Hidden Champions Fund Newsletters: December Updates

17th December 2018

Dear Valued Clients and Partners,

It is hard for one to open up the news channel (be it TV/Radio/Newspapers/social Media) nowadays without reading about the China-USA ongoing trade war that “officially started” with the United States in July 2018 launching the first salvo. While this seems like a recent issue, I believe that it is a festering issue brought to the surface. It is tough to truly believe in Win-Win when the two most powerful nations in the world are having a go at each other despite us being one human race.

Nearer to home, Singapore and Malaysia is also undergoing some challenges in their relationships as neighbouring countries. From Borders to Water to Air Space, these issues were surfaced recently under the current Mahathir administration. I can only hope that good sense prevails, and the issues are sought out amicably.

How does these impact investments? Besides the direct political and legislative impact, I believe that there is an economic impact from relationships. Be it at the country level, company level or even individual level, the economic impact to an entity (such as a listed company) materialises at different levels. Richard will discuss his perspective and how we took advantage of the market situation to invest in companies we deem as strong and likely to pan out in the mid to long term.

Over the span of my life, business and investing journey, I have come to know and experience the pains and pleasures of having relationships that work and those that don’t. I have come to realise that there is a certain level of trust and harmony need for a company to be managed and run well. However, how can we assess and forecast such situations before it is known to the public (companies being through released financials)?

Analogous to a marriage, to be able to predict how successful the partnership or management will be will very much rely on how the people handle their disagreements and conflicts. Do they ignore the issues on hand and simply not talk about it, or do they talk about it only in a superficial manner? Both are tell-tale signs but only the people who interacted with the relevant people can be aware of. All partnerships and relationships have their challenges but it is how the respective partners and managers work through the various issues that will determine if the partnership is going to be a successful one or not. From an investor’s point of view, it is tough to assess these sort of issues, hence the need for diversification and understanding our own circle of competence. And because the financial investment industry is such a “rational” industry, this part of the assessment of a public company is often ignored and put aside.

With relationships often built on the basis of the top leaders, is there any wonder when countries are at loggerheads with each other, it is the leaders who initiated it? Similar for companies, if there are signs of poor relations between the top leaders, it would be hard to imagine that the company can still do well on a long term and sustainable basis.

This month is a month of celebration and goodwill for many people around the world. Even though it is not yet Christmas when I wrote this, Orchard Road (the premium retail belt in Singapore) is already flooded with very shimmering Christmas lightings albeit with a commercial twist (Disney) this year.  I would like to wish all of you a Merry Christmas and an awesome 2019 ahead!

Warm regards,
Clive Tan | CEO
Hidden Champions Capital Management

It has been an eventful year filled with ongoing tension arising from the trade war between the United States and China. Tracing the roots of the events was  Chinese President Xi Jinping’s declaration at the Chinese Communist Party’s 19th national congress in October 2017 that the country will realize modernization by 2035. The gist of his message is: China will catch up with the U.S., at least on the economic front, within 17 years. This spurred U.S. president Donald Trump to respond with safeguard tariffs imposed by the US on washing machine and solar cell imports. While many  of these imports do not come from China, it was clear that the Chinese dominance of the global supply chain was a threat and they needed to do what it takes to contain the aggression of China’s growth.

Ten months later, the trade war evolved into a full-blown crisis with both sides slapping tariffs on the other’s imports. In July, the U.S. imposed additional tariffs on $250 billion worth of Chinese goods over what deemed to be unfair trade practices, and China immediately retaliated. Yet, the developments from both actions appeared to be moving in favour of the US. It was surfaced by Xi at the recent first China International Import Expo held in November who acknowledged the economic difficulties that China is facing. “The economic situation at home and abroad has created some significant challenges for the Chinese economy, such as more uncertainty in some sectors, more difficulties for some enterprises and growing risks in certain sectors,” Xi said. Such a blunt acknowledgment of the country’s ills from the stage of a big international event was indeed rare for China, and only reflects the severity of their current situation.

Besides trade, the countries are zealous in upholding their security. The U.S. government initiated an extraordinary outreach campaign to foreign allies like Germany, Italy and Japan, persuading wireless and internet providers in these countries to avoid using telecommunications equipment from China’s Huawei Technologies Co because of the cybersecurity risks they are potentially exposed to.
With an annual sales turnover of $92.5 billion, Huawei has revenues similar to Microsoft and Google’s parent Alphabet, and almost four times as large as e-commerce king Alibaba Group Holding. It has emerged as China’s top employer with 180,000 staff worldwide, and invests about $15 billion in research and development every year. Even though there are no clear links between Huawei and the Chinese government, as the largest company in China, any adversity faced will in turn affect China’s economy.

Several countries have since responded. New Zealand and Australia have stopped telecom operators from using Huawei’s equipment in new 5G networks because they are concerned about possible Chinese government involvement in their communications infrastructure.  Britain’s BT Group removed Huawei Technologies’ equipment from the core of its existing 3G and 4G mobile operations, and will not include the Chinese company for the central parts of the next network. And now, Japan plans to ban government purchases of equipment from China’s Huawei Technologies Co Ltd and ZTE Corporation (SZSE:000063 ) to beef up its defences against intelligence leaks and cyber-attacks as the stakes continue to rise.

Despite the gravity of the matter, the trade war has not been widely reported in China. The Communist Party has carefully controlled public opinion, giving top priority to maintaining social stability. Due to a lack of information on the internet as well as in newspapers, many ordinary Chinese have been left in the dark about how serious the impact of the trade war between the world’s two biggest economies is. However, the entire incident has not escaped the sentiment of investors as our team noted how the entire episode had contributed to the volatility in the China stock market this year.

But is volatility necessarily bad? Warren Buffett once mentioned to be fearful when everyone is greedy and to be greedy when everyone is fearful. The team has always bore that in mind and with the China stock market index correcting 25% to 2,500 from the high of 3559.47 on 24 January this year, you can be sure that many investors are fearful of the worse right now, fearing that this trade war will lead the world into a prolonged recession with many repercussions.
Even though understanding what is happening now in the world and how it impacts the business that we invested in is important, it is highly difficult and requires a great level of wisdom and luck to accurately predict the outcome of events. Who would have expected Trump to win the U.S elections in 2016, and two years later, be prepared to make sacrifices to fight to remain as the world’s No. 1.

Hence, one should not speculate the outcome, but be prepared for the worst case scenario with a plan in mind for our investments to take advantage of any volatility. During these past months, the team took the opportunity to invest in three companies in China that have low leverage, good corporate governance, and a long runway for growth. All these would not have been possible at the start of the year due to the rich valuations that they had.
In addition, I am excited to share that we have an opportunity to head down to China in December to visit two of these companies, touring their factories and meeting the management to further deepen our understanding on them. We will be sharing our experience in our January and February articles so do stay tuned and watch out for it!

To end off, I would like to wish all our investors a Merry Christmas and a Happy New Year! We look forward to a better 2019 with everyone!

Warm regards,
Richard Sim Zhipeng | Investment Manager, CFA, CA
Hidden Champions Capital Management