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Birth of a Hidden Champion: Cub Elecparts and You Shan Quan 尤山泉


Dear Clients and Partners,

Birth of a Hidden Champion (Issue 3): Cub Elecparts and You Shan Quan 尤山泉

Welcome to the third issue of the “Birth of a Hidden Champion” tribute series, where we highlight inspirational stories on the listing birth of Hidden Champions creating and compounding value in the Asian capital markets.

On the 16th of November 2010, a Hidden Champion was born in the Taiwanese capital market. Cub Elecparts Inc (TSEC:2231), led by the innovative and resilient founder You Shan Quan 尤山泉, went on to compound nearly 400% to a market value of nearly US$1 billion today.

In an article written earlier in March/April 2017, we reviewed this global leader in Tire Pressure Monitoring Systems (TPMS) in the automotive aftermarket segment to identify how a leader with an insurgent mission can ignore its naysayers and persevere to build a wide-moat scalable business, resulting in a leading global market share in TPMS.

Asian Wide-Moat Company: Global Aftermarket Leader in Automative Tire Pressure Monitoring System (Excerpts)

This month in March/April 2017, we investigate Cub Elecparts (TSEC: 2231), the global leader in Tire Pressure Monitoring System (TPMS) in the automotive aftermarket segment with its two sensor SKUs (Uni-Sensor: 315MHz & 433 MHz), which has 98% coverage ratio in all types of cars, the highest compatibility in the world, enabling tire shops and aftermarket operators to reduce inventory and free up working capital and replacement work using CUB’s universal TPMS sensor product is quicker and easier for onsite technicians. CUB is also the exclusive OEM supplier to Wal-Mart since 2015. In North America, CUB claims 50% market share in standalone auto tire shops and in regional auto tire chain stores. CUB will benefit from car safety regulations which required Advanced Driver Assistance System (ADAS) to be fitted in new cars in the US (2007) and Europe (2012) with more countries following suit.

Cub Elecparts started from manufacturing automobile switches, which include those for dimmers and headlights, power windows, ignition and combination switches. The company expanded into automobile sensors in 2000, producing sensors for oil pressure, crankshaft position, camshaft position and vehicle speed. It leveraged its knowledge base in automotive sensors to break into the TPMS manufacturing in 2003. After years of efforts, CUB launched the first generatio∆n of its TPMS products in 2008, and the successful breakthrough third-generation universal TPMS in 2013. With the acquisition of microwave vehicle radar specialist in Jan 2016, CUB looks to expand into the multi-billion Advanced Driver Assistance System (ADAS) market and will start shipping its first ADAS solution in July 2017 from its automated production line in Shanghai Pudong plant. CUB will also launch its advanced 77 GHz radar sensors in 3Q to 4Q 2017 and commit to mass production in 2018. At present, CUB is working with 2 automotive clients for this advanced 77 GHz radar sensor products, including targeting the Japanese truck market. The founder’s family is the biggest shareholder with 52.2% stake.

We are impressed by CUB’s founder and CEO SC Yoo’s dedication, patience and focus in not only building up a Tier-1 supplier capability in its original non-TPMS switches and sensors business that expanded into the breakthrough unique patented universal TPMS product but also in forging a corporate culture that feels like an enterprise of engineers, reminding us of automotive parts innovator Gentex (GNTX US)/John Bauer which compounded 190-fold to $6bn market cap. We like how CUB has consistently reinvested back into the business to develop its R&D and new product innovation capabilities, as well as making tough strategic business decisions in focusing on the automotive aftermarket and R&D of the universal TPMS while avoiding the China TPMS market. CUB has proven to be focused and farsighted in stayed ahead of the game by building up new products beyond its automotive sensors and TMPS in the new ADAS solution segment that is now building up sales momentum as well as set CUB on a long-term growth trajectory path in the race towards the autonomous car.

Below are excerpts of founder Yoo’s inspiring entrepreneurial story:

“2003, when I went to America to pay a visit to automotive component giant Lear who is also one of our customers, I saw a production line doing TPMS. The Chinese auto engineer who showed me around shared with me that America is going to pass a legislation for the mandatory adoption of TPMS which will be a standard component in all new cars. I thought instinctively then that a great business opportunity has arrived. Whether I will succeed or not, I do not know but I have to try. In 2005, America passed the law in mandatory TPMS installation and EU, Korea, Japan, China followed suit. Every time a tire is replaced, the TPMS needs to be replaced too. Even if the tire is not replaced, the TPMS also needs to be replaced. This is because the battery lifespan is only 5 to 7 years and the battery cannot be replaced and hence the entire TPMS needs to change. This is another big market just like the tire market.

At that time, I was thinking to myself that this is entirely different from what we have been doing in car switches as the car can break down but the car switch hardly gets damaged. I was thinking hard on how we can achieve a breakthrough from this bottleneck imposed by the durability of the product lifecycle and the low replacement rate by the customer. My thinking was simple, to focus on becoming the best and number one player, as long as we keep growing our customers even in this low replacement car switch, we can still do well. So we devoted our resources to developing molds, which has grown from 70 sets in 2007 to over 1,300 sets now. This mold capability know-how that was acquired and accumulated over the years has also helped our development of the universal TPMS product.”

When I was in Detroit discussing and negotiating new product development with General Motors, I was thinking aloud to myself that every year there are hundreds and thousands of new car models by various car makers and my first generation TPMS can only cope with around 10 car models. If only there is a universal TPMS product that can be used in all car models, I shared my thoughts with the aftermarket industry folks. They agree, commenting that there are too many variety out there and when they are servicing their customers’ cars, every car has different TPMS and they are like a locksmith who must carry hundreds of keys which is heavy, burdensome and tiring. What the aftermarket operators describe as carrying hundreds of keys is a reality in the real world in that the auto mechanic shop has to carry a lot of TPMS product inventory of different variety, tying up precious working capital, and when the mechanic is replacing the new TPMS, a lot of time is expended as every car model is different in the TPMS installation.

During 2010 and 2011, CUB faced a lull period without any shipments of our first and second generation of TPMS products. Yet we persisted in our R&D efforts. By the end of 2012, when we are certain that our third generation TPMS product has achieved a coverage that exceeds 98% of car models, we decided to officially launch the universal TPMS product in the market in 2013. 98% coverage means that when the market has a new car model, the tire shop and auto mechanic outlet only need to refresh the new code online. Schrader, the leader in Original Equipment (OE) TPMS, only has coverage of around 80%. Having the patent in the universal TPMS decoder means having a master golden key to open the door to all auto manufacturers original TPMS.

This competitive edge in universal applicability has widen our lead substantially against our competitors. However, people will not know that we have invested ten years of R&D efforts since 2003 to sharpen this sword, enduring all sorts of ridicule heaped upon us by the industry, laughing at me that I will bring the company to bankruptcy. During this long painful process, the snide and criticisms from the industry players never ceased. They all said that this small little factory wants to do R&D, how can they ever hope to compete with the world’s number one TPMS OE company? If they continue to waste money developing this TPMS, they will definitely go bankrupt. When we have our breakthrough product, even Schrader took the initiative to visit us to negotiate a contract and became our customer. The world’s two largest TPMS diagnostic tools companies BATEC and ATEQ also proactively looked for us to discuss about a strategic alliance.

This success is not gambling luck but due to foresight and persistence. When you have a focused target, you must persist all the way to the end! Our TPMS system has combined the applications in GPS, mobile, rear camera vision in blind detection system (BSD), winter tires, TPMS for trailers and semi-trailers (18- to 22-wheelers), a dash cam with integrated TPMS, advanced driver assistance system (ADAS), and so on. Our core values is once we have found the right path, we will persist in the journey to press onward.”

What Makes It a Wide-Moat Business? Fundamental Dynamics Behind 49.4% ROE

  • (1) Unique patented universal TPMS with highest 98% coverage: While there are more than 200 types of TPMS on the market, CUB’s patented universal sensor products are able to cover and replace 98% of the TPMS products (OE sensor) available through integration and recoding technologies providing car profiles including brands and mileage, therefore relieving retail channel’s inventory pressure and also making the replacement process quicker and easier for on-site technicians.
  • (2) Attention to details to solve problems faced by underserved aftermarket customers and translate customer insights to continually develop superior product: The history of CUB follows a timeline of product innovations in solving problems by paying attention to the details and understanding the market and customer needs at the grassroot level. Some of the patented innovations include developing a universal TPMS that is also mounted on a patented screwed valve, in which the angle can be adapted to the rim within the range of 0 to 30 degrees to suit most aluminium and steel rims. Replacement work is quicker and easier for onsite technicians and mechanics.
  • (3) Leadership in automotive aftermarket with customer stickiness: CUB offers its RF coding devices to retailers for free as an incentive to sell its TPMS sensor while CUB’s competitors usually around US$2,000-US3,000 for the tool. Free updates are also provided to the customers while competing products charges update fees of US$150-250 per year. CUB also provides on-call service and over 2,000 training per year while aftersales service is practically none for competing peers.
  • (4) Leveraging deep intangible know-how in R&D and engineering capabilities to create new categories of growth from TPMS to ADAS: We like how CUB has leveraged its knowledge base in automotive sensors to break into the TPMS manufacturing in 2003. After years of efforts, CUB launched the first generation of its TPMS products in 2008, and the successful breakthrough third-generation universal TPMS in 2013. Noteworthy is its commitment to developing and investing in its mold capability know-how and asset base, which has grown from 70 sets in 2007 to over 1,300 sets now. This mold capability know-how that was acquired and accumulated over the years has helped CUB’s development of the universal TPMS product. This mold asset has also been important in helping to generate stable profitability of CUB’s non-TPMS product segment of varied but low volume orders items as a Tier 1 OE supplier with customers such as Chrysler, General Motors.

Warm regards,

KEE Koon Boon | Chief Investment Officer & CEO

Hidden Champions Fund

www.hiddenchampionsfund.com

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Birth of a Hidden Champion: ABC-Mart and Masahiro Miki

Dear Clients and Partners,

Birth of a Hidden Champion (Issue 2): ABC-Mart and Masahiro Miki

Welcome to the second issue of the “Birth of a Hidden Champion” tribute series where we highlight inspirational stories on the listing birth of Hidden Champions creating and compounding value in the Asian capital markets.

Last week on 19 October 2000, a Hidden Champion was born. ABC-Mart (TSE: 2670) was born as a listed company in Japan and, led by billionaire founder Masahiro Miki, she went on to compound 530% to a market value of over US$4.1 billion.

Below is an excerpt from an article “Making Right Buffett’s Biggest Mistake in Asian Wide-Moat Innovators” written back in May 2015 which is still relevant today in understanding why ABC-Mart has succeeded in compounding value.

PS: An update on the 2nd anniversary of our Hidden Champions Fund – our YTD (January to September) 2017 returns (net after fees) is over 20%, with our Fund benefiting from the flight-to-quality effect as the overall market retreats while we see a 7.9% gain in the month of September, bringing our total absolute returns to over 37% since our inception in September 2015. We like our clients to ask us tough questions to make intelligent decisions. Our first HNW client who invested $1 million with the Fund in June 2017 after asking tough questions, and in the process appreciated the high-conviction investing approach to achieve investment resilience, is up over 18% in returns since our initial launch offering event that we held four months ago in June. We also have had existing clients subscribing additional capital into the Fund. We will be extending our Founding Partnership Cash Bonus till the end of October for both existing and prospective clients before our Fund soft closed. For investors who like to participate in the long-term non-linear growth of the underappreciated emerging Hidden Champions, please drop us an email at invest@hiddenchampionsfund.com to find out about the subscription process.

Warm regards,

KEE Koon Boon | Chief Investment Officer & CEO

Hidden Champions Fund

www.hiddenchampionsfund.com

Making Right Buffett’s Biggest Mistake in Asian Wide-Moat Innovators (Excerpts)

Masahiro Miki is the low-profile secretive billionaire founder of ABC-Mart who worked alongside employees in stores during weekends. Miki owns around 30% of ABC-Mart and is ranked #11 on Forbes richest Japanese list with a net worth of $3.5bn. Not many people know that Miki-san is Korean-Japanese with a Korean name of Kang Jeong-ho, as he seldom shows himself in public. Like Dexter’s Harold Alfond who was an outstanding athlete and developed his passion for sports, Miki was an amateur boxer and sports lover. Miki, who had been interested in import clothing retail, switched to selling shoes when he realized that the Japanese shoe industry was not particularly competitive. Kokusai Boeki Shoji (International Trading Corp) was established in 1985 in Tokyo’s Shinjuku ward. Miki pursued brand businesses early on by securing domestic general-distributor rights to Hawkins in 1986 (it acquired trademark rights in 1995) and Vans in 1991 (it concluded a domestic trademark usage contract in 1994). This brand-management know-how has contributed greatly to ABC-Mart’s private brand-driven growth strategy. Miki entered the retail market in 1990 with the launch of ABC-Mart and opened four stores in central Tokyo that sold sneakers and work boots, riding the casual fashion trend at that time. In the late 90s, ABC-Mart accelerated the rollout of self-branded products utilizing the trademarks it had acquired, and broadened coverage by adding business and walking shoes.

ABC-Mart compounded its market value nearly 10-fold since 2000 to $4.4bn by streamlining the procurement structure and removing the middlemen from Japan’s multi-tiered shoe retailing structure and built a high-margin format. This was made possible with two innovations.

First, ABC-Mart sold private brand products directly procured from manufacturers that account for half of its total sales. ABC-Mart has earned a reputation for purchasing low-priced foreign product lines and then repositioning them as a major private-label brand through well-targeted product development and promotion. Hawkins is a prime example. ABC-Mart founder Masahiro Miki spotted the brand’s potential during a trip to London. It ultimately won the trademark to manufacture the Hawkins brand as its own private label. It targets younger women and now generates 20% of ABC’s sales. In addition to becoming a sales engine, the Hawkins experience has given ABC-Mart knowledge about shoe production costs that has helped the company negotiate better deals with other shoe manufacturers.

Another example: ABC-Mart carries two types of New Balance-brand shoes: the national lineup available at numerous retailers and an exclusive line produced in collaboration with the U.S. manufacturer. The latter, planned and designed by ABC-Mart, features limited-edition colors and prices that are slightly lower than the national line. The arrangement works for both ABC-Mart and the manufacturer. With the exclusive line, New Balance only has to tweak small design details, materials and color, making the partnership an easy way to drum up sales and recoup costs. Those exclusive products are also less susceptible to discounts, since they do not face price competition in the same way as products sold at multiple retailers. Shoppers often look at a shoe in a brick-and-mortar store, but ultimately purchase the same item for less online. But ABC-Mart’s exclusive products are available only at its stores, allowing it to secure profit even if the retail price is set lower. Gross margins on private-brand products are fatter at around 70% as compared to around 40-45% for non-PB products. Thus, the real wide-moat innovator knows how to redefine a product’s quality, cost and price to better meet consumer needs.

But a potential downside to the private brand strategy is ABC-Mart’s responsibility for the entire stock. If it misreads trends, the retailer can be left saddled with leftover inventory that cannot be returned to the manufacturer.

Thus, the second innovation is the ability to gauge consumer trends and demand. ABC-Mart was an early pioneer in installing POS systems when it first entered the retail market in 1990 and manages product flow on a single-item basis. Industry leader Chiyoda introduced the POS system only in 2008. It effectively controls inventory risk by keeping close tabs on popular and fading items, adjusting store product policies based on this information and capitalizing on a procurement structure with direct upstream links. Product management is via POS, giving the head office and each store a view of sales and inventories. Front-end consumer intelligence data was also harnessed. Acting on feedback from customers who wanted to wear sneakers but were more comfortable wearing heels, ABC-Mart developed a full line of sneakers with hidden wedge heels. These shoes flew off the shelves to become a major contributor to sales.

ABC-Mart also sought to solve the inventory challenge with an innovative in-store service that allows customers to directly place orders for shoes that are not in stock at its brick-and-mortar stores to the shoe retailer’s web outlet. Customers can place orders for shoes of any desired model or size from the in-store terminal when they are out of stock at the outlet they visit. They pay for the shoes there and then, and can choose to arrange home delivery or pick up the goods the next time they visit. The number of outlets that provide such services is around 600, roughly 80% of all ABC-Mart stores in Japan. The iPhone-based service, called “iChock,” minimize missed business opportunities due to items being out of stock as well as to reduce inventory at each store and improve capital efficiency.

With its extensive name-brand lineup and exclusive private-brand products, sales has been brisk despite the April 1 2015 sales price hike, posting a 12th year record high profits. While ABC-Mart has been the poster child of deflation-era retailing, with stores advertising shoes for as little as ¥2,900 ($28) and ¥3,900, along with clearance sales, it has found success in rolling out products that appeal to fashionistas who do not mind paying a little extra for style. ABC-Mart stores are also hot spots for many Chinese tourists who buy four or five pairs at once. ABC Mart found overseas success with over 180 stores, with over 150 stores in South Korea and the rest in Taiwan.

In Aug 2012, ABC-Mart also completed the $138m purchase of LaCrosse Footwear, a rival to Berkshire’s HH Brown and Justin Brands. Workwear consumers of the LaCrosse and Danner brands in America include people in law enforcement, transportation, mining, oil and gas exploration and extraction, construction, government services and other occupations that require high-performance and protection footwear as a critical tool for the job. Outdoor consumers include people active in hunting, hiking, outdoor cross-training. LaCrosse purchased storied bootmaker Whites Boots in 2014. Both these brands also sell well in Japan.

We have emphasized in earlier articles our observation that most Asian companies are “one-man-shop” operations with the founder making all the decisions. The willingness to build a culture of decentralization/ empowerment and invest in a system to cascade decision rights throughout the organization is an important signal that the founder desires and cares to scale up the company in a sustainable manner by not hoarding knowledge. Technology is an important tool in empowering the employees and in giving them an informational advantage in their respective roles and responsibilities at work.

Sam Walton himself solved the major problem of inventory and working capital to scale up the business by having a continual commitment in the intangible IT investments. Sam Walton’s penchant for a reliable and speedy information system is grounded in pragmatism: “Once we had those scanners in the stores, we had all this data pouring into Bentonville over phone lines. I like my numbers as quickly as I can get them. The quicker we get that information, the quicker we can act on it. What I like about it is the kind of information we can pull out of it on a moment’s notice.”

Both Sam Walton and Masahiro Miki faced a lot of resistance and doubts when they spent heavily on IT system – the money could have been spent on tangible assets like property. In the end, the scale and constancy of the investments involved in building the indestructible intangibles discourage imitators and disrupts complacent incumbents. They “stick to their guns” and that made all the difference to understanding the wide-moat advantage that they have built up. The Heart of entrepreneurship is summed up best by Sam Walton in his inspiring autobiography Made in America:

“It is a story about entrepreneurship, and risk, and hard work, and knowing where you want to go and being willing to do what it takes to get there. It’s a story about believing in your idea even when maybe some other folks don’t, and sticking to your guns.”

Birth of a Hidden Champion: TSMC & Morris Chang

Dear Clients and Partners,

Birth of a Hidden Champion (Issue 1): TSMC and Morris Chang

Welcome to the first issue of the “Birth of a Hidden Champion” tribute series where we highlight inspirational stories on the listing birth of Hidden Champions creating and compounding value in the Asian capital markets.

On this day on 24 October 1994, a Hidden Champions was born. TSMC (TSEC: 2330) was born as a listed company in Taiwan and, led by billionaire founder Morris Chang, she went on to compound 965% to a market value of over US$203 billion, surpassing Intel.

Without TSMC, smartphones would not have arrived as early as they did which has also drastically changed the daily lives of people and Apple likely would have found more difficulty in delivering its iPhones with the computing power they now boast. TSMC controls 56% of the global market for contract chip production and has helped to spawn the birth of over 450 fabless IC designers who are its customers, including Qualcomm and Nvidia, As Morris Chang commented during his recent retirement in early October 2017: “Since we established ourselves, fabless companies began to mushroom worldwide. Most of the innovations in the semiconductor industry in the last 30 years came from those fabless companies. That’s probably my biggest pride, to have caused a lot of innovations in the industry.” All these are among TSMC’s contributions to the world.

Morris Chang said Intel’s advantage lies in its robust technological power and strong business operation foundation, having maintained No. 1 in the global semiconductor for decades. But its biggest drawback rests with its inexperience in the wafer foundry sector that highlights a service-oriented corporate culture, as Intel’s technology departments have long served the company’s own needs, totally different from the core culture of serving others seen in the pure-play foundry sector. With his 25-year experience at Texas Instruments before founding TSMC, Chang said he realized very well what kind of corporate culture was needed for the foundry sector. He said when establishing TSMC 30 years ago, he was able to easily inject the service-oriented culture into the TSMC at the very beginning.

TSMC is also holding its 30th Anniversary Celebration Forum and Concert in Taipei, Taiwan on October 23, inviting the many customers, colleagues, suppliers, investors, and partners from government and across society to mark the milestone together. Morris Chang commented: “In the last 30 years, we have joined hands with our partners to unleash numerous innovations in the semiconductor world whose products have been pervasively used in all parts of the world and have made many people’s lives more secure, comfortable and convenient. Through the process, we have also established long-term trusting relationship with not only our partners but also many of our major shareholders. At this 30th anniversary celebration for TSMC, we want to show our gratitude for all those who have been a part of our history.” The Hidden Champions Fund sends our heartiest congratulations to TSMC’s 30th anniversary.

Below is an article “Any Benjamin Franklins in Asia?” written back in May 2013 which is still relevant today in understanding why TSMC has succeeded in compounding value while Singapore learnt painfully, through the spectacular failure of its homegrown loss-making, debt-laden Chartered Semiconductor Manufacturing (CSM) which was started in the same year as TSMC in 1987 but sold in 2009 to GlobalFoundries for $1.8 billion, that the scalability and resilience of the business model is not about pouring ever more tangible resources and money with efficient centralized “leadership” to manage assets and people as costs but rather it’s about having a culture of values, trust and collaboration to foster innovation and customer service. And this indestructible intangible asset is the essence of deep moat competitive advantage found in the emerging underappreciated Hidden Champions that we invest in.

PS: An update on the 2nd anniversary of our Hidden Champions Fund – our YTD (January to September) 2017 returns (net after fees) is over 20%, with our Fund benefiting from the flight-to-quality effect as the overall market retreats while we see a 7.9% gain in the month of September, bringing our total absolute returns to over 37% since our inception in September 2015. We like our clients to ask us tough questions to make intelligent decisions. Our first HNW client who invested $1 million with the Fund in June 2017 after asking tough questions, and in the process appreciated the high-conviction investing approach to achieve investment resilience, is up over 18% in returns since our initial launch offering event that we held four months ago in June. We also have had existing clients subscribing additional capital into the Fund. We will be extending our Founding Partnership Cash Bonus till the end of October for both existing and prospective clients before our Fund soft closed. For investors who like to participate in the long-term non-linear growth of the underappreciated emerging Hidden Champions, please drop us an email at invest@hiddenchampionsfund.com to find out about the subscription process.

Warm regards,

KEE Koon Boon | Chief Investment Officer & CEO
Hidden Champions Fund
www.hiddenchampionsfund.com

Any Benjamin Franklins in Asia?

Why is Benjamin Franklin, Charlie Munger’s hero, the ubiquitous face on the hundred-dollar bill, the largest-denomination bill in circulation in the U.S. today? Why not a President – Abraham Lincoln or George Washington? And how does this “uncommon” insight help value investors to identify the resilient compounders globally and in Asia?

Even Americans who handled the familiar winking Benjamins daily are puzzled themselves when I asked them and there is no official answer as to why Franklin is honored, like a curious big blindspot. While Franklin is recognized as the only founding father who signed on all four major documents which led to the formation of the United States, including the Declaration of Independence and United States Constitution, Franklin is honored for contributing much to what is deemed most “American” about United States. He was a tireless inventor-entrepreneur solving the nation’s biggest problems and creating innovative solutions mostly from behind the scenes, having created the lightning rod, the first bifocal glasses, odometer, urinary catheter, the Franklin stove and yet he never filed for patent for all his inventions. He believed that “knowledge was not the personal property of its discoverer, but the common property of all.” Dean Kamen, the contemporary American inventor-entrepreneur of the infusion pumps for chemotherapy and treating newborn babies, the world’s first insulin pump, the technology used in portable home-use dialysis machine and many more, believe that solving problems and creating solutions create real wealth and is the essence of what makes America great for over two hundred years: “Real wealth is not a zero-sum game, like moving oil here or moving gold there.” In other words, inventor-entrepreneurs like Franklin and Kamen want to build and scale their ideas and inventions so that they can give or “empty” more. We need to “empty” ourselves before we become open to the possibilities to innovate. Only when we have the desire to “empty”, then can we want to persevere in building something meaningful. This urge to build in order to give is the magnetic north to scale a resilient compounder and they work obsessively to realize this vision. This “emptiness” is akin to the empty hollow center of a bamboo. The vitality and resilience of the bamboo growth revolves around its “emptiness”: the nutrients and moisture that would have been exhausted making and maintaining this empty center can be utilized for growth of other stems. It’s about having an intangible idea that is larger than our own individual self to provide useful products and services to benefit other people and in turn become a resilient compounder – the Bamboo Innovator.

Are there any Benjamin Franklins in Asia? In Part 1, we got acquainted with the insight that “entrepreneurship in Asia is usually driven not by a new idea but by the desire of being your own boss”. This comment was made by a Chinese entrepreneur who has built an Asian-listed global company that has multiplied over 26-fold in 19 years since its Sep 1994 listing to an all-time-high market value of $100 billion. He started the company at the young age of 55 in 1987 based on a “new idea” that he was laughed at and ridiculed everywhere. He is Morris Chang, recognized around the world as the creator of the world’s first pure-play dedicated semiconductor foundry, TSMC (2330 TT and TSM US [ADR]), the most valuable company in all of Taiwan and possibly the most valuable semiconductor in the world nearly on par with the mighty Intel in market value.

Recall how Franklin astonished the Europeans, who were accustomed to the solemn deliberations of royal academic societies, by venturing into a rainstorm with a kite to prove lightning was electrical, thus proving the resilience of the lightning rod? Without any strength in IP, circuit design, R&D, sales and marketing, Morris Chang also shocked his backers which include K.T. Li, the minister best known as the “Father of Taiwan’s Economic Miracle”, by boldly choosing a pure-play foundry business model that had a fatal problem then: “Where’s the market?” Who is TSMC going to manufacture the wafers for? The Intels and Texas Instruments are also manufacturers themselves and they would let TSMC manufacture their wafers only when they didn’t have the capacity, the leftovers, or didn’t want to manufacture the stuff themselves anymore. As soon as they got the capacity they would stop orders to TSMC, so it couldn’t be a stable market. And when they didn’t want to make the wafers anymore, the chances were that it was losing money for them. And so why would TSMC want to do it? Does TSMC want to take over the loss? And Taiwan is two generations behind in technological capabilities. As Morris Chang recalled, the experts all laughed, “What the hell is Morris Chang – and Taiwan – doing?”

The “lightning rod” that Morris Chang carried with him to bend and not break like the bamboo in the rainstorm with his “new idea” of a pure-play business model was this unusual insight that was a blindspot for everyone else. When he was a longtime executive at Texas Instruments, he saw that a lot of IC designers are unhappy at work and wanted to leave and set up their own business, but the only thing, or the biggest thing, that stopped them from leaving those companies was that they could not raise enough money to form their own company. Because at that time it was thought that every company needed wafer manufacturing and to build a wafer fab was the most capital-intensive part of a semiconductor IC company. With TSMC acting as a pure-play platform since the TIs are not interested in the success of their former employees by providing either fab capacity or important customer support services for them, TSMC could solve a major problem for these enterprising IC designers to strike out on their own. They will become TSMC’s customers, constituting a stable and growing market. Another thread that inspired and formed the foundation of the “new idea” for Morris was his reading of the academic writings of researcher Carver Mead who gave him the idea that the design part could be separated from the technology. CEOs or entrepreneurs or even value investors who pride themselves for being practical often scoffed at the term “academic” or “theory”. As Morris proved, nothing is more practical than “theory”! It is noteworthy to appreciate that Morris Chang returned to Taiwan as a relatively wealthy man and successful executive at 53 at K.T. Li’s invitation to head the think-tank ITRI (Industrial Technology Research Institute) at a much-reduced compensation. Yet his thirst for knowledge and learning never ceases. Morris reflected on his life path, “You need to follow your interests not where you think the big money is. Because, obviously, back in 1985 the big money was thought to be in financial venture capital, or maybe even continuing to manage a company in the U.S., but I felt that the Taiwan opportunity appealed to me from the interest point of view.”

As the fabless IC industry took off from 1991, its enabler TSMC became a powerful value compounder. The success of fabless innovators such as Qualcomm and UK’s ARM to leapfrog over their integrated rivals (known as IDMs, or integrated device manufacturers) such as TI was made possible because of TSMC. As Qualcomm President Steven Mollenkopf said, without ties to TSMC, “We wouldn’t have been here.” The IC designers are not able to trust that their proprietary work will not be copied by the IDMs if they outsourced manufacturing to them or to other foundries; they are able to trust TSMC. And Qualcomm is now as big as Intel in terms of market value, having compounded over 110-fold in 21 years since Dec 1991 to $112 billion! Naturally, the value investor in you might ask, what’s so moaty and innovative about this business model that others cannot replicate? Despite its capex-intensive nature, Bamboo Innovator TSMC has “emptiness” at its core that is rooted in a culture of trust and collaboration. One of the sources of “emptiness” is the indestructible intangibles that stem from having trust and support in the community. The exciting and important exchange at the market peak in Oct 2007 between Morris Chang and JH Huang, the founder of California-based gaming graphic chip designer Nvidia who is a TSMC customer, is worth reading over and over again whenever we are too caught up in the second- or third-order analysis of “technology curve” and geek-speak in looking at TSMC:

Huang: “In retrospect, most of the people who looked at the foundry industry thought that technology and capacity were important. It is important but they really missed what ultimately made TSMC extraordinary and more powerful in the end is this incredible focus on customer service. I remember, when you called and you said, and it was a phrase that I remembered then and that I’ve heard several thousand times since then, ‘We will jump through hoops for you.’ And one of the things that I really admired about that was that it wasn’t just what you told me that day. It was a phrase that drove through all of TSMC. Every employee believed in it and lived by it. People repeated it year over year. How did you do that? How did that start and how were you able to drive that through the culture?”

Morris: “In TSMC, we actually tailored everything in the company, the organization, the compensation system, the evaluation system, we tailored everything to customer service, to jumping through hoops. Let me tell you an anecdote. I was visited by a big company more than 10 years ago, and he was very big and we were still fairly small. We were couple billion dollars maybe and he was a lot more than that. His sales were several times that. He and I had dinner together and this CEO of this big company, he sort of intimidated me by saying, ‘Well, maybe I will go into your business and compete with you.’ So I let that go for the time being. Several minutes later, I asked him, innocently, ‘John, how do you evaluate your fab manager?’ So he gave me the list. ‘Well,’ he said, ‘yield, cycle time, productivity, ability to make billings every month,’ you know, all those things he told me. After he ran through his list of 10 or 12 factors, he said, ‘What else? Don’t you evaluate your fab managers the same way?’ I said, ‘No, no, no, John. I evaluate them according to how much complaints I get from customers about their fab.’ And that’s the honest truth. I really did that, have always done that, the evaluation of the fab managers. We don’t even keep P&L in each fab. We don’t. But we do keep very good track of how satisfied the customers are. If a fab manager has got very unsatisfied customers, he is in big trouble. I don’t care how much money he makes. He is in big trouble.”

The intense focus on providing superlative customer support services by jumping through the fire hoops for them is embedded into its open innovation business model. “Open innovation” is another source of “emptiness” in Bamboo Innovators as shared earlier. As demonstrated by the stunning success of Qualcomm, the largest fabless company, the chip industry is re-integrated in terms of knowledge flows rather than through integration within a single company. One industry insider puts it, “Design for manufacturing is a contact sport. You’ve got to be communicating closely, effectively, and systematically.” TSMC has become steadily involved with design. Although most of its customers rely on their own design teams or those at service providers allied with TSMC, the foundry has found it increasingly necessary to develop in-house expertise in order to help its customers create manufacturable designs and fill TSMC’s fabs. TSMC would develop and acquire technology files, process design kits (PDK), interface IPs, ERP and a rich portfolio of open libraries for use not only by its engineers but also by its customers. These reusable building blocks are essential for many design projects to help its customers complete their designs successfully and in less time, at lower cost. For instance, UK smartphone chip designer ARM and TSMC celebrated the completion of the implementation from RTL to tape out of the world’s first 20nm ARM Cortex-A15 MPCore processor in 2011 in six months, indicating the readiness of TSMC’s Open Innovation Platform® (OIP) 20nm design ecosystem. Thus, although ARM has 2,300 employees, it has a market cap of $23 billion and there are more than 35 billion ARM-based chips out there with the open innovation platform provided by TSMC.

Morris Chang was worried about being delayed by traffic in the TSMC’s shareholder meeting so the punctual down-to-earth Morris took the High Speed Rail from Hsinchu Science and Industrial Park to Taipei with the public in a photo taken in Oct 2012. Because a ‘big boss riding the train’ is truly too difficult to imagine, the photo was suspected to be doctored but later it was proven to be true. The female pictured in the photo sitting next to Morris was immersed in her study on the train and netizens jokingly said that if she would just raise her head and talk to Morris for ten minutes, it would be worth ten years of study.

The competitive edge in these design enablement via the open innovation technology platform is made sustainable because of focus on customer’s success carefully cultivated by Morris Chang: “All through the 1990s, and even now, really, the biggest joy I get out of this job was to see my customers grow and make money and succeed.” Interestingly, with the rise of the ARMs, once-proprietary chip design is increasingly commoditized. After all, nearly all mobile chips these days are centered on the ARM architecture. For the cost of a license fee, companies such as Apple can create their own modifications and hire a foundry to manufacture the resultant chip. The keen observers in the tech space would have noticed that the profits in the value chain, where the hockey puck is going as hockey legend Wayne Gretzsky would say, is shifting to manufacturers and there are only three or four manufacturers – Samsung, TSMC, Intel, GlobalFoundries – who have the capability and capacity to build the chips that are in every mobile device today and in everything tomorrow. Foundry price is about one-third of the final chip value. TSMC controls about half of the $39 to 40 billion market for contract-chip manufacturing. Morris Chang said that today about a third of industry sales is outsourced, a ratio that will continue to rise.

That’s why Intel, who prides itself as a design company, is eager to scale up its foundry business especially when Apple is dying to diversify out of Samsung’s supply chain in its smartphone and tablet chips. Apple’s transition will be complicated, because Samsung is involved in part of the processors’ design, in addition to fabricating the wafers that foundries normally handle. Intel has also recently promoted its COO Brian Krzanich to CEO in an apparent move to focus on manufacturing. It is noteworthy that Intel’s wafer cost is similar to TSMC’s wafer price and Intel’s fab arrangements is not as efficient as TSMC’s “mega fab” strategy. Intel’s fab ops are used to serving only internal customers and its corporate culture would have to change to a 24-hour customer service oriented one to compete effectively. Qualcomm, Nvidia, AMD, Altera, and Xilinx are currently the top five early adopters of technology at TSMC. Since Intel competes directly with Qualcomm, Nvidia, and AMD in PC microprocessor, smartphone, and tablet, Intel is unlikely to offer its leading-edge manufacturing technology to help these competitors. The exclusive contract between Intel and Altera also excludes Xilinx as a potential Intel customer. This leaves only Apple as the potential significant foundry customer for Intel. Yet, even Apple competes with Intel indirectly; Intel’s advanced technology could enable Apple’s SOC to replace Intel’s CPU on MacBook Air; and Intel is improving its own SOC to enable Apple’s competitors. The silent wisdom of Morris Chang in his “new idea” of building a pure play business model 25 years ago to be a partner to its customers and not a competing rival starts to ring louder, given the contradictions and limitations that Intel would face in its existing business model when it embarked upon scaling its internal foundry business for external customers. Interestingly, since the October 2007 market peak, TSMC is up 77% while its Taiwanese foundry rival UMC is down 37% and Intel is still down 5% as compared to the 20% rise for the Nasdaq index.

When fab managers at TSMC are measured and empowered to focus on customer service rather than P&L as Morris Chang shockingly points out, it rooted the corporate culture to treat employees as intangible assets to enable innovation at the customer level rather than as expenses to efficiently manage by the HQ “leaders”. As Singapore learnt painfully through the spectacular failure of its homegrown loss-making, debt-laden Chartered Semiconductor Manufacturing (CSM) which was started in the same year as TSMC in 1987 but sold in 2009 to GlobalFoundries for $1.8 billion, the scalability and resilience of the business model is not about pouring tangible resources with efficient centralized “leadership” to manage assets and people as costs but rather it’s about having “emptiness” at the core that is rooted in a culture of values, trust and collaboration. Nvidia’s founder JH Huang recalled with fondness that the first time when he visited Morris Chang in Taiwan, instead of a presentation about all the capabilities of TSMC, Morris gave him a brochure of the core values of TSMC. And Morris said, “And I do the same thing with a lot of visitors, with every customer, every potential customer.”

“I had decided at the start what the values of the company should be. Those values were very important to us, not only in the first phase of survival but from there on. We have maintained them. We have actually followed them. They are our compass, really. The values are pretty simple. At first, there were just three: integrity was number one; commitment, we really wanted our employees to be totally committed to TSMC but, in return, the company is committed to the employees, too. Also, commitment applies to customers. We want the customers to be committed to TSMC but we, in return, are totally committed to customers. Integrity is pretty simple, self-explanatory. Commitment works between employees and the company and between customers and the company. And then the third one is innovation. We knew that we couldn’t compete at all without constantly innovating. Those were our three values. The three values that we had at the beginning are still values today. Political candidates usually, before they start their campaigning, would call me so the presidential candidate came and told me all his big vision about Taiwan and I handed him our values: integrity, commitment and innovation. The presidential candidates from both parties saw that. In fact, I thought that I detected in each of them a little surprise? They don’t know what to do with it.”

Besides enabling the $300 to 400 billion fabless industry to sit on top of its resilient business model, TSMC has also played a pivotal role to Taiwan’s economy. As Acer’s founder Stan Shih commented in the Nov 2012 Forbes article on Morris Chang titled “Ageless and peerless in an era of fabless”, “TSMC buttresses Taiwan’s global competitiveness in industries ranging from machinery to auto parts because of the importance of chips in those businesses.” If all this is not enough, Morris Chang is also a bridge player who expresses a longtime interest to play with Warren Buffett and Bill Gates – and Nvidia’s JH Huang teases Morris jokingly that “he has quite a bit of confidence he would prevail.”

Sadly, if the comments by Morris Chang that “entrepreneurship in Asia is usually driven not by a new idea but by the desire of being your own boss” were shared with a number of wealthy and property-rich Asian and Singaporean businessmen without them knowing they were made by someone who built a $100 billion market-cap company and who started the firm at the age of 55, they are likely to react with scorn and disgust. “What new ideas?” Entrepreneurship to them is about “Can make money or not?” (a popular phrase in our local colloquial Singlish language which has deliberate grammatical errors). “If inventors were entrepreneurs, Thomas Edison would not have died a poor man,” a local expert commented in our local press two years ago in defending against well-intentioned observations on the award of the “Entrepreneur of the Year” to wealthy businessmen who can make good money largely for themselves but might not possess the “X-factor” in creating larger-than-self new business models or new ideas to benefit others.

At its best, entrepreneurship entails something far more important than mere money. The December 1949 issue of Fortune with the feature essay titled, “The Moral History of U.S. Business” was inspiring in its description of entrepreneurship: “An enterprising man not in haste to get rich, willing to run some risks, yet not willing to risk in hazardous enterprises the property of others entrusted to his keeping, careful to indulge in no extravagance and to be simple in his manner and unostentatious in his habit, not merely a merchant but a man, with a character to form, a mind to improve, and a heart to cultivate.” Ben Franklin, Charlie Munger, Morris Chang, Qualcomm’s founders Irwin Jacobs and Andrew Viterbi and ARM’s Warren East would add, “… and a new idea to innovate”.

Happy Diwali! The Inner Light of Asian Compounders

Dear Client and Partners,

Wishing you all a very happy Diwali! May this festival of lights awaken the Inner Light in all of us and bring with it inner joy and peace.

A Diwali-related business story that we find inspiring is from the fascinating book “The Resilience Dividend: Being Strong in a World Where Things Go Wrong”, in which Judith Rodin, president of The Rockefeller Foundation, recounted the well-known story of billionaire Anand Mahindra’s near death experience – and resilience – in the day before the Diwali festival in 1991.

Anand Mahindra was attempting to turn around the business with productivity improvements and broke down the barriers between the silos of manufacturing, marketing and sales, and finance in the company. On the day before Diwali, Anand Mahindra made an announcement to the factory floor that the traditional holiday bonus would be awarded differently than it had in the past. For the first time, it would be linked to the achievement of performance targets and negotiated through the labor unions. Not long after making the announcement, Anand Mahindra looked out of his window and saw a line of angry workers charging into the factory floor. Anand Mahindra and a group of union leaders he was with scrambled into Anand Mahindra’s inner office and locked the door. A four-hour standoff ensured. The union leaders advised Anand Mahindra to stay put until the workers left, but Anand Mahindra at last decided it would be best to have a direct conversation.

Anand Mahindra walked out of his office to the factory floor and asked everyone to sit down. “If you want to throw me over the railing, you can. But that won’t change anything. The world is changing and there’s not going to be a free lunch anymore.” The workers did not throw Anand Mahindra over the railing. The mood completely changed. They calmed down and waited to hear what he has to say. At the end of the “conversation”, there is a sense that “we’re-all-in-this-together” mentality and one of the workers even asked for Anand’s autograph!

We like to also share another Diwali-related article that we have written earlier: “The Inner Light of Asian Compounders: The Reborn of India’s Hero Motocorp”, also a tribute and remembrance to the wise leader Brijmohan Lall Munjal, the late billionaire founder of Hero Motocorp.

Warm regards,
KB and the team at Hidden Champions Fund
KEE Koon Boon | Chief Investment Officer & CEO
Hidden Champions Fund

The Inner Light of Asian Compounders: The Reborn of India’s Hero Motocorp

A Hero lights up this Diwali festival: Hero Motocorp (HMCL IN, MV $6.8 billion), the world’s largest two-wheeler manufacturer (by volume), announced on Nov 1, the first day of Diwali, that they achieved the highest-ever retail sales (625,420 units, +18.2% yoy) for any month in October in India. This is also the first time that any two-wheeler manufacturer has exceeded the landmark 6 lakh unit sales in a month. Hero sold 6.23 million units in the year ended March 31, and has a capacity to produce 7 million annually. Hero’s performance stood in contrast to the four-wheeler market in which the automakers from Maruti Suzuki, Tata Motor and Mahindra & Mahindra reported lower or nearly flat sales with the Indian economy growing at its slowest pace in a decade and accelerating inflation (onion prices has surged from Rs 16 a kg in Jun to Rs 100) leading the central bank to raise its lending rate twice in as many months. Interestingly, just three years ago on Dec 21, 2010, Hero hit a crisis and was thought to have problems surviving in India. Yet, Hero has emerged stronger from the crisis because of its “Inner Light”, just like the spiritual significance of Diwali.

Diwali, also called Deepavali or the “festival of lights”, is a five-day Hindu festival to celebrate the slaying of the evil demon Narakasura by Lord Krishna, the incarnation of Vishnu (the supreme god of Hinduism), signifying the victory of good over evil and light over darkness. The deeper spiritual meaning of Diwali celebrates the belief that there is something beyond the physical body and mind which is pure, infinite, and eternal, called the Atman or the Inner Light. With this awakening of the Inner Light comes compassion and the awareness of the oneness of higher knowledge which brings ananda (joy or peace).

Hero Motocorp (HMCL IN) – Stock Price Performance, 1995-2013

Hero Motocorp is an incarnation of Hero Honda, the JV formed between founder Brijmohan Lall Munjal and Japan’s Honda Motor (7267 JP) in 1984 in a country that did not think beyond scooters back then. By 2001, Hero Honda beat Bajaj Auto (BJAUT IN) to become India’s largest two-wheeler manufacturer – and also the world’s largest for 12 consecutive years. In the years between March 2000 and March 2011, Hero Honda’s revenue grew from Rs 2,118 crore to Rs 20,787 crore ($3.4 billion); profits increased from Rs 192 crore to Rs 1,927 crore ($314 million).

On Dec 21, 2010, Honda announced a bitter split up and Hero bought over their 26% stake for Rs 3,842 crore ($622 million), ending the 26 year-old JV which started with equity of Rs 16 crore, of which Honda contributed Rs 4 crore. Worse, Honda will be competing with Hero in India and Hero has to drop the Honda name from its brands, products, and distribution outlets after March 2014. How would customers know that the Hero bike is not Honda nad that the quality has not gone down? Dealers are thought to be stampeding out of Hero to join Honda. Prior to the termination of the joint venture, Honda supplies technology for products which Hero marketed in India and Hero’s right to use Honda’s new technology for Hero’s new products will end in 2017, though they can continue to use the existing technology. The 90 year-old Munjal commented, “They didn’t tell us that they want to leave. We told them that if they, themselves, are here to make motorcycles, then they become competitors. How can a competitor and principal be the same?” Since the split, Honda, the world’s biggest motorcycle maker, overtook Bajaj Auto to become India’s second biggest two-wheeler seller with around a 20% market share and vowed to overtake former partner Hero’s 43% leadership by 2020. “We want to be number one in every market we are in, it’s unacceptable at the company to not be number one,” said Tatsuhiro Oyama, senior managing officer in charge of Honda’s motorcycle operations.

The main reason for the split is the typical principal-agent case in Asia: Success. As Hero Honda grew enormously successful, it increased the aspirations of Hero to export and develop the products in-house with its own R&D. Honda, of course, refused any exports though they later modified the agreement to allow exports of limited products to a few countries, namely Sri Lanka, Bangladesh, Nepal, and Columbia. The second contentious issue was that of board representation. Hero felt that the four Honda representatives on the board had access to its plans and strategies, while they had access to none of Honda’s plans. This, Hero Honda had felt amounted to a conflict of interests when Honda decided to launch a 110cc motorcycle, the segment that formed over 70% of Hero Honda’s sales. The third issue was related to Hero Honda wanting to do its own independent R&D and manufacturing its own products. When it asked Honda to be allowed to do so, Honda’s response was “R&D is our heart and we can’t give our heart to anyone”. Honda in turn was unhappy with the Indian family for not injecting the lucrative spare parts business into the listed JV. When the split was announced, the share price fell from Rs 2,000 to Rs 1,500, which subsequently rebounded to over Rs 2,000. During the recent emerging market crunch with the sharp decline in rupee, share price again fell from Rs 2,000 to Rs 1,500 before rebounding to Rs 2,000. Even now, of the 66 analysts who track the stock, 27 rate it a sell, while 19 advise buying it, according to data compiled by Bloomberg.

So how did Hero survive the crisis? What are the lessons for value investors in assessing stocks in Asia beyond the quantitative financial numbers?

Munjal’s journey at Hero is an extraordinary story of entrepreneurship in the face of adversity. Importantly, it is the tale of a man who has lived his life on the principle that if you work hard and be good to people around you, success in business will, inevitably, follow. Munjal started off by manufacturing bicycle parts in 1944, travelling “across India carrying bicycle parts in a bag” and showing dealers the samples. In the initial phase, the dealers simply shoo off Munjal: ‘Sir, you’ll show something and send something completely different. This won’t work’.” Munjal never lose heart. Over a long chat, he would convince the dealer to place just one order; if it didn’t turn out to be as promised then the dealer was free to never order again. “Because we did that, our reputation, right from the first day, was very good. And then people stopped asking for samples. They would directly place the orders.” Munjal decided to manufacture bicycles, recalling that the bicycle-makers Raleigh, Hercules and Atlas mocked him, “They said they had got the technology from England, loans from banks and then started making bicycles. They would say, ‘Will you do it just like that?’ Within six months of us starting operations, they were all taken aback”.

What worked for Hero was simple – whatever was promised was delivered, and there was no attempt at profiteering. “Other people would show something and deliver something completely different. Or after one consignment, if sales were good, they would tell the dealer that the price of raw materials had gone up and then increase the prices. We never did anything like that, unless the Government of India announced that price of raw materials had gone up,” says Munjal. During his bicycle manufacturing days, while in search of machines, Munjal found inspiration from Germany. “People used to be surprised at why I would go to Germany so much. But I got the best technology, met such nice people and was very impressed with their working style,” he says. “I saw that if a person committed to something, even if it is a loss-making proposition for the company, he would go out of his way to keep his commitment. And the Germans would never do an incomplete or inferior job. That influenced me… that whatever I do, I should do it perfectly.” Those were the days of the ‘Licence Raj’. It was easy to get tempted and make money through a licence for a commodity in short supply, such as steel sheets, oil or even power. These could be traded in the market for a handsome profit. “We had a licence to buy steel sheets and if we were to just sell that, there would have been no need to make bicycles. But, with God’s grace, we never ever thought like that,” says Munjal.

These values helped Hero build a reputation where dealers and suppliers had unflinching trust in the company. Building a pan-India dealer and distribution network to reach out the rural consumers is critical for the business model to scale up sustainably. And reach is not just in terms of the sales touchpoint but importantly it’s about service and it is ultimately what determines how much one can sell. From day one, Munhal adopted a very personalized approach towards dealers. The final interview and selection of every dealer that the company has appointed in the last 30 years has been done by Munjal himself. At Hero, there are many such stories about Munjal – be it knowing the company’s thousands of dealers on a first-name basis or personally calling suppliers on their birthdays. But Munjal doesn’t find any of this surprising. “Wouldn’t you do that if it was your family?” he says. So people feel connected and engaged with the company. As a result, from December 2010, when the split happened to January 2012, only two dealers out of its vast network of 5,500 across the country have left Hero. This intangible quality in the trust and support from its community of customers, suppliers, employees, and partners is the Inner Light that helped Hero bend not break in the crisis like the bamboo.

Data from the Society of Indian Automobile Manufacturers show that sales of two-wheelers in India rose an astonishing 85% between 2007-2008 and 2011-2012, to 13.4 million units a year. Much of the growth was driven by demand for fuel-efficient transport in rural areas — where public transport is often poor or nonexistent — and from specific segments of the urban population such as students, office workers and working women. India’s rural spending was $67.57 billion between 2009-10 and 2011-12, compared to urban consumption of $53.95 billion in the same period, according to a November 2012 note by India Brand Equity Foundation. Rising incomes and low penetration of consumer durables are the reasons cited for the growth in spending. Nearly half of Hero’s sales come from rural markets where it has deep-rooted brand equity. Through its vast network of dealers, Hero organizes free vehicle servicing and free health checkups in medical camps in over 100,000 villages around the country to bolster its presence and attract new customers. Hero also has creative marketing campaigns over the years that have entered into the hearts of millions of consumers, ranging from “Fill It, Shut It, Forget It” emphasizing the low-maintenance fuel efficiency to “Why should boys have all the fun?” featuring the Bollywood film-star Priyanka Chopra to “Hum Main Hai Hero” (There is a hero in each one of us).

The company is still relying on technology from Honda for its best sellers, the 100-cc Splendor and Passion, and is struggling to introduce new independent models. Hero and Honda have signed a new licensing agreement under which Hero will pay Honda 45 billion yen ($458 million) or an annual royalty of $228 million till 2014. Since going solo, Hero has developed new engines of 100cc, 110cc and 250cc capacity with technical partners that include Austrian engine-developer AVL and Italian design firm Engines Engineering. Apart from the new engines, Hero is set to commercially launch its first motorcycle without the technology of Honda in the year ended March 31, 2014. “Our ultimate aim is to have our partners as an extended R&D arm for Hero MotoCorp. These partners have huge specifications available and we want to be known as a full-fledged global two-wheeler brand eventually,” Munjal has said. The company is investing Rs 450 crore ($73 million) to set up a R&D centre near Jaipur in Rajasthan. The facility would be commissioned in the first quarter of 2015. In July 2013, Hero acquired a 49.2% stake in US-based Erik Buell Racing (EBR) for $25 million after entering into a technology sourcing pact last year. The investment is part of the strategy to enhance its own technological prowess and have multiple technology sources for different segments. Erik Buell is one of the most revered names in the motorcycle industry Erik Buell has been instrumental in developing some highly advanced technologies for motorcycles over the years and is the only American sportbike maker in the world. Erik F. Buell (in photo with Hero’s Pawan Munjal) commented: “EBR is delighted to partner with a company as iconic as Hero MotoCorp. Both HMCL and EBR share the common commitment to manufacturing world-class two-wheelers with technology of the future. I have personally been deeply impressed with and inspired by Pawan’s vision. He has given us a challenging brief, and our highly-motivated team is working towards giving shape to that dream. We look forward to designing technology solutions which are in line with contemporary global standards and also futuristic in their appeal and utility.”

Hero also looked to expand in global markets to make up for lost time. In August this year, it had announced plans to enter 50 new markets by 2020 with a target of 20 manufacturing facilities across the globe and an overall annual turnover of Rs 60,000 crore ($9.8 billion). Hero currently exports about 200,000 two-wheelers annually while rival Bajaj sells more than 1 million, making significant progress in reaching out to emerging markets in the years Hero was restricted to South Asia. For instance, in Nigeria, Bajaj is the market leader and Bajaj has a significant presence in many Latin American markets and exports make up 35% of its two-wheeler revenue as compared to around 3% at Hero. Hero expects to export nearly 75% more (350,000 units) in 2013-14. Hero and EBR would also promote selling and marketing of motorcycles in the Western Countries, namely North America and Europe and Hero also plan to set up an assembly line for EBR.

The biggest challenge for Hero will be to allocate resources and capital. There is unprecedented demand for capital for initiatives ranging from R&D, spare parts capacity enhancement, developing exports markets, manufacturing capacity expansion, tying up with technology vendors and re-branding. These costs will put pressure on profitability as initiatives such as R&D and exports do not yield results immediately. However, it helps that Hero possess the three sources of “emptiness” in Bamboo Innovators: the indestructible intangible of the trust and support from its community of suppliers, dealers and partners; the core-periphery network of the 5,500-strong dealers, particularly in the rural areas; and the open innovation model that it now adopts in working with external technological partners such as EBR to co-develop new products. With this Inner Light lit up, value investors can see more clearly the uncertain path ahead for Hero in the face of the formidable partner-turned-rival Honda, just like how the lights of the oil lamps during the moonless night of Diwali are turned on to invite the blessings of Lakshmi, the goddess of prosperity and well-being.

Without the Inner Light to guide the path, it is easy for value investors relying on quant financials to always get overconfident and pick up “cheap”-stocks-turned-value-traps such as China’s largest two-wheeler Lifan Industries (601777 CH, MV $1.08 billion) or Vietnam Manufacturing and Export Processing (VMEP) (422 HK, MV $61 million), the third-largest manufacturer of scooters and motorbikes in Vietnam and 67% owned by Sanyang Industry (2006 TT, MV $884 million), not realizing that while the listed vehicles have some “net-net” tangible manufacturing assets, the lucrative intangible assets in distribution and spare parts are not injected into the listed companies which are just front vehicles to raise funds and pledge assets to finance the unlisted businesses in the group.

Even at 90, Munjal still clocks at least six hours in office every day. Ask him why and he informs you that everybody asks him the same question. And he doesn’t see the point of it. “When I am still on duty, what is the point of not coming to office? What will I do at home the whole day? You are being paid for this,” he points out. “What right do you have to not do a full day’s work and still draw a full salary? The biggest thing is that I enjoy working. I enjoy coming to the office and I look forward to the day. Till the time that I am capable of work, I will not think about retirement”. Munjal summed up:

“This company is going to last for a long, long time. Because it is neither in my heart nor my children’s hearts to become rich quickly. If we keep satisfying the customer, who pays money to purchase our products, there is no reason for us to fall behind. Our culture is not to overcommit and underdeliver. First, prove your capability and then talk. Not the other way around. I am very grateful to God that my kids Pawan and Sunil talk only about what they have accomplished or what they have the capability to deliver.”

Key Bamboo Takeaways:

  1. In emerging Asia, the growing rural consumer market is often overlooked because it is difficult to reach out to this group without the right business model.
  2. To assess whether companies can overcome a crisis, value investors would find it helpful to look for the three sources of “emptiness” in Bamboo Innovators: the indestructible intangible of the trust and support from its community of suppliers, dealers and partners; the core-periphery network; and the open innovation model in working with external partners to co-develop new products.
  3. The case of China’s Lifan and Vietnam’s VMEP highlights the extreme dangers of using the net-net approach in investing in “cheap” stocks that (usually) turn out to be scary value traps. While these listed vehicles have some “net-net” tangible manufacturing assets, the lucrative intangible assets in distribution/financing and spare parts are not injected into the listed companies which are just front vehicles to raise funds and pledge assets to finance the unlisted businesses in the group.
  4. In Asia, it is very likely that we will see more cases of the principal taking back their powers from their local partners and compete alongside. Other ways for MNCs to leverage their power include increasing the royalty payments. It is possible that some of the outperforming Asian-listed units of MNCs could start to reverse their earlier massive gains.
  5. The case of Hero also highlights that there is no perfect stock and value investors often commit the error of omission because of nitpicking the grains of sand. Confirmation bias can distort the view of focusing on the trees or “chess pieces” but missing the forest or the “chess board”. Investors need to keep away from the emotion of having to be right in spotting the negatives. The red flags include (1) the lucrative spare parts and financing business residing outside the listed vehicle and in the private pockets of the Munjal family – Hero Honda before the split and Hero Motocorp after the separation; (2) the Munjals, like almost all Indian business family, are also active in their private business interests ranging from renewable energy, financial services, education to retail in chocolate and clothing. However, the core intangible asset of the distribution and marketing that drives the value creation process is housed inside the listco. Often, only one or two questions really matter to the investment case.

Hidden Champions Fund October Updates

Dear Clients and Partners,

Achieving Investment Resilience Together with Hidden Champions – YTD Over 20%

An update on the 2nd anniversary of our Hidden Champions Fund – our YTD 2017 returns (net after fees) is over 20%, with our Fund benefiting from the flight-to-quality effect as the overall market retreats while we see a 7.9% gain in the month of September, bringing our total absolute returns to over 37% since our inception in September 2015. Please click to download our latest Hidden Champions Fund Factsheet as at end September 2017.

We like our clients to ask us tough questions to make intelligent decisions. Our first HNW client who invested $1 million with the Fund in June 2017 after asking tough questions, and in the process appreciated the high-conviction investing approach to achieve investment resilience, is up over 18% in returns since our initial launch offering event that we held four months ago in June. We also have had existing clients subscribing additional capital into the Fund. Thus far, since obtaining our Registered Fund Management Company (RFMC) license from the Monetary Authority of Singapore (MAS) in April 2017, we have raised over $5.5 million from external clients, generated over $8 million in absolute profit, bringing our total asset under management to over $35 million.

We will be extending our Founding Partnership Cash Bonus till the end of October for both existing and prospective clients before our Fund soft closed. For investors who like to participate in the long-term non-linear growth of the underappreciated emerging Hidden Champions, we like to invite you to our office over the next two weeks till the end of the month to find out about the subscription process. Please drop us an email at invest@hiddenchampionsfund.com.

We have also made some improvements to our website www.hiddenchampionsfund.com which includes a section of “Business Builders of Asian Hidden Champions – Hall of Fame” to map out a selected group of Asian entrepreneurs whom we have monitored over the decade plus and admire and respect them. Please let us know of your valuable comments and who else do you admire in Asia and would like us to include in the Hall of Fame, as well as share with us which Asian entrepreneur do you like most.

We are careening towards the end of the bull market. At the Hidden Champions Fund, we aim to protect and grow capital by positioning for and capitalizing on the upcoming downturn in the global/economic business cycle. How do we prepare for crisis? Time the market? Buy put options? Buy “safe haven” bonds? In Issue 2 of our Upward Toiling newsletter, we shared the insightful empirical research “The Best Strategies for the Worst Crises”. Evidence was reported that an investment strategy in quality stocks benefit from a “flight to quality” effect during crises: “While quality stocks logically deserve a higher price-to-book ratio, in reality they do not always exhibit such a premium. Towards the end of the bull market, quality stocks often looked underpriced. Then, when the market has a drawdown, these stocks have outperformed, benefiting from the so-called flight-to-quality effect.” Specifically, the quality factor delivered 43.7% returns when markets were down -45.3% in crisis periods.

At the Hidden Champions Fund, we expect to outperform when the market retreats as our Hidden Champions benefit from the flight-to-quality effect in which investors flee their speculative yield and cyclical bets to seek shelter in companies with higher quality fundamentals and long-term growth prospects. our Fund tends to do better when the overall market is tepid and lacklustre. For instance, in 2016, when MSCI and Singapore STI index were flattish to down at +2.5% and -0.1% respectively, the Hidden Champions Fund is up 14.3%.

With the Value-to-Quality (VQ) ratio of our Hidden Champions Fund presently over 170% superior than the market comparable, we believe that the Fund is significantly undervalued to its intrinsic value and the downside risks are limited to protect investors. As the CIO & CEO of the Hidden Champions Fund, a significant part of my personal savings is invested in the Fund along the same terms and fees as the incoming external client.

During the investment process, many investors are led astray by shortcuts. It’s hard to see how it could be otherwise when the experts and thought leaders wily talk us with shortcuts, hacks and tricks that optimize for quick and obvious success. How to build something that last through time and crises is a lifelong fascination and a calling for us at the Hidden Champions Fund where we seek to invest in the perennial compounders that last the distance to generate sustained returns.

The Hidden Champions Fund is not for everyone. Only for investors who see themselves in the Hidden Champions – their struggles, how they are misunderstood and overcome the odds with persistence, and the non-linear triumphs – that we invest in with high-conviction when the reward-to-risk and value-to-quality metrics are compelling. Only for investors who want to go the right way, not the easy way.

It’s easy to be good when things are good. It’s easy to be cheerful and generous with the wind at your back. It’s easy to stick with a philosophy when all is well. Things will not always go well. You will be driven back upon yourself. It could be today. It could be tomorrow. It could be for a short time or it could be years in the so-called wilderness.

Are you ready for that? Are you sure you’re going to like what you find there? Because if you’re not, now is the time to do that work—that “hard winter training” that the Stoics talk about. Do it now before it’s too late. We hope that you will be inspired by the lessons in business building and life of what the Hidden Champions have to share with us in how they overcome adversity in harsh conditions, rebound forward stronger to achieve resilience, sustainable growth and serenity.

To our clients, we are thankful and grateful for your trust and support in us all this while – and we will live and die and breathe our art and science into investing in Hidden Champions to protect your dreams because you protect ours.

Warm regards,
KEE Koon Boon | Chief Investment Officer & CEO
Hidden Champions Fund

Upward Toiling Issue 3 – Perennial Compounders: The Long View in How Hidden Champions Create Multi-Year Lasting Wide Moat (Part 1)

Dear Clients and Partners,

Perennial Compounders: The Long View in How Hidden Champions Create Multi-Year Lasting Wide Moat

If Singapore’s Changi Airport Group (CAG) is ever listed, it will be one of our top positions in the Hidden Champions Fund. CAG is the archetypal Hidden Champion with the winning characteristic of a “perennial compounder”, in similar ways to our top position ASX-listed SeaLink Travel which we will elaborate later about its transformation in business model in its latest corporate development in developing a new Townsville Strand ferry terminal hub with new recurring retail concession and rental income opportunity.

As our international gateway where more than 100 airlines connect Singapore to more than 300 cities across the world, Changi Airport gives all visitors an excellent introduction to the way Singapore works and Singapore’s reputation for excellence. But the non-linear success and growth was not an easy nor obvious path to undertake.

In 1975, then-Prime Minister Lee Kuan Yew had the Long View and made the critical decision to move from Paya Lebar to Changi, a site that was five times larger. This was despite the Cabinet’s decision for the go-ahead in 1972 to expand Paya Lebar Airport based on a British expert’s report that it would cost less and that there was not enough time to get Changi built up to meet increasing traffic needs. It was the single biggest public project at that time and the tough call meant writing off some S$800 million that had already been invested in Paya Lebar airport, a commitment of S$1.5 billion, six intense years, incredible foresight and the commitment of the entire nation to make it happen. But Mr. Lee himself described it as “one of the best S$1.5 billion investments we ever made”. Mr. Lee, Howe Yoon Chong, Sim Kee Boon, Teh Cheang Wan and Woon Wah Siang had the grand vision that the tangible infrastructure must have the intangible quality to engender the network effect and multiply in value. From airport management software to the texture of trolley handles, Sim insisted every aspect of customer experience must keep up with its impressive infrastructure. The quality of toilets – at night – was even under his radar. He was quoted saying that the first and last point of exposure to an airport is the toilet. It gives you an impression of the country.

As a result of the vision and attention to details, CAG was able to reap multi-fold gains from the infrastructural asset with multiple recurring income streams in airport concession and rental income, airport services and security services, generating over S$2 billion in sales and S$900m in EBIT from S$8.5bn in total assets (10.5% ROA) and S$6.6m in total equity (13.6%). Today, airport concession and rental income contributed over half on the back of strong retail sales which grew to reach a record high of more than S$2.3 billion as passengers are spoilt for choices by the 360 retail and services outlets and 140 dining outlets spread over 76,000 square metres of retail space. This placed Changi Airport as one of the top three airports in the world for concession sales. Because of CAG, Singapore serves over 100 world-class aerospace companies and commands over 6% of the global maintenance, repair and overhaul (MRO) industry market and about one quarter of the Asian market. The success of Changi Airport, SIA, the MRO and air cargo sectors and their spin-offs have all contributed significantly to Singapore’s economic growth.

Similar to Changi Airport Group, SeaLink Travel, Australia’s largest tourism travel and transport group which captures over 1.2 million international visitors, or 15% of Australia’s annual international tourist arrivals, is quietly transforming into a perennial business model with various strategic multi-year growth initiatives as part of its Long View. One of which is the new Townsville Strand ferry terminal hub to be completed by mid-2020 together with a consortium of developers to replace the aging Breakwater terminal facilities in a announcement by the Queensland government on 17 August.

The new Strand terminal will boost connections between Townsville, the Great Barrier Reef Marine Park, Magnetic and Palm Islands with city-link ferry service which could connect key CBD site, the new stadium, and transform the area into a thriving tourism precinct with potential Terminal retail opportunities for SeaLink (LINK1, LINK2). Sealink looks to explore the option of (1) Becoming an anchor tenant in the building, thereby giving others the confidence to invest in the development; (2) Acquiring/ purchase the Terminal (retail) component of the development to secure its long term position in that building; (3) Acquiring the full retail area, thereby allowing SeaLink the ability to attract the correct tenants to the retail space. The retail space of the development if acquired by SeaLink is estimated to under $10m and SeaLink would not be looking to raise capital to fund the project which will be financed internally. Traffic on the current Breakwater Terminal site includes an estimated 1 million passenger movements per annum, 120,000 car movements and 10,000 bus movements annually. As a comparison, Kangaroo Island, which SeaLink made famous as one of South Australia’s most popular tourist attractions and has quasi-monopoly ferry operations, attracts 200,000 tourists annually. SeaLink is negotiating to secure a multi-year contract with the Queensland Government to operate the Strand terminal exclusively and not shared with any other marine operators.


Perennial Compounder = Long View x Innovation x Multiplicity

(A) The Long View = Ecosystem Approach x Focus x Sacrifice

Perennial. Evergreen. Enduring.

In every industry – from aviation to books to movies and software – certain creations like the Changi Airport can be described as “perennial”. Works that seem to last forever. These products, services or solutions become timeless, dependable resources that have found continued success and more customers over time. In his thought-provoking book “Perennial Sellers: The Art of Making and Marketing Work That Lasts”, Ryan Holiday illuminates the brilliance of perennials in that they grow stronger with each passing day.

Perennials like Star Wars isn’t suddenly going to stop making money – in fact, the profits from the franchise are actually now accelerating, some forty years after conception. Despite getting little radio airplay, heavy metal group Iron Maiden has defied every stereotype, every trend, every bit of conventional wisdom about not just their genre of heavy metal but the music business, selling more than 85 million albums, 24 world tours and 2,000 concerts in 59 countries over the course of a four-decade-long career. They sell their own beer, they are one of the highest earning acts in the world, and they travel from sold-out stadium to sold-out stadium in a Boeing 757 piloted by the lead singer, often shuttling loyal fans and crew along for a ride.

How can perennials endure and thrive in an impatient, flustered world demanding quick success? How can we make works and build businesses that achieve longevity? Is there a common creative mindset, behaviors and decisions behind work that lasts? Is there a pattern to perennials that both entrepreneurs and value investors can learn from? So that their success can be your success.

During the investment process, many investors are led astray by shortcuts. It’s hard to see how it could be otherwise when the experts and thought leaders wily talk us with shortcuts, hacks and tricks that optimize for quick and obvious success. How to build something that last through time and crises is a lifelong fascination and a calling for us at the Hidden Champions Fund where we seek to invest in the perennial compounders that last the distance to generate sustained returns.

Thus far, the Fund has generated over 26% in positive absolute returns for our clients since our inception in September 2015 and the Fund has continued to make steady progress in the month of August 2017 as the overall market gyrates and retreats because all our core portfolio stocks from Australia’s SeaLink Travel (ASX: SLK) (“Blue Highway and Tourism Boom”), Taiwan’s Nyquest Technology (GTSM: 6494) (“Supercycle in Microcontroller”) to India’s Emmbi Industries (NSE: EMMBI) (“India’s Water Conservation Revolution”) have continued to generate record profits in this recent earnings season, and our recent additions in new potential core portfolio stock, as depicted in our factsheet, has done well too with double-digit gains. At the Hidden Champions Fund, we expect to outperform when the market retreats as our Hidden Champions benefit from the flight-to-quality effect in which investors flee their speculative yield bets to seek shelter in companies with higher quality fundamentals and long-term growth prospects.

The Hidden Champions Fund is not for everyone. Only for investors who see themselves in the Hidden Champions – their struggles, how they are misunderstood and overcome the odds with persistence, and the non-linear triumphs – that we invest in with high-conviction when the reward-to-risk and value-to-quality metrics are compelling. Only for investors who want to go the right way, not the easy way.

PS: Our Fund will be doing a soft close at the end of September. Investors who subscribe into the Fund before our soft close will qualify for a Founding Partnership Cash Bonus.

If making money is all you care about, and making it sooner is preferable to later, then building and investing in perennials is not the path for you. There are better, faster way to make a profit: work on commission somewhere, start another fusion restaurant, get a sell-side finance job on Wall Street or Raffles Place. Creating something that lives – that can change the world and continue doing so for decades – requires not just a reverence for the craft and a respect for the medium, but real patience for the process itself. By patience, it’s not just to the amount of time that creation will take, but also the Long View with which you evaluate your own work. It takes time and effort and sacrifice to make something that lasts.

Picture George Lucas literally ripping out his own hair as he struggled to complete the first draft of Star Wars. Consider stories of struggling artists who give up everything – even steady meals – for their work. Think of the writer working into the night well after everyone in the house has gone to sleep because it’s the only quiet time she gets. Whether these are clichés or inspiring images, there is very real pain involved. From sacrifice comes meaning. From struggle comes purpose. If you’re to create something powerful and important, you must at the very least be driven by an equally powerful inner force. In the course of creating your work, you are going to be forced to ask yourself: What am I willing to sacrifice in order to do it? A willingness to trade off something – time, comfort, easy money, recognition – lies at the heart of every great work.

Having the Long View is critical in a time when many entrepreneurs whom we observe are running harder and harder to opportunistically chase after short-term gains just so to stand still. Taking the Long View to build a multi-year lasting wide moat means having an ecosystem approach towards building and scaling up the work with various key players in a win-win partnership, having the strategic mindset to cultivate a multiplier effect instead of thinking about merely the addition of capital in a show of might, and a willingness to sacrifice and reject short-term opportunistic gains in posturing up to look good and focus on what matters for the long-term.

We remain impressed by the Long View of SeaLink Travel’s (ASX: SLK) Jeff Ellison and his team in creating an ecosystem approach in building a multi-year perennial revenue model and recurring income stream that the market underappreciates substantially. As the largest tourism travel and transport group, SeaLink captures over 1.2 million international visitors, or 15% of Australia’s annual international tourist arrivals, and with continued market share gains nationwide in NSW, Queensland, Western Australia and South Australia, beyond the Kangaroo Island which SeaLink made famous as one of South Australia’s most popular tourist attractions. Some recent strategic multi-year growth initiatives as part of SeaLink’s Long View:

  1. Creating a “Kangaroo Island 2.0” in Queensland with the $56 million Townsville Strand ferry terminal hub to be completed by mid-2020 together with a consortium of developers to replace the aging Breakwater terminal facilities in an announcement by the Queensland government on 17 August. This latest corporate development is a transformation in the business model with potential new recurring retail concession and rental income opportunity. The new Strand terminal will boost connections between Townsville, the Great Barrier Reef Marine Park, Magnetic and Palm Islands with city-link ferry service which could connect key CBD site, the new stadium, and transform the area into a thriving tourism precinct with potential Terminal retail opportunities for SeaLink (LINK1, LINK2). Sealink looks to explore the option of (1) Becoming an anchor tenant in the building, thereby giving others the confidence to invest in the development; (2) Acquiring/ purchase the Terminal (retail) component of the development to secure its long-term position in that building; (3) Acquiring the full retail area, thereby allowing SeaLink the ability to attract the correct tenants to the retail space. The retail space of the development if acquired by SeaLink is estimated to under $10m and SeaLink would not be looking to raise capital to fund the project which will be financed internally. Traffic on the current Breakwater Terminal site includes an estimated 1 million passenger movements per annum, 120,000 car movements and 10,000 bus movements annually. As a comparison, Kangaroo Island attracts 200,000 tourists annually. SeaLink is negotiating to secure a multi-year contract with the Queensland Government to operate the terminal exclusively and not shared with any other marine operators;
  2. Pioneering the launch of the first-ever direct high-speed ferry transport service from Manly to Barangaroo in September 2017 as an integral part of the “Sydney Blue Highway” and NSW 20-Year Ferry Plan and transportation masterplan (LINK).The new ferry hub at Barangaroo to replace Darling Harbour King Street Wharf was built to be the second major terminal for the Sydney Ferries network after Circular Quay ferry terminal. Situated at the western edge of the Sydney’s CBD, the recently opened ferry hub in June 2017 will relieve the capacity constraints at Circular Quay and connect customers to the western and central parts of CBD. Importantly, it will be the single largest development in Sydney’s CBD over the next 20 years. Once fully occupied, Barangaroo will accommodate more than 20,000 office workers and 2,500 residents. Cultural and recreational facilities at the site are also estimated to attract around 33,000 visitors a day. Thus, besides capturing a large portion of the working crowd seeking to escape the peak-hour motorway traffic congestion of Sydney, the new Barangaroo ferry hub will serve the new commercial development at this site with plans for a significant proportion of commuters and visitors to access the site by ferry, representing exciting perennial growth for SeaLink.

    Sydney’s Ferry Future – Modernizing Sydney’s Ferries Along the Blue Highway
    With over 5.2 million Manly/Sydney ferry trips per annum, Sydney Ferries currently provides 36 return services on a weekday on this route. Back of the envelope suggests that if SeaLink could capture a modest 1,000 passengers/day for a return fare of approximately A$15, it would generate additional revenue of A$5.5 million. If 20% of the passenger volume from the Manly/Sydney route is captured by the Manly/Barangaroo path, or 2,800-3,000 passengers/day, SeaLink could generate over A$15 million in additional revenue. With Manly and Darling Harbour having the top 3 highest patronage by line, this route dominates a very critical path in Sydney’s Blue Highway as the government invests in more frequent ferries to service growing areas such as Rhodes and Meadowbank. We expect Sealink to gain a material share of these passengers over time given there is currently no water access to Barangaroo from Manly.On 16th August, Sealink released record sales and profits for FY2017, with sales rising by 13.5% from $177.5m to $201.4m, EBITDA increasing 12.1% to a record of $49.4m and EBIT rose by 6.3% to a record $37.5m. The company also announced a 6.7% increase in final cash dividend of 8 cents per share, a decent 3.5% dividend yield, to be paid on 16 October 2017 which we look forward to reinvest in the compounding growth of Hidden Champions in our portfolio. As commented by the management, “Overall 2018 has started ahead of with expectations. We are excited about the outlook for further organic tourism and transport growth opportunities throughout Australia, which the Company is very well-placed to identify and execute through economies of scale, well-proven fleet management and deployment capability, a very strong international and domestic sales and marketing infrastructure, and a strong continuing focus on controlling costs.”
  3. Launching of the Rottnest Island service in Western Australia in November 2017 (LINK). With over 550,000 visitors to that island annually and increasing due to its high-profile wine industry and pristine surf beaches, Rottnest Island is one of the jewels in the crown of Western Australia. Operating between Freemantle and the main jetty on the island, the service will be coordinated to tie in with SeaLink’s Swan River operations, providing a seamless transfer between the two renowned tourist destinations. While SeaLink is the third ferry operator on Rottnest Island, they fill an existing growing supply gap for ferry services during peak periods. SeaLink is also planning a new tourism offering for North Stradbroke Island for its Western Australia business, commencing late calendar 2017. Like Rottnest, North Stradbroke Island attracts over 600,000 visitors yearly.

On 16th August, Sealink released record sales and profits for FY2017, with sales rising by 13.5% from $177.5m to $201.4m, EBITDA increasing 12.1% to a record of $49.4m and EBIT rose by 6.3% to a record $37.5m. The company also announced a 6.7% increase in final cash dividend of 8 cents per share, a decent 3.5% dividend yield, to be paid on 16 October 2017 which we look forward to reinvest in the compounding growth of Hidden Champions in our portfolio. As commented by the management, “Overall 2018 has started ahead of with expectations. We are excited about the outlook for further organic tourism and transport growth opportunities throughout Australia, which the Company is very well-placed to identify and execute through economies of scale, well-proven fleet management and deployment capability, a very strong international and domestic sales and marketing infrastructure, and a strong continuing focus on controlling costs.” SeaLink continues to trade at an attractive EV/EBIT 12.6x, EV/EBITDA 9.6x while generating an ROE of 25.4% and ROA 15.7% with a multi-year lasting wide moat.

 

TO BE CONTINUED…

Warm regards,
KEE Koon Boon | Chief Investment Officer & CEO
Hidden Champions Fund

Hidden Champions Fund – Monthly Factsheet (end July 2017) and Imminent Soft-Close of Fund

Dear Clients and Partners,

Our Fund NAV is up 8.6% YTD as at end July with the valuation re-rating that comes from the continued growth in fundamentals of our core portfolio stocks, bringing our cumulative total absolute positive gains since inception in September 2015 to 26.1%. Please click to download our latest Hidden Champions Fund Factsheet as at end July 2017.

We are also grateful to our clients who have entrusted their hard-earned assets with us since our initial fund launch offering at end June and all our clients have made positive gains – our first client who invested $1 million is up over 7% – despite turbulent market conditions with mounting concerns over “fire and fury” geopolitical instability; the impending unwinding of the Fed’s balance sheet and the exit strategies of a number of central banks in their monetary endgame policy; the unexpected magnitude of the potential China bond default wave; weak economic growth; trade tensions; concentrated gains in selected technology mega-cap stocks, cyclicals and financials; and a host of other risks.

We are careening towards the end of the bull market. At the Hidden Champions Fund, we aim to protect and grow capital by positioning for and capitalizing on the upcoming downturn in the global/economic business cycle. How do we prepare for crisis? Time the market? Buy put options? Buy “safe haven” bonds? In Issue 2 of our Upward Toiling newsletter, we shared the insightful empirical research “The Best Strategies for the Worst Crises”. Evidence was reported that an investment strategy in quality stocks benefit from a “flight to quality” effect during crises: “While quality stocks logically deserve a higher price-to-book ratio, in reality they do not always exhibit such a premium. Towards the end of the bull market, quality stocks often looked underpriced. Then, when the market has a drawdown, these stocks have outperformed, benefiting from the so-called flight-to-quality effect.” Specifically, the quality factor delivered 43.7% returns when markets were down -45.3% in crisis periods. At the Hidden Champions Fund, we expect to outperform as the current market hype over the “flight to junk” carry trade that’s groping for yield subsides and the overall market retreats – our Fund tends to do better when the overall market is tepid and lacklustre. For instance, in 2016, when MSCI and Singapore STI index were flattish to down at +2.5% and -0.1% respectively, the Hidden Champions Fund is up 14.3%.

With the Value-to-Quality (VQ) ratio of our Hidden Champions Fund presently 179% superior than the market comparable, we believe the Fund is significantly undervalued to its intrinsic value and the downside risks are limited to protect investors. As the CIO & CEO of the Hidden Champions Fund, a significant part of my personal savings is invested in the Fund along the same terms and fees as the incoming external client.

During the investment process, many investors are led astray by shortcuts. It’s hard to see how it could be otherwise when the top business experts and thought leaders wily talk us with shortcuts, hacks and tricks that optimize for quick and obvious success. How to build something that last through time and crises is a lifelong fascination and a calling for us at the Hidden Champions Fund.

The Hidden Champions Fund is not for everyone. Only for investors who see themselves in the Hidden Champions – their struggles, how they are misunderstood and overcome the odds with persistence, and the non-linear triumphs – that we invest in with high-conviction when the reward-to-risk and value-to-quality metrics are compelling. Only for investors who want to go the right way, not the easy way.

Our Fund will be doing a soft close at the end of September. Investors who subscribe into the Fund before our soft close will qualify for a Founding Partnership Cash Bonus. After the soft close, we will be single-minded monomaniacs focusing on investing. We are planning a trip to Taiwan and India in late October/ early November to visit a list of Hidden Champions, including our portfolio stocks Nyquest Technology (GTSM: 6494) and Emmbi Industries (NSE: EMMBI) in which we have declared to the exchanges as a substantial shareholder with over 10% and 5% equity stake respectively. All our core stocks have achieved record results in their sales and profits and have guided resilient growth outlook which we will update next week in the upcoming Issue 3 Upward Toiling of our Hidden Champions.

We have also revamped our website which we are still refining, do give us your valuable comments: www.hiddenchampionsfund.com.

Warm regards,
KEE Koon Boon | Chief Investment Officer & CEO
Hidden Champions Fund

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