The Miasmic Asian Capital Jungle and the Tranquil Bamboo Innovator Grove


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The Miasmic Asian Capital Jungle and the Tranquil Bamboo Innovator Grove

  1. 1. 1 The Miasmic Asian Capital Jungle and the Tranquil Bamboo Innovator Grove A weekly column on BeyondProxy exploring the sharp contrast between the dark side of Asian markets and the quiet opportunities that comes from identifying resilient compounders. Issue 13: 1997 Asian Financial Crisis, Redux? Aug 28, 2013 (BeyondProxy) Issue 12: Berkshire Hathaway Embracing Media? An Asian Perspective, Aug 21, 2013 (BeyondProxy) Issue 11: “Worthless, Impossible, And Stupid” Investing in Media Companies in Asia and Europe, Aug 14, 2013 (BeyondProxy) Issue 10: Fruit of the Loom vs. Gildan, or How to Avoid Value Traps in Low-Cost Businesses, Aug 7, 2013 (BeyondProxy) Issue 9: Snapped By Regulatory Storms? Braving Through Berkshire’s Former Iron Mountain to Asia (BeyondProxy) Issue 8: From Buffett’s Scott Fetzer to Asia, Are Oddballs Odious or Opportunities? July 24, 2013 (BeyondProxy) Issue 7: Are Boring Businesses Resilient or Risky? Pitfalls and Opportunities in Europe and Asia, July 17, 2013 (BeyondProxy) Issue 6: Supply- and Demand-side Moat Economics in Europe and Asia, July 10, 2013 (BeyondProxy) Issue 5: “Must-Have” vs “Nice-To-Have”: Exploiting the Sector-Company Gap in Asia, July 3, 2013 (BeyondProxy) Issue 4: Institutional Imperative and Differentiating Between the Tech Innovators, the Imitators and the Swarming Incompetents in Asia, June 27, 2013 (BeyondProxy) Issue 3: BNSF + JB Hunt = Buffett + Munger = Lollapalooza! How About Asia? June 19, 2013 (BeyondProxy) Issue 2: Why Berkshire Hathaway’s McLane Has a Moat, and Are There Similar Companies In Asia? June 12, 2013 (BeyondProxy) Issue 1: Investing in Korea: Staying Rational Despite Samsung’s Halo Effect, June 5, 2013 (BeyondProxy)
  2. 2. 2 1997 Asian Financial Crisis, Redux? The following article is part of The Miasmic Asian Capital Jungle and the Tranquil Bamboo Innovator Grove, a weekly column on BeyondProxy by Koon Boon Kee. The column explores the sharp contrast between the dark side of Asian markets and the quiet opportunities that come from identifying resilient compounders. This is the 13th article and will be the “last” in the series with the upcoming birth of The Moat Report Asia, a monthly in-depth report highlighting an undervalued wide-moat business in Asia with an innovative and resilient business model to compound value in uncertain times. Buffett: “Emerging markets aren’t our specialty. If we were poor enough, we might even consider doing that” Munger: “It’s a great way to sell investment advice – something in every category. Lots of commissions, lots of advice, lots of action.” Buffett: “Whenever you hear people talk about concepts, for instance, country by country ideas, they are probably better at selling than investing.” Munger: “’Our experts really like Bolivia’. You say ‘last year you really liked Sri Lanka.’” Buffett: “We usually think it is a lot of baloney.” - Berkshire Hathaway 2013 AGM Q&A “But leverage is addictive. Once having profited from its wonders, very few people retreat to more conservative practices. And as we all learned in third grade – and some relearned in 2008 – any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero. History tells us that leverage all too often produces zeroes, even when it is employed by very smart people.” - Buffett’s Annual Letter to Shareholders in 2011 Word of the Year in Asia in 2013 = Bloated. This was the title to the report that the Bamboo Innovator wrote last year on December 30 in a series of monthly articles called “On the Ground in Asia” (OTGA). The subtitle was “Do investors overvalue firms with bloated balance sheet?”, an investment view which was later expanded upon in a BeyondProxy article “Value Investors in Asia: How to Make Sense of the Micro Vs Macro Dilemma”. Before and after the recent sell-off in the emerging markets from currencies to bonds and equities, led by the Indian rupee, Indonesian rupiah, Malaysian ringgit and Thai baht on the 16th anniversary of the baht devaluation (July 2, 1997) which preceded the 1997/98 Asian Financial Crisis (AFC), the consensus opinion has always been that Asian economies are far healthier than before and faster growth can make debt loads manageable: central banks hold larger war chest reserves; some like Singapore, Korea, Taiwan, Philippines have current account surpluses; banking reforms have been carried out; and so on. Asia’s borrowing binge has led to private sector debt rising to 165% of GDP in 2012, higher than the 127% level prior to Asia’s financial crisis. Consumer debt has also soared from motor-scooter buyers in Indonesia, washing-machine purchasers in Thailand and property investors in HK and Singapore (property prices in HK are 40% higher than 1997 peak value). Public debt has soared from the massive hidden local government and shadow banking debt in China to Malaysia government borrowing to fund the new subway and to pay for cash handouts to
  3. 3. 3 citizens. Plaza Rakyat, the stalled skyscraper-shopping mall construction project in the heart of Kuala Lumpur started before the AFC, has seen little activity and remains abandoned. Yet, all the statistics missed out on Buffett’s wisdom that “leverage is addictive”. Asian corporates, entrepreneurs and consumers, used to operating at low leverage for a long time, have tasted the delicious “series of positive numbers” as “savvy” investors chasing yield-enhancing deals using the low cost of financing, rather than reinvesting into enhancing their intangible competitive advantages and widening the moat of their businesses. As Buffett elucidates, “any series of positive numbers, however impressive the numbers may be, evaporates when multiplied by a single zero.” The OTGA and the BeyondProxy articles highlighted that “bloat”, proxied by net operating asset (NOA), provokes excessive investor optimism and a fear of missing out. As a result, investors systematically overvalue firms with bloated balance sheet with a failure to discount for the unsustainability of earnings growth. Disappointment and subsequent correction in mispricing result in negative returns in the long-run. A recent Financial Times article “Too soon to buy unloved emerging markets” on Aug 23 pointed out that “Bottom-line, investors are now almost unanimously bearish on EM in their minds, but not so in their books. Contrarian investors looking for extreme distress ought not to announce a buying opportunity yet.” Interestingly, according to Barclays in a Reuters article in April before the sell-off, many Asian clients of private banks, lured by the rebates offered, used leverage including borrowing against their houses to boost purchases to as much as 20% of the region’s U.S.-currency and sub-investment “high-yielding” grade local-currency debt market. With yields near record lows, they risk having to meet margin calls as borrowing costs rise. As always, we believe that the value investor can gain a deeper insight about Asia not through the macro-prognosis but through the eyes of the resilient compounders who have survived the Asian Financial Crisis in 1997/98 and were reborned as Bamboo Innovators. This week, we travel to Indonesia to examine Kalbe Farma (KLBF), Indonesia’s and Southeast Asia’s largest listed pharmaceutical firm. Importantly, we go beyond the numbers analysis to understand the critical business decisions that Dr. Boenjamin Setiawan (photo), known affectionately as Dr Boen, took during the Asian Financial Crisis, when the company took “cheap” foreign currency debt to get lower interest rates like many others and was almost going bankrupt when it was unable to repay with the devalued rupiah. Dr Boen not only steer the company back to health but also become a Bamboo Innovator in the process. Since its listing in 1991, Kalbe Farma’s market cap has grown from around $180 million to nearly $900 million in 1994/95 before crashing to under $500 million in 1996, $70-80 million in 1997 and $20-30 million in 1998 during the Asian Financial Crisis. Kalbe Farma has since grown from strength to strength to a market cap of $6.3 billion with its unique business model that resembles somewhat Warner-Lambert, the consumer healthcare company that Buffett invested during the early 90s when the government was looking to regulate drug
  4. 4. 4 prices. Buffett took advantage of the selloff from the regulatory uncertainty to buy into WL, which owns brands such as Listerine antiseptic mouthwash, Halls cough drops, Rolaids antacid, at PE 13x, valuations which later tripled. Similar to WL, Kalbe Farma’s portfolio of consumer healthcare products such as Promag antacid, Neo Entrostop anti-diarrhoea, Komix cough remedies and ExtraJoss energy health drink (competing with Red Bull) and nutritional products such as Diabetasosl dependable powder milk and zero calorie sweetener are well known by generations in Indonesia. The original consumer healthcare business that Kalbe Farma started out now contributes around 16% of its revenue while the nutritional business accounts for 22% of its revenue. And we get to appreciate that the brand franchise provided by “products” is necessary but insufficient to create resilient value in emerging markets once we understand the “tipping point” event that occurred in 2005 for Kalbe Farma. Dr Boen is pictured in Fortune Indonesia (Oct 16, 2011) under the Bahasa-Indonesian headline “Never Stop Innovation” (Tak Pernah Berhenti Inovasi) in which the magazine wrote “A man with a white doctor's coat, his hair was sparse and entirely white. But his spirit still burning to innovate.” Sceptics will point to the magazine cover curse: with the recent sharp correction, Jakarta stock index is still up by 15% from Oct 2011; Kalbe Farma has doubled and the innovator’s heart beats to a different inner rhythm to break apart from the statistical averages to create value. Before we dive into the thoughts of Dr Boen, we like to give our heartfelt thanks to the readers of this column series as this is the last article with the upcoming birth of The Moat Report Asia, a monthly in-depth report highlighting an undervalued wide-moat business in Asia with an innovative and resilient business model to compound value in uncertain times. The Bamboo Innovator will continue to contribute periodically on BeyondProxy. We are grateful to the kind feedback from thoughtful readers who patiently go through these in- depth articles. One reader commented that the articles are like durian, the tropical fruit known for its formidable thorn-covered husk and strong odour that’s overpowering to some but pleasantly aromatic to others; “it takes some work to get to the edible flesh but it’s worth it”. Another highly knowledgeable American investor who found the readings and the Bamboo Innovator framework to be interesting had invested in the Malaysian-listed arm of Swiss multinational DKSH that was highlighted in BeyondProxy with an innovative business model akin to Berkshire Hathaway’s McLane at the valuation of PE 7-8x; the stock has since increased around 60% (vs 5% for the index) and has stayed resilient with improving business fundamentals despite the sell-off in the Southeast Asian markets. Kewpie, the “Heinz of Japan” that was highlighted in the in-depth stock presentation of the Emerging Value Summit on April 10, is up 14% (vs 1.8% for the index). The careful and sceptical reader would have noted the limitations of the in-depth articles: the valuations of these wide-moat innovators are deliberately not woven into the discussion unless they are available in the form of the in-depth stock presentation reports like Kewpie. Great businesses may not necessarily be great stocks. But we cannot get great stock returns unless we understand the messy non-linear and non-quantitative process of why and how they become great businesses. The lollapalooza result in business model and economic moat analysis is often why assessing companies rigorously using accounting numbers and tidy models to give the analysis an air of scientific respectability will often result in the value investor missing the resilient compounders while consistently picking up the value traps and cigar butts. As Benjamin Graham, known fondly as the father of value investing and Buffett’s idol and mentor, puts it aptly: “Investing is more intelligent when it is more business-like.” It is a purposeful attempt to hopefully present them as mini Harvard Business Review case studies to spark critical thinking and active discussion to enhance our understanding and assessment of wide moat businesses. Without being influenced by the
  5. 5. 5 short-term price movements, how much would a value investor be willing to pay for the wide-moat and the margin of safety that he or she is comfortable with? One of the most painful lessons for a value investor is the Pavlovian-attraction to the price signal without an adequate wide moat analysis of the business; the stock stays “cheap” as the business model hit a stall point due to the lack of an economic moat and reinvestment opportunities into the core business. Time becomes an enemy for the patient value investor as mean-reversion does not work its way to correct temporary mispricing to realize returns. In Asia, value traps and cigar butts often turn into misgovernance and fraud cases as the controlling owners simply expropriate and tunnel out the assets. The decision to shift gear into The Moat Report Asia is to close this gap. With vast information and limited attention, it appears that in-depth articles and research analysis are relics of the past, especially when we are one click away to snack on the next sensationalized (and commoditized) fast-moving news tidbit and we are often manipulated by the machinations of others who probably created these headline-grabbing content snippets to stimulate trading action and elicit compulsive response from people that they later regret. Just a few weeks ago, Google realized that the thoughtful serious thinkers care deeply about “slow media” - content that is not tied to a specific moment, that resists the eroding forces of faddism, and that favors quality over quantity – and is prioritizing links to in-depth articles in its search results. The problem these days is not how to find what to read, but how to find signal in the noise. In-depth analysis that stresses long-term nourishment rather than quick-hit fix develops a deeper relationship with readers who are swarmed by the frenzy of instant information and noise. Before this weekly column, there is the OTGA (On the Ground in Asia) monthly article series. OTGA was how I got to know Oliver, who’s the co-managing editor of The Manual of Ideas and BeyondProxy. Having found OTGA to be a thought-provoking read over the years, we met up when he visited Singapore in late February this year. Our meeting and friendship led from one thing to another which eventually culminated in The Moat Report Asia. We have always been fascinated why and how even under the most austere of conditions and environment, certain entrepreneurs and business models remain resilient and continue to compound value, just like the bamboo who bend, not break, even in the most terrifying storms that would snapped the mighty resisting oak tree. This has been the central fascination of our lifework and the reason why we are inspired to share our findings with a community of like-minded value investors. Our personal motivation, or why do we care so much about doing The Moat Report Asia for you, actually stems from this dangerous "Ride the Asian Growth Story!". We are driven by our sadness from observing up close and personal the hard-earned assets of many investors, including friends and their families, burnt badly by this popular "macro theme" when the companies that are supposed beneficiaries of the positive macro trend, be they "middle- class consumption" or "urbanization", turned out to be fraudulent set-ups with controlling insiders expropriating the cash and tangible assets away by intricate “tunnelling” acts via money-go-round related-party transactions. Famous Asian "blue-chip" companies are not spared from governance breakdowns, ranging from the “Best Buy of China”, “Nike of China”, “Wal-Mart of China” to Korean chaebols with well-known brand franchises and reputable Southeast Asian and Taiwanese family businesses. We witnessed firsthand the emotional upheavals that successful professionals go through when they invest their hard-earned money - and their parent's and family's - in these "Ride The Asian Growth Story" stocks either by themselves or through money managers and saw the previously-multibagger returns disappeared and even turned into hefty losses. And they were ashamed to visit their parents back in their home country as a result, tormented by guilt and living through anguish. We also lament the plight of promising entrepreneurs such as "Asia's J.K. Rowling" who are
  6. 6. 6 tempted into value-destroying deal-making when surrounded by shrewd fee-seeking bankers and syndicates. And then following fund-raising exercises, the share price typically plunged subsequently after a few years with missing cash and assets. Many Asian stocks (and “long-term track record” of Asian money managers) appear to live in two time periods with a distinctive structural break. Before the outbreak of the 2007/09 Global Financial Crisis (GFC), they were stock market darlings generating "multibagger" returns. During the GFC, their share prices nose-dived, but they either get cheaper and cheaper or erupt into some form of governance or accounting fraud scandals; there is no mean-reversion back to their previous promising growth and valuation levels. This prevalent situation in Asia is analogous to that of the Picture of Dorian Gray in the novel by Oscar Wilde (1890) - the face of Dorian Gray showed no signs of aging as time passed, whereas the sins of his worldly existence are vivid in the portrait of himself that he kept hidden in the attic. The Dorian Grays of Asia have been able to get away with their accounting frauds and misgovernance transgressions because they are branded as sexy growth companies who charm party-goers with their good looks (quantitative financials) and riding on “The Asian Growth Story”. At Bamboo Innovator, our task is to support fellow value investors to understand and appreciate the early signs of potential problems and red flags in Asian companies ahead of the market, to see the real attic portrait of the companies’ financial health and economic worth. We still hold on feverishly to the idealistic hope that a community of like-minded people can come together to spread their knowledge and kindness built around a resilient mental model, a home that everyone can breathe in it and make it their own. We hope that our candid and authentic views about value investing can be shared in our little community. Thus, despite self-doubts all the time, this mission to create value for our readers with the Bamboo Innovator analytical framework has pulled us forward to devote nights after nights and squeeze every ounce of our bludgeoned body to do this. This is why we care so much about doing The Moat Report for you. Having the inner compass of the Bamboo Innovator in our hearts can help us not lose our way in difficult and uncertain times as we journey together in the dangerous Asian capital jungles. We believe that the role of the value investor include that of an educator. Hence, we also highlighted the critical thinking gap in misgovernance and fraud detection when adapting
  7. 7. 7 western-based techniques to the analysis of Asian companies. Even sophisticated long-term institutional investors such as the $740-billion Norway’s sovereign wealth fund NBIM (Norges Bank Investment Management) have commented that in their decade-plus experience of investing in emerging markets and in Asia, they have learnt that related-party transactions (RPTs) is critical in identifying governance risk in Asia as compared to the West. This opinion is later espoused in their influential "Discussion Note 14" published in November 2012, pointing out that the fundamental governance problem is opportunism by controlling shareholders through tunnelling activities carried out via RPTs at the expense of public minority shareholders such as NBIM who suffer value expropriation. We hope our readers and subscribers can benefit from this hard-won investment insight that the world's largest and most thoughtful fund found especially useful. Over the years, we have also written and published articles that highlight the governance transgressions at Asian firms before their collapse in share price. An example is that of Hong Kong-listed China Green (904 HK), the green food producer and retailer whose share price fell over 90% when our article was published in Business Times Singapore on Nov 25, 2010. While uncovering potential misgovernance and fraud cases is important to avoid losses, we believe it is far more meaningful and rewarding to discover the overlooked and neglected wide-moat businesses. One keen reader and friend expressed some concerns that some of our articles might appear to be a little critical about Berkshire Hathaway. The sum of Berkshire Hathaway has always been greater than its individual parts and that’s the magic about Buffett-Munger that makes Berkshire so special and valuable. Through the weekly column, we are hoping for more readers everywhere to understand a little bit more about the multiple businesses at Berkshire, much like the objective of Omaha residents Nancy Rips and Tom Kerr who authored the wonderful illustrated book My First Berkshire ABC to show the companies that Berkshire owns or invests in - and to explore together whether there are potential Buffett- like opportunities in Asia too. We have the deepest respect and admiration for Buffett- Munger who are positive role models in the way they conduct their lives, build lasting great businesses and share their wisdom tirelessly, and we believe that those who care and cherish the value investing philosophy and ideals of Buffett-Munger will understand the need to also engage in the critical thinking that the sages so prize and carefully cultivate in their community and followers. ******** Back to Dr Boen and Kalbe Farma. Visitors to Kalbe Farma would have noticed a photograph of a garage hung in the waiting room. This humble garage in Tanjung Priok, North Jakarta gave birth to Kalbe Farma, started in 1966 by six siblings: Boenjamin Setiawan, Khouw Lip Tjoen, Theresia Harsini Setiady, Khouw Lip Swan, Maria Karmila and Franciscus Bing Aryanto. Looking back on the company’s growth curve to survive the Asian Financial Crisis and become Southeast Asia’s largest pharmaceutical firm with a $6.3 billion market cap, Dr Boen, who had earned his pharmacology doctorate from the University of California in San Francisco, believes Kalbe Farma’s success is a combination of many factors, including some “accidental” ones. At all times, the company has been driven by a set of simple principles: the company has to be innovative and must listen to customers and market trends. A company must provide benefit for stakeholders, whether they be government, patients, hospitals, doctors, suppliers, shareholders or, most importantly, the community. Dr Boen appreciates that human resources development must be at the center of corporate development strategy. The mental attitude of members of staff is an important factor in
  8. 8. 8 growing the company. “Staff must have the desire to be excellent, not just successful. Only people with skills, knowledge and a positive and honest attitude can help a company achieve longevity. All people in the company have to be tough in their efforts to grow the company,” says Dr Boen who is grateful to the 17,000 employees who have utilized the right attitude to help the company grow. Kalbe Farma spends 15% of its cash reserves on R&D in pursuit of its motto The Scientific Pursuit of Health for a Better Life. This commitment to investments in the intangible proprietary know-how and product innovations makes Kalbe Farma a rarity amongst Indonesian and Southeast Asian corporates, many of whom believe that me-too manufacturing combined with “relationship” with connected politicians will do for the huge domestic marketplace. This is the curse for many Asian companies whose wealthy founders and entrepreneurs do not believe in investments in the “indestructible intangibles” of know- how and trust and support in its community of customers, partners, suppliers and employees; they believe in relationship-based deal-making to scale up by amassing tangible assets in different business areas and by financial engineering and that only they themselves and maybe a few others in the “team” matter in the value creation process. Their definition of wide moat is who you know and how much visible tangible assets you can accumulate, all the more better if they are amassed from cleverly-structured schemes in which they put up little money but enjoy disproportionately larger economic equity gains with other people’s money. As they grow bigger, the business becomes riskier with many moving parts and hidden debt that would make the group balance sheet “bloated” but which is not observed by value investors focusing primarily and simplistically on quantitative net-net screens. The Asian Financial Crisis had been a blessing in disguise for Kalbe Farma which nearly went bankrupt when unable to repay the foreign currency debt it accumulated with the devalued rupiah. Dr Boen decided to sell off all the businesses from property to financial services except the original pharmaceutical one to pay off the debt. Kalbe is also one of the few Indonesian corporates who displayed integrity during the crisis by not simply defaulting on its debt like many others through the use of complex pyramid shareholding structure that could easily absolve them of all liabilities and creditors have no legal recourse. Kalbe Farma has stayed net cash since FY06 with net cash as a percentage of equity at 20-30%.
  9. 9. 9 "I'm suffering from hypertension. I take generic drugs from Kalbe everyday," says Dr Boen, who recovered from a heart attack at age 43 and now follows a regular exercise routine to stay fit. Kalbe Farma’s prescription and generic drug division now accounts for 24% of revenue and it has a 17.4% market share in generic drugs, almost even with Indofarma, the state-owned pharmaceutical company, which has a 17.6% share. This complemented its original consumer healthcare division (16% of sales) and nutritionals business (22%) with many well-known brand franchises just like Buffett’s former Warner-Lambert investment. A key success factor as to why Kalbe Farma has been able to fend off many domestic and foreign multinational challengers to stay resilient all through the years has been its “core- periphery” business model. At its “periphery”, Kalbe Farma’s marketing and sales infrastructure is the largest in Indonesia. Of its 15,000 employees, around 4,300 are sales and marketing professionals covering the entire Indonesian archipelago. Kalbe maintains coverage of more than 70% of general practitioners, 90% of specialists, 100% of hospitals, 100% of pharmacies across Indonesia for the prescription pharmaceuticals market and 80% for the consumer healthcare and nutritional markets. Kalbe Farma consumer healthcare products are available in over 1 million outlets and they directly cover 200,000 outlets. At its “core” is Kalbe’s most important and overlooked division which contributes to 38% of its sales: distribution and logistics. Given the geographical dispersion of the Indonesian archipelago of over 17,000 islands encompassing 34 provinces with over 238 million people, most Indonesian companies do not scale out of their localities particularly the central Java island. Kalbe Farma has the most extensive distribution network with its two regional distribution centres (RDCs) in Jakarta and Surabaya serving 65 branches in 47 cities to support the sales and marketing infrastructure to sell its multiple brand franchises in consumer healthcare, nutritionals and prescription drugs. This is the hidden wide moat that most western-based investors do not appreciate. With a formidable distribution network at its “core” to support the “periphery”, Kalbe Farma has an unmatched 24-hour order fulfilment capability with 4 hour order fulfilment for prescription drugs, 24-hour service for life-saving drugs and direct delivery to end customers. 3rd -party accounts for 22% of the distribution division revenue with gross margin of around 27%; the Kalbe Group contributes the bulk of distribution revenue at 64% and the overall gross margin is around 10%. Because the gross profit margin of “distribution and logistics” is much lower than the other “brands” (55% for consumer healthcare, 62% for nutritionals and prescription drugs), many western-based investors I have met at investment conferences believe that distribution is a deadweight that is far better to be “outsourced” as they lower the overall profit margins. The successful entrepreneurs in emerging Asia whom I am familiar with laugh secretly at the fund managers for such a “logical” view. The professionals do not realize that it is the “brands” and the “efficient” manufacturing factories that are the commodity assets in emerging countries. With control of the end customer relationships through the “distribution”, they can always construct another factory outside of the listed vehicle to rebuild the business should things fall apart like during the Asian Financial Crisis when many entrepreneurs simply allow the “high-margin” listed vehicles to default – but not before they pile up hidden debt that suddenly emerge from nowhere into the balance sheet of the listed vehicles. Without sales, there is no “profit margin” to speak of. The world’s largest and most thoughtful long-term fund, Norway’s sovereign wealth fund NBIM, discovered painfully that this is made possible because of “tunnelling” activities via related-party transactions (RPTs) facilitated by the complex pyramid shareholding structure of which the listed vehicle with its “nice” quantitative financial numbers usually lie at the bottom of the pyramid. The listed vehicles, with actual expenses in marketing and logistics kept off the income statements, are fronts for raising external funds from investors and bankers that are tunnelled out to the
  10. 10. 10 unlisted businesses. In the actual default cases during the Asian Financial Crisis, many investors realize painfully that the ownership of the tangible assets in the listed companies actually reside with the unlisted parent at the apex of the pyramid while the liabilities are real with no legal claims on the (disappeared) “assets”. The valuable “low-margin” distribution business is often unlisted and is sometimes the holding company, as are many crown jewel assets in Asia that remain in the private pockets of tycoons and families. Thus, any “high profit margin” businesses that value investors observe in the listed equities are often not the full picture when the valuable “marketing and distribution” businesses are not injected inside and they should be avoided no matter how “cheaply” they trade in terms of conventional valuation metrics such as low PE or Price-to-book ratios. The “secret” is this: A valuable rule of thumb is to only invest in the very few Asian companies whose controlling owners decide they want to be like Wal-Mart’s Sam Walton in putting all the related business assets into one listed transparent vehicle to eliminate the usually-undisclosed related-party transactions and to “lean in” with full commitment such that when things go wrong, they have few or no unlisted family jewels to fall back upon. This “lean in” commitment is why Wal-Mart, which fell two-third in its first three years of listing since its 1972 NYSE IPO, is able to bounce back over 1,000 times to $240 billion in market cap with resilience, like a bamboo which bend, but not break. Thus, the tipping point event for Kalbe Farma happened in June 2005 when the marketing and distribution businesses, Enseval Putera Megatrading Tbk (EPMT, now 91.75% owned) and Dankos, are merged into Kalbe Farma. Market cap has since soared nine-fold from $700 million to $6.3 billion. Till this date, I still keep the old 2005 copy of the “restructuring” slide (below), its “tipping point” event, from Kalbe Farma. Basic Financial Summary of Kalbe Farma (1991-2001) – Asian Financial Crisis Period US$M 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Sales 77.1 116.1 148.7 198.5 235.6 207.0 181.4 74.7 144.1 187.4 200.9 Net 11.4 16.8 24.0 27.3 29.1 31.4 -29.8 -51.7 27.0 -3.4 3.2 CFO -8.6 18.0 -1.7 15.6 -7.6 44.7 15.2 71.5 27.2 11.8 16.6
  11. 11. 11 Capex -21.5 -20.5 -20.1 -14.0 -1.3 -3.7 -10.9 -8.4 Profitability GP Margin 49.3% 50.7% 49.2% 47.9% 46.9% 51.4% 52.3% 50.5% 51.4% 53.3% 48.3% EBIT Margin 26.1% 22.4% 21.4% 21.4% 20.4% 21.4% 19.3% 23.6% 23.4% 25.0% 16.4% EBITDA Margin 29.4% 26.3% 26.7% 24.9% 24.0% 25.8% 22.7% 27.9% 27.9% 25.0% 19.4% Net Margin 14.8% 14.5% 16.2% 13.8% 12.3% 15.2% - 16.4% - 69.2% 18.7% -1.8% 1.6% GP/TA 25.2% 35.0% 29.3% 19.1% 19.7% 19.3% 23.6% 13.6% 26.3% 55.0% 53.7% ROA 7.6% 10.0% 9.6% 5.5% 5.2% 5.7% -7.4% - 18.7% 9.6% -1.9% 1.8% Cash Vs Accruals Capex% Sales -10.8% -8.7% -9.7% -7.7% -1.8% -2.6% -5.8% -4.2% AR Day 85 88 91 85 62 86 105 76 65 67 66 Inventory Day 150 128 113 115 120 138 134 115 112 120 106 AP Day 34 31 33 37 34 38 35 29 22 26 28 CCC 200 186 171 162 147 186 205 162 154 160 144 Leverage Mkt Cap 185.5 370.1 847.8 888.9 732.0 493.6 77.3 22.6 342.3 130.1 87.9 Bs Sh Out 38038 38038 40608 40608 40608 40608 40608 40608 40608 40608 40608 Net Debt 52.5 50.7 71.7 297.6 142.1 98.2 249.2 130.2 140.7 104.8 93.2 Debt Equity (Bk) 63.9% 55.0% 48.7% 186.5% 75.8% 46.5% 377% 1275% 189.2% 331% 280% Basic Valuation PE 16.25 22.00 35.27 32.51 25.16 15.71 12.70 27.40 P/Sales 2.40 3.19 5.70 4.48 3.11 2.38 0.43 0.30 2.38 0.69 0.44 P/Book 2.26 4.02 5.75 5.57 3.90 2.34 1.17 2.21 4.60 4.12 2.64 Basic Financial Summary of Kalbe Farma (2002-2012) – After Asian Financial Crisis US$M 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sales 275.8 337.4 565.0 605.2 662.7 766.8 819.4 880.3 1126.0 1244.0 1454.5 Net 28.7 37.7 50.5 64.5 73.9 77.3 73.5 90.0 141.6 169.0 184.9 CFO 43.0 59.2 33.4 53.7 79.3 39.7 84.0 132.1 138.1 177.7 152.9 Capex -11.0 -14.6 -19.5 -41.5 -36.2 -24.6 -31.7 -26.9 -51.7 -53.5 -83.6 Profitability GP Margin 53.0% 56.2% 48.6% 50.5% 51.0% 50.7% 48.3% 49.7% 50.5% 50.9% 47.9% EBIT Margin 20.1% 19.6% 18.3% 18.1% 17.6% 16.1% 14.5% 17.2% 17.5% 18.0% 16.3% EBITDA Margin 22.8% 22.1% 20.5% 20.3% 20.2% 18.5% 16.8% 19.5% 19.6% 19.8% 17.9% Net Margin 10.4% 11.2% 8.9% 10.7% 11.1% 10.1% 9.0% 10.2% 12.6% 13.6% 12.7% GP/TA 65.0% 65.2% 60.2% 64.9% 65.8% 71.1% 78.6% 63.9% 72.6% 69.9% 71.3% ROA 12.8% 13.0% 11.1% 13.7% 14.4% 14.1% 14.6% 13.2% 18.1% 18.7% 18.9% Cash Vs Accruals Capex% Sales -4.0% -4.3% -3.4% -6.8% -5.5% -3.2% -3.9% -3.1% -4.6% -4.3% -5.7% AR Day 59 60 37 34 37 40 42 43 44 47 45 Inventory Day 102 92 86 121 116 122 136 126 112 111 98 AP Day 31 30 24 38 42 31 27 32 35 44 40 CCC 130 122 100 116 111 131 150 138 121 113 102 Leverage Mkt Cap 124.8 482.1 481.2 1,021.8 1,343.7 1,339.4 338.3 1,285.4 3,393.3 3,486.3 5,157.0 Bs Sh Out 40608 40608 40608 50780 50780 49926 47896 46867.6 46875.1 46875.1 46875 Net Debt 64.0 58.8 79.3 10.4 -98.2 -85.4 -80.9 -128.9 -209.0 -235.2 -171.8 Debt Equity (Bk) 88.0% 48.4% 37.8% 3.6% -24.9% -20.0% -21.1% -25.5% -32.5% -33.0% -22.5% Basic Valuation PE 4.34 12.79 9.53 15.83 18.20 17.34 4.60 14.28 23.96 20.63 27.88 P/Sales 0.45 1.43 0.85 1.69 2.03 1.75 0.41 1.46 3.01 2.80 3.55 P/Book 1.71 3.97 2.29 3.58 3.41 3.13 0.88 2.54 5.28 4.89 6.74
  12. 12. 12 Dr Boen, 80 years-old this year, adds that all six siblings believed in the importance of dreaming to keep them motivated and that “we have been fortunate all the brothers and sisters were able to maintain a strong relationship”. The rare harmonious relationship allowed the different family branches to “lean in” to put in most of the privately-held family jewels inside one listed vehicle instead of stashing away some for themselves as a hedge should things go wrong in a crisis. Together, the Setiawan family maintains a 60% ownership of Kalbe Farma. Current CEO Bernadette Ruth Irawati Setiady is the niece of Dr Boen and the daughter of one of the co-founders Maria Karmila. Bernadette had worked at Kalbe Farma since 1987 and took over in 2008 as CEO/president director from professional executive Johannes Setijono, who had been in that post for ten years after joining Kalbe in 1969 and is now the chairman/president commissioner. When Johannes was asked what achievements he is most proud of, he answered that it is the decision that the company took to not default even when the Indonesian rupiah depreciated to four times its previous rate against the dollar and many of their raw materials were imported to bring costs spiralling out of control; “We found innovative ways to sustain sales such as selling drugs in smaller packs”. He is especially proud of meeting the “challenge of motivating people in an environment where employees can easily succumb to despair. The company made a huge effort to ensure that there were zero layoffs.” Kalbe Farma formulated these corporate values that Johannes espoused as the “Panca Sradha Kalbe” principles reflecting five ideas: (1) trust in each other, whether it be shareholders, management or employees; (2) awareness of a clear goal behind every activity; (3) continuous innovation to maintain the life of the company; (4) search for excellence; and (5) build synergies with other operations. “Since the beginning we had defined our corporate values and we embrace similar values right up until this day,” Dr Boen said. Thus, whether there is a redux to the Asian Financial Crisis in varying magnitude post-tapering depends on “Panca Sradha”, the intangible “belief system” that the corporates hold to guide their day- to-day behavior and during difficult uncertain times.
  13. 13. 13 PS: For most Indonesians, bamboo is an inseparable component from daily life. House wares, tools, and building materials are among the few things associated with bamboos. There is even a culinary delight made of young bamboo shoots called asrebung. Bamboo once played an important role in the struggle for Indonesia’s independence as a symbolic weapon known asbambu runcing, or bamboo spear. The creative and artistic hands of Indonesian artists also carve bamboo into several musical instruments and the national instrument is the Angklung. Angklung is an instrument made from joint pieces of bamboo. It consists of two to four bamboo tubes suspended within a bamboo frame, bound with rattan cords. The tubes are carefully whittled and cut by a master craftsperson to produce certain notes when the bamboo frame is shaken or tapped. Each Angklung produces a single note or chord, so several players must collaborate in order to play melodies. Angklung is Harmony in a Bamboo Orchestra. The instrument has been known since ancient times in some parts of Indonesia, especially in West Java, Central Java, East Java, and Bali. The Angklung is not truly an Angklung if it consists of only one tube. It symbolizes that humans cannot stand solitary; one needs others in life. The large and small tubes also illustrate the development of human life. The small tube illustrates that every person has dreams and desires to become someone “greater”, as symbolized by the large tube. As the Angklung is shaken, both tubes create a harmony illustrating life. The Guinness Book of Record for the world’s largest Angklung ensemble was set in Washington DC after 5,182 people of various nationalities turned up on July 9, 2011 to shake the traditional Indonesian bamboo musical instruments to the tune of We are the World.
  14. 14. 14 Berkshire Hathaway Embracing Media? An Asian Perspective The following article is part of The Miasmic Asian Capital Jungle and the Tranquil Bamboo Innovator Grove, a weekly column on BeyondProxy by Koon Boon Kee. The column explores the sharp contrast between the dark side of Asian markets and the quiet opportunities that come from identifying resilient compounders. This is Issue 12 in the series. (This is a follow-up article to last week’s “’Worthless, Impossible, and Stupid’ Investing in Media Companies in Asia and Europe” on the media industry) “Mother Nature is a serial killer. No one's better, or more creative. Like all serial killers, she can't help but have the urge to get caught or what good would all those brilliant crimes do if no one takes the credit? So she leaves crumbs. Now the hard part, is seeing the crumbs, the clues there. Sometimes it's in your thoughts where the most brutal part of a virus is. Turns out to be the chink in its armor. And she loves disguising her weaknesses as strengths.” - Virologist Andrew Fassbach in the movie World War Z Infected, they turned zombies and become scary, fast-moving attacking machines that bite. This scene from the movie World War Z starring Brad Pitt could well be describing the World War TV frenzy gripping the $160-billion-a-year TV ecosystem as the players are infected by the consolidation virus. Tribune Company (TRBAA), fresh out of bankruptcy, spent $2.7 billion to buy 19 stations from Local TV Holdings in June. Gannet (GCI) acquired Belo (BLC) with its 20 local TV stations for $1.5 billion in July to diversify away from newspaper, which could have prompted Berkshire Hathaway (BRK/A) to dump its entire $38 million stake in America’s largest newspaper publisher in its latest 13F disclosure filed on Aug 15. Buffett’s deputies Ted Weschler and Todd Combs have also bought $23.3 million (547,312 shares) in satellite TV provider Dish Networks (DISH) to add to its existing 6.8% stake (37.27 million shares) in rival DirecTV (DTV) that’s worth $2.2 billion – and to its growing media investments: $46.2 million (4.65 million) in Media General (MEG); $596 million (7.6 million shares) in Viacom (VIAB); and $928 million in “cable cowboy billionaire” John Malone’s Liberty Media (LMCA) (5.62 million shares worth $790 million) and Liberty’s spinoff Starz (STRZA) (5.62 million shares worth $138 million). All together, Berkshire’s media investments, not including Washington Post (WPO), now totalled around $3.8 billion. This is a remarkable shift given that DirecTV, the first non-publishing media investment, was added only two years ago in the 13F filing for 3Q11 and started at $179 million. Buffett himself, of course, is no stranger to the media industry, having invested $4 million, then a 5% stake, in Walt Disney (DIS) in 1965 (which he sold for $6 million), and in Tom Murphy-Dan Burke’s Capital Cities-ABC which was acquired for $19 billion by Disney in 1995. Buffett had also invested in Ralph and Brian Roberts’ Comcast (CMCSA) during 2Q 2004. Berkshire had, however, sold off its entire $200 million stake in Comcast during 2Q 2010. While the content “distributors” from cable to satellite TV companies still spew out attractive cashflow from the subscription- based business model, with some like DirecTV spending $20 billion over the last six years to aggressively buyback half of their outstanding shares, even to the extent of borrowing debt to do so, their subscriber base are in structural decline after 2009 and 2013 could mark the first-ever annual decline in pay TV subscriber numbers. Yet, Comcast had risen over 150% (vs the 45% rise for S&P 500 index) to a market cap of over $110 billion since Buffett sold the
  15. 15. 15 entire stake during 2Q 2010. So going beyond the obvious quantitative and historical cashflow numbers analysis is important to better understand the investment implications of World War TV as well as the potential opportunities and pitfalls in Asia. Quarter Year Value (US$M) Split-Adj Price $ Split-Adj Shares (M) Quarter Year Value (US$M) Split-Adj Price $ Split-Adj Shares (M) 3Q 2004 139.6 18.6 7.5 4Q 2007 217.4 18.1 12.0 4Q 2004 328.4 21.9 15.0 1Q 2008 227.6 19.0 12.0 1Q 2005 334.4 22.3 15.0 2Q 2008 225.1 18.8 12.0 2Q 2005 299.5 20.0 15.0 3Q 2008 236.6 19.7 12.0 3Q 2005 319.8 19.2 16.7 4Q 2008 193.8 16.2 12.0 4Q 2005 285.4 17.1 16.7 1Q 2009 154.4 12.9 12.0 1Q 2006 290.2 17.4 16.7 2Q 2009 169.2 14.1 12.0 2Q 2006 364.2 21.9 16.7 3Q 2009 193.0 16.1 12.0 3Q 2006 409.0 24.5 16.7 4Q 2009 192.1 16.0 12.0 4Q 2006 335.0 27.9 12.0 1Q 2010 215.6 18.0 12.0 1Q 2007 305.6 25.5 12.0 2Q 2010 197.2 16.4 12.0 2Q 2007 335.5 28.0 12.0 3Q 2010 3.2 17.0 0.2 3Q 2007 287.5 24.0 12.0 This subscriber decline has been the origin of the consolidation virus for content distributors to turn into biting machines in an attempt to scale their way to cut cost in cutting better negotiation deals with content owners by coming to the table with a subscriber base so big that content providers cannot afford to pass up, particularly as they expand their reach overseas to Latin America and Europe. Cable and satellite took in $97 billion in subscription fees in 2012 from 101 million subscribers while pay TV providers handed over $43 billion to content-rich owners such as Walt Disney, Viacom (MTV, Nickelodeon, Comedy Central), Time Warner (TWI) (HBO, Cinemax, WB, Turner), CBS (CBS), Discovery Communications (DISCA) (Discovery Channel, Animal Planet), Scripps Networks (SNI) (Travel Channel, Food Network, HGTV) and Grupo Televisa (TV) which owns a 38% stake in the privately-held Univision which produces the wildly-popular telenovelas, or prime-time romantic Spanish-language melodramas. Advertisers also bought a record $63 billion TV time last year. The distributors are also hoping that by scaling up, they can blunt the challenges from cord-cutting internet-TV disruptors from Netflix (NFLX) (30 million $7.99-a-month paying subscribers which accounts for 89% of US shows streamed online and sends a third of traffic through broadband pipes) and Hulu to newer ones such as Apple (AAPL), Amazon (AMZN), Intel (INTC), Microsoft (MSFT), Google (GOOG) (starting with the successful launch of its $35 Chromecast which delivers online and mobile content to the TV screen) and Aereo. The bite is accelerating ferociously: Comcast had acquired its remaining 49% of NBC Universal from GE in Feb 2011 for $16.7 billion to bring content and distribution together like Disney and Time Warner; Disney acquired Star Wars producer Lucasfilm for $4.05 billion in Oct 2012; Time Warner Cable (TWC) and Malone’s Liberty’s 27%-owned Charter Communications (CHTR) are rumored to be discussing a merger; Cablevision (CVC) is speculated to be merging with the privately-held Cox Communications; Buffett’s DirecTV and billionaire Charlie Ergen’s Dish, with a combined 34 million subscriber base, are also rumored to be merging, particularly with Berkshire’s recent purchase of Dish.
  16. 16. 16 Scale has mattered in the case of thwarting the price increase sought by Murdoch’s 24-hour sports channel Fox Sports 1, owned by Twenty-First Century Fox (FOXA), which launched this recent weekend on Aug 16 to challenge the dominance of Disney’s sports network ESPN. ESPN is the core piece of Disney’s cable TV arm, which is responsible for 40% of the company’s operating profits and 60% of its free cashflow, and the network comprises about half of Disney’s total value. Fox Sports wants to charge 80c per subscriber per month but the distributor network of DirecTV-DISH-Time Warner-Cablevision are flexing their muscle by refusing to pay Fox Sports beyond the 23c per subscriber per month that they previously paid for under the old Speed channel. Scale has not prevented the dominance of the $40-billion ESPN to charge $5 a month or $6.5 billion revenue from “affiliate fees” that’s “paid” by the distributors who charge consumer higher bills. “Live” sporting content is what 100 million American households are willing to pay for and what advertisers crave for ($3.3 billion revenue from ads) since we cannot skip the ads for “live” events and a price premium can be charged for the ads that are supposedly immune to the Netflix-Video-On-Demand (VOD) disruption. Even so, ESPN is laying off 5% of its 7,000-strong-workforce in recent months with escalating programming cost (over $5 billion) for rights to US Open, NFL etc. Despite the subscribers decline, cable guys such as Comcast and Malone are still making money off their broadband Internet infrastructure which provides 60% of US households with high-speed internet data and charging customers more for their bundled offering. As Malone puts it aptly, high-speed Internet is “the stickiest product I’ve ever seen. People would give up food before they give us the Internet.” While there are calls to force cable companies to unbundle their content with the view to lower the exorbitant bills that consumers are paying when they can cherry-pick their channels, content owners are likely to quickly renegotiate deals to make up for revenue losses and TV wouldn’t be cheaper. Internet disruptors have also struggled to obtain movies and shows for an Internet-based entertainment service as major content owners fear such services will jeopardize the $96 billion a year in fees they share with cable and satellite TV providers. Thus, the market view is that the economics tectonic plates in the TV ecosystem are difficult to unravel for a relatively long period in the face of the twin threats of regulatory shock and technology disruption. However, unlike cable companies, satellite providers don’t have broadband pipeline to fall back on and are perhaps under greater pressure to broaden and diversify its income stream. DirecTV, attracted by the 4 million Hulu Plus subscribers who pay $7.99 a month and a customer base that has doubled over the year-ago, wanted to buy Hulu for over $1 billion to diversify but failed as the JV owners of Disney, Fox and NBC abandoned the sale last month. Noteworthy also is that DirecTV had recently overstated its subscriber numbers in Brazil which was 100,000 lower than previously reported to Brazilian regulators and 200,000 lower than cited on March 31 as employees improperly credited customer accounts to reduce or eliminate churn. DirecTV Latin America accounts for 21% of the group’s revenue with its 16 million-plus subscribers through its ownership of about 93% of Sky Brasil, 41% of Sky Mexico and 100% of PanAmericana, which covers most of the region’s other nations. In short, every player in the TV ecosystem from content distributor to content owner is bulking up through M&A and financial engineering. The consolidation virus is finding suitable healthy hosts for reproduction.
  17. 17. 17 The strength of the frenzied consolidation virus that brings the promised deal negotiation leverage over suppliers and distributors to bring down cost may perhaps be its weakness in disguised. One, the weakest link of the TV ecosystem is that it is facing an affordability and trust crisis and consumers are simply paying too much for their TV entertainment content year after year that’s rising much faster than the inflation rate and any cost savings are unlikely to be passed on to consumers. How much more of an increase can the consumers absorb? This will be unsustainable when there is a viable alternative in the marketplace, something which many experts argue is not in sight and contend that those who have been cutting the cord are low-quality consumers at the bottom-half of the economy who struggle to make ends meet. Two, the cost savings after all the dealmaking may not materialize given the generally poor post-integration record of M&A deals in media. Cost-cutting through layoffs is particularly fraught with risk in media without the right culture to continually execute at the operational level, as illuminated by the acquisition experience of Capital Cities with ABC Networks when Tom Murphy and Dan Burke managed to keep morale of the creative workforce up when the newly acquired big-town media guys had to adapt to the frugal corporate culture DNA. The Murphy-Burke combination had been a rare exception, not the norm. Importantly, one cannot scale out of a shift in paradigm. Netflix’s business model has provided an alternative by initially streaming “unwanted” and out-dated cheap content to cater to the “long tail” of demand. TV and film studios also used to see Netflix as a way to make some extra money licensing older shows and movies. Now, the content providers view Netflix as a potential financier and a launch pad for original shows and an aggressive buyer of some programming that is less valuable in the TV world. Lions Gate (LGF) has developed original programming for Netflix and DreamWorks Animation (DWA) is planning to produce more than 300 hours of programming for Netflix in the coming years. The subscription-based business model is supposed to adhere to the pioneering philosophy advocated by Ben Franklin of providing men of moderate means the access to quality content. Through regulatory capture, the players in the TV ecosystem have destroyed the trust amongst the community of customers. As mentioned in last week’s article “’Worthless, Impossible, and Stupid’ Investing in Media Companies in Asia and Europe”, the bastion of safety from the seemingly inflation-proof subscription-based cashflow paid by the captive consumers may hit its limits when trust is abused and eroded. Rather than be locked into paying the price of $80 to over $100 per month (more than double the average $40 in 2001) at an increasing rate year-after-year to enjoy TV and internet entertainment, the 10X pricing disruption with increasingly compelling original content offered by Netflix and potentially Amazon might restore the trust pact with the customers and bring back the original Ben Franklin values of the subscription-based business model for a sustainable ecosystem. In Asia, pay TV piracy or revenue leakage is particularly rampant with over $2 billion lost every year and is difficult to stamp out. Original TV entertainment content that is screening on cable or satellite also becomes quickly available online, making the costly platform built by content distributors less valuable. Thus, while Asia accounts for half of the world’s pay TV market, it only enjoys around 10% of total revenues with the low ARPU (Average Revenue Per User). North America, with only 20% of the subscribers worldwide, rakes in over 60% of total revenue because of its high ARPU. Some like Hong Kong’s TVB (511 HK, market cap $3 billion) have a stranglehold on the popular local stars and still enjoy switching power over their subscribers for their local soap operas. Asian content owners are also at the mercy of the government-supported content distributors and a limitation of the cultural genre to scale to other regional and global markets. Also, there are few content franchises that are as lasting as a HBO or ESPN and many of them are discrete one-trick-pony productions.
  18. 18. 18 Despite the limitations and challenges, there are some niche local content producers that have innovative business models that have grown from around $80-90 million in market cap to $250-300 million over the past eight years. Thailand’s No. 1 TV producer Workpoint Entertainment (WORK TB, market cap $268 million) produced hit TV shows such as Ching Roi Ching Lan (featuring slapstick interludes), Game Tosakan (a face-guessing game inspired by the 10-faced ogre in Ramayana), Fan Pan Tae (The Fan), Khun Phra Chuay (traditional Thai culture in a new presentation) and Thailand's Got Talent and rarely makes a flop. Workpoint was founded in 1989 by creative guru Prapas Cholsaranon and TV tycoon Phanya Nirandkul. Prapas, better known as Jik, is a songwriter, author, play director, TV producer, and he became a household name when he wrote songs for the band Chaliang two decades back. Songs like Mr Omelette, Kluay Khai (Bananas), or Rae Khai Funn (Dream Hawkers) whose childlike lyrics hide meanings about the joy and vacuum of life. RS (RS TB, market cap $259 million), established in 1976 by Kriengkai Chetchotisak, has expanded beyond Thai country music (luk thung or “children of the fields”) and Thai pop music (pleng thai sakon) record label to film and TV series production, launching in 2008 Thailand’s first digital online music platform (and sold its compact-disc machinery and factory), radio programming (Thai Easy Listening: Cool Fahrenheit 93, rank #2; International Music: Cool Celsius 91.5, launched Mar 2013; Thai Country: Sabaidee Radio 88.5, rank #3) and satellite TV (Music: Sabaidee TV, YouChannel; Entertainment: Channel 8, Star Max Channel; Sports: Sun Channel/Spanish La Liga Soccer). Music and digital music still contributes to the bulk of RS revenue at 30%, followed by showbiz 27%, TV 23%, radio 11%, sport 7%, in-store media 3%. Workpoint’s Prapas Cholsaranon (L) and the Chetchotisak brothers of RS, Kriengkai and CEO Surachai (R). Basic Financial Summary of Workpoint US$M 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sales 21.6 27.8 34.6 38.3 36.3 29.3 41.2 60.2 68.8 Net 5.1 7.5 8.0 7.2 4.9 2.1 5.9 10.7 13.0 CFO 3.7 8.5 8.9 8.7 6.1 3.1 7.1 11.3 13.2 Capex -1.0 -4.8 -9.2 -1.3 -0.5 -0.5 -0.8 -1.1 -2.7 Profitability GP Margin 52.9% 56.7% 53.5% 49.5% 44.2% 36.4% 43.5% 46.8% 47.2% EBIT Margin 33.0% 35.0% 31.0% 25.2% 18.8% 9.9% 18.4% 25.7% 25.1% EBITDA Margin 34.4% 36.8% 32.8% 32.1% 25.4% 16.2% 23.3% 28.9% 28.9% Net Margin 23.7% 27.1% 23.3% 18.9% 13.4% 7.3% 14.3% 17.8% 18.9% GP/TA 45.9% 56.1% 52.6% 51.7% 47.9% 31.3% 41.3% 59.5% 55.4% ROA 20.6% 26.7% 22.9% 19.8% 14.6% 6.3% 13.6% 22.7% 22.2% CFO/TA 15.0% 30.2% 25.4% 23.7% 18.2% 9.1% 16.3% 23.9% 22.6% Cash Vs Accruals WK% Sales -9.1% 0.5% -1.4% -1.6% -4.0% -2.0% -3.4% -3.3% -4.8% Capex% Sales -4.7% -17.1% -26.5% -3.4% -1.3% -1.6% -1.9% -1.8% -3.9% AR Day 65 66 64 64 63 70 59 58 64 Inventory Day 20 29 29 29 28 28 38 34 27
  19. 19. 19 AP Day 26 25 27 26 27 24 18 23 27 CCC 59 71 66 67 65 74 78 68 63 Leverage Mkt Cap 81.7 92.2 122.0 115.8 28.6 41.6 80.5 99.1 382.4 Bs Sh Out 250.0 250.0 250.0 250.0 250.0 250.0 250.0 250.3 257.1 Net Debt -3.1 -4.9 -6.1 -6.9 -5.8 -5.6 -9.5 -11.6 -8.6 Debt Equity (Bk) -14.2% -20.9% -21.7% -22.0% -19.7% -18.4% -25.7% -30.4% -18.7% Basic Valuation PE 15.99 12.26 15.15 16.00 5.87 19.52 13.64 9.22 29.38 P/CFO 22.0 10.8 13.7 13.3 4.7 13.4 11.4 8.7 28.9 P/Sales 3.79 3.32 3.53 3.02 0.79 1.42 1.95 1.65 5.56 P/Book 3.75 3.94 4.32 3.70 0.97 1.36 2.18 2.60 8.33 Basic Financial Summary of RS US$M 2003 2005 2006 2007 2008 2009 2010 2011 2012 Sales 45.6 67.9 81.1 71.2 70.4 63.4 91.5 89.5 90.5 Net 2.6 -10.8 4.1 -3.5 -12.0 2.2 10.0 6.9 9.1 CFO -10.3 6.3 -1.6 -2.6 3.1 7.4 23.9 7.8 6.7 Capex -5.6 -1.7 -1.1 -1.7 -3.3 -0.4 -1.1 -1.1 -6.2 Profitability GP Margin 29.7% 26.4% 27.4% 25.0% 10.3% 23.4% 32.1% 32.1% 35.1% EBIT Margin 5.5% -14.2% 3.9% -7.1% -15.8% 3.3% 13.0% 10.4% 12.2% EBITDA Margin 10.0% -1.8% 7.9% -2.8% 0.6% 7.9% 23.8% 13.5% 15.5% Net Margin 5.7% -15.8% 5.0% -5.0% -17.0% 3.5% 10.9% 7.7% 10.0% GP/TA 24.1% 39.4% 37.5% 29.0% 13.4% 29.0% 56.6% 48.5% 39.0% ROA 4.6% -23.7% 6.9% -5.7% -22.1% 4.3% 19.3% 11.6% 11.1% CFO/TA -18.3% 13.9% -2.7% -4.3% 5.7% 14.4% 46.1% 13.2% 8.2% Cash Vs Accruals WK% Sales -30.9% 4.6% -3.3% 4.8% 5.2% 5.6% 1.8% -2.8% -7.0% Capex% Sales -12.2% -2.5% -1.4% -2.3% -4.7% -0.7% -1.2% -1.2% -6.8% AR Day 73 88 88 116 100 89 63 75 84 Inventory Day 146 81 33 21 13 14 9 9 18 AP Day 50 65 50 23 41 CCC 169 104 71 60 61 Leverage Mkt Cap 91.0 37.6 88.9 61.9 22.0 40.3 63.1 72.7 165.4 Bs Sh Out 700.0 700.0 700.0 700.0 700.0 700.0 708.1 882.7 865.0 Net Debt -3.2 -1.6 1.4 7.3 15.2 9.9 -11.3 -8.5 3.7 Debt Equity (Bk) -8.4% -7.0% 4.4% 27.1% 105.4% 59.6% -38.4% -22.9% 9.1% Basic Valuation PE 35.00 -3.49 21.76 -17.55 -1.84 18.27 6.31 10.58 18.27 P/CFO -8.9 5.9 -56.7 -23.7 7.1 5.5 2.6 9.3 24.7 P/Sales 2.00 0.55 1.10 0.87 0.31 0.63 0.69 0.81 1.83 P/Book 2.37 1.61 2.83 2.31 1.53 2.42 2.14 1.95 4.02 Korea’s Loen Entertainment (016170 KS, market cap $305 million) was founded in 1961 by former English- language-daily journalist Min Young-bin as YBM Sisa English, a language-learning tape creator. In the 1960s when Korea was an impoverished nation just out of war, the medium of studying English was limited to printed publications including magazines, books and dictionaries. YB Min launched the country’s first magazine for English learners in 1961 and “A Handbook
  20. 20. 20 of Business English” in 1967 in response to policies designed to drive exports. The next decade marked the use of audio and sound in language education. In 1970, supported by the U.S. government, YBM brought out English 900, a set of six books with 60 cassette tapes on 900 English sentence structures. YBM later expanded into a major K-Pop music record label which debuted hallyu celebrity Rain. SK Telecom bought a 60% stake in the music record firm in 2005, renaming it Loen to be put in charge of operating SK’s online music distribution service MelOn in 2009. MelOn grew to become the most used online music sales in Korea. YBM President Min Sun-shik is the founder’s son (photo). SK is looking to sell its stake in Loen to a foreign PE firm in a recent announcement last month. Basic Financial Summary of Loen US$M 2001 2005 2006 2007 2008 2009 2010 2011 2012 Sales 23.1 23.6 33.0 36.9 28.5 79.9 120.2 151.0 164.3 Net 1.8 -3.4 -0.7 -6.8 1.2 3.6 8.5 19.3 21.2 CFO 2.3 1.5 -5.4 5.1 -6.2 17.9 22.3 6.9 24.7 Capex -0.3 -0.4 -1.0 -0.1 -0.5 -3.6 -1.5 -3.9 -3.6 Profitability GP Margin 45.6% 40.9% 50.7% 53.9% 74.4% 97.8% 99.2% 98.2% 97.4% EBIT Margin 14.1% -24.2% -2.2% -11.4% 1.0% 6.3% 11.8% 17.6% 16.3% EBITDA Margin 25.0% -20.9% 0.5% -7.6% 5.9% 13.4% 18.4% 23.5% 22.3% Net Margin 7.7% -14.3% -2.2% -18.6% 4.1% 4.5% 7.0% 12.8% 12.9% GP/TA 35.4% 21.1% 32.8% 46.0% 34.1% 91.2% 102.2% 109.4% 98.3% ROA 6.0% -7.4% -1.4% -15.8% 1.9% 4.1% 7.2% 14.3% 13.0% CFO/TA 7.8% 3.4% -10.5% 11.8% -9.9% 20.9% 19.1% 5.1% 15.2% Cash Vs Accruals WK% Sales -9.0% 31.8% -18.6% 21.5% -29.5% 7.8% 9.6% -16.3% -3.2% Capex% Sales -1.2% -1.5% -3.1% -0.3% -1.8% -4.5% -1.2% -2.6% -2.2% AR Day 60 78 85 89 83 47 56 55 57 Inventory Day 107 72 36 28 29 42 78 49 38 AP Day 52 73 50 36 226 2,767 8,314 2,712 1,638 CCC 114 77 71 81 -114 -2,678 -8,180 -2,607 -1,542 Leverage Mkt Cap 23.6 86.7 66.1 71.5 78.7 139.8 176.2 290.3 329.3 Bs Sh Out 10.9 16.0 16.0 16.0 24.2 24.3 23.2 25.3 25.3 Net Debt 1.7 -4.8 -1.8 -3.9 -15.4 -16.9 -17.2 -19.2 -24.5 Debt Equity (Bk) 8.9% -12.3% -4.2% -11.7% -31.1% -31.6% -27.2% -20.4% -20.4% Basic Valuation PE 13.32 -25.61 -90.90 -10.44 66.47 39.31 20.84 15.01 15.55 P/CFO 10.3 56.3 -12.3 14.0 -12.7 7.8 7.9 42.0 13.3 P/Sales 1.03 3.67 2.00 1.94 2.76 1.75 1.47 1.92 2.00 P/Book 1.25 2.23 1.59 2.12 1.59 2.61 2.79 3.09 2.73 The unique challenges faced by Asian players in the entertainment content ecosystem have resulted in a sharp dichotomy of disappointments and resilient innovators. One such Asian pitfall has been Qin Jia Yuan Media (2366 HK) (QJY). Listed in June 2004 on the Hong Kong Stock Exchange, QJY had been a former stock market darling before the global financial crisis hit. Hong Kong’s “queen of drama” and writer-entrepreneur Anita Leung Fung-yee had started the business with her husband Philip Wong Yu-hong in 1995. Anita had written over 100 novels and essays since 1989 and many of her romance novels have been made either into movies or TV drama series in China, Hong Kong and Taiwan. QJY’s business model is to plan and invest in TV drama series in exchange for accompanying advertisement airtime. QJY boasts of a sizeable library with 5,000 hours of film stock which could provide recurrent income given that over 82% of TV programs in China are repeated programs. Out of the 18%
  21. 21. 21 of TV programs that are new programs, 58% are non-script (e.g. situation drama, chat shows, variety shows, documentaries) while 42% are drama with an escalating production cost of at least RMB 1 million per episode for the Grade A drama that content distributors wanted. During the listing in 2004, the shares were oversubscribed by 87 times and many powerful and prominent tycoons such as Cheung Kong-Hutchinson’s Li Ka-Shing, property billionaire Lee Shau-kee (chairman of Henderson Land Development) and Tsang Hin-chi (founder of Goldlion Group) are cornerstone investors. Market cap has grown from HK$500 million on the day of listing to over HK$3 billion in 2007. The year 2007 saw QJY generate record performance and the company made it to Forbes list of 200 best listed companies in the Asia-Pacific region. FY08 (year end Sep) also saw another record performance with net profit of over HK$217 million on revenue of HK$322 million. Anita has been an inspiring entrepreneurial story, writing scripts for TV stations in her university days to pay for her education, later opening HK’s first company providing trained Filipino maids in mid 1970s. Anita’s success in the maid agency caught the eye of the legendary Fung King-hey, the business magnate who founded Sun Hung Kai & Co and was reputed as “king of securities world” and “godfather of the stock market”. Fung invited Anita to become the head of PR in SHK & Co. Anita later joined Ogilvy in 1983 and also completed her PhD in two years. After the 1987 stock market crash, Anita turned to writing seriously and began writing a column in the Ming Pao newspaper called Qin Jia Yuan (which means “diligence and opportunity” in English), a name given by the legendary martial arts novelist Louis Cha. In 1989, she published her first novel and her fame skyrocketed in HK and China and many of her writings became adapted into TV plays. Anita was also the official biographer of tycoon Lee Shau-kee. Anita had the potential to be Asia’s JK Rowling or Oprah Winfrey. QJY’s market cap has since plunged to around HK$560 million ($73 million) with plenty of fund raising along the way that diluted and destroyed shareholders’ returns, including convertible bonds that are now more known as toxic “Happy Meals” - deals named after the McDonald's burger-and-toy combo. Companies strapped for cash serve up everything the funds need to profit: bonds that are convertible into stock if the borrower does well, and tools for short-selling and betting against the company if its prospects sour. Happy Meal deals represent a twist on the hedge-fund strategy called "convertible arbitrage," in which traders buy a bond that can be exchanged for stock, then short the shares, exploiting price discrepancies between the two securities. In the traditional version, hedge funds borrow the shares from other investors, which occasionally can be difficult and costly. In Happy Meal deals, companies themselves lend the stock - at a minimal cost to the hedge funds. In Asia, value investors need to avoid companies issuing these toxic CB, no matter how attractive the quant numbers may look or how exciting the corporate news announcement. QJY had
  22. 22. 22 suffered losses in its large-scale drama production and had to write off in FY09 HK$466 million on various intangible assets, reimbursement receivables, and prepaid long-term deposits related to the suspension of the long-production-cycle drama program. According to the company, after the financial tsunami, investors of large-scale TV dramas had turned cautious and divested while sponsors of TV drama series also became unwilling to accept projects with long production periods and diverted their sponsorships to other programs for immediate returns. QJY had also expanded into non-TV media services such as outdoor LED billboard advertising, home TV shopping, concert producer entertainment, marketing and public relation services which require investments and working capital and therefore cannot bind cash to programs with overly-long collection periods. Unlike Workpoint, RS and Loen who focused on crafting and refining their niche unique content development and distribution, QJY had strayed outside of its core expertise in content development to financial engineering ventures in crowded competitive space such as outdoor billboard advertising and home TV shopping that had little to do with the original strength in harnessing the romantic drama power and also require high capex investments funded by the plentiful capital before the global financial crisis. Surrounded by shrewd bankers and financial consultants looking for their fee commissions in dealmaking, Anita was distracted into building a media “conglomerate” which had too many moving parts. Workpoint, RS and Loen had been conservative all the while in their capex investments as they are aware that the entertainment content industry is full of creative surprises and disruptive dangers; staying financially prudent and focused is important in order to bend, not break, when the storm ravage through the ecosystem. In the movie World War Z, the old man and the sickly boy were ignored like a river around a rock: the infected do not bite people who are seriously injured or already terminally ill since they would be unsuitable hosts for viral reproduction. Given the prevalent expert view that the economics of the TV ecosystem is too entrenched to be dislodged by disruptive technology and regulatory shocks and the game is all about biting one another to get cost savings from scale, it may be interesting to think about the “sickly boy” who is “outside” of the system. In Asia, movie- going, which has been disrupted by piracy and internet, is experiencing a comeback to become an integral part of the leisure as people want to laugh and cry together in the high-tech box-office theatre instead of copping up at home to watch their TV entertainment. For instance, in China, now the world's second-largest film market after the U.S., Hollywood blockbuster "Pacific Rim," a giant monster-versus-robot movie, struggled in the U.S. but was a hit in China when it opened this month in thousands of state-of-the-art movie IMAX- and Dolby-equipped theatres that have sprung up in China in the past few years. The number of screens in China quadrupled to 25,000 from 2009 to 2012 and 5,000 more are expected to be added by 2015 by players such as Korea’s CJ CGV (079160 KS). The opening day grossing of Pacific Rim was the biggest for any Warner Bros movie in China. US grossing for Pacific Rim is $98 million (25%) while foreign grossing is $286 million (75%) on the $190-budget movie. Still, the higher real-estate cost, high capex investments and more competition makes chasing the growth and valuations a relatively risky proposition. In Japan, Toho Co (9602 JP, market cap $4 billion) has mastered the art of dominating the film and theatre production and distribution. There are three major film studios in Japan (Toho, Toei and Shochiku) which has many theatres equipped with the latest technology and
  23. 23. 23 mostly located around train stations. Toho has the largest domestic market share and almost all producers hope that their films will be distributed by Toho. Of the top Japanese films that earned more than ¥1 billion, Toho usually accounts for over 75% of them, demonstrating its overwhelming distribution power. Toho has over 65% of the total box-office takings for Japanese films as a whole and around half of the aggregate box-office takings for Japanese and imported films combined. Toho is also the creator of Japan’s favorite monster The Godzilla in 1954 by producer Tomoyuki Tanaka and the Big G is featured as the “Kaiju” (Japanese for monster) in Pacific Rim. Godzilla, Mothra, King Ghidorah, Mechagodzilla, and Rodan are described as being Toho's "Big Five" due to the monsters' numerous appearances in all three eras of the franchise, as well as spin-offs. Toho has also been involved in the production of numerous anime titles. Toho is also the producer and distributor of many tokusatsu (special effects) movies, including the Chouseishin superhero TV franchise. Toho is also the largest shareholder (7.96%) of Fuji Media (4676 JP, $market cap $4.4 billion). Toho was founded by the founder of Hankyu Railway, Ichizo Kobayashi (1873-1957) (photo), in Aug 1932 as the Tokyo-Takarazuka Theater Company. Kobayashi-san was an innovator when he merged four small production companies that had all embraced the production of sound films while older, more established movie studios were still clinging on to the tradition of silent movies with live narration (benshi). The railroad tycoon had also successfully revived the struggling Arima Electric Railway in Osaka by combining transportation with show business. In the early 1930s, Kobayashi-san extended a new railroad line to a sleepy Osaka suburb and, at the end of the tracks, he built a theatre staffed with an all-female opera troupe, the Takarazaku. Located off the beaten path and kept under monastic conditions, the Takarazuka girls developed a mystique and soon became all the rage – an entire burgeoning entertainment city sprang up around the theatre, with a zoo, a circus, and restaurants and Kobayashi-san made a fortune on his railroad. With the profits, Kobayashi began buying theatres in the Tokyo area, envisioning a nationwide chain of movie and opera houses. During World War 2, many of the theatres and tangible assets were bombed and destroyed but Toho was able to bounce back from the crisis with long-lasting intangible creations such as Godzilla which became one of Toho’s trademarks. It managed much of the kabuki in Tokyo and, among other properties, the Tokyo Takarazuka Theater and the Imperial Garden Theater in Tokyo. Kobayashi-san’s philosophy of providing widely popular entertainment of high quality in a beautiful environment of cheerful mood extends to the foundation of management of the firm. Financial Summary of Toho Co US$M, YE Feb 2005 2006 2007 2008 2009 2010 2011 2012 2012 Sales 1877.9 1812.8 1719.7 1777.0 2127.9 2161.1 2306.5 2300.1 2473.7 Net 54.4 96.1 66.5 63.2 22.9 84.4 132.1 125.0 204.4 CFO 193.5 214.9 196.7 102.1 272.8 282.0 326.2 178.3 471.2 Capex -176.1 -269.0 -169.8 -177.6 -149.1 -117.8 -160.5 -137.4 -105.0 Profitability GP Margin 36.2% 35.7% 37.2% 36.9% 39.2% 39.1% 38.3% 38.6% 40.7% EBIT Margin 12.6% 10.7% 11.6% 9.7% 10.9% 9.5% 11.3% 9.3% 14.1% EBITDA Margin 18.2% 16.8% 16.8% 13.8% 15.6% 14.0% 16.0% 15.0% 19.3% Net Margin 2.9% 5.3% 3.9% 3.6% 1.1% 3.9% 5.7% 5.4% 8.3% GP/TA 20.4% 20.1% 20.5% 20.6% 26.5% 23.6% 21.9% 22.4% 26.6%
  24. 24. 24 ROA 1.6% 3.0% 2.1% 2.0% 0.7% 2.4% 3.3% 3.2% 5.4% CFO/TA 5.8% 6.7% 6.3% 3.2% 8.7% 7.9% 8.1% 4.5% 12.5% Cash Vs Accruals WK% Sales 1.5% -1.0% -0.6% -0.2% 0.7% 5.9% 0.2% -0.7% 0.2% Capex% Sales -9.4% -14.8% -9.9% -10.0% -7.0% -5.5% -7.0% -6.0% -4.2% AR Day 28 28 30 31 31 38 44 50 46 Inventory Day 31 34 34 29 24 21 17 14 14 AP Day 28 33 34 33 33 35 37 39 38 CCC 32 29 30 27 22 24 24 25 22 Leverage Mkt Cap 3,012.9 3,530.2 3,759.6 4,408.0 2,840.7 3,054.2 3,024.5 3,288.0 3,572.5 Bs Sh Out 186.3 187.1 188.6 188.6 188.0 186.8 186.5 185.4 185.2 Net Debt 116.6 114.7 57.0 113.7 55.0 48.7 75.2 50.5 9.1 Debt Equity (Bk) 5.4% 5.5% 2.7% 5.2% 2.5% 1.9% 2.6% 1.7% 0.3% Basic Valuation PE 55.34 36.73 56.50 69.78 124.24 36.19 22.89 26.31 17.48 P/CFO 15.6 16.4 19.1 43.2 10.4 10.8 9.3 18.4 7.6 P/Sales 1.60 1.95 2.19 2.48 1.33 1.41 1.31 1.43 1.44 P/Book 1.41 1.68 1.80 2.00 1.27 1.20 1.05 1.13 1.31 PS: The Tale of the Bamboo Cutter is the oldest surviving work of fiction in the Japanese language which existed in the 10th century and is known by virtually every Japanese child in the world. A pocket-sized baby – Princess Kaguya – who was growing inside the stalk of a mysterious glowing bamboo plant was discovered and raised by an old, childless bamboo cutter called Taketori no Okina (竹取翁, "the Old Man who Harvests Bamboo"). She was named Kaguya-hime (Nayotake-no- Kaguya-hime "princess of flexible bamboos scattering light"). Thereafter, the old man found that whenever he cut down a stalk of bamboo, inside would be a small nugget of gold. Soon he became rich. Kaguya-hime grew from a small baby into a woman of ordinary size and extraordinary beauty. News of her beauty had spread and the Emperor fell in love with her and asked her to marry him. Kaguya refused – and returned to her people on the Moon when they came to fetch her, leaving her earthly foster parents in tears. The Emperor ordered his men to take a letter he wrote to Kaguya-hime to the summit of “the mountain closest to Heaven” and burn it, in the hope that his message would reach the distant princess. She offers a jar of the elixir of immortality to her adopted parents, but they refuse to taste any of it, saying that life has no appeal without their daughter. The Bamboo Cutter and his wife send the elixir of life to the emperor, who refuses it because he can never see Kaguya-hime again, and orders it to be burnt on the top of Mount Fuji—which explains the smoke that perpetually comes from the mountain. The legend has it that the word immortality (不 死 fushi, or fuji) became the name of the mountain, Mount Fuji. The kanji for the mountain, 富士山 (literally "Mountain Abounding with Warriors"), is derived from the Emperor's army ascending the slopes of the mountain to carry out his order. Toho’s Studio Ghibli will be remaking the iconic anime film Kaguya-hime no Monogatari (“The Tale of Princess Kaguya to be released probably next year.
  25. 25. 25 “Worthless, Impossible, And Stupid” Investing in Media Companies in Asia and Europe The following article is part of The Miasmic Asian Capital Jungle and the Tranquil Bamboo Innovator Grove, a weekly column on BeyondProxy by Koon Boon Kee. The column explores the sharp contrast between the dark side of Asian markets and the quiet opportunities that come from identifying resilient compounders. "If India were as well-organized as China, it will go at a different speed, but it’s going at the speed it is because it is India. It’s not one nation. It’s many nations. It has 320 different languages and 32 official languages. So no prime minister in Delhi can at any one time speak in a language and be understood throughout the country. You can do that in Beijing." - Singapore’s founding Prime Minister Lee Kuan Yew in the Charlie Rose interview Worthless, Impossible, And Stupid. The title to the inspiring must-read book by Daniel Isenberg - to describe the disdain and derision that entrepreneurs face in developing products and services that people initially don’t think they want, and ultimately go on to realize extraordinary value for their customers and society – could well be describing Amazon’s Jeff Bezos’ purchase of Washington Post’s (WPO) newspaper publication assets for $250 million. Warren Buffett had also acquired Omaha World-Herald for $200 million in Nov 2011 to add to his collection of daily small-town local newspapers that include Buffalo News (purchased in 1977) and Media General newspapers (purchased in May 2012 for $142 million in cash plus $445 million in loans at 4 times EBITDA). A contrarian mindset and an extreme sense of personal accountability for results allow these Worthless entrepreneurs to see hidden value in situations that others disparage, go through adversities, solve burning problems, and create opportunity where others see nothing. Interestingly, three days later after the Bezos-WaPo deal, Pearson (PSON LN) announced that they are selling Mergermarket, a financial information company founded in 2000 which employs 500 journalists, for $500 million. This is twice the value of the venerable brand Washington Post which employs over 800 unioned newsroom staff. And there are some reports that Bezos overpaid given that the 17 times 2012 EBITDA valuation is much higher than the average of 3.5 to 4.5 times of other newspaper and media companies. WaPo is closer to $60 million, the analysts argued, notwithstanding the pension plan which is overfunded by $604 million. Especially when valuation is declining like an ice cube: New York Times (NYT) recently sold Boston Globe for $70 million after acquiring for $1.1 billion in 1993; Murdoch’s News Corp writing off over $2.8 billion on its $5.6 billion acquisition in 2007 of Dow Jones, the publisher of Wall Street Journal; Axel Springer (SPR GR), Germany’s and Europe’s biggest newspaper publisher, announced earlier on July 25 the sale of its print assets for $1.2 billion. The old newspaper business model of scaling by circulation reach to win the disproportionate ad revenue is getting destroyed as readers migrate to the digital realm with print ad revenue down 60% to $19 billion in 2012 since hitting a historic peak in 2005. Print newspapers are increasingly losing their relevance and voice with the disaggregation of news sources. The promise of online ad did not grow to replace the yawning gap with newspaper online revenue up from $2 billion in 2005 to $3.3 billion in 2012. Yet, value investors have witnessed the rise of localized search review ad-based business models, such as loss-making Yelp (YELP, +110% since its 2011 IPO to $3.3 billion in
  26. 26. 26 market cap) and Angie’s List (ANGI, +53% since its Oct 2012 IPO to $1.4 billion in market cap), and the specialized vertical ad portals such as TripAdvisor (TRIP, +190% since its Dec 2011 IPO to $11.6 billion in market cap). So why the significant difference in value between WaPo and Pearson’s Mergermarket? This is critical to understand and explore in order to appreciate this evergreen question: how should value investors react when there is a creative destruction storm hurtling through the industry value chain? Do we swallow the “cheap” ice cubes? Are there resilient compounders with innovative business models that emerge from the disruptive upheaval? With Buffett’s bet on the “local” business model staying relevant and supposedly blunting the effects of digital migration (“In towns and cities where there is a strong sense of community, there is no more important institution than the local paper”, as Buffett elucidates), aren’t there even more such Buffett-like opportunities in Asia and Europe? This is especially when Asia is heterogeneous with geographical and language differences between countries and within itself amongst the different regional provinces, unlike America which is far more homogenous, providing fertile ground for the monetization of localized content. As Singapore’s founding Prime Minster Lee Kuan Yew pointed out wisely, Asian countries such as India have enormous language and geographical differences dividing the population – fuelling their thirst for relevant information. Buffett-Munger would also probably be shocked that the market cap of Singapore’s newspaper and media company Singapore Press Holdings SPH (SPH SP) at $5.2 billion dwarfs the iconic New York Times’ $1.8 billion and is also bigger than Washington Post’s $4.3 billion. Besides the language and geographical context in Asia that shaped valuation, “strategic” and “sensitive” industries such as media is still very much protected and closed, resulting in the quasi-monopoly value of companies such as SPH. Below is a simple map of the various listed Asian media companies. Serious value investors will know that these “opportunities” in the Asian context can be traps: geographical and language differences are a double-edged sword which can limit the scalability of the business model, while monopoly and government-protected status can breed management complacency and increase the probability for capital misallocation and ferment a toxic FFF (Fight-For-Favors) culture that snuffs out innovations. Media Companies Localized Business Models Specialized Vertical Business ModelsLanguage Geographical Protected Singapore SPH (SPH SP), Starhub (STH SP) Malaysia Star Publication (English) (STAR MK), Media Prima (Malay) (MPR MK), Media Chinese (685 HK), Astro (ASTRO MK) Catcha (CHM MK); CBSA (CBS MK) Indonesia Mediacom (BMTR IJ), Elang (EMTK IJ), Surya (SCMA IJ), MNC Sky (MSKY IJ) Visi (VIVA IJ) Thailand Nation (NMG TB) BEC (BEC TB), Workpoint (WORK TB), GMM (GRAMMY TB), RS (RS TB) Philippines ABS (ABSP PM), Lopez (LPZ PM) HK SCMP (583 HK), Sing Tao (1105 HK), Media Chinese (685 HK) HK Economic Times (324 HK), Next Media (282 HK), Pacific Online (543 HK), Sinomedia (623 HK) China BesTV (600637 CH), Jishi (601929 CH), Gehua (600037 CH), Huace (300133 CH), Enlight (300251 CH), HualuBaina (300291 CH), Jiangsu Phoenix (601928 CH), China South (601098 CH), Huawen (000793 CH), B-Ray (600880 CH), GZ Daily (002181 CH), Central (000719 CH), Zhejiang Daily (600633 CH) Huayi (300027 CH) India DB Corp (DBCL IN), Jagran (JAGP IN), HT Media (HTML), Dish TV (DITV IN) InfoEdge (INFOE IN) Korea SBS (034120 KS), KT Skylife (053210 KS), CJ Hellovision (037560 KS), Chosun (033130 KS) NHN (035420 KS), SM (041510 KS), YG (122870 KS), SBS Contents Hub (046140 KS), Loen (016170 KS)
  27. 27. 27 Thus, we need to go back again to the earlier question about the huge difference in value between WaPo and Mergermarket in order to avoid the value traps and importantly, to identify the resilient compounders. Mergermarket is part of the uprising “Subscription Economy” disruptive trend along with the (CRM) in CRM; Workday (WDAY), Concur (CNQR), Cornerstone OnDemand (CSOD), Citrix (CTXS), Ultimate Software (ULTI) and Jive (JIVE) in HR; NetSuite (N) in accounting, ServiceNow (NOW) in ERP, Demandware (DWRE) in ecommerce, Netflix (NFLX) in entertainment content and so on. Thus, rather than hire and commit to one single incremental M&A analyst for at least US$100,000 per year, the client can get superior products and services at a huge fraction of the cost by subscribing to Mergermarket for critical time-sensitive information. Importantly, the client becomes more productive in decision-making with the usage. “Subscription-based” companies are the new Wal-Marts in customer-centric, value-for-money and performance- for-value: the significantly lower entry-level pricing makes it a compelling value proposition for the client; the emphasis will be on consistent performance delivery and engagement to have happy loyal customers given the importance of renewals and churn rate; and the client can upgrade to a higher-level offering easily given the scalable subscription-pricing model through the digital distribution platform. Business is no longer about one-time transactions; it’s about forging an ongoing relationship and bond with the customers to create customer lifetime value. The value of the company is not about how much is sold in the last quarter or last year, but how much can the recurring income grow in the next year or next five years. In fact, the pioneer of the Subscription Economy is Benjamin Franklin with his founding of the world’s first lending library - the Library Company of Philadelphia. Because books from London booksellers were expensive to purchase and slow to arrive, Franklin and his friends, who are of moderate means, could not afford a decent library that cater to their far-ranging conversations on intellectual and political themes. In Franklinian fashion, fifty subscribers invested 40 shillings each and promised to pay ten shillings a year thereafter to buy books and maintain a shareholder's library. Thus, "the Mother of all American subscription libraries" was established, "the contribution of each created the book capital of all." Noteworthy is that successful “subscription-based” companies do not have slack, bloated bureaucracy and that FFF (Fight-for-Favors) culture that plagues the elite establishment as they need to deliver the offering and continually perform with an entirely different business model, cost dynamics, transparency and corporate culture. Using the Bamboo Innovator framework to examine the underlying source of the wide moat advantage of “subscription- based” companies, the value investor will find that it resembles the “core-periphery network” of the bamboo: the nutrients and moisture that would have been exhausted making and maintaining the empty hollow center of the bamboo can be utilized for growth of other culms (stem) and fibers of greatest strength occur in increasing concentration toward the periphery of the plant. By having the digital platform at its “core” and engaging the clients at the “periphery” with empowered frontliners to deliver on-the-ground intelligence without the dreary need to fight for favors and permission from the bureaucratic upper layer, the “subscription-based” companies eliminated the need for bloated, costly layers of bureaucratic elites who disengaged the innovative staff, resulting in the ability to engage the customer on an entirely different price dynamics and value proposition. Thus, while the wide moat advantage at “subscription-based” companies is “high switching costs” based on the existing Morningstar-like framework familiar to value investors, the challenge is that stocks are categorized into such moats after they are obvious when the share price has ran up substantially. Using the Bamboo Innovator mental model to
  28. 28. 28 examine the underlying source of the wide moat, that is, how they are created and sustained, and not the type/category of the wide moat when they are obvious, will imbue the value investor with an analytical advantage over others. Two newspaper and media companies in Europe and Asia stand out as Bamboo Innovators: the Norwegian Schibsted ASA (SCH NO) and India’s DB Corp (DBCL IN) on the “watchlist”. (Un)Surprisingly, both companies are not mentioned at all in the flurry of thoughtful articles and analysis that bombarded the media space since Bezos announced the purchase of WaPo on Aug 5 and Obama cryptically commented earlier on Aug 1 that the old newspaper era is over via Kindle. Over the past five years, WaPo, New York Times and even the digital Thomson Reuters (TRI CN) are down, as seen from the bottom-half of the chart above while Schibsted has rose over 150% to $5.6 billion in market cap. Interestingly, it is around five years ago when Buffett stopped including Washington Post, which he held 1.7 million shares (18.4%) at a $11 million cost, in the investment section of large holding of common stocks in the Berkshire Annual Report in FY2009. The long-term performance of Schibsted is also interesting as the upper-half of the chart pointed out that while NYT, WaPo and Thomson outperformed Schibsted prior to the decline in newspaper print ad revenue in 2005 and before the 2007/09 global financial crisis, Schibsted’s innovative business model in disrupting itself is paying off as it emerged from the crisis stronger than ever: 40% of the $2.5 billion revenue and 69% of the $406 million EBITDA comes from digital online activities. The transition at Schibsted began in 1995 when the company came to realise the media sector's centre of gravity would inevitably shift to digital. The unofficial motto is to accelerate the inevitable (before the inevitable falls on us). Led by a Berkshire-like lean team at the core of only 60 people at the Oslo headquarters to oversee the entire group operation that currently employs 7,800 people spread over 29 countries, Schibsted was ahead of major players in having a sense of urgency despite having quasi-monopoly status with its profitable print assets which have huge penetration in small Nordic markets immune to foreign players (Schibsted owns Aftenposten, Norway’s largest newspaper, and Swedish tabloid Aftonbladet), a similar situation to Singapore. With a stable ownership structure that’s
  29. 29. 29 controlled by a trust and a board that always encourages the management to aim high and take risks, Schibsted experimented with innovative business models. Basic Financial Summary of Schibsted US$M 1992 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sales 423.4 1440.4 1526.3 1818.7 2329.3 2466.9 2037.4 2280.6 2567.4 2538.7 Net 26.9 35.8 135.7 334.6 108.7 -162.7 63.1 462.8 132.5 31.8 CFO -42.9 161.4 152.8 128.2 196.0 135.9 113.5 297.7 265.0 199.0 Capex -25.5 -23.3 -43.3 -59.8 -64.2 -68.8 NA NA -63.2 -62.9 Profitability EBIT Margin 6.5% 8.8% 7.9% 7.0% 7.6% 6.5% 7.1% 11.4% 11.4% 10.3% EBITDA Margin 10.2% 16.5% 11.5% 10.8% 12.1% 22.4% 13.6% 16.5% 16.3% 16.0% Net Margin 6.4% 2.5% 8.9% 18.4% 4.7% -6.6% 3.1% 20.3% 5.2% 1.3% ROA 8.5% 2.9% 11.5% 12.6% 3.7% -6.9% 2.4% 16.4% 4.8% 1.2% CFO/TA -13.6% 13.2% 13.0% 4.8% 6.7% 5.8% 4.3% 10.5% 9.7% 7.2% Cash Vs Accruals WK% Sales -20.6% 0.9% 1.0% -0.1% 0.7% 0.7% 0.1% 0.5% 0.1% 1.9% Capex% Sales -6.0% -1.6% -2.8% -3.3% -2.8% -2.8% NA NA -2.5% -2.5% AR Day 34 34 37 41 46 48 50 46 46 44 Leverage Mkt Cap 368.8 1,885.8 1,938.4 2,388.1 2,857.1 770.1 2,321.2 3,060.1 2,664.7 4,537.5 Bs Sh Out 86.9 83.6 81.7 83.9 82.8 81.0 103.3 103.8 106.9 107.1 Net Debt -22.9 213.8 132.6 603.7 757.4 775.3 441.1 313.4 276.4 259.0 Debt Equity (Bk) -15.6% 53.4% 27.8% 72.9% 83.0% 144.3% 48.4% 26.1% 24.8% 25.1% Basic Valuation PE 13.7 52.6 14.3 7.1 26.3 NA 36.8 6.6 20.1 142.6 P/CFO -8.6 11.7 12.7 18.6 14.6 5.7 20.5 10.3 10.1 22.8 P/Sales 0.87 1.31 1.27 1.31 1.23 0.31 1.14 1.34 1.04 1.79 P/Book 2.51 4.71 4.06 2.89 3.13 1.43 2.55 2.55 2.39 4.39 The first breakthrough came in 2000 when they launched in Norway (Norwegian for “to search and to find”) after the Internet bubble bursts. Through various experimentations and with management unafraid of the potential cannibalization, the business grew strongly. In 2003, they acquired in Sweden for €18 million after failing to replicate the Norwegian success in Sweden. Both became incredible cash machines for the group, with margins above 50% and unabated growth. Another tipping point came ironically in 2005, the year when industry print ad revenue were at its peak, when Schibsted wanted its French partner Ouest-France – the largest regional newspapers group – to co-invest in a weird
  30. 30. 30 concept: free online classifieds. The thinking behind Schibsted in wanting to dominate the niche market is that: (1) the No. 1 player in the field ranks systematically among the top 10 websites, regardless of the category; (b) it is always much bigger than the No. 2; (c) it reaps most of the profits in the sector. Ouest-France eventually agreed to invest 50% in the new venture (French for The Right Spot), the French iteration of Schibsted's free classifieds concept. In Nov 2010, they sold their stake back to Schibsted at a €400m valuation. With more than 6 billion page views per month, LBC ranks No. 3 in France, behind Facebook and Google and has 17 million unique visitors. Since its startup, staff grew from 15 to 150 people and LeBonCoin generated €97 million in revenue with a EBITDA margin of 68% in FY2012. generates 10 times more revenue per page view than LBC, and 20 times more when measured by average revenue per user (ARPU). Analysts estimated that LBC may generate €500m revenue in 2015 and retain a 65% margin. Schibsted’s online classifieds now contributes 25% of revenue and 47% of EBITDA and is dominant in verticals such as cars, jobs, real estate, miscellaneous classifieds and so on. Schibsted’s top management has the rare courage of seeing the success of its people and is unafraid of incentivizing people to think like owners through spinoffs and independent entities. For instance, it owns 73% in and Blocket and 77-100% of the various assets of LBC, with management owning the rest. Schibsted also radically shut down print operations when it felt they were not profitable enough – or even when they were still profitable but declining. For instance in Spain, 60% of the turnover from classifieds came from print in 2006 but profitability was declining. In the fall of 2008, they decided to shut down the print titles for two reasons: “Instead of worrying about the future of print, it allowed us to focus on developing the online business. Instead of waking up and worrying about what you did in your print business last week, you can concentrate on what you will do online this week. All of your capacity becomes available to grow the digital business.” Schibsted’s philosophy to empower people in their daily life with their news and opinions shaped the way it builds its digital platform. People are increasingly lost in a jungle of pricing, plans, offers, deals, for the services they need. It could be cell phones, energy bills, consumer loans. Hence a pattern for acquisitions: a bulk purchase web site for electricity (the Swedish market is largely deregulated with about 100 utilities companies); a helper to find the best cellular carrier plan based on individual usage; a personal finance site that lets
  31. 31. 31 consumers shop around for the best loan without degrading their credit rating; a personal factoring service where anyone can auction off invoices, etc. Most are now number one one in their segment. Through acquisitions, JVs or internal creations, Schibsted now operates more than 20 franchises globally and it aims to be the world’s No. 1 for online classified by replicating its high-margin business one market after another, with great discipline. As Schibsted sums up, "We give the power back to the consumer. We are like Mother Teresa but we make money doing it." Founder Christian Michael Schibsted (1812-1878) and his family; great grandson Tinius Nagell-Erichsen (1934- 2007) and former Schibsted CEO (Jan 1989-Mar 2010) Kjell Aamot Inspired by the innovations developed in Toyota with its philosophy and culture of systematic, small and frequent innovations in all parts of their organizations, Schibsted has established an ambitious program to foster this new culture and way of working. Schibsted believe in sharing ideas and improving the flow of expertise which will allow them to move as quickly as a small company yet still enjoy the many advantages of being a large organization. The key to Schibsted’s management philosophy is local involvement, effective collaboration and an inclusive corporate culture. As Schibsted articulates, “We believe that extensive centralization and comprehensive directives would deprive Schibsted of some of its best attributes. It would diminish the level of diversity within the group and the level of local involvement by the individual organizations. We believe just as much in the advantages which small companies represent as we do in economies of scale. We want to strike the right balance between a sense of community and one of freedom; we want each company to derive pleasure from being creative while at the same time reaping the benefits of being part of an international media group.” Founded in 1839 by entrepreneur Christian Michael Schibsted (1812-1878) (photo) who lost both his parents at the age of 10, the family-owned publishing company has transformed into a media powerhouse led by his son Amandus Schibsted in 1878 and later his great grandson Tinius Nagell-Erichsen (1934-2007). Tinius joined Aftenposten as a junior manager, to the surprise of the owning families of the company and grew the publisher to become Norway’s largest newspaper. Tinius, who always had a love affair with printed papers, was highly sceptical to the online expansion Kjell Aamot, Schibsted's former CEO from Jan 1989 till Mar 2010, and his lieutenants masterminded. Importantly, Tinius is commended by Schibsted employees and other media insiders for leaving his executives free to experiment, most notably online and with freesheets. It is this freedom, editorial and otherwise, that will be Tinius' lasting legacy. Tinius puts it aptly, “If you prefer, or are dependent on the people to clap their hands and say yes, then nobody will do their job well. A society where everyone will agree leads to a catastrophe." Since its listing in 1992, market cap has soared over 15-fold from around $360 million to around $5.6 billion presently. ********