Idea of the Week: Rakuten Group, a Rare Opportunity to Capture 9% Return (New on Bond Express)

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Highlights:

• Rakuten's operating performance improved across the board in FY23, with the e-commerce and financial services segments growing at a high-quality and rapid pace. Loss in the mobile telecom sector notably narrowed and the group is expected to reach the breakeven points from 2025 onwards. We are positive about the group's prospects.

• Given the early stage development of mobile telecom, the high capital expenditure results in a somewhat tight liquidity. Owing to a decent capability of refinancing, Rakuten raised a large amount of funds in FY23 through equity financing and the IPO of a subsidiary. Considering that the group owns a lot of valuable assets. Including Rakuten securities and Rakuten life insurance, either through IPOs or equity sales are potential sources of liquidity. Coupled with the fact that entering into a profitable position of the telecommunication mobile telecom is just around the corner with a lower cash bleeding, we believe the overall credit risk remained at a manageable level.

• Based on the group's favorable prospects and relatively sound credit quality, we believe the investment risk of bond due in 2027 is still under control. The bond is currently yielding roughly 9%, which is one of the highest levels among BB-rated issuers. It also represents a rate investment opportunity in the Japanese high-yield space, we thus add it to Bond Express so that investors can gain access to it at a lower cost.

Last year we introduced a Japanese-based e-commerce giant Rakuten Group in our article "Idea of the Week: Is Rakuten Group with a yield of 10% Attractive?”. Rakuten's bonds are unique among Japanese corporate bonds in terms of their high yields, but some investors were concerned about their creditworthiness. One year on, the group's operations and credit profile improved to varying degrees, and the bond's risk-return profile was attractive enough for investors interested in Japanese corporate bonds.

Full-scale Improvement in Operation and EBTIDA Turns Around to Profitability

Speaking of the operation results in 2023, the total revenue amounted to JPY 2.3 trillion, up 7.8% from one year ago. Meanwhile, the group is finally out of the red, with EBITDA improving from a loss of around JPY 70 billion in 2022 to earnings of JPY 118.1 billion in 2023. Although the EBITDA loss of JPY 180 billion for the mobile telecom sector suggests ongoing headwinds, we still favor the overall performance of the group in 2023, which beat the market expectations with a significant improvement.

Table 1: Operating Performance of Rakuten in FY23

Stable Development of E-commerce and Financial Services, which are Expected to Maintain a Fast Growth Rate

We believe the group’s robust operating track records are mainly driven by the e-commerce and financial service segments, whose revenue grew by 9.8% and 11.2% year-on-year, respectively, and maintained double-digit growth rate for several consecutive years.

Diving in the results of the e-commerce segment, following the increasing acceptability of online shopping, E-commerce in Japan has been rapidly growing in recent years, and the total market size has been ranked third in the world. We see that Rakuten's Gross Merchandise Sales (GMS) grew by 9.8% YoY to JPY 6.0 trillion in 2023, with the take rate improving to 14.6%, suggesting that the group could covert 14.6% of its GSM into revenue through advertising or commissions. Looking at famous e-commerce players such as Amazon, eBay, and Alibaba, most of which have take rates of 10%-15%, Rakuten's profitability lies on the average level of the industry. Looking ahead, given a less than 80% penetration rate for E-commerce in Japan, we believe Japanese E-commerce could be able to maintain a high growth rate in the years ahead and continue to be bullish on Rakuten’s E-commerce segments, which are expected to grow at a low double-digit or high single-digit rate in the next few years.

Chart 1: Rakuten’s E-commerce SegmentRegarding the financial services segment, which includes Rakuten Bank, Rakuten Card, Rakuten Securities, and Rakuten life insurance, etc. Benefiting from the booming e-commerce business, Rakuten Card's revenue gained by 7.2% year-on-year to JPY 317.0 billion, posing as the largest source of revenue for the financial services segment, while operating income surged by 26.8% to JPY 51.6 billion. It is worth mentioning that Rakuten Securities performed quite well, with revenue and operating income soaring by 16.2% and 61.5%, respectively. The stock sentiment in Japan is very favourable, with the Nikkei index coming out of its "lost three decades" and hitting a new record high. We believe the increasingly active turnover on the stock market will undoubtedly drive Rakuten Securities' revenue to rise even higher, and the decent performance of the financial services segment is expected to continue this year.

Mobile Telecom Shows Early Signs of Success and Will Become Profitable Next Year at the Earliest

As we all know, Rakuten's mobile telecom business has been criticized for suffering huge losses since its inception, which weighs on the overall performance of the Group. However, after 5 years of start-up, the number of base stations and subscribers reached a stable level, and the quarterly operational cost was reduced from JPY 200 billion and around JPY 100 billion, and the group abandoned its low-priced promotional strategy, leading to a normalized telecom fee charges and remarkable improvement in 2023. 

We see that the quarterly EBITDA loss significantly narrowed, from JPY 90 billion in 1Q2022 to JPY 30 billion in 4Q2023. If the group could be able to maintain the momentum, we consider that the quarterly EBITDA loss will be likely less than JPY 10 billion this year, and the likelihood of turning to a profitable position in 2025 is very high. Additionally, average revenue per user (ARPU), a key indicator of measuring a telecom provider's profitability, also improved considerably from less than JPY 1,000 to around JPY 2,000 today, albeit there is still a gap with major Japanese telecom players, such as Softbank Corporation and DOCOMO, which have ARPU of around JPY 4,000.  All in all, we think that the mobile telecom segment is showing early signs of success and entering into a phase of stable development, and is expected to notably improve the earning quality in the next few years. 

Chart 2: EBITDA Loss and ARPU of Mobile Telecom Segment

Since the liquidity of Rakuten is quite tight, does it mean that the company is close to the edge of a crisis? The answer is no. In our view, the group has already weathered its most difficult phase, and as the mobile sector continues to improve, the liquidity will certainly improve. For one thing, given the mobile sector is close to a profitable position, the pace of cash bleeding slowed down, with capital expenditure dropping from JPY 300 billion in 2022 to JPY 177.6 billion last year (Chart 4), and planned capital expenditure for this year declines further to JPY 100 billion. As a result, we believe this segment is no longer posing a major liquidity pressure on the group. 

Chart 4: Capital Expenditure of Mobile Telecom