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Although it has been the largest contributor for the year, DTS saw its earlier gains erode over the quarter with a share price fall of -13%. As our largest position, it reduced returns by 105bps. It is hard to pinpoint a reason for the weakness beyond profit taking. Over the quarter DTS saw revenue growth of +13%, profit growth of +6% and an uptick in orders of +16%. DTS’ EV/EBIT valuation has fallen from 10x at the end of August to 7x, a substantial discount to the peer group’s 12x.

DTS, the IT systems developer, was the largest contributor over the quarter (165bps), with its share price reacting well (+16%) to sales and EBIT growth of +16% and +13% YoY respectively. Orders received leapt +25% YoY, marking a record high for Q1 orders and boding well for continued earnings growth. DTS has been a successful investment, with our thesis premised on the increasing demand for IT investment and an underappreciation by the market for DTS’ growth prospects. We acquired a 10% stake in the Company across AVI’s funds and have been engaging privately on various topics. Bar a few minor points, all our suggestions were accepted and included in a comprehensive mid-term plan announced in May. Since the announcement, DTS’ share price has appreciated by +22% vs +2% for MSCI Japan Small Cap, and year to date is up +40% vs -1% for MSCI Japan Small Cap. DTS’ valuation, albeit less compelling than when we initiated the position, is still attractive with the shares trading on an EV/EBIT multiple of 9x vs peers on 14x. We believe that as the company executes on its plan to double EBITDA by 2030 and return up to 30% of its market cap to shareholders, there is still further upside.

DTS was the largest contributor over the month, with its share price reacting well to first-quarter results, as sales and EBIT grew +16% and +13% YoY respectively, adding 74bps to returns. Orders received also leapt +25% YoY boding well for continued earnings growth. DTS has been a successful investment, with our thesis premised on increasing demand for IT investment and an underappreciation by the market of DTS’ growth prospects. We acquired a 10% stake in the Company across AVI’s funds, and have been engaging privately on various topics. Bar a few minor points, all our suggestions were accepted and included in a comprehensive mid-term plan announced in May. Since the announcement, DTS’ share price has appreciated by +17% vs +7% for MSCI Japan Small Cap, and year to date is up +45% vs +2% for MSCI Japan Small Cap. DTS’ valuation, albeit less compelling than when we initiated the position, is still attractive with the shares trading on an EV/EBIT multiple of 10x vs peers on 14x. We believe that as the company executes on its plan to double EBITDA by 2030 and return up to 28% of its market cap to shareholders, there is still further upside.

DTS (a Japanese provider of IT services) was a meaningful contributor over the month, with its share price reacting well to first-quarter results as sales and EBIT grew +16% and +13% YoY respectively, adding 23bps to returns. Orders received leapt +25%, boding well for continued earnings growth.

DTS has been a successful investment, with our thesis premised on increasing demand for digitalisation and an underappreciation by the market of DTS’ growth prospects. Across AVI’s funds we acquired a 10% stake in the Company and have been engaging privately on various topics. Bar a few minor points, all our suggestions were accepted and included in a comprehensive mid-term plan announced in May. Since the announcement, DTS’ share price has appreciated by +17% vs +7% for MSCI Japan Small Cap, and year to date is up +45% vs +2% for MSCI Japan Small Cap.

DTS’ valuation, albeit less compelling than when we initiated the position, is still attractive trading on an EV/EBIT multiple of 10x vs peers on 14x. As the company executes on its plan to double EBITDA by 2030, and return up to 28% of its market cap to shareholders, we believe there is room for further share price upside.

DTS was the largest contributor over the month and now comfortably the largest over the year. Its +11.8% share price return during July, which added 123bps to performance, came ahead of strong results released on the last day of the month. Sales and EBIT grew +16% and +13% YoY respectively, while orders received grew +25%. Trading on a 3.4% dividend yield coupled with a share buyback program to repurchase 4.1% shares this year and strong earnings growth, DTS’ 9.2x EV/EBIT multiple vs. peers which trade on over 12x seems unjustified. We’re still excited about the potential upside and continue to engage with management as the largest shareholder.

DTS, the IT system developer, was the largest contributor to returns with a +12.6% share price increase adding 71bps to performance. This compared favourably to DTS’ peers with an average share price increase of only +1.8%. DTS’ share price responded positively to a new mid-term plan that included a raft of shareholder-friendly announcements. Beyond higher shareholder returns which could see up to 33% of the market cap returned to shareholders in the next 3 years, DTS announced a strategy to double EBITDA by 2030, increase ROE to 16% and focus on high-value-added IT services. As the largest shareholder, owning 10%, we have been working closely with management and the Board behind the scenes. DTS’ response to our engagement has been exemplary – they allowed us frequent dialogue with senior board members and aside from a few minor issues, actioned all our suggestions. The positive share price performance, and significant outperformance vs the market, is we believe, a testament to our efforts and clearly demonstrates the real value of AVI’s constructive activism – something that we hope will not have gone unnoticed by our other investee companies as well as other investors in the Japanese markets.

On an EV/EBIT of 7.4x vs peers on 14.2x there remains a considerable amount of upside, and as the largest shareholder, we will continue engaging with management to achieve a higher share price.

For the second month in a row, DTS was a top-two contributor, adding 71bps to performance with a +7.6% share price return. The share price responded well to a new mid-term plan that included a raft of shareholder – positive announcements. Beyond higher shareholder returns which could see up to 33% of the market cap returned to shareholders in the next 3 years, DTS announced a strategy to double EBITDA by 2030, increase ROE to 16% and focus on high-value-added IT services. As the largest shareholder, owning 9.9% of the shares, we have been closely working with management and the Board privately. DTS’ response to our engagement has been exemplary – they have listened to our concerns, spent senior management time with us and taken on board our suggestions. The positive share price performance, and significant outperformance vs the market, is we believe, a testament to our efforts and clearly demonstrates the real value of AVI’s constructive activism – something that we hope will not have gone unnoticed by our other investee companies as well as other investors in the Japanese markets. Trading on only an 8x EV/EBIT we think DTS still has considerable upside.

DTS was the largest contributor over the month adding 35bps to performance as its share price increased by +6.4%. The share price moved higher on shifting perceptions surrounding DTS’ attitude towards shareholders, primarily driven by a raft of announcements over the past month. The first announcements came at the end of March, with DTS transitioning to a company with an audit committee, committing to a board composed of a majority independent directors, appointing two female directors (from zero) and changing the chair of the nomination & compensation committee to an outside director. This set the stage for the release of DTS’ results and mid-term plan which came out after market close on the last day of the month. The mid-term plan set a target to double revenue and EBIT by 2030, reduce net cash as % of assets to 40% from current 60% by 2025 and pay-out an average 90% of net income over the next three years.

On an EV/EBIT of 8x vs peers on 14x, there remains a considerable amount of upside, and as the largest shareholder owning just under 10% of the Company, we will continue engaging with management to achieve a higher share price.

It was pleasing to see DTS’ strong share price, increasing +12.6% over the month and adding 98bps to performance. DTS announced a doubling of its share buyback program taking the total shareholder payout ratio to 65%, cancelled 3% of its treasury shares and reported YoY profit growth of +11%.

Trading on an EV/EBIT of 6.9x with net cash covering 41% of the market cap, and with a promising growth outlook, DTS is severely undervalued. We attribute this to poor shareholder communication, a slow shift to digital transformation services, and excess cash. Through our regular meetings with DTS’ Chairman, President, Independent Directors and executive officers, we have been putting forward suggestions on how to address the situation. We have been encouraged by DTS’ response, with management willing to listen to our views and already implementing a number of our suggestions.  In DTS’ 2021 integrated report there were some encouraging comments from the independent directors that suggest the Board supports continued improvement –  “I think IR activity should be further enhanced” and “The issue of how to divert the cash that has been accumulated…is something to be considered going forward”.  We think we are at the start of a transformation in the way DTS is perceived by the investor community and see significant further upside in the share price.

DTS, the portfolio’s 4^th largest position, reported results just before month end. While sales and profits declined by -5% YoY, DTS saw a large upswing in orders, growing +8% QoQ, the highest growth in two years. Encouragingly, digital services (mainly cloud-related) grew +23%, now accounting for 36% of sales. Through our 9% ownership (across AVI funds) we have been engaging with management who have been open to our involvement and have implemented several of our suggestions, including stock-based compensation, improved IR presentation and a more extensive English website. For a business expected to grow at high single digits its 5.9x EV/EBIT valuation is extremely compelling and compares favourably to peers trading on 14.7x.

DTS, our third largest position, reported somewhat lacklustre results, having yet to return to pre-COVID levels of profitability. We are not overly concerned by this short-term weakness and are confident that DTS will benefit handsomely from the long-term structural growth of IT investment in Japan. Being an 8.9% shareholder (the largest), we frequently engage with the company on how to increase the share price. DTS have improved disclosure, introduced a share-based compensation scheme, and undertaken a more aggressive buyback) Over the last month we have held four meetings with DTS, including separate meetings with the President and an outside board member. We think we’ve gained management buy-in to our ideas on how to fix the undervaluation. It’s now a matter of time while they execute. Given our expectations for strong earnings growth, we can afford to be patient.

DTS Corporation – an IT services business – contributed 78bps to returns, as its share price increased by +20%. We first acquired shares in DTS in January 2020, and in combination with other AVI funds, have accumulated an 8.1% stake. As we move towards the formation of the Japanese Government’s Digital Agency in September 2021, the importance of upgrading legacy IT systems is at the forefront of companies’ agendas. We often see mid-term management plans place heavy emphasis on IT investment and we expect that the whole IT sector, including DTS, will benefit from increased demand. Over the quarter, DTS announced strong year-on-year profit growth of 12% and the establishment of a Digital Solutions Department to promote a cloud-first mission that will be headed by the new CEO, Mr. Kitamura. We met with Kitamura at the end of March, who was the head of the Business Solution Department at NTT Data until May 2020. He excitedly shared his ideas on how to transform DTS’s business to more recurring and cloud-based, as well as appreciating that DTS had too much cash on its balance sheet.

Over the past year we have been engaging with DTS, sending a detailed 54-slide presentation to management in June. They have been hugely receptive to our suggestions and although we have only held the shares for 14 months, DTS have implemented a number of our suggestions, including becoming an advanced consulting partner with Amazon AWS, improving the speed of English IR disclosure, and evaluating a stock-based compensation scheme for directors. While these changes are not radical, collectively they matter, and we believe DTS will continue to implement measures to increase its share price. The opportunity for growth and a proactive management team seems to have gone unnoticed by investors, with DTS trading on a 7.3x EV/EBIT multiple vs peers on 15.1x. With the changes that we expect the Company to make over the coming years, we do not expect this anomaly to last.

The third largest detractor was DTS, whose share price fell -5%. The company reported respectable results, with sales and profits down only -1% year-on-year and order intake growing +32% quarter-on-quarter (albeit still down -7% over the year).

Most encouragingly, DTS showed progress on building its Digital Transformation (DX) business, with DX sales growing +17% and accounting for 29% of sales in the first half of the year. DTS is one of our highest conviction ideas. We have been consistently adding to it recently, with the position ending the period at a 6.1% weight.

Pulling Japan’s IT into the 21st century
Japan’s IT systems are outdated, inefficient and in much need of improvement. For example, virtually every government office and company in Japan has a fax machine which relates to Japan’s reliance on the archaic practice of hanko stamps – a stamp required for over 11,000 procedures to sign off documents. During the coronavirus pandemic workers would have to go into the office just to stamp paper documents before either mailing or faxing them – a totally useless task.

High profile events over the quarter, including the Toshiba AGM voting scandal and the TSE shutdown, brought the need for digitalisation to the front of investors’ minds. Toshiba’s voting scandal saw shareholder votes cast at this year’s highly contentious AGM invalidated. The voting system is heavily reliant on counting postal votes, and although they arrived before the deadline the paper votes could not be counted in time. Then, on 1st October, the TSE’s main system failed and the switch to the back-up system malfunctioned, halting trading for the full day – the worst outage since the exchange shifted to an electronic system in 1999.

Suga has placed digitalising Japan’s economy at the centre of his administration. He is legislating for a new digital agency, created a ministerial post for ‘digital transformation’ and appointed a veteran cabinet minister, Taro Kono, to the role of ‘administrative and regulatory reform’. Mr Kono created a system for people to report excessive bureaucracy and within a few hours had received 3,000 emails before he had to suspend the service after being overwhelmed.

For our three IT service providers, this is good for business. AJOT has invested just over 11% of its NAV in DTS Corp, NS Solutions and Kanematsu Electronics (KEL) – all beneficiaries of rising demand for digitalisation. Compared to the US, Japanese companies rely more heavily on the services of third-party IT providers (65% vs 28%). As we approach 2025, a year that METI (Ministry of Economy, Trade and Industry) has coined the digital cliff, Japanese companies will need to increasingly utilise their services.

Our IT service providers are exposed to the same underlying growth trends of the market, yet, for reasons unrelated to their fundamental outlook, trade at steep discounts. DTS, NS Solutions and KEL trade on EV/EBITs of 6.2x, 8.1x and 7.4x, compared to a sector average of 12.9x.

All three companies suffer from inefficient balance sheets, poor shareholder communications, and weak corporate governance. Furthermore, NS Solutions’ & KEL’s valuations suffer from being part of a parent/child ownership structure, which creates a lack of incentive for management and poor protection for minority shareholders.
We are engaging with management to address these issues and we believe if they can be improved in line with our suggestions and the valuation normalises, we could see upsides in the order of 50-100%.

Two recent investments, DTS and NS Solutions, are good examples where we took the opportunity to add to our positions following weaker than anticipated Q1 results. Operating profits fell -22% and -26% respectively, as customers delayed IT investment and existing projects were disrupted by social restrictions. However, we do not believe that the short-term results reflect a change in the appealing long-term prospects for IT service providers.

In 2018 the Ministry of Economy, Trade and Industry (“METI”) warned companies that unless they take action to rectify years of underinvestment in IT systems by 2025, Japan could suffer an economic loss of ¥12 trillion per year, equivalent to 2% of GDP. Currently, 20% of mission critical systems are more than 20 years old (increasing to 60% by 2025) and, as an example of the digital transformation opportunity, an estimated 19% of companies use cloud-based accounting software in Japan compared to 53% and 35% in the USA and UK.

DTS and NS Solutions are well placed to capitalise on the increasing importance of IT investment. Both companies have achieved annualised five-year operating profit growth of more than 10% (12% and 11% respectively) and while we don’t anticipate profit growth to be as strong over the next five years, high-single digit annualised growth should be possible.

Despite the appealing industry dynamics DTS and NS Solutions trade on lowly EV/EBITs of 5.5x and 6.4x. Both companies suffer from inefficient balance sheets, poor shareholder communications, and weak corporate governance. DTS is overlooked by many investors on account of its small size and low level of sell side coverage, and NS Solutions from its parent/child ownership structure with Nippon Steel. These problems are surmountable, and in NS Solutions’ case the parent/child relationship presents an opportunity.

We have been building our investment in DTS and NS Solutions since January and March, and they are now key positions in the portfolio with weights of 4.7% and 4.3%.

Despite the attractive sector backdrop, we were able to identify two IT service companies, DTS and NS Solutions, trading on anomalous valuations of just 6x EV/EBIT with over 40% of their market caps covered by net cash and listed investments. These two companies accounted for 6% of NAV at the end of May.