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“Providing an information infrastructure suitable for an aging society” – H.E.R.O. Innovation Insights from SMS Co’s Natsuki Goto & Shuhei Morofuji | H.E.R.O. HeartWare | 13 August

“Providing an information infrastructure suitable for an aging society” – H.E.R.O. Innovation Insights from SMS Co’s Natsuki Goto & Shuhei Morofuji | H.E.R.O. HeartWare | 13 August

Modern monopolies in the manifestation of platform business models are increasingly dominating our digital lives and driving profound structural economic shifts, presenting critical opportunities and risks for value investing in this exponential world we now live in. Linear companies grow by adding staff or physical assets by directing resources within the firm, but platforms scale not because of what they own but by connecting more and more users within their networks, leading to greater value with all of the platform’s users as engagement takes root, which in turn attracts more users and further increases scale at an exponential rate with the network effects kicking in. But many are now questioning their sustainability and believe that they are becoming too large to be useful. Importantly for long-term investors, a little discussed critical risk is that reverse network effects can occur, which often cause a large and thriving network to implode as a result of poor governance of the network in connection, content and clout, which happened for MySpace, Friendster, Orkut, etc. Purpose is the all-important North Star for the sustainability in scaling for platforms.

How founder Shuhei Morofuji and CEO Natsuki Goto and their team scale SMS Co (TSE: 2175) into Japan’s leading information platform for nursing care, medical care and elderly care fields bears useful insights for value investors in understanding the dynamics of platform business models. SMS is the No. 1 player in online recruiting agent (RAG) and recruiting ads (RAD) for professionals and operators in nursing and medical care services. SMS also operates Kaipoke, an online management support service (eg operation efficiency, sales support and recruiting) for over 19,000 elderly care SME operators, an online community site for professionals or families engaged in nursing care; a certification course information portal; and a housing information portal for seniors, as well as a home-delivered meal search site. In addition, SMS owns 60% of MIMS (Mitsui has the other 40% ownership), Asia’s No. 1 drug information service provider in 11 Asian countries and 2 Oceania countries which also has a database of 2.3m healthcare professionals (HCP).

CEO Goto elucidated the vision and corporate philosophy of SMS since their foundation in 2003: “SMS sets the corporate philosophy of ‘to create value and contribute to society by providing an information infrastructure suitable for an aging society’. We create valuable services for many social problems caused by rapid aging and contribute to problem solving. SMS stands in the place of ‘aged society × information’, and I believe that this itself is one of the very few growth areas in future Japan, especially where rapid aging progresses among developed countries, the needs for services and products that have not existed in the past have continued to expand. The information related to the aged society is often highly specialized, such as nursing care and medical care, and the need to easily obtain correct information is growing, and there are enormous business opportunities.” Guided by this purpose “with a strong will to make SMS to be a company that will last for 100 years”, CEO Goto added that they do not post excessive advertisements just to improve profitability, unlike many of the platforms increasingly pressured to skate on the thin ice to loosen the governance quality to generate short-term profits that decrease network value for the users: “As long as SMS continues its business as an ‘information infrastructure in an aging society’, we will be necessary for society in the decades to come. We set the two objectives of ‘customer satisfaction’ and ‘profitability’, and we change the weight of evaluation for each business. For example, since SNS is for members to interact and exchange information, we place emphasis on the number of members and the utilization/ engagement rate. We will not post excessive advertisements to improve profitability. Meanwhile, we pursue profitability improvement in the online recruitment business of personnel and online ecommerce orders. We will clarify the purpose for each business and we will create a flow for users to use our services throughout the entire ecosystem.”

Network effects can only be achieved when critical mass is reached, when the value of new users of participating in the platform exceeds the cost of participation. Linear businesses can start generating revenue right away; platforms usually can’t and may generate less profit than a linear business would until the platform scales well beyond the critical mass. This dynamic imply that that building “small” platform business may backfire unless the “total ecosystem” can be expanded. SMS founder Shuhei Morofuji added an interesting insight on why SMS has been able to thrive in the niche nursing care and senior care industry by expanding the business into adjacent areas with multiple innovative services in rapid succession to increase the value add to the connecting users in its ecosystem, demonstrating their vision and capabilities: “I started to expand the business in the adjacent areas from the fear of competition by rivals. We started to introduce the care manager in the nursing care industry and started to increase new services every three months. As we expanded our business, there were also companies in the nursing care industry that were funded from venture capital to create a large-scale system rapidly. These companies did not work. Because of its complexity, the market that is initially emerging is too small, and there is no room for large companies to enter while securing profits. Also, such a market will not scale even if trying a system approach, and it cannot penetrate with one product like Uber. Many startups in the world are supposed to grow greatly with one product, and it is like a conventional VC or startup idea when VC invests in such a story. It may be hard to create a business like SMS.”

CEO Goto commented on creating synergistic effects between their services amongst the diverse users in its total platform, “Our fundamental strategy is to create a thriving community of members in the area of nursing care, medical care, healthcare and elderly with daily use of the services to create and expand businesses. We also place emphasis on creating synergistic effects between our services. For example, members of Care Manager.com, an online community which boasts membership of 56% of the total number of care managers (85k/150k) who answer questions regarding nursing care that are posted in Anshin Kaigo, an online community for families engaged in nursing care. The Q&A site on health, Narukara, enables posting health-related questions or concerns which are answered by such professionals as doctors, nurses, pharmacists, nutritionists and care managers who are members of our community. For the community membership of nurses (610k/1600k) and registered nutritionists (32k/60k), we have 60% share; 13% share for home-visit nursing care operators (15k/121k), 5% share for pharmacists (19k/280k). For the recruiting agent and ad market, we have 30% share for nursing care professionals (580k/1850k), 20% share for Physical Therapists/ Occupational Therapist/ Speech Therapists professionals, 50% share for large-sized nursing care operators, 10% share for clinics (9.5k/100k), 65% share for hospitals (5.4k/8.5k), 40% share for nurses and 20% share for student nurses (15k/75k).” Founder Morofuji added, “The basic strategy is to divide the information infrastructure into ‘daily’ and ‘extraordinary’ and combine them. It is extraordinary services like change job, get married, or buy a car, that users want to pay money for use of the information infrastructure. As the impact on the future life is huge or there is a movement of a large amount of money, we want to obtain the correct information even if we pay money, and the information infrastructure tends to be an easier to business. Therefore, we engage our customers with our daily service and monetize by having them move to dedicated non-routine services when in trouble.”

The exponential value creation of SMS is no coincidence and is enabled by the organizational culture which fosters innovation. Founder Morofuji shared: “I hope for every staff to do rewarding work and to live a life full of personal flourishing, and we have prepared some unique measures. With our ‘New Business Proposal System’, anyone can propose a new business plan and promote it at the ‘Innovation Office’ which specialized in new business development. As long as the business is part of the comprehensive information infrastructure that can contribute to the aging society, the staff who raised the new business proposal can operate the business as the person responsible for the project. There is a ‘profit return system’ that returns approximately 30% of company profits to all employees.” CEO Goto added, “The identity and organization knowledge of SMS is necessary to imprint and continue on the business creation method of the SMS flow and connect the 100 years of baton with promising management talent who can absorb this experiential value in a straightforward manner.”

Are there modern monopolies who are linear companies?

A possible example is Yamashin-Filter (TSE: 6240), the global number one leader in hydraulic filter materials for construction machinery with a dominant domestic market share of over 70%. Hydraulic filters are the ‘kidneys’ of machines and recurring sales for aftermarket markets in replacement parts comprise 55% of group’s sales while the remaining 45% of sales are for new machines. Yamashin is making the leap from a specialized manufacturer of construction machine filter to an integrated filter maker by expanding into two additional pillars: (1) industrial process filters used in process requiring high levels of filtration such as high-precision cleaning of electronic parts, and nanoparticle level sorting in capacitor and film production for the electronic parts, precision components, LCD displays, food and beverage, and fine chemical industries, as well as in a range of industrial machinery, such as machine tools, compressors for cooling equipment, agricultural machinery, railroads and ships, rolling stock, planes, helicopters, and cars, and (2) new materials, specifically synthetic polymer nanofibers with applications in medical, agricultural, aerospace, apparel, etc.

CEO Atsuhiko Yamazaki shared how they are the unsung heroes of industry: “Yamashin Filter’s management philosophy is 仕濾過事, which means ‘contribute to society through filter business’. Our company has continued this philosophy for 60 years and has contributed to society by delivering high quality filters. Filters are the unsung heroes of industry, working quietly behind the scenes, unnoticed by most people. Yamashin plays a vital role in our everyday lives. Our filters are installed in most of the world’s hydraulic excavators in use today and can be found in surprising places, such as on production lines in the alcoholic beverage sector. Customers across many industries have chosen our products because they recognize Yamashin’s superior development capabilities. Yamashin filter’s challenge has only just begun. We are positioning the present as the second foundation. We will continue to develop innovative technologies, aiming to offer solutions for different industries to expand its reach into even more fields. We aim to be a company that constantly develops and continues to challenge.”

What differentiates the typical linear companies from the innovators like Yamashin-Filter are that after they have built a solid foundation of strong market leadership with their mission-critical products and services, they are often at the tipping point stage to expand into new categories of growth based on their accumulated technological know-how. CEO Yamazaki commented on their leap to an integrated filter maker, propelled forward by his conviction inspired by the late American President JF Kenndy that “The time to repair the roof is when the sun is shining”: “In management reform, we aim to make a leap from a specialized manufacturer of construction machine filter to an integrated filter maker. Specifically, it focuses on establishing the company’s product structure with the three pillars of ‘filter for construction machine’, ‘industrial process filter’ and ‘new material’, and a review of supply chain. We are focusing on developing new products. Currently, about 90% of Yamashin filter sales are filter business for construction machinery. We are developing and establishing mass-production technology of the new fiber material of synthetic polymer nanofibers which are expected to be used in various fields such as medical, regenerative medical, agricultural, aerospace, apparel, other than hydraulic applications. Applications of the new nanofibers will also benefit liquids other than oil as well as gas, so our future business area will expand significantly. If we separate the conventional stereotype of filter for filtration, we think that there are also new ways to use filters. It will be expanded to insulation materials, sound insulation materials and water filters. The late American President Kennedy said, ‘The time to repair the roof is when the sun is shining.’ We are fortunate that we should do the work for this future when we are stable and growing as the global number one leader in this niche field. We will make sure to prepare for the next stage when we are in good shape.”

When asked about their competitive edge, CEO Yamazaki said that Yamashin-Filter is an R&D organization in designing products with VOC (voice of customers) in mind: “The biggest difference of Yamashin with other companies is that we are a R&D type of organization in designing products with VOC (voice of customers) in mind. If there is an order from the customer, we will do from the development of the filter material which is the essential part of the filter. Demand varies depending on the manufacturer. Normally, the finer the filter, just like when scooping water with a mesh or sieve, the greater the resistance to fluid flow. In addition, if the ‘garbage’ is blocked, the passing resistance becomes even bigger. However, filtration technology aims at resolving the contradictory properties of refining the fineness of the mesh while taking a lot of trash and having the ability to work in high pressure applications. For example, we are asked to develop filters with detailed specifications such as ‘how much garbage can be taken’, or ‘how quickly oil stains can pass through’, or ‘how not to miss the smaller oil stain particles’ or the filter durability or useful life in ‘how long can it last’. For the development of a small construction machine, the need could be to quadruple the operation time, yet halving the size of the filter. Yamashin takes into account flow rate, operating temperature, environment and total cost of ownership (TCO) when developing filter technology. This coupled with over 60 years of experience allows us to supply customized filters for each specific customer applications. Our greatest strength is that we can procure, design and develop the filter material according to these customer needs internally and we are pleased to accept such requests. In order to make filters useful for the construction machines or for the next generation aircraft, we are trying to make products that customers desire most. This quality and superior development capability is still the most important factor when customers purchase our filters. We keep in mind the fine-grained service. In order to respond to customer’s request, sales staff need knowledge equivalent to that of a ‘sales engineer’. Companies in Japan and overseas bother to purposely choose the filters of Yamashin when there are others that are more affordable and less expensive. This was because we conveyed quality, as well as various prompt delivery and after-sales services using IoT, and our attitude towards making things.”

CEO Yamazaki added on the IoT conversion of their hydraulic filters as a growth driver: “We are focusing on ‘IoT conversion’ of hydraulic filter. The filter is a consumable item and needs to be exchanged after a certain period of time. In the past, when the passage resistance of the filter became high to some extent, it was informed with an indicator. However, by developing a sensor called ‘Swift Lock’, we are now able to grasp in real time, such as 20% or 50% of consumption. By aggregating this together with GPS data, users can visualize exhaustion status of filters of construction machines operating around the world. The sensor checks the oil condition of the construction machine and judges whether it is normal or not. It is possible to prevent an emergency such as a sudden failure of the construction machine. It is also a great advantage for a construction and civil engineering company that is a user of a construction machine. If the hydraulic filter is the ‘kidney’ of the construction machine, the oil is just like ‘blood’. The same mechanism that humans check health condition at the hospital is also made for construction machinery. We are also experimenting the sensor in various environments such as desert.”

Intrigued and want to read more? Download this week’s H.E.R.O. HeartWare: Weekly Asia Tech News with brief highlights of the inspiring entrepreneurial stories of tech leaders in Asia whom we have been monitoring over the past decade in our broader watchlist of over 200 listed Asian tech companies and our focused portfolio of 40 HERO Innovators who reveal their problems and successes behind building the company. Inspired by Brandon Stanton’s photo-journalistic project Humans of New York which collects and highlights the street portraits and moving stories of people on the streets around us who were doing things that changed lives and made a difference in the city but often went unnoticed, we have curated a collection of Hear the Heart of the H.E.R.O. stories on our website which we aim to update with refreshing and uplifting new stories weekly. Please check them out and give us your valuable feedback so that we can improve to make them better for you. In this issue, we have:

(1) Natsuki Goto 後藤夏樹, CEO of SMS Co エス・エム・エス (TSE: 2175, market cap US$1,328m), Japan’s leading information platform for nursing care, medical care and elderly care fields with over 40 unique revenue streams in its business portfolio, including: (1) Career business: the No. 1 player in online recruiting agent (RAG) and recruiting ads (RAD) for professionals and operators in nursing and medical care services. In the nursing care field, SMS offers recruiting agent services for care managers, physical therapists (PT), occupational therapists (OT) and speech therapists (ST), centered on Kaigo Job (www.kaigojob.com), a recruiting ads website for nursing care jobs, which draws about 500,000 visitors per month. In the medical care field, SMS offers Nurse Jinzai-bank, a recruiting agent service for nurses, where two-thirds of the total number of nurses leaving work annually is registered to the website, while 60% of all hospitals in Japan are also registered as clients; (3) Kaipoke: management support service (eg operation efficiency, sales support and recruiting) for elderly care SME operators, an online community site for professionals or families engaged in nursing care; a certification course information portal; and a housing information portal for seniors, as well as a home-delivered meal search site; (3) Overseas business (MIMS, acquired in Oct 2015 as a 60:40 JV with Mitsui): Asia’s No. 1 drug information service provider in 11 Asian countries and 2 Oceania countries which also has a database of 2.3m healthcare professionals (HCP); (4) Others: Various sites that provide online community, mail order, and magazines/book services for nurses; services for pharmacists and pharmacies; hospital management and administrator services; and consulting services for national and local governments. In addition, it operates an online Q&A site on health that enables posting health-related questions which are answered by professionals, as well as online news column site and information websites. SMS has either invested in or acquired over 20 companies globally, including Philippines-based nurse recruiting agency MSR in May 2018 and Nurscape, the largest online community site services (recruitment, e-learning etc) for nurses in Korea with 150,000 registered nurses, or 60% share of registered nurses, as members. SMS Co was founded in 2003 by Shuhei Morofuji who led the company to a market cap of $500m before passing on the leadership to Natsuki Goto in 2013, and established PE/VC firm REAPRA. SMS Co is headquartered in Tokyo;

(2) Atsuhiko Yamazaki 山崎敦彦, CEO of Yamashin-Filter Corp ヤマシンフィルタ (TSE: 6240, market cap US$754m), the global number one leader in hydraulic filter materials for construction machinery with a dominant domestic market share of over 70%. Hydraulic filters are the ‘kidneys’ of machines and recurring sales for aftermarket markets in replacement parts comprise 55% of group’s sales while the remaining 45% of sales are for new machines. Yamashin is making the leap from a specialized manufacturer of construction machine filter to an integrated filter maker by expanding into two additional pillars: (1) industrial process filters used in process requiring high levels of filtration such as high-precision cleaning of electronic parts, and nanoparticle level sorting in capacitor and film production for the electronic parts, precision components, LCD displays, food and beverage, and fine chemical industries, as well as in a range of industrial machinery, such as machine tools, compressors for cooling equipment, agricultural machinery, railroads and ships, rolling stock, planes, helicopters, and cars, and (2) new materials, specifically synthetic polymer nanofibers with applications in medical, agricultural, aerospace, apparel, etc. Yamashin-Filter was founded in 1956 by Masahiko Yamazaki, listed on the second section of the Tokyo Stock Exchange in 2014 and migrated to the first section in 2016, and is headquartered in Yokohama.


It started with rethinking a few questions. Question No. 1: Can the megacap tech elephants still dance? Or is this the better question: Is there an alternative and better way to capture long-term investment returns created by disruptive forces and innovation without chasing the highly popular megacap tech stocks, or falling for the “Next-Big-Thing” trap in overpaying for “growth”, or investing in the fads, me-too imitators, or even in seemingly cutting-edge technologies without the ability to monetize and generate recurring revenue with a sustainable and scalable business model? How can we distinguish between the true innovators and the swarming imitators?

Question No. 2: What if the “non-disruptive” group of reasonably decent quality companies with seemingly “cheap” valuations, a fertile hunting ground of value investors, all need to have their longer-term profitability and balance sheet asset value to be “reset” by deducting a substantial amount of deferred innovation-related expenses and investments every year, given that they are persistently behind the innovation cycle against the disruptors, just to stay “relevant” to survive and compete? Let’s say this invisible expense and deferred liability in the balance sheet that need to be charged amount to 20 to 30% of the revenue (or likely more), its inexactitude is hidden; its wildness lurks and lies in wait. Would you still think that they are still “cheap” in valuation?

Consider the déjà vu case of Kmart vs Walmart in 2000s and now Walmart vs Amazon. It is easy to forget that Kmart spent US$2 billion in 2000/01 in IT and uses the same supplier as Walmart – IBM. The tangible assets and investments are there in the balance sheet and valuations are “cheap”. Yet Kmart failed to replicate to compound value the way it did for Walmart. Now Walmart is investing billions to “catch up” and stay relevant. Key word is “relevancy” to garner valuation.

We now live in an exponential world, and as the Baupost chief and super value investor Seth Klarman warns, disruption is accelerating “exponentially” and value investing has evolved. The paradigm shift to avoid the cheap-gets-cheaper “value traps”, to keep staying curious & humble, and to keep learning & adapting, has never been more critical for value investors. We believe there is a structural break in data in the market’s multi-year appraisal (as opposed to “mean reversion” in valuation over a time period of 2-5 years) on the type of business models, the “exponential innovators”, that can survive, compete and thrive in this challenging exponential world we now live in. Tech-focused innovators with non-linear exponential growth potential are the most relevant multi-year investment trend and opportunity.  

During our value investing journey in the Asian capital jungles over the decade plus, we have observed that many entrepreneurs were successful at the beginning in growing their companies to a certain size, then growth seems to suddenly stall or even reverse, and they become misguided or even corrupted along the way in what they want out of their business and life, which led to a deteriorating tailspin, defeating the buy-and-hold strategy and giving currency to the practice of trading-in-and-out of stocks. On the other hand, there exists an exclusive, under-the-radar, group of innovators who are exceptional market leaders in their respective fields with unique scalable business models run by high-integrity, honorable and far-sighted entrepreneurs with a higher purpose in solving high-value problems for their customers and society whom we call H.E.R.O. – “Honorable. Exponential. Resilient. Organization.”, the inspiration behind the H.E.R.O Innovators Fund, (surprisingly) the only Asian SMID-cap tech-focused fund in the industry.

The H.E.R.O. are governed by a greater purpose in their pursuit to contribute to the welfare of people and guided by an inner compass in choosing and focusing on what they are willing to struggle for and what pains they are willing to endure, in continuing to do their quiet inner innovation work, persevering day in and day out. There’s a tendency for us to think that to be a disruptive innovator or to do anything grand, you have to have a special gift, be someone called for. We think ultimately what really matters is the resolve — to want to do it, bring the future forward by throwing yourself into it, to give your life to that which you consider important. We aim to penetrate into the deeper order that whispers beneath the surface of tech innovations and to stand on the firmer ground of experience hard won through hearing and distilling the essence of the stories of our H.E.R.O. in overcoming their struggles and in understanding the origin of their quiet life of purpose, who opened their hearts to us that resilience and innovation is an art that can be learned, which can embolden all of us with more emotional courage and wisdom to go about our own value investing journey and daily life.

As the only Asian SMID-cap tech-focused listed equities fund in the industry, we believe we are uniquely positioned as a distinctive and alternative investment strategy for both institutional and individual investors who seek to capture long-term investment returns created by disruptive forces and innovation without herding or crowding to invest in the highly popular megacap tech stocks, and also provide capital allocation benefit to investors in building optionality in their overall investment portfolio.

The H.E.R.O. HeartWare Weekly highlights interesting tech news and listed Asian emerging tech innovators with unique and scalable wide-moat business models to keep yourself well-informed about disruptive forces and innovation, new technologies and new business models coming up, and the companies that ride on and benefit from them in some of the most promising areas of the economy in Asia as part of our thought leadership for our ARCHEA Asia HERO Innovators Fund to add value to our clients and the community. Hope you find the weekly report to be useful and insightful. Please give us your candid feedback and harshest criticisms so that we can improve further to serve you better. Besides the BATTSS (Baidu, Alibaba, Tencent, TSMC, Softbank, Samsung), do also tell us which Asian tech entrepreneurs & CEOs whom you admire and respect and why – we will endeavor to do up profiles of them for sharing with the community. Thank you very much and have a beautiful week ahead.

Warm regards,
KB | kb@heroinnovator.com | WhatsApp +65 9695 1860
www.heroinnovator.com

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About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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