Deep Dive: Rakuten (RKUNY, 4755 TYO)
Betting the ship on the future of telecom
Summary
Rakuten is Japan’s leading e-commerce and online consumer services company. Despite its dominant and growing core business, shares have underperformed and trades at a substantial discount.
We believe this is caused by the substantial investments associated with the company’s entry into the telecom business, which investors regard as being capital destructive. But in our view, the pessimism here is overdone.
We outline the business case for the telecom business and the potential for narrative change, driven by improving economics together with its strategic benefits and growth optionality becoming more apparent over time.
Rakuten is a “value” play, but with the unique opportunity that the core of the company is a growing consumer tech asset with a long growth runway.
Our 3-year target price is 2,200 yen for a 24% IRR (range: 7-38%).
If you are interested in a non-consensus long idea which lies at the intersection of value and tech, read on to learn more!
Introduction
Rakuten operates Japan’s largest e-commerce marketplace, called Rakuten “Ichiba”. The company is also a major player in financial services, which spans banking, credit card, payments, securities brokerage, and insurance. Rakuten is a dominant online consumer services empire, with the core of the company being a synergistic ecosystem comprised of e-commerce and financial services. While we have seen other companies around the world adopt this “e-commerce + financial services” model (e.g. Alibaba), Rakuten actually long pioneered this model before anybody else, and has been operating this model successfully in Japan for more than a decade.
The below chart gives you a sense of Rakuten’s scale and where it stands relative to the other major e-commerce platforms of the world. If you’re like me, your initial reaction when you see this might be: “$16 billion for the leading e-commerce platform operating in the world’s third largest economy…what’s going on here?” You might also scratch your head a little when you see South Korean Coupang, which trades at $46 billion and is almost 3x Rakuten (knowing South Korea has just 40% of Japan’s population). Hmm…
Rakuten’s “core” is on track to generate about US$1.4 billion of operating income on $11 billion of revenue this fiscal year, while growing the business in the mid-teens. It enjoys a long growth runway in the Japanese market. Considering this part alone, no matter how you want to look at it, a valuation (market cap) of $16 billion seems unusually cheap. So this begs the question – what seems to be weighing down the shares? To answer this, we need to go back a few years. In December 2017, Rakuten made the groundbreaking announcement that it planned to become a MNO (mobile network operator), in a bid to challenge Japan’s three-player telecom oligopoly. An e-commerce company getting into telecom – never heard of this one right? We’ll explain this in detail later and help you understand the company’s thinking behind this unusual move.
But as you can imagine, the spending required for entering the telecom business (Rakuten calls it mobile business, we’ll use the terms “mobile” and “telecom” interchangeably) is substantial, and this has pushed Rakuten into loss-making territory on a consolidated basis. Most investors were not a fan - “Why the heck is Rakuten doing this?” “Why not just focus on the core businesses which are profitable and growing?” Rakuten’s share price today remains the same it was four years ago, weighed down by the spending in its new mobile business, despite the continuing strong performances on the e-commerce and financial services side of the company.
Investors remain skeptical to this day, but we believe now is a good time to revisit the company. The strategic benefits of the mobile business are beginning to show. Synergy with the company’s core is being delivered, while the recent major partnership deal with Germany’s 1&1 is a validation of Rakuten’s technology and its global monetization potentials ahead. Looking at the economics of the mobile business, there are reasons to believe losses have hit its worst point and should improve going forward, as the business is moving past the heaviest phases of user/network subsidies. Re-rating could be in sight as the narrative surrounding the mobile business improves. Meanwhile, there is much to like with Rakuten’s core e-commerce and financial services ecosystem, which remains highly dominant and is poised to grow alongside Japan’s long runway of retail and financial digitization in the decade ahead.
Historical context
Rakuten was founded by Hiroshi Mikitani (“Mickey”), a former investment banker at the Industrial Bank of Japan. Mickey obtained his MBA from Harvard in 1993. Having been inspired from his time spent in the US, Mickey decided to embark on an entrepreneurial journey upon his return to Japan. In 1997 he founded Rakuten as Japan’s first online marketplace.
The history of Rakuten can be roughly broken down into three parts. The first part is the founding and establishing of the Rakuten consumer ecosystem. After establishing “Ichiba” in 1997, Mickey set out a path to make his company much more than just a goods marketplace. In 2001 Rakuten Travel was established, which has grown into one of the two major OTAs (online travel agency) in Japan. In 2002, Rakuten Points program was established, which today is the largest consumer rewards program in Japan. Rakuten branched out into financial services, entering banking, payments, and brokerage businesses by acquiring established players and then re-branding and integrating them. In this way, Rakuten became the pioneer as a builder of a diversified online services ecosystem.
The second part of Rakuten’s history is defined by its internationalization efforts starting in the early 2010’s. In a fashion typical of Japanese firms trying to grow overseas via acquisitions, this was mostly a failed effort. In 2010 Rakuten expanded into Europe through acquisition of PriceMinister (EC business in France), followed by a streaming player in Spain called Wuaki. In North America it acquired e-reader company Kobo (2011 for $315 million), streaming player VIKI (2013), and shopping rewards company Ebates (2014 for $1 billion). It also acquired the Luxembourg-based communications company Viber (2014 for $900 million). We won’t get into the details on each but suffice to say that most of these acquisitions have disappointed. The good news is that management seems to have had enough, having abandoned chasing overseas consumer tech acquisitions since 2014 (after years of racking up losses, Rakuten disclosed in the most recent quarter that profits at these overseas businesses have finally turned around to a point where it’s now nearing breakeven).
But there was actually also something positive that came out of all of this internationalization drive. In 2012, Rakuten made English the official company language. If you’re familiar with Japan, then you’ll know that this is no ordinary business decision! In fact, it was seen as crazy at the time, met with plenty of criticism and skepticism from both inside and outside the company. Today, 25% of Rakuten’s employees are non-Japanese, which is the highest of any Japanese tech company. While it led to a painful period of cultural adjustment at first, the visionary nature of the “Englishnization” move is becoming increasingly apparent over time, as Japan grapples with the problem of aging demographics and a shortage of skilled IT personnel. Mickey saw the increasing need for overseas talent, not just to fill the labor shortage, but he recognized that the best tech companies should be able to attract the best workers from around the world. This kind of decision making should give investors some insight into the kind of leader Mickey is - he’s a maverick, and is not afraid to make bold strategic decisions.
The third part of Rakuten’s story is where we are at today – expanding into the MNO business. In 2018, Rakuten was granted telecom license by Japanese government to build out its network. In the same year, Rakuten hired Tareq Amin, the current CTO and the key man behind the mobile business. Prior to Rakuten, Tareq was the Sr. VP at Reliance Jio (India’s largest carrier) where he focused on technology development of next-generation networks. Rakuten launched service using its own network in March 2020, and as of October 2021 has signed up more than four million subscribers and achieved a nationwide 4G population coverage rate of 94% in Japan.
Rakuten Core
Let’s first talk about the core of the company - the high conviction part which investors can fall back on.