What the Best Do Better Than Everyone Else – Asian Wide-Moat Innovators Surpassing Stall Points in Scaling New Heights
October 20, 2015 Leave a comment
| “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)
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| Dear Friends,
What the Best Do Better Than Everyone Else – Asian Wide-Moat Innovators Surpassing Stall Points in Scaling New Heights
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
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… <ARTICLE SNIPPED> 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… <ARTICLE SNIPPED> Read more at The Moat Report Asia Warm regards, KB The Moat Report Asia 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. |
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