On the Ground in Asia (2012)


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On the Ground in Asia (2012)

  1. 1. On the Ground in Asia (2012)January - The ASEAN 2015 Bloom: Gathering a Life at $3,000 and the “Second-GenerationGKCs”February - Are the Chinese Back to the “Real” Economy with the Invasion of Swabia?March - Is Avoiding Pitfalls in Value Investing in Asia All About Painted Puppets and theDalang?April - Do Asian Entrepreneurs Desire To Have ‘Black Cats’ To Become Multibagger Stocks?May/June - “I’m Only a Paperboy”; “I Can Still Run After the Bus!”(Special Edition – Berkshire Hathaway AGM 2012 from Omaha Trip)July - Beanie Babies Vs Vendor Financing: Can the ‘Product’ (and Asia) Stand On Its Own?August - The Great Asian Infrastructure Stimulus: Network Effect or Redcliff Battle?September - Resilience Investing with the Batfish and Buddha: Why Things Bounce Back(Or Not)October/November - Match: How to Patch the Asian Leadership & InstitutionalUncertainty Discount? - Match “Grill” and “Lidia” With “There Is an I in Team” For Stable Allocation!December 2012/January 2013 - Word of the Year in Asia for 2012 and 2013: “Bloated” and“Value Circle” (1) “Circle the Customer - Circle the Globe” to Rid “Bloat” and Get Asian Multibaggers (2) Do Investors Overvalue Firms With Bloated Balance Sheets? 0
  2. 2. The ASEAN 2015 Bloom: Gathering a Life at $3,000 and the “Second-Generation GKCs”In poignantly uncertain times with the Eurozone has arguably gathered a life of its own for thedebt challenge weighing on markets, it is easy to serious and farsighted Lion Entrepreneurs to scaleforget that 20 years has passed since Deng their businesses further. At the end of 2011, theXiaoping, then 88, embarked upon the historic 240-million-population Indonesia has not onlySouthern Tour (“南巡”). This trip on 18 January joined the “trillion-dollar GDP” club in Asia, along1992 was the tipping point for entrepreneurship, with China, India and Korea, but also crossed thereversing stalled economic reforms and setting $3,000 per capita tipping point level - a level that isChina to become the world’s second largest also double that of the high-profile India. Asean iseconomy. From the vantage point of Shenzhen much neglected as an asset class of its own,which was designated as a Special Economic Zone particularly with the emergence of the AEC (Asean(SEZ) as early as 1978, Deng’s expression of his Economic Community) in 2015 to spark intra-quiet, determined gaze for nearly nine minutes at regional trade, currently accounting 27% of thethe Hong Kong side was unforgettable. region’s GDP and expected to double to match the 55 to 60% figure in EU and NAFTA. However, the pitfalls for value investing from afar, based on garbled quantitative figures and macro and industry outlook (silhouette of “the horse”) and without an intimate understanding on the quality of management (“the jockey”), are aplenty. At the start of the Dragon Year, Indonesia’s largest oil tanker firm said it will freeze payment on its debt of $2 billion. Interestingly, this governance gap at the corporate level that has not kept pace with the glowing macro prospects presentsAfter 3 years of economic stagnation following the 1989 Tiananmen opportunities for the diligent value investor toSquare incident and the resultant governance crackdown, Deng’s ferret out the genuine builders of business. ForSouthern Tour reinvogarates economic reforms. instance, PT Fast Food Indonesia, the sole franchise owner for KFC in the country, founded byDeng’s thoughts were also on a number: $3,000. Gelael Group in 1978 and joined by Salim GroupSuch a level of GDP per capita was said to produce (led now by the second-generation Anthony Salim)accelerated economic growth for more than a in 1990, has seen its share price multiplied 7-folddecade in South Korea. From the solid foundations in the last 5 years amidst the global financial crisis.laid by Lee Kuan Yew and economic architect GohKeng Swee, Singapore broke past this level 13years after her 1965 independence in 1978 – alsothe year China embarked on its open-door policyand Deng visited Singapore officially for the firsttime. It is the desired “going-concern” level for“Stage 1” economies to have its own dynamism forsustainable growth. It is the level for a taste into agamut of what constitutes “a good life”: whitegoods, electronic products, autos, personal careproducts, fast food, healthcare, shopping, Three generations of the Kirk Christiansens of Lego.entertainment and travel. China’s outgoingPresident Hu Jintao aimed in 2004 to reach this At our Aegis factory, we have painstakinglytarget by 2020 – and achieved it in 2008, 16 and 17 accumulated knowledge over the past decade onyears after Deng’s Expedition and the inception of the serious entrepreneurs who are relentlesslythe Shanghai stock market. building their team, combining assets, technologies, and finance into more complex andThe striking point is this: While Asia is certainly not valuable products and services. A particular trendinvulnerable to the prolonged muddling along and is the “change of guard”, with the secondpotential fallout in Europe, the field on the ground generation scions stepping up to scale their 1
  3. 3. businesses beyond “guanxi” relationships through KEE Koon Boonan emphasis of innovation and teamwork to 31 January 2012compete regionally and globally. We coined themthe “GKCs”, named after Godtfred KirkChristiansen (GKC), the son of Lego’s founder, thesecond generation builder who innovated with the“Lego System of Play” with the first “Play andLearn” concept that encourage imagination andsystematic creativity. Interestingly, Legoland willbe opening the S$296 million, 31ha park inMalaysia’s Iskandar region in Johor in 2012, thefirst of its kind in Asia. It is also the biggest singleproject in the region, both in terms of investmentdollars and geographical size.Legoland Malaysia, the world’s sixth and Asia’s first, expects 1million visitors in its first year of operation, a target riding upon thefavorable demographics in Asia. Unlike other Legoland theme parkswhich only operated 8 months a year and closed during winter,Legoland Malaysia would operate all-year round.These GKCs lead their “Stage 2” businesses toattempt the multibagger climb to “Stage 3”; wehave been monitoring around 20 of thesecompanies for the past decade, each with aninvestable capacity of $20 to 50 million. At thesame time, our portfolio of founder-led companieshas continued to grow in their businessfundamentals and we continue to build depth inour knowledge in around 30 founder-ledcompanies as our high-conviction stock ideas toexecute at opportune times, each with aninvestable capacity of $10 to 50 million. Groundedin the value-creation framework of “SustainableMultibaggers = Lion Entrepreneurs x LionInfrastructure x Lion Shareholders”, we believethat these selective Lion companies possess theessential elements to potentially multiply by 5-foldin the coming decade to become oak-tree pillars ofthe economy. Ultimately, Lion Entrepreneurs arethe crucible to house sustainable value investing inAsia amidst the roiling heat of uncertainty in theglobal market environment. We remain steadfastand vigilant in our mission to fortify and expandthis crucible to provide sustainable multibaggerreturns for our long-term investors. Just like Lego’smotto: “Kun det bedste er godt nok” – “Only thebest is good enough”. 2
  4. 4. Are the Chinese Back to the “Real” Economy with the Invasion of Swabia?From the low hills and curving valleys of Swabia to be innovative to stay relevant in the globalboomed a quiet voice: “I am not paying high marketplace. As increases in raw materials, wageswages because I have a lot of money, but I have a and labor strikes continue to accelerate in coastallot of money because I pay high wages.” China – the minimum wage in Shenzhen was increased recently to RMB1,500 on December 30 last year, resulting in an annual increase of around 20% over the last 3 years - many Chinese companies, particularly those who have not been reinvesting their profits back into the “real” economy via productive capital investments in upgrading their core businesses through innovation, are finding it difficult to compete with the depressed margins. For instance, February saw one of the world’s largest cap makers announcing that it will be intensifying its relocation of half of its output from China to Dhaka in Bangladesh overRobert Bosch, focused and hard at work at his desk. the next two years; its share price had tripled in seven years prior to the outbreak of the FinancialThese famous words from Robert Bosch, the late Crisis and it has since fallen nearly 80% from itsfounder of the German multinational engineering peak. Its situation worsened after the Lunar Newand electronics group with sales of €51.4bn in Year holidays as only 1,600 migrant workers, or2011 and staff strength of more than 300,000, still 65% of the total workforce of 2,500, returned toreverberates in the hearts of the Lion work at the Shenzhen plant, despite offers of perksEntrepreneurs in Germany and Europe. Bosch is such as cash bonuses and a dinner banquet withalso Germany’s biggest privately-owned industrial wine and lucky draw prizes of iPhones, TV sets,company and the largest amongst the Mittelstand, washing machines and smart-phones. It is hard notthe “hidden global champions” who concentrate to notice that the stock prices of Ralph Lauren Polo,on sophisticated, hard-to-imitate niche products Limited Brands (Victoria Secrets), VF (North Face/that form the backbone of Germany’s resilient Nautica/Timberland/Wrangler/Lee Jeans) continueexport-driven economy. The region of Swabia to hit all-time highs despite the gloom.around Stuttgart is the spiritual home of theMittelstand. Swabia never had the coal and iron Many Chinese entrepreneurs simply intensify theirthat would be found in northern Germany, nor the shift into investments in property, stocks, futures,powerful commercial advantages of the Rhine trust funds, coal mines, collectibles ranging fromRiver, so Swabians were forced to be resourceful art, antique, jade, jewelry, gemstones to tea,and innovative. Swabia is also called Spatzle Valley ancient clay teapots, baijiu liquor, garlic, ginseng/(after the popular local food) - with a tip of the hat cordyceps herbs, and underground lending at highto Silicon Valley - because Swabians are such interest rates. It was estimated that everyconsummate inventors. household in Wenzhou, the bedrock of entrepreneurship located in the Zhejiang provinceThe bone and sinew of wisdom in paying high in China and home to more than 300,000 privately-wages to generate greater profitability and owned SMEs generating RMB600bn (US$95bn) ofsustainable wealth may not be so apparent – and sales, owns on average 1.2 properties in Shanghai.yet had profound implications for value investing The mania also manifested on their homeground:in Asia. When we tour factory floors in China in our the unbuilt luxury apartments of Versaillesdue diligence trips over the past decade in Asia, Residentiel de Luxe La Grande Maison in Wenzhou,we could often find that quite a number of them located next to a polluted river, went on sale indid not look as spotless as some of the better December last year for as much as S$1,300 psf,factories in Korea and the West, although they double the annual income of the averagewere well organized. Sometimes, surplus inventory Wenzhou resident, who would have to save everycould be found abandoned; low relative wages penny for 350 years to buy a 1,500 sq ft home inallow these companies to tolerate such this development. The high-profile cases of moreinefficiencies. The high-wage employers are forced than 90 Wenzhou entrepreneurs declaring 3
  5. 5. bankrupt, becoming fugitive and even committing means the violent downfall of a system. Sany wassuicide over underground lending activities, established in 1989 just after the Tiananmeninvalidating debts more than RMB10bn, have also incident as a small manufacturer of weldingprompted Premier Wen to visit Wenzhou, often materials. Back in 1998, Sany’s sales stood at €50m,likened to Swabia, in October last year to five times smaller as compared to the €240m atinvestigate the challenges faced by these SMEs. Putzmeister. Together with Schwing, the numberHardcore pessimists would not hesitate to call two in concrete pump and also a German company,China a city of glory built on the river of financial the Germans conquered two-thirds of China’sfilth: Just imagine what would happen when the market in the 1990s. By 2004, the purposefulriver runs dry, they shrilled in a cacophony of grand strategy of the Chinese government tohoots, cackles and wails. promote National Champions had propelled Sany to be the dominant domestic leader during theThe February invasion of Swabia by the Chinese nation’s two-decade building boom; market share“communists” for the first time ever struck fear in of the Germans plummeted to less than 5% in thisthe German business community. Sany, based in all-important market which accounts for 60% ofChangsha in Hunan province, the birthplace of worldwide concrete consumption. When touringMao Zedong, announced the €525m takeover of Sany’s facilities chauffeured in a Maybach,Putzmeister, the “hidden global champion” in Schlecht was impressed and commented that “itconcrete-pump equipment, made prominent as was as clean as a whistle there”. Sany’s stock pricethe technology that saved the Fukushima nuclear multiplied by 9-fold in 9 years (and up by 19-fold atplant disaster in 2011, just as it did at Chernobyl 25 its April 2011 peak) since its A-share listing in 2003years earlier and whose equipment were also used to S$20bn, making Sany’s Liang Wengen, 55, andto pump concrete up the record height of 700 once a socialist model worker in a weapons factory,meters to Burj Chalifa, the tallest building in the the richest man in China according to Forbes, andworld. Founded by Karl Schlecht (now 80) in 1958, possibly the first businessman by this fall to bePutzmeister has spent the past five decades appointed to the Central Committee of thefocusing on just one thing: making the best Communist Party (中共中央委员). Chinese mediaconcrete pumps in the world. heaped effusive praise on Sany and proclaimed that the global march of the Chinese companies is unstoppable.Sany’s Liang Wengen and Putzmeister’s Karl Schlecht exchanged their watches.When Schlecht and Liang met for the first time in Germany, Schlecht wasstunned when he received an oil portrait of himself as a gift from Liang. "Youare my teacher," Liang said flatteringly. Liang was in a hurry to get the Sany’s CEO Xiang Wenbo, 50, who owns 8% in Sany’s stock, is a toughpurchase agreement signed. The usual due diligence process was not leader who emphasizes hard work.”There are very few real geniuses” innecessary, he said, and he had no time for a plant inspection. business, says CEO Xiang. “Sany, including the Chairman, and our team are among the most willing to struggle in China.” Meetings start at 7:30 a.m., and staff work more than ten hours a day. ”In the world, especiallyBefore the Putzmeister deal, the Chinese can only in Europe and the U.S., basically, you can’t find this,” Xiangbuy once-prestigious consumer electronics adds.”Perhaps this isn’t very smart. But there’s an expression in China: ‘Hard work overcomes slowness.’”manufacturers facing bankruptcy or second-classsolar companies. Whilst “Chinnovators” such asthe solar companies get highly-visible market In our decade-plus journey applying valueshare, they were value destroyers with their share investing principles in Asia as professional moneyprices plummeting over the long-term. First-tier managers since 2000, we find that it is critical forGerman assets, the life work of the proud family diligent value investors to have a balancedbusiness owners, were never for sale to outsiders. perspective, for Truth lie somewhere betweenThe deal was described as a “Götterdämmerung” glory and disaster. Most importantly, value(“twilight of the gods”), a German expression that investors need to have the same Lion heartbeat as the multibagger Lion Entrepreneurs: value 4
  6. 6. investors cannot see the elusive emerging Lions as world, is built upon the internationally recognizedsome dragons to slay; we got to look at them with and self-funding technical supervisory association,soft eyes until everything becomes one. The Lions which the Germans call the TÜ V, whose qualityare the exceptionals who are able to rise above seal provide a powerful global sales pitch for thethe madness of the crowd to create value, just like Mittelstand. The German cost accounting system,Bosch, branded “Robert the Red” by his Grenzplankostenrechnung (GPK), has also led toindustrialist contemporaries for introducing the 8- sophisticated cost management system amongsthour workday in the factories in 1906 and paying the Mittelstand to reap superior informationalhigh wages to his workers - eight years ahead of insight. The integration of GPK into enterpriseHenry Ford’s revolutionary $5-a-day wage, which resource planning (ERP) software also led to thewas double the prevailing rate in the industry then scaling of SAP AG into a global giant valued at- and building entire housing projects and hospitals nearly S$100bn.for his workers and their families. Whilst thehighly-successful Hyena Entrepreneurs treat their SAP played a key – and hidden - role in theemployees as mere expenses to maximize short- dramatic turnaround story of loss-making Rollsterm profits, the multibagger Lions Entrepreneurs Royce in the 90s, which illuminates the importancebelieve they are valuable intangible assets to of having a Lion Infrastructure. Interestingly, Rollscultivate and harness. Royce opened on 13 February 2012 its S$700m high-end manufacturing facility at Singapore’sSingapore pioneer Lions were ahead of the curve Seletar Aerospace Park, the largest of its kind inin restructuring the economy through a deliberate Asia and the first time it is manufacturing the“high-wage high-skills policy” from 1979 to 1981 to critical component – the wide chord fan blade –prevent her Stage 1 economy from being caught in outside its home in Derby, United Kingdom. Thethe trap of low-wages, low-skilled and labor- investment is projected to contribute S$1.7bnintensive industries. Upgrade, move away, or close (0.5%) to Singapore’s GDP by 2015.shop was the message to employers. This shift washelped by the Malaccan-born economist LimChong Yah, now 80, serving as the foundingChairman of the National Wages Council (NWC) for29 years from 1972 to 2001. To help firms makethe shift, the Economic Development Board (EDB)promoted automation and computerization. Singapore Prime Minister Lee Hsien Loong (R) and Simon Robertson (L), chairman of Rolls-Royce, officiate the opening of a Rolls Royce“I owe my life to education”, Professor Lim Chong Yah exclaimed in a manufacturing and training facility in Singapore.2009 interview. Lim witnessed jobless rubber tappers die of starvationwhen he was young and resolved to move beyond a laborer’s life withthe help of education. Lim made a personal donation of S$100,000 to Turbine blades are difficult to make because theykickstart a bursary in his name in NTU which helps needy students with have to survive high temperatures and hugetheir university fees. Lee Kuan Yew’s second son is married to Lim’seldest daughter. stresses. The air inside big jet engines reaches about 1,600°C in places, 400 degrees hotter thanIn the same spirit, the German business ecosystem the melting point of the metal from which theis structured like a “Lion Infrastructure” to turbine blades are made. Without a proper coolingprivilege high-tech innovation. For example, system, this would be like trying to stir a cup of hotGerman accounting allows for very rapid coffee with a spoon made of ice. Each blade isdepreciation, which enables German grown from a single crystal of alloy for strengthmanufacturers to keep buying the latest in and then coated with tough ceramics. A networkmachinery. Also, the world-famous “German of tiny air holes then creates a thin blanket of coolprecision quality”, whose technical standards are air that stops it from melting. While it is easy to befar more exacting than any other countries in the enamored by the highly sophisticated engine 5
  7. 7. technology which only a few companies in the company’s reserves and profits to invest inworld possessed, namely GE and Pratt & Whitney, property during the recent financial crisis havean incremental advance by one manufacturer is come out on top of those who stick close to theirusually matched by the others within a couple of knitting in their core businesses. Interestingly,years. Researchers found that over the last 40 wealthy Germans typically make their fortunesyears, each of the three leading engine-makers has over time through private ownership of a goingin turn taken a technological lead, but none has concern. Germans believe that there is somethingheld it for much more than a decade. Thus, the distinctly unhealthy about getting rich by wheelingthree players have been locked in a Red Queen and dealing. To the German psyche, wealth comescut-throat race in giving away razors (the engine from production, not speculation. A betterproduct) to sell the blades (maintenance and allocation of resources through the financialrepair services). The trouble is that the juicy system may occasionally be necessary, but amargins in engine maintenance have attracted a wheeler-dealer must never make more moneyswarm of independent servicing firms. Rolls Royce than someone who actually produces something.innovated by convincing its customers to pay a fee At Aegis, we believe that while those who focusfor every hour that an engine runs. In other words, and toil quietly in their core businesses withoutRolls Royce offered to shave its customers every profitable forays into property may appear to havemorning, but this strategy requires a drastic “lost the battle” in the short-term (not to mentionchange in its accounting and ERP system. However, losing bragging rights in social functions aboutit is this “business model innovation” that enabled savviness in property trades and getting the wrongRolls Royce to multiply more than 7-fold during the attention as the social pariah), their single-mindedpast decade to trade at an all-time high of S$29bn, quest to build a lasting business will earn them theand the formidable SAP system was the stable multibagger valuations over time in a hockeyplatform that gave Rolls Royce the unfair blade-like manner, ultimately “winning the war”.competitive advantage to implement its strategymasterfully. The operations room in Derby, forinstance, continuously assesses the performanceof 50,000 jet engines around the world, raising analmost insurmountable barrier to any rival thathopes to grab the work of servicing them. The datacollected can be invaluable to airlines: it enablesRolls-Royce to predict when engines are morelikely to fail, letting customers schedule enginechanges efficiently. That means fewer emergency Great branding and advertising campaigns have made Nike one of therepairs and fewer unhappy passengers. The data most recognised companies in the world. Dan Wieden’s “Just Do It”are equally valuable to Rolls-Royce. Spotting slogan in 1988 had been the tipping point for Nike as it stopped selling shoes and started selling fitness and athleticism and Nike multiplied byproblems early helps it to design and build more 100- fold. Its inspiring 2011 campaign in China is “Use Sports” (用运动)reliable engines or to modify existing ones. The which aims to show how sports can help people achieve something greater: www.youtube.com/watch?v=2DPNJTcHcmkresulting evolution of its engines has steadilyimproved fuel efficiency and over the past 30 years Perhaps “focus” may not be an option increasinglyhas extended the operating life of engines tenfold for the Asian entrepreneurs, as evident from the(to about ten years between major rebuilds). “You cases of focused MNCs such as Nike and SAP incould only get closer to the customer by being on China. Bleeding quietly in their initial yearsthe plane,” says Mike Terrett, Rolls Royce’s COO. operating in China, the intense focus at several of these MNCs has hit the tipping point in scaling upOther focused niche British firms based at home the operations, helped in no small part by theand paying high wages such as Johnson Matthey, distraction of local entrepreneurs into propertyHalma, Spectris, Renishaw, Spirax Sarco, Rotork, and speculative activities, neglecting their coreUltra Electronics, Meggitt and Oxford Instruments businesses. Inventory pile-up and rampantare all multibaggers trading at all-time highs as discount characterized the state of affairs atwell despite the ongoing Eurozone problems. Chinese sports retailers as Nike, which has been active in the Chinese market for 30 years, ventures “Focus” appears to be a key difference between beyond the Tier-1 and 2 coastal cities into thethe wealthy in Germany and Asia. Some successful domestic brands’ strongholds in inner China. SalesAsian business owners like to point out to us in a in China at Nike surpassed US$2bn as at May 2011,well-meaning way that those who have used the 6
  8. 8. doubled from 2007. Nike aims to “just double it” in is up more than 4-fold since 1999 to S$11.7bn. Thethe next four years as Chinese consumers popularity of M&M’s tractors stemmed fromincreasingly lose the taste for domestic brands and producing low-powered tractors (under-70quality counterfeits while Nike continues its well- horsepower) suited for fragmented landholdings incrafted marketing campaigns in introducing more India and China. M&M realized that there is anlower-priced products and cultivating its brand underserved market in the United States to whichcachet at the top-end. Shares of the once- its low-powered tractor is well-suited: hobbymultibagger domestic brands were down by 50 to farming. John Deere promised a $1,500 rebate to70% from their 2010 peak; Nike’s shares hit an all- any American farmer who traded in an M&Mtime high. Like Nike, SAP had also struck right at tractor for a John Deere. M&M U.S. operationsthe heart of the customer base of the domestic located only a handful who responded to the ad.companies with its locally-developed Business One Because many of M&M’s customers in the Unitedsoftware targeted at SMEs, backed by the States are women, the company respondedcommitment of US$2bn investment and plans to tongue-in-cheek to the John Deere tractor ad withdouble the workforce by 2015. SAP moved in one of its own that featured a blonde, pony-tailedNovember last year from Germany its global American woman driving a tractor. The captionsupport organization now headquartered in Beijing. read: “Deere John, I have found someone new.”Shares of the domestic ERP software companies M&M’s market share for 30-40 horsepowerwere down by 30 to 60% from their 2011 peak as tractors in the U.S. grew to more than 40%, all theSAP signs up 14 new Business One customers in more remarkable given that the world’s majorChina everyday on average and SAP shares are tractor manufacturers – including New Holland,trading at their highest in over a decade since the Agco, and the Japanese firm Kubota – competedotcom years. aggressively in this space. Generating profits from the low-hanging fruits of riding along the waves of sector growth and low- cost operations will increasingly be no longer viable in China as she slows down. Diligent value investors will go the extra mile to investigate the company-specific innovations which will be the key to compete in the next decade in Asia, a central theme that has always dominate our dialogue with the top management of listed Asian companies over the past decade. The success of the British JCB in India again highlighted not only the feverish competition that globalization has wrought but also the insight that company-specific innovation is not an option forWatch M&M’s “#1” advertisement:www.youtube.com/watch?v=w3UTnwJpz1Y any company to stay relevant in the global marketplace. Founded in 1945 by J.C. Bamford, JCBAnd it is not just the American and German is one the world’s largest construction equipmentfocused MNCs who are left their Chinese manufacturer, particularly known for its backhoecompetitors squandering their home field loader (a tractor-like vehicle with an arm andadvantage, but even some of the Indians. Punjabi bucket mounted on the back and a loaderBhangra music is played in the local disco in mounted on the front). The vivid colour that theyNanchang in Jiangxi province, according to Anand always display has become a standard paint,Mahindra, 57, vice-Chairman and MD of Mahindra known as "JCB yellow". A non-smoking teetotaller,& Mahindra (M&M); M&M’s success in China has who was so careful with his money that he claimedpropelled them to be the world’s largest tractor his wife still made their own curtains, Bamfordmaker by volume, overtaking John Deere, as M&M worked from 09:00 until 23:00 every day. He sawlaunched a U.S. TV campaign in January this year his role in life similarly to that of his religiousto publicize its #1 claim. M&M is led by the third- predecessors, the Cadbury and Lever families. Hegeneration scion, Anand, nephew of the group’s built Rocester into an effective marketing homeoctogenarian K.C. Mahindra, since 1997, and M&M for the company, and an efficient production centre and a virtual “home” for his employees. He 7
  9. 9. saw no need to recognise Unions. The Rocester The spirit of innovation is an intangible asset andworks were surrounded by 10,000 acres of all-important ingredient for companies to competelandscaped grounds in which his companys effectively and cross the chasm to not onlyemployees could shoot, fish, swim, and sail. become a going-concern but also transform into aBamford paid more than fair wages, which rose sustainable multibagger, as did the multipleregularly, and annual bonuses based on reports of companies that were highlighted above – and theyindividual worth. This extraordinary focus in return all trade at all-time highs despite the uncertaingave unprecedented levels of workforce flexibility, macro outlook. Innovation can be productwith the average JCB employee through the strike- innovation or process innovation, the latter coulddominated 1970s and early 1980s being seven be a new way to sell a product or sell to a newtimes more productive than the average British group of underserved customers. Innovationmanufacturing worker. Born in the year JCB was investments are always painful and anfounded, Bamford’s son, Sir Anthony, succeeded uncomfortable process. Innovation in businesshim as Chairman and MD in 1975, and scaled the model is the hardest of all. The intangibles thatcompany further. yield innovation are indestructible and invaluable: The outbreak of World War I in 1914 hadIndia is the largest market for JCB: Of the total Germany’s wartime enemies seizing all of the51,600 machines that JCB sold globally last year, company’s tangible assets, property, plant and21,000 were in India. Its revenues rose almost 10 equipment, yet Bosch did not despair and he wastimes from Rs. 450 crore (US$91m) in 2001 to Rs. able to rebuild fairly quickly from the Lion4,429 crore in 2010, or a third of the group’s total Infrastructure and intangibles that he had laidrevenue of US$3.2bn. Backhoe loaders suit the since he started his Swabia “workshop” in 1886.Indian working style as they are versatile machines.Mainly used in excavation, digging and levelling, A Lion Entrepreneur, Robert Bosch is also a Lionthe same machine can be used to mop floors and Philanthropist and Lion Citizen. In 1910, Roberteven drill holes with attachments. And in India, Bosch donated one million marks to Technischeone can also see the machines transporting people! Hochschule Stuttgart (Technical University ofYet, JCB’s spectacular success in India is recent. Stuttgart), thereby embarking on “an outstandingUntil 2003, it was selling less than 3,000 machines career as a philanthropist”, as Theodor Heuss, whoa year. It was only by 2004, in its 25th year in India, was later to become the first President of thethat the company reached 25,000 machines. The Federal Republic of Germany, wrote in hisnext 75,000 though came in seven years. The biography “Robert Bosch - Leben und Leistung”breakthrough came when JCB went the retail route published in 1946. After the end of World War I,in India, a crazy move in a market where other big Bosch made further donations, primarily formultinationals like Caterpillar and Komatsu focus educational programs. What motivated Roberton institutional clients. JCB’s network of more than Bosch to act as a benefactor in Germany, and what400 outlets is double that of its closest competitor. defined the charisma behind his abiding influence? As Theodor Heuss noted in his biography, Robert Bosch came from a “prosperous rural middle-class family that knew no material wants, husbanded its wealth with dedication and sound judgment, and whose good nature and benevolence naturally led it to care for others, and especially the poor.” The changing role of the modern state was another factor that explains his exceptional dedication in education. At the time, Germans were firmly convinced that education, in particular, was the exclusive responsibility of the state, which should therefore assume and direct all associated activities. Robert Bosch, however, had unpleasant memories of his own schooling and vocational training and concluded that the state was evidently not capable of fulfilling this task. Robert Bosch did not seek public acclaim for his work. His primary concern was to provide practical support, which he did out of his sense of civic duty “to 8
  10. 10. make his growing wealth bear fruit for public stronger with time as a friend, a contrastingwelfare in the widest sense of the term.” Bosch approach to getting returns in any one year fromtoday is 8% owned by the family and 92% by the clever short-term tactical trades in which time ishighly-regarded Robert Bosch Stiftung (Foundation) an enemy, and more so when leverage is involvedto continue the philanthropic and social which can unwind prior gains in a painful fashion.endeavours of its founder. The greatness of value investing in Asia is that the diligent value investor will search the Field for the“Envy” is a word that comes up repeatedly when exceptional Lion Entrepreneurs who settle indescribing the German psyche. The sentiment is so deeper in their focus in innovating in theirrooted in German culture that the language businesses to create and sustain life for theirprovides two words to describe it: Neid and customers and society - and we swing ourMiβgunst. Germans frown upon Schickeria, the Authentic Swing for these multibaggers, anidle rich. Swabians do not show off their wealth, Authentic Swing that comes through totalperhaps a contrast to the Asian rich. Even Stuttgart devotion and immersion in this lifelong endeavor -women are said to sneak their fur coats into the “Lion Entrepreneurs for life”.BMWs and Porsches while the car is still in thegarage, putting them on only after the two-hour KEE Koon Boondrive down to chic Munich. Like Bosch, Susanne 17 February 2012Quandt of the ultra-low profile Quandt familybehind BMW, and possibly Europe’s wealthiestwoman, believed very much in tradition andservice, especially as they relate to her parents’interests in fostering entrepreneurship. She spent€2.8m of her personal fortune to establish atraining center for young entrepreneurs at theTechnical University in Munich. “Whoever wants toaccomplish something should be able to findsupport,” she told historian Rudiger Jungbluth forhis book, The Quandts, published in 2002. JCB’sBamford family has also put £2m into anengineering academy in Rocester that opened inSeptember 2010 for 14 to 19 year olds, and themotto of the JCB Academy is “developingengineers and business leaders for the future”.While the property boom in Asia in recent yearshas created enormous wealth as Asians look uponthem as the investment vehicle to store andprotect wealth against rising inflation, theresultant effect has also breed a visible group ofAsian Schickeria. This insidious effect on the Asianbusiness community has caused quite a number ofbusiness owners and their managers to neglect thepivotal task of building a Lion Infrastructure whilemore and more focused MNCs continue to steal amarch on their homeground.Robert Bosch’s motto of “invented for life”underscores their desire to deliver long-lastingproducts that you can depend on for life. Whilethe trajectory path to becoming a sustainablemultibagger can be - and will be – volatile as wasthe case for Robert Bosch, Lion companies do notblow up in the portfolios of diligent value investorsand they make all the difference to generating oaktree-like returns as they grow stronger and 9
  11. 11. Is Avoiding Pitfalls in Value Investing in Asia All About Painted Puppets and the Dalang?Why are the faces and clothes of puppets in the economic prospects given weak enforceable legalenduring wayang performance – a traditional rules of investor protection in emerging markets.Javanese show – painted with bright colors when Insiders closest to the dalang would have advancethe audience sitting behind the screen can only knowledge of the dalang’s short-term plans, suchsee their shadows? More importantly, why is the as major contract wins that can trigger a jump inphilosophy underlying the wayang performance the share price, or issuance of shares that arecritical for value investing in Asia? Why can the dilutive to existing shareholders, or transferring ofartful appreciation of the wayang dialectics also resources within the group of companies andhelp in understanding the longer-term investment affiliates via related-party transactions, positioningtrends and implications of the World Bank report themselves ahead of the minority investors.“China 2030” warning of economic crisis unlessstate-run firms are scaled back, and the sacking of Thus, it would appear that avoiding pitfalls in valueChongqing party chief Bo Xilai on March 15? investing in Asia is about having “knowledge” about painted puppets and the dalang. Financial numbers are mere shadows and quantitative analysis, however sophisticated, cannot capture the intricate plans of the dalang, rendering clever short-term tactical gains irrelevant – often reversing in dramatic fashion without time for the investor to react and take portfolio action - once the dalang alters his or her plans, as evident from how high-profile western investors have stumbled when applying their once-successful investment methods in Asia without any adaptation. Yet,The dalang manipulates the puppets, sings and taps out signals to the Hernando de Soto, the influential economist andorchestra. He also speaks the parts for all characters. Not everyone can be author of the book “The Mystery of Capital: Whya dalang. First of all, he must be physically strong and healthy; otherwise hewould not be able to stand the strain. Just imagine, he is seated cross-legged Capitalism Triumphs in the West and Failsfor nine successive hours. He cannot even have a wink of sleep. He also has to Everywhere Else”, sums up succinctly why such anstrike the kechrek (rattle) with his right foot almost incessantly. He handlesthe puppets with both hands, imitates their different voices, tell jokes at the opaque dalang system is not effective in the long-right times, and even sings every now and then. In addition, he controls the run for sustainable value-creation for both themusicians without anyone among the audience ever noticing it. entrepreneur and the value investor: “Knowledge lies at the heart of western capitalism; KnowingThe answer to the opening question is revealed: who owned – and owed – what allowed long-termColors are not meant to be seen by the common investors to take risks and allocate capitalmasses; only the audience behind the stage, those productively.” Our reply to whether avoidingwho are closer to the puppet master, the dalang, pitfalls in value investing in Asia is all abouthave the privilege of seeing the true colors of the painted puppets and the dalang? A resounding NO!faces and costumes of the puppets. When awarrior like Arjuna or Bima is about to appear, the Asian entrepreneurs whom we spoke to over thedalang places on that puppet a golden mask. The past decade are often perplexed and exasperatedprivileged few behind the screen close to the why sales and earnings growth at their companiesdalang know in advance that a war is about to do not necessarily translate into correspondingbegin before the front audience sees it over the market capitalization growth. Over time, some ofscreen and they have a deeper understanding of these entrepreneurs feel unappreciated andthe feelings and behavior of the manipulator. eventually give up on using the capital markets as an integral part of the ecosystem to grow theirShares of most companies in Asia are not as widely businesses. They no longer put all their hard-held as those in the West; the controlling owner earned assets and earnings into the listed vehicle;with the ultimate beneficial ownership is like the crown-jewel assets often remain privately-owned.dalang behind the screen, sitting at the apex of the They are often tempted to expropriate and tunnelcomplex pyramidal or cross-holding or dual-class out assets and resources out of the companies intostructure controlling the puppet firm(s) with their private pockets through related-party ordexterity through layers of intermediate money-go-round accounting transactions involvingcompanies, opportunistically misrepresenting 10
  12. 12. M&As or “investments” that offset the previously the piercing through of the leather screen to seecreated artificial trade receivables and roll-over the colors of the “puppets”!“cash equivalents”. The less-than-diligent “valueinvestor” would find these “value traps” attractive, The slowdown in China is a genuine concern forpatting themselves on their backs for any short- both Asia and the West. Foreign direct investmentterm gains, not knowing that these were all (FDI) in China slumped for a fourth consecutiveengineered by the dalang to suck in naï capital ve month in Feb as investors are becoming lessand that the returns can unwind any time. confident in business prospects in China amid escalating labor costs and difficulties hiring andAt Aegis, we honor the spirit of Hernando de retaining skilled labor, as well as the perceived orSoto’s insights - and go a step further: Without actual unfair advantages enjoyed by Chinese state-carefully attracting and cultivating long-term Lion owned companies according to SamsungShareholders and the powerful intangible Electronics’ Suzhou Industrial Park (SIP) MD Leereputational capital as the foundation of Hag Cheol. A pressing question is whether Chinabusinesses, well-meaning entrepreneurs would can make use of the slowdown to carry out much-find that the valuation of their businesses to be needed political reform and economiccondemned to single-digit earnings or cashflow restructuring. Interestingly, the 468-pages “Chinamultiples, frustrating any plans to utilize the 2030” report was released on Feb 27, a weekcapital markets productively to execute their before Premier Wen Jiabao announced soberly onstrategic gameplan in building the Lion March 5 at the opening of the annual NationalInfrastructure to earn the elusive multibagger People’s Congress (NPC) and CPPCC – the lastvaluations. We are blessed over the past decade to before the once-in-decade leadership transitionhave quality interactions with the entrepreneurs this year - that China’s economic growth targetand the top management over secular industry would be lowered to 7.5% from 8%. Wen, 70, wastrends and company-specific innovations, long- visibly emotional with an unprecedented apologyrange information which, when combined with our for the “many problems present in China’sextensive in-house research, would yield deeper economy and society” at the closing of the NPC onpractical insights into whether the company has March 14, adding that the turbulent “Culturalthe ingredients to scale up to become a Revolution may happen again” without a politicalmultibagger when it is at the emerging phase - reform which is an “urgent task”. Wen, consideredwhen it is “ugly” in that the “Lion’s mane” has not the most progressive of China’s top leaders andgrown to its full majestic stature. In addition, we ranked third in the powerful nine-man Politburocould also see nonverbal cues in managers’ Standing Committee (中央政治局常委) with 80responses – and non-responses – to questions in a million party members, told hundreds of reporters:less-rehearsed setting when their guards are down, “I sincerely hope the people will forgive me.”such as their ability to articulate their businessmodel and strategy, or their unwillingness toanswer a certain question.Take for instance this recent example: One Asiantop manager in the capital equipment industryshared with us how his MNC counterpart in Chinatold him that they might not be able to sell anynew equipment in China this year. He thought theywere joking until they told him the reason. Thehigh value-added equipment that they sold comewith installed GPS system, giving them superiorinformational insights, such as when the enginesare turned on and the usage level, so as to betterplan sales and provide superlative services to earnhigher profit margins. And two-thirds of theequipment they have sold have no “color” on theirmonitoring switchboard – the equipment are notswitched on at all and are left idle without enough The high-profile Chongqing party boss andproperly-financed project works to keep these “princeling” Bo Xilai was removed from his postmachines busy working. Technology has enabled 11
  13. 13. the next day on March 15, replaced by Vice-Premier Zhang Dejiang, another princeling who is Guangdong, with a population of 104 million andclose to the former President Jiang Zemin. Bo Xilai, GDP of US$840 billion which is bigger than Saudi62, is the eldest son of Bo Yibo, one of the “Eight Arabia, is one of the world’s biggest manufacturingImmortals”, the group of revolutionary veterans hubs. Wang has been actively upgradingwho included supreme leader Deng Xiaoping and Guangdong’s economic focus away from lowled China through the launch of economic reforms value-added exports and toward domestic servicesin 1978/79. The party elders have created an amid faltering demand for the goods its factorieselaborate system that seeks to balance power produce. German Chancellor Angela Merkel hadbetween the princelings and the tuanpai faction, also met with Wang on Feb 3 in Guangdongor the populist Chinese Communist Youth League because of the “big German presence” in the city.(CCYL) led by the outgoing President Hu Jintao and Joerg Wuttke, the former head of the EuropeanWen; their successor is First Vice-Premier Li Chamber of Commerce in China, pointed out thatKeqiang who is tipped to replace Wen as Premier. Merkel is obviously interested in how GuangdongGuangdong’s reformist party boss Wang Yang, wants to reform itself. Germany faced similarwhose liberal less-is-more “Guangdong Model” challenges in transforming the Ruhr industrialstood in contrast to Bo’s state-driven “Chongqing region and East Germany. Wuttke predicts that theModel” is considered another tuanpai leader given cost to manufacture in China could soar twofold orthat he is a protégé of President Hu, both of whom even threefold by 2020.are fellow natives of Anhui province. Known as the“two cannons” for their outspoken politicking andrivalry, Bo and Wang have presented very differentvisions for China’s future. Wang’s conciliatoryhandling of civil unrest that broke out in the fishingvillage of Wukan over land grabs by local officialslast year in Sep-Dec drew plaudits for defusing theprotracted standoff, which ended in abreakthrough for grassroots civil rights activism.Wang, 57, could be the youngest member in thepowerful nine-man Politburo Standing Committee. Deng Xiaoping wears a cowboy hat presented to him by his Texan hosts on Feb 2, 1979, during his historic visit to the United States which marks the beginning of the first visit by a senior Chinese official to the United States after 1949. Deng’s trip – symbolized by the wearing of the cowboy hat - catalyzed the whole attitude of Americans towards China. The original sin of any value investor is to see the world only from his or her point of view. Objectivity is illusory. As Don Quixote tells Sancho Panza, “This that appears to you as a barber’sGuangdong party chief Wang Yang attended the groundbreaking basin is for me Mambrino’s helmet, and somethingceremony of the Sino-Singapore “Knowledge City” in July 2010. else again to another person.” If you have ever been on a plane in China and it is about to land, the Chinese will all surge towards the exit, pushing each other out of the way to save a few seconds on exiting. They are a nation that has industrialized late and are pushing and shoving to catch up. Despite modern factories, spanking new airports, highways, and shopping malls, Chinas social and financial institutions are perhaps comparable to those of the U.S. 150 years ago in the late 19th century period of the "Robber Barons." The Chinese in China will cut corners, bamboozle,German Chancellor Angela Merkel and the hardworking Premier Wen harass, deceive and cheat, on par with any 19thpose in front of a model of a tunnelling system during their visit to aplant of the Herrenknecht Tunnelling Equipment Company in Guangzhou century “wily yankee” and “wild-wild-westFeb 3, 2012. Volkswagen AG CEO Martin Winterkorn, Siemens AG CEO cowboy”. Reminiscent of the Gilded Age of thePeter Loescher and Lenovo Group Chairman Yang Yuanqing were amongexecutives attending business forum with Merkel and Wen. robber barons, a turbulent period in the history of 12
  14. 14. the U.S., the widespread, systematic corruption One aspect of the U.S. experience seem salient toand abuse of power is estimated to cost as much China. China’s present system of Nationalas 14% of Chinas GDP per year. The July 2008 Champion capitalism bears some similarity to themelamine milk poisoning scandal in China is often U.S. robber baron era: an economy dominated byheld up as the worst example of Chinese large, politically connected conglomeratesentrepreneurs running amuck. Yet, it is an echo of operating in a weak institutional environmentNew York City in 1858 where “swill milk” killed without anti-trust scrutiny. China’s State-Ownedthousands. The horrors of working conditions in Assets Supervision and Administration CommissionChinese sweatshops is an echo of Upton Sinclairs (SASAC), established by the State Council of theexpose of the Chicago meat packers — which NPC in 2003, is known as the world’s largestcreated such an uproar that Roosevelt sent a controlling shareholder. Wu Bangguo is thesecret fact checking mission that largely Chairman of the Standing Committee of the NPC,corroborated Sinclairs novel. In the end, New York the No. 2 ranked party leader, ahead of the third-milk was cleaned up. It took stronger food laws, ranked Premier. In his role as the “chief legislator”,better policing, the advent of pasteurization and Wu wields significant power and influence overthe passage of the Food and Drug Act in 1906, 50 the NPC which has a collection of functions andyears after the worst of swill milk. Above all, it powers, including electing the President,took decades, not months or years. approving the appointment of the Premier, and approving the work reports of top officials.Comparing the institutions of 19th and 21stcentury U.S. corporate capitalism may beinstructive in considering China’s futureinstitutional trajectory. The system in existencetoday in U.S. – from firm ownership structures tothe surrounding set of regulatory and marketinstitutions – eventually emerged out of the so-called robber baron era. The robber baron termwas used in reference to a group of prominenttycoons who controlled the largest public firms atdifferent times between the end of the AmericanCivil War and the first decades of the 20th century. Li Yuanchao shaking hands with Lee Kuan Yew in a meeting in May 2010.Although these entrepreneurs contributed greatly LKY told Li in a short meeting that he had been deeply impressed by theto the industrial development of the U.S., they Chinese determination and commitment to build better lives and betterwere often mired in controversy. These individuals cities in the past decades. “When the Chinese people put their minds to it, they will do it,” LKY said in Mandarin, citing the example of Shanghaiscontrolled the majority of votes in vast corporate Pudong districts development, which was transformed from farmlandsempires with relatively small(er) amounts of to a thriving financial hub in just 20 years. Li replied that China is taking only the “first steps” in its development, and it would follow the axiomcapital, leaving ample room for self-dealing. During laid down by the late paramount leader Deng Xiaoping to “taoguangthis era, the formal institutional framework meant yanghui”, which means to “bide time and conceal capabilities. As party chief in his native province, Jiangsu, from 2002 to 2007 Li oversaw ato protect minority investors in the U.S. was rapid rise in personal incomes and economic development, attractingnoticeably weak. In other words, they are the foreign investment from global industrial leaders like Ford, Samsung anddalang in their heydays. Caterpillar. Shortly after taking over in Jiangsu, he personally phoned a European company, a major foreign investor in the province, to ask if there was anything he could do for them. Li had visited Bo in Chongqing in April 2011 and his comments highlighted the abrupt nature of Bo’s sacking: "Chongqings reform and development has created many good experiences and offers an inspirational example of how to address problems China faces in its scientific development." Li Yuanchao, the former Jiangsu party, is head of the party’s powerful Organization Department (中 共 中 央 组 织 部 ) which appoints and controls personnel at every level of government and industry, including major SOEs, and has detailed dossiers on every member of the CCP, using theWu Bangguo (right, pictured besides President Hu Jintao) is theChairman of the Standing Committee of the National People’s Congress nomenklatura method (“list of names” in Soviet(NPC), which is considered China’s top legislative body. The position is terminology) to determine appointment. Li, 61,ranked second in China’s political hierarchy, ahead of the Premier. whose father was Shanghai’s vice-mayor, is likely 13
  15. 15. to be in the powerful nine-man Politburo Standing and going forward for Asia - has to be “on theCommittee. Managed by Wang Yong who ground” at the corporate level in the lush thicketsucceeded Li Rongrong in 2010, SASAC “owns” 121 where Lions make the conscious choice to emerge.Chinese state-owned enterprises (SOEs), downfrom 196 when SASAC was set up, with total assets At Aegis, we often wondered aloud and lament atexceeding RMB24 trillion generating aggregate the low valuations in Asia as compared to theprofits over RMB2 trillion. West. Why is it that Asian entrepreneurs do not see the need to build “moats” and a LionThe presence of autocratic controlling Infrastructure, preferring to be the dalang buildingshareholders could have easily amplified adverse tents instead of the 100-storey castles? In short, toselection to the detriment of stock market growth be a Lion Entrepreneur as opposed to a Hyenain U.S. Historical data indicate that this, however, Entrepreneur. Is it because there is less room forwas not the case. Average daily trading volumes at Lions to roam in Asia because of the formal andthe New York Stock Exchange increased from informal intuitional infrastructure?1,500 shares in 1861 to more than 500,000 in 1900and annual trading volumes grew from estimates Alfred Chandler’s 1977 Pulitzer-Prize masterpiece,of 80 million shares in 1897 to 265 million in 1901. The Visible Hand: The Managerial Revolution inThe number of listed firms in the NYSE grew from American Business, offered timeless practical691 in 1920 to over 1,000 in under six years, while insights and fundamental lessons for diligent valueannual trading volumes had already exceeded 1 investors to stay ahead of the curve in Asia,billion shares by 1929. Ownership had already uplifting us beyond the unsustainable realm of thestarted to disperse in NYSE-listed firms well before painted puppets and the dalang. Chandler ththe enactment of the Securities Act in 1933 and narrated the emergence in 19 century America,the Securities Exchange Act in 1934. the age of robber barons, of firms which transform themselves by “organizational innovation” andThe rapid – and stable - development of US capital “managerial innovation” to generate and sustainmarkets during this period has been attributed - in competitive advantage – to become Lions.part - to the intervention of reputationalintermediaries. NYSE, in its capacity as a self- Besides GE in 1890s, Singer Sewing Machine andregulatory organization (SRO), undertook to McCormick Harvester were highlighted as firmsensure the quality of the firms it admitted for a which began to integrate mass production withpublic listing. The exchange set in motion a legal mass distribution and marketing for their ever-system in miniature, “with its own rules governing increasing technologically complex goods. Singersecurities trading and its own mechanism for was a pioneer in developing the channels ofresolving trade-related disputes”. By adopting and distribution; their consumer appliance was theenforcing this system of rules, the NYSE provided first product to be sold under a consumerassurances to outside investors concerning the instalment plan, and the first to be sold through aaccuracy of disclosure and the governance of its fully-developed franchised agency system, whichlisted firms. Firms that did not comply with the enabled greater adaptation and scaling whenNYSE listing requirements were not admitted to operating in markets with different social andthe exchange; those that violated the rules after economic characteristics. The new Singer productan IPO were forcefully delisted. In doing this, the required distributional innovation in order toNYSE dealt with adverse selection to an extent that demonstrate, instruct and assist the sewing-the state was unable to emulate at the time. NYSE machine user. By the mid 1950s, Singer had itsbecame the “dominant provider of reputational own salesrooms to market the product, deliver thecapital” in the U.S. for many decades. Although machines, assist consumers with trained personnel,there is controversy concerning the current role of maintain attractive outlets, carry on adequategatekeepers and the relative importance of their stocks of machines, parts and accessories, and toreputational incentives in modern U.S. markets, repair the machines. In addition, these salesthere is general agreement as to their significance outlets provided information on market trends andin promoting the initial development of U.S. competition so that product developmentcapital markets. So regulatory infrastructure advanced rapidly. The merchandizing efforts ofcannot provide value investors the laser gaze to Singer’s own outlets proved so successful that bysee past the thick shadows on why sustainable 1880, Singer severed their relations with allmultibagger growth has occurred in 19th century independent agents and distributors, and itsAmerica. The key reason for growth at that time – distribution network maintained 530 retail outlets. 14
  16. 16. Chandler observed that the economic advantage Household and Healthcare (LG H&H) to trade atof Singer resided inside the organization: “That near all-time highs. The premium market accountsmanagerial hierarchy recruited, trained, and for around 60% of the Korean cosmetic industrycarefully supervised the canvasser-collector, Korea has a unique door-to-door sales channelprovided long-term consumer credit; assured which sells mainly high-end cosmetics products,continuing service of the machine sold; and finally, with Amorepacific, whose brands include Laneige,permitted a smooth and reliable distribution of the Sulwhasoo and Mamonde, dominating this20,000 to 25,000 machines shipped each week to channel with 60% market share. Amorepacific hasall parts of the world.” Therefore, the essence of a long history (more than four decades) of successSinger’s sustainable competitive advantage in training and cultivating the sales counsellors andresided in its human and organizational capital and sticky relationships with the customers forits superior distributional capabilities. decades. Foreign cosmetics brands have little or no experience in this sales channel and as a result,Singer also devised new types of accounting and Amorepacific, with a market cap of S$7.8bn, hadstatistical controls; the management accounting secured for itself a durable franchise andsystems developed by Singer and others allowed formidable competitive moat.extensive vertical integration and coordination to“get closer to the end customer” since thesesystems not only lowered internal integrationmeasurement costs but also make the firm moreresponsive to customer needs and demand.Similar growth patterns were documented at GEand Westinghouse where the competitiveadvantages obtained were due to their human and Amorepacific Chairman Suh Kyung-bae (L) and LG H&H CEO Cha Suk (R)organizational capital. Thus the rise of thevertically-integrated enterprise brought with it Amorepacific was started from humble origins bymanagerial capitalism. In turn, the visible hand of the grandmother of current Chairman Suh Kyung-teamwork coordination helped integrate new bae, who began by making camellia-based hair oilsprocessed of production and distribution, and and creams as a sideline. The Chairman’s fatherenabled pioneering firms that adopted and Suh Sung-whan established the sideline as adeveloped this organizational innovation to proper business in 1945 as Pacific Chemicalgenerate and sustain competitive advantage. Industry, and ran it for more than five decades until his death, using his “holistic beauty” vision toThe examples may change but the ideas will not go create a comprehensive range of innovativeout of date. Even though technology advances skincare products based on natural extracts frombreathlessly, the economic principles by Chandler Asian botanical plants and herbs. KB Suh, 49,are durable – especially in Asia. In a follow-up to joined Amorepacific in 1980s after an MBA fromthe on-the-ground observation of slowdown in Cornell, and he was the only one out of six siblingsselected parts of China given that two-thirds of the to take an interest in the business and he becamemachines are not turned on as indicated by GPS CEO in 1997 with plans to globalize the brand. KBtechnology, this practical nugget of information Suh initiated restructuring in the mid-90s toallowed us to better assess the commentary of counter loss of market share to foreign players as aanother Chinese entrepreneur who was discussing result of sector liberalization (1996), selling offhow the tidal waves from the growth of the non-core assets (baseball, basketball teams,industry will lift their capital equipment business. securities arm, life insurance etc) and focusing onWhile they claim that their machines are premium brands. Amorepacific aims to triple Chinatechnologically advanced, they do not have their sales by 2015 to $626m and plans to complete theown distributional and sales team like those in the construction of its new Shanghai Production &West (e.g. GE) or Japan (e.g. Fanuc, SMC, Keyence) Research Center in March 2013. With 92,788 sqmwhere trained sales personnel with expertise in of land area and 41,001 sqm of building area, theengineering were essential. Instead, they rely on new facility will have an annual production“independent” distributors like most others. capacity of 7,500 tons and 100 million units, a 16- fold increase compared to current capabilities.Vertical integration and distribution innovation toget closer to the end customers have resulted in By eliminating agencies – the middleman betweencompanies such as Korea’s Amorepacific and LG manufacturers and specialty retail shops who used 15
  17. 17. to get 10% of product sales as commissions – for established a career path for Mars Chinabetter inventory control and pricing, along with employees, which encouraged them to stay withadding premium cosmetic lines, former P&G the company for the long-term. The result was anveteran Cha Suk-yong turnaround LG H&H after in-country organization with an esprit de corpsjoining the firm as CEO in Jan 2005; share price has that was evident, for example, in the well-since multiplied around 20-folds in under 8 years regulated militia of small-store bicycle salesmen. Itto S$9.6bn. CEO Cha had a three-year incentive took Mars 12 years to make its first profits in Chinabonus linked to share price performance and OP in 2005, and after hitting the tipping point, it hasmargin, and a 0.4% equity stake. He will get 5x his experienced exponential profit growth with a 40%salary if KPI are above the LG targets. market share, way ahead of any rivals.Distribution and organizational innovations has ********also led to Mars, with its Dove brand, becoming Some Asian tycoons believe that they have morethe only clear winner amongst the chocolate MNC than done their part for the family by leavinggiants Nestle, Hershey, Cadbury and Ferrero behind great wealth for their offspring. A LionRocher in the battle for China’s consumers, a Entrepreneur shared with us recently that he gotreminder yet again that size is not might. The wind of someone who whispered in the ears ofsalesmen who sold Mars chocolates were clean- one of his children that why should he study socut young men dressed in chocolate brown jackets hard since your father became a successfulwith Mar’s Dove brand emblem on the back who businessman despite the humble low-educationsell to small shops and kiosks throughout the cities background. As he is so busy building the business,in China on their bicycles. Veteran chocolate he shared that he can only be a role model andexecutive Lawrence Allen remarked: “Given the impart his wisdom whenever he sees his children.choice of buying Dove chocolate from one of the So he jokingly said to his son, “You must one ofwell-outfitted ‘boy scouts’, or another chocolate those sitting at the back row of the lecture hall!”brand from a nicotine-stained wretch, it was no The son said, “How do you know?” And they havewonder that Mars’ success was building on itself a quality interaction over the merits of educationexponentially.” The cost of this dedicated to broaden one’s mind and to cultivate one to be adistribution and sales force was shared 50-50 with better person. Since then, his son has become verythe distributors, allowing Mars to have a studious in his studies for its intrinsic values.formidable 250,000 point-of-sales (POS) networkacross China. In a video case study which Mars All of us try to be the dalang inadvertently at oneshared on YouTube this month, Mars has also point or another in our life. Without the dalang, noeffectively used Weibo, China’s Twitter, to market puppet can come to life. Leaving behind hugeDove, resulting in chocolate gift set sales during fortunes for our children may not be a blessing andthe Chinese Valentine’s day period last year to could be a curse as we leave them vulnerable toskyrocket 226%. the attacks by Hyenas who seek to exploit them and churn them with fees and transactions. At Aegis, we believe that creating a “going-concern” is the most sustainable way for the Lion Entrepreneurs to manage their family and personal affairs in wealth management. Create a “living organism” which can carry and sustain the aspirations of our loved ones, lifting them beyond the prying hands of short-term Hyenas. We are blessed to have worked with several Lion Entrepreneurs over the past decade in providingWatch Dove China videoclip: www.youtube.com/watch?v=x9Yq-ASSc78 our unique Family Office and Wealth Management services, with dedicated efforts led by theBecause Mars knew that Chinese prized higher experienced Massimo Catemario di Quadri andeducation, the Mars Academy was established in Damien Long, both of whom are illustrated scions2003 to significantly upgrade the knowledge and themselves and have first-hand intimateskills of high-potential company employees, and a knowledge in navigating the sensitive, thornyyear later the Mars China Graduate Development issues and the ups and downs with serenity and aProgram was begun. Both of these initiatives also win-win outcome. We also welcome in this Dragon 16
  18. 18. Year the addition of Ms. Seow Bao Shuen, a value investors should possess to stay ahead of thesuccessful and talented entrepreneur and CEO curve when investing in the tricky grounds of Asia.who has built and managed two Singapore-listedcompanies, as our COO to add to our businessdepth and expertise, our mother hen and ourlanding gear as Aegis seeks to fly higher for ourclients with our unique institutional multibaggerapproach to investing. Aegis Knowledge supportsour Family Office and Wealth Management withfamily education and training programs. Our beliefis similar to that of Waycrosse, Cargill’s familyoffice: “To encourage education for the nextgeneration as well as to maintenance of the familyglue.” Developing the next generation to be bothLion Entrepreneurs and Lion Shareholders is The devoted and loving couple: Pak Harto and his wife of 49 years, Ibu Tien. With the untimely death of his wife on 26 April 1996, Presidentcritical and we at Aegis work tirelessly as a team to Soeharto had lost the greatest ally in his life. Stories also surfaced that itassist them in pursuing their passions, to give had been Ibu Tien who could control her children to mind the sensitivitythem all the tools they need to be effective of their business dealings as Hyenas encircled the children. It was also Ibu Tien who had a premonition that Pak Harto should not seek re-shareholders, and to promote shared values as election in the early 1990s. As she was of minor aristocracy, the Javanesestewards of their family assets. believed that she had been the one given the wahyu (soul of the leader). It was her wahyu that made President Soeharto one of the greatest leaders in Asia. With her passing, the wahyu was gone and many thought ******** that President Soeharto’s days in power were numbered. Whatever the Javanese believed in, the fact remains that President Soeharto steppedValue investing in Asia has to progress beyond down just two years after her death. In her 1995 autobiography, “Thepainted puppets and the dalang. Short-term clever Downing Street Years”, former British Prime Minister Margaret Thatchertactical trades from “insider knowledge” about commented of the controversial Pak Harto: “A state created out of some 17,000 islands, a mix of races and religions… it is a marvel that Indonesiashort-term plans of the controlling shareholders has been kept together at all. Yet, it has an economy which is growingcannot be robust and sustainable. As the sagely fast, more or less sound public finances, and though there have been serious human rights abuses, particularly in East Timor, this is a societyWarren Buffett puts it aptly: “But in the end, the which by most criteria “works”. At the top, President Soeharto is anonly wealth creation comes about through what immensely hardworking and effective ruler. I was struck by the detailed interest he took in agriculture – something which is all too rare in oil-richthe business creates. If a company that’s not worth countries like Indonesia. He spent hours on his own farm whereanything sells for $20 billion and 5% of it changes experiments in cross-breeding livestock to maximize nutrition were thehands, somebody takes $1 billion from somebody order of the day.” In the survey findings by Sydney’s Lowy Institute released in March 2012, 55% of Indonesians say life was better underelse, but investors as a whole gain nothing. They Soeharto’s presidency.are all fee richer. It’s a very interestingphenomenon. But they can’t be richer as a group To make headway in understanding Indonesia andunless the company makes them richer.” To Asia, one must first understand the profoundparaphrase and adapt the wisdom of Buffett, it philosophy of the wayang. The Javanese liked tomeans that only by investing in a sustainable hear the jokes of the sagacious Semar, see themultibagger can the outcome be win-win for the mighty warrior Bima using his thumbnail to tearentrepreneurs, the managers, the investors and the cunning Sukuni into pieces, and they werethe society. Perhaps because this is so (ethically) always fascinated by the romantic adventures ofdifficult, there are few funds with a track record of the refined Arjuna. The Javanese like to comparemore than 10 years in Asia. We are grateful to our real personalities that they come across withloyal clients who have stayed with us through wayang personalities. Pak Harto, Indonesia’sthese years, with our flagship fund returning over second President who held office for 31 years from500% (net of performance fees; we have no fixed 1967 and had built Indonesia into a more modernmanagement fees and no soft dollars, a rarity in state, is said to identify strongly with the clownthe industry) since inception in June 2002 as god Semar, who in the wayang plays often steps incompared to around 150% for the Morgan Stanley to save the situation when more refinedAsia Pacific ex-Japan index. Asking the penetrating characters have failed. Semar’s role is also tolong-range Chandlerian fundamental questions, expose the evil in the human character. He looksidentifying the business model gaps of the ugly but is kind-hearted, powerful but humble,emerging companies, assessing the possibilities brave but faithful. He appears stupid but is oftenwhether they can cross the chasm to become brilliant and wise. Endowed with supernaturalmultibaggers, and adherence to good governance powers, Semar never once misuses them, butprinciples – these are what diligent long-horizon 17