Thinking Points

  • CAC Holdings (TSE: 4725) is primarily a system development and integration service and secondarily a contract research organization (CRO).
  • The company’s operating performance deteriorated significantly following an overseas acquisition in FY12/14, which resulted in continuing losses for its overseas business.
  • While restructuring efforts led to the overseas business effectively breaking even in FY12/19, the company’s CRO segment generated losses as one major contract concluded.
  • At 1,211 yen per share, CAC Holdings trades at 0.5x EV/EBIT and 119% NCAV with a market capitalization of 20,000 million yen ($182 million USD).
  • Investors can expect an investment CAGR of between 11.7% and 14.9%, inclusive of dividends, over the next three years.

Introduction

CAC Holdings (TSE: 4725) is primarily a system development and integration service and secondarily a contract research organization (CRO). The company has three reporting segments: Domestic IT, Overseas IT, and CRO.

Source: Kenkyo Investing, based on company data


CAC Holdings is entering the third year of its four year long medium term management plan with plans to improve corporate governance, speed up decision making, increase capital efficiency, and share incentives with shareholders. While the company’s delivered on all counts so far, business performance has lagged recently.

The business & environment

The predecessor of CAC Holdings, Computer Applications Co., Ltd., was founded in Tokyo in 1966. In its early days, CAC Holdings mainly focused on system development projects, with system integration and management operations to follow. According to the company, CAC Holdings is Japan’s first independent software company. 

In 1989, the company made its first leap overseas when it setup CAC America in New York. This was promptly followed by the launch of CAC Europe in 1990. CAC Holdings continued to establish system development, integration, and operations as its core business. 

In the 2000s, around the time of the dot-com bubble burst, CAC Holdings moved forward with its first acquisition, acquiring ARK System, a system development and management company previously backed by Kobe Steel (TSE: 5406) and Recruit Holdings (TSE: 6098). CAC Holdings has since gone on an acquisition spree, which more or less continues today.

Some of its early acquisitions include system development and management subsidiaries of CAC Holdings’ customers like Yuasa Trading (TSE: 8074) and seafood company Maruha Nichiro (TSE: 1333).

Since about 2006 going forward, CAC Holdings has focused on further developing its overseas business and CRO business. Key markets for the overseas business include India, China, and ASEAN.

More recently, CAC Holdings has been restructuring its overseas business. In July 2017, the company sold off a growing and profitable Singapore-based second-tier subsidiary Accel Systems & Technologies Pte. Ltd. engaged in cyber security system development for approximately 1,560 million yen ($14.1 million USD), or about 10x operating profits. The proceeds were used to pay off debt in India-based Accel Frontline Limited, a subsidiary of CAC Holdings and the previous parent company Accel Systems & Technologies. 

In November 2017, the company sold off loss-making Singapore-based healthcare SAP implementation and consulting subsidiary Sierra Solutions. CAC Holdings acquired Sierra Solutions in FY12/15, which remained profitable until FY12/16, but produced 245 million yen ($2.2 million USD) in recurring losses in FY12/17 as sales nearly halved over a two year period. The company did not disclose the sale price citing a non-disclosure agreement with the buyer.

In October 2019, CAC Holdings acquired a growing and profitable Singapore-based software development company (Mitrais Pte. Ltd.) at about 5.6x FY12/18 EBITDA plus earnout incentives.

CAC Holdings reorganized its reporting segments in FY12/18. These segments are Domestic IT, Overseas IT, and CRO. One thing particularly noticeable even prior to the segment reorganization is the company’s generally low margins:

Source: Kenkyo Investing, based on company data

The FY12/14 spike in revenues was a result of the company acquiring India-based Accel Frontline Limited. The steep decline in operating margins in FY12/15 was also a result of Accel Frontline. Namely, CAC Holdings’ auditors discovered accounts receivables that were unlikely to be collected, which quickly turned the seemingly healthy company into a loss-making subsidiary.

As CAC Holdings worked to restructure Accel Frontline, business performance at aforementioned Sierra Solutions started deteriorating in FY12/16. In effect, CAC Holdings hasn’t been able to book profits in its overseas business since FY12/15, when it uncovered issues at Accel Frontline.

Fast forward to FY12/19 and CAC Holdings managed to cut Overseas IT segment losses to 46 million yen ($420K USD), from 600 million yen ($5.4 million USD) in FY12/17. More importantly, CAC Holdings noted that the Overseas IT segment was profitable in FY12/19 excluding M&A expenses. With that said, the improvement in Overseas IT isn’t immediately obvious as the previously profitable CRO business produced losses in FY12/19.

CAC Holdings’ CRO business is operated through its subsidiary CAC Croit, a company created through merging two subsidiaries clinical trust (acquired in 2009) and CAC EXICARE Corporation (established in 2012 through company split, underlying businesses originally acquired in 2006 and 2007).

The roots of CAC Croit are traced to clinical data entry operations dating back to the 1970s. In 1990, the company started its data management service, officially making it a contract research organization. According to the company, CAC Croit is the first CRO in Japan, offering CRO services before the term CRO became familiar in Japan.

CAC Holdings’ involvement in CAC Croit didn’t come about until 2006. When looking into CAC Croit, it’s important to pay attention to CAC Holdings’ long-form filings as the short-form filings do not provide as much information. One key data point found in the long-form filing is a simple accounting of subsidiaries that account for more than 10% of total annual revenues.

CAC Croit is one of three subsidiaries that accounted for more than 10% of total annual revenues in FY12/18. According to the FY12/18 long-form filing, CAC Croit generated 892 million yen ($8.1 million USD) of recurring profits. 

At the time of this writing, only the short-form filing for FY12/19 is available. According to the short-form filing, CAC Croit recorded a severe revenue decline as one major contract ended, resulting in a loss of 278 million yen ($2.5 million USD) for the CRO segment (CAC Croit is the only company included in the segment).

Much of the improvement is in line with the company’s current medium term management plan (FY12/18 – FY12/21). In its plan, the company focuses on corporate governance improvement through the separation of management and execution functions, faster decision making, increasing ROE, and sharing incentives with shareholders. 

Initially, CAC Holdings was targeting revenues of 70,000 million yen ($634 million USD), operating profit of 4,000 million yen ($36.2 million USD), and ROE of 8% by FY12/21. However, it adjusted targets to revenues of 55,000 million yen ($498 million USD) and operating profits of 3,000 million yen ($27.2 million USD) while maintaining ROE target of 8%.

For FY12/20, CAC Holdings expects revenues of 52,000 million yen ($471 million USD, +2.6% YoY) and operating profits of 2,000 million yen ($18.1 million USD, +52.1% YoY). 

Shareholders

As of Q4 FY12/19 (ending December 31, 2019), CAC Holdings had 20,541,400 shares issued and 4,023,505 shares in treasury, putting outstanding shares at 16,517,895.

Here are the major shareholders:

Source: Kenkyo Investing, based on company and Nikkei data


Shogakukan (private) is one of the major publishing houses in Japan. Combined with Shueisha and Hakusensha, the three companies make up the HItotsubashi Group, a publishing powerhouse controlled and operated by the founding Oga family. 

Given Shogakukan and its group’s different industry background, the relationship with CAC Holdings appears a mystery today. However, it extends back to CAC’s founding. The company’s first permanent headquarters was located inside the newly constructed Shogakukan building in Tokyo (1967). The Oga family first found out about CAC founder Okubo when Okubo went to Shogakukan to sell computers. Eventually, Shogakukan contributed to 800 million yen ($7.2 million USD) of CAC’s initial 1,800 million yen ($16.3 million USD) in investment capital and contracted out computing operations to the company.

In November 2019, CAC Holdings repurchased 410,000 shares from Shogakukan in an off-market transaction for a purchase price of 1,394 yen per share. This was part of a broader effort by CAC Holdings, which repurchased a total of 2,006,100 shares (10.9% of FY12/18 outstanding shares) for 3,000 million yen ($27.2 million USD), or 1,495 yen per share, in FY12/19. This was the largest share repurchase by the company. Prior to FY12/19, the company most recently spent 999 million yen ($9.1 million USD) in repurchases in FY12/16, and has a history of conducting repurchases periodically.

The company also initiated an equity compensation plan in 2019 which enables the company to offer up to 50,000 company shares per year to directors of the company.

Financials & Valuation

  • CAC Holdings is primarily a system development and integration service and secondarily a contract research organization (CRO).
  • The company’s operating performance deteriorated significantly following an overseas acquisition in FY12/14, which resulted in continuing losses for its overseas business.
  • While restructuring efforts led to the overseas business effectively breaking even in FY12/19, the company’s CRO segment generated losses as one major contract concluded.
  • At 1,211 yen per share, CAC Holdings trades at 0.5x EV/EBIT and 119% NCAV with a market capitalization of 20,000 million yen ($182 million USD).
  • Investors can expect an investment CAGR of between 11.7% and 14.9%, inclusive of dividends, over the next three years.

CAC Holdings’ operating performance generally floated around an unimpressive 4 to 6% prior to its FY12/14 acquisition of Accel Frontline. While the company managed to remain profitable following the acquisition, its operating performance has deteriorated to the 1 to 2% range.

With that said, it appears that the worst of the storm is over as CAC Holdings managed to effectively reach break-even for its overseas IT segment. Although its CRO business raises some concerns, it has been a growth area for over a decade, and there is a good chance that a combination of cost cutting efforts and new contracts would mitigate losses to a reasonable level.

It goes without saying that CAC Holdings’ operating business quality is mediocre at best. Its M&A strategy is likely sub-par, particularly considering the post-acquisition performance of Accel Frontline and Sierra Solutions. However, it does not appear that CAC Holdings is overpaying, although the only recent benchmark is the 5.6x EBITDA + earnout acquisition of a growing and profitable Singapore-based software development company (Mitrais Pte. Ltd.).

The key risk for CAC Holdings is more post-acquisition performance deterioration. The company isn’t shy about M&A, but it’s paid the price. Excluding poor M&A, CAC Holdings will likely inch toward normalized operating profits as the overseas IT segment is under close watch.

CAC Holdings does hold some interesting assets. Roughly half of its 15,431 million yen ($140 million USD) in long-term investment securities is shares in Recruit Holdings (TSE: 6098), Japan’s largest recruiting company, which is likely better known overseas as the parent company of the job search website Indeed.

In fact, CAC Holdings sold 2,000,000 shares in September 2019, and booked capital gains of 5,291 million yen ($47.9 million USD). Interestingly, Recruit Holdings stock has since gone up nearly 50% (as of February 26, 2020). 

CAC Holdings still carries a small amount of debt on its balance sheet, although it’s been paying it off quickly in the last couple of years. The company maintains an equity to asset ratio of 0.57 as of Q4 FY12/19.

Overall, the company’s operating business is mediocre at best (but improving) and its M&A strategy is subpar, but it has recently upped the ante on improving capital efficiency and delivering shareholder returns.

At 1,211 yen per share, CAC Holdings trades at 12.3x EV/EBIT and 813% NCAV with a market capitalization of 21,490 million yen ($195 million USD). Adjusted for its long-term investment security holdings, however, it trades at 0.5x EV/EBIT and 119% NCAV.

Assuming a fair value EV/EBIT of 2x and gradual EBIT normalization (4-6% operating margins), investors can expect an investment CAGR of between 11.7% and 14.9%, inclusive of dividends, over the next three years. One potential upside unaccounted for is CAC Holdings further selling its long-term investment security holdings and applying the proceeds to shareholder return efforts. As mentioned earlier, one key risk is the company moving forward with another poor acquisition.

The bottom line

CAC Holdings is a recovering IT company with a mediocre but improving operating business, recently aggressive shareholder return efforts, and an interesting investment portfolio. Investing at 1,211 yen per share, investors can expect an investment CAGR of between 11.7% and 14.9%, inclusive of dividends, over the next three 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.