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HEROZ (TSE: 4382), “Japan’s DeepMind” AI Platform & SaaS Innovator – H.E.R.O. Innovators Insights from CEO Takahira Hayashi | H.E.R.O. HeartWare | 31 December

Question for 2019 and beyond: What is the significance and value of a world-class AI (artificial intelligence) platform that is profitable and generates positive free cashflow (FCF)?

When Google fought off Facebook to acquire DeepMind, the British AI lab behind deep learning algorithm AlphaGo which defeated the world champion in the complex ancient strategy game Go, for £400m (then around US$600m) in 2014, not everyone at Google saw it as a smart move. In the first year after Google’s acquisition, DeepMind had no revenue. Four years later, DeepMind achieved revenue of £54.4m (US$69m), mostly from projects with its parent Google, and its heavy losses accelerated to £281.9m (US$357m), according to records filed at the UK’s Companies House, although Google’s data centers have taken advantage of DeepMind’s technology to produce cost savings.

According to engineers swept up in a major round of layoffs within IBM’s Watson division in May 2018, the company’s promotions of its “cognitive computing” platform mask its own real difficulties in turning its AI into a profitable business, with clients such as M.D. Anderson, one of the world’s top cancer research institutions, shutting down the Watson AI project after spending more than $62m over four years. IBM’s Watson is the first commercially available AI platform that can interact in natural language, process vast amounts of big data and learn from interactions with people and systems, and it is integrated with the company’s cognitive-solutions business. Since Jeffries’ scathing equity research report in July 2017 on Watson that “it seems unlikely to us under almost any scenario that Watson will generate meaningful earnings results” because of the complexity of its services component and the cost of using it, IBM share price has fallen 26% while NASDAQ rose 5% over the same period.

So both Google DeepMind and IBM Watson, two of the world’s foremost AI platforms who have triumphed over chess champions, are finding profitability a challenge.

In Asia, there is another rare and listed world-class AI platform with its deep learning technology that not only trounced the grandmaster titleholder Amahiko Sato in shogi, the ancient Japanese chess, but is also highly profitable with EBIT margin of 30.7% (1H10/2019 margin 35.4%), positive FCF margin of 29.9%, and ROE (= EBIT/ Equity) of 23.5%, and has a healthy balance sheet with zero debt and net cash of 1.475bn yen (US$13.3m).

Chess enthusiasts would know that shogi is more complex because pieces return to the board after being captured, increasing the number of move permutations that must be considered. Shogi is played on a 9×9 grid with an average game length of 110 moves, and chess on a 8×8 grid with an average game length of 80 moves. There are about 10^120 possible moves in chess, compared to 10^220 for shogi. Shogi players are very respected in Japan. Japan’s reverence for shogi dates back to the Heian period (794 to 1185), when it was played by monks and samurai alike, and was a symbol of intelligence that was also loved by commoners. Top professional shogi players are also rewarded well. The legendary 48-year-old grandmaster Yoshiharu Habu, the only person to simultaneously hold seven major professional shogi titles at the same time and was defeated by grandmaster titleholder Amahiko Sato who went on to qualify for the memorable face-off with HEROZ AI, is reported to have earned over US$24m in tournament winnings and game fees (1993-2017) over his career.

This week, we highlight the Asian exponential innovator HEROZ (TSE: 4382), founded during the 2008-09 crisis in April 2009 by Takahira Hayashi who was a former world amateur champion in shogi at the age of 23. HEROZ MLaaS (Machine Learning-as-a-Service) B2B business model enables the generation of stable, sustained earnings, serving clients such as BANDAI NAMCO Entertainment (TSE: 7832), The Pokémon Company, Hearts United Group/Digital Hearts (TSE: 3676), Nomura Securities, Daiwa SMBC, Nikko Securities, Monex (TSE: 8698), Honda Motor, Takenaka Corporation (one of the largest architecture, engineering and construction firms in Japan) etc. HEROZ B2C games business generates monthly membership fees and AI usage fees. HEROZ flagship game Shogi Wars is free up to three games a day, and members pay 600 yen a month for unlimited games. The popular ‘summon shogun’ AI service is 120 yen a month for 5 hands. The number of downloads of the Shogi Wars app exceeded 4.9 million as compared to the estimated domestic shogi population of about 10 million adults and children. Shogi Wars is also an official application of the Japanese Shogi Federation and players can get an official diploma at the stage level in the app. We think HEROZ is also a potential takeover candidate by giants like Microsoft which has made five AI acquisitions in 2018 alone.

As highlighted last week, market positions are not redistributed during sunny and calm times, but during times of crisis. The specialization and innovative force of H.E.R.O. Innovators makes them indispensable for their customers and they have stood the test of time in facing crises, proving themselves to be adept consolidators in snatching market share from unfocused rivals to achieve market leadership and create new categories of growth. High-quality exponential innovators are also the strongest and fastest rebounders to emerge from gloomy crisis episodes, while “defensives”, dividend-type companies, and seemingly cheap bargains become increasingly disrupted to become cheap-gets-cheaper value traps with Asian-style misgovernance and accounting tunneling fraud risks when times get tougher.

Trade war and regulatory risks still linger on with the passing of the tumultuous year of 2018, which marks the 10th anniversary of the 2008-09 crisis. What lies ahead in 2019, or the next decade 2019-2028, especially as overall economic and corporate earnings growth across industries slow down substantially?

Thus far, of the 54 entrepreneurs and CEOs whom we had highlighted in our weekly research brief HeartWare, 25 are in our focused portfolio of 46 HERO Innovators while the rest are in our broader watchlist of 200+ stocks. YTD 2018 returns (Jan-Dec 2018) of our actionable model portfolio of 46 HERO Innovators (equal-weighted) are +22.2%; returns backtested since Mar 2013 are 527.1% (CAGR 38.2%). These 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 21.3%, weighted ROE of 31.2%, weighted ROA of 21.1%, and a healthy balance sheet with weighted net cash as a percentage of market cap of 6.5%. Weighted portfolio EV/EBIT and EV/EBITDA of our HERO exponential innovators stand at 31.2x and 27.7x respectively. A stock with seemingly cheap valuation of say Price-Earnings (PE) ratio of 5x is risky when it has a highly levered balance sheet and its ROE is 1%, or a “fundamental PEG ratio” of 5x (= Valuation as measured by EV/EBIT divided by Quality as proxied by ROE = = 5x/1%). A stock with valuation of say EV/EBIT 30x with ROE of 30%, or a fundamental PEG ratio of 1x (= 30x/30%), can be considered to have relatively more resilient valuation with potentially higher upside. 13% of our H.E.R.O. portfolio companies are selling “products”, such as Koh Young Technology (KOSDAQ: 048460) who is the global market leader in 3D AI test inspection system and software; 10% are ecommerce companies such as MonotaRO (TSE: 3064) who is Japan’s largest B2B ecommerce platform in MRO (maintenance, repair and operations) items; while the majority 77% are “software, information and data” companies (with zero exposure to “ad-tech” companies), a group which we believe is highly impervious to trade war risks.

As an addendum to the valuation of exponential innovators, we had a conversation with a fellow fund manager who commented on Salesforce.com’s (NYSE: CRM) Price-Earnings ratio of 143x. While Salesforce.com reported that its latest 12-month accounting earnings (as at Oct 2018) is US$721.5m, its SaaS (Software-as-a-Service) business model generates recurring predictable revenue streams and a positive free cashflow of US$2.55bn that has grown 40-50% yoy with a “ROE” of 17.4%. 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. 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$103bn, thus serving as a rough guide on the valuation path of exponential innovators.

In his deeply profound book Falling Upward, Franciscan monk and author Richard Rohr talks about the first and second halves of our life. In the first half of life, we are mostly building a strong “container” or our identity, “looking good” to ourselves and others; the second is to find the contents that the containers was meant to hold. In the second half of life though, we start to ask deeper questions as we embark on a “further journey”, one that involves challenges, broader horizons and “necessary suffering” that shocks us out of our prior comfort zone. Eventually, we need to see ourselves in a different and more life-giving way. Life is made up of many failings and fallings, amidst all of our hopeful growing and achieving. Rohr offers a new paradigm for understanding one of the most profound of life’s mysteries: how our failings can be the foundation for our ongoing growth, the stepping stone to the joys that our second half of life has in store for us. One of the best-kept secrets, and yet one hidden in plain sight, is that “falling down” is in fact moving upward. Those who have gone “down” are the only ones who understand “up”.

H.E.R.O. (Honorable. Exponential. Resilient. Organization) is a culmination of the learnings from my many mistakes in which I was “falling down” in the “overall” value trap – the Value 2.0 portfolio of investing in decent quality businesses with a certain competitive advantage (and some weaknesses & risks) run by hardworking entrepreneurs and have reasonably cheap valuations and so, based on an “overall” weighing of the strengths and weaknesses, while they do not have an “exponential edge” in their business model quality, 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.

In short, disruptive innovation forces sweeping across industries create ever more “value trap” losers and a selected under-the-radar group of winners. We think the implication for investors in one of the largest ever business model shifts in this “further journey” into “Value 3.0” is that a distinctive and alternative investment strategy 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 or risking to chase richly-valued loss-making cash-burning tech start-ups, and also provide capital allocation benefit to investors in building optionality in their overall investment portfolio, is ever more critical. 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.

Starting 2 January 2019, we will be moving from our Robinson Point office to 182 Cecil Street, Level 17 of the Frasers Tower building where Microsoft is one of the anchor tenants. Frasers Tower is located between the Bangkok Bank building and the Telok Ayer Chinese Methodist Church and is near the Amoy Street hawker food center. We welcome you to visit us over a warm cup of afternoon coffee at our new office on any day.

Our emotional labor of love over the past months in sharing openly our research ideas (to battle-test our ideas by critiques and avoid blindspots in investing) and setting up the proper regulated UCITS fund structure to protect investors’ interests has deepened our conviction for the positive change that we will make together with H.E.R.O. – and we are getting closer to giving birth in end January/February 2019 to H.E.R.O., the only Asia SMID-cap tech-focused fund in the industry and guarding investors’ interests in the regulated UCITS fund structure with daily NAV & daily liquidity and no exit fees.

There is something profound in shogi culture’s emphasis on seizensetsu, or the belief that humans are fundamentally good. A journey into the second half of our lives awaits us all. A “further journey” is a well-kept secret. Not everybody goes there. Many people do not even know there is one. There are too few who are aware of it, tell us about it, or know that it is different from the journey of the first half of life.

If you identify yourself in the values and bigger sense of purpose in H.E.R.O., or you wish to tell from your heart to your most important person, son, daughter, wife, husband, or best friend that you are a farsighted and thoughtful explorer in the H.E.R.O.’s Journey participating in the long-term exponential growth of a selected group of outstanding entrepreneurs, standing up for the embracement of the human spirit, please contact us via email or WhatsApp at +65 9695 1860. Thank you very much for your patience and support and we look forward to growing exponentially with you as we explore the H.E.R.O.’s Journey together. We wish you and your loved ones a fulfilling and healthy New Year 2019 ahead.


“Since May 2017 when our Shogi AI PONANZA won the grandmaster titleholder Amahiko Sato, who had ousted the legendary triple-crown master Yoshiharu Habu to qualify for the memorable face-off with PONANZA, many wanted to collaborate with HEROZ. There are many companies that not only want to improve work efficiency at AI, but also want to collaborate in projects and fields that have impacts that can change the industry,” said HEROZ CEO Takahira Hayashi thoughtfully.

CEO Hayashi added: “The AI industry is expanding rapidly in Japan, where a shrinking workforce is causing the tightest labor market in decades, creating an opportunity for companies to use the technology to help fill vacancies and improve efficiency. The domestic AI market may top $18 billion by fiscal 2030, a more than seven-fold increase from fiscal 2016, according to Fuji Chimera Research Institute estimates. There was a time when it was called the IT bubble around 2000 which collapsed spectacularly. The AI boom, at first glance, seems to be similar to the bubble. However, what is decisively different is that the overwhelmingly ‘demand side’ in the number organization involved in AI due to the large number of needs. The number of AI engineers is limited to meet the needs of the world, and supply can hardly catch up. Data is absolutely necessary for AI to demonstrate its abilities. Japan has the world’s number one manufacturing industry etc and have accumulated huge amounts of data. The country still has the power to create a next-generation platform by combining technologies such as AI and IoT with data. artificial intelligence is an industry oriented to Japan. When creating a service against the world, it is already a big minus when the language is not English, but the language barrier can be ignored for AI. When talking about AI, it is good to remember ABC. A is AI, B is big data, and C is cloud. Let the AI learn the data on the cloud. I think that it is easy to understand when we remember this flow.”

“Shogi AI is basically applied machine learning, so the way of thinking and doing it is applicable to various places everywhere. Chess and Shogi are games in which all the boards and pieces are seen and are called a complete information game. The next challenge is ‘incomplete information game’ such as poker and mahjong. There are also ‘strong AI’ and ‘weak AI’. We are aiming at simulating the structure of the human brain and having a creativity that is comparable to that of humans to create a new value on its own, rather than turning routine work at ultra high speed. Naturally, the degree of difficulty is overwhelmingly higher for ‘strong AI’. After building the new Deep Blue, HEROZ used the artificial intelligence technologies in deep learning and machine-learning skills we acquired to expand into a range of other services — everything from construction to financial services. We started collaborative research with Nomura Securities from May 2016 in the fintech field such as forecast of stock market. In December 2016, we entered into a capital and business alliance with BANDAI NAMCO Entertainment. In Nov 2017, we announced a capital alliance with Takenaka Corporation to introduce AI to the structural design of buildings. We input detailed data such as hundreds of thousands kinds of construction materials and devise the optimum structure of the building. In Dec 2017, we entered into a business alliance agreement with Monex to provide financial trading support services using AI.”

HEROZ, Inc. (TSE: 4382) is “Japan’s DeepMind” AI platform & SaaS innovator which develops AI engines for its B2C business to develop various intellectual games for smartphones worldwide, such as Shogi Wars, CHESS HEROZ, and BackgammonAce and for its B2B business to solve difficult problems in a wide range of industries such as the construction industry to better design buildings, the financial services industry, gaming industry in software testing, etc. Clients include Nomura Securities, Daiwa SMBC, Nikko Securities, Monex (TSE: 8698), Honda Motor, Takenaka Corporation (one of the largest architecture, engineering and construction firms in Japan), The Pokémon Company, BANDAI NAMCO Entertainment (TSE: 7832), Hearts United Group/Digital Hearts (TSE: 3676). HEROZ AI deep learning engine was also the first to defeat a professional player in Shogi, also known as Japanese chess, in 2013, including trouncing the grandmaster titleholder Amahiko Sato in May 2017. HEROZ co-founder Takahira Hayashi was a former world amateur champion in Shogi at the age of 23.

HEROZ MLaaS (Machine Learning-as-a-Service) B2B business model establishes an infrastructure which allows HEROZ to provide comprehensive AI services efficiently to solve various challenges in various industries just by changing input data, while achieving stable, sustained earnings with initial setup fee and recurring ongoing fees and high switching costs since output precision increases through repeated machine learning. Client’s input data are sent to HEROZ AI Kishin engine and the output generated after machine learning through deep learning are applied in business settings. Results are measured and used for further machine learning. In addition to fixed recurring ongoing fees, ongoing fees in the form of revenue sharing will be introduced in FY04/2019.

HEROZ B2C games business generates monthly membership fees and AI usage fees. HEROZ flagship game Shogi wars is free up to three games a day, and members pay 600 yen a month for unlimited games. The popular ‘summon shogun’ AI service is 120 yen a month for 5 hands. The number of downloads of the Shogi Wars app exceeded 4.9 million as compared to the estimated domestic shogi population of about 10 million adults and children. Shogi Wars is also an official application of the Japanese Shogi Federation and players can get an official diploma at the stage level in the app.

HEROZ’s overall marginal profit ratio, defined as ‘(net sales –app commission fees –royalties)/net sales’, improves as the composition of AI B2B services increases. HEROZ marginal profit ratio has increased from 67.6% in FY04/2017 to 76.3% in FY04/2018 and 83.4% in 1H10/2019.

With the compellingness and circumspection exponential edge, HEROZ’s SaaS business model generates stable and recurring monthly revenue, achieving a 32% and 299% yoy increase in sales and operating profit respectively in FY04/2018 with EBIT margin of 30.7% (1H10/2019 margin 35.4%), positive free cashflow margin of 29.9%, and ROE (= EBIT/ Equity) of 23.5%, propelling a 216% increase in market value since its listing on 18 May 2018 at the IPO price of 4,500 yen (split-adjusted price of 2,250) to US$442m. On 7 Dec 2018, HEROZ announced its 2Q2018 results (May – Oct 2018) and 1H sales of 646m yen, operating profit 229m yen, and expects FY2019 sales to increase 12.6% to 1.3bn yen and operating profit to increase 13% to 400m yen. Balance sheet is healthy with zero debt and net cash of 1.475bn yen (775m yen in cash raised from IPO), or 2.9% of market value.

HEROZ was co-founded by Takahira Hayashi and Tomohiro Takahashi in April 2009 who each own 36.542%, or a combined total of 73.084%. Strategic shareholders include KDDI 2.923%, Bandai Namco (TSE: 7832), Koei Tecmo (TSE: 3635) 1.291%, Digital Hearts (TSE: 3676) 1.291%, Netmarble (KOSDAQ: 251270) 1.289%, Takenaka Corp 1.192%.

Curious by the origin and meaning of HEROZ, we asked CEO Hayashi who went on to elaborate at length his philosophy: “HEROZ aims to achieve ‘to bring as many heroes into the world as possible’ by ‘AI x mobile’. HEROZ possesses a unique core technology of world-class artificial intelligence (AI) developed by our top engineers that has defeated professional shogi (Japanese chess) players in public matches developed by our top engineers. HEROZ has accumulated such a machine learning technique through the development of smartphone apps such as ‘Shogi Wars’, ‘CHESS HEROZ’ and ‘BackgammonAce’. Our mobile device is the closest and the most accessible device for everyone anywhere in the world today. We believe that every person has the potential to become a ‘hero’ of a certain kind. HEROZ has been and will continue to build on our concept of ‘heart filled with amazement’ which represents our fundamental thought to provide services that would bring excitement and amazement to everyone rather than simply introducing and applying information technologies.”

Noting how HEROZ’s overall marginal profit ratio, defined as ‘(net sales –app commission fees –royalties)/net sales’, improves as the composition of AI B2B services increases and that HEROZ marginal profit ratio has increased from 67.6% in FY04/2017 to 76.3% in FY04/2018 and 83.4% in 1H10/2019, we asked CEO Hayashi to elaborate on the MLaaS B2B business. CEO Hayashi commented: “HEROZ Kishin (棋神) is a unique AI machine-learning-as-a-service (MLaaS) built from the technology cultivated through the R&D of Shogi AI to solve difficult issues in the real world in a wide range of industries, unlocking the value that data possess and supporting your business expansion. Selected companies our AI technology is provided to include Nomura Securities, Daiwa SMBC, Nikko Securities, Monex, Honda Motor, Takenaka Corporation, The Pokémon Company, BANDAI NAMCO Entertainment (TSE: 7832), Hearts United Group/Digital Hearts (TSE: 3676). HEROZ Kishin includes intellectual game, game development, route optimization, placement optimization, prediction, optimal solution search, classification, abnormality detection, sentence processing, image recognition etc. Various engines are installed, and we customize it according to the issues of each company. By utilizing the company’s platform, we can clarify the cause of defective products at the production site, automate system verification in the software industry and respond to the shortage of IT human resources.”

“HEROZ has been working with Takenaka Corporation in the construction industry to create an AI system to help design buildings. The AI system will crunch hundreds of Takenaka’s existing structural design data and learn from its architects to provide various patterns for how buildings could be designed while inheriting the knowhow of craftsmanship. The AI will combine tags and lead to reform of building production system. Architects then compare the patterns and consult with clients to decide which one to use. Takenaka expects to reduce the routine work associated with designing building structures by some 70%, giving its professionals more time to focus on being creative. The ability of designers will also increase when they obtain different ideas from AI. One of the expected effects is to improve work efficiency, but I hope that AI will show a totally different proposal from existing one.”

Takenaka is one of the largest architecture, engineering, and construction firms in Japan with yearly sales of $9 billion, 20 overseas offices and have built some of the most important buildings in Japan, including the Tokyo Tower, the Tokyo Dome (the first large-scale stadium with air-supported membrane roof in Japan), the Fukuoka Dome (Japan’s first large-scale stadium with retractable roof), the Abeno Harukas (the tallest building in Osaka and Japan). Takenaka also has the largest construction R&D laboratory in the world with over 1,000 architects in its design department. Hirokazu Yoshioka, the head of technology planning at Takenaka shared his thoughts on their collaboration with HEROZ: “Structural design is a lot like shogi in that you’re choosing the best of various options. So HEROZ is the perfect partner for the AI system we want to make.”

CEO Hayashi continued: “HEROZ has also formed a partnership with Digital Hearts to use AI technology for software testing which typically accounts for 20 to 30% of gaming development costs. In the game ‘Pokemon Co-Master’. many Pokemon figures appear and move like shogi pieces. Like the AI help in Shogi Wars, the player’s partner is an AI character who think about how to move to the player’s thought in the game to consider combinations and strategies. Due to the presence of AI, Pokemon Co-Master is finished in a game that many people enjoy, as well as those who prefer the high level of strategy of Pokemon and board games. I believe that AI helps people, sometimes people help AI, and players experience a fighting relationship together with AI as a new way of playing and enjoy it. We will be launching AI CARDDASS, a new digital card game brand developed with Bandai, with the first series titled ZENONZARD smartphone app expected to be released in 2019.”

“Engines developed by our AI help improve service quality, prediction, maintenance etc. These include our
(1) Mind game engine which is applicable to various mind games such as Shogi, Go, Mahjong, Poker face, Chess and Backgammon;
(2) Prediction engine which makes prediction of credit scorings, capital markets and user purchases from accumulated data;
(3) Classification engine which is suitable for fraud detection or sorting of unnecessary data by understanding characteristics of various data and classifying them into appropriate categories;
(4) Anomaly detection engine which alerts when exceeding a certain value based on identified abnormal range calculated by sensor and numerical data;
(5) Route optimization engine which finds optimal route to the goal under several limiting conditions;
(6) Placement optimization engine which models optimal placement under several limiting conditions;
(7) Text generator engine which corresponds to individual requests such as FAQ, customer support and NPC (Non-player character) by understanding natural language;
(8) Optimal solution search engine which searches and forecasts optimum users and contents, identifying interests and tastes of users based on their previous actions;
(9) Game processing engine which corresponds to various requests from rule generation, NPC creation, automatic testing to operation support;
(10) Image recognition engine which recognizes faces, features of objects, ages and so on from pixel data of graphics.”

“In the world of finance, HEROZ has tied up with online brokerage Monex to provide robo-advice for people who trade currencies. The ‘Trade Medical FX’ system analyzes their past performance and transaction style and provides suggestions for investment skill improvement. HEROZ also commenced joint efforts with Sumitomo Mitsui Financial Group and Nikko Securities in AI equity portfolio diagnostic service taking customers’ risk appetite into account and AI stock price watch service with ‘LC-PH’ (loss-cut-profit-hold) strategy. The following services that are promoting practical use are services that enable equity investment based on advanced finance theory and investment method, even for customers with little investment experience, utilizing AI forecasts and trend analysis . It is the first attempt in Japan to provide services utilizing AI stock price prediction for individual customers, and we are also applying for international patents. We aim to offer to customers who have an account at SMBC Nikko Securities in the first half of 2019. HEROZ can successfully crunch the huge amount of data on consumers’ deposit and withdrawal information, and data from social networks, to assist banks when they are making decisions on giving out loans and deciding whether customers are creditworthy. Our AI also helps in abnormal transaction detection in which we learn past transaction information etc. and automatically detect and notify candidates for abnormal / fraudulent transactions.”

“In the construction industry, our AI helps in (1) optimizing, standardizing, and streamlining structural design by learning the structure of the property, design information on similar properties, know-how of craftsmen and others; (2) layout optimization by learning design criteria and trends and output optimal layout such as route and placement. We simulate flow lines of people and objects and propose a layout that reduces unnecessary movement as much as possible; (3) predictive maintenance by learning time series data, detects abnormality / trouble in real time, and prevents trouble beforehand. We learn images and sound data of the state of the building, and discover abnormalities and breakdowns. We will attempt to improve the accuracy and efficiency of personnel business such as visual inspection.”

“In the logistics industry, our AI helps our customers in delivery route plan optimization. We load the amount of baggage, various constraints (time, resources) and present a route that minimizes travel time, distance and so on. In the media industry, our AI helps in preventing cancellation of members in which we made analysis based on user’s registration information and behavior log, numerate the cancellation notice signs and apply it to prevent cancellation.”

“For various industries, our AI helps in
(1) Testing inspection in which we learn the test object, read the features, generate test cases, comprehensively test and detect problems and abnormalities. We will learn image data of non-defective / defective products of products and make inspection work more efficient.
(2) Automatic monitoring / abnormality detection in which we will learn time series data such as access logs and predict future trends. The threshold is automatically set for the target item, and abnormality detection is done in real time.
(3) Demand forecast in which we analyze trends from a wide variety of product information and sales performance and automatically predict future demand.
(4) Content delivery optimization in which we learn about users and content characteristics and responses, and optimize user reviews, as well as automatically adjust content and timing with high CVR and optimize personalized delivery.”

“Our HEROZ Kishin Monitor obtains historical data of various elements such as URLs, days, time slots and IP access by analyzing previous access log. It will alert when the value goes far beyond the norm, always analyzing and complementing data from the most updated access log. It also does automatic test case generation / automation of test. Our HEROZ Kishin Testing allows debugging such as automatic test case generation, automatic test execution and problem finding. For example, AI would analyze, extract features and associate items of a newly established website, then debug by testing various combinations including normal input.”

When asked about how he came about to start HEROZ, the challenges he faced and overcame and the breakthroughs during his early entrepreneurial period, CEO Hayashi shared reflectively his inspiring story: “I was born in 1976 in Numazu City in Shizuoka prefecture. Since young, I was told by my parents that ‘it is all right to do anything, finding what you can be number one is better.’ My parents are ordinary people. My house is a very homely family. ‘Being number one’ does not have any special meaning, probably because it was a very ordinary expectation as a parent to their child. But, whether it was imprinting or not, I was seriously looking for what I could be number one when in elementary and junior high school. After school, I read books on Shogi quietly when I get home. While pretending to be reading textbooks in school, I was solving the puzzle problems on shogi. Shogi is like a puzzle game and I liked to think. There is no element of luck in Shogi. You can win if your reading or idea exceeds your opponent, and you can lose if it falls below. It is only one point to decide the victory or defeat. Whether you win or lose, there is no unexplainable irrationality or absurdity. Everything is my own skill.”

“I won my first nationwide title in shogi while still in high school and by the age of 22 I was the world amateur champion. My coaches were urging me to turn pro. But I wanted to be an entrepreneur, not a shogi player. Also, I was presented with the condition that I will not go on to high school if I go pro. To become a professional in shogi, you must first enter the organization of the Japanese Shogi Federation where you need to win over the opponents there. You can become a professional shogi player who gets winning prize money and a game fee if you get to the fourth ties. It takes 4 to 5 years to become a professional shogi player. It is a fierce world with overwhelmingly more people abandoned without being able to become a professional although they have entered the encouragement society. To that end, going to high school will be an obstacle to becoming a professional shogi player. Because high school life seems to be fun (laugh), I thought that narrowing the options of life at that stage is not realistic. After that I continued shogi as a hobby, entering the Shogi club in high school and university.”

“After graduating from Waseda University with my co-founder Tomohiro Takahashi whom I met in the fourth grade at the university, we joined NEC in 1999 to acquire IT knowledge and experience. When I was in sixth grade in elementary school, I wrote in an article that I want to become an entrepreneur in the future. As I liked teaching and had been tutoring at cram schools in part-time jobs, I was thinking at one time I should start a business in a cram school. I thought about the business model and I gave up thinking. I met Takashi again in NEC where he was working as a system engineer and he is a shining star at the optical transmission R&D department which had close to 1,000 people, so I called out to him to do something together. After 10 years of working as a salaried worker, we started HEROZ in April 2009. But in 2009, it was in the midst of a Lehman shock. 2009 was really the Ice Age. I also thought that I would get a capital contribution from NEC. After the Lehman shock, capital investment was no longer being done, so it was a difficult situation. Two months after our founding in 2009, I found himself in a room with local venture capitalists from JAFCO, presenting a 120-page pitch about my firm and we received a 100m yen funding. It is useless material only if I try it now. Those who read will get tired (laugh). Mr. Nishioka of Mobile Internet Capital said that ‘You’re a world champion, so you’ll work something out.’”

“Prior to 2003, decision-making algorithms for intellectual game software such as Shogi were made by hand by programmers. However, when machine learning was introduced from about 2004, it became possible for autonomous judgment and decision-making by computer, and AI had undergone rapid evolution in acquiring human intuition with deep learning. I started having a strong interest in AI from 2009 when I founded the company. I had received an invitation from a research institution and I was chosen to be a subject in their research on AI focusing on people who are doing shogi. It was a research aimed at elucidating the information processing mechanism of the neural circuit of the brain related to situational judgment and the decision process of shogi and to elucidate the mechanism of intuition thinking peculiar to humans. I was interested in the workings of the brain because it was interesting, and I also had an interest in AI, which aims to elucidate ‘the mystery of knowledge.’”

COO and co-founder Tomohiro Takahashi also shared his version of the early entrepreneurial period: “I was born in 1976 in Chiba prefecture. After joining NEC, Hayashi was assigned to the IT Strategy & Corporate Planning department that alliances with external companies and ventures at the Tamachi headquarters. I was assigned to the overseas optical transmission department BIGLOBE as a system engineer and worked at the Musashi Kosugi office of R&D department. It was when I went to the head office in Tamachi for training that I met again with Hayashi who said, ‘Let’s do something together.’ At that time, I was making i-mode service shortly after it was released. The year when i-mode was released was the year when I joined NEC. It spreads explosively immediately after release. But there is no movement in NEC to do a small business like i – mode service in a large company. But creating a service is interesting anyway. While referring to women’s magazines and fashion magazines, I made content such as divination and romance diagnosis. While spending such a close time together with Hayashi, the intention of ‘Let’s start a business together in the future’ has become consolidated between us. i-mode boasted the world’s largest users temporarily, but it was disrupted by the smartphone. The iPhone was sold in 2007, and the smartphone era has come. Looking at the violent change that transforms the world, I thought that if we start a business, we should not miss this timing. Immediately after starting up the business, we were doing smart apps and released in 2012 Shogi Wars which is equipped with AI function.”

CEO Hayashi continued: “HEROZ released its game Shogi Wars in May 2012. The following year in 2013, an artificial intelligence engine developed by our company became the first to defeat a professional player in the game also known as Japanese chess. That was about 16 years after Deep Blue, a chess computer created by IBM, beat then-world champion Garry Kasparov in 1997. Google’s AI DeepMind AlphaGo defeated the world champion of Go in 2017. Shogi players are very respected in Japan. Japan’s reverence for shogi dates back to the Heian period (794 to 1185), when it was played by monks and samurai alike, and was a symbol of intelligence that was also loved by commoners. There is something profound in shogi culture’s emphasis on respect for ones opponents, whether one wins or loses. At its root, shogi relies on seizensetsu, or the belief that humans are fundamentally good.”

“The AI development of Shogi Wars began with the feeling ‘I want to convey the enjoyment of shogi’. Issei Yamamoto, who developed ‘Ponanza’, also has a career in the Shogi department of the University of Tokyo. There were other software in Shogi, but loses to a strong amateur. Yamamoto was working on the development of an AI with a clear goal of beating the professional master of Shogi. The reason why more people do not play shogi is the feeling ‘because I cannot win’. Shogi Wars contains a mechanism that improves shogi by playing games against each other. Specifically, when a player gets stuck in the game, the ‘summon shogun’ AI calls upon PONANZA analysis ability to point to the best hand instead. After the game, AI evaluates the various hands pointed to the player, and there are functions that advise how to approach victory. If you know how you can overcome difficult aspects, it will be a learning curve and it will be fun because you can win. It is fun to continue, to improve. Shogi Wars is free up to three stations a day, and you can play unlimitedly if you pay 600 yen a month. The popular ‘summon shogun’ AI service is 120 yen a month for 5 hands. The number of downloads of the app exceeded 4.9 million as compared to the estimated domestic shogi population of about 10 million adults and children. The number of opponents reaches about 240,000 stations per day, and it is calculated that 3 battle matches are organized per second. Shogi Wars is also an official application of the Japanese Shogi Federation and you can get an official diploma at the stage level in the app. Many professional players are also using this platform to learn.”

On 29 Oct 2018, HEROZ entered into a capital and business alliance agreement with Pocket Query (http://quantize-world.com) which provides practical AI applications in MR (mixed reality). When asked to elaborate about the AI+MR development and why did HEROZ invest in Pocket Query, CEO Hayashi explained: “The strength of Pocket Query’s business software is its high-quality graphics, expressive power, and production ability, and we are currently undertaking experiments to introduce MRs to electric power equipment inspection sites in collaboration with TEPCO using the QuantuMR solution. In addition, Pocket Query has obtained the ‘Microsoft Mixed Reality Partner Program’ certification, one of the 20 companies in Japan, and has high technical ability in MR field. This capital and business alliance will combine the strengths of our company’s AI technology and Pocket Query’s MR technology to visualize AI analysis by MR. We aim to create ‘work of the future’ using integrated technology with MR, AI and IoT. We want to successively engage in strategic investments in order to expand HEROZ Kishin clientele and to stay current on state-of-the-art technological trends.”

HEROZ team of AI engineers are also well aware of the potential breakthrough research development by Google DeepMind in an article published in the journal Science on 7 Dec 2018 about AlphaZero, a dramatically new version of its AlphaGo. With no prior knowledge or data input beyond the basic rules of the game, AlphaZero taught itself to play not only Go, but also chess and shogi. By playing against itself millions of times and updating its neural network as it learned from its mistakes, in a matter of only four hours, AlphaZero defeated supposedly the best existing game-playing computer programs such as world computer chess champion Stockfish. And in a distinctive, unorthodox, yet creative and dynamic playing style. Strikingly, by comparing Monte Carlo tree searches (MCTS), AlphaZero examines only 80 thousand positions a second, compared to 70 million for Stockfish. AlphaZero compensates for the lower number of evaluations by combining its self-play trained deep learning or deep neural network (DNN) with MCTS to focus much more selectively on the “most promising” variation, rather than to explore exhaustively. It was “wiser”, knowing what to think about and what to ignore.

In the published paper, DeepMind addressed many of the criticisms, especially that of AlphaZero winning because of its advanced hardware advantage. While AlphaZero only trained for four hours, the four hours of training was done on Google’s most advanced hardware: its prized Tensor Processing Units (or TPUs) which are at least 100x as fast as the highest-end GPUs, and thousands of times faster than the hardware available 2 or 5 years ago. Thus, it might have been impossible to create AlphaZero before 2017 – the technology just wasn’t there.

Does the development in AlphaZero suggest the disruption of AI players? We think it is too early to tell. To create intelligent systems capable of solving a wide range of real-world problems, we need them to be flexible and generalize to new situations. DeepMind admitted that the key weakness of the DNN-guided MCTS “random” searches for the “most promising” moves is that if surprised with a slightly modified set of rules mid-game, AlphaZero might get flummoxed. Interestingly, we noted that 15-year-old professional shogi prodigy Sota Fujii exhibited a counter-intuitive and abnormally aggressive playing style to set an all-time record of 29 consecutive victories. Asahi Shimbun pointed out that Fujii’s playing style changed and improved after he was introduced to HEROZ AI just before turning pro in 2016. With the AI training, Fujii achieved victory with fewer moves by abandoning the conventional strategy of building a defense before going on the offensive.

CEO Hayashi summed up by emphasizing the importance of having a bigger purpose and a nurturing corporate culture for engineers to immerse themselves in exploring innovations: “HEROZ aims to be a tech group where excellent AI engineers gather. Engineers account for three-quarters of the 40 members, 70% of which are engaged in developing AI and algorithms. For example, developers of Shogi AI PONANZA and APERY are from NEC Central Research Laboratory and engineers who published basic theory on Mahjong AI and are regulars in the ‘Supercomputer Contest’. A major feature is that all the engineering teams are in a almost flat relationship. In order for employees to have fun working, we have created an environment where we can express our opinions freely and fully demonstrate our creativity. It is an organization form in which leaders are born for each project. Sony’s Akio Morita also supported genius engineers such as Masaru Ibuka’s curiosity and chunk of inquiry and prepared an environment where you can immerse yourself in R&D as much as you like. The climate of SONY respects the pure feeling of engineers who want to please people with technology and innovations that change the world have been born one after another. Environments in which competent human resources can demonstrate themselves sufficiently to compete with your own abilities, and ‘impurities’ such as titles and hierarchical relationships are not mixed. We want to create a company where people can fully demonstrate their 100% ability and can enjoy the work. There is growth of HEROZ when we promote things quickly and value the climate that respects the individual’s capabilities. This is the starting point. I think that it is still an endless journey. I want to grow while cherishing the thought that ‘I want to impact society’ and ‘I want to create a service that surprises the world.’”


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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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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