KDDIF - Rakuten: Consider Portfolio Restructuring And Mobile Business Outlook

2023-07-11 14:06:12 ET

Summary

• I am positive on Rakuten Group, Inc.'s recent portfolio restructuring moves, which I think could narrow the valuation discount assigned to the company's shares.
• But I have a negative view of Rakuten Group's mobile business; Rakuten Mobile is still loss-making, and network quality continues to be an issue for the mobile operator for now.
• My Hold rating for Rakuten Group stays unchanged, after my analysis of its portfolio restructuring activities and the mobile business' outlook.

Elevator Pitch

My rating for Rakuten Group, Inc. (RKUNY) [4755:JP] stock is a Hold. I previously wrote about the potential impact of Rakuten Group's new partnership with Japan Post ( JPHLF , JPPHY ) on the company's mobile business in my prior June 4, 2021, update .

With this latest article, I maintain a Hold rating for Rakuten Group. On one hand, I have a favorable opinion of Rakuten Group's recent portfolio restructuring activities. On the other hand, I have a dim view of its mobile business' prospects.

Rakuten Group has shares listed on both the Tokyo Stock Exchange and the Over-The-Counter or OTC market. The company's OTC-listed and Japan-listed shares boasted three-month mean daily trading values of $200,000 and $130 million (source: S&P Capital IQ ), respectively. Rakuten Group's shares traded on the OTC market have decent liquidity. Investors also have the choice of investing in the company's relatively more liquid Japan-listed shares using U.S. stockbrokers like Interactive Brokers which offer trading services for Japanese stocks.

Portfolio Restructuring

Rakuten Group is a conglomerate which offers a diverse range of services to consumers and businesses as outlined in the chart below.

The Key Services Provided By Rakuten Group

The market currently values Rakuten Group at a consensus forward next twelve months' price-to-sales multiple of 0.53 times and a historical trailing price-to-book value ratio of 1.19 times as per S&P Capital IQ data. Rakuten Group's valuations are undemanding, as evidenced by the fact that it is trading at a modest premium to book value and its price-to-sales metric is slightly above 0.50 times.

Like many other listed conglomerates, Rakuten Group is suffering from a holding company discount, and there are lots of opportunities for the company to re-rate its shares by engaging in value-accretive portfolio restructuring activities. Therefore, it is encouraging to see that Rakuten Group has become more active in restructuring the company's portfolio in recent times.

One example is the proposed spinoff and IPO of Rakuten Securities. Rakuten Group announced last week that its securities brokerage business arm, Rakuten Securities, "applied for listing on the Tokyo Stock Exchange" on July 4, 2023. At the time of writing, there is yet to be a definite timeline for Rakuten Securities' public listing.

As indicated in its June 2023 corporate presentation , Rakuten Securities is the largest Japanese local broker in the country based on the number of client accounts it had (8.64 million) as of December 31, 2022. The future growth potential of Rakuten Securities is significant, as only a mere 16% (versus 54% in the U.S.) of Japan's household assets as of end-2022 were invested in bonds and investment trusts as indicated in Rakuten Group's corporate presentation.

But the value of Rakuten Securities is obscured by the fact that it is currently a non-listed business within the parent company's group of businesses. Following the completion of Rakuten Securities' planned IPO, Rakuten Securities will be able to obtain a market valuation for its business operations, which is expected to be a catalyst to push up Rakuten Group's share price.

Rakuten Group's banking business, Rakuten Bank [5838:JP] was previously spun off from Rakuten Group and listed on the Tokyo Stock Exchange in April 2023 . As such, it is realistic to expect Rakuten Group to spin off and list some of its other businesses in time to come, apart from the proposed listing of Rakuten Securities. As more of Rakuten Group's key businesses are listed separately going forward, it is very likely that Rakuten Group's conglomerate discount will gradually narrow.

Another example of Rakuten Group's value-accretive portfolio restructuring activities is the company's divestment of its 20% equity interest in supermarket operator Seiyu for JPY22 billion in May 2023.

Rakuten Group's businesses are largely related to digital services, so the company's interest in brick & mortar retailer Seiyu seems out of place. As such, the market might choose to assign a narrower "di-worsification discount" to Rakuten Group considering the sale of its stake in Seiyu. In the company's media release disclosing the sale of the stake in Seiyu, Rakuten Group noted that its partnership with Seiyu in terms of offering "Rakuten Pay" (cashless payment) and "Rakuten Points" (loyalty membership program) will continue after the transaction. Therefore, Rakuten Group's existing businesses won't be affected by the recent divestiture, and there are no reasons for Rakuten Group to retain its interest in Seiyu to maintain the current partnership between the two companies.

In a nutshell, Rakuten Group has levers to pull when it comes to enhancing the value of the company's shares through accretive portfolio restructuring moves like the ones discussed in this section.

Mobile Business

Rakuten Group first entered the Japanese MNO (Mobile Network Operator) market in 2018 , and the company's mobile business continued to be loss-making in Q1 2023, with an operating loss of -JPY102.7 billion .

At the company's Q1 2023 results call in mid-May this year, Rakuten Group acknowledged that it has "a challenging project in the mobile segment and the so-called burden or the liability has to be reduced." The woes relating to Rakuten Group's mobile business are reflected in the market's expectations of the company's financial performance in the near term. According to S&P Capital IQ data, the sell-side analysts' consensus FY 2023 net loss per share forecast for Rakuten Group has been revised from -JPY85 at the start of this year to -JPY104 now.

Rakuten Group also admitted at its most recent first quarter earnings briefing that Rakuten Mobile "ranked the sixth in terms of network quality" in Japan, and noted that the mobile business' current subscriber "churn rate" is above "the market average."

The company introduced a new mobile plan known as "SAIKYO" at the beginning of last month to address the issues of "network quality" and "churn." Under the old "UN-LIMIT VII" plan, Rakuten Mobile's subscribers suffered from slower speeds and incurred additional charges when they exceeded data usage limits in certain coverage areas.

A Comparison Of The Old UN-LIMIT VII Plan And The New SAIKYO Plan

But there are two caveats associated with Rakuten Mobile's new SAIKYO plan. Firstly, it is uncertain if subscribers will experience an improvement in network quality with the new mobile plan. Secondly, Rakuten Mobile's new SAIKYO plan is dependent on a new roaming agreement with KDDI Corporation ( KDDIY , KDDIF ), and Rakuten Group can't disclose the exact terms of this new roaming agreement due to confidentiality issues. As such, assuming that Rakuten Mobile does gain more subscribers with its new SAIKYO mobile plans, it might potentially come at the expense of higher roaming expenses.

Concluding Thoughts

A Hold rating for Rakuten Group is appropriate based on my mixed view of the stock. Rakuten Group's shares have valuation re-rating potential thanks to its value-accretive portfolio restructuring activities. However, Rakuten Mobile's continued losses are expected to weigh on Rakuten Group, Inc.'s bottom line for the foreseeable future.

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