Deep Value – ItoKuro [6049.T] Playing Devils Advocate – 22/01/2025
It’s hard to make a short case for a classic net-net. NCAV provides a solid floor to the long-term market price of the business. To make a short case, we look for what might erode NCAV, and the probabilities of such events occurring.
Poor Capital Allocation
An easy way to destroy the NCAV of any business is to use its cash pile for capital investments. This is not usually a problem, even in the case of net-nets, as competent management will only make such investments if they foresee a return above their opportunity cost (the rate on MMF’s for example). However, the history of business management is plagued with poor investment decisions – NCAV destruction for minimal benefit is a risk which must be acknowledged.
The long-term ROA of a business is a good approximation of management’s ability to make capital investments. Such returns for ItoKuro are mediocre at best – at a 3.09% average since 2019 (if you account for annualised Q2 2024 figures).
The business must use its cash at some point. This can be done in three forms: dividends, share repurchases, and investments. The history of the business suggests that they will choose the latter. This could leave investors, thinking they were buying assets at a heavy discount to NCAV, with significantly reduced downside protection and a business with returns less than an index fund.
Technological Advancement
Technology is a dog-eat-dog game. Innovation occurs so quickly that it is rather difficult to predict which companies will continue to thrive, and which will fall behind the curve. This is entirely possible in ItoKuro’s case. AI recommendation services could completely destroy their business, almost overnight. NCAV would soon erode with it. This isn’t particularly likely; however, it places a cloud over what seems like a clear upside.
Conclusion
There is not a strong catalyst for a decrease in NCAV. A short position against ItoKuro would primarily be a bet in management underperforming. Whilst innovation risk can’t be justified as a short case alone, in combination with the former point, it tilts the probabilities closer to being in the shorter’s favour.