Thinking Points

  • Nakayo is a well established telecommunications equipment company which has played a critical role, helping rebuild Japan’s telecommunication industry together with Hitachi and NTT after World War II.
  • In a shifting industry environment, however, the company is heavily reliant on its legacy business, and the company is exploring new business areas for growth.
  • So far, there have been no promising growth areas, but the company is still profitable, helped by a recently healthy Japanese and global economy. Moreover, Nakayo maintains a healthy balance sheet and holds attractive assets.
  • At 1,439 yen per share, Nakayo trades at an adjusted 54% NCAV with a market cap of 6,495 million yen ($62.5 million USD).
  • Investors can expect an investment CAGR of between 5.4% and 13.8% over the next 5 to 8 years.

Introduction

Nakayo (TSE: 6715) primarily manufactures and sells business phones and network equipment. More recently, the company is exploring various business lines including contract manufacturing, emergency call systems (nursing care/hospitals), and intercom systems. Although the company does not provide segment reporting, it categorizes revenues in its earnings presentation:

Source: Company earnings presentation


The Hitachi Group (TSE: 6501) and NTT Group (TSE: 9432) combined account for 50.3% of 2018 revenues. The two business groups have remained Nakayo’s largest customers for over a decade, generally accounting for more than half of company revenues.

The business & environment

The beginnings of Nakayo can be traced back to 1926, when Yoichiro Nakamura started a store in Tokyo. In 1944, he setup Nakayo Telecommunication Manufacturing, also in Tokyo. The company was then assigned as a designated manufacturer of telephones and switchboard parts by the Ministry of Communications in 1948. This was a part of the new Japanese government’s effort to rebuild a war-torn Japan.

By 1952, Nakayo was receiving technical training from Hitachi to manufacture wired communication equipment. This was the company’s first contact with Hitachi, and the business relationship continues today. In 1956, Hitachi invested in Nakayo, although it no longer holds a meaningful stake in the company.

Then in 1959, Nakayo becomes a designated manufacturer of PBX systems for NTT, a government-owned telecom company at the time. The company later expanded its offerings to NTT, supplying telephones and switches for electronic exchanges.

The Hitachi Group and NTT Group both remain as Nakayo’s two largest customers. Over the last decade, the two groups have consistently accounted for more than 50% of company revenues:

Source: Company filings


Much of the Hitachi business consists of contract manufacturing, and some of the NTT Group business is based on bidding.

The 2008-2010 global financial crisis had a significantly negative impact on Nakayo’s business performance. The company changed its name from Nakayo Telecommunications to Nakayo in 2014, noting that the company intends to expand outside of telecommunications. In 2016, Nakayo started disclosing its new revenue categories:

Source: Company earnings presentation


The Next Communication and Legacy Communication categories are closely related as much of the Next Communication revenues is focused on digitized offerings of the Legacy Communication business. In other words, business phones that run on computers rather than legacy networks. Additionally, Nakayo entered the intercom systems business, which is included as a part of the Next Communication category.

The EMS Solution category is for electronics manufacturing services. Similar to what Nakayo does for Hitachi, the company offers its facilities for custom manufacturing of electronics. The company is focused on the Next Communication and EMS Solution categories as its key growth areas.

Source: 2018 company earnings presentation, translated and modified by Kenkyo Investing


Although Nakayo is aiming for 21.9 billion yen ($197 million USD) in revenues for fiscal 2020, the company has been unable to reach its targets over the last several years. So far, revenue performance has been unstable throughout the various product categories.

For fiscal 2019, Nakayo guided for 19,300 million yen ($173.6 million USD, +2.3% YoY) in revenues and 800 million yen ($7.2 million USD, -7.2% YoY) in operating income. Three quarters in, the company has delivered 12,650 million yen ($113.8 million USD, -4.1% YoY) in revenues and 299 million yen ($2.7 million USD, -30.3% YoY) in operating income, lagging considerably compared to initial guidance. Guidance has not been adjusted, but it is unlikely that Nakayo will hit its targets for fiscal 2019.

Shareholders

As of Q3 2019 (ending December 31st, 2018), Nakayo had 4,794,963 shares issued and 380,514 shares in treasury, putting outstanding shares at 4,414,419.

Here are the major shareholders:

Source: Company filings & Nikkei


There is nothing particularly noteworthy about Nakayo’s shareholders. There are no management equity compensation plans.

Financials & Valuation

  • Nakayo has played a critical role as a leader in telecommunication equipment, helping rebuild Japan’s telecommunication industry together with Hitachi and NTT after World War II.
  • Legacy communication systems, namely business phones, are still a core part of Nakayo’s business, and the company is exploring new business areas for growth.
  • So far, there have been no promising growth areas, but the company is still profitable, helped by a recently healthy Japanese and global economy.
  • At 1,439 yen per share, Nakayo trades at an adjusted 54% NCAV with a market cap of 6,495 million yen ($62.5 million USD).
  • Overall, Nakayo’s business quality is mediocre at best, but maintains a healthy balance sheet and holds attractive assets. With this in mind, investors can expect an investment CAGR of between 5.4% and 13.8% over the next 5 to 8 years.

Since its formal founding in 1944, Nakayo has played a critical role in the Japanese telecommunication industry. Together with Hitachi and NTT, the company helped rebuild Japan’s telecommunication network after World War II through the manufacture of telephones and switches.

Today, the legacy telecommunication equipment business, which accounted for 72.1% of 2018 revenues, is a core part of Nakayo’s business. However, the industry landscape is shifting with the emergence of the internet and the subsequent shift to digital. Hence, there is a considerable amount of uncertainty with Nakayo’s business model. On the bright side, the company is still profitable.

Source: Company filings


With a heavy dependency on a legacy business that is largely affected by the economic cycle, Nakayo’s business quality is mediocre at best. Although the company is exploring various new business opportunities, it has yet to find promising growth areas.

Meanwhile, Nakayo’s balance sheet is more than healthy. Cash, receivables, and investment securities account for 60.5% of assets, and the company maintains a net cash positive balance sheet. At 1,439 yen per share, the company trades for 69% of NCAV with a market cap of 6,495 million yen ($62.5 million USD). Adjusted for investment securities, Nakayo trades at 54% of NCAV.

Nakayo’s land assets are on the books for 984 million yen ($8.9 million USD). These lands are located in rather remote areas of Gunma and Akita prefectures. We estimate these lands to be approximately 600 million yen ($5.4 million USD) below current market prices.

Overall, Nakayo’s operating business is mediocre at best, but the company is exploring new business opportunities, maintains a healthy balance sheet, and holds attractive assets. With this in mind, it’s fair to expect Nakayo to trade between 80% and 100% of adjusted NCAV. Investors can expect an investment CAGR of between 5.4% and 13.8% over the next 5 to 8 years.

Source: Kenkyo Investing estimates


The bottom line

Nakayo is a well established telecommunication equipment company that has played a critical role in the development of the Japanese telecommunication industry. Today, in a shifting industry environment, the company is still heavily reliant on its legacy business while exploring new business opportunities. Overall, the company quality is mediocre, but with a healthy balance sheet and attractive assets. Investors can expect an investment CAGR of between 5.4% and 13.8% over the next 5 to 8 years investing at today’s 1,439 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.