re looking at 464,560 shares unexercised (which seems off). The long form financials should tell us more in a few weeks. For the time being, it’s best to perform valuation work assuming there will be at least 25,000,000 shares issued at some point in the near future.

 

Financials & valuation

Several things to note when thinking about i-mobile financials and valuation:

  • Internet advertising business highly lucrative, but also in highly competitive environment. Recently declining operating performance (~35% YoY decline).
  • Consumer business highly lucrative, lead by Furunavi and growing explosively. Dependent on the existence of a government tax program, which is in question.
  • Effectively debt free balance sheet, net cash of 8,363 million yen ($74 million USD), or net cash per share of 334.5 yen.
  • Best to assume 25,000,000 issued shares, but keep in mind 1,128 yen per share exercise price for 251,300 shares (current share price is 725 yen).
  • Adjusted EV/EBIT at 3.2x. Management expecting lower operating performance for fiscal 2019. No clear catalyst in sight for a positive shift in investor sentiment.

Although it’s clear that management views the Consumer business (Furunavi in particular) as a key growth area, the business is near worthless if the government’s home tax donation program is discontinued. While it’s unlikely the program will be discontinued, it will most certainly be modified. Hence, it’s best to look at the internet advertising business as a going concern and the consumer business as icing on the cake.

Internet Advertising operating income can realistically come in anywhere in between 1,200 million yen ($10.6 million USD) and 2,400 million yen ($21.2 million USD). Consumer operating income is a wild guess, but we can assume between at 100 million yen ($1.8 million USD) and 1,000 million yen ($18 million USD). This was 680 million yen ($6 million USD) for fiscal 2018.

For a conservative estimate, we can use the low end of the assumptions for an operating income of 1,300 million yen ($11.5 million USD). Adjust for about 50 million yen of inter-segment operating income and we’re looking at 1,250 million yen ($440K USD) of operating income. That’s an EV/EBIT of 5.5x with current prices.

For an optimistic estimate, we can use the high end of assumptions. Operating income sums up to 3,400 million yen ($30.1 million USD). Adjust out 150 million yen ($1.3 million USD) for inter-segment operating income and we’re looking at 3,250 million yen ($28.8 million USD) in total operating income. That’s an EV/EBIT of 2.1x with current prices.

For a more realistic estimate, we can extrapolate recent performance for Internet Advertising (~1,400 million yen) and take a low figure for the Consumer business (~200 million yen). Adjusted for inter-segment operating income of 70 million yen ($620K USD) or so, we’re looking at 1,530 million yen ($13.5 million USD) in operating income. That’s an EV/EBIT of 4.5 with current prices.

Now, there are several listed companies engaged in internet advertising that are similar to i-Mobile in size:

Notes: i-Mobile EV/EBIT is adjusted for 25,000,000 issued shares and counting investment assets as cash equivalent. EV/EBIT for other companies are unadjusted.

 

From a relative valuation perspective, i-Mobile is discounted considerably even if the Consumer business is worth nothing. Taking the conservative estimate from above and assigning a 9.1 EV/EBIT would give us a share price of 908 yen (assuming 25,000,000 outstanding shares), which is 25.2% above the current share price of 725 yen. With the realistic estimate, we’re looking at a share price of 1,010 yen, or 39% above the current share price.

There is no clear catalyst in sight for a positive shift in investor sentiment. i-Mobile is only suitable for investors willing to accept volatility, both from business performance and market price perspectives. With that in mind, investors can expect to gain an investment CAGR of between 7.8% and 11.7% over the next three years.

 

The bottom line

i-Mobile’s core business is in a highly competitive internet advertising industry. While operating performance has deteriorated in internet advertising, its consumer business segment has grown explosively. With that said, the consumer business segment is largely dependent on a government tax program. Combine this with a large number of stock options recently exercised by two directors and there isn’t a whole lot to be excited about. Still, patient investors can expect to gain an investment CAGR of between 7.8% and 11.7% over the next three years.

 

Author: Kenkyo Investing

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