BRIDGE REPORT
SAKURA Internet Co.,Ltd.(3778)
Kunihiro Tanaka, President
Kunihiro Tanaka,
President
Corporate Profile
Company
SAKURA Internet Co., Ltd.
Code No.
3778
Exchange
Tokyo Stock Exchange Mothers
Industry
Information and communication
President
Kunihiro Tanaka
HQ
Sakaisuji Honmachi Bldg. 1-8-14 Minami-Honmachi, Chuo-ku, Osaka
Business description
Operates data centers in three areas; Tokyo, Osaka, Hokkaido. A leading enterprise in the industry. Sojitz Corporation executed TOB in 2008 aiming to acquire the Company as its consolidated subsidiary, but the Company maintains its policy to be listed on the Tokyo Stock Exchange.
Year-end
March
URL
Stock Information
Share Price Shares Outstanding
(excluding Treasury stocks)
Market Cap. ROE (Actual) Trading Unit
287yen 34,709,956shares 9,962million yen 13.9% 100shares
DPS (Est.) Dividend Yield (Est.) EPS (Est.) PER (Est.) BPS (Actual) PBR (Actual)
2.50yen 0.9% 17.00yen 16.9times 119.50yen 2.4times
* Stock price as of the close on October 27, 2015. Number of shares outstanding at the end of the most recent quarter excluding treasury stocks.
 
Non-consolidated Earnings Trends
Fiscal Year Sales Operating Profit Current Profit Net Profit EPS Dividend
March 2012 (Actual) 9,164 873 808 556 64.13 5.00
March 2013 (Actual) 9,482 867 812 479 55.20 5.00
March 2014 (Actual) 10,045 736 633 353 40.73 5.00
March 2015 (Actual) 10,576 964 857 516 59.52 10.00
March 2016 (Est) 12,000 1,050 880 590 67.99 2.50
* Estimates are those of the Company. Starting in FY 3/16, "net income" is presented as "net income attributable to owners of parent" (The same applies to all other "net income" described hereinafter).
* Switch to consolidated accounting from FY3/16. In September 2015, conducted 4-for-1 stock split.
 
This Bridge Report provides details of SAKURA Internet's earnings results for the first half of fiscal year March 2016.
 
Key Points
 
 
 
Company Overview
 
The Company operates data centers in three areas: Tokyo (Nishi-Shinjuku, Higashi-Shinjuku and Daikanyama: all are renting spaces), Osaka (Dojima: renting space) and Hokkaido (Ishikari: owned land and building). Its main businesses include housing service, which provides space for servers to be installed, power supply and network lines, and hosting service, which provides server environment (computer resources) on the Internet. While many hosting service providers depend on external infrastructure (data center facilities), the Company seeks for higher profits by owning their own infrastructure (driver of price competitiveness). It manages to raise utilization rate and to lower the risk of fixed costs (risk of owning infrastructure) by using the same infrastructure in providing housing service as well.
 
Business overview
The Company's business is divided into housing service, hosting service, and other services including domain acquisition and line/network related services. The share of these businesses in total sales of FY3/15 were 25.4%, 66.0% and 8.6%, respectively (equipment sales business was included in other services in the past, however, starting from FY3/15 part of its services closely related to main services have been moved either to 'Housing' or 'Dedicated Server' business. Therefore, the Company has made some adjustments and disclosed the revised sales of FY3/14 in accordance with this new classification.)
 
Housing Service
This service includes lending out space within the Company's data centers to customers who can install their own communication equipment as they like, together with lines and electric power supply for Internet connection. Although the Company used to focus on 'Rack-lending' (plus lines and power supply), it started 'Space-lending' (large scale housing) upon commencement of the full operation of Ishikari Data Center, where it owns its land and buildings.
 
Hosting Service
It is divided into 'Physical hosting' which includes Dedicated and Rental Server services and 'Virtual hosting' which includes VPS and Cloud services.
 
Dedicated Server Service
This service is to provide a physical server owned by the Company to a customer for its own use ('SAKURA Dedicated server'). It gives more freedom to its user than rental server service as the user can choose its own server configuration or install any software as it likes.
Rental Server Service
It consists of two types of services: one is to provide physical server owned by the Company to multiple customers for their shared use ('SAKURA Rental Server') and the other is to provide an individual server for one user ('SAKURA Managed server'). Users are subjected to some restrictions in terms of server configuration and software installation, but are able to significantly reduce their work burden as they can leave server maintenance to the hands of the Company's professionally skilled staff.
VPS/Cloud Service
This service is to create multiple virtual servers on physical servers by using virtualization technology, each of which can be used as a dedicated server. There are mainly two services: 'SAKURA VPS' provides one virtual server to a single user, whereas 'SAKURA Cloud' allows a single customer to use multiple servers and any network configuration. The latter enables the Company to adopt pay-as-you-go tariff and provides better cost performance and more flexibility than physical (dedicated and rental) servers.
 
 
First half of Fiscal Year March 2016 Earnings Results
 
Following the acquisition of Joe's Cloud Computing, Inc. (Kita Ward, Osaka City, hereinafter referred to as Joe's.) as a subsidiary on April 1, the Company shifted to consolidated settlement of account from FY 3/16. Joe's offers the hosting service (Shared, Dedicated and VPS) mostly based on rental servers, SSL Server certificate issuance service, domain acquisition service, etc. and has so far offered the rental servers to more than 35,000 companies and issued over 15,000 SSL Server certificates.
 
 
Sales Up 14.9% YoY, Current Profit Up 9.9% YoY
With VPS and Cloud Services as leading businesses, sales increased by 14.9% from the non-consolidated sales in the previous year. While sales cost increased by 11.8% YoY due to an increase in the number of engineers and equipment for sale, cost ratio decreased by 2.0 points and gross profit increased by 23.6% YoY. This increase in gross profit offset the augmentation of SG&A expenses due to the increases in depreciation expenses (the internal system), sales personnel/employment/training costs, outsourcing in conjunction with service enhancement, etc. As a result, operating profit increased by 12.3% YoY.

According to the Company, "sales did not meet the Company goal because the growth of monthly subscription sales (VPS and Cloud services) slowed down, but profit was steadily ensured" and "considering the full year outlook, we will continue to hire outstanding engineers (because recruitment is proceeding successfully, personnel expenses are expected to exceed the initial estimate)." Furthermore, as for monthly subscription sales, "measures toward sales growth in 2H will be continued."
On September 1, 1 share was divided into 4 shares in order to expand investor groups and improve money-market liquidity.
 
 
 
Because of the success in reinforcement of sales measures, the basic trend of an increase in sales from the 3rd quarter in the previous term is maintained. In the 2nd quarter, while sales of the Housing service (in the 1st quarter, spot sales were recorded) and Dedicated Server service shrunk, compared to the sales in the 1st quarter,, sales of VPS and Cloud services and others (spot equipment sales contributed) increased. Sales of Rental Server service also grew slightly, which led to the increase in the consolidated sales by 0.8% (sales of 78 million yen and 74 million yen raised by Joe's, which was acquired as a subsidiary in April were included in the sales in the 1st quarter and the 2nd quarter, respectively).

However, in addition to the increase in sales costs due to the increase in the number of engineers for corporate growth, SG&A expenses also augmented because of the increase in outsourcing in conjunction with service reinforcement, advertising associated with services, as well as sales measures, which led to a drop in operating profit by 32.3%.

Sales of Housing service is expected to continue on the declining trend but it is expected to grow in the 3rd quarter due to spot earnings. As for Dedicated Server service, a new service was introduced in October and the overall price was raised. With regard to VPS and Cloud services, which have slowed in sales growth, measures were taken in the 1st and 2nd quarters in order to expand monthly subscription sales.
 
 
Total assets as of the end of 1H was 15,003 million yen, up 905 million yen from the non-consolidated total assets at the end of the previous term. On the debt side, in addition to the increase in receivables due to spot sales accumulated in the 2nd quarter, tangible lease assets also increased due to floor space expansion of Ishikari Data Center. On the credit side, long-term loans and lease obligations augmented due to construction of Building 3 and floor space expansion of Ishikari Data Center. Equity ratio is 27.6%.
 
 
In the 2nd quarter, operating CF increased from the 1st quarter because of the elimination of consumption taxes, corporation taxes and other taxes as well as dividends to be paid. CF from investment activities decreased further because of purchase of service equipment and site for Ishikari Data Center, but free CF of 111 million yen was secured. CF from financing activities went into the black due to the increased amount of a long-term loan toward payment of construction on Ishikari Data Center Building 3.
 
 
Fiscal Year March 2016 Earnings Estimates
 
 
Full Year Earnings Estimates Remain Unchanged: Sales Up 13.5% YoY and Current Profit Up 2.6% YoY
Sales were 12.0 billion yen, up 13.5% compared to the non-consolidated results in the previous year. An increase in sales of Dedicated Server and Rental Server services is expected by maintaining favorable VPS and Cloud, providing new services, etc., and sales measures toward target customers are expected to bear fruit.
As for profit, labor cost is estimated to augment due to the increase in the number of engineers, and sales cost is estimated to increase, as costs of electricity, maintenance, lines, depreciation, and lease will increase after the investment in equipment of data centers and devices for services in the previous and current terms. Although the cost for sales and promotion staff and SG&A expenses, mainly depreciation, will increase, operating profit is expected to rise 8.9%, thanks to sales growth.

Year-end dividend is scheduled to be 2.5 yen per share (considering 4-for-1 stock split, the amount is the same as that for the previous term).
 
 
Key Challenges and Actions to be Taken in Fiscal Year March 2016
 
With the idea of "necessity to enhance actions for further growth," the following are the four key challenges in FY 3/16: sales growth; enhancement of service, technology and operation; optimization of costs; as well as reinforcement of organization and human resources. Specific actions to be taken for these challenges are as follows:
Key Challenges and Actions
Sale growth Continuing sales measures toward each target customer
Enhancement of service, technology and operation Introduction of new services and enrichment of functions
Optimization of costs     Announcement of construction of Ishikari Data Center Building 3
Reinforcement of organization and human resource Increase of contact points with future IT engineers
Sales Growth      Continuing sales measures toward each target customer
Multifaceted sales activities were continuously strengthened in order to further expand the customer base. Specifically, the Company's unique approaches such as promotion of a partnership system (sales partner, product partner, solution partner), start-up assistance (discovering venture enterprises, etc.), sponsoring and participating seminars and events (discovering general companies) as well as alliance and M&A were made toward new customers. On the other hand, toward existing customers, the Company sponsored customer interaction events, assisted user communities, and reinforced customer support in order to improve customer satisfaction.
 
Enhancement of service, technology and operation      Introduction of new services and enrichment of functions
The Company reinforced services for companies other than IT enterprises and customers with their own operational environment, such as entering the rapidly growing domestic private Cloud market, responding to need for secure environment development from enterprises, and expanding SSL services. The Company also reinforced security services which have high needs.
 
Optimization of costs      Announcement of construction of Ishikari Data Center Building 3
The Company announced the construction of Building 3 of Ishikari Data Center (hereinafter referred to as Bldg. 3). Although in a short run, the increase in depreciation expenses will be a burden, high cost-effectiveness can be expected at full operation. The investment amount (construction cost) of Bldg. 3 is estimated to be about 4.3 billion yen, and the necessary fund will be covered by a long-term loan from financial institutions and the Company's own money. The construction is slated to start in October 2015 and be completed in the winter of 2016 with the aim of starting operation in the spring of 2017.
 
Reinforcement of organization and human resource      Increase of contact points with future IT engineers
In order to maintain and improve technological strengths, which are the strong point of the Company, outstanding engineers will be continuingly recruited. Employment with the focus on engineers has been enhanced since 2H of the previous term, and the current number of employees on the consolidated basis as of the end of 1H is 320, up 54 from the end of the previous term (the number of employees on the non-consolidated basis was 266). The increased number includes 36 engineers, 8 sales and promotional staff, as well as 10 staff from Joe's (no increase or decrease in the management division).
In the first half of this term, in order to employ new graduates, the Company accepted 12 students from all over Japan through an internship system for 5 days and provided them with experiences ranging from server development to control panel design and organized a data center guided tour for the students.
 
 
Conclusions
 
Because VPS and Cloud services, which are main growth drivers, are delivered within a few minutes from orders, the Company needs to prepare servers beforehand. This results in a large advanced investment burden. In addition, because of continued expansion of the floor space of data centers, operating profit kept shrinking from FY 3/11. Recently, in addition to the fact that economy of scale is gradually actualized by building up contracts, in FY 3/15, the period of depreciation of the initial investment made when VPS and Cloud services were initiated ended. Because a system to maintain a basic trend of increasing profit by offsetting an advanced investment burden was ready, operating profit increased in FY 3/15 after an interval of 4 terms, and operating profit is expected to grow for two consecutive terms also in FY 3/16 by offsetting an advanced investment burden.
In the Tokyo metropolitan area, demand for data centers is great, but competition is fierce. Bit-isle (3811), which develops their own data center business in the metropolitan area, decided to become a direct subordinate of Equinix, the world's leading Company in the U.S. in the data center field. Bit-isle gained a contrasting result to that of the Company, which avoids risks of a fall in the rack price by leasing facilities of other companies by floor in the Tokyo and Osaka metropolitan areas, while establishing a stable growth basis by their unique business expansion in Ishikari, Hokkaido.
Disclaimer
This report is intended solely for information purposes, and is not intended as a solicitation to invest in the shares of this company. The information and opinions contained within this report are based on data made publicly available by the Company, and comes from sources that we judge to be reliable. However we cannot guarantee the accuracy or completeness of the data. This report is not a guarantee of the accuracy, completeness or validity of said information and or opinions, nor do we bear any responsibility for the same. All rights pertaining to this report belong to Investment Bridge Co., Ltd., which may change the contents thereof at any time without prior notice. All investment decisions are the responsibility of the individual and should be made only after proper consideration.
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