Let’s Meet the “Amazon” of Japan

In this episode of Industry Focus: Tech, Dylan Lewis and Brian Feroldi take on a listener's request and do a deep dive into Rakuten (RKUNY -0.61%). It's one of the major players in the Japanese e-commerce space and has a vast ecosystem. Find out more about its various businesses, its competition, its growth strategy, and why you might put Rakuten on your watchlist.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 6, 2020.

Dylan Lewis: It's Friday, March 6, and we're tackling a listener question. I'm your host, Dylan Lewis, and we are stuck again with the "just OK" Brian Feroldi. You know, Brian, I'm not even the one writing these intros at this point. This is you being self-deprecating.

Brian Feroldi: I mean, it's amazing, isn't it? I think it's good branding right there.

Lewis: I think it's good to be humble. I don't think you need to be that humble, though. Happy to have you on again to talk about a tech company that got thrown our way thanks to a listener review. We're going to get to that in a second. Before that, though, you're doing a kids' stock market challenge, Brian. What's going on over there?

Feroldi: Yes, for listeners that remember, from a couple of months ago, I've been going to my children's elementary school to teach the kids about stocks, and I have kids from second grade to fifth grade picking from a list of stocks and we're, kind of, tracking them throughout the school year to see how they do. And I'm trying to go back in year after year to kind of hammer home the long-term investing.

But I got to tell you, some of these kids are just crushing it. I mean, since September, I have kids that are up 40%, 50%, or even 60% since September. So, absolutely stomping the market. And a big shout-out for Tesla Motors for being the star performer. But the kids are just so excited about this, this is such a cool thing. And I actually have a meeting coming up with the Rhode Island Treasurer's Office to show them what I've been doing and hopefully to spread this system out to other schools in the state. So, spreading Foolishness.

Lewis: Well, I'm glad you're doing that. And that's a heck of a first introduction to investing, being up 40% or 50% in about six months. I hope that you're telling the kids this is not necessarily normal. [laughs]

Feroldi: No, I don't want to bum them out, man, this is what happens every time. [laughs]

Lewis: [laughs] Every time, yeah. Well, I'm sure there are a lot of folks sitting on some nice gains via Tesla. Today, we are going to be talking about Rakuten -- I hope I'm saying that correctly. And the reason we're talking about this company is we had an iTunes review from a listener, Will. Will wrote, "I haven't found a better podcast about investing. The hosts are well-prepared and the analysts give great insights." Thanks, Will. "The people behind the scenes are great as well." Can't forget about them, shout-out to Austin Morgan. "Thanks for all the great work. P.S.: If you guys could talk about Rakuten, it would be much appreciated."

And this is awesome, Brian. We got a review -- we love getting reviews -- and we also love show ideas, and Will gave us both here.

Feroldi: Yeah. And Rakuten is a company that I had never heard about before until this review. So, thank you, Will, for putting this company on our radar.

Lewis: Yeah, this was one of those companies where I was, like, I know that I kind of know that name, but I'm not exactly sure why. And immediately, after I started doing some homework, I understood why. Folks that follow soccer, specifically, FC Barcelona and the Golden State Warriors in the NBA, might be familiar with Rakuten. See that name on the jerseys.

Feroldi: Yeah. Rakuten has become a big sponsor of both of those companies. So they've done a good job with making their name known. And I wonder if that's how Will found out about this company in the first place.

Lewis: Well, as for what they actually do, Rakuten was founded in 1997 by Hiroshi Mikitani, who is still the CEO today. And it's kind of an e-commerce company, it's kind of a financial services company, they're trying to become a mobile company. They do a lot, Brian.

Feroldi: Yeah, this company is referred to as the Amazon of Japan. And they were the No. 1 e-commerce player in their home country of Japan for quite some time, and they're basically the homegrown business-to-business and business-to-consumer online marketplace.

Lewis: And Brian and I are talking about this, having done a lot of research about the company and looking at the financials, their presentations and stuff like that. We do not have the firsthand experience using their products, and so I know we reach listeners around the globe, if there's anyone in Japan or anyone in other parts of the world that's regularly using Rakuten, and we either get something wrong or we don't totally get the story right, write in and let us know: [email protected].

It's one of the perils of covering these international tech stocks, is we don't always have familiarity with the platform, but we did spend a lot of time looking at the business itself. It has been publicly traded since 2000, but U.S. investors buy the stock OTC under the ticker symbol RKUNY. And based on what you look at in terms of YCharts and some of the other approximations out there. It's about a $12 billion company, although it was quite a bit larger a couple years ago.

Feroldi: Yeah, so this is about a $12 billion company. And that number used to be much higher. This stock has actually been cut in half over the last couple of years for some reasons we'll talk about a little later in the show. But I was actually surprised to learn that Rakuten actually has purchased a couple of sites that I've been much more familiar with. So a couple of years ago, they purchased Buy.com which was a leading e-commerce site in the U.S. And they also purchased Ebates, which is a rewards portal in the U.S. and around the world. And they recently rebranded that as just Rakuten. So there is some reason for U.S. investors to be a little bit more familiar with this company.

Lewis: Yeah. And really this was one of the most interesting companies I've had come across my desk in a while. One of the most staggering things with this business is the visual representations of everything they do. So in their investor presentations, they basically give this huge chart of all the different industries that they're currently playing in. They really got started in e-commerce, and that's what they're known for, but they also have card and payment services, banking services, security services, insurance, they're in ads and media, digital content, they're building out a mobile network. There's just a lot going on here.

They wind up breaking their business out, basically, into their core e-commerce company and the operations that are a little bit older and then some of the financial services stuff that they're working on as well that's very digital payments friendly. And then there are more, kind of, future ambition growth stuff, primarily mobile.

But if you look at the Japanese e-commerce market, this is one of the big players. And up until a couple of years ago, it was the No. 1 player in terms of market share.

Feroldi: Yeah, these guys have done a nice job of building out their presence, and they have more than, I think, a billion users, globally, have touched at least one of their services. And the thing that excited me when we were digging into this company was their card and payment network. So this is actually one of the top cards in all of Japan, with more than 19 million cardholders. And they actually have 46 million users of their Rakuten pay network. And we've seen that fintech companies can be wonderful long-term investments for shareholders, because that's just a great model for producing predictable profits and recurring revenue. And their pay business is actually very interesting.

Lewis: As you might imagine with a company this size, for every element of the ecosystem that you participate in, there are some benefits. And so it's no coincidence that they are doing all these different things. I'm right there with you, Brian. I think that the financial services is one of the most compelling parts of it. But it's something where, if you participate with the financial services, you're likely also participating on the e-commerce platform, because you'll probably get a little bit of a discount. They have basically a points-based reward system that they use to incentivize customer behavior.

But it's really easy to look at a business like that and draw the comparison to the Amazons, the MercadoLibres of the world, because on paper, it seems so similar.

Feroldi: Yeah. And they do have a good track record of bringing people into their ecosystem and then getting them to spread out across more than one of their products. And I think the majority of their users actually do interact with at least two of their products, so that does make them somewhat sticky and then does give them opportunities to cross-sell into existing members.

Lewis: So, looking at the books for this company, revenues are up 14% year over year in fiscal 2019. I mentioned before, they break up their business into a couple different categories. You have this internet services segment, which is a little bit more than half of their revenue and a lot of the stuff that you would expect with an e-commerce player. That part of the business is growing at about 17%. You have fintech, and that's about 35% of revenue, growing at 15%. And both of these segments are producing operating income for the company.

Can't say the same with their mobile segment; it actually ate into gross revenue by 10%. And this is a portion of the business that is currently in aggressive growth mode. They are, I guess, trying to continue to build out their ecosystem with a MVNO to offer customers and just keep offering more and more suites and services to them.

Feroldi: Yeah, they're kind of following the Google [Alphabet] playbook, if you will, where they take the profits from their core businesses that are growing and they are plowing them into other businesses to kind of grow them as rapidly as they can. That, thus far, has been costing this company over the last couple of years, because the losses from the mobile division have basically caused their net income to just drop like a rock, which explains why their stock has not performed well over the last couple years. The hope is that those investments pay off in time to much higher revenue growth and eventually higher profitability, but the company isn't there yet.

Lewis: There are some signs that they're able to get that nice, sticky ecosystem that so many companies vie for. You know, 72% of their members have used two or more Rakuten services in the past year. And they look at this total global gross transaction value figure. And it's a combination of e-commerce, credit cards, payments, basically everything that they facilitate. For fiscal 2019, it was about 19 trillion yen or about $170 billion, which is up 24%. And that is an acceleration from the year-over-year growth that they saw in the previous two years.

So there are signs that there is a lot of merit to this approach. It just happens to be a very expensive one right now.

Feroldi: Yeah, digging into the losses and funding those can only happen for so long. But the CEO here definitely has a vision to make Rakuten a much bigger company and is clearly willing to invest like [...] to make it happen.

Lewis: One of the other things that you have to talk about with this business is they have kind of core operational businesses and then they also have an investment arm that owns stakes in other businesses. And so, they have investments in Pinterest. I know it's a Brian Feroldi favorite right there. Lyft. And they have some smaller stakes in internet, fintech, ridesharing and healthcare companies.

That does give me a little bit of a reason for pause, just because we have seen a lot of companies that have a take in this approach, struggle with these start-ups ultimately going public and not faring quite as well in terms of their valuation once they're on the public markets.

Feroldi: Yeah, it could be a hit or miss when you see companies like this taking shareholder money and making investments on their behalf. If it's for a strategic reason, that is something that I am generally all for. Like, for example, if they took an equity investment in Pinterest in order to help promote their own platform in the United States or elsewhere, that, to me, makes a lot of sense, but just taking the money sheerly to invest on behalf of shareholders isn't a perfect strategy, but they've done fairly well with it so far. And I know that the Pinterest investment, in particular, has paid off well for them. So that is something that investors have to be aware of if they're going to be interested in this company.

Lewis: Yeah, I think one of the biggest risks with this business is just that they're trying to do a lot. You know, you have that huge [laughs] chart that I mentioned before, with all the different segments that they participate in, and on top of that, they're also trying to be, kind of, like a venture fund for some of these smaller businesses and make money that way as well.

I think that's all good and well, but the reality is, at core, people know this for e-commerce; and I think part of the strength of all the other services comes with the e-commerce introduction. And I worry that Amazon's coming in. And there was a while where Rakuten was beating Amazon, it seems that Amazon has eclipsed them in terms of market share and has become the No. 1 e-commerce player in Japan. I do wonder how that will affect their ecosystem long term.

Feroldi: Yeah, I completely agree with your thoughts there. To me, there is the thought that this company is just spreading itself out way too thin, given its resources. I would way rather prefer them to just hyper-focus on, say, e-commerce or fintech within their own market and just throw all the resources behind there. I mean, you mentioned at the top of the show that this company has signed multiyear deals with FC Barcelona and the Golden State Warriors. Those deals were very expensive. I mean, the Barcelona deal cost them $220 million. The Golden State Warriors deal cost them $60 million. Is that money that's well spent to really boost their brand name? I don't know. But that does show me that this company might be a little bit too reckless with its investment. So it's not terribly surprising to see that the stock has not performed well for investors over the last couple of years.

Lewis: Yeah. I think when you start spreading out your investments and trying to do all these things and then also do flashy brand advertising and that kind of stuff, you may neglect some of the things that you need to do to really compete actively. And, I think, where Amazon has been able to get a leg up in Japan is by focusing on delivery, the supply chain, and really all the infrastructure things that get packages to people faster.

I know as of 2019, Rakuten wasn't owning and operating quite in the same way that Amazon was, and so they weren't really able to compete and deliver packages quite as quickly as Amazon, which very quickly can become a competitive disadvantage.

Feroldi: Yeah. And we have seen Rakuten invest in its own fulfillment services in its home country, but we do know that building out those logistic networks is [laughs] incredibly, incredibly expensive. Rakuten is making those investments now, and it has been for the last couple of years. Will those investments pay off for shareholders in time, or is it basically they're already behind Amazon and they're unable to recapture their market share that they've lost? That's something that we don't have the answer to at this point.

Lewis: Yeah. And I think what's tough is this is a company that is very interesting. There's a lot of really cool stuff going on, particularly with the financial services side of what they're doing. I think the insurance side is also kind of interesting, just because you don't see as many publicly traded companies trying to disrupt that space in quite the same way. And there's a lot of stuff that gets you excited as an investor. I do think that the risks are a little too high, especially given the struggling stock over the last couple of years, for me to really consider it too seriously.

Feroldi: Yeah, I'm right there with you. I mean, I do really like the fintech aspect of this company here. And if I had a say, I would just say, just dump everything else and just throw all of your resources into the fintech, because that is an exciting, very profitable business, but this company clearly has a different strategy in mind. But there are definitely some positive things that this company has going for it.

But as you said, I think the threat of Amazon just cannot be ignored, and I think that they're spending their money, kind of, a little bit too aggressively for my own liking, and they're just throwing it around. This company doesn't have nearly the focus and the track record of just unbelievable success for me to get super excited about it. So I think this is an interesting company but not one that I'm personally going to rush out to buy.

Lewis: Yeah, sometimes it's OK to look at a stock and say, "This seems a little hard. What they're trying to do seems a little difficult. And I can watch that from the sidelines and enjoy it without having to have my own money on the line." That's kind of how I'm looking at them.

Feroldi: Yeah, same here. I mean, after doing the research here, I put this, basically, in my "why bother" pile. You and Danny Vena did a great show, last week, on another foreign e-commerce company called MercadoLibre, and that company is just crushing it across the board. They also trade on the U.S. exchanges. So if I was interested in a foreign e-commerce company, MercadoLibre would be a company that would be far more interesting than Rakuten.

Lewis: Well, thank you for the praise there, Brian. I think MercadoLibre does benefit from some competitive advantages that Rakuten is kind of struggling with. They are local in South America, they are in a highly fragmented space where they're in, I think, 18 countries, many of them report in their own currencies. That creates problems for them from an operating basis, but it also means that it's harder for someone to swoop in and immediately steal a lot of their business at once.

I think that because Rakuten is so reliant on Japan, and it's a pretty developed country in terms of its infrastructure and supply chain logistics and all these kinds of things, it's been a little bit easier for Amazon to hop in there and disrupt their business.

Feroldi: Yeah, I think that's exactly right. So for me, whenever I'm looking at any potential stock, I always rank it against every other stock that I want to own or already invest. And for me personally, Rakuten checks many of the boxes that I look for, but not enough for it to crack into, say, my top hundred ideas.

Lewis: [laughs] Well, Brian, I'm always happy to talk about stock ideas with you, even if it doesn't crack the top 100.

Feroldi: Hey, they can't all be winners, right?

Lewis: And I appreciate Will writing in to the show. I mean, this is just our opinion, but wanted to give a shout-out there and thank Will for putting this one on our radar.

Brian, I think I'm going to let you go there, man. Thanks for hopping on today's show.

Feroldi: Hey, anytime. And thank you to Will for bringing this company to our attention. Don't let us talk you out of it if you're interested in it.

Lewis: Alright, listeners, that's going to do it for this episode of Industry Focus. If you have any questions or you want to reach out and say, "Hey!" shoot us an email over at [email protected] or tweet us @MFIndustryFocus.

If you're looking for more stuff, subscribe on iTunes or wherever you get your podcasts.

As always, people on the program may own companies discussed on the show, The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear.

Thanks to Austin Morgan for all his work behind the glass today. For Brian Feroldi, I'm Dylan Lewis. Thanks for listening, and Fool on!