01 Apr Adapting the Search for Hidden Champions in Asia
“You look at all the successful companies, what is the key? Their brainpower. The thinker, good management, good innovators… Successful CEOs are like gems you find on a beach. There are many pebbles, many beautifully colored ones, but they are all stones. Now and again, you will come across a real precious gem, a real emerald, pick it up, polish it. He must have a set of qualities that fits with the job, has energy, drive, ability to interact with people, ability to get people to work with him in a team.”
– Lee Kuan Yew, founding Prime Minister of modern Singapore, in Hard Truths to Keep Singapore Going
In the Asian capital jungles, outbreaks of accounting frauds, corporate governance lapses, and asset expropriation are erupting on a systematic basis at the firm level. These render elaborate quant screens and valuation metrics increasingly less relevant, and value investors need to go the extra mile beyond the accounting numbers and factors.
Good is not the absence of evil. Even if the investor somehow manages to eliminate the “evil” ones with potential mis-governance and accounting tunnelling fraud to limit the downside risks, we might still neglect and overlook the good resilient compounders.
Each time there is a credit crisis punctuating the markets, there is an increasing premium on valuation for wide-moat business models in Asia as the Innovators stand apart from the Imitators and the swarming Incompetents.
Value investors in Asia need to take the leap to become more Munger-like in selecting companies with wide-moats that can generate compounding returns, rather than dwell with a false sense of security in the realm of statistically cheap stocks that can turn out to be either fraudulent or value traps as time progresses.
Value investors also cannot scale up their position size in these stocks with conviction, especially in the Asian capital jungles. The fund manager that takes on new money “diversifies” into more stocks in hundreds of small bets that melt down with a destructive destabilising price impact in systematic risk and market deleveraging situations. This results in the all-too-common phenomenon in which managing a bigger asset size perils performance to achieve superior long-run investment returns.
Thus, we have focused on a two-step process to identify wide-moat compounders in the Asian capital jungles:
Step 1: Eliminating firms with potential accounting fraud and mis-governance risks, taking away the fear factor of investing in fraudulent stocks. These are stocks with deceptive visual signals that include low price-to-book, low PE ratios, high profit margins and ROE, decent accounts receivables & inventory turnover period and high net cash / high net current asset value as percentage of market cap.
Accounting information can be used to inform or to deceive. In other words, Step 1 eliminates Asian companies which escape the western-based financial tools by intricate “tunnelling” acts via unusual related-party transactions, money-go-round off balance sheet activities, consolidation craftiness fraud, and so on, leaving defiled returns for the minority shareholders;
Step 2: Analysing and assessing the business model for its resiliency, innovations, and wide-moat characteristics to eliminate the risk of investing in value traps. This cause companies appear cheap based on conventional valuation metrics such as Price-Earnings Ratio but their business models may have hit a stall point in scaling up further, and cheap gets cheaper.
To assess whether companies can overcome a crisis, we systematically evaluate the underlying source of the wide-moat:
(1) the “indestructible intangible asset” that stems from having proprietary know-how in product, process, and first-hand knowledge of the ground situation. This is accompanied by their focused targeted under-served customer group, and/or the trust and support from its community of suppliers and partners;
(2) the “core-periphery network” concerning decentralisation and empowerment of the frontliners, scaling the business with technology as an enabler embedded into the business model design; and
(3) the “open innovation model” in working with internal and external partners to co-develop new products.
We believe we are fairly adept in Step 1; we are honoured and grateful to have had the opportunity to share our thoughts and to have a sincere and productive conversation on 23 September 2015 with the top management team of the Monetary Authority of Singapore (MAS) – Mr Paul Yuen, Head of Market Conduct; Ms Gillian Tan, Head of Enforcement Division; Ms Lee King See, Director (Enforcement & Investigations); Mr Ang Eng Seng, Deputy Director; Mr Eric Chia, Deputy Director; and the team at the Secondary Markets & Enforcement Division – about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore as well as the public and investment community.
When it comes to Step 2, it is easy to commit the mistake of fitting what we see and learn about the competitiveness of the firm into the “model” of wide-moat characteristics such as “high switching cost”, “network effect”, “low cost advantage”, “efficient scale”, or “intangible assets”.
This descriptive approach into fitting observations into the model is categorisation through analogy, and its #1 flaw is stocks are categorised into moats AFTER they become obvious.
We realise that for the wide-moat companies in which we have thought deeper about a Step 3 –
Step 3: The story and validated committed actions of how when they Love, Serve, and Care with a Purpose larger than themselves, they tend to outperform.
In essence, the story of Lee Kuan Yew and the founding pioneers and entrepreneurs of Singapore Inc, visionaries, business model architects, and capital allocators-administrators par excellence bringing important experiences and making critical choices that leave a lasting organisational imprint.
The “real precious gems” Lee Kuan Yew describes in the opening quote that clearly distinguish themselves from the “many beautifully colored” pebbles on the beach “but they are all stones”.
Consider this: Would you use cheap wood for the back of a cabinet, since nobody is going to see it?
A great carpenter wouldn’t. Steve Jobs and Warren Buffett wouldn’t.
Steve Jobs shared the story of how he was inspired by his dad who taught the young Jobs that it was important to craft the back of cabinets and fences properly, even though they were hidden.
“He loved doing things right. He even cared about the look of the parts you couldn’t see,” Jobs explained, a motto that guided him to build Apple with a craftsmanship drive and “process” to make “insanely great” creations that customers love to use and that will “put a dent in the universe”.
In his inspiring book The Carpenter: A Story About the Greatest Success Strategies of All, Jon Gordon explained that while a carpenter builds things, a great carpenter creates a work of art like a craftsman. While most people approach their work with the mindset that they just want to get it done, craftsmen are more concerned with who they are becoming and what they are creating rather than how fast they will finish it. After all, it’s no use finishing something if it’s not a work of art.
Craftsmen would pour their hearts and souls and love into everything they build, knowing that everything they create is a reflection of themselves. When they create art, they feel energised and they energise all those who experience their work. And with each creation, they become more of the person they were meant to be.
Warren Buffett’s greatest investing strategy of all is having an eye for these “great carpenters”. These great carpenters take the form of outstanding entrepreneurs who put their love into the work they do.
Love isn’t just a feeling. It is a commitment and ongoing action. Choosing to love meant you were choosing to make a commitment to love regardless of how you feel and you will put love into action regardless of your circumstances.
Like Nebraska Furniture Mart’s Mrs B, whose work ethics were phenomenal: “I come home to eat and sleep, and that’s about it. I can’t wait until it gets daylight so I can get back to the business.” She was on the floor until retiring at 103, and died the following year in 1998. She was committed to serving her customers with dedication. Because we Love, we Serve. And when we serve others, we fill up their cup and our own with love as well.
As Buffett explained, “One question I always ask myself in appraising a business is… [to identify the] business built upon delivering exceptional value to the customer that in turn translates into exceptional economies for its owners”.
Buffett elaborated further that everyone should study Mrs B: “They would learn the essence of business. They would learn that taking care of customers is what it is all about. Taking care of them… She did and working like crazy she was there day after day. She had a passion for it.”
Buffett summed up his value investing philosophy: “When we buy businesses, we are looking for people that will not lose an ounce of passion for the business even after their business is sold.”
In essence, Buffett goes beyond the numbers to identify wide-moat innovators by also sensing that an entrepreneur takes care of his or her customers in a deep way and keeps delivering exceptional value to them. Even if it means pain and sacrifice. Even if it takes a long time, working day-in-day-out. Even if they grow rich. All possible only because they are committed to an idea larger than themselves to serve others.
When you love and serve, you care about the work you do and show people you care about them; you stand out in a world where most don’t care. The world will flock to people who care and buy products that were made with care, and support businesses that care.
We can tell whether the person making the products or services cared enough to make it great. When we care, we build things that others care about. When we care, we are craftsmen and craftswomen who are always looking to get better, work harder, and care more.
Until we go the distance and extra mile in Step 3 – the story and validated committed actions of how they Love, Serve, and Care with a Purpose Larger than Themselves – we could fall into the dangerous trap of overpaying for the moat even if the valuation metrics appear cheaper with seemingly lower downside risks.
We dig deep into the underlying source of the wide-moat before we commit your funds. Consider SET-listed Major Cineplex, which delivered a 77.4% return in local currency from our investment cost for our portfolio. Major is Thailand’s dominant cinema chain operator with an 80% domestic market share, a “spider-web” lifestyle entertainment business model attracting 25-30 million Thai consumers to its “destination to be”.
Major’s CEO Vicha Poolvaraluck shared how he cares deeply about the consumer experience, using creativity to fight foreign competition that dominated the local cinema industry. Vicha elaborated that he made:
“all theatres different, more colorful and invested in interior decoration. Thais are people who are eager to see and experience something new and exciting all the time. In the West, many theatres may use the same style of carpet for three or more years without any renovation. But I cannot do that with my cinema here. If people get bored with the atmosphere of the place, they can instead stay at home and watch a DVD. We have to always make everything fresh [design and concept of the cinema] to draw them to go out of home.”
Vicha demonstrated his love and care to serve his customers in the committed action of taking photos of nice places during his travels and sending them to his marketing and engineering team to see the possibility of adapting the décor, carpet, toilet, unique objects, welcome drinks, and services to the cinema.
Consider another portfolio stock that we had accumulated around 3.5% of our NAV in the second-half of the financial year: a unique “Retail Wonderland in Home Improvement” which dominates the customer wallet share and mind share in its region.
The entrepreneurial management demonstrated care in serving and also delighting their consumers with details that include composing their own catchy and heartwarming songs that are played in the stores – and in our office! As customers stroll through a carefully curated collection of over 200,000 assortments displayed meticulously in their aesthetically pleasing store, they constantly deliver new discoveries for its customers and an easy and enjoyable retail experience, all these supported by helpful and cheerful customer service consultants.
No wonder the loyal lifelong fans dubbed the company as a “Retail Wonderland” as they hummed in enchantment to one of the songs played in the store: “Let’s go to Wonderland… Let’s go to Wonderland…”
This portfolio stock has delivered over 30% in absolute returns from our initial investigative investment stake; we average up to scale our bet size as the company continues to deliver in its business fundamentals with upward revision in profit forecast due to higher same-store sales growth and higher average customer visits which they tracked, and we are up around 10% in its local currency from our cost.