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Grace Technology (TSE: 6541), Japan’s Leading e-Manual Software-as-a-Service (SaaS) & AI/AR Innovator – H.E.R.O. Innovators Insights from CEO Koji Matsumura | H.E.R.O. HeartWare | 3 December

“When it comes to the SaaS (Software-as-a-Service) industry, perhaps no market is more fascinating than Japan,” points out Hiro Maeda, a tech investor in the Forbes Asia 30 Under 30, in the recent Forbes article Why Japan Will Become a SaaS Nation.

Fueling the SaaS industry’s expected growth from US$3.5bn to US$6bn by 2021 is Japan’s declining population that drives companies’ urgent demand for increased automation and efficient solutions such as the SaaS model to address the challenges. Some of these exponential innovators solving high-value problems for their clients include Takanori Nakamura’s Rakus (TSE: 3923) and Takafumi Kusano’s BrainPad (TSE: 3655) that we had highlighted earlier. SaaS companies have demonstrated resilience in difficult and uncertain market and economic environment because of their recurring and predictability of the revenue model in growing monthly-paying subscribers. And unlike many of the SaaS companies in the US or China that are still loss-making and cash-burning, a selected group of Japan’s exponential innovators such as Rakus and BrainPad have quietly built highly profitable business models generating positive free cashflow. Over the past three years, Rakus and BrianPad had compounded 238% and 1,306% respectively to reward long-term investors.

This week, we will be highlighting another highly profitable (ROE 37.9%, EBIT Margin 30.8%, FCF Margin 22%) SaaS innovator Grace Technology who is helping its clients such as Fanuc (one of the world’s largest industrial robots) and Toyota with its new and revolutionary patented Artificial Intelligence (AI)-guided augmented-reality smart glasses using Microsoft Hololens: https://www.youtube.com/watch?v=gyTOV5Xbv3A 

Over a warm cup of afternoon coffee last week with a super investor in Singapore, who’s the founder & CIO of a highly successful billion-dollar asset management firm in Asia ex-Japan equities and was the former MD of one of the world’s largest sovereign wealth fund, this HERO of Singapore expressed his farsighted view on the increasing investment relevance of exponential innovators and that he is intrigued by the quality of the business models and entrepreneurs of the Japan/Asia exponential innovators that we highlighted, commenting that he is well-read himself given his 30-year experience in Asia ex-Japan stocks and is positively surprised by these under-the-radar companies. He added that Japan fund and Asia tech fund tend to invest in the typical old-tech component makers/OEM/Apple-suppliers which could be disrupted value traps, unlike the pure focus on exponential innovators that we are doing – we are the only Asia SMID-cap tech-focused fund in the industry. Thus far, of the nearly 50 entrepreneurs and CEOs whom we had highlighted in our weekly HeartWare, 25 are in our focused portfolio of 48 HERO Innovators while the rest are in our broader watchlist of 200+ stocks.

We are very grateful to this super investor for his kind comments. We are also very thankful to another of our reader, a German billionaire and one of the world’s foremost thought leaders, who emailed his comments that he finds AI exponential innovators such as BrainPad “intriguing” and “really interesting” and that he has shown our brief research writeup to the head of his AI unit and we have learnt a great deal from his insights about AI applications in Germany and Europe.

The relentless drive of this German business management wizard and Singapore super investor for a better and more relevant worldview and to stay ahead of the curve as the world changes, so that they can be a positive force for people around them, has inspired us to stay the course to serve the community of long-term investors in this Value 3.0 journey as we progress from Charlie Munger’s disruptive Value 2.0 nudge to Warren Buffett towards the direction of not paying for the Value 1.0 Graham-type net-net bargains.

H.E.R.O. (Honorable. Exponential. Resilient. Organization) is a culmination of the learnings from my many mistakes in which I was caught in the “overall” value trap – the Value 2.0 portfolio of investing in decent quality businesses with a certain competitive advantage run by hardworking entrepreneurs and have reasonably cheap valuations and so, “overall”, while they do not have an “exponential edge”, they should be good investments over time with mean reversion in valuation working in favor. But these Value 2.0 stocks turn out to be the “new” group of cheap-gets-cheaper value traps in an exponential world where 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. While tech-focused innovators with non-linear exponential growth potential are the most relevant multi-year investment trend and opportunity, it is important to have the fortitude to not chase after the popular shiny things and overpay for growth and the Rosetta stone lies in understanding and deciphering the business model dynamics of exponential innovators.

The greater our challenges, the more important it is for us to embrace the values and principles to provide pivotal guidance that can help us right in the moment. Living in alignment with our values and principles will help to keep us strong and find ways to be a positive force every day, even when the winds are whipping up. We are encouraged and inspired in learning from our readers who displayed the emotional courage to make the choice to stay ahead of the curve while rooted in principles and values. I am also heartened to know from the Singapore super investor that my former student and teaching assistant when I was teaching at the Singapore Management University is doing well as an analyst at his firm. We have been working hard to create resources and opportunities that are inspiring and practical and we 
remain grateful to have shared with the top management team at Singapore’s financial regulator Monetary Authority of Singapore (MAS) about implementing a world’s first fact-based forward-looking accounting fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community.

There’s a Japanese word, okagesama, which is often used conversationally to express thanks. The root of this word, kage, means “shadow” or “shade”. It acknowledges that there are unseen forces, energy and people in this world which make our life possible. These are the elements of our life that are in the shadow, so to see them, we have to look very deeply. We have to see with more than just our eyes. When we bring the light of awareness and gratitude to that shadow as we begin the HERO’s Journey, we often find love. Quiet, inconspicuous, unassuming love. Love to revitalize ourselves and to inspire and encourage one another, as we make our way, day by day. Okagesama.

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Imagine the game-changing industry benefits if there is an Artificial Intelligence (AI)-guided manual that can completely guide anyone by conversation through all necessary steps to accomplish value-added tasks such as operating and maintaining a complex machine. For instance, if we do something wrong during the operational/maintenance procedure, such as inserting the right-colored wire into the proper outlet or injecting liquid three times instead of five times into the tube at a consistent speed or recognizing the correct shape of the parts used or how the valve is tightened and whether it is properly tightened, the AI will notice and warn us. This AI-guided GRACE VISION also allows the workers to call each other and communicate, even record, the progress of their work; a supervisor can even look over the newcomers who are in distant places. Note: The demo video below is not science fiction:


“We are trying to switch from ‘reading manual’ to ‘viewing manual’ while using movies and audio. GRACE VISION is the ultimate AI manual that anyone can use easily, which does not need the user to see nor memorize tens of thousands of pages of manuals, not only in Japanese and English, but also in any language. We want to escape from the conventional manual that has bothered engineers so far and have AI to monitor and guide the worker to prevent mistakes and complaints, and to shorten the training period for new workers. We have over 30 years experience in preparing manuals entrusted by manufacturers and we incorporated our existing product of cloud ‘e-manual’ know-how in AI and developed GRACE VISION with AI-related companies. GRACE VISION is possible only because we know the manual. We are familiar with where to watch out and what kind of warning should be given. With this know-how, you can input 100% of the necessary information to AI, so that 100% guided manuals will be possible,” CEO Koji Matsumura, founder of Grace Technology (TSE: 6541), exclaimed with a quiet confidence.

Grace Technology is Japan’s leading e-manual database software-as-a-service (SaaS) innovator expanding into its revolutionary patented AI/AR-guided manual smart glass “GRACE VISION” (registered patent no. 6321879 received in May 2018) using Microsoft Hololens. Grace Technology focuses on technical manuals for complex B2B applications serving over 1,700 manufacturers & IT companies that include Fanuc (one of the world’s largest makers of industrial robots), Toyota, ABB, Advantest, Agilent Technologies, Applied Materials, Atlas Copco, Bosch, Bureau Veritas, Canon, Dell, Dassault Systemes, Emerson, Harmonic Drive Systems, Heidelberg, Honeywell, IHI, KLA-Tencor, KUKA, Kurata, Nvidia, Qualcomm Japan, Park Systems Japan, Pitney Bowes, Sandvik, Saint-Gobain, Samsung Japan, Siemens, Sirona Dental Systems, Teradyne, Texas Instruments, Thales, Thermo Fisher Scientific, Tokyo Electron, Trimble, Xilinx; Apple, Autodesk, Citrix, EMC, ESRI, Fortinet, Intel Japan, Oracle, SAP, Trend Micro, Wipro, etc. Grace Technology specializes in the technical maintenance manual of critical industrial machinery of manufacturers from the computer control system of the nuclear power plant to the trajectory control system of the satellite, biotechnology and pharmaceutical inspection scientific equipment and robot engineering, an area with low competition because of the high industry expertise and knowledge required. Compared to the estimated potential market size of 100bn yen, the current market share of Grace Technology is less than 2%.

Orders for the patented AI-guided “GRACE VISION” prototype have been received from several customers. Grace Technology had also acquired related trademarks in a wide range of ways of thinking and making method for creating manual incorporating AI. Grace Vision was exhibited at JIMTOF 2018 (Japan International Machine Tool Fair) held from 1 Nov to 6 Nov 2018. Grace Technology will be announcing the release of the prototype version at the Tokyo FM Hall this week on 5 Dec 2018.

With the compellingness and circumspection exponential edge in solving headaches for its customers to result in substantial cost and time savings, Grace Technology’s SaaS business model generates stable and recurring monthly subscription revenue (based on the data capacity of the manual and the number of users), achieving a 103% and 229% absolute increase in sales and operating profit in the recent 3 years with EBIT margin of 30.8%, positive free cashflow margin of 22.0%, and ROE (= EBIT/ Equity) of 37.9%, propelling a 388% increase in market value since its listing in Dec 2016 to US$278m. On 7 Nov 2018, Grace Technology announced its 2Q results (Apr-Sep 2018) in which 1H sales increased 26.8% yoy to 761m yen, operating profit rose 21.7% yoy to 202m yen, while 2Q operating margin rose from 38.2% to 45.5%, operating cashflow 327m yen and positive free cashflow 325m with positive cashflow margin at 22%. Balance sheet is healthy at net cash 1bn yen (gross cash stands at 1.15bn, with 438m yen raised during its Nov 2016 IPO). Average sales per company has increased 60% from 4.58m yen in 1H17 to 7.32m yen in 1H19 due to the deepening of existing customers.

Grace Technology’s cloud-based portal site enables users to centrally manage, edit and distribute digitized manual data with user-friendly functions that include its patented “Term Filter” (patent no. 5696280 “Linguistic system and language consolidation program and term collection method”) that allows users to convert technical terms regardless of when or how they are written and replaces all technical terms that need to be unified based on the glossary. The e-manual cloud service also enables on-demand printing service to reduce logistics and warehousing costs, as well as the online ordering and purchasing of component parts linked with the maintenance manual to the EC site. Grace Technology’s MMS (manual management system) e-manual SaaS business contributes 66% of sales and 57% of profit. A key strength of Grace Technology in winning clients such as Fanuc and Toyota is its consulting know-how based on its deep understanding of manuals cultivated from over 30 years of experience. Its MOS (manual order-made service) consulting business  accounts for 34% of sales and 43% of profit.

Like Keyence (TSE: 6861), Grace Technology commands a high-profit structure by business model design in adopting a “fabless” business model, outsourcing most of the non-core labor-intensive manual writing to 40 external partners, concentrating on the higher-margin front-end design, planning & consulting solution-proposing business and the SaaS-based e-manual database management, thereby positioning itself at the apex of the fragmented manual industry of around 2,500 manual translation companies and differentiating itself from conventional lower-margin manual companies with non-recurring revenue model such as CDS (TSE: 2169), CMC Corp (JQ: 2185), Honyaku Center (JQ: 2483), Crestec (JQ: 7812), etc, who are increasingly being relegated to “subcontractor” status. Grace Technology was the predecessor of Japan’s first specialized manual production company Japan Manual Center Co Ltd founded by Koji Matsumura in 1984 which was merged in 2008 with Grace Technology. Grace Technology was listed in Nov 2016, upgraded to TSE 1st section on 27 Aug 2018, and is based in Tokyo.

Grace Technology commented that they are preparing the establishment of a local subsidiary in the US to penetrate the US market in earnest, having won customers such as ANSYS (NASDAQ: ANSS), the Pennsylvania-based engineering simulation software for manufacturers such as Continental in the automotive industry. In Oct 2017, Grace Technology announced a strategic business agreement with Mitsui Sumitomo Finance & Leasing (MSFL) to offer SmartPartner production expense reimbursement service to provide the smart financing of the manual creation and production and to ensure that there is no discrepancy in the cost at the time of contracting and the completion. In Jun 2017, Grace Technology opened a sales office in Nagoya to further expand its business in the Aichi prefecture area where there is a a large number of various industrial machine manufacturers such as automobiles, automobile parts, textile machinery, industrial vehicles, machine tools. Grace Technology commented that they had begun a meeting with Toyota Motor on the existence and creation of “new technical data” and hence opened the Nagoya office in anticipation of expanding demand and to improve the convenience of their customers.

In Sep 2018, Grace Technology started a one-year TVCM campaign (one year from Sep 2018 on NTV, TV Asahi, TBS TV, TV Tokyo, Fuji TV, ads in newspapers, magazines, outdoor etc) to raise brand awareness and reported around 150 companies have since made inquiries as a result of the of TVCM. Shareholder NMC Co, which is a personal vehicle of CEO Matsumura, will be responsible for all expenses. This is rare and it is the first time we come across the founder of a listed company who uses his own personal money to pay for the company’s expenses, speaking volume about the long-term stewardship of CEO Matsumura in taking care of the minority shareholders from a one-off expense item in advertisement/marketing. CEO Matsumura disposed 2.4% of shares (~US$6.3m) in November 2018 to pay for the TVCM expenses and his shareholdings fell from 46.05% to 43.65%, an action which has resulted in a short-term correction and volatility in the share price.

When asked how the user would go about using the AI-guided GRACE VISION, as well as the benefits and potential that it brings, CEO Matsumura explained: “The AI recognizes the motion with the camera installed in the dedicated glasses and instructs the work by displaying the instruments and instructions on the operation procedures with guided arrows etc. on the spot in AR display. If unknown points occur with the guidance of AI, you can ask AI through the microphone installed in the glasses and you can proceed with the conversation. Also, if an engineer makes a mistake in work, the AI points it out. By introducing the AI manual, troubles such as complaints, mistakes in operations, accidents, etc. can be drastically reduced, and the period of educating maintenance work for newcomers is reduced to less than a third. With optional functions, the health condition such as the worker’s pulse and body temperature can also be measured, leading to prevention of accidents due to poor physical condition.”

“In the field of maintenance, it took time to educate the workers who need to check the manual each time if there was an uncertain point, and ask the manufacturer about the trouble. Grace Technology has pursued the ultimate manual that is easy to understand for everyone so far. High performance in complicated shape recognition is also a big feature of GRACE VISION. There are many kinds of parts used for maintenance work, and many parts are similar. As the camera will judge immediately whether it is a correct part, it will shorten the picking time. The AI also recognizes through the camera procedures such as tightening the valves, injecting liquid etc and tells the workers how to do it and displays how many times to do so. In addition, it is also possible to call and talk to workers working in different places, so it will be useful for tasks that require team work, such as checking the work progress of the members.”

“GRACE VISION can switch modes according to the worker’s level. For newcomers who need detailed instructions, the “operation mode” in which AI always guides is appropriate. Experienced, veterans who can work even without instructions are able to work in “monitoring mode” which is minimum or necessary without guidance. However, since AI records and monitors through the camera even in the state of guidance off, when a veteran worker has a mistake in any chance, AI will point out, so it is safe. With GRACE VISION, even if there is a difference in skill of the workers, constant maintenance quality can always be maintained with induction according to the level. AI also supports creation of laborious reports. For GRACE VISION, you only need to instruct AI to report on the end of work. If you tell AI, data is written to the prepared template, AI verifies based on camera record, and it checks whether there were no mistakes in work. Attachment of images can be easily done through the camera, and the completed report can be sent from the work site immediately. Work supervisor can also instantly receive reports from each worker on Grace Vision and check the contents. In this way, GRACE VISION can do what you need at any level and in any language, enabling you to work efficiently, reduce costs, and shorten the learning curve on mastering the technology in operation and maintenance of the product.”

“There are several points that can contribute to society. First of all, it is possible to shorten the education that each manufacturer takes to train the workers in a short period of time. Because there is no language restriction, I can use in any country and language, and I think that it helps to solve the shortage of manpower. Checking with the camera helps to prevent accidents and improve yield, and by the answering AI dialogue, we can reduce inquiries to the manufacturer on the manuals, which will lead to improved customer satisfaction. By capturing and collecting records of experienced workers with the AI using the camera, I think that we can contribute greatly to the learning curve succession of technology. In this way, GRACE VISION has a great many potentialities.”

Given that we almost never read the manuals of our smartphones or household/electronics products, it is difficult to comprehend and easy to misunderstand the business of Grace Technology which specializes in manuals for B2B products and does not do B2C products such as smartphones or white goods. CEO Matsumura explained: “There are many opportunities to rely on manuals in everyday life, such as initial setting of TV, PC, etc., response to sudden troubles that suddenly stop working, new employee training at company, confirmation of work flow. It is a reassuring amulet that covers the correct response method. Besides our own living scenes, there are various manuals for B2B industrial machinery, such as maintenance of automobiles, maintenance of engines of power plants and maintenance of semiconductor manufacturing facilities. In the technical manual market, the number of volumes and pages has increased more than 20 fold compared to 30 years ago due to advancements in IT and factory automation. For instance, there are thirty thousand pages in the automobile maintenance manual. In addition, as products from various major manufacturers have become more sophisticated and complex year after year, the descriptions in manuals have accordingly become more sophisticated and complex. However, despite this, the quality of current manuals is a matter of great concern. The reality is that few improvements have been made over the last 30 years.”

“Manufacturers routinely employ ‘modularization’ and ‘reuse’ of parts, but the manuals for their products are not ‘modularized’ or ‘reused’, which shows a disregard for users. Specifically, manufacturers pay a lot of money to produce manuals that are essentially difficult for users to understand because even manuals in the same series have completely different configurations, and the notes, expressions, and visuals are not consistent, which makes these inefficient. The most disappointing thing is that manufacturers themselves do not even realize this situation. In addition to the contents and quality, manufacturers must consider how these manuals are being used in the workplace and how much money is being wasted annually. Many of the manuals of industrial machines are written by manufacturers’ technical development personnel. In-house production by professional personnel is reasonable, but it is difficult to understand, unlike those for consumers. The New York Times also criticized that ‘Japan’s manual is a joke’. In the first place, the person in charge of technical development is not a professional writer. In addition, there is no department to oversee the production of the manual inside the manufacturer’s company, and terms and expressions also vary based on the writer. When it is translated as it is, it is a ‘joke’ due to language. While the product boasts first-class quality, the poor quality of the manual result in a big drop in brand image in Japan and abroad. Manual quality is the blind spot of Japanese manufacturing industry. Inquiries and complaints come at the customer consultation window. However, since it does not reach the person who is writing the manual, the same inquiries will come in the next manual. It is iteration.”

“Therefore, Grace Technology encourages production of an easy-to-understand manual that acts as a communication tool connecting manufacturers and users and to store knowledge. Since our company was founded in 1984, we specialize in B2B products as opposed to the B2C consumer white goods manual. This was the very first company in Japan to specialize in producing manuals. Among them, we are good at the operation manual and maintenance manual where the volume is large and specialized. Unlike a mere production company that just creates a manual, we are a proposal-type problem-solving company that will not only improve the quality of manuals, but also drastically reduce costs related to production, and even reform the client’s system. The manual is actually very important, and it is possible to reduce about 70% of complaints and costs. The creation of the optimum manual not only reduces the cost burden but also improves the inefficiency of the manufacturer and the user and increases product value and usability. In fact, our key customer Fanuc recognized the importance of the manual and actually stopped operating the factory for one day just for manual production. Grace Technology is the only company in the country that is engaged in consulting and producing of this ‘professional’ manual. During our 30 years of experience in the industry, we have gained trust from many major manufacturers with our solutions, especially focused on technical manuals. Although this may not be a well-known fact, the market related to manuals is actually very large. Manufacturers cannot survive without creating new products, and these products always need a manual. According to certain estimations, the size of the market only for Japanese listed manufacturers is about 7 trillion yen. In recent years, the shorter cycles for new product releases, and the improved performance and functions of products is continuously increasing the information that needs to be covered by manuals. In addition, the globalization of the product market has expanded the needs for manuals for other countries. Some products may require up to 30 to 50 types of manuals in English and other languages such as European languages, Arabic languages, and Asian languages.”

“In this expanding market for manuals, many manufacturers are having difficulties in improving efficiency, quality, and reducing costs related to manual production. Since manuals are mandatory for releasing products, some manufacturers even attach documents that look like manuals but are very poor quality. The situation for manuals is quite confusing; manufacturers are neglecting the user’s safety and convenience, increasing support expenses, and even ignoring the risk of tremendous compensation that could be caused by lawsuits. In other words, problems regarding manuals cannot be solved just by outsourcing production and translation. The solution for this problem is to: 1) Thoroughly plan the manual production phase when planning and developing the product itself. 2) Create modules with the information and data in the manual and manage them so that they can be reused in other manuals. 3) Manage the schedule and resources thoroughly so that specification changes of the product will not affect the manual production phase. This is easy to say, but very difficult to execute. In order to solve these difficulties, we have launched a cloud service called “Grace Cloud” which is specialized for manuals. The core of this system is the production support system, on-demand printing and delivery system that we have been providing with “e-manual”. In addition, we plan to offer the following services: 1) Management and distribution of product/design information. 2) Management of reusable information and data that the manual consists of. 3) Project management functions such as schedule management, resource management, and change management. 4) Management of work flow. 5) Order/delivery system integrated with information from documents such as part catalogs. We consider ‘Grace Cloud’ as a manual production tool that will drastically change the situation for current manuals.”

As highlighted earlier, we were intrigued by how Grace Technology is able to command a high-profit structure by business model design in adopting a “fabless” business model, outsourcing most of the non-core labor-intensive manual writing to 40 external partners, concentrating on the higher-margin front-end design, planning & consulting solution-proposing business and the SaaS-based e-manual database management, thereby positioning itself at the apex of the fragmented manual industry of around 2,500 manual translation companies and differentiating itself from conventional lower-margin manual companies with non-recurring revenue model who are increasingly being relegated to “subcontractor” status.

CEO Matsumura explained further on its fabless business model, the MOS (manual order-made service) consulting business and MMS (manual management system) e-manual SaaS business: “Actual production is done in ‘fabless’ format, working with external experts other than retaining the core value-add activities in planning and progress management. Grace Technologies undertakes the entire preparation of this manual. Many of the staff in charge of the manual planning are former engineers who would read design documentation and check the procedures through repeated interviews with the designer. We would consider the usability of the manual by the workers and grasp detailed contents. When I was in charge of the manual of the power generation engine for a major heavy industrial maker, I worked closely with all workers for over 10 days and confirmed what kind of place the workers are confused. Furthermore, we analyze log inquiries that came to the call center of the customer company and make use of it in the manual. Contents are modularized appropriately, making manuals that can be understood by the maintenance personnel of the manufacturer or the worker at the machine delivery destination.”

“In the MOS (manual order-made service) business, we provide technical writing of various specialized manuals (creating accurate and easy-to-understand documents from the user’s point of view) and technical translation. MOS business is the consulting and planning work of technical writing and translation of various manuals. Manufacturers tend to shorten lead times from product development to market release, and we would like to produce manuals as efficiently as possible. On the other hand, the user asks the manufacturer for an easy understanding of the manual so that it can be operated easily. As a result, a big gap is born between them, which extends to the tens of thousands of telephone inquiries from the user, a hindrance to both the user and the manufacturer business. We regard the manual as an important communication tool connecting the manufacturer and the user and propose a manual preparation that accurately responds to notes and potential doubts according to user’s purpose of use. Specifically, we gather and analyze the contents of inquiries sent to the manufacturer’s call center, help desk, etc., research on product usage status, read product design data, interview with technicians, check operation and monitor, etc., and do technical writing from zero base. Through such consultative work in manual production from the user’s viewpoint of ‘what is a really necessary manual for this company’, the user can understand the performance, functions, characteristics etc. of the product accurately, which in turn leads to the improvement of the loyalty for the product or the manufacturer. Based on our manual consulting service, a number of manufacturers have been able to streamline operations and transform their way of working.”

“Another business is the MMS (manual management system) that is growing fast. The MMS business is a SaaS-type business that provides cloud-type manual planning, composition, production and management service in e-manual and receives monthly subscription usage fee. The terms are automatically unified, digitized manuals can be easily produced by the manufacturers themselves, and if necessary, it enables on-demand printing services. When making a revised version, pages are automatically updated for each item and in the table of contents just by replacing the necessary place. Since it is possible to interpose moving images, complicated tasks can be conveyed in an easy-to-understand manner. Not only can it dramatically reduce production costs, but even amateurs can operate it easily, so it is also possible to re-employ technicians who retired and make manuals. We would like to support the manufacturing industry in Japan.”

CEO Matsumura also cited some examples on how its customers have achieved substantial cost savings: “Here are some examples of how we have achieved substantial cost reductions through effective e-manual creation. At Company U, digitizing manuals saves more than 2 billion yen annually. It cost a lot annually to print manuals and manage inventory in a warehouse. After consulting, Company U restructured their production system, digitized manuals, eliminated the printing process, and completely eliminated inventory for printed materials, which saves them more than 2 billion yen a year. At Company K, implementing e-manual saved hundreds of millions of yen mainly related to outsourcing expenses for editing. Company K asked an existing contractor to edit their manuals. Editing expenses totaled over 100 million yen a year. By implementing e-manual, they are able to automatically handle editing work, which reduces outsourcing expenses. The number of employees involved in this work could be reduced from five people to one person, resulting in a significant cost reduction. By using our manual creation know-how, it is possible to reduce the cost to about a quarter on average. There is no case where the manufacturer did not lower its cost when we helped with the manual consulting. dramatic changes can be expected visibly in terms of both time and cost.”

We were also intrigued by another operational data reported by the company, the average sales per customer, and this statistics has increased 60% from 4.58m yen in 1H17 to 7.32m yen in 1H19 due to the deepening of existing customers. CEO Matsumura elaborated on their strategy to cultivate and win priority customers: “We have a clear target company list of 2,000 companies. We carefully select 10 priority customers for each fiscal year. ’Please let me study your manual,’ one of our sales representative asked of a major machine tool maker in 2016. From there, our manual creation team corrects everything in about a month, and creates new manuals. The total number of pages reached 24,000 pages. The machine tool company was astound at the returned manual and asked to reform the entire company manual. Since we narrowed down our business targets to priority customers, we have reduced the number of customers significantly from 2012 by about one third in 6 years, and on the contrary, the sales per company has increased over six times. Sales to new customers are said to be five times the cost of selling to existing customers and deep cultivation of existing customers is be a cost-effective strategy. Since our proposal will be for the upper-level companies with decision-making power, it is imperative for each and every employee to have advanced proposal skills and consulting skills. The goal is to become an indispensable presence for manufacturers.”

When asked about how he came about to start Grace Technology, the challenges he faced and overcame and the breakthroughs during his early entrepreneurial period, CEO Matsumura shared reflectively his inspiring story: “I was born in the Osaka prefecture in 1955 and I am 63 years old this year. I loved reading and writing and was interested in English since I was an elementary school student. I was reading Einstein’s Relativity Theory in English as a 6th grade elementary school student and also disintegrated the machine. After graduating, I worked for a translation company in 1979 and was involved in translating product manuals. When I was in charge of translating manuals from one manufacturer, I was surprised that Japanese sentences are messed up even before I fix it in English. So I wrote the manual in an easy-to-understand manner and I thought that it was very pleasing for the manufacturer customer, and while the feedback from the manufacturer was very good, it was dismissed by the translation company that ‘I do not do any extra things and I only need to translate’. I decided to start a business. In 1984, I established Japan’s first specialized manual production company ‘Japan Manual Center’ for engineers of B2B products.”

“At that time, computers began to emerge, foreign-affiliated IT companies began to enter Japan. Initially, we focused on the IT industry and succeeded in receiving orders from IBM Japan and HP Japan. When I was younger, I always wondered what the management people are thinking, I have read a lot of books to find out what it is. However, I do not understand by myself without experience. I can only truly learn by listening and meeting the direct managers directly. I pleaded with Mr. Fujita who was president of McDonald’s Japan at that time to show me his management manual so as to acquire the know-how of manual production. I keep on calling for half a year every day, and I finally got permission to browse their manual. Mr. Fujita called me directly to met him. Thus at the age of 26, I was introduced to various managers and continued listening to over 300 founders. This is the starting point of all our work now. In the year 2000 when the Internet was rapidly spreading, Grace Technology was establish to digitize manuals. Since PCs were not popular at that time, I borrowed a manual of car of thousands of pages, wrote out all technical terms in about two weeks, and created a dedicated glossary of terms. Glossary is to define the usage of words that make up a document before creating a manual. For example, when creating a manual for a car, field technicians express the same device in different words such as ‘steering wheel’ and ‘steering’. If the rules of the term are not unified, the user reading the manual is confused. Currently, this method has evolved into a patented system called ‘Term Filter’ which can automatically unify terms, but the attitude of creating ‘glossary’ for each company is still based on our company.”

As an addendum to the valuation of exponential innovators, we had a conversation with a fellow fund manager who cried out at Salesforce.com’s (NYSE: CRM) Price-Earnings ratio of 151.8x. Three points are usually discussed as a guide:
(1) Exponential innovators are doubling their core earnings over a three-year period based upon a powerful business model with exponential edge; our model portfolio of 48 HERO Innovators have achieved a weighted absolute growth in operating profit of 144% over the recent three years with weighted margin of 21.1% and weighted ROE of 30.5% and a healthy balance sheet with weighted net cash as a percentage of market cap of 6%.
(2) Weighted portfolio EV/EBIT and EV/EBITDA of our HERO exponential innovators stand at 36.3x and 32.2x respectively. A stock with seemingly cheap valuation of say Price-Earnings ratio 5x is risky when it has a highly levered balance sheet and its ROE is 1%, or a fundamental PEG ratio (Valuation as measured by ROE divided by Quality as proxied by ROE) of 5x (= 5x/1%). A stock with valuation of say EV/EBIT 20x with ROE of 20%, or a fundamental PEG ratio of 1x (= 20x/20%), can be considered to have relatively more reasonable valuation. Thus far, YTD 2018 returns (January-Nov 2018) of our actionable model portfolio (equal-weighted) of 48 exponential innovators are 36.8% with a healthy 5.9% bounce in November; returns backtested since March 2013 are 590.1% (CAGR 40.6%).
(3) Using the valuation path of exponential innovators framework that we developed based on the empirical observations of the multibaggers over the past three decades and applying it to Salesforce.com, a reasonable fundamental PEG ratio for a Stage IV Built-to-Last mega-cap innovator like Salesforce.com is 2-2.5x. While Salesforce.com reported that its latest 12-month accounting earnings (as at Oct 2018) is US$721.5m, its SaaS business model generates recurring predictable revenue streams and a positive free cashflow of US$2.55bn growing at 40-50% yoy with a “ROE” of 17.4%. Applying a fundamental PEG ratio of 2-2.5x to Salesforce.com’s positive free cashflow of US$3.3-3.5bn (growth of 30-40%) indicates that a valuation multiple of 34.7-43.4x, yielding a market value range of US$115-144bn vs its current market value of US$109bn, thus serving as a rough guide on the valuation path of exponential innovators.

CEO Matsumura shared that the company’s management philosophy matter a great deal in guiding, shaping, transforming and scaling up Grace Technology in serving its customers, illuminating the path to new realizations, breakthroughs and innovations along the journey: “We are professionals. Therefore, not only do we not tolerate major mistakes, any mistake, even a minor one, that results in a complaint is unacceptable. We are proud of our ‘wisdom’ and ‘ability’ to produce the best quality with advanced methods that others cannot match. Therefore, we do not tolerate complaints or anything else that can ruin this. Failing to receive praise is also unacceptable. We take quality more seriously than other companies, and we are always thinking of ways to solve customers’ problems. Therefore, being treated the same as other companies is unacceptable and unforgivable. It takes effort to aim to be a professional. This is basic for handling work. To work in a professional way, one must never be satisfied by half-hearted effort. True professionals enjoy being devoted to work both in public and private, 24 hours a day, 365 days a year, even while sleeping.”

“We are constantly striving to gain the loyal support of our customers. By loyal support, we do not mean mere praise. While it includes praise, it also refers to the heartfelt commitment of our customers leading to the transformation of their organizations. We at Grace Technology have established our credo to dignify the philosophy we are pursuing, and by having each employee understand this, all employees will be able to provide reliable and consistent services. Five pledges of our credo: (1) We will not compromise when it comes to quality. (2) We will utilize various methods and unique approaches to fully appeal our products to customers. (3) We will utilize all of our knowhow to reduce the stress of our customers. (4) We will keep our promises to customers regarding the accuracy of our work and production schedule. (5) We have a system in place where management items for services and products are strictly observed within our company, and we conduct double and triple checks to prevent mistake.”

“We thoroughly provide services and proposals that other companies cannot offer to our customers, and continue to distinguish ourselves. We do not view doing what we are supposed to do as work. We view it as basic to do what we are expected. Therefore, we quickly move one after another even for small proposals. The wider the angle of a proposal, the better. If a job does not require proposals or special work, it does not need to be handled by our company. As professionals, we pursue work that is meaningful and extraordinary. Our desire is to provide deliverables that are near perfect without simple or careless mistakes.”

“As professionals, we realize that we must be able to create things that are technically difficult without excess or deficiencies. Therefore, we keep in mind that careless or simple mistakes show a lack of professionalism with our work. Excuses like ‘I thought I checked it,’ ‘I thought I told you,’ or ‘I didn’t notice’ are amateurish. As professionals, the only words we want to hear from customers are complimentary words equal to admiration—not complaints. We believe that professionals always pursue this. If we receive a complaint from a customer, all employees take it seriously, and we implement specific measures to prevent the same mistake from happening again. We must also pay our “business debt” to that customer in order to regain their trust. We believe that three times the effort must be made to regain trust when a complaint is made and to repay a debt of gratitude. Business must always be conducted in this way. Of course, the proper attitude toward work is essential with the goal of never receiving a complaint. In the unlikely event that a complaint is received, our priority will be to handle it as quickly as possible and make corrections in good faith.”

“We will never back down, hide, or be deceived when facing any daily challenge. Cowardly actions like backing down, hiding, deceiving and making excuses when something goes wrong are considered vulgar in our company. As members of society and as business people, we view such acts as unacceptable and unforgivable. We never cower. Rather, we take positive steps until we accomplish what we have set out to do. Once we are determined to ‘succeed’, we do not give up until our work is done. Even if someone utters heartless slander, our hearts will continue to burn. We will continue making effort with all our might until we are finished regardless of the time needed or the effort required.”

“We never murmur, complain, or express displeasure. Rather, we utilize such time to make improvements. People who complain are usually not aware of their ugliness. If you have the time to complain, you should keep in mind that it is better to use that time to think of ways to make improvements. Cowards, complainers with negative thinking, and the people who listen to them ruin a company, interfere with work, and destroy young talent. We will never allow such behavior to exist. We do not associate with people who do not work or who neglect their work, and will never become a disorderly mob. Work is not just a matter of earning a living, it is a social obligation. Workplaces where different people gather are divided into senior and junior workers, experienced and inexperienced workers, and those who receive tasks and those who assign tasks. In such relationships, if someone neglects their work or does not take work seriously, they cannot convey the truth of the situation, and are incapable of inheriting precious experiences and cannot provide satisfactory services. Therefore, we do not associate with such people, and will never become a disorderly mob.”

“We will never be defeated, will always inspire ourselves, and will view everything as a matter of life or death. Even if things do not go as planned, we do not become subservient, and even if our ability is meager, we will continue to rouse ourselves without shame. We take every job that we are involved in personally, regardless of the size. We never look away, but rather, we take initiative to find solutions. Pretending not to see something is worse than actually not seeing something. Pretending that something is not your problem is unacceptable. We admire those who take initiative to resolve issues, even if they are only partially involved, rather than expecting it to be handled by someone else. We constantly improve our skills as professionals, and are aware that to do otherwise would be to just get older and notice there is no one around. We should not have delusions of grandeur or become haughty, thinking that we can succeed based on our current ability without improving. Every day, we should make effort to grow and improve ourselves so as not to become isolated with no one around to help. We are not afraid of conflict and understand that it makes us stronger. We understand that nothing can be resolved if we are afraid of conflict with others. Holding back or failing to express one’s self is not the same as being humble, and is not being truly kind to others. We should say what we need to say and should listen to what we need to hear. Otherwise, our relationships with people will deteriorate, things will stagnate, and our minds will become dull. This leads to groveling, lingering regret, and darkness.”

CEO Matsumura summed up: “It is our mission to produce manuals that are ‘truly useful’ based on our 30 years of experience and wisdom, and we will strive to distribute high-quality manuals that are ‘free of wasteful spending and man-hours’. For manufacturers who engaged us to work with them, Grace Technology has become a partner to our clients who can receive a lot of ideas and mechanisms unique to this company to promote efficiency. Domestic major manufacturers are aggressively pursuing R&D investment to respond to advanced technologies, labor saving investment to cope with labor shortage, renewal of obsolete equipment, etc. The compatibility of our mission with market needs is increasing.”


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 300 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.


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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