SK Japan (7608) Deep Dive: Hidden Growth
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In this post, I go over why I believe SK Japan is value-with-a-catalyst investment.
SK Japan is undervalued given the company has been:
-increasing revenues
-has no revenue concentration risk
-has substantially untapped US revenue potential
-demonstrates operating leverage through increasing margins.
SKJ’s share price has a 50-130% upside over a 1-1.5 year holding period.
SK Japan (7608) will be releasing its financial summary of annual results on April 12th.
Post-April 12th Update: SK Japan just had a major earnings beat. Stock went up 10-15% post Q4 Financial Summary release. Paid subs who acted would be up 10-15% on the stock now (I am definitely adding to your FOMO here).
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Table of Contents:
-Ultra Quick Pitch Summary
-Key Highlights
-Debunking Customer Concentration
-Major US Revenue Upside (Core of Investment Thesis)
-Growth potential in Round1 JP Operations
-SK China
-Segmented Revenue Analysis
-Narrative and Hidden Advantage (Very unconcise ranting, will refine later)
Business Overview:
SK Japan has two segments:
Character Entertainment Business: This segment primarily involves the design and sale of character plush toys, keychains, and other promotional items to amusement facilities/capsule toy operators domestically and internationally, as well as planning and selling promotional products for businesses. (i.e. Round1)
Character Fancy Business: This segment primarily involves the sale of character plush toys, keychains, and other products to specialty stores and retailers, including department stores and discount stores. (i.e. Don Quijote, Pokémon Specialty Store). D2C e-commerce sales are also included in this segment.
SKJ is 32% owned by Round1, an amusement facility operator with 100 stores in Japan, 49 stores in the US, and 4 stores in China. Since 2022, Round1 has undergone massive increases in crane game machines in JP and US. Given that SK Japan supplies the prizes used in crane game machines, SK Japan is a direct beneficiary of this positive development.
My previous quick pitch on SK Japan was a quick idea going through a buyout scenario:
TLDR of the SK Japan Ultra Quick Pitch:
-Round 1 (4680) owns a 32% stake in SK Japan (7608) and is the largest shareholder of SKJ by a large margin (next in line owns 4%)
-SK Japan (706 yen per share at the time) is trading at 9.3x FY2024 P/E, 3.0x FY2024 EV/EBIT(Operating Profit). SK Japan has a market cap of 5.9bn yen and net cash of -3.3 bn yen with no debt, resulting in an EV of 2.5 bn yen.
-Given Round1 already owns 32% of SK Japan, the true price for R1 to acquire SK Japan is only 650 mm yen
-Round1 has 32.5bn yen of cash, 25.6 bn yen in debt, hence liquid net cash of 6.9bn on its balance sheet. Round1 accounts for its ownership in SKJ under the equity method (R1’s share of SKJ’s net income is recognized on the IS, and a carrying amount at cost for the investment is recorded on the BS), hence balance sheets are separate. Net cash is more than 10x over the true acquisition price and over 2x SK Japan's EV.
-Given SK Japan’s financials, R1's financials, and R1's continuous store growth trajectory, Round1 is a natural acquirer of 100% of SK Japan’s equity.
*For the initial ultra quick pitch, I initially spent very little time on the quality of the business given how statistically cheap the stock was, trading at 3x EV/EBIT, because the filings were all in Japanese. The stock looked like a no-brainer acquisition target for R1 regardless of growth prospects or revenue growth being completely tied to R1’s growth. However, upon deeper inspection, SK Japan as a standalone company has been improving it’s quality of earnings through diversified revenue growth and improving margins.
As an investor it is important to kill your original ideas once you realize the thesis has changed. I have now taken a 180 on the stock and believe it is better to long SK Japan for its growth prospects. It is better for the SK Japan investor if company is not bought out in the next 1-2 years.
Key Highlights:
-SK Japan is not as dependent on Round1 for growth as I had initially thought. Outside of Round1, SKJ generates revenue from a client base that is not highly concentrated.
-SKJ’s sales to Round1 JP increased by 71% in 2023, but Round1 sales as a % of total Character Entertainment Business remained unchanged at 29%. In fact, the entire revenue segment increased by 73% in FY2023.
-The core of my investment thesis is that Round1 has barely used SKJ as a supplier for its US operations. R1 has only started converting stores into Mega Crane Game stores in FY2024. Based on my estimate, Round1’s US Crane game machine count will increase by 3.7x by FY2025. SK USA currently accounts for only 4-7% of R1’s crane game prize COGS. If SK USA is given a COGS allocation that is in line with R1’s Japanese operations of 18-22%, we could see SK USA’s current prize COGS allocation increase 3-5x.