Obic 4684
February 01, 2011 - 2:01pm EST by
gocanucks97
2011 2012
Price: 15,920.00 EPS $1,325.00 $1,535.00
Shares Out. (in M): 10 P/E 12.0x 10.4x
Market Cap (in $M): 2,000 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 17,247 19,000
TEV ($): 0 TEV/EBIT 2.0x 2.0x

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Description

Japanese sum-of-parts stories have trapped countless investors over the years. Nevertheless, I am recommending yet another possible Japanese value trap, as I find valuation too cheap to resist - where else can you buy a highly profitable and growing software company for under 2x EV/EBIT? The company is OBIC (Bloomberg 4684 JT).

 

A couple of caveats. First, OBIC has a market cap of $2B US, but it doesn't trade a lot. With some patience, you can accumulate a decent position over time. Secondly, OBIC doesn't report in English (not even press releases on quarterly/annual results). Therefore much of the numbers in this write-up comes from my colleague and sell-side sources, which may not be entirely accurate. That said, I think the stock is so cheap that being approximately right is good enough.

 

Company description: OBIC is an ERP/system solution vendor targeting mid-sized enterprises in Japan. The core product OBIC7 is an integrated application package that handles functions like accounting, payroll and inventory management. The company also offers some industry specific systems. They don't directly compete with SAP/ORCL, but more with local players like Fujitsu. Roughly 60% of sales/EBIT comes from "System Integration Services", which are mostly new license sales. 25% of sales (35% of EBIT) comes from "System Support Services" (software maintenance sales), and the rest from "Office Automation Services". Roughly 15% of sales are hardware related. Customer verticals are pretty evenly split between Finance, Manufacturing, Wholesale/Retail, and Distribution Services. Intuit in US, Sage in UK, Totvs in Brazil may be decent global comps.

 

Like most other software companies, OBIC has a very sticky user base, and the business model is highly profitable and FCF generative. Frankly, I have rarely seen such profitable companies in Japan.


2003.3 2004.3 2005.3 2006.3 2007.3 2008.3 2009.3 2010.3 2011.3 2012.3 2013.3
Revenue 40,104 42,124 44,943 45,749 45,746 47,357 47,423 46,318 48,834 52,012 55,993
SI 26,453 27,881 29,743 29,653 29,037 29,972 30,176 29,140 30,597 32,739 35,358
SS 8,936 9,299 9,659 10,209 10,673 11,036 11,613 11,966 12,504 13,255 14,315
OA 4,713 4,943 5,540 5,886 6,035 6,348 5,633 5,211 5,732 6,019 6,320












Growth rate   5.0% 6.7% 1.8% 0.0% 3.5% 0.1% -2.3% 5.4% 6.5% 7.7%
























Gross Margin 19,041 19,930 21,151 21,508 22,227 23,212 24,584 25,411 27,347 29,387 31,916

47.5% 47.3% 47.1% 47.0% 48.6% 49.0% 51.8% 54.9% 56.0% 56.5% 57.0%












SG&A 8,486 8,842 8,950 8,921 9,377 9,642 10,277 10,033 10,100 10,200 10,300

21.2% 21.0% 19.9% 19.5% 20.5% 20.4% 21.7% 21.7% 20.7% 19.6% 18.4%












OP 10,555 11,088 12,201 12,586 12,849 13,570 14,307 15,377 17,247 19,187 21,616












OP Margin 26.3% 26.3% 27.1% 27.5% 28.1% 28.7% 30.2% 33.2% 35.3% 36.9% 38.6%
OP Growth   5.0% 10.0% 3.2% 2.1% 5.6% 5.4% 7.5% 12.2% 11.2% 12.7%
























RP 11,381 12,654 14,005 15,220 16,237 17,671 17,318 18,839 21,293 23,322 25,732
Net Profit 4,990 7,640 8,376 9,394 10,203 9,868 9,419 11,433 13,202 14,460 15,954
Tax 39.0% 39.2% 37.7% 37.9% 37.0% 35.7% 41.0% 37.5% 38.0% 38.0% 38.0%












EPS 498 774 857 966 1,051 1,017 976 1,187 1,325 1,535 1,693
DPS 85 80 110 160 200 300 320 350 370 420 470

Fundamentals Improving: OBIC's growth slowed down dramatically after '05 for a number of reasons - subpar product release, going after larger clients/projects, and obviously the sluggish Japanese economy. However, mgmt did a nice job through the downturn, improved margins through cost cutting, and finished 2010 at the highest margin in corporate history. Importantly, with the new Obic7FX product release, revenue and orders are starting to grow again. Through first 3 quarters of FY '10, topline grew 3%, orders grew high single digits, and EBIT grew 9%. There should be a catalyst next year, as Japan is starting to adopt IFRS, which may spur demand. For the next 2-3 years, I think the company can deliver 6-7% topline growth and close to 10% EBIT growth with continued margin expansion.

Valuation: The stock closed at 15,920 Yen today and has a market cap of 158B Yen. It is already a pretty cheap software stock at 10x '11 EPS, but the stock is screaming cheap on EV basis.

Mkt Cap 158,563
Total Cash/ST/LT inv 100,151
 Cash 45,000
 ST 6,000
 LT 49,151
Russia Bond (high yield) 21,000
    Others 28,151
 Land  23,931
 Unrealized gains (not included in EV) 10,000
EV (mkt cap - cash/st/lt inv - land)  34,481
EV/ 2011 EBIT 1.8

I know what you are thinking. Russian Bonds? Like many other investors chasing high yield (ARS feels like a distant memory now), OBIC invested in some Russian high yield bonds denominated in Yen. My understanding is that the company should see the first of three issues (6b Yen) redeemed by next month with the other two in September 2013. There are already a couple of delays with the first tranch, as it was supposed to redeem in May 2010. So this is creating a lot of angst/uncertainty among analysts about how to value the securities. I find it comical that one of the recent sell-side notes with a title "B/S Risks Remain", as it is clear that nobody is giving them any credit for cash/investments/Russian bonds.

Like most other Japanese companies, proper capital allocation is not in their dictionary, which is the only knock on the company (albeit a big one). Company pays a token 2% dividend, and buys back very few shares. One can argue how much of a discount we need to apply to these idle assets on the balance sheet. One thing we can be certain is that they probably won't touch any exotic investment in a long long time. My point is that the stock is fairly cheap on earnings, and screaming cheap in the hands of right owners. It is really hard to find a global software company trading under 8-9x EV/EBIT, much less 2x.

The stock sold off 5% two days ago, after Fujitsu, one of the largest Japanese IT players, warned on weak IT spending. With topline returning to growth, I think it is safe to suggest OBIC has minimal downside from here and is easily worth 30-50% more from here. One can only dream of a similar event to Daito Trust, where the company bought back 30% of shares and stock popped 20% in one day. For reference, OBIC used to trade north of 24000 Yen 3 years ago. Earnings and cash are both 50% higher now.

Dead money is the biggest risk here.

Catalyst

Catalysts:

1. Continued earning growth

2. Redemption of Russian Bond at par.

3. Mgmt suddenly found religion with capital allocation, or emergence of Gordon Gekkos in Japan.

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