In this newsletter we look for exceptional investments that are uniquely available to small investors.
I like to think of the different reasons why these become available as different ‘classes’. Investment opportunities of a given ‘class’ have a few key traits in common. Understanding these helps us find and assess different opportunities through different ‘mental models’.
Over the past several weeks we have been diving into mutual savings banks. These have a relatively limited upside but are generally very safe and simple to understand.
Today we take a break from that series to dive into an example of a more complicated — and more exciting — ‘class’ of opportunities: quality microcaps.
‘Quality’ companies share the following traits:
They have outstanding business economics.
They have a strong balance sheet with little or no debt.
They have one or more strong competitive advantages.
They are not at risk of becoming obsolete or going out of fashion.
They are growing and have a long runway ahead of them.
They are run by managers with talent and integrity that are also owners.
These are the kind of companies we want to buy and hold — ideally forever.
The trouble with these companies is that because everybody loves them, they tend to trade at very expensive prices.
‘Quality microcap’ companies share all the traits above, plus:
They are very small — typically under $100M in market capitalization. And because management owns a chunk of the company, the volume available to investors (float) is even smaller.
Large institutional investors simply can’t play in this field. They could never deploy enough money into these companies to move the needle. Oftentimes they are downright prohibited by their investors from investing into companies that small.
And because of this, once in a while we are able to find an example that also possesses an elusive eighth trait:
They are available at an attractive price.
Which brings us to today’s opportunity.
The Business
Shin Maint Holdings Co (TSE: 6086) is Japan’s #1 outsourced facility-maintenance network. They connect corporate multi-site chains — mostly restaurants but growing into retail/nursing-care/hotels — to a vetted network of 10,000+ independent local maintenance contractors. 90% of their business is 24/7/365 emergency repair services, with the rest coming from scheduled preventative maintenance.
This business has some wonderful attributes:
It is a cash machine
Some companies make a lot of money on paper but are required to reinvest most of their profits just to ‘replenish their stock’ (maintain facilities, purchase inventory, etc.).
This means that $1 in net income translates into well below $1 in free cashflow for the owners. Free cashflow is what pays the dividends, buys back shares, funds growth, finances accretive acquisitions, etc.
For Shin Maint, $1 in net income translates into over $1 in free cash flow.
This is because the business can grow with almost no need for additional capital investment. Shin Maint also gets paid first and pays the contractors later, so it can actually operate with negative capital.
It has a fortress balance sheet
All that cash generation has allowed Shin Maint to operate without debt and to build a pile of cash equal to 25% of its market capitalization. This gives them a lot of staying power and optionality in a crisis.
It has a strong competitive advantage
Shin Maint business benefits from what is known as network effects. Every new customer Shin Maint wins adds more value to its contractor partners — more demand for their business — and every new contractor Shin Maint signs up adds more value to its existing customers — better response times and broader service-type coverage.
When a business like this gets going, it’s hard for competitors to catch up. In this case, there are only a few competitors remotely close to Shin Maint in terms of network size, and Shin Maint is about to merge with the second largest (more on this below).
The main threat left is large customers taking their business in-house. While this may turn out to be the case for some customers, generally it is not worth it for customers to set up and manage their own in-house maintenance teams, as long as Shin Maint doesn’t overdo it with their pricing.
It provides mission-critical services
90% of Shin Maint’s revenue comes from emergency repair services. Shin Maint’s clients simply can’t operate if their equipment isn’t working.
It is growing and has a long runway ahead of it
Shin Maint has grown revenue at a 15% annual rate and net income at more than a 20% annual rate over the past 8 years. And yet, it only has a 6% share of its target market.
The Japanese maintenance market is very fragmented, and Shin Maint is well positioned to continue taking share through both organic and inorganic growth.
It has talented and aligned management
Shin Maint was founded by Hideo Naito, who remains the Chairman and President. Between Hideo and his son Tsuyoshi, who is the designated successor and an EVP, the Naito family owns 31.6% of the company.
The Naitos have not only grown the company into its current dominant position but have also embraced returning capital to shareholders. They have done this through a consistently growing dividend as well as opportunistic buybacks.
The Value
Price is what you pay, value is what you get. — Warren Buffet
When thinking about the value of a quality business, I like to think in terms of owner earnings.
‘Owner earnings’ is not an accounting term with a clear-cut definition. It means the actual cash an owner could take out of the business without hurting its operations — i.e., after taking care of any necessary maintenance, buying inventory, etc.
At the time of this writing, I estimate we can buy Shin Maint for about 10x its owner earnings. This means that even if the business didn’t grow at all, we could get all of our money back in ten years and still own the business.
While that price wouldn’t be bad for a stable business with a strong competitive advantage, for one that is also growing earnings at a 20% CAGR, it looks like an exceptional bargain.
The Merger
As I mentioned above, Shin Maint is merging with the #2 scaled outsourced facility-maintenance network company in Japan.
The company is called Sanki Services. Sanki is Panasonic Group's designated maintenance provider for large commercial air conditioning and absorption chiller/heat-pump equipment. They also service other OEMs like Daikin, Mitsubishi Electric, etc.
Sanki is also a family business. The Nakajima family owns 34% of the shares. The founder, Yoshikane Nakajima, remains the chairman. Back in 2020, he handed over the role of President and most day-to-day responsibilites to Tatsuo Kitagoe, a company veteran.
Sanki services is a pretty solid business in its own right and has greatly improved since Tatsuo Kitagoe took the reins. Revenue has grown at 16% CAGR and net income at an impressive 37% CAGR over the past 5 years (12% and 35% over the past 2 years).
Sanki runs a hybrid model. Their 2,900-partner network works similarly to Shin Maint’s and is responsible for half of their revenue, while their in-house technician workforce is responsible for the rest.
This partially-fixed cost base makes them more vulnerable than Shin Maint to slowdowns in the economy. For example, it took them over two years to regain their footing after the 2020 COVID crisis, while Shin Maint rebounded strongly in 2021 despite its high exposure to the restaurant industry.
Sanki also benefits less from the negative working capital than Shin Maint does from getting paid first and paying their contractors later.
These relative disadvantages show up in the bottom line. While Sanki has a strong and improving ROCE (18.6% last year), it is still lower than the 20-30% ROCE Shin Maint has maintained for the last decade.
Shin Maint and Sanki are performing a ‘merger of equals’ whereby Sanki shareholders will own about a third of the combined company while Shin Maint shareholders will own the other two thirds.
From a management standpoint, Sanki’s founder and Chairman will become the Chairman for the combined company, while Shin Maint’s founder, President and Chairman will become the President.
The merger doesn’t change the price we are paying, since Sanki is trading at a similar price-to-earnings ratio as Shin Maint.
In terms of the value we are getting, I like Sanki less than I like Shin Maint on a standalone basis, but I think strategically the merger seems smart and the value of the whole should be greater than the sum of the parts.
The Risks
I have painted a pretty rosy picture so far. Time to look into what could go wrong.
They could pursue value-destructive M&A
In their merger presentation, the companies stated that they intend to continue growing through acquisitions, at home and abroad.
Given the current state of the Japanese maintenance market, this could be a very smart way to expand their lead and become dominant in other verticals.
However, there is always the risk that they will overpay or expand into businesses or geographies they don’t really understand. This is something any investor should watch closely.
They could abandon shareholder-friendly capital return strategies
Shin Maint’s management has been pretty forthcoming with dividends and buybacks. 70% of net income over the past 5 years has been returned to shareholders.
Sanki’s track record is worse. The dividend has been steadily rising, but the payout ratio (percent of earnings paid out as dividends) is only 20%. They have never bought back any shares.
If Sanki’s management ends up on top after the leadership transition, there is no guarantee that capital returns will continue at Shin Maint’s historical levels.
The leadership transition could turn ugly
We are going from a family-led business to a two-family-led business where the two patriarch founders are 82 and 71. Leadership transitions in family businesses can be tricky, and in this case, we have not only one, but two families involved.
There are no young Nakajima in management. The most likely case is that the Naito family eventually holds the chairmanship, and professional management runs the day-to-day. Still, you never know…
They could lose a key customer
There is moderate customer concentration. Skylark will account for 18% of combined revenues and Lawson for ~5%. Skylar has its own in-house maintenance team too. While the relationship seems strong and goes back many years, there is a scenario where a significant percent of revenue is suddenly lost.
A different version of this would be for Sanki to lose Panasonic’s designated maintenance provider status. This also seems unlikely.
I wouldn’t expect either occurrence to be more than a temporary setback though.
There could be adverse price action after the merger
Some Sanki shareholders not interested in owning the combined company may dump their stock after the merger, which could depress share prices. This is always a possibility after a merger.
Given how similar the two companies are, this seems unlikely here. And besides, this should only be a temporary dislocation — and possibly an opportunity to buy more.
Labor laws could hinder their business model
Any regulation that greatly increases the obligations of a company like Shin Maint towards its contractors could hurt the economics of the business. You may be familiar with recent instances in New York and California.
Japan passed a ‘Freelance Act’ in 2024. However, it only covers individuals with no employees, and the protections it grants are reasonable.
Last but not least, I don’t speak Japanese
I have compiled over 100 pages of research into Shin Maint, Sanki, their competitors, etc. And yet, other than the financials, I haven’t been able to read any of the original, primary-source documents myself because I don’t speak Japanese.
Instead, I have had to rely on AI to read documents for me, summarize, and answer questions about them. In some cases, I have uncovered inconsistencies by triangulating information between sources.
This also happens doing ‘regular’ research, but I have found that this AI-as-translator process is more prone to misunderstandings than me reading through filings and other documents on my own.
Ultimately, I believe the conclusions in this report are solid, but I could be missing something.
The Verdict
I find this opportunity very compelling and have established a full-sized position.
I invested about two-thirds into Shin Maint and one-third into Sanki, to match the expected composition of the combined company.
Technically Sanki is about 5% cheaper, but this way I am more protected if the merger gets called off.
As for what’s next, my plan is to continue with our mutual savings bank series after this article, but I will make sure to share any other quality opportunities as I find them.
Until then, happy hunting!
The Lynx Investor is for informational and educational purposes only. Nothing published here constitutes financial advice or a recommendation to buy or sell any security. I am not a registered investment advisor. Always do your own research and consult a licensed financial professional before making investment decisions. I may hold positions in securities discussed.
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Me ecanta lo bien estructurados que haces los posts y lo fácil que explicas algo que es tan complejo. ¡Gracias por tus consejos!