Daniel Loeb's Comments on Fanuc

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Feb 27, 2015

During the fourth quarter we invested in Fanuc ( FANUY), the leading factory automation and robotics company in the world with a market capitalization of $33 billion and an enterprise value of $25 billion. Based in Japan and spun out of Fujitsu in the 1970’s, Fanuc is a unique company with a long history of being the best and fastest to market in everything it does. Its visionary founder describes the Company’s mission as “walking the narrow path,” which refers to its relentless focus on producing only a limited number of products that are technically superior with the lowest possible cost structure. This targeted innovation combined with a strong emphasis on reliability and service has made virtually all of Fanuc’s products blockbusters. While serving completely different, cyclical markets, Fanuc reminds us of Apple in its product approach.

In its core Factory Automation division, Fanuc has capitalized on structural growth in automation by creating a huge moat in Computerized Numerical Control (“CNC”) systems and servo motors. It has become the global standard for machine tool control software and motors with a worldwide market share of 60%. The Company has built a global service/aftermarket support organization that is unrivaled by competitors in a business where switching costs are high. The division’s revenue correlates closely to Japanese machine tool orders, which are on the rise for multiple reasons including strong demand from the US and a depreciating yen. Additionally, Chinese factory automation is a substantial growth opportunity as rising wages, low productivity, and quality issues force companies in the region to automate. To get a sense of the opportunity: China’s CNC penetration rate of 30% today equals Japan’s levels 40 years ago. Fanuc is expanding CNC capacity by 40% in the next twelve months to meet these higher demand levels. Fanuc’s Robots division has achieved a cumulative sales growth of 60% in the past two years, capitalizing on a robust opportunity set across all major economies. In China, automotive industry robot density is still at less than 15% of the levels seen in Japan, while general industry robot density is at less than 5% of Japan’s. In Japan, capital equipment replacement demand, some re-shoring of manufacturing and labor shortages are creating multiple drivers for robot demand. The resurgence in US manufacturing is also providing strong demand, as automotive and general industry customers are increasing orders for lifting, picking, welding, painting, and dispensing robots. Virtually every large manufacturing footprint expansion in North America – from Airbus to Ford to Tesla – is taking place with Fanuc’s robots. Fanuc’s internal development of low cost full artificial vision systems and collaborative robots makes it best positioned to drive adoption in industries that have traditionally been unable to automate. We think that these innovations will double the size of the Robots division in only a few years.

Finally, Fanuc’s Robodrill product, a small CNC machining center, is a great example of how the Company consistently becomes the manufacturing standard in new industries. A relatively obscure product a few years ago, used only by Apple in its unibody metal casings process, the Robodrill has grown sales six-fold over the past five years. Apple is now using the Robodrill for all of its products and has driven many of its competitors (Samsung, Xiaomi, etc.) to do the same. Due to fragmentation and Fanuc’s cost competitiveness, there is no machine tool company in the world that can step in and create incremental supply sufficient to diminish the profit pool of rising demand, a phenomenon we have seen repeatedly in the semiconductor industry. Fanuc stands to benefit greatly as metal casings become the standard for most smartphone manufacturers and Apple’s CNC replacement cycle takes hold. Fanuc's productivity is among the highest in the world, on track to achieve $2.4 billion of operating profit and 40% margins in FY14 with just 5,500 employees. It is generating 25% more income per employee than Goldman Sachs. This can be explained not only by its dominant market position and significant pricing power but also by the fact that Fanuc practices what it preaches – it uses robots to manufacture everything it sells in assembly plants at the foot of Mount Fuji that run 24/7. Furthermore, this highly automated manufacturing platform has unparalleled vertical integration, as CNCs and servo motors are used internally for robots and Robodrills, allowing Fanuc to amortize its fixed cost base and generate a return on capital in excess of 40%. There is a reason that Fanuc remains cheap at 13x FY15 earnings: the company’s illogical capital structure which does nothing for shareholder value. Fanuc has $8.5 billion of cash, 44 million treasury shares (repurchased from Fujitsu) and no debt, which is hard to understand given the company’s business quality, growth opportunities and low capital intensity. Furthermore, because Fanuc as a rule does not communicate with investors and sellside analysts, its future earning potential is obscured. We believe the stock could rerate significantly if a buyback program was initiated, which the company has done in the past and would be consistent with a trend we have recently observed at a number of far less advantaged Japanese companies.