7893 JP - Pronexus Inc

[MrB]

Elevator pitch

Pronexus Inc (7893 JP) is the market leader of disclosure and investor related products for corporations in Japan, with a market share of 62% and a 98% customer repeat rate. It has an oligopoly with Takara printing.  The company is 80 years old, family controlled and managed. It is experiencing temporary weakness due to fewer IPOs, REITs listing, fewer listed companies, etc all as a result of the general economic weakness in Japan and globally. This created the opportunity to pick up the company for almost the same value as its net cash and investments and for a EV/Sales ratio seen only twice, since 1998. It trades on a normalized PE of 6, EV of less than one year’s normalized earnings and the dividend yields 5.2%. The company is about to restart its share repurchase program.

Business

Listed companies are required to submit digital financial statements and preliminary results to the FSA and stock exchanges. Pronexus has already brought in 70% of listed companies as customers, some 90% of which use Pronexus’ Edits/Edinet system (similar to Edgar and/or Sedar) to create disclosure documents. The company’s repeat customer rate is 98.3%. Using the Edits system allows customers to efficiently and accurately create their disclosure documents. Pronexus then stores the data entered directly into the system by customers in its own database, after which the data may be used for other documents such as preliminary results, financial statements and shareholders meeting invitation letter. Based on customer-provided financial data, Pronexus can offer integrated services, and thereby make it more work for the customer to change providers, which leads to Pronexus’ high repeat rate.

Companies that come to Pronexus for help in preparing for IPOs can similarly use the data they entered with Pronexus’ other services to create security reports (yuho) and quarterly documents even after the IPO.

Segments

 

Companies Act-related (35% of sales)

Shareholder meeting related, resolutions, etc.

 

Financial Instruments and Exchange Act-related (45%)

Securities reports, quarterly reports, IPO, stock listing, Investment trusts, REITs, etc

 

IR-related and other (20%)

English language IR documents, websites, financial database, seminars, etc

 

Market

Pronexus’ main competition in almost all of its business fields is Takara Printing. Pronexus and Takara Printing split the market between them for company legal products, financial statements, IPO and PO prospectuses, and other documents, with the two dominating these areas and thereby limiting pricing competition. Pronexus took the lead in surveying the REIT-related market, and has secured an overwhelming large market share for supporting REIT IPOs. Meanwhile, Pronexus has numerous competitors in fields of investment trusts and IR.

Recent notable transactions

Considering that earnings fluctuate between ¥800m and ¥2,600m the ¥3,500m extraordinary gain as a result of land that was expropriated by the Tokyo Metroplitan Government is meaningful. However, there are also extraordinary losses due to the cost of demolishing the former plant, relocation costs, etc. At the same time the company decided to withdraw from the existing arrangement of its employee pension funds at a cost of ¥2,251m. The point is that there are extraordinary moving pieces in the financial statements from 2008-2010, which obscures the underlying performance.

Valuation

Pronexus has a market value of $190m or ¥15,629m, but it has net cash and investments of ¥13,656m, so the enterprise value is ¥1,973m. This is for a company of which the net margin averaged 7.9% over the last decade, which translates into normalized earnings of ¥1,540m on the ¥19,500m of sales, management guided for the full year to 31 March 2011. However, this is not a normal year and net earnings will be significantly lower. Management guides for ¥800m, which puts the company on an EV/NI of 2.4 Not sure where free cash flow is going to come in, but it averaged ¥1,688m per annum over the last 5 years. Pronexus has tones of cash and investments, but management is not just sitting on it. The dividend, which increased by 12.1% per annum over the last decade currently yields 5.2% With the share price starting to come down, since 2007, management repurchased 1.3m and 1.95m shares in 2008 and 2009, respectively; thereby reducing shares outstanding by 8.5% Management, suspended the buybacks as the issues around the expropriation and pension plans played out and feedback from a recent management visit is that management said to “watch this space”.

Outlook

The immediate outlook for the industry is weak, but it is cyclical due to its correlation to the stock market and surrounding activity (IPOs, Post listing offerings, number of listed companies, etc). Note that on the previous two occasions when EV/Sales came down to this level, which were in 1998 and 2003 the share price rallied by 180% from Feb 1999 to Sep 1999 and by 86% from Jan 2004 to Jun 2004 and by May 2006 the share price was 330% higher. Also, on this occasion the market will correctly value Pronexus again, which it is not doing right now. For a company with a 62% market share, a 98% customer repeat rate, a 5.2% DY and EV/NI of 2.6, operating an oligopoly this valuation just does not make sense. Especially considering the family running it owns 30% of the shares and are buying back stock.

For further research start here http://eir.eol.co.jp/EIRNavi/DocumentNavigator/ENavigatorBody.aspx?cat=ir_material&sid=7044&code=7893&ln=en&tlang=en&tcat=ir_material4&disp=simple&groupsid=158

 

Variant view

-I’ve heard that Takara is not considered a rational competitor. My research does not confirm this.

-It is inconceivable that Pronexus and/or Takara will never face issues regarding insider trading or misuse of sensitive information. Yet, according to my knowledge this has not happened in the 80 years the company has been handling sensitive information.

-Japan macro risk

 

DO YOUR OWN DD

[Baoxiaodao]

Thanks MrB. Very informative. I will take a look and looking for holes to fill.

 

One question, Mr.Buffett said cash is absolutely the worst investment going forward and if I read your thesis correctly, those cash comprise around 90% of the market capital. Let's say I buy the shares. Then what I bought is cash sitting in the bank and the valuable operating business. The dividend and buyback is decent, but it hardly moved the needle here. This is obviously a company operating in a mature market. So while the investor is getting a decent yield, the cash sitting on the balance sheet is deteriorating. Am I missing something here?

[beerbaron]

Compared to Broadridge Financial Solutions this is dirt cheap!!!

 

BeerBaron

[MrB]

Dear Baoxiaodao,

You're comments re the cash is accurate. The fact that the average ROE (including the cash) is 8.1% gives management a pass and buyback/dividend increases, since 2007 is apparently due to shareholder pressure. So management seems responsive. Lastly, I feel I'm being paid to take on the risk.

[Baoxiaodao]

MrB, the real risk going forward would be hoarding cash, no matter one put cash in the bank or invest in a business which as a lot of cash. Of course, this is just my opinion. My parents-in-law in China went to Beijing a few months ago. When they came back, they found out the underpants they used to buy went from 5/piece to 8.9. To me, it is useless to count the nominal return nowadays. I always ask myself, how many barrels I can buy with this investment in a year? How many kilos of rubber and how many pounds of sugar? Those questions make me very uncomfortable. There is nothing to be bragged about if you return 10% a year nowadays because it can barely catch up with the incoming inflation.

 

There is a also a point I want to make, which is the Japanese culture. I am reading a book called "The Chrysanthemum and the Sword“, and I recommend anyone who wants to invest in Japan to read it carefully, because it answered a lot of questions and dispelled a lot of illusions. For example, why a recession can go on for two decades? How can the Japanese not learn something and take the right action? Despite the familiarity with Japanese cartoons, movies, I was still shocked by those words in the book. Without understanding the culture first, it is quite dangerous to invest alongside with Japanese business people.

 

I have to say I did not read the annual reports, so this is my preliminary comments. Do not take it too seriously.

 

Thanks again for sharing a well-thought, carefully-rehearsed idea. We can never have enough of those on this board.

 

 

[dolce2think]

As I see the "keynesian end" approaching to Japan within the next few years, the stock market is surely worth considering, and so

are the financial shares especially.

 

You should look for Marc Fabers recent comments and for the VIC write-up on the Japanese payer swaptions.

Without that macro view, it will be hard to make money, since Japan Inc does not want to "liquidate".

Only a shift into equities, a falling yen, a monetization of the debt will bring rising shares.

When I think it through, this scenario is the most convenient for the government, the others

beeing even longer retirement age with forced JGB fund buys or a (partial) default.

 

And for all those naysayers, the market had decent rallies during the 20 year blues, e.g. 2004 to 2006/7.

Buying the brokerage shares, even local banks, or anything levered to this should be a huge winner.

Lots of stocks below cash value to be found.

 

dolce

[Baoxiaodao]

Dolce, I certainly appreciate the education here. I am a fan of Marc Faber and respect everything he says. Being ignorant of economics, I have several questions to ask, please shed some lights on these:

 

1. How does monetization work exactly in Japan's case? I understand Japan Inc. is bound to print money soon, but aren't that going to devalue its currency? Do we need to get hedged before we go in there?

2. It is very likely the money will go to the stock market since there is tremendous pressure to get real returns to fund government obligations. However, is it possible the money will also go to other sectors, like real estate?

3. Could you please give me an idea just how cheap the Japan stocks are? I recently read an article about Japan stocks' P/E ratio, and it is in the low teens. You also commented that there are lots of companies selling below cash. Could you give us a few names?

4. I am not familiar with Japanese market. Do those companies generally file in English? It would be a huge hurdle to overcome if they do not.

5. I certainly am not a naysayer and my only concern investing in Japan is the cash-rich balance sheet will be very disadvantaged in a inflation environment. What is your thought on my concern?

6. The last question would be, why the financials will do especially well if this happens?

 

Thank you very much in advance for any insights. I am looking forward to learning from you!

[rszutu604]

Great write up on a wonderful find, MrB.

 

Why is the cap ex so much higher than Depr & Amort? Thanks.

[MrB]

The land on which their main factory used to be was expropriated. They purchased land in Toda City and built a new factory. This all happened in the last two years, which skews the capex/depr ratio and gives the impression that it is out of kilter. Total capex for the last 10 years was ¥6.4Bn of which 63% was in the last two years.  If you "normalize" the last two years by taking the average of the preceding three years as the capex charge and then look at the total capex/depr for 2000-2010 then it comes out to 1 (¥3,168m/¥3,133m).

Let me know if I did not explain it well.

[rszutu604]

I'm trying to figure out what the cap ex would be going forward. The cap ex and D&A figures you quoted over the last ten years represent periods when PP&E was much lower than current levels. For example, net PP&E is about JPY 7 billion now whereas it was JPY 4 bil in 2007. Although the last two years' cap ex looked abnormal relative to prior cap ex, it may have been appropriate given current asset size.

 

Also, do you know what the market value of their real estate is? Since the company is so old it wouldn't be surprising to have some unbooked real estate value. Thanks again.

[MrB]

This is an asset light business returning 30% if you adjust for the cash and investments. In light of that the average Capex/Rev for 2000-2008 of 1.5% makes sense. The high for that period was of 3.1% (2001) and this translates into capex between ¥300m and ¥600m.

If company land was not expropriated it would likely have been years before a new factory was built. You can argue that they were subsidized to upgrade the factory. However, it was not necessary from an operational point.  The current ¥680m of depreciation charge is also a good indicator and comes to 3.4% of revenue . Another point of reference is Takara, the main and really only competitor. Takara did not have to build a new factory and averaged capex/rev of 2% over the last decade. The businesses are virtually carbon copies, so I do think it makes for a good comparison.

Considering the nature of the business I would include expenditure on intangibles (software) too, which bumps up the "capex"/rev over the last decade to 3.8% and 3.3% for Pronexus and Takara, respectively. This once again supports the notion that ¥680m of depreciation for 2010 is a good indicator of "capex".

 

In terms of the real estate I doubt that there is any significant hidden value due to the expropriation, which means most of it passed through the IS recently and sits on the balance sheet at close to market value.

Even if there is hidden value then I will not count on seeing any of that value anytime soon. It is hard enough for shareholders to pocket the cash & investment value in this business.

[dolce2think]

Bao,

 

Faber is great, he has a 1000 foot macro view - globally.

I have bought on Tuesday more shares. I think this here is a buying opportunity,

and the monetization scenario will play out sooner, due to the reconstruction money needed.

Please read the VIC report on the payer swaps (type in "japan" in the search box).

 

Japans government sector is much smaller relative to GDP vs Europes, but since

the economy (GDP, tax incomes, nominal prices) is on the downslope, I don't think

that they can raise taxes, this would kill the economy and lead to lower

taxes later on. So if the interest rate spend is 30% of total spending at a 1.5% rate,

well at 4.5% it is close to 100%, this is default. They could only amass this debt because

the population bought all the bonds internally - global investors would demand a higher

rate. So as the deficit is coming on top of this - I see no way of not defaulting somehow

in the next 5 years or so.

 

What could they do? Default - cut all bonds by 50%. Shock and awe. Unlikely.

Raise the pension age - already the highest, could be. Force bond buying.

 

OR - and now most likely since the desaster "finished all debates" and gave

the government every extra power to do what could not be done otherwise -

think of 9/11 and President Bush. Monetization of debt, means simply, that

all of the "funding gap" will be directly funded by the central bank at 1.5% interest.

Then a lot of people will at some point sell their bonds - to the central bank at

the fixed price - and put the money elsewhere. (this might happen

in the US at some point as Gonzalo Lira describes). Since there will be a huge

reconstruction program, the money will get spent by government order,

creating inflation - maybe not visible at the beginning.

Also then, the Yen will fall, creating rising profits from exports (like Germany

is having a killing due to the weak Euro vs the Deutsche Mark would have been).

This creates rising profits and taxes.

People will shift their money overseas and into stocks as they always do -

just look at 2003 - 2006. So yes, you should hedge the Yen.

I guess the "nice part" of this reflation will be short, followed by massive

dumping of the bonds into the central banks hands. What happens then is

hard to know (political decisions), but I would guess, they will let the interest

rate rise at a rate slower than inflation is, so to get rid of the debt and never

default technically (rising government income, faster than rising debt service).

 

The money will find its way into the real estate, of course, but "normally" later on,

as inflation picks up and loans are cheap. The banks (local) are very levered to the

real estate.

The local companies - are mostly not internationally owned - sell around book value,

with generally little debt and lots of cash (depending on the sector). This is after

the long bear market (kontratieff winter) typical.

 

I own: JP 1615 (banking sector etf)

JP 8622, 8614, 8625 brokerage shares, selling for around 0,33x tangible book,

mostly cash. Only Toyo (8614) has english annual reports. simple and short.

They were loosing money, but turned positive in q4. Peak earnings from 2006

were around 50% of current share prices. You can do the math what happens

when the business picks up.

Share count is lower now, due to buybacks.

More international are: Daiwa, Mizuho, Nomura. Selling below book, but lots of different

stuff on the balance sheet.

 

I see the cash rich balance sheets as a cushion - as is now evident.

Companies in Japan generally never liquidate, they bleed cash and wait

for the cycle to turn, so they can stay in business.

All that cash cushions you now, later it will find its way into stocks, etc.

The stocks will - in my view - only rise, when the earnings come in, as

was in 2006. Until then they can hold through.

 

Financials will do well since they are most levered to inflation - rising assets.

THis is the reverse of what happened in 2008 in the US.

Just imagine 30% higher assets and run the numbers in a banks balance sheet.

THe insurers would suffer, however, in rising inflation.

 

I think the broker shares are exceptional bargains here, once in a decade or so,

they could easily go up 5 to 10 times. And they tend to raise dividends and

buyback stock when they make dough, this will be a catalyst of its own.

 

dolce

 

[MrB]

"Also then, the Yen will fall"

Against what?

[dolce2think]

Mr B,

 

the Yen will certainly fall against hard assets, but I think your question

relates more to whether it will fall against other currencies, especially the USD.

I would suspect, that the Yen will fall towards 100 to 120 Yen per Dollar over

the next 3 years - baring a USD meltdown.

 

The banking and brokerhouse shares are levered to this reflation wave and will

rise much more than the Yen should fall. If you were to play safe you could hedge

50% to your home currency.

 

I am also long the Nikkei futures, holding the margin (without leverage) in my base currency.

 

It is interesting to see that McIlvaine bought into Monex (JP:8698), as it is selling

below book value and profitable, due to its low cost structure. The other more

traditional brokers are much cheaper - because they have not been profitable.

But once the masses come back into the market, I think they will "demand"

"consulting" - i.e. investment tips - as they always have.

 

dolce