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.
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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 |
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| Growth rate |
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5.0% |
6.7% |
1.8% |
0.0% |
3.5% |
0.1% |
-2.3% |
5.4% |
6.5% |
7.7% |
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| Gross Margin |
19,041 |
19,930 |
21,151 |
21,508 |
22,227 |
23,212 |
24,584 |
25,411 |
27,347 |
29,387 |
31,916 |
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47.5% |
47.3% |
47.1% |
47.0% |
48.6% |
49.0% |
51.8% |
54.9% |
56.0% |
56.5% |
57.0% |
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| SG&A |
8,486 |
8,842 |
8,950 |
8,921 |
9,377 |
9,642 |
10,277 |
10,033 |
10,100 |
10,200 |
10,300 |
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21.2% |
21.0% |
19.9% |
19.5% |
20.5% |
20.4% |
21.7% |
21.7% |
20.7% |
19.6% |
18.4% |
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| OP |
10,555 |
11,088 |
12,201 |
12,586 |
12,849 |
13,570 |
14,307 |
15,377 |
17,247 |
19,187 |
21,616 |
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| 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 |
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5.0% |
10.0% |
3.2% |
2.1% |
5.6% |
5.4% |
7.5% |
12.2% |
11.2% |
12.7% |
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| 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% |
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| 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.