07 July 2016 Asia Pacific/Japan Equity Research Internet Rakuten (4755 / 4755 JP) Rating NEUTRAL* Price (06 Jul 16, ¥) 1,098 INITIATION Target price (¥) 1,220¹ Chg to TP (%) 11.1 Market cap. (¥ bn) 1,566.09 (US$ 15.46) Initiating at NEUTRAL; waiting for recovery in Enterprise value (¥ bn) 1,735.87 Number of shares (mn) 1,425.66 earnings momentum in domestic e-commerce Free float (%) 55.0 52-week price range 2,082 - 991 ■ Action: We initiate coverage of Rakuten with a NEUTRAL rating and a *Stock ratings are relative to the coverage universe in each target price of ¥1,220 (potential return 11.1%). While we are positive on the analyst's or each team's respective sector. ¹Target price is for 12 months. company’s solid business model, we would need to see a turnaround in domestic e-commerce (EC) earnings to take a more bullish view. Research Analysts Keiichi Yoneshima ■ Investment case: As the top player in the domestic EC market, Rakuten is 81 3 4550 9740 positioned for medium- to long-term growth with a business model that [email protected] combines financial and Internet services. However, with changes in the competitive environment, three issues cloud near-term earnings visibility: (1) slowing near-term earnings growth amid escalating competition in the domestic EC market, (2) the possibility that the timing of improvement in Rakuten’s growth rate will depend on the strategies of its rivals, and (3) moves by telecom carriers and other major companies to bolster their financial and Internet services. ■ Catalysts/risks: Major catalysts include: (1) a change in momentum for gross platform sales in the domestic EC business and (2) the start of earnings improvement in the domestic EC business. We also focus on a possible pickup in the growth rate for the FinTech business, earnings improvement resulting from greater selection and focus in the overseas business. Risks include: (1) the impact of new businesses and M&A deals on the income statement and balance sheet and (2) the additional impairment losses on goodwill. ■ Valuation: Our target price is derived by using SOTP (sum of the parts) methodology. We use DCF for Internet services (including adjustments), P/E (peer multiples) for Rakuten Securities and Rakuten Credit, and book value for Rakuten Bank and Rakuten Life Insurance (details on page 7). Share price performance Financial and valuation metrics Year 12/15A 12/16E 12/17E 12/18E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 713.6 800.9 882.8 963.3 4000 160 Operating profit (¥ bn) 94.7 113.3 132.5 150.4 3000 Pre-tax profit (¥ bn) 92.0 110.3 129.6 147.5 2000 110 Net income (¥ bn) 44.4 64.9 77.8 88.5 1000 EPS (¥) 31.5 45.6 54.6 62.1 0 60 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 47.2 60.5 75.3 The price relative chart measures performance against the EPS growth (%) -36.5 44.8 19.8 13.8 TOPIX which closed at 1234.2 on 06/07/16 P/E (x) 44.6 24.1 20.1 17.7 On 06/07/16 the spot exchange rate was ¥101.31/US$1 Dividend yield (%) 0.32 0.55 0.64 0.64 EV/EBITDA(x) 12.8 11.2 9.9 9.0 Performance over 1M 3M 12M P/B (x) 2.9 2.3 2.0 1.8 Absolute (%) -7.3 -9.8 -43.0 ROE(%) 8.2 9.6 10.7 10.9 Relative (%) 0.6 -5.6 -21.0 Net debt/equity (%) 22.7 21.8 19.6 17.6 Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE 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 07 July 2016 Table of contents Key charts 3 Investment opinion 4 Initiate at NEUTRAL with ¥1,220 TP 4 We give high marks to Rakuten, but near-term earnings outlook is unclear by changes in the competitive environment 4 Earnings forecasts and key assumptions 5 Reasons for our NEUTRAL rating 5 Share price and valuation trends 6 Valuation 7 Risks 8 Company profile 9 Corporate history 9 Executives 10 Shareholders 11 Business portfolio 12 Internet services segment 13 Domestic EC: take-rate approximately 10%; seasonal factors tend to boost 3Q–4Q 13 Other Internet services: improving, but broad mix brings high volatility 15 FinTech (finance) segment 16 Rakuten Card: helps drive consolidated earnings with a successful business model that combines Internet and financial technologies 16 Rakuten Bank: revenue and profits continue to rise on loan growth 18 Rakuten Securities 19 Others segment 19 Outlook 20 Longer-term strategy: Vision 2020 clarifies numerical targets and withdrawal guidelines 20 Concrete profit targets 20 Three principles to lead to business withdrawals, scaled down overseas operations 20 Business portfolio restructuring likely to continue 21 Far-sweeping reform of domestic e-commerce business could take some time 21 SPU introduction has increased new uses but heavy users might be puzzled 21 Yahoo Japan used reforms to narrow gap with Rakuten 21 Yahoo (4689) catching up might have provided catalyst for reform 22 Gradual recovery of other Internet services 23 FinTech business likely to advance steadily 24 Plenty of room for growth in Rakuten Card membership 24 Bank and insurance businesses making effective use of Rakuten ecosystem 24 Rakuten Securities: reducing volatility by increasing weight of asset management business 25 Others segment: looking for improvement from Rakuten Mobile 26 Remaining goodwill of ¥350bn indicates risk of additional impairment losses 26 Market environment: domestic EC market 26 Market environment: growing number of entrants into the Internet field 29 Earnings forecasts 31 Rakuten (4755 / 4755 JP) 2 07 July 2016 Key charts Figure 1: Domestic EC (GMS, EC sales and Take rate) Figure 2: Domestic EC sales and OP Domestic GMS Domestic EC sales Take Rate (RHS) Domestic EC 800,000 11.4% 100000 11.3% 90000 700,000 11.2% 78,430 80000 71,069 72,484 71,239 600,000 11.0% 65,850 65,802 67,853 70000 65,021 61,928 10.8% 500,000 10.8% 60000 10.7% 10.8% 400,000 10.6% 50000 10.6% 10.6% 10.6% 10.5% (JPYmn) (JPYmn) 40000 300,000 10.4%10.4% 30000 22,982 22,745 25,145 22,856 23,228 25,017 25,305 200,000 10.2% 21,256 18,891 20000 100,000 10.0% 10000 0 9.8% 0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q Sales OP Sales OP Sales OP Sales OP Sales Q1/14 Q3/14 Q1/15 Q3/15 Q1/16 FY2014 FY2015 FY2016 Source: Company data, Credit Suisse Source: Company data, Credit Suisse Figure 3: Increase in transaction value (YoY) Figure 4: Credit card: sales and OP 100 92.7 Credit card 77.4 73.4 76.5 200,000 64.6 165,232 150,731 150,000 135,446 50 42.5 117,504 (JPYbn) 24.4 98,163 100,000 18 76,840 (JPYmn) 0 50,000 37,194 29,586 33,551 RAKUTEN Yahoo! RAKUTEN Yahoo! RAKUTEN Yahoo! RAKUTEN Yahoo! 18,529 24,124 Japan Japan Japan Japan 12,583 Apr-Jun Jul-Sep Oct-Dec Jan-Mar - Sales OP Sales OP Sales OP Sales OP Sales OP Sales OP 2015 2016 12/13 12/14 12/15 12/16E 12/17E 12/18E Source: Company data, Credit Suisse Source: Company data, Credit Suisse estimates Figure 5: Balance of goodwill B alance of Goodw ill (JP Y m n) 31-D ec-14 31-D ec-15 31-D ec-16 Internet Services 214,111 213,813 202,754 P R ICE M INISTE R S.A.S 15,679 - - R akuten Kobo Inc. 20,813 10,374 10,328 V IKI, Inc. 19,961 18,888 17,646 R akuten M arketing Group 13,279 14,972 13,988 E bates Group 99,493 97,211 91,929 O verDrive Group - 37,664 34,842 S lice Technologies, Inc. 13,478 13,485 13,267 O thers 31,409 21,218 20,754 Fintech 46,971 52,234 52,111 R akuten Securities, Inc. 7,544 10,935 10,935 R akuten Bank, Ltd. 32,886 32,886 32,886 O thers 6,540 8,413 8,290 O thers 102,564 103,381 96,792 V iber Group 99,349 100,175 93,588 O thers 3,215 3,206 3,204 Total 363,646 369,428 351,657 Source: Company data, Credit Suisse Rakuten (4755 / 4755 JP) 3 07 July 2016 Investment opinion Initiate at NEUTRAL with ¥1,220 TP Figure 6: Rakuten (4755) – Earnings summary Rakuten (4755) Earnings Summary EV 06-Jul-16 Sales Operating profit Recurring profit Net profit EPS P/E /EBITDA ¥1,099 ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥ YoY (%) (x) (x) Consolidated FY Dec-15 A 713,555 19.2% 94,689 -11.0% 91,987 -11.8% 44,436 -37.1% 31.5 -36.5% 12.8 44.6 Dec-16 CS E (new) 800,898 12.2% 113,349 19.7% 110,277 19.9% 64,886 46.0% 45.6 44.8% 11.2 24.1 CoE NA NA NA NA NA NA IBES E 814,784 14.2% 118,651 25.3% 118,553 28.9% 67,030 50.8% 47.2 50.1% 11.7 23.3 Dec-17 CS E (new) 882,848 10.2% 132,478 16.9% 129,598 17.5% 77,759 19.8% 54.6 19.8% 9.9 20.1 IBES E 932,329 14.4% 148,806 25.4% 147,885 24.7% 85,860 28.1% 60.5 28.0% 9.7 18.2 Dec-18 CS E (new) 963,318 9.1% 150,420 13.5% 147,540 13.8% 88,524 13.8% 62.1 13.8% 9.0 17.7 IBES E 1,029,416 10.4% 179,710 20.8% 178,551 20.7% 106,238 23.7% 75.3 24.5% 8.3 14.6 Source: Company data, I/B/E/S, Credit Suisse estimates We give high marks to Rakuten, but near-term earnings outlook is clouded by changes in the competitive environment We give high marks to Rakuten for creating a business model that combines e-commerce and financial services.