Thinking Points

  • Gamecard Joyco (TSE: 6249) is the market leader of prepaid card systems in the Pachinko/Pachislot gaming industry, a uniquely Japanese form of gambling.
  • Its market position, however, is quickly weakening as the industry faces tighter regulations, driving increased competition.
  • While the company remains profitable, its business strategy is defensive, with no solution to its revenue freefall.
  • Gamecard Joyco technically trades at 56% of NCAV, however, 18.8% of its current assets are kept in deposits, which are required by law.
  • Adjusted for deposits, the company trades at 79.5% of NCAV. Seeing that Gamecard Joyco has a weakening operating model (with no foreseeable improvement) and no material tangible assets, the company is already fairly valued today.

 

Introduction

Gamecard Joyco (TSE: 6249) is the market leader of prepaid card systems in the Pachinko/Pachislot gaming industry, a uniquely Japanese form of gambling. The industry size, along with Gamecard Joyco’s revenues, has declined amid increased regulation and the emergence of alternative entertainment.

Source: Company presentations

 

The company is technically a single segment operation, but categorizes revenues into four types: Equipment, card usage, system fees, and other.

*Note: I visited Gamecard Joyco with a client in mid-2018.

 

The business & environment

What is Pachinko/Pachislot?

Pachinko/Pachislot is a form of gaming unique to Japan. A pachinko machine is basically a vertical pinball machine and the pachislot machine is similar to slot machines you’d see in Las Vegas.

Source: Sega Sammy

 

Since gambling for cash is illegal in Japan, people gamble with game balls (Pachinko) and coins (Pachislot).

A player first inserts money into the Pachinko/Pachislot machine, which dispenses game balls/coins. Players can then start playing.

With Pachinko, the player hopes to get the game balls into a catcher, which gives the player a chance at hitting the jackpot (or small payout). With Pachislot, the player hopes to get straight 7s for a jackpot, and other straights for a small payout or replay. For both machines, when a player hits the jackpot or a small payout, game balls/coins are dispensed.

When the player is done playing, s/he can take the game balls/coins to an exchange counter to convert his/her winnings into a prize. While the player cannot legally convert the game balls/coins or prize into cash on premise, the “gray area” with Pachinko/Pachislot parlors is that there is normally a separate shop outside of the parlor for players to exchange prizes for cash.

 

The industry

The Pachinko/Pachislot industry is heavily regulated by the Entertainment Business Law. In recent years, the Japanese government has further tightened regulation, aiming to reduce gambling addiction. Implemented in February 2018, the regulation reduced maximum payouts by a third. The net effect is that players win/lose money slower than they did prior to the change.

The history of Pachinko regulation goes back and forth between tightening and loosening regulations, mostly through adjustments in the probability of hitting a jackpot and the maximum payout of jackpots. From 2005 on, the industry has faced increasingly tighter regulation.

The Pachinko market peaked in 2005 at 34,862 billion yen ($306 billion USD), and gradually declined to 19,540 billion yen ($172 billion USD) in 2017. The number of Pachinko players gradually declined as well:

Source: Q2 2019 earnings presentation

 

Gamecard Joyco’s market position

The prepaid card systems that Gamecard Joyco makes attaches to the Pachinko and Pachislot machines like this:

Source: Gamecard (Japanese)

 

While there is little difference to the consumer’s eye, there are technically two types of prepaid card systems:

House issued – Card company keeps track of card transaction data between parlours and players, but does not assume responsibility for payments.

Third party issued – Card company stands in between parlours and players, assuming responsibility for payment settlement.

 

Gamecard is the only company in the industry using the third party system while Joyco uses the house issued system.

With both systems, players load the card with cash and purchase game balls/coins. While each ball historically costed 4 yen, some pachinko parlours started offering “low-cost” pachinko, setting ball prices at 1 yen. With this sort of prepaid card system, pachinko parlours are better able to track its players.

Gamecard Joyco commands a 43% market share in prepaid card systems used in the Pachinko/Pachislot industry:

Source: 2017 & 2018 company earnings presentations

 

Daikoku Denki (TSE: 6430) entered the market in 2012 and is quickly growing its market share. While Daikoku is a newcomer to prepaid card systems, it is a dominant player in pachinko parlour operations systems.

According to its fiscal 2018 presentation (Japanese), Daikoku commands a 34.6% share in these systems, and 69.9% when narrowing the scope to large parlours with over 1,000 machines. Additionally, Daikoku offers other peripheral equipment and systems, and has gained share through offering package deals.

Meanwhile, number 2 player Glory Nasca (TSE: 6457) has maintained share by partnering with Kita Denshi (Japanese), another pachinko parlour operations systems maker, and offering package deals.

Both with increased competition and the overall industry decline, Gamecard Joyco is quickly losing its market share, which was at 52% prior to fiscal 2013.

 

Where Gamecard Joyco is headed

Needless to say, the industry decline and increased competition has negatively impacted Gamecard Joyco’s business performance:

Source: Company filings

 

So far, Gamecard Joyco has successfully cut costs, mostly by incentivizing early retirement (2017), consolidating 3 offices in to 1 (also 2017) and cutting R&D. Still, the company hasn’t addressed the revenue freefall. In its fiscal 2018 long form filings, the company recognizes the need to build a new line of business, but only mentions partnering up with machine and system makers.

Overall, the company’s strategy is defensive. Mid-term prospects for revenue increase is likely to be driven by external factors, like deregulation.

 

Management guidance

Gamecard Joyco originally guided for revenues of 14,200 million yen ($125 million USD, 16.1% YoY decline) and operating income of 1,200 million yen ($10.6 million USD, 66.6% YoY decline) for fiscal 2019 year end. However, the guidance was adjusted right before Q2 2019 earnings to revenues of 15,000 million yen ($132 million USD) and operating income of 2,000 million yen ($17.6 million USD).

According to the Q&A portion of Gamecard Joyco’s Q2 2019 materials, the company projected lower revenues for H1 2019 because it expected parlours to increase new regulation compliant machine purchases prior to the new regulatory standards taking effect in February 2018, leading to a projected decrease in investment on peripheral equipment. In reality, machine makers weren’t able to get as many compliant machines on the market, and parlours’ allocated budget to peripherals, resulting in stronger-than-expected revenues.

 

Shareholders

As of Q2 2019 (ending September 30th, 2018), Gamecard Joyco had 14,263,000 shares issued and 121 shares in treasury, leaving outstanding shares at 14,262,879.

Here are the major shareholders:

Source: Nikkei and company filings

 

Most of the names in the major shareholder list are pachinko and/or pachislot machine makers, and others (like Data Art and Saxa) make related equipment/software.

The company offers no stock options and the board members (including CEO) own a cumulative total of 2,700 shares (basically nothing).

 

Financials & Valuation

  • Gamecard Joyco operates in a declining Pachinko/Pachislot gaming industry, with tightening regulations and intensifying competition.
  • Though still a market leader in prepaid card systems, the company’s dominant position is quickly weakening, with market share dropping from 52% to 43% in the last 5 years.
  • Thus far, Gamecard Joyco has taken a defensive stance, mostly focusing on cost cutting. While still meaningful, the company has yet to figure out how to stabilize the freefall in revenues.
  • The company is deep value stock, but regulation requires Gamecard Joyco to keep a considerable amount of assets tied up in deposits.
  • Adjusted for cash tied up in deposits, the company trades at 79.5% NCAV. With no material tangible assets and a weakening operating model (with no improvement in sight), Gamecard Joyco trades at about fair value today.

Gamecard Joyco shares closed at 1,413 yen on November 28th, 2018. Net cash per share is 1,543 yen and NCAV per share is 2,544 yen. With share price at 56% of NCAV, the stock is definitely in deep value territory. However, because the company actually sits in between parlours and players, it assumes responsibility for payment settlement. And by law, the company must deposit 50% of unused prepaid cash balance. On the Q2 2019 balance sheet, this deposit amounted to 8,619 million yen ($76 million USD), or 18.8% of current assets. Net of the deposited amount, NCAV per share comes out to 1,940 yen. Using this figure, the company trades at 79.5% NCAV.

The good thing is that Gamecard Joyco has successfully cost cut and is still profitable. With that said, its defensive strategy isn’t a solution to the revenue problem. Without building out a new line of business, the company’s future profitability is largely dependent on external factors, like relaxed regulation. And without a more offensive business strategy, under current regulations, it’s difficult to see a scenario where business performance or investor sentiment is internally driven toward a positive shift. This combined with the fact that the company is already trading at 79.5% of adjusted NCAV and holds no material tangible assets, it’s appropriate to say Gamecard Joyco is already trading at about fair value.

 

The bottom line

Gamecard Joyco still holds strong market share in an increasingly tough Pachinko prepaid card system market. Its market position, however, is quickly diminishing. And the company, though still profitable, has not figured out a solution to the revenue freefall. At November 28th, 2018 closing price of 1,413 yen, Gamecard Joyco trades at an adjusted 79.5% NCAV. With no foreseeable improvement in its operating model and no material tangible assets, the company is fairly valued.

For additional reading, check out Dynam Japan (HK: 06889), the largest pachinko parlour operator in Japan trading on the Hong Kong Exchange. Also see Shared Research’s coverage.

 


Kenkyo Investing
Kenkyo Investing

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