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Play the wireless Internet revolution with this forgotten Japanese electronics giant
by James Passin
"Convergence" is an ugly word. But it's an inevitable yet potentially lucrative trend. Internet, TV, radio, telephony are converging into a seamless reality. The first great .com era was about bringing people to the Internet. I believe the next .com era will be about bringing the Internet to the people.
LCD screens will be imbedded into nearly every artifact of daily life. Wireless technologies will add Internet connectivity to appliances and clothing. Eventually, nanotechnology will enable the direct exchange of data between your body and the Internet.
 One of the pillars of convergence is miniaturization. As chips and circuit boards shrink in size, the consumer applications get more compelling (remember the once fashionable bag phones of the mid 1980s?). And no one knows more about miniaturizing electronics than the Japanese.
Casio Computer Co., Ltd. (CSIOY-OTC) is a leading manufacturer of branded consumer electronics. Casio dominates the lower- to mid- end market for digital watches and calculators. With over US$3.5 billion in annual sales, Casio is a global marketing powerhouse. Recently, Casio has switched its focus to value-added Internet products. I believe that Casio will dominate the exploding market for cheap wireless devices.
At current levels, Casio is trading at just 0.7x sales and 1.4x book value. If Casio succeeds in transforming itself into a major wireless/Internet player, the current market capitalization will look like a joke. As a conservative, long-term, blue chip play on the market for wireless Internet access, I recommend Casio as a Strong Buy at current levels.
Rising sun
Japanese manufacturers tend to suffer from unacceptably low profitability. Casio is no exception. In 1999, Casio generated a pathetic operation profit margin of 2.8%. The old line Japanese companies suffer from excessively high fixed costs. An inflexible labor market and culture of bureaucracy make it difficult for managers to squeeze out fat. Lacking in any clear shareholder value focus, managers have squandered capital on worthless investments, piling up assets and hurting return on equity (ROE).
This view is the consensus. But it no longer describes corporate reality in Japan. Unemployment recently hit a post-WWII high — an unequivocal sign that the labor market is loosening up. Managers at Internet companies have been rewarded with exploding stock prices (Yahoo Japan climbed from US$4,000 to US$1,000,000 per share since the 1997 IPO!). The gray-suited career middle managers are doomed to disappear...
In my opinion, the long-awaited restructuring of corporate Japan is already occurring. You can position yourself now or wait for mainstream investors to pile into the market.
Voodoo analysis
The collapse of the dollar against the yen is over. Technically, it's evident that the dollar has hit a major bottom. The yen broke the 100-day moving average in early January. If you follow voodoo technical analysis, you can see the clear head-and-shoulders bottom on the daily chart. In my view, the dollar could rally to 120-125 against the yen.
The reversal of the yen signals the end of the deflationary era. Japan has been trapped in a deflationary spiral since the collapse of the 1980s equity bubble. In a deflationary environment, falling prices trigger falling prices. Deflation tends to lead to a rising currency, since a decline in the general level of prices is equivalent to an increase in real purchasing power. A sustained weakening of the yen would indicate that the massive expansion in Japan's monetary base in the late 1990s and loose fiscal policy has finally kickstarted a reflationary spiral.
 The Japanese exporters have been clamoring for yen weakness. If your sales are denominated in dollars and your costs are denominated in yen, you want the yen to decline. The robust yen has strangled profit margins for even the most competitive exporters. I suspect that lobbyists and bagmen have finally persuaded the central bank to quietly intervene against the yen (I wouldn't be surprised to see a "coincidental" yen downtrend lasting until mid-March, right before the end of the Japanese fiscal year).
Casio immediately benefits from yen weakness. 50% of Casio's sales are exports, while almost 100% of Casio's costs are in yen. If my bearish outlook for the yen is accurate, then Casio is on the verge of a dramatic turnaround in profitability.
Casio's stock price exhibits a high inverse correlation with the yen. The major peaks and valleys line up when you eyeball a chart. Applying an historical regression analysis, there is a strong 50% statistical correlation between the yen and Casio. Based on my technical view of the yen, a significant rally in Casio is imminent.
Escalating inflationary fears will force Japanese households to switch their savings from bank deposits to equities. Since the average household has US$200,000 in savings, this represents a tremendous source of liquidity for the stock market.
Just as the Koreans converted into daytrading fanatics (only one year after the Asian crisis), the Japanese are culturally susceptible to the e-trading bug. NASDAQ and Softbank are setting up new electronic exchanges in Japan to bypass the traditional Yakuza-tied brokerage industry. Casio's new wireless devices will become handheld platforms for daytrading. The Japanese stock market is setting up for speculative frenzy... And, of course, the money will flow into tech stocks like Casio...
Robust brand equity
I remember banging on a Casio keyboard when I was 10 or 11. My parents were grateful that I quickly abandoned my music career. While a Casio is no Yamaha (and I am no Kitaro), it is dirt cheap — and fun for children.
Electronic musical instruments only represent 11% of total sales and are insignificant contributors to operating profits. In fact, this product segment declined 10% in 1998 and 25% 1999 in absolute (yen) terms. Casio is deploying its resources in higher margin, faster growing product segments.
But I bring up the ubiquitous Casio keyboard as a strong testimony to the company's marketing and distribution muscle. It's hard to find a household that wasn't graced at some point with a Casio keyboard.
I've owned numerous Casio calculators over the years. While I've never owned a Casio watch, I see them everywhere. Casio has a deep understanding of the consumer electronics market and rock solid market position.
Casio crushed the high end market for digital watches with its G-Shock brand in 1998. G-Shock and Baby-G's rugged metal and plastic construction appealed to young consumers in the U.S., Japan, and Europe. While the initial trendiness of G-Shock is beginning to wane, it is still a powerful brand.
Real estate of the wrist
Casio recently unveiled its new line of value-added digital watches. The Casio Wrist Audio Player can play 30 minutes worth of CD-quality music using MP3 compression. You can download music from your computer to the watch. Headphones attach to the watch. The retail price of watch will be around US$200.
The Casio PC Unite is an amazing watch: it can exchange data with Palm Pilots using infrared signals. The retail price will be around US$100. Casio Wrist Camera is an excellent spy gadget. You can take up to 100 digital black-and-white photos in JPEG or BMP formats with your watch. The retail price will be around US$200.
I anticipate that sales of Casio's new watches will explode. None of them are excessively bulky or expensive. The wrist represents prime real estate for the Internet era. Everyone wears a watch. I glance at my watch five or six times per day. There is no more convenient Internet terminal than the face of a digital watch. I would expect Casio to increase the breadth of its value-added product line with a co-branded wireless watch over the next eighteen months.
Forget Palm
Palm Pilots (made by COMS-NASDAQ) are a pain in the neck. I can't stare at the screen without getting a headache. Call me an idiot, but I can't get the hang of Palm's orthography. Don't get me wrong: Palm Pilots are great products. But there's definitely room for a more convenient device.
Casio's Cassiopeia handheld PC is widely regarded as superior to the Palm Pilot. But sales have fallen below expectations. The initial retail price of ¥79,800 (US$730) priced it out of the market. Only 300,000 Cassiopeias have been sold worldwide. While international sales have dragged, Cassiopeia has achieved the #2 market position in Japan. Recently, Casio linked up with NTT DoCoMo (Japan's cellular giant) to produce a Cassiopeia for DoCoMo phones. While the market views Cassiopeia as a failure, I view it as an invaluable training ground for Casio's next generation palm-sized PCs.
Casio's master plan
Casio has been forging some interesting alliances. While Casio could easily have jumped on the Java (SUNW-NASDAQ) or Linux bandwagon, Casio partnered with Microsoft (MSFT-NASDAQ). Software gurus consider Windows CE to be an inferior operating system for handheld devices. They're probably right. But Microsoft desperately wants to extend its global hegemony to wireless software architecture. As the PC loses relevance, control over the post-PC operating systems becomes critically imporant. Bill Gates' return to the software side of the business suggests that Microsoft isn't going to bend over willingly. Casio has made itself a preeminent component of Microsoft's grand strategy for survival.
Casio's agreement with AOL (AOL-NYSE) is highly significant. Casio acquires access to AOL's 20 million Internet subscribers. While I personally detest AOL's service, it has an unrivalled brand and tremendous marketing power. Like Microsoft, AOL will stop at nothing to achieve a quasi-monopoly position. Casio's systematic choice to side with market leaders, however imperfect their products, reveals the brilliance of management's master plan.
Recently, Casio announced separate agreements with both Siemens and Vodafone to develop palm-sized wireless Internet devices. Neither Siemens nor Vodafone would have partnered with Casio unless they believed in the company's miniaturization technology.
The total worldwide market for palm-sized computers is expected to grow four fold to US$7 billion by 2003. Assuming 20% market penetration, Casio's handheld PC division will generate US$1.4 billion in sales. Projecting a 4x price/sales multiple, this would imply a US$5.6 billion market cap for this division alone — double the current share price. The coming flotation of 3Com's Palm Products subsidiary is likely to trigger a re-rating of Casio.
Ball bumping IPO
Casio is taking concrete action to realize value in the company. Casio is planning to spin off Casio Micronics in an IPO. Casio Micronics is involved in semiconductor capital equipment. This subsidiary has the world's largest market share of "ball bumping," a new method of semiconductor packaging (the old connectors are made of metal pins; the new connectors are spherical). Casio Micronics's rapid sales growth, healthy margins, and unique story warrant an independent listing. The successful flotation of Casio Micronics should give a huge short-term boost to Casio shareholders.
I am extremely bullish on Casio's liquid crystal display (LCD) division. Casio specializes in small LCDs called thin-film-transistor LCDs, or TFT-LCDs. There are only two significant competitors in the TFT-LCD market: Sharp and Hosiden (HOD-GR). TFT-LCDs are tiny flat screens used in digital video cameras. Eventually, LCDs will be embedded everywhere (washing machines, toilet stalls, dashboards).
Buy this giant today!
Given Casio's massive sales force, extensive distribution channels, outstanding brand name, and powerful partners, I believe that the company's Internet strategy has a high probability of success. Casio's current market cap does not reflect any significant "Internet bubble" valuation. Regardless of the success of future products, the imminent rebound in the dollar/yen exchange rate will lead to a material recovery of profitability.
I consider Casio to be a Japanese turnaround story with an Internet kicker. While Casio ADRs trade in the US under ticker CSIOY, the ADR is illiquid. The Berlin-traded Casio GDRs are a better buy (CAC-Berlin). 10 GDRs = 1 ADR (the GDR is trading around US$9; the ADR is trading around US$90). However, you will need to have access to foreign stocks to trade the GDR (I recommend contacting Peter Schiff, Euro Pacific Capital, tel. 949-863-9500). Casio ADR (CSIOY) is a Strong Buy under US$90 with a three year target of US$300.
James Passin is a Portfolio Manager with Firebird Management and Contributing Editor to Taipan. James Passin's views are strictly his own and not necessarily the views of Firebird Management or Taipan.
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