Compounding Hidden Champions

Special tribute to Hermann Simon, Honorary Chairman at Simon-Kucher & Partners, who first coined the term Hidden Champions almost 30 years ago in his best-selling books Hidden Champions: Lessons from 500 of the World’s Best Unknown Companies and Hidden Champions of the 21st Century.

         

The Hidden Champions-type companies have their roots in the esprit de corps of Germany’s Mittelstand who are the 3.5 million small and midsize family enterprises that form the backbone of Germany’s resilient export-driven economy, employing more than 78% of workers and contributing more than half of the country’s GDP. ​

Mittelstand enterprises that became well-known giants include BMW, Audi, SAP AG, Adidas, Robert Bosch, Siemens, consumer giants Beiersdorf and Henkel, dialysis giant Fresenius, pharmaceuticals giant Bayer, chemicals giant BASF, industrial gas specialist Linde AG, truck and engine maker MAN SE, and so on. ​

There are also lesser-known, quiet, resilient, successful compounders, including sanitary systems specialist Geberit, commercial kitchen equipment company Rational AG, diagnostic and life-supporting equipment maker Ambu A/S, ophthalmic lenses and ophthalmic optical equipment maker Essilor International S.A., door technology systems specialist ASSA Abloy. ​

Asian Hidden Champions include the world’s leading velcro maker Taiwan Paiho, Australia’s premier plumbing and bathroom specialist Reece Ltd, Japan’s dominant home furnishing retailer Nitori Holdings, India’s Godrej Consumer Products, Indonesia’s integrated consumer health and nutrition specialist Kalbe Farma, and many more.​

Why Hidden Champions?

From a value investing perspective, investing at an earlier stage in the long-term growth trajectory path of these Hidden Champions – in Asia – should be rewarding.

Traits of Hidden Champions:

  • Extremely Successful, yet Low Profile​.
  • Top 3 Global or Domestic Market Leadership​.
  • Innovative champions in sophisticated, hard-to-imitate niche products and valuable critical niches that are largely invisible to the average consumer, yet are indispensable to our daily lives. The Hidden Champions create maximum benefits for a target customer group, solving their most burning problems better than any competitor. This innovation strategy requires a deep knowledge of customer needs, which is generated through direct customer contact. Successfully solving this customer problem would then create a “success spiral”.

Why Hidden Champions?

  • Outcome of corporate events and intrinsic outperformance of Hidden Champions is often not linked to economic conditions, thus offering potential de-correlated returns​
  • Overlooked and underappreciated​
  • Scalable business model with long runway to compound growth​

Pitfalls in the Asian Capital Jungle

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 misgovernance 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.