Kaonavi (4435 JP)

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Kaonavi (4435 JP —US$182 million) is a Japanese developer of talent management software.

Talent management is a subcategory of the human resources technology market. The recruitment industry makes up the largest part of the industry. The other part is managing people after their employment. And that’s where Kaonavi fits in.

Kaonavi’s software helps companies manage their employees by helping design the organization structure, staffing, evaluations, surveys, training, internal recruitment, etc.

This software has been a massive success. Kaonavi’s revenues have grown at a 35% compound annual growth rate in the past five years. It’s been steadily ramping up its marketing expenditures, on which it enjoys a 10x return. The churn rate is only 5% per year － and falling. Kaonavi is clearly doing something right.

So what’s Kaonavi’s edge? In my view: user-friendliness. Its initial “hook” was the ability to view each employee's pictures and key details. While that feature is somewhat of a gimmick, it does serve a purpose, and Kaonavi has now been able to build a rich feature set around it.

I also think that Kaonavi’s product has significant switching costs. Exporting employee data from Kaonavi’s software is challenging, so customers are more or less tied to the system. With an ever-increasing number of features, the software's stickiness should improve further. Alpha Consulting’s Talent Palette is a competitor, but so far, they haven’t competed much for the same customers.

The long-term outlook is positive. The penetration rate of talent management software in Japan is only 23%. There are reasons to believe this number could eventually reach 60%. You can also estimate the upside by looking at the number of companies in Japan with 100 or more employees: more than 60,000 compared to Kaonavi’s current user base of 3,677. I also think there’s an upside in the current average revenue per user of JPY 187,000/month (US$1,228/month).

The near-term picture is also encouraging:

• Kaonavi just released a complementary labor management product called “Roum Mate”, built on software recently acquired through M&A. Kaonavi thinks this software could eventually reach the same sales and market share as the core talent management system.
• It’s also launched a new budget control system called “Yojitsutic”. This system centralizes budget data, helping management track the performance of each division and keep employees aligned towards key performance indicators.
• The last quarterly billings number suggests a large uptick in new orders, perhaps thanks to the release of these new products.
• The number of Google search queries is now rising +37% year-on-year, with momentum exceeding competitor Talent Palette's.

Kaonavi’s stock now trades at 2.3x EV/Sales, an incredibly low multiple for a Software-as-a-Service stock. This multiple represents half of its historical multiple and also half of those of its peer group.

With long-term operating margin guidance of 20%+, the stock trades at ~10x business model margin-adjusted EV/EBIT. With top-line growth of 20-30%, we should see its multiples contract steadily. On my numbers, the stock will reach an EV/EBIT of 4.5x by 2029e.

Investors are concerned about competition. For example, here is one bearish take. Indeed, Kaonavi’s software is not protected by patents. However, switching costs are high, and the company is gradually improving the platform’s feature set. A low churn rate of 5% and a high LTV/CAC of 10x suggest that growth is going to continue.

Another concern might be that parent Recruit will use Kaonavi’s software for their own benefit. That’s certainly possible. On the other hand, you could equally well argue that having a powerful company like Recruit as a parent should help Kaonavi succeed over the long run. That’s the interpretation that I personally favor.

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