（3778） | Publish:Mon, Dec 08, 2014 IR「BRIDGE REPORT」

BRIDGE REPORT
（3778）

プライム

SAKURA Internet (3778)

Kunihiro Tanaka,
President

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
Year-end	March
URL	http://www.sakura.ad.jp/

Share Price	Shares Outstanding (excluding Treasury stocks)		Market Cap.	ROE (Actual)	Trading Unit
535Yen	8,677,489 shares		4,642 Million Yen	10.6%	100 shares
DPS (Est.)	Dividend Yield (Est.)	EPS (Est.)	PER (Est.)	BPS (Actual)	PBR (Actual)
5.00Yen	0.9%	38.03Yen	14.1times	401.53Yen	1.3times

* Stock price as of the close on 10/27. Number of shares at the end of the most recent quarter excluding treasury stocks. ROE, BPS based on previous term's results.

Fiscal Year	Sales	Operating Profit	Current Profit	Net Profit	EPS	Dividend
March 2011 (Actual)	8,584	1,225	1,194	572	13,202.24	1,000.00
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 (Est)	10,450	690	550	330	38.03	5.00

* Estimates are those of the company. In October 2011 a stock was divided into 200 stocks.

This Bridge Report provides details of SAKURA Internet and its first half fiscal year March 2015 earnings results.

Key Points

Company Overview

The company operates data centers in three areas: Tokyo (Nishi-Shinjuku, Higashi-Shinjuku, Daikanyama: renting space), Osaka (Dojima: renting space) and Hokkaido (Ishikari: owning land and building). Its main businesses are 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. Although 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 for housing service.

Business overview

The company's business is divided into co-location service ('co-location' hereafter), Hosting and other associated services (such as consulting on domain acquisition and server construction). The shares of these three businesses in total sales of FY 3/14 were 31.0%, 65.5% and 8.5% respectively. Co-location mainly deals with housing (rack-lending: one customer possesses one rack), as well as lending out space for large-scale users at Ishikari Data Center. The data center also provides remote housing services and is offsetting its handicap of being in a remote location by doing all physical work on behalf of its users. On the other hand, hosting is divided into physical hosting, where the company lends out physical servers (providing both dedicated servers and rental servers), and virtual hosting (providing both cloud and VPS services), where the company creates various virtual machines (VM) on physical servers and provides specific services for each VM.

Physical hosting is divided into dedicated servers, where one customer possesses one physical server ('SAKURA Dedicated server'), and rental servers, where typically several customers use one physical server. Dedicated servers offer high flexibility in server configuration and software in use. On the other hand, rental servers have to be used under the more constrained environment compared to dedicated servers, but users are not responsible for their maintenance. Rental servers are divided into 'SAKURA Rental server', mainly used by individual users, and 'SAKURA Managed server', typically rented out to smaller companies and SOHOs.
Meanwhile, virtual hosting is divided into VPS (Virtual Private Server) service ('SAKURA VPS'), providing high flexibility similar to that of a dedicated server at low cost similar to that of a rental server by using virtualization technology, and Public Cloud IaaS ('SAKURA Cloud'). The latter, unlike the former, enables the company to adopt pay-as-you-go tariff or to increase/decrease resources flexibly. While the former is unable to provide as high flexibility as the latter, it has a cost advantage. For the company, 'SAKURA Cloud' needs a larger investment than 'SAKURA VPS', but its unit price is higher.

Fiscal Year March 2015 1H Earnings Results

Sales Up 3.5% YoY, Current Profit Up 12.2% YoY

Sales increased by 3.5% YoY to ¥5.123 billion. While the sales of Housing slumped, sales of VPS/Cloud, which is a growing business, expanded by 59% YoY. Sales of Dedicated Server decreased only slightly as a decline in existing services was largely absorbed by a strong growth in new services.

Gross profit margin weakened due to a large investment on service equipment executed in the previous term (replacement of all the equipment for rental servers), combined with an increase in depreciation & lease expenses after a further investment on Ishikari Data Center. However, operating profit increased by 14.4% YoY to ¥435 million on the back of sales growth and lower SG&A costs.

Meanwhile, cost of sales increased by 4.1% YoY to ¥3.794 billion. While we saw increases in depreciation & lease expenses (up ¥129 million), repair expenses including maintenance costs (up ¥29 million) and recruiting costs (up ¥20 million), rent (down ¥17 million) and other expenses declined. Compared to the company's earnings estimates, sales turned out to be better than expected thanks to the growth in VPS/Cloud business. Electricity charges were lower than assumed mainly due to the revision of contracts with vendors and other expenses were reduced more than expected.

Housing business has gone through increasing price competition especially in the Tokyo Metropolitan Area where the market is in oversupply. In 1H of FY3/15, not only the price cut for some properties but also the cancellation of a large contract in the previous term as well as the unfavorable YoY comparison for equipment sales affected in a negative way. Although sales of Dedicated Server shrunk overall, a new service launched in February 2012 has now become prevalent in the market and offset a decline in sales for existing services. Sales of Rental Server expanded due to the strong growth in sales volume and also because many users switched to `SAKURA Rental Server' upon the termination of hosting service provided by its competitor. VPS/Cloud business saw strong sales increase on the back of the growing market.

The new service for Dedicated Server is a rival product of the cloud service. It enables physical servers to be used in the same way as cloud, while its performance and security functions are far superior to those of ordinary cloud service based on virtualization technology (price for the minimum plan unchanged with enhanced service specification). There is no limit on the number of servers applicable to this service and it can be structured with multiple servers. Furthermore, the service is available only in ten minutes after the application in the fastest case.

Overview of 1H: Penetration of New Service for Dedicated Server Changed Customer Attitude

At the start-up of a business, cloud is convenient as users can boot their computers quickly and can use as much services as they need. With the expansion of the business, however, it becomes recognized that physical servers are more useful because of their high performance. Furthermore, physical servers are more economical when used on a large scale. Looking at the company's customers, although they use the company's cost-effective hosting service at the start of the business, they tend to switch to services offered by its competitors during the course of business expansion. As the business grows, solutions need to be in place to deal with more system requirements. But the company was not prepared to offer outbound marketing or solutions, as they only accept applications via online sign-up. So the company has enhanced the outbound solution marketing and now the customers understand the merits of dedicated servers, allowing the company to respond to its customers' need. As a result, more customers now use cloud and dedicated servers concurrently or switch from cloud to dedicated servers. In the latter case, unit value per customer will decrease in the short run but the company will enjoy a lot of benefits from retaining customers in the mid-and-long term, enabling it to capitalize on its customers' business growth in order to expand its own business.

VPS/Cloud Achieved Record-high Quarterly Sales but Up-front Investment Placed Burden on Profit

Sales increased by 1.2% (¥29 million) compared to 1Q (Apr-Jun) to ¥2.576 billion. Sales of Housing business shrunk due to fierce price competition but VPS/Cloud business achieved the record-high sales on a quarterly basis. Sales of Dedicated server started to increase after hitting bottom thanks to the strong performance of a new service. Rental server also recorded solid sales by acquiring hosting service users from a competitor. Meanwhile, operating profit decreased by 1.8% (¥3 million) QoQ to ¥188 million. Cost of sales swelled by ¥17 million due to increases in recruitment cost (up ¥15 million) and electricity expense (up ¥5 million by seasonal factors). SG&A costs also rose ¥ 9 million mainly due to larger overhead (up ¥6 million) related to aggressive marketing activities.

In FY3/15 2Q (Jul-Sep), sales of a new service for Dedicated Server increased by ¥23 million QoQ, absorbing a decrease (¥16 million QoQ) in sales of existing services.

Total assets as of the end of 1H was ¥13.886 billion, up ¥21 million from the end of previous term. On the debit side, cash and deposits increased reflecting the company's strong performance, while tangible fixed assets decreased as a result of depreciation. On the credit side, advance receipt (received upon application for the services) turned out to be larger and interest-bearing liabilities (loans payable and lease obligations) shrunk compared to the previous term. As the company secured free cash flow of ¥11.89 million and expedited the repayment of interest-bearing debt, capital ratio improved by 1.4 pp from the previous term to 26.5%.
The company has been focusing on the efficient use of its assets since FY3/12 (to increase revenue by restraining investments) and its effort is now paying off. Regarding advance receipt, most of the users, excluding some large customers, pay a one-month fee in advance while some prefer to pay annual fee upon application.

Fiscal Year March 2015 Earnings Estimates

No Changes for Full Year Earnings Estimates: Sales Up 4.0% YoY and Current Profit Down 13.2%

In spite of better-than-expected sales and profits in 1H and the strong outlook for VPS/Cloud business in 2H, the company has not changed its conservative estimates, saying 'we will enhance measures and policies to contribute to the future growth and make investments to acquire relevant human resources in the ongoing competitive environment'. It intends to strengthen its marketing capabilities and services in order to acquire new customers as well as retaining existing customers and to secure additional orders.

Year-end dividends are scheduled to be ¥5 per share (same as the previous term and the dividend payout ratio is estimated to be 13.1%).

Conclusions

IBM announced that it acquired SoftLayer (based in Texas), a leading IaaS (Infrastructure as a service) provider in US. The strength of SoftLayer is to provide a hybrid environment with a flexible combination of high-performance dedicated serves and virtual machine, which is the area SAKURA Internet has a competitive advantage as well. Although the service is yet to be fully recognized in Japan, it is the area closely watched by IBM and potential demand for this service has become increasingly evident. In addition to the outsourcing of IT infrastructure, the growing demand for BCP/DR and the further penetration of new services such as cloud should bring about a positive effect on the company's business development in future.

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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