KDDI Corporation: Pricing Pressure And New Entrant Draw Attention (OTCMKTS:KDDIF)


Elevator Pitch

I have a Neutral rating on Japanese telecommunication services company KDDI Corporation (OTCPK:KDDIF) [9433:JP].

KDDI Corporation faces significant pricing pressure after a change in political leadership in Japan with Yoshihide Suga becoming the new prime minister and the proposed privatization of its competitor NTT Docomo (OTCPK:DCMYY) (OTCPK:NTDMF) [9437:JP]. But this is partly mitigated by its multi-brand strategy with budget brand UQ mobile offering affordable mobile plans. Also, Rakuten’s (OTCPK:RKUNF) (OTCPK:RKUNY) [4755:JP] entry into the Japanese mobile services market translates into stiffer competition. On the flip side, Rakuten’s mobile subscriber growth has been disappointing in the early stages of launch due to limited network coverage, and KDDI Corporation also earns money from the provision of roaming services to Rakuten.

KDDI Corporation’s valuations are undemanding. It trades at 10.8 times consensus forward FY 2021 P/E (YE March), and offers a consensus forward FY 2021 dividend yield of 4.0%. Taking into account the above-mentioned factors, I see a Neutral rating for KDDI Corporation as fair.

Readers have the option of trading in KDDI Corporation shares listed either on the Over-The-Counter Bulletin Board/OTCBB as ADRs with the ticker KDDIF, or on the Tokyo Stock Exchange with the ticker 9433:JP. For those shares listed as ADRs on the OTCBB, note that liquidity is low and bid/ask spreads are wide.

For those shares listed in Japan, there are limited risks associated with buying or selling the shares in terms of trade execution given that the Tokyo Stock Exchange is one of the major stock exchanges that’s internationally recognized and there’s sufficient trading liquidity. Average daily trading value for the past three months exceeds $200 million, and market capitalization is above $68 billion, which is comparable to the majority of stocks traded on the US stock exchanges.

Institutional investors which own KDDI Corporation shares listed in Japan include Daiwa Asset Management, Nikko Asset Management, The Vanguard Group, BlackRock, and MFS Investment Management, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers and Fidelity, or international brokers with Asian coverage like Hong Kong’s Monex Boom Securities and Singapore’s OCBC Securities.

Company Description

Started in 1984, KDDI Corporation is one of the three mobile services providers in Japan alongside its peers and competitors, NTT Docomo and SoftBank Corporation (OTCPK:SOBKY) (OTCPK:SFBQF) [9434:JP]. KDDI Corporation derived 85.6% and 13.9% of the company’s FY 2020 revenue from Personal Services (individual customers) and Business Services (corporate clients) segments, respectively. The Others segment contributed the remaining 0.5% of its top line in the most recent fiscal year.

I will be primarily focusing on KDDI Corporation’s core mobile services business for the purpose of this article.

Pricing Pressure

Similar to almost any other developed country in the world, mobile telecommunications are essential services in Japan, and Japanese regulators are keen to promote competition and push for lower prices for the benefit of consumers. The pricing pressure for mobile players in Japan such as KDDI Corporation became more intense with a change in political leadership in the country.

Yoshihide Suga became the new prime minister of Japan in September 2020, and one of the first things he did was to ask Internal Affairs and Communications minister Ryota Takeda to look into reducing mobile charges. Ryota Takeda subsequently mentioned that a 10% cut in mobile fees will be reasonable.

Notably, Yoshihide Suga has taken a tough stance towards mobile operators in Japan, prior to becoming prime minister. A September 18, 2020 Bloomberg article titled “Suga Win Boosts Data-Firm Stocks While Mobile Carriers Drop” noted that Yoshihide Suga had “called for a 40% reduction in mobile fees, repeatedly blasting the fat profit margins at the three main carriers” in 2018 when he was chief cabinet secretary.

Pricing pressure for KDDI Corporation is further complicated by a recent deal in the Japanese telecommunications market. In September 2020, telecommunications company Nippon Telegraph and Telephone Corporation (OTCPK:NTTYY) (OTCPK:NPPXF) [9432:JP] announced that it proposed to acquire all of the shares it does not own (34% equity interest) in its mobile business arm, NTT Docomo. If the deal goes through as expected, NTT Docomo will be privatized and no longer be a listed company.

Given that the Ministry of Finance is Nippon Telegraph and Telephone Corporation’s largest shareholder with a 34% stake, the privatization move is widely speculated to allow NTT Docomo to cut its mobile fees in future without public shareholder opposition.

According to a October 1, 2020 news article published in The Japan Times, Nippon Telegraph and Telephone Corporation has “denied that the (privatization) deal was linked to the government request (to lower mobile charges).” However, it was noted in the same article that Nippon Telegraph and Telephone Corporation emphasized that NTT Docomo “will be more competitive through closer collaboration with NTT group firms, which will enable the carrier to offer cheaper plans.” If NTT Docomo cuts mobile fees aggressively after becoming a private company, this could compel its competitors such as KDDI Corporation to follow suit.

A key mitigating factor for KDDI Corporation is the company’s multi-brand strategy. KDDI Corporation’s premium brand is “au,” while its key budget brand is “UQ Mobile.” In response to pricing pressure from regulators and competitors, KDDI Corporation recently introduced a new 20GB mobile plan priced at an affordable JPY3,980 referred to as SUMAHO Plan V for its UQ Mobile brand. With SUMAHO Plan V and other similar affordable mobile plans, KDDI Corporation hopes to satisfy the demands of the regulators, while protecting the pricing and margins for its premium brand au.

At the company’s 2Q FY 2021 earnings call on October 30, 2020, KDDI Corporation highlighted that the company’s new mobile plans and efforts to lower mobile pricing are “being viewed favorably by the minister (for Internal Affairs and Communications).” But the company also acknowledged at the recent earnings call that there could be down-trading by its existing au brand customers, noting that “some customers might move to UQ because of this price.”

New Entrant

On top of pricing pressure highlighted above, the entry of Japanese e-commerce giant Rakuten into the mobile market as the fourth player is another key negative factor for KDDI Corporation. Rakuten first disclosed its plans to enter the Japanese mobile services market in late-2017. The company did its full-scale commercial launch of its mobile services in April 2020, and its 5G services were subsequently introduced in September 2020.

Rakuten operates the largest e-commerce marketplace in Japan known as Rakuten Ichiba, which had approximately 115 million members in 2019. Earlier, the company had set a target of having 15 million mobile subscribers by 2028. As a comparison, Japan’s largest mobile player NTT Docomo has around 75 million mobile subscribers. Notably, KDDI Corporation emphasized at the company’s recent 2Q FY 2021 results briefing on October 30, 2020 that “we are living in competition” and “the government is saying that prices should be brought down in competition.” It is inevitable that competition in the Japanese mobile services market will intensify with the entry of Rakuten.

On the positive side of things, Rakuten’s mobile subscriber growth has been below expectations. In November, the company disclosed that it has approximately 1.6 million subscribers. Rakuten’s network roll-out in Japan was slower than expected (only three major Japanese cities thus far), so limited network coverage has prevented the company from signing on more mobile subscribers.

In addition, KDDI Corporation has collaborations with Rakuten, which will help to reduce the negative impact of Rakuten’s entry into the Japanese mobile services market on its businesses and financial performance. Reuters reported in November 2018 that “KDDI will give Rakuten access to its nationwide roaming services, while Rakuten will provide KDDI its expertise in mobile payments” as part of an agreement between the two companies.

Valuation And Dividends

KDDI Corporation trades at 10.8 times consensus forward FY 2021 P/E (YE March) and 10.4 times consensus forward FY 2022 P/E, based on its share price of JPY3,080 as of November 18, 2020. As a comparison, the company’s peers NTT Docomo and SoftBank Corporation trade at consensus forward FY 2021 P/E multiples of 20.5 times and 11.9 times, respectively.

KDDI Corporation is also valued by the market at consensus forward next twelve months’ EV/EBITDA and EV/EBIT multiples of 5.0 times and 8.3 times, respectively.

The stock offers consensus forward FY 2021 and FY 2022 dividend yields of 4.0% and 4.1%. Market consensus expects KDDI Corporation’s full-year dividends per share to increase by +6% and +4% to JPY122 and JPY127 in FY 2021 and FY 2022, respectively.

Risk Factors

The key risk factors for KDDI Corporation are lower-than-expected profitability due to pricing pressure from regulators and competitors, larger-than-expected loss of market share to new entrant Rakuten, and an unexpected cut in dividends.

Note that readers who choose to trade in KDDI Corporation shares listed as ADRs on the OTCBB (rather than shares listed in Japan) could potentially suffer from lower liquidity and wider bid/ask spreads.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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