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On the Ground in Asia (2012)

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  • 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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
  • 19. always comes to the rescue of the helpless.Although Semar is only a symbolic clown god inJavanese Mahabharata wayang play, it is hard tobelieve that most Javanese believe that Semar is adeity and real. In order to communicate with him,one should visit either of the two holy caves ofSemar – the Guwa Ratu cave on Gunung Srendangnear the village of Adipolo or the Guwa Ratu onthe Dieng Plateau, both in central Java. PresidentSoeharto had been known to spend a night therewhen things became tricky. Before the Indonesianrevolution, the young Soekarno, later the foundingPresident often went there for inspiration andmeditation. The cave is said to be the physicalcenter of Java. This Javanese habit of associatingsome real personalities with mythical figures isvery much like that of educated Chinese, who arefond of nicknaming a leader who is royal, loyal andcool-headed as Liu Bei, or an upright, just andcourageous leader as Guan Gong, or a daring butimpulsive personality as Zhang Fei – the threesworn brothers in the Three Kingdoms period wholived about 2000 years ago. Zhuge Liang, themilitary strategist to Liu Bei, is the intelligent andlearned scholar. If one is smart and cunning, he isalways compared with Cao Cao.Apart from excitement, the people went to thewayang to gain wisdom, insight, and peace ofmind. When Arjuna was groomed to be a goodleader, the dalang said: “To be a knight or a good leader, one must have a strong mind and character to bear troubles and sorrows, just as the earth has to bear everything which exists on the surface of the planet. A good leader must be like the sun, giving warmth and life to all creatures without expecting anything in return; like the moon, giving peace and joy to all; and like the stars twinkling in the sky, maintaining high ideals to serve mankind. He must also be like the ocean, vast and broad-minded; like the fire, fierce and just; like the wind, intelligently knowing the aspirations of the people; and like water, giving knowledge to all who thirst for it.”And our unyielding mission as value investors is toinvest for our clients such emerging LionEntrepreneurs, whether visiting factories in thehot sun, working late at night with the moon forcompanionship, or crossing the oceans in Asia toconduct due diligence!KEE Koon Boon19 March 2012 18
  • 20. Do Asian Entrepreneurs Desire To Have ‘Black Cats’ To Become Multibagger Stocks?Imagine that you have to oppose the well- bring about a haulage revolution which changedrespected founder of a successful “Stage 1” how Japanese travel inside the country. Nobodycompany in stopping business with an important carries skis or golf bags when they travel to skitop-tier quality customer since the beginning of slope or a golf club. Travellers by the Shinkansenthe company’s establishment for 6 decades and (bullet train) comfortably move around withoutthe customer makes up around half of the luggage as they have sent it to their destinationcompany’s revenue. The founder also repeatedly beforehand by Yamato’s Takkyubin service, nowadvised against a decision that would imply any doing over 200,000 parcel deliveries each day fromlack of respect toward that customer. Think the their famed high-tech Kanagawa Distributiondecision is hard? How about if that founder of the Terminal in Tokyo. The hardnosed decision createdfamily-owned business is also your father? a S$8.7 billion market cap multibagger, symbolized by their “Black Cat” corporate logo. The “Black Cat” – a symbol of tough decisions made by tough leaders - is also a chilling reminder to value investors in Asia that the successful transition of the founder-led family businesses into a going-concern in “Stage 2” might not be a smooth affair - even if there are no tough businessLion Entrepreneur Masao Ogura (1924-2005), the second-generation decisions to be made, like Masao Ogura had to.builder of Yamato’s Takkyubin service. The companys logo is a yellow The ICAC (Independent Commission Againstoval with a black mother cat carrying her kitten in her mouth,symbolizing the companys promise that they take care of items Corruption) high-profile arrest on March 29 of theentrusted to them as though the items were their own family. Ogura-san Hong Kong property billionaire brothers, Thomaswas first inspired by the Yoshinoya chain which specialized in beef-meatserved with rice. He observed that its profits increased when it focused and Raymond Kwok, of the family-owned businesson one menu item to the exclusion of others. Logic dictates that if you Sun Hung Kai (SHK) over suspected bribery chargescut the number of dishes offered, the number of customers mightdecrease as well. The reality was that Yoshinoya ended up with more involving former HK government Chief Secretarycustomers. Ogura wondered if Yamato and its customers might be better Rafael Hui highlights the succession and in-fightingoff if the firm only offered a focused service. The second inspirational risks of many Asian family-controlled companiesmoment occurred when his family tried to send old clothes to relativesin the Chiba prefecture. Haulers would only handle cargo from corporate run by aging patriarchs and matriarchs which couldcustomers. Ogura could not, even as president of Yamato, send the override any advantages of the family model.items. The only way open to a housewife was parcel services offered bythe National Railway or Post Office, which would take days for the parcelto arrive at the destination. SHK, 42% owned by the Kwok family, was co- founded by the late patriarch Kwok Tak-Seng inThis tough decision taken by Yamato Transport’s 1963 with Lee Shau-Kee and Fung King-Hei. SHKLion Entrepreneur Masao Ogura in 1979 to cease rode the three-decade surge in Hong Kong homelong-haulage business with Mitsukoshi (Sogo prices to become the world’s second biggestdepartment store) to focus on Takkyubin developer by value since its 1972 listing. The two(Japanese word for next-day home delivery) went Kwok brothers are known for being extremelyagainst the industry’s mainstream players who devoted to their mother and for their evangelicalwere concentrating resources on long-distance, Christian faith. In 2009, the Kwok brothers built alarge-volume cargo. “Quality” customers such as 137m replica of Noah’s Ark, with nearly 70 pairs ofMitsukoshi and Matsushita are extremely fibreglass animals, as a theme park “to promotedemanding, particularly more so during the 1973 positive values”. In the 1990s, Thomas pushedenergy crisis. For instance, Mitsukoshi demanded successfully to establish a church in the pyramidYamato pay parking fees for trucks parked on their atrium on the 75th floor of Central Plaza, one ofpremises, plus office space used by Yamato’s Hong Kong’s three tallest buildings. They took overemployees in handling of cargo, amongst other last year the chairmanship of SHK from theirdemands, which resulted in a huge loss for Yamato. mother who had ousted elder brother WalterMasao Ogura was of the view that Yamato could Kwok, 60, from the family trust and as chairman innot pursue the two businesses: large-lot haulage a 2008 boardroom struggle. There is speculationand Takkyubin. With that fateful decision to focus that the current investigation by ICAC may be tiedon Takkyubin, Masao Ogura turned around a to a High Court case filed by Walter four years agohaulier which had been slipping in rankings and in an effort to save his chairmanship which he took 19
  • 21. over when the patriarch passed away in 1990 at exceptional, not the mean; by the catastrophe, notage 79. Walter alleged in the 2008 writ trying to the steady drip... We need to free ourselves fromprevent his ouster that he had concerns about the ‘average’ thinking.”way the company was being run, including doubtsabout a land acquisition in Hong Kongs rural New We conducted an overseas due diligence exerciseTerritories, the way the firm granted construction in late March on several companies, including acontracts and questions about a lease at the potential “Asian Starbucks/ McDonald’s” and aInternational Commerce Centre on the Kowloon company operating in a similar business as Ta-Q-peninsula. As was pointed out in a Wall Street Bin for the past 12 years in the Asean region, bothJournal article, real estate entrepreneurs, once in expansionary mode. “Kicking the tyre” for thehighly admired figures in society, are now being latter company was a unique experience as thiscast in the role of villains as property prices in Asia was the first time we had to visit the facilities andremain at elevated levels beyond the affordability warehouse in the night-time, from 6.30 p.m. tillof the masses, prompting some views on a secular 11.30 p.m., as this was their peak operating period.de-rating in valuations in the sector, particularly The passionate business duo - the controllingsince the arrest was made just five days after the owner and the CEO - led us around the newly-selection of C.Y. Leung as the territorys next chief expanded 68,000 sq ft facilities, a three-foldexecutive. Leung defeated Henry Tang who was expansion, with additional land space totallingbacked by most property developers. Leung has over 200,000 sq ft for further expansion. We havelong voiced concerns about housing affordability a firsthand look on the process flow of the system.and availability and proposed reform of HKs land The seamless integration of warehouse (withsystem that has created startlingly high prices. In barcode labelling on the shelves and items forSingapore, news of two listed companies involved efficient inventory management) and distributionin family disputes also broke out in March. hub (equipped with loading/unloading bay, conveyor belt and auto- weighing system, coldThe late Nobel laureate Merton Miller (1923-2000), storage, temperature and humidity control, andco-author of the Modigliani-Miller theorem which data and bill payment center) in the same buildingproposed the irrelevance of debt-equity structure, facilitates the quality service provided by them toonce commented: “For investors who do not rely their customers.on professional advisers, stocks are usually morethan just the abstract ‘bundles of returns’ of oureconomic modes. Behind each holding may be astory of family business, family quarrels, legaciesreceived, divorce settlements, almost totallyirrelevant to our theories of portfolio selection.That we abstract from all these stories in buildingour models is not because the stories areuninteresting but because they may be toointeresting and thereby distract us from thepervasive market forces that should be ourprincipal concern.” This investment insight by the Just as a significant number of successful Asianeminent researcher could ring true in countriespopulated by companies with dispersed, widely- tycoons in the past have poured money to createheld shareholding structure, but may be less money management companies but few have succeeded, similar attempts have failed inrelevant in Asia where companies are usually replicating a “Ta-Q-Bin” or scaling up atightly controlled by families and blockholders.Sophisticated portfolio management attempts to “McDonald’s”. These are “services” businesses“average out” what is arguably a “systematic” which require daily grit, teamwork, decision-rights decentralization, organizational and managerialeffect in Asia may backfire. And the role of the innovations to scale up successfully, as opposed todiligent value investor is to search for the“outliers”, the multibaggers that are not captured the well-established business path of relationship deal-making typical in Asia. The case of Kingfisherin the “statistically significant averages” in Airlines, India’s second-biggest airline with a 19%tractable, winsorized and truncated models. Nobellaureate Philip Anderson puts it wisely: “Much of market share, is also noteworthy on the difficultiesthe world is controlled as much by the ‘tails’ of of a “services” business model. Kingfisher has not posted a profit since it was founded in 2005. It haddistributions as by means or averages: by the 20
  • 22. not paid its staff since December last year and vastly different mindset to scale services andowed $1.3 billion to banks. Its bank accounts were knowledge-based business models successfully.frozen by the tax authorities. A Reuters article on22 March commented: “Rich, famous and well- The owners of Burger Chef, which was bigger thanconnected may not be enough for billionaire liquor McDonald’s with 1,200 stores in 1968 as comparedbaron Vijay Mallya to rescue his Kingfisher to the 970 “Golden Arches” and opening at thriceAirlines.” The fortunes at “India’s Ta-Q-Bin” Blue the rate, sold out their business to General Foods.Dart Express stood in sharp contrast. Founded in Burger Chef’s EVP Robert Wildman recalled:1983 by Khushroo Dubash, Clyde Cooper andTushar Jani, Blue Dart has multiplied 24-folds in 18 “We sold out to General Foods because weyears since its listing in 1994 to over S$1.2 billion thought they could finance our faster growth. Itin mkt cap (Bloomberg chart on the left). DHL didn’t work out that way. They were used to running a Jell-O factory, filling up boxes andExpress (Singapore) completed the acquisition of building demand through advertising. Our81% of Blue Dart in 2005. business was foreign to General Foods managers, who were inexperienced in dealingAsian companies are predominantly “product directly with consumers and with service people.manufacturers”, which, ironically, could be a result When General Foods managers were assignedof the Asian values of hardwork and sacrifice. It is to Burger Chef, they felt as if they were beingfar easier for the Asian entrepreneur to get orders, sent to Siberia. By 1971, it was obvious totake capital risk in investing in tangible assets, and everyone that Burger Chef’s expansion programwork hard in producing the required products with was out of control: General Foods brought new store development to a screeching halt andquality and precision, rather than to build business took a $75 million write-off on its fast-foodmodels that have direct ownership of the end operation. In a single year, General Foods hadcustomers. To do the latter would require managed to lose more money in the hamburgerinteracting intensively with the end customers, a business than McDonald’s had earned in thetask which is beyond that of a lone powerful preceding decade. Fast-food business was notentrepreneur. As a result, successful Asian the source of easy money that they had thoughtentrepreneurs are usually unwilling to share the it was. We were in no position to duplicaterewards with their “undeserving” staff who did not McDonald’s base of entrepreneurial operators.”take risk or sacrifice, thus treating employees asexpenses, making most or all of the decisions,keeping most of the resources and informationthemselves, running the firms as a “one-man-show”, and facing potential business continuitychallenges from succession woes.In the case of McDonald’s, aggressive competitorswho sold out to major food processing giants tofinance their growth find themselves eliminatedout of the race. The packaged foods giants This 1968 photo was taken in White Plans, New York, on the occasion ofbelatedly discovered that there was an enormous the formal signing of papers making Burger Chef Systems a wholly-difference between the management of owned subsidiary of General Foods Corporation. Backrow (L to R):manufactured food sold to supermarkets and food Robert Wildman (EVP), George Perry (Chairman), Donald Thomas (VP); Frontrow (L to R): Frank Thomas (President), A.E. Larkin (President ofprepared and sold directly to customers at a fast- General Foods).food outlet. In the former, manufacturing iscentralized and more easily controlled, and the When Masao Ogura started Takkyubin service Insale to the consumer is indirect and depends January 1976, their first month saw only 9,000highly on branded advertising. In the latter, parcel deliveries. Ogura was scared and concernedproduction is decentralized and difficult to control, but decided not to pressure his employees tosince each store is a self-sustaining production unit. make money. Instead, he emphasized theFurthermore, the sale to the consumer is direct importance of service quality. His motto was “Firstand depends highly on local service. This is also a the service, then the profit.” For him, drivers werelesson for most Asian entrepreneurs who grew the primary force. Therefore Ogura emphasizedtheir businesses as a manufacturer because it that drivers must operate like sushi chef. Sushiallows them centralization and control – it takes a restaurant performance is largely dependent on 21
  • 23. sushi cooks who prepare sushi, attend to While touring the tangible facilities and warehouse,customers, calculate bills etc. They must take we were also on the lookout for the intangibledecisions on their own. The reputation of the “Black Cats”. We like to assess whether theTakkyubin service spread like wildfire. In the first founding entrepreneurs desire to surroundyear, they handled 1.7 million parcels. Positive themselves with “Black Cats” who dare to disagreeaspects of Takkyubin became clear: housewives with them because both care so much about thedid not try to negotiate the pricing, unlike greater purpose of the company’s mission, likecorporate customers, and freight was paid in cash, Masao Ogura’s insistence to drop Yamato’s biggestwhich gave a breathing space to Yamato’s treasury, customer and focus on a new and unprovensince corporate customers only paid by bills of business model. Importantly, Lion Entrepreneursexchange. By 1980, the Takkyubin business grew desire to place these “Black Cats” in key leadershipexponentially, reaching 33.4 million parcels, positions to drive innovation and sustainableequivalent to cargo handled by the National growth. Guan Gong and Zhang Fei, the two swornRailway. After five years, the Takkyubin finally brothers of Liu Bei, the “Han King” in the Threebroke even. As soon as other competitors saw the Kingdoms period 2,000 years ago, are very unlikelyTakkyubin was lucrative, new entrants were legion. to disagree with their leader. It took the arrival ofYamato’s trademark was the “Black Cat”. Others the “Black Cat” military strategist Zhuge Liang toadopted Pelican, Red Dog, Small Bear, and Giraffe scale up their “Shu” kingdom. Lion Entrepreneursas their trademarks. At one time, there were 35 of are made complete with “Black Cats”. Yet, “Blackthese trademarks. This was called the “Animal Cats” are often controversial, misunderstood andWar”. Ogura stoically welcomed the competition; volatile, just as genuine multibaggers are, and thehe was sure that Yamato’s service quality was far ability and discipline to understand and embracebetter than competitors’. In 1981, he started a volatility reaps sustainable outperformance. Likethree-year campaign – Dantotsu Keikaku, or Plan Apple’s Steve Jobs and Steve Wozniak, Andrewto Keep the Clear Top Position – to extend the Carnegie and Henry Phipps, Charles Rolls andnext-day service area. Yamato won the “Animal Henry Royce, Sony’s Masaru Ibuka and Akio Morita,War”. By 1984, 150 million parcels were handled Berkshire’s Warren Buffett and Charlie Munger.by Yamato, more than the number of parcels sentthrough the mail.Sony’s Masaru Ibuka (L) and Akio Morita (R). Sony’s founding prospectus:www.sony.net/SonyInfo/CorporateInfo/History/prospectus.html Yet, it is so difficult to desire a “Black Cat” as a leader. Take the case of Winston Churchill and Neville Chamberlain. Unlike the respectable, pragmatic, reliable and upright Chamberlain, Churchill was a drinker and surrounded himself with a “disreputable crowd of roués” and hence was snubbed in his early views on Hitler’sRolls Royce’s Charles Rolls (L) and Henry Royce (R) rearmament of Germany. Both Churchill and Chamberlain were realists, calculating possibilities and outcomes based on past experience and self- interest. So the question arises: how was Churchill a realist in a way that Chamberlain was not? What did Churchill seem to know, in that particular circumstance, which can guide Lion Entrepreneurs and value investors? German rearmament was, historically speaking, normal, as pointed out by Robert Kaplan in his 22
  • 24. book “Warrior Politics: Why Leadership Demands a misunderstood engineer - a den for thePagan Ethos”, and in the mid 1930s, Hitler could misunderstood “Black Cats”:have been seen as simply another contemptibledictator with whom the world had to deal, rather "The first and primary motive for setting up thisthan as the self-described maniac of Mien Kampf. company was to create a stable workFor the appeasers like Chamberlain, permitting a environment where engineers who had a deep and profound appreciation for technology couldrearmed Germany to check Soviet Russia seemed realize their societal mission and work to theirperfectly reasonable. Chamberlain was very hearts content. I experienced how passionpragmatic: he knew his people wanted peace and together with capabilities can be driven by atheir money spent on domestic needs rather than profound and fascinating mission. On the otheron armaments, so he gave them those things. hand, I also realized what could weaken theseWhen Chamberlain returned from Munich after intense motivations. Thus I began to conceive ofappeasing Hitler, he was proclaimed a hero. As ways for these motivated individuals to beHitler grew from strength to strength, united on a personal level, to embrace a firmChamberlain’s fatalism kicked in and he believed cooperative spirit and unleash their technological capacities without any reserve. IfHitler’s rearmament was a troubling but inevitable this could be accomplished, the organizationoutcome of Germany’s industrial capacity, its large would bring untold pleasure and tremendousand dynamic population, and its strategic position results, regardless of the meagreness of itsat the heart of Europe. Thus, the Nazi leader could facilities or the limited number of employees.”not be stopped. However, it was precisely such apersonality like Churchill’s, unstable and All of these extraordinary Lion Entrepreneurs andoverbearing, that was an antidote to “Black Cats” have something in common – theyChamberlain’s fatalism. Churchill was blessed with witnessed first-hand the problems that beset thea moral passion – a “clean hatred” – that proved masses and wanted to build a business to providemore effective than Chamberlain’s shallow realism. useful products and services. They want to buildChurchill saw through Hitler early on, because and scale their businesses so that they can giveChurchill was familiar with monsters to a degree more. Only when we have the desire to give, thenthan Chamberlain was not. Churchill was a man can we want to persevere in building somethingwith fewer illusions. He knew how intractable and meaningful. This urge to build in order to give isirrational human beings were. Like all wise men, the magnetic north to scale a Lion Infrastructurehe thought tragically: for we create moral and they work obsessively to realise this vision. Atstandards in order to measure our own Aegis, we work obsessively to deliverinadequacies. A merely rational man might not “Performance by Values” since our inception inhave challenged Hitler the way Churchill did, 2000. We believe clients deserve a dependableseeking not only to contain Hitler but, ultimately, investment product by insisting upon assetto destroy him. managers who do not get paid any fixed fees and are paid only performance fees when these managers deliver results that surpass the competitive norms by rigorously pursuing enduring investment principles. The ablest and most dedicated navigators are ruled by this spirited behavior, providing value above all without loads or hidden sales charges and without management expenses unless they execute their job with excellence. Just like Takkyubin’s corporate logo which is a black mother cat carrying her kitten in her mouth, symbolizing the companys promise that they take care of itemsWinston Churchill stroking a black cat in the photo above. Churchill entrusted to them as though the items were theirowned many animals throughout his life and he was particularly fond of own family. The works and the roar of Lionfelines. In his will Churchill requested that there "should always be a Entrepreneurs are akin to the resolute gong of themarmalade cat named Jock in comfortable residence". temple bell. They resonate because the sound reverberates in our hearts, stirring the everlastingIbuka-san, in the founding prospectus of Sony, values that matter: Sacrifice, Honor, Duty,made it clear that above all else, Sony would exist Hardwork, Fairness, and Humility. The Lion’s roaras a welcoming workplace for the eternally 23
  • 25. of these eternal values is heard most clearly bydiligent and caring value investors. And the rhythmof a Lion’s Heart – a performance-basedinvestment model with no fixed fees and no softdollars – has the same courageous heartbeat tothe roar of the Lion Entrepreneur.KEE Koon Boon19 April 2012 24
  • 26. “I’m Only a Paperboy”; “I Can Still Run After the Bus!” (Special Edition – Berkshire Hathaway AGM 2012 from Omaha Trip)"Im only a paperboy a paperboy in the 1940s helped him earn theJust as happy as I can be $5,000 that launched the investments that grewCause the money you pay for this into Berkshire Hathaway Inc and made him one ofIt all goes to me." the richest people in the world. In Buffett’s reply- Buffett singing "Im Only a Paperboy" to the tune of the to Question 58 out of 66 in this “Woodstock for1933 song, "Its Only a Paper Moon." Capitalist”, Buffett’s longtime partner Charlie Munger revealed one of the secret recipes for Berkshire’s phenomenal 6777-fold multibagger success from $18 when Buffett took over an ailing textile company in 1965 (also the same year Singapore achieved her independence) to $122,000 or nearly $200 billion in market cap: “What is interesting about Berkshire is that Berkshire’s record would have been terrible if Warren didn’t keep learning. He had to learn to do things at beginning of every decade.” The farsighted Lion Entrepreneur always has the “I’m-only-a-paperboy-beginner’s-mindset” to learn and adapt to an uncertain and complex world - in order to create value, resolving to be a proactive “Maker” as opposed to a stagnant “Taker” with an entitlement mindset. As Zen masters love to say: "Zen mind, beginners mind." Life may not be fair. But fair has nothing to do with who you are inside. What you dream about, who you love and what you stand for. Life cannot touch that. Life cannotLong before he was a billionaire and the world’s touch the “beginner’s mindset”. Because of thegreatest investor, Warren Buffett was a paperboy “beginner’s mindset”, “neither riches nor honorsand he called upon his newspaper-tossing skills can corrupt”, as articulated by the ancientagain to impress the crowd at the Berkshire philosopher Mencius:Hathaway AGM 2012 at the CenturyLink Center on5 May which we attended along with 35,000 “Neither riches nor honours can corrupt him;shareholders during our trip to America from 29 Neither poverty nor destitution can shake orApril to 12 May. We were in Omaha to present for modify him; Neither force nor mighty can thour third time in the 9 Value Investor Conference subdue him.” “富贵不能淫,贫贱不能移,威武不能屈:此on the topic of “Value Investing in Asia” upon the 之谓大丈夫” -《孟子· 滕文公下· 第二章》kind invitation of our old friend Robert Miles,author of several best-selling books on Buffett, andin New York and Chicago to meet up with business The “beginner’s mindset” is also the originationpartners as we hit our ten-year track record for power to overcome adversities and bounce backour flagship Aegis Special Opportunities Fund. stronger each time round. In a recent Wall Street Journal article on 24 May titled “Timing Isn’tBuffett issued a challenge to any shareholder that Everything for Value Investors”, Spencer Jakabhe can throw a copy of the Omaha World Herald highlighted Berkshire’s three worst years offurther and offered anyone who can land the investment performance relative to the broadpaper closer to a porch than he can a dilly bar from market came in 1967, 1980 and 1999 and how itsDairy Queen, the ice cream company Berkshire cumulative outperformance relative to the S&Powns. “I’ve asked Dairy Queen to supply several 500 over the following three-year periods was 49%,for the contest, though I doubt that any will be 102% and 48%, respectively - and the 6777-foldneeded,” Buffett added. Warren Buffett’s career as overall returns since 1965. Jakab noted the 25
  • 27. matching of the patient fund client with the right long-term vision to build their business modelsvalue manager will be a win-win combination: into a durable legacy.” And selecting and surrounding ourselves with friends and partners “They say good things come to those who wait. who dare to disagree – the “Black Cats” that we Trouble is, most people cant, or wont, stick wrote about last month on the intangible asset around for long- at least not when it comes to that we like to observe in companies – is critical their money. That helps explain a great mystery for multibagger success, as Buffett himself testified of investing - why, despite the hundreds of in response to Question 13 that: millions of dollars spent each year on advice and management fees, a free lunch of sorts has persisted in the form of value investing. Such an “If you start investing or selecting friends and opportunity shouldnt persist, but it does. That is neighbours by who agrees with you, you’ll have probably because there are bad periods for a pretty funny life”. value stocks of three or more years interspersed In our relentless task to find and invest in Lion among the good ones. Those are long enough Entrepreneurs in Asia for the past decade since our for fickle fund investors to dump their managers, inception in 2000, we detect that Lion often forcing them to sell holdings. The years Entrepreneurs have the commitment, focus, after long periods of poor relative performance perseverance, persistence, gumption, and staying are some of the best for patient value power to make sacrifices and last the distance in managers.” building one focused vehicle, particularly during adversities and the gut-wrenching tough periods. As observed in the newly-created Bloomberg Billionaires Index this year, “Most of these billionaires got super-wealthy because they had one big position, one big activity they were a majority owner of, that did amazingly well.” While some controlling owners in Asia may view the tunnelling of that $1 out of the firm through related-party transactions or other money-go- round accounting transactions to be enhancing or protecting their own interests - albeit at the detriment of the minority shareholders - particularly in bad times when they fear losing the value of what they have built, they need to appreciate that they are putting to risk the going concern of their companies to enjoy that elusive valuation premium of a multibagger that usually comes from putting that $1 - and more - back into a single, focused business vehicle, and ridingAnd Lions, as we at Aegis are fond of saying, are through the ups and especially downs of thethe only cats who hunt in a team in order to go business cycles with their reputations intact. Bothafter bigger game; bigger game means more food Buffett and Munger have interesting replies tofor everyone. Not the ferocious tigers. Not the Question 25 on “Focus”:fastest cheetahs. Not agile leopards. Only Lions. Asdescribed in our first of three articles in a series Buffett: “98.5% of my money is in Berkshire. Ifpublished in Business Times Singapore on 15 May you spend your time on the 1.5% you are crazy.”2010, one day after Singapore’s economicarchitect Goh Keng Swee passed away, Lions Munger: “The Munger family is in 2 or 3 things. I“surround themselves with like-minded people - have no interest in diversification. It happens automatically at Berkshire. I rejoiced the day Iand there is a remarkable transformative effect. got rid of stock quote machine. You deal with aThey affect deeply the people around them with better class of people.”their unwavering commitment, attracting anetwork of partners who respect them and want Buffett’s achievement is all the more amazingto work together with them. The central tenet of given his simple lifestyle and equanimity over hisvalue investing is really about finding and investing recent health condition. Buffett continues to drinkin the Lion entrepreneurs, the team of people with his favorite Cherry Coke and eat See’s Candy andthe character to make things happen and with a Dilly Bar throughout the 6-hour long Q&A session. 26
  • 28. To have a glimpse of his simple lifestyle, we drove deluge of incomplete data in an increasinglyfrom our hotel at Dodge Street to the nearby complex and uncertain world, both Buffett andFarnam Street – named for a Connecticut railroad Munger believe that it is not about sophisticatedspeculator – where Buffett lives in the first house “formulas”, nor do they “calibrate mathematically”he ever bought, which cost $31,500 in 1957. using the likes of VaR, in their replies to QuestionsDespite the modest price, he dubbed the house 48, 54 and 59:“Buffett’s Folly.” His license plate, THRIFTY, wasfamous around Omaha, until he gave it away along Buffett: “Not a magic number, there is no magicwith his Lincoln Town Car in a charity auction, number. I’d worry about someone telling meowing to worries about his safety. Berkshire’s head every morning that we were secure to 3rd sigma on our cash balances. We think about worstoffice at Kiewit Tower, also located at Farnam cases all the time and add on margin of safety.Street, is also simple and had only 23 staff – “all on We don’t want to go back to go. I enjoy tossingone floor”! Munger had added that “we have a papers but don’t want to do it again. We arevery small head office, no HR, no legal, no never going to risk what we have and need inconsultants, no compensation consultants. I would order to stretch for what we don’t need. Charlierather throw a viper down my shirt than hire a thinks the same way. It is our job to figure outcompensation consultant.” what can really go wrong with this place. We will want to know what we can do with the excess money we have around. We don’t calibrate mathematically. There are some really great organizations with advanced math who don’t really get at the problem. It is at top of our mind. In 99 years out of 100 your return will be lower, but 1 in a 100 we’ll survive when others don’t. We make mistakes, we think about avoiding mistakes which will hurt our ability to play tomorrow. We like to do things big, so we have to think about consequences. I don’t worry about my mistakes. I’ve learned something about people over the years. I make mistakes with people. But I think I’ll make more goodWith their simple lifestyle, the Lon Entrepreneurs judgments about people as I’ll recognize the extraordinary ones better than 40-50 years ago.are akin to the ancient “javelin warriors” who Reading financial history helps. I’ve always beenknew they have to travel light to journey far. All absorbed at reading about disasters. This gavethe weight is in their weapons. The crafting of each us advantage over others with a lot of math.javelin can take months, with sacrifices offered to They didn’t understand other humans. We havethe shaft of ash or cornel while it still grows on the been a student of other’s folly, and it has servedtree. “Truth” is the missile weapon’s supreme us well.”virtue, meaning the absolute straightness of itsline, for a warped javelin will not fly true. No Munger: “We don’t have standard formulas. Xmeasure is spared to protect its truth. The on x, and Y on something else. Big humanjavelineers sleep with their spikes, wrapping them resources, every incentive arrangement is specific. It would be crazy.”in their cloaks while they themselves shiver, tokeep the snow and wet from swelling the grain. To On creating upside opportunities and buildingbehold the perfection of flight achieved by a barriers to entry and economic moats, Buffett andmaster, his missile neither “pluming” nor “tailing”, Munger were humble in acknowledging that thebut “holding its head up” as it tracks in to its target Berkshire managers were the heroes; just about– this is a thing both beautiful and terrifying, and every single business at Berkshire Hathaway hasthe man who can do it is accounted of supreme been acquired rather than “created”. Even theconsequence. Training with the javelin looks easy; entertaining hour-long video at the start of theit is impossible. The mere appearances of AGM put together every year by Buffett’s daughter,javelineers in the field has caused valiant foe to Susan, had the famous oldies song “My Favoritewithdraw without a fight. Things” from “The Sound of Music” to recognize the heroes: “Berkshire managers… these are a fewOn their unfair advantage in managing downside of my favorite things”. Buffett also discussedrisks and minimizing mistakes in an Information briefly about how he goes about building aand Social Media Age in which we experience a 27
  • 29. structure - “Lion Infrastructure” - to incentivize the performance of their own portfolio, and thatand motivate the Berkshire managers in his replies 20% of the payout is based on the performance ofto Questions 54 and 60. the other managers investments. Through conversations with people familiar with the two Question 60: How to build barriers to entry? managers, Combs, who ran a fairly concentrated fund at Castle Point Capital Management before Munger: “We sort of buy barriers to entry, we he joined Berkshire in October 2010, is an investor don’t build them. You’ve got to remember most more in the mold of Munger, while Weschler, who small businesses don’t become big businesses, and ran his own Peninsula Capital Advisors before most big businesses lapse into mediocrity. We’ve only created from scratch one business I can think joining Berkshire in September 2011, evokes a bit of that became a big business – the reinsurance more of Buffett’s investing style. Buffett disclosed business – out of thin air.” that the duo is now working with $5.5 billion, exclusive of any gains/losses on capital that had Buffett: “Think about that, because it is true. already been put to work. Perhaps the future Some industries don’t have barriers. You had Berkshire AGM will be fronted by a team of five for better be running very fast. If you gave me $30 the three business parts (investments, insurance billion, and told me to try to knock off Coca-Cola, I and non-insurance): Todd and Ted for the listed wouldn’t have the faintest idea how to do it. The investment activities, Ajit Jain, 60, for the great brands we bought, we didn’t create them. Richard Branson – Virgin Cola. Brand is a promise, insurance business division and railroad operator not sure what promise Virgin is. [laughter] Burlington Northern Santa Fe’s Matt Rose and Haven’t heard anything about it since. Hundreds utility operator MidAmerican Energy’s Greg Abel have tried, those are real barriers. It is hard to for the operating business division. do.” Through the pair in Todd and Ted, Berkshire has Buffett: “Why do we do what we do? We don’t been making more investments in the tech and need the money. Why is that the case? We get to media space, an area that Buffett confessed since paint own painting every day, it will never be 1998 that he had an aversion in: “Technology is finished. If someone is telling us to use more red than blue, we might tell them what to do with the something we don’t understand, so we didn’t paint brush. We like applause. We let them keep invest in it”. The purchases include Intel, media the paintbrush, we applause, and we pay fairly. companies Liberty Media, DirecTV and Viacom, Over 40 years, the times when compensation was and software analytics firm VeRisk. Interestingly, an important part of conversation were practically for Buffett’s massive $12 billion purchase of IBM nil. Ted Weschler and Todd Combs will make accumulated secretly since Mar 2011 at an below hedge fund manager money and pay more average price of $170 and first disclosed in Nov tax. It is a different way to live your life. We want 2011 through Berkshire’s 13F for 3Q11, many to have our managers enjoy their lives. We get rid people still have the perception that IBM is of what they don’t like. I can’t put passion into someone. But I can create a structure that takes predominantly an IT services company given the the passion away. We focus on not messing up successful turnaround from an ailing mainframe something that is already good. We have a bunch hardware firm as engineered by former CEO Lou of managers that no one else can hire. How many Gertsner; more than half of the earnings now others can say that? I think we will retain that come from analytics software, a new growth advantage. It is self-reinforcing.” engine built by Lou’s successor Sam Palmisano who handed over the reins to Virginia Rometty inBuffett highlighted the important insight on how Oct 2011. The credit rating of IBM was upgradedhe desires to create a lasting structure to to AA- from A+ by S&P on 31 May in recognition ofincentivize Berkshire’s investment managers Todd its lucrative shift to software. On his decisionCombs and Ted Weschler to collaborate and yet process in buying IBM, Buffett said while he hasenable autonomy for each to display their always followed IBM through its annual reports forindividual flair. Each are paid a base salary of $1 50 years, he had read the 2011 Annual Report withmillion, and that each would be eligible to receive a “different lens” and he had changed his mindbonuses equivalent to 10% of the amount by about IBM after talking with IT departments atwhich their portfolio beat the S&P 500 index on a Berkshire subsidiaries.three-year rolling basis. Thus, the bigger theamount they invest, which reflects the conviction Buffett: “… I’ve probably read the annual reportof their ideas, the bigger their bonus. Each of IBM every year for 50 years. And this year itmanager gets paid 80% of their bonus based on came in on a Saturday, and I read it. And I got a 28
  • 30. different slant on it, which I then proceeded to While America is “homogenous”, enabling do some checking out of. But I just – I read it technology and distribution innovation to scale up through a different lens.” relatively easier, Asia is “heterogeneous” which requires adaptations to local conditions. WeInterestingly, Buffett does not think we are in a highlighted how even though Chinese techtech bubble currently, adding that while he would company Tencent is not an innovator, essentially anot buy shares of Apple, Google or Facebook, he copycat in ripping off instant messaging (IM) offwould not short them either: "It is not a bubble … Israel’s ICQ in 2000 as a free online download, itthis is not what we were seeing in late 1999 all the eventually became a multibagger, up more thanway into 2001. We arent in any bubble phase of 50-fold in 8 years since its listing to over US$50anything." This is a sharp contrast to the message billion in market cap (see below Bloomberg chart).that Buffett said forcefully during the 1999 Tencent monetized IM when western giants failedinternet boom: “The fact is that a bubble market by building chat not as a productivity tool but as ahas allowed the creation of bubble companies, community for bored kids to hang out and itsentities designed more with an eye to making tipping point came when Tencent offered virtualmoney off investors rather than for them." goods – avatar, outfits, pets, and emperor-kids th spend serious money and hours collecting.One of the topics in our presentation in the 9Value Investor Conference at the College of We also asked the audience the rhetoricalBusiness, University of Nebraska is about “Tech question on why they think a Renren, China’sInvesting in Asia”. We talked about how most version of Facebook, is possible in China but not inAsian companies are “one-man-shop” operations India? Besides China being a protected market aswith the founder making all the decisions. The Google and Microsoft found out painfully, she iswillingness to build a team and invest in a system also a linguistically homogenous country unliketo cascade decision rights throughout the India. We borrowed the wisdom of modernorganization is an important signal that the Singapore’s founding father Lee Kuan Yew in hisfounder desires and cares to scale up the company reply to Charlie Rose in an interview:in a sustainable manner by not hoardingknowledge. Technology is an important tool in Charlie Rose: "Will India have an advantage,empowering the employees and in giving them an some argue, because it’s a democracy and Chinainformational advantage in their respective roles is not?”and responsibilities at work. Hence Wal-Mart is asmuch a retailer as it is a tech company with Sam LKY: "Let me put it this way. If India were asWalton using technology to scale up the firm in a well-organized as China, it will go at a different speed, but it’s going at the speed it is because ittough industry. Yet it was IT investments that is India. It’s not one nation. It’s many nations. Itkilled Kmart when it declared bankruptcy in 2002 has 320 different languages and 32 officialafter being weighed down by the $2 billion languages. So no prime minister in Delhi can atspending in technology investments in 2000. What any one time speak in a language and beKmart did not realize was that Wal-Mart was able understood throughout the country. You can doto integrate its tech investments with its Every- that in Beijing."Day-Low-Prices (EDLP) business model by sharinginformation with its network of suppliers in We must also not confuse “Chinnovation” withexchange for greater discounts; Kmart simple sustainable value-creating multi-baggers. A prime“invest” and “collect data” without a purpose. example is how China now dominates the world’s solar panel market due to massive government subsidies, resulting in how Germany’s Q-Cell, once the largest in the industry, to declare bankruptcy. However, none of the stocks of Chinese solar companies are multibaggers; in fact, they are value-destroyers. The fearsome National Champions and Chinese telecom equipment makers Huawei and ZTE are also accused of foul play by the European Commission by getting massive government subsidies and cheap loans to dump their products into their markets. Economist Michael Pettis estimated that the Chinese state- 29
  • 31. owned enterprise sector (SOE) consists of firms ZTE and Huawei. CDB gave ZTE and Huawei acompanies that are actually “value-subtractors” in combined $45 billion line of low- to no-interestthe economy. Take away SOEs pricing power, and loans credit starting in 2004 to provide financingSOEs would be only 30% as profitable as they are for customers, including Mexico’s AmericaMovil.today. Direct government subsidies account formore than 100% of the profitability of SOEs. A significant part of the financing might came from“Implicit guarantees” on loans made to SOEs -- the RMB4 trillion stimulus package announced ingenerally at a level of 90-100 basis points -- November 2008 to counter the 2008-09 globalaccount for yet another 100% of SOE profitability. financial crisis, resulting in local governmentsThe entire Chinese SOE sector – around half of spending close to at least RMB14 to 20 trillion viaChina’s output - actually subtracts six to eight the local government financing vehicle (LGFV)times as much economic value as it produces. conduit. Local authorities have used LGFVs to divert funds borrowed for authorized projects toThe probes into the Chinese National Champions other ends, that is, loans for infrastructurealso come at a time when there is intense tussle spending channelled into real estate speculation orbetween the tuanpai or the populist Chinese commodities hoarding by local officials, or toCommunist Youth League (CCYL) faction within the borrow and feed back the proceeds to localChinese Communist Party and the princelings for governments. Importantly, this estimated RMB20the once-in-a-decade leadership transition this trillion hidden LGFV debt is 180-330% of the bankyear. The tuanpai wants to flatten out leverage in equity capital, meaning that a loss-given-defaultthe financial system as the elites increasingly use ratio of 30%, or a RMB3.5-6 trillion loss, wouldmoney as a political tool to establish their power wipe out half to all of the existing bank equity inand influence, but the flood of money has China’s financial system. Chinese companies areincreasingly posed systemic risks to the economy encouraged in 2011 to sell “dim-sum” or offshoreand financial system. An instance of this can be yuan-denominated bonds with their lax-covenantseen in how outgoing Premier Wen Jiabao planed restrictions and cut their reliance on bank loans soin 2011 to strip China Development Bank (CDB), as not to place additional constraints on thethe influential policy bank run by the elite Chen banking system. This shifting of risk to externalYuan, of its sovereign-debt status in special investors comes at a time when the two conduits –financing bonds. Unlike debt issued by other state- the banking system and the LGFVs - are seeminglyowned banks, CDB bonds are classified at the same saturated. Starting this year, the Chineselevel as sovereign debt by the government. Banks government has also begun to make it easier forthat buy the bonds can count them at a zero-risk foreign and private investors to put their moneyweighting on their balance sheets. Wen’s plan into the stock markets and the domestic bankingreclassified CDB as a commercial bank instead of a industry.policy lender. That means the bank, almostcompletely financed by RMB3.95 trillion in bonds, The going opinion is that China is a closed-systemwould have to pay much more to borrow money. fortified by $3.2 trillion forex reserves and policyCDB is the second-biggest bond issuer in China levers that they can operate at political-will toafter the Ministry of Finance. Chen has since turbo-charge the economy forward and to makefought back Wen’s plan and the government sure that everything will be under control. Theextended its special financing status through the slowdown is also believed to be engineered toend of 2012. CDB was created in 1994 to support consolidate its economic structure to a morethe government’s economic and infrastructure domestic-consumption-oriented one and to coolgoals. CDB has been led since 1998 by 66-year-old down property and asset inflation. Yet, capitalChen Yuan, the son of Chen Yun who is among the flight risk from the powerful and secretive 1% inCommunist Party’s “eight immortals” who wielded China could increasingly be the swing factor. Victorpower in the 1980s and 1990s. The elder Chen was Shih from Northwestern University estimated inMao’s chief economic planner, and drafted China’s his paper High Wealth Concentration, Porousfirst five-year plan in the 1950s and emerged in the Exchange Control, and Shocks to Relative Return:1980s as an elder leader opposed to Deng’s the Fragile State of China’s Foreign Exchangeprogram of rapid economic reform. CDB also led Reserve that the wealthiest 1% households inChina Inc’s aggressive push into Africa and MENA, China commands wealth that is at least as large asloans to foreign governments and foreign SOEs 2/3 of the foreign exchange reserve and possiblysuch as Venezuela and Russia, to clean energy as high as nearly twice its size. Thus, if the top 2(solar and wind) companies and telco equipment million households in a nation of 1.3 billion people 30
  • 32. decide to move even 30% of their wealth overseas, dollars in dividends to its owners and will alsothe foreign exchange reserve will reduce by a hold assets worth many more trillions (and,trillion dollars or more. According to a statement remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and stillon the Chinese Communist Party website posted incapable of producing anything. You can fondle24 May, the Central Disciplinary Inspection the cube, but it will not respond.”Commission has set up a “flight-preventioncoordinating mechanism” for every province and Buffett: “You’ll still have a single ounce of goldenhances “passport management” measures. 100 years from now. But I’ll have had 100Between 2000 and 2009, according to a 2011 harvests. Hard for an unproductive investmentreport by Global Financial Integrity (GFI), China’s to be productive over long period of time. Bondscitizens ranked first in the world in illicit financial no good and Bernanke still smiles. If you sayoutflows: $2.74 trillion, more than five times the anything negative about gold, it arouses passions. If you thought through intellectually.second-place contender, Mexico. As of 2010, Facts and reasoning. If you run into people reallyaccording to a study by China Merchants Bank and excited about gold, they can’t discuss it.”Bain consultancy, Chinese who possessed morethan RMB10 million in investable assets had Always having a “going-concern” view to assessingcollectively parked over $550 billion abroad. the value of assets is the task of diligent value investors in order to compound sustainable ******** multibagger returns. As we accountants know,Buffett’s comparison of the long-term investment without “going-concern”, the terminal value inmerits of gold versus going-concern assets using whatever form of dividend- or cashflow- discountanalogies is also fascinating. Analogies are the model will amount to naught, and that usuallytools of practical geniuses, as William James puts it amounts to more than 90% of the value of a firm!aptly in his book The Principles of Psychology: “The And as we wrote in Business Times in May 2010,faculty for perceiving analogies is the best the magic of going-concern emanates from “Lionindication of genius.. People who can analogize are Entrepreneurs”:the wits, the poets, the inventors, the scientificmen, the practical geniuses”. In his annual letter to “Lion entrepreneurs are alert to existingshareholders, Buffett pointed out that the value of paradigms of how things ought to function andthe world’s 170,000 metric tonnes of physical gold behave in the marketplace. It is this alertnessstock at $9.6 trillion could buy an investor all the that leads to their discovery through their strongprime farmland in America (400 million acres with conviction and belief that they can do itan output of $200 billion annually), plus the significantly better. And if the Lions sacrifice and persevere in doing this well enough, they willmarket cap of 16 Exxon Mobils (the world’s most soon have a country or business which canprofitable company, one earning more than $40 survive the vicissitudes of commercial life,billion annually), plus having 1 trillion “walking- booms and busts, mania and panics. Only thenaround money”. Which is more attractive? And can the country or business begin to have a lifemany synthetic gold products not backed by the on its own. That is what is called going concern,physical asset have been created, which could in accounting terms, so that the numbers makepossibly lead to inflated value. Buffett then went sense, and a PE (price earnings ratio) can beon to liken how the purchase of See’s Candies in applied to value the business meaningfully. ButJan 1972 for $25 million has generated an this is not enough. The next generation of Lions is needed to bring the country or business to theaccumulative $1.65 billion in pre-tax earnings, next level of success.”while the equivalent purchase of gold at $58/oz in1972 would have generated around $750 million in At the basic human level, perhaps “going concern”investment gains. In his replies to Question 24 is really about how we want to be remembered asabout gold, Buffett commented that gold in 1970 a person from how we live our life and how wewas $20 and Berkshire was $120. Now, gold is at impact the lives of others over the course of our$1,600 while Berkshire is $120,000. life, particularly if it has ramifications on our surviving loved ones and offspring. Munger has Buffett: “A century from now the 400 million acres of farmland will have produced staggering this to say about their legacy: amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable Munger: “Ask Warren how he wants to be bounty, whatever the currency may be. Exxon remembered. He wants to be remembered as a Mobil will probably have delivered trillions of teacher. Who in the hell is saying that from the 31
  • 33. top of a company, from a record like Warrens? from Warren Buffett’s CEOs and Directors by Why wouldnt I like being associated with that Omahan Karen Linder. In the foreword written by ethos? I have a little different twist. I have less Buffett’s daughter, Susan, she described how her ambition than Warren about being a great mother, Susan Thompson Buffett, as crucial to teacher. I am trying to emulate my great- Warren Buffetts early and continued success: grandfather. When he died, they said about him, Nobody envied the success, so fairly won and “My father freely admits that there would be no wisely used. Its a simple philosophy. And Berkshire Hathaway if he had married someone wouldnt Wall Street have worked better if more else. My dad was a self-described "mess" when people had tried to imitate my great- they got married. He credits her with changing grandfather?” his life. Its probably not an exaggeration to say ******** she saved his life. When I told him I was going toA mainstay event at every Berkshire Hathaway do the foreword for this book and talk aboutAGM is to visit the “exhibition hall”. Filled with Mom, he said again, "I learned as much fromshareholders hanging the blue “Shareholder’s her as anyone." My mother described her role inPass” proudly over their necks, the hall is also my fathers life as the "watering can to hiscrammed with stores displaying nearly every flower." That my mother could see my father —products and services that Berkshire Hathaway’s an aspiring but nerdy businessman with lowcompanies offer. And shareholders get good self-esteem — as a flower is a testament to her vision and her faith in the human spirit. That mydiscounts in their purchases! I bought a Polo shirt dad allowed himself to be "watered" is awith the “Berkshire Hathaway 2012” imprint from testament to his ability to recognize that he wasFruit of the Loom for my dad. At the Burlington safe with her and could trust this woman withNorthern Santa Fe (BNSF) store, I bought two T- his transformation. My dad came into the worldshirts with the cute caricature of Buffett and as a mathematical genius: He sees the world inMunger riding happily in the BNSF trains; one for odds, percentages and numbers (and of coursemy dad and one for my university accounting dollars). My mother is the one who taught himprofessor. I could not find anything interesting at how to be a human being — to love and beBorsheim’s and other booths to add to my gift loved. Her influence made him a better man in business and in life. Until the day she died, mypurchases for my mom. I also bought for my five dad relied on my mother for advice, counsel andyear-old niece a cute pink T-shirt from Garanimals, support in every aspect of his life — includingthe children’s apparel brand belonging to Garan, Berkshire Hathaway.”which was acquired by Berkshire in Sep 2002 whenits sales was $257 million. See’s Candies are too Having a great spouse and family support is thesweet for the Asian tooth so we skipped the most valuable asset that an entrepreneur cancrowded booth. And of course, we both head to possess and this made me recall the story ofthe bookshop to grab the latest books about Chinese “auto parts king” Lu Guanqiu as told toBuffett, Munger and Berkshire. We bought Andrew Wall Street Journal and other media sources. Lu isKilpatrick’s massive 1,250-pages book Of the billionaire founder of the Wanxiang Group, thePermanent Value: The Story of Warren Buffett, largest auto-parts maker n China and a US$102012 Odyssey Edition, complete with more than billion giant with manufacturing facilities around1,800 photos – and the author’s signature. the world. Even Harvard Business School uses his remarkable success story as a case study for students. Lu is also the third-richest person in the National Party Congress (NPC) who travelled with incoming President Xi Jinping to the U.S. during his official visit earlier in Feb 2012. “What can I do to help you invest more in the United States? President Barack Obama asked innocuously when he hosted some Chinese entrepreneurs at the White House in Jan 2011. The response he got from Lu whose factories in the US account for half the 10,000 American jobs created by ChineseThe Buffett family photo in 1977 (L to R): Susan, Warren, investments, spoke volumes. “China is our home,Howard, Susan Thompson, Peter. and America is our home too. The most important thing at home is to be able to relax and feelOne of the books recommended by Buffett this comfortable. If theres tension all the time, thenyear is The Women of Berkshire Hathaway: Lessons you dont want to go home, because you feel 32
  • 34. stressed.” Lu had accompanied outgoing President the nations political spasms in the 1960s and 70sHu Jintao on his state visit to the White House and worked to Wanxiangs advantage. With managersdisplayed Wanxiang’s electric-vehicle dashboards at state-owned companies often tied up in politicalto then Chicago Mayor Richard Daley. struggles, Lu tended to their neglected customers. In 1973, his factory bought 300 tons of cannon barrels from the Chinese army because local authorities kept steel for state enterprises. His wife cut open the cannon barrels with an electric saw and transformed them into brisk-selling tractor blades. As more multinationals arrived in China, executives from General Motors, Ford Motors and Volkswagen sought out Wanxiang as a supplier. Wanxiang racked up global orders, many coming from other parts makers such as Visteon, which bought their chassis components. Wanxiang’s US subsidiary, with its austere headquarters in the north-western outskirts of Chicago, is built in the early 1990s by Lu’s son-in- law Ni Pin, 48. It owns 28 manufacturing plants in 14 states throughout the US and employs 5,686 people. In just 15 years, Ni grew annual revenue from US$3.5 million to US$2 billion, making it one of the most successful Chinese companies to go abroad. From an early stage, the firm decided it would promote the American brands it acquiredLu is the first Chinese entrepreneur featured in Newsweek. instead of the Wanxiang name. It would also maintain a low profile, so much so that it does not exhibit at auto shows. Ni has fewer than 10 mainland Chinese - all engineers - among his staff of 5,600 across the US. Now, one in every three US cars has Wanxiang’s products in them. ******** “You are one of the few people whom I know who understood how important David Glass is to Wal- Mart and Sam Walton”, Jeff Matthews said during our dinner conversation post the Berkshire Hathaway 2012 AGM. David Glass is Wal-Mart’sBillionaire Lu in his simple office where he reads more than 20 key architect (and successor to Sam when he diednewspapers every day amongst other tasks. in 1992), as recounted by Sam Walton himself in his autobiography Sam Walton: Made in America:When Lu, a blacksmith’s apprentice, his wife andfive others pooled $500 to start a tractor-repair “All along, the history of Wal-Mart has beenshop in rural China in eastern Zhejiang province in marked by having the right people in the right1969, local officials laughed off their job when we needed them most. But I don’tefforts."Youre a farmer. You should be in the think our distribution system ever really gotfields," he remembers them saying. Lu built a under complete control until David Glass finallysmall village commune into something rare for the relented and came on board in 1976. More than anybody else, he’s responsible for building theera: a market-driven family enterprise. Lus wife, sophisticated and efficient system we useZhang Jinmei, became an expert welder and today... Many people have contributed over theworked through four pregnancies. In 1972, she years, but David Glass has to get the lion’s sharegave birth to her only son, now Wanxiangs chief of the credit for where we are today inexecutive, Lu Weiding, literally on the factory floor. distribution。David had a vision for automatedThree of Mr. Lus daughters worked at Wanxiang. distribution – linked by computer both to ourWhile private companies were still illegal in China, stores and to our suppliers – and he set about 33
  • 35. building such a system, beginning in 1978 at Jeff is the author of the insightful book Pilgrimage Searcy, Arkansas… From the time David Glass to Warren Buffett’s Omaha: a Hedge Fund came on board in 1976, he’s been pushing me to Manager’s Dispatches from inside the Berkshire invest and invest and invest in that system, and Hathaway Annual Meeting and he has been thank goodness he managed to be so running his own hedge fund Ram Partners since persuasive.” 1994. His distinctive financial blog, Jeff Matthews Is Not Making This Up, is regularly featured in the Wall Street Journal’s blog roll. Jeff also shared how he find that great entrepreneurs like Sam Walton are able to articulate their business in a simple and yet profound way. He related the incident about how he was present when Sam Walton was under attack by Wall Street analysts over Wal-Mart’s huge training expenses. “Why are you spending so much money in training people?” they demanded Sam to answer. Sam Walton threw back the question at them: “We will be growing our stores and sales by one-third. So what does this mean?” The analysts were puzzled by Sam’s question and kept quiet. “Well, it means that about one-third of our workers do not know what they are doing! So don’t you think they need training?”David Glass joined Wal-Mart in 1976 and was the CEO from1988 to Jan 2000. The Pilgrimage book left me with the impression“Exactly, Jeff, finding the combination of Walton- that Jeff possesses one of the hallmarks of a valueGlass is what we have been trying to do in Asia for investor: Authenticity. Authenticity includes thethe past decade since 2000 – finding Lion willingness and courage to ask the uncomfortableEntrepreneurs and their team building a questions and feel vulnerable, with the purpose tosustainable economic moat with proper corporate improve the way we look at things and movegovernance in place. Both the West and East have forward firmer with a better understanding of thetheir own set of governance challenges, such as issues and challenges involved. Because Buffett isthe recent high-profiled Chesapeake Energy and so well-loved as a result of his long-termGreen Mountain Coffee. Our framework is this: outperformance, the audience always hang on to“Sustainable multibaggers = Lion Entrepreneurs x his every word, oftentimes “slurping them all up”.Lion Infrastructure x Lion Shareholders”. Theabsence of Lion Shareholders, which include Jeff asked several interesting questions in his book,proper governance, is like putting a zero into the such as how amongst the “Sainted Seven” (See’smultiplication equation: anything multiplied by Candies, World Book Encyclopedia, Buffalo News,zero yields zero in the end. Get the right team and Kirby vacuum cleaner, Fechheimer work uniform,we get multibaggers like Wal-Mart, up 1000 Scott Fetzer, Nebraska Furniture Mart or NFM),times,” I said. Chesapeake is the second-largest dubbed fondly by Buffett in 1987, only See’sproducer of natural gas in U.S. and its founder Candies earns enough money to be mentioned inAubrey McClendon ran a $200 million personal MD&A (management discussion & analysis) ofhedge fund that trades in the same commodities Berkshire’s financials. Others such as World Bookthat Chesapeake sells and never told investors Encyclopedia had almost disappeared entirely.about that, amongst other financial conflicts of While See’s Candies had delivered $1.65 billion ininterest. Chesapeake’s aggressive accounting also accumulated pre-tax earnings over the past 40rang alarm bells. Green Mountain’s founder years, it not a global brand like Hershey’s, Lindt,Robert Stiller bought costly property, piled up Godiva, or Ferrero Rocher. Or Berkshire’s Dairyhundreds of millions in debt borrowed against his Queen versus the likes of Starbucks, Subway orcompany’s stock, and was forced to sell a large McDonald’s. NFM versus Bed Bath & Beyond. Jeffchunk of his shares to meet margin calls. asked the question of whether Buffett’s famed penny-pinching had hurt the ability of Berkshire subsidiaries, which have to repatriate their earnings upwards to the holding company 34
  • 36. Berkshire for Buffett’s deployment in capital as opposed to “just paying for bargains”? Also,allocation into value-creating opportunities, to which of these two business models would deliverscale up to be global champions. greater multibagger returns in the long-run?As I was buying my presents from Fruit of the Both Fruit and Limited have floundered whilst inLoom, I cannot help but compare it with The “Stage 1”: Fruit was laden with debt inLimited Brand which owns brands such as disappointing M&A deals after John HollandVictoria’s Secret and VF Corp which owns brands retired in 1996; Limited was running out of steamsuch as North Face, Nautica, Timberland. Berkshire by 1993 as it was outmanoeuvred by nimblerhad rescued the debt-laden Fruit from bankruptcy competitors such as Gap and J Crew. For much ofby acquiring it with $835 million in cash in Jan the decade, growth at Limited chilled and earnings2002. A condition of the purchase required that sputtered as its women’s apparel storesformer COO and then interim CEO John Holland, floundered, losing their direction and customers.who was rehired back after he retired in 1996, Limited is founded in 1963 by Russian Jewishremain available to be the CEO. Buffett joked how migrant entrepreneur Leslie “Les” Wexner. WithMunger encouraged him to buy the underwear many investors giving up on Limited, Les began acompany. “Warren, we have to get into women’s long, personal crusade to change both his ownunderwear,” Buffett said, imitating Munger. He management style and the company’s internalthen added, “And he’s 78. It’s now or never!” The structure. He eventually began spending less timedecision was facilitated by an earlier purchase of picking sweaters and more time attending to theFruit’s distressed bonds (“occasionally, a purchase company’s executive ranks. We think Les is a Lionof distressed bonds leads us into something Entrepreneur for having made the necessarilybigger”). Berkshire purchased the debt at 50% of painful transition from the entrepreneurial-ledface value, earning a low-risk 15% return that “Stage 1” to a team-based-led “Stage 2”. Les wasended up returning them 70% of face value. interviewed by WSJ in 2002:Downside risk was limited in the structuring of thedeal in which they reduce the purchase price for WSJ: “As The Limited has grown from a singlethe whole company by a small amount. store to a retailing giant, how has your role as Chairman and CEO evolved?” Wexner: “I was an entrepreneur… You start with one store and you do all the jobs in the store, and then you have two stores, and then ten stores, and then fifty and one hundred… I think the second phase of the business was replicating, creating other businesses and making acquisitions.” WSJ: “Looking back, what went wrong at The Limited?”Both Fruit and Limited/VF have done well despite Wexner: “I think what went wrong was the …having different business models: Fruit is entrepreneurial style wasn’t working. Theessentially a quality low-cost producer of basic business has outgrown that in terms of complexity. Working harder at the specialtyproducts selling in North America and store format wasn’t the way. Leading brands isconsolidating market share, while Limited/VF different from being an entrepreneur… It wascommands pricing power because of their global about looking at how the business wasbrand appeal. Limited and VF are up 220% and organized.. Are we a large group of specialty250% respectively since 2002 and trading near all- stores or are we … a family of brands?”time highs despite macroeconomic uncertainties.An interesting question for the value investor is WSJ: “What does a family of brands mean?”this: The same $835 million can buy either theentire Fruit at a bargain price or 20% of Limited at Wexner: “The reason I like that term is that I like the association of family, in terms ofa reasonable price, so which is more attractive, relationships. I think what it really speaks to usparticularly given the all-important nudge by is that it is a team. Everyone in the business hasMunger to Buffett towards the direction of to work together as a team. It speaks to how“buying a wonderful business at a moderate price” you think about sharing ideas.” 35
  • 37. had to lay off 1,300, or 15%, of its employees. Wexner: “I became pretty well acquainted with Market cap plunged to below $3 billion in 2001. Sam Walton. Sam had asked me to be on their board, which is one of the sillier mistakes I made Here comes the critical role of the jockey in “Stage – I didn’t accept. I didn’t want to take the time 1”: the tipping point breakthrough came in 2002 from my business. When I talked with Calloway [former PepsiCo Inc Chairman and CEO], I asked when Amazon embarked on a strategy of broad him how he spent his time. And he said that he discounting and free shipping (for purchases >$25) probably spent … 40 percent or 50 percent of rather than spending money on marketing ads as his time on people. To me, it was startling. I like advised by experts, dramatically increasing sales, people, but I am busy picking sweaters, visiting decreasing the operating leverage and risk stores, doing things. How do you find that associated with Amazon’s fixed costs while more much time? And he said, because the talent in fully utilizing its newly-developed distribution the organization is the most important asset network. Amazon survived and outlasted the that you have… basically, he saw himself as the critics and made the successful transition into goalie or the guardian, where he was the last set of eyes.” “Stage 2” in which the economic moat – the Lion’s mane - becomes more visible. In a 2008 interview,We are often asked whether value investors Jeff Bezos credited their long-term orientation inshould place more weight on “the jockey” (the building the business: “Our willingness to beentrepreneur) or “the horse” (business model and misunderstood, our long-term orientation and oureconomic moat). In adapting value investing willingness to repeatedly fail are the three parts ofprinciples to Asia, we think a third dimension our culture that make doing this kind of thingneeds to be added: the (booby) racetrack, btu this possible”. Of course, market cap is also moreis another huge topic to discuss. The Amazon visible as it soared over six-folds to $20 billion byexample is classic to understand the dynamics 2003. While Amazon has climbed further bybetween the jockey and the horse. In the Q&A another five-fold to around $100 billion, valuesession, Buffett thinks Amazon has been an investors who placed more emphasis on the horseincredible success and will affect a lot of are faced with the psychological turmoil of havingbusinesses. Munger says Amazon could be terrible greater confidence in the more visible economicfor a lot of retailers, and not a little terrible, moat but facing a stock that had already gone up 6"hugely" terrible. or 7 times in 1 to 2 years. Buffett: “Amazon is a tough one to figure. It could affect a lot of businesses who don’t think they will be affected. Amazon has millions of happy customers. They can introduce to new items. It could affect a lot of businesses. Munger: “It is almost sure to hurt a lot of businesses a lot. Anything that can be easily bought with a home computer or iPad. I think it will hugely affect a lot of people. It is not slightly terrible, but really terrible”.Long before Amazon developed an economic moatsuch that the jockey matters less, Amazon faced At Aegis, we believe it is critical to follow andsevere financial difficulties when founder Jeff understand the motivation of the entrepreneur inBezos built five $60 million automated fulfilment order to profit from the lifecycle of thecentres in 1999 against the advice of experts: "For multibagger from Stage 1 to Stage 3 whilea company that only had $1 billion in sales, embracing volatility along the way as a friend. Thespending $300 million on fulfilment centers is a computer-science-electrical-engineering Princetonvery big investment." And the experts were “right” graduate Jeff Bezos was so convinced of hisgiven that its warehouse capacity was three to five ecommerce idea that he borrowed $300,000 fromtimes more than it needed in 2000. In 2001, sales his father and quit his well-paid hedge fund job athad fallen short of expectations, two of its DE Shaw, where he was the youngest ever VP atdistribution facilities were closing, and Amazon age 28 and promoted to SVP two years later, to found Amazon in 1995. Importantly, Jeff Bezos had displayed the passionate “beginner’s mindset” all 36
  • 38. along: he turned down several job offers from Even MSG is listed and it is trading at near all-timelarge MNCs when he graduated with highest high with a market cap of $2.7 billion.honors and Phi Beta Kappa and instead took aposition with the newly formed fiber opticcompany Fitel to help the company build acomputer network specifically for internationalfinance. Without that critical managementdecision in the free-shipping policy, it is likely thatAmazon would not have the economic moat thatwe know of today. But to appreciate theimportance of that single business decision a prioriis beyond a value investor, for the passionateentrepreneur knows more about his or herbusiness than the fund manager. But if the diligentvalue investor had followed the motivation of theentrepreneur and the overall business model he orshe is building, the volatility of Amazon’s stockprice becomes a friend and the value investorwould be able to ride the 120-fold multibaggerreturns, particularly when it experienced volatilityin transitioning from Stage 1 to Stage 2 in 2001-02. ********As we walk down the streets in search of ourmeals in our routine checks at the variousmultibagger food chains trading at near all-timehighs despite macroeconomic uncertainties to findout what makes them tick and what has changed,we were thinking aloud that what is striking about New York City is dubbed “the city where one willAmerican businesses is how they utilize the capital be excited, frustrated, but never bored”. Buffettmarkets to scale up, as opposed to how the crown- said he would never live in New York becausejewel assets in Asia often remain privately-owned “Living in Manhattan is expensive and you need toand not part of the listed vehicles. There’s be rich. There is a lack of sense of community andCheesecake Factory – up over 770% in 10 years life style, thus lack of the enjoyment of life. Yousince 1992 to $1.7 billion; Panera Bread – up 23- may need to do fifty things a day in New York, butfold in 21 years since 1991 to $4.2 billion; Darden I’d rather to do some reading in my office and do 1Restaurants (with brands such as Red Lobster) – up to 2 things a day and do them well.” In just a few610% in 17 years since 1995 to $6.4 billion; years, New York City has emerged to become theChipotle Mexican Grill – up 840% in 6 years since “New Tech City” with more than a thousand start-2006 to $19 billion. We also visited multibagger ups in Manhattan neighbourhoods such as thestores trading at near all-time highs, such as Ross Flatiron District, Hudson Square and SoHo, andStores – up 58-fold in 27 years since 1985 to $14 more recently in Dumbo in Brooklyn, trailing onlybillion; Under Armour – up 270% in 6 years since Silicon Valley, according to a report by Center for2005; Lululemon Athletica - up 400% in 5 years an Urban Future. The activities sparked a propertysince 2007 to $10 billion. We went inside Madison boom: the going rate in rental for a 900 sq-ft oneSquare Garden (MSG), known colloquially as “The bedroom in Manhattan is around $3,000 a month;World’s Most Famous Arena”. MSG owns the this made me wonder about the boom in shoeboxfamous multi-purpose indoor arena Madison apartments and property without an anchorSquare Garden Arena and The Theatre at Madison homegrown industry in MNC-laden Singapore.Square Garden in New York City, as well as The Monthly rental is $3,000 for a 550-sq-ft oneChicago Theatre in Chicago. Opened on Feb 1968, bedroom in River Valley at a time when HPit is the longest active major sporting facility in announced 27,000 jobs cuts, or 8% of its workforce,New York. Famous music legends such as on 18 May with HP APAC HQ in Singapore affected.Madonna, The Rolling Stones, Frank Sinatra, Elton One reason that the development of digitalJohn, Elvis Presley, Michael Jackson, Lady Gaga, technology is taking root in the city is that theJacky Cheung etc have performed at “The Garden”. 37
  • 39. current wave of innovation is not about designing beautiful women here – if one does not work hardcomputers or chips or building infrastructure for to be successful, they ain’t gonna get any; and thethe Internet, but about devising creative pretty girls are in New York because they know theapplications of mobile technology for various guys will be successful.industries. New York’s dominant positions inindustries like finance, advertising, media and In our quick tour of this energetic, noisy and multi-fashion have made it a natural place for those cultural city, we came across the Cooper Union forseeking to invent digital services in those fields. the Advancement of Science and Art in Manhattan.New York’s mayor Michael Bloomberg was in Behind this great educational institution is LionSingapore on 22 to 23 March to accept the Entrepreneur Peter Cooper (1719-1883). Peterprestigious Lee Kuan Yew World Prize for New Cooper is the American industrialist, inventor andYork’s inspiring urban rejuvenation. philanthropist who conceived of the idea of having a free institute in New York, similar to the Ecole Polytechnique in Paris, which would offer free practical education to adults in the mechanical arts and science, to help prepare young men and women of the working classes for success in business. Founded in 1859, the school established a radical new model of American higher education: its mission reflects founder Peter Coopers fundamental belief that an education “equal to the best” should be accessible to those who qualify, independent of their race, religion, sex, wealth or social status. Since 1902, The Cooper Union has granted each admitted student a full-tuition scholarship, according to the belief of Abraham Hewitt, Peter Coopers son-in-law and a major figure in the early organization of the curriculum, that education should be "free as air and water." Today Cooper Union is recognized as one of the leading American colleges in the fields of architecture, engineering, and art. Born in New York City of mixed Dutch, English and Hugenot descent, Peter Cooper became a highly successful entrepreneur who designed and built the first steam locomotive in the U.S. despite having little formal education. Despite his status as one of the richest man in New York City, he lived relatively simply in an age when the rich were indulging in more and more luxury. He dressed in simple, plain clothes, and limited his household to only two servants; when his wife bought an expensive and elaborate carriage, he returned it for a more sedate and cheaper one. Cooper remained in his home at Fourth Avenue and 28th Street even afterCartoon of Peter Cooper the New York and Harlem Railroad established freight yards where cattle cars were parkedWe catch up with an old friend in New York, an practically outside his front door, although he didenterprising technopreneur who had scaled his move to the more genteel Gramercy Parktech start-up by 10-fold in the past 3 years. He development in 1850.shared that he had moved from Manhattan toQueens with the rental savings reinvested back What makes America great are these Lioninto the business. We joked about how the guys in Entrepreneurs who forged and left behind a LionNew York are stressed because there are so many Culture, a culture of integrity, meritocracy, 38
  • 40. teamwork, commitment, and performance-based distributed at the microstructure level, even whenfairness. The spirit of competitive market-based there are nearly 50 million Americans living onmeritocracy is key to understanding the psyche food stamps and almost half of Americans living inbehind “what makes America great.” In our a household that receives government assistanceinteraction opportunities with various types of to the tune of $2 trillion, up 75% a decade ago,people in New York, Chicago and Omaha – be they and less than half of Americans pay income taxes.entrepreneurs, financial elites, teachers, taxi The taxi driver in Omaha, a local black lady, told usdrivers or service staff – there is a sense that quite how things in their sleepy city in Midwest Americaa number believe that it could be America’s turn to “are moving” but she finds it hard to catch up andrise again (“Made-in-America, Again”), particularly that, surprisingly to us, she is not a supporter ofgiven how both Europe and China are down and Obama. A WSJ article on 20 May reported that themoney is moving onshore in this presidential Midwest has largely closed the cost gap inelection year. BCG estimated that the impact of competing for companies with the South,the changing math of manufacturing will be felt traditionally the nation’s cheapest region in whichthe most in seven industry sectors that would to do business. The Midwest has been the largestreach a tipping point in around five years, when beneficiary of luring foreign companies and of thethe rising costs of producing in China will make it “onshoring” trend, with some large manufacturersmore economical to shift the manufacture of such as GE, Whirlpool and Ford bringing jobs backgoods consumed in the U.S. to the U.S. Together, to the US from overseas.these industries account for nearly $2 trillion inannual U.S. consumption. In 2010, the U.S.imported nearly $200 billion worth of products inthese categories from China—almost two-thirds oftotal Chinese exports to the U.S. (see below figure).Even the unison of the Rothschilds andRockefellers signal a U.S. shift with Lord JacobRothschild’s listed investment trust RIT CapitalPartners buying a 37% stake in Rockefeller’swealth advisory and asset management group in adeal announced on 29 May. The 76 year-oldpatriarch Lord Jacob said, “I think the UnitedStates has an edge. To have a strong presence inthe US will be extremely important.” The taxi driver in Chicago, a black migrant from Haiti who married a Polish migrant girl, told us how “the government is the Al Capone” and rattled off statistics that Illinois ranked as one of the most corrupt states in America. Chicago has the third largest GDP in US at around $530 billion after only New York and LA. While Chicago is a major world financial center with the second largest CBD in the US, it is also rated as having the most balanced economy due to its high level of diversification with companies as diverse as Wrigley’s, Boeing, Pritzker, McDonald’s and Playboy. Chicago was also named the fourth most important business center in the world in the MasterCard Worldwide Centers of Commerce th Index and ranked 9 on the UBS list of the world’s richest cities. Chicago was the base of commercial operations for many industrialists and commercial visionaries who laid the foundation for the global industry. A dedicated teacher in Chicago told usHowever, there is growing scepticism over how how there are many school teachers who arethe potential gains are practically translated and retrenched and yet there are more and more 39
  • 41. superintendents at the top earning half-a-mil. The extent has copied Singapore. And I think theyDaleys – Richard M and his father Richard J – were deserve some admiration."lifelong residents who ruled Chicago for 43 of thepast 57 years. A Bloomberg magazine article on 7 Singapore’s Kishore Mahbubani, chairman of theMay described how they “symbolized the prize nominating committee for the Lee Kuan YewByzantine ward political system, the World Prize, said Singapore can learn from howneighbourhood-level machine that for decades New York City has managed to accept and live withdetermined who got elected and who, in turn, got diversity:city jobs.” Chicago’s new mayor Rahm Emanueltook office a year ago in May 2011. "I think one of the biggest mistakes Singapore has made recently is the belief that it is actually quite easy to be open, to welcome immigrants,“The question is not whether the problem is about to absorb them and to live with them. Nowa big or small government,” they say emphatically, were discovering its not so easy. Frankly, New“but that each special-interest group are simply York Citys capacity for absorbing immigrants isexpanding their own individual sphere of power probably number one in the world. New Yorksand influence ironically because they are building a capacity to accept diversity and to live with it is,system of checks and balances such that no one I think, one of its great strengths - and I thinkcan aggregate enough power to make any thats something Singapore can learn from.important and effective decisions. They ignore the Singapore now has the great opportunity to become the capital city of Asia. Frankly, wererules and commit acts with impunity that ordinary entering the Asian century; everybody wants tocitizens couldn’t possibly attempt, much less get come to Asia. And just like New York City wasaway with, believing that they can do whatever the iconic city for the American century,they want without any reprisal.” It used to be that Singapore can become the iconic city for theAmericans will cheer for those who are successful Asian century. So to become the iconic city ofas they aspire to be and believe they can be the Asian century, we must learn to be moresuccessful themselves. This American spirit, rooted open, accept diversity and take full advantagein meritocracy, appears to have faded with many of it - the way New York City did."on the ground expressing disillusionment over howthey are like “leaf in the wind” because the “rules But why is America able to attract, accept and liveof the game in social advancement is rigged”. For with “value-creating diversity”? In a rendition toall the ruthlessness of competition, it was Buffett’s “I’m only a paperboy”, Madonna said in astructured now by complex rules. The recent interview that “I can still run after the bus.”consequence was yet further paradox: meritocracy, Madonna, whose father was a first-generationreal and relentless as it was, nevertheless served Italian American, commented that in her youth, “Ito perpetuate a society in which only the rich and cared about good at something.” The straight-Aelites, the special-interest groups, and the student from Rochester Adams High Schoolconnected could afford time, money and resources dropped out of college and relocated fromto devote themselves to pursuing this closed-form Michigan to New York in 1978 with “$35 in mymeritocracy. This is a sharp contrast to the original pocket” – and the extraordinary career ofopen, competitive, market-based form of Madonna Louise Ciccone took off. New Yorkmeritocracy in which the underdogs, the migrants, attracts those with the urge to create and be athe “Rocky Balboas”, the ones with no background, Maker instead of a Taker with an entitlementcan all build something from scratch and mindset and this can only come from those with acontribute back to the mosaic of the society. “beginner’s mindset”, from those who can “still run after the bus” or “still toss the paper” at anyInterestingly, Munger commented about stage in their life, in the worst and best of times.meritocracy and Singapore in a long interview with As I took the free ferry between Manhattan andCNBC one week before the Berkshire AGM: Staten Island to enjoy the sight of the majestic Statue of Liberty, the wind seems to carry the "I regard what happened in Singapore as the words from “The New Colossus” engraved on a best example of successful governance in the bronze plaque and mounted inside the lower level history of the world. To take a handful of people of the pedestal of the Statue of Liberty: in a malarial swamp and turn them into a meritocratic civilization as well as Singapore has “Give me your tired, your poor, your huddled is a huge achievement. I think China to some masses yearning to breathe freedom; the wretched refuse of your teeming shores, the 40
  • 42. homeless, and the tempest-tossed; I lift my lamp meritocracy, hardworking, humbleness – are the beside my golden door.” very same ones that were provided by theThe New Colossus reinvented the statues purpose, pragmatic and visionary leadership led by Lee Kuanturning Liberty into a welcoming mother, a symbol Yew and his team of entrepreneurs in buildingof hope to the outcasts of the world, articulated modern Singapore. Stage 1 of the assetbest by Lion Entrepreneur Steve Jobs: management industry is like how John Bogle set up Vanguard in 1974 to pioneer low-cost index “Here’s to the crazy ones. The misfits. The rebels. mutual funds. By passing back savings to the The troublemakers. The round pegs in the investors from advisory fee reductions, its low- square holes. The ones who see things expense model enables Vanguard to deliver differently. They’re not fond of rules. And they have no respect for the status quo. You can competitive returns without chasing complex risk quote them, disagree with them, glorify or vilify that they did not understand or respect. Stage 2 them. About the only thing you can’t do is requires a sense of caring to inspire the extra level ignore them. Because they change things. They of intensity and dedication in performing for push the human race forward. While some may investors. Such performance-based caring is an see them as the crazy ones, we see genius. exacting and demanding business that requires the Because the people who are crazy enough to ablest and most dedicated navigators providing think they can change the world, are the ones value above all without loads, hidden charges, soft who do.” dollars, and without fixed management fees. Asset managers who truly care do not get paid any fixedParaphrasing Steve Jobs, the great city is a “City of fees and are paid only performance fees after theyLions” at every layer in every corner, one who execute their job with excellence. This is how weattracts and absorbs Lions who “stay hungry, stay at Aegis desire to “improve it, mark our mark uponfoolish” with a beginner’s mindset, those who it”. We believe commerce is not merely about thewants to “build your own things so that others can measurement of the weight of profits collected inuse”, those who wants to “embrace it, change it, multiple clever transactions to build measurableimprove it, mark your mark upon it” instead of wealth, fame and power, but rather it should be“just gonna live in it”: defined by the immeasurable integrity and virtue. Only in the endeavor to perform first for “When you grow up you tend to get told the world is the way it is and your life is just to live customers, and serve them with the highest your life inside the world. Try not to bash into possible integrity and character, can commerce the walls too much. Try to have a nice family life, find its foundation for durable business success have fun, save a little money. That’s a very and create society’s abundance. We at Aegis lift limited life. Life can be much broader once you our lamps for those who yearn to breathe discover one simple fact, and that is - everything performance-based fairness. around you that you call life, was made up by people that were no smarter than you. And you KEE Koon Boon can change it, you can influence it, you can build 3 June 2012 your own things that other people can use. The minute that you understand that you can poke life and actually something will, you know if you push in, something will pop out the other side, that you can change it, you can mold it. That’s maybe the most important thing. It’s to shake off this erroneous notion that life is there and you’re just gonna live in it, versus embrace it, change it, improve it, make your mark upon it. I think that’s very important and however you learn that, once you learn it, you’ll want to change life and make it better, because it’s kind of messed up, in a lot of ways. Once you learn that, you’ll never be the same again.”Aegis has been based in Singapore since ourinception in 2000. We wished for Aegis to be a“Made-in-Singapore” financial institution brand.The values that Aegis espoused – integrity, 41
  • 43. Beanie Babies Vs Vendor Financing: Can the ‘Product’ (and Asia) Stand On Its Own?Is this happening in America or Asia? All day long, entrepreneurs as they distinguish themselves frompeople are charging in and screaming, “Which the weaker companies reliant on “Beanie Baby”Beanie Baby do you have today?” Tempers flared incentives to push sales of products that might notas long lines forms for the stuffed toys, sold along be able to “stand alone” and at the expense ofwith a Happy Meal, which were the cause of many their balance sheet. This “Beanie Baby” incentivefights. Theft of toys was prevalent at the height of practice is increasingly being questioned in variedtheir popularity and there was an active secondary industries, from shipyards, construction andsecond-hand market for them after the promotion. telecom equipment to property, autos and retail. Emboldened by attractive Beanie-Baby-like vendor financing and generous credit terms with zero downpayment provided by construction equipment companies, buyers of these machines have been very aggressive in their purchases, resulting in China to account for 60% of worldwide concrete consumption, bubbling far above the so- called “concrete scowl” (see chart below).The Beanie Babies craze from 1996-2000 causedWarren Buffett to be cautious in McDonald’s, one There are concerns that these buyers, whichof the most recognizable brand names in the world. include debt-laden and cash-strapped propertyYet, McDonald’s is not one of the core buy-and- developers, are using the machines as collateralhold stocks in Berkshire’s holdings, as explained by for further loans. Analysts at Jefferies in HK, whoBuffett in a talk to MBA students in 1998: were reported by the media this month to have “People don’t want to be eating – exception to travelled to Jiangsu province to study the concrete the kids when they are giving away Beanie market, said that more than half of the concrete Babies or something – at McDonald’s every day. machines sold by a prominent Chinese If people drink five Cokes a day, they probably construction equipment company had not even will drink five of them tomorrow... I like the products that stand alone absent price been switched on and were lying idle in storage. In promotions or appeals although you can build a our “On the Ground in Asia” March edition, we very good business based on that.” mentioned that one Asian top manager shared - Warren Buffett, October 1998 with us how his MNC counterpart in China told him that they might not be able to sell any newAs China slows down, the classic quote of Buffett equipment in China this year. He thought his MNCbecomes increasingly relevant: “It’s only when the friend was joking to him until he was told thetide goes out that you learn who’s been swimming reason for the pessimism was because two-thirdsnaked.” When everyone is enjoying good times, of the machines sold were not turned on asyou don’t know who has taken on excessive risks. indicated by the GPS tracking signal. IndustryAnd multibagger opportunities present themselves executives are reported to be talking of ato the diligent value investors who have been “collapse” and are looking to export their way outmonitoring closely the few swimmers with unique, of trouble via acquiring overseas companies andscalable business models run by farsighted Lion 42
  • 44. setting up overseas factories, often used as fronts by WikiLeaks in late 2010 to have commented infor more loans. 2007 that the figures that go into China’s GDP are “man-made” and “for reference only.” Li said heImportantly, the slowdown has started to result in focused instead on three sets of data – electricitysweeping layoffs at these “Beanie-Baby” consumption, rail cargo volumes andcompanies. Outgoing Premier Wen Jiabao warned disbursement of bank loans. This year is the firston July 18 that China’s unemployment situation time since 1989 that an economic slowdown haswill become “more severe” and “more complex”. coincided with the once-a-decade changeover inWen’s hardnosed warning was unusual given the the country’s top leadership. As a saying in Chinasensitive nature of unemployment on social goes: “The cadres produce the data, and datastability and it came soon after the July 13 produces the cadres.” Officials at all levels ofannouncement of China’s 2Q GDP growth of 7.6%. government are under pressure to report goodWhile such a growth rate would be the envy of economic results to Beijing as they wait formany countries, it is also China’s slowest pace in promotions, demotions and transfers to cascadethree years since Q1 2009 when the global down from Beijing.financial crisis choked world trade flows and saw20 million Chinese jobs axed in a matter of months. Pounding the streets of the Huaqiangbei district inSany Group, China’s biggest maker of construction Shenzhen would bring the data alive. Many shopsmachines by revenue, denied media reports that it in the biggest electronic components market inis laying-off as much as 30% of its 51,000-strong China – possibly the world - were now closed, withworkforce through dismissals and forced lease and sale signs hanging on their premises, anresignations. Its new “performance-based” wage unimaginable situation. During its peak in 2008,system has cut the salaries of some workers by the 70-million-sqm area had more than 20 malls,40%, according to International Finance News, a many of them boasting a floor space of more thandirect subsidiary of the Communist Party-run 10,000 square meters, and a district-widePeoples Daily. A Barclay analyst commented that employee count of more than 130,000. At that“lay-offs [in China’s machinery industry] have time, more than one million people visited thesenever happened in the last 10 years, even during shops every day, bringing business worth 26 billionthe downcycles in 2005 and 2008. Definitely this yuan (US$3.36 billion) a year to the businessdowncycle is much tougher than before.” center. This entrepreneurial hot area – hotspot seems to be a euphemistic description – dependedReports of layoffs of 10,000 employees at telecom on the many electronics factories in nearbyequipment giant Huawei by year end were also Dongguan for the supply of components, as well asdenied. ZTE, China’s second largest telecom on electronics appliances smuggled from Hongequipment maker after Huawei, announced plans Kong to escape taxes.on July 18 to lay off 10,000 employees this yearafter its first-half profit fell by 80%, sharper thanexpected, due to order delays, declining profitmargins, price wars in mobile phone markets andforex losses. Many of ZTE’s employees overseashave been called back from February and now facebecoming redundant if new tasks cannot be foundfor them, according to China News. Both Huaweiand ZTE had come under close scrutiny by USlawmakers and the European Commission overtheir unfair usage of government subsidies andlow-cost loans to win customers by bidding forcontracts at lower prices and offering vendorfinancing. More than 2,000 Hong Kong-owned The iconic Huaqiang Electronic World, one of the over 20 shopping malls in the Huaqiangbei district, was established in 1998 and is the largest offactories in China’s Pearl River Delta may close this its kind in China.year as export orders fall and wages rise, theFederation of Hong Kong Industries said during the Financial Times reported on 11 July that “job cutssame week of Premier Wen’s warning. are spreading” in China. At Sinovel, the third- largest wind turbine maker in the world,First Vice-Premier Li Keqiang, expected to be the employees who leave are not being replaced, andincoming Premier succeeding Wen, was revealed 43
  • 45. hundreds of new hires had their contracts government still relies heavily on selling land-usecancelled in May before they had even started rights for revenue with tax revenues related to thework. China’s coal industry – the largest in the realty development accounting for 63.8%. The cityworld and the backbone of the country’s power projected to generate 4.2 billion yuan (US$661sector – could also be headed for job cuts, million) from leasing land to developers for 2012 inaccording to traders. “Some coal mines have its budget plan. But not a single dollar was broughtstarted taking turns taking ‘holidays’,” said a in from this sector in Q1 this year.gloomy coal trader in Dalian. Coal stockpiled atQinhuangdao port in Hebei province, the largest in New credit stimulus could also bring morethe world and handling half of China’s coal needs, problems, as evident from the steel industry. Steelreached 9.5 million tons, as coal arrives on trains companies, from mills to traders, were among thefaster than needed by power plants in southern biggest beneficiaries of the 2008 stimulus push,China. That surpasses the previous record of 9.3 but a rush to expand has left them overleveragedmillion tons, set in November 2008, near the and overexposed as the economy cools. Chinesebottom of the global financial downturn. The next steelmakers lost Rmb1bn in 1Q this year,three largest coal storage areas in China — in compared with a profit of 25.8 billion yuan lastTianjin, Caofeidian and Lianyungang — are also at year, the first time that the entire industryrecord levels. The slowdown has reduced demand recorded a loss since 2000, according to the Chinafor thermal coal in China, which was caused by Iron and Steel Association. China is already theovercapacity in downstream industries, including world’s largest steel producer, accounting forthe cement, steel, electricity and real estate. 45 percent of global output, and now has 2,700Reuters also reported that Chinese buyers were steel mills and will soon have 940 million tons ofdefaulting on coal and iron ore shipments as capacity, already outstripping demand byinventory piled up and prices fell. 220 million tons, resulting in a potential glut that could take years to work off.No one questions the ability of the Chinesegovernment to reverse the trend, by relaxing banklending and restarting 25 trillion yuan worth ofinfrastructure building projects earmarked for fiveyears, which were being delayed from last year.China’s over 20,000 property developers arebanking on the loosening of property and creditcontrol to turn their fortunes around. Manyproperty developers have not cut prices. Theywould rather stay in business by borrowing moremoney at high interest rates from lenders outsidethe banking system. It is possible these companiesgenuinely cannot afford to reduce prices to pumpup home sales. So they borrow and, by stayingafloat, feed hopes that the market may recoverand rescue them in time. An urgent governmentnotice on July 20 banning the relaxation ofproperty control highlighted the tension betweencentral government and the local provincialofficials in implementing policy decisions andexemplified a popular Chinese saying: “shang youzhengce, xia you duice” (上有政策,下有对策) –policies come from above; countermeasures frombelow. For instance, Guangdong’s Zhuhai relaxedhousing control measures on July 13 after 252 daysof controls that began on November 1, 2011, onlyto hastily retract the policy after just five hours asannounced by He Ningka, the mayor of Zhuhai. Wang Zhongbing, an official in Guangdong and the town mayor of Donghai, kisses a document approving an $11 billion steel plant built byWhile the city has manufacturing industries with Baosteel to produce 10 million metric tonnes of steel annually by 2015.investments from HK and MNCs, the city The new complex is expected to create tens of thousands of jobs and contribute to the city’s tax coffers. 44
  • 46. Suffering from the downturn, they have sought than 300 clients and 3.3 billion yuan worth of loanprofits in other ways. The China Banking guarantee contracts, had raised concerns on theRegulatory Commission (CBRC) said in its April 26 scale and scope of the risk posed by the shadowdirective that steel trading companies had banking system.borrowed from banks for steel-related activities –sometimes then using the same collateral to get In the case of the construction machinery industry,multiple loans from different financial institutions. the accounting bent in us also noted how theThen, with little demand for steel, they had used sellers of these machines have not recorded thesethe money for risky investments, such as stocks vendor financing activities on the balance sheetand property. Others are diversifying to non-core and do not have proper bad debt provisions on theareas such as Wuhan Iron & Steel, China’s fourth corresponding ballooning off-balance-sheetlargest by production, announcing that it is receivables despite the fact that banks requireinvesting 30 billion yuan over the next five years in them to guarantee loan/lease payments in thepig-farming. Shanxi Coking Coal, a leading supplier event of customer defaults. These off-balanceof coking coal to steel mills, is also building a pig sheet receivables, estimated to be connected toslaughtering house with an annual output of 2 around 30% of total sales in the industry, shouldmillion pigs with Shuanghui Group, one of the be treated as debt on the liability side since it islargest food processing companies in China. CBRC the same as the machinery companies incurring awarned in its directive on lending to steel debt and then selling the machines to customerscompanies. on credit. The cashflow from operations that come from this vendor financing activity should be re- categorised as cashflow from financing, which would turn most of these companies to be running negative cashflow positions in the last four years. Since the loss amount on a loan default is the difference between the outstanding loan and the residual value of the machine that can be salvaged, and most of the financing consider the equipment as collateral, the second-hand market is important in understanding the scope of loss. In North America, the fair market value (FMV), orderlyUnconventional non-bank financing channels also value (OLV) and forced liquidation value (FLV) ofappear increasingly to be tapped out. For instance, used equipment were around 75%, 64% and 54%the recent collapse of one of Beijing’s most of the equipment costs, respectively, generally inprominent loan-guarantee firms, Zhongdan line with the write-off ratio of 40% on average. TheInvestment Credit Guarantee, which counted more second-hand machine market in China, however, is 45
  • 47. much less mature than that in the developed the weaknesses are less obvious unless one digscountries. Domestic machinery manufacturers‟ deeper (its tangible common equity was 27.2single-minded focus on new machine sales and billion euros, making its leverage ratio 63 times,lack of refurbishing capabilities also hurt the value which means it will be insolvent if its asset baseof second-hand machines. Most machines can only fell in value by a mere 2%). For Asia to be its ownbe sold at around 30-40% of the original price source of growth without being implicated by thewhen they are three year-old. Yet, the loss rate of contagion effects of the potential Eurozone or USthese receivables reported at the machinery or China problems in this interconnected world,companies are less than 1%, much lower than the she requires Asian entrepreneurs who can pierce40% write-off ratio on average at say Caterpillar’s through these inefficient transaction costs andfinancing receivables. It is likely that many compete and stand on their own economic meritsrepossessed machines were sold internally within with business model innovations and distributionthe company and became part of its operating & marketing innovations. They will enjoy thelease fleet, consequently hiding the net impact on outsized returns in valuation re-rating as theP&L. It is now very prevalent for dealers to give slowdown reveals the true performers.their customer cash advance to avoid towing backof equipment and reflected in the default rate forthe machinery companies. We are cautiouswhenever we hear from bullish analysts andpromoters about how machinery and cyclicalcompanies are “cheap” on a price-to-bookhistorical valuation basis.Asia’s appealing headline growth story need toaccount for the absence of “Beanie Babies” andthe presence of transaction costs in various factorand product markets, which can revealinefficiencies and barriers to better performance.An examination of transaction costs in global anddomestic supply chains would reveal the extent towhich rent-seeking activities and policy distortionsdeter the emergence of competitive markets andcompanies. Otherwise, such complacency willresult in one to plunge headlong into the glowingheadline numbers with high expectations butwithout a distinctive strategy to capitalize on thedynamic opportunities while avoiding the pitfalls.Take the case of the stockbrokers and investmentbankers who have flocked to “rising Asia” since the2008 global financial crisis with the mantra Tsai, pictured with an enormous painting of his childhood dog, Happy,“Shanghai, Mumbai, or goodbye”. They are now who is reborned under the name Yappy, part of the collection of brandsretreating, for example, Samsung Securities shut and mascots targeted at young consumers.operations in the region outside Korea a fewmonths ago; Royal Bank of Scotland is selling most We find that entrepreneurs who are thirsty forof its Asian equities division to Malaysia’s CIMB; knowledge and demonstrate a willingness to workCredit Agricole is offloading its stake in CLSA to collaboratively with partners are the multibaggerChina’s Citic Securities for $1.25 billion. value-creators in this turbulent environment. Take the case of Mr Tsai Eng-Meng, the 55 year-oldPerhaps the analysis of the world riddled by founder of Want Want, whose Chinese charactersturbulence and uncertainty – be it US, Europe or signify prosperity. Tsai succeeded his father, whoAsia - is complicated like Credit Agricole to varying founded the company in 1962 in Taiwan’s Ilan, asdegree: the strengths are well-known, familiar and the Chairman in 1987 when he was 30 and createdeasy to roll off the mouth (having crown jewels like a S$20 billion-market-cap F&B giant by workingCLSA and a strong deposit-taking franchise in rural collaboratively with the Japanese for technologicalFrance which showed 1.7 trillion euros of tangible breakthroughs to distinguish its quality in anassets on its March 31, 2012, balance sheet), but industry mired in food safety problems. 46
  • 48. entered into a food processing JV in August 2011 with Japanese trading house Marubeni and snack food maker Natori to produce and sell snacks from Nanjing, Jiangsu province. Want Want expanded into China from Taiwan in 1992, the year when China’s paramount leader Deng Xiaoping went on his famed “Southern Tour” to spark entrepreneurship, but not before Tsai became the first Taiwan company to apply for a trademark on the mainland in 1989 as decades of tension between the two sides began to lift. The company was later listed on Singapore stock exchange in 1996 from where it was delisted in September 2007 and relisted on HK in April 2008. The Singapore listing then included his hotels and later Tsai went into hospitals, an approach that did not interest investors, and the valuation never got very high. The restructured HK listing was more focused on its core F&B business and its stock multiplied from HK$3 to the current HK$9.3. Sales had climbed from US$860 million in 2006 to nearly US$3 billion in 6 years and profits rose from US$123 million to around US$420 million.When he was 19, he came up with an idea for anew product: crackers made from rice flour. The The more-than-tripling in sales and profits at Wantidea was unconventional back then in 1977 when Want was not inevitable simply because of the risecrackers in Taiwan were made from wheat and of consumerism in China. Distribution andtook far less time to make. While Taiwan has marketing innovations played a large part inample, low-cost supplies of rice, none had figured achieving the performance in the hyper-out the know-how to create crackers from the competitive Chinese market. In the initial yearsingredient. Perhaps they do not even see the when Want Want started out in China, it had apotential given that rice is too obvious and familiar hard time getting paid, even though consumersas a staple food to be anything else. When Tsai gobbled up its rice crackers as the flavor popular intravelled to Japan in search of technology from Taiwan caught on quickly in China and there wasIwatsuka Confectionery, the 65 year-old Japanese little competition. Its success was due to itsboss, Maki Keisaku, told Tsai that he was too network of independent distributors, which grewyoung to work with. Undeterred, Tsai tried for to 15,000 in 2007. Years of comfortable successtwo-and-a-half-years before landing a deal. Today, had resulted in its distribution network to beWant Want dominates the China market in rice bloated with problems such as channel stuffing.crackers with a market share of over 70% with the Want Want appears to have reached a stall pointubiquitous Hot-Kid company mascot, the smiling in its growth.cartoon boy in a tank top, and the bulk of itscompetitors are small-scaled local producers with The first tipping point came when the companya weak brand franchise. Even its popular Hot-Kid established a new distribution system inflavoured milk is sold in unconventional small September 2006 whereby their salespackages and Tsai charges twice as much per representatives liaise directly with small andounce as domestic rivals and still dominates the medium-sized retailers not covered by the existingmarket with a 40% market share. Its soft-candy is network, including local supermarkets, smallalso well-received by consumers with a 30% independent stores, restaurants, schools,market share. Iwatsuka held a strategic 4.9% stake transportation hubs, tourist spots, retail kiosks,in the HK-listed Want Want China that is worth entertainment centres and internet cafes, andS$980 million versus its market cap of S$280 obtains sales orders from these points-of-salemillion. A statue of Iwatsukas Keisaku-san graces directly and a select group of distributors arethe first floor of Want Wants 16-story responsible for providing logistics support such asheadquarters in Shanghai. Want Want also delivery of goods to these retailers. This new 47
  • 49. system allowed them to have direct ownership of Japanese-style breads daily under the brand “Sarithe customers, better price negotiation control, Roti” thorugh its six factories spread acrossand the ability to launch new products to the Indonesia has climbed more than 270% since itsmarket in a shorter timeframe. All the products listing at Rp 1,250 in June 2010 to S$680 million inare delivered to wholesalers in China on a cash-on- market cap presently. Before joining her familydelivery basis, which also provides them an firm, Wendy herself was an entrpreneur, havingincentive to distribute our products on a timely brought the fastfood chain Wendy’s to Indonesiabasis rather than accumulating as inventory on and sold the business after scaling it to 50 stores.hand. Performance targets were set for thedistributors, which include pre-determined sales Shikishima Baking, the second largest breadtargets, sufficient warehouse facilities and company in Japaan, has been instrumental intransportation capability. Sales rebates rather than helping Indosari in its technological processes andcommissions were provided to the distributors is also a key strategic shareholder with a 8.5%who hit the performance targets. The second stake, along with Japan’s trading house Sojitz withtipping point occurred at around December 2008 a 4.3% stake. The company has also built trust withwhen it planned a new exclusive distributor model, retailers and customers through its strongbefore launching it in 10 provinces in April 2010 distribution network for its highly-perishablebefore rolling it across the country in August 2010. products, resulting in high barriers to entry andThe number of distributors was reduced to around the “Sari Roti” brand to achieve a dominant 90%7,000, out of which 3,500 are exclusive distributors. market share in the mass production category. ItWant Want also upgraded its in-house inventory sells more than a third of its products throughmanagement and ERP system to the German SAP modern distribution channels with more thansystem and it is able to more accurately monitor 30,000 point-of-sales, such as over 12,000its distributors’ inventory level and real sales minimarts, including Alfamart and Indomaret, andperformance. over 600 supermarkets/ hypermarkets such as Hero and Carrefour. The remaining are sold through an innovative system of 2,800 mobile tricycle carts to penetrate over 17,000 small traditional shops in the rural parts of Indonesia. MNC giants such as SaraLee and Simplot had tried to expand in Indonesia earlier but all did not manage to get the secret recipe and retreated. While Buffett was right on the “sector” as hypercompetitive and hence reliant on unsustainable “Beanie Babies” to push sales, Buffett was perhaps too bearish on McDonald’s as a “company” with its own unique strengths and the Golden Arches went on to triple to $93 billion in market cap since Buffett’s comments in October 1998. Similarly, it is easy to be distracted by the macro headline news about the slowdown and contagion effects on China and Asia with our limited attention focus while ignoring the Lion Entrepreneurs who are scaling up their businesses with innovations. The key to the success at McDonald’s, Want Want and Indosari to scale beyond “products” that may not, as Buffett puts it, “stand alone”, is what Mr Robert Kwan, theShikishima Baking’s senior MD Kaneyoshi Morita and PT NipponIndosari’s President director and CEO Wendy Yap (Yenni Husono). entrepreneur who first brought McDonald’s into Singapore in 1979, described: “McDonald’s sells aThe growth trajectory at PT Nippon Indosari is also system, not products.” The System of People,quite similar. Co-founded by Wendy Yap and Products, Place, Price and Promotion. The Systemfamily and the Salim family in 1995, the mass that accumulates knowledge to synthesize themarket producer of more than 2 million pieces of factors of production in land, labor, capital, and technology to scale the business sustainably. And 48
  • 50. the emotional capacity to leverage collaborativelywith partners and to share the economic benefitsand risks together as “Lion Shareholders”demonstrates the intangible quality to completethe often missing piece in the investmentframework that has guided us in Asia over adecade to hunt for the outsized performers:“Sustainable multibaggers = Lion Entrepreneurs xLion Infrastructure x Lion Shareholders”. Just likeMcDonald’s who is able to cultivate a massive baseof entrepreneurial long-term dedicated operatorsand suppliers in a way that rivals cannot. WithoutLion Shareholders, most entrepreneurs willinevitably find themselves operating a tougherbusiness over time as the “system” to scale “theproduct that may not stand alone on its own” willdisintegrate. This is also the reason why mostother restaurant retailers, be they from the westor Asia, are not close to one-tenth of McDonald’ssize.As Confucius puts it aptly, “Virtue is not left tostand alone. He who practices it will haveneighbours”, so too does Asia and herentrepreneurs who practices collaborativeinnovations together as Lion Shareholders.KEE Koon Boon22 July 2012 49
  • 51. The Great Asian Infrastructure Stimulus: Network Effect or Redcliff Battle?Seven different men were thinking about thissame thing at different times: “Network Effect”, a Networks – railroads, highways, telephone – haveterm with enormous implications for value been around for a long time and played aninvestors to proactively find the real value-creating important role in global economic developments.multibaggers in this decision-paralyzing global A network effect exists when the value of a goodmacro environment ensnared by uncertainty. or service increases exponentially in a multibaggerThese seven men are: Dr Sun Yat-Sen (1866-1925); fashion as more and more people use that good orHowe Yoon Chong (1923-2007), Singapore’s late service after a certain “critical mass” or tippingtop civil servant and public infrastructure top brass; point has been reached. Tech companies fromMalcolm McLean (1913-2001), “Father of eBay, Apple, Amazon, Google to Facebook,Containerization” and founder of Sea-Land (now LinkedIn and Twitter/Weibo scale exponentially inMaersk); Asia’s richest businessman Li Ka-Shing, value as more users “like” them.who owns Cheung Kong Infrastructure (CKI);Rupert Soames, Winston Churchill’s grandson andAggreko’s CEO since 2003; Li Jiaxiang, director ofCivil Aviation Administration of China (CAAC); andCao Cao, the military warlord in the Eastern HanDynasty of the Three Kingdoms period.This term “network effect”, formalized by Ethernetinventor Bob Metcalfe, was recently invoked byCAAC’s Li Jiaxiang who was announcing the grandstimulus plan to build 82 new airports and expand101 existing ones by 2015. Most of the newfacilities will be feeder airports in central andwestern China. In addressing the criticism thattwo-thirds of the existing 180 airports werebleeding up to RMB2bn in losses, Li said they were Source: "Share Investing for Dummies" by James Dunnmoney losers because China had too few of them,not too many. “It’s like planting trees. One tree willdie, but if you plant more, it will become a forest,and the trees will grow higher and higher.” Linoted all 12 regional airports in Yunnan provincewere profitable due to the “network effect.”Infrastructure is hot. Australia’s A$77bn sovereignwealth fund – Future Fund – also announced onAugust 24 that it will buy Australian InfrastructureFund (AIX) for A$2bn, acquiring stakes indeveloped airports such as Perth Airport,Melbourne Airport, and Queensland Airports. As China prepares for the next round of infrastructure-based fiscal stimulus to counter the slowdown like it did when it engineered the RMB4 trillion stimulus, around 5% of the GDP, during the 2008/09 global financial crisis, the understanding of network effect will be essential to distinguish between the average infrastructure plays which could blow up, such as Allco Finance Group, Babcock & Brown, MFS/Octaviar, Centro Properties etc as shown in the chart above, and the few who are multibaggers such as CheungAIX 5-year share performance vs Aussie dollar against USD Kong Infrastructure (CKI). 50
  • 52. CKI more than doubled in the past five years was drawing maps of rail networks across China.(above chart) to US$15bn during the financial crisis He had been on board a train crossing thewhen the Shanghai Index is down two-thirds from American continent when China’s revolution6,000 to below 2,100 and the Morgan Stanley Asia started. It was on such trips abroad that heex-Japan Index is still down 28% from its pre-crisis realised the importance of the railroads to thepeak. Also, the knowledge of network effects will development of the United States; he hoped theyhelp spot the unique value creators, such as would do the same for his own country. An articleAggreko, the global provider of temporary power in The Economist pointed out that much ofsolutions in a world that is structurally short of the current rail system closely matches a mappower. Aggreko, powering anything from the drawn by Sun in the early years of the Republic ofLondon 2012 Olympics and pop concerts to China. “Commerce will develop only if theinfrastructure projects, is up more than 4-folds in transportation system is well developed.”the past 5 years to US$3.8bn (below chart). Sun would later say: “Today, nations regard railroads as lifelines rather than a way to facilitate their merchants’ shipping.” Thus, Sun, with his larger-than-self revolutionary mission to liberate the people of his homeland, had unknowingly mapped out to value investors how infrastructure can exhibit network effects to be multibaggers, a simple fact that is easily dismissed as obvious: the infrastructure must have an intangible larger-than- self purpose in order to multiply in value, and not merely a headline multi-million or billion number or projection that “adds” to the GDP.It is easy for the inner sceptics in value investors tobelieve that large and quick jumps in assetvaluations are irrational and that large investmentmanias always end up badly when the bubbleburst. An interesting research by Andrew Odlyzko,a mathematician and former head of University ofMinnesota’s Digital Technology Center, serves as arefreshing antidote. He investigated how theBritish Railway Mania of the 1830s, which involved Dr Sun Yat-sen at Shanghai Railway Station, 1911, Francis E.real capital investment comparable, as a fraction Stafford collection, Album C, Hoover Institution Archivesof GDP, to about $2 trillion for the U.S. today,turned out to be a great investment success. Nearly two-thirds of capital stock in China todayHowever, it did suffer its setbacks first: By January were added since 2003 and the compression of1850, railway shares had declined from their peak infrastructural activities had resulted in variousby an average of over 85%, and the total value of embarassments over the past few years: costall railway shares was less than half the capital overruns; widespread rumors of contractors andexpended on them. Owing to over-construction of officials lining their own pockets such as formerrailroads and increased competition, the average railway czar Liu Zhijun; and safety concerns. Fromreceipts per mile of rail track were a third less than the deadly Wenzhou highspeed rail collision lastthose before the Mania. With over 8,000 miles of July to the latest floods in Beijing and the collapsetrack in operation by 1855, Britain possessed the of a highway in Harbin this month after less than ahighest density of railways in the world, seven year from its opening, the great fiscal stimulustimes greater than that of France or Germany. This revealed the lack of regional planning, renderingbrought great benefits to the Victorian economy in many facilities redundant and even unsafe. Theterms of faster and cheaper transportation for Harbin incident, part of an airport expresswaypassengers, raw materials, and finished goods. after two years of construction that cost RMB1.9bn, was one of at least six highway bridgeThis observation of network effect underpinned collapses to occur across the country since July lastwhy one of Dr Sun Yat Sen’s favourite pastimes year. Since 2007, 18 major, expnsive bridges 51
  • 53. connecting key corridors had collapsed, according receive calls every few months for $3 or $5 up toto data aggregated by South China Morning Post. the limit of $50 per share. That is how VC orAs pointed by Simon Rabinovitch in his Financial private equity investments function today. PensionTimes article titled “China: The road to nowhere”, funds and university endowments do not send inthe concern is not that China has run out of good all their money at once. Instead, they respond toinvestments to make, but rather that it has already calls when fund managers find appropriatemade too mnay bad ones, and must pay the price opportunities to deploy the money.in the form of a sharp economic slowdown.Rabinovitch noted that the world’s longest sea The new Basel III rules focus on addressing assetbridge, opened a year ago in Qingdao, has few cars mismatches, requiring lenders to better match theand has yet to meet usage targets. Officials duration of their own funding to their loans and toprivately admit the project was a mistake and the increase the size of the capital buffer they have tolocal party chief had since been sacked for hold against losses, undermining interest in large,corruption. When the local government of longer-term project finance loans which are vital inChangsha, a city of 7 million in central China’s funding infrastructure projects. In the FinancialHunan province, announced plans last month for Times article "Infrastructure projects face fundingRMB829bn in infrastructure-based fiscal stimulus, gap" on 2 May, it is reported that many big playerswhich is a jaw-dropping 150% of GDP, skeptical are retreating from project finance loans. RBS,analysts such as BoAML’s Lu Ting decried: “There is previously one of the worlds biggest projecta tradition for local governments to announce financiers, has put its entire project financeplasn which might be too ambitious to believe.” In portfolio in its "non-core" arm. French banks,order to pay for the last round of the RMB4 trillion traditionally dominant in the market, are seekingstimulus unleashed in 2009, most local to shrink. Passing the buck to bonds in projectgovernments set up investment vehicles to get finance faces constraint in that few bond investorsaround restructions that forbid them from want to risk in the initial, construction phase of aaccessing credit makets directly. These LGFVs project that may later fall by the wayside before(local government financong vehicles) borrowed completion. According to Reserve Bank of IndiaRMB14 to 20 trillion that in turn blast the money annual report released on 24 August, half of theon all manner of facilities that “add” to the GDP ambitious $1 trillion infrastructure investmentfigure, from fancy govenrment buildings, luxurious target set for 2012 expected to be met withresidential buildings to high-end shopping centers. private capital are falling short of investor interestThere is no “interoperability” – no network effect. and "existing infrastructure investments are atKenneth Lieberthal, a political scientist at the risk." The blackout that left 620 million people inBrookings Institution, commented that most of India without power last month is a prime examplethese infrastructure are financed by three-year of the infrastructure woes that plagued urbanizingbank loans on projects with insufficient cashflow Asia. Much of the problems arose from the factto service the interest, let alone principal that significant sums of the funding for long-termrepayment. The mismatch means that these loans infrastructure projects come from short-termare going to have be rolled over for years. money. Short-term fixes for long-term projects.In the British railway mania of the 1830s in which Short-term fixes for a long-held situation appearsthe seemingly “stupid money” gets multiplied to be similar to the problem that the powerfulinstead of being devoured, it is interesting to note military warlord Cao Cao faced during the famousthat the infrastructure construction was funded by Redcliff Battle in 208 AD of the Three Kingdomequity, which is radically different from the Period. Cao Cao had all the odds and numericalaccumulation of large debts. Odlyzko examined advantages stacked up in his favor and a stronghow the investors did not just buy shares when a "asset base". However, Cao Caos million-strongcompany was organized and put them away. They army comprised mainly of northerners who werebecame subscribers, liable for calls up to the full familiar with fighting on the land but were notamount of their shares. Thus somebody involved used to living and fighting on ships in the sea. Caoin a railway project that had nominal $50 shares Cao was advised to train his naval fleet for a yearmight initially put down $2 per share as a deposit. in order to be familiar with sea battles. Too long,This would pay for the preliminary expenses of the Cao Cao thought, although he was agreeable toventure. If approval was obtained from Parliament, the training of the navy for three months.and construction started, that investor would Subsequently, Cao Cao was tricked into accepting an ingenious short-term fix to address the 52
  • 54. "duration mismatched" situation - by mooring and Cheng Junyi, a famous author, made an insightfulconnecting his grand fleet of two thousand ships interpretation of Cao Cao’s poem. Despite Caofrom stern to stern with steel chains into a Cao’s wealth and power as the Prime Ministernetwork to stabilize the fleet against waves and commanding a-million-strong army, he was notreduce seasickness. In the event of an extreme happy. In fact, the great leader Cao Cao wasmarket stress situation, the short-term fix unravels. feeling very lost, lonely and troubled deep insideThe allied forces of Liu Bei, Zhuge Liang and Sun his heart at such a tense moment just before theQuan sent unmanned ships lit up by fire, carried by great battle, like the crows – definitely not a goodthe "mysterious" southeastern wind, towards Cao sign. The reason for his emotional upheaval wasCaos chained fleet and set the network ablaze. because he felt that his whole life had been builtThe unexpected market stress ("fire") to the around, in Aegis language, the Hyena’s way. With"financially-integrated" ships chained by the short- his political and military genius, he can always getterm fix resulted in a contagion effect and a large wealth and power - for himself. But so what? Thisnumber of men and horses either burned to death was a shallow and empty life in the end. Unlike theor drowned. Lion who has created a larger-than-self purpose and a Lion Infrastructure to carry the dreams andInterestingly, a famous poem recited by Cao Cao at aspirations of multiple stakeholders.a gala dinner prior to the Redcliff Battle appearedto have predicted his "unexpected" defeat:对酒当歌,人生几何?譬如朝露,去日苦多。慨当以慷,忧思难忘。何以解忧?惟有杜康。月明星稀,乌鹊南飞。绕树三匝,何枝可依?- 《短歌行》 I lift my drink and sing a songFor who knows if life be short or long Howe Yoon Chong, the former top civil servant, politician andMan’s life is but the morning dew banker. He held many senior appointments, including Head ofPast days many, future ones few Civil Service as well as Chairman and CEO of major statutoryThe melancholy my heart begets boards such as HDB, PSA. He was Chairman of DBS Bank (1985- 90). Howe also fast-tracked the public housing programmeComes from cares I cannot forget while serving as the HDBs CEO under then-chairman Lim KimWho can unravel these woes of mine San in the early years, solving the chronic housing shortage inI know but one man: the God of Wine the 1960s.Stars around the moon are fewSouthward the crows flew Contrast this to Lion Entrepreneurs Howe YoonFlying with no rest Chong and Sim Kee Boon. Both were instrumentalWhere shall they nest in the building of Singapore’s Changi Airport,- Excerpts from Cao Cao’s poem “A Short Song” which won them credit in Lee Kuan Yew’s memoirs. Howe fought strongly against the extension plansAfter Cao Cao finished reciting his poem, Liu Fu (刘 for a second runway at Paya Lebar Airport and馥), Yangzhou’s provincial governor, mustered up advocated the building of a new internationalthe courage to stand out from the crowd to say: airport in Changi. This was despite the Cabinet’s“Prime Minister, why do you sing such unlucky decision for the go-ahead in 1972, based on alyrics just before the great Red Cliff Battle?” (“大军 British expert’s report that it would cost less to相当之际,将士用命之时,丞相何故出此不吉 expand Paya Lebar Airport and that there was not之言?”) Cao Cao was stunned and asked him, enough time to get Changi built up to meet“Why do you say it’s unlucky?” Liu replied, “The increasing traffic needs. The short-term optimal fixcrows flew and they have no place to nest.” was to keep to the planned schedule for PayaAlthough Cao Cao was still in a stupor from the Lebar. For an airport of that size, the buildingdrinking, he understood the meaning behind Liu’s period was usually ten years. Singapore completedreply and he was enraged. “How dare you spoil my Changi Airport in six and opened in July 1981. Lee,mood!” Cao Cao then drew out his sword and Howe and Sim had the grand vision that theplunged it straight into Liu, killing him on the spot. infrastructure must have the intangible quality to engender the network effect and multiply in value: 53
  • 55. “The airport and the pleasant 20-minute drive airlines and their passengers.” It’s all about into the city made an excellent introduction to “adding” and not “multiplying”. Singapore, the best S$1.5 billion investment we ever made.” As Chairman of Port of Singapore Authorities (PSA), Howe went against the advice of professionals to build Singapores first container terminal in the early 1970s. Howe was cognizant of the network effect in containerization that was multiplying in value since the first seed was sown on 26th April 1956 by Malcolm McLean, also dubbed the man who made the Asian economic boom possible. On that significant economic event more than five decades ago, a converted tanker was loaded with 58 modified, 35 foot truck containers and sailed from Newark to Houston. Thus began the containerisation revolution and McLean became lauded as the “Father of Containerization” for his revolutionary role in developing the metal shipping container to replace the traditional break bulk method of handling dry goods and changing intermodal transport with the founding of Sea- Land (later acquired by Maersk). While most scholars sneered that the innovation was simple –The attention to details in building this S$1.5bn “just a box”, there was a lot to maketangible infrastructure was also centered on this containerization profitable. Ships had to beintangible vision, much to the credit of the redesigned (the first was introduced in Australia inattention to details displayed by Sim Kee Boon. 1964). Contracts had to be re-written. Ports needFrom airport management software to the texture overhauling. Unions needed busting. Logistics andof trolley handles, Sim insisted every aspect of reinforced steel had to be invented. And finally, acustomer experience must keep up with its tipping point had to be reached. So it was not “justimpressive infrastructure. The quality of toilets a box" at all.was even under his radar. He was quoted sayingthat the first and last point of exposure to anairport is the toilet. It gives you an impression ofthe country. Today, the Changi Airport Group,formed on July 2009 to take over the rolepreviously undertaken by the Civil AviationAuthority of Singapore (CAAS), generates S$1.4bnin sales and S$337m in net profit from a net assetbase of S$3.8bn.In a Forbes commentary by Gordon Chang, theplan to build a second airport in Beijing 50kilometres away from the existing CapitalInternational Airport was criticized for lacking theintangible quality – the most pleasant and hassle- Malcolm McLean was named in 1995 by American Heritage magazine as one of the ten outstanding innovators offree passenger experience - that Lee Kuan Yew, the past 40 years. In 2000, he was named Man of the CenturyHowe and Sim pursued. Beijing seems to be by the International Maritime Hall of Fame. McLean is the onlyrepeating Shanghai’s inconvenient Pudong person to found three companies that were later listed onInternational Aiport-Hongqiao network which in the New York Stock Exchange (plus two others on the NASDAQ). However, McLean died in relative obscurity. After selling Sea-turn replicated New York’s inefficient Kennedy- Land in 1969, he went into property. In 1982, McLean made theLaGuardia arrangement, essentially because Forbes 400 Richest Americans list with a net worth of $400building-crazy officials took over from technocratic million, however, a few years later, having gambled on rising oilplanners. “It’s all about stimulating the economy, prices that failed to materialize, McLean had to file for Chapter 11 bankruptcy owing debt of $1.3 billion.no matter how inconvenient that will be for the 54
  • 56. McLean’s "containerization” process of using large Maersk and Singapore’s NOL were down morecontainers to hold goods on cargo ships allowed than 40% and 75% to mkt cap US$29bn andhuge increases in port and ship productivity, US$2.3bn respectively over the same 5-year period.helping to lower the cost of imported goods. The Wilhelmsen (WW), the largest car carrier in thecontainer transformed economic geography, world, was a strategic shareholder in Glovis sincedevastating traditional ports such as New York and 2004 and now holds around 12.5%. Glovis was ableLondon and fuelling the growth of previously to benefit from the outsourcing trend of Koreanobscure ones, such as Oakland, California, Tanjung companies such as Hyundai Auto and Kia in notPelepas, Malaysia, and PSA. Today, the cost of only delivery, transportation, warehouse andshipping dropped by a factor of 100 and transport inventory management but also order entry, clientcosts account for about 1 percent of the final price service management, assembly and informationof consumer goods, making country of origin systems, particularly with its core CKD (completelargely an afterthought in purchasing decisions. By knock-down) semi-finished automotivemaking shipping so cheap that industry could components logistics business.locate factories far from its customers, thecontainer paved the way for Asia to become theworlds workshop and brought consumers apreviously unimaginable variety of low-costproducts from around the world. At its heart,ocean shipping is a network business, just likeairlines and telecommunications. Within thissystem is a network of stakeholders who providethe necessary capital and know-how to build,maintain and continually expand this global freighttransportation network. The Lions in McLean andHowe enabled them to coordinate and co-createvalue with the various stakeholders to bring aboutthe network effect and make the infrastructuralhardware a multibagger success. Also, the networkeffect multiplied even further withinformationalization. More than a dozen years ago,Stewart Taggart predicted that by 2010 half of thevalue in the delivery of a shipping container fromhalfway around the world would be in the dataassociated with the container. Most think Taggartwas overly optimistic and wrong - by about fiveyears. His prediction came true - in 2005. ******** Few would have realized that Aggreko is now bigger than household names such as Marks & Spencer or Sainsbury’s. Aggreko has grown rapidly since it was demerged from logistics company Salvesen Group in 1997 and as mentioned earlier, it has multiplied more than 4-folds in the past 5 years. Aggreko has grown so much because it does a pretty decent job in an increasingly volatile and developing world. A charity pop concert? AnInformationalization was critical in why Korea’s earthquake? A war? Aggreko can be there in aGlovis, a non asset-based logistics provider as matter of hours with its orange generators to fuelcompared to its asset-based peers Korea Express your emergency hospital or a year-long project inand Hanjin, was able to multiply by more than 4- fast-growing nations without enough powerfolds in the past five years to US$7.4bn despite the stations. It is now the global leader in the rentalterrible doldrums in the overall shipping industry. 55
  • 57. of power generation and temperature control National Grid. This involves powering all theequipment and has supported the Glastonbury international broadcasters equipment, themusic festival, the inauguration of President stadium lights and security. "If the clock fails onObama, the World Cup in South Africa and the the 100m final, you can blame me," Rupert says.London Olympics 2012. Its global responsiveness is The London 2012 contract is worth US$87m.also key to its multibagger success. After theJapanese earthquake-tsunami in March 2011, they Its bi-annual employee survey reveals that overhad people on the ground within three days, and 90% of Aggreko staff say they love working there,Aggreko’s CEO Rupert Soames, the grandson of Sir which Towers Perrin confirms is unusually high.Winston Churchill, was there himself within 10 Interestingly, the survey also reveals a very lowdays. "As people were flying out from the airports, tolerance of poor performance and a deepwe were flying in," Soames said in a Telegraph irritability with those Aggrekans who do not pullinterview in March 2012. The disaster led to the their weight. In a troubled world where manycompany winning a US$103m contract. Aggreko is managers are up against it, Rupert Soames is astill in the country now, powering schools and rare happy bunny. I love my job and the buzz.factories. Rupert took over as Aggreko’s CEO since Being a chief exec means being on permanent2003 after the previous CEO Phil Harrower was transmit - giving out energy, enthusiasm and lovekilled in a car accident. Sales have ballooned from of the business. People watch me. It isntUS$258m to US$2bn and market cap has climbed acceptable to come off a 24-hour flight lookingmore than 4-folds to US$3.8bn. anything other than full of bounce. Personally, I am reminded of a local entrepreneur whom we met around a decade ago operating in the same space as Aggreko. The company looks to be a “value stock” with its “cheap” valuations and a niche business operating in a “rising tide”. The flamboyant founder boasted to us then that he changes his sports or luxury car every few months and that he “can always make money”. Its market cap has halved in the past decade to the current S$15m and continues to trade below its book value. I am immediately reminded of a classicIn a fragmented industry populated by thousands quote in a Bloomberg interview in July done on theof small local businesses, Aggreko differentiated Freitag brothers – Markus, 42 and Daniel, 41 –itself with its unique network of locations and behind the highly successful eponymous-brandedservice centers to create a network effect, rugged but sexy bags and fashion accessoriessupporting companies in generating profits by made from recycled old truck tarpaulins in theirreducing risk, solving problems and creating new Zurich factory since 1993:opportunities. Also, its control of design,manufacture and supply chain resulted in high “Our company is our Rolls Royce. We reinvestefficiency with low average capital cost/MW. everything because we want to grow by our ownAggreko’s international power projects are still means.”designed and manufactured at Aggreko’s factory inDumbarton, Scotland. In the London Olympics We had written something similar about our2012, Aggreko will be providing all the power that observations that Lion Entrepreneurs tend to live athe Olympics use that is not taken from the simple lifestyle and reinvest profits back into the 56
  • 58. business like Warren Buffett in our “On the moats before self-perpetuating growth kicks in forGround in Asia” (June edition) after our Berkshire the company to grow stronger over time.AGM trip: The Globes interview on 26 July of Eyal Waldman “With their simple lifestyle, the Lion was also fascinating in understanding network Entrepreneurs are akin to the ancient “javelin effect. Waldman, 52, is the founder and CEO of warriors” who knew they have to travel light to Mellanox, the maker of technology used to journey far. All the weight is in their weapons. transfer and store Big Data. Record results on The crafting of each javelin can take months, strong storage, data and cloud trends has with sacrifices offered to the shaft of ash or cornel while it still grows on the tree. “Truth” is propelled Mellanox to multiply more than 4-folds the missile weapon’s supreme virtue, meaning in the past year to US$4.6bn in market cap, making the absolute straightness of its line, for a it the 6th most valuable company on the Tel Aviv warped javelin will not fly true. No measure is Stock Exchange, worth more than some of Israel’s spared to protect its truth. The javelineers sleep foremost banks and industrial concerns. "We are with their spikes, wrapping them in their cloaks seeing InfiniBand become more dominant as a while they themselves shiver, to keep the snow storage interconnect across various markets and and wet from swelling the grain.” applications,” Waldman explained at the record results briefing last month. Interestingly, a year ago, the combined value of social media darlings Groupon and Zynga is 27 times that of Mellanox! Now, both are feeling the “reverse” network effect and Mellanox is trading at near equivalence to their combined value.The Freitag brothers: Markus, 42 (L) and Daniel, 41 (R)Accounting researchers Abbie Smith, RobertDavidson and Aiyesha Dey had written in Nov 2011the intriguing Chicago Booth empirical researchpaper “Executives’ ‘Off-the-Job’ Behavior,Corporate Culture, and Financial Reporting Risk” inwhich they examined U.S. firms over the periodfrom 1980 to 2010 how two aspects of CEObehavior outside the workplace, as measured byprior legal infractions and the ownership of luxurygoods, are related to the likelihood of misstatedfinancial statements, including frauds and materialreporting errors. Frugality affects an executive’sstewardship of corporate resources and indicatesan enduring corporate trait of consistentdisciplined management of spending to achievelong-term strategic objectives. Personally, I think Eyal Waldman, 51, Mellanox founder and CEOthat entrepreneurs without a long-term strategicmission and a larger-than-self purpose for their One might have thought that Waldman would becompany and its stakeholders are more inclined to able to let go of some of the sense of fear that hasindulge in ostentatious lifestyle and to tread the accompanied him like a shadow ever since hehedonistic treadmill that befit their personal status founded Mellanox in 1999, and free up time in hisand to reward their personal hard work. Such diary for a few whoops of joy. "Im afraid all thebehavior outside the workplace could be damaging time. You cant rest on your laurels," Waldmanto getting the network effect in creating powerful explained his inner feelings. “There are expectations all the time. You are under constant 57
  • 59. pressure to continue to execute. Many people into such trouble" (郭奉孝在,不使孤至此). Caohave said to me, ’Youve done it. But we still Cao was said to have cried only twice in his entirehavent done anything; we are halfway there, life: the first time was when Guo died and theperhaps even at the start. You don’t feel that you second time when he was defeated at the Red Cliff.have done something. As far as I am concerned,we are still a small company." Some of the Asian Bringing about the network effect to createentrepreneurs and CEOs whom we have interacted powerful moats is what building a Lionover the past decade have said that they are Infrastructure is about. And having a Lionalready a big company when they are less than Infrastructure is but one of the three parts in theone-tenth (or even one-hundredth!) of Mellanox’s investment framework that has guided Aegis in thevalue. As discussed in our “On the Ground” June past decade in Asia - “Lion Entrepreneurs x Lionedition, Lion Entrepreneurs have a “Beginner’s Infrastructure x Lion Stakeholders = Multibaggers”.Mindset” regardless of their “stage” or “size”; they And the crucial quality to bring about the network“can still run after the bus”. Interestingly, Lions effect is having Lion Entrepreneurs who desire tooften do not talk about themselves but rather how build a larger-than-self institution to co-createthey have enriched the people and stakeholders value with the multiple stakeholders; as what Leearound them. Waldman is proud that Mellanox has Kuan Yew observed in his memoirs:turned many workers into millionaires. "All theemployees have made a great deal of money," “The key to success was the quality of the menWaldman declares. "The distribution of the wealth in charge. Not all our top administrators possessat Mellanox is amazing, in my view. Its not just the business acumen, an intangible gift. Several did.senior managers who earn well; it goes from the NatSteel with Howe Yoon Chong as chairman, Keppel Corp with Sim Kee Boon, and Singaporeyoungest secretary or student to me. Those who Airlines with Joe Pillay became household names,dont talk about it but simply do their work in their leading stocks on the Stock Exchange ofcubicle also earn well. All the employees also Singapore.”receive an annual bonus and the samecompensation elements as me.” KEE Koon Boon 30 August 2012 ********Despite the strategic acumen that military warlordCao Cao displayed in earlier campaigns, he hadsimply assumed that numerical superiority wouldeventually defeat the Liu Bei-Sun Quan alliedforces. Cao Caos first tactical mistake wasconverting his massive army of infantry andcavalry into a marine corps and navy without theappropriate duration of training. Cao Caos troopswere ravaged by sea-sickness and lack ofexperience on water. Tropical diseases, to whichthe southerners had long been immune, alsoplagued the soldiers of the north with thedebilitating effects of sickness rampant in CaoCaos camps. Although numerous, Cao Caos menwere already exhausted by the unfamiliarenvironment and the extended southern campaign,as military strategist Zhuge Liang observed: "Evena powerful arrow at the end of its flight cannotpenetrate a silk cloth" The uncharacteristicallypoor preparation and miscalculations displayed byCao Cao may have been partly due to the recentdeath of his strategist Guo Jia due to sickness atthe age of 37; Guo’s brilliance greatly aided CaoCao in his critical victories over rival warlords Lu Buand Yuan Shao. Cao Cao himself had commented:"Had Guo Jia been with us, I would never have got 58
  • 60. Resilience Investing with the Batfish and Buddha: Why Things Bounce Back (Or Not) What’s Next After QE3, Draghi’s OMT, China’s Slowdown, America’s Fiscal Cliff and Tail-Risk Events“Why have you forsaken me?” thousands of employees and suggested that worse could come. BHP also announced on 24 Sep that itThis was the impassioned question asked by is pushing a decision on the $20 billion-plus InnerGovinda to his good friend Siddhartha, the Harbour Project infrastructure expansion in Portprotagonist in the book “Siddhartha”. Written by Hedland, the export facility for iron ore miners inthe German-Swiss author and Nobel laureate Pilbara, out at least 12 months.Hermann Hesse in 1922, this deeply profoundnovel deals with the journey of self-discovery ofSiddhartha during the time of Buddha.This was also the question asked by iron orecompanies to their capital providers, particularlyironic given that the continuous samsara-flow ofthe monetary easing rounds is supposed to feedcommodity price inflation, benefiting theseresource miners. On 6 Sep, ECB president MarioDraghi announced an Outright MonetaryTransaction (OMT) to buy “unlimited” amounts ofbonds issued by eurozone member states. A weeklater on 13 Sep, on the same day the Fedannounced QE3, the “indefinite” $40 billionmonthly purchase of mortgage-backed securities,iron ore giant Fortescue was reported to haveasked its lenders to waive all its debt covenants forthe next 12 months amid a sharp slump in iron oreprices as demand from China slows down, puttingto doubt A$10 billion in debt payment forAustralia’s third-largest iron ore exporter and theworld’s fourth-largest iron ore producer. Fortescuehad declined more than 70% from its peak A$38billion market cap in June 2008 to just above A$10billion now. At the start of July, iron ore spot pricewas $125 a tonne; it had fallen to a low of $86 inthree months. Such price decline in iron ore issupposed to be “soft” and “gradual” with a “$120floor” according to experts, and not the dramaticfast-and-furious plunge that characterized therecent event in the anniversary month of theLehman collapse. The plunge is because of awillingness in China to walk away from shipmentsif the spot price falls below the contracted price of Shell chief executive Peter Voser describeda shipment, often at the last minute. Suppliers are Australia as a construction “hotspot” and heforced to dump their defaulted-cargos in the spot warned that projects would have to be slowed tomarket at knock down prices, further depressing avoid the worst of the cost pressures. Voser’sthe spot market; this triggers a fresh round of comments followed warnings on costs on LNGChinese defaults. The spiral feeds itself, producing projects from a string of senior executivesdramatic price corrections. Fortescue would also including Chevron and ExxonMobil in their Augdelay its much-vaunted expansion project in the briefings with investors. In particular, the costs andPilbara in an effort to save $1.6 billion. Giant timing of Chevron’s massive Gorgon LNG inminers BHP and Rio Tinto have cancelled planned western Australia was under review. When thebig projects, such as the $33 billion expansion of project was announced in Sep 2009, the budgetthe Olympic Dam mine in South Australia, laid off was $37 billion with gas delivery tipped in early 59
  • 61. 2014. Now cost blowout could rise to $47 billion energy, from 1% in 2006. In 2005, Americaand a 2015 start-up. The Gorgon project is the imported 60% of its oil, now down to 42%. U.S. oilbiggest among nearly a dozen terminals under production surged in Sep to the highest level sinceconstruction or planned along Australia’s coastline January 1997, reducing the country’s dependencethat aims to ship LNG to Asian economies. on imported fuels. America met 83% of its energyAustralia, taking advantage of its proximity to Asia, needs in the first six months of the year. If theis home to more than 70% of LNG projects under trend continues through 2012, it will be theconstruction worldwide. Valued at $100 billion, highest level of self-sufficiency since 1991. Whenthese greenfield projects are also at risk not only America consumes its own oil, it drains less fromfrom rising costs but also something unexpected: global markets, leaving more for others who aresignificantly cheaper U.S. exports. The record U.S. increasingly feeling the impact of China’soutput driven by extraction from the shale slowdown. Many large US chemical companies arefracturing boom, largely in Texas and North switching from oil-based to natural-gas-basedDakota’s Bakken shale formation, resulted in chemicals and investing heavily in plant upgradesnatural gas to trade at a decade low in U.S. At and new facilities in America, bringing the supplyabout $2.50 to $3 per million Btu based on Henry chain back home.Hub futures (as compared to a record high of$15.78 in Dec 2005), Asia is paying a hefty Australia’s economy was bolstered by the biggestpremium at $14 to $17. Asian utilities are resources bonanza since a gold rush in the 1850sencouraged to seek a new pricing regime linked to as Chinese-led demand for iron ore, coal andthe U.S. benchmark given that American LNG could natural gas surged to A$121 billion in trade withbe delivered at about $7 to $9, which include China, in part because of Beijing’s RMB4 trillioncapacity fees, shipping costs and fuel. With the stimulus package in 2008. The impact of theheightened speculation around the timing of slowdown in China on Australia has gottenShell’s and PetroChina’s $20 billion-plus Arrow Australians – including, or especially, theEnergy LNG venture in Queensland and A$250,000 truck-driver - to be somewhat nervous.Woodside’s Browse LNG project in which Shell has At Fortescue, a Wall Street Journal article on 24just increased its stake, Shell’s global downstream Sep reported that the company’s barbeques, adirector Mark Williams commented on 19 Sep that: quintessential part of Australian culture, are not“I wouldn’t go so far as to say as projecting a gas safe from spending cuts. The Australian Primeglut, but you know as technology around LNG Ministers special adviser on Asia, Ken Henry,improves it is certainly possible that Australia “affects an air of unconcern” as reported in thecould be facing a level of cost competitiveness Sydney Morning Herald on 8 Sep. Asked whetherfrom these other resource plays that make it less the mining boom was over, he reframed thelikely that these reserves will be developed at question. “There are people who would call thepaces that people used to think.” The slump in gas boom that is presently under way boom No. 2, soprices has also caused BHP to write off $2.84 maybe the question should be: Is boom No. 2billion in Aug on its recently acquired U.S. shale over?’” he told a seminar at the Australiangas business. National University. “I would suggest to you that if this really is the end of boom No. 2, we will see boom No. 3 and we will see boom No. 4 and we will see boom No. 5 and so on.” Fred Smith, the founder of the global airfreight titan FedEx, commented in an earnings conference call on 18 Sep that he is “somewhat amused watching some of the China observers completely underestimate the effects of the slower exports on the overall China economy”, joining a chorus of other multinationals from Caterpillar, Burberry to Nike. In addition to the great political will backing fiscal and infrastructure stimulus, there is also theImportantly, the growing American energy great urbanization story: 18 million Chinese - theindependence is a game-changer. Shale entire adult population of Australia - were pouringconsumption in the U.S. last year accounted for from the countryside into cities each year. Housing25% of world’s biggest user and importer of them had required steel, which could only be 60
  • 62. made from iron ore. This consensus view is China’s sudden political pivots, as U.S. Defenceincreasingly being challenged. China’s top steel Secretary Leon Panetta warned on 15 Sep.producer Baosteel announced at a conference on27 Sep that they have halted production at its 3 Panetta was the first foreign visitor to have met upmillion tonne-a-year loss-making Shanghai plant with China’s incoming President Xi Jinping on 19and expressed doubt that government attempts to Sep after Xi cancelled a Sep 5 meeting with U.S.stimulate the slowing economy would revive Secretary of State Hilary Clinton and Singapore’sdemand in the worlds biggest market for the Prime Minister Lee Hsien Loong. Xi’s publicmetal which buys 60% of the ore traded globally. disappearance for two weeks without any officialLiu Xiaoliang, executive deputy secretary general explanation added to an already tense atmosphereof the Metallurgical Mines Association of China, ahead of once-a-decade leadership transition at thsaid 40% of the countrys iron ore mines were idle the 18 Party Congress on 8 Nov. The Dailydue to depressed prices. The steel industry had Telegraph reported that Xi, 59, came under attackbuilt up $400 billion of debt during years of from party elders, “especially Qian Shi (87) anddouble-digit growth. The ingenuity in the old magic Song Ping (95)”, who described him as "unreliable"trick of producing steel regardless of profitability in and questioned whether he should be elevated toorder to use the hoarded stockpiles as collateral to the pinnacle of Chinese power. On 20 Sep, themake illicit borrowing to invest in property appears Commerce Ministry said that foreign directto have reached its limit as the continued huge investment (FDI) fell 3.4% year-on-year to $75iron ore inventory levels – breaking 100 million at billion in the first eight months of 2012. Tradethe 25 major ports - triggered the bank regulator relations with Japan have also been hurt by anto issue strict orders to tighten such rampant loans. increasingly bitter territorial dispute over the Diaoyu Islands in the East China Sea after the move on 11 Sep by the government of Japan to buy the islands from their private owner for $26 million. Cumulative annual FDI flow is now at risk of missing the $120 billion target in each of the four years to 2015. After more than a decade of surplus in the balance of payments, the banking system has grown used to the liquidity created by the accumulation of forex reserves in which forex intervention in creating more Chinese yuan is necessary to keep the currency from appreciating too quickly. If capital outflow persists and even accelerate, liquidity will be siphoned out of the system, just as other demands on bank capital are growing, limiting monetary easing options when unconventional shadow banking sources fromGrowing pessimism could spark a dangerous flight trust loans to underground banking are drying up.of capital. In the second quarter, China recordedits first quarterly balance of payment deficit since ********1998, dragged down by a capital account deficit of All the credit gorging reminds me of a paragraph$71.4 billion. Lombard Street Research estimates from the deeply profound book Siddhartha, inthat capital flight has reached $320 billion over the particular the underlined last sentence:last year. A survey by Hurun and Bain & Co lastyear showed that 60% of the 1 million Chinese “Siddhartha lost the composure with which hewith assets of more than RMB10 million are had once greeted losses, he lost his patienceconsidering emigrating or have already begun the when others were tardy with their payments,process and the top 1% in China controls 70% of lost his good-naturedness when beggars camethe country’s financial assets that is at least as to call, lost all desire to give gifts and loanlarge as two-thirds of China’s $3.2 trillion forex money to supplicants. The one who laughed as he gambled away ten thousand on a single tossreserves and is possibly twice its size. This capital of the dice turned intolerant and petty in hisflight appears to be “tail-risk” insurance by well- business dealings, and at night he sometimesinformed Chinese, a hedge in case the 10-year dreamed of money. Whenever he awoke frompower transition goes badly wrong or in case the this hateful spell, whenever he saw his facepressures of a secular downturn cause another of grown older and uglier in the mirror on his 61
  • 63. bedroom wall, whenever he was assailed by shame and nausea, he fled further, seeking to escape in more gambling, seeking to numb himself back into the grind of hoarding and acquisition. In this senseless cycle he ran himself ragged, ran himself old, ran himself sick. Siddhartha had spent the night in his home with dancing girls and wine, had made a show of superiority before others, of his standing, though he was no longer superior, had drunk a great deal of wine, and had gone to bed long after midnight, weary and yet agitated, close to tears and despair. For a long time he sought sleep in vain, his heart full of misery he felt he could no longer endure, full of a nausea that coursed through him like the vile, insipid taste of the wine, like the dreary all-too-sweet music, the all-too-soft smiles of the dancers, the all- too-sweet perfume of their hair and their breasts. But nothing made the nausea well up in him more bitterly than his thought of himself. He felt nausea at his perfumed hair, the smell of wine on this breath, the wary slackness and reluctance of his skin. Just as someone who has eaten or drunk too much vomits it up again in agony and yet is glad for the relief, sleepless Siddhartha yearned for a monstrous wave of nausea that would rid him of these pleasures, these habits, this whole meaningless existence Old timers would say that the most profitable and himself along with it.” businessman during a gold rush is the one selling the spades, shovels, carts and Levi’s Jeans to theIt appears that a “monstrous wave of nausea” is diggers. Interestingly, American oil servicesneeded to have relief from the massive gorging. companies are increasingly feeling the effects ofYet, Siddhartha is able to bounce back with cutbacks to drilling operations. Nabors Industries,resilience and attain enlightenment: “I have had to the world’s largest provider of land drilling rigs,experience so much stupidity, so many vices, so said the market deteriorated sharply toward themuch error, so much nausea, disillusionment and end of the second quarter. Nabors CEO Tonysorrow, just in order to become a child again and Petrello said in July, “Operators are even morebegin anew. I had to experience despair; I had to reluctant to sign contract extensions of meaningfulsink to the greatest mental depths, to thoughts of length since both cash flow and drilling budgetssuicide, in order to experience grace.” The word are declining”. Houston-based Baker Hughes, anSiddhartha is made up of two words in the Sanskrit energy service provider, is seeing its own pricinglanguage: Siddha (achieved) and Artha (meaning or pressured by the declines. CEO Martin Craigheadwealth), which together means “he who has found said in July, “I characterize it as a knife fight rightmeaning (of existence)” or “he who has attained now in terms of pricing”. In the Bloomberg charthis goals.” In fact, Buddha’s own name, before his above comparing the past five-year performancerenunciation, was Siddhartha Gautama. of Chevron with the “spades-seller” from Schlumberger to Baker Hughes and Nabor, it is not ******** hard to see that the old timers were caught flat-It is in this macroeconomic backdrop that we get footed – the tide does not lift all boats. Take theto understand clearer why a highly successful local case of Lamprell, the London-listed group foundedentrepreneur in the thriving offshore and marine by Steven Lamprell and other family members in(O&M) services sector would comment: “Doing 1974 which specialized in jack-up oil rigs or floatingproperty development projects is far better. No rigs with retractable legs used to secure the unitmore hard work in flying to Houston to deal with on the sea floor. Lamprell had announced multiplethe oil majors in the pricing of contracts and in contract wins, even strategic partnerships withwearing greasy overalls to execute the cost important industry players, but poor execution inmanagement of the projects.” cost control and delivery resulted in its share price 62
  • 64. to plunge two-thirds since May. Lamprell now residential home owners pocketed at least S$20.3trades below book value with a market cap of billion in gross profit since the sector recovered inS$560 million and has decoupled significantly from late 2009, explaining robust developer sales ofSingapore-listed Keppel, as shown in the around S$60.1 billion in the period, according to aBloomberg five-year chart below. Keppel is the report by Square Foot Research.world’s largest oil rig builder with a market cap ofS$20.5 billion trading at Price/Book 2.4x. Thestakes for good stock-picking has never beenhigher in this uncertain environment.Because credit-induced growth at the macro levelhides a lot of ills at the micro and institutional level,the retreat of the credit tide can expose those whohave not been building an economic moat in theirbusiness. That is the reason why we continue toobserve that the Lion Builders continue to ascendand create astounding value even in tough anduncertain markets. The investment strategy is toinvest in these corporate leaders who havecreated powerful economic moats for self-perpetuating growth to kick in for the company togrow stronger – and easier – over time. Timebecomes a friend in growing and scaling theirbusiness due to years of accumulation of know-how and building of team and system. Theportfolio with such current holdings would havewithstood every kind of investment fad andmarket condition to multiply value for theshareholders. They would continue to ascend andgo on to become the “Ascendant Lion” companiesin Asia. In contrast, the operators of the Hyenabusinesses would find that the risks of handling alocal property development project in a rising In a Credit Suisse report on 27 Sep titledmarket are more controllable, unlike those in “Mortgage profitability – too good to be true?”,coping with the vagaries of the industry dynamics there are some interesting comments and charts:in which their core business is operating in. They “In Asia, most mortgage loans are priced off acannot do it alone for the game is no longer about short-term benchmark which, by definition, makesgetting deals; the disruptive nature of the game them floating rate loans. This is very risky for therequires a higher-order level of economic borrowers, and we believe most of them are notcompetitiveness to remain relevant. Harbour no even aware of this, let alone be concerned. Thedoubt though, as the lone Hyena will always make reason banks don’t offer fixed rate loans of 15-30loads of money, albeit only and always for year maturity is that they don’t havethemselves: Find a decent location or project, corresponding fixed rate funding. Taking the US aswear a nice suit to get cheap bank financing, an example, banks offer 15-30 year fixed ratesqueeze the contractor to wring out cost savings, mortgages because they can then sell those loansand build to flip with a 20-50% net profit margin to to agencies such as Fannie Mae or Freddie Mac. Inan eager crowd. After all, there is supposedly Asia, typically banks keep the loans on their booksbuoyant end demand; a 30-year S$1 million loan at until they are fully paid back, which explains why1.7% interest works out to S$3,500 in monthly they cannot afford to take such huge interest raterepayment and rental income of S$4,000 would risk. But if long-term fixed rate loans were to begenerate a tidy surplus. All to ride the yield curve. applied, demand for investment property wouldWhy work hard in business? Be a fashionable, suffer as rental yields would then be lower thanrespectable and profitable property entrepreneur the mortgage rates (i.e., negative carry). If thatinstead. The recovery of Singapores property were to be the case, many borrowers would thinkmarket since 2009 has been a welcome fillip for rationally and decide against purchasing their nextthe wallets of private home owners. Private property for putting on rent.” 63
  • 65. “sympathy turned to antipathy, however, once people learned how the once-promising corporate group drove itself to near dismantlement through diversification beyond its capacity, and what Yoon did at critical junctures.” As described vividly in the report, “Trouble began when Yoon bought the building company paying US$600 million, nearly twice the optimal price, in 2007 just prior to the breakout of the Lehman Brother’s fiasco, from Lone Star, a Texas-based private equity fund. ItsThe above charts showed that banks in Hong Kong subsequent acquisition of a savings bank dealt anand Singapore enjoy the lowest risk weight of 10% additional blow. What forced Yoon to make thesefor mortgage loans, amongst the lowest globally. untimely and unwise moves was his ambition toAustralian banks can claim similar results from emerge as another chaebol, complete withtheir Basel II models but their regulator, ARPA, has construction and financing arms. Many Koreansimposed a floor of 20% on the mortgage risk may be experiencing a sense of déjà vu, becauseweight, and that the same risk weight is applied on Woongjin’s collapse reminds them of theboth owner-occupied and investment-driven nightmare of the 1997-98 Asian financial crisis,mortgages. They conclude that they “cannot rule during which 16 family-controlled conglomeratesout the possibility of the regulator imposing higher took the same course, starting with steelmakerrisk weights as a countercyclical macro-prudential Hanbo. More disappointing is that like 15 yearsmeasure or as a property market cooling measure ago, the system ― financial supervisors, creditors,(to bring up mortgage pricing), which could stock market analysts and even rating agencies ―severely impact mortgage profitability”. failed, or neglected, to catch the looming collapse, which is why some cynics are calling Woongjin’s ******** fall their joint work. At the end of the day, theAsian entrepreneurs who come to regard banks and nonbank lenders are left holding thethemselves as infallible particularly in property bag of up to US$3 billion of loans, not backed withdeals and construction projects might find the sufficient collateral and prone to end up as badstory of Yoon Seok-geum to be instructive. Yoon, debts. No less lamentable is an egregious lack offounder and chairman of Woongjin Group, Korea’s corporate ethics on the part of Yoon. His wife and nd32 -largest conglomerate, is a living legend large shareholders have disposed of their equity inamong salaried workers here. Starting as a door- the group (in Feb for over US$1 billion), handingto-door salesman of Britannica Encyclopedia 32 losses to a number of small, innocent investors.”years ago, Yoon was crowned global sales king atBritannica in just a year. In 1980, Yoon has ********launched his own company with just seven Most would argue that pushing up the value of theemployees and 70 million won in capital and built property assets would protect the wealth of theup a billion-dollar empire which engaged in home- individual in the event of any imminent sharpstudy materials, water purifiers or bidets, slowdown in global economic activities. At leastconstruction and energy sectors. In particular, people still have their million-dollar homes as aWoongjin Coway, the flagship cash-cow vehicle, safety net to bounce back.has climbed over 10-folds since 2001 to overUS$2.1 billion in market cap. Yoon represents Why is it that some individuals, institutions,another rags-to-riches story and a victory for free- systems, and cultures tend to bounce back frommarket capitalism. The world knocked on his doors, disruptive change better than others? The answer,begging to access Woongjins formula for success. explain Andrew Zolli and Ann Marie Healy in theirYoon soon began to tour corporate Korea to important new book on the topic, is resiliency. Zollipreach on how compassion is the key to a great and Healy define resilience as “the capacity of acompany. A couple of years ago, Forbes magazine system, enterprise, or a person to maintain its corefeatured Yoon as one of the 40 richest in Korea. purpose and integrity in the face of dramatically changed circumstances,” and argue that theYet on 27 Sep, the group’s two core units, resilient mindset allows some to adapt toWoongjin Holdings and Kukdong Construction, technological, cultural, and environment changefiled for court receivership, similar to bankruptcy much better and faster than others. In their bookprotection in the U.S. As Korea Times reported, “Resilience: Why Things Bounce Back”, several 64
  • 66. important case studies were used to illustrate how entirely dependent on a single species (e.g.“preserving adaptive capacity - the ability to adapt property profits and its related wealth effect)to changed circumstances while fulfilling once core continuing to do that job. The loss of the urchins,purpose - is an essential skill in an age of an otherwise modest trigger, caused the reef tounforeseeable disruption and volatility.” Their collapse virtually overnight. Yet, had you asked abook is interesting in framing challenging issues by marine scientist to describe the reefs, you wouldthinking in a refreshing and practical RYF mindset. have received a promising assessment: The reefRYF, or Robust-Yet-Fragile, is a term coined by had proved robust in the face of significantCalifornia Institute of Technology research disturbances, ranging from hurricanes to extensivescientist John Doyle to describe complex systems human fishing. There was little evidence of thethat are resilient in the face of anticipated dangers hidden fragility that was being exacerbated by thebut highly susceptible to unanticipated threats. slow loss of biodiversity. Such clarity is available to us in hindsight, but consider the challenges posedTake coral reefs, popular robust-yet-fragile (RYF) by truing to manage such a system at the time.habitats for hundreds of varieties of fish, including The interactions between the various agentslarge predatory species which were harvested as a affecting the health of the reef (fish, urchins, algae,reliable and time-honoured food source; let’s think corals, and human beings) were imperfectlyof coral reefs as economies with a diversity of understood and nonlinear – small changes couldeconomic actors with their outputs harvested in lead to bug outcomes. What’s more, recentthe system. Zolli and Healy described how RYF experience suggested that the system couldsystem can break down – and bounce back. rebound from a disturbance on the scale of a hurricane. The authors summarized that “whetherAs smaller plant-eating fish, such as parrotfish we’re dealing with fish stocks or financial stocks, towere harvested (think SME or family business improve the resilience of the system as a whole,owners embarking on property deals and we first need measurement tools that take theneglecting or even abandoning their core health of whole systems into account, not justbusinesses), the reefs still appeared healthy and in their pieces.”fact seemed to be thriving. Sea urchins wereflourishing since they no longer had to compete Thus, parrotfish which are voracious algae eaters –with the plant-eating fish for algae, the mainstay “lawn mowers” – play a critical role in regulatingof their diet. After a devastating hurricane strike, the competitive relationship between algae andthe general consensus among marine biologists at corals. By cleaning the system of excess algae andthe time was that the reefs had survived enabling new corals to compete for space,remarkably well. Then something terrifying parrotfish keep a coral-dominated reef in ahappened. An unidentified pathogen decimated continually self-regenerating state and prevent itthe entire population of sea urchins. The illness from flipping into an algae-dominated state. Onewas unprecedented in its lethality and its speed. would have thought that parrotfish (e.g. SME orOne year later, the sea urchin had been virtually family business owners) is the main source ofeliminated from its normal habitat. With no resilience in all states. Yet, when a team ofurchins to keep it in check, algae quickly came to scientists planted dense algae with a variety ofdominate every corner of the reef system, plant-eating fish and huge densities of parrotfish ineventually covering the entire surface area and an experiment, they thought this parrotfishkilling the corals underneath. With the loss of the equivalent of eat-all-you-can buffet will bringcorals went the remaining fish – reefs that about a feeding frenzy with the algae to besupported hundreds of species for thousands of gobbled down, primarily by parrotfish, in 24 hours.years were transformed into vacant algal The team sat waiting in anticipation for the firstwastelands seemingly overnight. few hours. That anticipation soon turned to bafflement. Not only were there no parrotfish,The authors explained that on a healthy reef, a there were no fish to be seen at all.new pathogen decimating a single species (like theurchin) might not have had catastrophic What the team did notice, over the next fewconsequences, because an essential reef function weeks, is that the algae were slowly getting– like keeping algae in check – could be performed thinner. So what was eating them given the no-by more than one species. On the highly show by the parrotfish and the many other plant-compromised reef, however, the continued eating fish? From out of the murk, a completelyflourishing of the ecosystem as a whole became unrelated species, a small black fish with a golden 65
  • 67. fringe, the batfish, appeared to feed on the algae. $462 billion, according to Hedge Fund Research Inc.Batfish aren’t supposed to eat algae. The research Investors are showing signs of getting frustrated.suggests that while the parrotfish act as the Ray Nolte, chief investment officer of SkyBridgelawnmowers for the reef, they can do so only Capital, a fund of hedge funds with more than $3when the reef is in the healthy, coral-dominated billion under management that brought down itsstate. When the system has flipped and algae have allocations to macro funds beginning in 2009,taken over, they’re no longer able to provide this commented: "Low correlation is nice, reduction offunction. And that’s when the batfish is volatility is nice, but at some point you need the“deployed” on the reef to correct the imbalance. returns to pay the bills."One prevents a flip, the other reverses it. Whenthe lawnmowers are broken, the weeds on the Frustration was an undercurrent in a letter sent ingarden start to get big. By the time the August to investors by star hedge-fund billionairelawnmowers show up, they won’t work. You need manager Louis Moore Bacon. Citing the difficultya chainsaw and a bush saw. The batfish are part of of navigating markets dominated by governmenta group of species capable of performing a and central-bank intervention, Mr. Baconparticular functional role under exceptional announced he was returning $2 billion to investorscircumstances. The good news is that fish exist in Moore Capital Managements $8 billion flagshipwith the capability to help reverse a system flip fund. The backdrop of over-indebted developed-from an algae-dominated state back to a coral- market economies, coupled with unprecedenteddominated state. The bad new is that in many efforts by central banks and policy makers to joltcases, scientists have no idea which fish they are. those economies, has created "short start-stop- start growth cycles that exacerbate trendlessPerhaps we could now be operating in an algae- volatility," hurting profits, he wrote. That means itdominated reef-economic system and investing in is hard for macro funds to have strong convictionsthe “batfish” is the more resilient investment in their trades and they have to reduce the size ofstrategy while the preferred investment methods their positions or even increase leverage and risk– in particular “macro” funds - that had worked so unnecessarily to generate returns. In addition,well during the global financial hurricane is proving banks have cut back their proprietary-tradingharder to generate sustainable returns. desks over the past year in preparation for the Dodd-Frank provision that limits banks’ ability to make bets with their own money. That is making it more difficult to trade large positions, Bacon said. Markets are moving in tandem and “idiosyncratic opportunities, particularly in liquid markets where volume can be exploited, are becoming oases in an investment desert.” Like Siddhartha, we believe in listening to the river of markets for the idiosyncratic batfish investment opportunities – how to listen with a quiet heart and an open, waiting soul. Unlike the scientists who are clueless on knowing in advance which fish have the capability to win in an algae-dominated,In a Wall Street Journal article on 5 Aug titled tough and uncertain market, we at Aegis have“’Macro’ Funds Show Micro Returns”, it was been accumulating our process-driven know-howreported that while many macro fund managers - in the past decade in Asia in investing in Lioninvestors who bet on big economic trends and Entrepreneurs who desire to build a Lionpolicy decisions - had predicted a scenario where Infrastructure to multiply value for their Lioncentral banks become increasingly ineffective and Stakeholders. We believe that this investmentdeveloped economies remain weighed down by framework of “Sustainable Multibaggers = Liondebt, frustrating markets are translating into Entrepreneurs x Lion Infrastructure x Lionmeagre returns for them. After many of these Stakeholders” remains an evergreen philosophyfunds posted big gains during the financial crisis, and even more relevant in this frustrating “algae-money poured in. From the end of 2008 through dominated” macro environment punctuated bythe first quarter of this year, assets surged 66% to “imminent” tail-risk events that paralyzes high- conviction decision-making. To summarize, the 66
  • 68. investment strategy is to invest in corporateleaders who have created powerful economicmoats for self-perpetuating growth to kick in forthe company to grow stronger – and easier – overtime. Time becomes a friend in growing andscaling their business due to years of accumulationof know-how and building of team and system.The portfolio with such current holdings wouldhave withstood every kind of investment fad andmarket condition to multiply value for theshareholders. They would continue to ascend andgo on to become the “Ascendant Lion” companiesin Asia.KEE Koon Boon30 September 2012 67
  • 69. Match: How to Patch the Asian Leadership & Institutional Uncertainty Discount? Match “Grill” and “Lidia” With “There Is an I in Team” For Stable Allocation!Chaos would descend unto a world when there is perspective is that if institutional investors such asno “price” – reflecting the interaction between pensions and insurers were to channel funds intosupply and demand – to act as the guiding light to EMs to build their weightings from the current 5-allocate resources. But how about resources which 8% to 10%, at least $4 trillion would be comingprice or money alone cannot buy? Resources such into developing markets, so the idea is to positionas authentic leadership and “moaty” institutions early during the global rebalancing process.(like the Silicon Valley ecosystem) that’s absolutelycritical for sustainable growth and for scaling up tobe easier as it gets bigger? These resources appearincreasingly rare in the wake of the New YorkTimes cover story on 25 Oct on assets worthbillions held by relatives of China’s premier WenJiabao, the Bloomberg article on 29 Jun revealingthe financial affairs of the family of China’sincoming president Xi Jinping, the fall of theinspirational Lance Armstrong, the bankruptcy ofone of the property investment companies held by“Rich Dad Poor Dad” charismatic author Robert Source: Joe Light, “Is Your Bond Strategy Working?” Wall StreetKiyosaki who advocated to his followers to take on Journal, 26 Oct 2012debt to buy multiple property etc. Interestingly, arecent 24 Oct study showed that the alumni of In fixed income, switching from the traditionalStanford University, arguably the wellspring of the market-cap-weighted bond portfolio to GDP-“moaty” Silicon Valley, created nearly $2.7 trillion weighted would also increase the weighting ofin economic impact each year and created 39,900 EMs more than 4-folds from 4.8% to 20.9%, all thecompanies and 5.4 million jobs since the 1930s. more compelling when it goes against all senses to have exposure to countries with spiralling debt, like those in the euro zone or Japan, take up ever- larger portions of the index and investors portfolios. Noteworthy was the jump in the market value of the 144 Asian-based REITs from $2 billion in 2001 to $128 billion now, accounting for 22.5% of the $568 billion global REIT market, according to the Asia Pacific Real Estate Association, exceedingEmerging and developed markets’ share of global GDP: the GDP-weighted percentage for EM bonds.According to the IMF, by 2014 EMs will have overtakendeveloped economies in terms of share of global GDP. Yet, the guiding light of “price” had cast a pall in the boom in the market for some of Asias riskiestThe Asian leadership and institutional resource corporate bonds on the way private bankers areallocation uncertainty in the coming leadership compensated for selling these securities totransition in China on 8 Nov - and Malaysia (latest investors, as reported in the Wall Street Journalby 27 Jun 2013), Indonesia in 2014, Korea on 19 article “In Asia, Rebates on Rise in Some BondDec 2012 – appears to attenuate the “omitted Deals” on 17 Oct. “This year, there has been anvariable bias” problem in factor risk models that increase in the number of companies with less-explain the systematic risk and deep-seated than-pristine credit ratings offering privatevaluation discount as to why emerging markets bankers a cash bonus, or rebate, for every below-(EMs) weighting in the world indices at 13% does investment-grade bond they sell to clients. Thenot reflect their 50% contribution to global GDP, rebates act as an incentive for banks to find buyersaccording to IMF data. And given the continued for the debt,” WSJ discovered. Some of these high-process of deleveraging across the developed yield securities “arent even rated by credit-ratingsworld, the IMF expects EMs to contribute over firms”. More than 60 bond issues in Asia ex-Japan,80% of world GDP growth in 2012 in a report in Jan valued at about $12.5 billion, were sold with2012. The commonsensical asset allocation rebates this year, or about half the total corporate- 68
  • 70. bond issuance, double the 34 sales in 2011 and So, can money-free transactions and resourcehigher than the four deals in 2010. allocation be possible in markets? This year’s Nobel winners Lloyd Shapley, 89, and Alvin Roth, 60, showed that such markets function well with their ground-breaking work in cooperative “matching” as agents seek to align their choices. From allocating kidney organ donations to assigning medical graduates and students to hospitals and schools, real-world problems with institutional constraints that are difficult to imagine or study within the abstract world of theory are resolved fairly and efficiently with stable matches that are immune to manipulation by either party in the matching process. Essentially, a “stable” match occurred when each side’s preferences were met, when there is an alignment in interests. The Shapley-Roth “match” reminded me of what was written in the “On the Ground”Source: Fiona Law, “In Asia, Rebates on Rise in Some Bond April monthly edition about Winston Churchill:Deals” Wall Street Journal, 17 Oct 2012 match the person to the situation or organization for multibagger or outsized success. Churchill was the right person - probably the only person - who could have faced down Hitler in May 1940. No amount of money can be used to get or attract the right leader. But earlier in his career Churchill made mistakes after mistakes, and these missteps discredited him so thoroughly his prescient warnings against Hitler were ignored during the 1930s. So looking for the "best" leader is the wrong way to go about in the search. Theres usually no such thing - there are just leaders who are or are not suited to a particular situation. It is about matching the "right" leader to the problems and opportunities facing the organization in aSource: Natasha Brereton-Fukui, “Asian Debt Luring Buyers rapidly changing world.Abroad” Wall Street Journal, 31 Oct 2012 When Asia and her corporates can match to patchIn most cases, investors do not know their bankers up the leadership and institutional uncertaintyreceive extra cash for selling bonds to them since discount in valuation, its long-term multibaggerdisclosure is not needed. As a result, artificial valuation would be actualized to multiply wealthdemand and low-quality supply could be created, for its various stakeholders. To effectively do so,distorting the market. The investors also tend to we need to understand the story of “Grill”, “Lidia”flip their holdings, which creates volatility. The and “There Is an I in Team” and how they matchissuers may also seek to alter the terms of their together, starting with “Grill” – John Grill.borrowing during stress periods, at a time wheninvestors needed the basic protective function of a The notoriously media shy John Grill, 66, is verybond. Like IPOs and new property launches, the respected in engineering circles, having foundedactive primary issuance market of debt may mask WorleyParsons back in 1971 and over the yearsthe relative illiquid nature and institutional flaws built it into a engineering and professional servicesof the secondary market for bonds in Asia. Some heavyweight giant with more than 40,000individual investors are borrowing heavily to buy employees in 44 countries. After listing in 2002these local-currency bonds. And if bond prices with a market cap of A$430 million, Worley hasstart to fall, the unwinding of these leveraged bets multiplied over 14-fold in a decade to its presentcould have a snowball effect on the market. A$6 billion. As pointed out by the Sydney Morning Herald on the 10th listing anniversary of WorleyParsons in the article “Building on a culture 69
  • 71. of credibility”, Australia’s “biggest engineering projects, bringing benefits at all levels of ourcompany and Grill have earned the respect of the society.” The Centre also aimed at undertakingmarket by consistently performing, rarely getting internationally competitive research to keepinto trouble and having a board and senior Australia at the forefront of executive educationexecutives who are not afraid to hear criticism and thought leadership. Business school deanfrom staff or investors”. SMH added, “Grill also Geoff Garrett said, “Australia is thinking hardbuilt a culture of transparency, strong risk about what a post-mining future might look like.management systems and empowerment. It Project leadership is an area where (it) could be ameans staff stick around, ugly surprises rarely global leader."happen and employees have respect for eachother, all the way up the line. It is this culture that Grill’s philanthropic act is both productive andhas allowed Grill to build the company from a fascinating because it has gone beyond money andsmall operation to a global business without has embraced the core of what matters in thehaving big embarrassing bombshells”. Shapley-Roth “matching” application: agents seeking to align their interests in the cooperative game theory sense. By flattening the playing field for the multiple individual agents and empowering them as individuals to seek to align their interests to a matching party or organization, productivity is elevated to new heights. The cooperative Shapley- Roth game theory is opposed to the more familiar non-cooperative game theory in which agents act independently. Work in non-cooperative game theory has won Nobels for John Nash (1994),John Grill and Sydney University Vice-Chancellor ReverendMichael Spence Thomas Schelling (2005) and others. As science writer Philip Ball pointed out in Nature, “It isGrill, an engineer who began his distinguished notable that the Nobel committee has chosen tocareer with Esso Australia, also set a benchmark reward work that offers practical solutions forfor productive philanthropy on 23 Oct when he ‘markets’ in which money is of little consequence.donated A$20 million to set up the John Grill The work of Shapley and Roth shows that there isCentre for Project Leadership at his alma mater room for economic theory outside the ruthlessUniversity of Sydney. The decision to set up an cut-and-thrust of money markets — and that,industry-oriented project leadership course aimed perhaps, in that more cooperative world, it can beat managers in their mid-career came from the more effective.”valuable knowledge that worldwide 65% of majorprojects in engineering fail, either in schedule, cost Most project-based companies fail to scale beyondor quality. If this course makes even a small the billion-dollar market cap barrier because theydifference to this percentage of project failure, it lack the core of WorleyParson’s align-and-matchwill translate into a savings of billions of dollars a philosophy and discussion of the P/E ratios oryear. Grill, who is the biggest single shareholder in growth rate of these companies can be misleading.WorleyParsons with a 10% stake said: "I thought (a I recalled a meeting several years ago with a highlyproject management centre) would have the most successful local entrepreneur who is a highly-value for the industries I have spent so much time respected veteran in the engineering and project-in, and Australia generally. Across the globe there based industry. He shared his observation thatare more large projects than ever before, many of smaller one-trick-pony project-based companieswhich are vitally important to society. are valued at around 10% of their “orderbook”Unfortunately the track record of delivering them while successful ones who have embeddedagainst the primary objectives of schedule, cost recurring design, maintenance or value-addedand quality is not good. There is a great need in services into their business model are typicallyAustralia and around the world for project valued at more than 50% of their “orderbook”. Forleadership My vision is to create a world-class instance, there is an Australian-listed globalcentre for project leadership which will attract infrastructure group who competes withsenior executives across a broad range of WorleyParsons and has a large orderbook of overindustries from both the private and public sectors, A$11 billion but a market cap of A$830 million.who will gain the skills to effectively deliver large The well-connected rainmaker or dealmaker may be able to pull in high-dollar projects but because 70
  • 72. of the difficulties in coordinating and executing “team” effect. This brings us to the next story tolarge-scale complex projects, these projects or patch up the “Grill” story – a matching “Lidia”deals cannot be repeated and the hype associated effect. In the book “Click: The Magic of Instantwith big orderbook starts to fade, particularly Connections”, the Brafman brothers investigatedwhen cost overruns and delivery delays start to how one can foster an environment where we canrear their ugly heads. click with another person to achieve greater things. One of the fascinating examples used to illustrateAnd it is not a matter of simply throwing more their insight was “Lidia”.money or resources or “teams” or more rules andstructure to solve the performance problem inexecuting the projects. After all, are people likelyto work harder or less hard than they wouldindividually when part of a team? And what doesthis depend upon? French agricultural engineerMax Ringelmann (1861-1931), in a set of simplerope-pulling trials, asked volunteers to pull as hardas they could on a five-meter horizontal rope spunalong a garden path. Ringelmann would diligentlyrecord their strongest pull, both individually andcollectively, during a four- to five-second period ofmaximum collective exhortation. Unsurprisingly,his numbers showed a decrease in power perindividual as teams grew in size. What no one hadexpected was the sheer extent of the decrease:two subjects pulled at 93% of their capacity, threeat 85%, and eight of them at only 49% of what he Since 1998, chef Lidia Bastianich has hosted aknew they were capable of pulling as individuals. series of cooking shows on PBS. The BrafmansThus, eight people together pulled less hard than described, “To viewers, there’s somethingfour individuals added together. This deterioration mesmerizing about the way she cooks. She takesin “team” performance became known as the her time, explaining to her audience where she gotRingelmann effect, and he attributed it to the her ingredients and how she plans to use them todifficulty of coordinating. re-create an old family recipe.” They added, “Of all the people who watch her shows, Lidia has beenJohn Grill understood that the only way to perform most surprised by the effect of the resonance sheand execute large-scale complex projects projects on autistic children. Autistic childrenrepeatedly is to create an environment where the typically have a very difficult time connecting withinterests of the mid-level, mid-career individuals other people. Yet they tend to sit glued to Lidia’smatter. Align their interests and empower them to program. One mother wrote to Lidia, ‘I taped threebecome leaders to form the intangible culture of of your shows, one after another – which meansexcellence which results in a kind of match or an hour and a half – and my child, who usually“click” effect with everyone. And customers are doesn’t sit still, stood there for the entire time andattracted to this contagious performance culture watched you.’ At times, Lidia has invited autisticrather than to the rainmakers or dealmakers on a kids to come watch her cook in person. Lidia wentrelationship basis, or even to the “team”, on to talk about one such encounter. ‘After thepropelling a multibagger valuation re-rating. There presentation, I approached the mother and thenis a magical “flow” effect when the empowered began talking to her son. And slowly he came close.individual enters into an interaction with a sense And ultimately I got a hug and a kiss from him. Youof purpose instead of going through the motions see the tears in his mother’s eyes. It was justor being preoccupied with other things, unbelievable.’ One explanation for the responsedemonstrating care through active involvement in Lidia Bastianich engenders in her viewers is thatwhich we are authentic and aware of our own she is so immersed in her craft – so resonant – thatgenuine emotional reactions. When we achieve just being in that space with her, watching herthis state of resonance – the combination of create her culinary magic, brings about a similar“flow” and attentive presence - we change and state of magic in those who watch her.”charge those around us with this contagious state,resulting in the elusive and much-misunderstood 71
  • 73. This power of resonance is subtle. Lidia isn’t one of together and overcome the unproductivethose brash individuals whose ego demands the Ringelmann effect. Rather than nurturingroom’s attention, as the Brafmans pointed out individuals, a desire to keep everyone on the teamwisely. And this brings us to the third piece of the happy by suppressing the individual’s dedication topuzzle to patch things up: “There Is an I in Team”. his or her craft means the result is that winningIn the intriguing new book “There Is an I in Team: often becomes secondary to avoiding conflict. ReidWhat Elite Athletes and Coaches Really Know Hoffman, the co-founder and Chairman of LinkedIn,About High Performance”, the author Mark de pushed this idea even further in his autobiographyRond, an associate professor of strategy and “The Startup of You: Adapt to the Future, Invest inorganisation at Judge Business School at the Yourself, and Transform Your Career”:University of Cambridge, pointed out that a settledand happy team is the result of success rather than “The self-made man may be a myth, butits cause: “When teams work well, it is because, the old saw “There is no I in team” is wrong,and not in spite, of individual differences.” That is, too. There is an I in team. A team is madewe tend to observe the end final result, rather up of individuals with different strengthsthan the dynamic process that lead to the and abilities. The nuanced version of theoutcome, and start to categorize the factors of story of success is that both the individual“team” success based on such superficial and team matter. “I” vs “We” is a falseobservations, such as the simplistic labelling of choice. It’s both. Your career’s success“competent jerks” and “lovable fools” in yet depends on both your individualanother “us versus them” and “conquer-and- capabilities and your network’s ability to Wedivide” balancing game that the “emperor” or the magnify them. Think of it as I . Anleader must engage in to achieve “team” individual’s power is raised exponentiallyperformance. Richard Hytner, deputy Chairman of with the help of a team (a network). ButSaatchi & Saatchi, commented that the ideas in just as zero to the one hundredth power is“There Is an I in Team” is “not for the faint-hearted. still zero, there’s no team without theIt debunks many of the long-held assumptions that individual.”we’ve built into our development of teams andperformance, and outlines a set of guiding The story of John Grill and Lidia Bastianichprinciples for how to approach team performance reminded me of the home-based physiotherapistdifferently.” What Hytner said bears emphasis: (PT) whose services I engaged. Both my father and myself find this PT to demonstrate not only “At Saatchi & Saatchi, a purpose-inspired competence but importantly, care for her patients. creative company, the ideas in this book In fact, we find that she demonstrates far more are especially relevant. We employ highly care than the hospital PTs, some of whom my creative people and need them to be able father said are just going through the motion in to perform at their individual peak, while at doing their job; they are no “Lidias”. I was the same time embracing our team values somewhat surprised when she told me that she and collective aspirations – to help our has quit her full-time job at the hospital to be a clients fill the world with “Lovemarks” freelancer, following the footstep of the (Saatchi & Saatchi’s term for those brands occupational therapist (OT), also another highly that earn “Loyalty Beyond Reason”). We competent and caring professional whom we have have used the ideas in There Is an I in Team engaged as well. She told me that she is so to reconcile the tensions between the I and frustrated that too much of her time is spent in the We in our daily activity. What matters doing things that she feels is not value-adding to to individuals is something to care about the patients, such as fulfilling the bureaucratic more than themselves, what we at Saatchi demands of her internal customers, and this is not & Saatchi call a lovable purpose. What also what she subscribes to since the day she plunged matters is an environment in which the I wholeheartedly into this profession many years can flourish; without it people may still ago. In other words, she cannot achieve understand the greater purpose, but they “resonance” and “flow” in her work in the can, and will, choose to withhold their environment despite her dedication and devotion discretionary effort.” to her craft and her patients which was obvious to my dad and myself. Both the PT and OT have alsoA “Grill” environment in which the I, the “Lidias”, spent their spare time outside of the workingcan flourish in order for the “Team” to click hours to master and perfect their craft. 72
  • 74. creative new work, as opposed to business-as-According to experts on team studies, the typical usual work, are done outside the working hours, inresponse will be to label her as a un-team player our spare time, often toiling away dark at night.since she couldn’t “fit in” to the organization and Interestingly, Tencent’s WeChat had recentlyshe cannot work with her internal “team” mates announced on 17 Sep that it had 200 million userswho are also her “customers”. Experts and after 20 months, taking 2 months faster thanindependent outsiders observing snapshots of Sina’s Weibo, China’s Twitter, to reach the sametheir frustration would shrill in judging them as critical number of user base. Tencent, listed inegoistic people who cannot work with the “team” June 2004 and up 67-fold in 8 years to US$66needs. The role of the individual must be billion, is bigger by value than Facebook which hassubordinate to the needs of the “team”. I was a market value of US$46 billion. Tencent’ssurprised because all the ingredients for success spokesperson for WeChat commented:appear to be present: the hospitals have indeed ameaningful greater purpose on a macro level, the “We hire very talented people; we hire thePT/OT are dedicated and love their work, most hardworking people in the industry.everything looks reasonable, so why can’t things Chinese people are working crazy hard –match and click? The same goes for the Asia: she the WeChat team works until 4am or 5am;has the growth and GDP-underweighted story at that’s normal, that’s the whole team, we’rethe macro level, the people are relatively not talking about a certain division, that’shardworking, so why is there a huge valuation the whole team working very late.discount in which things don’t match up with Everyday I wake up, I ask myself, “What“fundamentals”? In contrast, the pain specialist drives me to work?” My dream is to havedoctor whom my dad criticizes is the best “team” more people use my product [WeChat] –player according to these same experts. The that becomes my happiness. Every teamdoctor neither makes much eye contact, nor member shares the same goal, the sameexamines the patient physically. Instead he clicks dream, so you can largely make them workthrough the documented records in his computer, past 2 or 5am to make this product theignores the patient’s distress, and talks down most successful. We don’t do that bycondescendingly to the patient. In less than 5 ordering [them], but everybody is doingminutes, the patient, having waited almost an that for themselves.”hour to see the doctor, is shown the door,repeatedly and consistently over all occasions. Therecords are properly documented and updated,the medicine for the patient is the best availablewhich reflects his specialised skills, the collectiveneeds of the “team” in the organization arefulfilled in pristine fashion. All KPIs checked. A Back to the David Weiss story. In the formativeproductive team player! years of Microsoft when it was a typical Singapore- SME-size company, Bill Gates and Steve BallmerThere is a well-intentioned letter recently from a could not get Windows 3.0 to work. Windows 3.0reader to the editor of a local newspaper talking was the platform software that the Office Suite,about “productivity” and “hours clocked”. The Outlook and other apps run on. It was thesuccessful professional wrote that in order to show keystone that allowed Microsoft to build a globalthat he had the right attitude towards work, he empire. Yet, the centrepiece of Microsoft’stold one of his first bosses then that he could work grandmaster strategic plan was an abandonedlong hours. His boss replied, “I’m not interested in project. Gates and Ballmer went for the logicalthe hours you work but the work you do in the survival plan: hooking up with giant IBM tohours.” For business-as-usual work in a relatively develop OS/2. As retold by Frans Johansson in thestable organization where the boss is the fascinating new book “The Click Moment: Seizingrainmaker or dealmaker seeking workers to merely Opportunities in an Uncertain World”, “Ballmerexecute orders rather than to carry out innovative lobbied aggressively to have Windows killed offwork, this argument about productivity makes completely. IBM was Microsoft’s life raft: if thesense. Interestingly, Microsoft Word probably company had sensed that Microsoft might keepwould not exist if not for the unproductive and un- working on Windows as some sort of hedge, theyteam mid-career manager David Weise. The story might have pulled back. That would have been aof Dave exemplifies the fact that meaningful 73
  • 75. disaster.” It made perfect sense for Microsoft to Morgan Stanley Asia Pacific ex-Japan (MXAPJ)partner with IBM. But great strategies are not Index are flat and up 20% respectively during thebased on what made sense. Rather, they are based same corresponding period.on what sets you apart.One Friday night Microsoft was hosting a partyduring the opening of a new manufacturing plant.Sargent Murray, David Weiss’s old friend andformer colleague, happened to bump into Dave.Sargent decided to give his old friend a hard time.“Windows … is a joke,” he started. “You just added64K to the high memory area, but Windows needsan awful lot more than 64K. It needs a major Flexigroup CEO John DeLanotransformation. What you really should do is getWindows into protected mode and blow away the Flexigroup was founded in 1988 by Andrew640K RAM barrier altogether.” By placing Windows Abercrombie and David Berkman who identified ainto “protected mode”, significant memory might gap in the office equipment finance space. CEObe freed up. Sargent didn’t expect to be taken John DeLano, 51 joined as CEO in Sep 2003. It laterseriously, but to his surprise, Weise countered built the business around the Flexirent businesswith intent in his voice. “You’re absolutely right,” with its interest-free offers for purchases throughhe said. “Let’s go do it.” “Uh, okay,” Sargent retail chain Harvey Norman. During the globalanswered. “How about tomorrow?” “No, now,” financial crisis, its shares collapsed from $2 to justWeiss said. “Let’s go do it right now.” It was Friday, 22c as fears about its ability to refinance its3 June 1990, and the clock just struck 7 pm. They consumer credit business Flexirent took hold.left the party, charged up the computer, loaded There was worse: Gerry Harvey, the retailMurray’s debugging software, and started going billionaire on whose back the business had beenthrough the Windows code line by line. “And Dave born, went on national television questioningjust fixed it,” said Sargent. They told Gates about whether many of his Harvey Norman customersthe findings later and fate smiled down on should actually be using those Flexirent leases toMicrosoft – all because of the unproductive and buy wide-screen TVs and laptop computersun-team David Weiss who just wants to work on because of the cost of the finance.his craft with devotion and dedication. But instead of fatally crippling the business, thoseOn “alignment” as a business model strategy, dark days through 2008 are described by DeLanothere is this Australian-listed company called as the making of the company, setting it on a pathFlexigroup which has embodied this principle. We of diversification and expansion that ensured itssaw Flexigroup in a May 2010 conference, one of survival. The better-than-expected FY12 results ofthe two companies which I chose amongst the A$61 million in net profit announced in Seplong list after doing up some research, mindful of confounds the lacklustre outlook for both retailersthe need to be productive. Flexigroup, listed in Dec and lenders. Harvey Norman is down more than2006, has since tripled to over A$1 billion in 40% since May 2010 while Flexigroup has tripled inmarket cap in around 2½ years (the other the Bloomberg chart shown above.company which we saw has also since tripled toA$475 million), while the S&P Australia 200 and 74
  • 76. DeLano had perhaps unknowingly applied the Paymate offering to capture the 300,000“alignment” principle to match and partner with merchants trading online in Australia.retailers and scale up Flexigroup from financingretail and business purchases at the point of salefor some 11,000 retailers. DeLano said in a Sep2011 interview with The Australian: "We arebringing funding to them (small businesses) at atime when they need funding. There was the casethe other day of a business that needed a $14mprinting press; they went to their bank and theywerent interested. It is identifying where theopportunities are with retailers, aligning ourselves(italics emphasis mine) with the strategy andbasically capitalising on where retailers are going.It is like a soufflé: if you dont have all theingredients, you cant make it rise. We do anumber of different things. We motivate the retailchannel on an everyday basis with competitionsbetween stores and sales people." The decade-long effort by John DeLano is akin to that of John Grill at WorleyParsons – both have built up a culture of credibility and innovation in alignment with their customers, partners, employees and investors who are attracted to thisToday, one third of Flexirents volumes now come contagious energetic culture and not to anyfrom outside retail and FlexiGroup provides mobile rainmakers or to a “team” label. Flexigroup puts itbroadband, commercial funding products, lay-by aptly, “We remain focused on preserving ourpayment processing and deferred payment unique fast paced, fun culture with a team ofprocessing for internet transactions, modelled on talented people who challenge themselvesthe Bill Me Later offering in the US, which was everyday to make it ‘Too Easy’ for customers,bought by eBay for more than US$800 million. retailers and shareholders to interact with us at allFlexigroup has also launched in Aug 2012 its levels of the business.”Paymate OntheGo credit card reader package, aproduct that removes the need for small ********businesses to have EFTPOS terminals after One might argue that the earlier case of privateacquiring the business for less than A$5 million in bankers and dealmakers who were selling below-Dec 2011. The Paymate solution was launched to investment-grade high-yield bonds to high net-enable the customer to better perform since “fast worth individuals and getting undisclosed cashand regular cash flow is the lifeline of small rebates are also experiencing “flow” andbusiness” and Paymate processed credit card “resonance”. But where perhaps is the alignmentdetails on the spot with payment made directly in interests with the end customers? The secularinto the business bank account. There were 2.7 trend of asset under management (AUM) gatheredmillion small businesses in Australia and 61% of and managed under the conventional “high-touch-Australians were expected to own a smartphone in high-cost” labor-intensive wealth management/2012. Flexigroup believes it will leverage its 20 private banking and financial advisory vehicle hasyears of experience in credit assessment and in seen its business valuation plunging to “less thanprocessing 11 million payments a year to more 2% of AUM”, which is “half of its 2010 levels”, andthan 2 million businesses and consumers in its 75
  • 77. the trend “looks set to drop further over the next 2 Switzerland, and the US. The economists came upyears”, according to a research in Oct 2012 by with a second "quite striking" discovery: "Thewealth global consultancy Scorpio Partnership. The faster the financial sector grows, the slower therecent fallout of the deal to acquire one of the economy as a whole grows." To demonstrate theiroldest, largest and most complete licensed findings, they gave the examples of the "extremefinancial planning advisories in Singapore which cases" Ireland and Spain. "During the five yearshas an AUM of S$2.25 billion for S$25 million or a beginning in 2005, Irish and Spanish financialvaluation at 1.1% of its AUM by a Hong Kong-listed sector employment grew at an average rate ofwealth manager (AUM US$5.5 billion with market 4.1% and 1.4% per year, while output per workervalue US$63 million, or 1.1% of AUM) has cast a fell by 2.7% and 1.4%, respectively. Our estimatespall on the exit value and going-concern of such imply that if financial sector employment had beenventures, which ultimately is a bane for their constant in these two countries, it would haveclients. The analysis by Scorpio implies that the shaved 1.4 percentage points from the decline inentire AUM in Singapore, which has reached a new Ireland and 0.6 percentage points in Spain. Inhigh of S$1.2 trillion in 2012, could be valued at other words, by our reckoning financial sectorS$12 to 24 billion, which is less than the value of growth accounts for one third of the decline insay a Keppel group or half the value of indexing Irish output per worker and 40% of the drop ingiant Blackrock’s market cap of S$40 billion, up 13- Spanish output per worker."folds since its Oct 1999 listing. The relative successof Blackrock, and companies such as Financial In his extremely moving autobiography “AgainstEngines and WisdomTree who are able to achieve the Odds”, Sir James Dyson, the well-respectednot only a much higher valuation of 5 to 10% of billionaire inventor of the Dual Cyclone baglessAUM but more importantly business sustainability, vacuum cleaner, also deplored the insidious effectis primarily because these companies are able to of big finance on creative entrepreneurship:scale with innovative knowledge-basedfoundations so that AUM wins do not become a “I was very close to despair – and the statecelebrated Pyrrhic victory. of the country under Margaret Thatcher was ramming it home to me every day. WeAccording to “startling” findings at the Bank for had become the nation of shopkeepers thatInternational Settlements (BIS) in a 29 Oct report, Napoleon had mocked us as so long ago.finance drives growth, but too much of a good Eighties values were vaunting the efforts ofthing sucks the lifeblood, brains and brilliant ideas city bankers who moved money around butfrom an economy. "At low levels, an increase in created nothing. Advertising was fastthe size of the financial sector accelerates growth becoming the British disease, and Britainof productivity. But there comes a point - one that was choosing to advertise its way out ofmany advanced economies passed long ago - recession. From the inside, thewhere more banking and more credit are contemporary notion of the 80s as theassociated with lower growth." The analysis of the ‘Design Decade’ was a mockery. All itBIS economists Stephen Cecchetti and Enisse meant was that they were revamping theKharroubi, writing in a personal capacity, showed shops a bit, and places like Next, Sock Shop,that when private credit grew to a point greater and Tie-Rack were becoming popular. Butthan GDP, "it becomes a drag on productivity the products inside the shops were notgrowth". They have even come up with a cut-off or changing. And so British companies decidedturning point at which the size of the financial that the best way to give themselves ansector does more harm than good: when the overhaul was to call in a big advertising ornumber of people in finance exceeds 3.9% of all PR consultancy, and spend millions onpeople in employment. Examples of countries persuading the public that they were betterbeyond this "growth-maximising point" are Canada than everyone else, and were in some way(with about 5.5%), Switzerland (5.1%), Ireland new and exciting. It never occurred to them(4.6%) and "to a lesser extent" the US (about 4.2%). to invest the money in the research andThe sample used for analysis at the BIS, the so- development of something genuinely, andcalled central bankers central bank, comprises 21 tangibly, new and exciting. The easy creditcountries: Australia, Austria, Belgium, Britain, offered, and easy money sought, by theCanada, Denmark, Finland, France, Germany, Thatcher Revolution encouraged selling,Ireland, Italy, Japan, Netherlands, New Zealand, not making. Engineering and design is notNorway, Portugal, South Korea, Spain, Sweden, about that; it is a long-term way of 76
  • 78. regenerating a company, and by extension, since its May 2011 IPO. Facebook is down nearly a country. If the City fat cats and banks, the half since its May IPO while Groupon is down 85% monsters the Thatcher Revolution made since its Nov 2011 IPO. I find it interesting that into prime movers, demand an instant LinkedIn is able to turn a crisis into an opportunity: return, we just sell our products better. We as it grew bigger and bigger to have more users at don’t improve them. Advertising is the 20 million in 2008 from 1 million in 2003/04, it was British answer to everything. But that is the getting riskier and incurring more losses, running a way to a fast buck, not real money.” $4.5 million loss, and they are paying bills mostly by hawking online ads and peddling “premium ******** subscriptions” for as little as $9.95 a month toWe are now facing an increasingly uncertain and journalists, hedge fund managers, unable to scaletough world. LinkedIn’s co-founder Reid Hoffman and monetize its business model in the $27 billion-alluded to the fact that we all could be facing a a-year recruiting industry. After Jeff Weiner joined“10X” (ten times bigger) force in our workplace as CEO in Dec 2008, LinkedIn scaled its quarterlyand life: revenue 10X from $23 million in Q1 2009 to $228 million in Q2 2012. LinkedIn’s market cap is now “We could be fired, new technology could over $11 billion, around the same peak value at automate or offshore our routinized job, or Monster.com during the earlier tech boom in 2000, the entire industry we work in could be albeit with a more resilient business model. The disrupted. Or we might undergo a major sense of urgency at Monster is palpable as it is life change, like having children that down 60% in the 1½ years since the listing of reorders life priorities and necessitates a LinkedIn’s “10X force”. pivot into a situation that offers more work/life balance. Andy Grove, the Intel co- founder, refers to these kinds of events as inflection points. In a business context, Grove says a strategic inflection point is what happens when a “10X” force disrupts a business. For example, for a small-town general store, a Wal-Mart setting up shop nearby is a 10X force on the general store. For a midsize financial firm, a huge corporate takeover is a 10X force. Countless once-giants like Blockbuster, Kodak, and the New York Times are all in the midst of environmental inflection points But what exactly did Jeff Weiner do to the business brought about by the 10X force of the model of LinkedIn to make it relevant and resilient digital revolution. In the same way that with real recurring cashflow and earnings? Can it external forces threaten companies, so too be adapted to the unique Asian context? That is can they have profound effects on your one of the topics that I will be sharing with a group career. For an autoworker in Detroit, the of top management team of a listed tech company closing of a major plant is a 10X force. For a in mid-Nov in HK. We will be visiting some HK public school teacher, the slashing of school companies too; interestingly, the “Asean budgets is a 10X force. As Grove says, ‘A Starbucks” and the “Asean Ta-Q-Bin” which we career inflection point results from a subtle visited in late March this year and wrote about in but profound shift in the operating the “On the Ground” April monthly edition had environment, where the future of your since climbed 40-50% while the MXAPJ index is flat. career will be determined by the actions The systematic investment thought process of you take in response.’ An inflection point at identifying companies in the Asia-Pacific region your company or industry usually will since 2002 has resulted in an accumulated require you to either change your skills or knowledge base about their business models, change your environment. In other words, quality of management and governance system, it will often require you to pivot.” their critical success factors and the industry and institutional dynamics in which they operate in.LinkedIn, founded in 2003, managed to buck the This know-how is leveraged upon to develop thetrend in the social media collapse by doubling “Master Entrepreneur Program: Scaling SMEs into 77
  • 79. MNCs”. One of the CEOs who had attended the Interestingly, Johansson asked the hypotheticalearlier Program commented that she liked the question of whether the irrationally strong desireAsian flavor and case studies in the Program and to act might have subsided if Weise and Sargentshe has subsequently asked for an in-house had waited until the next morning to debugprogram for her entire management team. Windows 3.0. As Johansson said: “It is hard to tell.” Indeed, we might not have the Microsoft that isEnergy and enthusiasm are increasingly critical to still so dominant today. Johansson added:cope with an uncertain world; we need to beemotionally involved to demonstrate care in our “But we do know that ideas that seeminteraction with work and people and to commit brilliant one day often seem to fade if weto the hard work of change in tackling bigger get a chance to sleep on them. Thischallenges and relevant opportunities. To uncertainty suggests that one should at theemphasize, there is a magical “flow” effect when very least process a click moment when itthe empowered individual enters into an happens so as not to let it slip throughinteraction with a sense of purpose instead of one’s fingers.”going through the motions or being preoccupiedwith other things, demonstrating care through KEE Koon Boonactive involvement in which we are authentic and 4 November 2012aware of our own genuine emotional reactions.When we achieve this state of resonance – thecombination of “flow” and attentive presence - wechange and charge those around us with thiscontagious state, resulting in the elusive andmuch-misunderstood “team” effect. Such “match”or “click” moments often elicit an emotionalresponse such as happiness, awe, or excitement.Microsoft’s former mid-career manager DavidWeise’s reaction to Sargent’s teasing suggestionwas emotional, not purely rational. As FransJohansson puts it aptly in his new book “The ClickMoment: Seizing Opportunities in an UncertainWorld”, “Emotion is critical because it provides uswith an irrationally strong desire to take the ideato the next level, bypassing our need for logicalsolutions. Emotions fortify our instincts and allowus to avoid the type of over-analysis that can kill agreat early-stage idea. Instead of asking whetheran idea makes a lot of sense, for instance, we maystart to work on a solution right away.” This is verydifferent from Warren Buffett’s wise rules of “Youdon’t have to swing at everything – you can waitfor your pitch” and “The trick is, when there isnothing to do, do nothing”. For instance, waitingpatiently in investments allows one to observe theoutcomes for learning since the asset’s intrinsicvalue does not change with or without our onesingle participation in a real market mechanismand the asset prices can come back in our favor. Inbusiness building or activities whose outcomes canchange with our active participation and thewindow of opportunity may close and not openagain, such luxuries can be wasteful andunproductive. 78
  • 80. Word of the Year in Asia for 2012 and 2013: “Bloated” and “Value Circle” (3) “Circle the Customer - Circle the Globe” to Rid “Bloat” and Get Asian Multibaggers (4) Do Investors Overvalue Firms With Bloated Balance Sheets?“Circle the Customer - Circle the Globe” - If you “proven” companies grow, they could be tempted,had invested $100,000 in the company that or under high pressure, to move beyond theirarticulate this tipping point phrase as a core specialization, taking on activities that may not bebusiness strategy in 1992 when its market their core strength and becoming asset-heavy incapitalization was US$130m, that sum would be “balance sheet”, that is, the “income statement”worth $15m today as the market value of this figures of revenue and profit may continue toenvironmental and water solutions company grow but the growth is of a lower quality and theirEcolab (Ticker: ECL US) multiplied over 150-fold in return on capital starts to decline. In other words,20 years to over US$20bn. they become “bloated” in their balance sheet and business model; the Price-Earnings (PE) ratio,Exchange Median Mean Mkt Cap <S$1B Total commonly used as a heuristic valuation metric, MC MC % by % by Mkt Cap does not measure the “bloated” effect in both the (S$M) (S$M) No. Value (S$B)Singapore 78 1,072 88% 11% 735 balance sheet and the business model. Thus,Malaysia 46 644 91% 15% 562 entrepreneurs and managers pushing the sameIndonesia 172 1,243 80% 13% 512 familiar levers of success that resulted in theirThailand 109 1,109 84% 13% 616 companies to grow multiple times to a billionHK 195 3,445 76% 5% 5,054 dollar in market value may find it perplexing whyTaiwan 88 577 92% 25% 974 their efforts are not helpful in moving the needleKorea 85 780 91% 15% 1,350India 52 533 >90% 13% 1,545 towards “Stage 3”, the ten billion dollar target.Australia 58 1,410 >87% 8% 1,673 Instead, they might have inadvertently push to create a “bloated” effect.The Ecolab example is critical for both valueinvestors and entrepreneurs in Asia as manycompanies are still stuck in “Stage 1” of theircorporate lifecycle. Presently in Asia, the medianlisted company size is around S$50 to 100m,somewhat similar to that of pre-1992 Ecolab, and asignificant number (>80%) of companies are belowthe billion dollar mark in market cap, as tallied inthe simple table above from Bloomberg datacollected at the beginning of Dec 2012 for theuniverse of listed stocks in the various Asianexchanges. With her “solution-specialist” businessmodel, water treatment specialist Hyflux (Ticker:HYF SP) is a classic example of a company that hasshifted gear successfully thus far to “Stage 2” in itscorporate lifecycle in the past decade in fast-growth Asia. Interestingly, the initial and presentmarket cap of Hyflux, S$54m in January 2001 and abillion dollar now respectively, is also quite similarto the median and mean value of the universe oflisted stocks in the Singapore exchange. In 11 years,the market value of Hyflux has jumped 12-fold In a way, this “bloated” effect is parallel to thefrom “median” to “mean”. Thus, understanding developments at the “macro” level as pointed outhow business models and their profit patterns on Dec 21 by the Wall Street Journal article “Asianevolve is critical in the context of Asia, given that rise in borrowings ring some alarms”: “Asia hasthe competent entrepreneurs over the past been able to withstand some of the economic anddecade have grown their companies multi-fold to financial distress felt elsewhere, largely due to thethe half-billion to billion dollar mark in market sound balance sheets with which local businessesvalue during “Stage 1” to “Stage 2”. Yet, as these entered the crisis. Asias economic resilience amid 79
  • 81. the global slowdown masks a disturbing trend - a bonds favoured by private wealth clients returnedswift rise in debt levels across the region as over 20% this year, while the MSCI Asia-Pacific ex-companies and households load up on cheap Japan index of stocks returned 18.7%. Private-credit - rapidly in many areas. By June, Asias banking clients accounted for 16% of corporatecredit-to-GDP ratio had climbed to 104% - bond purchases in the region this year, up from 6%surpassing levels seen at the time of the regions in 2008. Chinese companies are also raising moneyfinancial crisis of the late 90s - from 82% in in their own domestic bond market at a recordDecember 2007. By contrast, the euro zones ratio pace as Chinese banks scale back lending. $327bnhad risen more slowly to 131% from 123%, while worth of bonds issued by non-financials has beenthe U.S. ratio had ticked down to 62% from 63%.” sold almost exclusively to domestic investors this year, led by mutual funds. As WSJ reported on 26In China, the smell of lemon from the “bloated” Dec, “the buying spree by mutual funds has beeneffect gets stronger with the default in Dec of the underpinned by one belief: What many companieswealth management product (WMP) sold by lack in profit and cash flow, they make up for withHuaxia Bank, following which, CITIC Trust and their close relationship to local-governmentChina Construction Bank (CCB) also reported authorities that would step in to repay their debtsproblems in their WMP. The unregulated sale of if needed.” Reuters reported on 19 Dec thatWMP has racked up a staggering RMB20tr wealthy Asian investors may lose their appetite for(US$3.2tr) in China, estimated by the Chinese corporate bonds after getting burned in recentAcademy of Social Sciences. The China Banking deals. Agricultural commodities supply chainRegulatory Commission caps interest rates offered specialist Olam (Ticker: OLAM SP), which soldby banks and they have been issuing WMP to get $500m in five-year bonds in Sep, was cited in thearound the restrictions. They typically offer yields report for its high debt levels and unrated bonds.of 4 to 5%, about 1% higher than the ceiling on Olam was also targeted by an attack from short-deposit rates. To obtain the higher returns, banks seller Muddy Waters for its accounting practices.funnel the savers’ money into riskier The price of Olam bonds, whose 5.75% couponinvestments that are largely held off-balance attracted private-wealth clients to buy $350m,sheets. CCB’s product was backed by a mixture of were knocked as much as 17%. Rather than beingequities, bonds and money-market instruments. fixated by the short-term PE ratio or yield level inCITIC’s product was based on a loan to a assessing investment opportunities, the long-rangesteelmaker, while Huaxia’s product was backed by fundamental question “Is there a balance sheetrevenue from a pawnshop and an automobile and business model constraint to growth anddealer. Financial Times Kate MacKenzie coined earnings?” is always on the mind of value investors.WMP as “Weapons of Mass Ponzi”, in reference toBank of China’s Chairman Xiao Gang’s op-ed in At the “firm” level, for “solutions-specialist”China Daily on 12 Oct prescient warning of shadow business model such as Hyflux and Ecolab,banking risks in the proliferation of off-book WMP, amongst the twelve different types of businesssaying that “this is fundamentally a Ponzi scheme. models that value investors should study carefullyThe music may stop when investors lose for mutlibagger returns, project complexities inconfidence.” In her FT article “Questioning China’s replicating the solution to a different set of globalgovernance” on 29 Oct, MacKenzie commented customers ranging from cost overruns and deliverythat “Only recently have many investors realised delays to financing and receivables risk start tothat the main reason for China’s resilience – a emerge. For instance, in 2005, Hyflux was asset-huge government-directed lending and spending light and lowly-geared in its business model withspree – cannot and will not continue, at least not around S$10m in net debt and its market cap waswithout further distorting the economy and risking around S$1.5bn; now, Hyflux has interest-bearinga bigger crash in future.” net debt of over S$470m and over S$390m in non- convertible perpetual preference shares paying 6%While “Bloated” might be disputed as the Word of and its market cap had fallen to a billion. As athe Year in Asia for 2012, “Bond” would not, result of mishandling these risks, or preventingnotwithstanding scores of companies have them in the first place through business modelattempted to cure the “bloated” effect in balance design, companies fail to make the successfulsheet using bond financing. Asian companies have transition to “Stage 3” from a billion to $10bn inborrowed more via the bond market than through market value. The investment analysis andsyndicated bank loans this year for the first time valuation impact of the moaty “horse” (businessever, having raised $133.4bn this year, up ten-fold model) matters more than the “jockey”a decade ago. The sub-investment high-yield grade (entrepreneur) in the transition from “Stage 2” to 80
  • 82. “Stage 3”, the transition period which Asia is “horse” (business model) is not moaty enough tocurrently in. At this transitition point in Asia, race towards Stage 3, and (B) the Stage 1 and 2besides the group of entrepreneurs and managers “jockey” (entrepreneur) is too distracted, toowho are still trying very hard but are pushing the disillusioned or too contented to scale their coresame, possibly inappropriate, levers for growth, business further to Stage 2. Yet, there is plenty ofthere is another conspicuous group, particularly in dazzling action and “growth” in Asia although thethe below billion-dollar camp. These are people risk from the “bloated” effect is rising. While thewho find themselves stuck in “Stage 1”. They grow stock prices might correct downwards for bothto either become either disillusioned with their Group (A) and (B) as a result of the earliercore business or contented with what they have “bloated” effect in the balance sheet and businessachieved. Often, these successful, achievement- model, like Kingdee or the Chinese sports retailers,oriented entrepreneurs start to “stray” as they making them “cheaper” and more “attractive” infind it easier to seek “growth” by engaging in valuations, the careful value investor must also beprivate business interests outside of the listed aware of the risks of catching a falling knife.vehicles, particularly in property development. So what is this “Circle the Customer – Circle theHowever, at the same time, the multinational Globe” strategy that Ecolab employed in 1992 tocorporations have hit their own tipping point in get rid of the “bloated” effect in its balance sheettheir penetration into emerging markets after and business model as it scale up beyond theyears of persistence – and losses. Perhaps a billion dollar cap? Founded in 1923, Ecolab had itsstriking example is enterprise resource planning foundation from a single product, Soilax, which is a(ERP) software and solution-specialist business cleanser designed for mechanical dishwashers, andmodel Kingdee (Ticker: 268 HK). A multibagger Ecolab subsequently expanded beyond sellingwhich has grown successfully 36-fold from products by providing cleansing services forUS$13m in market cap in 2001, Kingdee is down institutional customers such as restaurateurs. Now,over two-thirds from US$1.6bn since 2011 to Ecolab is a global provider of water, hygiene andUS$470m on in market value currently after losing energy technologies and services to the food,its core customer base of small and medium energy, healthcare, industrial and hospitalityenterprises (SMEs) to SAP AG when the German markets with a market value of $20bn generatingMNC rival introduced a local and price-competitive over $500m in profits from $7bn in revenue.version of an ERP software, Business One, as was Ecolab also merged in July 2011 with Nalco, ahighlighted in the “On the Ground” February water purification and environmental processedition. Another example is the success of Nike in technology company that Warren Buffett’sChina who has been active in the Chinese market Berkshire Hathaway invested in 2008. This “Circle”for 30 years as it ventures beyond the Tier 1 and 2 strategy is simple: the company would seek tocities into the domestic brands’ strongholds in continually expand its portfolio of related productsinland China. Sales in China at Nike surpassed and services for its existing customers, no matterUS$2.5bn in fiscal year 2012, more than doubled where they did business around the world. Forfrom 2007. Nike aims to “just double it” in the next instance, one of the divisions sells all the productsfour years as Chinese consumers increasingly lose needed to clean a restaurant, especially thethe taste for domestic brands and quality kitchen. These include the detergents andcounterfeits while Nike continues its well-crafted computer-controlled dispensing systems that hookmarketing campaigns in introducing more lower- up to the dishwasher and all the other productspriced products and cultivating its brand cachet at needed to clean and sanitize a restaurant. Thethe top-end. Shares of the once-multibagger sales force is not only responsible for selling thesedomestic brands were down by 50 to 80% from items, but also for training the restaurant staff ontheir 2010 peak; Nike’s share is trading at around how to use them. They audit results on a monthlyits all-time high. basis. They make sure that the dishes are clean and recommend ways to minimize dishwareIdeally, a portfolio of companies comprising of breakage. They balance the dishwasher and make“Stage 1 to 2” companies growing 10-fold from sure it is operating correctly. They capture all this$100m to $1bn, and “Stage 2 to 3” companies information on a tablet PC and share it with thescaling up 10-fold from $1bn to $10bn, will reduce restaurant’s manager. If the restaurant is part of avolatility, while continuing at the same time to chain, they download the information to a centralgenerate multibagger returns for the patient repository so that the chain’s headquarters cancapital. Thus, the key investment risks for value see what is going on in all their units. Every day,investing in Asia are twofold: (A) the Stage 2 Ecolab products are used to clean more than 250m 81
  • 83. dishes. Each year, cleaning products sold in the U.S. pays to walk around the neighbourhood sundryalone stretch 2,150 miles, the length of the Great stores to digest things off. While organized retail inWall of China. All of this activity also sets the stage the form of department stores and hypermarketsfor sales-and-service associates to offer the are booming, most parts of emerging Asia andcustomer Ecolab products and service solutions in particularly Asean are still dotted with the mom-adjoining categories. They can sell that restaurant and-pop sundry stores and a large group ofpest-elimination products and services and kitchen consumers is still largely served by the smallequipment parts and repair services and they can private operators of these stores. An untappedsell water-purification products and services and treasure, business models which “get horizontal”audit services. Each month, Ecolab sales force to reach closer to and “circle” the end Asiandrive more than 8m miles, the equivalent of consumers are getting steep upward re-rating incircling the globe 10 times per day. valuations. When I first started out in the investments industry a decade ago, I find myselfThus, the system of over 8,000 solution providers discovering “new” things everyday by simplyand local field experts and 1,300 scientists and looking at the usual with a fresh pair of curioustheir knowledge base working consultatively with eyes. I remembered that one such “walkingthe end customers is designed right into its around” expedition at my usual neighbourhoodbusiness model, becoming the source of sundry store a decade ago led me to investigatecompetitive advantage and economic moat for “Jack n Jill”, the potato chips brand.Ecolab. The best strategy is always “simple” butoften difficult to really do it. Every employee thushas the opportunity and incentive to takeownership in their ideas and initiative and eachone matter in the value creation process of“circling the customer”, rather than a fewrainmakers. It is far easier to hire high-profileddealmakers who may be able to pull in high-dollarprojects or make centralized decisions, butbecause of the difficulties in coordinating andexecuting large-scale complex projects, theseprojects or deals cannot be repeated and the hype Perhaps not many would bother to look behindassociated with big orderbook starts to fade, the packaging to find out which company producesparticularly when cost overruns and delivery the potato chips. They would have missed outdelays start to rear their ugly heads. Ecolab is also finding out the story behind the companyrated consistently by its employees as one of the Universal Robina Corp (URC) (Ticker: URC PM),Best Places to Work. This contrast with the vast one of the largest brand food product companiesmajority of Asia-Pacific companies who continue in the Philippines which pioneered the savouryto struggle with attracting and retaining the high- snacks industry since 1966 and has grown morepotential and critical-skill employees needed to than 6-fold in the past 5 years from under a billionincrease their global competitiveness in the recent in market cap in 2007/08 to over S$5.4bn now.Towers Watson survey “The Next High-Stakes URC is started in 1954 by the 86 year-old ChineseQuest: Balancing Employer and Employee Hokkien Filipino tycoon John Gokongwei (吴奕辉),Priorities”. When the focused strategy was often described as well-read, simple-living andunveiled in 1992, Ecolab’s market cap soared 7- workaholic. The eldest child and breadwinner offold over the next five years to a billion dollar in his family, he learned at an early age how to sell1997. From 1997 onwards, Ecolab’s “Circle the food and other goods in the streets of Cebu,Customer” business model continue to gather competing with men and women who were atmomentum with a series of synergistic acquisitions least twice his age. In his teenage years,that are synonymous and integrative to the “Circle Gokongwei bought his own bicycle so he can go tothe Customer” culture to expand into new market nearby towns and barrios to sell soap, thread,and new customers and market value climbed 20- candles and other things that people need.fold in 15 years from $1bn to $20bn in marketvalue during the “Stage 2” to “Stage 3” transition. Philippines is a country with 7,000 islands and decentralizing production and distribution helps to ******** save on costs and to better launch new products.Rubbing around a “bloated” stomach in a circular URC has 11 plants – 9 in the main island Luzon,motion after a good meal feels good - and it also 82
  • 84. including 3 in Manila, and 1 each in Cebu andMindanao. URC also operates 11 distributioncenters (DCs) located next to the plants, areduction from 26 previously, following the launchof Project Geometry in 2005 to realign itsdistribution system. Q: Since it’s almost your birthday, it’s good for you to share some wisdom, especially with the youth. What’s your advice to young people on success? JG: Just follow the Chinese immigrants (laughs). It’sJohn Gokongwei and wife Elizabeth Yu. Gokongwei has said true, just follow their values and work ethic.that having a good wife like he did is not only good support for Throughout Philippine history, it’s the immigrantslife and career, it’s great to come home daily to good rest. Herevealed that ever since he got married, he has stopped going who built fortunes and in the process helped buildout to parties and stayed at home every night with his wife Philippine economy.(PhilStar, 14 Aug 2011). Q: What has changed in the Philippines since? JG: I observed that every 50 years, there’s a cycle of change, new business leaders rise. Even us the present-day business leaders, if we and our families are not vigilant, others will rise to the top. This is true not only here, even in the US, look at the Rockefellers before; they’ve been overtaken by modern-day business leaders like Warren Buffett, Bill Gates, the late Steve Jobs of Apple and others. Before over a century ago, there were tycoons like John D. Rockefeller, Edward Henry Harriman, etc. IThis extensive network to get closer to the end think, there’s a cycle of change, every 50 years.consumers has resulted in its resilience post When I first came here to Manila in 1949, all thefinancial crisis and URC’s market share in the then-famous business leaders, they’re gone, not avarious product categories from biscuits, snacks, single one existing.candies to Ready-To-Drink (RTD) tea beveragescontinue to rise, prompting the sharp 6-fold jump Another Asian “Circle the Customer – Circle thein market cap in the past 5 years as investors re- Globe” example from my neighbourhood sundryrate its business model. In particular, URC’s RTD store which I started to notice in 2005 is the Oriontea beverage brand C2 was not only launched in a Choco Pie, a snack cake consisting of two smallrecord six months in Oct 2004, but it was also the round layers of cake with marshmallow fillingsfirst RTD tea in Philippines, single-handedly driving with chocolate covering. Introduced in 1974 bygrowth of the RTD tea market, establishing itself as Tong Yang Group’s confectionery spinoff Orionthe dominant leader with a 73% market share. Corp (Ticker: 001800 KS) after a member of the R&D team was inspired by the chocolate-covered thOn Gokongwei’s 86 birthday this August, a sweets in the hotel’s café during a visit to Georgiachildren’s book on his life story entitled “Big John” in US, the cake was well-received by many Koreanis launched, part of a “Dream Big Books” series of children and senior citizens because of itsinspirational children’s books with personal sagas. inexpensive price and good taste.Gokongwei also gave an interesting interview withPhilSTAR, with excerpts below: 83
  • 85. President Park is set to take a relatively restrained line in dealing with the powerful chaebols, particularly the complex “circular shareholding” structures that allow the groups’ founding families to retain control, as she believe abolishing the structures would undermine the companies and leave them vulnerable to hostile takeovers. Failing to do so may reinforce concerns about the nation’s corporate governance that contribute to the widely-known Korea Discount in the stock market. Charles Lee, North Asia research director for theOrion Choco Pie sharing the spotlight in Sep 2011 with Russian Asian Corporate Governance Association,President Dimitry Medvedev during his midday tea. commented that: “Korea’s renewed momentum on corporate governance may lack conviction and could fade once this year’s election passes. We sense a widely shared fatalism among most Koreans that the reform process can only go so far, because certain features of the current system - such as the chaebol structure - are simply accepted as the Korean way of doing business.”Orion has seen its market value rising sharplyduring its 20 years of overseas expansion, with its Interestingly, investment indexing giant Vanguardoverseas business now contributing 50% and 43% made a switch in benchmark in Dec for six of itsof 2012 sales and operating profit respectively. emerging markets (EM) equities fund from MSCI toSince 2005 when its overseas business expansion FTSE to lower its licensing fees, resulting in Korea,starts to bear fruit, Orion is up more than 7-fold to classified by FTSE as “developed market”, to beS$7.3bn, boosting the family fortune of Tong Yang bumped out of the portfolio. Investors yankedGroup which was founded in 1956 by the late $900m from Vanguard’s popular EM ETF in Nov,founder Lee Yang-gu who died in 1989, leaving even as other EM ETFs had inflows. The $67bn ETFbehind his two daughters and son-in-laws to run will need to boost investment in equities of China,the empire. The Tong Yang Group is one of the India and Taiwan given their higher weights.largest chaebol conglomerates in Korea; the 10 topchaebol make up more than half the value of the A key tipping point happened when Orion invested1,800 companies on the Korea Stock Exchange. in localizing its overseas production facilities andThe 30 largest chaebols accounted for 84% of distribution channels. Its Shanghai factory,South Korean exports in 2010, according to completed in Sep 2002, became the growth engineFederation of Korean Industries. The father of for Orion in China and Asean. By Sep 2003, OrionKorea’s newly-elected 18th lady President Park Choco Pie achieved KRW 1tr in accumulated sales,Geun-hye, was the late military strongman Park the first snack brand in Korea to achieve thisChung Hee until his assassination in 1979, who milestone as a single item. Orion now controls aallowed the chaebol to flourish under his 1962-79 two-thirds share of the Chinese snack marketautocratic rule and attain their dominant position which contributes 34% of the group’s sales and thein the national economy, now Asia’s fourth-largest. Choco Pie is a popular wedding gift since it took on 84
  • 86. the Chinese name “Good Friend” (好朋友). What value chain. Sallet argued the new value chain isdifferentiates Orion against other foreign the “value circle” in which multiple companies addconfectionary/snacks companies in China is that it value to each others’ products without directlyoffers support for merchandising, displaying and competing with each other, as opposed to asales promotions to build strong relationships with traditional value chain in which each company sellswholesale agents. Wholesalers are willing to take its goods to another or directly to the consumer.transportation cost and pay cash upfront in a Thus Asian companies whose business modelscountry in which the use of credit has become king, embrace the “value chain” strategy in circling thewhich shows Orion’s strong brand value. Choco Pie customers will not only get rid of the “bloated”is also popular in Vietnam, in which it has over effect as they scale up, but also compound value60% market share, and it is even served for exponentially and enjoy PE re-rating multibaggerancestral rites ceremonies. Choco Pie has also returns. “Bloated” and “Value Circle” are the Wordbecome a favorite snack of North Korean workers of the Year for 2012 and 2013.and “the 35g diplomat” has come to symbolizecapitalism. Orion also maintains a “Choco Pie ********Index” created as a parody of The Economist’s Big “Do investors overvalue firms with bloated balanceMac Index. Another key tipping point was when sheet?” This is the title of the empirical researchOrion sold its media entertainment assets paper in the Journal of Accounting & Economics inMegabox cinema chain in Jul 2007 and cable 2004 by the US-based Singaporean accountingoperator On*Media in Dec 2009 to CJ Group to doyen Teoh Siew Hong and her colleagues. Proffocus on its growing confectionery empire. Orion Teoh is also the dean at Paul Merage School ofwas also able to replicate its success in new Business, University of California, Irvine (UCI).products in tough markets, such as Market O Real Given limited attention and vast information,Brownies which debuted in Japan in 2010. investors simplify their judgment and decisions byMarketed as a specialty product free of artificial using rules of thumb and by processing onlyaddictives and vegetable oils, Market O are subsets of available information. An investor whopopular gifts (omiyage) among young women and values a firm based on its earnings performancethe product took top seller spot in Japan’s hyper- rather than a complete analysis of financialcompetitive cookie and biscuit market. variables is following such a strategy. Teoh et al argued that investors fail to discount for the unsustainability of earnings growth and are unaware of “balance sheet bloat”, proxied by net operating assets (NOA), a cumulative measure of the deviation between accounting value-added and cash value-added. An accumulation of accounting earnings without a commensurate accumulation of free cash flows raises doubts about future profitability. Investors with limited attention overvalue in the short-term firms with high NOA which provoked excessiveHowever, there are also negative examples of investor optimism, followed by disappointmentKorean companies which failed to “circle” the that the high level is a result of an extendedcustomer, such as Nongshim (Ticker: 004370 KS, pattern of earnings management, and themarket cap S$1.8bn) ramen business in China, due subsequent correction in mispricing result inprimarily to poor control of channels and pricing negative returns in the long-run. For instance, NOAdespite their “brand” and also because of a strong increases when firm books a sale as a receivablerival Master Kong owned by Tingyi (Ticker: 322 HK, before it has received the actual cash inflow, ormarket cap S$18.7bn). So it is important for value when a firm records expenditure as an investmentinvestors to understand how the “circling” is rather than an expense. In both these cases,drawn to compound value. Orion’s co-creation of current accounting profitability may not bevalue with its wholesalers is a simple example of sustained in the future, so investors who focus on“value circle” described by Jonathan Sallet, former accounting income may overvalue the firm. Even ifDirector of the Office of Policy & Strategic Planning managers do not manage earnings, certain typesof the Department of Commerce under President of problems in the firm’s operations will tend toClinton. Sallet presented a new way to look at the increase NOA. For example, high levels of lingering, 85
  • 87. unpaid receivables may contain adverse resulted in the correlation to melt; bothincremental information (beyond that in past companies now trade at roughly the same marketearnings) about future earnings. Therefore, when cap of S$3.6-7bn. In Feb, the MSCI Asian index washigh cumulative working capital accruals increase 448 and retreated 15% in Jun, before climbingNOA, an investor who fails to discount for adverse back up to above 460 to be up 18% for the year.information about low quality receivables will Graincorp also received a A$2.7bn takeover cashovervalue the firm. To test for investor bid by Archers Daniel Midland (ADM) on 22 Octmisperceptions of firms with bloated balance which was subsequently rasied to A$2.8bn; bothsheets, the accounting researchers measure stock offers were rejected. There is a wave ofreturns subsequent to the reporting of NOA. The consolidation in the agricultural commoditieslevel of NOA scaled by beginning total assets is a sector with Toronto-listed Viterra acquired bystrong and robust negative predictor of future Glencore for US$6.1bn, while Marubeni of Japanstock returns for at least three years after balance swooped on privately held Gavilon in a deal worthsheet information is released. They call this the US$5.3bn. Australia is the world’s second largestsustainability effect, because high NOA is an wheat exporter and Graincorp owns seven of theindicator that past accounting performance has nine bulk grain ports on the east coast of Australiabeen good but that equally good performance is and has about 20m metric tonnes of storage atunlikely to be sustained in the future; and that more than 280 inland grain handling sites,investors with limited attention will overestimate handling more than 75% of annual production onthe sustainability of accounting performance. A Australia’s east coast and moving a third oftrading strategy based upon buying the lowest Australia’s wheat corn. The integrated, strategicNOA decile and selling short the highest NOA portfolio of assets gives Graincorp ready access todecile is profitable in 35 out of the 38 years in the the growing Asian and east African markets.sample, and averages annual returns in excess of Interestingly, Graincorp does not have the fairthe market in the first, second and third year by value accounting concerns in reporting gains on14.9%, 10% and 6.8%, or 32% for the 3-year period. the biological assets of plantations, crops or cattle, nor the opaque business model that plagued Olam. Teoh et al concluded in her study that “An important scientific and policy issue in accountingDuring my Sydney trip in Dec 2009 to present my is how extensively and effectively investors useempirical research paper findings at the 23rd different kinds of reported accounting information.Australian Banking and Finance Conference, I Our findings indicate that the balance sheetwanted to visit some Australian companies as part contains information above and beyond thatof the due-diligence investment process. At that contained in the income statement that is usefultime in Oct 2009, I made a simple observation that for evaluating the financial prospects of the firm.both Olam (Ticker: OLAM SP) and Graincorp Furthermore, our evidence indicates that investors(Ticker: GNC AU) have around the same level of do not make full use of this balance sheetnet tangible asset at S$1.7bn, but Olam is trading information. These findings suggest that firms, theat S$6.7bn while Graincorp is S$1.9bn in market business media and policymakers should considercap. Both are agricultural commodities supply possible ways to make balance sheet informationchain specialist. Singapore Inc’s Temasek Holdings more salient and transparent to investors.”had invested in Olam in Jun 2009. Three years later,Olam is down over 40% to S$3.7bn; Graincorp is ********up 90% to S$3.6bn. The interesting Bloomberg 5- If intangible human capital were also counted asyear chart above shows how the share prices of part of the asset in the “balance sheet” inOlam and Graincorp are moving in tandem to each generating the income statement figure of GDPother until the strucural break in Feb 2012 that “earnings”, the broader zeitgeist and socio-cultural 86
  • 88. climate now in Asia can be understood better as a industry on how SMEs scale to become“bloated” effect in the balance sheet in generating multibagger MNCs.earnings and coping with growth. Signals of a“balance sheet” breakdown include: theobservation of “I have never seen more peoplewho talk to themselves than in Jakarta” (JakartaGlobe, 27 Aug) with “mental disturbances” risingamongst Jakartans as they struggle to cope withthe rapid changes, chaos, congestion and intensecompetition in recent years; violent robberies onthe rise in Jakarta with one crime registered everyminute (JG, 27 Dec); the sex and money scandalsthat plagued Singapore’s top elite; the first strikein 26 years in Singapore by bus workers over lowwages and poor living conditions; the violent gang-rape of a 26 year-old physiotherapist on a bus inDelhi and the ensuing violent protests.The “bloated” effect in the balance sheet of a“leader” can also be seen in his or her “attitude”. Aquote in the Forbes article “Death By Hubris: TheCatastrophic Decision That Could Bankrupt A GreatAmerican Manufacturer” on 2 Aug caught by eye: “Dan is telling his technical people, ‘You’ve got to deliver,’ and they’re saying, ‘We don’t know how, but we’ll try,’” says the former executive. “There was a lot of tension in the technical community, from the scientists on up to the Paccar manufactures and distributes medium- and managers, about whether we should be agreeing to something we don’t know how to do. heavy-duty trucks under the names of Peterbilt, Dan didn’t want to hear any of it. ‘You’re going Kenworth, Leyland, and DAF. It is third behind to get it done.’ He’s a positive thinker. He Daimler AG and Volvo. William Pigott founded doesn’t like negative thinking.” Paccar in 1905; sold it in 1924 but son Paul Pigott bought back in 1934. Current CEO since 1997 is 4thDan Ulstian was the former CEO of Navistar (Ticker: generation Mark Pigott. Since Mark Pigott tookNAV), one of the great lines of manufacturing DNA over as CEO in Jan 1997, Paccar is up over 66-foldin U.S. history, a company whose roots date back from US$230m to US$15.7bn in market cap, nearlyto Cyrus McCormick’s 1831 invention of the ten times larger than Navistar at US$1.6bn. Somechanical reaper. In 1902 his McCormick what exactly did Paccar, led by Mark Pigott, doHarvesting Machine Co. merged with Deering since 1997? A key tipping point that year was thatHarvester Co. to form International Harvester. Paccar calls itself a technology company, not aUntil the mid-1980s International Harvester was a truck company or manufacturing company; itdiversified manufacturer of farming equipment, technology-enabled its entire supply-chain, itsconstruction equipment, gas turbines, trucks, manufacturing process, and its dealer chain andbuses and related components. During World War built a world-class call center for truckers. It hasII it also supplied military trucks for the U.S. Army the capacity to let each customer build his or herand Navy. The company sold many of its farming- own custom truck as efficiently and as fast asrelated assets in the late 1980s, when times were building a standard truck through its use of atough, leaving just its truck and engine divisions. In robotic assembly. But all of these fancy “tech” will1986 it changed its name to Navistar. I come to naught if there is no “Value Circle” toremembered Navistar because it competes with circle the customer – the “right” customer. In theVolvo and Paccar (Ticker: PCAR) and Paccar was a heavy truck industry, many buyers operate largecase study that I shared with CEOs, entrepreneurs, fleets and these “blue-chip” customers areinstitutional clients and high net-worth individuals. motivated to drive down truck prices. Trucks areI also shared this story last month in Nov during built to regulated standards and offer similarthe productive trip to HK to a group of top features, so price competition is stiff. Unionsmanagement team of a listed company in the I.T. 87
  • 89. exercise considerable supplier power and buyers her extremely enlightening book, “Daring Greatly:can use substitutes such as cargo delivery by rail. How the Courage to Be Vulnerable Transforms the Way We Live, Love, Parent, and Lead”, thoughtTo create and sustain long-term profitability within leader Brene Brown offers a powerful new visionthis industry, Paccar chose to focus on one that encourages us to dare greatly: to embracecustomer group where competitive forces are vulnerability and imperfection, to liveweakest; individual drivers who own their trucks wholeheartedly, and to courageously engage inand contract directly with suppliers. These our lives. Brown, who also gave the blockbusteroperators have limited clout as buyers and are less TEDTalks “The Power of Vulnerability”, evoked theprice sensitive because of their emotional ties and immortal quote by Theodore Roosevelt:economic dependence on their own trucks. Forthese customers, Paccar has developed features as “It is not the critic who counts; not the man wholuxurious sleeping cabins, plush leather seats, and points out how the strong man stumbles, orsleek exterior styling. Buyers can select from where the doer of deeds could have done them better. The credit belongs to the man who isthousands of options to put their personal actually in the arena, whose face is marred bysignatures on these built-to-order trucks. dust and sweat and blood; who strives valiantly;Customers pay Paccar a price premium and Paccar who at best knows in the end the triumph ofhas been able to earn a long-run return on equity high achievement, and who at worst, if he fails,above 16%. The technology and world-class call at least fails while daring greatly.”center people service is integrated into Paccar’sbusiness model in working together as a coherent And added:whole to circle the right customer to scale upsustainably. This interesting quote by Mark Pigott “When we spend our lives waiting until we’reis also uplifting: “We want to be able to look perfect or bulletproof before we walk into thepeople right in the eye and say we did it squarely, arena, we ultimately sacrifice relationships andethically, and to the best of our ability, and these opportunities that may not be recoverable, we squander our precious time, and we turn ourare the results. That’s exciting. They don’t teach backs on our gifts, those unique contributionsyou that in business school.” that only we can make.”Compared to Mark Pigott, Dan Ulstian and “Vulnerability” is also the thought-provoking Word“positive thinker” leaders are, perhaps harshly- behind the Word of the Year 2013 “Value Circle” inworded, like Cixi, the empress dowager in the Qing observing and investing in the multibaggers in Asia.Dynasty who was known to only want to hear Happy New Year 2013.positive news, so much so to the extent thateveryone around her report only goods news and KEE Koon Boondare not voice out any concerns (“报喜不报忧”). 30 December 2012Cixi also diverted critical money earmarked for thenavy to pay for her elaborately-carved marble boatthat sat on the tranquil lake in the center ofBeijing’s ancient Summer Palace. The Qing empirewas overthrown after 267 years in power by arepublican revolution in 1911 three years after thedeath of Cixi. Perhaps authentic leaders andserious value investors do their very best topractice the deeds of the bodhisattva Goddess ofMercy or Guanyin (观音), which means “Observingthe Sounds (or Cries) of the World”, who goes allout to hear and see the pains and sorrows andnegative things to help with her thousand handsand eyes (“即发誓言,若我当来堪能利益安乐一切众生者,令我即时身千手千眼具足.” 《千手千眼 观 世音 菩萨 广 大圆 满 无碍 大 悲心 陀罗 尼经》). Seeking to hear and see the negative thingsand acknowledging sadness and failures is perhapsthe first step into the “Value Circle”. And theenergy to step in comes from “Vulnerability”. In 88