Thinking Points

  • Fuji Shoji (TSE: 6257) is an established maker of pachinko and pachislot machines, best known for its horror-themed gameplay based on famous Japanese horror films.
  • The company operates in a challenging pachinko industry, which has been on a 23-year decline and counting. Thus far, it has managed to maintain revenues, except with a bleak outlook for fiscal 2019.
  • The Matsumoto family controls 67.3% of outstanding shares after Fuji Shoji repurchased 1,000,000 shares each in fiscal 2018 and 2019, opening up the possibility of going private in the near future.
  • At 957 yen per share, Fuji Shoji trades at 76.6% of adjusted NCAV with a market capitalization of 22,389 million yen ($201 million USD).
  • Investors can expect an investment CAGR of between 7.1% and 11.9%, inclusive of dividends, over a 5 to 8 year period.

Introduction

Fuji Shoji (TSE: 6257) designs, manufactures, and sells pachinko and pachislot machines (Japanese-style pinball and slot machines). The company is a single segment operation, but categorizes revenues into two categories: Pachinko and Pachislot:

Source: Company filings


The company operates in an industry which has been on a decline for over 20 years, mostly as a result of increasingly tightening regulation. Still, Fuji Shoji has managed to maintain profitability for the most part, and is currently the #7 market share holder in the pachinko industry.

The business & environment

Fuji Shoji was founded in Osaka in 1958, originally manufacturing Jankyu machines, another form of gaming machine with elements similar to Mahjong. The company was the first in the industry to lease machines, which it sold across Japan.

For the first 15 years in operation, Fuji Shoji didn’t step outside of Jankyu machines. In 1973, however, the company made its first leap into Arrange Ball machines, a form of gaming machine that closely resembles pachinko machines.

It wasn’t until 1989 that Fuji Shoji started manufacturing pachinko machines. Then in 2003, the company started manufacturing and selling pachislot machines as well.

Source: Company website


As you can tell from the pachinko and pachislot images above, the two machines have an entertainment aspect beyond simple gaming. Often times, intellectual property (IP) of popular movies, singers, and animes are incorporated as a part of the experience. While Fuji Shoji uses a wide variety of IPs for its machines, the company is best known for horror-themed machines.

The pachinko machine in the image above is one of Fuji Shoji’s best selling series based on a famous Japanese horror movie, The Ring. The pachislot machine above is based on the movie, Sadako vs. Kayako, a crossover of The Ring and another famous horror movie series, Ju-on. As an aside, both horror movies were remade in Hollywood as The Ring (2002) and The Grudge (2004).

Pachinko and Pachislot are both a form of legal gambling in Japan. Over the last 23 years, however, the industry has been on a decline as regulations surrounding the industry are increasingly tightening. In its peak (1995), the industry had 18,244 pachinko/pachislot halls nationwide. 2018 statistics provided by the Japanese National Police Agency shows 10,060 pachinko/pachislot halls operating today.

Some reputable sources point to Japan as a gambling hot spot (here and here), referencing the pachinko/pachislot industry’s 20+ trillion yen of gambling revenues. This is, however, largely a function of revenue recognition. Generally speaking, casinos recognize revenues on a net basis while the pachinko industry recognizes revenues on a gross basis, distorting industry size. Click here for more details.

Before players start their pachinko session, they first rent pachinko balls. This is equivalent to chips in a casino. After their pachinko session, players then take their pachinko balls to get them exchanged for prizes. After leaving the pachinko hall, players can find a nearby “exchange shop” to exchange their prizes for cash. This system exists because it is technically illegal for the pachinko halls to offer cash prizes.

The pachinko ball rental revenues is the key metric used when measuring industry size:

Subtracting the cost of prizes (estimated 85% of revenues) from the ball rental revenues above generates an industry figure more comparable with the casino industry.

Interestingly, despite operating in a pachinko/pachislot industry which as been on a decline for 23 continuous years, Fuji Shoji has fared better than some of its competitors:

Source: GuruFocus


Revenues for pachinko machine makers tend to fluctuate depending on changes in regulation and machine lifecycle. Technically speaking, a pachinko machine is good for 3 years of use after passing inspection, although many are often removed from pachinko halls much earlier depending on popularity.

For fiscal 2019, Fuji Shoji originally guided 38,000 million yen ($341 million USD, -27.4% YoY) in revenues and 2,000 million yen ($17.9 million USD, -55.6% YoY) in operating income. This was adjusted upward to 38,000 million yen ($341 million USD, -27.4%) in revenues and 2,500 million yen ($22.4 million USD, -44.5% YoY) in operating income after including subsidiary financials.

Then, the company adjusted guidance downward to 27,900 million yen ($250 million USD, -46.7% YoY) in revenues and 1,000 million yen ($9 million USD, -77.8% YoY) in operating income, noting that regulatory inspection is taking longer than expected for some of its new releases.

Shareholders

As of Q3 2019 (ending December 31st, 2018), Fuji Shoji had 24,395,500 shares issued and 2,000,000 shares in treasury, putting outstanding shares at 22,395,000.

Here are the major shareholders:

Source: Company filings & Nikkei


The Matsumoto family collectively controls 67.3% of outstanding shares.

Fuji Shoji has periodically repurchased shares (fiscal 2011, 2014) while consistently paying out 2+% of equity in dividends over the last ten years. More recently, the company repurchased 1,000,000 shares in 2018 and another 1,000,000 shares in 2019:

Source: Company filings


Given the Matsumoto’s large stake in the company and the recent large repurchases increasing the family’s influence, there’s a possibility that the family may be looking to take Fuji Shoji private in the near future.

Financials & Valuation

  • Fuji Shoji is a long established maker of pachinko and pachislot machines best known for its horror-themed gameplay based on famous Japanese horror films.
  • Although the company operates in a pachinko industry which has been on a 23-year decline, it has so far managed to maintain revenues at a historically consistent level, with projected declines for fiscal 2019.
  • The Matsumoto family controls 67.3% of outstanding shares after Fuji Shoji repurchased 1,000,000 shares each in fiscal 2018 and 2019, opening up the possibility of going private in the near future.
  • At 957 yen per share, Fuji Shoji trades at 76.6% of adjusted NCAV with a market capitalization of 22,389 million yen ($201 million USD).
  • Investors can expect an investment CAGR of between 7.1% and 11.9%, inclusive of dividends, over a 5 to 8 year period.

Fuji Shoji first started out in 1958 by making Jankyu machines. It wasn’t until 1989 that the company started making pachinko machines, its core business today. While the company incorporates a wide variety of IP into its machines, it is best known for horror-themed machines based on popular Japanese horror films The Ring and Ju-on.

The pachinko industry as a whole is shrinking. With increasingly tight regulations, the industry has been on a continuous 23-year decline, with its player base at nearly half of what it was a decade ago. Meanwhile, the number of pachinko hall operators declined at a 10 year CAGR of -2.3% and ball rental revenues declined at a 10 year CAGR of -3.3%.

Over the last 10 years, Fuji Shoji has managed to keep its revenues stable, however, it is expecting a sharp revenue decline of -46.7% YoY for fiscal 2019. The company attributes the decline to inspections taking longer than expected for new machines. It’s likely that Fuji Shoji revenues will continue to fluctuate from year to year while declining in line with the industry over the long run.

Fuji Shoji maintains a strong, debt-free balance sheet with a net cash balance of 14,545 million yen ($130 million USD), or equivalent to 65% of its market cap. While the company owns land, the book value of its land holdings are roughly in line with current market prices.

At 957 yen per share, Fuji Shoji trades at 85.8% of NCAV with a market capitalization of 22,389 million yen ($201 million USD). Adjusted for investment security holdings of 3,118 million yen ($27.9 million USD), the company trades for 76.6% of NCAV.

Overall, Fuji Shoji operates a medium quality business in a challenging industry environment. Keeping in mind that the company has consistently returned value to shareholders through dividends and repurchases, 80% to 100% of adjusted NCAV is a fair valuation.

Assuming company revenues decline 5% annually (industry decline ~3.3%) with operating margins at 5% (historically ~9%) while maintaining a dividend to equity ratio of 2%, investors can expect an investment CAGR of between 7.1% and 11.9%, inclusive of dividends, over the next 5 to 8 years.

Source: Kenkyo Investing estimates


The bottom line

Fuji Shoji is an established maker of pachinko and pachislot machines, particularly known for its horror-themed machines. The company operates in a challenging industry environment, facing a continuous decline of 23 years and counting. Still, the company remains profitable for the most part while consistently paying dividends and occasionally repurchasing shares. Investors can expect an investment CAGR of between 7.1% and 11.9%, inclusive of dividends, over a 5 to 8 year period.


Kenkyo Investing
Kenkyo Investing

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