|52,186 million yen|
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In this article, we would like to sort out the questions and expectations of investors. Hopefully these may help investors when they have a think on the shares. Please refer to other materials for details of the business. The video presentation by President Morimoto is recommended. Also, there are plenty of charts and data in the handout of his briefing session.
It should be easier to understand the company if you keep in mind that there are three major revenue streams. These are Life Science AI, Business Intelligence and Legal Tech. The company calls the former two AI Solution. And it divides Life Science AI into AI diagnosis and drug discovery, and Legal Tech into Legal Tech AI using KIBIT and conventional business to disclose sales in detail.
Fronteo’s stock price has risen nearly six times in three months during early 2020, gaining the impressively high price multiples of bioscience stocks and is highly valued in the stock market. Management’s goal is to achieve sales of 30 billion yen and operating income of 6 billion yen in what they call a Stage 4 by driving AI Solution. However, it is not clear when that is. In FY March 2021, sales were 10.5 billion yen and operating income was 500 million yen. BPS registered 114 yen and ROE marked a nice 9.5%. Currently market capitalization is about 40 billion yen. If the company’s long-term goals are achieved and the stock price is valued at a PER of 20 times at that time, the market capitalization should be a little over 70 billion yen. Stage 3 took 6 years. Assuming that Stage 4 is also six years away, the target will be achieved in the FY March 2027. As a very rough estimate, assuming that PBR will not change and the stock price will only reflect the growth of BPS, the market capitalization will double if ROE is maintained at 11%. If PBR is derated to 5x, ROE must be over 20%. It is felt that there is still a lack of information for institutional investors to anticipate a bright medium- to long-term that gives some degree of confidence to think about a position in their funds. However, the stock of Fronteo does present a possibility of an opportunity to earn attractive investment returns over the long term.
Thoughts on the long term
Recently, President Morimoto has been passionately telling investors that business expansion will progress by converting Fronteo to a company-wide AI business and expanding solution businesses. In a nutshell, the core business will shift from the traditional labor-intensive Legal Tech to the AI business. The results are already visible in the business results.
According to President Morimoto, each of the three businesses in Stage 4 will have sales of 10 billion yen. Life Science will have an OPM margin of 30% and an OP of 3 billion yen, Business Intelligence will have an OP margin of 20% to generate OP of 2 billion yen, and Legal Tech will carry an OP margin of 10% and produce OP of 1 billion yen. In total Fronteo will achieve an OP margin of 20% on sales of 30 billion yen and OP will be 6 billion yen for the entire company. The driver of Life Science business will be medical devices to be covered by national healthcare insurance, which will lead to explosive sales growth. Business Intelligence will see the number of customers double from the current 200 companies to 400, while sales per company will rise threefold. To this end, the company will raise the unit price while increasing the number of products. As well as sales, Legal Tech will see its OP margin increase by bringing the proportion of AI products from the current 19% to 100%.
Based on the company materials, we tried to quantify the long-term market size and the sales of the company. It should actually be a non-linear development as. The numbers are simple productions by multiplying with the growth rate calculated back from the stage 4 goal. At a glance, the market expansion of AI Solution is attractive, growing at an annual rate of 24%, whilst Fronteo needs more than 40% growth in AI Solution to achieve its FY2026 target. Life Science requires a growth rate of 50%. These should be very high hurdles. On the other hand, Legal Tech’s 10 billion yen target looks fairly conservative.
Revenue Simulation for Fronteo
|2015||2016||2017||2018||2019||2020A||2021Co||2022||2023||2024||2025||2026||2027||6YR CAGR %|
|Legal Tech AI||1,170||1,547||2,500|
Market Size Forecast
|(100mn US $)||Sub-segment||Region||2019||2020||2021||2022||2023||2024||2025||2026||2027||6YR CAGR %|
|Business Intelligence||Digital Transformation||Japan||76||86||97||109||123||139||158||178||201||13|
Fronteo Market Share
OP by Segment
|(million yen)||2016||2017||2018||2019||2020||2021 Co|
Sales of AI Solution have increased remarkably since the FY March 2018, accounting for 13% of the sales in FY2020. Operating income posted a surplus rising from the deficit of the previous year, and registered an OP margin of 13%, which proved to be an alarming improvement. Of more importance to investors is the record that the combined sales of the AI Solution and the AI projects utilising KBIT within the Legal Tech segment have increased by more than 40% year-on-year, and commanded 36% of the consolidated sales. We feel it a little strange that the President does not emphasise this index so much in his presentation, as it is considered to be a major factor in considering the stock investment.
Previously, investors felt that Legal Tech, which is the core business of Fronteo, has been sluggish in recent years due to the severe operating environment, and although there may be growth thanks to AI, they thought that overall, the company is fragile and its long-term cannot be viewed optimistically. Their view was that even though Legal Tech will generate profit, no growth opportunity is found. Currently the company is expanding sales of its own AI solution called KIBIT Automator, and the legal business is also a strategy to increase the AI ratio and grow both sales and profit. This is also becoming more evident in business results. By the way, the report of the third-party committee submitted on June 10, 2021 regarding the corporate governance of Toshiba (6502) was made by three lawyers, who adopted Fronteo’s AI analysis method and conducted a forensic surgery of 520,000 emails and 250,000 documents attached to them.
KBIT is an AI developed by Fronteo in its Legal Tech business and was launched in November 2015. Roughly speaking, the business that applies this AI to other fields is the AI Solution, so KBIT can be regarded as the foundation of the company’s AI technology. Life Science AI for medical and drug discovery, and Business Intelligence for financial and manufacturing industries are operated using the AI technologies. The characteristic of the company’s AI is that it specializes in languages. In addition, it requires only a small amount of teacher data and a small amount of computer power and is highly accurate. At Legal Tech, there is a step to process a large amount of documents, and the cost of lawyers is prohibitively high. If one uses KIBIT, one can just teach the document as it is, and KIBIT captures the sequence and characteristics of words and analyzes it with a small amount of teacher data.
Institutional investors have sold their positions following the soaring stock prices since last year, and two large individual investors have sold their stakes in a total of just under 230,000 shares. After that, only a few institutional investors made a few purchases, and institutional investors generally find it difficult to start a position given expensive valuations after the stock price surge. Except insiders, it is presumed that most of the shares are held by individuals. So, for the time being, stock prices are likely to be influenced by short-term news flows. There should be many investors who want to deepen their understanding of the company so that they can buy the shares quickly if the stock price falls in a timely manner or when exciting positive news comes out. It seems that there are few foreign shareholders. According to the Shikiho, the foreign ownership ratio was 12.5% in March 2018, but it was 1.98% as of March 2021. It was 1.2% in March of the last year, and has increased slightly.
The current shareholder composition of the company is 1.2% by institutional investors and 36.4% by insiders, of which 25.1% are individuals including President Morimoto, and of the listed companies, i.e., Focus Systems (4662) and Gakken Holdings (9470). The two listed companies hold a total equity of 10.3% and other than these there are very small holdings of private companies and employee stock ownership. It is estimated that the remaining 62.4% is mostly owned by individuals. The free-float ratio is 63.5%, of which 1.9% is held by institutional equity.
During the six months since the beginning of 2021, the top institutional investors sold their shares, resulting in a 1.2% stake in institutional investors, which exceeded 10% in FY3/2019. One large company sold all the 1.8 million shares and the other significantly reduced its position. Mr. Shiraishi and Mr. Nozaki, who were the top two non-management individual shareholders, sold all the 110,000 and 117,000 shares, respectively. The only institutional buyer after the stock price surge is a Japanese asset management company, which bought 205,000 shares during the last year and currently accounts for less than half of the institutional stake as a 0.52% shareholder. In December 2008, there was a third-party offering of new shares, and Focus Systems (4662) and Gakken Holdings (9470), which had been shareholders for some time, acquired a total of 1.04 million shares at a price of 766 yen. Prior to that, the new shares were issued in September 2014, and the Deutsche Bank London branch acquired 1 million shares for 1,155 yen. The impression is that funding in the stock market was fairly inactive.
Source: Made by Omega Investment from various materials.