Thinking Points

  • Showa System Engineering (TSE: 4752) is a system development company with long term ties to the Japanese financial industry.
  • Although the company’s financial industry exposure has largely remained proportionately unchanged over the last decade, it has increasingly become dependent on its largest customer Nikko System Solutions.
  • Without setting tangible medium term targets, Showa System Engineering aims to focus its resources on the securities brokerage industry, although performance over the last few years shows a decline in financial industry revenues.
  • At 683 yen per share, Showa System Engineering trades at 138% of adjusted NCAV with a market capitalization of 3,022 million yen ($27.6 million USD)
  • Investors can expect an investment CAGR of between 10.5% and 17%, inclusive of dividends, over the next 5 to 8 years.

Introduction

Showa System Engineering (TSE: 4752) is a system development company mainly catering to the financial industry. Although the company operates through two segments, System Development and Business Process Outsourcing (BPO), revenues are best broken down by customer industry as over 95% of revenues are generated through System Development.

Source: Company filings

Some of Showa System Engineering’s biggest customers include Nikko System Solutions (under Sumitomo Mitsui Financial [TSE: 8316]), Nihon Unisys (TSE: 8056), Tokyo Stock Exchange, NTT Data (TSE: 9613), and Mizuho Johosoken (under Mizuho Financial [TSE: 8411]). In 2019, Nikko System Solutions was Showa System Engineering’s largest customer, accounting for 21.5% of revenues.

The business & environment

Showa System Engineering was founded in 1966 to provide data entry and processing services in Tokyo. With the data processing business rapidly expanding, the company soon implemented OUK 1040 general purpose computers to handle larger volumes of data. These computers were purchased from Oki Univac, which is now Nihon Unisys, one of Showa System Engineering’s largest customers.

The company’s data processing business continued to expand and in 1973, Showa System Engineering made its first leap into software development. The business environment was in a state of rapid change, requiring Showa System Engineering to bring in new and better computers every few years. The company started with the OUK 1040 in 1969, then implemented the OUK 9400 in 1976, then the UNIVAC 1100/60 in 1977, and so on.

In 1995, Showa System Engineering officially became a registered system integration company with the Ministry of Economy, Trade, and Industry (METI). Today, over 95% of the company’s revenues come from software development. In fact, BPO revenues came in at 128 million yen ($1.2 million USD), or 2.1% of 2019 revenues.

The company has been involved in financial system development from early on. More specifically, Showa System Engineering builds and customizes security brokerage systems. Securities brokers are the company’s largest customers by far, accounting for 49.8% of 2019 revenues. Combined, finance and insurance industry customers account for 79% of 2019 revenues.

Source: Company filings

Showa System Engineering only started breaking out revenues by customer industry in 2012. Going back further, the financial industry dependency becomes clearer, with net margins falling to 0.14% in 2010 compared to 3.3% in 2008 and 5.2% in 2019.

Still, the company managed to remain profitable throughout the global financial crisis:

Source: Company filings

While the distribution between finance and non-finance has remained around an 80:20 split, Showa System Engineering’s customer concentration has changed, with Nikko System Solutions increasingly accounting for a larger share of company revenues.

Source: Company filings

As Japanese companies are only required to disclose customer revenues accounting for over 10% of annual revenues, some fields are left blank in the above table.

Showa System Engineering generally stays out of the public eye, with no recent management interviews found online. It did, however, have a medium term plan originally created in 2016 covering fiscal 2017 through 2019. The 2017-2019 medium term provided no target business performance metrics. Instead, it provided qualitative descriptions of strategies like focusing on securities brokerage systems, training technical staff, and strengthening project management office operations.

Despite the focus on securities brokerage systems, finance industry related revenues declined over the 2017-2019 term:

Source: Company filings, compiled by Kenkyo Investing

No new medium term plan has been announced so far after 2019 earnings release.

For fiscal 2020, Showa System Engineering is guiding for 6,400 million yen ($58.4 million USD) in revenues and 492 million yen ($4.5 million USD) in operating income.

Shareholders

As of Q4 2019 (ending March 31st, 2019), Showa System Engineering had 4,810,000 shares issued and 385,169 shares in treasury, putting outstanding shares at 4,424,831.

Here are the major shareholders:

Source: Company filings & Nikkei

Hirokazu Ozaki is the son of founder Osamu Ozaki. Osamu passed away in 2016, leaving his stake to Hirokazu and Kyoko as inheritance. While there are no documents disclosing Kyoko Furutono as Osamu’s daughter, it’s safe to conclude that she is part of the founding family.

Hirokazu has been with Showa System Engineering since 1995. He became CEO in 2000 and continues to lead the company today.

There are no unexercised options.

In fiscal 2018, the company performed a large-scale share repurchase for the first time since 2014. While the disclosure statement (Japanese) noted that the purpose of the repurchase was to improve capital efficiency and provide returns to shareholders, Kyoko Furutono offloaded 140,000 of her 614,000 total shares in an off-market transaction with the company (Japanese). In total, Showa System Engineering repurchased 231,200 shares for 139 million yen ($1.3 million USD), or 603 yen per share.

The Tokyo Stock Exchange’s (TSE) JASDAQ section requires a minimum of 150 shareholders to maintain listing. Showa System Engineering had 1,304 shareholders as of fiscal 2018 filings (2019 long form filings not released as of this writing). While further share repurchases are possible, TSE requires a minimum shareholder count of 800 to transfer to the Second section and 2,200 to transfer to the First section. Hence, further large-scale repurchases are unlikely.

Financials & Valuation

  • Showa System Engineering is a system development company with long term ties to the Japanese securities brokerage industry.
  • Although the company’s financial industry exposure has largely remained proportionately unchanged over the last decade, it has increasingly become dependent on its largest customer Nikko System Solutions.
  • Without setting tangible medium term targets, Showa System Engineering aims to focus its resources on the securities brokerage industry, although performance over the last few years shows a decline in securities brokerage industry revenues.
  • At 683 yen per share, Showa System Engineering trades at 138% of adjusted NCAV with a market capitalization of 3,022 million yen ($27.6 million USD)
  • Investors can expect an investment CAGR of between 10.5% and 17%, inclusive of dividends, over the next 5 to 8 years.

Showa System Engineering is a long-established system development company with customer ties spanning decades. The company is particularly experienced in building and working on securities brokerage systems, generally having 80% of its revenues coming from the financial industry.

While the company managed to weather through the 2008-2010 global financial crisis profitably, its business performance significantly deteriorated during the period. Revenues declined by 24.8% and operating income by 64.9% from 2008 to 2010.

With no notable self developed and released software, Showa System Engineering relies on a healthy capital investment environment. More recently, the company has become increasingly dependent on long term customer Nikko System Solutions, which accounted for 21.5% of revenues in 2019. In terms of business quality, Showa System Engineering falls in the spectrum of between low and medium quality given its dependencies on work passed down from other development companies. With that said, Japan has a shortage of IT personnel, which may benefit the company.

As far as the balance sheet goes, Showa System Engineering is debt-free with an equity to asset ratio of 0.65. 67.7% of its assets come in the form of cash. Including long term investment securities, cash & equivalents account for 71.2% of assets. The single largest liability line item is the accrued retirement liabilities which accounts for 65.2% of total liabilities.

AT 683 yen per share, Showa System Engineering trades at an unadjusted 153% of NCAV with a market capitalization of 3,022 million yen ($27.6 million USD). Adjusted for long term investment security holdings, the company trades at 138% of NCAV. It’s enterprise value, adjusted for long term investment security holdings, is at negative 1,342 million yen (-$12.2 million USD). In fact, the company has not traded at a positive EV since fiscal 2014.

Industry peers include Sios (TSE: 3744), Nextware (TSE: 4814), Keyware (TSE: 3799), and Daiwa Computer (TSE: 3816).

Source: Nikkei, compiled by Kenkyo Investing

Aside from Daiwa Computer, Showa System Engineering’s operating performance has consistently been profitable and stronger than its peers. Despite this, the company trades below its peers:

Source: GuruFocus, except for Showa System Engineering. Peer metrics are unadjusted.

Given Showa System Engineering’s consistent profitability and asset-light nature of the operating business, EV/EBIT is a better indicator for valuation.

Assuming 10-year normalized earnings over the next 5 to 8 years and a fair value EV/EBIT of 2x, Showa System Engineering’s share price should appreciate to 1,260 yen ~ 1,280 yen over 5 to 8 years. Inclusive of dividends, this equates to an investment CAGR of between 10.5% and 14.5%.

Assuming a stronger 5-year normalized earnings over the next 5 to 8 years and a fair value EV/EBIT of 2x, the company’s share price should appreciate to 1,500 ~ 1,730 yen over 5 to 8 years. Inclusive of dividends, this equates to an investment CAGR of between 12.3% and 17%.

Source: Kenkyo Investing Estimates

The main risk factor that would prevent Showa System Engineering shares from appreciating is a mix of investor sentiment, the size of the company, and a downturn in the Japanese financial industry. Frankly, the market cap is too small for even smaller investment funds. Moreover, the long-term objectives are unclear, with only brief qualitative commentary provided in medium term plans.

With all that said, Showa System Engineering is still profitable and generally more stable than its peers, yet trading at considerably lower valuations (negative EV). Investors can expect an investment CAGR of between 10.5% and 17%, inclusive of dividends, over the next 5 to 8 years.

The bottom line

Showa System Engineering is an established system development company with close ties to the financial industry. The company has maintained long-term relationships with its customers, with some extending over 50 years. Although business performance is dependent on a healthy investment environment, Showa System Engineering managed to profitably weather through the 2008-2010 global financial crisis. With a long-term investment horizon, investors can expect an investment CAGR of between 10.5% and 17%, inclusive of dividends, over the next 5 to 8 years.


Kenkyo Investing
Kenkyo Investing

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