In conclusion, using an earnings measure from which goodwill amortization has been deducted to determine enterprise value would result in a double deduction of enterprise value for the reasons discussed below.

First, we believe that for a normal company that only does organic growth, it is appropriate to measure it in terms of operating income. This is because depreciation is something that will “actually” continue to cash out in the future due to capital expenditures. We do not believe that it is inherently necessary to add it back to operating income.

On the other hand, there is no additional cash outflow for amortization (of course, capital investment will be made, and the same arguments apply for depreciation as described above). In this respect, it differs significantly from depreciation, that actually need additional cash outflow whereas none for amortization.

Because of this difference, if goodwill amortization is also deducted in the analysis of performance, as discussed below, it is doubly deducted from the value of the enterprise. This is because the cash outflow has already been completed at the completion of the acquisition, it has already been factored into the balance sheet either through a decrease in cash or an increase in debt, and unlike capital expenditures, it will not occur in the future.

In the DCF method, which measures the intrinsic corporate value of a company, the equity value is calculated by adding up all the free cash flows that will be generated forever, and then deducting the “Net Debt” on the balance sheet at the end, which exactly deducts the completed cash out for the M&A. Therefore, judging the M&A company by its operating income afterwards is a double deduction of value.

M&A companies emphasize the addition back of goodwill amortization because only the amortization of goodwill differs from companies with organic growth, and GENDA, in that regard, is an appropriate inspection indicator as long as the goodwill amortization is added back to operating income. In other words, it is precisely speaking, “EBITA”.

In addition, companies that only grow organically basically have zero goodwill amortization, so in a sense, operating income = EBITA as a figure that adds back (zero) goodwill amortization to operating income.

However, EBITA is not an indicator that is displayed in a general-purpose database, so we recommend that you make your decision based on EBITDA, which is a common indicator.

The above is the concept of calculating value on an all-share basis based on the assumption that control is acquired. When looking at value per share without control, we believe that it is common to refer to P/E multiple and compare relative to other companies in the same industry.

For investors who look at valuations of M&A companies in terms of P/E multiple, we believe it is appropriate to think in terms of P/E multiple before goodwill amortization. This is because it is the same as P/E multiple under pseudo IFRS. This is because P/E multiple before goodwill amortization is almost the same regardless of which accounting standard is adopted.

In other words, if GENDA were to adopt IFRS in the future, the P/E multiple based on GENDA’s net income in each database would suddenly drop, giving the appearance of being undervalued, even though there would naturally be no essential change in GENDA, because this is not inherently correct. Therefore, we believe that the P/E multiple before amortization of goodwill, which remains unchanged regardless of which accounting standard is introduced, is appropriate.

On the other hand, P/E multiple before goodwill amortization is not available in general databases, so for your reference, I will explain a simplified way to look at GENDA’s P/E multiple before goodwill amortization. In GENDA’s case, it is “P/E multiple of net income × 0.8x = P/E multiple of net income before amortization of goodwill”.

This is because GENDA’s forecast for the current term is 5.4 billion yen for net income before amortization of goodwill and 4.3 billion yen for net income, a difference of approximately 1.25 times, and thus a PER of (1/1.25=) 0.8 when calculated at 1.25 times the P/E multiple normally seen in a database.

In conclusion, to prioritize the speed of M&A.

Our company, along with SHIFT, became “the company with the most M&A deals in Japan in 2023 (10 deals)”. We went public in July 2023, and we executed those 10 deals (and 15 others combined) in the 5 months following our listing. You can see that we are currently executing M&A projects most speedily in Japan.

On the other hand, all of the subject companies in our past projects have adopted Japanese GAAP, and we believe that this trend is likely to continue. If we adopt IFRS, we will need to recalculate prior year financial statements for the companies we M&A (even if they are small) as if they had adopted IFRS. We understand that this would fall far short of the speed of M&A at the beginning of this section.

In light of the above, when weighing the nominal profit-increasing benefits of IFRS adoption against the speed of our M&A activities, and considering M&A as our biggest growth driver, our final decision was to prioritize the speed of M&A and return the fruits of discontinuous growth to our shareholders, even if we had to forego the adoption of IFRS.

On top of that, in order to compensate for the disadvantages of not adopting IFRS as an M&A company, we are in a situation where we repeatedly emphasize the explanation of EBITDA and income before amortization of goodwill from the perspective of informing investors of the actual situation.

There are many M&A companies (commonly known as Serial Acquirors) in Europe and the United States, and the concept is common in Western capital markets. In addition, IFRS and U.S. GAAP, which do not amortize goodwill, are common for both the M&A company and the acquiror.

In the Japanese market, where the above concept has not been widely accepted, I believe that it will take time for it to spread. Conversely, however, we believe that until the above ideas become widespread, there are still opportunities for further investment by our company. This is because, if GENDA were to switch to IFRS, operating income and net income would suddenly rise significantly, and P/E ratios would suddenly drop significantly, making the company look cheap, even though there would be no substantive difference as a company.

When our company, which aims to be the world’s largest entertainment company by 2040 in terms of market capitalization and EBITDA, is five to ten times larger than it is today, we will reach a point where the overall importance of repeating a number of small M&A transactions will decrease, or the organization will be large enough to handle them adequately. At that time, we will be in a position to make the change to IFRS. At that point, I think it is possible that the benefits of the change to IFRS will prevail at some point.

In conclusion, the various businesses we acquire as M&A companies are not necessarily the same profit margin, and this will naturally occur as we are acquiring businesses with different profit margins. And that is not a problem from an M&A perspective, as we will explain below.

GENDA, as an M&A firm, sometimes acquires companies in industries different from its existing businesses, which causes profit margins to fluctuate. For example, comparing FY2024/1 and FY2025/1, GENDA acquires a karaoke business, and since the profit margin of the karaoke business is lower than that of the amusement arcade business, the profit margin will be lower.

So, in the case of GENDA, based on the above assumptions, would a lower profit margin as a result of M&A be a negative?

Indeed, for many general business companies with only organic growth, it is negative if the same business has a lower profit margin on a year-to-year comparison. However, as an M&A firm, GENDA merges and acquires companies with different business models and different profit margins; therefore, if a company has a lower profit margin, its profit margin will naturally decrease.

So next, is it negative to M&A a company that is less profitable than the existing business?

This is the point in M&A that is a bit difficult to understand, but in conclusion, it depends on the acquisition price.

For example, Shin Corporation, which is responsible for GENDA’s karaoke business, is expected to generate more than ¥2 billion in EBITDA in the proceeding fiscal year, the highest profit in its 35-year history.

The acquisition price of the company is undisclosed, but just as an extreme metaphor for intuitive clarity, if you could buy the company for 100 million yen, would you pass on M&A because of low margins? 100 million yen is an investment that will turn into 2 billion yen a year later.

Rather, forgoing this M&A is what must be avoided as a company is required to maximize shareholder value. In other words, you can see that high or low margins are a means, not an end. GENDA, led by its Investment Committee, adheres to the basic principle of investment, which is solely to invest funds and recover more funds than they are invested.

We would also like to add that we have already seen synergies in many areas of the companies we have acquired, not only in the amusement arcade business, which is our forte, but also in the karaoke business, and these synergies have actually materialized as a result. We will disclose these results at the appropriate time once we have comparable data for a certain period of time after the M&A.

Currently, we continue to see a positive cycle of acquisitions at appropriate valuations and growth for the company.

In conclusion, we have not lost goodwill in either the first half or the full year. In other words, in both the first half and the full year, operating income from M&A target companies > amortization of goodwill from M&A target companies.

Next, I would like to explain the reasons for the year-on-year decrease in profit, although we did not lose goodwill in the first half of the year.

First, due to the seasonal nature of the GENDA group, sales are more heavily weighted toward the second half of the year (August through January), when consecutive holidays and farewell parties are more frequent than in the first half (February through July). On the other hand, amortization of goodwill is expensed on a straight-line basis.

While All.Net usage fees begin to rise, “sales are seasonal, being lower in the first half and higher in the second half,” while “goodwill amortization expenses are always recorded in the same amount in both the first and second half (ultimately, every day of every month),” and if only the first half is taken out, operating income, a profit indicator after goodwill amortization, does not appear to be beating back the cost increase.

On the other hand, if we take only the first half of the year, even after taking into account the increased cost of All.net usage fees, EBITDA is expected to increase significantly from the previous year, even after deducting the impact of amortization of goodwill. GENDA uses EBITDA as an indicator to judge the health of the actual business.

Above all, the company plans to increase operating income after amortization of goodwill by 30% from 5.3 billion yen to 7.0 billion yen for the full year as planned (EBITDA after deducting goodwill amortization is expected to increase by 60%).

Although GENDA tries to avoid “full year” operating income reductions due to goodwill amortization as much as possible, goodwill amortization does not affect the decision-making process in the first place, and “whether the first half of the year is a goodwill loss” is even less relevant to decision-making.

Goodwill is likely to occur when there is a large difference between an asset that has been depreciated on its book value over time (e.g., a karaoke or amusement arcade) and an asset that is generating ample cash flow each year in the future.

At GENDA, we determine the amount of capital to be invested in an M&A transaction based solely on the total amount of cash flow that we expect to recover in the future. In other words, we thoroughly adhere to the basic principle of investment, which is to invest capital and recover more than the amount of capital invested.

This is essentially the same concept that applies to capital investment in the core business, which is the same act of making a capital investment and earning cash flow over and above that through the business. However, in today’s entertainment industry, GENDA has experienced discontinuous growth over the past six years due to the outstanding efficiency of capital investment in mergers and acquisitions (it has succeeded in increasing the amount of money invested to far more than it has invested).

First of all, it is assumed that the acquisition price of the four former Avice stores is recoverable from the cash flow from the four stores, and there is no actual problem from the standpoint of investment recovery, i.e., from the standpoint of M&A.

Rather, GENDA has repeatedly rolled up amusement arcade M&As and generated numerous synergies, and in fact, the four former Avice stores (now referred to as three stores due to a change in store definition) have a high comparable store growth rate of 107% in GENDA’s pre- and post-GENDA in-place comparison.

Despite this, the goodwill impairment is due to the following structural factors in management accounting.

Briefly stated, the four former Avice stores will incur a loss in management accounting if GENDA GiGO Entertainment’s Headquarters SG&A expenses are allocated to the four former Avice stores. However, the existing GiGO stores will incur less expenses, and their profits will increase in management accounting, by the same amount that the Headquarters’ SG&A expenses are allocated to the four former Avice stores. Therefore, the debate is which store will have its profits prorated for management accounting purposes.

On the other hand, from a company-wide perspective, the acquisition of the four former Avice stores has increased both company-wide profits and cash flow, and the increased cash flow will be used to recover the original acquisition price, so there is no problem with this investment.

For details, please refer to page 11 of the “Financial Results for the Fiscal Year Ended January 31, 2024 and Forecast for the Fiscal Year Ending January 31, 2025” disclosed on March 11, 2024.

https://ssl4.eir-parts.net/doc/9166/ir_material_for_fiscal_ym/152154/00.pdf#page=11

Simply put, corporate income taxes will be paid from the fiscal year ending January 31, 2025.

In other words, while total income taxes for the fiscal year ending January 31, 2024, were suppressed to only approximately 200 million yen due to the loss carried forward, the plan for the fiscal year ending January 31, 2025 is approximately 2 billion yen due to the normalization of income tax payments. In fact, the fact that net income is expected to increase despite a 1.8 billion yen increase in income tax payment compared to the previous year is something that would not have been possible without the M&A in the previous year.

While net income, the numerator of EPS, has increased, EPS has decreased because the number of shares outstanding, the denominator, has increased due to the exercise of stock options.

As stated above, this matter does not inherently impair GENDA’s intrinsic value.

In addition, Net income before amortization of goodwill per share (Cash EPS), which reflects the reality of GENDA’s earning power, is expected to grow 18.8% despite a 1.8 billion yen increase in income taxes, from131.91 yen for the full year ended January 31, 2024 to 156.73 yen for the year ending January 31, 2025.

GENDA will continue to pursue “maximization of shareholder value” as well as “maximization of Net income before amortization of goodwill per share (Cash EPS).

In conclusion, we have seen strong organic growth, particularly in amusement arcades and karaoke, in our footprint.

Originally, in the guidance disclosed on January 22, 2024, we expected net sales of approximately 90 billion yen, EBITDA of approximately 12 billion yen, and operating income of approximately 6.5 billion yen (please refer to “M&A Progress and Earnings Forecasts from December 2023” on page 25).

https://ssl4.eir-parts.net/doc/9166/tdnet/2382538/00.pdf#page=25

However, the various synergy measures implemented in the M&A target company have been successful, and we have observed strong organic growth, especially in amusement arcades and karaoke. We will disclose these results at the appropriate time once we have comparable data for a certain period of time after the M&A.