Livedoor Illustrates Hazards
Of Investing in Japan Start-Ups
By ANDREW MORSE and ICHIKO FUYUNO 
Staff Reporters of THE WALL STREET JOURNAL
October 29, 2004

TOKYO -- To see some of the challenges presented to investors by Japanese start-ups, take a look at Takafumi Horie and his Internet company, Livedoor.

Since its founding in 1996, Livedoor has had three names and has constantly revamped its business model. The company divulges little about how it makes money, and it is so illiquid an investor could have trouble selling shares without moving the stock price.
Mr. Horie, a 31-year-old university dropout, has become a minor celebrity in Japan, showing off his blue Ferrari on television and pictured in glossy magazines. In a recent interview, he offered little insight into why investors should buy Livedoor shares, saying simply, "We prioritize making our company continue to exist." Livedoor's businesses include Web design, software and running an online brokerage.

While Mr. Horie may be brusque, his business has boomed. Revenue at the company surged 127% to ¥16.23 billion ($152.4 million) in the nine months ended June 30. The strong sales helped push Livedoor to a net profit of ¥2.28 billion for the nine months, after a loss of ¥84 million in the same period a year earlier.

The company is both an enticing and nerve-wracking investment; the share price recently has fluctuated wildly. After hitting ¥1,002 in late June, Livedoor shares have skidded 65%, closing yesterday at ¥346. Analysts who cover the sector can't agree on where the stock will go next.

Livedoor's problems aren't unique, say analysts who cover Japan's colorful small caps, or companies -- often start-ups -- with a market capitalization of below ¥100 billion. The entire sector is crawling with companies that disclose little about their operations and whose shares move mostly on momentum.

In recent years, Japan has helped small companies raise capital by making it easier for them to list. But analysts say investors' perceptions of many small-cap companies are hurt by poor disclosure and illiquidity.

"It takes a bit of courage to buy some of these companies," says Hiroshi Naya, an analyst at Ichiyoshi Securities Research Institute, which specializes in small caps.

In Japan, several markets offer only small caps. Livedoor trades on a market known as Mothers, created in 1999 to specialize in new technology companies. Like many technology-based markets, it has proved volatile. After hitting a peak in July, the Mothers index has slid 46%. The largest market for small companies, the Jasdaq, has dropped 22% from its recent top.

Japanese companies are getting better about disclosure. But few hold analyst meetings or webcast results, a common practice in the U.S. and Europe, analysts say. Claiming that too much disclosure would give competitors insight into their operations, they provide information in bits and pieces, like reporting revenue by business lines, but not breaking down operating income the same way.

Livedoor, which has multiple arms, is trying to buy a baseball franchise. It says it also is interested in running a horse-racing track.

Mr. Horie, who often dispenses management advice on Japanese talk shows, defends diversification as necessary for survival, particularly for companies in fast-changing fields. "It is dangerous to depend on a single business," he says. "A company could go bankrupt by doing that."
But Mr. Horie won't tell investors or analysts how much each of the Livedoor arms contributes to its operating income, which Ichiyoshi Securities estimates hit ¥4.2 billion in the year ended Sept. 30.

The absence of fuller disclosure bothers analysts who like Livedoor.

"If you push them, you can get some idea of how much comes from each business," says Hiroshi Kamide, an analyst at KBC Securities Japan. The analyst, who estimates that about 85% of the company's profit comes from the financial businesses, says he thinks Livedoor shares could rise 70% over the next year.

Another issue with many small caps is their small free-floats, the number of shares available to the investing public rather than kept by the founders or original investors. Mr. Horie holds more than half of Livedoor's shares.

Small Japanese companies will often allow only about 20% of their shares to trade freely, estimates Laurent Halmos, the small-cap analyst at UBS Securities Japan. In the U.S. and Europe, the free-float figure is closer to half, he says. Mr. Halmos, who says he expects the sector to fall, has buy recommendations on only 30% of the Japanese stocks he covers.

Small-cap companies often try to disguise their small free-floats by conducting stock splits, which increase the number of shares outstanding without changing proportionate ownership. Splits, which usually create new shares in ratios of 5-for-1 or 10-for-1, will often boost a company's adjusted share price, says Mr. Halmos of UBS. That's because investors feel more comfortable buying it since they can trade it more easily, he says.
Livedoor has also played the stock-split game, in dramatic fashion. Last Christmas, Mr. Horie conducted a 100-for-1 split that pushed shares almost three and a half times higher on an adjusted basis. In June, he announced a more modest 10-for-1 split that again pushed shares higher.

To be sure, start-ups remain attractive because of their high growth potential. Outside of Japan, once-little enterprises such as Yahoo, Amazon.com and eBay have gone from start-up chaos to established brand names. In Japan, Rakuten, a successful Internet company, has become something of a household name.

Peter Tasker, a strategist at Dresdner Kleinwort Wasserstein, considers many older small caps, such as machinery manufacturers, worth attention because they have benefited from the rise of China's economy. With more small stocks than large ones, a savvy investor who puts in the time and effort will be able to find bargains, Mr. Tasker wrote in a recent report.

Nevertheless, he said, many small caps remain expensive, and "finding good investments will be much harder work."

Write to Andrew Morse at andrew.morse@wsj.com and Ichiko Fuyuno at ichiko.fuyuno@wsj.com 

Wall Street Journal, October 29, 2004