Is this the Alibaba of Japan?

We’ve all heard of Alibaba and Tencent and we’ve also all heard that we should reconsider investing in China due to regulation fears. So what if we told you that there’s a company in the same e-commerce space, in an under-appreciated market, growing at a rapid rate and you had never heard of it. Well, Marco Anselmi, Partner and Senior Analyst at VGI Partners says he would like to introduce you to a Japanese e-commerce and online retailing company giving its Asian peers a run for their money.

In this extended interview, Anselmi provides his thesis on this relatively unknown company, walks through the business model, and explains why its three-pillar approach to innovation sets them apart from other e-commerce companies. He also explains the reasoning behind the company’s recent share price hike and why the management can take this company all the way. 

Transcript

In our Asian Fund, which is ASX:VG8, the approach to finding new opportunities is actually very similar to our global fund, ASX:VG1. We look for high-quality businesses - businesses that have strong moats, high barriers to entry, high switching costs, businesses that operate in favourable industry structures (such as monopolies and oligopolies with pricing power), businesses that have high secular growth and structural growth that can continue to compound over time. That's easily said, but harder to put in practice because often a lot of these attributes are already reflected in the valuation of the businesses.

I think a good live example from our Asian portfolio is Rakuten (TYO: 4755). Now, we came across Rakuten by studying these dominant tech platforms in China, Tencent and Alibaba, and looked at what they've done very successfully with their business in terms of growing e-commerce, social media and payments across many different verticals.

We studied and tried to see if anyone else was trying to replicate this across Asia and we came across Rakuten, who we think is having a go at doing this in Japan. So, Rakuten really has three pillars to its business. 

The first is e-commerce - it's one of the leading marketplaces in Japan with an offering similar to Amazon from traditional to online, buying all sorts of items.

Then the second pillar to Rakuten’s business is a sprawling FinTech operation. They've got traditional banking with credit cards and loans, as well as digital payments, insurance services, online securities trading. What's interesting about Rakuten is that it brings all these services together - all of the FinTech and all the e-commerce come together through a single loyalty point ecosystem. We think that's very powerful. If I shop on the Rakuten e-commerce website for some items to get delivered to my door, and use my Rakuten credit card to do so, I accrue more points. We think it's a very powerful incentive mechanism and a very strong network, because then, for instance, if I go and book travel using Rakuten Travel, again, my points accumulate. And so we think they're on the way to creating something similar to WeChat and WePay like Tencent has in China or Alibaba with Ant Financial in China.

The third pillar to Rakuten's business is a newer venture into telecommunications. What they're trying to do is essentially start offering mobile phone plans to customers. Obviously that's very capital intensive and traditionally been more of a competitive space because you have to build a network infrastructure to start offering these mobile plans. Now, what's interesting is that the market has taken a very negative view about these investments into the mobile telco business. We think that because they do have this profitable e-commerce and FinTech operation, they can continue to fund the investment into the telecommunications business. But, the market is very focused on the near-term capex requirements into this mobile business, and therefore has taken a negative view.

The last point worth touching on with Rakuten is that it's led by its founder, Hiroshi Mikitani, who still owns a third of the company. We see him as a bit of a visionary, he's a long-term thinker and we really like to invest in businesses that have these types of almost fanatical management pushing the business forward.

So, I think that's a good example of one of our current businesses. We invested in Rakuten last year and it's grown into one of the larger positions in the portfolio due to performance, but we still see a long runway for growth.

The telco project certainly is very ambitious - Rakuten announced its intention to build this 4G and 5G network back in 2017. Since then, I think the latest update is that they expect to spend something like US$10 billion, which is a massive investment in building this network and which obviously creates very high barriers to entry for anyone to replicate. But we think the way Rakuten is going about this mobile investment is also very interesting. A traditional telco, like a Telstra, would have gone to purchase expensive equipment from vendors like Nokia, Ericsson, or Huawei even. 

The way that Rakuten is going about it is they're pioneering a new type of cloud infrastructure and we think that has the potential to provide them with a cost advantage essentially. That's what we're seeing them do. They're undercutting all the incumbent telco operators in Japan and pushing very aggressively to gain market share because of this cost advantage that they have. So, we think the market is at the moment focused on the near-term short-term losses that its generating from this investment, but we're taking a longer-term view. We think firstly they'll be able to continue to fund these operations from the profitable existing business that they have, but we really like the vision and the bigger picture of creating a wider ecosystem and improving the customer proposition in terms of offering more services.

Even if the business doesn't necessarily turn profitable - I'm talking about the mobile business - we think they can run that and break even and continue to gain significant share from the incumbent telcos. 

Ultimately this is a fixed cost business so the more subscribers they get, they should be able to leverage that investment. So, we think over time, they'll be able to land subscribers given the incentives that are in place from using and entering the Rakuten ecosystem, which is already very commonly used in Japan. So, consumers do have a very strong incentive to switch from the existing telco provider to Rakuten's. Overall we’re very excited about what Rakuten is trying to do with the telco business and trying to lock consumers in even more.

The stock is up 35 or 40% over the last week because they announced the capital raise, which was very positive news for a couple of reasons. Firstly, it alleviated some of the funding concerns that were around building out the mobile telecommunications infrastructure. There were questions around how they would fund it, but I think a lot of these have gone away for the time being. It's also very interesting with this recent capital raise in terms of which partners they've brought on board. Some of the key investors have been Japan Post, Tencent, and Walmart. 

The Japan Post partnership makes a lot of sense, Japan Post will end up owning almost 10% of Rakuten after this capital raise. And, Rakuten has been investing in their own logistics network to improve fulfilment and delivery capabilities for the e-commerce business. Obviously Japan Post has over 1000 outlets throughout Japan so it will really help with that last mile delivery. It will also help to distribute the mobile phone plans - the incumbent telco operators in Japan have got a store network and Rakuten will be able to leverage the existing Japan Post retail distribution to sell those mobile plans.

The other interesting investor is Tencent, and they've proven to be very savvy, successful investors. 

We think they bring a lot of expertise to the table in terms of their experience in e-commerce and building this ecosystem that we've talked about. So, we think it's a very smart move and while it surprises us that Tencent will now be on the register, they will own 4% of Rakuten which we see as very positive. But I actually think the most bullish thing about the capital raise was the fact that the founder himself, who already owns a third of the company, wrote a cheque for a $100 million to reinvest into the business. That’s as powerful a signal as you'll see. We love to see the management team or the founders of the businesses that we invest in double down on their investment. So, overall we thought the capital raise was very positive news, and we’re very excited by the long-term prospects of Rakuten.

Obviously the founder’s been a visionary, he started the business back in the '90s. He was very early in e-commerce, almost as early as Jeff Bezos with Amazon. And the fact he constantly reinvests in his business does remind us a little bit of Jeff Bezos who we’ve followed very closely over the years, given Amazon is our largest position in the global portfolio, VG1. So, we do see some similarities there in terms of how he's a long-term thinker, how he's fanatical about the business and how he wants to continuously reinvest.

Not many people out there would have had the appetite to invest over US$10 billion in building a mobile telecommunications infrastructure. He knew that it probably wouldn't be good for the share price and that it wouldn't be taken very well, but he's the kind of leader that has that vision. So, we really like that and we share the same vision because we're long-term investors and we can see the bigger picture. We see the near-term losses that the telecommunications business is generating, but we also see the bigger picture that he's trying to achieve. And we think it has the potential to be very powerful.

Diversification preserves wealth. Concentration builds wealth

VGI Partners is a high conviction global equity manager, focussing on businesses with secular growth, attractive industry structures and where they believe they possess insights not appreciated by the wider investment industry. For further information, please use the contact form below.