08 July 2015 Asia Pacific/Japan Equity Research Consumer Internet (Internet (Japan)) / MARKET WEIGHT Rakuten (4755 / 4755 JP) Rating OUTPERFORM* Price (07 Jul 15, ¥) 2,022 INITIATION Target price (¥) 2,400¹ Chg to TP (%) 18.7 Market cap. (¥ bn) 2,878.52 (US$ 23.45) King of Japanese e-commerce Enterprise value (¥ bn) 2,868.91 Number of shares (mn) 1,423.95 ■ Action: We initiate coverage of Rakuten with a ¥2,400 target price (potential Free float (%) 55.0 return 18.7%) and an OUTPERFORM rating. Rakuten is our top pick in the 52-week price range 2,358 - 1,138 *Stock ratings are relative to the coverage universe in each Internet sector. We look for business domain expansion to drive continued analyst's or each team's respective sector. double-digit growth. For details, see our report Internet/Telecom sector: ¹Target price is for 12 months. Battling ecosystems: Search for winners among telecom/Internet stocks, Research Analysts also published today. Hitoshi Hayakawa 81 3 4550 9952 ■ Investment case: Rakuten operates Japan’s largest e-commerce site, [email protected] Rakuten Ichiba, and is the country’s undisputed e-commerce leader. It boasts over 70mn customer login IDs, a key measure of competitiveness in our view, which is by far the highest count among the five ecosystems (Rakuten, Softbank Group, Recruit Holdings, NTT DoCoMo, KDDI). In addition to e-commerce, it is also strong in travel booking, with Rakuten Travel ranking as one of Japan’s two dominant players in this area along with Recruit’s Jalan. Through targeted acquisitions, Rakuten has also aggressively entered the finance arena to quickly become an Internet finance conglomerate, offering services in the areas of consumer credit (Rakuten Card), banking, securities (including forex), and life insurance. ■ Catalysts/risks: (1) Expansion or reduction of overseas M&A transactions, (2) acceleration or slowing in equity financing and profit growth (3) expanded earnings or losses at overseas subsidiaries, (4) growth or contraction in e- commerce transaction value, (5) increased competition from Yahoo!Shopping, Amazon and others, (6) developments in the Japanese stock market, and (7) improvement or deterioration in economic conditions. ■ Valuation: We derive our ¥2,400 TP for Rakuten by applying the stock’s past-three-year-average P/E of 37.4x to our FY12/16 EPS estimate of ¥65. Our FY12/16E EBITDA is ¥168.3bn. EV/EBITDA on our ¥2,400 TP is 20x. Share price performance Financial and valuation metrics Year 12/14A 12/15E 12/16E 12/17E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 598.6 680.0 778.9 884.7 4000 160 Operating profit (¥ bn) 106.4 122.9 140.5 160.1 3000 140 Pre-tax profit (¥ bn) 104.2 121.9 139.5 159.0 2000 120 Net income (¥ bn) 70.6 76.1 92.8 105.8 1000 100 EPS (¥) 53.5 56.7 64.9 74.0 0 80 Jul-13 Nov-13 Mar-14 Jul-14 Nov-14 Mar-15 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 56.3 72.0 85.5 The price relative chart measures performance against the EPS growth (%) 64.0 6.0 14.5 14.0 TOPIX which closed at 1637.23 on 07/07/15 P/E (x) 31.5 35.7 31.2 27.3 On 07/07/15 the spot exchange rate was ¥122.74/US$1 Dividend yield (%) 0.27 0.22 0.22 0.22 EV/EBITDA(x) 17.5 17.8 15.3 12.8 Performance over 1M 3M 12M P/B (x) 6.3 4.6 4.2 3.6 Absolute (%) 6.6 -12.0 45.3 ROE(%) 22.0 15.8 14.2 14.2 Relative (%) 8.4 -15.1 17.4 Net debt/equity (%) 45.4 net cash net cash net cash Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 08 July 2015 Rakuten (initiating coverage) Consolidated Figure 1: Rakuten (4755): Consolidated earnings forecast summary Sales Operating profit Pre-tax profit Net profit EPS DPS P/E ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥ YoY (%) ¥ (x) Consolidated Dec-14 Actual 598,565 15.4 106,397 17.9 104,245 17.6 70,614 64.6 53.5 64.0 4.5 31.5 Dec-15 CS E (new) 680,049 13.6 122,945 15.6 121,903 16.9 76,132 7.8 56.7 6.0 4.5 35.7 CoE - - - - - - - - - - - - IBES E 695,029 16.1 130,625 22.8 127,701 22.5 75,537 7.0 56.3 5.3 4.9 35.9 Dec-16 CS E (new) 778,923 14.5 140,531 14.3 139,451 14.4 92,778 21.9 64.9 14.5 4.5 31.2 IBES E 786,998 13.2 163,136 24.9 159,570 25.0 97,220 28.7 72.0 27.9 5.3 28.1 Dec-17 CS E (new) 884,711 13.6 160,071 13.9 158,991 14.0 105,779 14.0 74.0 14.0 4.5 27.3 IBES E 865,569 10.0 190,382 16.7 185,099 16.0 115,402 18.7 85.5 18.8 5.8 23.6 Source: Company data, I/B/E/S, Credit Suisse estimates Rakuten's revenue and profit fall under three segments: (1) Internet services, (2) Internet Double-digit growth set to finance, and (3) Other. FY12/14 consolidated sales were ¥598.6bn (¥641.7bn before continue consolidation adjustment), with Internet services accounting for 57%, Internet finance for 37%, and Other for 7% of the total (pre-consolidation adjustment). Note that Rakuten uses IFRS. FY12/14 consolidated OP was ¥106.4bn (¥106.5bn before consolidation adjustment), with Internet services and Internet finance making nearly equal contributions of ¥58.8bn and ¥48.4bn, respectively, but with the Other category making a loss of ¥0.6bn (pre- consolidation adjustment on an IFRS basis). Figure 2: Rakuten (4755): Consolidated revenue (FY12/14) (¥bn) Others Segment 42 Internet Finance Segment 237 Internet Services Segment 363 Source: Company data, Credit Suisse Rakuten (4755 / 4755 JP) 2 08 July 2015 Figure 3: Rakuten (4755): Operating income (IFRS, FY12/14) (¥bn) 120 100 80 Internet Services Segment 59 60 40 Internet Finance 20 Segment 48 Others Segment -1 0 FY12/14 -20 Source: Company data, Credit Suisse We expect double-digit growth in sales and OP at the consolidated level to continue over Overseas M&A deals a the next three years. That said, the company’s appetite for investment in overseas Internet variable companies remains strong, so there is every possibility that further expansion of the roster of consolidated subsidiaries will significantly influence future earnings. For FY12/15, we expect to see continued double-digit growth in both sales and profits. We look for expanded sales in both the Internet services and Internet finance segments to drive 13.6% YoY growth in consolidated revenue to ¥680bn and 15.6% YoY growth in OP to ¥122.9bn (IFRS basis). Figure 4: Rakuten (4755): Revenue (¥bn) 885 900 779 30% 680 25% 700 599 519 20% 400 500 15% 300 10% 5% 100 0% -100 -5% FY12/12 FY12/13 FY12/14 FY12/15E FY12/16E FY12/17E Internet Services Segment Internet Finance Segment Others Segment Adjustments Revenue, % YoY Source: Company data, Credit Suisse estimates Rakuten (4755 / 4755 JP) 3 08 July 2015 Figure 5: Rakuten (4755): Operating income (¥bn) 200 160 20% 141 123 150 106 15% 90 100 50 10% 50 5% 0 -50 0% FY12/12 FY12/13 FY12/14 FY12/15E FY12/16E FY12/17E Internet Services Segment Internet Finance Segment Others Segment Adjustments OP margin Source: Company data, Credit Suisse estimates Internet services The Internet services segment comprises e-commerce site Rakuten Ichiba, travel booking site Rakuten Travel, and other Internet businesses. FY12/14 sales were ¥362.8bn for the segment as a whole, with Rakuten Ichiba contributing ¥151.2bn (41.7%), Rakuten Travel ¥37.2bn (10.3%), and other Internet ¥174.2bn (4.8%). Segment OP in the Internet services segment was ¥58.8bn on an IFRS basis, but ¥68.4bn Offsetting overseas losses on the non-GAAP basis used for segment disclosures. This reflects operating profits of with domestic gains ¥79.8bn for Rakuten Ichiba and ¥15.2bn for Rakuten Travel and an operating loss of ¥26.6bn for other Internet. The basic pattern is to use profits generated in the domestic market to offset overseas losses, regarded as upfront costs to develop future businesses. Figure 6: Rakuten (4755): Internet service segment revenue (FY12/14, Non-GAAP) (¥bn) Other Internet Services Rakuten Ichiba 174 151 Rakuten Travel 37 Source: Company data, Credit Suisse estimates Rakuten (4755 / 4755 JP) 4 08 July 2015 Figure 7: Rakuten (4755): Internet service segment OP (non-GAAP) (¥bn) 100 80 60 Rakuten Ichiba 80 40 20 Rakuten Travel 15 0 Other Internet -20 Services -27 FY12/14 Source: Company data, Credit Suisse estimates Primary drivers of earnings in the core Rakuten Ichiba business are domestic e-commerce Rakuten Ichiba earning gross merchandise volume (GMV) and growth in Rakuten login members (active users drivers with a login account) who use the domestic e-commerce site.