Muddy Waters believes Nidec is significantly overvalued due to very aggressive accounting, poor governance, and very low organic growth. The company’s lofty sales and profit goals have gone unmet for several years.
Muddy Waters Capital LLC (“Muddy Waters”) is short Nidec, and we value its shares at JPY 4,764. We view Nidec as a gigantic stock promotion. The company’s management, led by Mr. Shigenobu Nagamori, repeatedly give uber-bullish predictions about Nidec’s business, and then massively misses them. Nidec missed a three-year forward sales projection by 29%. The company missed its 2015 sales target of JPY 2,000 billion by 41%, and now tells investors that number is its 2020 target. Nidec missed a two-year projected overall operating profit target by 27%. Nidec’s track record with short, medium, and long-term projections in its Automotive product group seems even worse.
On top of the arbitrariness of Nidec’s projections, we calculate the company showed effectively no organic growth over the past four years, despite having projected its organic growth CAGR during this time would be 11.4%. Instead, we calculate that Nidec’s actual organic growth (ex-currency effects and M&A) CAGR from FY 2011 through FY 2015 was only 0.05%. The quality of Nidec’s earnings growth seems poor. We estimate that effective tax rate reductions have boosted Nidec’s reported EPS by 11.4% since FY 2013. Given Nidec’s meager top line organic growth, it is probably fair to say that the vast majority of the remainder of Nidec’s reported EPS growth has been due to currency effects and M&A.
Analysts and investors appear to have gone blind from staring at The Man Hotter Than the Sun. (This is a reference to Mr. Nagamori’s self-published comic book about himself.) Sell-side analysts heap praise on the company, and write about their expectations for future organic growth as though Nidec were a completely different company. At the same time, they remain oblivious to the incessantly missed predictions. As a result, Nidec’s sky high valuation implies a valuation for its non-HDD businesses close to that of Facebook, Inc., which is one of the strongest consumer brands in the world, generates 35%+ organic growth, and generally converts a much higher percentage of its operating cash flow to free cash flow than Nidec does.
Nidec’s failures to meet targets are made even worse by the highly aggressive accounting the company employs to boost reported profitability, and make the trend in its automotive business look more favorable than it really is. Nidec’s JPY 36 billion in write-offs seem unjustified, and could have been improper. According to the company, the write-offs boosted reported profit by JPY 10 billion to JPY 15 billion per year. Nidec has transferred businesses into the Automotive group in ways that misleadingly flatter the Automotive group’s results. Furthermore, we have interviewed four former employees who have attested to Nidec Automotive group salespeople in China stuffing the channels (thereby improperly boosting reported sales). Nidec’s auditor probably offers little safeguard against misleading accounts – in our opinion, Nidec’s auditor is to audit failures what Michael Jordan was to basketball.
Part of the myth underpinning Nidec’s valuation is a notion that it is a superior acquirer of businesses. We think Nidec’s acquisition strategy is more effective at masking weak organic growth than at creating value, and we see the extent to which it generates synergies as greatly overestimated. While Mr. Nagamori speaks publicly about buying companies such as Renesas Electronics Corp. (6723 JP) and Calsonic Kansei Corp. (7248 JP), he makes some highly questionable purchases, such as a recent acquisition of a small Romanian company from a convicted felon. Former employees of some of Nidec’s acquisition targets question the thoroughness of Nidec’s due diligence, and the notion that there were synergies with Nidec’s existing businesses. At the time Nidec announced it was acquiring Ansaldo Sistemi Industriali S.p.A., Mr. Nagamori brushed aside the rare analyst question about whether Nidec would be able to achieve its goal of generating a 10% operating profit margin in the business. The most recent financials we have for that entity show that its OP margin halved since around the time of acquisition to 2.8%. Nidec’s reasons for acquiring minority stakes in six formerly listed subsidiaries are unclear, but we note that Mr. Nagamori received JPY 29.5 billion in Nidec shares (at today’s share price) for his ownership of these companies.
Nidec in our view unduly promotes business opportunities with sex appeal, such as haptics (which led to a write-off), robots, drones, and LIDAR. These exciting products account for a tiny sliver of Nidec’s overall business, and in our view, have received an inordinately large amount of attention from investors. Nidec’s margin on sales of drone motors to Amazon.com (AMZN US) is likely to be significantly compressed once any scale is achieved.
We have real corporate governance concerns about Nidec. There are indications that management is able to override internal controls. Mr. Nagamori’s receipt of Nidec shares worth today approximately JPY 29.5 billion for his stakes in subsidiaries raises questions, as does the JPY 14.5 billion loan he received from the company, which was repaid a few months later by mostly selling his Nidec shares to the company. It is disconcerting that Nidec was unable to hold onto Bunsei Kure, while the company’s Chief Technology Officer, Mikio Katayama, was instrumental in running Sharp into the ground.
We value Nidec’s shares at less than half of the price – JPY 4,764. At the current price, the implied valuation ascribed to its non-HDD businesses is approximately 21.5x EV / EBITDA. (Facebook trades at 24.9x.) Given Nidec’s anemic organic growth, the seeming commoditization of many of its products, and the capital intensity of manufacturing, we can see no reason to justify a share price anywhere close to Nidec’s current valuation. Unfortunately, Nidec’s transparency has been decreasing over the years, and is poised to take a large step backward as the company plans to no longer file financial statements in the U.S. Unless Nidec resolves the U.S. filing and other transparency issues, we believe investors should exercise extreme caution when considering purchasing Nidec’s shares.