Thinking points

  • Cybernet Systems (TSE: 4312) is a mid-sized IT software distributor and developer primarily specializing in Computer-Aided Engineering which is used for engineering simulation in manufacturing and R&D fields.
  • Key challenges for the company include a high dependence on a key software vendors and a need to diversify its product offering.
  • Key opportunities include the upward trend in CAE software demand, not only at a global level, but also in Japan and other Asian countries.
  • At JPY640 per share, Cybernet trades at an adjusted EV/EBIT of 4.5x with a market capitalization of JPY20bn.
  • Assuming a fair value EV/EBIT of 2-4x, investors can expect an investment CAGR of +1.6% to +12.4% including shareholder returns, over the next 3-5 years.

Introduction

Cybernet is a IT service company selling and developing CAE (Computer-Aided Engineering) software for engineers in both manufacturing and non-manufacturing industries. The company operates under two segments. In the CAE Solution Service segment, Cybernet sells CAE software in Japan as a distributor for overseas vendors and also develops, maintains, and sells in-house developed CAE products.  In its IT Solution Service segment, the company offers products other than CAE software, such as cloud-security, endpoint security, and big-data analysis.

Source: Kenkyo Investing, based on company data

Business & operating environment

Company History

Cybernet was founded in 1985 as a subsidiary of the Japanese arm of Control Data Corp., the pioneer in supercomputing in the US. In 1985, it was acquired by KOBELCO (Kobe Steel, Ltd., TSE: 5406), a major Japanese steel manufacturer, then in 1999 was transferred to Fujisoft (TSE: 9749) which is the current parent. In 2003, the company listed its shares on the Tokyo Stock Exchange, and from the subsequent year Cybernet started to advance into Asian markets including Shanghai in 2004, Taiwan in 2008, South Korea in 2012, and Malaysia in 2018. The company acts as an agency of globally renowned vendors, such as MathWorks (1998-2009), Synopsys (1985-2020), Broadcom (ex Symantec, 1994-), and ANSYS (1985-).

Industry and Business Model

CAE (Computer-Aided Engineering) is a mathematical model written in a programming language using a set of algorithms which define the manufacturing processes. It is mainly used by engineers in a factory-based environment, allowing for more computations than by hand and for optimization.

CAD (Computer-Aided Design) and CAM (Computer-Aided Manufacturing) are often confused with CAE, but they have different functions and purposes as follows:

  • CAD (Computer-Aided Design) is used for sketching designs on a computer;
  • CAE (Computer-Aided Engineering) is used for simulating design data such as pressure resistance and heat resistance; and
  • CAM (Computer-Aided Manufacturing) is used to manufacture products according to CAD drawings. CAM creates NC (numerical control) programs to control machine tools based on CAD drawings.

Engineers first create designs using CAD software, then simulate the designs using CAE software before finalizing and passing them to CAM software. As such, the three areas complement one another.

The CAE market in 2020 is estimated to be $8bn at the global level and JPY86bn ($0.8bn) in Japan.  The global market is forecasted to grow through 2028 with a CAGR of +9.1%, owing to the increased outsourcing of manufacturing processes to emerging economies such as China, India, and Russia. 

Although the Japanese market is projected to slow down in 2021 because of COVID-19 and the stagnated demand for capital investment, it is forecasted to recover to 2020-levels by 2025, with a CAGR of +5.6% between 2021 and 2025. As for other noteworthy trends, there has been a shift from on-premise to cloud-based software, which was triggered by the COVID-19 pandemic and the subsequent need for engineers to work from home.

Source: Kenkyo Investing, based on Yano Research Institute

The company specializes in CAE, with the CAE Solution Service segment accounting for 81.5% of FY12/21 sales. As illustrated above, the size of the domestic CAE market in 2019 was JPY 83.7bn, which means Cybernet’s market share is approximately 21%. On the other hand, by product, distribution revenue accounts for 76%, while sales of in-house products and service fees such as maintenance and management account for only 24%. 

Looking at Cybernet’s product portfolio, EndoBRAIN, an AI image analysis software for colonoscopes, and Maple series, a STEM computing platform with mathematical processing, target niche fields. However, overall business performance is largely dependent on distribution contracts, and Cybernet experienced a substantial drop in revenues in FY03/09 when Mathworks (one of the biggest vendors at the time) founded its own Japan operations and terminated its distribution contract with Cybernet. Similarly, the company’s FY12/22 revenue is expected to fall by 12% as Synopsis, which accounted for 20% of Cybernet’s revenue in FY12/20, terminated its agency contract.

Source: Kenkyo Investing, based on company data

Source: Kenkyo Investing, based on company data

The company’s operating profit has hovered between 7.6% and 12.5% for the last five years, showing an improvement in OPM from 5% in the early 2010s.

Since the company focuses on selling licenses as a distributor, it does not carry the significant investment risk that comes with software development. This helped the company secure its OPM around +4% even during FY12/09-FY12/11, when sales fell significantly due to the termination of the distributorship agreement with Mathworks. One of the factors behind this was that Cybernet’s internal team was transferred to Mathworks’s newly established Japanese operations after the distribution contract was terminated. As such, the company managed to shed the bulk of its fixed costs related to its Mathworks operations.

Source: Kenkyo Investing, based on company data

Shareholders

As of the end of June 2021, the company had 32,076,000 shares issued and 883,900 shares in treasury, putting outstanding shares at 31,192,100. Foreign shareholders accounted for approximately 9.2% of total. Major shareholders are as follows.

Source: Kenkyo Investing, based on company data

Fujisoft (TSE: 9749) is one of the largest system integrators in Japan, with a market-cap of $1.6bn.  Among Cybernet’s 9 board of directors, 3 are dispatched from Fujisoft, including the president and the vice president.

In February 2022, the company announced a change to its dividend policy, going from a DOE of 6.0% to the higher of 50% dividend payout ratio or DOE of 3.0%.  The actual payout ratio so far has been 60-77% over the last 5 years.

Furthermore, on February 14, 2022, Cybernet also announced a share repurchase amounting to 320,000 shares (1.03% of issued), or JPY 230mn.  There are no share acquisition rights outstanding.

Financials & valuation

  • Cybernet Systems (TSE: 4312) is a mid-sized IT software distributor and developer primarily specializing in Computer-Aided Engineering which is used for engineering simulation in manufacturing and R&D fields.
  • Key challenges for the company include a high dependence on a key software vendors and a need to diversify its product offering.
  • Key opportunities include the upward trend in CAE software demand, not only at a global level, but also in Japan and other Asian countries.
  • At JPY640 per share, Cybernet trades at an adjusted EV/EBIT of 4.5x with a market capitalization of JPY20bn.
  • Assuming a fair value EV/EBIT of 2-4x, investors can expect an investment CAGR of +1.6% to +12.4% including shareholder returns, over the next 3-5 years.

Thanks to stable demand for its products, Cybernet has been operating completely debt-free over the last decade, and is extremely cash-rich, with cash and equivalents  of JPY16.0bn out of total assets of JPY23.3bn as of December 2021. As a result, it maintains a strong balance sheet with an equity ratio of 65.7%.

Some challenges the company faces include a high dependence on specific products and their distribution contracts, as well as the need to diversify their product portfolio. As mentioned above, the company’s topline plummeted when major contracts were terminated in 2009 and 2020, and thus it is essential for Cybernet to maintain a healthy relationship with Ansys, Inc. (Nasdaq: ANSS), the current largest vendor. Whilst Cybernet was awarded as “Channel Partner of the Year 2019” by Ansys, Inc. and has been authorized as “Ansys Elite Channel Partner” for 6 years in a row since 2015 (Cybernet is the only Ansys distributor in Japan), Ansys itself launched its Japan subsidiary in 2001. Currently, Ansys Japan focuses on marketing activities for Ansys products and services, but may insource its sales and maintenance business in the future. If this materializes, Cybernet may experience a substantial drop in sales once again.

In terms of opportunities, Asian countries including Japan, which are Cybernet’s main operating area, will continue to be the core of global manufacturing engineering for the foreseeable future, and demand for CAE software sold by the company is likely to remain strong.

At JPY640 per share, Cybernet trades at an adjusted EV/EBIT of 4.5x with a market capitalization of JPY20bn. Assuming a fair value EV/EBIT of 2-4x, DOE of 6%, and stable IT investment, the company trades roughly at fair value, and investors can expect an investment CAGR of between +1.6% and +12.4% including shareholder returns, over the next 3 to 5 years.

The bottom line

Cybernet is a mid-sized IT software distributor and developer specializing in CAE (Computer-Aided Engineering), with roughly 21% market share in the Japanese CAE market.  Although the company faces some challenges such as a dependence on certain software vendors and a need to diversify its product portfolio, it also has tailwinds such as  the upward trend in CAE software demand in Japan and Asia. Buying in at JPY640 per share, investors can expect an investment CAGR of between +1.6% and +12.4%, including shareholder returns, over the next 3 to 5 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.