Description
Thesis
The recent turmoil in Japan has led to a good deal of bargain hunting among Japanese equities. Among these stocks, I believe that Monex Group (8698 JP / MNXBF) provides a uniquely skewed opportunity, with a reasonable margin of safety and significant upside potential.
At JPY 19,500, Monex is valued like many other 2% ROE Japanese companies, trading at a discount to book. However, unlike a typical stock with this profile, Monex has tremendous operating leverage that is capable of spurring a dramatic increase in profitability.
Company Overview
Monex Group is the 2nd largest online broker in Japan. It was founded in 1999 by Oki Matsumoto (8.7% owner) who left his position as a partner at Goldman pre-IPO to start an online brokerage, walking away from a rumored $100m payout. I'm hoping he proves crazy like a fox, instead of just crazy.
The company was listed on Section One of the TSE in 2005 and began trading around JPY 140,000 a share. Monex has since fallen to JPY 19,500.
Monex's poor performance has largely been driven by steadily declining trading volumes. According to data from the Japan Securities Dealers Association, online trading value from 2006 to 2010 has sequentially decreased as follows (trillions JPY): 273, 260, 231, 167, 155.
This decline in trading has led to a magnified decrease in Monex's profitability. Net income from over the same period has steadily fallen ('06-'10 in billions JPY): 13.6, 9.5, 7.2, (2.1), 3.7.
This amplified drop in profitability relative to trading volumes is easily understood after considering Monex's cost structure. As you can imagine with an online brokerage, the majority of Monex's costs are fixed. As of 2010, 76% of costs were considered fixed (primarily systems and personnel-related).
This operating leverage has led to significant pain on the way down and Monex has hovered close to break-even over the past two years. In response, Monex has attempted to reduce its market-sensitivity by targeting new geographies and business segments. Despite some progress, Monex remains heavily sensitive to market conditions, with over 70% of 2010 revenue coming from market-sensitive "flow" sources (equity, fixed income, mutual fund, FX, and option commissions).
Current Valuation
At current levels, Monex provides an asymmetric opportunity. Its price tag is reasonable: a depressed valuation from a market downswing has been further exacerbated by the recent panicked market selloff. This presents a reasonable margin of safety, with Monex trading at 90% of book.
However, Monex is heavily geared on the upside. I don't want to seem like another fool calling for a renaissance in Japanese equities - it is not necessary for the market to return to '06 & '07 levels. Even a modest pickup will have a levered impact on Monex's results. Additionally, the post-crisis spike in volume and newfound bullish sentiment on Japanese equities seen around the market (see: the latest cover of Barron's, every single sell side strategist, and even the influx of Japanese companies seen on VIC!) bodes well for trading activity and next Q's results. In the event interest in Japan doesn't fade and we see a secular increase in market activity, upside could be tremendous (we can dream, can't we?).
If none of the above materializes and volumes quickly fall back to pre-crisis levels, you are left holding a marginally profitable Japanese company you bought at a discount to book value.
Balance Sheet Risks
With a brokerage, you're likely concerned whether you're buying into any gargantuan hidden exposure à la E*TRADE. While this can be a difficult determination, I have a reasonable degree of comfort with Monex's assets due to (1) a conservative balance sheet, as demonstrated by capital adequacy ratio of 411% vs. a 150% regulatory requirement, (2) Monex's ability to withstand the '08 crash, and (3) proactive disclosure, exemplified by the near-immediate release of a likely loss of JPY 1.3B due to uncollectible credit following the Sendai quake and tsunami.
Catalyst
Improved results following recent spike in trading activity