CFA Institute Research Challenge hosted by CFA Society Japan Kyoto University
[Kyoto University] Student Research This report is published for educational purposes only by students competing in the CFA Institute Research Challenge. Rakuten, Inc
Date: 2015/9/30 Ticker: 4755 Recommendation: BUY Exchange: Tokyo Stock Exchange Price: 1,524 (As of 2015/9/30) Sector/Indusry: Service Price Target: 2,124(39% Upside)
Highlights We issue a BUY recommendation on Rakuten, Inc (Rakuten) with a one-year target price of JPY2,124, offering 39% upside from its closing price of JPY1,524 on September 30, 2015. We believe the largest profit source of Rakuten “Rakuten Ichiba” will remain as competitive as it is. Also, the loss from digital contents business is understandable as it is intended to bring users to overseas EC business. Our recommendation is primarily driven by:
Successful Realization of “Rakuten Ecosystem”: Rakuten has been steadily building up Rakuten Ecosystem, which consists of the core EC business Rakuten Ichiba and other services Rakuten offers, including financial services. Rakuten membership can access to all services by Market Profile using a single ID called “Rakuten ID” and they can obtain “Rakuten Super Point”, which can Closing Price (JPY) 1,524 be used as money in the Rakuten Ecosystem. Through the generous assignment of Rakuten 52-Week High / Low (JPY) 1,138 / 2,358 Super Point, Rakuten ID users flow into other services of Rakuten Group, and the synergy Diluted Shares Out 1,429,987,000 effect will continue to give Rakuten competitive advantages for sales expansion. Market Cap 2,179.3B Loss from Digital Contents to Be Paid Off: Rakuten has greatly invested in digital contents Dividend Yield (JPY) ¥4.50 business and losing money because of it. However, we understand this investment is necessary for Rakuten’s future growth. Digital contents is one of the most fast growing area in Beta 0.89 the internet business and they are trying to exploit this opportunity to get new Rakuten ID EV / Revenue 8.77 member. We understand this is successful and will benefit the EC businesses. EV / EBITDA 52.66 Competition with Yahoo!: The biggest threat is Yahoo! Shopping. They are offering market Sources:Sources: Yahoo! Yahoo! Finance place for free and some small shop moved there from Rakuten Ichiba. Although this is not critical at the moment, it could be critical if larger-scale shops move there. This is because we Target Price Breakdown understand the larger-scale shops make Rakuten Ichiba attractive. Component Value (Million JPY) Valuation: We set the target price of JPY2,124 per share by EVA. The high debt/equity ratio Internet Services 1,823,766 and the low cost of debt are combined to keep the capital cost low. In our EVA, we applied Rakuten Bank 268,548 different WACCs for each major business of Rakuten. We also valued Rakuten by DCF and multiple and they showed quite similar price to the one from EVA. Rakuten Card 632,843 Recent News Rakuten Securities 308,550 Rakuten Insurance 33,049 The company announced their new slogan of “Connecting the Dots”; building an efficient network what we call Rakuten Ecosystem, between the existing Rakuten’s business and Enterprise Value 3,066,756 recently acquired business Less: Interest Bearing Liabilities 732,390 182 billion yen of public offering in 2015 Q2 to repay debts pushed down D/E ratio from Less: Minority Equity 2,227 1.40 to 1.11 Plus: Cash and Equivalents 704,685 Overseas EC merchandise sales soared 55% in 2015 Q2 (YoY) Unique users of Viber exceeded 600 million in 2015 Q2 Diluted Shares Out 1,430 Target Price 2,124 KEY INDICATORS in Billions 2013 2014 2015E 2016E 2017E 2018E 2019E Sources: Team estimates Sales 519 599 756 825 918 1,007 1,097 Net Operating Income 90 106 133 168 203 233 263 NOI Margin 17% 18% 18% 20% 22% 23% 24% NOPAT 59 69 86 109 132 151 171 Invested Capital 306 850 1,176 1,283 1,421 1,539 1,657 ROIC 19.1% 8.1% 7.4% 8.5% 9.3% 9.8% 10.3% Domestic MS 1,734 2,006 2,237 2,489 2,763 3,057 3,438 Overseas MS 64 224 785 908 1,051 1,171 1,306 Overseas Rate 4% 10% 26% 27% 28% 28% 28% 1
CFA Institute Research Challenge 2015/9/30
Figure 1. Sales and Operating Income Business Description Rakuten was founded in 1997 and is the leading Internet Service company in Japan. Rakuten Ichiba, the oldest and core business of Rakuten, was one of the earliest EC websites in Japan. With a hope to transform into the top Internet service provider in the world, they went through aggressive M&As and diversified their business portfolio (Appendix A). Besides the diversified revenue sources, they have succeeded in generating synergy among the businesses. For example, Rakuten Ichiba users are promoted to use Rakuten Bank account to complete the payments for their purchase, and Rakuten Bank can easily get new clients through Rakuten Ichiba. Rakuten aim to establish Rakuten Ecosystem, where consumers Source: Annual Reports can access to various Internet services, only with one Rakuten ID. The number of Rakuten membership reached 100 million in 2015, almost 80% of Japan’s population (Appendix B).
Figure 2. Operating Income Annual reports break down Rakuten’s business into three segments: Internet Services, Internet Finances and Others (Appendix C). Internet Services includes Rakuten Ichiba, Rakuten Travel and other digital contents such as SNS and video streaming websites. Internet Finances covers Rakuten Card, Rakuten Bank, Rakuten Securities and Rakuten Insurance. Other Services includes a baseball team, wifi provider and etc. The transition of Rakuten Group performance is shown in Figure 1, while the composition of net operating income in Figure 2. Due to the recent sound economic conditions, Internet Finances segment occupies more and more of the entire Rakuten’s profit.
Rakuten Ichiba, the core business of Rakuten, is a virtual online shopping mall. It accounts for 68% of the operating income of Rakuten as of the end of 2014. It provides 41,659 shops, as of 2015 Q2, with Source: Annual Reports web platform that each shop can customize its pageto maximize their sales. Registered shops pay for (1) registration fee, (2) monthly service charge (3) service charge on merchandise sales (MS) and (4) around Table 1. Global Network 1% commission of MS. These account for Rakuten Ichiba’s sales (Appendix D). The number of registered shops is a significant input to its performance, and keeping the platform appealing is critical. Services Region Time The company is eager to apply the know-hows gained by domestic EC business to overseas operation, Rakuten.com.sg Singapore Jan-14 and they already invested in Europe, North America and South East Asia (Table 1). Rakuten.es Spain Oct-13 Rakuten.at Ausutralia Jun-13 Rakuten.com.my Malaysia Oct-12 Rakuten has been eagerly engaged in M&As over digital contents providers in the last three years, and Rakuten.com.uk UK Oct-11 they are one of the highly prospective businesses. Major examples are Viber, a Cyprus based Ozon.ru Russia Sep-11 communication app, Viki, a subtitled video streaming service provider and Kobo, a Canada based Rakuten.de Germany Jul-11 electronic book company. Figure 3 indicates the numbers of unique/active users of these services in the Rakuten.com.br Brasil Jun-11 last three years. Although their profitability is currently negative, we believe they will be able to Rakuten Belanja Online Indonesia Jun-11 contribute greatly to Rakuten, by advertisement sales and by bringing consumers to Rakuten Ecosystem. Priceminister France Jul-10 Rakuten.com US Jul-10 Strategies TARAD.com Thailand Sep-09 The Company’s main strategies are (1) to reinforce Rakuten Ecosystem both domestically and overseas, Rakuten Taiwan Taiwan Jun-08 by means of fulfilling a variety of services and enhancing user usability within the ecosystem, and (2) to grow overseas EC and digital contents. Specifically speaking, Rakuten will: Source: Investor Relations Reposition Rakuten Ichiba within EC industry to keep it appealing – There are fewer registered shops year by year, after Yahoo! Shopping began to offer their marketplace for free. Figure 3. Growth of Users Some of small-size shops are suspected to leave or have left Rakuten Ichiba as shown in Appendix D, and in response to this Yahoo!’s activity, Rakuten Ichiba made the policy stricter for starting a new shop at Rakuten Ichiba. This implies their strategy to redefine their marketplace as a higher quality EC platform. Go global through Digital Contents and EC – In 2014, the CEO shared his idea of first entering foreign markets through digital contents to create a customer base, and then bringing in EC business to the world. Viber and Viki, for example, are positioned as an entrance to Rakuten Ecosystem, as Rakuten is planning to integrate all accounts into Rakuten ID. Based on this tactic, Source: Annual Reports we interpreted acquisition of digital contents is aimed to expand and increase Rakuten ID holders. This sets out a foundation of overseas EC business to be launched, and attaining to reach 50% of Figure 4. Shareholders transaction volume deriving from overseas.
Shareholders’ Structure Mr.Hiroshi Mikitani founded Rakuten, and his family owns controlling interest of Rakuten. The biggest shareholder of Rakuten is a limited liability company CZ-group, which was established to manage assets of Mr.Mikitani. CZ-group owns 17% of common shares, and Mr.Mikitani himself owns 13% as well (Figure 4). Also, his wife Haruko Mikitani owns 10% of the shares. This means Mr.Mikitani and his family own nearly 40% of Rakuten’s stocks and this allows the CEO to hold great power over the management. Source: Investor Relations 2 CFA Institute Research Challenge 2015/9/30 Figure 5. PEST Analysis Industry Overview and Competitive Positioning Our research on Rakuten concludes: Domestic EC segment will remain competitive and grow as the industry itself will do Digital contents segment is successful in bringing in new customers to Rakuten Ecosystem Overseas EC is promising in the future growth Internet Finance segment, especially card will be a solid cash generator The following analyses are to explain the logic behind this our view. For industry overview, we utilized three tools, PEST (Figure 5), five-forces and SWOT analyses. See Appendix E for the details. Source: Team Analysis
Figure 6. 5F of EC in Japan Industry Overview Japan Macroeconomic Performance Japan’s household final consumption expenditure has grown at 3.71% CAGR for the last three years according to IMF, and served as a healthy ground for Rakuten as it is a consumer service company. This upward trend is considered to continue, and our projection of Rakuten’s performance uses 3% as an input to household consumption through the end of our forecasted years (Appendix F). In addition, the stock market has enjoyed so-called Abenomics and Rakuten Securities more than tripled net operating income within the last three years. Furthermore, Japanese yen became around two thirds weaker in Source: Team Analysis September 2015 since the beginning of 2013, and this facilitates cross-border transaction of goods and services of Rakuten Group. Figure 7. Growth of EC High Growth of EC/Digital Contents Industry According to Ministry of Economy, Trade and Industry of Japan, the market size of EC in Japan has expanded from 10.2 trillion yen in 2010 to 12.8 trillion yen in 2014, and is expected to reach 20.8 trillion yen in 2019 (Figure 7). This reflects increasingly high people’s inclination to purchase goods online. The BtoC EC over total consumption, namely EC rate, was 2.8% in 2010 but is now 4.4%. We forecast this to be 7.0% in 2019 as a result of our study on U.S. society as a prior example (Appendix G). This is an encouraging implication for Rakuten Ichiba.
Source: Nomura Research Institute and On the other hand, we witnessed a significant trend of customer-oriented EC services. The trend is Ministry of Economy, Trade and Industry represented in a growth of CtoC industry, and Yahoo! Shopping is taking advantage of this by offering of the marketplace for free (Appendix H). This is due to lower delivery cost and a development of safer Figure 8. Smartphone Penetration transaction system served as a foundation of CtoC EC business. This is included in our 5-force analysis (Figure 6).
Digital content industry has been growing rapidly and also expected to grow at a CAGR of 13.73% over 2014-2019 by Research and Markets. This is due to the increase in the numbers of smartphones and tablets and the need of digitalization.
High Mobile Penetration Rate Domestic and Overseas Asia Pacific Transaction by mobile devices, such as smartphones or tablets, has been increasing. Rakuten reported Source: eMarketer that 44% of the purchase at Rakuten Ichiba was through mobile devices(mobile rate) in 2014, and is now Table 2. Regional EC Growth 48.5% now in 2015 Q2. This is a good news for Rakuten, as most of the services in Rakuten Ecosystem can be used with smartphone and the profitability is higher. This high compatibility to smartphone will Components EU NA SEA allow Rakuten to easily obtain young consumers into their ecosystem. Also, the growth of smartphone Investment/Market Size 15% 12% 25% penetration rate is higher overseas, especially in Asia-Pacific (Figure 8), where Rakuten has invested a Competition 8% 10% 15% lot already. Digital contents such as Viber and Viki are going to make the best of this trend. Unique Growth 7% 2% 10% Industry Growth 13% 12% 23% Overseas EC Market Growing Rapidly Growth Rate 20% 14% 33% The trend of using EC is steady throughout the world, and the market size of EC worldwide is forecasted Source: Euromonitor and to grow 15% till 2018. Table 2 summarizes the invested areas of Rakuten with its forecasted industry growth, and the growths mainly consists of Asia, especially China’s 20% growth and ASEAN’s 23%. Team Analysis Aslso, Europe is expected to grow at 13% and the US at 13%. These projections are very promising for Figure 9. Transaction Volume Rakuten, though it should be also noted that the competition is severe against major EC players such as (JPY in Billions) Amazon or Alibaba Group.
Virtual Money Transaction More and more transactions are done virtually, and for example, the transaction volume by credit cards has been increasing at a CAGR of 6% over the ten years (Figure 9) and the statistics shows one adult owns 2.6 credit cards. This trend is favorable to Rakuten Card, which is the biggest cash generator within Internet Finances segment. Also, people gradually do not hesitate to invest their money on risk- assets at the age of “From saving to investment”, and Rakuten Securities will continue to benefit from Source: Japan’s Credit this trend. Card Association 3 CFA Institute Research Challenge 2015/9/30
Table 3. Point Card Competitors Competitive Positioning T Point Ponta Point R Point Rakuten Super Point Year Started 2003 2013 2014 Rakuten Super Point is one of the most popular points in Japan, and the others are T-Point and Ponta Number of Point. Their popularity comes from compatibility of points in a wide range of affiliated shops, including 231,792 23,400 12,600 Affiliated Stores EC shops. Their comparison is summarized in Table 3, and in short, Rakuten Super Point is expected to Number of Card bite into the share of T-Point by generous assignment of points and collaboration with more shops. On Holders (in 51 66 94 Millions) the other hand, the mission of Rakuten Super Point is not exactly to be individually profitable but to Point Rate 1 point per 100yen promote use of other Rakuten’s services, and thus its biggest competitiveness lies in the Ecosystem. Point Rebound NA NA Available Source: Payment Navi Rakuten Ichiba In terms of the threat of new entrants, a barrier to EC industry is considerably high, as existing EC businesses leverage the scale of economics in attracting both users and shops. Point system also works to motivate consumers to repeat purchase in the same marketplace. What Rakuten Ichiba should be careful Figure 10. Comparison of EC Sites about is existing competitors, especially Amazon and Yahoo! Shopping (Figure 10). As a result of our in-depth research in Appendix I, we assume that, however small shops at Rakuten Ichiba might will gradually flow out to Yahoo! Shopping for its free offering of marketplace, Rakuten Ichiba will keep fascinating consumers and thus shops. This is because our research says that the core value of the Rakuten Ichiba derives from larger shops and generous assingment of Rakuten Super Point.
Rakuten Ichiba’s strength to the larger shops is that each shop can easily design its page on their own. Shops can differentiate themselves in appearance, and send mail magazines to the customers. This unique service strongly attacts middle- or large-sized shops which wish to maximize their sales in spite of expensive tenant charge. Furthermore, they are now tightening up shop screening to prevent entry of poor shops, and the rate of denying new tenant grew to 12% in 2014. These conditions imply that Rakuten Ichiba is now transforming into a well-ordered EC website with only high-quality shops.
Overseas EC Source: Team Analysis All the areas where Rakuten already invested are subject to formidable competition (Appendix J). However, Rakuten’s competitive advantages are assured by its new strategy “Connetcting the Dots”: there will be a thick flow of consumers between Digital Contents and EC business, and this synergy is unique only to Rakuten among major EC companies. Therefore, a degree of DC’s penetration will be a Figure 11. SWOT of Digital Contents watershed matter.
Furthermore, Rakuten makes difference from other majorplayers by acting as a middleman between buyers and sellers. Rakuten can collaborate with local shops who can send their products at a low cost to the customers, while Amazon do not collaborate with them and the shipping cost is higher (Appendix K). Also Rakuten has not represented themselves overseas, and it is expected to establish their position as a more localized EC website.
Digital Contents Source: Team Analysis The recent M&As by Rakuten have been targeted solely at digital contents companies overseas, and the competitive advantages of the companies are these: Viber’s strengths are (1) high quality calling service, (2) low battery usage and (3) easy communication as users can register to Viber with their phone number (Appendix L) Figure 12. % of Message App Users Viki, a Singapore-based video streaming service company, has more than 40 million of active users as of 2015, and is increasingly popular for its unique crowd translating service Kobo received the highest award for electronic book device from Wired Magazine in 2012 Wuaki was chosen as Best Spanish Startups in 2012 by First Hand News, and awarded with Best Web App in the 2013 Spanish Startup Awards Competitive Positioning Rakuten Amazon Yahoo! Market Cap 2,179 Billion 28,730 Billion (JPY120 / $) 2,586 Billion Number of Goods 150 Million 50 Million 140 Million Number of Shops 41,442 161,000 243,000 Number of Monthly Visiters 62.8 Million 93.1 Million 17.6 Million EC Type Middleman Retailer Middleman Financial Subsidiaries Bank, Card, Securities, Insurance Amazon Payment FX, Card, Insurance Digital Contents Kobo, Viber, Viki, Wuaki, Overdrive Kindle GYAO Europe, North America and South Overseas Operation Throughout the World NA East Asia Source: Global Web Index Sales 598,565 10,678,560 428,487 Operating Income 106,397 21,360 197,212 4 CFA Institute Research Challenge 2015/9/30
Figure 13. Valuation Unit Investment Summary Rakuten We issue a BUY recommendation on Rakuten, Inc with a target price of JPY2,124, using Economic Ichiba Value Added (EVA), further backed up by a Discounted Cash Flow (DCF) method and Sum of the parts (SOTP). Figure 13 illustrates the image of our EVA valuation, and this valuation is supported by merits, Rakuten as outlined below, as well as several concerns taken into account. Travel
Overseas Merits Internet EC Flourishing EC Industry Services Digital Rakuten Ichiba will be positively affected by socioeconomic factors. The EC rate is 4.37% in 2014, and Rakuten Contents expected to rise constantly to 7.0% in 2019. High smartphone penetration rate explains an increasingly Bank Other high EC inclination, as we found out in Appendix G. The industry overview and competitive positioning Rakuten Services of Rakuten Ichiba supports our hypothesis of around 11% growth each year, which is primarily driven by Rakuten Card increasing transaction volume in Rakuten Ichiba. Others Rakuten Securities High Growth Potential of Digital Contents Rakuten has done serial aggressive M&As over global digital contents providers in the last three years. Rakuten These businesses still remains not profitable, but the strategic implications the CEO put on these Insurance businesses are: first create worldwide customer base by popular digital media such as Viber, Viki and Kobo, Sources: Annual Reports and monetize them through mobile game, advertisement or paid services, Team Estimation and ultimately lure customers into overseas EC. We can say that Viber, Viki and Kobo are successful, considering that unique users of Viber Figure 14. Growing Cross Use outnumbered 600 million, and active users of Viki and Kobo amounted to 40 million and 23 million respectively. In other words, they are ready to invite their users to Rakuten Ecosystem and to be monetized (Figure 16).
Promising Overseas EC Businesses Coupled with the synergy effect with digital contents as mentioned above, overseas EC segment is expected to grow in each region. Despite the already harsh competition, Rakuten’s advantages will be assured by the large customer base built by digital contents and acquisitions of local EC services. The following explains a region-specific conditions of Rakuten: Sources: Team Estimation Europe – Rakuten purchased local EC companies in France, England and Germany, and is expected to grow, may not at the same rate with the local industry growth, because of the harsh Figure 15. Operating Income competition with Amazon, which already established their logistics network locally. (in Millions) North America – It underwent the record biggest M&A over Ebates, a U.S. based cash back service, and it made the overseas merchandise sales 10 times bigger. Not only does it contribute huge sales to Rakuten, but can promote other services of Rakuten through its channel. South East Asia – Prior investment has been made in Singapore, Malysia, Thailand and Indonesia, and given 23% of yearly growth of EC industry, Rakuten is expected to gain a huge amount of sales from the region. High mobile inclination and Viki’s penetration in the region are favorable conditions for Rakuten’s expansion. We believe that these condition will lead the EC business in each region successful.
Solid Business Performance of Internet Finance Sector By the acquisitions of Rakuten Bank, Rakuten Card, Rakuten Securities and Rakuten Insurance, the Internet Finances segment has grown rapidly utilizing ten millions of customers from Rakuten Ichiba Sources: Team Analysis (Figure 14). In particular, Rakuten Card is now not just a transaction system for Rakuten Ichiba, but also an individually profitable business as no more than 20% of its sales is from Rakuten’s business. Furthermore, the recent sound economy enabled Rakuten Securities to triple their net operating income, Figure 16. Membership After and in order to establish business style that is not affected severely by economic conditions, it is Account Integration (in Millions) undergoing restructuring of its revenue composition (Appendix S4). These circumstances made us affirm that the Internet Finances segment will be a stable profit contributor for Rakuten (Figure 15).
Concerns Yahoo! Shopping Could Be Very Attractive EC Website The biggest concern for us to estimate the future performance of Rakuten Ichiba is how competitive Yahoo! Shopping could be. After Yahoo!’s free offering of the marketplace, small-sized shops shifted to Yahoo! Shopping over the last two years already, and we are concerned if Yahoo! Shopping will be more appealing for both shops and customers, as (1) it welcomes more shops for free and (2) consequently, the marketplace will be full of contents and thus appealing. Furthermore, Yahoo! is Sources: Team Estimation popular among Japanese people as a top page of web browser, which could work to attract consumers into shopping. This concern was taken into account in the competitive positioning done in Appendix I.
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Table 4. Comparative Apps Viber’s Worldwide Penetration Plan Ending Up Being An Exageration Table 4. Comparative SNSs The CEO is excited to boast on his dream that Viber will expand throughout the world to serve as an SNS Users Type Popular Region entrance for Rakuten Ichiba. However, we suppose this expansion is quite limited to a particular region 600M Unique Viber Asia of the world. Table 4 shows a breakdown of communication app use by region. Given network effect of 250M Active proceeding communication app, we assume it is unrealistic that Viber is going to be actively used in Whatsapp 700M Active English Speaking other areas than Asia. Line 170M Active Japan and Asia Facebook 1,400M Active Worldwide Messenger Skype 300M Active Worldwide
Sources: Statistas
Table 5. WACCs
Business WACC Relative Valuation Yahoo! Japan, Several valuation methods were utilized in reaching an intrinsic value of JPY2,124. Our evaluation is Internet Services 5.14% StartToday, Rakuten mainly driven by EVA, further supported by DCF and SOTP. EVA was the most reliable method as Aeon Financial DCF was highly affected by financial services and there was not enough comparable companies for Holdings, Sony Rakuten Bank 4.62% SOTP. These methods involve estimating the firm’s value and adjusting it for net debt to arrive at equity Financial Holdings, Kansai Urban Bank value. See Appendix M for the forecasted financial statements. Orient Corporation, Rakuten Card 3.86% JACCS, Pocket Card Both of EVA and DCF methods are computed based on (1) 1% of risk free rate and (2) 4.5% of market SBI Holdings, Matsui Rakuten Securities 4.50% premium. The risk free rate comes from our expectation that Japan GDP’s CAGR will be 1% in the long Securities, Monex run. The market premium is obtained by deducting the risk free rate from 5.5% of TOPIX CAGR MS&AD, T&D through January 4th 1968 to September 30th 2015. Rakuten Insurance 7.13% Holdings, Sompo Japan Economic Value Added (EVA) Sources: Team Computation In applying the EVA, Rakuten was broken down into five components: Internet Services segment and 4 different businesses within Internet Finances segment. Our estimation is based on a five year forecast Table 6. Permanent Growth Rates and terminal value to reach enterprise values of each business, and then summed up all of them borrowing the idea of value additivity. WACCs are computed through research on comparative Business PGR companies of each unit of business, in order to reflect different risks around different types of business (Table 5 and Appendix N). Permanent growth rate is set by an expected inflation as a reference, and the Internet Services 1.50% inflation rate is 1%, according to our analysis (Appendix F). Refer to the left chart for the rates for each Rakuten Bank 1% business (Table 6). Rakuten Card 1.50% Rakuten Securities 1% We prepared a pessimistic scenario and an optimistic scenario besides the most probable scenario on which our valuation is based on, and we obtained an intrinsic value of JPY 1,853 and JPY 2,269 per Rakuten Insurance 0.80% share respectively. These target prices still offers 21.6% upside and 49% upside respectively from the Sources: Team calculation current price JPY 1,524 on 30th September 2015, and hence our recommendation still remains BUY (Appendix R).
Most Probable Scenario The scenario we used for valuation is that DCs as a whole will be monetized in 3 years, as Rakuten’s annual reports announced that they will generate profits soon. This scenario assumes DCs will create a 6 CFA Institute Research Challenge 2015/9/30
Table 7. Valuation by Scenarios large customer base that can be connected to OEC business, and add up competitiveness and presence of Scenario Most Probable Scenario OEC. OEC is expected to grow faster than the overall industry growth in all the regions, Europe, North Price 2,124 America and South East Asia. Furthermore, a sales profit ratio of OEC, currently 8%, is projected to grow at 1% per year, gradually catching up with domestic Rakuten Ichiba. Upside 39%
Recommendation BUY Pessimistic Scenario Possibility High However, there is no strong ground to believe DCs and OEC will succeed as they are planned to. DC's Monetization 3Y Competition overseas may be harder than Rakuten is expecting, and this scenario was created to mitigate OEC's Profitability 1% up per year uncertainty risk we have over the base scenario. In this scenario, DCs would go through tough 5 years Scenario Pessimistic Scenario till monetization and profitability of OEC would not increase. In particular, OEC will unexpectedly face Price 1,853 the hard competition in North America, and its growth there is slower than the whole industry. Upside 22% Recommendation BUY Optimistic Scenario The optimistic scenario about the future performance of DC and OEC was also prepared. It assumes that Possibility Little DC’s monetization will be possible from next year, and OEC’s profitability will dramatically improve at DC's Monetization 5Y 2% every year. However, we believe this scenario is not much likely to happen because of the hard OEC's Profitability does not improve competition in the regions Rakuten has invested in. Scenario Optimistic Scenario Price 2,269 Discounted Cash Flow (DCF) Upside 49% A DCF method was also utilized to reach JPY2,221 per share. We used the nearly same PL projection as Recommendation BUY we used in the EVA method and built the financial statements. The operating profit slightly differs from Possibility Very Little the EVA’s as we built DCF’s PL in accordance with the items on the yuho. However, the difference is DC's Monetization 2Y small enough to make no significant difference to the target price. See Appendix P for the financial statements. OEC's Profitability 2% up per year
Sources: Team calculation The calculation of free cash flow is provided in the left (Table 8). Note that we assumed working capital in financial services will not increase in order to keep the valuation not too sensitive to the performance Table 8. Free Cash Flow Calculation of financial services. 2015E 2016E Revenue 692,472 754,440 The terminal growth rate is set 1.685%, the average of 1% of Japan nominal GDP growth and 2.37% of nominal GDP growth of the world. 2.37% is the CAGR of the world economy over the last 3 years, (Operating expense) -558,761 -603,944 according to the World Bank. We used an average, because in the near future 50% sales can derive from Financial Income 266 290 overseas. (Financial expense) -4,718 -5,113 Income form equity method 957 899 (in Millions) 2014 2015E 2016E 2017E 2018E 2019E Earnings before tax 130,217 146,572 FCF 39,635 -47,217 68,604 90,563 93,386 108,454 Income tax rate 35.6% 33.1% (Income tax) -46,409 -48,515 WACC 3.47% 4.08% 4.08% 4.08% 4.08% Cash flow from operation 83,808 98,056 Terminal Growth Rate 1.685% TV 3,730,615 EV 3,909,536 (Increase in working capital) -118,413 -12,975 Debt 732,930 Diluted Shares Out 1,430 Target Price 2,221 Depreciation and amortization 34,869 37,989 Sum of the Parts (SOTP) (Capital Expenditure) -47,480 -54,467 According to SOTP, our target price is JPY2,159. We used price to sales as sales was the only metrics Free cash flow -47,217 68,604 available. In order to use comparable multiples method, we decided to use sum of the parts method as Sources: Team calculation Rakuten have diversified their business portfolio in many business areas. We divided Rakuten’s business Table 9. Sum of the Parts areas into seven parts, which are Internet Services, Rakuten Bank, Rakuten Card, Rakuten Securities, Rakuten Insurance, other financials and Others. We selected the multipliers for each business by our Business Value financial analysis on each business. The inconsistency between EVA and SOTP is the difference Internet Services 2,309,300 between the financial statements they are based on. You may find the details in Appendix Q. Rakuten Bank 79,268 Rakuten Card 265,161 Rakuten Securities 177,200 Other Corporate Information Rakuten’s Effort to Improve Rakuten Ichiba Rakuten Insurance 32,715 Rakuten Ichiba has started 2 new services to make it more convenient. Other Financials 18,576 Others 61,770 Rakubin Total 2,943,990 This service will allow the customers to receive the goods 24/7 they ordered, at fastest, in twenty Diluted Shares Out 1,430 minutes. This is applicable for around 450 items on Rakuten Ichiba. You can specify where to receive as th Target Price 2,059 well. This was launched on August 20 2015.
Sources: Team calculation Receiving goods at convenient stores This allows the customers to receive goods at roughly 20,000 convenient stores and 4,000 offices of Yamato Holdings. Rakuten has entered a contract with the largest distributor Yamato Holdings as well as Japan Post Holdings. This will be launched in 2015 summer.
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Financial Analysis Figure 17. Net Operating Income Financial Analysis 2013 2014 2015E 2016E 2017E 2018E 2019E Transition (in Millions) Profitability Operating Profit Margin 17.4% 17.8% 19.3% 19.9% 21.0% 21.9% 22.5% Net Profit Margin 8.4% 11.9% 12.1% 13.0% 13.9% 14.5% 14.9% ROA 1.4% 2.1% 2.1% 2.2% 2.4% 2.5% 2.5% ROE 14.3% 19.4% 14.6% 12.9% 13.8% 14.1% 14.0% Liquidity Current Ratio 91.5% 93.2% 114.4% 133.4% 136.6% 139.8% 146.9% Quick Ratio 70.3% 75.3% 100.6% 120.3% 123.4% 126.5% 133.6% Cash Ratio 54.9% 57.8% 81.0% 100.7% 103.7% 106.8% 113.7% Efficiency Accounts Recievables Turnover 6.39 6.28 6.47 6.38 6.44 6.39 6.30 Total Asset Turnover 0.16x 0.17x 0.18x 0.17x 0.17x 0.17x 0.17x Credit Analysis Debt to Equity 128.5% 133.4% 117.9% 104.9% 101.0% 97.2% 94.0% Financial Leverage 1058% 938% 690% 586% 576% 565% 552% Interest Coverage 52.84 37.58 27.34 28.44 30.97 32.62 33.81
Overview The chart above reveals Rakuten’s key metrics in the future. This is based on the financial statements in Appendix V. The graphs in the left represent the trend and our forecast of key metrics of Rakuten. Some indexes are different from the table shown in Highlights, and this is because we used consolidated financial statements for this chart, while the data in Highlights is a sum of financial statements of each business. Note that Rakuten switched accounting rule from J-GAAP to IFRS in FY2013.
Sources: Team estimation Improvement in Operating Profit Margin The operating profit margin is expected to improve gradually, and this is primarily because digital contents will enhance its profitability year by year. Overseas EC is also expected to increase the sales profit ratio from 8% to 12% towards the end of the forecasted years. These also explain the gradual hike Table 10. Transition from J-GAAP to of net profit margin. IFRS and its impact
Account Title J-GAAP IFRS Impact Solid Cash Generation and Less M&A Activities minus Rakuten will retain solid cash generation. In contrast, Rakuten has announced that they will less engage Deducted from Point Expense JPY35,684 Sales in M&A. Therefore, generated cash will accumulate as retained earnings and shareholder’s equity will M increase. This will lead financial leverage to decline and liquidity to improve. minus Sales of Goods Gross Net JPY26,488 M ROE Decomposition plus Rakuten’s ROE will decrease as financial leverage decreases till 2016. The decrease in financial Goodwill Depreciation Impairment JPY14,202 leverage is due to the accumulation of retained earnings. As Rakuten will be less engaged in M&A in the M future, more cash will accumulate as retained earnings. However, profit margin will boost from 2017 as Sources: Team research the profitability of digital contents improves. Total asset turnover will fluctuate in accordance with expansion of financial services. The tables below show the ROE decomposition of Rakuten and that of each segment.
Figure 18. Sales of Internet Services ROE Decomposition 2013 2014 2015E 2016E 2017E 2018E 2019E Net Profit Margin 8% 12% 12% 13% 14% 14% 15% Table 5. Beta Analysis Total Asset Turnover 0.162x 0.174x 0.175x 0.170x 0.172x 0.172x 0.170x Financial Leverage 1058% 938% 690% 586% 576% 565% 552% ROE 14.3% 19.4% 14.6% 12.9% 13.8% 14.1% 14.0% Decomposition of Internet Rakuten Rakuten Rakuten Rakuten Dupont formula Services Bank Card Securities Insurance Profit Margin 27.7% 15.8% 5.4% 29.3% 5.6% Total Asset Turnover 0.31x 0.04x 0.18x 0.05x 1.15x Financial Leverage 192% 1858.9% 1359.4% 1414.8% 582.1%
ROE 16.6% 13.0% 13.0% 21.8% 37.7% Sources: Team Estimation
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Internet Services We further divided the segment into five groups (Appendix O): (1) Rakuten Ichiba, (2) Rakuten Travel, (3) Overseas EC, (4) Digital Contents and (5) Others, and then we consolidated all EVs to calculate the present values of residual profits in the future, using Beta for Internet Services. See Appendix S for the Figure 19. Rakuten Ichiba’s Business detailed explanation, and the following focuses on evaluation of the three main businesses. Model (in Millions) Rakuten Ichiba (RI) As elaborated in Appendix D, we estimated RI’s sales by adding up (1) shop registration fee, (2) fixed service charge, (3) variable service charge and (4) commission. As our estimation is similar enough to the disclosed sales amount, our estimation is reasonable and the inputs we used to project sales are: Domestic consumption likely to go up 3% each year over the forecasted years (Appendix F) EC rate likely to reach 7% in 2019, from 4.37% in 2014 (Appendix H) Registered shops will decrease at 2% year by year, due to Yahoo! Shopping Merchandise sales of RI will grow at 11% based on our competitive positioning analysis Observation of historical data gave us an implication that the operating expense will decrease to 50%. This is because its investment phase is already done and RI will remain as the top-tier EC website in Japan. The invested capital will be growing at the sales growth rate in our calculation. See Appendix S11 for the detail of our analysis. Sources: Team calculation Digital Contents (DC) Our estimation of the Internet Services segment’s value is sensitive to DC’s performance in the future. Most of the DCs were acquired recently and few financial data are disclosed. Therefore, Uncertainty of the Rakuten’s performance arise from them in our analysis. They are still in an investment phase, but our analysis says their future is optimistic based on the following reasons: Viber has over 600 million of unique users and 236 million of monthly active users throughout the world. Also it pursues a business model to earn cash from phone services, game and stickers. Therefore, we suppose it will bring sales and profits as other communication apps do Viki and Wuaki are expected to earn profits from advertisement fee, according to our analysis comparing them to You Tube. Based on these reasons, digital contents business will shift to a cash generating phase from an investment phase in the near future. Table 11. Regional Growth Rates Components EU NA SEA Overseas EC (OEC) Significant investment has been made in the last three years in Europe, North America and South East Investment/Market Size 15% 12% 25% Asia. We assume growth rates in each region are based on the local growth rates of EC industry. In Competition 8% 10% 15% addition to that, as the competition levels differ depending on areas, adjustments are made on the basis of Unique Growth 7% 2% 10% the research on regional competitions and the investment Rakuten already made (Table 11). Industry Growth 13% 12% 23% Internet Finance Growth Rate 20% 14% 33% Here we discuss the main three businesses. Refer to Appendix S for the details. Rakuten Bank (RB) Sources: Team calculation Finding out a high correlation between RB’s sales and total deposits, and between total deposits and open accounts, we estimated the number of accounts to forecast the RB’s future sales. As Rakuten Ichiba promotes shops to use Rakuten Bank for payments, open accounts increased at CAGR of 0.6% over the last five years, and we assume this to continue. Other indexes are set to grow at the sales growth rate, Figure 20. Transaction Volume by and the permanent growth rate is 1.0%. Credit Cards Rakuten Card (RC) Payment through credit card has increased steadily and it is expected to annualy grow by 6%, CAGR of the last 10 years. The fact that RC credit card was chosen as the most satisfactory card for customers for six years in a row, we confidently set the growth rates of transaction volume to be 30% in 2015. Then it is expected to step down year by year and finally to 6% in 2019 (Figure 20). This estimation is not too optimistic, given that less than 20% of its sales is from Rakuten Group. This implies RC is profitable and competitive itself. These are the ground of our 1.5% estimation of the terminal growth rate.
Rakuten Securities (RS) Although commission revenue from stock exchange is forecasted to decrease to 10% due to entrance of Sources: Team calculation other providers with formidable price power. FX and financial revenues are expected to grow at 10%, as a result of RS’s effort to capture young customers through mobile friendly services. The permanent growth rate is set to be 1.0%, however, as security service providers are, in the long run, unable to differentiate their services from others.
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Figure 21. Risk Matrix Investment Risks Operational Risks Delayed Globalization (OR1) ER
HIGH Rakuten is currently allocating considerable amount of resources to increase the gross merchandise sales from overseas EC up to 50% of the total merchandise sales. In addition, they bought global digital OR2 contents companies in the last three years. If Rakuetn cannot successfully expand their business in overseas markets, it will significantly impact on the scenario we assumed. One of the key value drivers for Rakuten is the expected sales and profitability of overseas EC and digital contents. We prepared the MR OR1 pessimistic scenario of Rakuten to take this risk into consideration.
MEDIUM Possibility MNR FR Potential Harsh Competition with Yahoo! Shopping (OR2) Since the net operating income of Rakuten Ichiba in 2014 was about 75.6% of the whole company, the RR change in its competitive positioning in the domestic EC market will be one of the biggest risks for LOW Rakuten. Especially, free offering of the marketplace by Yahoo! Shopping afftects Rakuten. The number LOW MEDIUM HIGH of shops increased by more than ten times at Yahoo! Shopping, while some shops already left Rakuten. Impact However, the merchandise sales is the biggest contributor for Rakuten Ichiba’s sales so the decrease in Sources: Team research the number of shops does not greatly affect them.
Table 12. Risk Mitigation Managerial Risk Malfunction of Governance Both Inside and Outside the Country (MNR) Risks Mitigation Regulatory Risk The reliability of Rakuten’s governance system is in doubt to some degree for the following reasons: They caused the doubling-pricing issue in 2013 due to their low consciousness in compliance. Fall of CARR and Solvency Strengthening shareholders' Margin Ratio equity; Release of risk assets They falsely displayed the price of their products on their EC website. Eighteen employees in total, instructed 28 shops to pretend that original price of products are much higher and they were Financial Risk Utilizing equity finance; offering significant discounts. This issue shows Rakuten has been failing to make their High Dependency on Debt Accumulation of current employees conscious of compliance. Finance assets In addition, not only the governance of their domestic companies, but also that of their overseas Market Risk companies should be paid more attention to. For the last five years, Rakuten has conducted quite Unexpected Rise in Currency Swap Interest Rates a few M&A over overseas companies, and they have not had the legal right of management yet Economic Risk over some of the companies they acquired such as Viber. Poor Stock Market Diversification of revenue sources Shadowing the Operational Risks Regulatory Risk Fall of Capital Adequacy Rate(RR) Delayed Globalization Investment of more resources This risk is regarding Rakuten’s Interent Finances segment. In order to maintain healthy business Differentiation by Shop Harsh Competition with conditions, Rakuten Bank and Rakuten Sercurities are required to have Capital Adequacy Regulation Screening; Entry to CtoC Yahoo! Shopping Ratio (CARR) over 4% and over 200% respectively. As shown in Table 11, Rakuten’s businesses have a market higher standard than other comparative companies we referred to for the Beta calculation. Managerial Risk Malfunction of Post merger integration; Governance Both Financial Risk Careful due diligence Domestic and Overseas High Dependency on Debt Finance (FR) Sources: Team analysis What is outstanding about Rakuten’s liquiduty indicators is an extraordinarily high debt/equity ratio. A potential financial risk is a degradation of its credit rating to bigger capital cost and lower cash ratio. Table 13. Comparison of Regulative However, their rating is now A from JCR and A- from R&I and these ratings are understandable given Ratios that the interest coverage ratio has been adequately high. Incidentally, Rakuten did 188 billion yen of public offering in June 2015 to establish healthy financial fundamentals. 2013 2014 2015
Securities CARR Market Risk Rakuten 366% 363% 396% Unexpected Rise in Interest Rates (MR) SBI 384% 323% 319% Sudden rise in interest rates will push up debt cost, as 58% of bonds and liabilities are floating rate. The Matsui 847% 771% 844% high dependency on debt finance makes Rakuten subject to interest rates. According to Rakuten’s annual Monex 459% 395% 424% report, this risk can be hedged by interest swap to some extent. It is estimated that 1% rise of the interest Bank CARR rate will lead to a loss of 2.7 billion yen. But we assume the 1% change is unrealistic in our forecast and Rakuten 23.70% 12.80% 10.22% also this amount of loss is not critical for Rakuten. Aeon 9.10% 9.00% 8.10%
Sony 11.98% 11.72% 10.66% Kansai Urban 8.38% 8.74% 8.32% Economic Risk Insurance Solvency Margin Rate Poor Stock Market Shadowing the Performance (ER) Rakuten 1077% 809% 1403% Rakuten will be negatively affected if the condition of Japan’s stock market goes worse. Rakuten MS&AD 773% 804% 835% Securities, as an example, tripled their net operating income, as a result of the favorable stock market’s T&D 944% 1115% 1221% conditions for the last two years. However, this strong correlation would be also true when the stock market is not profitable. Sompo 688% 783% 803%
Sources: Team analysis
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Appendix A: M&As by Rakuten Group
Date Company Name Sector Date Company Name Sector Date Company Name Sector
Nov-03 DLJ F Jun-11 Rakuten Belanja EC Jun-12 Wuaki DC May-04 Aozora Card F Jun-11 Rakuten Brasil EC Sep-12 Airio Insurance F Feb-09 Ebank F Jul-11 Rakuten Deutschland EC Sep-13 Viki DC Sep-09 TARAD Dot Com EC Oct-11 Play Holdings EC Mar-14 Viber DC Jan-10 Bit Wallet F Jan-12 Kobo DC Oct-14 Ebates EC Jul-10 Buy.com EC May-12 Kenko Com EC Apr-15 OverDrive Holdings DC Jul-10 Priceminister EC May-12 Pinterest DC
*F= Internet Finance, EC= Ecommerce, DC= Digital Contents
Source: Biz-journal Rakuten has been growing through aggressive M&A, and the table above shows their major M&A activities since 2003. As this graph clearly shows, we can break down the phase of Rakuten’s growth into the following three stages; 1. Entry to the Internet Finance Industry (2003-2010) Rakuten attempted to expand their business to the Internet Finances industry so they could generate synergy between their businesses, EC enterprises and the Internet finances business. In fact, this expansion became the base for the future development of Rakuten Ecosystem. Though almost all major M&A of the Internet finances segment finished in 2010, they acquired Airio Insurance in 2012. As a consequence, the companies’ composition of Rakuten’s Internet finances segment became even more well-balanced. 2. Expansion of the EC sector (2010-2014) Rakuten moved the direction of their strategy back to the ecommerce sector, which is their original business after 2010. However, they did not only try to expand their domestic EC websites, but also take a step toward overseas markets as proven by the successive M&A of the overseas EC companies in 2011. Moreover, their focus was on the vertical development over companies as well as on the horizontal one over countries. Rakuten’s acquisition of Ebates, in particular, is considered important for the channel development. 3. Investment in Digital Contents(2012-the present) Based on their solid management basis thanks to the growing Internet Finance and EC segments, Rakuten began to have connections with many aspects of our life by investing on digital contents. Although the investments on digital contents are still in progress, a variety of Rakuten’s businesses became even wider, and this makes their businesses more innovative by the expected synergy among different types of enterprises and safer since the sources of their profits do not rely only on a few enterprises.
Appendix B: Transition of Rakuten Membership and Account Integration in Store
Rakuten has continuously expanded its customer base and domestic Rakuten membership reached 101 million in 2015, including 27% of non-active users. This number is close to 128 million of Japan’s population, and it tells us how popular Rakuten is in Japan. 11 CFA Institute Research Challenge 2015/9/30
We suppose Rakuten membership will be found overseas in the near future as a result of account integration. The account integration is to integrate accounts of digital contents such as Viber, Viki or Overdrive into a single Rakuten account, and this will surely bring a tremendous impact on Rakuten’s economic field. Viber’s unique users outnumbered 600 million in 2015 and Viki’s active users amounted to 40 million. These users will drive up the number of membership and Rakuten will be ready for swifter and more far reaching business activities.
Appendix C: Business Map of Rakuten Group There are several ways to divide this conglomerate company, one of which follows annual reports, another takes Rakuten Ecosystem into consideration, another is done for our EVA valuation. We created our images of Rakuten’s businesses to avoid misunderstanding throughout our report.
Annual reports recognize the following businesses:
Sector Business Name Service Provider Internet Rakuten Market Rakuten, Inc Services Rakuten Books Rakuten, Inc Rakuten Gora Rakuten, Inc Rakuten Travel Rakuten, Inc Kenko-com Kenko-com Rakuten Kobo Rakuten Kobo, Inc Rakuten Marketing LLC Rakuten Marketing LLC Priceminister Priceminister S.A.S Rakuten.com Shopping Rakuten Commerce LLC Viki Viki, Inc Ebates Ebates, Inc Internet Finance Rakuten Bank Rakuten Bank Rakuten Card Rakuten Card Rakuten Securities Rakuten Securities Rakuten Insurance Rakuten Insurance Rakuten Edy Rakuten Edy Others Fusion Communications Fusion Communications Tohoku Rakuten Eagles Rakuten Baseball Team Viber Viber Media LTD. O-net O-net
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Rakuten Ecosystem idealizes the situation where Rakuten customer base flows into different businesses within Rakuten Group, and each business is interconnected at its advantage by use of Rakuten Super Point:
Rakuten Market
Portal & Digital Media Contents
Rakuten Rakuten Rakuten Travel Ecosystem Securities
Rakuten Rakuten Insurance Bank
Rakuten Card
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The following image is for our EVA analysis, and thus we would like readers to be reminded of this image reading our report. We incorporated Others into Internet Services for the simplicity, and Viber is incorporated into Digital Contents for our calculation.
Rakuten Group Annual Internet Internet Report Others Classification Services Finance
Internet Rakuten Services Bank
Rakuten Rakuten Market Card EVA Valuation Unit
Rakuten Rakuten Travel Securities
Overseas Rakuten EC Insurance
Digital Contents
Other Services
Others
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Appendix D: Business Model of Rakuten Market and Its Business Sphere Although this point is elaborated more in Competitive Positioning, Rakuten Ichiba has pursued a unique business model compared with other EC websites. Leaving the detailed comparison between Amazon or Yahoo! Shopping to Competitive Positioning section, we here provide a brief information about Rakuten Ichiba. The most unique point of Rakuten Ichiba is represented in how they derive sales from business activities. It supplies shops with its marketplace, what they call Internet shopping mall, and receive (1) registration fee for opening shop, (2) fixed service charge, (3) variable service charge and (4) commission from merchandise sales. Registration fee is 60,000JPY, and fixed monthly service charge differs from shop to shop, and the following chart summarizes the cost of different size of shops. Variable service charge also depends on plans, ranging from 2% ~ 7%, and so we assume it to be 5%. We set the commission rate to be 1.36%, a sum of: 1. 1% of Rakuten Super Point for buyers 2. 0.1% of miscellaneous cost 3. and 0.26% of affiliate commission** **Affiliate commission occurs when customers buy products through affiliated advertisements outside, and the commission for purchase through affiliated ads is 1.3%. Suppose that 20% of total purchase at Rakuten Market is induced by affiliated ads, we obtained 0.26% (=1.3%*20%) and the commission rate is 1.36% (=1% + 0.1% + 0.26%). Plan Mega Standard Gambare Light Max. Items Unlimited 20,000 items 5,000 5,000 Max. Image Data Unlimited 2GB 500MB 500MB Monthly Charge 100,000 yen 50,000 yen 19,800 yen 39,800 yen The 4 components of sales is summarized below, with their contribution pie chart together. 1. Registration Fee for Opening Shop (Only one time) 2. Fixed Service Charge (Regardless of sales) 3. Variable Service Charge (Set Proportionate with Merchandise Sales) 4. Commission (Set Proportionate with Merchandise Sales)
We summed up the above 4 components of sales, and we got 146,429 million yen for 2014, which is close to the disclosed sales of 151,274. This is proved not to be a mere coincidence, when we compared other years’ sales with our computation. See the below chart for the detailed numbers. Our calculations go a bit lower than actual sales, and we suppose miscellaneous sales will bridge the gap. Hence, we used the same assumption to forecast the future sales of Rakuten Ichiba. Computation of Rakuten Market Sales JPY in Millions 2011 2012 2013 2014 Team Calc. 95,775 109,183 128,708 146,429
Actual Sales 99,681 113,718 137,275 151,274
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Since Yahoo! Shopping started to offer their marketplace for free, the number of registered shops in Rakuten Ichiba has gradually decreased as shown below, and our hypothesis holds that industry transformation (Appendix H) causes a leak of shops from Rakuten to Yahoo! Shopping: traditional EC industry has been limited to BtoC, but Yahoo! Shopping eroded into CtoC to take in prospect small sized, or even individual, customers who wish to start their business at a low cost. We expect that shops on Light Plan in Rakuten Market will shift to Yahoo! Shopping as they did from 2013 to 2014. Yahoo! Shopping’s consumer-oriented service will surely be a game changer in that the more shops there are, the more attractive the market will be with full of contents.
Appendix E: The Details of the Analysis Methods of Industry Overview and the Relationship among Each Analysis Methods
The analyzing process of the industry overview is divided into three steps. PEST, Porter's 5 Forces, and SWOT Analysis are used in each part. Each analysis corresponds to the range of their focuses. In other words, PEST Analysis will be about macroscopic factors such as politics and economic situation, Five Forces Analysis primarily about the industries the company is in, and SWOT Analysis about both the industries and the company itself PEST Analysis is one of the frameworks which evaluate a company’s strategy or situation by considering its macro environment from the perspectives of Politics, Economy, Society, and Technology. Porter’s Five Forces Analysis is a management tool for measuring the attractiveness of the industry a company is trying to enter or has already been operating in. In this framework, there are two main types of indicator; internal factors and external factors. The former contains “the bargaining power of customers”, “the bargaining power of supplies”, and “intensity of competitive rivalry”, and the latter is composed of “threat of substitutes” and “barriers to entry”. SWOT Analysis is a conceptual framework used for analyzing the relationship between a company and its external environment, based on the four viewpoints as follow; Strength, Weakness, Opportunities, and Threats. Strength and weakness are categorized as inner factors, and opportunities and threats are classified as external factors.
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PEST Analysis
Politics Economy Increase of Growing comsumption household final tax expenditure P E S T Society Technology High growth rate of Crowd translating EC Increasing amount of Spread of smartphone data traffic
Politics: The Japanese government determined to rise the consumption tax in 2017, which will cause last minute surge in demand.
Economy: The household consumption expenditure in Japan is currently growing at a stable pace, which is also a positive trend for the whole company.
Society: BtoC ecommerce is growing both in the domestic market and foreign countries. This trend will continue for a while according to various companies’ forecast, and it will give a significant impact on Rakuten since their main enterprise is now ecommerce business. Widespread of smartphones will also promote the use of the Internet services Rakuten are producing such as ecommerce and digital contents.
Technology: The technology of cloud translating has recently been attracting attention. If the technology will be put in practice more, it will be much easier for Rakuten to expand their business worldwide. In addition, the data processing technology is now proceeding, and due to this, video streaming services became able to provide more and longer video stably.
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Porter’s Five Forces Anlysis
5 Forces Analysis of Rakuten Ichiba Bargaining Power of Customers 4 3.5 3 2.5 2 1.5 Bargaining Power of Barriers to Entry 1 Suppliers 0.5 0
Intensity of Competitive Threat of Substitutes Rivalry
We conducted five forces analysis for examining the ecommerce industry where Rakuten Ichiba is operating their business since Rakuten Ichiba is their core business so far.
Bargaining Power of Customers: Though, to be exact, the bargaining power of customer for Rakuten Ichiba ultimately depends on each product, one of the unique features of Rakuten Ichiba is the flexibility in designing shop pages, and high added value of the products the shops are selling. This suggests that Rakuten Ichiba is following differanciation strategy, and their customers do not buy their product because of their price, but the quality of their products. Therefore, bargaining power of customers would be low.
Bargaining Power of Suppliers: Due to the free of charge strategy by Yahoo!, ecommerce retailers got more options, and they consequently became more sensitive to the cost which they have to pay to EC sites. For this reason, the bargaining power of suppliers became stronger.
Intensity of Competitive Rivalry: Above-mentioned business model change by Yahoo! made the industry harsher with respect to competition. In fact, Yahoo! increased the number of their shops by ten times, and the number of shops Rakuten Ichiba has decreased.
Threat of Substitutes: There are not only integrated type of ecommerce site, but also specific EC site, and they can be strong substitutes for Rakuten Ichiba. For example, ecommerce site specialized for fashion items, ZOZOTOWN is quite popular. These different type of EC site can be a threat for Rakuten Ichiba.
Barriers to Entry: In terms of integrated type of ecommerce site, the barriers to entry are anticipated to be fairly low since the market is already dominated by Amazon, Yahoo!, and Rakuten. On the other hand, specialized type of ecommerce site is much easier to enter particularly for the companies which are already operating a specific business.
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SWOT Analysis of Digital Contents
Strength Weakness Synergy with other Small size services Crowd translating S W
O T Opportunity Threat Gradual increase of Harsh competition the market with other digital contents providers
We conducted SWOT analysis for examining the digital contents sector since they are one of the most important actors for accurately anticipating the future growth of Rakuten, and moreover, the industry of digital contents is in fairly competitive situation.
Strength: Some of Rakuten’s digital contents have synergy with other Rakuten service. For example, Rakuten Kobo, which sells electronic books, is closely linked with Rakuten Books. In addition, the technology of cloud translating by Viki can be one of the most important strengths, and it is expected to have more impact on expanding Rakuten’s business worldwide.
Weakness: Most of the digital contents enterprises in Rakuten has newly added during the past few years, so the size of each service tend to be still small. Digital contents are the industry which need the scale of economy, and therefore this point would be a weak aspect of Rakuten’s digital contents sector.
Opportunity: The size of digital contents market are gradually expanding. The use of smartphone is also becoming more and more popular, which will encourage people to easily have access to digital contents.
Threat: Since digital contents market has recently been expanding, a lot of companies are attempting to enter the industry. Therefore, as seen in the competition between Viber and LINE, every corners of the market has harsh competition among competitors.
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Appendix F: Macroeconomic Analysis We here discuss the macroeconomics of Japan in the future, and what we needed for our valuation of Rakuten is listed below with the research result:
Yearly growth rate of final household consumption expenditure – 3% The growth rate was used as an input to compute the size of EC industry in the future.
Expected inflation rate – 1% An expected inflation rate is used as a reference when we estimate the permanent growth rates. After Prime Minister Abe took an initiative for the 2% inflation target in February 2013, the rate reached 2.74% in 2014 but IMF’s forecast is pessimistic about the efficiency of the financial policy, as shown below. Our team is also sceptic about 2% inflation target to be met, and so we set the expected inflation rate 1% rounding the 2015’s forecast by IMF.
IMF Forecast 2012 2013 2014 2015E 2016E 2017E 2018E 2019E
Inflation Rate -0.04% 0.36% 2.74% 1.01% 0.88% 1.75% 1.28% 1.21%
Appendix G: EC Rate and Smartphone Penetration Of the significant external factors that affect Rakuten Ichiba’s performance, EC rate is the most critical. According to Ministry of Economy, Trade and Industry of Japan (METI), BtoC EC rate has grown steadily from 2.84% in 2010 to 4.37% in 2014. For the purpose of estimating the EC rate in the future, our team utilized another two data, (1) EC Consumption Volume Forecast by Nomura Research Institute (NRI) and (2) our forecast of Gross Domestic Consumption as discussed in Appendix F. Then we divided EC volume by total consumption to get EC rates ahead. Since no data is available for 2019 estimated year, the EC rate is set 7% that seems to be a safe guess from observation of American society, where the EC rate is 7.2% in 2015 Q2. Since America’s EC rate moved in line with smartphone penetration rate (R2 = 0.991), an increasingly high smartphone penetration in Japan will reasonably bring the EC rate up to 7%.
JPY in Millions 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E EC Volume 8,459 9,513 11,166 12,797 14,500 16,400 18,500 20,800 23,764 Growth Rate 9% 12% 17% 15% 13% 13% 13% 12% 14% GDE 266,845 279,794 290,026 292,838 301,623 310,671 319,991 329,591 339,479 EC Rate = EC / GDE 3.17% 3.40% 3.85% 4.37% 4.81% 5.28% 5.78% 6.31% 7.00% Sources: Ministry Of Economy, Trade and Industry
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Our hypothesis about a strong correlation between smartphone penetration rate and EC rate is further supported by the fact that mobile purchase rate in Rakuten Ichiba is becoming higher and higher up to 44% in 2014 Q4. And the latest annual reports of 2015 Q2 reported that the mobile rate reached 48.5%.
Appendix H: Electronic Commerce Industry Transformation, BtoC and CtoC Industry transformation is represented in the below table. The horizontal axis runs from CtoC to BtoC and the vertical axis goes down from general marketer to specialized marketer. Currently, major general BtoC players are Rakuten Ichiba, Amazon and Yahoo! Shopping, and these three marketplaces have competed over their share within this section of EC industry. Taking in more and more individual customers, however, Yahoo! Shopping is expected to be a more fascinating marketplace for both buyers and sellers. This trend led Rakuten to launch a new CtoC EC business called Rakuma, but it does not disclose enough details for us to discuss it in our report.
General Marketplace
Rakuten Line Mall Market Amazon
Yahoo! Shopping CtoC BtoC
Pinterest Zozotown Enigumo Oisix
Specialized Marketplace
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Appendix I: Competitive Positioning with Amazon and Yahoo! Shopping
We carefully chose 7 impact factors of EC business, and evaluated 3 major services, Rakuten Ichiba, Amazon and Yahoo! Shopping in terms of these impact factors. Evaluation was made in such a way as to choose the top brand for each wise, and then to assign relative points to the other brands. Each point is weighted by importance factor (ranging from 0.5 to 1.5), to take into account the different impacts of different factors on EC business. The following explains way of our point assignment for the 3 businesses. 0. (Factor Name) – (Importance Factor) 1. Number of products – 1.0 Rakuten Ichiba(2014/12) Amazon (2013/12) Yahoo! Shopping (2014/12) 150,000,000 50,000,000 140,000,000 2. Price and Point System – 1.5 3. Visitors – 0.6 Rakuten Ichiba(2015/4) Amazon (2015/4) Yahoo! Shopping (2015/4) 62.8 million 93.1 million 17.6 million (but will grow using its top page) 4. Number of Shops – 0.5 Rakuten Ichiba(2014/12) Amazon (2014/2) Yahoo! Shopping (2014/12) 41,442 161,000 243,000 5. Delivery Speed – 1.2 6. Visibility – 1.2 7. Promotion – 1.2 7 Competitive Points = ∑ 푁(푘) ∗ 퐼퐹(푘) 푘=1 ** N: Factor Name, IF: Importance Factor
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The sum of weighted points follows: Rakuten Ichiba Amazon Yahoo! Shopping 26.8 28.6 25.1
This competitive positioning and the points we obtained are used for a projection of growth rate of merchandise sales. With Amazon used as a reference point, Rakuten is -2.0% and Yahoo! Shopping is -3.5%. Supposing that Amazon as a reference will grow at the same rate as the EC industry (Appendix G), we formulated that Rakuten will grow at -2.0% of industry growth, whilst Yahoo! Shopping at -3.5% less industry growth. Note that we are now discussing merchandise sales, not sales. See Appendix T for how the formulation is used in EVA valuation model.
Appendix J: Market Size of EC Business by Region A trend of E-commerce is common throughout the world. Thanks to a higher smartphone penetration rate and better network environment, a size of E-commerce is expanding rapidly. The below chart is a five-year CAGR of growth rate, data taken from Euro- monitor. High growth rates are found in Asian area, and China is expected to become the biggest market in the near future. As for the regions Rakuten has already invested in, ASEAN’s growth is remarkable and North America and Europe are expected to yield 12% and 13% growth respectively. Appendix R utilizes these growth rates for the computation of Rakuten’s Overseas EC growth.
Table 2. Regional Industry Growth Region Next 5Y CAGR Major Competitors Europe 13% Amazon North America 12% Amazon ASEAN 23% Amazon, Alibaba China 20% Alibaba Japan 12% Amazon, Yahoo! Global 15% Sources: Euromonitor and team research
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There is no data available about merchandise sales (MS) by region. All we can know about Rakuten’s Overseas EC business is (1) that Rakuten did M&A over Western Europe, North America and ASEAN and (2) that the MS is 80 million yen excluding that of Ebates, which began to appear since 2014 Q4. Given that a size of EC industry in WE, NA and ASEAN in 2014 is 225 : 251 : 4, we applied this ratio to break down 80 million yen of Rakuten’s overseas EC MS, and we got 38, 42 and 1 million yen respectively. JPY in Millions 2014 Merchandise Sales 224 Ebates 143,500 Europe 37,500 North America 41,833 South East Asia 666
Appendix K: Competitive Positioning of Rakuten Overseas Amazon, Alibaba and Rakuten are not exactly positioned similarly. There are two vectors found in the business model of EC: retailer and middleman. These categories are not mutually exclusive and collectively exhaustive, but are to the point when a comparison is made for these three players. Retailer type of business is represented by Amazon, which has a network of inventory worldwide by itself and ships products throughout the world. A wide range of products is available and the shipping fee is discounted or exempted when they buy more than a certain amount at once. Therefore, Amazon’s global competitive positioning is their well-established worldwide logistics and discounts for big shopping. Furthermore, its premium membership service called Amazon Prime can be subscribed to have shopped goods delivered for free. This paid membership system gives consumers a loyalty to Amazon. Rakuten’s business model is positioned in the opposite extreme. Basically, it does not own goods but offers its marketplace to assess a commission fee and monthly service charge. Its strategy for global expansion is to attract local shops and make the marketplace localized. The advantages of this business model are (1) lower delivery cost, (2) localized lineup of products and (3) no inventory in need. Rakuten is planning to apply the know-hows they gained in its home market to overseas operation. Alibaba lives in the middle of these two businesses. It is successfully divided into a retailer type of Tmall and a middleman type of Taobao. Its business already settled in South East Asia, thanks to geographical advantage, and it ranks the first in Singapore market and within the 5 top EC websites in other parts of South East Asia. Their competitive strength in the region is that there live people with Chinese literacy, and Alibaba is free from linguistic cost and localization cost. On balance, the 3 companies are positioned slightly differently, so their competitive advantages come from how aware each one of them can be about their slightly unique position, and speaking about Rakuten, it is on the right track as they went through M&As over local EC companies for localization.
Amazon Retailer Alibaba Middleman Rakuten Ichiba
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Appendix L: Viber’s Regional Penetration and Comparison with Other SNS Services Viber is a cross-platform VoIP solution developed by Viber Media Inc. The number of users is reportedly more than 600 million in over 190 countries. It was first introduced to iOS in December 2010, and since then they adjusted its system to other smartphone platforms such as Android, Windows Phone, BlackBerry, Nokia Symbian and Samsung Bada. The application does not cost anything, and it only requires a SMS to be sent for validation of your phone number. In addition, they are also providing a solution for Windows and Mac based workstations. We can use Viber on our smartphone and desktop client at the same time. What is remarkable about Viber is that we can make a call to any active call to the other device, not only to Viber users, but also to any users with phone number. Viber is exposed to intense competition with other VoIP services, such as Whatsapp, Line, KakaoTalk, Skype and Facebook Messener. The below is the list of the VoIP services. Name Users in Millions Main Features; especially popular locations Viber 600 (Jun/2015) Easy registration with cellphone number, high call quality; massive user base in the West and emerging countries; calls to fixed-line phones, non-users also possible Whatsapp 700 (Jan/2015) Huge user base in English-speaking countries, especially the U.S.; Simple, easy-to-use design Line 560 (Sep/2015) Overwhelming market share in Japan; Growing Asia, South America; virtual “stickers” to express emotions gaining popularity KakaoTalk 100 Overwhelming market share in South Korea; simultaneous chat among up to five users; alied with Yahoo! Japan Skype 300 Established global reach through free VoIP application; calls to fixed-line phones, non-users also possible; expanding smartphones application offering Facebook 800 Has strong user base from Facebook service, the users are in literally all over the world Messenger As shown in the table above, Viber is surrounded by strong competitors. However, the number of Viber users will grow as a result of taking in emerging Asian countries. In addition to the potential in those countries, Viber will possibly be used for the business purposes. It is of convenience if we can call anyone just without asking accounts for other SNS services such as Skype and Whatsapp. Viber is proud of its high quality call and video conference via VoIP, and these may inspire business use of Viber.
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Appendix M: Forecasted Financial Statements for EVA The chart below summarizes our projection of sales and net operating income in the 5 years to come. The drivers of each business are elaborated in Appendix S based on historical analysis and competitive positioning, but Overseas EC (OEC) and Digital Contents (DC) are full of uncertainty for the lack of historical data and financial statements. So their growth is heavily dependent on our choice of growth rate, and we carefully selected the rates for OEC and DC by studying qualitative their aspects (Appendix P). Financial statements are shown separately by scenario:
Economic Value Added JPY in Millions 2013 2014 2015E 2016E 2017E 2018E 2019E Sales 518,568 598,565 755,890 824,584 918,083 1,007,491 1,096,545 Internet Services 315,228 362,751 439,428 485,546 537,081 591,166 655,394 Rakuten Market 137,275 151,274 160,833 176,686 193,884 212,394 236,420 Rakuten Travel 34,690 37,246 43,598 44,782 45,910 47,045 48,214 Overseas EC 17,270 60,756 70,279 81,324 90,622 101,103 Ebates 11,088 53,224 61,207 70,388 77,427 85,170 Europe 3,168 3,897 4,793 5,895 7,251 8,919 North America 2,936 3,435 4,019 4,703 5,502 6,438 South East Asia 77 105 143 194 264 360 Digital Contents 94,315 108,463 124,732 143,442 164,958 189,702 Other Services 62,646 65,778 69,067 72,520 76,146 79,954 Internet Finance 201,494 236,520 271,895 292,242 331,867 364,734 386,980 Rakuten Bank 26,336 30,618 33,784 37,735 41,967 46,518 51,410 Rakuten Card 111,427 133,561 157,430 167,326 197,444 221,138 234,406 Rakuten Securities 45,773 45,705 42,841 44,113 45,678 47,501 49,549 Rakuten Insurance 27,062 33,428 37,840 43,069 46,778 49,577 51,615 (Adjustment) (9,104) (6,792) 0 0 0 0 0 Others 35,746 42,445 44,567 46,796 49,135 51,592 54,172 2013 2014 2015E 2016E 2017E 2018E 2019E Net Operating Income 90,244 106,397 133,045 168,399 202,958 233,020 262,852 Internet Services 47,455 58,806 78,949 109,047 135,166 156,965 181,884 Rakuten Market 73,838 79,400 80,417 88,343 96,942 106,197 118,210 Rakuten Travel 13,038 15,503 14,917 14,874 14,790 14,685 14,568 Overseas EC 1,382 5,459 7,016 8,930 10,853 13,115 Digital Contents (50,008) (35,000) (15,000) 0 10,000 20,000 Other Services 12,529 13,156 13,813 14,504 15,229 15,991 Internet Finance 44,174 48,399 49,639 54,672 62,878 70,896 75,550 Rakuten Bank 7,176 11,153 11,824 13,207 14,688 16,281 17,993 Rakuten Card 16,398 14,756 18,892 21,752 27,642 33,171 35,161 Rakuten Securities 22,393 20,418 17,032 17,559 18,209 18,965 19,815 Rakuten Insurance 1,311 1,775 1,892 2,153 2,339 2,479 2,581 (Adjustment) (3,104) 297 0 0 0 0 0 Others 3,762 (639) 4,457 4,680 4,914 5,159 5,417
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Appendix N: Industry Beta Analysis and WACC Computation
5Y Monthly Beta Internet Services Rakuten Bank Rakuten Card Rakuten Securities Rakuten Insurance Relative 1 Yahoo! Japan Aeon Financial Hld. Orient Corporatioin SBI Hld. MS&AD Raw Beta 0.9081 0.7271 1.4631 2.1533 1.4515 R-Squarred 0.3311 0.2577 0.2796 0.7231 0.8145 Adjusted 0.938427 0.817157 1.310277 1.772711 1.302505 Relative 2 Start Today Sony Financial Hld. JACCS Matsui Securities T&D Hld. Raw Beta 0.6951 0.6519 1.511 1.8083 1.2528 R-Squarred 0.0865 0.3318 0.4231 0.6743 0.6915 Adjusted 0.795717 0.766773 1.34237 1.541561 1.169376 Relative 3 Rakuten Kansai Urban Bank Pocket Card Monex Sompo Japan Raw Beta 0.8044 0.6126 1.5466 2.28 1.3037 R-Squarred 0.07 0.3863 0.3759 0.7451 0.7524 Adjusted 0.868948 0.740442 1.366222 1.8576 1.203479 Average 0.8016 0.663866667 1.5069 2.080533333 1.336 Adjusted Average 0.867697333 0.774790667 1.339623 1.723957333 1.22512 Sources: Team calculation
Rakuten Group has a vast range of business, and it is inappropriate to discount all business by a single capital cost as there should be different risks around different types of business. Our team carried out Beta analysis by examining three relative companies to get industry Beta. In doing so, we set several rules to standardize all calculations. Book value was used for equity, except Internet Services. Since almost all equity of subsidiaries is held by Rakuten, there is no stock exchange and thus no price change. For the Internet Services, however, market value on September 30th 2015 was used because equity of this body is out there priced in the market. Adjusted Beta was used for the following reason: As many financial companies in Japan are subsidiary companies of the parent holding, their Beta could be lowered through strong dependency on debt finance from their parent company. If we averaged unlevered Beta of these subsidiaries, the industry Beta we get would be biased. Therefore, we used adjusted Beta instead, what they call Bloomberg Beta, and it is 0.33 + 0.67*(Raw Beta), as Beta is supposed to be 1 in the long run. Cash and equivalents are subtracted from debt to adjust it to net debt. Rakuten Group possesses an enormous amount of idle assets, and so net debt is proper to use.
Internet Services (2015/6) Relative companies: Yahoo! Japan, StartToday, Rakuten The three relative companies above have a similar business to Rakuten’s Internet Services segment, especially in a sense that they are operating EC business in Japan. As for Yahoo! Japan, it bears high similarity to Rakuten in their size and type of their EC services. StartToday was chosen because it operates Zototown, EC website for fashion items. Rakuten’s Beta was used itself.
Rakuten Bank (2015/3) Relative companies: The three relative companies we chose as samples for industry Beta analysis have some important features in common with Rakuten Bank. Aeon Financial Holdings operates one of the most popular Internet Banks in Japan, and its associated company Aeon also does BtoC retail services. Hence, its business model is considered highly similar to that of Rakuten Bank. Sony Financial Holdings is also a popular Internet-banking company, and Kansai Urban Bank is putting more and more resources on strengthening Internet banking service lately. For the reasons above, we believe these 3 companies are suitable for industry Beta analysis for Internet banking industry.
Rakuten Card (2014/12) Relative companies: Orient Corporation, JACCS, Pocket Card The selected three companies are all closely related to big banks. Orient Corporation has a strong partnership with Mizuho Bank, Jaccs with MUFG and Pocket Card with SMBC. Rakuten Card also has a close linkage with Rakuten Bank, and the linkage facilitates the stable business operation. With respect to their size, the three companies are large enough to compare with Rakuten Card, and we suppose they are appropriate for our industry Beta analysis to be based on.
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Rakuten Securities (2015/3) Relative companies: SBI Hld., Matsui Securities, Monex SBI Holdings, Matsui Securities and Monex are the biggest securities service providers, and what is remarkable in compareing these companies with Rakuten Securities is the similarity of their sales composition such as commission from stock exchange, asset management and leveraged loans. And these 3 companies are operating Internet-based securities services in a similar scale.
Rakuten Insurance (2015/3) Relative companies: MS&AD, T&D Hld., Sompo Japan All these companies do insurance business, and are similar to each other in that they have a strong support by holding companies. Admitting that the scale of Rakuten Insurance is not as large as the samples, we do not recognize major differences in their products and services.
Based on the above discussion, our team computed the weighted average cost of capital (WACC). Debt, by our definition, is debt finance from external financial sectors (excluding intra-group debt) minus cash and equivalents. There is no data available about the cash and equivalents for Internet Services, so we divided consolidated cash and equivalents into the one for Internet Finance and the other for Internet Services. Cash and equivalents for Internet Finance was 89,927 million yen, so it was subtracted from 428,635 million yen of consolidated cash and equivalents. The outcome, 338,708 million yen, is taken away from 436,500 of the debt, to obtain net debt for Internet Services.
JPY in Millions Internet Services Rakuten Bank Rakuten Card Rakuten Securities Rakuten Insurance Cost of Debt 1.49% 0.97% 3.24% 0.40% 0.00% Interest Expense 1956 44 3884 322 0 Debt 131383 4550 119923 79973 0 Cost of Equity 5.34% 4.87% 7.70% 9.62% 7.13% Free Risk Rate 1 1 1 1 1 Risk Premium 5 5 5 5 5 Beta 0.867697333 0.774790667 1.339623 1.723957333 1.22512 Debt 97792 4550 119923 79973 0 Equity 2025396 70240 54740 66169 6145 WACC 5.137% 4.616% 3.858% 4.499% 7.126% Sources: Team computation
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Appendix O: Breakdown of Internet Services Please be reminded of our own breakdown of Internet Services for EVA valuation in Appendix C. It consists of (1) Rakuten Market, (2) Rakuten Travel, (3) Overseas EC, (4) Digital Contents, (5) Other Services, and (6) Others. Overseas EC was estimated to be 30,147, a product of merchandise sales by 7.727%, which is the take rate of Ebates. Rakuten Marketing is an American based company, so we swapped the currency at 120 JPY/USD. The sales of digital contents is the residual within the sector.
JPY in Millions 2015 Q 1+Q 2 Estimation Description Internet Services for EVA 239,205 Internet Services 217,109 Rakuten Market 71,683 Rakuten Travel 18,300 Overseas EC NA 30,147 Merchandise Sales*7.727%(Ebates Take Rate) Digital Contents NA 67,760 Residual Other Services NA 29,219 -Rakuten Books 11,173 -Kenko-com 11,176 41.1(Last Q1+Q2 Sales)*1.393(Annual -Rakuten Marketing NA 6,870 Growth Rate)*120(JPY / USD) Others 22,096 -Fusion Communications 10,006 -Tohoku Rakuten Eagles 5,207 -Other Services 6,883
Sources: Team calculation
This breakdown is indispensable for our projection. The ratio is applied to estimate the 2014’s performance of digital contents and overseas EC, which are not disclosed in 2014’s annual reports. For instance, digital contents account for around 28% in the above breakdown, so this ratio is used to reach DC’s performance last year in comparison with the total sales last year.
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Appendix P: Projected Financial Statements for DCF Balance Sheet IFRS IFRS IFRS IFRS IFRS IFRS IFRS JPY in Millions 2013 2014 2015E 2016E 2017E 2018E 2019E Assets Cash and cash equivalents 384,008 428,635 807,257 918,889 1,033,516 1,180,386 1,394,314 Accounts receivables 73,443 88,871 101,856 112,312 124,126 136,646 151,676 Financial Assests for securities business 1,218,987 1,110,888 1,022,017 1,103,778 1,158,967 1,216,916 1,265,592 Loans for card business 544,314 692,886 810,677 907,958 1,016,913 1,169,450 1,239,617 Investment securites for banking business 197,897 222,297 245,638 275,115 308,129 354,348 391,554 Loans for banking business 239,818 321,877 355,674 398,355 446,158 513,081 566,955 Investment securities for insurance business 10,233 12,205 14,133 15,829 17,729 19,147 20,105 Derivatives 12,588 13,927 15,389 17,236 19,304 22,200 24,531 Investment Securities 34,025 50,506 58,430 63,659 70,844 77,748 84,672 Other financial assets 159,058 144,283 166,919 181,856 202,382 222,108 241,888 Investments in companeis recognized by equity method 8,189 8,932 14,157 13,288 15,017 17,720 20,539 Property, Plant and Equipment 30,408 34,811 40,272 43,876 48,829 53,588 58,360 Intangible assets 235,881 490,679 510,609 523,761 541,833 559,200 576,615 Goodwill 142,226 363,645 363,645 363,645 363,645 363,645 363,645 Software 48,413 56,464 65,322 71,168 79,201 86,920 94,661 Others 45,242 70,570 81,642 88,948 98,987 108,635 118,309 Deffered tax assets 31,594 35,006 40,498 44,122 49,102 53,888 58,687 Others 29,365 24,892 28,797 31,374 34,915 38,318 41,731 Total Assets 3,209,808 3,680,695 4,232,324 4,651,409 5,087,763 5,634,744 6,136,836
Liabilities Accounts payable 115,357 137,042 154,616 167,119 183,614 199,128 215,159 Deposits for banking business 959,960 1,137,195 1,256,600 1,407,393 1,576,280 1,812,722 2,003,057 Financial liabilities for securities business 1,077,971 995,141 915,530 988,772 1,038,211 1,090,121 1,133,726 Derivative liabilities 8,023 11,769 13,005 14,565 16,313 18,760 20,730 Other financial iabilities 226,771 242,616 280,679 305,797 340,312 373,480 406,741 Bond and borrowings 389,683 589,927 762,368 827,261 880,857 962,899 1,041,287 Bonds 1,819 31,140 25,000 25,000 0 0 0 Short-term borrowings 147,399 155,511 207,650 229,067 249,939 277,504 299,869 Long-term borrowings 183,665 356,776 455,379 492,203 540,787 586,478 633,692 Commercial papers 56,800 46,500 74,338 80,991 90,132 98,917 107,726 Income taxes payable 30,191 27,129 0 0 0 0 0 Provisions 41,020 43,969 52,875 58,303 64,435 70,935 78,737 Policy reserve and others for insurance business 18,852 19,847 22,983 25,741 28,830 31,136 32,693 Deferred tax liabilities 9,123 12,437 14,388 15,676 17,445 19,145 20,850 Other liabilities 26,403 35,537 40,418 43,687 47,999 52,054 56,245 Liabilities total 2,903,354 3,252,609 3,513,462 3,854,313 4,194,296 4,630,382 5,009,225
Equity Equity attributable to the parents company Common Stock 109,530 111,602 293,870 293,870 293,870 293,870 293,870 Capital surplus 116,555 118,528 118,528 118,528 118,528 118,528 118,528 Retained earnings 61,226 124,796 154,613 190,874 235,624 290,207 353,590 Treasury stock -3,649 -3,649 -3,649 -3,649 -3,649 -3,649 -3,649 Others 16,401 70,285 145,159 187,767 238,126 292,463 350,271 Non-controlling interests 6,391 6,524 10,340 9,705 10,968 12,943 15,002 Total Equity 306,454 428,086 718,862 797,095 893,467 1,004,363 1,127,611 Total liabilities and equity 3,209,808 3,680,695 4,232,324 4,651,409 5,087,763 5,634,744 6,136,836
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Pro Forma Balance Sheet IFRS IFRS IFRS IFRS IFRS IFRS IFRS 2013 2014 2015E 2016E 2017E 2018E 2019E Assets Cash and cash equivalents 12.0% 11.6% 19.1% 19.8% 20.3% 20.9% 22.7% Accounts receivables 2.3% 2.4% 2.4% 2.4% 2.4% 2.4% 2.5% Financial Assests for securities business 38.0% 30.2% 24.1% 23.7% 22.8% 21.6% 20.6% Loans for card business 17.0% 18.8% 19.2% 19.5% 20.0% 20.8% 20.2% Investment securites for banking business 6.2% 6.0% 5.8% 5.9% 6.1% 6.3% 6.4% Loans for banking business 7.5% 8.7% 8.4% 8.6% 8.8% 9.1% 9.2% Investment securities for insurance business 0.3% 0.3% 0.3% 0.3% 0.3% 0.3% 0.3% Derivatives 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% Investment Securities 1.1% 1.4% 1.4% 1.4% 1.4% 1.4% 1.4% Other financial assets 5.0% 3.9% 3.9% 3.9% 4.0% 3.9% 3.9% Investments in companeis recognized by equity method 0.3% 0.2% 0.3% 0.3% 0.3% 0.3% 0.3% Property, Plant and Equipment 0.9% 0.9% 1.0% 0.9% 1.0% 1.0% 1.0% Intangible assets 7.3% 13.3% 12.1% 11.3% 10.6% 9.9% 9.4% Goodwill 4.4% 9.9% 8.6% 7.8% 7.1% 6.5% 5.9% Software 1.5% 1.5% 1.5% 1.5% 1.6% 1.5% 1.5% Others 1.4% 1.9% 1.9% 1.9% 1.9% 1.9% 1.9% Deffered tax assets 1.0% 1.0% 1.0% 0.9% 1.0% 1.0% 1.0% Others 0.9% 0.7% 0.7% 0.7% 0.7% 0.7% 0.7% Total Assets 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Liabilities Accounts payable 4.0% 4.2% 4.4% 4.3% 4.4% 4.3% 4.3% Deposits for banking business 33.1% 35.0% 35.8% 36.5% 37.6% 39.1% 40.0% Financial liabilities for securities business 37.1% 30.6% 26.1% 25.7% 24.8% 23.5% 22.6% Derivative liabilities 0.3% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% Other financial iabilities 7.8% 7.5% 8.0% 7.9% 8.1% 8.1% 8.1% Bond and borrowings 13.4% 18.1% 21.7% 21.5% 21.0% 20.8% 20.8% Bonds 0.1% 1.0% 0.7% 0.6% 0.0% 0.0% 0.0% Short-term borrowings 5.1% 4.8% 5.9% 5.9% 6.0% 6.0% 6.0% Long-term borrowings 6.3% 11.0% 13.0% 12.8% 12.9% 12.7% 12.7% Commercial papers 2.0% 1.4% 2.1% 2.1% 2.1% 2.1% 2.2% Income taxes payable 1.0% 0.8% 0.0% 0.0% 0.0% 0.0% 0.0% Provisions 1.4% 1.4% 1.5% 1.5% 1.5% 1.5% 1.6% Policy reserve and others for insurance business 0.6% 0.6% 0.7% 0.7% 0.7% 0.7% 0.7% Deferred tax liabilities 0.3% 0.4% 0.4% 0.4% 0.4% 0.4% 0.4% Other liabilities 0.9% 1.1% 1.2% 1.1% 1.1% 1.1% 1.1% Liabilities total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Equity Equity attributable to the parents company Common Stock 35.7% 26.1% 40.9% 36.9% 32.9% 29.3% 26.1% Capital surplus 38.0% 27.7% 16.5% 14.9% 13.3% 11.8% 10.5% Retained earnings 20.0% 29.2% 21.5% 23.9% 26.4% 28.9% 31.4% Treasury stock -1.2% -0.9% -0.5% -0.5% -0.4% -0.4% -0.3% Others 5.4% 16.4% 20.2% 23.6% 26.7% 29.1% 31.1% Non-controlling interests 2.1% 1.5% 1.4% 1.2% 1.2% 1.3% 1.3% Total Equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Total liabilities and equity 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
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Profit and Loss IFRS IFRS IFRS IFRS IFRS IFRS IFRS JPY in Millions 2013 2014 2015E 2016E 2017E 2018E 2019E Revenue 518,568 598,565 692,472 754,440 839,593 921,424 1,003,483 Internet Services 315,228 362,751 436,225 481,006 531,599 585,222 649,591 Internet Finance 201,494 236,520 271,895 292,242 331,867 364,734 386,980 Others 35,746 42,445 44,567 46,796 49,135 51,592 54,172 Adjustment -43,151 -60,215 -65,604 -73,008 -80,124 -87,259 Operating expense 420,374 491,279 558,761 603,944 663,557 719,622 777,554 Advertisement and Promotinon 75,408 83,884 97,044 105,729 117,662 129,130 140,630 Employee benefits 93,206 108,898 125,983 137,257 152,749 167,636 182,565 Depreciation and amortization 26,086 30,140 31,596 32,557 33,878 35,147 36,420 Communication and maintainance 18,254 19,055 20,550 21,469 22,681 23,786 24,845 Consignment and subcontract 27,959 31,343 35,183 37,558 40,597 43,124 46,372 Allowance for doubtful accounts 12,928 16,964 19,443 21,439 23,694 26,084 28,952 Cost of goods sold 84,625 101,367 113,785 121,468 131,297 139,469 149,972 Interest expense for financials 4,864 5,590 6,425 7,196 8,060 9,269 9,952 Commision for financial 5,300 6,399 7,346 8,227 9,214 10,597 11,388 Insurance claims and others 11,215 15,963 18,485 20,703 23,188 25,043 26,295 Others 60,529 71,676 82,921 90,342 100,538 110,337 120,163 Other income 1,831 6,724 0 0 0 0 0 Other expenses 9,781 7,613 0 0 0 0 0 Operating income 90,244 106,397 133,711 150,496 176,036 201,802 225,929 Financial Income 197 230 266 290 323 354 386 Interest 140 184 213 232 258 283 308 Dividend 57 46 53 58 65 71 77 Financial expense 1,962 2,986 4,718 5,113 5,506 6,003 6,491 Interest 1,676 2,758 4,718 5,113 5,506 6,003 6,491 Comission fee 286 228 0 0 0 0 0 Income from investment recognized by equity method 131 604 957 899 1,015 1,198 1,389 Income before taxes 88,610 104,245 130,217 146,572 171,868 197,352 221,212 Income tax 45,129 33,142 46,409 48,515 55,582 63,823 71,540 Net income 43,481 71,103 83,808 98,056 116,286 133,528 149,672 Net income attributable to the parent company 42,900 70,614 83,308 97,556 115,786 133,028 149,172 Net income attributable to non-controlling interest 581 489 500 500 500 500 500 Pro Forma Profit and Loss IFRS IFRS IFRS IFRS IFRS IFRS IFRS 2013 2014 2015E 2016E 2017E 2018E 2019E Revenue 100% 100% 100% 100% 100% 100% 100% Internet Services 61% 61% 63% 64% 63% 64% 65% Internet Finance 39% 40% 39% 39% 40% 40% 39% Others 7% 7% 6% 6% 6% 6% 5% Adjustment 0% -7% -9% -9% -9% -9% -9% Operating expense 81% 82% 81% 80% 79% 78% 77% Advertisement and Promotinon 15% 14% 14% 14% 14% 14% 14% Employee benefits 18% 18% 18% 18% 18% 18% 18% Depreciation and amortization 5% 5% 5% 4% 4% 4% 4% Communication and maintainance 4% 3% 3% 3% 3% 3% 2% Consignment and subcontract 5% 5% 5% 5% 5% 5% 5% Allowance for doubtful accounts 2% 3% 3% 3% 3% 3% 3% Cost of goods sold 16% 17% 16% 16% 16% 15% 15% Interest expense for financials 1% 1% 1% 1% 1% 1% 1% Commision for financial 1% 1% 1% 1% 1% 1% 1% Insurance claims and others 2% 3% 3% 3% 3% 3% 3% Others 12% 12% 12% 12% 12% 12% 12% Other income 0% 1% 0% 0% 0% 0% 0% Other expenses 2% 1% 0% 0% 0% 0% 0% Operating income 17% 18% 19% 20% 21% 22% 23% Financial Income 0% 0% 0% 0% 0% 0% 0% Interest 0% 0% 0% 0% 0% 0% 0% Dividend 0% 0% 0% 0% 0% 0% 0% Financial expense 0% 0% 1% 1% 1% 1% 1% Interest 0% 0% 1% 1% 1% 1% 1% Comission fee 0% 0% 0% 0% 0% 0% 0% Income from investment recognized by equity method 0% 0% 0% 0% 0% 0% 0% Income before taxes 17% 17% 19% 19% 20% 21% 22% Income tax 9% 6% 7% 6% 7% 7% 7% Net income 8% 12% 12% 13% 14% 14% 15% Net income attributable to the parent company 8% 12% 12% 13% 14% 14% 15% Net income attributable to non-controlling interest 0% 0% 0% 0% 0% 0% 0%
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Cash Flow Statement IFRS IFRS IFRS IFRS IFRS IFRS IFRS JPY in Millions 2013 2014 2015E 2016E 2017E 2018E 2019E Cash flows from operating activities Income before income taxes 88,610 104,245 130,217 146,572 171,868 197,352 221,212 Depreciation and amortization 26,086 30,140 34,869 37,989 42,277 46,397 50,529 Other loss 5,509 1,643 0 0 0 0 0 Increase in operating receiveables -3,035 -1,901 -12,985 -10,456 -11,813 -12,521 -15,030 Increase in operating payable 29,464 17,917 17,574 12,503 16,496 15,514 16,031 Increase in loans for credit card -141,895 -148,572 -117,791 -97,281 -108,955 -152,537 -70,167 Increase in deposit for banking business 150,429 177,383 119,405 150,792 168,887 236,442 190,336 Increase in call loans for banking business -32,000 15,000 -16,575 -18,564 -20,792 -23,910 -26,421 Increase in loans for banking business -50,149 -82,060 -33,797 -42,681 -47,803 -66,924 -53,874 Increase in financial assest for securities business -603,284 132,864 88,871 -81,761 -55,189 -57,948 -48,677 Increase in financial liablities for securities business 519,916 -106,851 -79,611 73,242 49,439 51,911 43,605 Others 16,374 20,476 23,688 25,808 28,721 31,521 34,328 Income tax paid -11,308 -48,424 -46,409 -48,515 -55,582 -63,823 -71,540 Total cash flows from operating activities 1,485 111,860 107,456 147,647 177,554 201,472 270,332
Cash flows from investing activties Increase in restriced deposit -20,138 0 0 0 0 0 Increase in time deposit -8,089 -11,187 0 0 0 0 0 Decrease in time deposit 5,155 8,162 0 0 0 0 0 Purchase of PPE -10,018 -9,959 -11,580 -12,617 -14,041 -15,409 -16,782 Purchase of intangible assets -22,412 -26,783 -35,899 -41,850 -48,902 -53,668 -58,448 Acquisition of subsidiaries -30,198 -174,469 0 0 0 0 0 Net increase of investment securities for banking business 100,666 -23,697 -23,341 -29,477 -33,014 -46,219 -37,207 Net increase of investment securities for insurance business 3,363 -1,926 -1,928 -1,696 -1,900 -1,418 -957 Purchase of investment securities -4,728 -8,845 -7,924 -5,229 -7,185 -6,905 -6,924 Proceeds from sales and redemption of investment securities 5,654 12,907 0 0 0 0 0 Other payments -10,418 -13,396 0 0 0 0 0 Other proceeds 1,609 8,246 0 0 0 0 0 Total cash flows from investing activties 30,584 -261,085 -80,673 -90,868 -105,041 -123,620 -120,317
Cash flows from financing activties Proceeds from issuance of shares 0 0 182,268 0 0 0 0 Net increase in short-term borrowings 62,305 8,126 52,139 21,417 20,871 27,566 22,364 Increase in commercial papers 23,000 -10,300 27,838 6,652 9,141 8,785 8,809 Proceeds from long-term debt 63,210 251,860 98,603 36,824 48,583 45,692 47,214 Repayment of long-term debt -66,966 -82,817 -25,000 Proceeds from issuance of bonds 29,828 0 0 0 0 0 Cash devidends paid -3,962 -5,251 -6,511 -7,329 -8,593 -9,868 -11,061 Others -2,335 -1,934 -2,499 -2,712 -2,888 -3,157 -3,414 Total cash flows from financing activties 75,252 189,512 351,839 54,853 42,115 69,018 63,913
Effect of change in exchange rates on cash and cash equivalents 6,573 4,340 0 0 0 0 0 Net increase in cash and cash equivalents 113,894 44,627 378,622 111,632 114,627 146,870 213,928 Cash and cash equivalents at the beginning of the year 270,114 384,008 428,635 807,257 918,889 1,033,516 1,180,386 Cash and cash equivalents at the end of the year 384,008 428,635 807,257 918,889 1,033,516 1,180,386 1,394,314
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Pro Forma Cash Flow Statements IFRS IFRS IFRS IFRS IFRS IFRS IFRS JPY in Millions 2013 2014 2015E 2016E 2017E 2018E 2019E Cash flows from operating activities Income before income taxes 78% 234% 34% 131% 150% 134% 103% Depreciation and amortization 23% 68% 9% 34% 37% 32% 24% Other loss 5% 4% 0% 0% 0% 0% 0% Increase in operating receiveables -3% -4% -3% -9% -10% -9% -7% Increase in operating payable 26% 40% 5% 11% 14% 11% 7% Increase in loans for credit card -125% -333% -31% -87% -95% -104% -33% Increase in deposit for banking business 132% 397% 32% 135% 147% 161% 89% Increase in call loans for banking business -28% 34% -4% -17% -18% -16% -12% Increase in loans for banking business -44% -184% -9% -38% -42% -46% -25% Increase in financial assest for securities business -530% 298% 23% -73% -48% -39% -23% Increase in financial liablities for securities business 456% -239% -21% 66% 43% 35% 20% Others 14% 46% 6% 23% 25% 21% 16% Income tax paid -10% -109% -12% -43% -48% -43% -33% Total cash flows from operating activities 1% 251% 28% 132% 155% 137% 126%
Cash flows from investing activties Increase in restriced deposit 0% -45% 0% 0% 0% 0% 0% Increase in time deposit -7% -25% 0% 0% 0% 0% 0% Decrease in time deposit 5% 18% 0% 0% 0% 0% 0% Purchase of PPE -9% -22% -3% -11% -12% -10% -8% Purchase of intangible assets -20% -60% -9% -37% -43% -37% -27% Acquisition of subsidiaries -27% -391% 0% 0% 0% 0% 0% Net increase of investment securities for banking business 88% -53% -6% -26% -29% -31% -17% Net increase of investment securities for insurance business 3% -4% -1% -2% -2% -1% 0% Purchase of investment securities -4% -20% -2% -5% -6% -5% -3% Proceeds from sales and redemption of investment securities 5% 29% 0% 0% 0% 0% 0% Other payments -9% -30% 0% 0% 0% 0% 0% Other proceeds 1% 18% 0% 0% 0% 0% 0% Total cash flows from investing activties 27% -585% -21% -81% -92% -84% -56%
Cash flows from financing activties Proceeds from issuance of shares 0% 0% 48% 0% 0% 0% 0% Net increase in short-term borrowings 55% 18% 14% 19% 18% 19% 10% Increase in commercial papers 20% -23% 7% 6% 8% 6% 4% Proceeds from long-term debt 55% 564% 26% 33% 42% 31% 22% Repayment of long-term debt -59% -186% 0% 0% -22% 0% 0% Proceeds from issuance of bonds 0% 67% 0% 0% 0% 0% 0% Cash devidends paid -3% -12% -2% -7% -7% -7% -5% Others -2% -4% -1% -2% -3% -2% -2% Total cash flows from financing activties 66% 425% 93% 49% 37% 47% 30%
Effect of change in exchange rates on cash and cash equivalents 6% 10% 0% 0% 0% 0% 0% Net increase in cash and cash equivalents 100% 100% 100% 100% 100% 100% 100% Cash and cash equivalents at the beginning of the year 270,114 384,008 428,635 807,257 918,889 1,033,516 1,180,386 Cash and cash equivalents at the end of the year 384,008 428,635 428,636 807,258 918,890 1,033,517 1,180,387
Appendix Q: Sum of the Parts
2008 2009 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Net Profit Margin NA 18.0% 10.1% NA 4.4% 8.4% 11.9% 12.1% 13.0% 13.9% 14.5% 14.9% ROE NA 30.3% 15.9% NA 8.1% 14.3% 19.4% 14.6% 12.9% 13.8% 14.1% 14.0% ROIC NA 9.2% 6.1% NA 3.4% 10.3% 9.8% 7.8% 7.5% 7.9% 8.0% 7.9% Total Asset Turnover 0.111x 0.105x 0.093x 0.098x 0.110x 0.162x 0.174x 0.175x 0.170x 0.172x 0.172x 0.170x Debt to Equity 252.0% 229.9% 158.6% 151.8% 135.9% 128.5% 133.4% 117.9% 104.9% 101.0% 97.2% 94.0% Financial Leverage 628.2% 804.5% 842.4% 820.5% 837.5% 1058% 938% 690% 586% 576% 565% 552%
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Decomposition of Dupont formula Rakuten average median Yahoo Japan Kakaku.com START TODAY MonotaRO Profit Margin 27.7% 22% 20% 14% 43% 25% 7% Total Asset Turnover 0.31x 1.47 1.25 0.49x 1.36x 1.15x 2.89x Financial Leverage 192% 170% 159% 276% 87% 137% 182% ROE 16.6% 36% 37% 19.4% 50.1% 39.9% 34.9%
Decomposition of Dupont formula Rakuten Card average median Credit Saison Orient JACCS Aplus Financial Profit Margin 5.4% 6.1% 6.6% 4.2% 6.9% 6.3% 7.1% Total Asset Turnover 0.18x 0.07x 0.06x 0.15x 0.04x 0.04x 0.07x Financial Leverage 1359.4% 1453% 1443% 524% 1970% 2401% 915% ROE 13.0% 4.8% 5.0% 3.3% 5.8% 5.4% 4.6%
Decomposition of Dupont formula Rakuten Securities average median SBI Monex Group Matsui Securities kabu.com Securities Profit Margin 29.3% 28% 29% 21.2% 8.5% 46.2% 37.0% Total Asset Turnover 0.05x 0.05x 0.05x 0.07x 0.05x 0.05x 0.03x Financial Leverage 1414.8% 1247% 1078% 913% 1234% 922% 1920% ROE 21.8% 15% 17% 14.2% 5.6% 19.4% 22.8%
Decomposition of Dupont formula Rakuten Bank average median AEON Financial Sony Financial SBI Shinsei Bank Profit Margin 15.8% 13.6% 14.8% 10.4% 3.8% 21.2% 19.1% Total Asset Turnover 0.04x 0.09x 0.09x 0.10x 0.15x 0.07x 0.04x Financial Leverage 1858.9% 1326% 1279% 1260% 1832% 913% 1299% ROE 13.0% 11.8% 11.6% 12.9% 10.3% 14.2% 9.9%
Decomposition of Dupont formula Rakuten Insurance average median Dai-ichi Life T&D Tokio Marine Sompo Japan MS&AD Insurance Group Profit Margin 5.6% 3.8% 3.6% 2.7% 3.9% 5.9% 2.6% 3.6% Total Asset Turnover 1.15x 0.22x 0.21x 0.16x 0.15x 0.21x 0.32x 0.26x Financial Leverage 582.1% 938% 659% 1573% 1223% 622% 614% 659% ROE 37.7% 6.6% 6.7% 6.7% 7.5% 7.7% 5.2% 6.1%
Appendix R: Prospect of Rakuten’s Overseas EC Businesss and Digital Contents Our forecast of growth rates of Rakuten’s Overseas EC (OEC) considers (1) industry growth rate as explained in Appendix J and (2) unique growth rate in each strategic region, Europe, North America and South East Asia. This is formulated as below: Growth Rate = Industry Growth Rate + Unique Growth Rate 퐼푛푣푒푠푡푚푒푛푡 = Industry Growth Rate + ( − 퐶표푚푝푒푡푖푡푖표푛) 푀푎푟푘푒푡 푆푖푧푒 Unique growth of OEC in each region is generated by how much investment it does and how competitive the market is. Investment is divided by market size in the formula, to make sure measuring Rakuten’s relative presence in each market. However, it is in fact at our discretion what numbers to put to inputs, and therefore uncertainty analysis is put forward to create three scenarios.
Before explaining the three scenarios, let us sort out what we already know here: Investment over market size is the biggest in South East Asia, considering that market size is much smaller than Europe and North America and that digital contents on which prior investment was made will help attract more customers. Europe is a slightly smaller market than America and Rakuten made more investment in Europe than in America as well (the chart below), and these conditions made us certain about the order of investment/size running from South East Asia to Europe to North America.
Acquisition Country Price Time Rate Price Europe >25,411 Priceminister France € 200 Jul-10 ¥112 22,400 Tradoria Germany NA Jul-11 Play.com UK $39.10 Oct-11 ¥77 3,011 North America 22,000 Buy.com US $250 Jul-10 ¥88 22,000 Source: CrunchBase
Another thing we are sure about is the order of competition. SEA is the most competitive market, NA is the second, and EU ranks lastly. SEA is now full of major EC players, not only Amazon but Alibaba Group from China, because the region is geographically and culturally proximate to China. High growth potential there also attracts these players. North America is the second most competitive place as it is the home market for Amazon. Although EU is ranked as the least competitive, it is the second biggest source of revenue for Amazon and thus still thought to be competitive.
Moving forward, our team created three scenarios below:
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Most Probable Scenario This scenario is the one our team is most confident in. Digital contents, such as Viber, Viki or Wuaki, will settle on a healthy growth track and be able to yield profits in three years, as Rakuten said inside the presentation material of 2014 that they can be monetized soon. In addition, these digital contents will be an entrance to EC business and add up the competitiveness of OEC. The sales profit ratio of OEC will be improving at 1% per year from 8%.
Most Probable Scenario Europe North America South East Asia Investment/Market Size 15% 12% 25% Competition 8% 10% 15% Unique Growth 7% 2% 10% Industry Growth 13% 12% 23% Growth Rate 20% 14% 33%
Sources: Our calculation
Overseas EC 2015E 2016E 2017E 2018E 2019E Sales Profit Ratio 8% 9% 10% 11% 12%
Pessimistic Scenario Actual performance of DC and OEC may not match what it is planned to be like. Harsh competition with Whatsapp or other SNS may await Viber, and in turn this may hinder a synergy effect between DC and OEC. In this scenario, a growth of DC is kept low at 10% and the North America area will yield a lower growth than the industry will do. The degree of monetization, namely sales profit ratio, will remain 8% for OEC, due to delayed localization.
Pessimistic Scenario Europe North America South East Asia Investment/Market Size 15% 12% 25% Competition 13% 15% 20% Unique Growth 2% -3% 5% Industry Growth 13% 12% 23% Growth Rate 15% 9% 28%
Sources: Our calculation
Overseas EC 2015E 2016E 2017E 2018E 2019E Sales Profit Ratio 8% 8% 8% 8% 8%
Optimistic Scenario The assumption of this scenario is slightly different from the most probable scenario in that the sales profit ratio will be improving at 2% per year as shown below.
Overseas EC 2015E 2016E 2017E 2018E 2019E
Sales Profit Ratio 8% 10% 12% 14% 16%
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Appendix S: EVA Valuation and Findings of Value Drivers
We have used an Economic Profits (EPs) method in which to discount the projected residual profits into the present value, and then summed up the serial present values of each business to obtain the enterprise value of Rakuten as a whole. EPs, by our definition, are calculated in the following equation:
EPs = (Invested Capital) + (Present Values of Forecasted EVAs) + (Terminal Value) 푁푂푃퐴푇(푘) − 푊퐴퐶퐶 ∗ 퐼퐶(푘 − 1) 푁푂푃퐴푇 − 푊퐴퐶퐶 ∗ 퐼퐶 = IC(0) + ∑ + (1 + 푊퐴퐶퐶)푘 푊퐴퐶퐶 − 푃퐺푅
Residual profits are gained by subtracting the capital cost on Invested Capital (IC) from Net Operating Income After Tax (NOPAT). Discounting the residual profits by Weighted Average Cost of Capital (WACC), we then added up all these with the IC as of the latest. The terminal value of residual income is represented by the last term, where PGR stands for Permanent Growth Rate. We carried out the calculation of enterprise values of each business, and in the end reached the enterprise value of Rakuten as a whole.
Definition of Terms
Terms Definition Invested Capital Interest Bearing Liabilities + Equity – (Cash and the Equivalents + Marketable Securities) [All in Book Value] Tax on NOI Tax excluding those on Interest Dividends, Interest Expense, Non-operating Income and Extraordinary Income, but for the simplicity tax on NOI is set to be 35% of NOI, unless another consideration is needed. EVA Economic Value Added, namely residual profits that solely belong to investors Permanent Growth Permanent growth rate is set with expected inflation as a reference. The inflation rate for Rate the next 5 years is projected to be 0.8% (Appendix G)
Appendix S1: Internet Services (IS)
Historical Forecasted Income Statement JPY in Millions 2013 2014 2015E 2016E 2017E 2018E 2019E Sales 350,974 405,196 483,995 532,342 586,216 642,758 709,565 NOI 51,217 58,167 83,405 113,726 140,080 162,124 187,301 Tax on NOI 29,192 39,804 49,028 56,743 65,555 NOPAT 54,214 73,922 91,052 105,381 121,746 WACC 5.14% 5.14% 5.14% 5.14% 5.14% Invested Capital 729,286 1,094,885 1,204,254 1,326,128 1,454,036 1,605,166 Residual Income 16,749 17,676 29,187 37,255 47,050 Terminal Value 1,293,574 Present Value 729,286 15,931 15,991 25,114 30,490 1,006,954 EVA 729,286 15,931 15,991 25,114 30,490 1,006,954
1,823,766
The invested capital grew by 50% in 2015, because Rakuten did equity finance of 182 billion yen plus 142 billion yen of debt finance in 2015 Q2. The permanent growth rate is set 1.5%. The EC industry is considered a growing industry and the Internet Services segment is expected to take in a growth of overseas market as well. Therefore, it is 0.5% higher than the expected inflation rate.
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Appendix T11: Rakuten Ichiba
Back to Appendix D, we would like to review Rakuten Ichiba’s sales decomposition, each of which the following will elaborate on.
1. Registration Fee for Opening Shop (Only one time) 2. Fixed Service Charge (Regardless of sales) 3. Variable Service Charge (Set Proportionate with Merchandise Sales) 4. Commission (Set Proportionate with Merchandise Sales)
1. Registration Fee for Opening Shop (Only one time) As discussed in Appendix D, more and more small-sized shops are suspected to leave Rakuten Ichiba for Yahoo! Shopping, and the number of registered shops is expected to decrease. And the fee is only 60,000JPY, so it would not be a major problem if we leave out registration sales in the calculation.
2. Fixed Service Charge (Regardless of sales) Total shops will decrease at 2%, but Rakuten is successful in its strategy to reposition its marketplace to attract medium or large sized shops, as the number of Mega Plan and Standard Plan has gradually been increasing. This contrasts against leaks of small-sized shops to Yahoo! Shopping. Multiplying net shops of each type by respective monthly charge, our team computed the sales from fixed service charge.
Registered Shops 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total 38,553 40,735 41,996 41,442 40,613 39,801 39,005 38,225 37,460 Growth Rate 5.66% 3.10% -1.32% -2% -2% -2% -2% -2% Mega Plan 3.19% 3.41% 3.86% 4.31% 4.40% 4.50% 4.60% 4.70% 4.80% Net Shops 1,230 1,389 1,621 1,786 1,787 1,791 1,794 1,797 1,798 Standard Plan 28.7% 30.7% 34.7% 38.8% 39.6% 40.5% 41.4% 42.3% 43.2% Net Shops 11,069 12,502 14,589 16,075 16,083 16,119 16,148 16,169 16,183 Gambare Plan 58.1% 57.8% 55.1% 51.8% 52.0% 51.5% 51.0% 50.0% 49.0% Net Shops 22,399 23,545 23,140 21,467 21,119 20,497 19,892 19,112 18,356 Light Plan 10.0% 8.1% 6.3% 5.1% 4.0% 3.5% 3.0% 3.0% 3.0% Net Shops 3,855 3,300 2,646 2,114 1,625 1,393 1,170 1,147 1,124 Sources: Team estimation
3. Variable Service Charge (Set Proportionate with Merchandise Sales) This sales is dependent on merchandise sales. Please be reminded that Appendix G was for projection of EC merchandise sales in Japan as a whole, and competitive positioning was carried out in Appendix I, for the sake of assigning these growth rates for the major three players: Rakuten Ichiba, Amazon and Yahoo! Shopping. Amazon will grow with the whole industry, whereas Rakuten at -1.8% and Yahoo! Shopping at -3.5% of the industry. The variable service charge is obtained by multiplying the merchandise sales by 5% of take-rate. Incidentally, the share of the three players is expected to decrease, because of new entries in the future.
JPY in Billion 2012 2013 2014 2015E 2016E 2017E 2018E 2019E EC Volume 9,513 11,166 12,797 14,500 16,400 18,500 20,800 23,764 Growth Rate 17.4% 14.6% 13.3% 13.1% 12.8% 12.4% 14.2% Rakuten 1,446 1,734 2,006 2,237 2,489 2,763 3,057 3,438 Growth Rate 19.9% 15.7% 11.5% 11.3% 11.0% 10.6% 12.4% Amazon 630 754 845 958 1,083 1,222 1,374 1,570 USD 7,800 7,639 7,912 JPY / USD 80.82 98.65 106.85 Growth Rate 19.5% 12.2% 13.3% 13.1% 12.8% 12.4% 14.2% Yahoo! 986 1,107 1,191 1,308 1,433 1,567 1,706 1,890 Growth Rate 12.2% 7.6% 9.8% 9.6% 9.3% 8.9% 10.7% Total 3,063 3,594 4,042 4,502 5,006 5,552 6,138 6,897 Share of 3 32.2% 32.2% 31.6% 31.0% 30.5% 30.0% 29.5% 29.0%
Sources: Team computation
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4. Commission (Set proportionate with Merchandise Sales) This revenue source also depends on merchandise sales. Rakuten Ichiba can take 1.36% of sales from merchandise sales.
The below chart is a summary of sales decomposition.
Sales 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E (1) Registration Fee 83 131 76 0 0 0 0 0 0 (2) Fixed Services Charge 15,938 17,087 18,350 18,893 18,584 18,357 18,132 17,955 17,778 (3) Variable Service Charge 62,700 72,300 86,700 100,290 111,831 124,472 138,170 152,861 171,888 (4) System Service 17,054 19,666 23,582 27,279 30,418 33,856 37,582 41,578 46,754 Sum 95,775 109,183 128,708 146,462 160,833 176,686 193,884 212,394 236,420 Actual Sales 99,681 113,718 137,275 151,274 Sources: Team estimate
Expense Rate The expense rate has increased from 43% in 2012 to 48% in 2014, and we assume this increase was brought by investment against Yahoo! Shopping. We estimate it will keep increasing till 50% and be stable from then onwards.
Appendix T12: Rakuten Travel (RT)
Business Description RT is one of the biggest Internet travel agencies in Japan, and they earned 37.2 billion yen as the total revenue, and 15.1 billion yen as the operating profit. RT is the second largest enterprise in Rakuten’s Internet service sector, and accounts for about 5% of the total revenue of Rakuten. We expect that though RT’s future growth rate is not so high, compared with the growing enterprises of Rakuten such as Foreign EC and Digital contents, they will gradually increase their profit.
Revenue Growth RT’s revenue will grow little by little for the following three reasons. The first reason is that the increasing number of inbound foreign travelers will come to use Rakuten Travel since Rakuten is currently paying more attention to attract foreign users by promoting multilingualize their businesses. Furthermore, the number of inbound travelers is becoming larger and larger, which is also a positive trend for RT. Secondly, RT is strengthening their connection with foreign countries. In fact, they established foreign branches in Singapore, Philippines, Vietnam, and so forth the last few years. As a result, the number of the registered facilities overseas will increase, and then more and more users will come to use RT for a foreign trip too. However, thirdly, the present biggest revenue source, use of domestic users to travel in Japan, will decrease due to the increasing competitive intensity of the market, and less domestic travel expenditure. Therefore, though RT’s revenue composition is now nearly dominated by the revenue related to the domestic market, it will change toward the one more driven by the revenue from foreigners and overseas travel. The detailed projection is shown as a figure.
Cost Rate and Operating Profit The cost rate of RT is set as 65%, considering it has been fluctuating around 65% and it is expected that their basic business structure (Ex: the cost and revenue ratio) will not easily change since RT is already a mature company. Because the cost rate will not differ from the current one, the operating profit will move in conjunction with the change in RT’s revenue.
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Appendix T2: Rakuten Bank (RB)
Historical Income Statement Projected Income Statement JPY in Milllions 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Sales 35,745 38,283 41,221 45,453 54,165 59,270 66,202 73,626 81,611 90,193 Cost Rate 47% 43% 38% 42% 44% 43% 43% 43% 43% 43% Gross Profit 19,036 21,889 25,635 26,336 30,618 33,784 37,735 41,967 46,518 51,410 Expense Rate 81% 74% 67% 73% 64% 65% 65% 65% 65% 65% NOI 3,704 5,697 8,389 7,176 11,153 11,824 13,207 14,688 16,281 17,993 Tax 3,021 4,525 2,063 (37) (1,498) (1,774) (2,641) (3,672) (4,884) (6,298) NOPAT 6,725 10,222 10,452 7,139 9,655 10,051 10,566 11,016 11,397 11,696 WACC 4.252% 4.252% 4.252% 4.252% 4.252% Invested Capital 74,790 81,839 91,410 101,661 112,687 124,536 Residual Profits 6,871 7,086 7,130 7,074 6,904 Terminal Value 212,324 Present Value 6,590 6,520 6,292 5,989 172,416 EVA 74,654 6,590 6,520 6,292 5,989 172,416 272,462
Business Description RB is a major Internet-bank in Japan and has the largest number of accounts open among Japan’s Internet banks. After being incorporated into Rakuten Group in 2009, the sales grew dramatically as Rakuten Ichiba obliges shops to use Rakuten Bank account. Most of the RB’s profits come from asset management. We cut into customers’ deposits, namely RS’s asset, to find out the strong correlation between deposits and accounts as shown in the figure below. We also confirmed a correlation between deposits and sales. Therefore, the projection of accounts to be opened in the future enables us to foresee the future deposits, and eventually the RB’s sales.
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Projection of Open Accounts, Deposits and the Sales Five year monthly growth rates of open accounts fluctuated around 0.6% with the standard deviation around 0.0942%. We expect a five year CAGR of 0.6% to continue for the forecasted years. It allows us to predict the number of newly opened accounts and the sales in the forecasted five years. Making use of the equation in the tables above, our team built an equation for sales calculation. The table below is the result of our calculation.
(Sales) = 3.4403 × (Deposits) + 11241 = 3.4403 × {5.3382 × (푁푒푤푙푦 푂푝푒푛푒푑 퐴푐푐표푢푛푡푠) − 14350} + 11241
Historical Income Statement Projected Income Statement JPY in Millions Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 2016E 2017E 2018E 2019E 2020E Accounts Open 3722 3980 4255 4602 4963 5331 5794 6222 6683 7177 Deposits 7151 7583 8362 10165 12468 14106 16577 18866 21324 23964 Sales 35745 38283 41221 45453 54165 59270 66202 73626 81611 90193
Cost Rate, Expense Rate and Invested Capital Observation of the historical transition of cost rate gave us a realization that it ranges from 38%-47% and hence, we averaged the last 5 year cost rates to get 43% for the projection. Also, we used 65% for the expense rate, 5% lower than the average expense rate of the banking industry according to Bank of Japan. The 5% down estimation derives from (1) 64% of the last year’s expense rate and (2) smaller investment in need due to the nature of internet banking. For the invested capital, we projected it to increase at the sales growth rate.
Tax on Net Operating Income For the last five years, the tax on net operating income was either under zero or, if any, very little. This is because extraordinary income is relatively large in PL f RB, and thus the corporate tax looks irrelevant with net operating income. In our forecast, however, a presence of extraordinary income will be smaller and tax is projected to be 35% of net operating income gradually in five years’ time.
Permanent Growth Rate As we assume the industry growth rate of Internet Banking will be saturated soon and go parallel to the whole economy. So the permanent growth rate is set the same as the expected inflation rate 1%.
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Appendix T3: Rakuten Card (RC)
Historical Income Statement Forecasted Income Statement JPY in Millions 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Sales 5,588 32,929 85,600 111,427 133,561 157,430 167,326 197,444 221,138 234,406 Expense Rate 88% 81% 81% 85% 89% 88% 87% 86% 85% 85% NOI 698 6,345 16,223 16,398 14,756 18,892 21,752 27,642 33,171 35,161 Tax on NOI (277) (824) (4,394) (6,540) (5,907) (6,612) (7,613) (9,675) (11,610) (12,306) NOPAT 421 5,521 11,829 9,858 8,849 12,280 14,139 17,967 21,561 22,855 WACC 3.648% 3.648% 3.648% 3.648% 3.648% Invested Capital 209,040 246,398 261,886 309,025 346,108 366,875 Residual Profits 4,654 5,150 8,414 10,287 10,228 Termianl Value 476,147 Present Value 209,040 4,490 4,794 7,556 8,914 398,049 EVA 209,040 4,490 4,794 7,556 8,914 398,049 632,843
Business Description RC is positioned as one of the most important businesses among Rakuten Ecosystem, as it plays two key roles: (1) to facilitate transactions in the Ecosystem and (2) to lure people into the Rakuten’s business sphere by Rakuten Super Point. RC issues credit cards for cashing and card loans, and consumers can enjoy better services and lower interest rate, if they use Rakuten Bank at the same time. Furthermore, credit cards by RC received the most satisfactory credit card award by JCSI for six years in running, and the radar chart shows the scores. Furthermore, we believe RC’s profitability is stably high as 80% transaction by RC cards is, in fact, not within Rakuten Group, and so we can safely say that RC is an individually profitable business.
Expectation 100 80 60 Loyalty Quality 40 20 0
Recommendabili Cost ty Performance
Satisfaction
Transaction Volume by Credit Cards and the Sales Projection Use of credit cards for shopping has become more common in our society and sizable in the transaction volume. According to Japan Consumer Credit Association, the transaction volume by credit cards has been growing at a CAGR 6% over the last ten years. This is a favorable trend for RC, and coupled with the award mentioned above, RC has achieved an average 39% growth of the transaction volume over the last five years. Our team expects RC’s competitive edge will last till 2019 when the growth rate of transaction by RC cards will be parallel to transaction by all credit cards, due to competition and catch-ups of other credit cards. The take rate, sales over transaction volume, will be 3.3%, an average of the last five years, and the forecasted data is shown below.
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JPY in Billins 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Transaction by All Cards 33,474 33,489 35,980 37,769 40,686 43,268 46,013 48,933 52,038 55,340 Growth Rate 0% 7% 5% 8% 6% 6% 6% 6% 6% Transaction by RC's Cards 920 1,330 1,800 2,560 3,460 4,498 5,578 6,581 7,371 7,814 Growth Rate 45% 35% 42% 35% 30% 24% 18% 12% 6%
Invested Capital RC puts all net profits into net assets every year, and liabilities are pushed up to cover a growing amount of installment accounts receivable. So the invested capital is expected to rise constantly, and for the simplicity we suppose it should rise at the same rate as sales.
Permanent Growth Rate The permanent growth rate is set 1.5%. Transaction volume of credit cards is expected to grow at 6%, and this is well over the whole economy. Furthermore, RC started to operate in Taiwan in 2015 and is increasing its presence there. These conditions give us an expectation that RC will go overseas to take in sharp growth of local markets.
Appendix T4: Rakuten Securities (RS)
Historical Income Statement Forecasted Income Statement JPY in Millions 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Sales 22,957 20,798 24,548 45,773 45,705 42,841 44,113 45,678 47,501 49,549 Cost (1,612) (1,330) (1,079) (1,205) (1,674) (1,499) (1,544) (1,599) (1,663) (1,734) Expense (15,155) (15,384) (16,404) (22,175) (23,613) (24,310) (25,009) (25,870) (26,873) (27,999) NOI 6,190 4,084 7,065 22,393 20,418 17,032 17,559 18,209 18,965 19,815 Tax on NOI (2,928) (1,125) (2,285) (8,955) (6,820) (5,961) (6,146) (6,373) (6,638) (6,935) NOPAT 3,262 2,959 4,780 13,438 13,598 11,071 11,414 11,836 12,328 12,880 WACC 4.109% 4.109% 4.109% 4.109% 4.109% Invested Capital 146,142 136,984 141,050 174,541 181,670 187,863 Residual Profits 5,066 5,786 6,041 5,156 5,416 Termianl Value 174,232 Present Value 4,866 5,338 5,353 4,389 142,461 EVA 146,142 4,866 5,338 5,353 4,389 142,461
308,550
Business Description RS is a major Internet securities services provider, and was incorporated into Rakuten Group in 2003, by which Rakuten Group doubled its sales at that time. There are 1.8 million accounts open and privileged services available for those who connect RS and Rakuten Bank account, such as lower interest rate and lower commission rate. RS earns its revenue from commission fee, trading, and financial revenue as shown below. As other providers, such as Kabu.com, GMO Click Securities and Monex Securities, entered this industry with a lower commission rate, the RS revenue from commission fee has decreased, and financial revenue and trading revenue have grown to cover the loss. One of the RS’s strategies is to diversify its source of revenue, as it announced in 2015 that it would buy FXCM to complement the existing FX services, and also to strengthen NISA business.
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Diversification of Revenue Sources RS depended on commission fee of stock exchange for most of its sales, but with FX business and financial revenue from NISA business, it will diversify revenue sources and build relatively stable sales base. Under this understanding, our forecast is based on the following: Commission revenue will be in the same standard for the reason that (1) although commission from stock exchange will decrease at 10% due to new entries of other service providers with strong price power, (2) commission from FX will increase at 15%, driven by the acquisition of FXCM. Plus, FX sales of the first forecasted year takes into consideration a 15.86% growth, which is a relative size of FXCM compared with RS. Growth rate of trading revenue is set to step down by 1% from 10% - , but for the first projected year, we inputted an average of sales in 2013 and 2014 to remove a bias from the irregularly high sales in 2014 brought by temporal soar of stock market. Forecast for financial revenue is set in the same way as trading revenue, and the same modification was made for the first forecasted year to remove the bias of the 2014’s performance.
The chart below is our sales forecast. The reason why there is a difference between total sales and actual sales in 2014 and 2015 is that we used rough percentages from disclosure to reach each one of sales. JPY in Millions 2014 2015 2016E 2017E 2018E 2019E 2020E Commission 27,161 23,706 23,187 22,494 22,113 22,051 22,317 Stock 22,675 18,541 16,687 15,018 13,517 12,165 10,948 FX 4,486 5,165 6,500 7,475 8,597 9,886 11,369 Trading 5,142 6,508 5,825 6,408 6,856 7,199 7,415 Growth Rate 10% 9% 8% 7% Financial Revenue 12,722 14,935 13,829 15,211 16,276 17,090 17,603 Growth Rate 10% 9% 8% 7% Total 45,025 45,149 42,841 44,113 45,245 46,340 47,335
Actual Sales 45,773 45,705
Cost Rate and Expense Rate The cost rate has become lower in the historical 5 years, from 7% to 3.7%, and we expect it to be around 3.5%. For the expense rate, RS has been cutting down on administrative fee and trading fee, the two biggest expenses, so our forecast is based on 50% of expense rate plus 747.4 million yen of ten year depreciation of the FXCM acquisition.
2011 2012 2013 2014 2015 Cost Rate 7.0% 6.4% 4.4% 2.6% 3.7%
Expense Rate 66.0% 74.0% 66.8% 48.4% 51.7%
The pie charts below show the sales breakdown in 2014 and 2019.
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Permanent Growth Rate We set it 1%, as securities service providers are expected to find it difficult to differentiate their service from others. In addition, new entrants with price power will threaten RS’s current position in the industry. So the rate is set to be the same as the inflation rate.
Appendix T5: Rakuten Insurance
Historical Income Statement Forecasted Income Statement JPY in Millions 2011 2012 2013 2014 2015 2016E 2017E 2018E 2019E 2020E Sales 33,517 28,411 26,796 27,062 33,428 37,840 43,069 46,778 49,577 51,615 Expense Rate 97% 99% 92% 95% 95% 95% 95% 95% 95% 95% NOI 966 321 2,090 1,311 1,775 1,892 2,153 2,339 2,479 2,581 Tax on NOI 386 128 836 524 710 662 754 819 868 903 NOPAT 580 193 1,254 787 1,065 1,230 1,400 1,520 1,611 1,678 WACC 6.513% 6.513% 6.513% 6.513% 6.513% Invested Capital 5,918 6,303 6,714 7,151 7,617 8,113 Residual Profits 844 989 1,083 1,145 1,181 Termianl Value 20,679 Present Value 7,094 793 872 896 890 15,084 EVA 7,094 793 872 896 890 15,084 33,049
Business Description Rakuten Insurance (RI) is established by the M&A between Rakuten and Airio Insurance in 2013, and is one of the Internet insurance companies which are rapidly growing (the number of new insurance contracts doubled in the fiscal year 2013-2014). They provides the Internet insurance services such as life insurance and medical insurance. Table A41 shows the composition of the ordinary revenue in 2014, and suggests that most of the RI’s ordinary revenue come from premium revenue and reinsurance revenue. Ordinary Revenue Composition (2014)
2%
17%
81%
Premium revenue Reinsurance revenue Other revenue
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The premium revenue can be divided into the following three parts; the continuing contract premium (CCP), the new contract premium (NCP), and premium from the contracts expired during the year (ECP). This division is from the difference of the insurance price per contract. Their services and the insurance price have been changing year by year. The new contract premium is applied new pricing system to, and also the contracts expired during the year use the same pricing system as the continuing contract in general though the premium from the expired contracts should be considered after discounted based on the month when they expire. Thus, by analyzing each revenue respectively, we can reasonably project the future premium revenue from the current insurance price per contract and the number of contracts. Table A42 shows the calculation formula of the above-mentioned premium revenue elements. This calculation formula is not set up by RI, but assumed by us since RI doesn’t disclose the details of the premium revenue contents. However, this formula is found reliable enough, considering the high correlation between the actual premium revenue and the self- estimated premium revenue.
CCP=(No. of continuing contracts-No. of new contracts)*previous year's one-year-long insurance fee per contract
NCP=No. of new contracts*one-year-long insurance fee per new contract
ECP=No. of expired contracts during the year*previous year's one-year-long insurance fee per contract/2
Approximate premium revenue=CCP+NCP+ECP
Calculation Formula of the Premium Revenue Elements
Corelation between the Actual Premium and the Self-estimated Premium (2009-2013) (¥ in million) 27,600 27,500 y = 0.7169x + 7833.4 R² = 0.9734 27,400 27,300 27,200
27,100 estimated estimated Premium
- 27,000
Self 26,900 26,800 26,500 26,600 26,700 26,800 26,900 27,000 27,100 27,200 27,300 27,400 27,500 27,600 Actual Premium
The number of continuing, new, and expired contracts after 2014 can be projected once the growth rate of the number of new contracts and the persistence rate of their clients are estimated, and they are respectively about 34% and 90% (the former is calculated by geometric mean, and the latter by arithmetic average based on the data between 2008 and 2014). One-year-long insurance fee per contract or new contract can also be expected by the past data. From these data, the projected premium revenue are shown below.
2015 2016 2017 2018 2019
CCP 24,880 28,236 31,707 34,297 36,151 NCP 5,466 6,250 6,250 6,250 6,250 ECP 927 1,108 1,310 1,491 1,655 Premium revenue 31,273 35,594 39,267 42,038 44,056 Projected premium revenue
Reinsurance revenue is the other source of the revenue, and on the whole it fluctuates between 20% and 25% of the premium revenue though the reinsurance revenue between 2011 and 2013 rapidly dropped due to the legal issue with a reinsurance company. Considering the risk from legal issues, the rate of reinsurance revenue to the premium revenue are set up as 20%. And after 2016, it will not change since the market size of reinsurance is not so large. In terms of the other revenues, its ratio has been around 1% of revenues, and therefore the projected revenue is as shown below.
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2015E 2016E 2017E 2018E 2019E
Premium revenue 31,273 35,594 39,267 42,038 44,056 Reinsurance revenue 6,255 7,119 7,119 7,119 7,119 Other revenue 313 356 393 420 441 Ordinary revenue 37,840 43,069 46,778 49,577 51,615
Cost Rate and Invested Capital After 2009, the cost rate to the operating revenue is fluctuating around 95%, and this ratio won’t change easily without a radical business structural reform. For the same reason, the amount of the invested capital is fixed as 15%.
Permanent Growth Rate The inflation rate is estimated to grow by 1% every year, but the Internet insurance industry is becoming in more severe situation, and therefore we anticipate 0.8% as the permanent growth rate of Rakuten Insurance.
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Disclosures: Ownership and material conflicts of interest: The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company. The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias the content or publication of this report. Receipt of compensation: Compensation of the author(s) of this report is not based on investment banking revenue. Position as a officer or director: The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject company. Market making: The author(s) does not act as a market maker in the subject company’s securities. Disclaimer: The information set forth herein has been obtained or derived from sources generally available to the public and believed by the author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report should not be considered to be a recommendation by any individual affiliated with CFA Society Japan, CFA Institute or the CFA Institute Research Challenge with regard to this company’s stock.
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