Thinking Points

  • Iwatsu (TSE: 6704) is among Japan’s earliest information communication equipment maker with a proven track record for technological competence.
  • Over its 80+ year history, the company established itself as a large maker for fixed-line telephones while building out its electronic measurement and printing equipment businesses.
  • Over the last decade, however, business performance deteriorated considerably, generating operating losses in 6 of the last ten years.
  • At today’s 785 yen per share price, Iwatsu trades at 81.3% of adjusted NCAV with a market cap of 7,828 million yen ($70.7 million USD) and an enterprise value of negative 175 million yen (-$1.6 million USD).
  • With its core business in secular decline, however, Iwatsu is currently appropriately valued, and investors are best advised to avoid investing in the company.

Introduction

Iwatsu (TSE: 6704) manufactures and sells information communication, printing, and electronic measurement equipment. The company is among the larger makers of fixed-line telephones, with its largest customers being NTT East and NTT West. Iwatsu operates through three segments: Information Communication, printing, and electronic measurement:

Source: Company filings


For the better part of the last decade, Iwatsu has either generated operating losses or modest operating profits (i.e., less than 1%). Revenues have also steadily declined during this time. The company achieved profitability at the operating level in 2017 and 2018 after cutting its workforce through early/special retirement offerings. Still, Iwatsu’s core business is in secular decline.

The business & environment

Iwatsu is one of the older Japanese information communication equipment makers around with a history extending over 80 years. The company got its start with fixed-line phones, which it continues to manufacture and sell today. In 1954, Iwatsu developed Japan’s first oscilloscope, marking the beginning of the company’s electronic measurement business. Today, the company offers information communication, electronic measurement, and printing equipment.

Iwatsu has a strong track record of technological aptitude. Some examples of this include Japan Aerospace Exploration Agency’s (JAXA) use of Iwatsu’s fuel injector controls in its rockets during countdown and developing the world’s fastest storage oscilloscope (1980s). Despite its strong technological aptitude, the company has been unable to reverse its continually declining revenues over the last decade:

Source: Company filings


Operating performance has been weak as well:

Source: Company filings


In June of 2016, current CEO Toru Nishido took his post. Shortly before this, the company announced a medium term plan which primarily focused on improving profitability through personnel adjustment, consolidating subsidiaries, increasing development efficiency, and reducing production costs. As for growing the company, Iwatsu looked to invest in venture capital, M&A, and partnerships with universities.

The financial targets set for the end of the medium term plan (2018, fiscal 2019) is revenues of 26,000 million yen ($234.8 million USD) and operating income of 500 million yen ($4.5 million USD). Three quarters into fiscal 2019, however, Iwatsu is considerably behind its target, and generating losses. In fact, the company’s originally guidance for fiscal 2019 (issued June 2018) was for revenues of 22,500 million yen ($203.2 million USD) and operating income of 150 million yen ($1.4 million USD). This was subsequently adjusted down to 21,000 million yen ($189.6 million USD) in revenues and -120 million yen (-$1.1 million USD) in operating losses on February 12th, 2019.

Iwatsu’ return to operating profits was more a function of cutting personnel costs and R&D expenditures than anything else. As a part of the medium term plan, the company announced that it would offer early retirement to interested employees. With this, the company recorded one time losses of 1,309 million yen ($11.8 million USD) for severance pay. At the same time, the Tokyo government expropriated Iwatsu’s land, resulting in a capital gains of 2,914 million yen ($26.3 million USD) and relocation compensation of 889 million yen ($8 million USD).

More recently, when the company absorbed three of its subsidiaries, Iwatsu recorded 461 million yen ($4.2 million USD) in one time losses from a change in retirement benefit liability calculation. Separately, the company sold its Tokyo rental office building during Q2 2019, recording capital gains of 573 million yen ($5.2 million USD) for the land and 84 million yen ($760K USD) for the building.

Source: Company filings


Put another way, Iwatsu has managed to reduce operating costs faster than its revenues declined in the last couple of years. For fiscal 2019, however, the company expects to record operating losses once again.

Shareholders

As of Q3 2019 (ending December 31st, 2018), Iwatsu had 10,080,344 shares issued and 179,761 shares in treasury, putting outstanding shares at 9,900,583.

Here are the major shareholders:

Source: Company filings, Nikkei


Virgin Islands based Peninsula Rock Limited submitted filings to EDINET disclosing a 627,300 share stake in Iwatsu on January 31st, 2019. This is equivalent to 6.22% of issued shares. Although unconfirmed, it is possible that this is the founding family’s fund as Iwatsu’s Japanese business name is Iwasaki Tsushinki, and the literal English translation for Iwasaki (a Japanese last name) is rock peninsula.

There are no management equity compensation plans.

Financials & Valuation

  • Iwatsu is among Japan’s earliest information communication equipment maker with a proven track record for technological competence.
  • With that said, the last decade has been challenging, particularly as its core business is in the manufacturing and selling of fixed line telephones.
  • Revenues have declined considerably while the company generated operating losses in 6 out of the last ten years. Although Iwatsu managed to turn a profit during 2017 and 2018 through cost cutting, it expects further losses for fiscal 2019.
  • At today’s price of 785 yen per share, Iwatsu trades at 81.3% of adjusted NCAV with a market cap of 7,828 million yen ($70.7 million USD) and an enterprise value of negative 175 million yen (-$1.6 million USD).
  • As the company’s core business faces secular decline, the company is appropriately valued currently, and investors are best advised to avoid investing in Iwatsu.

Iwatsu is among the earliest Japanese information communication equipment maker, and one of the largest fixed line telephone manufacturer in Japan. Over its 80+ year history, the company managed to expand its offerings to include electronic measurement equipment and printing systems. The company has a proven track record for technological competence, as evidenced by JAXA’s use of Iwatsu’s fuel injection control parts.

With its core business in information communication equipment, and more specifically fixed-line telephones, however, the company has faced a challenging ten years. Revenues have continuously declined while the company recorded operating losses in 6 out of the last ten years. The management team’s efforts so far have revolved around cost control, which lead to operating profits in 2017 and 2018. But the company expects further losses in 2019 as revenues continue to decline.

Iwatsu has been unable to meaningfully monetize its technological competence. Although it is entirely possible that the company would figure out a way to build a new and profitable business in domains like sensors, signal processing, image processing/printing, wireless/communication technology, etc none of its new endeavors have converted meaningfully to business performance so far.

At today’s price of 785 yen per share, Iwatsu trades at 100% NCAV with a market cap of 7,828 million yen ($70.7 million USD) and an enterprise value of negative 175 million yen (-$1.6 million USD). The company no longer owns land significant enough to affect valuation, but it does have 8,003 million yen ($72.3 million USD) in cash & equivalents as well as 1,783 million yen ($16.1 million USD) in investment securities, with 9,218 million yen ($83.2 million USD) in total liabilities.

Adjusted for investment security holdings, Iwatsu trades for 81.3% of NCAV with an enterprise value of negative 1,958 million yen (-$17.7 million USD).  With its core business in secular decline generating consistent losses, the current price is either fair value or overvalued. Investors are best advised to avoid investing in Iwatsu.

Interestingly, however, Q3 2019 filings show land holdings of 3,724 million yen ($33.6 million USD) while nothing was listed for Q2 2019. An acquisition of this scale would typically come with a disclosure statement, however, there is none. As short form filings (i.e., “Tanshin”), are not audited, this could be an error. Long form filings, which are filed at a latter date, ought to clarify this.

The bottom line

Iwatsu is among Japan’s earliest information communication equipment maker with a proven track record for technological competence. Over its 80+ year history, the company established itself as a large maker for fixed-line telephones while building out its electronic measurement and printing equipment businesses. Over the last decade, however, business performance deteriorated considerably, generating operating losses in 6 of the last ten years. At today’s 785 yen per share price, Iwatsu trades at 81.3% of adjusted NCAV. With its core business in secular decline, however, Iwatsu is currently appropriately valued, and investors are best advised to avoid investing in the company.


Kenkyo Investing
Kenkyo Investing

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