Escalating Data Rules And AI Commoditization Will Pressure Margins

Key Takeaways

• Rising regulatory scrutiny and commoditization of AI tools threaten LY's advertising effectiveness, net margins, and differentiation in a fragmenting digital landscape.
  
• Stagnating user growth and unreliability of new monetization efforts increase exposure to cyclical risks and pressure the long-term sustainability of profits.
  
• AI-driven service integration, digital payments growth, and unified ad platforms position LY for sustained user engagement, revenue diversification, earnings growth, and increased capital efficiency.

Catalysts

Engages in the online advertising and e-commerce businesses in Japan.

• The growing global emphasis on user data privacy-through intensifying regulatory regimes in Japan and abroad-poses a threat to LY's ability to access and leverage consumer data, which will likely weaken the effectiveness of targeted advertising, reducing both digital advertising revenue and the company's long-term profitability.
  
• The rapid proliferation of generative AI could commoditize core aspects of LY's content curation and automation, exposing the company to higher technology costs while eroding the competitive differentiation of their AI-driven services; this could translate into structurally lower net margins even as required investment levels rise.
  
• User growth in LY's mature domestic markets is showing signs of stagnation, and as the broader digital landscape fragments with new entertainment, streaming, and social media platforms vying for user attention, sustained engagement is at risk. Over time, this would constrain both top-line revenue growth and average revenue per user, weighing on earnings expansion.
  
• The company's heavy dependence on advertising and payment platform revenues leaves it exposed to significant cyclical risk, and upcoming ad platform integrations or AI product rollouts have yet to demonstrate clear, material monetization potential. If these efforts fail to deliver, revenue volatility is likely to increase and the company's projected profit growth could prove unsustainable.
  
• Intensifying operational costs for content moderation, AI innovation, and ongoing compliance with cybersecurity and privacy requirements, combined with rising regulatory scrutiny in Japan and globally, will put persistent downward pressure on LY's net margins and threaten the durability of current earnings levels.

LY Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on LY compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming LY's revenue will grow by 6.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 8.0% today to 7.8% in 3 years time.
• The bearish analysts expect earnings to reach ¥178.8 billion (and earnings per share of ¥27.36) by about July 2028, up from ¥153.5 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 18.6x on those 2028 earnings, down from 25.8x today. This future PE is lower than the current PE for the JP Interactive Media and Services industry at 23.9x.
• Analysts expect the number of shares outstanding to decline by 4.99% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.2%, as per the Simply Wall St company report.

LY Future Earnings Per Share Growth

Risks

• The ongoing digital transformation and expansion of AI-driven personalized services, such as AI agents embedded across LINE, Yahoo!, and payment platforms, could drive increased user engagement and retention, which supports sustained growth in revenue and potentially higher net margins.
  
• Continued integration and enhancement of the PayPay platform into a comprehensive digital financial ecosystem leverages the secular trend toward cashless payments in Japan, offering significant runway for GMV and fee income expansion, which would benefit top-line growth and profitability for LY.
  
• Major investments in the development and unification of ad platforms-specifically, the integration of LINE and Yahoo! advertising solutions-are likely to improve ad efficiency and appeal to advertisers over time, which may drive medium-term growth in advertising revenue and improved earnings.
  
• Expansion of MINI Apps and Official Accounts into large, underpenetrated business-to-business digital transformation and sales promotion markets could generate new, high-margin revenue streams, supporting growth in both revenue and net income in the coming years.
  
• Strong shareholder return commitments, including large-scale share buybacks and a policy aiming for over a 70% total payout ratio, directly improve capital efficiency and may enhance earnings per share, which can provide downside protection for the share price.

Valuation

• The assumed bearish price target for LY is ¥440.88, which represents two standard deviations below the consensus price target of ¥574.19. This valuation is based on what can be assumed as the expectations of LY'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 ¥650.0, and the most bearish reporting a price target of just ¥350.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be ¥2304.6 billion, earnings will come to ¥178.8 billion, and it would be trading on a PE ratio of 18.6x, assuming you use a discount rate of 7.2%.
• Given the current share price of ¥556.3, the bearish analyst price target of ¥440.88 is 26.2% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• 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.