Japanese Market Pressures Will Squeeze Margins Yet Recovery Emerges

Key Takeaways

• Heavy investment in new technologies, metaverse, and proprietary content is weighing on short-term profits and creating risk if monetization is slower than expected.
  
• Reliance on the Japanese market and existing revenue streams, coupled with rising competition and user demographics, could structurally limit growth and profit recovery.
  
• Heavy investments and slow new business growth, coupled with sales underperformance and reliance on a shrinking domestic market, threaten profitability and future revenue stability.

Catalysts

Engages in game and Metaverse businesses.

• Although GREE Holdings is positioned to benefit from the growth of the global digital economy and expanding online communities, the company faces a near-term profitability squeeze as upfront investments in new game development, the metaverse, and proprietary IP depress operating margins and earnings, particularly with costs peaking before expected revenue contribution from these projects.
  
• While long-term smartphone adoption and digital entertainment demand provide a secular tailwind for GREE's expanding VTuber and platform businesses, persistent declines or delays in existing revenue streams-such as weak avatar sales and postponed anime distribution revenue-could result in flat topline growth and muted near-term net profit improvements.
  
• Despite ongoing diversification into blockchain, Web3, and merchandising, GREE's transition to new business models requires substantial R&D and marketing spend, and there is significant risk these segments will not mature quickly or generate sustainable profits, increasing the company's exposure to lower net margins if monetization lags.
  
• Although international expansion and operating leverage in digital distribution are potential growth drivers, GREE continues to be heavily reliant on the domestic Japanese market, making it vulnerable to Japan's aging core user base, which could structurally limit revenue growth and decrease average revenue per user over the long term.
  
• While strategic partnerships and content pipeline enhancements are underway, intensifying competition from global and Asian mobile gaming studios, as well as tightening regulations and rising platform fees, may further erode GREE's market share and pressure both gross margins and future earnings recovery.

GREE Holdings Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on GREE Holdings compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming GREE Holdings's revenue will grow by 5.4% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 2.1% today to 9.3% in 3 years time.
• The bearish analysts expect earnings to reach ¥6.2 billion (and earnings per share of ¥36.3) by about August 2028, up from ¥1.2 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 20.4x on those 2028 earnings, down from 65.9x today. This future PE is lower than the current PE for the JP Entertainment industry at 24.2x.
• Analysts expect the number of shares outstanding to grow by 0.16% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.31%, as per the Simply Wall St company report.

GREE Holdings Future Earnings Per Share Growth

Risks

• GREE Holdings continues to report declining or flat sales in several business segments, including the Game and DX businesses, as well as underperformance in reaching annual sales targets, which could pressure overall company revenue and future growth prospects.
  
• Heavy upfront investments in new game development, VTuber talent acquisition, and transition to recurring-revenue models are causing profitability to decline in the near term, and there is considerable uncertainty whether these new initiatives will mature quickly enough to offset rising development and operating costs, threatening both net margins and future earnings.
  
• The medium-term sales target for the Game business was revised downward by eighteen percent due to a reassessment of the development pipeline and other factors, indicating management's lower confidence in future sales growth and raising concerns over the company's ability to consistently deliver hits necessary to drive top-line revenue.
  
• The Metaverse and IP businesses face challenges such as weaker-than-expected avatar sales and negative earnings contributions from proprietary anime projects, as well as ongoing one-off costs, increasing the risk that growth businesses may not reliably achieve profitability or provide support to group earnings.
  
• GREE's international expansion efforts and attempts to diversify revenue streams, particularly in new business lines and through M&A, are still at a nascent stage with limited scale, which leaves the company heavily reliant on its shrinking domestic market and exposes it to risks of stagnating or declining revenue as domestic demographics worsen.

Valuation

• The assumed bearish price target for GREE Holdings is ¥580.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of GREE Holdings's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ¥800.0, and the most bearish reporting a price target of just ¥580.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be ¥66.9 billion, earnings will come to ¥6.2 billion, and it would be trading on a PE ratio of 20.4x, assuming you use a discount rate of 8.3%.
  
• Given the current share price of ¥459.0, the bearish analyst price target of ¥580.0 is 20.9% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.