Thinking Points
- INES Corporation (TSE: 9742) is a system development company with a particular focus on the financial and public sectors.
- The company was originally set up as Gibraltar Life Insurance’s data processing arm, which was subsequently spun off.
- Shortly after the spin off, INES Corporation ventured into the public sector and grew into a nationwide operator after landing several contracts with the central government.
- At 1,437 yen per share, INES Corporation trades at an adjusted 1.5x EV/EBIT with a market capitalization of 34,152 million yen ($324 million USD).
- Investors can expect an investment CAGR of between 5.8% and 16.8%, inclusive of dividends, over a three year timeframe.
Introduction
INES Corporation (TSE: 9742) mainly engages in system consulting, development, operations, and maintenance with a particular focus on the financial and public sectors. The company is a single segment operation, but discloses revenues by category:
One quick look at historical financials would suggest that INES Corporation operates a substandard business. However, the company adopted ROE as a management metric in recent years, and has taken steps to improve capital efficiency such as large-scale share repurchases and selling its Tokyo HQ office building.
The business & environment
The roots of INES Corporation can be traced back to Kyoei Life Insurance (now Gibraltar Life Insurance, under Prudential Financial). In 1964, the data processing arm of Kyoei Life was spun out, marking the birth of INES Corporation.
The company’s involvement with the Prudential Financial Group, as well as the broader financial industry, continues today. Prudential Systems Japan/Gibraltar Life Insurance have been listed as major customers (accounting for over 10% of annual revenues) from time to time through FY03/18, and Prudential Systems Japan accounted for 9.8% of revenues in FY03/19.
Not long after the spin off, however, INES Corporation ventured out into the public sector. In 1968, it became the first private data processing center to develop a resident register information system for local governments.
In 1972, the company proceeded to develop an accounting system for the Japanese Ministry of Finance. After gaining a stamp of approval, INES Corporation was hired again by the Ministry of Finance to build and operate an operations and management system in 1973. After receiving this contract, the company started operating nationwide, opening offices in Sapporo, Northern Kanto, Nagoya, and Osaka.
Meanwhile, INES Corporation pursued system-related contracts in the financial industry as well. In 1974, it was awarded a contract for the operation of cash dispenser centers for Sogo Banks, a type of bank mainly catering to SMEs which were converted into second regional banks after 1989.
After being awarded several system and network development contracts by the Ministry of International Trade and Industry in the 1980s, INES Corporation started working on developing its own packaged software. In 2000, it released its first packaged software system WebRings, aimed for overall civil service management. This was followed by the introduction of asset management system InsAsset geared for banks as well as its own ERP system Aerps tailored for the automotive industry in 2007.
The company grew closer to the Hitachi Group around the same time, signing a business and capital partnership agreement with Hitachi Software Engineering (now Hitachi Solutions) in 1999. In 2004, INES Corporation acquired Hitachi Soft Service (now SK Support Service).
As the Hitachi Group works to consolidate its portfolio and partnerships, INES Corporation has recently grown closer to the Mitsubishi Group. In 2018, the company signed a business and capital partnership agreement with Mitsubishi Research Institute (TSE: 3636), which subsequently made Mitsubishi Research Institute the leading shareholder of INES Corporation. In October 2019, Mitsubishi Research Institute purchased Hitachi Solution’s stake in INES Corporation.
Over the past decade or so, INES Corporation hasn’t been able to grow its business:
Interestingly, the context of the above chart changes when looking at revenues by customer industry:
While INES Corporation’s overall revenues has gone roughly nowhere in the past decade, its Public & Financial sector revenues have gone up while revenues generated from other industries has declined.
More importantly, the company’s gotten more profit and capital efficiency conscious in the recent few years.
It’s important to note here that the company posted net losses in FY03/08, not because of the global financial crisis, but because it wrote-off about 2,300 million for WebRings, its civil service management software system, amid intensifying competition. For those looking further back, FY03/06 losses stemmed from higher than expected data transfer costs for the civil service management system when transitioning away from mainframe systems.
One way to look at the company’s historically low operating margins is its tie-up with major corporations. INES Corporation is now a mid-tier system developer and integrator, but profitability may have been pressured for contracts with some of its larger business partners. Looking through filings dating back to FY03/06, at least the last three CEOs (including current CEO Etsuro Mori) came from the Hitachi Group. More recently, board members with a Mitsubishi background have been elected. Kouichi Yoshimura, who is set to assume the CEO position on April 1, 2020, appears to have spent his entire career with INES Corporation.
With that said, the company doubled down on efforts to improve capital efficiency, taking tangible steps like selling its two Tokyo buildings in the last few years, and applying some of the proceeds to share repurchases. In 2013, the company moved its Tokyo Akasaka HQ to Tokyo Chiyoda, and proceeded to sell the Tokyo Akasaka building in 2015.
In March 2015, when the company announced the sale of its Tokyo Akasaka HQ, it had a book value of about 2,318 million yen ($22 million USD) and the agreed upon selling price was 3,200 million yen ($30.4 million USD) for a gain of 882 million yen ($8.4 million USD). The company successfully completed the transaction as planned during FY03/16.
More recently during FY03/19, the company signed an agreement to sell its Tokyo Chiyoda office building (land included). According to the November 2018 announcement, the book value of the property was about 8,200 million yen ($77.8 million USD) and the selling price is 12,500 million yen ($118.7 million USD) for an expected gain of about 4,300 million yen ($40.8 million USD). The agreement was set to take effect in November 2019, but according to Q3 FY03/20 filings, the company successfully sold the Tokyo Chiyoda office building in October 2019.
Additionally, the company did a sale leaseback on its Yokohama office, selling the office for 5,900 million yen ($56 million USD) and booking a 2,500 million yen ($23.7 million USD) impairment charge in the process.
In FY03/20, the company expects the sale of Tokyo Chiyoda office (4,400 million yen gain), the sale of Yokohama office (2,500 million yen loss), the expected sale of miscellaneous properties (1,100 million yen loss), and office relocation costs (8 million yen cost incurred under operating expense) to net out to a 0 gain/loss.
Interestingly, for each sale, the identity of the purchasing party is not disclosed. Perhaps, it may be a Mitsubishi affiliate. If this is the case, INES Corporation may not have gotten the full market value of its properties.
On the operations side, the company initially forecasted revenues of 39,000 million yen ($370 million USD, +2.2% YoY), operating profit of 2,200 million yen ($20.9 million USD, +1.4% YoY), and no net income forecast for full-year FY03/20. After multiple revisions (mostly due to sale of properties), the company’s FY03/20 forecast (as of January 30, 2020) is revenues of 42,500 million yen ($403 million USD, +11.4% YoY), operating profit of 3,000 million yen ($28.5 million USD, +38.3% YoY), and net income of 1,900 million yen ($18 million USD, +27.3% YoY).
As of Q3 FY03/20 (ending December 31, 2019), the company reported revenues of 29,713 million yen ($282 million USD, +12.5% YoY), operating profit of 2,214 million yen ($21 million USD, +83.7% YoY), and net income of 2,741 million yen ($26 million USD, +244.2% YoY).
Shareholders
As of Q3 FY03/20 (ending December 31, 2019), INES Corporation had 23,900,000 shares issued and 96,058 shares in treasury, putting outstanding shares at 23,803,942 shares.
Here are the major shareholders:
Perhaps the most interesting part about INES Corporation’s shareholder list is that group companies of two large conglomerates topped the list until recently. While the current CEO (Etsuro Mori) of INES Corporation is from the Hitachi Group, the next CEO (Kouichi Yoshimura) will be a career-long employee of INES Corporation.
In October 2019, Mitsubishi Research Institute purchased Hitachi Solutions’ shares in INES Corporation. Currently, 4 of 9 board members have a Mitsubishi background, and we can expect Mitsubishi’s influence to be greater than before.
As for shareholder returns, INES Corporation periodically repurchased shares leading up to the global financial crisis, but stopped after the crisis. In FY03/13, the company repurchased 8,732,300 shares (21.4% of outstanding shares in FY03/12) for 6,200 million yen ($58.9 million USD), or 700 yen per share. Approximately half of the shares repurchased were from Hitachi Solutions, which subsequently offloaded another 2,543,700 shares within weeks of the end of the repurchase program.
In FY03/16, after selling the Tokyo Akasaka HQ office, INES Corporation repurchased 3,744,904 shares (11.7% of outstanding shares in FY03/15) for 4,350 million yen ($41.3 million USD), or about 1,161 yen per share.
In FY03/17, the company proceeded to repurchase 2,159,252 shares (7.6% of outstanding shares in FY03/16) for 2,433 million yen ($23.1 million USD), or about 1,127 yen per share.
In FY03/18, INES Corporation repurchased a trivial amount of shares.
In FY03/19, the company repurchased 4,828,694 shares (18.5% of outstanding shares in FY03/18) for 6,002 million yen ($57.0 million USD), or 1,243 yen per share. During the same period, the company sold 2,490,000 of treasury shares to Mitsubishi Research Institute for 2,946 million yen ($28.0 million USD), or about 1,183 yen per share as a part of the business and capital partnership.
As of Q3 FY03/20, the company repurchased 3,348,100 shares (14.1% of outstanding shares in FY03/19) for 4,134 million yen ($39.2 million USD), or about 1,235 yen per share.
Meanwhile, INES Corporation has generally paid out between 400 million yen ($3.8 million USD) and 700 million yen ($6.6 million USD) in dividends since FY03/10.
Financials & Valuation
- INES Corporation is a system development company with a particular focus on the financial and public sectors.
- The company was originally set up as Gibraltar Life Insurance’s data processing arm, which was subsequently spun off.
- Shortly after the spin off, INES Corporation ventured into the public sector and grew into a nationwide operator after landing several contracts with the central government.
- At 1,437 yen per share, INES Corporation trades at an adjusted 1.5x EV/EBIT with a market capitalization of 34,152 million yen ($324 million USD).
- Investors can expect an investment CAGR of between 5.8% and 16.8%, inclusive of dividends, over a three year timeframe.
Despite operating as a system development company, INES Corporation’s operating margins trails that of similarly sized peers:
The reason behind this may be attributable to the influence of major shareholders on INES Corporation’s business. In any case, the operating business is substandard to say the least.
With that said, the company maintains a debt-free balance sheet with an equity to asset ratio of 0.70. Furthermore, it not only started focusing on ROE, but has taken drastic tangible steps to improve capital efficiency in recent years.
INES Corporation went from having a net cash balance sheet and an oversized real estate portfolio through the financial crisis to aggressively applying excess cash to share repurchases in FY03/13, then unlocking its real estate portfolio for further repurchases from FY03/16 until now (Q3 FY03/20). For reference, from FY03/12, the company’s outstanding share count has gone down by 41.6% (as of Q3 FY03/20).
With its Tokyo Chiyoda and Yokohama offices sold, INES Corporation appears ready for another large scale buyback given its recent history.
At 1,437 yen per share, INES Corporation trades at 2.1x EV/EBIT with a market capitalization of 34,152 million yen (324 million USD). Adjusted for long-term investment security holdings, the company trades at 1.5x EV/EBIT.
Assuming about 2,000 million yen ($19 million USD) in operating profits (vs. ~3,200 million yen TTM as of Q3 FY03/20) and repurchasing between 5% to 14% of outstanding shares each year, investors can expect an investment CAGR of anywhere between 5.8% and 16.8%, inclusive of dividends, over the next three years. This is likely a conservative scenario given the lower operating profit estimates, the company’s history of large scale buybacks vs. ~5% outstanding shares repurchases on the low end, and the three year timeframe.
The bottom line
INES Corporation operates a substandard but profitable business with a historically overcapitalized balance sheet. In recent years, however, the company has taken tangible steps to improve capital efficiency, and is expected to continue on this track. Investors can expect an investment CAGR of between 5.8% to 16.8%, inclusive of dividends, over a three year timeframe.
