| Dear FriendsCan You Guess This Asian Wide-Moat Company?
The Machine Behind “Mass Flourishing” and the Artisan Revolution
When China’s Premier Li Keqiang was in Africa in May 2014, he gave away a particular machine to the African people as a gift to highlight the global competitiveness of China products and to promote the ‘Love Made-in-China Product’ idea. After his trip, he was told that they were made by a hidden wide-moat champion from another Asian country. Out of the 11 million units sold worldwide every year, 3.3 million are manufactured by this Bamboo Innovator in 2014, or nearly 1 out of 3 machines, tripled from 1 million units in FY2005.
Li was partly inspired by a book called “Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge, and Change”, that innovation comes from the grass roots rather than top-down planning laboratories, so everyone can contribute; and that innovation contributes to personal growth – or “self-development,” as Li phrases it. Interestingly, this product is behind the handicraft revolution enabled by Etsy, the fifth most-visited website in the U.S., after Amazon, eBay, Walmart and Best Buy. Etsy is said to be planning to raise $300m in an IPO this year, the biggest IPO to come out of New York since 1999. An article last week talks about a lady who is said to have sold $80,000 worth of merchandise on Etsy and earning about $65,000 a month: “I really wanted to be able to sell the products and make a few extra dollars for dance lessons for my children. I would have been thrilled to make $100 to $200 a month to pay for my daughter’s dance lessons. I’ve tasted loss and felt what it does to you personally. Second chances are so much more appreciated.” Etsy is part of a rising trend of companies that enable the freelance economy. Like Uber, AirBnB, these companies allow people to do what used to be full-time work as part-time gigs, or to strike out on their own instead of working for an established company. It gives more choice to consumers while enabling people in need of cash to easily pick up extra work. Etsy is part of the maker movement led by housewives and avid DIY crafters.
Our latest monthly Moat Report Asia for March 2015 examines an Asian company that was established in 1968 and is now the world’s largest ODM (Original Design Manufacturer) in the machine behind this mass flourishing and the handicraft revolution with a 30% global market share. This company has focused on this product for the past 40-plus years and does not carry major non-core investments on its balance sheet.
There are over 400-500 different precision engineering parts that go inside this product, which is far more than the 25-30 parts that are needed to make a modern smartphone. Just one malfunctioning part, or if the parts do not coordinate with one another, and the entire product would have to be discarded. Thus, the complexity in manufacturing and coordinating hundreds of parts in the machine can result in production challenges, working capital and inventory management problems, delivery delay, and lost clients. The company designs and makes 40-50% of the machine parts in-house, while most of its peers purchased the parts.
The company recognized early on the importance of R&D in order to quickly launch new models and products for its clients who require speed-to-market in introducing new designs for the end consumers. Because the company proactively proposed the designs, they have control and power over the backbone system and structure in the hundreds of internal parts inside the machine. This is crucial because it translates into tangible procurement and cost advantages. As the company’s Chairman Mr. L puts it: “Only when you have R&D capabilities can your road be wider in the long competitive journey. This is our secret to why we enjoy a powerful cost advantage over our rivals that they find very hard to replicate!”
As a result of its vertical integration strategy and R&D capabilities, the company has consistently the highest ROA, ROE, profit margin and working capital efficiency in the industry despite rising cost pressures and the volatile cycle. ROA at 13.2% and ROE at 18.9% is significantly higher than its rivals. Its inventory management is also very impressive at only 36 days (vs peers’ 60-90 days), an extraordinary feat given that there are 400-500 parts to manage.
The company has demonstrated remarkable resiliency in winning in industry crisis over the past 47 years, forging formidable competitive advantages in scale, product quality, R&D design capabilities. In each industry crisis and consolidation phase, the company is able to emerge as a winner and continue onward its growth path in a traditional, boring industry that is experiencing resurgence with the handicraft revolution.
Valuation is also decent and reasonably cheap for a world-class company at PE 12.1x, EV/EBIT 9.6x and EV/EBITDA 8.2x. Its short-term downside is protected by its healthy net cash balance sheet and an attractive 5.3% dividend yield. With the handicraft revolution enabled by Etsy-like online marketplace, as well as growth in demand in emerging markets in China, Russia and ASEAN, Latam, EBITDA and net profit could potentially double, pointing towards a 120-180% growth in market value to $720-900m based on a modest EV/EBITDA 12-15x.
We are most impressed by the company’s corporate culture. Led by Mr. L, the corporate culture has been a nurturing one towards cultivating continuous R&D innovations and the philosophy of owner-operator mindset at every level of the company:
Q: “After all these years, what is the one thing or one event that is the most memorable or touches your heart the most?”
Mr. L: “I am most touched by the dedication of our employees towards the company. During the natural disaster in.., [our factory site] was in the catastrophic zone.. Yet, our employees continue to come to work, with the collective understanding and commitment that ‘if we receive orders, we have the responsibility to deliver them’. With courage and tears, [Company’s name] overcame the challenges and managed to stand up once again. I was appointed the Chairman in 2002 and I put greater emphasis on human capital development, from training to career advancement opportunities and performance-based compensation. I actively promoted the philosophy of owner-operator mindset at every level of the company, that ‘[Company’s name] belongs to everyone’, to continue the spirit that touches my heart during the disaster. As we rebuilt the buildings and factory that were destroyed, we have cultivated a revolutionary feeling.”
We think this is rare in Asian firms and the company deserves a valuation premium.
Who is Mr. L and this wide-moat Bamboo Innovator?
PS: We are very honored to be able to invite Mr. Hemant Amin, Founder, Chairman and CEO of Asiamin Capital, a successful single family office, and Founder and Chairman of the BRKets investor group (www.brkets.com) to be the guest speaker on March 17 (Tuesday) at 5.30pm till 7pm. Mr. Jarrod Baker, the Senior Managing Director at NYSE-listed forensic specialist FTI Consulting Inc (NYSE: FCN, MV $1.5bn), was our previous guest speaker and his presentation materials are available here. Hemant will be talking about accounting fraud in Asia with actual Indian cases from his wealth of experience in investing in Asia and India, where he is an early investor in Narayana Murthy’s Infosys which compounded over 60-folds for him: http://www.beyondproxy.com/grey-world/. KB will be moderating in the second half of Hemant’s session which will be in the dialogue-style. We will be making this exclusive content available for our Moat Report Asia subscribers only.
Warm regards,
KB
The Moat Report Asia
www.moatreport.com
http://accountancy.smu.edu.sg/faculty/profile/108141/KEE-Koon-Boon
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Bamboo Innovator 