AVI Japan Opportunity Trust has published results for the year ended 31 December 2022. Over the period the NAV total return was -4.3% and the share price return -4.5%, both a little behind the return on the MSCI Japan Small Cap Index (in sterling) which was -1.1%. The chairman notes that performance across the portfolio was generally good but was dragged down by two large detractors, Wacom and Pasona.
This underperformance has been more than made up since the end of the year with an NAV return of +7.7% versus the benchmark’s return of +2.4%. Perhaps encouraged by this, the company continues to expand by issuing shares at a premium to NAV (which enhances returns for ongoing shareholders and improves liquidity).
The dividend was increased to 1.55p from 1.40p.
The chairman notes that at the end of December 2022, the TOPIX traded at 1x price to book, lower than its long-term average, since 1993, of 2x. Similarly, the TOPIX’s trailing price/earnings ratio stood at 14x at the end of December, below its long-term average of 21x (to 1993).
Extracts from the manager’s report
Our engagement was mostly behind the scenes, sending 24 detailed letters or presentations and holding 121 meetings with our 25 portfolio companies. This led to notable successes at DTS when in May 2022 it announced a new mid-term plan with a raft of shareholder-friendly measures, and Teikoku Electric when management committed to paying out 100% of earnings to shareholders and announced a 4.3% share buyback, the second in the space of nine months.
Our public engagement was limited to four companies, which were continuations of prior campaigns. We submitted shareholder proposals to NS Solutions, SK Kaken and Tokyo Radiator for the second year in a row, ranging from seeking higher shareholder returns to greater board independence. While all companies have controlling shareholders, we received good support from minority shareholders. The fourth was Fujitec, where at the end of June 2022 we released a public statement questioning whether Fujitec’s independent directors were acting in the best interests of shareholders. This followed Fujitec’s decision to retain the then President as Chairman, despite his appointment not having been approved by shareholders at the AGM.
There are a number of exciting engagement campaigns developing amongst portfolio companies. We intend to keep these discussions private and will only pursue them in the public domain when our progress stalls and management fail to accept our suggestions. Our lack of public activity this year is evidence of the successes we are having privately and we hope that this continues next year.
Contributors – DTS
DTS, an IT system developer, was the largest contributor to returns with a +22% share price increase, adding 140bps to performance.
We first invested in DTS in January 2020 premised on the appealing backdrop for increased IT development demand and management’s openness to engaging with us on how to rectify the undervaluation. Across all AVI funds, we built a 10% ownership stake, becoming the largest shareholder. Since then, we have sent 12 presentations and letters to management covering corporate governance, employee remuneration, balance sheet efficiency and its growth strategy.
In May 2022 DTS responded to our suggestions and announced a new mid-term plan that included a raft of shareholder-friendly policies. Beyond higher shareholder returns which could see up to 35% of the market cap returned to shareholders in the next three years, DTS announced a strategy to double EBITDA by 2030, increase ROE to 16% and focus on high-value-added IT services.
We have been working closely with management and the board behind the scenes on the mid-term plan, holding multiple meetings, including face-to-face discussions in Japan. DTS’ response to our engagement has been exemplary – they allowed us frequent dialogue with senior board members and, aside from a few minor points, actioned all our suggestions. The positive share price performance, and significant outperformance vs the market is, we believe, a testament to our efforts and clearly demonstrates the real value of AVI’s constructive activism – something that we hope will not have gone unnoticed by our other investee companies, as well as other investors in the Japanese markets.
DTS’ share price sold off towards the end of the year, ending on an EV/EBIT multiple of 6.9x vs peers’ 13.5x. There remains considerable upside and, as the largest shareholder, we will continue engaging with management to achieve a higher share price.
Wacom and Pasona had an outsized impact on performance, reducing returns by -6.4%. Wacom suffered from a deterioration in its business environment while Pasona’s decline was driven by a broad sell-off in growth equities.
The largest detractor over the year was Wacom, who saw its share price decline -35%. Starting the year with a 8.3% weight and being the largest position, the decline had a meaningful impact, detracting 346bps from performance. Wacom is the global leader in digital pen solutions and our investment was premised on the increased adoption of digital drawing and writing. Wacom manufactures both its own branded tablets and sells its technology to other electronic device manufacturers. For example, the S22 Ultra smartphone which launched at the start of 2022 has an embedded Wacom pen.
While we continue to believe that digital writing solutions will see strong growth over the long term, inflationary cost pressures and diminished consumer spending power have weighed on short-term profits. Encouragingly, Wacom’s B2B business has been resilient with a growing customer base and higher adoption of digital pens, but the consumer business has suffered from a demand-led slowdown. In October 2022, Wacom released a profit warning revising down its full-year sales and profit guidance by -11% and -56% respectively. We have been a little disappointed in Wacom’s investor communications surrounding the profit decline, with comments shortly before the profit warning now appearing naively optimistic, and poor planning to control gross margins and Selling, General and Administrative (“SG&A”) expenses. We sent a letter during November 2022 outlining seven actions we think management can take to aid the situation. We recognise that the consumer environment is out of management’s control, but there are several self-help measures that we would like to see implemented.
Our conviction in Wacom’s technology and long-term growth potential is unchanged, and the market’s myopic focus presents an opportunity to take advantage of the share price dislocation. Using normalised earnings, Wacom trades on an EV/EBIT multiple of only 5.3x, a remarkably low valuation considering Wacom’s technology and structural growth tailwinds from the increased adoption of digital writing solutions.
We increased our holding in Wacom by 24% over the year, adding to our position on share price weakness. As a top three shareholder, we are working closely with management to address the underperformance and ensure that efforts are being made to maximise shareholder value. With a return to normalised profits, our estimated potential upside to the current share price is in the order of +100%.
Pasona was a large detractor, reducing returns by 294 bps to performance. The shares returned -43% over the period, driven by a -60% decline in Benefit One’s share. Pasona is one of Japan’s largest recruitment and outsourcing companies, mainly operating through three business segments: HR, Life, and Public Solutions. Pasona owns a 50% stake in Benefit One, which accounts for 202% of Pasona’s market cap. Benefit One is a market leader in providing outsourced HR services, from education and training to healthcare and employee benefit options.
Benefit One’s -60% fall was less driven by fundamentals but more by general market concerns over higher valued companies. Benefit One’s share price strongly correlated with the MSCI Japan Growth Index which fell -16% over the year vs a smaller fall of -4% for the MSCI Japan. While Pasona traded on a large discount, Benefit One’s valuation was on the richer side at the end of last year. We reduced our position by -30% ahead of the fall, but did not manage to exit entirely.
Pasona is making a greater effort this year to help realise the value in its business portfolio. Over the year, it IPO’d Circlace, a 43% owned digital experience consulting firm and Bewith, a business process outsourcing company. It is encouraging to see Pasona’s newfound proactivity, and we expect that as the transparency of Pasona’s businesses improves and the company continues to grow earnings, we will see a narrowing of the discount to its valuation.
Benefit One has 11.3m captive members on its platform, about 19% of the 60m employed workers in Japan, providing stable cash flows and an opportunity to sell additional services. With Pasona’s 69% discount coupled with a more appealing Benefit One valuation, we see upside to Pasona’s knocked down share price.
AJOT : AVI Japan Opportunity claws back underperformance and remains optimistic