17 Jan Hidden Champions Fund Newsletters: January 2019 Updates
17th January 2019
Dear Valued Clients and Partners,
2018 has been a year of many changes and upheavals for HCCM. For much of the year, HCF’s fund performance was masked by the legacy issue of a portfolio allocation that made it hard to determine how well (or badly) the team and I was actually doing. The major step that I had to do, in conjunction with 8I Holdings, was the restructuring done in October 2018 where we split HCF into 2 classes. HCF Class 1 comprises the stock picks and portfolio allocation by the current team, whereas HCF Class 2 comprises mainly of the 3 stock picks (Sealink, Nyquest and Emmbi), which made up the bulk of the HCF portfolio previously.
I am optimistic of the fund’s performance going forward, considering the team, portfolio allocation and stock selection processes that we have in place. This is however too short a time period to determine if the fund is truly performing well in a sustainable manner. In fact, with the trade war issues between the US and China, the performance of the fund may be negatively affected since we are focused in the Asia Pacific region, which will likely bear the brunt of the trade war impact.
As with practically any fields of human endeavours, be it physical or intellectual, in order to do well, there has to be a conscious effort towards doing it better, faster and easy to duplicate. The same applies to investing. However, there is one major difference. In many endeavours (such as running the fastest 100m, making the most number of pizza in an hour etc), there is a definite goal and way of measurement. In investing, we are looking at achieving a goal in a dynamic environment and future with multiple factors, many of which is out of the control or influence of the manager. However, that doesn’t mean that humans will ever stop attempting to do so.
To do long term investing, one should have a certain view of the future. And telling the future is one hard endeavour. While many events seem inevitable, this is only possible to say on hindsight and retrospectively. After all, life would be so much more predictable if we can foretell the future accurately. Foreseeing the future of humankind is one thing; predicting the future of a singular entity or person is definitely much more difficult. This is made harder with technology which grows exponentially in its capability while humans have evolved to think in a linear manner.
How do we have an investment process that filter out the winners from the also-rans? We can only work on improving our probability of doing so by reviewing the many processes that we do when assessing each company. And that will require many more pages of research, discussion and presentation. We will not do that in this issue; instead we will review and emphasize 2 aspects of investing that I personally felt is important. One is the physical act of actually doing a company site visit; the other is the importance of understanding and assessing the corporate culture of a company.
In this issue, Joyce Pang wrote an article on the company visit with Richard Sim to Sunny Optical corporate headquarters in Yuyao, Zhejiang, China. While an analysis of any company can be done by research via the internet, as emphasized previously, I believe that it is important for us to “Touch the Brick”, and do a company visit from time to time, particularly on positions that we want to have a larger stake in. This is to ensure that what we are seeing “on paper/online” is what we are getting “on the ground”. There’s a certain level of congruency and integrity required in a company to achieve that and while it is not a foolproof method, it does support us to reduce the mistakes made in just purely doing desk research. Also, the corporate culture of any company plays an important role in determining if the company is able to do well in the long run. And if we are going to do investing long term, this is something that we will want to have a better feel of, even if it is fairly superficial when doing company visits.
I hope you enjoy this issue of our Newsletter. The first part is in Chinese, and you will find the translated version after the Chinese portion.
Here’s also wishing you an early Happy Chinese New Year ahead and have fun with all the preparations, feasts and relatives and friends!
Clive Tan | CEO
Hidden Champions Capital Management
抓住2018年的尾巴，有幸踏入浙江余姚参访舜宇光学。舜宇光学2007年在港交所上市，公司以光学零件和光学仪器起家，最早可以追溯到1984年的校办配套工厂——创始人王文鉴带领8名高中生、6万元贷款和4间厂房创办的余姚第二光学仪器厂。经过30多年的发展，舜宇光学的产品从单一的光学镜片发展到涵盖三大事业（光电产品、光学零件和光学仪器）的十个板块，实现了车载镜头销量全球第一、手机摄像模组销量全球第二，玻璃镜片销量全球第二、手机镜头销量全球第二的成绩。我心中一直很好奇，这家民企是如何从只有8名农民组成的乡办小作坊，成长为一个在国际资本市场上挂牌的公司， 市值从2007年上市时候的39.2亿港币到如今的 738亿港币。抱着这样的疑问，我们的投资经理沈志鹏和我来到了余姚。
刚进入大门，映入眼帘的便是硕大的条幅 – 舜宇的策略口号“坚定不移实施名配角战略”，“打造驰誉全球的光电企业”。要了解这两句口号，需对公司背景有所了解，我会在之后得文中解释。
Joyce Pang Qin | Investment Analyst
Hidden Champions Capital Management
We had the opportunity to pay Sunny Optical a visit at Yuyao Zhejiang China in December 2018. It was an eye-opening experience which gave us greater insights into the business, which we will be sharing more in this article. We have also included some of the questions we asked and responses towards the back of this article.
Sunny Optical has been listed in Hongkong Stock Exchange since 2007 but first started out in 1984 manufacturing optical components and optical instruments. The founder, Mr. Wang Wenjian, set up the school-supported factory (Yuyao No.2 Optical Instrument Manufacturing) with just 8 fresh graduates from senior high school, a loan of just RMB60,000, and 4 workshops. Over a span of 30 years, Sunny Optical has blossomed into a business with three major business sectors (Optical Components, Optoelectronic Products, and Optical Instruments), and boasts fantastic achievements, such as being No.1 in vehicle lens shipment volume globally, No.2 globally for handset camera module shipment volume, No.2 globally in glass lens and handset lens.
Naturally, we were curious and eager to visit Sunny to discover how a small-town workshop with only 8 workers were able to grow so immensely to become a public company listed on an international capital market, and add value to its shareholders (through her share price as an 18 bagger!) by reaching a market value of HK$73.8billion from HK$3.92billion in 2007. With many questions in our mind, Richard and I touched down at Yuyao to begin our trip.
The company is located on the west of Yuyao high speed rail station and took us about 10 minutes to get to the headquarters by taxi from the station. The location is quite convenient and is easily accessible by both inland transportation and for overseas exports.
Upon stepping through the main gates, we noticed a huge sign on top of the building, with Sunny Optical’s slogan emblazoned on it: “坚定不移实施名配角战略”，“打造驰誉全球的光电企业”. This roughly translates to “Well-known Supporting Role”, and “To create a world-renowned optoelectronic company”. To understand more, a little history of the company would be needed and elaborated shortly.
Besides the corporate office and R&D building, there are production lines in the Yuyao headquarters mainly for vehicle lens sets and handset camera modules. Unfortunately, photo-taking was not allowed during the plant visit so we will not be showcasing any photographs of the office, factory and plant production lines.
“This is a vibrant & youthful company”
In an attempt to understand more about the company’s culture during this short visit, I had a lovely conversation with one of the staff who was accompanying us (a young lady who graduated from university not more than 3 or 4 years ago): “How do you feel about this company?” “Sunny Optical feels just like an university town. We have competitions for different skills, we have the ‘Voice of Sunny Optical’ (singing competition modelled after the popular ‘Voice of China’, there are canteens, staff dormitory and talent apartments,” she said excitedly. This little exchange provided a glimpse of the company’s ability to understand, attract and retain young talents.
This short trip is definitely insufficient for us to fully understand the culture of a company. However, during the interview with the management, it was mentioned time and again that as part of Sunny Optical’s team and cultural building, the whole organization refers to 《Practice and Exploration》, a book that collated the founder’s quotes, that support in building up the company’s values and beliefs with their staff. In a bid to learn more about Sunny Optical’s corporate culture, I read through the book, which contained Wang’s thoughts on building up the company from right at the start up to 2015, containing 30 years of wisdom.
Sunny Optical’s culture can be summarized to 3 main points: First, to uphold “co-creation” as the core belief. Second, the management should follow the principle of “Generosity: Do not hoard cash; instead reward it to the people. This way, more talented people will gather”. Third, to uphold a “modern management” system of meritocracy, where talented people who perform well will have the chance to lead the business.
1.1 First Core Value: “Co-Creation”
Sunny Optical was able to reach where they are today only through a history of “Co-creation”, where they “co-created” new products by working with their partners, “co-created” markets for their products together with customers, and “co-created’ today’s Sunny Optical through the combined efforts of all the employees. The meteoric growth of Sunny Optical would not be present without “Co-Creation”.
Mr. Wang’s likened “Co-creation” to a chemical reaction, similar to how hydrogen atoms and carbon atoms are able to combine to form water, forming something larger and more useful than themselves individually. This “co-creation” ideology is able to motivate employees and create a united bond like no other, allowing synergies to happen: creating their careers and value for the company together, enduring difficulties and risks together, sharing the results and profits together, and seeking growth and development together.
1.2 Second Core Value: Cherish the talents, spread the money and people will gather
When Mr. Wang realized that the wealth of the company was created by everyone in the organization, he came up with the idea of “spreading the money, and the people will gather.”
He once said, “For each time money is distributed, talents will be retained, and attract more talented people; which in turn will lead to more wealth being generated, and so on. The cycle repeats, and thus the business ends up growing well.”
Ultimately, the company is only as good as its people, and talent is the key competitive advantage for a company like Sunny Optical, which operates in a niche market. The saying: “The one with the most talents will win over the world”, can be modernized to “The company who has the most talented people will win over the market”. To attract more talents to join and stay with Sunny Optical, there were 4 instances of this “spreading the money and people will gather.” When the employees feel like the future of the company is correlated to their future, only then will the employees and company work hand in hand and to grow together.
1.3 Third Core Value: “Modern management”
Sunny Optical started out in a small village. Traditionally in China, such businesses tend to end up being “family-owned” and will be handed-over to sons or relatives.
If one closely analyses the history of China, one will be able to observe that the rise and falls of almost all 26 dynasties were most commonly caused by the internal chaos created by the Emperor’s family, relatives or people close to him. In the series of books “二十六史”, or a literal translation of “26 Past History”, we often find such occurrences leading to the downfall of many great empire.
To avoid such instances, Mr. Wang insisted on avoiding employing family members or relatives to run the business; instead, he set up a meritocratic system to establish a smooth succession plan to ensure that the company will be in the best hands. Thus, in 2012, after five years of careful preparation, Mr. Wang handed Sunny Optical over to Mr Ye Liaoning (another founder) and Sun Yang as the Chairman and President respectively. On 20th December 2013, the company appointed Wang Wenjie (the first graduate from ZheJiang University to join Sunny Optical, and is not related to Mr. Wang) as an executive director & executive Vice President. As of 2013, Sunny Optical was successfully handed over to the next generation of management completely.
2. Setting Up A Modern Management System, Turning “Guerrillas” Into A Proper Army.
Sunny Optical’s employees experienced a change in culture, natural for any company undergoing such growth: employees found themselves evolving from a “guerrilla” team where individuals were capable of handling a range of problems to the current system where everyone has their unique role in the company (more analogous to an “army” system. Going through this process was not easy, but they were able to be “reborn” and emerge from this greater than before.
The management realized that to be able to lead well, they should lead with ambition, knowledge, and consistency.
With this knowledge, they were able to implement a strong management system through 3 core values: To inspire people with Goals, be zealous in sharing knowledge and keeping talents, and always be focused and uphold their mission and vision. In a way, we can find the same core values in a highly successful person.
Ambition is just but the start, and the goal.
“Vision: Sunny Optical must become Stronger, Bigger, and have ambitions to become a ‘century old brand’ of the optoelectronic industry. Mission: To maximize value for customers through providing outstanding products and service. Strategy: “Be well-known for Supporting”, and become THE strategic partner for well-known international companies.”
“Supporting Role: With the help of larger companies, Sunny Optical is able to enter the global market.”
Everyone has his strong and weak points: In the first 30 years of Sunny Optical’s history, they were no match for the competitive strength and knowhow of their foreign counterparts in their optoelectronic products & technology; however, they were able to produce optical components for larger companies that were similar in quality, at a much cheaper cost. This allowed Sunny Optical to seize market share in the global optical component industries by helping foreign companies manufacture their optical components, and thus able to grow to today.
Knowledge is just accumulated experience over time.
The key to implementing their “Supporting Role Strategy” is through their human capital. To become an international company specializing in such a niche area, it needs a team of international talents with professional knowledge.
All these years, the management noticed that those “knowledge-based” employees were vastly different from those labor-oriented employees in terms of their characteristics, as they are able to create additional value using their knowledge and wisdom. Therefore, the management felt that primary task for Sunny Optical was to motivate those people and release their potential, which will propel the company forward.
Consistency through steadfast and continuous efforts.
Sunny Optical has deeply integrated its entrepreneurial spirit with the core values: “Co-Creation”, “Generosity”, and “Modern management” within the company. By focusing on the main business of optical industry and upholding their “support the large players” strategy, Sunny Optical has been quietly increasing their market share despite the intense competition in the industry and has successfully transformed their business from OEMs to ODM, and also transformed themselves from the a hardware manufacturer to a solution provider. It has evolved from being the leading player, to the most essential player.
As an investor, we are used to analyzing the business model or their economic moat. However, we should pay attention to a company’s soft competitive advantage: eg. company’s culture. Many companies are able to grow tremendously fast in a tailwind, but only resilient companies can survive with headwinds blowing. A company’s soft competitive advantage can be a hidden weapon that helps companies to pull through difficulties and achieve continuous breakthroughs.
As the saying goes: “If you work at it hard enough, you can grind an iron pestle into a needle”. This is applicable for a company, especially for one that aims to be a century old company; they will need constant upgrading and improvements to achieve domination. We are looking forward to Sunny Optical’s journey of becoming a “century old” brand in the optoelectronic industry.
Summary of Interview Q&A
Q：Will the US-China trade war affect Sunny Optical’s business a lot?
A: We acknowledge that due to the uncertainty caused by the current macro environment, especially in the Q3 and Q4 of 2018, the customers are generally more conservative when ordering from us. They reduced their speed of launching high-end products, leading to smaller orders. In addition, the depreciation of RMB will definitely have an impact on the procurement of raw materials. To face the difficulties, we will do our best to reduce the whole manufacturing cost through continuously improving our production line and product adjusting.
Q: What is the biggest risk facing by Sunny Optical?
A: The constant evolution of technology tends to result in ever-changing specifications. We will not know what the next disruptive technology will be, and when it will come out. However, to face this challenge, Sunny Optical places the R&D in priority. This priority allows us to be at the forefront – for example, we started R&D of the current trend of dual-cam and triple-cam handsets 2 to 3 years ago. We established the central R&D center in Hangzhou mainly for the early stage and long-term development.
Human resources is also of the most concern to Sunny Optical. We are able to attract top talents mainly through the share incentive plan to provide an international platform for talents to display their talents. (We have R&D center in China, South Korea, and Singapore). Through cooperation with well-known Universities, and the establishment of a joint laboratory, we can leverage on their ability to develop our own capabilities.
Q: How did Sunny Optical grow so fast within the 30 years?
A: Our management is very focused on what they are doing. Since day one, Sunny Optical is focused in the optical industry; from grinding lenses, producing camera lenses, to making microscopes, to the wave of mobile phone lenses in 2004, we continued to seize opportunities and continue to grow. As being focused allows us more insights and expertise, the management are able to have a more accurate judgement towards the future of industry. In addition, we are good at execution. To attract more talent to join the company, our founder Mr.Wang has his own philosophy called 钱散人聚: Money spread and people gathering.
Q: Sunny Optical has evolved into an international company. How do you maintain the team spirit when it is such a big company? How does Sunny maintain team cohesion?
A: Mainly through a mentoring system. We have a series of training programs for our employees, and currently the whole company is studying quotes from our founder Mr. Wang Wenjian, from the book <<Practice and Exploration>>. We are studying how to turn knowledge to practice.
Joyce Pang Qin | Investment Analyst
Hidden Champions Capital Management