GMO Internet Inc

TSE:9449

Earnings Call Analysis

GMO Discusses Decline in Profits and Strategic Initiatives

GMO highlighted a decline in profits compared to V-shaped recovery trends, with a reduction in media gross profit not offset by cost-cutting. In Internet Finance, profit measures strengthened last year, led to year-on-year gains, but recorded weaker performance against the prior quarter, impacted by forex changes. The company booked a JPY 500 million gain due to a reversal of allowances for doubtful accounts. Forex sales dipped with lower volatility, while commodity trading volumes were sluggish. Cryptoassets business faced a shrinking transaction volume but improved year-over-year losses. Strategic initiatives include leading cybersecurity efforts and becoming a top AI corporate group, aiming for superior security solutions and AI industry infrastructure services.

Strategic Focus on Technology Development and Talent Expansion

The company displays a solid commitment to advancing its proprietary technology to maintain leadership in the dynamic Internet industry. Their emphasis on being a 'manufacturing' firm that innovates and operates its own products underpins their strong position. Guided by this philosophy, they have nearly reached their goal of having a workforce comprised of 50% engineers and creators, a target set back in 2011 that has seen significant progress from 37.1% in 2014 to 49.8% now, indicating a robust investment in human capital to fuel innovation.

Balanced Business Growth Tempered by Market Challenges

The company’s quarterly sales suggest a healthy expansion across diverse sectors while aiming to sustain its status as a leading service provider. An 11% growth rate this quarter, even with a modest downward trend, illustrates resilience. Particularly noteworthy is the GMO Sign business, thriving amidst network effects and enlarged customer bases, including major financial institutions. However, challenges in the advertising domain and foreign exchange markets reflect an environment of fluctuating demand and market volatility, stressing the need for strategic adaptability.

Cutting-Edge Cybersecurity Initiatives

Upholding the slogan 'Safe and secure Internet for everyone,' the company is intensifying efforts in cybersecurity. They boast a strong trifecta: encryption security, a formidable White Hacker team, and brand security expertise. Remarkable achievements include winning a prominent security contest and receiving government recognitions, which underscores their preeminent position in the cybersecurity landscape. Innovations like the [Net de Diagnosis] SaaS product reveal a proactive stance in anticipating and addressing cyber threats.

Embracing the AI Revolution

With strategic foresight, the company is steering towards becoming a premier AI-centric enterprise. They are rolling out new AI-based services and integrating AI to enhance current offerings. Two standout developments are 'Oshiete AI', a generative AI prompt portal, and the GPU-powered cloud service 'ConoHa VPS'. The engagement of AI luminary, Professor Yutaka Matsuo, as an advisor, signifies a robust commitment to leading the AI transformation.

Commitment to Sustainability and Long-Term Value Creation

Reflecting a deep-embedded ethos of 'Internet for everyone,' the company not only provides essential Internet services but also aligns its business strategy with sustainability. By identifying six key materialities that represent both stakeholder interests and corporate ethos, they are dedicated to solving social issues through innovating #1 services and taking accountability for a secure, sustainable digital society. As such, they reaffirm their role as a corporate steward focused on making lasting, positive impacts.

Earnings Call Transcript 2023-Q3

[Operator]

Hello, everyone. Thank you for joining the GMO Internet Group's Fiscal 2023 Third Quarter Results Presentation. Let me introduce the speakers for today. Group Executive Vice President and Group CFO; Masashi Yasuda, and Group Executive Officer, General Manager of Group Financial Department, Noriko Inagaki, the outline of the results will be explained followed by Q&A session.

You will be able to find the financial results presentation material on our website. We would appreciate very much if you could respond to the survey through the link that will appear on the screen after the results briefing. I ask for your cooperation.

Now Mr. Yasuda, Executive Vice President, will explain.

[Masashi Yasuda, executive]

Hello. I am Yasuda, CFO of GMO Internet Group. Thank you very much for attending GMO Internet Group's third quarter results presentation for the fiscal year ending in December 2023. Our fiscal year ends in December. Thus, I will be explaining about the results for July to September period.

These are the agenda for today. This is the executive summary. As you can see, if we compare year-on-year, we have increased in both sales and profits. Net profit was negative last year as there was an extraordinary loss related to stocks of an affiliated company. As such, we saw a big increase in net profits this year. This is the executive summary by segment. On the right side, we have qualitative evaluations by the management for Q3, along with Q2. Infrastructure is a double circle with an increase in both sales and profits. Each of the business is growing in a balanced manner, leveraging the strength we have, which is a collection of overwhelming #1 services.

Online ad media business is x. Both sales and profits decreased. While in-house media sales remained strong, ad agency sales declined due to a reactionary drop in some industries and customers' budget downsizing. In addition, the decline in gross profit was not compensated for by cost containment. Although profits are expected to decrease in the current fiscal year, a reversal from the reshaped recovery that have been underway until last year. The company will promote measures to achieve renewed growth in the next fiscal year and beyond.

Internet finance is a circle, both sales and profits increased. FX is a circle. Although the market environment was difficult to generate earnings due to the one directional depreciation of the Japanese Yen, the effect of measures to improve earnings since Q4 of the previous year has been realized. CFD is a circle. Trading volume was negative compared to the previous year when commodity-related activity was brisk. But sales remained strong, and it has become the second mainstay product after FX. Overseas is a triangle. There was a gain of approximately JPY 500 million on a reversal of allowance for data accounts in the securities business in Thailand. The company will continue to collect nonperforming loans and also reduce the balance of credit transactions themselves.

Cryptoassets business is a triangle. Sales increased. Profits decreased. In the exchange business developed by GMO Coin, the number of accounts has remained steady. On the other hand, although the environment is showing signs of reversals such as a rise in the bitcoin price, trading volume remained low in the industry in general.

Despite such conditions prevailing, we have not changed our view that crypto assets is an area with potential. We will continue to make efforts to build a structure to be able to generate profits when the timing comes.

This is year-on-year change of sales and profits by segment. Sales are on the left. Profits are on the right side. Although online ad media remained weak, sales and profits were accumulated in infrastructure and Internet and finance, resulting in a consolidated sales increase of JPY 4.9 billion and profit increase of JPY 2.3 billion.

This page shows cumulative figures for January to September. Year-on-year, it is increased in sales but decreased in profits. Main causes for pushing down profits. Our profit contribution in incubation business last year and a special factor, which I explained in the previous fiscal -- previous results briefing.

This is about shareholder returns. The basic policy is total return ratio of 50%. The breakdown would be dividends of 33% or more, remaining 17% for share buyback and cancellations. This is a change in dividends per share. We are not disclosing performance forecast nor the dividends forecast this year again. Therefore, we will be announcing the dividends amount on a quarterly basis.

In the same period last fiscal year, we did not pay dividends due to net loss in the quarter. But this year in Q3, dividends will be JPY 10.2. Last of all, I would like to report on share buyback. As you can see, we have completed buyback already.

Before going into the details of the business performance, I'd like to reiterate our group's strengths. There are 2 major ones. The first is our commitment to operations and development of our own technology. In order to stay a winner in the fast-changing Internet industry, we are committed to providing #1 services. To maintain this, we believe that we must be a manufacturing company that creates and operates its own products. The key would be people engaged in creation such as engineers, creators and directors. As of the end of September, a number of partners stood at close to 7,400 who are employees.

Out of this, people who are engaged in monozukuri or who are engineers and creators were 49.8%. The target ratio of workforce are engineers and creators was set in 2011. The target back then was 50%. And the actual ratio was first presented to investors in February 2014. The ratio was 37.1% back then.

We raised the target to 60% this February because our target of 50% is now in sight. The age of the Internet is the age of sensibility. We will increase the number of great creators and continue to grow as a manufacturing company in order to be known as GMO of UI, UX and creatives.

And the second strength, which is a GMO term is the group's earnings model called solid recurring revenues. We believe we have been continuing to increase sales and profits for the past 14 years steadily is because of accumulation of solid recurring revenue since the founding of the business. We believe solid recurring revenue is based on indispensable and recurring revenue products as long as the Internet continues to exist. This is consolidated sales trends. As you can see, we have continued sustainable growth since the company has been established. This is a breakdown of sales into solid recurring revenue and others. The red line shows the ratio of solid recurring revenue out of the consolidated sales.

Solid recurring revenue includes recurring revenue type of infrastructure business and transaction-type revenue, which is more like recurring billings. As you can see, solid recurring revenue is what supports our sustained growth.

This is a breakdown of solid recurring revenue into unit price and number of contracts. Both the unit price and number of contracts are continuing to grow. Last year's solid recurring revenue of JPY 130.1 billion is generated from annual unit price of around [ JPY 10,000 times ] around 13 million contracts.

As for the number of contracts, we are receiving around 10,000 applications every day. We expect this to continue to grow with the increase in information volume and transactions on the Internet. This slide shows the number of Internet infrastructure contracts. It can be rephrased as solid revenue base that supports our solid recurring revenue. The number of contracts as of the end of September was $14.92 million. The pace of increase is not constant since there are changes in product mix but it has been growing at around 810,000 contracts a year when we look at the trend based on year-end numbers.

Considering the upward trend in the unit price, the unit price is slightly more than JPY 10,000. And when multiplied by this figure, incremental annual sales are expected approximately JPY 10 billion.

From the next part, the group overview, Ms. Inagaki, Group Executive Officer, General Manager of Group Financial Department will be explaining.

[Noriko Inagaki, executive]

Hello, everyone. I am Inagaki, GMO Internet Group Executive Officer and General Manager of Financial Department. I will explain the group overview. This is a bird's eye view of the business areas. The size of each area represents the sales composition. We have 14.92 million infrastructure contracts for our recurring revenue base, which has been explained by CFO Yasuda earlier. If we add a number of accounts for FX securities and crypto assets accounts, we'll have 17.5 million customer base.

This is the market cap of 10 listed companies in the group and our equity share. The total market cap of the group exceeds JPY 1 trillion, and our equity share is over JPY 300 billion.

This is quarterly sales by segment. Although there has been a change in the rules about posting of sales in the same period last year, the growth trend shown in dark blue led by internet infrastructure is continuing its growth trend shown at the bottom. This is a slide in profit by segment.

There are no changes in our view at all of continuing growth based on solid recurring revenue from infra and sustainable growth of highly profitable financial business. This is about infrastructure.

This is our infrastructure business. We have domain hosting and cloud e-commerce platform, SSL security, e-signature, cybersecurity, settlement, access, which are all a collection of #1 services that are essential and indispensable for the Internet society.

This slide shows quarterly sales and the breakdown. Each business is growing in a well-balanced way, taking advantage that we are a collection of overwhelming #1 services. We have a strong growth rate of 11% plus for this quarter as well. However, there is a slight downward trend starting from the last quarter. But it is not that there are any changes in the trend. Rather, this is because there was a large contribution from a major project in face-to-face settlement area run by GMO Financial Gate shown in blue.

This is a quarterly operating profit trend. Each business grew well in a balanced manner to achieve year-on-year growth rate. Now I'd like to report about the progress of our strategic business, GMO Sign, a crypto asset crypto security business rolled out collectively as a group. We are #1 in terms of not only the number of contracts, but also in terms of the number of contracts sent.

First, here is the status of the number of contracted companies. Even after the Farewell Seal campaign launched as a group collectively during COVID-19 in May of 2020, network effect and expansion of customer base, thanks to group synergy is continuing. Most recently, 2 mega banks have introduced GMO Sign, followed by other large enterprises shown here. This implies that we are still in the market expansion phase.

This is the number of contracts sent. Number of contracts sent is the most important KPI as it shows the level of activities of the customers. We are expanding sales to real estate companies whose activity levels are high, which is leading to sales increase.

Now, the digital government initiative. We are promoting the introduction of GMO Sign electronic delivery by utilizing the strength of our enhancing certification authority. We have already been selected by 65 local governments to be the #1 local government IT solution provider. A result we aim to achieve the third crown along with #1 in the number of e-contract accounts and number of contracts that will lead us to further growth.

Next is online Advertising & Media. This is a trend of quarterly sales and its breakdown. The dark blue Media performed well, especially in affiliate advertising due to an increase in the number of owned media PBs. On the other hand, light blue, online advertising is experiencing a change in trends related to advertising demand.

While some advertisers have seen an increase in demand as a result of the easing of restrictions on activities due to COVID, others have seen a decrease in budget in previously booming industries due to the demand for [indiscernible]. These changes in the business environment have had a significant impact on the advertising budgets and its decrease. In addition, unit price declines in ad network advertising resulted in a slower trend.

The chart shows the quarterly operating profit trends as with sales in-house media also performed well but we were not able to compensate for the decline in gross profit from advertising agency by cost reduction. Although profits are expected to decline this fiscal year, a reversal from the V-shaped recovery trends seen until last year.

GMO ad partners is moving forward with measures aimed at renewed growth in the next fiscal year. Now over to Internet Finance. The chart shows the quarterly performance trends. Both sales and profit increased on a year-on-year basis due to the continued effects of profit improvement measures that have been strengthened since the end of last year. On the other hand, both sales and profits were sluggish versus the previous quarter due to the weakening of the yen and lower volatility in the exchange rate.

As for profits, there was a reversal of the provision of allowance for doubtful accounts in the securities business in Thailand since the fourth quarter of the previous year, resulting in a gain of about JPY 500 million in the quarter under review.

The page shows the net sales by product. Sales of dark blue FX declined due to lower volatility in Forex as the Yen weakened recently. In addition, CFDs shown in light blue remained strong as the mainstay products, although trading volume in commodity-related indices was sluggish. We will continue to actively cross-sell our expertise in derivatives trading, which is one of our strengths to our other companies.

This chart shows the relationship between sales and trading volume in the FX business. The one way depreciation of the Yen during the quarter increased trading volume, but profitability also declined due to lower volatility, resulting in lower revenues versus the previous quarter. However, profitability is on the road to recovery on a year-over-year basis, thanks to measures to improve profitability that have been strengthened since the end of last year.

Now over to Cryptoassets. Cryptoassets has 3 businesses as shown: mining, exchange and payment. Quarterly sales trend and its breakdown. The exchange business was a weak market and sales will commensurate with that market. Meanwhile, the number of GMO Coin accounts is growing steadily despite the ongoing headwinds in the global crypto asset market.

Now this shows the quarterly operating profit. Although the losses continue to be recorded, the loss amount decreased year-over-year. Transaction volume itself continues to shrink, making it difficult to generate revenue. Under these circumstances, we are also controlling costs and working to minimize losses as much as possible.

Although the market environment is showing signs of reversal, including the rise in the Bitcoin prices, GMO will continue to work on the internal initiatives in a nonchalant manner, so to build a scheme an organization that can generate profits when the market becomes active again. That is all for the business performance.

CFO Yasuda will be the presenter of the topics.

[Masashi Yasuda, executive]

Today, I would like to share 3 important topics for the company. First, we will discuss initiatives in the security domain. Safe and secure Internet for everyone is a slogan for the Security business. On a number of occasions, we have been sharing our view on cyber attacks as a serious social issue and management risk. Recently, media has been reporting increasingly on the moves by domestic and foreign governments and organizations to strengthen measures against cyber attacks. This is why our group has adopted this slogan to meet the ever accelerating need for security.

Let us introduce the 3 areas of our security business once again. First, encryption security such as SSL using authentication technology. Cybersecurity by Japan's strongest White Hacker group. And then there is Brand security by domain and trademark professionals.

This time, we would like to introduce you to Japan's most powerful group of White Hackers who joined our group last January, an update of the activities by GMO Cybersecurity by IERAE. First, an example of a cybersecurity implementation. The greatest strength of GMO cybersecurity by IERAE is its technological capabilities.

As you can see, our vulnerability assessment conducted by White Hackers with an attacker's perspective are used by companies in a wide range of industries and sectors both domestically and internationally. In addition to group synergies, we are also steadily expanding our businesses with banks.

Allow me to share some of the achievements by IERAE. We have established a new vulnerability and research team to participate in national and international security contests. Recently, we won the world's most prestigious security contest. We became #1 in the world.

IERAE also assets in the education and training of cyber units as the government, the National Police Agency and the Ministry of Defense take counter measures in earnest. We have also received letters of appreciation for our technical support. We will continue to contribute to the realization of a safe and secure Internet society in Japan and around the world, and we are bringing the skills of those top engineers to more customers with a SaaS-type product, cyberattack [ Net de Diagnosis ] or online diagnosis. This GMO cyberattack, [ Net de Diagnosis ], automatically checks holes in the sites by entering the domain name and notifies you with the scoring results. Anyone can easily diagnose the safety of a site with a high level of security.

In May of this year, the Ministry of Economy Trade and Industry released guidance for the introduction of ASM. ASM stands for Attack Service Management, and it is gaining attention as a method to protect one's IT assets from cyber attacks. [ Net de Diagnosis ] is a tool categorized as ASM.

We have recently launched an initiative for API integration with 14 million Internet infrastructure customers. We will work to make [ Net de Diagnosis ] the next indispensable service. Please look forward to its future development.

Next is our initiative to become #1 corporate group in utilizing AI. The GMO Internet Group is responding to generative AI based on the 3 things as you see on this slide. The first is time and cost savings. The second is improvement in the quality of existing services and the third is offering new services to the AI industry.

We intend to provide new services that serve as the basis for the development of the AI industry as a group of companies that provide the infrastructure for the Internet. We also aim to improve the quality of existing services to enhance functionality, AI is being incorporated in the infrastructure, advertising and media services, as you can see.

Next is offering new services to the AI industry. GMO Internet Group is releasing a series of services that we serve as infrastructure to support the AI industry to use an analogy. They are the jeans, shovels and pickaxes of the gold rush. We will introduce 2 examples this time.

First is Oshiete AI or Teach me AI, a prompt portal for generative AI. A prompt that could be described as the art of interacting with AI. The ability to use these prompts fully will be the key in the AI era. Oshiete AI is free, easy and high-quality prompt portal. We will provide new value to the AI industry by creating a place where people interested in AI can gather and share their knowledge.

And now the GPU server, ConoHa VPS. With the acceleration of the GEN AI movement, many businesses are working to develop large-scale language models that will serve as the foundation for the moment, development requires a lot of computation resources, and there is a strong demand for GPUs with high computational power.

ConoHa VPS is a cloud service equipped with the latest GPU from NVIDIA based on the large-scale infrastructure technology and operation know-how cultivated over many years as a hosting provider in Japan and while leveraging our procurement and sales capabilities as well. By providing this service, we will contribute to the further development of the domestic market.

Then there is a move to strengthen group-wide AI efforts. We are pleased to announce that Professor Yutaka Matsuo of the University of Tokyo has agreed to serve as our adviser. By appointing Professor Matsuo, who is an authority on AI research in Japan as a deep knowledge of its application to business as an adviser, we will further strengthen our group-wide AI-related efforts.

Finally, on the topic of sustainability management with Internet for everyone as its corporate catchphrase, GMO Internet Group has consistently provided indispensable and imperishable services of Internet infrastructure and service infrastructure since its founding.

We have defined 6 materialities by defying key ESG issues for the GMO Internet Group and examining them from the perspective of both stakeholders and the company itself. While ESG-related disclosures tend to be a bit of a cliche. We have identified 6 based on the GMO-ism, the GMO Internet Group's way of doing things rather than borrowed words.

The contents of the 6 materialities are as shown: solving social issues through business, challenge, dedication to the #1 services, safety, responsibility to protect our customer smiles, environment, solving social issues through business activities and strengthening the foundation of management to support these efforts: human resources, cultivating a group that evolves together; trust, maximizing stakeholder smiles; governance, foundation for hundreds of years.

The company has set forth this materiality. Through our efforts to address these materialities, we will seek to contribute to the development of a sustainable society and to continuously enhance our corporate value. Now, this concludes today's agenda. Thank you for watching. Internet for everyone.