GMO Internet Inc

TSE:9449

Earnings Call Transcript 2017-Q4

[Masashi Yasuda, executive]

Good afternoon. My name is Yasuda. I'll present the first half of today's presentation, focusing on performance and the overview up through Global Strategy, after which, Kumagai will share about the Cryptocurrency Business and outlook for the 2018 fiscal year.

This slide shows business performance of the 2017 fiscal year. Net sales came to JPY 154.2 billion, operating profit equaled JPY 17.64 billion. Ordinary profit totaled JPY 17.31 billion and net profit came to JPY 8.03 billion. Earnings achieved a record high and operating profit and ordinary profit did not achieve the forecasts as Internet Finance lagged in the first quarter. But net profit achieved the forecast of JPY 8 billion.

This is an executive summary of operating profit covering January to December for each segment. Looking at each segment, while infrastructure grew, profit decreased in Internet Finance due to the volatile market last year. So the consolidated operating profit increased by only JPY 600 million year-on-year. As for Q4, this is an analysis of the year-on-year growth and operating profit for October to December. Quarterly operating profit achieved a record high of JPY 5.65 billion, as infrastructure saw record high earnings and the cryptocurrency exchange business GMO Coin achieved positive figures.

Next is the summary of each segment. Internet Infrastructure saw very steady growth, as profit was up almost 30% year-on-year. All products are growing, especially the payment-related services. Internet Finance on the other hand saw profit decrease by 15% from last year. Internet Finance recovered from its late start in Q1 through improvements in FX profitability and the expansion of the cryptocurrency exchange business. However, profit decreased due to the volatile market last year.

In Online Advertising & Media, profit decreased by 25% and seasonal factors impacted both new and existing products. New ad technology products grew, but profit was down due to weak existing media products and the change in ad network advertisement distribution regulations.

In Mobile Entertainment, both revenue and profit decreased. We have completed organizational restructuring and are now able to focus on the business. These charts show historical results for the past 5 years. Consolidated earnings achieved a record high, driven by solid growth in the earnings of Internet Infrastructure segment despite the harsh market environment, as compared to the volatile market Internet Finance saw in 2015 and 2016.

I'll share more about each segment later. But in 2017, I really felt the strength of the Internet Infrastructure segment, which makes up the foundation of the GMO Internet Group.

Next is the summary of financial results for the 2017 fiscal year. This graph shows the growth in quarterly earnings. Quarterly operating profit achieved a record high of JPY 5.65 billion, and net sales and operating profit increased by 19.1% and 40.1% year-on-year, respectively. This graph shows net sales by segment. Revenue and infrastructure drove the Group's net sales, which exceeded JPY 40 billion.

Moving on to operating profit. Profit reached a record high as discussed earlier. Infrastructure's record high operating profit, GMO Coin's achievement of positive figures in Internet Finance and posting gain via sale of listed and unlisted shares in our Incubation business led to the results above. Here you can see an overview of profit and loss.

The next slide shows the balance sheet. There have been some changes due to entering the cryptocurrency mining business, so we will explain the balance sheet in the next slide along with the cash flow. We are currently investing in the cryptocurrency mining business. Operating cash flow was JPY 5.48 billion, which includes JPY 700 million in expenses for the cryptocurrency mining business. Investment cash flow included JPY 7.7 billion of investments in the cryptocurrency mining business. So the total expenses for the cryptocurrency mining business in 2017 came to JPY 8.5 billion. We expect quite a bit more to be spent on the cryptocurrency mining business in the future, so we will continue to announce any updates promptly.

Moving on to the Group overview. This slide shows the market cap and equity share of our listed companies. This diagram shows GMO Internet's 4 segments. The segment sizes are based on the net sales ratio, which between infrastructure, media and finance is approximately 5:3:2. Our customer base is expanding across all segments with growth in infrastructure contracts and customer accounts in FX and securities. The cryptocurrency business will be added to this diagram this year. I'll explain in more detail later. Here are the trends of the number of partners and the ratio of engineers, who make up the base of our strength as a group. At the end of December, the number of partners totaled 5,316 people, 44.2% of our partners are engineers and creators. The ratio of creators is increasing steadily. Our goal is to see it surpass 50%.

Next is the summary of each segment. This slide shows the composition of the Internet Infrastructure segment. All products in this segment are #1 in their respective markets. The next 2 graphs show the growth of Internet Infrastructure's net sales and operating profit over the past 5 years. Net sales have increased by 29.5% year-on-year, driven by payment and provider businesses. Profitability of payment and security-related products increased despite additional investments in minne. So operating profit increased by 28.7%, reaching a record high.

This graph shows performance by quarter. Orange shows strategic investment in Z.com, .shop and minne. Operating profit achieved a record high despite minne's TV commercial in Q4. This shows the net sales for each subsegment. As you can see, net sales continue to increase. In Internet Infrastructure, the number of contracts came to a total of 8.92 million. For .shop, services began 15 months ago and the number of customers has exceeded 500,000. .shop was #10 in registration rankings out of about 1,200 new domains, and the number of contracts continues to grow. Renewals began in September and the average renewal rate over the past 3 months was 66.2%, making for a good start.

Moving on to Internet Finance. Next is the growth of Internet Finance's net sales and operating profit over the past 5 years. In 2017, the lack of market volatility compared to 2015 and 2016, led to a decrease in profit. This is historical performance by a quarter for the past 3 years. Profitability declined temporarily in Q1, but recovered through an analysis of big data as shown on this slide. We launched our cryptocurrency exchange business GMO Coin in Q2, which achieved positive figures in Q4. Cryptocurrency is a business that could grow substantially as the market matures. Although profit still changes due to price fluctuations, we'll apply our knowledge of FX to build up this new pillar of business. Shown here are FX trading volume trends by quarter. We've achieved the highest trading volume globally for 6 consecutive years, though trading volume declined slightly.

Next is the cryptocurrency exchange business, managed under GMO Coin. Our Cryptocurrency Business launched in May and as you can see, customer accounts and trading volume are growing rapidly. We are now expanding to offer currency pairs besides just Bitcoin. I'd like to explain the cryptocurrency exchange business-related security measures. At GMO Internet Group, the majority of customer assets are kept in cold wallets. We will segregate the assets that we keep for customers. As for security measures, we support multi-signature, a method that distributes and saves multiple private keys to access cryptocurrency. GMO Internet strives to offer a safe and secure system by leveraging our achievements over the past 10 years as an Internet Finance business.

This slide shows our current alliances in finance and payment services. Developments in each area are continuing to progress steadily.

Next is Online Advertising & Media. The next 2 graphs show the growth of Online Advertising & Media's net sales and operating profit over the past 5 years. Net sales and operating profit decreased by 0.2% and 24.5% year-on-year, respectively. Our in-house ad tech products grew, but the scale is still small, so they were unable to offset the drop in the sales of existing products in online media. Changes in ad network advertisement distribution regulations resulted in decreased revenue.

This slide shows performance trends by quarter. Our current situation was discussed earlier. We will continue to strengthen our in-house products. Shown here are each segment's revenue trends by quarter. Net sales of our in-house ad technology products, mainly AkaNe, have grown but the segment's net sales have been flat as the ad agency is working on internal strategies, such as organizational restructuring.

Moving on to Mobile Entertainment & Other Businesses. Group companies at the core of the Mobile Entertainment segment were consolidated through organizational restructuring. The purpose is to further cost optimization and to focus more on game development. In our Incubation business, we posted a gain via sales of listed shares that went public in 2016.

Next, I would like to talk about our global strategy. GMO Internet Group has already expanded to 58 locations in 20 countries and includes 1,272 partners. In overseas sales, the Internet Infrastructure business, which offers services under the Z.com brand, is growing steadily. The overseas sales ratio continues to increase and with the cryptocurrency mining business, we will aim to increase our overseas sales ratio to 50% in the midterm.

And that concludes my part of the presentation. Thank you very much.

[Masatoshi Kumagai, executive]

Good afternoon. Thank you for taking time out of your busy schedules today. I'd like to discuss the cryptocurrency market environment. The chart on the left shows the number of wallet users who have cryptocurrency in their accounts. We pulled this information from Blockchain info, which is a standard source of information in this industry. This number includes wallets that contain Bitcoins as well as Altcoins. The total global number of wallet users is around 23 million people with an additional 100,000 wallets being created daily. The chart on the right shows the market cap of Bitcoin, which peaked at $323 billion, but has since dropped to about JPY 12.6 trillion. This is due to rapid price fluctuations.

Moving on to the next slide. The chart on the left shows cryptocurrency mining businesses including GMO Internet. Shown is the global total revenue miners receive per day for Bitcoin. Mining is conducted every 10 minutes, 144 blocks are generated each day, revenue from mining is 12.5 Bitcoins per block. So 12.5 Bitcoins x 144 blocks x Bitcoin's market value on the given day equals the miners' revenue. Miners' daily revenue peaked at around JPY 6 billion, but has since dropped and now averages JPY 1.8 billion. In this industry, miners worldwide compete to record transaction data in a blockchain and JPY 1.8 billion is then distributed among them. The chart on the right shows Bitcoin's total hash rate. You can see the fluctuation in the hash rate of mining hardware all over the world. The previous chart showed the number of wallet users who have cryptocurrency in their accounts, but this chart shows the total hash rate of Bitcoin only.

Each cryptocurrency has its own hash rate. Miners prefer Bitcoin, because of its high profitability. It has a computing capacity of 24,000 PH/s. I said in the results presentation in November that the total hash rate would probably reach 20,000 PH/s by the end of 2018, but it's already increased to 24,000 PH/s since the end of 2017. We think that speed is the key to win in the cryptocurrency industry. This is especially the case for cryptocurrency mining industry. If the total hash rate goes up, a given company's market share goes down, so only profitable businesses that can reinvest some of their profit will remain. So increasing market share and making enough profit to reinvest is the first step towards winning. Our belief is that speed is of the utmost importance.

Please see the next slide. I gave a speech on our plan to be the first Japanese listed company to enter the cryptocurrency mining industry at the press conference on September 7 last year. But we're not planning to enter the industry just as miners. People who succeeded the most during the gold rush were not only the ones mining, but also those who sold jeans and shovels. And Levis was the winner during the gold rush. On September 7, I announced our plan to mine cryptocurrency and also take the same stance as Levis. We announced in September that we expected to invest a total of JPY 10 billion in this business and the computational power to reach 500 PH/s in the first half of 2018.

In the third quarter financial results announcement, we announced that we have revised our expectations and our planning to achieve a computational power of 1,500 PH/s in the second half of 2018. We also announced that we expected to invest a total of JPY 38 billion from January to August this year. I'd like to announce that we have again revised our expectations and as of today, they are to achieve a computing power of 3,000 PH/s by the end of this year. As I said before, speed is the key to win in this industry, so we need to continually reinvest to increase our hash rate, so our aim is to achieve a computing power of 3,000 PH/s. Although the target hash rate has doubled from 1,500 to 3,000 PH/s, the amount of investment will not double from JPY 38 billion to JPY 76 billion. This is because we will launch a large-scale cloud mining service as announced today. Some of our competitors purchased mining boards to offer cloud mining service, whereas we are semiconductor manufacturer, so we will manufacture our own mining boards to offer cloud mining service. Our cloud mining service is similar to a rental server or a credit card payment service. We will first charge customers a rental fee and change our business model afterwards to collect some of their profit as a rental fee, so we won't need to increase the amount of investment. We will start recouping the investment the moment we launch the cloud mining service. I'll explain in more detail later. Our mining businesses' performance depends on cryptocurrency's market value, so we will explain it based on hash rate. 12.5 Bitcoins x 144 blocks x Bitcoin's market value on the given day equals the miners' revenue, a certain percentage of which is our revenue and this percentage is our market share. We will explain mainly the hash rate in the future as the earnings can be easily calculated based on the hash rate.

Next, this slide shows our performance for February. Red shows our hash rate. We set up mining centers in 2 countries in Northern Europe and launched mining on December 20 last year using existing mining technology. We have currently achieved a computing power of 74 PH/s. Bitcoin's total hash rate has already increased to 24,000 PH/s as shown earlier. We are currently mining Bitcoin, but our hash rate is still low, so we are mining Bitcoin Cash as well. For Bitcoin Cash, our hash rate is about 2,000 PH/s, so in 1 month to 2 months, we expect to see our company name in the online pie chart of Bitcoin Cash's total hash rate. We will mine at our data centers in Northern Europe using existing technology until June or July when it starts to get warmer.

I think you've noticed a sudden spike in the hash rate. We're currently developing a cutting-edge 7-nanometer process technology for chips, with which our mining boards will be equipped and this is expected to be the fastest commercial mining board in the world. This spike is sudden, because this is when we will start producing and introducing our own mining boards. You may think that mining machines are affordable, but that is no longer the case. The Antminer, which is the product of Bitmain, led by Jihan Wu, is the most popular mining machine and has the largest market share. Its supply's falling, which has led to a price increase from JPY 150,000 to JPY 500,000 since last fall according to Amazon website. The Antminer is always out of stock and Bitmain sells them only to certain existing customers, which makes it difficult to purchase mining machines.

We have secured a procurement channel, so we can purchase mining machines. Even if you have the money and are willing to dole it out, it's still difficult to purchase mining machines. So the spike is due to our producing our own mining machines. After we see good results in this area, the next thing to do will be cloud mining. Many people from around the world want to try mining. Since the announcement in November, we have received around 800 cryptocurrency mining-related inquiries. We receive dozens of inquiries every day from various investors, who are willing to commit hundreds of millions of yen, form business alliances with us or offer data centers with the capacity of tens of megawatts. But we rarely receive inquiries written in Japanese. Right now, we receive a lot of inquiries written in English or other foreign languages. This is because it is currently difficult to purchase mining machines. That is why we've received so many inquiries from around the world since we have announced our plan to develop and sell our mining machines. That's why we believe that our cloud mining business is going to really take off. We can secure a monthly computing capacity of 450 PH/s and increase it by 450 PH/s every month. We will look for people who want to rent machines and charge them a rental fee. This is the business model of our cloud mining business.

Next, these are the actual figures for in-house mining, which launched last December. These are calculated based on the number of mined Bitcoins and Bitcoin's market value on that day. The actual figures were JPY 90 million in December, JPY 110 million in January, and the outlook for February is about JPY 230 million at the current market price for Bitcoin due to the price drop. As you can see, this is just for your reference; we will announce the figures again, at the next presentation. The figures continue to grow. In regards to accounting, last December, the Accounting Standards Board of Japan disclosed the exposure draft practical solution on the accounting for virtual currencies under the Payment Services Act. We will record the revenue in line with these rules after they are finalized this spring. Please visit the Accounting Standards Board of Japan's website for more details.

This is an actual photo of the mining center we are operating in Northern Europe, as announced in the press release. This is the inside of a mining center. You can see that we are mining using existing mining technologies. Our cloud mining business will rent out part of our mining facilities. We will charge a one-time upfront payment of $5 million for a 2-year rental contract. We will also take a portion of our customers' profits on a monthly basis. The cost of maintenance, electricity and labor, such as for engineers and security guards who monitor the facility grounds at all times, make up this fee. Our business model is to collect fees in this way. The important point is that our rental fee is a one-time upfront payment to cover the capital expenditure. This will have a positive effect on the cash flow.

This photo was already included in our press release a few days ago. This is a semiconductor chip we succeeded in developing along with some of the related parts. This is a 12-nanometer FFC process-based semiconductor chip. Actual production of the 7-nanometer mining chip has begun, and we will be receiving them in April. This 12-nanometer FFC process-based semiconductor chip is a significant milestone as it shows that we are closer to realizing a 7-nanometer mining chip. Integrated circuits for specific usage are collectively referred to as the ASIC. We have succeeded in developing a cutting-edge 12-nanometer FFC process-based semiconductor chip, which marks a huge step towards realizing a 7-nanometer mining chip to be introduced in the second half of this year. I'd like to explain the development plan. As mentioned earlier, we launched mining using existing mining technologies last December. The 7-nanometer mining chip will be delivered in April. It will then take about 2 weeks to 3 weeks to make mining boards. Then, we will take the mining boards to Northern Europe, by air, and install them in our mining centers. In June, we will launch mining using the 7-nanometer mining chips. After we have confirmed [ a month ] of stable operations, we will start offering the cloud mining service.

I'll explain the cloud mining service in more detail now. The name of our service is Z.com Cloud Mining. GMO is our domestic brand, whereas Z.com is our global brand. We will offer a service under the Z.com brand. We will start accepting applications in March and launch the service in August. GMO Internet will rent out part of its mining facilities and manage the facilities full of mining machines equipped with our original next-generation 7-nanometer mining chips. The profitability of cryptocurrency mining will be high, because we will use a machine equipped with cutting-edge 7-nanometer semiconductor chip, and its power consumption will be a half or third of that of the competitors' products. The point at which the profit for cryptocurrency mining will break even, depends on the Bitcoin price. If the Bitcoin price drops, the competitors operating their mining centers in regions with expensive power supply and using expensive machines will be the first ones to turn off their machines. We manage our revenue daily, so we will notice immediately if the figures turn positive or negative. The cost of electricity in Northern Europe, where our facilities are built, is less than a quarter of that in Japan. There are countries where the electricity cost is as low as tenth of that in Japan. The electricity cost in Japan is about JPY 20 per kilowatt hour depending on the time period in terms of the contract, but in Northern Europe, it's about JPY 5 per kilowatt hour. The electricity cost in Russia and certain Asian countries, such as Taiwan, is about JPY 2 per kilowatt hour. Every day we receive e-mails from people around the world trying to sell us their electricity. Offers from Russia drew our attention, but they use fossil fuel, which is not environmentally friendly as it pollutes the atmosphere. We do not want to pollute the atmosphere by mining gold. We chose to operate a mining center in Northern Europe to secure clean and inexpensive power supply. An advantage of the 7-nanometer semiconductor chip is that it will only consume 1/3 to a half as much power as competitors' products. If our competitors turn off their machines first, our market share, and therefore our revenue, will increase. Minimizing the cost of mining is the most important thing to win in this competition, but just securing a place with cheap electricity doesn't lead to profitability. The main point is to produce and to offer the best product in the world in order to satisfy our customers. Those are the fundamentals of business. Our products and services will also be environmentally friendly. Even if the rate of Bitcoin declines suddenly, the competitors will turn off their machines before we do, so we expect our market share, and therefore the return, to increase. We initially didn't know anything about semiconductors and have spent the past few months studying them and gaining enough knowledge to be able to talk on equal terms with semiconductor engineers, and now, we're considering a visit to a semiconductor factory in Taiwan. We're putting our effort into producing and offering the best products in the world. After I gave a speech on our plan to be the first Japanese-listed company to enter the cryptocurrency mining industry at the press conference in September, the media published a story saying that we will mine cryptocurrencies. However, we're also developing mining boards, not just mining cryptocurrencies.

Next, this slide shows the details of Z.com Cloud Mining. As I mentioned, we will charge a rental fee of $5 million as a one-time upfront payment for a 2-year contract. We plan on accepting up to 8 new contracts each month. Some people may find it difficult to tell whether this is expensive or not. Our competitors' rental fees are generally between tens of thousands of yen and hundreds of thousands of yen. These competitors are mostly in overseas. I'm using the cloud mining services offered by 3 companies and receive mining rewards every day. Don't worry, I file my tax return.

Monthly revenue from mining has been decreasing dramatically. If the total hash rate goes up, a given company's market share declines, and therefore its profit decreases. So if our rental fees are low and we accept a large amount of contracts, we won't be able to survive. We, again, will charge a high rental fee of $5 million and accept limited number of contracts per month to build a win-win relationship with our customers. That's why based on high demand for our service, we are planning to do business with people who can invest at least this much. We plan on holding information sessions all over the world. We will accept applications online for customers all over the world. We'll announce the details on our website on March 1. We are thinking of holding the sessions in 9 cities, including London, New York, Frankfurt, Singapore, Dubai and Tokyo. These are some of the world's most famous cities with lots of investors and where people go for RR activities. We want to hold the information session in such cities. That concludes the cloud mining section.

Next, for our cryptocurrency business, our internal goal is to become #1 in the field of cryptocurrency. Cryptocurrency-related startups can be divided into 3 categories: one is cryptocurrency mining business; another is cryptocurrency exchange business; the other is cryptocurrency payment business. These are the only categories of cryptocurrency-related businesses. History will decide if cryptocurrency is gold or a currency. Only time will tell. Personally, I strongly believe that cryptocurrency is like gold. Cryptocurrency is unmistakably gold or a useful asset. We don't know yet whether it will turn into a currency, whether it be Bitcoin, Bitcoin Cash, other Altcoins or cryptocurrencies issued by the government or perhaps the Lightning Network, which is a second-layer payment protocol that operates on top of a Bitcoin blockchain, may be used like a currency. Only history will decide. GMO Internet Group strongly believes that cryptocurrency is like gold. If so, cryptocurrency mining and exchange businesses will be profitable. That's why I have put "okay" circles beside mining and exchange and have put a "maybe" triangle beside payment as it is uncertain whether cryptocurrency will become a currency and investing a lot in this business may pose risks. We'll invest in this business in the future, but right now, we are watching how it develops. We are planning large-scale operations for the first 2 businesses. We're aiming to be #1 globally in at least these 2 business areas. That concludes the cryptocurrency section.

Next, I'd like to explain the outlook for the 2018 fiscal year. We will change certain segment names as shown on the slide, since we will be devoting all our energy into this cryptocurrency business. Mobile Entertainment segment will be merged into other businesses. We will also create a new cryptocurrency segment. The cryptocurrency segment has 2 subsegments: one is the mining business by GMO Internet; and the other is GMO Coin's cryptocurrency exchange business. We will disclose the financial results for these 2 subsegments beginning in Q1.

We would also like to inform you of our new policy.

Regarding our forecast earnings, because of our FX, securities, cryptocurrency and several other businesses that are affected by market volatility, we will no longer announce consolidated forecast earnings from this year. However, to help you forecast our financial results, we will begin reporting the KPI of our cryptocurrency mining business on a monthly basis starting in March. Also GMO Financial Holdings reports their KPI on a monthly basis, so we would like you to use that information to make forecasts about our finance and cryptocurrency businesses. Internet Infrastructure trends are relatively stable, so I think you can make forecasts by looking at trends over the last few years. Please combine the data released about the finance and cryptocurrency businesses to make the most accurate forecast. Rest assured that we will continue to communicate with all of you on a regular basis. The shareholder return policy will, of course, remain the same. Based on our 50% shareholders return ratio policy, we will pay out more than 33% of the net profit each quarter and execute our share buyback for the remainder, which is 17%. After executing share buyback, we will retire our treasury stocks. As for dividends, since we will not disclose our guidance, we will also not be able to disclose our dividend forecast. However, we will report our dividends on a quarterly basis as shown on the previous page, so please rest assured. Based on our policy, we will execute share buyback for the remainder, which is JPY 1.36 billion. We will execute share buyback from February 13 to December 28.

That concludes my presentation. By fully utilizing our 22 years of experience and expertise cultivated through Internet Infrastructure and Internet Finance businesses and our own chips, we aim to be the global #1 in the field of cryptocurrency.

Thank you for listening.