Aiful Adapting to Change

As stated previously, a portfolio position was established in Aiful Corp. (AIFLY/OTC) and it closed Tuesday at $6.60. I purchased the ADRs, the ordinary shares trade in Japan under the symbol 8515. One ADR = 1/4 ordinary share.

Aiful is one of Japan’s four major consumer lenders and ranks as the largest by assets. The market cap is approximately 469 billion yen (almost $4 billion) and there are 142 million shares outstanding (most owned by foreigners). The stock trades at roughly 1.85 times stated book value and yields 1.82%.

Unlike when I first bought my other Japanese consumer lender, Takefuji (8564/JP or TAKAF/OTC), these are no longer plays on stated book value discounts. I’ve recently added to my (currently underwater) Takefuji stake and established a new position in Aiful because now these stocks are a play on a changing industry. And their financial strength is such that they can adapt to the new environment and benefit from the coming consolidation.

I believe that’s true for the other two major players as well -- Acom and Promise -- but I bought Aiful. Why? Primarily because Aiful leads the Japanese consumer lending industry in diversifying away from the traditional consumer finance and into credit cards, home equity loans and small business loans. So it’s well-positioned for successfully adjusting in a sector that’s restructuring, cutting costs and tightening lending standards.

I mentioned industry consolidation. In the next few years the number of moneylenders in Japan is expected to shrink from 10,000 to about 3,000. Many of these outfits are financially weak, and many will have to sell out or even go out of business. Aiful should be among those cherry picking assets from its smaller rivals.

Aiful’s stock price, like those of all Japanese consumer lenders, collapsed last year. The factors involved government imposed interest rate caps, government scrutiny of collection practices and a Japanese Supreme Court ruling that opened the door to interest rate refund claims. Aiful and others set aside substantial provisions for repaying claims, leading to losses for the year ended March 2007. Aiful and the others are forecasting a return to profits in 2008, and I expect the stock price to recover.

What could go wrong with this pick? Primarily that Aiful could need to keep setting aside more and more provisions to pay claims. So much so that the balance sheet gets trashed and the company’s existence is threatened. I do not think that will happen -- but reports out of Tokyo last week were that excess interest claims are still rising. So there are no guarantees.

Finally, I should point something out. Most of the stock picks made on Controlled Greed.com have performed nicely.

But my other Japanese consumer lender, Takefuji, certainly hasn’t. Regular readers will recall that I originally thought Takefuji would be “dead money” until it worked out. It was trading for $62.50 then, and is currently stuck in the $30s. I hope Aiful does better, yet Japanese consumer lenders could always prove to be the Little Big Horn of my brokerage statement.

Comments

[saresh]

Aiful and Takefuji have sold off about 10% in the past week or so. In general I agree that they could be bargains but am concerned about my own lack of information and limited ability to check up on the stocks.

Do you have any idea what is happening there to cause the selloff? Has anything changed?

[John]

saresh: I feel your pain. But these are not going to pop up suddenly. These are long term plays. Both have good English-language websites. You can get current price quotes on Bloomberg for free. Aiful's ADR is traded OTC, and the quote is updated daily after market close.

[Eddie Bravo]

Well timed sir, Promise is apparently in discussions to merge with Sanyo Shinpan. Personally of the big four Japanese consumer finance firms I think Promise is the nicer bet but I agree with your thesis that the industry is in for reorganization... some deals have already happened in Dec - SBI holdings bought an unlisted Kyoto lender for about 0.6 book.

[John]

Eddie: Thanks for the kind words. But it's way too early to start popping corks. I think this is more of a 2008 story, though I'd love to be proved wrong. :-)

[Anon]

This from the 2nd quarter Tweedy Browne shareholder letter...

"For instance, we sold our shares in Takefuji, the Japanese consumer finance company, at roughly a 23% loss from our original cost. Japanese regulators were able to successfully lower the ceiling
on interest rates that these finance companies could charge their customers, thus clouding their earnings prospects going forward."

[Eddie Bravo]

I think one factor you may want to look at here is that Japanese mega-bank SMFG has a 20% stake in Promise and using Promise as its bridgehead it can undertake M&A in the sector and gain mkt share. A no. of other megabanks have also been doing capital injections into the lenders - MUFG & JACCs is one example.

[nsn]

the great hope for these companies is that they can expand into the mid-tier consumer lending to make up for the loss of sub-prime business. I wonder do they have the brand strength to take on the banks in this area, my impression is that they are not viewed that highly within the middle classes.

[svd]

John or Anybody knows what is causing this price collapse?

[John]

svd: A smaller rival of Aiful filed for bankruptcy last week, hurting all the consumer lenders. And a credit card firm has announced it will post a loss, furthering investor sentiment against the consumer lenders. (You can get these stories by searching Bloomberg and Reuters.) I'm still holding Aiful and Takefuji, because I think they're a 2008, 2009 story. But I'm certainly taking it on the chin for now.

[svd]

Thanks John,
I read about credia and JCB and Mitsh. UFJ during the week, but other then that I couldn't find anything else. The august 07 data from aifly(and takefuji) doesn't look that bad. Looks like this is an overreaction. I just wanted to make sure that I am not missing anything other then credia news.
thanks again.

[John]

svd: I agree it's an overreaction.

[svd]

John,
what do you think about CEO and relatives buying(or diluting) ~20% of the stake? I see good and bad- CEO putting his money and captial ratio will be around 20%. But then they are diluting current investor and they may not be getting any money from market. I would like to get your take on it.

[John]

svd: I'm still digesting it. Like you, I see good and bad. I like the top guy putting his own money in, but don't care for the shareholder dilution. FFH did something dilutive a while back but that hasn't hurt at all over the long term. Of course, FFH and AIFLY may be an apples and oranges comparison.

[Hamed Elbarki]

It's always nice when the execs are buying, but that doesn't necessarily mean anything these days...

[svd]

Hi John,
What do you think about Lehman's comment that aiful parent may be insolvent due to npa. I checked the 2008 financial info from their website, nothing on non performing assets to varify.
svd

[John]

svd: Bloomberg reports that an Aiful spokesperson saying they're not having any trouble accessing funds, but won't comment on the Lehman thing directly.

Aiful (and Takefuji) have certainly been disappointing for me.

[sdesai]

John,
Any idea for the further slide? I don't see anything in the news. Funding problem? The last bad news I see about bonds and funding is from http://www.jcr.co.jp/english/top_cont/rat_info04.php?no=08d0475a
Looks like someboday is dumping the equity big time.
Thanks,
svd

[John]

svd: No, I haven't seen anything. Usually the Bloomberg site has good info, but nothing new last I checked. I tend to believe that if financials get hit at all, Aiful gets slammed. Also, you may be on to something with regards to major stockholders dumping shares. Wish I knew more.

[sd]

Any idea why this thing is dropping everyday?I am down 90% now.