This month’s outperformance was primarily due to a tender offer of our largest position, Macromill. I will elaborate more on this below, but it was not just the TOB that drove our outperformance. Our gross return would have been an estimated +2.22% vs the benchmark of -0.80% even without Macromill, driven by our #2 and #4 positions, both who clocked strong Sep quarter results. In fact, outside of the bottom 3 names (all sized around 1% or less), post-earnings reactions were generally positive. In terms of top-down, factor exposures, I believe there are 2 significant factors. First, by nature, we tend to weight long-term underperformers larger (with our IT services company being an exception). This is because of our “value” tilt. As a reminder, we do not regard “value” to mean price-to-book or other relative measures but by the margin-of-safety between what we believe is fair value, or its intrinsic value, and the current stock price. If the stock is growing slower than our intrinsic value computations, its “value” is rising and, all else equal, would be weighted higher. This will probably always be true due to our investment philosophy based on “quality” and “value” (as we define both). Note, this does not mean that we are always buying stocks that are down or that we are always contrarian. The margin-of-safety is the spread between the stock and the value of its business. If the value of the business rises faster than the speed at which the stock is rising, it could still be cheap on our metrics (which is true for our #2 IT services company).

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The second reason, however, is non-structural. Since late 2022, we had been highly underweight large cap tech, industrials, and general cyclicals, simply because the fundamentals looked bad and was worsening (after the inventory buildup during the post-COVID recovery in 2022). As I’ve mentioned in past monthlies, the majority of our underperformance in 2023 can be attributed to these variables alone. And this is not from a lack of trying as we saw what was driving the markets higher as easily as anyone else. But the fundamentals did not support the valuations. One other reason for the underperformance during that period was the sudden interest in sub-book companies (for the reasons we’ve discussed in the past). Similarly, we actively researched many sub-book companies but found that they were usually trading at sub-book for a good reason, and it wasn’t just bad balance sheet management. We ended up only finding one company that was trading sub-book with strong industry competitiveness that we were willing to invest in, but we never made it very big and is now a very small position. Now the tables have reversed; the stocks are catching up to the fundamental weakness of technology (ex AI-related), industrials, and autos while the low hanging sub-book trade has faded somewhat. I hope to balance our industry exposures as we enter 2025. However, the ever-changing geopolitical environment makes timing very difficult. But we’ve already begun some additions with very high-quality tech and auto parts that have idiosyncratic reasons why, should the cycle stay difficult, they can still outperform. Also, I have several larger tech and industrials that are on standby which do require macro tailwinds to be on their side. While I’m not actively seeking out large caps, the macro headwinds are causing some great, high-quality companies to trade at attractive valuations, and we certainly won’t want to miss such rare opportunities.

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In terms of idiosyncratic points, our #2 company is an IT services company whose management I have known since the mid-2000s. They are a leading supplier of office hardware and software (including internally developed solutions), mostly to SMEs. They have both buyer power (being the largest distributor of PCs, copiers, major 3rd party software, and a variety of other office supplies) and supplier power (with one of the most highly paid, highly efficient salesforce that can cover the mom-and-pops with half of their revenue from clients that have annual revenues of US$65 mln or less) which allows not only purchasing and pricing power but also solutions suited for the small business owner, most who need hands-on customer care due to their low IT proficiency and lack of capital to hire or outsource dedicated IT personnel. What makes the timing interesting is that multiple waves of demand are set to converge including an increase in office IT spending held back during the pandemic, back-to-the-office trend while replacing the extra hardware purchased for remote work, a Windows 10 replacement cycle, Gigaschool replacement cycle (a government-led initiative to provide a laptop/tablet for every student in Japan), and municipality DX reform (probably the last bastion of business users that still use faxes and floppy disks as office tools). While the stock is hardly “value” in the normal sense of the word, the potential demand has never been higher.​

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We’ve discussed our #4 name which is a software provider to auto maintenance shops in the past. The model is simple where they are moving from package software to a SaaS model. However, given the long-term leases, it takes 6 years before all users have fully converted, thus causing earnings to be artificially depressed for longer than most such conversions. Still, they are achieving a 99+% conversion ratio of existing clients as well as expanding new clients who now find the SaaS solution more affordable. Furthermore, they are adding new services and options to slowly increase ASP per user. We are 1/3 way in the conversion cycle and this past quarter was the second quarter where earnings have finally turned in the black. We expect this trend to continue and that they should exceed peak trailing 12-month earnings in less than 2 years and double it in 3~3.5 years.

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As I look toward 2025, I am both worried about the global environment but incredibly excited about the domestic environment. Of course, Japan is highly susceptible to the global economy, especially that of the US and Asia, and it will be nearly impossible to shield our economy from what happens outside. However, the opportunity set within Japan seems to be exploding, whether it be large caps, small caps, private, or public markets (one thing we could really use is a functioning corporate debt market … but that’s another story for another time). I look forward to sharing our thoughts with all of you in the coming year. In the meantime, I hope you and your families stay safe in this troubling times

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Best,

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Masaki Gotoh​​

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“Life, at best, is bittersweet.” – Jack Kirby, American comic book artist.

 

I’m not much of a DC/Marvel comics person. I never had a chance to read them and had only seen them through movies and television, the first being the Saturday morning Justice League cartoons, then the TV series Incredible Hulk as well as the Superman movies, where I found that I liked Gene Hackman’s portrayal of Lex Luthor more than Christopher Reeve’s Superman, although he was definitely the best Superman in my view. I have since enjoyed the most recent run of comic-based movies in the last decade or so though I prefer the darker DC Universe to the light-hearted Marvel series, but they are equally entertaining (Jack Kirby worked at both, by the way, even before they were called Marvel Comics or DC Comics).
 
I don’t know what the tone was of the original comic books, but the basic plot seems to be the same in the animation versions. Superheroes with superpowers defeat supervillains also with different superpowers. The villains always try to figure out a new way to take over the world and they look to succeed at first but, of course, the superheroes save the planet at the last minute. Now that I think about it, my favorite movie series, the James Bond series, has the same M.O.
 
While I don’t read American comics, I have always loved Japanese manga/anime (manga are the comics and anime is short for “animation” which are the TV/movie adaptations). And it is incredibly popular here in Japan; according to a recent survey, over 50% of the Japanese population across ages 18~69 read manga. And I’m proud of the fact that its fan base has grown internationally. But I notice that the ones that are popular overseas are similarly action-based good characters fighting with other not-so-good characters such as Dragon Ball, One Piece, Naruto, and even Pokemon. Of course, there are some with the surreal feel that is also very popular in Japan like Spirited Away. And others are apocalyptic like Akira or Demon Slayer; and who doesn’t like a good apocalypse story?
 
In actuality, I would guess that the bulk of manga in Japan aren’t necessarily “good beats evil” and they often have a reality-driven theme or just an unsatisfying ending (meaning it isn’t necessarily a happy one). Of course, there’s a very good chance that I’m simply biased, and I end up reading those with similar endings. But this is across all genres that I own, excluding maybe the sports-based anime that usually has the protagonist winning the final, most important match after, of course, a tortuous period of mental and physical training.
 
My very first manga I read in elementary school was a series called “Galaxy Express 999” starting in 1977 to 1981. In the first episode, the 10-year-old boy Tetsuro is living in deep poverty with his mother on Earth. In this futuristic world, wealthy humans can buy mechanized bodies to extend their life indefinitely. His father was killed by such humanoids because he opposed these unnatural transplants. During this episode, his mother is killed in front of him simply because she was a naturally beautiful woman who were commonly hunted down and stuffed and displayed like a trophy for the humanoids’ entertainment. On her deathbed, his mother tells Tetsuro to get to the Andromeda galaxy where it is rumored that one can get the transplant for free so that he could live for both his father and mother. Over the course of 113 episodes, he travels aboard the Galaxy Express 999 and struggles toward the goal of immortality in order to avenge his parents against elitist humanoids who look down upon natural humans. Ultimately, he comes to realize the beauty of living a short, finite life with all of its sorrows and joys and chooses to keep his natural body. In the end, he joins the resistance in the coming war between humans and humanoids (sound familiar?).
 
Some other favorites include “Death Note” about a high school student on a crusade to eliminate criminals from the world after discovering a notebook capable of killing anyone whose name is written in it vs an elite security force committed to stopping this unknown vigilante. Or “Monster” which is about a highly renown neurosurgeon who successfully heals a boy in critical condition, but not before refusing to operate on the city mayor that was rushed in at the same time, causing him to lose his status in the hospital after the other surgeons failed to save the mayor. Years later, he learns that the boy has become a serial killer “Monster” and vows to right his wrong by pursuing and killing the boy. Neither have your typical, happy-go-lucky storyline though there are bouts of both satisfaction and discontent throughout.
 
But most of the manga that I own is about everyday life mixed with lots of fiction. And everyday life isn’t happy. Things never go exactly as you want them. It’s generally very frustrating with sparing moments of light and joy. I’d argue that, like Tetsuro found after his yearlong travel, the joys are worth living for because of the hardships we face to get there. But sometimes, it doesn’t go exactly as planned; it is, as Mr. Kirby says, bittersweet.
 
We’ve been invested with Macromill for quite some time. Our initial placeholder position started at inception in Jan 2020, but we made our first filing as a large shareholder in Sep 2020. We continued to increase our filings in 2021 and early 2022. We reduced the position a little in late 2022 (coincidentally near the current TOB price) but bought that back in early 2024 as the stock stumbled again. During this time, there was the macroeconomic disruption from COVID starting in 2020, a major management change in late 2020 (which, we later realized, was much slower than a simple change in people and took 3 years for the culture to change), the Great Resignation in 2022 (which affected the labor-dependent marketing research industry), and the marketing slowdown in 2023 (driven from cost increases and profitability decline leading to tightening of marketing budgets at major advertisers). And in the meantime, we’ve had 4 states-of-emergency, 3 quasi-states-of-emergency, and a quasi-mask and social distancing mandate until as recently as Mar 2023. And these directives were different by prefecture, although Tokyo which leads the economic activity of the country, was the strictest.
 
Despite these market-led setbacks, we believed in the fundamental strength of the business. The new incoming management team was, while inexperienced, willing to accept outside help (particularly as we were the largest shareholder with a significant stake so the term "willing" may be subject to opinion). We helped the company advance their lead in the market through improving profitability to secure stronger talent, ultimately culminating in their biggest competitor being acquired by DoCoMo while the other smaller players slowly dwindled (and continue to see a decline in earnings growth). Macromill, on the other hand, has now strengthened their already leading position and have seen 3 quarters of significant annual and sequential profitability improvements. Furthermore, with the unloading of the extra baggage they were carrying during the Bain and post-IPO days, outside of some accounting variabilities that makes like-for-like historic comparisons difficult, anyone who was willing to dig a little could see the underlying strength of the business. After another year or two, both the accounting quirks and the historic comps would become insignificant as their primary domestic business continued to expand its leading position. Therefore, we were unconcerned with the low valuations given the lack of real coverage or understanding of the economics and that the numbers would prove themselves in the coming quarters.
 
As such, we were taken by surprise, not so much the TOB itself, but at the ridiculously low price that the private equity firm was offering. We were aware of some of the frustrations that management felt and the constraints that were being caused by being publicly listed. We promised that after they hit their midterm numbers next fiscal year, they would have the free cash flows to reinvest into the business at greater velocity. But it was imperative that they regain the trust from the market and insisted that they maintain their present course for another year. It was, after all, only 2 quarters of a reversal and that the real acceleration would come from this Sep quarter’s number and beyond. And so, the timing of the TOB was also unfortunate (and I’m sure well timed for the PE firm). For the quarter, the company announced a +50% YoY growth in business profit and +139% growth in EBIT on just +4% topline growth. At the results meeting, the company expressed their strong confidence in this year’s performance and that of the last year of their midterm plan.
 
Of course, there were no questions at the results meeting, and no one cared about the numbers. The PE firm had, on the same day, announced a tender at a 40% premium to the close. While that may seem like a lot, the stock was at that level just 2 years ago when the market environment was worse, the competitive environment was worse, and they were still saddled with the excess baggage of their weakening overseas business (where a competitive advantage did not exist). Also, the IPO price was still 70% higher than this new TOB price. If the company successfully reaches their midterm plan as we believe they will, their current EBIT which is now generated from just their original Japan and Korea business will exceed that at the IPO when they still owned a profitable overseas business (acquired while under Bain’s watch). With more efficient tangible assets, lower debt, and rising profitability, the offer was excessively low.
 
Furthermore, the process by which the “independent special committee” came to unanimously vote in favor of the deal possibly represents, what we believe, to be a grave miscarriage of corporate governance and one of the clearest weaknesses of the corporate takeover process despite the efforts by METI’s “Guidelines for Corporate Takeovers” and other bureaucratic reform literature announced in the past several years. While they may be following the “Fair M&A Guidelines”, they thwart the intent of the guidelines, particularly as it pertains to “evaluation and decide on [the] transaction from the prospective of benefiting general shareholders” and the “the reasonableness of transaction terms and the fairness of procedures”. I would note that in the most recent JPX follow-up meeting this October, the Exchange publicly cited that (with regards to MBOs), “some investors have also stated that fair procedures and prices are still not being achieved in some cases, and that the Fair M&A Guidelines themselves are more relaxed than in the US, so as an exchange, we should aim for a level that is comparable to the US when viewed by global investors.” I’ll need to add this to my list of grievances that I provide on a regular basis to the Exchange.
 
In either case, the market appears to agree since the stock has not once traded below the TOB price and has consistently traded at a slight premium, implying that “the reasonableness of transaction terms” has not been met.
 
We still have a few weeks before the deal closes and, officially, we have not taken a stance. However, we are in contact with other shareholders both those who have filed as large shareholders and those that have not. We shall see how this unfolds and, at present, it is only bittersweet … but we will endeavor to work towards making it as sweet as honey.

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