- Rakuten is now officially the 4th telecom operator in Japan after SoftBank, NTT, and KDDI.
- As a new entrant with no legacy debt, it has a competitive advantage, which allows leveraging the latest cloud-based virtual network technology from the start.
- Rakuten has partnered with KDDI to launch an offering at 50% cheaper price than SoftBank and NTT. KDDI has a bleeding market share and will be very incentivized to win.
- At 1x P/S, Rakuten is an attractive buy. The stock has received a lot of pressure in the last few years, potentially due to the volatile profit margins and perception of over-expansion.
- Rakuten is still the largest eCommerce player in Japan by far. Core business still grows at +18%, while it also has enough scale and capital to enter virtually any market.
Rakuten (OTCPK:RKUNY) is the largest eCommerce company in Japan. At ¥1.3 trillion (~$12 billion) of revenue in 2019, it is roughly 8 times smaller than SoftBank (OTCPK:SFTBY). Given its success in eCommerce, the company has diversified its business by expanding into fintech, media, logistics, and more through M&As, organic, and also minority investments in the last decade. Despite consolidated revenue consistently growing at +15% and even accelerating to ~18% in recent times, net income and ROE have been quite volatile.
The stock reached its all-time-high of ~¥2,000 per share in 2015, right after the business delivered an all-time-high ROE of 19.5%, driven by the five-year-high net income of ~¥71 billion. Since then, however, share price has been in a downward trend and now trades at ~¥976 per share, even after the company finally achieved an all-time-high net income of ~¥141 billion two years ago. Rakuten's continuing investments into new ambitious projects, which many view as over-expansion to some extent, may have played a role in driving such less favorable sentiment. All that aside, we found its recent ambitious expansion into the telecom sector to be highly attractive. We are bullish on Rakuten and believe that the current price level provides a good entry point.
Before Rakuten entered the market, there were three big telecom players in Japan: NTT Docomo (OTCPK:DCMYY), SoftBank, and KDDI Corporation (OTCPK:KDDIY). Given that these players have been relying on legacy infrastructures for decades, Rakuten has a strategic position as a new entrant since it will be able to leverage all the latest technology, such as the virtual cloud-based network, without having any legacy debt. This is why SoftBank, NTT Docomo, or KDDI will not be able to easily copy this move. KDDI, in the meantime, has entered a partnership with Rakuten to launch the offering. This is a good move by KDDI, whose revenue has been flat in recent times while some of its businesses are declining.
(Source: company's Q1 earnings call slide)
As expected, Rakuten's lower-cost cloud-based technology has allowed the company to launch its mobile plan offering at a very aggressive pricing point. At ¥2,980/month, the plan comes at ~50% cheaper price than those of SoftBank or NTT. For context, a 5GB plan offered by NTT costs +¥5,000, while the similar one offered by SoftBank costs ~¥6,500.
(Source: company's Q1 earnings call slide)
We believe Rakuten has a strong positioning to succeed in reaching its target of 3 million users by the end of 2020. As it stands, it is well-capitalized and already has a strategic presence in other online consumer areas such as eCommerce and fintech, which will accelerate the overall user acquisition at a lower cost. Indeed, the majority of the registration has happened online so far. Since the launch in Q1, data consumption has increased by 3x while the number of base stations on air has also exceeded the initial plan.
When it comes to expanding into new businesses, Rakuten has been very aggressive. The ambitious mobile project comes at a time where the company has also been investing in several other new capital-intensive businesses, such as logistics. Over the last five years, the company has burned through ~¥700 billion of cash to finance these initiatives.
(Source: Rakuten's financial report)
As a result, its cash-flow-positive core business has pretty much been subsidizing these projects. To provide additional liquidity, the company has also consistently raised massive amounts of capital. In the last two years alone, it raised over ¥650 billion.
Going forward, we also expect operating margin in the mobile segment to continue declining as it expands its coverage nationwide. This reported mobile segment, however, also potentially includes the results from its Viber business unit, which is likely loss-making. Viber is a WhatsApp-like mobile messaging app that belongs to one of Rakuten's M&A initiatives, which at times has been questionable. The OverDrive business, which it recently sold to KKR, was also one of them.
With ~¥1.3 trillion market cap and consolidated revenue of ~¥1.2 trillion, Rakuten's ~1x P/S is fair and attractive. In addition to the interesting bet on the mobile segment, this is the reason why we rate Rakuten as a buy. With ¥1.2 trillion of revenue, Rakuten is still the largest eCommerce company in Japan with enough capital and scale to invest in almost anything. It is rare to find an innovative market-leading company trading at such a multiple. Amazon (AMZN) and Alibaba (BABA), for instance, trade at ~4x and ~7x P/S respectively, considering their stronger growth and cash flow profitability.
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