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Japan-Update

Rakuten's profitability takes a hit on e-commerce costs

Cultivating online flea market operations proves a financial burden

TOKYO -- Profitability at Rakuten is suffering as the Japanese virtual mall operator pours funds into the online flea market business to revive floundering e-commerce operations that must increasingly contend with the likes of Amazon.com.

Consolidated operating profit jumped 39% on the year to 68.6 billion yen ($619 million) for the half ended June 30 under international accounting standards. The operating margin rose 2.2 percentage points to nearly 16%. But these figures should not be taken at face value.

A look at the "other income" line paints a clearer picture. It quintupled to 17.8 billion yen, thanks to unrealized gains from such investments abroad as a car-sharing business in the U.S. Excluding these temporary factors, profitability retreated to around 12% as margins continued to deteriorate.

Competition with Amazon and Yahoo! has dulled growth in Rakuten's virtual mall operations. April-June margins for domestic e-commerce operations fell nearly 5 points to about 19%. Although sales rose thanks to growth in the direct sales business, where Rakuten stocks and sells products on its own, rising costs from flea market app investment are lowering profitability.

Last September, Rakuten acquired Fablic, the provider of the Fril flea market app that the e-commerce giant hopes will be its next big growth engine. Fril is Japan's second-largest flea market app but trails top player Mercari in size and name recognition. After the purchase, Rakuten waived Fril's commissions on sales in order to catch up with Mercari, and such marketing costs as television commercials have ballooned.

"It is hard to expect better profitability right now," a domestic securities analyst said. Investors are not actively buying Rakuten shares, with prices hovering around the 1,300 yen range -- substantially below the recent peak of 2,395 yen reached in April 2015.

But the online flea market business enjoys considerable room for growth. "The value of transactions on our flea market app has reached 100 billion yen," Rakuten CEO Hiroshi Mikitani proudly told a news conference Monday. Transactions on such apps reached 300 billion yen in 2016, according to the Ministry of Economy, Trade and Industry, and could near 1 trillion yen eventually.

Deteriorating profitability is one growing pain for a company undergoing business model changes. E-commerce costs could remain high as Rakuten tries to expand Fril's market share. Profitability and share price will hinge on whether the company can reap the fruits of its labor in the online flea market business.

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