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The Opposable Mind: How Successful Leaders Win Through Integrative Thinking; John Dewey on How to Find Your Calling, the Key to a Fulfilling Vocation, and Why Diverse Interests Are Essential for Excellence in Any Field – Bamboo Innovator Daily: 20 Oct (Tues)

Life

  • John Dewey on How to Find Your Calling, the Key to a Fulfilling Vocation, and Why Diverse Interests Are Essential for Excellence in Any Field: BP
  • Manny Stul takes out Australian EY Entrepreneur Of The Year; Stul says the secret to Moose Enterprise’s success is “innovation with integrity”. TheAge
  • Dilbert creator Scott Adams presents his 10 favorite comics of all time: BI
  • Watch A Clip From Pixar’s Super Team of Hindu Deities: WSJ
  • The histories of Judaism and Christianity suggest that words alone won’t pacify Islam. Its transformation will be long and bloody. WSJ
  • Richard Branson explains his 10 rules for being a great leader: BI

Books

  • The Opposable Mind: How Successful Leaders Win Through Integrative Thinking: Amazon

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What the Best Do Better Than Everyone Else – Asian Wide-Moat Innovators Surpassing Stall Points in Scaling New Heights

“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”
BAMBOO LETTER UPDATE | October 19, 2015
Bamboo Innovator Insight (Issue 105)

  • The weekly insight is a teaser into the opportunities – and pitfalls! – in the Asian capital jungles.
  • Get The Moat Report Asia – a monthly in-depth presentation report of around 30-40 pages covering the business model of the company, why it has a wide moat and why the moat may continue to widen, a special section on “Inside the Leader’s Mind” to understand their thinking process in building up the business, the context – why now (certain corporate or industry events or groundbreaking news), valuations (why it can compound 2-3x in the next 5 years), potential risks and how it is part of the systematic process in the Bamboo Innovator Index of 200+ companies out of 15,000+ in the Asia ex-Japan universe.
  • Our paid Members from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing.
Dear Friends,

What the Best Do Better Than Everyone Else – Asian Wide-Moat Innovators Surpassing Stall Points in Scaling New Heights

Training CampCan a small guy with a big heart succeed against all odds?

In the masterful book “Training Camp: What the Best Do Better Than Everyone Else” that was based on interviews with top professionals from a wide variety of fields, author Jon Gordon tells about the tale of Martin Jones, an undrafted rookie trying to make it in the NFL. After spraining his ankle in the preseason, Martin thinks his dream is lost, until he meets a very special coach who shares life-changing lessons that keep his dream alive as he strives for excellence and brings out the best in others every day.

The story of Martin bears some resemblance to the hidden fear and doubt that blighted many SME business owners whom we have interacted over the years. Despite attaining a certain level of success and personal wealth, their hearts are ever more unsettled as time passes, because they have hit a stall point in their core business model and they are unable to unlock the valuation potential of their business. In other words, they failed the acid test that value investors should employ to gain conviction in sizing up the investment bet to outperform in times of volatility and uncertainty, a seemingly simple but profound question: “Does the business get easier as it gets bigger?”

We like to share an article “Surpassing Stall Points in Scaling New Heights” below that we wrote in May 2011 in which we kicked ourselves and asked the tough question: “Is there a “natural limit” or “stall point” in the size of the business by industry and country as the entrepreneur attempts to scale up before he or she faces the challenge of their corporate lives to overcome the start of a secular reversal in fortune?” We had used the story of Ray Kroc to highlight how he and his team scaled McDonald’s with tenacity amidst the thicket of resource-rich incumbents, aggressive competitors under the wings of corporate giants, and copycats.

It has been four years since the article was written and we like to update the question for value investors to address the power of disruption lashing SME business owners and even giants who had hit the stall point in the growth of their core business model. Even seemingly stable wide-moat companies are not spared: McDonald’s is upended by fast casual disruptors such as Chipotle Mexican Grill; big beer firms are forced to merge with consumers switching to craft beer with innovative styles; Coca-Cola challenged by the secular decline of soda consumption as consumer taste change toward healthy and natural beverages. The decay in valuation once accorded to these incumbents and the narrowing of the economic moat had accelerated, posing an incredible dilemma for value investors:

“Should value investors hunt for what seemed to be “bargains” in disrupted business models hitting stall points? Or should they pivot and switch to buying the richly-valued disruptors instead?”

The icon of disruption is epitomized by Travis Kalanick, Uber’s co-founder, who entered and thrived in city after city, despite the opposition of giant taxi companies, lawsuits, strikes, consumer privacy woes, and other controversies from some of its drivers, who are private contractors rather than full-time employees. The question on the minds of value investors is undoubtedly: how do you value a company like Uber, as was asked and updated in Oct 2015 by NYU’s finance professor Aswath Damodaran. Uber was last valued at over $50bn from its last bond term sheet in Jun 2015 revealing $470m in operating losses on $415m in revenue. Even the disruptor Uber was not spared from being disrupted itself – by Google, who could end up undercutting Uber’s revenue by offering a service for free in a free app called “Free Ride” using its Google autonomous cars. Some venture capitalists have called the disruption risk of Google’s Free Ride to be overblown because Google was only trying a carpooling service internally for employees.

Asian Wide-Moat Innovator (Red) vs S&P 500 Index – Stock Price Performance, 1997-2015

WMI

The business of carpooling reminded us of an Asian wide-moat innovator in our Index who is the largest developer and operator of time-rental parking spaces. This innovator had updated the antiquated parking lot business and pioneered 24-hour automated time-rental parking services and became the most well-known brand of unmanned pay-by-the-hour parking lots, pulling itself ahead of its competitors who range from large real estate operators to sole proprietors. In terms of vehicle units managed, this innovator is over twice the size of rivals. The company disrupted itself by starting a car sharing business in June 2009, which was unprofitable for quite due to heavy up-front investment, but it turned profitable in FY14 and becomes an earnings driver to generate ROE of over 18% and this highly profitable world-class innovator is trading at EV/EBITDA 9x. Contrasting with Uber’s $470m in operating losses, this Asian innovator has created possibly the only profitable car-sharing business in the world, owning 60% of all vehicles used for car sharing services in its country.

The second generation leader of this family business has also introduced an innovative system that made it possible for the parking lot operator to…

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Read more at The Moat Report Asia

Importantly, as a result of striving for excellence every day, the low-profile family leaders are able to surpass its stall points in its business model to scale new heights. It is the task of value investors to dive through the rumpus and bustle of cabal in poignantly troubled times in a vigilant watch for Bamboo Innovators devoted in their intensive task of building a wide-moat business.

Surpassing Stall Points in Scaling New Heights

BY KEE Koon Boon, 9 May 2011

2011 marks the 50th “anniversary” since Ray Kroc, 59 years old then, bought out McDonald’s for US$2.7 million from the McDonald brothers who were the original pioneers of the fast food restaurant “system”– an expensive valuation then and with no secret recipe for hamburgers, no patents, and no technological breakthroughs. Since fully taking charge of McDonald’s destiny, Kroc, the visionary leader, enlisted the help of a team with Fred Turner as the execution extraordinaire, June Martino as the human resource specialist, and Harry Sonnenborne as the numbers guy who advised him that real estate was the key to a franchise’s financial success.

By 1965, the year when McDonald’s was listed – interestingly, at the same time as Singapore’s independence – the team had scaled the business nationwide with tenacity to more than 700 restaurants amidst the thicket of resource-rich incumbents, aggressive competitors under the wings of corporate giants, and copycats. McDonald’s now has more than 32,000 restaurants worldwide in 117 countries and two-thirds of its sales are now contributed from outside of America. More than 75 percent of McDonald’s restaurants worldwide are owned and operated by independent local men and women. McDonald’s is also one of the largest property companies with US$17.6 billion in self-owned “McProperty” real estate retail assets. The company’s market capitalization has since multiplied 140 times in 45 years to US$88 billion currently.

Why McDonald’s, easily one of the most recognizable brand name in the world, is not a core buy-and-hold stock in the portfolio of Warren Buffett, the world’s greatest value investor, is probably one of the greatest underexplored enigmas in value investing. The non-investment by Buffett’s Berkshire Hathaway is all the more ironic given that McDonald’s is the biggest buyer of Coke – and the Golden Arches was also listed in the same year as Berkshire. Having multiplied his returns by 10-folds after investing in Coca-Cola in a big way in 1988, the ubiquitous beverage brand is arguably the business model that most define Buffett’s philosophy in value investing.

When asked whether he would buy McDonald’s and go away for twenty years, Buffett gave an intriguing reply in a lecture at the Florida School of Business back in October 1998. “It is a tougher business over time“, Buffett said, “People don’t want to be eating – exception to the kids when they are giving away Beanie Babies or something – at McDonald’s every day. If people drink five Cokes a day, they probably will drink five of them tomorrow… I like the products that stand alone absent price promotions or appeals although you can build a very good business based on that.”

Buffett’s Berkshire Hathaway did purchase McDonald’s in 1995/6 when it was probably around US$17 to 20 billion, but he exited in 1997/8 at around US$26 to 30 billion. Although McDonald’s grew to US$50 billion around a year later, it started its precipitous trend to fall to US$13 billion by February 2002 as it posts its first ever quarterly loss. Singapore’s dynamic entrepreneur Robert Kwan, who had a small wholesale toy store, was earlier than Buffett, opening with sharp foresight the first McDonald’s in Singapore in 1979 at Liat Towers, although he sold off his share in the business in 2003. Mr. Kwan carried his experience and insights to rejuvenate the Singapore Zoo, Bird Park and Night Safari, bringing them back into the black in his role as the executive chairman of Wildlife Reserves Singapore in 2003, later stepping down in 2007.

“A tougher business over time”, an all-important axiom for entrepreneurs and value investors.

Coca-Cola itself hit its peak at around US$200 billion in market cap in Jul 1998 before dwindling to US$90 billion by 2005 and recovering to US$165 billion presently. Starbucks, in its 40th “anniversary” this year, poured its heart to scale one cup at a time after Howard Schultz bought over the six Starbucks shops for US$4 million in 1987 to reach US$28 billion in 2006 before hitting the roadblock to tumble to US$7 billion by end 2008 and is now back up again to US$38 billion.

Most businesses are not so fortunate to be able to recover. In 1962, the year IBM turned 50, Tom Watson Jr. – IBM’s chairman and the son of its founder – commented that of the top 25 industrial corporations in the United States in 1900, only two remained on that list by 1961. This year in 2011, as IBM celebrated its centennial, its current CEO Sam Palmisano carried on Watson’s insight and said that of the top 25 companies on the Fortune 500 at the time of Watson’s lecture, only four remained in 2010.

Is there a “natural limit” or “stall point” in the size of the business by industry and country as the entrepreneur attempts to scale up before he or she faces the challenge of their corporate lives to overcome the start of a secular reversal in fortune? After all, if an elephant were larger by a mere 15 percent, its body weight would require such bone and muscle strength in its legs that its weight would make it simply too heavy for the muscles to lift, and the beast, unable to move, would starve.

Yet, elephants can dance, as what Lou Gertsner said in describing how he led IBM to overcome a near-death experience in the early 1990s when he took over as CEO in April 1993. IBM then was at US$10 billion after falling from its 1987 peak at US$50 billion. By reducing the Big Blue’s dependency in mainframe manufacturing, which was supplanted by personal computers and servers, and building the global platform for services to provide higher value to customers, a core business which today accounts for over 40 percent of its overall profits, Lou had multiplied the market cap 10-folds to US$100 billion by the time he passed over the leadership baton in 2002 to Sam Palmisano. Palmisano quadrupled earnings and created another US$120 billion in shareholders’ value in 10 years as he positioned IBM in software and analytics, an area which now contribute more profits than services do.

Understanding the dynamics of this stall point can illuminate important lessons for both the Asian entrepreneur trying to scale his or her enterprise to a greater height and the diligent value investor wanting to generate sustainable compounding returns. In other words, value investing is about investing in the outstanding entrepreneur building the durable economic moat which means the business gets easier, not harder, as it gets bigger.

One key to McDonald’s success is what…

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Read more at The Moat Report Asia

Warm regards,

KB

The Moat Report Asia

www.moatreport.com

A new monthly issue of The Moat Report Asia is now available!

Access the in-depth idea presentation:

http://www.moatreport.com/members/

In the month of October, we investigate a listed Asian family business founded in 1975 that is now a leader in the foodservice industry with multiple brand format across several categories to capture a bigger chunk of the dining-out market where >12% of its local domestic population dine at one of their outlets every week, led by their flagship brand which dominates the market with a share of 57% which is 3x the value share of its next largest peer. The under-penetrated domestic market, where foodservice spending per capita is one of the lowest in Asia, paves the way for acceleration and long-term structural growth in outlet expansion, especially in the provincial areas where margins are potentially higher, as urbanization rise. Such market dominance and brand equity in generating consistent cashflow is underappreciated and deserves valuation premium.

We believe that the outstanding leadership provided by the inspiring visionary founder and his management esprit de corps team which has out-trumped the foreign and local rivals to dominate its domestic market, deserves a valuation premium. Most would have been contented to rest on their laurels but Mr. C has international ambitions, the “Maker’s” mentality to create value, by taking calculated risks to expand smartly with its own brands in selected countries and to acquire already-popular brands and work to improve their strength. The management has also fostered a powerful performance-based empowerment corporate culture and positive work environment where everyone has a sense of pride and emotional commitment in sustainably growing the company, which we believe is rare for an Asian company and is the underappreciated source of its wide-moat it enjoys in executing the scaling of the multi-brands, the product innovation, the support for franchise partners and identifying and integrating synergistic M&A targets. In essence, the company provides resilient growth with visible long run-way and upside surprise from outstanding execution track record in M&As.

What the most successful people understand about creative work; Best-selling author Elizabeth Gilbert shares her ideas about the importance of constantly moving between extremes for creative success – Bamboo Innovator Daily: 19 Oct (Mon)

Life

  • What the most successful people understand about creative work; Best-selling author Elizabeth Gilbert shares her ideas about the importance of constantly moving between extremes for creative success. FastCo
  • Physicist Lisa Randall on the Sublime, Our Human Quest for Meaning, and the Crucial Differences Between How Art, Science, and Religion Explain the Universe: BP
  • This Is The #1 Mistake Parents Make When Arguing With Kids: barker
  • How to train your brain by thinking like an expert: Wired
  • How to Work More Efficiently — The Eisenhower Matrix: Farnam
  • Marijn Dekkers, Bayer: From GE to Germany; Running a €90bn life sciences group without burning out: FT

Books

  • Avoiding Disaster: How to Keep Your Business Going When Catastrophe Strike: Amazon
  • 5 Gears: How to Be Present and Productive When There Is Never Enough Time: Amazon

Read more of this post

Why this VC who sold his last company for $3 billion asks this unusual interview question: “What did you learn from your mom?” “Basically I’m testing them to see, ‘How human are you ready to be with me?’ – Bamboo Innovator Daily: 18 Oct (Sun)

Life

  • Why this VC who sold his last company for $3 billion asks this unusual interview question: “What did you learn from your mom?” “Basically I’m testing them to see, ‘How human are you ready to be with me?’”: BI
  • Lars Dalgaard: Build Trust by Daring to Show That You’re Human: NYT
  • ‘What quality do you look for in a spouse? Do you look for beauty? Do you look for brains? Do you look for character? Do you look for honesty? Do you look for humor?’ No, no no,” added Buffett. “You want to marry the last-look for someone with low expectations”: Fortune
  • Why this CEO thinks a 6-figure salary isn’t always worth your time; If you only look at financial compensation, you might miss out on doing something you truly love: Fortune
  • Why What You Learned in Preschool Is Crucial at Work: NYT
  • Office Shows the Person: The assumption of authority brings out the leader’s inner world. It reveals whether the leader has undergone a process of honest self-discovery that allows for the productive application of power. Forbes
  • Girl, 3, takes care of bedridden mother in hospital: AsiaOne
  • Worry less, live more: Star
  • Why What You Learned in Preschool Is Crucial at Work: NYT

Books

  • Word Hero: A Fiendishly Clever Guide to Crafting the Lines that Get Laughs, Go Viral, and Live Forever : Amazon
  • Confessions of the Pricing Man: How Price Affects Everything : Amazon
  • Power Pricing: How Managing Price Transforms the Bottom Line : amazon
  • Manage for Profit, Not for Market Share: A Guide to Greater Profits in Highly Contested Markets: Amazon
  • Anxious: Using the Brain to Understand and Treat Fear and Anxiety: Amazon

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The Best Leaders Are Constant Learners; Hard Work Makes Children, and Families, Stronger; Think Like an Author, Not an Owner; Trailblazing Astronomer Vera Rubin on Obsessiveness, Minimizing Obstacles, and How the Thrill of Accidental Discovery Redeems the Terror of Uncertainty – Bamboo Innovator Daily: 15-17 Oct (Thurs-Sat)

Life

  • Hard Work Makes Children, and Families, Stronger: NYT
  • The Best Leaders Are Constant Learners: HBR
  • Think Like an Author, Not an Owner; Oswald’s story teaches us that what is most valuable in an economy is not what authors make, but their ability to make it. The executives at Universal tried to extort Disney and Iwerks by holding one of their creations hostage. But this was a naïve move. HBR
  • Trailblazing Astronomer Vera Rubin on Obsessiveness, Minimizing Obstacles, and How the Thrill of Accidental Discovery Redeems the Terror of Uncertainty; Why all creative endeavor is a matter of “getting hung up on little interesting things.” BP
  • Nietzsche on the Journey of Becoming and What It Means to Be a Free Spirit; “.become master over yourself, master of your own good qualities. acquire power over your aye and no and learn to hold and withhold them in accordance with your higher aims: BP
  • The Top Ten Resilient Animals on Earth: KM
  • What They Don’t Teach You in Business School: AWCS
  • Head to head: Michelangelo and Raphael; Leibniz and Newton; Constable and Turner. Does every creative genius need a bitter rival?: Aeon
  • The Innovative Mindset Your Company Can’t Afford to Lose: HBR
  • How to Turn a Bad Day Around: HBR
  • Be Your Own Best Advocate: HBR
  • The Best Data Scientists Know How to Tell Stories: HBR
  • A Simple Formula for Changing Our Behavior: HBR
  • The fascinating science behind your tastes and preferences: qz
  • Is necessity really the mother of invention? 14 speakers at TED@IBM challenge this adage: TED
  • You’re a Great Man, Charles Schulz: The soulful wit of Schulz’s writing is framed by his spare art—blanks left for the eye and brain to fill. WSJ
  • Success depends on succession: KH
  • The billionaire founder of Sam Adams shares his top 4 productivity tips: BI
  • A worthy journey to rethink how, what, where and when we learn: TODAY
  • Education ‘needs rethink to focus on individual’; “Kids want to grow into vocations, professions and careers that can allow them to protect the ones they love, to walk through fire to save others, to cure the sick, to build cars, to fly to the moon, to understand Mother Nature … the higher education system must help people uncover and pursue their passions, and chase their respective rainbows.”: TODAY
  • ‘This is what I was put on earth to do’: Elizabeth Holmes and the importance of passion: WaPo
  • How Injustice Affects Decision-making: K@W
  • The Social-Network Illusion That Tricks Your Mind; Network scientists have discovered how social networks can create the illusion that something is common when it is actually rare. TR
  • VW’s Problem Is Bad Management, Not Rogue Engineers: HBR
  • Professor Dr Robot QC: Once regarded as safe havens, the professions are now in the eye of the storm: Economist
  • Reality cheque: Angus Deaton wins the Nobel prize for bringing economics back to the real world: Economist
  • How The Apprentice Explains Donald Trump’s Campaign; His base is Apprentice viewers; and his Iowa coordinator is an Apprentice finalist who chooses delegates using Apprentice-style games.: Bloomberg
  • The Funny Thing About Adversity; It makes you more compassionate. Except when others are suffering just as you did. : NYT
  • Back to business: Michael Bloomberg; He ran New York for 12 years. Now the politician must fix the company he started 30 years ago: FT
  • A college entrance consultant with 19 years of experience describes the best essay she has ever read: BI
  • 9 tricks to motivate yourself to reach your goals: BI
  • Richard Branson, Tony Robbins, and 5 other successful people share their best productivity tricks: BI
  • Authors, Beware: Billionaire Subjects Don’t Make For Best-Selling Biographies: Forbes
  • The 10 funniest Dilbert comic strips about idiot bosses: BI
  • The riff: Mastered by ‘The Apprentice’; The TV show’s amorality has seeped into business culture: FT
  • How to unlock your secret productivity powers: FastCo
  • Help for Pantsers and Plotters: SP
  • Frontline Leadership: A New Source of Competitive Advantage: BCG
  • Demand-Centric Growth: How to Grow by Finding Out What Really Drives Consumer Choice: BCG
  • The Self-Tuning Enterprise: Wouldn’t it be nice if an algorithm could tell you when to develop a new business model or whether to enter a new market? BCG
  • Creating Exponential Growth at the Edge; An Interview with Entrepreneur and Author Salim Ismail: BCG
  • The Tim Ferriss Way: Life Is a Choose-Your-Own-Adventure Game: Success
  • You’re not as virtuous as you think: WaPo

Books

  • Rocket: Eight Lessons to Secure Infinite Growth: Amazon

Read more of this post

Reflections on Leadership from Gettysburg – Bamboo Innovator Daily: 13-14 Oct (Tues-Wed)

Life

  • Reflections on Leadership from Gettysburg: HBR
  • A Child Who Treats Their Parents With Respect Is An Employee Any Boss Would Be Thrilled To Hire: Forbes
  • Oprah Winfrey hates meetings so much she once persuaded Coretta Scott King not to visit her; “[I] really, really, really try to avoid meetings.” She prefers that her staff instead send her detailed emails. BI
  • Minimizing our problems can help us cope. Maximizing our strengths can help us flourish. Forbes
  • Louis I, King of the Sheep: An Illustrated Parable of How Power Changes Us; “Never be hard upon people who are in your power,”Charles Dickens counseled in a letter of advice to his young son: BP
  • The Gentle Giant: Oliver Sacks and the Art of Choosing Empathy Over Vengeance; An existential lesson gleaned from a brush with death and foolishness.: BP
  • The Four States of Mind: Farnam
  • Hunter S. Thompson on Living versus Existing: Farnam
  • The cofounder of Apple talks about how Steve Jobs viewed innovation and instilled it into the company’s products: BI
  • 13 tricks Steve Jobs, Jeff Bezos, and other famous execs have used to run effective meetings: BI
  • Why Angus Deaton Deserved the Economics Nobel Prize; Angus Deaton: A Skeptical Optimist Wins the Economics Nobel; Angus Deaton is a meticulous scholar who believes that reducing the world to simple theories is almost always dangerous; Nobel Economist Showed We’re Helping the Wrong People: NYT, NewYorker, Bloomberg
  • Former Indonesia investment banking head of UBS fined by Singapore regulator for insider trading; currently works for private equity firm Carlyle Group as the Indonesia head: Reuters
  • An email adding one letter to his domain name almost cost Centrify’s Tom Kemp $500,000. Here’s his 4 tips for avoiding ‘CEO fraud’. BRW
  • New Billionaire: Martin Selig Escaped Nazi Germany to Seattle, Where He Built Fortune In Real Estate: Forbes
  • Mental competency tests in the C-suite are more common than you think: Fortune
  • How Charles Koch made his billions; His new book Good Profit shows another side to the billionaire businessman: Fortune
  • The Innovative Mindset Your Company Can’t Afford to Lose: HBR
  • 4,000 Starbucks workers are going to college for free: CNN
  • Giant, ancient viruses are thawing out in Siberia – and they’re changing everything we thought we knew about them: BI
  • How Office ‘Bad Guys’ Handle the Role; Whether they are axing pet projects or firing underperformers, some managers learn how to be comfortable with being unpopular. WSJ
  • GE’s Jeff Immelt on evolving a corporate giantGE’s Jeff Immelt on evolving a corporate giant, what’s driving the company’s evolution, how he leads, and why he’s different from Jack Welch. McKinsey
  • What’s the Difference Between Data Science and Statistics?: PN
  • Chinese scientists are developing color-changing paint you can remotely control: BI
  • Famous last words of 18 famous people: BI
  • Woody Allen inspired billionaire Uber CEO Travis Kalanick to get back into startups: BI
  • Uber CEO Travis Kalanick knows a thing or two about when to call it quits if your company’s not finding success.: BI
  • Lunch with the FT: Jonathan Franzen; What is it about the great American novelist that provokes such strong reactions? FT
  • How Google’s head of marketing handles 20 meetings a day: FastCo
  • How Ads for Big Brands Could Benefit Rivals Instead: Strategy&
  • Freakonomics author Steven Levitt got a whole bunch of college kids to confess to cheating: BI

Books

  • 100 Baggers: Stocks That Return 100-to-1 and How To Find Them : Amazon

Read more of this post

Capital Allocation in Asian Wide-Moat Innovators: The Story of the Jin and Hui Merchants – Bamboo Innovator Weekly Insight

“Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.”
BAMBOO LETTER UPDATE | October 12, 2015
Bamboo Innovator Insight (Issue 104)

  • The weekly insight is a teaser into the opportunities – and pitfalls! – in the Asian capital jungles.
  • Get The Moat Report Asia – a monthly in-depth presentation report of around 30-40 pages covering the business model of the company, why it has a wide moat and why the moat may continue to widen, a special section on “Inside the Leader’s Mind” to understand their thinking process in building up the business, the context – why now (certain corporate or industry events or groundbreaking news), valuations (why it can compound 2-3x in the next 5 years), potential risks and how it is part of the systematic process in the Bamboo Innovator Index of 200+ companies out of 15,000+ in the Asia ex-Japan universe.
  • Our paid Members from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing.
Dear Friends,

Capital Allocation in Asian Wide-Moat Innovators: The Story of the Jin and Hui Merchants

“…the heads of many companies are not skilled in capital allocation. Their inadequacy is not surprising. Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration or, sometimes, institutional politics. Once they become CEOs, they face new responsibilities. They now must make capital allocation decisions, a critical job that they may have never tackled and that is not easily mastered. To stretch the point, it’s as if the final step for a highly-talented musician was not to perform at Carnegie Hall but, instead, to be named Chairman of the Federal Reserve. The lack of skill that many CEOs have at capital allocation is no small matter: After ten years on the job, a CEO whose company annually retains earnings equal to 10% of net worth will have been responsible for the deployment of more than 60% of all the capital at work in the business.”

– Warren Buffett

Intelligent capital allocation is possibly the most important skill that entrepreneurs need to master to cross the chasm to “Stage 2” to become a true wide-moat compounder. It requires understanding the long-term value of an array of opportunities to reinvest back into widening the economic moat of the business; sourcing and using money prudently and sagaciously in capital expenditures, R&D, M&As; having a sharp analytical framework and independence of mind to avoid “institutional imperative” and the illusory comfort of equating “busyness” in embarking different projects and multiple activities as “productive”.

Having recently visited the facilities and interacted with the top management team of one of Singapore’s most beloved consumer brands last week, we are confident that with the right capital allocation capabilities, selected Asian entrepreneurial companies can build upon their strong foundation, brand heritage and brand equity to scale to greater heights and create and compound value in a sustainable way.

Michael Mauboussin and his colleagues have written a great guide to capital allocation for investors: Capital Allocation: Evidence, Analytical Methods, and Assessment Guidance. The authors shared a Checklist for Assessing Capital Allocation Skills, reproduced below:

Past Spending Patterns

  • Have you analyzed how companies have spent money in the past, separating operating uses from return of capital to claimholders?
  • How has the company funded its investments?
  • Identify the prime use of capital. Do you know if management thinks about that use of capital properly?
  • Have there been shifts in the pattern of spending?
  • If there is new management, has spending changed?
  • Who makes which capital allocation decision?
  • How does the company conduct its budgeting process?

 Calculate ROIC and ROIIC

  • Have you calculated ROIC over time and observed a trend?
  • Examine composition of ROIC through a DuPont analysis—does this suggest a consumer or production advantage?
  • Have you compared the company’s results to those of its peers?
  • Have you calculated ROIIC for one year and rolling three- and five-year periods?

Incentives and Governance

  • How is the company’s incentive compensation structured?
  • How much stock does senior management own?
  • Is total shareholder return calculated on a relative basis?
  • Have you examined the company’s incentive score?
  • Are the measures in place to encourage management to think for the long term?

 Five Principles of Capital Allocation

  • Does the company use zero-based capital allocation or is it dominated by spending inertia?
  • Is the company focused on funding strategies or projects?
  • Does the company have a “scarce but free” attitude about capital, or “abundant but costly?”
  • Does the company prune businesses with poor prospects for creating value?
  • Does the company know how to calculate the value of its assets and does it act accordingly?

We like to share a story that we had written back in February 2011 about Hengan (1044 HK) to illustrate thoughtful capital allocation during 2004-2009; Hengan invested heavily to move up the value chain in higher-end products and to distinguish itself from the hundreds of low-end producers, becoming the largest producer of personal hygiene products such as tissue paper, sanitary napkins, pantiliners and baby diapers and compounding its market cap from a billion to $12 billion in the process.

Importantly, to complement the checklist approach, we explore why the once-powerful Jin and Hui merchant groups in China did not manage to cross the chasm to “Stage 2” to become true wide-moat compounders and blew up because they did not understand thoughtful capital allocation; while the Ningbo entrepreneurs “were more far-sighted, reinvesting their profits into building sustainable industrial businesses rather than making speculative asset transactions that yield transient profits, making the successful transition to Stage 2.”

We hope the story of the eclipse of the Jin and Hui merchants will provide positive and uplifting lessons for entrepreneurs and value investors: the compounding power of capital allocation when mastered properly.

Eclipse of the Jin and Hui Merchants: Lessons for Entrepreneurs and Value Investors

By KEE Koon Boon, 20 Feb 2011

Pinnacle to pits. Such is the tragic and thought-provoking path of the powerful Shanxi-based “Jin Merchants” (晋商) and Anhui-based “Hui Merchants” (徽商) during China’s Ming Dynasty till their demise in the late-Qing Dynasty as they could not cross the chasm to “Stage 2”.

They were richer than the emperor and their business empires stretched as far as to Asia, Russia and Europe. The powerful Shanxi “banks” (piaohao 票号) offered a full array of financial services, establishing the remote inland Shanxi province’s Pingyao and the nearby Qixian and Taigu counties as the premier financial centers or China’s Wall Street then; the first and largest of them, Sunrise Provident (Rishengchang 日升昌), was the modern equivalent of JPMorgan.

They were extremely hardworking; the Hui Merchants were also called “Hui Camels” as camels symbolize their propensity to tolerate hardwork and overcome adversity in harsh conditions. They were highly educated and cultured; the Hui Merchants were also called “Confucius merchants” and one in five imperial scholars came from the Anhui province then. They worked in “teams”; family groups and clan members collaborate to dominate geographies and industries ranging from tea, timber to textile.

So why and how did these two powerful business empires went into oblivion?

Both the Jin and Hui Merchants, for all their vast accumulated wealth, did not invest for growth in building an economic moat, a unique durable business model.

Take the case of Dashengkui (大盛魁), one of the largest business empires established by three “Jin Merchants” then. It had 20,000 camels, dominating the logistics business in China, particularly in the transport of tea to Mongolia, Xinjiang and Russia. Its assets were said to be so vast that they can be converted into enough 50-liang tael to lay a road that stretches from Ulan Bator (the capital and largest city of Mongolia) to Beijing.

Despite the advent of steamship as a low-cost and efficient transportation means, Dashengkui failed to invest any of its profits or reserves in upgrading its logistics assets. Also, the Jin Merchants who dominated the tea trade and became very rich, used the profits and cashflow from the businesses to fund their lavish lifestyles and indulge in asset speculation, purchase land and rebuilt their houses.

In 1866, without the burden of tariffs, the Russians started to transport tea from China via the sea route and subsequently exported the tea to Europe and Middle-East. They established modern processing and manufacturing facilities in places such as Hankou, Jiujiang, Fuzhou, making use of coal-based steam turbine technology and machines rather than the manually-driven turbines and labor-intensive manufacturing methods used by the Chinese Jin Merchants.

The Russians produced high quality and low-cost tea bricks in huge quantities and had the added advantage of transporting via the cheaper sea route instead of the conventional land-based path dominated by Dashengkui. The fortunes of the Jin Merchants started to take a sharp deterioration. They were contented to rely on their core business of piaohao and pawnshops for the cashflow to speculate in property and to fund their lavish lifestyles. As a result, they missed the opportunity to convert their piaohao into banks, including declining the invitation to invest in the current HSBC.

Hu Xueyan胡雪岩 (1823-1885), dubbed the richest-ever Chinese entrepreneur and known as the “Red-Topped Merchant” (hongding shangren 红顶商人) after the scarlet tasselled hat which reflected his position as a first-grade imperial official and awarded the “yellow mandarin jacket”, was probably the most celebrated Hui Merchant.

Despite the realities of the Industrial Revolution exposing the weaknesses of the labor-intensive manufacturing methods employed by most of the Chinese merchants as compared with the modern machines which western companies invested heavily in, Hu, a veteran in the silk business, insisted on using labor to process raw silk. At that time, the western companies had the upper hand and deliberately depressed the price of raw silk in China.

In May 1882, Hu purchased raw silk in bulk, hoping to monopolize the supply in order to force the cartel of western companies to buy at higher prices. Hu was an accomplished opportunistic trader all his life and he was highly confident that his Fukang “Bank” was “rock-solid” in providing the financing to fight the battle with the western companies.

Unfortunately, after two consecutive years of drought in Europe prior to Hu’s purchase, Italy had a good silk crop harvest. Raw silk prices plummet and Hu’s unsold inventory depressed the silk market further. A French navy fleet also arrived at Shanghai, threatening to attack China.

With the prospects of a Sino-French war breaking out, cash became king and banks withdrew their short-term loans. Trade halted and there were massive property and asset disposals in Shanghai. Bank runs erupted, impacting Hu’s “rock-solid” Fukang Bank. By December 1883, Hu was bankrupt. Hu died in 1885 in the same year as did General Zuo Zongtang 左宗棠, who provided Hu protection and patronage, enabling Hu to get and stay rich.

Their neighbors, the Ningbo Entrepreneurs, were more far-sighted, reinvesting their profits into building sustainable industrial businesses rather than making speculative asset transactions that yield transient profits, making the successful transition to Stage 2.

While investing for growth is critical, it is important for value investors to note that making capital investments without allocating them to build a team and an economic moat is likely to be an inefficient and value-destroying exercise. They will fall into the general category of firms described by finance researchers Sheridan Titman, John Wei and Xie Feixue in their 2004 JFQA paper. These firms that increase capital investments substantially destroy future firm value in the long-run because investors consistently fail to appreciate managerial motivations to put the best possible spin on their new “growth opportunities” when raising capital to fund their “expenditures”.

In addition, value investors need to be discerning in understanding that investing to build an economic moat to build up the intangibles and core competencies for sustainable and scalable growth could depress short-term cashflow. Thus, the financial numbers may not look appealing from a historical snapshot perspective.

Established by Mr. Sze Man Bok and Mr. Hui Chit Lin in 1985, Hengan grew over 20-fold from US$480 million to US$11 billion since its HK listing in 1998 to become the largest producer of personal hygiene products such as tissue paper, sanitary napkins, pantiliners and baby diapers.

Interestingly, Hengan was below a billion market cap post listing until 2004. From 1998 to 2003, Hengan invested a total of around S$140 million in capital expenditures and conserved cash. The capex figure scaled six-folds to a total of S$830 million from 2004 to 2009 as Hengan invested heavily to move up the value chain in higher-end products and to distinguish itself from the hundreds of low-end producers. Annual profits grew six-folds from a size of S$57 million in 2003 to S$400 million in 2009, creating S$12 billion in firm value in the process.

Long-term entrepreneurs need to appreciate that generating profits via collecting transactions will not lead to sustained compounding returns. Hu Xueyan, the consummate trader in accruing multiple profitable transactions all his life, witnessed the horror of not building a durable economic moat when he opened his warehouses that were stockpiled with unsold silkworm pupae. The silkworms had metamorphosed into moths and Hu literally watched his fortunes flutter away.

Profits need to emanate from, housed and reinvested in an economic moat to be rejuvenated, propelling the enterprise to scale new heights and generate sustained compounding returns. Without doing so, they risk blowing up in Stage 1 like the Jin and Hui Merchants.

It is the task of value investors to dive through the rumpus and bustle of cabal in poignantly troubled times in a vigilant watch for outstanding entrepreneurs devoted in their intensive task of building an economic moat.

PS: We also like to share with you an article “Scouring Accounting Footnotes to Prevent Tunneling” which we penned for our local newspaper Business Times Singapore that was published on 19 Aug 2015: PDF article link on SMU website. We are honoured to be able to have the opportunity to present to the top management of the regulatory authorities in Singapore about implementing the fact-based forward-looking fraud detection framework in a world’s first for Singapore.

Warm regards,

KB

The Moat Report Asia

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In the month of October, we investigate a listed Asian family business founded in 1975 that is now a leader in the foodservice industry with multiple brand format across several categories to capture a bigger chunk of the dining-out market where >12% of its local domestic population dine at one of their outlets every week, led by their flagship brand which dominates the market with a share of 57% which is 3x the value share of its next largest peer. The under-penetrated domestic market, where foodservice spending per capita is one of the lowest in Asia, paves the way for acceleration and long-term structural growth in outlet expansion, especially in the provincial areas where margins are potentially higher, as urbanization rise. Such market dominance and brand equity in generating consistent cashflow is underappreciated and deserves valuation premium.

We believe that the outstanding leadership provided by the inspiring visionary founder and his management esprit de corps team which has out-trumped the foreign and local rivals to dominate its domestic market, deserves a valuation premium. Most would have been contented to rest on their laurels but Mr. C has international ambitions, the “Maker’s” mentality to create value, by taking calculated risks to expand smartly with its own brands in selected countries and to acquire already-popular brands and work to improve their strength. The management has also fostered a powerful performance-based empowerment corporate culture and positive work environment where everyone has a sense of pride and emotional commitment in sustainably growing the company, which we believe is rare for an Asian company and is the underappreciated source of its wide-moat it enjoys in executing the scaling of the multi-brands, the product innovation, the support for franchise partners and identifying and integrating synergistic M&A targets. In essence, the company provides resilient growth with visible long run-way and upside surprise from outstanding execution track record in M&As.

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