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Urbem's 'Wonderful Business' Series: Nihon M&A Center

Tokyo-based Nihon M&A Center (TSE:2127) is Japan's largest independent mergers and acquisitions company with a history of more than 28 years in the space. The company provides M&A support services for small and medium-sized enterprises (referred to as "SME"), mainly domestically. It has also been expanding overseas, with offices established in Singapore and Indonesia and partners across China, India, South Korea and Southeast Asia.

In 1991, two computer salesmen, Yasuhiro Wakebayashi and Suguru Miyake, founded Nihon M&A Center, leveraging their network with accounting firms and financial institutions across the country. Since then, the company has supported over 5,000 friendly merger and acquisition transactions. According to FactSet, the two founders together own over 12% of the company as of Dec. 11, 2019.

Nihon M&A Center delivers its value to customers through efficient matching and high-quality execution. In return, the company charges service fees at multiple stages - before the advisory starts (retainer fee), when a deal is soft-confirmed (interim fee) and when a deal is closed (contingent fee).

We particularly appreciate the dominance of Nihon M&A Center in the SME sector. The company's annual revenue doubles the combined revenues of its two major competitors (Strike Co. (TSE:6196) and M&A Capital Partners (TSE:6080)) and is growing the most rapidly among the three. Its operating margin is also best-in-class, indicating a scale advantage. For the past few years, Nihon M&A Center consistently delivered higher returns on assets than its peers (see below).

We think that the superior asset efficiency at Nihon M&A Center is mainly due to the reputation earned through decades and the expansive deal network. The company cooperates with approximately 100 regional banks (over 90% coverage) and more than 890 top accounting firms in Japan to source sellers and buyers. It also claims to have the largest in-house M&A database, implying a complementary data moat.

Furthermore, the lack of direct participation from large financial conglomerates in the SME niche supports the durability of the market-leading status of Nihon M&A Center. It would not be economically viable for international banks like Nomura (NYSE:NMR) or Mitsubishi UFJ (NYSE:MUFG) to invest capital in this area, which requires a different set of know-how and resources. Instead, they cooperate by introducing deals to Nihon M&A Center in exchange for referral fees.

Moving forward, we believe that the megatrend of the aging population in Japan continues to propel the long-term growth at Nihon M&A Center. These days, Japanese SMEs face unprecedented challenges, including hiring younger leaders, low desire/qualification of family members to take over and an aging workforce. At the same time, the SME segment employs nearly 70% of the total workforce in the country, and 99 out of 100 Japanese businesses are SMEs. This backbone of Japan's economy is creating a massive runway for Nihon M&A Center. The management estimates a total market potential of ?23 trillion yen while expecting to capture total revenue of only ?32.4 billion yen for fiscal 2019.

Nihon M&A Center also reinvests its earnings internally to fuel growth. In addition to overseas expansion, the company enhances its online presence through platforms such as Batonz.jp, the site that offers succession-matching service for micro-cap businesses. Moreover, towards its target client base, it launched adjacency services, including Tokyo PRO Market listing support and Japan Investment Fund.

On the risk front, the M&A business is not immune to economic downturns. Both yearly revenue and operating income at Nihon M&A Center decreased in 2009, the only year of negative growth over more than a decade (see below). Besides, due to the high labor intensity of the consulting model, we remain concerned on the scalability of the business, especially during the current high-growth stage.

Disclosure: The mention of any stock in this article does not constitute an investment recommendation; investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market; we own shares of Nihon M&A Center.

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This article first appeared on GuruFocus.