The Paradoxical Thinking of Hidden Champions to Compound Value – 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 | February 22, 2016
Bamboo Innovator Insight (Issue 119)

  • 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,

The Paradoxical Thinking of Hidden Champions to Compound Value

Why do “hidden champions” thrive in uncertainty, even chaos, and others do not?

Over our years of interacting with Asian wide-moat “hidden champions” who are quietly innovating value to dominate their specialized market with hard-to-imitate products, we find that they concentrate their organizational resources to solve a specific burning problem for a well-defined customer group better than anyone else. Successfully solving this customer problem would then create a success spiral. A key source of their wide-moat is their commitment to customer needs. The hidden champions have control over the value chain and deep knowledge in understanding and serving their customers which allow them to feed knowledge from customers into organizational learning processes and a high performance work culture that generate a continuous stream of innovations that enabled the champions to stay resilient with pricing power and outperform in difficult economic conditions.

However, the journey of a hidden champion is riddled with paradoxical tensions that challenge the innovative behaviour. Doubts will emerge in the paradoxical tension of handling tradition and change, control and autonomy. Facing the tradition-change tension, we find that Asian family firm leaders often fall into the “strategic simplicity” trap, clinging to what has worked in the past despite needed change. With many Asian firms at the critical transition phase in managing the fragile succession process, we find that while founders are often highly innovative, subsequent successors may feel constrained by ingrained routines and norms. Founding generations tend to be creative risk takers, yet reliance on their early ideas can foster stagnation, hindering stagnation. If only one side of a tension is stressed (tradition, control), demands for the other side (change, autonomy) will intensify. The result of paradoxical tensions is growing anxiety and potential decision-making paralysis, inhibiting innovative behaviour.

We find that hidden champions approach paradoxical tensions as opportunities to explore, experiment and learn. Paradoxes fuel creative problem solving that energizes firm innovation. We discover over the years that the leaders running these hidden champions have “paradoxical thinking”– the ability to embrace and synthesize competing demands with a sense of speed, scope and significance of change. Interestingly, this is also the insight of a recent study “The CEO Report: Embracing the Paradoxes of Leadership and the Power of Doubt” jointly conducted by the professional services firm Heidrick & Struggles and the University of Oxford Said Business School based on over 150 conversations with CEOs from a wide range of sectors around the world.

In our investment process to identify and evaluate hidden champions, we like to probe deeper the question of ‘how do the hidden champions manage paradoxical tensions?” We look for strong signals that they embrace the founding traditions that made the firm successful while simultaneously searching for novel associations and new opportunities that fuel innovation and there are pressures to explore new ways of doing things. Some of these signals that we like to observe and evaluate in the potential hidden champions include whether they:

  • Create new ideas for improvement?
  • Mobilize support for innovative ideas?
  • Search out new work methods, techniques, or instruments?
  • Acquire approval for innovative ideas?
  • Transform innovative ideas into useful applications?
  • Generate original solutions to problems?
  • Make organizational members enthusiastic for innovative ideas?
  • Thoroughly evaluate the application of innovative ideas?

“CNN/Bloomberg of Weather” – Stock Price Performance (Red) vs Index (Blue), 2003-2016

Weather

Last week, we highlighted an Asian wide-moat hidden champion who is the CNN/Bloomberg of weather as the world’s largest and most comprehensive private weather information services company. From the excerpts of the conversations below, we can see that the business leader of this hidden champion exhibits “paradoxical thinking” in founding and building the company. The founder Mr. I was just a desk worker in charge of transporting wooden lumber when tragic marine accident for which he felt responsible persuaded him to move towards starting a business with a “demand-side of thinking” to solve a specific customer problem with focus and deep knowledge:

Q: “So how do you go about setting up a business around that idea? What did you do?”

Mr. I: “I thought that first the government weather services would say, ‘We’re issuing warnings and it’s up to the captain and we’re not responsible’. The government weather services is very much saying I’m doing my job, which is in my words, a supply side of thinking. And the captain would say ‘I need information that would help me to make a decision.’ And the official services are very much just about data provision. What the captain would like to have is content. And the captain say ‘Should I move the ship out of the harbour or not?’ Government services is very much concerned about the accuracy of wave height, wind speed and so forth. But captain’s idea is ‘Should I move the ship outside of the harbour or should we prepare for this contingency?’… And now we working with over 2,000 shipping companies in the world. And all these top 25 liner companies around the world are our customers. We are very much worldwide in that respect… We are very much driven by the need and want of the customer. So it’s not a supply side of thinking like government weather services. It’s a demand side of thinking.”

The hidden champion also mobilize the support of both internal employees and external stakeholders and customers for innovative ideas:

Q: “[Company’s name] has continuously launched a series of innovative new services, like alerts about the approach of tornadoes. Where do these ideas come from?”

Mr. I: “Our company’s speed in responding to supporters’ needs is tremendous. We get requests for services, and our biggest strength is our workers being able to quickly kick off new offerings. For example, in the construction industry, [Company’s name] offers advice on when to build a roof, while Tokyo Disneyland pays for counsel on how to stage its fireworks shows when the winds are stiff. Weathernews tells gas stations when to advertise tire chains in advance of snowy weather and instructs 7-Eleven on when to stock up on certain types of beer – sales vary according to changes in humidity and temperature.

In order to begin any new undertaking, workers don’t need to get approval from me or the president for every little thing. Since personnel have the right to make decisions, when there’s a request from supporters for a service, it’s vital to quickly get it up and running. Of course, employees are always thinking about services as well. We always want to be half a step in front of our supporters. Rather than a full step, we’ll stay half a step ahead so as not to leave our supporters behind. At the same time, the mark of an entrepreneur is originality. [Company’s name] presidents must each year develop a completely new market or technology. My successor Mr. K established a market for the aviation industry. And recently, we’ve created a market for disaster-prevention content.”

Q: “With weather information services almost completely dominated by government meteorological bureaus, providing such data is a rare undertaking in the global market. There are few or no publicly traded companies like yours. How do you sum up your approach to entrepreneurship and what you can achieve?”

Mr. I: “We see ourselves as the CNN or Bloomberg of weather. Essentially, we’re a content provider. For things to go smoothly, hardware and content production must be in harmony. In the 20th century, Japan prospered from producing hardware. I wanted to be a contents provider… We’d like to see the World Meteorological Organization privatized. This would trigger a global shift taking weather businesses away from governments to the private sector… The weather information business should be developed by people who know local conditions. I’ve set the goal of becoming a weather station for all of the 6.4 billion people on the planet.

My original paradigm was ‘How can I make money for this company?’ But in weather, it was ‘What can I do for seamen? What can I do for you?’ It was so mentally rewarding. It’s not ‘We are making money, so OK’ but ‘What kind of contribution are we making to society?’ Get that right and the business success will follow. Weather information is a public resource and an asset shared by all. It’s the same as water, electricity and transportation. But unlike electronic appliances, there are no quick hits. This is the reason we switched to providing content based on long-term agreements to pocket ongoing revenue. We’re still pushing ahead with plans to have 150,000 of our 2.5 million [paying] supporters become shareholders. We want supporters involved in content and engaged even more in management. We want to be the first stakeholder-type firm… An inward-looking company is in danger. But [Company’s name] is in good shape now because our supporters encourage us to improve.”

Purpose

Above all, we peer deep into the hidden champion for that overarching sense of purpose which is a powerful source of internal resilience to resolve the paradoxical tensions for being adaptable yet authentic and steer their way with resilience through the many challenges in the entrepreneurial journey. As Mr. I commented:

“My original paradigm was ‘How can I make money for this company?’ But in weather, it was ‘What can I do for seamen? What can I do for you?’ It was so mentally rewarding. It’s not ‘We are making money, so OK’ but ‘What kind of contribution are we making to society?’ Get that right and the business success will follow.”

We look forward to participate in the long runway to compound growth with resilience in these Asian wide-moat hidden champions and we target to invest with high conviction and transparency to be in their Top 20 shareholders list in the annual report.

PS1: We like to share our Investor Day Presentation held on 1 December 2015 for our shareholders. The presentation material is available for download on the ASX website:

http://www.asx.com.au/asxpdf/20151102/pdf/432nk9r3hhw4nf.pdf (pg 10-14)

http://www.asx.com.au/asxpdf/20151201/pdf/433hdp24p2twyj.pdf

and our Value Investing Summit 2016 presentation “Quietly Innovating Value with Hidden Champions”:

http://www.moatreport.com/value-investing-summit-2016-quietly-innovating-value-with-hidden-champions/

PS2: We will be back on the week of 7th March with the Riddle to the Monthly Moat Report.

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 this month of February 2016, we investigate an Asian wide-moat innovator who is the CNN/Bloomberg of weather as the world’s largest and most comprehensive private weather information services company, providing customized mission-critical weather information with a recurring-income “toll-gate” business model to help its worldwide customers to access accurate and timely weather information to make better decisions in a world with abnormal weather accelerating.

In its B2B (business-to-business) segment (57% of sales), [Company’s name] provides Total Fleet Management Service (TFMS) with optimal ship routing, performance monitoring, safety status monitoring for over 2,000 shipping companies from 31 offices around the world and commands a 90% domestic market share and 35% global market share (7,000/20,000 vessels). According to CEO Mr. K, “Cargo movement has slowed in the last fall of the Lehman shock, but demand for TFMS is increasing” with the company growing its market share from 5,000 to 7,000 vessels.

The B2B business also helps multiple industries that range from sea (shipping, fishery, oil & gas) to land (road management, railway, logistics, retail, local government) and sky (aviation). For example, in the construction industry, [Company’s name] offers advice on when to build a roof, while Disneyland pays for counsel on how to stage its fireworks shows when the winds are stiff. [Company’s name] tells gas stations when to advertise tire chains in advance of snowy weather and instructs 7-Eleven on when to stock up on certain types of beer as sales vary according to changes in humidity and temperature. This deep accumulated and insight becomes more valuable over time and creates a long-lasting relationship with their customers.

In its B2C (business-to-consumer) segment (43% of sales), [Company’s name] designs and produces weather programs for radio, TV, digital media, including digital signage with original weather content for train stations, airports, elevators building lobbies, vending machines and restrooms. [Company’s name] provides content for over 90 commercial broadcasting stations in its country (80% share of the domestic market) and for over 200 cable television station in its country reaching 15 million households, as well as for Hong Kong and Taiwan satellite broadcasts. The B2C business also co-creates user-generated and crowdsourced weather information for its 20m users/”supporters”, of which 2.5m pay around US$2-3 per month for premium version of the service. As a result of this powerful crowdsourced and user-generated social data, [Company’s name] has been able to build a mechanism, such as putting out a warning forecast alert via smartphone service to occur 30 minutes to an hour before the local thunderstorm and has succeeded in capturing more than 70% of local thunderstorms since 2008. This network of users has created a network effect in that the system of localized content becomes more accurate and the usefulness attracts even more users to participate in the co-creation process, and the network becomes a valuable intangible property and competitive asset of the company.

Mr I.’s family and management continues to own 44.6% of the company which was listed since 2000 and its shares outstanding has reduced by 4.4%, demonstrating its prudence in capital management policy, and its net cash has also more than doubled since 2013 that is now 18% of its market capitalization. The company generates ROE of 27.2% and trades at an attractive EV/EBIT 9x, EV/EBITDA 7.5x. Sales has increased 12% in the past four years and EBIT and OCF (operating cashflow) growth is faster at 23% and 53% respectively due to the scalability of its toll-gate business model in launching higher value-added innovative services and effective cost management. We believe the company can build on the growth momentum in the next 4-5 years, spurring an upward valuation re-rating towards a potential doubling in market cap.

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“CNN/Bloomberg of Weather” as the World’s Largest and Most Comprehensive Weather Information Services Company – Bamboo Innovator Monthly Riddle

“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 | February 15, 2016
Bamboo Innovator Insight (Issue 118)

  • 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,

Can You Guess This Asian Wide-Moat Company?

“CNN/Bloomberg of Weather” as the World’s Largest and Most Comprehensive Weather Information Services Company

CEO Mr K: “Business is what starts from a dream. [Company’s name] is founded from the dream of Mr. I to become the ‘world information communication platform’ for weather. I graduated from college sympathetic to Mr I’s dream and joined as the first graduating class. Mr. I is a true entrepreneur and I say that it means the people who create a new industry. SECOM (TYO: 9735, MV $15.9bn)’s founder Ryo Iida created the security services industry; Masao Ogura re-created Yamato Holdings (Ta-Q-Bin) (TYO: 9064, MV $8.1bn) into a unique parcel delivery services company. Both thought of their own business model, to create employment, a great entrepreneur who pioneered the market. Mr I sets a dream of creating ‘weather information’ and caused the weather revolution.

This dream started after Mr. I graduated from college in 1970 to join a large trading house. Mr. I was assigned to the headquarters’ timber and building materials division to purchase the wood from the United States and to arrange a charter to the cargo back to Japan and sell to wholesalers. A tragic shipping accident on January 31, 1970 that claimed the lives of several crew members triggered our founder Mr. I to establish [Company’s name] to realize the righteous idea, ‘I want to protect the lives of mariners’ and “I want to help in times of crisis’. If only better information were available, this accident could have been avoided. As Mr. I said, ‘If there had been really useful weather information, maybe this accident could have been prevented.’ Weather information is an essential service in protecting people’s lives and property in the voyage. Feeling a sense of responsibility for this incident, Mr. I advanced the private weather forecasting industry by establishing [Company’s name] in 1986 after doing a MBO (management buyout) of the American weather forecast company that he joined in a career change after the incident.”

In this month of February 2016, we investigate an Asian wide-moat innovator who is the CNN/Bloomberg of weather as the world’s largest and most comprehensive private weather information services company, providing customized mission-critical weather information with a recurring-income “toll-gate” business model to help its worldwide customers to access accurate and timely weather information to make better decisions in a world with abnormal weather accelerating. Weather is probably the single largest swing factor in business performance — it impacts 1/3 of the world’s GDP and in the U.S. alone, weather is responsible for about half a trillion dollars in impact. Weather affects every aspect of the economy – energy usage, travel and transportation, new construction, agricultural yields, mall and restaurant traffic, etc. A changing global environment means more phenomena like typhoons, hurricanes, cyclones and flooding from torrential rains running rampant across our planet, so countermeasures against these risks has become increasingly important.

The above conversation from CEO Mr. K recounts how the business all started as a result of a tragic marine accident for which Mr. I felt responsible. He was just a desk worker in charge of transporting wooden lumber when tragic circumstances conspired to persuade him to move towards starting a business. Mr I.’s family and management continues to own 44.6% of the company which was listed since 2000 and its shares outstanding has reduced by 4.4%, demonstrating its prudence in capital management policy, and its net cash has also more than doubled since 2013 that is now 18% of its market capitalization. The company generates ROE of 27.2% and trades at an attractive EV/EBIT 9x, EV/EBITDA 7.5x

In its B2B (business-to-business) segment (57% of sales), [Company’s name] provides Total Fleet Management Service (TFMS) with optimal ship routing, performance monitoring, safety status monitoring for over 2,000 shipping companies from 31 offices around the world and commands a 90% domestic market share and 35% global market share (7,000/20,000 vessels). According to Mr. K, “Cargo movement has slowed in the last fall of the Lehman shock, but demand for TFMS is increasing” with the company growing its market share from 5,000 to 7,000 vessels.

The B2B business also helps multiple industries that range from sea (shipping, fishery, oil & gas) to land (road management, railway, logistics, retail, local government) and sky (aviation). For example, in the construction industry, [Company’s name] offers advice on when to build a roof, while Disneyland pays for counsel on how to stage its fireworks shows when the winds are stiff. [Company’s name] tells gas stations when to advertise tire chains in advance of snowy weather and instructs 7-Eleven on when to stock up on certain types of beer as sales vary according to changes in humidity and temperature. This deep accumulated and insight becomes more valuable over time and creates a long-lasting relationship with their customers.

In its B2C (business-to-consumer) segment (43% of sales), [Company’s name] designs and produces weather programs for radio, TV, digital media, including digital signage with original weather content for train stations, airports, elevators building lobbies, vending machines and restrooms. [Company’s name] provides content for over 90 commercial broadcasting stations in its country (80% share of the domestic market) and for over 200 cable television station in its country reaching 15 million households, as well as for Hong Kong and Taiwan satellite broadcasts. The B2C business also co-creates user-generated and crowdsourced weather information for its 20m users/”supporters”, of which 2.5m pay around US$2-3 per month for premium version of the service. As a result of this powerful crowdsourced and user-generated social data, [Company’s name] has been able to build a mechanism, such as putting out a warning forecast alert via smartphone service to occur 30 minutes to an hour before the local thunderstorm and has succeeded in capturing more than 70% of local thunderstorms since 2008. This network of users has created a network effect in that the system of localized content becomes more accurate and the usefulness attracts even more users to participate in the co-creation process, and the network becomes a valuable intangible property and competitive asset of the company.

The reason why [Company’s name] had strong and stable recurring cashflow was a result of the tough business decision made by the founder in building a ‘toll-gate’ business model that had long-term contracts or/and subscription-based revenue with its customers, revolving around the content and services rather than one-off lumpy hardware-based project sales in systems integration. Without loyal customers who are “sticky” to the innovative services continuously delivered by the company, this business model is unable to take off and hence it takes knowledge and time to build and scale such a valuable business model. The ‘toll-gate’ business model has cost-efficiencies given that the standardized system becomes stronger over time with more customer usage that helps to improve and refine the workings of system, and that the multiple ‘customized’ applications leveraged upon the standardized system to deliver a more cost-effective solution to the customers. Accumulated deep know-how is required to build such a system and the applications, making it difficult for any competitors to set up, and this business model gets more valuable and scalable over time.

Sales has increased 12% in the past four years and EBIT and OCF (operating cashflow) growth is faster at 23% and 53% respectively due to the scalability of its toll-gate business model in launching higher value-added innovative services and effective cost management. We believe the company can build on the growth momentum in the next 4-5 years, spurring an upward valuation re-rating towards a potential doubling in market cap.

Image 075

IBM recently acquired The Weather Company for >$2Bn in Oct 2015 which indicated a valuation with a Price/Sales of 5-8x as compared to [Company’s name] which trades at EV/Sales 2x, suggesting that the global hidden champion is severely undervalued by 250-400%. The high valuation that IBM is willing to pay also indicate that accurate and timely weather data is an increasingly critical and valuable information, as well as the scarcity of good companies, let alone global players like [Company’s name], who operate in this field with excellent track record.

We are awestruck by the burning sense of mission and sense of responsibility forged by the late founder Mr. I that is visible as the moving thrust for not only all employees of [Company’s name] but also its 2.5m paying internet/mobile subscribers who are co-creating weather content, to deliver mission-critical weather information and services that can help mankind and save lives and property and protect the safety of the sea, land and sky from weather-related disasters such as preventing a shipping disaster or local thunderstorms. The weather never sleeps and the nature of the work demands working as a team for 24 hours a day, 365 days a year. At its headquarters building, on the 24th floor of the forecast center, which is the heart, the light never disappears even late at night. At the entrance to the top level of the [Company’s name] office is a cordon. When the rope is blue, visitors can enter because it means the weather is calm. When the rope is red, visitors are not permitted to enter. The staff will be giving tense instructions about whether aircraft should take off or how to reroute shipping. Employees are motivated under the unique corporate culture to launch innovative new services.

[Company’s name] is now in the fourth growth phase aimed at full-fledged global expansion through innovation to create new markets and the technology and system to achieve it. The voyage of the world’s largest and most comprehensive weather information services and big-data analytics company has just begun.

Who is Mr. I and this wide-moat Bamboo Innovator?

PS: We like to share our Investor Day Presentation held on 1 December 2015 for our shareholders. The presentation material is available for download on the ASX website:

http://www.asx.com.au/asxpdf/20151102/pdf/432nk9r3hhw4nf.pdf (pg 10-14)

http://www.asx.com.au/asxpdf/20151201/pdf/433hdp24p2twyj.pdf

and our Value Investing Summit 2016 presentation “Quietly Innovating Value with Hidden Champions”:

http://www.moatreport.com/value-investing-summit-2016-quietly-innovating-value-with-hidden-champions/

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/

Our latest monthly Moat Report Asia for January 2016 investigates an Asian-listed wide-moat innovator who is the world’s largest ODM producer of an important tool with multiple applications for automobiles, aerospace and homes with a global market share of 20-25%. Its 18.9% operating profit margin and 18.5% ROE is higher than that of its branded clients because of its negotiating and pricing power, technological prowess and vertically-integrated business model from upstream tooling design/ manufacturing to downstream final assembly.

This deep vertical integration allows the company to achieve high precision standards in each part of the production process, and enhances its design ability to innovate lighter but stronger tool products. Due to its mastery of critical end-to-end know-how, the company also utilize its magnesium alloy die casting technology in pneumatic tools to produce aluminium-magnesium alloy bicycle frames for all top 7 global bicycle manufacturers. In 4Q15, the company also penetrated into the supply chain of possibly the most important American customer in a game-changing private label partnership that provides a long visible runway for the company. The company started shipping industrial-level tools to this American MNC in 4Q15. This private label order yields a higher gross margin of 50-60% as compared to the typical 10-40%. The company was co-founded in 1983 by Mr. L after his retirement as Chief Judge in his local region and the L family controls 30-35% of the company.

Since the 2007/08 Global Financial Crisis, we like how the company has emerged stronger with major positive transformations to its business model resiliency: (1) Shifting to higher-margin industrial-level tools; (2) Successful new growth in auto tools which grew from 6% of total sales in 2006 to 37% in FY14; (3) Penetration into Europe, which contributed from 11% of total sales in 2006 to 33% in 1H15; (4) Client concentration risk reduced: its top 2 clients used to contribute 64% of revenue in 2006 and that proportion was down to <20% in 1H15.

The company has been prudent and shareholder-friendly in its capital allocation decisions. In particular, the company announced a capital reduction plan in Aug 2015 and shares outstanding will decline 10% to return excess cash to shareholders and improve its ROE. As at Sep 2015, the company has a healthy balance sheet with net cash at 54% of book equity (21% of market cap), which could provide some short-term downside protection when coupled with its 5.3% dividend yield.

Sales has increased 32% in the past four years and EBIT and EBITDA growth is faster at 41-74% due to effective cost management in its vertically integrated strategy and higher weightage of higher-margin products in product mix. We believe the company can build on the momentum to at least double its profits in the next 4-5 years, pointing towards a potential doubling in market cap.

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