CENTERED With H.E.R.O. Issue 6: Dassault-Medidata; Asian SaaS-AI Medical Imaging Software; “100X: Exponential Innovators in the H.E.R.O.’s Journey to Navigate the Volatile Uncertain World”

The destabilizing force of easy money from growing rate-cut expectations and additional stimulus already impounded into the capital pricing mechanism has split the overall volatile market atom into three polarizing asset particles growing further apart:

(1) Ever-riskier and unstable “flight-to-junk” and interest rate & sentiment-sensitive yield-type scorching and crowded assets fed by the opportunistic grope for yield in passing from one hand to another, from over US$13 trillion worth of negative-yield global bonds (which doubled in the last six months) to property to alternative currencies in bitcoin and gold; and to alternative assets in illiquid loss-making cash-burning tech startups dependent on subsidies/promotions to acquire fleet-footed fickle customers.

(2) Ever-riskier growing chilling dark void of cheap-gets-cheaper disrupted value traps and conventional “defensives” which VALUE 2.0 investors and cashed-up bargain hunters priding themselves on their abstinence continue to have a fatal temptation for and shoot themselves in the foot, reminiscing for the previously comfortable mean-reversion bounce despite a growing painful realization that there is an uncomfortable structural break in the market’s multi-year appraisal of businesses that can survive and compete in the exponential world.

(3) Structural serenity and resilience in “flight-to-quality” assets held firm and added with growing conviction by farsighted long-term investors, especially in a selected group of listed liquid and transparent under-the-radar quiet exponential innovators with highly-profitable recurring-revenue business models and strengthening fundamentals/ increasing returns-to-scale who are exponentially widening their competitiveness gap with most corporates who continue to struggle in adjusting and adapting themselves to stay relevant in an exponential world.

Assets in Category (1) also remind us of this quote by Professor Dr. Andrei Shleifer: “When noise traders are optimistic about particular securities, it pays arbitrageurs to create more of them. These securities might be new share issues, penny oil stocks, or junk bonds anything that is overpriced at the moment. Just as entrepreneurs spend resources to build casinos to take advantage of gamblers, arbitrageurs build investment banks and brokerage firms to predict and feed noise trader demand.”

Thus, lurking beneath the aggregate market data statistics and sentiments – analogous to that of the Picture of Dorian Gray in the novel by Oscar Wilde (1890) in which the face of Dorian Gray showed no signs of aging as time passed, whereas the sins of his worldly existence are vivid in the portrait of himself that he kept hidden in the attic – its wildness lie in wait. Analyzing the Dorian Gray-aggregate market data for risk on-risk off decision to scurry in and out of assets might increasingly prove less reliable.

Farsighted long-term investors in Category (3) assets include the fabled French Dassault family with over US$27bn fortune. Dassault Systèmes SE (EPA: DSY), which sells 3D design, simulation and industrial data management software, announced in June 2019 that it is paying US$5.8bn in cash in the largest deal in its history for SMID-cap exponential SaaS (software-as-a-service) cloud innovators Medidata Solutions (NASDAQ: MDSO), a specialist in analyzing data from clinical trials with over 1,300 clients, including 18 out of the top 25 pharma firms and nine out of 10 of the top contract research organisations, and generates over 14% in operating cashflow (OCF) margin in the fast-growing life sciences sector. Earlier in the week, Salesforce.com (NYSE: CRM) had announced the acquisition of big data visualization SMID-cap SaaS innovator Tableau Software (NYSE: DATA) for US$15.3bn. Both Medidata and Tableau are part of a group of 46 US-listed SaaS companies with positive OCF and a combined market value of over US$680 billion, and have stayed resiliently positive amidst the US-China trade war tensions.

Similarly, there is a selected under-the-radar group of highly-profitable Asian SMID cap exponential innovators which are also attractive acquisition targets for the tech giants to expand into new categories of growth or/and deepen their footprints in Asian markets, which provides long term downside protection in terminal value and supports their long term valuation.

Consider the case of a listed Asian AI medical diagnostics imaging software SaaS H.E.R.O. Innovator which lets radiologists and doctors view and manipulate the increasingly large and complex medical images. 90% of all Electronic Health Record (EHR) is imaging data (by volume) and growing exponentially. Nearly all other diagnostics imaging software take an image and compress so it can be transmitted, the Asian-listed medtech technology can stream images in such a way that no quality is lost.

This Asian SaaS/AI innovator is highly profitable with healthy balance sheet: OP Margin 46.9%, ROE 37%, ROA 30%. net cash (zero debt) in balance sheet is 35.7% of total assets. It is up over 32% since the trade war escalated from 6 May 2019, extending its YTD 2019 gains to 139%. On 2 April 2019, it announced a new round of share buyback to acquire up to 10% of the shares issued; it had recently completed a previous round of share buyback announced last year.

There are many clinical cases with proven ROI that include a publicized case of a child with severe headache in CT scan showing aneurysms requiring emergency intervention. There is no time to wait for tech or 3D lab post-processing. MRA/VRA (magnetic resonance arthrography) is performed on-the-fly with this innovative software. It had expanded to US with prestigious hospital groups including Mayo, Mercy, Yale New Haven, Duke Health and Partners Healthcare, and doctors graduating from Harvard and Yale will have been trained on the software.

The resilient H.E.R.O. Innovators are at the inflection point of their exponential growth trajectory to generate potential higher multi year gains ahead. Besides the breakthrough AI tech, an even more powerful new product is released: a single viewer for ALL images in the medical record (EMR).

“There’s a lot more image processing, a lot more looking at the body in different angles rather than just one, and clearly you can reconstruct in 3D. We don’t know of anyone at this point that has been able to match the functionality or the speed or the scalability of what we do. We’re a little unusual for an IT company because we make money, pay dividends and don’t have any debt. We’re the 37-year overnight success story,” comments CEO Dr. H, a medical doctor who co-founded the SaaS-AI firm in 1983 with fellow tech expert and wine buddy.

For a Southeast Asian UNHW/family office client who owns a hospital operator as a key asset in his business portfolio, we have advised a portfolio of Asian-listed SMID-cap medtech innovators to multiply his investment returns and business profit by becoming the distributor of this transformative diagnostic imaging software-as-a-service with his hospital operator, while benefiting the society/health of his home country.

Markets are also getting more discerning of the different quality of the SaaS companies. For recent outperformers Slack Technologies (NYSE: WORK) and Zoom Video Communications (NASDAQ: ZM), both had high net dollar retention rates (NDRR) — a commonly used SaaS metric that measures the percent of revenue from current customers retained from the prior year, after accounting for upgrades, downgrades, and churn. Slack’s NDRR was 143%—a figure above 100% is often called “negative churn”—and Zoom’s was 140%. Zoom had highly efficient customer acquisition costs: every dollar that Zoom spent in sales and marketing generated $1.80 in profit in the next year.

In contrast to the Uber or loss-making cash-burning marketplaces peddling undifferentiated cheap rides or goods with subsidies/promotions to millions of fickle individuals, the likes of Medidata and Zoom sell higher-margin subscriptions to tens of thousands of business customers. Like the SAAS – Salesforce.com, Adobe, Atlassian and ServiceNow – a selected group of emerging SaaS innovators like Zoom had cracked the code of distribution and adopted freemium pricing models that lowered barriers to initial adoption.

Enterprise software did not feature prominently in the original dotcom mania. Before the advent of cloud computing, selling and installing such on-premise software programs was tedious and labor-intensive. Big firms like Oracle and SAP dominated the market with bundled products which had to be customized to meet a customer’s needs. Today cloud-based SaaS innovators can lure clients with free trials that is near costless, since adding an extra customer requires little more than a tweak to a database.

And in an important industry trend which we highlighted in a previous issue as “The Power of One”, struggling SaaS firm Dropbox announced in June 2019 that it is revamping its user experience across all its platforms in its biggest redesign in 12 years to create a new integrated workspace with Slack, Zoom and Atlassian, so that workers can send Slack messages or set up Zoom meetings right from Dropbox and don’t have to keep switching between different apps.

Dropbox seems to have realized that file storage by itself is a dying business. With storage prices dropping and any app being able to add their own storage system, it needed to move up the enterprise stack and become a portal that opens and organizes your other tools. The question is whether files are always the central unit of work that comments and tasks should be pegged to, or whether it should be the task and project at the center of attention with files attached, or if it can become the identity and collaboration layer that connects the fragmented enterprise software, so that it could outlive file storage and stay relevant as new cloud office tools emerge.

Having the inner compass of the H.E.R.O. in our hearts can help us not lose our way in difficult and uncertain times as we journey together in the treacherous capital jungles.

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Our strategy remains: 0% in OEM/ODM + 0% in component makers + 0% in semiconductor & related sector + 0% in capital equipment, tech hardware & big-ticket items + 100% singular focus in a portfolio of highly-profitable listed Asia SMID-cap tech-focused exponential innovators = Higher probability of resiliency in both fundamentals and investment returns that are highly impervious to the US-China trade war risk and market volatility which have escalated since 6 May 2019.

The portfolio of 40 H.E.R.O. innovators, which has an average market cap of US$1.36bn (median market cap of US$868m), delivered strong interim results growth amidst the US-China trade tensions: overall weighted sales rose 30.6% YoY and operating profit grew faster with increasing returns to scale at 59.2% YoY, supporting the portfolio returns.

An overwhelming majority (82.5%) of the 40 HERO portfolio stocks are highly profitable “SaaS (software-as-a-service), information & data analytics/AI” companies and “platform business models”, a group which we believe is highly impervious to trade war risks.

One of our focused portfolio stocks, the Korean SMID-cap tech innovator NICE Information Services (KOSDAQ: 030190) with a dominant 75% domestic market leadership in the recurring information & big data services in personal credit information, is up over 25% since the trade war escalated from 6 May 2019, extending its YTD 2019 gains to 66.7%.

With the impending “MY DATA” industry deregulation in Korea on big data business by revising currently the world’s most restrictive personal information protection law and a strengthening in loan reviews, market leader NICE is set to expand its decision analytics and big data marketing services revenue contribution from the current 8% to a potential 24% that its London-listed peer Experian is producing. NICE is also developing new artificial intelligence (AI) solutions with the convergence of financial and non-financial information to support loan decision-making, intelligent fraud bureau services and financial risk management.

Since we highlighted this Korean innovator about four months ago to one of our advisory clients, a business owner/CIO of an established Asia ex-Japan value fund management company in Singapore who manages sovereign wealth and pension/endowment money, the stock is up over 80% to a market value of US$930m. We are grateful to be able to deliver our recently operationalized bespoke investment solution for family offices, UNHW, corporates and long-term institutional investors with satisfactory results to this wise business owner/CIO client whom we like and respect and care for.

Farsighted investors and our clients are experiencing first-hand and benefitting from the flight-to-quality effect in the market to quality listed innovators that are most relevant in this exponential world, because each time the market corrects, the stronger hands of longer-term farsighted investors will accumulate more and more of these quality innovators, while the weaker short-term opportunistic hands sell out, creating a resiliency effect in these stocks. Listed profitable SMID-cap tech innovators with non-linear exponential growth potential are the most relevant and mispriced multi-year investment trend and opportunity.

Inspiration for CENTERED with H.E.R.O.: Our clients, just like our H.E.R.O. innovators and business owners, understood the profoundness that it’s not about a Maslow-type pyramid that they need to scale upwards in profits and returns; the H.E.R.O. journey is not upwards, but a deeper journey inwards and towards the center, about the kind of person you want to become through the work you build and invest in to serve those you care about.

Deeper and inwards towards the center. As Einstein elucidates: “Strive not to be a success, but rather to be of value” – Amid all of life’s chaos and challenges, a restorative balm to all of us to be Centered in values with focus and purpose to be of value in serving an idea larger than ourselves and the people we care deeply for.

Amidst escalating trade war, 29 May 2019 was the eventful inaugural roundtable of the Singapore’s Super H.E.R.O.s who come together to brainstorm about “Re-Imagining Value Investing in an Exponential World: VALUE 3.0 With Ever More Value Trap Losers & A Selected Under-the-Radar Group of Winners With Exponential Edge”. The Singapore Super H.E.R.O.s in the Roundtable are:

• François Badelon, business owner/CIO of French-headquartered Amiral Gestion Group who manages over 4bn euros in AUM
• Raymond Goh, business owner/CIO of New Silk Road Investment who manages over US$2bn AUM in Asia ex-Japan equities; Raymond was the former MD in equities at GIC
• Benjamin Ng, business owner/CIO of Whitefield Capital who manages money for sovereign wealth fund and pension/endowment fund in Asia ex-Japan equities
• Hemant Amin, business owner/CIO of Asiamin Capital, a highly successful single-family office and one of the early major investors in Indian-listed Bajaj Finance/Bajaj Finserv which compounded >100X to a market value of US$24bn/US$17bn

We are grateful to also have two great friends of H.E.R.O. joining the Roundtable: Jacqueline Too, senior advisor and award-winning veteran banker at multi-generational wealth management & IAM group Crossinvest; and Anton Chua, one of the branch business owners of Finexis which is one of the largest independent financial advisor firms in Singapore.

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Thus far, of the 72 entrepreneurs and CEOs whom we had highlighted in our previous weekly research brief HeartWare, less than one-third are in our focused portfolio of 40 HERO Innovators, while the rest (50+) are in our broader watchlist of 200+ stocks.

If you are not moving forward in this exponential world, you are going backwards. If you want to join us at the leading edge of opportunity, 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.

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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 recurring-revenue profitable 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 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.

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