Philippine Markets Newsletter

This company’s effort in penetrating the esports space sends them winning, with Uniform profitability of 22%, not 9%!

July 8, 2020

The gaming industry has provided multi-faceted gaming experience through state-of-the-art graphic interfaces and unique, quality gameplay experience. Esports, gaming’s professional competitive arm, has even gained a dramatic following through the years.

This Japanese company aims to become the global leader in the esports industry. It continuously provides gamers with an up-to-date game experience as well as diverse game genres.

However, as-reported metrics do not seem to reflect the company’s success in penetrating the world of esports. Uniform Accounting shows that the business has a better Uniform return on assets (ROA) than what you might think.

Also, below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Daily:
Wednesday Uniform Earnings Tearsheets – Asia-listed Focus
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The world of esports has been gaining a much bigger following, especially with mobile phones making high-quality gameplay more accessible to anyone with internet connection.

The first recorded esports tournament was in 1972 wherein Stanford University gathered 24 participants to compete in the game Spacewar.

Today, esports have become pervasive as technology continues to provide and improve accessibility. From having only 24 participants at its inception, esports have gained over millions of gamers worldwide, providing them with varied and quality gameplay experience.

One of the recent drivers of the esports industry is Konami Holdings Corporation.

Konami started out manufacturing amusement machines for arcades. It was the first Japanese company to enter the world’s largest gaming machines market in the United States.

In 1999, the company also entered the card game business and successfully launched the Yu-Gi-Oh! trading cards. The card game, with more than 22 billion cards sold around the world in 2009, remained popular even after over 20 years since its launch. This prompted Konami to release an online mobile game based on these cards called Yu-Gi-Oh! Duel Links in 2016.

Konami entered the esports industry even before it was as lucrative as it is now. Since 2001, the company has been hosting World Championships for its eFootball Winning Eleven series, also known as its Pro Evolution Soccer (PES) series.

In addition, Konami has been producing and distributing mobile games for devices that were on the rise, such as smartphones and tablets, since 2010.

However, in 2014, Konami’s software sales significantly declined from the previous year. Its PES franchise was facing difficulties, having to compete with Electronic Arts’ FIFA.

To remedy the declining sales, the company rehashed its independent enterprise and hired renowned game designers in 2015. Furthermore, Konami restructured its game creation by focusing on understanding customer trends to better curate its games.

With this, Konami was able to release Metal Gear Survive in 2018 and Death Stranding in 2019. Death Stranding became the recent magnus opus of Konami, and it was recognized as one of the Games of the Year in 2019.

Recently, the company built an esports studio in its new headquarters, Konami Creative Center Ginza. The new esports Ginza studio serves as a distribution studio for esports competitions, an esports school, and an interactive showroom, aiming to further expand the awareness and acceptance of this industry in Japan.

Now, Konami continues to set its goal in becoming the global leader in esports. This includes the development of its Amusement Business that is incorporated with its esports events and competitions like “The KONAMI Arcade Championship.”

Considering the company’s success in penetrating the esports industry, and its initiatives to further expand its presence in the space, its as-reported returns of 9% in 2019 is weaker than what it actually is.

Konami’s real economic profitability is better reflected with Uniform Accounting adjustments, which show its TRUE earning power.

One key metric that causes distortions in as-reported ROAs is R&D expenses.

Since 2015, Konami has made regular material investments in research and development that it records as an outright expense, in accordance with accounting standards. However, expensing R&D fails to recognize the matching principle of recognizing expenses in the period when the related revenue is incurred.

R&D investment is actually an investment in the long-term cash flow generation of the company. If this remains treated as an expense, the company’s profitability may appear substantially weaker than it actually is.

After R&D and other significant adjustments are made, Konami’s Uniform ROA is at 22% in 2019, which is much stronger than its as-reported ROA of 9%.

Konami’s valuations are cheaper than corporate averages

Konami Holdings Corporation (9766:JPN) currently trades below corporate averages at a 9.7x Uniform P/E (blue bars), below its as-reported P/E of 17.9x (orange bars).

At these levels, the market is pricing in expectations for Uniform ROA to fall to 12% in 2024, accompanied by 1% Uniform asset shrinkage going forward.

Analysts have similar expectations for its profitability, projecting Uniform ROA to decline to 13% levels in 2021, although accompanied by a 14% Uniform asset growth.

Konami’s profitability is much better than you think it is

As-reported metrics are distorting the market’s perception of the firm’s profitability.

If you were to just look at as-reported ROA, you would think that the company is a weaker business than real economic metrics highlight.

Konami’s Uniform ROA has actually been higher than its as-reported ROA in the past sixteen years, except for 2014 when Konami experienced a decline in its software sales. For example, as-reported ROA is 9% in 2019, significantly lower than its Uniform ROA of 22%. When Uniform ROA peaked at 28% in 2018, as-reported ROA was just at 8%. The company’s Uniform ROA for the past sixteen years has ranged from 1% to 28%, while as-reported ROA ranged only from 3% to 10% in the same timeframe.

From 10% levels in 2004-2005, Uniform ROA gradually fell and trended at 6% to 9% levels from 2006 to 2013, before declining further to 1% in 2014. Afterwards, Uniform ROA expanded to a peak of 28% in 2018, before compressing to 22% in 2019.

Konami’s Uniform earnings margins are weaker than you think but its robust Uniform asset turns make up for it

Volatility in Uniform ROA has been driven by trends in both Uniform earnings margins and Uniform asset turns, with peaks and troughs lining up historically with that of Uniform ROA.

Uniform earnings margins trended 5% to 9% from 2004 to 2013, before falling to 2% in 2014. It then recovered to 23% in 2015, before fading to 19% in 2019.

Meanwhile, Uniform asset turns trended at 1.1x to 1.3x levels from 2004 to 2009, before it gradually fell to 0.6x in 2015. Uniform turns then recovered back to 1.3x in 2018, before compressing to 1.2x in 2019.

SUMMARY and Konami Holdings Corporation Tearsheet

As the Uniform Accounting tearsheet for Konami Holdings Corporation (9766:JPN) highlights, the Uniform P/E trades at 14.6x, which is below corporate average valuation levels but above its own recent history.

Low P/Es require low EPS growth to sustain them. In the case of Konami, the company has recently shown a 1% Uniform EPS growth.

Sell-side analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, sell-side analysts’ near-term earnings forecasts tend to have relevant information.

We take sell-side forecasts for Japan’s Modified International Standards (JMIS) earnings and convert them to Uniform earnings forecasts. When we do this, Konami’s sell-side analyst-driven forecast is a 23% and 2% earnings shrinkage in 2020 and 2021, respectively.

Based on current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Konami’s JPY 3,515 stock price. These are often referred to as market embedded expectations.

The company can have Uniform earnings shrink by 11% each year over the next three years and still justify current prices. What sell-side analysts expect for Konami’s earnings growth is below what the current stock market valuation requires in 2020, but is above what the market is requiring in 2021.

The company’s earning power is 4x the corporate average. Also, cash flows are more than 3x higher than its total obligations—including debt maturities, capex maintenance, and dividends. Together, this signals low credit and dividend risk.

To conclude, Konami’s Uniform earnings growth is below its peer averages in 2019. However, the company is trading in line with its average peer valuations.

About the Philippine Markets Daily
“Wednesday Uniform Earnings Tearsheets – Asia-listed Focus”

Some of the world’s greatest investors learned from the Father of Value Investing or have learned to follow his investment philosophy very closely. That pioneer of value investing is Professor Benjamin Graham. His followers:

Warren Buffett and Charles Munger of Berkshire Hathaway; Shelby C. Davis of Davis Funds; Marty Whitman of Third Avenue Value Fund; Jean-Marie Eveillard of First Eagle; Mitch Julis of Canyon Capital; just to name a few.

Each of these great investors studied security analysis and valuation, applying this methodology to manage their multi-billion dollar portfolios. They did this without relying on as-reported numbers.

Uniform Adjusted Financial Reporting Standards (UAFRS or Uniform Accounting) is an answer to the many inconsistencies present in GAAP and IFRS, as well as in PFRS.

Under UAFRS, each company’s financial statements are rebuilt under a consistent set of rules, resulting in an apples-to-apples comparison. Resulting UAFRS-based earnings, assets, debts, cash flows from operations, investing, and financing, and other key elements become the basis for more reliable financial statement analysis.

Every Wednesday, we focus on one company listed in Asia that’s relevant to the Philippines and that’s particularly interesting from a UAFRS vs as-reported standpoint. We highlight one adjustment that illustrates why the as-reported numbers are unreliable.

This way, we gain a better understanding of the factors driving a particular stock’s returns, and whether or not the firm’s true profitability is reflected in its current valuations.

Hope you’ve found this week’s Uniform Earning Tearsheet on an Asian company interesting and insightful.

Stay tuned for next week’s Asia company highlight!


Angelica Lim
Research Director
Philippine Markets Daily
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