Mr. Nobuzane, Representative Director and President of CGS, who has a career as a foreign institutional investor mainly in Fidelity, prepared this report for the purpose of verbalizing to investors the reality of our roll-up M&A strategy and the resulting transformational growth in equity value (through increased corporate value by increased cash flow).

As a result, while the index of “investment recovery” relative to “invested capital” (=Incremental ROI), which is important for the company which conducts M&A, was at the highest level compared to other companies in the same industry, the EV/EBITDA multiple, which took growth rate into account, was discounted by approximately 70% to 80% compared to other companies in the same industry.

While the selection and the forecast for growth rate by other companies in the same industry are based on CGS, the above analysis is a mechanical calculation based on actual market value, and we believe that we have quantitatively presented the upside to investors. We present the specific summary below.

As a company whose core business is M&A, we have consistently emphasized “M&A at appropriate valuations” since we got listed. Specifically, we have emphasized the importance of “investment recovery” (EBITDA of the target company) relative to “invested capital” (EV of the target company) through M&A.

However, we focused only on EBITDA growth of the target company after the M&A in IR to date. While it is true that an increase in cash flow of the target company promotes the investment recovery is good, this is only a means, not an end. We were not able to measure the effect of “investment recovery” relative to “invested capital,” which was the main objective.

Therefore, in this report, in order to measure the effect of “investment recovery” against “invested capital,” we measured the increase in operating cash flow (≒ EBITDA) ÷ the increase in invested capital (=”Incremental ROI”) by using the increase (due to M&A) in GENDA’s consolidated balance sheet (≒EV), not the one of the target company itself, as “invested capital” and the increase in operating cash flow (due to M&A) (≒EBITDA) as “investment recovery” and compared it with other companies in the same industry.

The other companies in the same industry are defined as “companies from a boarder range of industries that similarly employ roll-up M&A strategies within mature markets (p21 of CGS Report)”. There are a number of companies that are engaged in this industry on a large scale in the U.S. Among those companies, the report mentions Waste Management, which conducts roll-up M&A in industrial waste services (Incremental ROI is about 20%), Service Corp International (about 8-9%), which conducts roll-up M&A in funeral services, Rollins (about 25%), which conducts roll-up M&A in pest control industry, and Danaher (about 10%), a leading company that achieves growth through M&A.

In contrast, the result of the analysis shows that our index is approximately 25%, which is the highest level in comparison to other companies in the same industry (“This expected performance compares favorably with global companies in other sectors following a roll-up M&A growth strategy (p. 20)“). Therefore, it is quantitatively shown that it is justified even if valuations are relatively high compared to other companies in the same industry.

However, it is noted that when calculating the EV/EBITDA multiple relative to growth rate, our company is 0.3x while Waste Management is 1.5x, Service Corp International is 1.1x and Rollins is 2.5x (“…at an approx. 70-80% discount. This suggests a strong sense of undervaluation per growth, from an objective standpoint (p.1)”)

EV/EBITDA multiple compared to growth rate is calculated as “EV/EBITDA multiple divided by EBITDA growth rate.” A similar approach is commonly used for PEG (Price/Earnings-to-Growth), which is calculated by dividing P/E multiple by EPS growth rate, but this analysis is performed for EBITDA. The idea behind this approach is that a higher multiple is justified for a company with a higher growth rate. Following is a concrete example.

If Company A and Company B have the same EBITDA (e.g., 10 billion yen), and Company A grows at 10% (11 billion yen, 12.1 billion yen, 13.3 billion yen…) annually while Company B grows at 20% (12 billion yen, 14.4 billion yen, 17.3 billion yen…) annually, even over 3 years alone, EBITDA growth of Company A is 1.3x and that of Company B is 1.7x, which is a large difference, justifying Company A < Company B in corporate value. As a result, even if Company A = Company B in the current EBITDA, it is justified that Company A < Company B in EV/EBITDA multiple calculated by dividing because it is Company A < Company B in corporate value.

In addition to growth rates, higher multiples are also justified if there are higher figures measuring cash flow generation capacity (such as Incremental ROI, ROIC and operating CF conversion rate etc. in the CGS report).

This is because, although EBITDA is a concept similar to cash flow, in reality, it is steady free cash flow from which (taxes and) investments necessary to maintain the business (maintenance CAPEX) are taken into account that affects the theoretical corporate value. In other words, even if EBITDA is the same amount, a company with a higher conversion rate from EBITDA to cash flow will have a higher theoretical corporate value.

From this perspective, the CGS report states, “From FY21 to FY23, GENDA’s invested capital has increased by approx. ¥15.5bn, with cumlative operating CF over the same period totaling around ¥2.9bn (¥3.8bn if including FY24 estimates by CGS). This results in their incremental ROI of 20-25%, which CGS considers an impressive figure based on our long-time investment experience (p. 20).”

Based on that assumption, he added, “Based on the CGS forecast, GENDA’s expected FCF generation per profit growth may not reach the level of Rollins (given differences in organic CapEx requirements and Cash ROIC) but is relatively comparable to Waste Management’s figure. (snp) The EBITDA multiple currently assigned to GENDA per 1% projected growth (0.3x) appears undervalued in light of GENDA’s long-term FCF generation potential. Given GENDA’s expected growth rate, CGS thinks there is considerable upside potential in its current EV/EBITDA multiple from an objective standpoint. (p22).”

The CGS report makes an evaluation based on the capacity to generate cash flow right down the line, centered on EV/EBITDA multiple. We believe that EV/EBITDA, which is a valuation based on cash flow, is more appropriate to evaluate companies which core business is M&A (compared to general PER).

This is because a roll-up M&A style company repeats M&A by relying on its own cash flow or the one of the target company and financing, however, if it cannot raise funds, it cannot conduct M&A and as a result, the growth in corporate and equity value suspends.

In other words, cash flow itself is a source of growth and an indicator of potential for future growth. We will keep showing investors EBITDA, the most common indicator to show cash flow simply, as a KPI which we emphasize.

Regarding PER, since we believe it is show the reality better to use PER based on “current income before amortization of goodwill” (which is a pseudo current income under IFRS) from the viewpoint of cash flow-based valuation and comparison with overseas companies, we present the PER on our website for your reference.

The Definition of Growth

Growth is growth in “Cash EPS,” and we use “EBITDA,” which is a common index to show cash flow simply, as the KPI.

Reproducibility of GENDA’s growth

(1)Appropriate invested capital: M&A at appropriate valuations

(2)Maximize investment recovery: Growth of each company’s cash flow through synergy effects
 →”Flywheel effect” resulting from (1) and (2)

(3)Leverage effect: Raising debt by taking advantage of low interest rates

We believe that GENDA’s growth of “Cash EPS” can be replicated in the future due to the above three factors. We will explain each of them in detail below.

(1)Appropriate invested capital: M&A at appropriate valuations

There are various approaches to stock price calculation, but one of theoretical approaches is the DCF method, which calculates the “stock value per share,” or the theoretical value of the stock price, by “dividing stock value calculated by deducting net interest bearing liability from (current value of) the total amount of future cash flow by the number of stock.”

Of these, the explanatory variable that has the greatest impact on stock value is “the total amount of future cash flows.” There are two main ways of thinking about future cash flows. Specifically, one is to grow future cash flows at the expense of immediate cash flows by making additional investments, and the other is to maximize immediate cash flows by restraining additional investments and return them to shareholders so that future cash flows will be stable.

As in the former case, when additional investment is made at the expense of immediate cash flow, it is meaningless unless the investment recovery by generating cash flow in the future equal to or greater than the invested capital (invested capital < investment recovery). Furthermore, since it must be equal to or greater even after it adds the cost of capital which a listed company is required, the absolute amount must be significantly greater than the invested capital (invested capital < investment recovery).

There are two main means of increasing future cash flow through additional investment: organic growth (opening new stores) and inorganic growth (M&A). Although these two seem to be different, they theoretically have the same economic effect in terms of “economic activity that recovers investment against invested capital.”

  Therefore, we measure the effect by regarding investing one unit of capital for organic growth (opening new stores, etc.) and investing one unit of capital for inorganic growth (M&A) as the same “additional investment.” Specifically, we use IRR to measure capital efficiency (≒a profitability indicator that takes into account the speed of return on invested capital). In order to accurately determine the return to shareholders, we also use Equity IRR, which takes into account the leverage effect of utilization of debt.

However, M&A, which is especially inorganic growth, has the advantage of pursuing the “scale” of the investment. In other words, when considering investment, not only IRR but also “size” that is the absolute amount of increased cash flow (= the size of NPV) is important.

Because of the big “scale” of a single unit of investment, M&A can have the same effect of increasing stock value as opening [100] new amusement arcades or karaoke stores in one year, for example. We believe that you can understand how significant meanings M&A has, considering that it is impossible to open [100] new stores in one year in reality.

Furthermore, in most cases, inorganic growth through our M&A activities results in not only a revenue amount (NPV) but also a rate of return (IRR) that is higher than organic growth. However, we are currently able to achieve both investments in organic growth (new store openings, etc.) and inorganic growth (M&A) because the absolute IRR values for both are well above the expected rate of return for a listed company, and we are able to raise funds for each.

We will continue to invest the funds entrusted to us by our shareholders, both organic and inorganic, in investment projects that we expect will exceed our expected rate of return as a listed company, after making appropriate leverage on the funds. This is because reinvestment of funds is more conducive to maximizing share value than returning them to shareholders as long as it exceeds the expected rate of return.

Therefore, even if the cash flow of the target company does not grow after the M&A, it is possible to increase Cash EPS simply by conducting M&A at an appropriate valuation. The reproducibility of M&A at an appropriate valuation itself has been well documented in the CGS report (“Equity Story 1: GENDA’s M&A strategy shows strong potential for success (P3)“).

(2) Maximize investment recovery: Growth in cash flow of each company through synergy effects

Increased cash flow of the target company after M&A will further accelerate the investment recovery, increase IRR and NPV, and ultimately enable GENDA to achieve the growth that GENDA should aim for. This is the synergy effect, which is the best part of a roll-up M&A.

In addition to the aforementioned (1), it has already been announced that the cash flow (EBITDA) of each target company after M&A has grown and is highly reproducible. By combining (1) and (2), we have shown the “flywheel effect,” which is a cycle in which the initial capital investment (M&A) is appropriate and the subsequent growth in cash flow of the target company further maximizes the investment recovery.

Specifically, in the “M&A Progress and FY2025/1 Q1 Outlook” released on April 23, we disclosed that it had already established a PMI pattern in amusement arcade M&A, and had successfully increased EBITDA (YoY +20% to + 2,970%) on all projects for Takarajima, Sugai Dinos, Avice, Amuzy, YK Corporation and PLABI.

In addition to amusement arcades, Fukuya HD, which designs prizes for prize games, Ares Company, which runs the wholesale of prizes, and Shin Corporation, which runs karaoke business, also increased their EBITDA (YoY +142%, +305% and +85%, respectively), as shown in the “FY2025/1 Q1 Earnings Presentation” released on June 11, showing that it is possible to improve the business performance by generating synergies within the group through the cross-selling of countless products in the entertainment industry by utilizing our Entertainment Ecosystem.

(3) Leverage effect: Debt financing by taking advantage of low interest rates

The flywheel effect of (1) and (2) up to this point alone is sufficient to increase growth in stock value. However, we are thoroughly committed to maximizing the growth of “Cash EPS,” which is the Company’s goal, through the use of debt with low interest rates.

We proactively approach financial institutions and initiate borrowing transactions in “normal times,” and currently we actually borrow from a total of 52 banks and leasing companies. This enables us to raise funds promptly in case of contingency (M&A). We are taking appropriate steps to ensure that financing will not become a bottleneck in our M&A activities, while we also have an option of issuing corporate bonds after the recent capital increase through a public offering.

As described above, we believe that our goal of “growth” can be achieved with reproducibility through M&A at appropriate valuations × growth of each company’s cash flow by synergy effects after M&A × debt financing that takes advantage of low interest rates.