Thinking Points

  • Axell (TSE: 6730) is a leading fabless LSI graphics chip maker in the pachinko & pachislot industry commanding a 50+% market share.
  • With that said, the industry has faced challenges over the last 15 years as regulations tightened and consumer leisure activities shifted.
  • Axell is expecting to record its first loss since its IPO in 2002, with no foreseeable improvement in the industry environment and no notable successes outside of the pachinko & pachislot industry.
  • At today’s price of 481 yen per share, Axell trades at 59.7% of adjusted NCAV and 82.3% of adjusted net cash.
  • Despite this, investors ought to steer clear of Axell as its cash position can quickly diminish if current operating performance continues.

Introduction

Axell (TSE: 6730) is a fabless developer and manufacturer of large scale integration (LSI) graphics and sound chips, primarily for the pachinko & pachislot industry (a form of gambling). The company is a single segment operation and splits its revenues into three categories: LSI chips for pachinko & pachislot, embedded LSI chips, and other.

Source: Company filings


With increasing regulation in the pachinko/pachislot industry and shifting consumer leisure activities, Axell’s core business faces serious headwinds. Moreover, the company has been unable to expand its business into other industries. The pachinko & pachislot industry still accounts for over 95% of annual revenues.

The business & environment

Prior to Axell’s founding, founder Yuzuru Sasaki worked at another company on a team specializing in graphics chips for arcade games (Japanese). This team became the founding members of Axell in 1996. Since its founding, the company has developed chips for the pachinko/pachislot industry while leaving the manufacturing process to partnered firms.

The company makes it a policy to focus on research and development rather than manufacturing. Axell mostly consists of technical personnel. In fact, the company has relied on electronics trader Midoriya Electronics for sales since 1998. Midoriya historically accounted for over 90% of revenues until Okaya Electronics started selling more of Axell’s products.

Source: Company filings


Six short years after its founding, Axell managed to go public (2002). For the first ten years, the pachinko & pachislot industry size was stable, generally shy of 30 trillion yen ($273 billion USD). Business continued to expand as Axell developed top-of-the-line LSI chips, leading to the company’s current 50+% market share in LSI graphics chips for the pachinko & pachislot industry.

Since 2003, however, the pachinko & pachislot industry has continuously declined. In 2017, the industry size was at 19,540 billion yen ($178 billion USD), or roughly two-thirds the size it was when Axell was founded.


Much of the industry shrinkage is due to increasingly tightening regulation and shifting consumer leisure activities. In order to strengthen its business, Axell started designing embedded LSI chips for computers in 2009. Thus far, however, the company has been unable to build this into a meaningful business. The pachinko & pachislot industry still accounts for over 95% of annual revenues.

Source: Company filings


When a pachinko machine manufacturer wants to take a new machine to market, it is required to go through an approval process with the police. Approved machines are good for use for three years from the date of approval. A pachinko hall replacing an old machine with a new one, however, does not necessarily mean every part in the pachinko machine is new, and graphics LSIs are one of the components that are often reused. Historically speaking, revenues spiked when Axell introduced new products. More recently, the industry environment has become increasingly difficult.

Going forward, Axell management is focused on three areas: Middleware, encryption technology, and machine learning. The middleware focus is essentially to expand and modify its current graphics technology used in pachinko/pachislot LSI chips for use in computers and video game consoles. For encryption technology, Axell strives to develop hardware and software security systems internally and help improve the security and operations of VIPPOOL, one of Japan’s largest Monacoin (cryptocurrency) mining pool. As for machine learning, the company released a deep learning framework which helps detect objects, categorize images, and extracts characteristics.

For fiscal 2019, Axell originally guided for revenues of 6,300 million yen ($57.3 million USD, -25.7% YoY), operating losses of 1,450 million yen ($13.2 million USD, op income of 156 million yen in 2018), and net losses of 1,050 million yen ($9.6 million USD, net income of 80 million yen in 2018). The guidance was issued with the decreasing demand of pachinko machine makers and prototype development delays carrying over to fiscal 2019 in mind.

The original guidance was adjusted down in January 2019 along with an announcement of recording one-time losses of 234 million yen ($2.1 million USD) from investment securities.

Source: Company filings

Shareholders

As of Q3 2019 (ending December 31st, 2018), Axell had 11,187,749 shares issued and 152 shares in treasury, putting outstanding shares at 11,187,597.

Here are the major shareholders:

Source: Company filings, Nikkei


There are no equity compensation plans for the management team.

Financials & Valuation

  • Axell is a leading LSI graphics chips maker in the pachinko & pachislot industry with a 50+% market share.
  • With tightening regulations and shifting consumer leisure activities, the pachinko & pachislot industry has been on a 15+ year decline, and Axell is expecting to record its first loss since its IPO in 2002.
  • In order strengthen its business, the company is focusing on three areas going forward: Middleware, encryption technology, and machine learning.
  • At today’s price of 481 yen per share, Axell trades at 59.7% of adjusted NCAV and 82.3% of adjusted net cash.
  • Although the company trades below net cash, investors ought to steer clear of Axell as its cash position can quickly diminish if current operating performance continues.

Axell is a leading fabless LSI graphics chip maker in the pachinko & pachislot industry with over a 50% market share. With that said, the macro environment has been difficult over the last 15 years. As regulations have tightened and consumer leisure activities shifted, the pachinko & pachislot industry is now two-thirds the size it was when Axell was founded (1996). The company is expecting to record its first loss since its IPO in 2002.

Caught in a challenging environment, Axell is focused on developing three areas: Middleware, encryption technology, and machine learning. Although all areas are related to Axell’s core technologies, the company virtually has no business outside of the pachinko & pachislot industry currently. It is prudent to expect that difficult times will continue over the medium (3~5 years) term.

At first glance, the scale of Axell’s projected operating losses may drive some investors away. The company’s revised 2019 guidance is a 1,700 million yen ($15.5 million USD) operating loss compared to Q3 2019 shareholder equity of 10,346 million yen ($94.1 million USD). With that said, research and development has historically accounted for 65% of operating expenses, and 70+% over the last few years in particular. Although highly unlikely, the company can technically turn a profit by scaling back R&D.

In a two-part 2012 Nikkei Radio show (Japanese), Yuzuru and CEO Kazunori Matsuura were interviewed. In the interview, Kazunori mentioned that he intends to keep three years worth of operating expenses in cash and a dividend payout ratio of 50% (unconsolidated). In the current environment, it’s highly likely that Axell will suspend dividends.

At today’s price of 481 yen per share, Axell trades at 90.6% net cash and 64% NCAV. Adjusted for investment security holdings of an estimated 600 million yen ($5.5 million USD), the company trades for 82.3% net cash and 59.7% NCAV. The company holds no notable fixed assets.

With its core business in a challenging environment and no notable developments in its new endeavors, Axell is in a difficult position. Presumably, fiscal 2020 results will fare better than 2019, as the 2019 R&D expenditures were at an inflated level from delayed 2018 prototype developments. Still, without no notable success outside of the pachinko & pachislot industry, Axell’s operating performance is likely to remain negative.

Although Axell trades below NCAV, investors ought to steer clear of the company for now as its cash position can quickly diminish if current operating performance continues.

The bottom line

Axell is a leading fabless LSI graphics chip maker in the pachinko & pachislot industry with over a 50% market share. With that said, the industry has faced challenges over the last 15 years as regulations tightened and consumer leisure activities shifted. Axell is expecting to record its first loss since its IPO in 2002, with no foreseeable improvement in the industry environment and no notable successes outside of the pachinko & pachislot industry. Although the company trades below net cash, investors ought to steer clear of Axell as its cash position can quickly diminish if current operating performance continues.


Kenkyo Investing
Kenkyo Investing

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