Deep Value – Sonocom [7902.T] The Hands On Approach – 19/02/2025

Purpose

This piece describes changes we’d implement in a management position.

Activities

No advertising has been disclosed in their SGA notes. They have a stagnant cash position (17x NI for ‘24Q2) and high-quality service which they are not advertising. Any business should advertise if doable at low opportunity costs - and it’s not apparent why management hasn’t. Although, small businesses typically prefer to reinvest in their operation as an alternative method of attracting customers. The problem with that is the business goes unnoticed. We would implement a 5-year campaign, allocating 25% of cash (c.JPY1Bn), focusing on online advertisements and small business trade shows. No matter how much cash Sonocom throws at their operation, it will remain largely the same. Investments in advertising to grow their customer base will yield a far greater return.

Finances

Sonocom’s 5-year average dividend yield is 1%. Whilst insignificant, this is inefficient in delivering shareholder returns. We suggest a replacement with share repurchases, which have been absent recently, speaking to management oversight. While the concern with shareholder value is beneficial, dividends are inefficient in creating value due to capital gains tax – unlike repurchases. As we don’t know how long the stock will trade below NCAV for, we’d urgently suggest using half of cash for repurchases and discontinuing dividends.

Management compensation has been entirely salary based. The omission of stock-based compensation forgoes two benefits. Firstly, the business has more cash (for now) to allocate towards our proposed changes, which they can deploy at a higher ROI through repurchases. Secondly, it aligns shareholder – management incentives. The main concern of management should be shareholder value – it’s their fiduciary duty. As management aren’t paid in stock, they’re less incentivized to maximise shareholder value. It’s important to note that we’re not proposing all salary based pay be converted - We think ½ stock-based pay is suitable, with 5-10 year lock-up periods. The disadvantage is management are now incentivised to boost stock prices through aggressive accounting policies. This is not productive in the long run, as it’s transferring performance from tomorrow to today. This ignores long-term shareholder value, and puts us back at square zero. However, we do not consider this likely as the cost of violating regulation, combined with cultural values, incentivises honesty.

Shareholders (IR)

Sonocom's investor relations page is difficult to navigate. The minimum information required by Japanese law is available – which provides us very little of real value. The lack of English copies makes it trickier still. This informational barrier diminishes investor confidence. Even the market knows not to invest in things they don't understand. It also doesn't help that when contacted, management are in no rush to reply (if they do at all). While relevant information is deducible on the whole, it's far more difficult than necessary. Why not make things as easy as possible? We recommend a comprehensive IR webpage be up as soon as possible. This need is magnified by the fact that market attention is required for our thesis to play out.