Thinking Points

  • E-Store (TSE: 4304) mainly provides e-commerce solutions to small and medium sized businesses.
  • More recently, amid increasing competition, the company started developing marketing solutions for its existing customer base.
  • So far, this has resulted in a meaningful revenue gain, but has not yet contributed to margins.
  • As long as the company maintains business performance at current levels, investors can conservatively expect a three year investment CAGR of 9.6% at today’s 710 yen per share price.

Introduction

E-Store (TSE: 4304) mainly provides e-commerce solutions to small and medium sized businesses. More recently, amid increasing competition, the company started developing marketing services for its existing customer base. The shift in business model isn’t anything new, however, as E-Store has overhauled its business every 7 years or so since its founding in 1999. Today, the company reports through a single segment, but splits its revenues in four main categories: Stock, flow, Marketing Service, and Other:

Source: Company filings, chart by author


While E-store started out as a tool for individuals and small businesses to setup their own online store, the company is shifting into more of a total solution provider. This is a conscious decision on the founder CEO’s part, noting that e-commerce systems are increasingly becoming a commodity. Hence, the company has been focusing on its marketing arm in recent years.

The business & environment

Revenue category descriptions

E-Store generates revenues in several ways, but the key driver today is its shopping cart software Shopserve. Customers pay a monthly fee to use this software, which is hosted on E-Store servers. The company calls this model ASP, or application service provider. The modern day term for this is software-as-a-service, or SaaS. This sort of monthly subscription billing is categorized as “stock” revenues.

Source: E-Store website


In addition to Shopserve, E-store offers order and payment processing services. This is where transaction volume and value directly affect revenues. A variety of plans are offered, but the basic idea is that the higher the monthly billing, the lower the transactional billing, and vice versa. Moreover, E-Store offers individually tailored enterprise plans for medium and large businesses. This sort of transactional billing is categorized as “flow” revenues.

Then we have the more recent focus area: Marketing Services. E-Store helps individuals and businesses with everything from website design to online advertising. So far, as the company notes in its filings, this has been a human-intensive process contributing to revenues, but not to margins.

With the marketing support focus, E-Store’s business is shifting toward higher flow revenues. Interestingly, the stock revenues has actually been decreasing, but flow revenues have been growing enough to mostly offset the stock revenue decline over the last few years. Management expects this trend will continue, and views its marketing arm as a key driver for future growth.

Source: Company presentation, translation by author


Management guidance

Founder CEO Kenichi Ishimura often brings up Amazon (NASDAQ: AMZN) and Rakuten (TSE: 4755) when discussing the e-commerce landscape. Both companies are prime examples of online malls which have been the center of attention (and source of rapid growth) over the last couple decades. Interestingly, Kenichi believes the growth of these giant online retailers will slowdown. Instead, he projects boutique online shops will be the name of the game over the next few years.

What’s mildly concerning is that E-Store’s customer count is not growing or flatlining, but actually declining despite Kenichi’s projection of a growing online boutique shop landscape:

Source: Company presentation, translation by author


Still, this is within E-Store management’s projections. In a December 2018 interview with Japan Interview Press (Japanese), Kenichi noted the commoditization of shopping cart software, commenting that the need for sales and marketing support will characterize the next few years in e-commerce. He also says the company is currently in a transitional period.

For fiscal 2019, management guided 5,540 million yen ($51.8 million USD, +9.8% YoY) in revenues and 531 million yen ($5 million USD, -4.1% YoY) in operating income. The company expects weaker operating performance as it invests in the development of its marketing services. Two quarters in, revenue performance has come in weaker than expected, with revenues at 2,389 million yen ($22.4 million USD, -2.6% HoH). Operating performance, on the other hand, came in solid at 278 million yen ($2.6 million USD, +20.8% HoH).

In November 2018, E-Store setup a new subsidiary Cross Trust. In the process, E-Store published guidance for consolidated performance with revenues at 5,546 million yen ($51.9 million USD) and operating income at 508 million yen ($4.8 million USD), with no change in guidance for the reporting company.

Shareholders

As of Q2 2019 (ending September 30th, 2018), E-Store had 5,161,298 shares issued and 30 shares in treasury, leaving outstanding shares at 5,161,268.

Here are the major shareholders:

Source: Company filings & Nikkei


Unicom is Kenichi’s asset management company. In effect, Kenichi owns 40.8% of E-Store. Kenichi reduced his stake in E-Store between May and July of 2018:

Source: EDINET Filings


According to the same filing (Japanese, filed on July 24th, 2018), Kenichi (combined with Unicom) has about 222 million yen ($2.1 million USD) in debt. This could pose as a market risk in the event that Kenichi becomes a forced seller. On December 28th, 2018, E-Store closed at 710 yen per share, putting the company’s market cap at 3,665 million yen ($34.3 million USD) and Kenichi’s stake at 1,495 million yen ($14 million USD). As a reference, Kenichi is a strong proponent of bitcoin and virtual currencies in general. In a 2017 Nikkei Radio interview (Japanese), he spent half of the 15 minute interview talking about bitcoin, which has little to do with E-Store’s current business other than the fact that the company offers payment processing for virtual currencies.

Youichi Yanagida is the Chief Information Officer for E-Store.

Over the last ten years, split adjusted outstanding shares have decreased by 4.17 million shares, or roughly 45%. Most notably, E-Store repurchased its shares from Yahoo Japan (TSE: 4689) in May of 2013, which amounted to 32.4% of issued shares.

More recently in November 2018, E-Store issued unsecured, zero coupon convertible bonds which are convertible to 970,400 shares (18.8% of currently issued shares) at 1,030 yen per share. These were issued to private equity firm InfleXion. The two parties have agreed that the bonds will not be converted prior to November 28th, 2020. As of this writing, Q2 2019 financials is the most recent available, which does not include the convertible bonds.

Currently, there are no equity compensation plans.

Financials & Valuation

  • E-Store was on the forefront of internet retail, offering shopping cart software before online shopping became commonplace.
  • While this gave the company a head start, the standalone offering is no longer differentiated, with many competing services emerging and E-Store losing accounts.
  • In order to get back on a growth track, E-Store is focusing on transitioning into a total solution provider for business operators, starting with sales and marketing support services.
  • Though the marketing services has generated meaningful revenues, it has not led to profits yet. With that said, E-Store’s flow revenues have increased over the last decade.
  • At today’s 710 yen per share price, investors can conservatively expect a three year investment CAGR of 9.6%.

One big thing to note about E-Store is that, despite the declining stock revenues, the company is more than healthy, comfortably remaining free cash flow positive for over a decade. Interestingly, however, the company’s equity-asset ratio is uncharacteristically low at 0.45 for an operationally healthy internet company.

Capital allocation has been a strong suit for E-Store so far, with ROE increasing from high teens to 30+% over time. With that said, it’s difficult to tell whether this is coincidental. While the company maintains a dividend payout ratio of around 30%, the major share repurchase from fiscal 2014 was a reaction to Yahoo Japan’s intent to sell. To be sure, E-Store has repurchased shares on other occasions as well (fiscal 2010, 2011, 2016).

There are some operating concerns with the business, like the decline in stock revenues. So far, this hasn’t materially impacted overall performance, thanks to strong flow revenues. But there is some uncertainty about where the floor is. Moreover, recent growth in revenues has been driven by marketing services, which has grown to 22% of total revenue but doesn’t contribute to margins just yet. Without segment reporting, it’s difficult to gauge where E-Store’s operating performance is headed.

At a current EV/EBIT of 2.6, however, it’s probably best to make conservative overall operating performance assumptions and figure out whether an investment in E-Store is prudent.

The average operating income over the last 10 years was 538 million yen ($5 million USD). The lowest point was 407 million yen ($3.8 million USD) in fiscal 2017. This is when E-Store started hiring more people for its marketing expansion, and the company actually guided for 331 million yen ($3.1 million USD) in operating income.

When using 331 million yen ($3.1 million USD) as the baseline operating income, current EV/EBIT would be 5x. This isn’t a particularly high multiple for E-Store, which has generally traded around 4 times EV/EBIT, but has gone as high as 8x and as low as 1x over the last decade.

What’s more, price to free cash flow would still be around the low teens. The current 3.9% dividend yield should help with the possible volatility that may ensue. And E-Store continues to generate strong operating performance, having delivered 278 million yen ($2.6 million USD) in operating income in the first half of 2019. While the long term outlook is still up in the air, E-Store should be more than okay in the next few years.

Assuming 500 million yen ($4.7 million USD) in operating income, current level of dividends (28 yen per share), and an EV/EBIT of 4x over the next three years, share price should come out to 850 yen and total dividends paid of 84 yen. With today’s 710 yen share price, this would translate to a three year investment CAGR of 9.6% (850 yen share price + 84 yen cumulative dividends). As a reference, if we use 331 million yen ($3.1 million USD) operating income as the baseline with all other assumptions left the same, shares should trade at roughly the same price it is trading for today (710 yen).

This is a rather conservative scenario. Depending on how marketing services and stock revenues perform, investors may have an even stronger upside.

The bottom line

E-Store was on the forefront of internet retail, offering shopping cart software to individuals and small businesses before online shopping became commonplace. Today, amid increasing competition, the company is pushing to establish itself as a total e-commerce solution provider. So far, it’s focus on marketing support has resulted in a meaningful revenue gain, but has not yet contributed to margins. As long as the company maintains business performance at current levels, investors can conservatively expect a three year investment CAGR of 9.6% at today’s 710 yen per share price.


Kenkyo Investing
Kenkyo Investing

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