Terrie's Take 624 -- Is Rakuten Over-extending? e-biz news from Japan

Sun Jul 31 22:19:04 JST 2011

* * * * * * * * * T E R R I E 'S T A K E * * * * * * *
A weekly roundup of news & information from Terrie Lloyd.
(http://www.terrie.com)

General Edition Sunday, July 31, 2011, Issue No. 624

+++ INDEX

- What's New -- Is Rakuten Over-extending?
- News -- Jump in single-person households a social problem
- Candidate Roundup/Vacancies
- Upcoming Events
- Corrections/Feedback
- News Credits

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+++ WHAT'S NEW

This week Rakuten, Japan's largest Internet company,
announced that it is acquiring Tradoria GmbH, Germany's
largest online shopping firm. With the acquisition, Rakuten
is now in eight international markets and is on track to be
knocking on Amazon's door in the next three years to become
the largest online shopping company globally in terms of
net profits. For comparison, Amazon had 2010 global sales
of around US$34bn and net earnings of US$1.2bn, while
Rakuten's 2010 global sales were roughly US$4.2bn with a
net profit of US$428m. But Rakuten profits are growing the
quickest.

It's interesting to see that even though Rakuten's revenues
are just 15% or so of Amazon's that its net profit ratio is
double that of the US firm's. Commentators say this is
primarily because Rakuten doesn't operate physical
warehouses, and it is much more deeply into the financial
sector, cross-feeding customers into financial services from
its customer base. No doubt it is also because Rakuten is
strategically choosing to only set up in high-growth
countries at a time when it doesn't have to invent a new
business model. Being Number Two can be helpful sometimes.

The Tradoria business was purchased for an unknown sum, but
given the size of the business, we expect that they paid
more than the US$263m paid for France's PriceMinister last
year. This acquisition and a number of others made by
Rakuten in the last 12 months underscores the relative
advantage that Japanese companies have in making foreign
high-grade purchases using cheap funds from home. Tradoria
will add another 8m products and 4,400 member stores to
Rakuten's Japanese empire of 37,000 merchants and 75MM
SKUs.

The Tradoria acquisition comes hard on the heels of another
purchase by Rakuten, this time in Brazil, of one of the
leading e-commerce companies in that country, Ikeda. Also
this year, Rakuten set up in Indonesia a joint venture
with domestic media conglomerate PT Global Mediacom. The
new Internet shopping mall there is called “Rakuten Belanja
Online” and will compete with a number of incumbents.

[Continued below...]

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------------------------------------------------------------

[...Article continues]

So, if you include the Baidu joint venture and Buy.com in
the USA, in the last 14 months Rakuten's international
M&A and investments have almost hit a billion dollars:
* 2010 May -- Rakuten bought Buy.com in the US for $250m
* 2010 June -- Priceminister in France for EUR200m, company
had EUR40m revenues in 2010, so Rakuten paid 5x
* 2010 October -- Rakuten/Baidu j/v, Lekutian, opens website,
Rakuten will put US$50m into j/v over 3 years
* 2011 June -- Rakuten/MNC j/v opens website, undiclosed
investment amount but probably US$20m or so
* 2011 June -- Ikeda purchase in Brazil, undisclosed amount
but our guess is around US$50m
* 2011 July -- Tradoria purchase in Germany, undisclosed
amount and again, our guess is around US$300m

This seems like a lot of activity, given everything the
company is also doing here in Japan and in a number of
other countries (Taiwan, Thailand, etc.) and makes us
wonder if Rakuten isn't running the risk of over-expansion
before it is internally capable of managing the pressures of
an international business.

Now we don't know what measures are being put in to place
to cope with the new companies and people becoming part of
the global Rakuten network, but looking at the Amazon
financial report for 2010, they very helpfully list up the
four major challenges that they face with their
international business: Management, Operations, Financial
and Other. For Rakuten, let us recast these risks slightly as
Internal and External, then pick up on a few that we see as
being threats that hopefully they are focusing on.

Internal
==========
1. Continuity and Consistency
Rakuten CEO Hiroshi Mikitani has stated that his key to
expansion is the "federation" of different businesses in
different countries, and to keep local management in place.
This may sound good as a concept, but in pursuing
convenience for a rapid-fire M&A strategy, it is also
creating a negative balancing factor, which is
inefficiency. To really keep Rakuten's margins where they
are -- and they are excellent -- the company needs to
figure out how to roll out common systems (managerial and
IT) amongst all its properties. This is only going to get
harder as more acquisitions get done.

2. HR
Unlike Japan, most employees at the newly acquired
businesses will owe little loyalty to a company in far off
Japan and as the founders leave with their buy-out
packages, the middle managers and those close to them will
leave as well. In other large Japanese firms, the solution
has been to send out Japanese top managers to run each
country, and have these people provide the communications
and controls lifeline back to headquarters. We presume that
Rakuten plans to do the same, but since it's a young
company, one wonders if they can hire the quality and
experience needed for such positions. Lack of experienced,
loyal managers has been the undoing of many a fast-growing
company in the past.

Back at Headquarters in Tokyo, another challenge is for
Rakuten is to internationalize and bring in more
experienced foreign managers. Currently on the board of 16
directors there are only two foreigners, and neither
appears to be involved in an executive role. This means
that day-to-day operations don't have international depth
and this probably needs to be fixed fairly quickly.

3. Complexity
The company is a reflection of the founder, who has an
interest in a wide range of industries and segments. Some
of these have been really well chosen, such as matching
finance to shopping -- and follows the examples of
successful US companies such as GMAC (now Ally Financial).
But with such broad scope, the ability for operations
people to keep a handle on all the moving parts, especially
as the company starts linking the businesses together
internationally, will create some massive logistical and
technical headaches. We can only imagine that this has
already started and is probably the strongest point of risk
to the company. This is a risk that can only be resolved
with some serious top-level policies and procedures being
put into place.

External
==========
1. Reputational risk through software malfunction
What if it was revealed that Rakuten systems had a piece of
"back door" code, or incorrectly processed certain
transactions over a long period of time? We're not saying
these problems exist, but if they did, then Rakuten could
have a situation similar to Toyota with sticking gas pedals.
As Rakuten rolls out its own software into multiple
acquired firms and j/v's, the risks involved in possible
flaws in the software magnify tremendously, and the company
may not be ready to address multiple law suits in multiple
countries, let alone handle the massive PR fall-out that
would occur on multiple fronts.

2. Hackers
Rakuten handles cash, and profits from doing so, thus
putting more onus on it than some other players to be sure
that its systems are hacker proof. As we've seen with Sony,
the more diverse a company becomes, the more likely it is
that it has weaknesses in the business and security systems
of its international operations. Further, given that
Rakuten is a Japanese company, we're surprised that it
hasn't yet been the target of sustained attacks by Chinese
nationalists looking to "teach the Japanese a lesson". Loss
of user data, planting of viruses, or sustained Denial of
Service attacks are all likely scenarios.

3. Anti-monopoly laws
In some lesser developed countries, such as Indonesia,
Thailand, etc., it is likely that Rakuten's solutions are
sufficiently technologically advanced that over the next 3
years or so the company will kill the competition -- much
as Amazon has killed Borders in the USA. We imagine that
the governments of each country, where business and
government are tightly bound together, will not take such
successes lightly.

4. Taxes
Amazon is fighting interstate sales taxes in the USA and
what is driving this development is the disparity between
tax levels of those various states. Since Rakuten wants to
open up cross-border sales as a major plank in its
expansion strategy -- Indonesian and Thai business
operators are really excited about the opportunity to sell
directly to Japanese shoppers -- then we believe that
taxation differences will surely provoke new legislation as
trade levels increase.

*************

If Mikitani is able to overcome these risks, and given how
the quality of the business model is really starting to
produce some solid profits, then we think that Amazon
should see Rakuten as a major threat in the coming 3-5
years. The M&A strategy that Rakuten is following obviously
is a very compelling one. For the cost of 1% or less of the
purchase price of US$300m (our guess) to finance the
acquisition of Germany's leading online shopping mall,
Rakuten has secured an additional chunk of EUR60m or so in
revenues and EUR15m in net profits (again, our guess). This
is a pretty good value proposition, and a strong reason for
the M&A activity by Rakuten to continue apace.

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+++ NEWS

- Jump in single-person households a social problem
- Unemployment numbers don't include Tohoku
- Shinsei starts path to recovery
- One-time Yankee pitcher Hideki Irabu dies
- Japan Tobacco buys out Sudan tobacco company

-> Jump in single-person households a social problem

A report from last year's census has found that of the
50.9m households in Japan, the number of single-person
residences was 32%, the first time that singles outnumber
those households with couples and children. Apparently
there are no 15.9m people living alone, up 10% over the
last census in 2005. Trends show that by 2030 there will
also be more couples living together without kids, than
those with kids -- not a good omen for the nation's
child-support industries. Another fact to be highlighted
was that of low salaries. In 1997, couples with children
had incomes of JPY5m-JPY6.9m, however, by 2007 the income
range had plummeted to JPY3m-JPY3.9m annually. (Source:
TT commentary from japantimes.co.jp, Jul 31, 2011)

http://search.japantimes.co.jp/mail/ed20110731a1.html

-> Unemployment numbers don't include Tohoku

We wonder if the Ministry of Internal Affairs and
Communications is doing anyone any favors by not publishing
the real total number of unemployed in Japan. The
government put out the seasonal adjusted numbers, showing
that unemployment was up slightly at 2.89m people, or 4.6%
of the population. However, by our reckoning the real
number if it included about 400,000 unemployed in Tohoku,
would be more like 5.3%. There were 59.63m people working
in Japan in May, 2011. (Source: TT commentary from
e.nikkei.com, Jul 29, 2011)

http://e.nikkei.com/e/ac/tnks/Nni20110729D29JF112.htm

-> Shinsei starts path to recovery

Investors in Shinsei bank must be relieved to know that it
seems to be on the path back to recovery, after a
near-death experience relating to its consumer finance
business. The bank said that consolidated net profit for
the first quarter (Apr-Jun) was up 31% over last year, to
JPY18.1bn. A statement said that the improved performance
was due to reduced consumer finance business costs and
gains from foreign shareholdings. (Source: TT commentary
from e.nikkei.com, Jul 28, 2011)

http://e.nikkei.com/e/ac/tnks/Nni20110728D28SS057.htm

-> One-time Yankee pitcher Hideki Irabu dies

We were a bit shocked to hear that Japanese pitching
pioneer in the US Major Leagues, Hideki Irabu, was found
dead at his Los Angeles home aged just 42. Police said
that he had hanged himself. This is a sad end for someone
who followed Nomo in the relatively recent trend of
Japanese baseball stars moving as a free agent to the USA,
in 1997. Irabu had a great start with the Yankees, but
faded quickly and bounced around the Minor Leagues for a
while after that. He is survived by a wife and two
children. (Source: TT commentary from nytimes.com, Jul 29,
2011)

http://nyti.ms/okUV16

-> Japan Tobacco buys out Sudan tobacco company

Facing falling sales at home, Japan Tobacco has long since
embarked on a foreign expansion strategy based on M&A and
cheap funds from Japan. The company has reportedly agreed
to buy for US$450m the Haggar tobacco firm in the newly
established Republic of South Sudan. The price paid was 9.9
times FY2010's earnings -- less than the premium it paid
for the Gallaher Group in the UK back in 2007. ***Ed: The
M&A strategy has been good for Japan Tobacco and the
company expects net income of JPY161bn for FY2010, up
JPY16bn from the year before. (Source: TT commentary from
bloomberg.net, Jul 29, 2011)

http://bloom.bg/prvRkY

NOTE: Broken links
Many online news sources remove their articles after just a
few days of posting them, thus breaking our links -- we
apologize for the inconvenience.

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***------------------------****-------------------------***

+++ CANDIDATE ROUND UP/VACANCIES

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***------------------------****-------------------------***

+++ UPCOMING EVENTS/ANNOUNCEMENTS

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This is an ideal opportunity to find out what is involved,
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-----------------------------------------------------------

***------------------------****-------------------------***

+++ CORRECTIONS/FEEDBACK

In this section we run comments and corrections submitted
by readers. We encourage you to spot our mistakes and
amplify our points, by email, to editors at terrie.com.

*** No feedback or corrections today.

***********************************************************
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+++ ABOUT US

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Written by: Terrie Lloyd (terrie.lloyd at japaninc.com)

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