Makiko Yoshimura Japan Corporate Director Corporate Ratings Credit Spotlight Katsuyuki Nakai Director October 22, 2020 Corporate Ratings Hiroki Shibata Senior Director Corporate Ratings Advertising; Electronics; IT Services; E-Commerce; Telecom And Investment Holding Companies This report does not constitute a rating action. Japan Corporate Credit Spotlight Sector Comments Pages 3 - 13 Advertising Electronics Appendix IT Services Pages 14 - 16 E-Commerce Telecom And Investment Holding Companies All graphics show data for companies studied. Sector Comments Pages 3 - 13 Advertising Outlook: Negative Gradual Recovery After Temporary COVID-19 Hit Trend And Changes – Advertising revenue, which is vulnerable to economic downturns, will contract more sharply than Japan's GDP during the COVID-19 pandemic. – Digital media will likely lead a recovery thanks to cost advantages and demand for marketing data. – Companies in this study are among domestic leaders in digital advertising and media. – Competitive differences among Japan-based and overseas advertisers will not change significantly as all face similar conditions. – Future creditworthiness of the companies studied largely hinges on their financial standings. Key Assumptions – Total advertising revenue in Japan in fiscal 2021 will not recover to fiscal 2019 levels, despite the contribution from internet advertising. – Profitability of the companies studied will not recover to pre-COVID-19 levels in the coming one to two years despite cost reductions. – COVID-19's degree of impact on the companies studied will differ according to their financial health before the crisis. 4 Advertising Risks And Key Credit Drivers: – A resurgence of COVID-19 further souring advertising clients' appetites. – Priorities for use of cash flow, such as growth investments and shareholder returns, under difficult conditions. – Ability to maintain a competitive digital edge as changes in business structures accelerate amid the pandemic. Free operating cash flow (left) Tril. ¥ Revenues (left) EBITDA margin (right) % Bil. ¥ x Debt/EBITDA (right) 4.5 18.0 400 1.6 4.0 16.0 350 1.4 3.5 14.0 300 1.2 3.0 12.0 250 1.0 2.5 10.0 200 0.8 2.0 8.0 150 0.6 1.5 6.0 100 0.4 1.0 4.0 0.5 2.0 50 0.2 0.0 0.0 0 0.0 2015 2016 2017 2018 2019 2015 2016 2017 2018 2019 Source: S&P Global Ratings. Source: S&P Global Ratings. 5 Electronics Outlook: Slightly Negative Japanese Companies Pressured More Than Global Peers Trend And Changes – We have revised our outlook for demand for electronics globally three times amid COVID-19. – Performance has declined further in fiscal 2020, particularly in office equipment. – Pressure on credit quality is growing, with rated issuers assigned negative outlooks up to 50% from 25% a year ago. – The credit quality of companies in this study is under greater pressure than that of overseas peers. – Most companies have relatively sound finances thanks to business restructuring. Key Assumptions – Electronics orders will slump in 2020, with demand for office equipment falling 12% year on year. – Average EBITDA will fall to about 10.5% in fiscal 2020 and fail to recover to fiscal 2019's 12.1% level the year after. – Many companies will persevere with capital spending and acquisitions to boost competitiveness, despite current conditions. – EBITDA will decline, but median debt to EBITDA will remain sound at 1.2x in fiscal 2020. 6 Electronics Risks And Key Credit Drivers: – A resurgence of COVID-19 prolonging the slump in demand in consumer electronics and office equipment. – Fallout from rising U.S.-China tensions on supply chains and demand from customers. – Risk of continued large investments and generous shareholder returns undermining conservative financial management. Free operating cash flow (left) Tril. ¥ Revenues (left) EBITDA margin (right) % Bil. ¥ x Debt/EBITDA (right) 35.0 14.0 1,600 1.6 30.0 12.0 1,400 1.4 1,200 1.2 25.0 10.0 1,000 1.0 20.0 8.0 800 0.8 15.0 6.0 600 0.6 10.0 4.0 400 0.4 5.0 2.0 200 0.2 0.0 0.0 0 0.0 2015 2016 2017 2018 2019 2015 2016 2017 2018 2019 Source: S&P Global Ratings. Source: S&P Global Ratings. 7 IT Services Outlook: Stable Limited COVID-19 Impact And Quick Recovery Trend And Changes – COVID-19 will only mildly affect information technology (IT) services, which are somewhat resilient to economic downturns. – Digital transformation, 5G, and other growth areas will mitigate a mid-single-digit decline in the conventional system integration market. – Companies studied are strong at generating free operating cash flow because restructuring hardware businesses has lightened their capital spending burdens. – Outlooks on the three rated entities in this study are stable and their credit quality faces little pressure. – Japan's IT service companies lag U.S. peers in earnings from growth areas such as digital transformation. Key Assumptions – Nonessential IT investments will be further postponed or cut in the coming one to two years. – IT investments will grow in low single digits from 2021 after falling roughly 3% year-on-year globally in 2020 and a similar decline in Japan. – NEC Corp. and Fujitsu Ltd. will have relatively favorable profitability thanks to past business restructuring. – EBITDA margins will fall by only about one percentage point in fiscal 2020. – Growth investments and shareholder returns will be kept within free cash flow under disciplined financial management. 8 IT Services Risks And Key Credit Drivers: – Further economic decline triggering more delays or cuts in IT investment, adding pressure on earnings. – Lost earnings opportunities from a slow response to digital transformation. – Further risk to earnings from uncompetitive overseas businesses. – Large acquisitions in pursuit of growth and generous shareholder returns. Free operating cash flow (left) Tril. ¥ Revenues (left) EBITDA margin (right) % Bil. ¥ x Debt/EBITDA (right) 12.0 12.0 500 2.5 10.0 10.0 400 2.0 8.0 8.0 300 1.5 6.0 6.0 200 1.0 4.0 4.0 100 0.5 2.0 2.0 0.0 0.0 0 0.0 2015 2016 2017 2018 2019 2015 2016 2017 2018 2019 Source: S&P Global Ratings. Source: S&P Global Ratings. 9 E-Commerce Outlook: Negative Investment Burden Outweighs Robustness Trend And Changes – Japan's business-to-customer market continued to grow in 2019--at about 8% year on year. – E-commerce demand has risen globally in 2020 due to restrictions on movement amid the COVID-19 pandemic. – The two companies studied have seen strong revenue growth from e-commerce and flea market applications. – The credit outlook is negative for both companies owing to significant upfront investments in non-e-commerce and overseas businesses. – Both entities' credit quality is under heavy pressure because their investment burdens are larger than those of major overseas peers. Key Assumptions – Japan's e-commerce market will see mid-single digit growth even after a pandemic-induced boost eases. – The e-commerce market is set for continued growth fueled by shifts in consumer behavior. – Capital expenditure will remain high at both companies as they look to strengthen non-e-commerce businesses and peripheral operations like logistics, and expand overseas. – The two companies' revenues will increase in fiscals 2020-2021, but negative EBITDA will drive up their financial burdens. 10 E-Commerce Risks And Key Credit Drivers: – Failure of strong revenues from e-commerce to cover upfront investments in non-e-commerce and overseas businesses, worsening key financial metrics for the companies studied. – A resurgence of COVID-19 further hurting the economy and depressing consumer sentiment, resulting in muted growth. – Risk of increased competition with the emergence of new technologies and sales channels, such as online stores that do not rely on e-commerce malls. Free operating cash flow (left) Tril. ¥ Revenues (left) EBITDA margin (right) % Bil. ¥ x Debt/EBITDA (right) 1.0 20.0 100 25.0 80 20.0 0.8 16.0 60 15.0 40 10.0 0.6 12.0 20 5.0 0.4 8.0 0 0.0 -20 -5.0 0.2 4.0 -40 -10.0 0.0 0.0 -60 -15.0 2015 2016 2017 2018 2019 2015 2016 2017 2018 2019 Source: S&P Global Ratings. Source: S&P Global Ratings. 11 Telecom And Investment Holding Companies Outlook: Negative Investments And Shareholder Returns To Crimp Creditworthiness Trend And Changes – COVID-19 has had relatively little impact on the telecom industry because of long-term contracts and its importance as infrastructure. – The investment holding company in this study, which has a telecom company in its portfolio, benefits from a stable stock price and steady business performance. – Significant investments and aggressive shareholder returns are increasing pressure on the creditworthiness of the three companies studied. – Downward pressure on creditworthiness is weaker in the U.S. and Europe thanks to consistent performance and investment policies. Key Assumptions – Growth in demand for fiber optics and networks for corporate users will be robust as the pandemic has swelled the number of people working remotely. – Rakuten's entry to Japan's mobile communications market will minimally affect the EBITDA margins of companies studied in fiscal 2020, although competition will intensify the following year. The average EBITDA margin will improve about one percentage point in fiscal 2021 as they reduce costs. – Companies studied will cover growing investments in 5G with operating cash flow, enabling them to secure ample free cash flow. – Investments in 5G, group restructuring, and shareholder returns will weaken average debt/EBITDA to 1.8x in fiscal 2020 from 1.2x a year earlier. The ratio is likely to be about 1.7x in fiscal 2021.