Mieko Network 4668
May 16, 2010 - 11:09pm EST by
2010 2011
Price: 640.00 EPS Y60 Y65
Shares Out. (in M): 28 P/E 10.5x 9.8x
Market Cap (in $M): 198 P/FCF 10.5x 9.8x
Net Debt (in $M): -70 EBIT 30 32
TEV ($): 128 TEV/EBIT 3.8x 3.3x

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Meiko Network (4668 JP) is one of only two after school prep schools operating academic tutoring and exam preparation on a national basis. The company provides services for elementary, junior high, and high school students. Meiko is the market leader in the low pupil to teacher segment and is the only school operating on a national level with this product offering. Meiko has a 30 year history and is a well known and long established national brand. The company runs 1,813 schools, of which 201 are operated directly and 1,612 are operated as franchisees. Although half of the consolidated revenue comes from the directly run stores, the franchisee operation generates much higher margins and accounts for a disproportionate share of the company's overall profitability.

Meiko is a classic franchise business with wonderful economics in which shareholders participate in growth funded by other people's money. Operating margins have consistently been in the range of 22-25%, and return on capital employed is sort of impressive at 300%+ on a pretax level (typical franchise model with de minimis PPE and very little working capital requirements).  The business is very defensive and the company has basically grown through the great recession without missing a beat.

There are two types of cram school markets in Japan, traditional large classroom and low pupil to teacher.  Meiko operates in the low pupil to teacher segment.  Overall the cram school market has shrunk from Y960bn in 2005 to Y914bn in 2009.  However during this time period the low pupil segment has grown from Y354bn to Y363bn, as this teaching model has been taking share.  Within the low pupil to teacher segment, Meiko is the market leader with 11.7% market share in 2009 (vs 9.5% in 2005).  As a result, despite operating in a stagnant industry, share shift towards the Meiko model, and share gains within the segment, have allowed Meiko to grow the top line at a CAGR of 4.7% since 2005 (and 5.7% since 2003).

Going forward the company seems capable of achieving similar growth.  Several years ago Meiko purchased a small stake (USD6mn current market value) in another publicly listed education company, Gakken Holdings. Though such an investment raises eyebrows, there is a strategic merit to the tie-up. Gakken has about 14k franchise style classrooms educating about 200k elementary school students. Meiko targets middle school students and currently has approximately 120k students. The intention is for Gakken to act as a feeder for Meiko for both siblings and students leaving the Gakken system, thereby stimulating demand for Meiko's offering.  Although it has taken longer than anticipated, it is expected that Meiko will start seeing some revenue synergies from the Gakken tie-up this coming fiscal year.

Demand is expected to be further stimulated by recent changes to the Japanese education system.  Without going into great detail, in 2011 curriculum guidelines will be introduced that place greater emphasis on creating a rigorous academic environment.  The foundations of these changes are longer instruction times and mandatory English classes.  The net result is forecast to drive an increase in demand for cram schools to assist students in handling the increased workload.

Even without the assistance from the above, the company has done an excellent job growing locations over the past four years (1,451 to 1,831) and has a target of 2,300 within five years.   As a data point, the company has grown the number of students in the system from 37,317 in 1997 to 119,848 in 2009 (CAGR 10.2%).  During this time period the number of students has never declined, and though growth has slowed as the organization has grown, the number of students still managed to grow at a 5 year CAGR of 5.9%.

With respect to whether the business deserves to exist, it is profitable model for the franchises.  There are 1,612 franchise locations operated by 461 independent owners.  More than half the franchisees operate 2 or more locations, with more than half of the multiple operators having 3 or more locations.  The cost of a new franchise is relatively modest at Y11.5m (~USD115,000), of which only about USD30k is an initial license fee.  A new location can reach b/e at about 28 students if the owner is teaching, or 40 students if a third party is hired to provide instruction.  In comparison the avg number of students per location in August 2009 (August fiscal year-end) was 66.1 students.

The company is significantly larger than its regional peers, allowing for scale that manifests itself in brand development.  The company is the only player in its segment to have the advertising budget to engage in national advertising using television, newspapers, magazines, and promotional gifts that employ the infamous Helllo Kitty in combination with the company’s logo.  This allows for a virtuous cycle, whereby the larger Meiko gets, the more they can invest in marketing, which further strengthens the brand.  The company also invests not insignificant sums in a quality training program as well as a recently implemented IT system that was customized to increase the effectiveness and efficiency of how teachers interact with students (picture a student does a test, results are fed into the computer, system sends back what type of activities should be worked on to increase effectiveness based on statistical significance of historical studies).

The founder owns about 14% of the company and is not a bad guy.  Dividends have been increase every year since 1998 and the company has never diworsified.  The company just moved to a new HQ, however they are renting, so no worries about anybody buying a building.  Management has intermittently bought back shares, including a rather large 15% buyback that was completed last month.  The dividend was 18/share in 2009, which I would expect to increase to at least 20/share for fiscal 2011, which would imply a 3% dividend yield based on my forecast (33% payout ratio, in-line with historical).

Net of the buyback there are about 28.4m shares outstanding (Bloomberg does not exclude treasury shares from the share count).  This implies a market cap of Y1.8bn against the company’s forecast of Y0.180bn in net income for fiscal year ending August 2010.  So you are paying about 10x earnings for a nice business that Buffett would probably buy at these prices if he could.  As an added kicker the company should have cash and securities equal to about Y6.5bn by the end of August, which would be a little more than a third of the market cap….treat them as you would like.


Nothing sexy.  Good business at a good price.
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