Thinking Points

  • Charle (TSE: 9885) sells women’s clothing, health supplements, and cosmetics through its online store and network of sellers.
  • Key characteristics of the company include: declining sales over a decade, poor governance, questionable operating model, net cash per share of 614 yen, and NCAV per share of 861 yen (vs. current share price of 472 yen).
  • The company is best considered as a small part of a net net basket approach. Investors can potentially gain a five year investment CAGR of 7.9% (~690 yen per share), but need to be aware that the company hasn’t traded at this level since 2008, when the founding family attempted an MBO (which failed).

Introduction

Charle (TSE: 9885) sells women’s clothing (mainly undergarments), health supplements, and cosmetics through its online store and network of sellers. Charle calls its sellers “Mates”. And similar to Tupperware parties, mates organize fitting parties where women get to test the products before purchasing.

Source: Charle filings

 

The little bit of English coverage on Charle revolves around it being a net net stock (here and here). Meanwhile in Japan, internet discussions mainly revolve around the failed MBO by the founding family in 2008 and whether Charle’s sales program is a scam (it’s not).

For fiscal 2018, revenues came in at 17,510 million yen ($156 million USD) and operating income at 537 million yen ($4.8 million USD). Revenues have been on a decline for over a decade while operating income has fluctuated wildly between 1,549 million yen ($13.8 million USD) in fiscal 2009 to 537 million yen ($4.8 million USD) in fiscal 2018.

Source: Charle

 

The business

Aside from its online store, Charle’s sales force is organized as a multi level marketing scheme similar to Amway. There are three business membership tiers, from highest to lowest ranking:

  • Agency (代理店)
  • Distributor (特約店)
  • Business Mate (ビジネスメイト)

The chart below describes the sales model for Charle well:

Source: Charle (in Japanese), translation by author

 

If an end customer is purchasing product for 1,000 yen ($8.92 USD), then the Agency is purchasing the same product for 500 yen ($4.46 USD), the Distributor for 600 yen ($5.35 USD), and the Business Mate for 750 yen ($6.69). The Agency purchases product from Charle and sells to every membership tier below. Distributor purchases from Agency and sells to Business Mates, Mates, and Normal Customers. And so on and so forth.

In addition to the discounted purchase prices, Agencies and Distributors have different incentive plans based on monthly total purchasing, Business Mate signups, etc. Here is how business membership has fared over the last few years:

Source: Charle (in Japanese), translation by author

 

One thing to point out here is that a purchase of more than 10,800 yen ($96 USD) automatically qualifies customers to become a Mate and purchase products at a 25% discount. There are no membership fees. This makes the Mate figures irrelevant.

Sales from Charle’s online store, which was started in 2009, is directly fulfilled by Charle. This means revenue by sales channel (Agency or Online store) is an important performance indicator. Unfortunately, the company does not breakdown revenue by sales channel.

That said, gross margins came in at 46% for fiscal 2009 (when online store started) and 48% for fiscal 2018. Judging by the business membership structure, gross margins ought to be considerably higher for product sales coming through the online store. Unless gross margins for sales to Agencies are in a free fall and the Online store sales has made up for it, it’s probably safe to say the Online Store hasn’t meaningfully contributed to revenues.

Although Charle is a single segment company, it started reporting revenues by product type in fiscal 2015:

Source: Filings

 

Health Supplements is the only product type to improve performance in recent years. There was an interesting comment in the annual long form filing for 2018 which highlighted that the company’s subscription package (launched in February 2017) saw a rise in subscribers and contributed to increased sales.

Operating income came it at 537 million yen ($4.8 million USD), the lowest level in over a decade, for fiscal 2018. For fiscal 2019, management is guiding for even lower at 100 million yen ($890K USD). The company originally targeted 19,400 million yen ($173 million USD) in revenues and 5% operating margins (970 million yen, or $8.7 million USD) for fiscal 2020 in the mid term plan, but is reviewing the plan since business performance has continued to decline.

 

Shareholders

At the end of fiscal 2018 (March 2018), Charle had 16,086,250 issued shares and 250,101 treasury shares. Here are the top 10 shareholders as of fiscal year end 2018 (March 2018):

Source: Company filings

 

According to EDINET filings (here and here, both in Japanese), G&L Corp and Lam’s Corp are both Hayashi family funds. Going back to 2008, in the disclosures for the failed MBO attempt, Itsuha Sezaki is included in the founding family members. Collectively, the Hayashi family owns at least 47.7% of outstanding shares. The “at least” phrase is important here, as companies only list their top 10 shareholders in the annual filings. Tatsuzo Hayashi had a 476,000 share stake at fiscal 2017 year end, but no longer appears on the top 10 shareholder list. He could very well still own a material ~1.64% stake in the company (along with other family members) for a collective controlling stake.

G&L Corp sold off 2.53 million shares in late 2016 at 508 yen per share, which was purchased by Charle. Several family members increased and decreased their stakes over the last few years, but there have been no other material transactions.

There are some governance concerns with Charle. Two main concerns in history are:

  • Retirement benefits amounting to 895 million yen ($8 million USD) for Hiroko Hayashi (co-founder along with husband Masaharu Hayashi) paid in fiscal 2007, resulting in a net loss for the year (and a shareholder-led lawsuit later on).
  • Conflict of interest in 2008 MBO attempt. Then CEO Katsuya Hayashi (eldest son of Hiroko and Masaharu) worked against shareholder interest to adjust down tender price.

While there are no Hayashi family members listed on the board of directors, key influencers from the past (namely Masaharu, Hiroko, and Katsuya) are still major shareholders.

 

Financials & Valuation

Several key points to note in thinking about Charle financials and valuation:

  • Frowned upon historical operating model (MLM sales) with signs of shift to direct sales (online store) and expansion of health supplement business with a focus on subscription packages. Declining sales for over a decade.
  • Still (barely) profitable business with net cash per share of 614 yen and NCAV per share of 861 yen compared to current share price of 472 yen. Equity to asset ratio at 0.90.
  • Founding family likely to have collective controlling stake. Questionable governance, mainly pertaining to key family members (Masaharu, Hiroko, Katsuya) still major shareholders.

Charle makes a pretty good case for explaining why investors ought to take a basket approach on net net stocks: Some attractive characteristics (i.e., cash), with concerns over operating business as well as other aspects (i.e., governance) of the business. It’s impossible to tell whether the operating model will work out or if bad governance will get in the way of minority shareholder interests.

Hence, investors thinking about investing in Charle ought to make it a small part of a net net basket, and sell out when or if share price reaches 80% NCAV. This currently equates to 690 yen per share, or a 46.2% premium to the current 472 yen share price. Stretched out over five years, this would be a 7.9% investment CAGR. Keep in mind that the last time shares traded at that level was in 2008, when share prices jumped after the MBO announcement.

 

The bottom line

Charle is a rather typical net net with some attractive characteristics (cash, share price) coupled with unattractive characteristics (operating model, declining sales, poor governance). When considering the company as an investment, it’s best to include it as a small part of a net net basket. If share price appreciates to 80% NCAV in the next five years, investors can expect a investment CAGR of 7.9%. With that said, the stock has not traded at this level since 2008.

 

Author: Kenkyo Investing

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