On the Ground in Asia – January/February 2013 The Revenge of the Geographical Value Investor in Asia & The Year of the Fis...
most powerful business empire. Charoen                 sceptics and experts as everyone in the industryPokphand means “com...
areas who have no access to formal banking credit        In his provocative book “The Revenge ofbased on a monthly instalm...
soup that I often visit during lunchtime to beat the    geography. Crowded megacities, beset by poorcrowd. The place is ar...
trillion by the end of 2012, making it the largest in     Youngme Moon described of the Nobel laureatethe world, accountin...
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On the Ground in Asia (Jan/Feb 2013): The Revenge of the Geographical Value Investor in Asia & The Year of the Antifragile Fishball Snake


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On the Ground in Asia (Jan/Feb 2013): The Revenge of the Geographical Value Investor in Asia & The Year of the Antifragile Fishball Snake

  1. 1. On the Ground in Asia – January/February 2013 The Revenge of the Geographical Value Investor in Asia & The Year of the Fishball Snake Or Why a Powerful Dragon Cannot Crush a Snake in its Old Haunts (强龙不压地头蛇)Dedicated value investors are more likely to see a Hollywood DVDs. All the macro-related and “risingcommon fork in the road in the success of 7 Habits tide” stars appear aligned for Siwei, which makesauthor-cum-entrepreneur Stephen Covey and the safety roof support used in underground coalmultibagger genealogical paid-subscription mining. Chinas appetite for coal is the largest inwebsite Ancestry.com as well as the failure of the world and accounts for two-thirds of itsCaterpillar’s revelation on 18 Jan of its massive domestic consumption needs, but its mines are$580 million goodwill impairment charge and among the worlds deadliest, with thousands of"deliberate, multi-year, coordinated accounting workers killed annually in accidents. Based inmisconduct" in its China unit it acquired last year Zhengzhou, the capital and largest city in thein June for around $700 million – and map out the central China province of Henan, where there arefuture overlooked true-north investment large reserves of coal in the surrounding area,opportunities in the Asian marketplace jungle with Siwei appears well-endowed geographically likeits myriad micro microstructure and institutional Stephen Covey and Ancestry.com to have anbooby-traps, and not lose their way as a result of established customer base for its mine safetythe distractions from the “Great Rotation” macro products. And when highly reputable people aresiren shrills. involved in the deal, often a short-cut used by investors in assessing the merits of an investment,Both Stephen Covey and his NYSE-listed the company appears to be a sure-winner withoutFranklinCovey and Ancestry.com have their start in the usual “governance risks”. Notwithstanding allselling their unique offering to an initial loyal set of the positive “macro” top-down factors, Siwei’saudience and customer base from the rocky state business model was unsustainable at the “micro”of Utah, where Mormons predominate. firm level. Sales were boosted only by extendingAncestry.com got its start years ago in Provo, Utah, credit and better terms to the “middleman”partly as an outgrowth of the Mormon church’s distributors in order to compete with state-ownedinterest in genealogy. But it quickly grew into a rivals with deeper “guanxi” relationship inglobe-girdling business and claims more 2 million establishing direct sales channels. Working capitalpaid-subscribers, 39 million family trees and 4 at Siwei was stretched to the limit; it took morebillion profiles of individuals to help people track than 180 days to collect payment, twice thefamily histories. Ancestry.com is up 130% in two industry average. Improper revenue recognitionyears since its Nov 2009 listing to $1.6 billion in and cost allocation in inventory also resulted invalue and bought out by private equity investors in overstated sales and profits.Dec 2012. Covey’s 1989 book on The 7 Habits ofHighly Effective People laid the foundation of his The multibagger investment opportunities aremulti-million training and consulting business often undiscovered and overlooked because ofempire and he propagated the ideas initially local “geographical” specialization in knowledgethrough lectures amongst the Mormon community. which is embedded into the business model to translate into a powerful competitive advantage.Caterpillar’s acquired unit in China, ERA Mining Hence the ancient Chinese wisdom that a powerfulMachinery, had its start in a reverse merger deal dragon cannot crush a snake in its old haunts (强with the injection of the assets of Zhengzhou Siwei 龙 不 压 地 头 蛇 ). Consider Charoen Pokphandinto a nearly defunct HK-listed distributor of Group (CP) (Ticker: CPF TB), arguably Thailand’s 1
  2. 2. most powerful business empire. Charoen sceptics and experts as everyone in the industryPokphand means “commodity development” in operated on cozy dealer relationships whoThai and had its beginnings in a small seed typically took 2 to 10% of the retail price. Goingcompany named Chia Tai, founded in 1921 by two direct meant that Dynasty was destroying its ownChinese brothers Chia Ekchor and Chia Seow Nooy. distribution channels. Yet by having its ownIt is hard to imagine now given its present success geographical channels, Dynasty can translate thebut CP was a struggling business until the 1970s, lower inventory and marketing costs into lowerwhen Bangkok Bank asked it to assume control of prices for the farmer customers who wanteda bankrupt chicken farm. Following this experience, cheap basic home remodelling to express theirCP began lending money to farmers, providing wealth. The first cash-and-carry warehouse outlettechnical expertise, and selling poultry feed. CP with cheap and quality tiles at Hinkong Sub-Districtalso purchased grown chickens for distribution to of Saraburi was a big hit amongst the farmers andgrocers and restaurants. This “geographical” Roongroj expanded and deepened its geographicalpenetration into the provincial network of the network with the capable help of currentfarmers with value-added services and local president Sanchai Janejarat.expertise worked phenomenally well and CPexpanded its operations successfully outside ofThailand as well. Since Roongroj’s son Maruth joined in 2005/07, he has used his skill in computer science picked up from his masters at MIT to turn Dynasty into an integrated computerised company with timely informational advantage on inventory, allowing Dynasty to use pricing strategy by changing itsAnother classic multibagger case is Thailand’s product mix while other manufacturers who relyDynasty Ceramic (Ticker: DCC TB) which sells on dealers are unable to do so, and Dynasty hasceramic tiles to the middle-to-low-end market and since catapulted more than 3-folds to S$880is founded in 1995 by the accountant Roongroj million in value.Saengsastra, 63. Its business model is direct salesvia its own distribution channel of more than 200factory outlets covering every province across thecountry to penetrate to targeted customers,effectively managing its inventory and pricingstrategy to establish a dominant market share ofover 50% in Thailand, more than double of itsclosest rivals. Dynasty is able to hold its own evenwhen competing against the royal family’sbusiness unit Siam Cement which has to closedown many of its direct outlets as dealers refuseto cooperate. During the Asian Financial Crisis,Roongroj acquired his rival Dynasty for $1 millionwhen it was auctioned off in late 1997 and he Similar “geographical” local expertise penetrationmerged the firm with his own Tile Top. Inspired by has catapulted the value of boring Singer Thailanda roadside shoe-seller he had seen on a business (Ticker: Singer TB) by 12-fold in the past five yearstrip to Dallas, Roongroj wanted to implement his to S$226 million in value. Singer sells boringfactory-direct to deepen its geographical products (sewing machines and electricalpenetration but he faced initial ridicule from many appliances) directly to households in the rural 2
  3. 3. areas who have no access to formal banking credit In his provocative book “The Revenge ofbased on a monthly instalment basis which is Geography: What the Map Tells Us About Comingtailor-made to fit the customer’s income level Conflicts and the Battle Against Fate”, Stratfor’srather than product prices. Leveraging upon the Chief Geopolitical Analyst Robert Kaplan cited thesame business model, Singer has built a new group example of the great British geographer Halfordof SME customers by selling them freezers and Mackinder who gave a singular example in 1890 ofbeverage coolers for commercial purposes, petro how knowledge of “geography” enriches one’svending machines, motorbike wash vending thinking on world affairs:machines, air-time vending machines (for mobilephones), commercial-sized air cons and also built a “Suppose that I am told that a certain sample oflucrative after-sales service maintenance business. wheat comes from Lahore, and that I do not know where Lahore is. I look it out in the gazetteer and ascertain that it is the capital of the Punjab. If I know nothing of geography, I shall get up with the idea that Lahore is in India, and that will be about it. If I have been properly trained in geography, the word Punjab will probably connote to me many things. I shall see Lahore in the northern angle of India. I shall picture it in a great plain, at the foot of a snowy range, in the midst of the rivers of the Indus system. I shall think of the monsoons and the desert, of the water brought from the climate, the seed time, and the harvest. Karachi and the Suez Canal will shine out from my mental map. I shall be able to calculate at what time of theAgain, big cap companies with “geographical” local year the cargoes will be delivered in England.expertise business model to get closer to the end Moreover, the Punjab will be to me the equal incustomers have demonstrated similar market size and population of a great European country,outperformance characteristics and PE re-ratings a Spain or an Italy, and I shall appreciate the market it offers for English exports.”in uncertain macroeconomic conditions. ConsiderSwiss-listed DKSH (Ticker: DKSH SW) which has The year 2013 is not only the Year of the Snake forrisen over 40% to S$6.2 billion in market value in companies with the local expertise to outwit theless than a year since its Mar 2012 listing while the powerful Dragon, but also the year of the RevengeEuro Stoxx index and Swiss market index is nearly of the Geographical Value Investor. To borrow theflat and up 18% in the same period. DKSH is description by the Black Swan author Nassim Talebfounded in the 1860s by three Swiss entrepreneurs in his latest book “Antifragile: Things that Gainwho sailed east to Asia. Over the years, they from Disorder”, it is the dedicated artisans withestablished flourishing trading houses, which later “soul in the game” and going the extra mileevolved into major players in South East Asia, beyond the usual macro reasoning who are able toChina, the eastern Asia Pacific region, and Japan. ferret out the multibaggers with antifragileDKSH handles the full value chain of market business models that outperform even in – orexpansion services (MES) from marketing, to because of - volatile, uncertain market conditions.providing the sales force, distribution and logistics, The geographical “snakes” with local expertise thatinvoicing and credit control, handling of inventory I have mentioned in the previous editions of “Onand returned goods to help emerging and the Ground in Asia” have continued to outperform,established western and local consumer brands, such as Madison Square Garden (Ticker: MSG), thedrugs, scientific instruments etc to penetrate into Asean-listed Ta-Q-Bin last-mile parcel expressthe domestic market via their comprehensive delivery carrier whose operations I visited in Feb“capillary network”, particularly important as 2012 and its “comparables” listed elsewhere suchAsian markets are evolving from being the as India’s Blue Dart (Ticker: BDE IN), Taiwan’s Kerry“extended workbench” of the West to becoming TJ Logistics (Ticker: 2608 TT) etc. I have posted thepromising domestic markets. Strong increases in compilation of “On the Ground” on SlideShare forconsumer demand throughout Asia are driving those who are interested to read at leisure.growth in inner-Asian business. StagnatingWestern consumer markets are causing Asia’s Overlooked and undiscovered multibaggerexport economy to transfer its focus into its own investment opportunities are perhaps akin to theregional markets. quiet stall selling tasty Foochow fishball noodle 3
  4. 4. soup that I often visit during lunchtime to beat the geography. Crowded megacities, beset by poorcrowd. The place is around ten minutes away from living conditions, periodic rises in the prices oftown by the MRT metro train system (require commodities, water shortages, and unresponsivesome time in “research”) as compared to the municipal services, will be fertile petri dishes forconvenient popular eating haunts in the noisy the spread of an invisible and intangible diseasecrowded town area with long queues (so called that cannot be cured by tangible infrastructure“blue chips”). But some are still able to enjoy their and urbanization buildouts. This invisible disease isfood at these crowded popular eating places what Ibn Khaldun writes in his Muqaddimah, orbecause they went in “early” (insider trading on “Introduction” to a world history, that desertprivileged private information or participation into nomads, in aspiring to the physical comforts ofinside news on syndicates buying the shares sedentary life, create the original dynamic forcollaboratively together to ramp up the price?). urbanization that is then captured by powerfulThe fishball stall is perhaps quiet because it is rulers and dynasties, which in turn, by providingaway from town, located in a place where it is security, allow cities to flourish. But becauseharder for those with big cars to drive in (funds authority requires luxury, decay eventually sets in,with very big AUM who needs to trade “macro” as group solidarity erodes and individuals, throughthematic ideas to deploy the assets) and only has a their accumulation of wealth and influence,few tables (relatively lower liquidity), though weaken executive power. Thus, systems growtakeouts are frequent amongst loyal customers brittle and fragment, and are superseded by otherwith 40 fishball at one go (long-horizon investors formations. For this first time in history, thiswho buy in relatively concentrated or meaningful- process is operating on a global scale. Vast citiessize bets and hold for the longer-term). Opposite and megacities have formed as rural dwellersthe fishball stall is a budget Italian restaurant throughout Eurasia, Africa, and South Americawhich serves good food too. I usually go for the migrate toward urban centers from thecheapest dishes in the menu which are cooked by underdeveloped countryside. As a consequence,the “lower-ranked” chefs. If the quality is as good the mayors and governors of these conurbationsas their top dishes, it is a testimony that there is can less and less govern them effectively from asome human capital development process for the central dispatch point, so that these sprawlingbusiness to scale up and maintain quality earnings concentrations informally break up into suburbswithout a bloated and blowup effect. Next to the and neighbourhood self-help units, whose ownItalian restaurant is a 100 year-old Singapore soy local leaders are often motivated by their own self-sauce and condiment company with a history older dealing interests. Cities are large piles of small,than Singapore itself. It reminds me of HK’s Lee very different things – neighbourhoods, networks,Kum Kee which celebrated 125 years of innovators, and infrastructure. These tie together thanniversary with the current 4 generation different people and groups in loose, informal,Chairman Eddy Lee (李慧森) scaling the sauce and ever-shifting affiliations. Until the invisiblecondiment family company to greater heights with integration of the clustering of density andten consecutive years of double-digit growth in diversity is resolved, increasing scale by a singlesales and profit based on the ancient sage Lao- curve – reaping the benefits of a single mode ofTzu’s “Invisible Leadership” (自动波领导模式) wealth and capital creation – will ironically speedphilosophy, a stark contrast to the “Asian up the demise and collapse of the robust-yet-Emperor” model prevalent everywhere. And Lee fragile system, perhaps a contrast to the optimisticKum Kee was also rated by Hewitt and Fortune urbanization-led prosperity story for Asia.China as Asia’s and China’s Best Employer. However, just as markets can stay irrational longerIn the realm of biological world, scale made than one can stay solvent, the growth of cities canorganisms slower; in the realm of the durable stay extended on debt and capex-led investment“moaty” business models, it made them faster in financed by increasingly fragile confidence, as wasvalue creation. This is also supposed to be the case suggested in a widely-noticed IMF study “Is Chinaeven in the realm cities: the bigger the city, the Over-Investing and Does It Matter?”. It was alsohigher the wages, the more patents produced, the reported by Bloomberg news on 2 Feb that Chinamore it delivers per capita, but also the greater the registered its first capital exit last year, since 1998number of violent crimes, more traffic, more when investors deserted China during the Asianinfrastructure breakdowns, more impersonal financial crisis, with a deficit of $117.3 billion in itsinteraction, more loneliness in which strangers are capital and financial account. This had followedmany and true friends and family relatively few. another news on 1 Feb that China’s M2 money stThe megacity will be at the heart of 21 century supply increased by RMB 27 trillion to RMB 97.4 4
  5. 5. trillion by the end of 2012, making it the largest in Youngme Moon described of the Nobel laureatethe world, accounting for a quarter of the global physician Richard Feynman in her highly thought-money supply, 1.5 times the total of M2 in the US, provoking and “similarly”-styled conversational4.9 times that of UK, 1.7 times more than Japan. book “Different: Escaping the Competitive Herd”:The RMB 27 trillion increase in M2 also meant thatChina accounted for half of the increase in global When I was in college, I remember reading a book bymoney supply last year. China’s M2/GDP has the Nobel Prize–winning physicist Richard Feynman,surpassed 200%, the highest in the world. A seven- entitled Surely You’re Joking, Mr. Feynman! What was interesting about the book was that it appeared to befold jump in December’s lending by China’s trust nothing more than a compilation of rambling anecdotescompanies in short-term financing loans as — about his personal life, his teaching, his work. Andreported by Bloomberg news on 17 Jan is also yet the weight of these anecdotes crept up on you, sosetting off alarm bells for regulators to guard that by the time you finished the book it was impossibleagainst the risk of default. A Financial Times article to regard it as anything less than a finely honedon 27 Jan reported that China’s brokerages have indictment of the scientific discipline. What Feynmanalso emerged to become shadow banks, a seemed to understand was that there are in fact twodevelopment that underscores how financial risks ways for a scholar to contribute to our understanding ofare spreading more widely in China. For 2012 as a something. The first is to adopt the PowerPoint approach, which is to take a complex phenomenon andwhole, shadow financing via brokerages appears to attempt to distill it down to its core. The second is to dohave increased almost 600%. Total short- and long- the reverse: to take a complex phenomenon andterm borrowing by 3,895 publicly traded non- attempt to shed new light on it, not by removingfinancial companies rose to almost $1.7 trillion in information but by layering on unexpected shades oftheir latest filings, from $604 billion at the end of nuance, from unexpected sources. This is what2007, data compiled by Bloomberg show. Feynman did: He wove his subject into the broaderFinancing costs, including interest, on all forms of tapestry of everyday life. He added richness, texture,debt climbed to the highest level as a percentage context. He was a man I wish I could have invited toof GDP last year, according to Sanford C. Bernstein dinner… All of these works exist across wildly different disciplines, and yet they have something very much in& Co. As the prominent economist Yu Yongding common: They were written by scholars who were ablenoted in his Project Syndicate article “China’s to bring their respective disciplines to life, byNarrowing Policy Horizon” on 31 Jan, “Though the humanizing them somehow, without dumbing themfull implications of this uniquely high ratio for down. Their relationship to their work is akin to the onemacroeconomic stability need further Calvin Trillin has to food, which is to say that theyinvestigation, it certainly implies financial fragility regard their subject—whether it be medicine, orand a weakening of the PBOC’s ability to control architecture, or technology—as constituting one smalloverall liquidity in the economy. If the shadow piece of a much larger fabric. These are writers whobanking system collapses, the consequences for meander, certainly, but only as a means of getting straight to their point. Their books inspire, becausethe financial system will be much graver than the although they provide a running commentary of all thatproblems caused by underground credit networks is wrong with their respective disciplines, they do notand local-government finance platforms, which stop there. I have always thought that the way to keepwere much discussed in 2012. No wonder, then, criticism from devolving into cynicism is to make it thethat one influential banker regarded as a possible starting point rather than the punctuation mark, andsuccessor to PBOC Governor Zhou Xiaochuan has that’s what these writers do: They look hard to identifywarned of the possibility of a “Chinese-style the good amid the bad, and when they find it, theysubprime crisis.” shine a light on it, they celebrate it, they encourage us ******** to learn from it. If scholarship is a conversation, then in my mind these are the ones who make the mostIt is deliberate that this monthly “On the Ground in compelling conversationalists — the ones braving theAsia” newsletter that I have written since 2012 is unfamiliar dialect, the ones pushing the dialoguenot like the usual sell-side market research reports forward in unexpected and provocative ways.following a certain writing format with charts andfigures spewing multiple stock recommendations This will be my last “On the Ground in Asia” piecebased on PE/CAPE, DCF or various forms of as I embark on a transition phase in my career. Ivaluation ratios. Instead, I attempt to discuss hope this monthly writing over the past year hasabout the investment thought process behind the pushed the dialogue on value investing in Asiastocks in Asia in a purposeful story-like manner forward and that you have enjoyed reading it.with a central theme and mental model, in a waythat is entirely “different” from all these reports to KEE Koon Boonstimulate critical thinking and conversation, or in a 4 February 2013way that Harvard Business School Professor 5