Investment Idea #32 - JPX (Part 2)
“If the monopolists pretend not to have monopolies & the non-monopolists pretend to have monopolies, the apparent difference is very small” - Peter Thiel.
This post is a continuation for the Part 1 on Japan Exchange Group (JPX, 8697 JP), our the latest activist investment idea as JPX is activists’ biggest cheerleader in Japan. JPX benefits from an additional tailwind - Nikkei has exceed 50,000 but JPX’ stock price has not moved much.
✳️ In Part 1, we discussed the Background and Business of JPX and started on the Fundamentals. Here’s a quick recap:
JPX was formed via the merger of Tokyo and Osaka Exchanges in 2013 and it subsequently acquired the Tokyo Commodity Exchange (TOCOM) in 2019. It is 3rd largest stock exchange globally, hosting >USD6trn market cap of Japanese stocks but ranked 8-12th largest in terms of market cap.
As Japan’s primary trading venue, it is market participants’ de-facto choice to trade Japanese stocks and to use its product and services such as clearing and settlement. JPX also provides index and data services.
JPX’s main cost buckets are i) system maintenance & operation and its depreciation, ii) personnel expenses. With its simple cost structure, JPX has solid margins, ROEs and robust free cashflow generation.
Activism in Japan will continue to create shareholder value as activists are holding Japanese management accountable, pushing for better shareholder returns and elevating share prices above book values.
JPX, the biggest cheerleader for activists, needs to hold itself to higher standards. Therefore, share price should not under-perform the index.
Top management has been drafted from the luminaries of Japan Inc - Andy Saito, Akira Kiyota and currently CEO Hiromi Yamaji. We have more on this later. Current CEO is working hard to improve Japanese companies.
Employees mostly ex-government elites. Staff quality is therefore inherently high and are diligent and capable.
We will be following through with the usual initiation format as shown below. We have covered the first two in the previous post:
1. Background and Business
2. Investment Thesis
3. Moats
4. Positives
5. Management
6. Risks
7. Technicals
8. ValuationsMoats
Let’s start with a quick commentary on JPX’s moat. At the risk of stating the obvious, exchanges are monopolies and their business moats are incredibly strong.
First, exchanges are regulated, so you and I couldn’t just open one, and even if we do, who would want to trade on 8percent Exchange? As monopolies, they surely have a lot of pricing power on listing fees, trading and clearing fees. But it seemed that JPX has not been utilising its pricing power. More on this later.
For JPX specifically, if you want to buy Japanese stocks, there isn’t really many other choices. There are some ADRs some dual-exchange listed Japanese socks, but the liquidity is the highest on the Tokyo or Osaka stock exchanges.
✳️ Furthermore, if you want to buy cheap activist stocks, you can only do so on JPX.
Let’s go into the positives.
Positives
JPX stands to benefit from several structural tailwinds that could keep driving share price north. We shall discuss them below:
As discussed, shareholder activism is the big wave lifting all boats. The slide below shows the close coordination between FSA and JPX continues to encourage shareholder activism in Japan. This improves capital efficiency and raises the appeal of Japanese equities to both domestic and global investors.
To grow revenue further, JPX has plans to launch many new products – Interest Rate Derivatives, FX futures (USD/JPY, EUR/JPY, CNH/JPY) FX derivatives and more tradeable single stock options. This would also drive business growth in OTC and clearing services.
JPX has managed to grow at single digit CAGR over the past decade (this is a good thing because revenue rarely grow in Japan, land of declining population and declining revenue). Over time, revenue has also grown across all sub-segments as shown in the red boxes below. But there should be more upside. Case in point: JPX’s revenue is almost as big as SGX’s, which is unthinkable because Japanese economy is at least 10x bigger than Singapore’s and population is c.20x bigger.
While revenue grew, expenses has kept up (orange box above), but over time, JPX should continue to reap operating leverage even though it already has high margins, which is slightly better than its peer group average.
Lastly, Nippon Individual Savings Account or NISA, a government-backed initiative designed shift Japanese households’ cash savings into financial assets has been a driving force for the Japanese market. NISA investments, which was negligible just three years ago, currently accounts for c.JPY40trn vs Japan’s market cap at c.JPY900trn. There is still much room to grow. The following excerpt from A.I. gives the background of NISA and how it has become very successful over the last few years.
Japan’s NISA (Nippon Individual Savings Account) program, modeled after UK's Individual Savings Account (ISA), is a tax-advantaged investment account designed to encourage Japanese residents to shift their assets from low-yield cash into the stock market.
The program was significantly revamped in January 2024 to make it more appealing and effective in achieving its goal of promoting a “savings-to-investment” culture.
The core feature of NISA is that it makes investment gains tax-free within certain limits, which is a significant incentive given that profits from standard investment accounts are typically taxed at about 20%.
By encouraging millions of new and existing retail investors to allocate more funds annually (up to 3.6 million JPY per person) to stocks and funds, NISA provides a steady, structural, and substantial flow of demand for market-listed assetsManagement
JPX was helmed by Atsushi “Andy” Saito from 2013 to 2015. He was an ex-Nomura banker and after his stint at JPX, he went on to become the Chairman of KKR Japan and led the private equity firm to become the deal powerhouse it is now in Japan. Mr Saito laid the foundation for JPX to grow under his successor Akira Kiyota from Daiwa. Mr Kiyota then trailblazed JPX’s corporate governance focus and growth in ETF offerings.
https://www.jpx.co.jp/english/corporate/news/press-conference/b5b4pj000000n3ug-att/20150710_en.pdf
The pdf above has the details of the successes of Mr Saito and Mr Kiyota in those early days. Mr Kiyota led JPX to greater heights by driving new business in derivatives trading and the merger of Tokyo Commodity Exchange (TOCOM). While he also tried to expand overseas, the end result was that focusing on Japan bore better fruits. He retired in 2023 and passed the reins to Mr Hiromi Yamaji.
Mr Yamaji ruffled a lot of feathers in Japan by pushing corporate governance reform and siding with activists to “improve” Japanese companies. He is the key driving force behind JPX’s goal to lift the 40% of Japanese companies still trading at <1x PBR to trade above their book values.
Mr Yamaji recognized that activists are simply capitalists looking to unlock value. When activists target some company trading below book, it is for the betterment of all shareholders and employees that their firm is worth more. However, just like anyone who wouldn’t want a stranger to tell him or her to lose weight or stop smoking, Japanese companies hate it when outsiders / foreigners tell them they shouldn’t keep cash or they should divest their non-core business or improve their board and corporate governance.
JPX, under Mr Yamaji, is trying to play the role of the non-outsider, as the stock exchange, to advise its listing companies to improve. The best defense against activist is a high stock price. Activists will not target expensive companies.
The best defense against activists is to optimize the firm's balance sheet, improve earnings power and ROE, thereby commanding a valuation premium in the stock market. That said, as we can imagine, it is not easy. Various activist case studies in the past showed how companies will try all ways and means to thwart activists’ efforts. Sometimes the corporates prevail, and other times, the activist wins. Owning JPX is one neutral way to ride the activist megatrend in Japan.
Levers
Next, we discuss what levers JPX’s management can pull to grow faster.
