Zigen (TSE:3679)

A platform roll-up with 40%+ ROCE and trading at less than 3.5x EV/EBIT

Zigen (TSE:3679)

If you like this short snippet, you can read my full writeup here.

Disclaimer: Nothing in this write-up, any prior write-ups, or content posted on the @Feathertopcap twitter account is financial advice. I am a private investor (with no accounting qualifications) documenting my thought process publicly - mainly for review by others and feedback. I am not a financial advisor. Don’t take financial advice from strangers on the internet and always do your own research.  Disc: I hold shares in Zigen with a cost basis of ~304 JPY.  I may add or sell at any time.

Some stats:

• ROCE: 45%

• Gross margin / operating margin: 83% / 48%

• Debt/equity: 18%

• Piotroski score: 9 (perfect)

• Montier C-Score: 0 (perfect)

• FCF Yield: 12.4%

• EV/EBIT: 3.4x

• LTV/CAC: 4-10x (depends on subsidiary)

• Monthly churn: 2%

• Cash from operations CAGR (7y): 23%

• Annual return on M&A investment in 2021: 27% - investments are on track to pay themselves off within 3-4 years.

• EBITDA growth rate for acquired companies: 208%

• Cumulative return on all M&A deals: 155% (EV/EBITDA multiple expansion).

Background

Zigen was founded in 2006, and was subject to a management buyout by current CEO Joe Hirao in 2009. He now holds just under 50% of the company. In 2013 it was listed on the mother’s market in Japan, and moved to the TSE in 2018. The Company operates a variety of platform businesses and data aggregators in Japan.

Why does the opportunity exist?

The Company incurred a loss (across group EBITDA) for the first time in its listed history due to a goodwill writedown - a poor acquisition (Miraxs) and COVID impacts to three of its platform businesses being the culprit. The company’s top line growth had also slowed to 2.7% in 2020, and shrunk -4.8% from FY20 to 21. It was previously growing revenues at ~60% a year from 2014-17. Has been sold off hard, now trades at an EV/EBITDA of 3.3x.

Why is it compelling?

Platform businesses have strong economies of scale and network effects. Zigen runs about 30 vertical/niche platforms, but three make up the majority of its revenue. One key factor driving growth and competitive advantages for platforms is matching technology. A stronger matching capacity amplifies value for both consumers and producers on platforms. Zigen claims to have valuable proprietary data/matching technology which it leverages across all platforms. Zigen is cheap at 3.4x EV/EBIT with a 12% FCF yield. The company has a 45.3% return on capital employed and has compounded its cash from operations at a 23.4% CAGR over the last 7 years. Subsidiaries have LTV/CACs of 4x - 10x and only 2% monthly churn (both metrics are exceptional vs market standards). It has higher operating income margins vs its direct competitors.

The CEO is a good capital allocator, focussing on total shareholder returns - he is currently prioritising the massive reinvestment opportunity in Zigen’s operations (both internally and through cost-conscious M&A). Overall, the CEO’s strike rate on M&A is good (70% success rate vs industry standard 30%). In addition, a buyback program (provided prices & lack of investment opportunities both align) is in place. We haven’t seen much buyback activity yet, but it is “highly likely” (CEO’s words) that we see it in 2022.

What are the risks?

Zigen may not return Miraxs to breakeven. Larger marketplaces might come to dominate niches where Zigen’s platforms operate (or more likely, draw users away from the niche platforms towards larger ones). The stock may never re-rate its multiple. It is also exposed to cyclical industries - heightening risk of losses during bad economic times. It may struggle to grow organically and run out of M&A opportunities (although the CEO has indicated current deal flow is strong). Alternatively, cash may just sit on the balance sheet forever & not be used on buybacks/acquisitions. Marketing/advertising costs will increase in the near term and they may not yield growth in platform MAUs.

Decision

I’ve bought shares @ a 304JPY average, but sized it accordingly, given the remaining question marks over pricing and target markets which I’m working through (and waiting for management to reply, if they get back to me). I may add in the future if additional conviction is built based on management’s responses or pricing research, or I might even sell, but that feels unlikely at this stage. I’m more than happy to start building size now given:

1. Management’s new plan to grow the ‘pull’ element of its platforms (described in more detail in the full write-up as to what this means) should amplify network effects.

2. High CROIC and rock-solid balance sheet.

3. Focus on price paid & LTV/CAC for potential M&A targets. M&A done to date has been value accretive, and on track to pay themselves off in 3-4 years after completion.

4. LTV/CACs within subsidiaries of 4-10x and a 2% monthly churn.

5. Focus on shareholder IRR (maximised currently through internal & external reinvestment), including an intelligent approach to buybacks - though actions on buybacks will speak louder than words and we’re yet to see bold action.

6. Perhaps most importantly from a timing perspective - a 3.4x EV/EBIT multiple for a business with metrics like Zigen is cheap - especially when put against competitors and comparative businesses in other sectors. We’re also going to see buybacks in 2022, so I’m not sure how long these prices will persist, so I’ve started nibbling.

If you liked this short snippet, read my full writeup here. It contains:

1. Breakdowns of the main platform subsidiaries and revenue streams.

2. Fundamentals of growing a platform, and how Zigen is aiming to grow.

3. Risks.

4. Competitive advantages through network effects and Zigen’s matching data.

5. Capital allocation (past, present and future).

6. Comparisons with direct competitors.

7. DCF.

8. Questions I’ve asked management (without answers yet).

And before you go…