EUR 850.00 For Business Accounts Only

Morningstar | Cutting Rakuten FVE to JPY 950; Concerns Remain Regarding Tough Competition for E-Commerce

We have trimmed our fair value estimate for Rakuten to JPY 950 per share from JPY 1,080 as we now believe the company's operating margin will be lower than our original forecast, owing to larger customer incentives and heavier up-front investment. While we acknowledge the strength of Rakuten’s unique ecosystem, which is a combination of e-commerce and financial businesses and the source of our narrow moat rating, costs necessary to improve the service and retain users in this ecosystem, such as improving logistics and establishing mobile payment service, may be higher than we had anticipated. We retain our view that revenue growth of the financial technology segment, which is underpinned by Rakuten’s solid user growth, will mitigate the margin contraction on domestic e-commerce business. The company says 70% of its active users use more than two Rakuten services, which suggests that most Rakuten users enjoy the benefit of its ecosystem.

Our impression of Rakuten’s fiscal 2018 results is mixed. While operating income increased to JPY 170 billion from JPY 149 billion on the previous year, it is driven by the gains from investment business, but not from its mainstay businesses such as e-commerce or fintech. Despite the 11% growth in gross merchandise sales, the operating margin of the domestic e-commerce business dropped to 14.4% from 19.1% on the previous year and from 34.9% in fiscal 2014, implying tough competition with Amazon Japan. As 70% of users enjoy plural services on Rakuten’s ecosystem, we think Rakuten will be able to retain its user base in the future. However, we are concerned that Rakuten needs to continue paying incentives to encourage users to enjoy multiple services, use more acquisition expenses to maintain the growth of its merchandise value in e-commerce, and invest more to improve its logistics to catch up with Amazon Japan. Thus, we have cut our operating income forecast for fiscal 2022 to JPY 140 billion from JPY 160 billion.

Rakuten mentioned that its entry plan to the mobile network operator business is on track. Rakuten reiterated that its capital expenditure for the first 10 years will be less than JPY 600 billion, which looks unrealistic as other existing MNOs invest JPY 250 billion-300 billion per year. However, Rakuten showed confidence at the earnings briefing because a roaming alliance with KDDI will help reducing the initial cost to establish a nationwide network, and the company will introduce a fully virtualized cloud mobile network to differentiate itself from other MNOs. While we are unable to assess the efficacy of the virtualized network at the moment, we think the MNO will not be profitable in our five-year forecast period, as we believe the roaming alliance will drag down the profitability of the business.