IIJ hits high on earnings beat, has much upside


Internet Initiative Japan (IIJI) (JP: 3774) is not a household name in the U.S., but it has carved out a niche in Japan in internet connectivity and related system services and outsourcing (essentially it is a high-tech ISP catering to businesses and government with growing potential in cloud computing and mobile access). Overnight in Tokyo it reported better-than-expected full-year earnings, forecast top and bottom-line growth in the current fiscal year ending next March (albeit on the soft/conservative side), hiked its dividend for the fiscal-year ended in March by 11% and is targeting an 11% hike for the current year’s dividend. IIJ surged in the afternoon session in Tokyo following its earnings release, reaching limit-up at ¥259,300 (ADR equivalent of $7.00) and closing at ¥245,000 ($6.61), compared its Nasdaq close $5.68 on Thursday. This is all good news, but it will likely get even better, much better, because IT investments in Japan have been largely held back, and IIJ’s board can take more of an initiative to enhance shareholder value, something for which I hope to be a catalyst.

Since so much attention is placed on the P/E ratio, know that while having been ostensibly pricey (prior to its earnings release), IIJ is actually now trading at 22x trailing earnings and 19x forward earnings, but prior to its release last night, it was trading at around 30x ttm. Thus, for illustrative purposes, at 30x ttm it would trade at ¥330,900 ($8.93) and at 30x f/pe/ it would trade at ¥385,110 ($10.40), which respectively represents 35% and 57% upside. Those prices would certainly get IIJ closer to fair value, but I think it would still be attractively undervalued for reasons including:

  • Revenues are constrained by tight corporate/govt. IT budgets, but investments can be delayed for only so long.
  • Net income is misleading and effectively understated due to depreciation from capex; cash flows are solid, and should capex be reined in a bit, earnings would improve markedly.
  • Its ATM business will reportedly breakeven in the second half of this fiscal year; thus far its been a drag in terms of costs and since it hasn’t generated meaningful revenues.

In late February, I submitted a shareholder letter and proposals to IIJ’s board of directors. Subsequently, I have revised my proposals and re-submitted them by way of the Bank of New York Mellon, with a co-sponsor whom holds a sizable position in IIJ which rivals insiders’ holdings (excluding Chairman Suzuki). We are waiting to hear whether our proposals will be adopted or will be included for shareholder resolution at the annual meeting in June. Nevertheless, there are some positive takeaways from the earnings release that related to our proposals, in addition, of course, to leaving real opportunity to boost shareholder value:

  • We are not pleased that IIJ ventured outside of its core net connectivity and services business to launch an ATM business. Nevertheless, we requested an update on its and financial guidance, as well as the shareholder right to vote on any subsequent non-core investments exceeding ¥1 billion. We are awaiting notice of the latter, but in terms of guidance, the good news is as mentioned above, the ATM business is expected to breakeven after accumulated losses of more than ¥1 billion.
  • In terms of enhancing shareholder value, the board can easily provide a jolt to IIJ’s stock by splitting its ordinary shares and reverse splitting its ADRs. This would provide both individual and institutional investors with greater liquidity in Tokyo and allow institutional investors to consider its ADRs on the Nasdaq. See my original proposals hyperlinked above for details.
  • While IIJ hiked its dividend by 11% and is targeting another 11% hike, which is certainly better than some non-dividend paying cash hoarding tech stocks that will remain nameless, it continues to hold an excessive amount of cash and investments on its balance sheet ($100M+ or about 20% of its market cap). Not only is it excessive, but it is low-yielding given rates in Japan and subject to mis-investment by management. Therefore, while the dividend hike is welcomed, it is not enough, and we have proposed further stock repurchases, given our belief that it is undervalued and also consideration of a special dividend.

Unfortunately for IIJ shareholders and those considering the company, until a stock split is implemented, trading liquidity will likely remain tight. Volume did surge overnight, which is promising, but it is not anywhere as actively traded as it should be. That being said, its ADRs often trade at a significant discount to its ordinary shares. This offers potential for arbitrage, of course, but at a cost and necessitates execution of timing, but it more importantly means that long-term, patient investors can buy at an even greater margin of safety. Finally, if the stock is split/reverse-split, then there should be a convergence, rewarding ADR holders.

Disclosure: The author owns shares of IIJI.