RKUNF - Rakuten: A Tale Of Two Businesses

2024-01-18 02:26:22 ET

Summary

• Rakuten Group's fintech business segment is benefiting from Japan's transition to a cashless society.
• Uncertainty remains over the mobile business segment's ability to meet its EBITDA profitability targets, despite positive subscriber growth.
• I stick to a Hold rating for Rakuten Group, considering that the prospects for the company's two key businesses are different.

Elevator Pitch

I rate Rakuten Group, Inc. ( OTCPK:RKUNF ) [4755:JP] as a Hold. I first initiated on Rakuten Group with an article published on November 29, 2020.

My focus is on Rakuten Group's key Fintech and Mobile business segments in this latest update. It is a tale of two businesses for Rakuten Group which justifies my Hold rating for the stock. The company's fintech business segment is a beneficiary of tailwinds relating to an increase in Japan's cashless payment penetration rate, but I have doubts about Rakuten Mobile's ability to meet its operating profitability targets.

Investors can deal in Rakuten Group's shares on the OTC (Over-The-Counter) market and the Tokyo Stock Exchange. The trading liquidity of Rakuten Group's OTC shares is decent with a 10-day average daily trading value of roughly $150,000 as per S&P Capital IQ data. The relatively more liquid Japan-listed Rakuten Group shares ($125 million 10-day mean daily trading value) can be bought and sold with US stockbrokers such as Interactive Brokers.

Fintech Segment Is Benefiting From The Transition To A Cashless Society

The proportion of cashless payments as a percentage of total payments in Japan grew in 15.4% for 2013 to 36.0% for 2022, according to data sourced from Statista . In 2022, the pace of cashless transition picked up meaningfully as Japan's cashless payment ratio was much lower at 32.4% in 2021. Although the latest cashless payment statistics for 2023 are not available yet, it is reasonable to assume that the percentage of cashless payments in Japan should have increased last year considering historical trends.

Moving ahead, Japan's goal is to reach a cashless payment penetration rate of 40% for 2025 and 80% in the long run, as highlighted in a September 20, 2023 article published by Deutsche Bank ( DB ).

Rakuten Group's key businesses that are part of its fintech segment are expected to benefit from Japan's transition to a cashless society in the intermediate to long term.

The company's online banking business, Rakuten Bank, issued a media release on January 4, 2024 revealing that its deposits reached the JPY10 trillion mark at the end of last year. In this press release, Rakuten Group attributed the growth in Rakuten Bank's deposits to the internet bank's attractive offerings like "the Rakuten Pay App, which allows customers to directly debit their Rakuten Bank account" and the "Rakuten Bank Debit Card, which offers a contactless payment function."

At the company's most recent Q3 2023 earnings briefing in November last year, Rakuten Group disclosed that around 31% of its banking clients have Rakuten Bank as their "main account", and it is reasonable to assume that the cashless payment transition has boosted the popularity of internet bank Rakuten Bank among Japanese consumers.

Last month, RKUNF shared in an announcement that the total number of cards issued by the company's card & payment business (Rakuten Card) increased by +50% from 20 million in the middle of 2020 to 30 million as of end-2023. Rakuten Group credited the substantial growth in card issuance to initiatives like "promoting the use of a second Rakuten Card and the unveiling of new card designs" to "accelerate the adoption of cashless payments" in its December 2023 announcement.

Rakuten Group's fintech segment, which includes the Rakuten Bank, Rakuten Payment and Rakuten Card businesses, accounted for a third of the company's top line for full-year FY 2022. Looking forward, the rise in Japan's cashless payment penetration rate over time is likely to be a tailwind for the company's Fintech segment.

Uncertainty Over Mobile Segment's Operating Profitability Target

RKUNF's mobile segment (Rakuten Mobile) is another key business division for the company that is worth watching, as this business segment contributes close to a fifth of its FY 2022 revenue.

Towards the end of last month, Rakuten Group published a press release highlighting that its mobile subscriber base has expanded to more than 6 million. But Rakuten Mobile's subscriber numbers aren't as impressive as what they seem to be on paper, as 6 million mobile services subscribers will only translate into a market share of less than 3% for Rakuten Group's mobile business in Japan.

As per S&P Capital IQ data, Rakuten Group's actual Q3 2023 operating loss margin of -10.5% was much worse than the sell-side analysts' consensus forecast of -6.1%, and this is likely attributable to the mobile segment's wider-than-expected operating loss of -JPY81.2 billion for the most recent quarter.

In Rakuten Group's Q3 2023 results presentation slides , the company noted its target of achieving EBITDA breakeven for its mobile segment on a monthly and a yearly basis by end-2024 and in FY 2025, respectively. But Rakuten Mobile can only meet its operating profitability goal if it grows its subscriber base from the current 6 million to 8-10 million and also raise its ARPU (Average Revenue Per User) from JPY2,046 (as of end-Q3 2023) to JPY2,500-3,000 as per its assumptions.

My view is that there is a good chance of Rakuten Mobile hitting its subscriber growth target, but it might be much tougher for Rakuten Group's mobile segment to increase its ARPU.

In my previous July 11, 2023 write-up , I had mentioned that Rakuten Mobile "introduced a new mobile plan known as 'SAIKYO'" in June 2023 to "address the issues of 'network quality' and 'churn'". This new mobile plan has been successful as Rakuten Group's number of mobile subscribers rose from 4.8 million as of June 30, 2023 to 5.1 million at the end of Q3 2023 before exceeding 6 million near the end of last year. As such, I think the positive subscriber growth momentum driven by the new mobile plan will allow Rakuten Mobile to meet its 8-10 million subscriber target.

On the flip side, it could be challenging for Rakuten Mobile to increase prices to achieve its JPY2,500-3,000 ARPU target. A November 29, 2023 Reuters commentary piece quoted sell-side analysts covering Rakuten's shares indicating that "many of Rakuten's customers are quite price-conscious." This isn't a surprise, as Rakuten Mobile would have adopted an aggressive pricing strategy as a relatively new entrant in Japan's mobile market beginning in 2020. Therefore, it is reasonable to assume that a significant proportion of Rakuten Group's mobile subscribers will have pricing as a key consideration in selecting mobile service plans.

In summary, there is no certainty that Rakuten Mobile can achieve EBITDA breakeven as per its targets.

Final Thoughts

I have a Neutral opinion of Rakuten Group. On one hand, I am positive on the prospects of the company's fintech business segment in view of the growth in cashless payments for the Japanese market. On the other hand, I am not confident that Rakuten's mobile business segment can achieve its EBITDA profitability goal.

Also, I think that Rakuten Group is now trading at a reasonably fair valuation. The market currently values Rakuten Group at 0.80 times (source: S&P Capital IQ ) trailing Enterprise Value-to-Sales or EV/S. The fair EV/S multiple for Rakuten Group is calculated to be 0.87 times (which implies a modest upside of +9%) based on a valuation rule of thumb that a stock's EV/S ratio can be derived by dividing the company's projected EBIT margin by 10. As a reference, Rakuten Group's consensus FY 2027 EBIT margin forecast is 8.7% (source: S&P Capital IQ ).

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