Rakuten (OTCPK:RKUNY) continues to be everywhere except in the mobile space, where aggressive investments are underway to expand the network across Japan. As a result, EBITDA profitability remains elusive as high operational costs, including from roaming payments, weigh on margins. According to my previous reporting Financial risk is an issue for the stock, albeit declining, following improving Rakuten Bank IPO prospects and the recent sale of Rakuten Securities’ stake in Mizuho (at a bargain price). However, a more sustained P&L improvement remains out of reach in the short term as the turnaround in the mobile business is expected to take at least a few years. At ~1.1x book, the stock is cheap, but given the need for more funding to offset losses in the mobile space, I’d hold off for now.
Higher cellular losses cloud quarterly results
Total revenue was up a solid ~15% year-on-year in the most recent quarter as stronger-than-expected growth in internet services, driven primarily by a rebound at Rakuten Travel, offset inline mobile performance. That didn’t stop EBITDA from continuing to slide year-over-year in the mid-teens, however, as more wireless losses weighed on earnings. The silver lining is that e-commerce and fintech businesses remained strong – domestic GMV was up 13%, boosting segment profits by an impressive ~31%, while fintech sales and profits were also up 10% and 19% respectively.
Mobile KPIs also gave investors little cause for optimism. The end of free service periods played a role, but the extent to which net adds have fallen to -280,000 (consisting of MNO subscriptions at -220,000 and MVNO subscriptions at -60,000) is worrying. However, the improved disclosures were helpful and confirmed that ARPU had increased following a promotional campaign in September; However, the decline in free service plans likely skewed this metric positively as well. Now that Rakuten Mobile’s subscribers are essentially paying customers and the churn of free users is eliminated, it’s worth keeping a close eye on subscriber trends from here to gauge the underlying health of the company.
Positive signs for the mobile outlook
Heading into the fourth quarter, things are looking up on the mobile side – management says signups outpaced cancellations in November, potentially signaling a turnaround in subscriber additions. As all customers will also be billed from November onwards, achieving further ARPU gains (vs. JPY 2.6k ARPU in mobile business released in September) will be key to achieving operational profitability. Also, the decline in roaming costs, base station installation and associated maintenance costs will benefit margins as 4G network rollout completes in FY23 with ~60,000 base stations deployed (vs. ~50,000 current). However, pending better visibility of a reversal in mobile, I would be cautious about guaranteeing a fundamental bounce for the foreseeable future.
Looking beyond the near term, Rakuten continues to aim to break even for its mobile business in one month by the end of 2023. Meanwhile, operational trends are forecast to improve as early as H1 2023 due to cost cutting and the launch of new business services. Management also highlighted the launch of “Platinum” band frequencies by the end of March 2024 (assuming the standard five-year migration period), which will help improve in-building coverage as a potential earnings contributor. On this front, however, I am less optimistic given the differing views of the major airlines on the reallocation of spectrum and as such the process could take longer than expected.
Strategic connection with Mizuho reduces financing risk
Heading towards the profits, Mizuho Securities announced its decision to acquire a ~20% minority stake in Rakuten Securities for JPY80 billion (or US$552 million). The upside surprise was the price — based on recent earnings reports, Mizuho is paying an expensive >40x trailing earnings (or ~2.7x book value) for the stake. Notably, the transaction follows similar mergers between Sumitomo Mitsui (SMFG) and SBI Holdings (OTCPK:SBHGF) and Mitsubishi UFJ (MUFG) and Kabu.com, signaling good monetization prospects for the securities business ahead of a potential listing in mid-2023.
More broadly, the transaction confirms Rakuten’s access to capital and could pave the way for further non-dilutive fundraising in the coming months to strengthen the balance sheet. The main funding options that have been floated include the issuance of hybrid securities and a potential Rakuten Bank IPO (scheduled for later this year). In summary, Rakuten Group appears to be well positioned to maintain its financial flexibility despite the difficult market conditions and as such I view any credit risk (recalling that Rakuten had received a negative credit outlook from S&P) as limited at this time.
Mobile losses weigh on prospects
Over the long term, Rakuten has a clear winner in e-commerce, but its entry into the telecom business is an expensive complicating factor. The outlook for the profitability of the mobile business, even at an operational level, is bleak, and given the recent subscriber weakness, I’d be reluctant to sign a reversal here. However, management deserves credit for addressing funding risks — Mizuho’s recent stake in Rakuten Securities at a cheap valuation suggests that funding options should remain open, easing any near-term credit worries. While the ~1.1x P/Book valuation is visually cheap, the prospect of more book depreciation from mobile means the risk/reward trade-off remains unfavorable at this point.