Hey everyone, Round 1 (R1) owns a 32% stake in SK Japan (7608). Another way to invest in the growth of anime and crane games is to invest in SK Japan. In this related write-up, I explain why SK Japan is undervalued and ripe for being acquired by Round1:
Amusement revenues (crane games, arcade games, and other) are the largest revenue segment for Round1. Understanding the business economics of crane games and arcade games is imperative to understanding why you should invest in Round1.
Seems like a good chunk of the thesis hinges on the conservative depreciation. How confident are you in the usual lives of the machines. 10+ years seems a long time to not refresh your offering. People won't get bored before then?
Is this maybe why they are depreciating them so fast? Or is there a good reason for that?
Well I'll answer your question with a question. How much technological advancement do you see in crane games? Imo it's going to be rather marginal. Each new version of Sega UFO catcher is a marginal improvement from the previous version. What keeps consumers coming are the prizes, not the crane game machine itself. I.e. new season of Jujutsu Kaizen/Demon slayer comes out and new figurines/plushies are released to crane games.
This is what makes this new crane game trend so much better than video game arcade machines. After 3-5 years ppl can get bored of the latest iteration of Street fighter or a new numbered release comes out, Street fighter 7. But crane games all we need to replace are the prizes. So yes, I do believe 10+ yrs to be the useful life because all they need to replace are worn out parts.
Jan 29·edited Jan 30Liked by Olivier at Emerging Value, Continuous Compounding - Alan
Hey Alan
A very detailed analysis. So what's the upside potential here and where do you see its price in the next 2-3 years when the lease obligations are fully depreciated? Why do you think the debt will remain consistent and not increase as they expand into new markets like North America? How will they finance their expansion ? Do you think the funding will come from within i.e., through organic growth and if that's the case, would it suffice? thanks!
*I have inputted some of my assumptions in my attached financial models so you can check them there as well
1) I will cover the upside in more detail as it pertains to each scenario 1-4. But the very simple answer is when will the company adds on an additional 50-60 stores in US (regular/spo-cha equivalent sales stores, so if they open small amusement stores could take 2-3 stores small stores to reach the profitability of a regular store). Once this happens, their earnings are roughly 200-250 mm USD, at FX 140yen/USD, roughly 28-35 bn operating income, apply a 10x EV/EBIT multiple gets you 300+bn yen valuation, which is roughly double the current EV. So it really depends on the speed of execution here. If they open 10 stores per year could take 5 years, if they open 15 stores per year, could take 3.5 years. If China stores become profitable or they expand to other countries could be even faster. It could also double faster if there is further multiple expansion to say 12x.
2) Just based on S.1 alone, I see the stock trading at around 1000 yen/share in 2/3 years. Range estimate is 800-1200.
3) The answer to this question is in my model. Very non-technical answer. The company has more cash than debt. They can pay it down anytime. But they have consistently kept a debt balance regardless. This could be due to working capital needs. Having cash in US they don't want to move to JP, maybe for tax reasons. Or cash in JP they don't want to convert to US, given how weak the JP yen is relative to USD. So instead they tap into their debt. Debt is definitely not a burden, and they generate so much cash, they can self-finance. If they have so much growth opportunity that cash reserves aren't enough, that is not a bad thing, I don't mind them taking on some leverage if that were the case. In this scenario, needing to tap into debt for growth, the stock would be in a multiple expansion state.
4) So yes, they can definitely grow organically, and they generate enough funds internally to do so, unless they have so much growth opportunity that need to raise debt to capitalize on the opportunity.
*DYODD. Not investment advice. Entertainment purposes only.
Really enjoyed this, and as a dad with 3 young kids, I can see the allure of spending some time in a crane game arcade here in the US.
Couple comments/questions that you may get to in your follow-up article:
1. I follow Jeremy Raper on Twitter, and he has had some interesting comments about investing in Japanese equities. Seems like there is so much potential value to be unlocked through basic corporate governance and shareholder returns. Stock buybacks seem to not be a big part of the culture there, which leads to all these value traps. Have you looked at governance here to have any confidence these guys actually reward shareholders? (Note, Jeremy has also commented that the Japanese govt. seems to have identified this as a focus area for capital market reforms).
2. In America, R1D is going to be dead on arrival. Fine dining combined with a multi-format "food court" feels like a stretch too far. However, this would be a great product in China. Everyone is already eating in malls with zero ambience, so dropping some premium Japanese offerings should do gangbusters in any Tier 1 or Tier 2 city.
3. I also think crane games as more abstract gambling is probably one of the reasons they do so well in Japan and likely would in China. Yes, there's probably some regulatory risk, but at the same time it is a trend I'd expect to grow.
4. Look at the Round1 USA website vs. Dave and Busters or Bowlero. Looks like Round1 ported a Japanese site with way too many buttons and options straight to the US market. They're also still using Spocha, which is a terrible portmanteau. Makes me concerned they don't really get the American market or are too Japanese-focused to really customize their offering like they should.
Looks like there is a Round1 Bowling and Arcade near me. Maybe I should check it out with the kids!
Glad you enjoyed it Allan, please do check out Round1 with your family and let me know what you think. I like a little Peter Lynch/Scuttlebutt kinda market research. What do you like as a parent, what do your kids like about it, and what are things you dislike?
1. I follow JR as well, great investor. I address your concerns in my "Why Round1 is not a value trap" section. For 1, the company has increased dividends. And 2, they have opportunistically bought back shares. They recently maxed out their 10 bn yen share buyback program. We have to wait for the FY2024 annual meeting to see if they will implement another share buyback program. In all my scenarios, you will see that the company will be flooded with cash. The best use of excess cash not for growth capex is to repurchase shares and increase our % of the pie or should I say okonomiyaki.
2. R1D is not a food court, I know the 3D rendering looks a little confusing. It is a location with 7 different restaurants. Each restaurant has 8-10 seats if I recall correctly. And they will do 2 services an evening so serve 16-20 guests per day. An alternative to your idea that would be cool, is if they partner with a fast-food or semi-fast food chain in Japan, and elevate their food/beverage offerings at R1 regular/spo-cha stores.
3. Yeah in Japan the regulation is that the prize has a max value of 1000 yen, which is clearly not the case cuz some prizes are worth 3000 yen and cost 500 yen to play. Crane games have been around for forever, there aren't really any degenerate crane game players, but I can see ppl going on tilt and overspending. This is likely why you can ask for help, and the workers will put the prize in an easy spot to win. Crane games aren't predatory by nature.
4. Well they are adapting. But 46/48 stores are profitable, so their offering is working. Furthermore, they only have 4 spo-cha stores in total. When I first thought of spo-cha offering in US, I thought ppl literally have so many better sports options in the US so its good they limited spo-cha store openings. Spo-cha is for population-dense concrete jungles without many open-air options. i.e Tokyo. I believe they are striking a balance, part of the value prop is the japanese-focused offerings like initial d, street fighter, japanese rhythm games, anime prizes, and etc that really hit the spot for the niche fan. The offerings from Dave and Busters, and Bowlero are identical. I am probably a bit biased here, given that I would take japanese arcade games over American-titled arcade games any day.
Thanks for the input and feedback. Pls get back to me on your visit to R1. And if you've taken your kids to Dave and Busters or Bowlero, pls give me a comparison.
Hey everyone, Round 1 (R1) owns a 32% stake in SK Japan (7608). Another way to invest in the growth of anime and crane games is to invest in SK Japan. In this related write-up, I explain why SK Japan is undervalued and ripe for being acquired by Round1:
https://continuouscompounding.substack.com/p/sk-japan-7608-ultra-quick-pitch
Hey everyone, my follow-up post on the business economics of crane games and arcade games is live: https://continuouscompounding.substack.com/p/round-1-4680-in-depth-analysis-part
Amusement revenues (crane games, arcade games, and other) are the largest revenue segment for Round1. Understanding the business economics of crane games and arcade games is imperative to understanding why you should invest in Round1.
Great write up, thanks!
Seems like a good chunk of the thesis hinges on the conservative depreciation. How confident are you in the usual lives of the machines. 10+ years seems a long time to not refresh your offering. People won't get bored before then?
Is this maybe why they are depreciating them so fast? Or is there a good reason for that?
Your welcome, glad you enjoyed it.
Well I'll answer your question with a question. How much technological advancement do you see in crane games? Imo it's going to be rather marginal. Each new version of Sega UFO catcher is a marginal improvement from the previous version. What keeps consumers coming are the prizes, not the crane game machine itself. I.e. new season of Jujutsu Kaizen/Demon slayer comes out and new figurines/plushies are released to crane games.
This is what makes this new crane game trend so much better than video game arcade machines. After 3-5 years ppl can get bored of the latest iteration of Street fighter or a new numbered release comes out, Street fighter 7. But crane games all we need to replace are the prizes. So yes, I do believe 10+ yrs to be the useful life because all they need to replace are worn out parts.
Hey Alan
A very detailed analysis. So what's the upside potential here and where do you see its price in the next 2-3 years when the lease obligations are fully depreciated? Why do you think the debt will remain consistent and not increase as they expand into new markets like North America? How will they finance their expansion ? Do you think the funding will come from within i.e., through organic growth and if that's the case, would it suffice? thanks!
Hey Mehmood,
*I have inputted some of my assumptions in my attached financial models so you can check them there as well
1) I will cover the upside in more detail as it pertains to each scenario 1-4. But the very simple answer is when will the company adds on an additional 50-60 stores in US (regular/spo-cha equivalent sales stores, so if they open small amusement stores could take 2-3 stores small stores to reach the profitability of a regular store). Once this happens, their earnings are roughly 200-250 mm USD, at FX 140yen/USD, roughly 28-35 bn operating income, apply a 10x EV/EBIT multiple gets you 300+bn yen valuation, which is roughly double the current EV. So it really depends on the speed of execution here. If they open 10 stores per year could take 5 years, if they open 15 stores per year, could take 3.5 years. If China stores become profitable or they expand to other countries could be even faster. It could also double faster if there is further multiple expansion to say 12x.
2) Just based on S.1 alone, I see the stock trading at around 1000 yen/share in 2/3 years. Range estimate is 800-1200.
3) The answer to this question is in my model. Very non-technical answer. The company has more cash than debt. They can pay it down anytime. But they have consistently kept a debt balance regardless. This could be due to working capital needs. Having cash in US they don't want to move to JP, maybe for tax reasons. Or cash in JP they don't want to convert to US, given how weak the JP yen is relative to USD. So instead they tap into their debt. Debt is definitely not a burden, and they generate so much cash, they can self-finance. If they have so much growth opportunity that cash reserves aren't enough, that is not a bad thing, I don't mind them taking on some leverage if that were the case. In this scenario, needing to tap into debt for growth, the stock would be in a multiple expansion state.
4) So yes, they can definitely grow organically, and they generate enough funds internally to do so, unless they have so much growth opportunity that need to raise debt to capitalize on the opportunity.
*DYODD. Not investment advice. Entertainment purposes only.
Nice write-up, enjoyed reading it.
Thank you, glad you liked it. Follow-up write-up with more analysis to come, stay tuned!
Really enjoyed this, and as a dad with 3 young kids, I can see the allure of spending some time in a crane game arcade here in the US.
Couple comments/questions that you may get to in your follow-up article:
1. I follow Jeremy Raper on Twitter, and he has had some interesting comments about investing in Japanese equities. Seems like there is so much potential value to be unlocked through basic corporate governance and shareholder returns. Stock buybacks seem to not be a big part of the culture there, which leads to all these value traps. Have you looked at governance here to have any confidence these guys actually reward shareholders? (Note, Jeremy has also commented that the Japanese govt. seems to have identified this as a focus area for capital market reforms).
2. In America, R1D is going to be dead on arrival. Fine dining combined with a multi-format "food court" feels like a stretch too far. However, this would be a great product in China. Everyone is already eating in malls with zero ambience, so dropping some premium Japanese offerings should do gangbusters in any Tier 1 or Tier 2 city.
3. I also think crane games as more abstract gambling is probably one of the reasons they do so well in Japan and likely would in China. Yes, there's probably some regulatory risk, but at the same time it is a trend I'd expect to grow.
4. Look at the Round1 USA website vs. Dave and Busters or Bowlero. Looks like Round1 ported a Japanese site with way too many buttons and options straight to the US market. They're also still using Spocha, which is a terrible portmanteau. Makes me concerned they don't really get the American market or are too Japanese-focused to really customize their offering like they should.
Looks like there is a Round1 Bowling and Arcade near me. Maybe I should check it out with the kids!
Glad you enjoyed it Allan, please do check out Round1 with your family and let me know what you think. I like a little Peter Lynch/Scuttlebutt kinda market research. What do you like as a parent, what do your kids like about it, and what are things you dislike?
1. I follow JR as well, great investor. I address your concerns in my "Why Round1 is not a value trap" section. For 1, the company has increased dividends. And 2, they have opportunistically bought back shares. They recently maxed out their 10 bn yen share buyback program. We have to wait for the FY2024 annual meeting to see if they will implement another share buyback program. In all my scenarios, you will see that the company will be flooded with cash. The best use of excess cash not for growth capex is to repurchase shares and increase our % of the pie or should I say okonomiyaki.
2. R1D is not a food court, I know the 3D rendering looks a little confusing. It is a location with 7 different restaurants. Each restaurant has 8-10 seats if I recall correctly. And they will do 2 services an evening so serve 16-20 guests per day. An alternative to your idea that would be cool, is if they partner with a fast-food or semi-fast food chain in Japan, and elevate their food/beverage offerings at R1 regular/spo-cha stores.
3. Yeah in Japan the regulation is that the prize has a max value of 1000 yen, which is clearly not the case cuz some prizes are worth 3000 yen and cost 500 yen to play. Crane games have been around for forever, there aren't really any degenerate crane game players, but I can see ppl going on tilt and overspending. This is likely why you can ask for help, and the workers will put the prize in an easy spot to win. Crane games aren't predatory by nature.
4. Well they are adapting. But 46/48 stores are profitable, so their offering is working. Furthermore, they only have 4 spo-cha stores in total. When I first thought of spo-cha offering in US, I thought ppl literally have so many better sports options in the US so its good they limited spo-cha store openings. Spo-cha is for population-dense concrete jungles without many open-air options. i.e Tokyo. I believe they are striking a balance, part of the value prop is the japanese-focused offerings like initial d, street fighter, japanese rhythm games, anime prizes, and etc that really hit the spot for the niche fan. The offerings from Dave and Busters, and Bowlero are identical. I am probably a bit biased here, given that I would take japanese arcade games over American-titled arcade games any day.
Thanks for the input and feedback. Pls get back to me on your visit to R1. And if you've taken your kids to Dave and Busters or Bowlero, pls give me a comparison.