The Manual of Ideas - Asia Insights

Value-oriented Equity Investment Ideas for Sophisticated Investors
© 2008-2014 by BeyondProxy LLC. All rights reserved. JOIN TODAY! www.manualofideas.com April 2014 – Page 11 of 116
Exclusive Insights into Investing in Asia
We are pleased to present the following insights by value-oriented investment
managers with deep expertise in equity investing across Asia.
Adam Weinrich, Portfolio Manager, Pala Fund
We recently had the pleasure of interviewing Adam Weinrich, portfolio manager
of the Pala Fund based in Hong Kong. The fund, seeded in 2012 by Chinese
asset manager China Everbright Limited, focuses on value plus catalyst equities
in Asia. Adam has considerable experience investing in equities and credit
globally, having previously held senior positions at JANA Partners and
Basswood Partners in the U.S.
The Manual of Ideas: Please tell us about your background and how you
became interested in value investing.
Adam Weinrich: I have no quaint anecdotes about receiving Berkshire shares
from an uncle when I was 8, or buying stocks with paper route money when I
was 12. My first career ambition was to be a Buddhist monk. I changed my
mind when I decided that reincarnation was nonsense and celibacy even more
silly. But the experience made me very interested in understanding how the
world works and, in particular, the transition from poverty to wealth in
numerous Asian countries. Like many, I had my initial training in an investment
banking program, where I quickly realized I want to be compensated for being
right (i.e. picking securities) rather than being persuasive (i.e. advising CFOs).
That led to working at two different hedge funds in New York – Basswood and
JANA – where I learned a great deal from some experienced value investors.
I think events have had the biggest influence on my investment thinking.
Important ones include visiting South Korea in 1998 during the Asian Financial
Crisis; watching the internet bubble pop; watching China rise in the 2000s;
anticipating and profiting from the subprime crisis; seeing the world economy
bounce back after U.S. QE and the EU sovereign crisis.
MOI: What are some key differences between the Asian and U.S. equity
markets? Which aspects do you think are generally misunderstood by U.S.
investors who invest in Asia?
Weinrich: I think most of the key differences between Asian and US markets
are well known: investors have fewer checks on companies; there is more
insider dealing; stocks tend to be more volatile. But there are some aspects that
may be under-appreciated. For instance, investors must also understand the
incentives of controlling shareholders and/or governments – “shareholder value
creation” may not be their leading consideration. Fighting momentum in stocks
is even more difficult in Asia than the US – I think value investors have a
natural tendency to want to pick the bottom for longs and call the top for shorts.
There are many wonderful businesses in Asia, but there are also more value
traps than in the US (few stocks at 5x P/E are actually cheap, and buying
conglomerates because of the discount to some mythical NAV is almost a losing
strategy).
MOI: How do you generate ideas in Asia? Are there any differences between
your home market in Hong Kong versus other equity markets in Asia that have
implications for how you approach each market as an investor?
“Investors must understand
the incentives of controlling
shareholders and/or
governments – ‘shareholder
value creation’ may not be
their leading
consideration…”

Weinrich: For me generating ideas in Asia is no different than in the US (you
see, I have this big dartboard…). I look for changes, events, and disruptions
leading to mis-valuations. The changes may apply at the company level, to an
industry, or to an entire country. So I read a lot of news and company reports. I
talk with friends at other funds. I listen to what insightful people on the sell-side
have to say.
Part of the appeal, and challenge, of investing in Asia is that each market and
economy is unique. Each country is at a different stage of development and has
different trading dynamics. The Hong Kong market is quite speculative with a
lot of fast money and small caps that go up 3x in two months. Korea has some
similarities. But in both markets there are terrific opportunities if you do your
own work and are careful. Japan has a plethora of liquid stocks, a wide range of
industries and is relatively transparent. But one has to understand how corporate
decision making there differs from other countries. Taiwan, Australia and
Malaysia are very different economies, but each has stable equity markets
supported by big domestic institutional buyers.
MOI: What are some major sources of equity mispricings that occur across Asia
and that you are looking to exploit?
Weinrich: I try to find situations with change or dislocation that could result in
mispriced securities. This generally involves corporate events, changes in
management, change in competitive balance, or government/regulatory activity.
We try to do more research than the next guy to identify securities where value
and price don’t match, and with catalysts to fix that.
The other opportunity in Asia is finding the great businesses run by honest,
capable management teams, to follow them for several years, and to initiate
positions when Mr. Market throws a fit. This obviously applies to equity
markets anywhere. But in Asia it is particularly appealing given the combination
of sustainably high economic growth, the large number of listed small and mid-
cap companies, and markets that tend to overshoot in both directions.
Admittedly I don’t do a lot of this type of investing currently, but my list of such
companies is growing.
MOI: Please elaborate by way of a past case study and lessons learned from it.
Weinrich: In December 2012 I invested in the Osaka Exchange, which was
about to become Japan Exchange Group (Japan: 8697). This was near the end
of a long and complicated merger process that was essentially a backdoor listing
of the much larger Tokyo Stock Exchange. Japan Exchange Group had fallen
substantially following the first stage of the merger, which was a partial cash
tender that resulted in arbs selling a lot of shares. If one was willing to do some
work to understand the numbers and the business, you found a company with a
monopoly position, high returns, merger synergies, half its market cap in cash,
trading at 3x EV/EBITDA and 6x P/E. And then there was the potential boost to
all Japanese equities from Abenomics, which at the time appeared promising but
of indeterminate scale. The merger closed in January 2013, and by April the
stock had tripled.
So what were the lessons from this investment? Look for complicated situations,
do some in-depth research, and you just might see something that few others
have noticed yet. There are fewer people running around doing this kind of
investing in Asia compared to the US, and sometimes that works in your favor.
“I try to find situations with
change or dislocation that
could result in mispriced
securities. This generally
involves corporate events,
changes in management,
change in competitive
balance, or
government/regulatory
activity.”

MOI: What is the biggest mistake foreign investors make when investing in
Hong Kong or other parts of Asia? What do you do to avoid the same mistake?
Weinrich: I’m not sure I can answer this one, but I think one common error is
failing to distinguish when securities are moving due to macro factors and
investor flows, and when they are moving due to company-specific factors. I
can’t say I always avoid this mistake, but I spend a lot of time trying to separate
county, industry and company-level components of an investment thesis.
MOI: What CEOs or owner-operators do you admire most in Asia, and why?
Weinrich: HDFC Bank (India: HDFCB) in India is one of the best banks I’ve
ever seen. Their combination of execution, strategy and market potential is rare.
Another one is Naver (Korea: 035420), which is listed in Korea but their biggest
business is Line instant messaging in Japan. They have been the best in the
world at monetizing mobile messaging. Matahari Department Stores
(Indonesia: LPPF) in Indonesia is a terrific business. Their scale and execution
ability results in little competition and sustainable 20% growth. And lastly, I
admire the chutzpah of Masayoshi Son at SoftBank (Japan: 9984) in Japan.
MOI: What lessons have you learned from mistakes made in Asia?
Weinrich: Unless you have a very long time horizon, make sure investments
have identifiable catalysts. Stay focused on good ideas – don’t spread yourself
too thinly. Stick with your convictions and with things that are working – they
often go on longer than you expect.
MOI: Would you briefly share one of your current investment ideas in Asia?
Weinrich: One of our current investments is in Mitsubishi Motors Corp.
(Japan: 7211). Anytime a company raises a lot of equity to fix their balance
sheet I pay attention. They recently raised $2.6 billion in a large secondary
placement to repay preferred stock. The company went through a major
corporate scandal ten years ago, which resulted in a recapitalization with
convertible preferreds whose conversion price adjusts when the common stock
price falls. This left the company essentially uninvestable and ignored for most
of the last decade. Moreover, their products were lousy for a long time. But the
company has undergone a quiet turnaround over the last several years with new
management, better products, and now a clean balance sheet and stable share
count. I think the stock does well in the short term just as investors start to pay
attention again and move it from the “lousy” category to “average”. Over the
medium term, I think the margin expansion is underappreciated and some of
their hybrid vehicles could do very well, in which case the stock has even more
upside. The margin of safety is solid, but it’s just a medium-sized position in the
portfolio given the number of ways it could fail to deliver.
MOI: Are there any instructive English-language resources that you could refer
investors to who are interested in learning more about Asia and related
investment opportunities?
Weinrich: I personally think the equity research from CLSA and Macquarie is
best one of the resources. Both firms are notable for the breadth of their
coverage and their willingness to take strong views. For an honest understanding
of the economies and corporate structure of Hong Kong and Southeast Asia, I
highly recommend Asian Godfathers by Joe Studwell.
MOI: Thank you very much for your time and insights.
“HDFC Bank in India is one
of the best banks I’ve ever
seen. Their combination of
execution, strategy and
market potential is rare.”

Sid Choraria, Managing Partner, Marwar Capital
We recently had the pleasure of interviewing Sid Choraria, Managing Partner of
Marwar. Based in Hong Kong, Sid applies a bottom-up value approach,
including extensive scuttlebutt research, to investing in Asia. Prior to Marwar,
Sid worked at Goldman Sachs, Bandera Partners, Morgan Stanley and Merrill
Lynch.
became interested in value investing. Which people or events have influenced
your investment thinking the most, and why?
Sid Choraria: Firstly, I grew up in India around an entrepreneurial family from
the region of Marwar (Rajasthan), where I learned about business as my father, a
first generation entrepreneur, worked hard to start and grow his company.
Though I did not know it at the time I was learning, at an early age, the
importance of returns on invested capital, free cash flow, and the power of
compounding.
Second, early in my finance career, I read the early partnership letters (late
1950s – 1970) of Berkshire when Mr. Buffett was in his 20s. I was immediately
struck by the simplicity and elegance of value investing. Outside of my family,
these letters have had the single biggest influence on my life which has led to a
deep interest in value investing. The letters sparked my interest to read
constantly, be curious, and engage in something you love. Along the way,
several investors have further shaped various aspects of my thinking, like Peter
Lynch on finding niche ideas in day to day life, Munger on incentives, Fisher on
scuttlebutt research, Mohnish Pabrai’s book The Dhandho Investor and the
annual letters of Third Avenue, Baupost and Dalton Investments.
In terms of my background, I have spent most of my career in Asia at Goldman
Sachs and Merrill Lynch. Prior to Goldman, I worked at a value fund in New
York for a Columbia adjunct value investing professor and an NYU alum
analyzing under-researched small and mid-cap companies and special situations.
I have an MBA from NYU Stern, where I was a Harvey Beker Scholar and
member of the Michael Price Value Fund (part of the university endowment
fund). I have been incredibly lucky to meet mentors in my career along the way
who have encouraged me…it is the people that we meet that make a difference!
MOI: Please describe the opportunity set for a value investor in Asia. What are
some key differences between the Asian and U.S. equity markets? Which
aspects do you think are generally misunderstood by U.S. investors who invest
in Asia? Also, how should one think about the differences across the various
Asian equity markets?
Choraria: Asia is a rich fertile hunting ground for bottom-up, value investors
willing to conduct primary investigative research. The investing opportunity set
is huge with more than double the number of listed companies than in the U.S.
Moreover, hedge fund assets in the region are a mere fraction of global assets,
which creates significant opportunity. A large number of companies in Asia
have practically no dedicated sell-side research coverage providing a disciplined
analyst an immediate edge. The opportunity set in Asia today reminds me of a
quote by legendary value investor, Michael Price “In 1984, very few investors in
London looked at securities like in New York. Many companies in London
would have no analyst visit them. Invest where others are not looking.”
“The investing opportunity
set is huge [in Asia], with
more than double the number
of listed companies than in
the U.S.”

In addition, perceived differences in regulations, language, culture, corporate
governance and accounting standards across the myriad countries in the Asia
Pacific region create the perception of the opportunity set in Asia as “too far, too
hard” amongst U.S. investors. While there are differences across various Asian
markets, the same bottom up principles to understanding the competitive
position of a business and the capital allocation record of management apply.
MOI: How do you generate investment ideas?
Choraria: I concentrate my idea generation efforts within the under-researched
areas of the market, typically small and mid-cap companies in Asia Pacific,
which tend to be ignored, misunderstood and provide the most interesting
opportunities. I like generating original ideas, companies that are off the beaten
path and with potential to grow but the underlying theme is always finding
value.
I look to source ideas constantly, through a variety of sources that keep me
intellectually curious. Some of my ideas can come from just paying attention to
companies in Asia in day to day life. I developed an exhaustive screening
database that assists me mine for key factors I look for in a forensic way,
quantitative and qualitative. These can include return on invested capital, quality
of earnings and free cash flow, significant share repurchases, insider buying,
brand, customer captivity and pricing power. I also generate leads by asking
companies “Which of your competitors do you fear the most?”. Finally, I
regularly read value oriented publications.
Once I narrow it down to a certain set of opportunities, my investment process is
driven by a bottom-up, fundamental research approach. I like to spend a
substantial amount of time understanding the business, specifically its
competitive position (i.e. pricing power, economies of scale, customer
captivity). Then I look for an alignment with and incentives of management with
shareholders (i.e. capital allocation, compensation, sticking to core competency,
etc.). Finally, I look for opportunities to purchase companies at a substantial
discount to the price a rational private owner would pay for the business.
I keep a watch list and add companies when they pass the first two criteria but
do not meet the price. Accumulated knowledge about the business, industry and
management often lead to additional opportunities. I also follow some
prominent value and private equity investors to see if they might be shareholders
in the business. While their presence is not necessary, if the value discrepancy is
large, it can be an advantage to have an informed investor engage in value
creation and invest alongside them.
MOI: What are some major sources of equity mispricings that occur in Asian
equity markets and that you are looking to exploit?
Choraria: In looking for mispriced stocks, I pick my spots and do research
where the general consensus is not – a differentiated portfolio is key to generate
alpha. The Asia Pacific small and mid-cap segment is naturally an exciting place
to be as it is less followed by informed investors, typically unrelated to the
merits of investing in the business, which offers scope for material inefficiency.
Additionally, Asian markets can be a lot more inefficient in the short-run, as
markets tend to be focused on the short-term and fixated on growth. There is
also a big premium on liquidity and one can be paid handsomely for taking a
longer term view and position in “temporarily” illiquid stocks. I also tend to
look at out-of-favor industries and stocks as well as special situations and try
“I concentrate my idea
generation efforts within the
under-researched areas of
the market, typically small
and mid-cap companies in
Asia Pacific, which tend to
be ignored, misunderstood
and provide the most
interesting opportunities.”

and understand if there exists a large gap in valuation to the underlying value of
the business. All this creates a time arbitrage by taking a longer term view. An
example of a mispriced stock in an out-of-favor sector was Tata Sponge (India:
TTSP) (http://www.beyondproxy.com/take-tata-sponge/), where the market was
valuing the company for less than 0.5x FCF despite being profitable every year
for 20 years and with strong management, given the “Tata” corporate
governance.
MOI: Would you elaborate on the previous question by way of a past case study
and lessons learned from it that you can apply to future investment
opportunities?
Choraria: An illustrative past case study of a mispriced stock was Clear Media
(Hong Kong: 100), a Hong Kong listed small cap company with majority
ownership by US listed, Clear Channel Outdoor (CCO) and with value
oriented shareholders, International Value and Bain Capital on the Board. The
company has a predictable business with long-term contracts and is the
dominant outdoor bus shelter advertising network in China with over 75%
market share in key cities. The company has a track record of prodigious free
cash flow generation through several market cycles. Just a little over a year ago
in January 2013, the company’s shares traded around HK$4.1. The company at
HK$4.1 had a market capitalization of approximately US$300m and enterprise
value of US$140mm with a strong balance sheet with over 50% in net cash. The
stock was available at less than 1.5x EBIDTA, 2.8x EBIT and a 35% free cash
flow yield all this time while the company on earnings call (that few were
listening in to!) was intent on returning some excess cash to shareholders. Fast
forward to March 2014, at recent share price of HK$7.20 and including the
special dividend of HK$1.32 paid to shareholders in August 2013, the shares
have more than doubled with a market capitalization currently of $500mm.
Several reasons unrelated to Clear Media’s business contributed to the stock
being mispriced. First, the stock was not covered by the sell-side community
(Morgan Stanley discontinued coverage in 2012 due to allocation of internal
resources, while admitting to undervaluation with their last report titled “Ad
sales to climb, yet valuation at historical low”). Second, the shares were
relatively illiquid, and institutional constraints prevented most large cap funds
from covering the name, again unrelated to the business. Third, uninformed
investors were likely incorrectly valuing the stock on P/E instead of cash flow
due to non-cash amortization charges given Clear Media’s business model.
Finally, the sector was oversold with the common perception that corporate
governance broadly was poor, incorrectly in the case of Clear Media with value
oriented management, shareholders and board members.
Another example is Mayur Uniquoters (India: MUNI), an under-followed gem
in India with a niche in artificial leather (India’s largest manufacturer of
synthetic leather with ~25mm linear meters installed capacity). Mayur was off
the radar with limited institutional ownership. Just a little over six months ago,
the shares traded at INR 260 (pre 2:1 stock split in March 2014) at US$100mm
market cap at an undemanding valuation of 7x EBITDA with only one local
analyst covering the name when I spoke with the CEO who is based in Jaipur,
Rajasthan, India. Mayur had already demonstrated consistent earnings power
(net profit positive every year for 14 years and free cash flow positive for 10 out
of the last 14 years), high returns on tangible capital employed (over 80%) and a
competitive moat due to local economies of scale, 2.5x larger than the next
“Another example is Mayur
Uniquoters (India: MUNI),
an under-followed gem in
India with a niche in
artificial leather (India’s
largest manufacturer of
synthetic leather with ~25mm
linear meters installed
capacity).”

competitor in terms of production capacity and significantly higher operating
margins. Mayur also had an impressive client list including Bata, Ford and
Chrysler and was voted in Forbes Best Under a Billion in 2012. Fast forward, to
April 2014, the company’s shares have doubled and institutional ownership
rising with the company recently securing an important investment of
approximately $20mm from well-known private equity firm, West Bridge
Capital.
MOI: What is the biggest mistake foreign investors make when investing in
Asia? What do you do to avoid making the same mistake?
Choraria: An inherent bias foreign investors perhaps have is characterizing
certain Asian markets as “value traps” and or the overall opportunity set as “too
far, too hard”. There are several reasons for that initial bias, which include
perception about corporate governance. Another common mistake any investor
can make is to accept accounting earnings at face value without a deep
understanding of business drivers, competitive advantage, and profits. It is
important to do your own work and understand how companies generate cash
flow and if it is sustainable. It is critical to evaluate management alignment with
shareholders and be wary of promotional management. Good management will
be equally as forthcoming about mistakes and I look for that more often than the
successes. It is not just about investing alongside “excellent” management – but
studying capital allocation record and seeking out owners that eat their own
cooking, either through ownership, repurchases, compensation alignment, etc.
An example is Japan, a market that is often characterized as a “value trap”
where perception is that management is not focused on value creation. I would
like to highlight Kobayashi Pharmaceutical (Japan: 4967), an under-
researched Japanese mid-cap, despite a market capitalization of over $2.5bn and
with a rich 125 year old history of dominating niche markets with limited
competition and products with sustained market share over 40%. I am a captive
customer myself of several Kobayashi products. Kobayashi is not your typical
Japanese value trap with the company having grown net income and dividends
for 15 consecutive years. The core business has returns of tangible capital
employed in excess of 50%. Management have a track record of good capital
allocation and have actively divested off two non-core divisions (wholesale and
medical devices) which were lower margin businesses to focus on their core
cash cow business (divestments led to a large drop in total sales while core
group sales increased and margins expanded). Finally, the company has had six
CEO’s in their 125 year history (average tenure over 20 years). Impressively,
Kobayashi instituted a proprietary management index indicator (adopted from
EVA of Stern Stuart) called Kobayashi Value Added (KOVA) starting FY2002,
which measures the efficiency of capital employed and capital efficiency in
working capital. KOVA is reflected in the performance appraisal of officers and
those with senior titles, so that the entire group will fully appreciate the cost of
capital. Management have skin in the game with insider ownership and were
buying back stock at the depth of the financial crisis in 2008.
MOI: If valuation were not a factor currently, which is one of your favorite
companies and why?
Choraria: One of my favorite companies in Asia is Tsui Wah (Hong Kong:
1314), a Hong Kong-style fast casual dining restaurant chain, the leading “Cha
Chaan Teng” chain operator in Hong Kong based on revenue and market share.
Cha Chaan Teng, or Hong Kong-style restaurant, is an iconic representation of
“An inherent bias foreign
investors perhaps have is
characterizing certain Asian
markets as ‘value traps’ and
or the overall opportunity set
as ‘too far, too hard’.”

Hong Kong’s dining culture. The company traces its humble roots to 1967 in the
bustling streets of Mongkok in Hong Kong. At its current share price, Tsui Wah
has a market cap of nearly $800mm. As of January 2013, the company has 22
stores in Hong Kong, 1 store in Macau, and 5 stores in China. The company’s
operational effectiveness, sales floor efficiency and per store EBITDA is higher
than most restaurant operators globally. Tsui Wah has incredible pricing power,
very low payback period for each incremental restaurant and strong customer
captivity. The company has a significant growth opportunity ahead of it as the
company expands in China, where it currently has only 5 stores. Admittedly, I
visit Tsui Wah several times a month as I am a captive customer. For those that
have not been to Tsui Wah, take a look at the “Top 10 Dishes” -
http://www.tsuiwah.com/en/business/restaurant/brand_food/ (I recommend the
milk tea for new comers to Tsui Wah and to Asia).
MOI: Would you briefly share one of your favorite current investment ideas –
what were the key criteria for assessing it?
Choraria: I like Nesco (India: NSE), an underfollowed mid cap in India. The
company is a mispriced stock providing downside protection given its huge
asset value and significant upside due to its core exhibition and IT park business
(with EBIT margins over 70%). In addition, the market has not caught on to
future earnings potential which further accentuate the Heads you win, Tails you
don’t lose much investment thesis with Nesco. Nesco owns a 70 acre plot of
land with close proximity to the Mumbai airport, which the company bought in
the 1950s. This provides the company’s core business with a wide and enduring
moat and is currently held at cost (approx. $1mm) on the balance sheet.
However, the asset value of Nesco alone is conservatively worth 2.5-3x times
the current market cap of the company ($180mm market cap; $140mm
enterprise value, $40mm net cash).
Further, the core business has high barriers to entry and is a cash cow currently
available for under 6x EBIT. On this 70 acre land Nesco owns, the company has
developed and operates India’s largest private exhibition centers, a 450,000 sq ft
exhibition center which is booked a year or so in advance counting blue chip
global companies as its customers. Additionally, Nesco owns two IT park
buildings that it leases to blue chip clients like Tata Consultancy on a long-term
basis. The company just finished development of IT Park 3, which is 660,000 sq
ft and is expected to grow revenue conservatively by 25% in FY 2015. The
exhibition and IT park business historically have had EBIT margins over 70% as
they own the land. There has been talk of supply with the BKC center, but that
has had ongoing delays since 2006 and land cost prohibitively expensive
providing some guidance on the asset valuation of Nesco. In sum, to compete
with Nesco’s exhibition and IT park business, a competitor must i) secure a
large space in Mumbai, ii) with proximity to an attractive location, iii) pay
almost zero for it to have a similar margin profile and iv) secure long-term
clients. Even one of these would be difficult, all four highly unlikely. Mr.
Sumant Patel, Chairman is educated at Penn and his younger son, Krishna Patel
has joined the business and the board. Capital allocation has been good with
capex funded entirely through cash flow. Insiders are paid conservatively and
eat their own cooking.
investors to who are interested in learning more about Asia and related
“I like Nesco (India: NSE),
an underfollowed mid cap in
India. The company is a
mispriced stock providing
downside protection given its
huge asset value and
significant upside due to its
core exhibition and IT park
business (with EBIT margins
over 70%). In addition, the
market has not caught on to
future earnings potential…”

Choraria: I find The Moat Report Asia an excellent source on learning about
Asia. I think investors looking at learning about Asia can learn a lot by reading
the letters and following investors who have been in Asia for a long time
through market cycles, including Third Avenue, Dalton Investments, APS Asset
Management, Value Partners, GaveKal Research etc.
Doug Barnett, President, Quest Management
We recently had the pleasure of interviewing Doug Barnett, President of Quest
Management based in Thailand. Doug, who exclusively focuses on Thai
equities, has been managing a large portfolio of Thai stocks since April 1990,
with an IRR of 16.9% vs. the SET Index 0.9%. Prior to founding Quest in 1994,
Doug was the Managing Director of Swiss Fund, the Thai division of the global
Unifund group.
became interested in value investing. Which people or events have influenced
your investment thinking the most, and why?
Doug Barnett: I got interested in investing when I was a mechanical engineer at
Chevron in San Francisco. Chevron publicly announced it was buying Gulf Oil
at $80 per share, but the listed share price was only $39 per share. To me, this
seemed like a good investment opportunity, so I bought some Gulf shares in the
market and later sold it at $80. This seemed like a lot easier way to make money
than grinding away at engineering projects!
A few years later, I got into UCLA Graduate School of Management and
focused on Entrepreneurial Studies, Finance and Portfolio Management. My
Portfolio Management professor, Dr John Shelton, told us that the best way to
avoid the inaccuracies inherent in estimating company earnings was to find
companies with high earnings per share (EPS) growth and low price-to-earnings
(P/E) ratios. Even if you made a very large mistake in your earnings estimate,
the subsequent EPS growth would make your investment cheap in the not too
distant future, he said. It made sense to me. I have been following Dr. Shelton’s
advice and investing with successful results for the past 27 years.
MOI: Please describe the opportunity set of the Thai equity market.
Barnett: The “tapering” sell-off, followed by the exit of foreigners due to
political problems, has created a great buying opportunity. In many cases, while
prices have dropped between 25% and 60%, the consensus earnings estimates
for 2014 have increased significantly. This has led us to hold our current
portfolio, which trades at about 11x 2014 EPS with EPS growth of about 60%.
The Thai market, like other Asian markets, is dominated by local retail
speculators who do very little fundamental research and focus mainly on
momentum and technical analysis. This provides many instances in which
stocks become unreasonably cheap or insanely expensive.
MOI: How do you generate investment ideas?
Barnett: We screen for stocks with high growth using Bloomberg, then go and
visit the companies and construct our own financial models. We read broker
research to see what companies are doing, but we never rely on broker earnings
estimates as they are usually wrong. We also read the newspapers, The
“The “tapering” sell-off,
followed by the exit of
foreigners due to political
problems [in Thailand], has
created a great buying
opportunity. In many cases,
while prices have dropped
between 25% and 60%, the
consensus earnings estimates
for 2014 have increased
significantly.”

Economist, Fortune, Forbes and Marc Faber’s Doom, Boom and Gloom
newsletter.
MOI: What are some major sources of equity mispricings that occur in Thailand
Barnett: The major source of mispricing in Thailand is due to local retail
speculators who do very little fundamental research and focus mainly on
momentum and technical analysis. This provides many instances in which
stocks become unreasonably cheap or insanely expensive.
MOI: Would you elaborate on the previous question by way of a case study and
lessons learned from it that you can apply to future investment opportunities?
Barnett: A good example is Banpu Coal (Thailand: BANPU), the largest coal
producer in Thailand, in which we made a small investment in 1995.
Banpu was running out of coal at their three mines in Thailand, and was starting
to move into building small, independent power producers (cogen facilities) to
produce electricity and sell to the government.
In 2001, Banpu sold their investments in the cogeneration company to two big
institutional buyers, and then they had net cash sitting on their balance sheet of
30 baht per share, and the market price was 13 baht (how is that for a
mispricing)? We thought that was pretty interesting and increased our exposure
to 15% of our portfolio, making it a core holding.
In July 2012, we decided to exit our Banpu investment. We sold out because of
the effect of fracking gas in the US. Utilities in the US found it much cheaper
and more environmentally friendly to use the abundant, domestically-produced
fracking gas, but these utilities were locked in to long-term, take-or-pay
contracts with US coal producers. Since the utilities had no use for the coal but
still had to pay for it, they decided to ship it to anywhere but the US. As a result,
coal prices dropped from $130 per ton to less than $80 per ton, which had a
huge effect on Banpu’s earnings potential. So, being good fundamental
investors, we sold out.
Most people thought the coal business was boring, and so there was nobody
scrambling for the shares. But from when we bought at 13 baht per share, to
when we sold in mid-2012 at 450 baht, we made a 3400% percent gain and
Banpu paid another 111 baht of dividends over the same time period.
The lesson we learned from this was to do our fundamental analysis, and buy
even if no one else thinks it’s good.
MOI: What is the biggest mistake foreign investors make in Thailand?
Barnett: Foreigners tend to focus too much on political uncertainty, which leads
to forced selling at unattractive prices. In fact, over the medium term politics
makes very little difference since every Thai political party is strongly pro-
business. They are only arguing over who gets to lead.
We did a regression of Thai stock earnings performance versus subsequent total
performance over the period from 2006 – 1q2011. This period included the 2006
military coup, exchange controls, the 2008 world-wide banking crisis, 2009
airport closure by anti-Thaksin yellow-shirt protesters, deadly street fighting in
2010, nationwide flooding in 2011, and a continuing insurrection in the South.
“The major source of
mispricing in Thailand is due
to local retail speculators
who do very little
fundamental research and
focus mainly on momentum
and technical analysis.”

As you can see, the top 20% best EPS growth companies 2006 – 1q2011
average total return was 239%. The Thai market average total return was only
79%. And the bottom 20% EPS growth companies had average total return of
only 33%. So the stock market, for all its flaws, accurately rewarded the
companies that created value and punished the companies that destroyed value,
even with all of the political noise!
Whichever party ends up running the country will certainly continue Thaksin’s
populist policies which have brought real benefits to lower and middle class
Thais, such as increasing free education from 4 years to 12 years, the 30 baht
($1) universal healthcare program, a minimum wage increase from 140 – 160
baht ($4.29 - $5.91) per day to 300 baht ($9.20) per day, and the One Tambon
One Product program in which the government helps villages identify
marketable products and then helps them package and market their products
overseas.
So in the medium term, politics doesn't matter, and any drops in the stock
market due to political fears are great buying opportunities.
MOI: What CEOs or owner-operators do you admire most in Thailand?
Barnett: Aloke Lohia at Indorama Ventures (Thailand: IVL) has done a great
job of consolidating the PET plastic industry, and is now the largest producer
worldwide. He noticed that, due to global overcapacity, most PET
manufacturers were operating at below breakeven run rates, causing them to be
motivated sellers. He could buy these assets at around half of replacement cost,
and, due to his relationships with major packaged goods manufacturers, sell
100% of their output, typically making the plants profitable within six months.
Thirapong Chansiri at Thai Union Frozen (Thailand: TUF) has grown his
family tuna canning business from $200 million in sales in 1997 to $4 billion
this year, first by taking over most of the other Thai manufacturers, then buying
Chicken of the Sea brand in the US and MW Brands in Europe. TUF is now the
largest tuna canner in the world.
MOI: What mistakes have you made investing in Thailand and what are your
lessons learned?
“Aloke Lohia at Indorama
Ventures (Thailand: IVL) has
done a great job of
consolidating the PET plastic
industry, and is now the
largest producer worldwide.”

Barnett: We make mistakes all the time, typically in the exact amount of our
companies’ earnings. However, if we have accurately judged the growth
potential and comparative advantages of our companies, they are usually able to
grow and dominate their competitors, giving us a very nice return.
Sometimes, even though the company we invest in has good manufacturing skill
and conservative capitalization, an industry competitor will just decide to sell
below cost to buy market share. This is a clear sell signal, no matter how much
we like the management team.
MOI: Would you briefly share one of your favorite current investment ideas?
Barnett: Sino Thai Pressure Vessel and Ironworks (Thailand: STPI), 21% of
our portfolio, is the largest world-class steel fabricator in Thailand. STPI has
over 30 years’ experience in design, supply and fabrication of “ASTM stamp”
high pressure, high temperature and cryogenic vessels and piping systems which
are used for power & process plants, refineries, industrial equipment, and LNG
liquefaction facilities.
We invested in STPI in the mid-90’s, after they had completed work on major
refineries for all the large oil companies. At that point, they were ASTM
certified and could have easily done major jobs for US oil companies, but the
owner, for whatever reason, didn’t pursue this opportunity so we got frustrated
and sold our shares. A few years ago, the owner retired and his son took over
with an eye toward expanding abroad.
STPI initially worked with an Australian contractor to learn how to bid on
foreign jobs, but soon got a job on their own with Australia’s Woodside
Petroleum. When we saw STPI finally making its foreign expansion, we decided
to invest again.
STPI won an award from Woodside Petroleum for its excellent safety record.
STPI completed 262 modules requiring 49 million man-hours, without a single
lost time incident while building the Pluto LNG Train 1 project. (The record
now stands at more than 60 million man hours and counting).
STPI enjoys a huge competitive advantage on labor costs. STPI pays their
ASTM stamp certified welders only US$3 per hour versus more than US$100
per hour for western operators. This may seem like very low pay, but it’s
actually triple Thailand’s minimum wage of $1 per hour. By Thai standards,
STPI’s welders make a very attractive wage, and so labor turnover is low.
STPI is currently ramping up module fabrication for Inpex Corporation of Japan,
an LNG importer who is building its Ichthys project Onshore LNG Facilities in
northern Australia. STPI’s contract is worth US$740 million, and will generate
revenues of around $400 million in 2014, with net margins of 25%. At the
current price (THB21.2), it trades at 9.9x P/E 2014, with EPS growth of 63%.
Due to the widespread adoption of hydraulic fracturing and directional drilling
(fracking) technology, and large offshore finds of deep water gas, there are
hundreds of billions of dollars of LNG development projects around the world,
providing a huge opportunity for STPI. The Managing Director mentioned that
there are several of these large projects that have asked him to bid on contracts
worth $750 million to $1 billion each, so demand is very strong.
STPI recently bought additional yard space near the Thai Navy port in Sattahip,
which will add about 25% to their production capacity.
“Sino Thai Pressure Vessel
and Ironworks (Thailand:
STPI), 21% of our portfolio,
is the largest world-class
steel fabricator in Thailand…
STPI enjoys a huge
competitive advantage on
labor costs.”

We like this company because of its incredibly low labor cost vs. the
competition, and bought our maximum size of 15% of portfolio at cost.
investors to who are interested in learning more about Thailand and related
Barnett: Bloomberg has data on every Thai listed company, the Stock
Exchange of Thailand has live streaming of quarterly company earnings
announcements (http://www.set.or.th/set/oppdaybyperiod.do) and many
international brokers (Goldman, Merrill Lynch, Morgan Stanley) write research
on the larger, more liquid Thai companies.
Wong Yu Liang & Victor Khoo, Managers, Lumiere Capital
We recently had the pleasure of interviewing Wong Yu Liang and Victor Khoo,
co-founders and fund managers of Lumiere Capital based in Singapore.
Lumiere, established in 2007, invests in undervalued equity securities in Asia,
combining bottom-up analysis of individual stocks and contrarian thinking.
became interested in value investing.
Wong Yu Liang and Victor Khoo: We started our value investing journey in
2001 after being inspired by the writings of Warren Buffett and Benjamin
Graham. The scientific approach of assessing the intrinsic value of a company
and buying at a substantial discount to intrinsic value appealed to us
immediately. We have always liked hunting for bargains in all areas of our lives
and value investing is a natural extension of that personality make-up.
MOI: What are some key differences between the Asian and U.S. equity
markets? Which aspects do you think are generally misunderstood by U.S.
investors who invest in Asia?
Lumiere: The U.S. market is more developed, transparent and has greater extent
of corporate disclosure than Asian markets. Investors are able to rely on
published information on the U.S. market more in making the investment
decision, as there is a greater depth of information made available. The
information is also somewhat more reliable as there are more stringent reporting
requirements in the U.S. Another difference is U.S.-listed companies tend to be
run by a professional management team compared to Asian listed companies
which have a higher proportion that are controlled by the founding families of
the business. U.S. investors who invest in Asia may believe that the quality of
information released by Asian companies is as transparent or as reliable as that
disclosed by U.S.-listed entities, which may not be true. A lot more work needs
to be done to establish the veracity of information and accuracy of facts.
Another misunderstanding is that shareholder activism, which works well in the
U.S. in unlocking value, does not work as well in Asia due to cultural
differences and the fact that a lot of companies are family owned or controlled.
MOI: How do you generate investment ideas in Asia? Are there any differences
between your home market Singapore versus other equity markets in Asia that
have implications for how you approach each market as an investor?
Lumiere: Our primary source of ideas is from reading corporate announcements
and annual reports, especially during the earnings results season, because this
“Our primary source of
ideas is from reading
corporate announcements
and annual reports,
especially during the
earnings results season,
because this will allow us to
pick up ideas that may not be
found using valuation
screens…”

will allow us to pick up ideas that may not be found using valuation screens or
from the media or broker reports. We look primarily at the Singapore and Hong
Kong markets which have similarly high standards of corporate disclosure hence
the approach is pretty similar. For other markets like Indonesia and Malaysia,
we will scrutinize corporate governance and management motivations a lot more
closely.
MOI: What are some major sources of equity mispricings that occur across Asia
Lumiere: Equity mispricings can come from a few sources – growth that is
underappreciated by the markets, or risk that has been misunderstood by
investors, or a business that has suffered a temporary setback and is turning
around, or assets that are not reflected on the balance sheet at true market values,
or restructuring plays where previously inefficient operations were overhauled
to create a new leaner company which is more focused on the business.
MOI: Would you elaborate on the previous question by way of a past case study
and lessons learned from it that you can apply to future opportunities?
Lumiere: One of the companies we invested in, APT Satellite (Hong Kong:
1045), could serve as a good case study of a growing company that is
underappreciated by the market. The market has also misunderstood some of the
risks facing this company, hence further contributing to its undervaluation. APT
Satellite operates three satellites with coverage over Asia Pacific, Middle East
and Africa. Due to the its stable long-term contracts with a blue-chip client base
which includes HBO, Sony and Walt Disney, the company has a recession-proof
business that is poised to benefit from the rising demand for high definition TV
content. Over the period of 2008–12, APT's business grew rapidly, with revenue
increasing 120% and net profit increasing by 7-fold. We started buying APT in
September 2010 at $2, paying a cheap valuation of 6.2x P/E, 2x OCF and 0.5x
P/B then. Despite the low valuation and good growth prospects, APT fell to as
low at $1.08 in September 2011 after our initial purchase. We continued buying
more of the stock, eventually lowering our average cost to $1.70.
APT's valuation stayed low in 2010-12 as most investors were concerned about
the large amount of capital expenditure for the two satellites that it was building
then (first one to be launched, the other as a back-up). Although the capital
outlay was large, APT had signed an agreement with its parent company to sell
the back-up satellite to them at cost once the first one was launched successfully.
As such we believed the market had overestimated the risk facing this company.
The first satellite was successfully launched in April 2012 and the back-up
satellite was eventually sold to recoup the investment, thus lifting the overhang.
We exited the position fully in early 2014, realising a 4-fold return over a 3-year
holding period. The lesson here is: value investing works, but it needs patience.
MOI: What is the biggest mistake foreign investors make in Singapore or other
parts of Asia? What do you do to avoid making the same mistake?
Lumiere: In Asia, one cannot just rely purely on the published financials. It is
important to also look at management’s track record and the way they treat
minority shareholders.
Many years back, we owned a Singapore-listed company which designs,
manufactures and distributes home furniture in China. Manufacturing in
Dongguan, China, this company enjoys relatively low production costs. Its use
of readily available raw materials such as MDF and fabrics makes it less
“Equity mispricings can
come from a few sources –
growth that is
underappreciated by the
markets, or risk that has been
misunderstood by investors,
or a business that has
suffered a temporary setback
and is turning around, or
assets that are not reflected
on the balance sheet at true
market values, or
restructuring plays where
previously inefficient
operations were overhauled
to create a new leaner
company which is more
focused on the business.”

susceptible to fluctuations in raw materials prices. With over 100 stores in 66
cities in China and a good range of simple, stylish yet affordable products, it
reminded us of IKEA. Back in 2007, housing starts in China was still growing
well, so we believed that its affordable furniture would enjoy strong demand
given the relatively modest incomes of the general Chinese first-time
homeowners. This company had listed for less than a year, but the stock was
trading at 4.5x PE, 1x NTA and had half of its market capitalization in net cash,
so we felt that the extremely low valuation gave us a huge margin of safety.
Furthermore, the founders also did not sell any vendor shares during the IPO, so
it didn’t seem like they were trying to cash out. The share price dribbled lower
after we invested and the founding Chairman sold out half his stake instead of
buying back shares. That immediately raised a huge red flag. We did a
conference call with their CFO, who was not able to give us a satisfactory
answer as to why the Chairman was selling out. Despite sitting on losses, we
immediately sold the position. Today, this company trades at a fraction of the
price we sold out at.
Today, we do not invest in companies that are listed for less than 2 years,
preferring to wait for the company and its management to prove themselves and
also to ascertain their treatment of minority shareholders before we will consider
investing.
MOI: Would you briefly share one of your current investment ideas in Asia.
Lumiere: One stock which we feel is currently significantly undervalued is
Rexlot Holdings (Hong Kong: 555). Rexlot is the market leader for Welfare
Computer Ticketing Games (CTG) services with a monopoly position in 17
provinces in China.
It provides the ticketing hardware to the state Welfare lottery and receives a 1%
commission on ticket sales. The company also supplies the ticketing terminals
for the Sports Lottery. At the same time, Rexlot also has a scratch-card lottery
distribution business with over 80,000 points of sales via tie-ups with China
Post, Petrochina, Sinopec, major supermarkets and convenience stores where it
receives a 2.5% commission of sales and it shares part of its commission with
the partners. In addition, the company also sells single match games via 50
physical outlets, call centres and online website (okooo.com) in 7 provinces
where it gets a commission of 4.5% of sales.
The lottery market in China grew 18% in 2013 and is expected to continue
posting strong growth in the future, due to economic growth and the current low
per capita spending on lottery in China. China’s lottery spending per capita is
only US$25, compared to US$178 in US, US$433 in Spain and US$900 in
Singapore. In addition, the World Cup in 2014 will give single match games a
big boost.
Rexlot now trades at 9x current year earnings, which is cheap for a company
which is a market leader in a strong growing industry. Management has also
committed to increasing its dividend payout ratio from 20% in FY12 to 50% by
2014, which would give it a 5% dividend yield.
“One stock which we feel is
currently significantly
undervalued is Rexlot
Holdings (Hong Kong: 555).
Rexlot is the market leader
for Welfare Computer
Ticketing Games (CTG)
services with a monopoly
position in 17 provinces in
China.”

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