Birth of a Hidden Champion Issue 4: Keyence & Nitori 

Dear Clients and Valued Partners,

Birth of a Hidden Champion (Issue 4): Keyence & Takemitsu Takizaki, Nitori & Akio Nitori
Welcome to the fourth issue of the “Birth of a Hidden Champion” tribute series, where we highlight inspirational stories on the listing birth of Hidden Champions creating and compounding value in the Asian capital markets.

On the 6th of January 1992, two Hidden Champions were born in the Japanese capital market. Keyence (TSE:6861), led by the quiet and low-profile founder Takemitsu Takizaki, went on to compound nearly 2100% to a market value of over US$70 billion today; and Nitori, led by the farsighted and passionate Akio Nitori, to go on and compound over 5,000% to a market value of over US$16 billion today.

These extraordinary Hidden Champions have pushed us to delve deeper into the inner workings of what make Hidden Champions stood the test of times. We had mapped out a selected group of Asian entrepreneurs whom we monitored over the decade plus and have admire and respect them, including Keyence. Since we wrote about the learning insights of Keyence’s innovative business model in the TODAY newspaper article back in April 2013, it had quadrupled in market value. In the inaugural Intervarsity Stock Research Challenge held during the annual Value Investing Summit 2017 in January 2017, the eventual champions from NTU impressed the judges and audience with their research on Keyence, which went on to nearly double a year later. You can read more about their research here: Intervarsity Stock Challenge Booklet 2017.

By investigating deeper into understanding the owner-operators’ higher Purpose to add value to society by solving high-value problems and serving underserved customers with their unique products and services, you would be able to invest with a higher conviction and be rooted in investment resilience even and especially in fragile and weak market conditions. We dug deep to craft up-close-and-personal insights to why Akio Nitori started his business, whose Purpose has carried on till today with the mission of improving the quality of life Japanese are able to enjoy with affordable yet stylish furniture. You can find our series on the owner-operators building our Hidden Champions called “Inside the Leaders Mind” here: Inside the Leader’s Mind: Akio Nitori.

Please check out our website which includes a section of “Business Builders of Asian Hidden Champions – Invisible Heroes in our Lives” and let us know ( who else do you admire in Asia and would like us to include in the “Heroes in our Lives”, as well as share with us which Asian entrepreneurs do you like most.

Warm regards,
KEE Koon Boon
Chief Investment Officer & CEO
Hidden Champions Capital Management
Hidden Champions Fund


Value Investing Summit 2018 – Building a League of Hidden Champions

Dear Clients and Valued Partners,

Professor Dr. Hermann Simon, the godfather of Hidden Champions and founder of one of the world’s most profitable consulting firm Simon-Kucher & Partners, will be in Singapore for our Value Investing Summit 2018 (VIS2018) on the 27-28 of January.

The Value Investing Summit (VIS) is a two-day, annual conference featuring some of the best investing minds in Asia and around the world, where industry experts and investors alike meet to share ideas, discuss investment strategies and support one another to navigate the investing scenes internationally.

Now in its 7th year, VIS started an audience of just 500 (in 2012) and has grown to the average 1,300-strong crowd today, where renowned speakers like Professor Dr Hermann Simon (Founder and Partner, Simon-Kucher & Partners), Francois Badelon (Founder and President, Amiral Gestion), Hemant Amin (Founder and Managing Director, Asiamin Capital), Vishal Khandelwal (Founder,, Kee Koon Boon (Chief Investment Officer & CEO, Hidden Champions Capital Management), Zhou Guiyin 周贵银先生 (Chief Trainer, Shanghai Rongdao Culture Communication) will be present.

For all clients, we hope you will be able to attend our exclusive session in the Value Investing Summit that we have arranged for you to interact with Professor Simon, as well as interact with the CEOs of Hidden Champions that include Makrand Appalwar, CEO of India’s Emmbi Industries, and Judy Kuo, CEO of Taiwan’s Nyquest Technology. It is unusual for investment firms to invite their shareholders and clients to meet and question the chief executives of businesses in which their savings have been invested and to meet and question the investment firm’s managers and analysts about those investments. At Hidden Champions Fund, we believe in providing our shareholders with unique insights and access to the entrepreneurs and businesses that are disrupting and improving our world to see first-hand the opportunities we see.

Attached are the slides that I will be presenting during VIS2018. Hope to see you there!


Hidden Champions Fund Investment Letter – Ikigai: Achieving Investment Resilience Together with Hidden Champions

Investment in Public Markets: Hidden Champions Fund

Ikigai: Achieving Investment Resilience Together with Hidden Champions

“Just as humans have lusted after objects and money since the dawn of time, other humans have felt dissatisfaction at the relentless pursuit of money and fame and have instead focused on something bigger than their own material wealth. This has over the years been described using many different words and practices, but always hearkening back to the central core of meaningfulness in life.”

“Your ikigai is at the intersection of what you are great at, what you love doing, what the world needs, and what people value and pay you for. The place where passion, mission, vocation and profession intersect.”  

Dear Clients and Valued Partners,

Portfolio Performance

Your funds in listed Asian equities achieved a calendar year-to-date 2017 return (net after fees) of 20.1% as at 30 September 2017 against an increase of 21.1% for the MSCI Asia Pacific index and 11.8% for Singapore’s FTSE STI index over the same period, with our Hidden Champions Fund benefiting from the flight-to-quality effect as the overall market retreats in 3Q2017. This September 2017 marks the 2nd year anniversary of our Fund since her birth in September 2015. The YTD 2017 returns of 20.1% has brought our cumulative consolidate absolute gains to 37.6% since our inception when we adopted the focused investment strategy of investing in successful yet low-profile underappreciated Hidden Champions.

* Our investment income from investment in public markets for 8IH during 1HFY2018 is S$4.0m.

Hidden Champions are all around us if we look hard enough. They are an exceptional group of focused market leaders in sophisticated, hard-to-imitate niche products and valuable critical niche services that are largely invisible to the average consumer, yet are indispensable to our well-being in daily life. The investment objective is to invest at an earlier or tipping point stage in the long-term growth trajectory path overlooked and underappreciated wide-moat, innovative Hidden Champions in Asia. These Hidden Champions weather multiple crises and recession to deliver outperformance often not linked to general economic conditions, thus offering de-correlated and resilient investment returns. We are of the conviction that Hidden Champions are the ultimate “shock absorbers”, transforming crises and trauma into opportunities for the future.

Our portfolio weighted winners-to-losers ratio in the 10 Hidden Champions companies as at 30 September 2017 remains healthy at around 99.4% : 0.6%; in other words, over 99% of our weighted portfolio stock value have positive absolute returns. We are a Top 20 Shareholder for 7 of these Hidden Champions. We aim to be a Top 20 Shareholder of the companies we invest in as a demonstration of our conviction and transparency in the investment process. We look to become a substantial shareholder with a 5% stake as they continue to deliver in their business fundamentals.

We can be a Top 20 Shareholder in some of these Hidden Champions because: (1) they are under-researched despite their quality and sustainable growth; (2) we are one of the earlier foreign institutional investors; (3) founding owner-operator have a substantial equity stake to provide stability in the shareholder base, and we have a rigorous and unique systematic investment process to eliminate entrenched controlling owners who treat the business as their personal ATM and abuse minority shareholders.

More importantly, our portfolio stock characteristics continued to display excellent and improving fundamentals with many of our portfolio companies delivering record profits on the back of innovative products and services, including Australia’s largest tourism travel and transport group Sealink Travel Group (ASX: SLK), India’s technical textile specialist Emmbi Industries (NSE: EMMBI), Taiwan’s innovative fabless IC designer Nyquest Technology 九齊科技 (GTSM: 6494) and so on, with their corporate developments and business prospects elaborated in the ensuing section on Portfolio Activity.

When we say we invest with high-conviction to deliver sustainable outsized non-linear returns with time as our friend, we act on it. For our top 3 core stocks, we are a substantial shareholder: as at 30 September 2017, we have a 3.36% equity stake in Sealink Travel, 14.97% stake in Nyquest Technology, and 6.78% in Emmbi Industries. In addition, we are going to have a board seat on Nyquest Technology which is creating new categories of growth with its innovative cost-effective value-added customized solutions for their targeted underserved customers amidst the super-cycle in microcontroller chip in the Internet-of-Things (IoT) world of interconnected household and industrial devices, a development which we will update in the coming months in “Stage 2.0 of Fund’s Investment Performance and Business Development” in below section.

Our portfolio weighted market capitalisation is US$276 million. Weighted revenue grew by a CAGR of 16.4% over the past three years, generating increasing returns to scale with a 32.4% CAGR growth in operating profit with weighted return on equity (ROE) of 26.6% (Dec 16: 23.9%). This is due to the scalability of the business model forged by an indestructible intangible know-how accumulated over the years to create new categories of growth for their targeted customers and compound growth with resilience in a difficult business environment. In particular, Nyquest Technology and Emmbi Industries have mission-critical products and services-based (MCPS) moats that make them durable businesses to own in difficult market conditions. MCPS moats are businesses that have built a strong reputation as a reliable provider of products/services that cater to mission-critical requirements of the customer.

For instance, the Hatchimal interactive egg toy, one of the popular smart toys that has propelled Canadian-listed Spin Master (TSX: TOY) to record profits and record market value of $5.39 billion, is exclusively using Nyquest’s innovative cost-effective customized touch controller MCU chip.

Share Price Chart of Spin Master (TSX: TOY)

The solution provided by Nyquest is critical because all other vendors cannot solve the power problem in that a power button needs to be switched on and off when playing with the egg in touching, rubbing and tapping it to encourage the Hatchimal to respond, tap back and peck out of its egg shell – which is a big turn off for the kids as they need to flick on a switch to play with a supposed “living egg”. Nyquest’s touch controller solution is so low power consumption at only 5 microamperes, which is at least 3 to 10 times superior to other vendors, that the egg does not need a power on/off button and the kid can play with the egg anytime and does not need to consciously remember to turn on/off a power button.

We strongly urge the CEOs of toymakers and household devices to explore Nyquest innovative cost-effective touch, voice and LED MCU chip solutions and they have uploaded:
(1) Interesting product application demos on YouTube:
(2) In-house software development tools including Q-MIDI, Q-Sound, Q-Touch, Q-Light that is user-friendly to the clients who have increasingly lesser time in new product development as product lifecycle shortens and speeds up:

(3) In-house hardware development tools user manual:

Nyquest is the archetypal frugal innovator with the right innovator’s DNA, corporate culture fostering innovation and low-cost business model by design, underappreciated with its deep moat in customer-centric development tools in software and hardware to provide excellent technical support for its clients and to deliver innovative cost-effective value-added customized OTP MCU/chip solutions in voice/touch/LED speedily (in as fast as less than 3 days!) which can also scale up in bigger volume orders using the Mask-ROM technology, enabling Nyquest to generate consistently superior profit margin and ROE amongst its industry peers of fabless MCU/IC designers and a market share leadership in Greater China and Taiwan of over 50% in the low- to mid-tier voice synthesizer IC/MCU and over 30% in the mid-to-high end segment.

Nyquest’s distinctive strength in building its own deep intangible know-how asset in development tools for clients remind of one of the critical success factors of TSMC in an earlier article that I wrote some years ago before TSMC tripled to $210 billion in market value which exceeded that of Intel: “TSMC has become steadily involved with design. Although most of its customers rely on their own design teams or those at service providers allied with TSMC, the foundry has found it increasingly necessary to develop in-house expertise in order to help its customers create manufacturable designs and fill TSMC’s fabs. TSMC would develop and acquire technology files, process design kits (PDK), interface IPs, ERP and a rich portfolio of open libraries for use not only by its engineers but also by its customers. These reusable building blocks are essential for many design projects to help its customers complete their designs successfully and in less time, at lower cost.” Nyquest epitomizes the essence of what Benjamin Franklin, one of the founding fathers of the United States of America, say best about frugal innovators:

“The way to wealth is as plain as the way to market. It depends chiefly on two words, industry and frugality: that is, waste neither time nor money, but make the best use of both. Without industry and frugality nothing will do, and with them everything.”

In determining our high-conviction investments in Nyquest and Emmbi, we have screened all of Asia Pacific’s listed companies whose market value are below $100 million with a long runway to compound growth using our systematic investment framework and process and determined that these two small-caps have the highest potential to deliver excellent risk-adjusted outsized returns and at least double or triple in the next 3-5 years based on earnings growth and upward rerating in valuation multiples. We have further tightened the selection criteria to examine only companies who are capital light compounders with agile working capital dynamics and low-risk capex and product development.

As at the latest time of writing in mid-November 2017, Nyquest trades at an attractive EV/EBIT of 11.7x, EV/EBITDA of 8x and EV/Cashflow from Operations of 8.4x while generating a sustainable cash dividend yield of around 5% and ROE of 27.1% from a healthy zero-debt-net-cash balance sheet with net cash comprising 15% of the market value, and an agile cash conversion cycle of 33 days with low receivables collectability risk. Nyquest provides low-risk product development, lower total system cost and faster time to market for thousands of diverse customer applications worldwide and enjoys high free cash flow with its financial prudence and discipline unlike most chip companies who burn plenty of cash in the latest R&D project without ensuring sufficient end application demand. Fabless IC designer Nuvoton Technology Corporation (TSEC: 4919), part of Winbond Electronics (TSEC: 2344), is also a strategic shareholder with a 16.9% stake to provide stability in the shareholder base and to enhance firm governance value with institutional monitoring.

Our portfolio construction has also ensured that the Fund will receive from our core stocks over $1 million in annual cash dividends that is both sustainable and growing and we look forward to reinvesting the dividends back into wide-moat Hidden Champions to compound the portfolio returns with resilience.

Infusing toys and devices with a soul via a voice and interactive touch through the MCU solution has been the sense of Purpose in Nyquest that imbue them the power of resilience to generate increasing profitability in difficult market conditions and the energy to get up in the morning to keep executing and innovating.

The Hidden Champions Fund with Nyquest’s management in their Hsinchu, Tapiei office (L to R): investment analyst Joyce Pang; EVP Kevin Lin Meng-i; President Chen Chien-lung; CEO Judy Kuo Chiu-li; and KB

Dinner with Nyquest’s management (Bottom L to R): CFO Ann Chen; CEO Judy Kuo Chiu-li and KB; (Top L to R): President Chen Chien-lung, marketing manager Nicholas Huang and investment analyst Joyce Pang.

We find that resilience and Ikigai are connected in life, business and value investing in Hidden Champions. What’s your reason for getting up in the morning? Ikigai (生き甲斐) is a Japanese concept that means “a reason for being,” “a reason to get up in the morning”, an intense internal burning desire to carry out a personal mission that we have a strong affinity to. It is similar to the French phrase Raison d’être. Due to having a powerful connection to our ikigai, a strong purpose or something you deeply care about, we have the stamina and endurance to keep on the path to staying true to yourself, to persevere when the going gets tough and focus on persisting through difficult times, while others who do not have the same resonance may give up and fall by the wayside. Regardless of the blood, sweat and tears that are shed to put the work in, we tend to stay loyal to our ikigai and weather all storms that attempt to keep us from it once we have evoked and embraced it. When we are immersed in any endeavor that brings us into our hearts, that makes us come alive – and we are bringing ourselves fully to it, we’re in flow and we have no idea where the time went because we were so engrossed – instantly we become more generative, more magnetic and more dynamic in our ability to navigate challenges and discover pathways of breakthrough.

Your ikigai is at the intersection of what you are great at, what you love doing, what the world needs, and what people value and pay you for. The place where passion, mission, vocation and profession intersect:

  • What do you Love? What aspects of your life bring you into your heart and make you come alive?
  • What are you Great at? What unique skills do you have that come most naturally to you? What talents have you cultivated and what do you excel at even when you aren’t trying?
  • What Cause do you believe in? What breaks your heart or pulls at your gut? What change would you most love to create in the world? What would you give your life for?
  • What do people Value and pay you for? What service, value or offering do you bring, or could you bring, that brings real value to others? Something people need and are happy to pay for or share some value in exchange?

Another of our portfolio stock, an asset-light educational services innovator established in 1972, displayed the power of ikigai and puts its purpose to action to improve the well-being of its underserved customers of young children in the early childcare niche with a unique, overlooked and important educational service – recurring revenue from contracts in conducting physical education services for over 1,090 kindergartens nationwide and running extracurricular sports clubs (rhythmic gymnastics, soccer, garden development) with a strong membership base of over 64,000 – and a long runway of growth ahead with Japan having a total of 20,000 kindergartens that comprises of 8,000 private kindergartens and 12,000 private nurseries, and the government planning to let kindergartens accept 2 year-olds from 1 April 2018 to address the severe shortage of daycare centers which would effectively double the addressable demand of the company overnight. This company generates over S$80 million in sales and S$12 million in operating profit with an ROE of 17.6% and is up 67.5% since our initial purchase in July 2017 and up 42% from our average cost as at 30 September 2017, yet it remains attractive in valuations with EV/EBIT of 6.7x.

Under the guiding belief that “the possibilities of children are infinite”, the company imparts lessons for children on how to live, the importance of getting results through trying hard with constant efforts and enjoying the challenging process, to undertake challenges without giving up and to become a fine person who can contribute to society through physical education guidance. Nobody can imagine that a kindergarten child of 4 to 6 years old can jump over a 10-tiered box that is two heads taller than their standing height and display feats of strength when they walk 10 meters on handstands with their proud parents watching. Yet these are only the surface results of the education and values they embody.

Their intangible knowledge lies in its scheduling know-how in maximizing coach deployment and system-based lesson plan after the “Yokomine-style educational method” to create an energetic learning atmosphere that fosters teamwork, grit and resilience in children. “Yokomine” is an educational method revolving around the concept that “all children are geniuses”, that acquainting and acquiring ethical and moral views is indispensable for social life and self-reliance at a young age, and that the etiquette and behavior style worn by a young child becomes a treasure over the child’s lifetime. Its founder did not only see his company’s operations as solely running sports clubs, but is also building the very foundation of Japan’s economy:

“If you are only involved in educating children, there are options such as running training schools and swimming clubs. I want to raise and improve children through early childhood education who ultimately build the future of Japan. So far, there have been hundreds of thousands of children who have been sent to our company in the past 40 years who are out in the world. The thought that each person is active in society and contributing to the world, the magnitude of our company’s significance is enormous. Our main goal has always been to teach ‘basics as a person’ through it and contribute to the whole child education.” 

We are planning to make high-conviction investments in two small- to mid-cap tech innovators in Japan. One of them is an existing stock position which is up 45% since our initial purchase in July 2017. This tech company generates an ROE of 30.1% with growth in its operating profit of 50% over the past 3 years to over S$11 million and trades at an EV/EBIT of 16x and recently achieved a 39% increase in operating profit for its first-half results for the financial year ended March 2018 announced in October 2017 which is also a record high. Its recurring revenue business model is focused around its unique proprietary database content management software used by over 135,000 corporate clients in a freemium model. 60% of its revenue comes from customers in the food industry and the rest of the revenue are contributed by clients in the household appliances, tool making, building materials and construction.

Imagine thick catalog information of images, pictures, installation drawings, logos and videos of thousands of building materials products and housing construction manufacturers, and the product information exchange mechanism. Such unstructured data beyond word search and numbers is beyond Google and SAP. Established in 2001, this company has developed a highly flexible XML-type database structure which solved the difficult problem in content management in unstructured data such that updates and changes with different categories of content can be done easily without new programming.

Aeon Topvalu is Aeon’s global private brand and they have been using the company’s cloud-based database content management platform services in planning, development, production and sales of its private label products, coordinating and disseminating the information across the value chain from raw material manufactures, manufacturing consignees, quality inspection companies to Aeon’s GMS (general merchandise stores). For instance, over 130 food manufactures outside of the Aeon Group are using the company’s database system. Thus, Aeon Topvalu is a fabless company that does not have production facilities but entrusts the manufacturing to external parties, and compliance such as product liability and quality control obligated by the food industry is required. However, many small and medium-sized manufacturing enterprises may not be as sophisticated in IT and compliance and they are able to become Aeon’s business partners by using this company’s database content management platform. Aeon Topvalu has expanded the quality management system beyond food to household goods such as detergents and cosmetics.

More and more companies in food industries are beginning to tackle the issue of food safety and security in response to growing concerns among consumers about the safety of food products amid an unending stream of incidents involving false labeling about the country of origin, failure to list known allergens, as well as problems with foreign contaminants. For instance, if we want to search for soybeans that have no genetic modification and high protein retention, they are difficult to find in the Google search services. This company’s database software preserves detailed information on all people involved in the distribution, from the farmer who inputs the characteristics of the species used for cultivation and information on the agricultural chemicals used and provides the information to the wholesaler and trader of soybeans who then analyzes the ingredients of the soybeans and enters the information into the database. Soybean processors and manufacturers and retail stores that sell the soybean products would use that information for sales promotion. In the distribution of food, there is increasingly a requirement to disclose and disseminate information of traceability from the producer to the seller.

In November 2017, the company started its new business in home appliances database content management platform, collecting over 100,000 product data in their cloud-based system from manufacturers, saving electronic merchandisers and manufacturers the trouble of managing product information and the information can be utilized easily for leaflets, catalogs, over the counter promotion advertisement, ecommerce where the importance is increasing because it is necessary to incorporate detailed product information in ecommerce sites and the company can customize the product information output for easy use.

Since listing in December 2006, the company has been healthy in its internal free cashflow generation after investing in R&D and innovation and did not raise any capital from new shares issuance. There is no goodwill in the balance sheet to worry about potential impairment risk. Selling, General and Admin expenses (SG&A) as a percentage of sales has been steadily declining from 27.4% in FY2012 to 23.3% in LTM 1HFY2018, which is critical factor as a demonstration of scalability of the software business, while gross margin has increased from 40.9% to 49.7% with the expansion into higher value-added software services and new categories of growth.

The founder’s vision is that “countless commodities and products are circulating around the world and if we could search them from every angle, business could change and the new distribution of products in Web 2.0 revolution has begun.” We believe this unique database content management company with its cloud-based services expanding into new verticals has a widening mission-critical business moat and long runway to compound growth.

Another tech innovator that we intend to take a possible sizeable position is a new stock addition into the portfolio. Founded in 2007, the company is a recruitment site specializing in F&B industry such as full-time / part-time recruitment, head-hunting services, recruitment advertisement postings, training & seminar for chefs and restaurant owners, and has its own community-based social networking platforms and operation of F&B online magazines. This focused online recruitment specialist generates an ROE of 37.6% and has a domestic market share of 12.5% – one in eight restaurants in Japan uses them for recruitment. Around two-thirds of the revenue is contributed by the personnel introduction business based on fees corresponding to the annual income of the company’s recruits and the remaining one-third of the revenue is accounted in the job ads business in which flexible ad placements purchased in advanced using a ticket system with ads posted within the ticket validity period and additional revenue is generated from prioritized display to the top of the site.

Importantly, this innovator has solved a critical problem plaguing the F&B industry which is very high employee turnover and the costly disruption to operations as well as incurring high advertising cost in new recruitments. The mission of this innovator is to solve the shortage of kitchen-role specific talent, eliminating job mismatch and prevent high turnover rate in the F&B industry. The successful retention rate of personnel introduced by this innovator’s online platform is over 90%!

A key success factor and wide-moat of the innovator is that it is not merely a well-functioning online jobs portal but it also builds a sticky community of informational exchange through interviews with chefs, staff members, executives, restaurant business owners to share nuanced information that include the actual real challenges of the work, the pleasures in the job, tips on doing well and more. Food craftsmen usually speak poorly and cannot present themselves properly at the interview and they are represented by the innovator with relevant and useful profile information. There are regular follow-ups by the company’s career consultants and a refund policy for any mismatch and resignation within the first three months of employment. The company also has a two to three times faster client response time for matching suitable candidates with higher accuracy compared to other recruitment agencies by using personalized chat group for each client, something like a Bloomberg Chat. Candidates can search the database of scout talents and send direct “hot messages” to meet scouts and F&B professionals with abundant experiences and motivation. This innovator has also developed a separate online and mobile media platform for professional chefs that is like a LinkedIn superstar profile and more with the dissemination of interview content of the professional chefs, Instagram-like photos of their culinary creations, timely topics of the F&B industry, and so on.

The company has also created a Food College, holding regular seminars for personnel staff working in the F&B companies with the sharing of success stories and panel discussions by recruiters. Tie-ups with over 130 vocational schools and college cooking schools nationwide are also established to support around 20,000 students who aim to find employment in the F&B industry.

This innovator’s short-term goal is to become Japan’s largest food staffing service company by 2020; its long-term goal is to aim for global expansion to be the world’s largest food talent bank. Japanese food cuisine culture is highly regarded globally, and as Japanese restaurant groups expand overseas, there is a growing demand for good chefs and restaurant personnel. Good chefs travel internationally to learn various techniques and skills and there are also many international chefs interning in Japan to learn Japanese food cuisine techniques, providing opportunities for the innovator to expand.

Business Performance

We like our clients to ask us tough questions to make intelligent decisions for themselves. Our first high net-worth client invested $1 million with the Fund since our initial launch offering event that we held in June 2017 after asking tough questions, and in the process appreciated the high-conviction investing approach to achieve investment resilience; she is up over 18% in returns from June to September 2017. We also have had existing clients subscribing additional capital into the Fund. As the CIO & CEO of the Hidden Champions Fund, a significant part of my personal savings is invested in the Fund along the same terms and fees as the external client. When we have real skin in the game – when we have upsides and downsides – we care about outcomes in a way that we wouldn’t otherwise. We act in a different way. We take our time. We use second-order thinking and inversion. We look for evidence or a way to disprove it.

Thus far, since obtaining our Registered Fund Management Company (RFMC) license from the Monetary Authority of Singapore (MAS) in April 2017, we have raised over S$5.5 million from external accredited clients, generated since our inception in September 2015 over S$8.29 million in absolute profits for our clients as at 30 September 2017, bringing our total asset under management (AUM) to over S$35 million.

Permanent long-term capital to provide stability to the investment strategy contributed by 8IH comprises 82% of our AUM, while the remaining 18% is contributed by external clients. Our Fund NAV (after fees) as at 30 September, which is reviewed by both auditors KPMG and PwC and reported by our independent award-winning fund administrator Trident Trust, is US$126.29. Due to ASX regulations, our ASX-listed parent company and main investor 8IH had to transfer the permanent capital into the Fund in stages since our inception in September 2015, resulting in a difference in the Fund NAV and the consolidated total positive absolute returns of 37.6%, with both sets of numbers audited by KPMG and PwC and reported in the ASX announcements.

One of my proudest business milestone is that the transformation into an asset management business with the support of the investment team has passed the going-concern acid test with recurring income from both management and performance fees and the sustainable returns generated from the pool of permanent capital, thereby creating an estimated intrinsic business value of S$50 to 70 million for 8IH shareholders from scratch since I joined 8IH in September 2015, an ongoing business value that is still growing. As advised two years ago on what could make or break a fund management business by our wise and kind friend Hemant Amin, a highly accomplished and thoughtful Munger-like value investor who builds and runs Asiamin Group, his own multi-million single-family office, what we have yet to put in place in the Hidden Champions Fund is a performance-based incentive plan for the investment and business development team.

We have also obtained approval from the financial regulator on 26 September 2017 to scale up our fund structure of collective investment scheme (single fund) into an umbrella fund with multiple share classes (more than one fund). Thus, we now have the fund platform structure to create unique bespoke funds that can be switched on in 2 to 3 weeks for selected corporate clients and family offices to invest in listed companies in related and synergistic fields to their core businesses to supercharge the value of their business group in the spirit of Softbank’s US$100 billion Vision Fund. We will elaborate on this longer-term business development in the below section on “Stage 2.0 of Fund’s Investment Performance and Business Development”.


We are careening towards the end of the bull market. At the Hidden Champions Fund, we aim to protect and grow capital by positioning for and capitalizing on the upcoming downturn in the global/economic business cycle. How do we prepare for crisis? Time the market? Buy put options? Buy “safe haven” bonds? In Issue 2 of our Upward Toiling newsletter, we shared the insightful empirical research “The Best Strategies for the Worst Crises”. Empirical evidence was reported that an investment strategy in quality stocks benefit from a “flight to quality” effect during crises: “While quality stocks logically deserve a higher price-to-book ratio, in reality they do not always exhibit such a premium. Towards the end of the bull market, quality stocks often looked underpriced. Then, when the market has a drawdown, these stocks have outperformed, benefiting from the so-called flight-to-quality effect.” Specifically, the quality factor delivered 43.7% returns when markets were down -45.3% in crisis periods.

At the Hidden Champions Fund, we expect to outperform when the market retreats as our Hidden Champions benefit from the flight-to-quality effect in which investors flee their speculative yield and cyclical bets to seek shelter in companies with higher quality fundamentals and long-term growth prospects. Our Fund tends to do better when the overall market is tepid and lackluster. For instance, in 2016, when MSCI Asia Pacific and Singapore STI index were flattish to down at +2.5% and -0.1% respectively, the Hidden Champions Fund is up 14.3%.

With the Value-to-Quality (VQ) ratio of our Hidden Champions Fund presently over 170% superior than the market comparable, we believe that the Fund is significantly undervalued to its intrinsic value and the downside risks are limited to protect investors and to provide superior risk-adjusted active returns as opposed to exposure to passive index market risks.

Stage 2.0 of Fund’s Investment Performance and Business Development

In Stage 2.0 of the Hidden Champions Fund’s investment performance and business development, a more activist approach will be undertaken to unlock non-linear jumps in market value creation of our key portfolio companies (Australia’s Sealink Travel 3.36% equity stake, Taiwan’s Nyquest Technology 14.97%, India’s Emmbi Industries 6.78%) in which we are substantial shareholders to increase NAV unit price of the Fund exponentially via:

  • Seeking strategic shareholders and business partners for key portfolio companies. For instance, Nasdaq-listed fabless IC and microcontroller designer giant Microchip Technology (market value US$21bn) has an active acquisitive strategy for unique companies in its field that include Nyquest Technology;
  • Creating unique bespoke funds for selected corporate clients to invest in listed companies in related and synergistic fields to unlock the value of our clients in the spirit of Softbank’s US$100 billion Vision Fund. For instance, Singapore’s Sentosa Corporation has over S$1 billion in idle cash in the balance sheet that can be invested in a Tourism Fund that invests in related tourism Hidden Champions that include Sealink Travel. Listed tourism and leisure operator Genting Group/Star Cruises will be another potential corporate client and beneficiary of such a focused bespoke Tourism Hidden Champions Fund.

A friend and successful value investor from Italy who runs his own fund visited us at our Singapore office in October 2017 and we discussed the potential of creating a unique co-managed bespoke fund that invests in Asian companies with great everyday products and services for the Africa market. We are also in discussion with an accomplished European value investor about the possibilities of distributing the Fund to their European clients.

Microchip Technology is a fabless IC and microcontroller designer which compounded over 13,000% since its listing in 1993 to a market value of over US$21 billion. Microcontrollers are used for all sorts of electronic control applications, ranging from consumer applications to industrial applications, automotive, telecommunications and office automation type of applications. Even though everybody talks about digital all the time, sound/voice, music, video, temperature, etc., are all analog functions, and there is a large and increasing amount of analog required to convert the signals from analog to digital and then process them within a microcontroller — and then, at the end, you still need to convert it back to analog to light a bulb, to make a sound, to turn a power switch on, to fly a drone — in other words, to control something. The world forgets that the real world is analog. The real world does not operate merely in zeros and ones. Therefore, there is a continuous need for analog microcontrollers that Microchip continues to benefit from.

From the brink of financial ruin in 1989-1993, Microchip’s founder Steve Sanghi focused his attention on the microcontroller market which accounted for only 10% of its sales. Microchip was then relying heavily on commodity EPROM memory chip products, often compared to “jelly beans”, that have no inherent defendability and which is easy to switch from one supplier to another in a price competition. Steve added design programmability to their microcontroller products and development tools to provide the unmatchable offers and technical support to customers they need to succeed, something which the prevailing industry players in the marketplace did not have. As the semiconductor industry consolidates, Microchip continues to execute a highly successful consolidation strategy with a string of “elbow-out” acquisitions to expand its solutions, propelling Microchip to No. 3 in terms of worldwide microcontroller market share, just behind NXP and Renesas.

Journeying together with a 13,000% winner in Microchip seems obvious on hindsight but all great investment opportunities are never straightforward; Microchip has been consistently misunderstood and mispriced by the investment community – and we believe the same misperception persists in Nyquest despite its sustainability, consistency and scalability in its quality earnings and cashflow generation ability. Below are insightful comments by Microchip’s founder and CEO Steve Sanghi about their business model and why they are misunderstood by investors in an interview with Wall Street Journal back in March 2006 that is more relevant than ever today and in the years ahead when analysing the investment merits of microcontroller companies:

“Our 8-bit microcontrollers control things like thermostats and remote controls and toasters and blenders and irons and refrigerators and industrial machinery and so on and so forth, and many of these parts do not require the power, the memory capability, the performance of 16-bit, 32-bit microcontrollers. So while industry pundits, including the industry analysts, have been calling the demise of 8-bit microcontrollers for the last 15 years, saying that the entire business is going to switch over to 16-bit and 32-bit microcontrollers — and indeed, the people who make 16-bit and 32-bit microcontrollers keep touting that — if you look back over those 15 years, the most successful microcontroller company has been Microchip. We’ve dominated 8-bit microcontrollers because we understood the trends. We understood that 8-bit microcontrollers would not migrate over because those applications I just listed do not need the higher performance and transistor count of a 32-bit microcontroller. Yet the misconception continues. Year after year after year, Microchip makes a brand new record and achieves higher sales and significant growth and gains more market share in the 8-bit microcontrollers, yet every time they look at those results, investors and analysts say, “Well, you did that last year, but how is it possible to do it in the future when the business is going to 16 and then to 32?” Then we post another brand new record of 8-bit microcontrollers almost quarter-after-quarter. I think that’s the largest misconception.”

“Financially, we’re among the most profitable semiconductor companies, one of the top three or four most profitable semiconductor industry companies. We have grown every year in our 13 years of being public, except one year, which was the tech bust of 2000-2001. Other than that, we have grown every year. So it’s a very, very strong financial company, very profitable, and the highest dividend paying company in the semiconductor industry. The third area I’d emphasize is consistency. If you look at the revenue and earnings-per-share volatility of the company relative to the entire semiconductor company, Microchip is the least volatile in revenue and earnings over the industry cycle. The semiconductor industry continues to be cyclical, and we can never say there will not be another recession, or another tech bust of some kind — these things have happened in the business cycle — but as you go through these business cycles, Microchip shows the lowest volatility in revenues and earnings of anybody in the semiconductor industry. I think that ought to be interesting to investors, that one can sleep comfortably at night with an investment in Microchip. Microchip is generating very, very strong free cash flow, something we didn’t talk about. You are talking about $0.35 to $0.40 of every dollar of free cash flow after investment in capital expenditures and all the expenses of the company, and that’s a very, very strong cash flow earner. As a result, we are able to pay consistently very strong dividends — again, something that investors ought to be interested in.”

We believe Nyquest is an attractive takeover target for giants such as Microchip which should result in a takeover premium in its price and provide long-term downside protection in terminal value. We will be crafting and sending out an “Open Letter to the CEO to Superscale with Hidden Champions” series.

Interestingly, Winbond Electronics, the parent of fabless IC designer Nuvoton Technology who is the strategic shareholder of Nyquest with a 16.9% stake, had made an accepted offer to acquire Microchip for a mere US$15 million in 1989/90. Then in May 1990, the Taiwanese stock market had a setback and Winbond backed out of the deal – and Microchip looked inward to reinvent itself to compound to over US$21 billion. Winbond must have learnt from the Microchip experience and invested in Nyquest as a strategic investor. There are some overlaps in the business and clients between Nyquest and Nuvoton and Nyquest has been mostly superior in profitability and efficiency in these segments given that Nuvoton is not as focused as Nyquest and Nyquest has been “giving face” to Nuvoton in not competing headlong. We believe it would a win-win corporate action for Nuvoton to further increase its strategic stake in Nyquest and then carve out these business segments which contribute a small part to Nuvoton’s overall revenue to pass them over to the more profitable and focused Nyquest. We will be writing a letter to Winbond’s dynamic founder Mr Arthur Chiao to share with him our suggestions that such a strategic action would benefit the shareholders in Winbond, Nuvoton and Nyquest. We have learnt that Mr Arthur Chiao is an advocate of the Hidden Champions business management philosophy and has given multiple speeches on this and even insisted his top management team to read the Hidden Champions book by Hermann Simon. We hope Mr Arthur Chiao and the shareholders in Winbond and Nuvoton are reading this message and will contemplate the strategic action to unlock value in the entire group.

Branding, Marketing & Distribution

We are renaming our asset management company from 8 Capital Pte Ltd to Hidden Champions Capital Management Pte Ltd (HCCM) to better align our branding, marketing and distribution initiatives and efforts, especially as we embark upon our long-term strategic initiatives to expand our suite of solutions with the bespoke fund products and advisory services.

We have made some improvements to our website that will make it easier for investors to appreciate our unique investment philosophy and process. The website also includes a section of “Business Builders of Asian Hidden Champions – Heroes in our Lives” to map out a selected group of Asian entrepreneurs whom we have monitored over the decade plus and admire and respect them. Please let us know of your valuable comments and who else do you admire in Asia and would like us to include in the Hall of Fame, as well as share with us which Asian entrepreneur do you like most.

I would like to highlight the contributions of Tho Jinliang, our new Business Development Analyst, to the team and Fund. With Jinliang’s support, the Hidden Champions Fund is now listed on HFM Global database and EurekaHedge which highlights some unique statistics of our Fund, such as the percentage of positive months which stands at over 70%, and also puts our Fund in the radar screen and direct scrutiny of the asset allocators and institutional investors. Through the database, we were contacted in November 2017 by one prominent Japan-based fund advisor who flew down to visit us in our Singapore office; this award-winning advisory group has created access to “Best in Class” local and Asia-focused Private Equity and Hedge Fund investment opportunities across multiple, non-correlated strategies and asset classes. We believe that as we continue to deliver strong investment performance for our clients and with time as our friend in compounding returns, our Fund will attract greater interest from these intelligent “fund scouts”.

Our Fund aims to continue to grow our external asset management business in various market segments including institutional clients, insurance companies, family offices, business owners, financial advisors, accredited high net-worth. Our objective and focus is clear: manage our client’s money thoughtfully and well, and the business should prosper and shareholders’ interests should be well served. Specific strategic efforts are being contemplated or are underway:

  • Leveraging off the network of our Group’s database of accredited high net-worth investors who have attended the value investing seminars;
  • Building distribution channels: 3rd party distributors in banks, insurers, agencies and financial advisors;
  • Reaching out to the right targeted gatekeepers, asset allocators, consultants, fund databases and marketing platform to initiate and maintain the communication of the fund literature to seek pension, endowment and institutional inflow;
  • Going direct in contacting business owners of small and medium enterprises who exhibit the characteristics and traits of the Hidden Champions companies;
  • Communicating our thought leadership in our own website and other media and fund platforms to attract the right clients who understand and appreciate our investment process to deliver long-term results;
  • Launching a seminar and workshop platform about the Hidden Champions way of value investing to create awareness;
  • Increasing awareness of the Fund via launching the Intervarsity Stock Research Challenge with the mission to promote the study of value investing and to foster intelligent research on “Hidden Champions” in Asia;
  • Providing portfolio advisory services in helping other funds and accredited investors to review the risk of accounting irregularities and misgovernance in their portfolio. We have seen funds permanently crippled from having just one of their portfolio holdings, even if it were a minor stake, tainted in an accounting scandal which leads to an erosion of investor’s confidence in the fund manager’s ability. We see this unaddressed risk gap in funds as a business development opportunity.

Our Fund is good for distribution in US and UK and we are looking at targeted distribution in Australia, Malaysia, Hong Kong and Taiwan. Taiwan’s offshore fund asset in equity funds is around US$90 to 100 billion, amongst one of the largest in Asia, and we are exploring the appointment of a reliable regulated local fund agent to market and distribute our Fund in Taiwan, including holding of regular road-show presentations with local business partners.

Portfolio Updates of our Core Stocks

Exponential non-linear growth is a topic of discussion with one of our high net-worth clients who is also an astute C-suite executive at an American MNC. This client shared, “I always ask my teams what High Value Problems (HVP) are they solving for our customers…there will be no inflection if we are not focus on solving HVP.”

This business and investing wisdom by our client is akin to Larry Page’s gospel of 10x. Most companies would be happy to improve a product by 10%. Not the CEO and cofounder of Google. The way Page sees it, a 10% improvement means that you’re doing the same thing as everybody else. You probably won’t fail spectacularly, but you are guaranteed not to succeed wildly. That’s why Page expects his employees to create products and services that are ten times better than the competition. That means he isn’t satisfied with discovering a couple of hidden efficiencies or tweaking code to achieve modest gains. Thousand-per-cent improvement requires rethinking problems, exploring what’s technically possible and having fun in the process.

Understanding surge – the nonlinear flourishes of intensive growth activity preceded or followed by periods of lull – can yield deep insights for value investors and entrepreneurs to have a fresh perspective on nonlinear growth and sustained value creation. We explore three potential surge situations with HVP in Asia: (1) the super-cycle in microcontrollers (MCUs); (2) Sydney’s multimillion Blue Highway; (3) India’s multimillion water (conservation) war.

HVP #1: Are we in the early stage of a super-cycle for microcontroller (MCU), the microchip that enable the growing Internet-of-Things (IoT) world of interconnected household and industrial devices? Everyday products and machines can now be embedded with sensor technology to process data or interact with other electronic devices, from Amazon’s voice-enabled smart speaker to smart toys, drones and medical equipment. This quiet super-cycle in demand for connected devices has powered the IoT microcontroller market to expand from $1.98 billion in 2016 to an estimated $6.49 billion by 2024.

Nyquest Technology (GTSM: 6494), Taiwan’s innovative fabless consumer IC designer specializing in the design and development of voice controllers and MCUs for toys, learning machines, medical equipment, electric cars and other consumer electronics products, has announced on 10 July 2017 that it is expected to report a record EPS for 2Q2017 when revenues also hit a record high of NT$306 million (news link). Nyquest posted consolidated revenues of NT$109 million in the month of June 2017, up 28.9% on year and hitting an all-time high. Nyquest has enjoyed robust shipments of its 8-bit MCUs, of which its shipments for the first five months of 2017 already exceeded the total for all of 2016. Strong demand for 8-bit MCUs, as well as demand for high-end 32-bit MCUs, will buoy further Nyquest’s sales and profits in the years ahead.

HVP #2: How much is a Blue Highway worth?

In Italy, Netherlands and Japan, there is a structural trend of forward-looking initiatives and action to move domestic freight traffic off highways into high-speed ferries traversing across the Blue Highway.

We remain impressed by the Long View of SeaLink Travel’s (ASX: SLK) Jeff Ellison and his team in creating an ecosystem approach in building a multi-year perennial revenue model and recurring income stream that the market underappreciates substantially. As the largest tourism travel and transport group with 75 vessels and 39 coach and touring vehicles and over 1,200 dedicated staff around Australia, SeaLink captures over 1.2 million international visitors, or 15% of Australia’s annual international tourist arrivals, and services over 8 million customers annually with continued market share gains nationwide in NSW, Queensland, Western Australia and South Australia, beyond the Kangaroo Island which SeaLink made famous as one of South Australia’s most popular tourist attractions.

Some recent strategic multi-year growth initiatives as part of SeaLink’s Long View:

(1) Pioneering the launch of the first-ever direct high-speed ferry transport service from Manly to Barangaroo in September 2017 as an integral part of the “Sydney Blue Highway” and NSW 20-Year Ferry Plan and transportation masterplan (Link).

The new ferry hub at Barangaroo to replace Darling Harbor King Street Wharf was built to be the second major terminal for the Sydney Ferries network after Circular Quay ferry terminal. Situated at the western edge of the Sydney’s CBD, the recently opened ferry hub in June 2017 will relieve the capacity constraints at Circular Quay and connect customers to the western and central parts of CBD. Importantly, it will be the single largest development in Sydney’s CBD over the next 20 years. Once fully occupied, Barangaroo will accommodate more than 20,000 office workers and 2,500 residents. Cultural and recreational facilities at the site are also estimated to attract around 33,000 visitors a day. Thus, besides capturing a large portion of the working crowd seeking to escape the peak-hour motorway traffic congestion of Sydney, the new Barangaroo ferry hub will serve the new commercial development at this site with plans for a significant proportion of commuters and visitors to access the site by ferry, representing exciting perennial growth for SeaLink.

Sydney’s Ferry Future – Modernizing Sydney’s Ferries Along the Blue Highway

With over 5.2 million Manly/Sydney ferry trips per annum, Sydney Ferries currently provides 36 return services on a weekday on this route. Back of the envelope suggests that if SeaLink could capture a modest 1,000 passengers/day for a return fare of approximately A$15, it would generate additional revenue of A$5.5 million. If 20% of the passenger volume from the Manly/Sydney route is captured by the Manly/Barangaroo path, or 2,800-3,000 passengers/day, SeaLink could generate over A$15 million in additional revenue. With Manly and Darling Harbor having the top 3 highest patronage by line, this route dominates a very critical path in Sydney’s Blue Highway as the government invests in more frequent ferries to service growing areas such as Rhodes and Meadowbank. We expect Sealink to gain a material share of these passengers over time given there is currently no water access to Barangaroo from Manly.

(2) Creating a “Kangaroo Island 2.0” in Queensland with the $56 million Townsville Strand ferry terminal hub to be completed by mid-2020 together with a consortium of developers to replace the aging Breakwater terminal facilities in an announcement by the Queensland government on 17 August. This latest corporate development is a transformation in the business model with potential new recurring retail concession and rental income opportunity.

The new Strand terminal will boost connections between Townsville, the Great Barrier Reef Marine Park, Magnetic and Palm Islands with city-link ferry service which could connect key CBD site, the new stadium, and transform the area into a thriving tourism precinct with potential Terminal retail opportunities for SeaLink (Link1, Link2). Sealink looks to explore the option of (1) Becoming an anchor tenant in the building, thereby giving others the confidence to invest in the development; (2) Acquiring/ purchase the Terminal (retail) component of the development to secure its long-term position in that building; (3) Acquiring the full retail area, thereby allowing SeaLink the ability to attract the correct tenants to the retail space. The retail space of the development if acquired by SeaLink is estimated to under $10m and SeaLink would not be looking to raise capital to fund the project which will be financed internally. Traffic on the current Breakwater Terminal site includes an estimated 1 million passenger movements per annum, 120,000 car movements and 10,000 bus movements annually. As a comparison, Kangaroo Island attracts 200,000 tourists annually. SeaLink is negotiating to secure a multi-year contract with the Queensland Government to operate the terminal exclusively and not shared with any other marine operators.

In addition, at North Stradbrook, SeaLink is collaborating with Walker Group to submit a proposal to develop the Toondah Harbour. SeaLink’s CEO Jeff Ellison told the Government in his company’s submission that: “A new marina, improved ferry facilities and improved amenities around a new residential corridor, will mean North Stradbroke is an idyllic and close holiday destination for thousands of new residents. Importantly the Toondah Harbour ocean front will be a place to visit and the community will again face the waterfront and the islands of Cleveland Bay.”

With SeaLink being consulted by the Western Australian government on ferry tourism/transport route strategic planning at Elizabeth Quay to crystalize the government’s plans for Perth 2.0, there might also be talks in its terminal development (Link 1, Link 2, Link 3). There are also opportunities for expanding the Perth ferry service network which included ferry services to Perth Stadium by raising the vertical clearance of the Causeway Bridge and setting up a fund for ferry infrastructure supplemented by private contributions, as well as fast service between the CBD and Fremantle, and a ferry stop at Guildford. Short to medium-term opportunities included a Perth Stadium jetty and loop runs linking it with Elizabeth Quay, Waterbank, Claisebrook Cove, Crown Perth, Burswood Peninsula, Belmont Park and East Perth power station, and a service linking Canning Bridge, Matilda Bay and the Quay.

(3) Launching of the Rottnest Island service in Western Australia in November 2017 (Link). With over 550,000 visitors to that island annually and increasing due to its high-profile wine industry and pristine surf beaches, Rottnest Island is one of the jewels in the crown of Western Australia. Operating between Freemantle and the main jetty on the island, the service will be coordinated to tie in with SeaLink’s Swan River operations, providing a seamless transfer between the two renowned tourist destinations. While SeaLink is the third ferry operator on Rottnest Island, they fill an existing growing supply gap for ferry services during peak periods. SeaLink is also planning a new tourism offering for North Stradbroke Island for its Western Australia business, commencing late calendar 2017. Like Rottnest, North Stradbroke Island attracts over 600,000 visitors yearly.

Interestingly, Australia is on the brink of its biggest tourism boom since the influx of Japanese tourists in the 1980s, as a rising Asian middle class and new aircraft technology encourages airlines to launch hundreds of new flights and re-map the traditional aviation hubs linking the country with the rest of the world. A dramatic shake-up of Qantas and Virgin Australia’s international routes, at a time when a record number of foreign airlines are opening new routes into Australia, will spur the growth and further cut airfares, which have fallen 30% over the last decade. International aviation capacity in Australia has grown 30% over the last five years.

Virgin Australia chief executive John Borghetti, on board his airline’s first Melbourne to Hong Kong flight, commented, “I used to say Australia was geographically challenged, now I think it is geographically privileged because it is only one sector away from the biggest population in the world which is transforming so much.” The Australian government is in talks with a host of countries to secure more liberalized air services agreements. Australia could also become an important hub for Latin America into Asia.

The industry is particularly excited about the possibility of direct routes to Europe and North America for the first time in Australia’s history. This should open up markets such as the United States east coast where travelers have traditionally been put off by the prospect of taking two long flights. “I remember growing up and having to fly via Singapore-Bahrain and into London. We are becoming more and more part of the international community and it is a very exciting time. The tourism industry now is becoming more about technology. It has been one of the most disrupted industries since the advent of the low-cost carrier. Every time it is disrupted, it throws something out that makes it easier for the consumer”, Tourism Australia managing director John O’Sullivan said.

Meanwhile, an Australian Museum of Underwater Art off Townsville could boost the region’s tourism visitation by hundreds of thousands of people a year. Acclaimed British international sculptor Jason deCaires Taylor visited Townsville in July to assess the feasibility of establishing underwater sculpture at four sites. Taylor’s underwater museum off Cancun, Mexico, listed among the Top 25 Wonders of the World – which would be of a similar scale to the Townsville proposal – attracted an additional 400,000 tourists every year. SeaLink Queensland general manager Paul Victory said a budget of about $2 million was being considered for the underwater museum. The Morris Group, which owns The Ville Resort-Casino and the Orpheus Island Resort, has pledged $200,000. This project is hailed a possible “game-changer” for the region’s marine tourism industry, a win-win for Sealink Queensland which runs the Magnetic and Palm Island ferry services and a boost to the local economy. Walkways and associated infrastructure similar to that on Kangaroo Island, Tasmania and in New Zealand are expected to open up previously inaccessible parts of Magnetic Island, according to Queensland Parks and Wildlife Service who have identified tracks and lookouts to help attract visitors from the adventure tourism market as key recreational opportunities for the island.  Walks that include stunning scenery and high-quality infrastructure have been hugely successful in attracting tourists in Australia and overseas.
On 16th August, Sealink released record sales and profits for FY2017, with sales rising by 13.5% from $177.5m to $201.4m, EBITDA increasing 12.1% to a record of $49.4m and EBIT rose by 6.3% to a record $37.5m. The company also announced a 6.7% increase in final cash dividend of 8 cents per share, a decent 3.5% dividend yield, to be paid on 16 October 2017. As commented by the management, “Overall 2018 has started ahead of with expectations. We are excited about the outlook for further organic tourism and transport growth opportunities throughout Australia, which the Company is very well-placed to identify and execute through economies of scale, well-proven fleet management and deployment capability, a very strong international and domestic sales and marketing infrastructure, and a strong continuing focus on controlling costs.” SeaLink’s Jeff Ellison shared his management philosophy: “Our philosophy is to link the best tourism, transport and technology. We do our best to provide what our people need to make it happen. We have a real focus in providing top class customer service, training and promoting staff, and getting out and developing the marketing of our products through our networks.” SeaLink continues to trade at an attractive EV/EBIT 12x, EV/EBITDA 9x while generating an ROE of 25.4% and ROA 15.7% with a multi-year lasting wide moat.

HVP #3: India is in a Water (Conservation) War battle mode.

With about 2.4% of the world’s land area, India supports 15% of the world’s population, but has only 4% of the world’s water resources. World Bank data shows that only 35% of India’s agricultural land is irrigated. This means that a huge 65% of the farming community in the country depends on rains. 25% to 60% of India’s renewable fresh water capacity has been depleted. Access to water, hit by successive droughts and erratic monsoons, also paints a worrying picture with over nine-tenth of the country experiencing either physical or economic water stress. There is a clear divide between the water stress experienced in south India, which is physical stress due to water shortages, and that in north India, where access to water is limited by a lack of capital and resources.

In India’s water wars, rivers are a resource to be harnessed and extracted for each riparian party’s maximum benefit. Very little emphasis has been placed on conserving and protecting existing water sources. Big infrastructure programs, such as the Indian river-linking plan, envision large-scale water transfer from one river basin to another, again seeking to augment supply rather than conserve water. Indian Governments have done little to conserve water for off-season use. Sadly, despite the construction of 4,525 large and small dams, the country has managed to create per capita storage of only 213 cubic meters; compared to 6,103 cubic meters by Russia; 4,733 cubic meters by Australia; 1,964 cubic meters by the US; and China’s 1,111 cubic meters. Agriculture consumes 83% of India’s national freshwater resources. A staggering $52.7 billion has been expended on major and medium irrigation projects from the first Five-Year Plan (1951-1956) to the 11th plan (2007-12) periods, but irrigation has reached only 45% of India’s net sown area. India’s wells are running dry, fast and it needs to act now. Drought is expected to affect at least eight states in 2017.

Low rainfall during the last 3-4 years has caused great distress to the farmers and many have committed suicides which has been widely reported in media. Interstate disputes over river waters are becoming increasingly intense and widespread. India’s need is to conserve water, utilize the available water for the best spread, avoid all sorts of water losses in the complete water management system. Various losses are identified through percolation and evaporation while in storage, transit through canals.

Emmbi Industries (NSE: EMMBI), one of India’s largest specialty polymer processing company and technical textile specialist who has leveraged upon its intangible know-how in woven fabric to create new categories of growth in innovative water conservation products that include technical textile-based pond liners and flexible water tanks, has announced on 29 June 2017 the incorporation of Emmbi WatCon LLP to undertake turnkey water conservation contracts including provision and installation of canal liners for various government irrigation corporations, which will be using the Canal Liner fabric manufactured by Emmbi.

Emmbi Industries has focused on its product solutions to cut the losses at the time of storage and transportation. With their revolutionary High Tenacity Composite Polymer Membrane manufactured in their factory at Silvassa, this product has proved to be a globally successful in cutting water losses through ground seepage at various man-made water bodies, ponds and canals percolation. Use of High Tenacity Composite Polymer Membrane (HTCPM) for canal liners, a substitute to traditional Cement Concrete (CC) lining, resulting in a water loss reduction of up to 95%.

Building their brand of water conservation products did not come easy as farmers were initially apprehensive about the use of Emmbi’s pond liners as this would mean giving up approximately 10% of their land space and crop yield to test out a seemingly new water irrigation and storage system when they were already barely making ends meet. To help the farmers improve their yield and to convince them to adapt newer technologies, Emmbi’s CEO Makrand Appalwar and his team personally guaranteed to top up the losses should there be a drop-in crop yield. At the next harvest resulted in a 30% increase in crop yield and Emmbi’s brand and reputation grow as the farmers spread the word.

Emmbi which operates in this niche segment of water conservation products is expected to gain out of increased adoption of water conservation methods backed by the government’s mandatory laws on drip irrigation techniques on majority crop types which require the construction of a static water source and pond lining. Almost 200,000 ponds lining need to be done in Maharashtra alone and Emmbi looks to have a long runway ahead to compound growth.

This water conservation solutions business through their deep know-how in woven textiles was the passion of Emmbi’s Makrand & Rinku Appalwar, who recently commissioned a State of The Art Water Products facility in Silvassa that is capable of producing the world’s widest width pond lining fabric and have launched multiple initiatives such as brand mascot “Dr.M” to educate and advise farmers on water conservation techniques through the right usage of pond liners. This has been a strategic play by the company to add value at multiple levels such as a shift its revenue mix from B2B to B2C in order expand profit margins, strengthen brand image and diversify the current product mix. Emmbi yearns to take its B2C business to ~20% of sales from its current level of 3.1% by 2020 by expanding its retail distribution network. Emmbi CleanTec, the new contamination-free product manufacturing facility has commenced production as scheduled in Q2FY2018.  At peak utilisation this facility is expected to generate revenues of ~Rs 40 crore with 15%+ EBITDA margins thereby providing a thrust to the company’s export sales. Emmbi has commenced supply to industry leading customers in FMCG and Pharma segments. Innovative products continue to be launched, including the Poultry Curtain which has a market potential of Rs 20 crores per annum in the state of Maharashtra alone. The Poultry Curtain is a low-cost light polarizer to improve the growth of chicks. Poultry players such as Venky’s are using the conventional tarpaulin of yellow color which has no precise control on the light frequency. The uniqueness of Emmbi’s patented Poultry Curtain is that it is designed to filter a light of the particular frequency which helps in the growth of the chicks.

Emmbi’s Makrand Appalwar voices his passion for the water situation in India and shares vision and plans in the development of innovation in the water conservation system of pond liner products and accessories that include animal discharge route, water landing strip and anti-evaporation cover with these three new product patents filed:

“It pains me to see our country suffer from acute water shortages and hence water conservation has been at the heart of Emmbi. In the recent years water has become a national priority, so our investments in this line has paid off positively, we expect the Water Conservation segment to grow in double digits over the next five years. This business is not only about weaving textiles that find applications in lining of lakes, or canals; it is also about touching human lives. We have been exporting our pond lining, canal lining, and check dam products across the globe, and now we are adapting to the Indian market. We have researched, designed, and perfected collapsible water tanks that are convenient for storage at homes while saving space. We have also devised flexible tanks for easy transportation of water on bicycles and motorbikes. Our customers love this product, and now we have engaged a well-reputed international consultancy firm to devise a strategy to grow this business. In short this would be Emmbi’s foray into the consumer segment, whilst the core remains specialized polymer processing. The latest segment we have entered is the Agri-Business. With India being an agrarian economy, this segment offers tremendous growth potential.”


Perennial. Evergreen. Enduring. In every industry – from aviation to books to movies and software – certain creations like the Changi Airport can be described as “perennial”. Works that seem to last forever. These products, services or solutions become timeless, dependable resources that have found continued success and more customers over time. In his thought-provoking book “Perennial Sellers: The Art of Making and Marketing Work That Lasts”, Ryan Holiday illuminates the brilliance of perennials in that they grow stronger with each passing day.

Perennials like Star Wars isn’t suddenly going to stop making money – in fact, the profits from the franchise are actually now accelerating, some forty years after conception. Despite getting little radio airplay, heavy metal group Iron Maiden has defied every stereotype, every trend, every bit of conventional wisdom about not just their genre of heavy metal but the music business, selling more than 85 million albums, 24 world tours and 2,000 concerts in 59 countries over the course of a four-decade-long career. They sell their own beer, they are one of the highest earning acts in the world, and they travel from sold-out stadium to sold-out stadium in a Boeing 757 piloted by the lead singer, often shuttling loyal fans and crew along for a ride.

How can perennials endure and thrive in an impatient, flustered world demanding quick success? How can we make works and build businesses that achieve longevity? Is there a common creative mindset, behaviors and decisions behind work that lasts? Is there a pattern to perennials that both entrepreneurs and value investors can learn from? So that their success can be your success.

If making money is all you care about, and making it sooner is preferable to later, then building and investing in perennials is not the path for you. There are better, faster way to make a profit: work on commission somewhere, start another fusion restaurant, get a sell-side finance job on Wall Street or Raffles Place. Creating something that lives – that can change the world and continue doing so for decades – requires not just a reverence for the craft and a respect for the medium, but real patience for the process itself. By patience, it’s not just to the amount of time that creation will take, but also the Long View with which you evaluate your own work. It takes time and effort and sacrifice to make something that lasts.

Picture George Lucas literally ripping out his own hair as he struggled to complete the first draft of Star Wars. Consider stories of struggling artists who give up everything – even steady meals – for their work. Think of the writer working into the night well after everyone in the house has gone to sleep because it’s the only quiet time she gets. Whether these are clichés or inspiring images, there is very real pain involved. From sacrifice comes meaning. From struggle comes purpose. If you’re to create something powerful and important, you must at the very least be driven by an equally powerful inner force. In the course of creating your work, you are going to be forced to ask yourself: What am I willing to sacrifice in order to do it? A willingness to trade off something – time, comfort, easy money, recognition – lies at the heart of every great work.

The Work is what matters. To be great, one must make great work, and making great work is incredibly hard. It must be our primary focus. We must set out, from the beginning, with complete and total commitment to the idea that our best chances of success start during the creative process. The decisions and behaviors that bring you to creating the product – everything you do before you sit down to build whatever it is you’re building – trump any individual marketing decisions, no matter how attention-grabbing they turn out to be. It’s why all the pre-work mattes so much. The conceptualizations. The motivations. The product’s fit with the market. The execution. These intangible factors matter a great deal. They cannot be skipped. They cannot be bolted on later.

It starts by wanting to create a classic. People who are thinking about things other than making the best product never make the best product. It must be the highest priority of the creators – they must see this as their calling. They must study the classic work in their fields, emulate the masters and greats and what made their work last. Timelessness must be their highest priority. They have to learn to ignore distractions. Above all, they have to want to produce meaningful work.

The fact is, many people approach their work with polluted intentions. They want the benefits of creative expression, but they desire it without any of the difficulty involved. They want the magic without learning the techniques and the formula. When we look to great works of history as our example, we see one thing, that powerful work is a struggle and that it requires great sacrifice. The desire for lasting greatness makes the struggle survivable, the sacrifice worth it.

Having the Long View is critical in a time when many entrepreneurs whom we observe are running harder and harder to opportunistically chase after short-term gains just so to stand still. Taking the Long View to build a multi-year lasting wide moat means having an ecosystem approach towards building and scaling up the work with various key players in a win-win partnership, having the strategic mindset to cultivate a multiplier effect instead of thinking about merely the addition of capital in a show of might, and a willingness to sacrifice and reject short-term opportunistic gains in posturing up to look good and focus on what matters for the long-term.

During the investment process, many investors are led astray by shortcuts. It’s hard to see how it could be otherwise when the experts and thought leaders wily talk us with shortcuts, hacks and tricks that optimize for quick and obvious success. How to build something that last through time and crises is a lifelong fascination and a calling for us at the Hidden Champions Fund where we seek to invest in the perennial compounders that last the distance to generate sustained returns.

The Hidden Champions Fund is not for everyone. Only for investors who see themselves in the Hidden Champions – their struggles, how they are misunderstood and overcome the odds with persistence, and the non-linear triumphs – that we invest in with high-conviction when the reward-to-risk and value-to-quality metrics are compelling. Only for investors who want to go the right way, not the easy way.

To our clients, we are thankful and grateful for your trust and support in us all this while – and we will live and die and breathe our art and science into investing in Hidden Champions to protect your dreams because you protect ours. We believe that the steadfast one with persistence possess invisible wings, and the one who sow tears in her heart will blossom into brave flowers. Glad that on this journey we hold a tacit bond and mutual understanding; through the wind and winding routes in the market, our hearts are still as one.

If you believe you are successful in your work and life (congrats!), and you would like to participate in the long-term non-linear growth of the underappreciated emerging quality Hidden Champion and push the knowledge lever to scale up to achieve something far more valuable than wealth – sustainable growth, serenity, and resilience – please contact us with any questions, thoughts or comments or

Warm regards,
KEE Koon Boon
Chief Investment Officer & CEO
Hidden Champions Capital Management
Hidden Champions Fund

PS: Below are the links to our previous investment letters:


(1) Annual Letter FY2017 – Just Monozukuri It Like the Hidden Champions: Finding Investment Resilience in a Wild World;
(2) Interim Letter FY2017 – The Insurgent Mission of Hidden Champions: Willingness to be Misunderstood and Travel Light to Journey Far;

(3) Annual Letter FY2016 – Hidden Champions: Our North Star Investment Strategy to Navigate Turbulent & Fragile Markets;

(4) Interim Letter FY2016 – Investing with Conviction to Outperform in Times of Volatility and Uncertainty.

(5) Upward Toiling Issue 1

(6) Upward Toiling Issue 2 – Surge: Nonlinear Growth in Hidden Champions – Super-Cycle in MCUs; Sydney’s Multimillion Blue Highway; India’s Water (Conservation) War

(7) Upward Toiling Issue 3 – Perennial Compounders: The Long View in How Hidden Champions Create Multi-Year Lasting Wide Moat

(8) Birth of a Hidden Champion Issue 1 – TSMC & Morris Chang

(9) Birth of a Hidden Champion Issue 2 – ABC Mart & Masahiro Miki

(10) Birth of a Hidden Champion Issue 3 – Cub Elecparts and You Shan Quan

Birth of a Hidden Champion: Cub Elecparts and You Shan Quan 尤山泉

Dear Clients and Partners,

Birth of a Hidden Champion (Issue 3): Cub Elecparts and You Shan Quan 尤山泉

Welcome to the third issue of the “Birth of a Hidden Champion” tribute series, where we highlight inspirational stories on the listing birth of Hidden Champions creating and compounding value in the Asian capital markets.

On the 16th of November 2010, a Hidden Champion was born in the Taiwanese capital market. Cub Elecparts Inc (TSEC:2231), led by the innovative and resilient founder You Shan Quan 尤山泉, went on to compound nearly 400% to a market value of nearly US$1 billion today.

In an article written earlier in March/April 2017, we reviewed this global leader in Tire Pressure Monitoring Systems (TPMS) in the automotive aftermarket segment to identify how a leader with an insurgent mission can ignore its naysayers and persevere to build a wide-moat scalable business, resulting in a leading global market share in TPMS.

Asian Wide-Moat Company: Global Aftermarket Leader in Automative Tire Pressure Monitoring System (Excerpts)

This month in March/April 2017, we investigate Cub Elecparts (TSEC: 2231), the global leader in Tire Pressure Monitoring System (TPMS) in the automotive aftermarket segment with its two sensor SKUs (Uni-Sensor: 315MHz & 433 MHz), which has 98% coverage ratio in all types of cars, the highest compatibility in the world, enabling tire shops and aftermarket operators to reduce inventory and free up working capital and replacement work using CUB’s universal TPMS sensor product is quicker and easier for onsite technicians. CUB is also the exclusive OEM supplier to Wal-Mart since 2015. In North America, CUB claims 50% market share in standalone auto tire shops and in regional auto tire chain stores. CUB will benefit from car safety regulations which required Advanced Driver Assistance System (ADAS) to be fitted in new cars in the US (2007) and Europe (2012) with more countries following suit.

Cub Elecparts started from manufacturing automobile switches, which include those for dimmers and headlights, power windows, ignition and combination switches. The company expanded into automobile sensors in 2000, producing sensors for oil pressure, crankshaft position, camshaft position and vehicle speed. It leveraged its knowledge base in automotive sensors to break into the TPMS manufacturing in 2003. After years of efforts, CUB launched the first generatio∆n of its TPMS products in 2008, and the successful breakthrough third-generation universal TPMS in 2013. With the acquisition of microwave vehicle radar specialist in Jan 2016, CUB looks to expand into the multi-billion Advanced Driver Assistance System (ADAS) market and will start shipping its first ADAS solution in July 2017 from its automated production line in Shanghai Pudong plant. CUB will also launch its advanced 77 GHz radar sensors in 3Q to 4Q 2017 and commit to mass production in 2018. At present, CUB is working with 2 automotive clients for this advanced 77 GHz radar sensor products, including targeting the Japanese truck market. The founder’s family is the biggest shareholder with 52.2% stake.

We are impressed by CUB’s founder and CEO SC Yoo’s dedication, patience and focus in not only building up a Tier-1 supplier capability in its original non-TPMS switches and sensors business that expanded into the breakthrough unique patented universal TPMS product but also in forging a corporate culture that feels like an enterprise of engineers, reminding us of automotive parts innovator Gentex (GNTX US)/John Bauer which compounded 190-fold to $6bn market cap. We like how CUB has consistently reinvested back into the business to develop its R&D and new product innovation capabilities, as well as making tough strategic business decisions in focusing on the automotive aftermarket and R&D of the universal TPMS while avoiding the China TPMS market. CUB has proven to be focused and farsighted in stayed ahead of the game by building up new products beyond its automotive sensors and TMPS in the new ADAS solution segment that is now building up sales momentum as well as set CUB on a long-term growth trajectory path in the race towards the autonomous car.

Below are excerpts of founder Yoo’s inspiring entrepreneurial story:

“2003, when I went to America to pay a visit to automotive component giant Lear who is also one of our customers, I saw a production line doing TPMS. The Chinese auto engineer who showed me around shared with me that America is going to pass a legislation for the mandatory adoption of TPMS which will be a standard component in all new cars. I thought instinctively then that a great business opportunity has arrived. Whether I will succeed or not, I do not know but I have to try. In 2005, America passed the law in mandatory TPMS installation and EU, Korea, Japan, China followed suit. Every time a tire is replaced, the TPMS needs to be replaced too. Even if the tire is not replaced, the TPMS also needs to be replaced. This is because the battery lifespan is only 5 to 7 years and the battery cannot be replaced and hence the entire TPMS needs to change. This is another big market just like the tire market.

At that time, I was thinking to myself that this is entirely different from what we have been doing in car switches as the car can break down but the car switch hardly gets damaged. I was thinking hard on how we can achieve a breakthrough from this bottleneck imposed by the durability of the product lifecycle and the low replacement rate by the customer. My thinking was simple, to focus on becoming the best and number one player, as long as we keep growing our customers even in this low replacement car switch, we can still do well. So we devoted our resources to developing molds, which has grown from 70 sets in 2007 to over 1,300 sets now. This mold capability know-how that was acquired and accumulated over the years has also helped our development of the universal TPMS product.”

When I was in Detroit discussing and negotiating new product development with General Motors, I was thinking aloud to myself that every year there are hundreds and thousands of new car models by various car makers and my first generation TPMS can only cope with around 10 car models. If only there is a universal TPMS product that can be used in all car models, I shared my thoughts with the aftermarket industry folks. They agree, commenting that there are too many variety out there and when they are servicing their customers’ cars, every car has different TPMS and they are like a locksmith who must carry hundreds of keys which is heavy, burdensome and tiring. What the aftermarket operators describe as carrying hundreds of keys is a reality in the real world in that the auto mechanic shop has to carry a lot of TPMS product inventory of different variety, tying up precious working capital, and when the mechanic is replacing the new TPMS, a lot of time is expended as every car model is different in the TPMS installation.

During 2010 and 2011, CUB faced a lull period without any shipments of our first and second generation of TPMS products. Yet we persisted in our R&D efforts. By the end of 2012, when we are certain that our third generation TPMS product has achieved a coverage that exceeds 98% of car models, we decided to officially launch the universal TPMS product in the market in 2013. 98% coverage means that when the market has a new car model, the tire shop and auto mechanic outlet only need to refresh the new code online. Schrader, the leader in Original Equipment (OE) TPMS, only has coverage of around 80%. Having the patent in the universal TPMS decoder means having a master golden key to open the door to all auto manufacturers original TPMS.

This competitive edge in universal applicability has widen our lead substantially against our competitors. However, people will not know that we have invested ten years of R&D efforts since 2003 to sharpen this sword, enduring all sorts of ridicule heaped upon us by the industry, laughing at me that I will bring the company to bankruptcy. During this long painful process, the snide and criticisms from the industry players never ceased. They all said that this small little factory wants to do R&D, how can they ever hope to compete with the world’s number one TPMS OE company? If they continue to waste money developing this TPMS, they will definitely go bankrupt. When we have our breakthrough product, even Schrader took the initiative to visit us to negotiate a contract and became our customer. The world’s two largest TPMS diagnostic tools companies BATEC and ATEQ also proactively looked for us to discuss about a strategic alliance.

This success is not gambling luck but due to foresight and persistence. When you have a focused target, you must persist all the way to the end! Our TPMS system has combined the applications in GPS, mobile, rear camera vision in blind detection system (BSD), winter tires, TPMS for trailers and semi-trailers (18- to 22-wheelers), a dash cam with integrated TPMS, advanced driver assistance system (ADAS), and so on. Our core values is once we have found the right path, we will persist in the journey to press onward.”

What Makes It a Wide-Moat Business? Fundamental Dynamics Behind 49.4% ROE

  • (1) Unique patented universal TPMS with highest 98% coverage: While there are more than 200 types of TPMS on the market, CUB’s patented universal sensor products are able to cover and replace 98% of the TPMS products (OE sensor) available through integration and recoding technologies providing car profiles including brands and mileage, therefore relieving retail channel’s inventory pressure and also making the replacement process quicker and easier for on-site technicians.
  • (2) Attention to details to solve problems faced by underserved aftermarket customers and translate customer insights to continually develop superior product: The history of CUB follows a timeline of product innovations in solving problems by paying attention to the details and understanding the market and customer needs at the grassroot level. Some of the patented innovations include developing a universal TPMS that is also mounted on a patented screwed valve, in which the angle can be adapted to the rim within the range of 0 to 30 degrees to suit most aluminium and steel rims. Replacement work is quicker and easier for onsite technicians and mechanics.
  • (3) Leadership in automotive aftermarket with customer stickiness: CUB offers its RF coding devices to retailers for free as an incentive to sell its TPMS sensor while CUB’s competitors usually around US$2,000-US3,000 for the tool. Free updates are also provided to the customers while competing products charges update fees of US$150-250 per year. CUB also provides on-call service and over 2,000 training per year while aftersales service is practically none for competing peers.
  • (4) Leveraging deep intangible know-how in R&D and engineering capabilities to create new categories of growth from TPMS to ADAS: We like how CUB has leveraged its knowledge base in automotive sensors to break into the TPMS manufacturing in 2003. After years of efforts, CUB launched the first generation of its TPMS products in 2008, and the successful breakthrough third-generation universal TPMS in 2013. Noteworthy is its commitment to developing and investing in its mold capability know-how and asset base, which has grown from 70 sets in 2007 to over 1,300 sets now. This mold capability know-how that was acquired and accumulated over the years has helped CUB’s development of the universal TPMS product. This mold asset has also been important in helping to generate stable profitability of CUB’s non-TPMS product segment of varied but low volume orders items as a Tier 1 OE supplier with customers such as Chrysler, General Motors.

Warm regards,

KEE Koon Boon | Chief Investment Officer & CEO

Hidden Champions Fund

Birth of a Hidden Champion: ABC-Mart and Masahiro Miki

Dear Clients and Partners,

Birth of a Hidden Champion (Issue 2): ABC-Mart and Masahiro Miki

Welcome to the second issue of the “Birth of a Hidden Champion” tribute series where we highlight inspirational stories on the listing birth of Hidden Champions creating and compounding value in the Asian capital markets.

Last week on 19 October 2000, a Hidden Champion was born. ABC-Mart (TSE: 2670) was born as a listed company in Japan and, led by billionaire founder Masahiro Miki, she went on to compound 530% to a market value of over US$4.1 billion.

Below is an excerpt from an article “Making Right Buffett’s Biggest Mistake in Asian Wide-Moat Innovators” written back in May 2015 which is still relevant today in understanding why ABC-Mart has succeeded in compounding value.

PS: An update on the 2nd anniversary of our Hidden Champions Fund – our YTD (January to September) 2017 returns (net after fees) is over 20%, with our Fund benefiting from the flight-to-quality effect as the overall market retreats while we see a 7.9% gain in the month of September, bringing our total absolute returns to over 37% since our inception in September 2015. We like our clients to ask us tough questions to make intelligent decisions. Our first HNW client who invested $1 million with the Fund in June 2017 after asking tough questions, and in the process appreciated the high-conviction investing approach to achieve investment resilience, is up over 18% in returns since our initial launch offering event that we held four months ago in June. We also have had existing clients subscribing additional capital into the Fund. We will be extending our Founding Partnership Cash Bonus till the end of October for both existing and prospective clients before our Fund soft closed. For investors who like to participate in the long-term non-linear growth of the underappreciated emerging Hidden Champions, please drop us an email at to find out about the subscription process.

Warm regards,

KEE Koon Boon | Chief Investment Officer & CEO

Hidden Champions Fund

Making Right Buffett’s Biggest Mistake in Asian Wide-Moat Innovators (Excerpts)

Masahiro Miki is the low-profile secretive billionaire founder of ABC-Mart who worked alongside employees in stores during weekends. Miki owns around 30% of ABC-Mart and is ranked #11 on Forbes richest Japanese list with a net worth of $3.5bn. Not many people know that Miki-san is Korean-Japanese with a Korean name of Kang Jeong-ho, as he seldom shows himself in public. Like Dexter’s Harold Alfond who was an outstanding athlete and developed his passion for sports, Miki was an amateur boxer and sports lover. Miki, who had been interested in import clothing retail, switched to selling shoes when he realized that the Japanese shoe industry was not particularly competitive. Kokusai Boeki Shoji (International Trading Corp) was established in 1985 in Tokyo’s Shinjuku ward. Miki pursued brand businesses early on by securing domestic general-distributor rights to Hawkins in 1986 (it acquired trademark rights in 1995) and Vans in 1991 (it concluded a domestic trademark usage contract in 1994). This brand-management know-how has contributed greatly to ABC-Mart’s private brand-driven growth strategy. Miki entered the retail market in 1990 with the launch of ABC-Mart and opened four stores in central Tokyo that sold sneakers and work boots, riding the casual fashion trend at that time. In the late 90s, ABC-Mart accelerated the rollout of self-branded products utilizing the trademarks it had acquired, and broadened coverage by adding business and walking shoes.

ABC-Mart compounded its market value nearly 10-fold since 2000 to $4.4bn by streamlining the procurement structure and removing the middlemen from Japan’s multi-tiered shoe retailing structure and built a high-margin format. This was made possible with two innovations.

First, ABC-Mart sold private brand products directly procured from manufacturers that account for half of its total sales. ABC-Mart has earned a reputation for purchasing low-priced foreign product lines and then repositioning them as a major private-label brand through well-targeted product development and promotion. Hawkins is a prime example. ABC-Mart founder Masahiro Miki spotted the brand’s potential during a trip to London. It ultimately won the trademark to manufacture the Hawkins brand as its own private label. It targets younger women and now generates 20% of ABC’s sales. In addition to becoming a sales engine, the Hawkins experience has given ABC-Mart knowledge about shoe production costs that has helped the company negotiate better deals with other shoe manufacturers.

Another example: ABC-Mart carries two types of New Balance-brand shoes: the national lineup available at numerous retailers and an exclusive line produced in collaboration with the U.S. manufacturer. The latter, planned and designed by ABC-Mart, features limited-edition colors and prices that are slightly lower than the national line. The arrangement works for both ABC-Mart and the manufacturer. With the exclusive line, New Balance only has to tweak small design details, materials and color, making the partnership an easy way to drum up sales and recoup costs. Those exclusive products are also less susceptible to discounts, since they do not face price competition in the same way as products sold at multiple retailers. Shoppers often look at a shoe in a brick-and-mortar store, but ultimately purchase the same item for less online. But ABC-Mart’s exclusive products are available only at its stores, allowing it to secure profit even if the retail price is set lower. Gross margins on private-brand products are fatter at around 70% as compared to around 40-45% for non-PB products. Thus, the real wide-moat innovator knows how to redefine a product’s quality, cost and price to better meet consumer needs.

But a potential downside to the private brand strategy is ABC-Mart’s responsibility for the entire stock. If it misreads trends, the retailer can be left saddled with leftover inventory that cannot be returned to the manufacturer.

Thus, the second innovation is the ability to gauge consumer trends and demand. ABC-Mart was an early pioneer in installing POS systems when it first entered the retail market in 1990 and manages product flow on a single-item basis. Industry leader Chiyoda introduced the POS system only in 2008. It effectively controls inventory risk by keeping close tabs on popular and fading items, adjusting store product policies based on this information and capitalizing on a procurement structure with direct upstream links. Product management is via POS, giving the head office and each store a view of sales and inventories. Front-end consumer intelligence data was also harnessed. Acting on feedback from customers who wanted to wear sneakers but were more comfortable wearing heels, ABC-Mart developed a full line of sneakers with hidden wedge heels. These shoes flew off the shelves to become a major contributor to sales.

ABC-Mart also sought to solve the inventory challenge with an innovative in-store service that allows customers to directly place orders for shoes that are not in stock at its brick-and-mortar stores to the shoe retailer’s web outlet. Customers can place orders for shoes of any desired model or size from the in-store terminal when they are out of stock at the outlet they visit. They pay for the shoes there and then, and can choose to arrange home delivery or pick up the goods the next time they visit. The number of outlets that provide such services is around 600, roughly 80% of all ABC-Mart stores in Japan. The iPhone-based service, called “iChock,” minimize missed business opportunities due to items being out of stock as well as to reduce inventory at each store and improve capital efficiency.

With its extensive name-brand lineup and exclusive private-brand products, sales has been brisk despite the April 1 2015 sales price hike, posting a 12th year record high profits. While ABC-Mart has been the poster child of deflation-era retailing, with stores advertising shoes for as little as ¥2,900 ($28) and ¥3,900, along with clearance sales, it has found success in rolling out products that appeal to fashionistas who do not mind paying a little extra for style. ABC-Mart stores are also hot spots for many Chinese tourists who buy four or five pairs at once. ABC Mart found overseas success with over 180 stores, with over 150 stores in South Korea and the rest in Taiwan.

In Aug 2012, ABC-Mart also completed the $138m purchase of LaCrosse Footwear, a rival to Berkshire’s HH Brown and Justin Brands. Workwear consumers of the LaCrosse and Danner brands in America include people in law enforcement, transportation, mining, oil and gas exploration and extraction, construction, government services and other occupations that require high-performance and protection footwear as a critical tool for the job. Outdoor consumers include people active in hunting, hiking, outdoor cross-training. LaCrosse purchased storied bootmaker Whites Boots in 2014. Both these brands also sell well in Japan.

We have emphasized in earlier articles our observation that most Asian companies are “one-man-shop” operations with the founder making all the decisions. The willingness to build a culture of decentralization/ empowerment and invest in a system to cascade decision rights throughout the organization is an important signal that the founder desires and cares to scale up the company in a sustainable manner by not hoarding knowledge. Technology is an important tool in empowering the employees and in giving them an informational advantage in their respective roles and responsibilities at work.

Sam Walton himself solved the major problem of inventory and working capital to scale up the business by having a continual commitment in the intangible IT investments. Sam Walton’s penchant for a reliable and speedy information system is grounded in pragmatism: “Once we had those scanners in the stores, we had all this data pouring into Bentonville over phone lines. I like my numbers as quickly as I can get them. The quicker we get that information, the quicker we can act on it. What I like about it is the kind of information we can pull out of it on a moment’s notice.”

Both Sam Walton and Masahiro Miki faced a lot of resistance and doubts when they spent heavily on IT system – the money could have been spent on tangible assets like property. In the end, the scale and constancy of the investments involved in building the indestructible intangibles discourage imitators and disrupts complacent incumbents. They “stick to their guns” and that made all the difference to understanding the wide-moat advantage that they have built up. The Heart of entrepreneurship is summed up best by Sam Walton in his inspiring autobiography Made in America:

“It is a story about entrepreneurship, and risk, and hard work, and knowing where you want to go and being willing to do what it takes to get there. It’s a story about believing in your idea even when maybe some other folks don’t, and sticking to your guns.”

Birth of a Hidden Champion: TSMC & Morris Chang

Dear Clients and Partners,

Birth of a Hidden Champion (Issue 1): TSMC and Morris Chang

Welcome to the first issue of the “Birth of a Hidden Champion” tribute series where we highlight inspirational stories on the listing birth of Hidden Champions creating and compounding value in the Asian capital markets.

On this day on 24 October 1994, a Hidden Champions was born. TSMC (TSEC: 2330) was born as a listed company in Taiwan and, led by billionaire founder Morris Chang, she went on to compound 965% to a market value of over US$203 billion, surpassing Intel.

Without TSMC, smartphones would not have arrived as early as they did which has also drastically changed the daily lives of people and Apple likely would have found more difficulty in delivering its iPhones with the computing power they now boast. TSMC controls 56% of the global market for contract chip production and has helped to spawn the birth of over 450 fabless IC designers who are its customers, including Qualcomm and Nvidia, As Morris Chang commented during his recent retirement in early October 2017: “Since we established ourselves, fabless companies began to mushroom worldwide. Most of the innovations in the semiconductor industry in the last 30 years came from those fabless companies. That’s probably my biggest pride, to have caused a lot of innovations in the industry.” All these are among TSMC’s contributions to the world.

Morris Chang said Intel’s advantage lies in its robust technological power and strong business operation foundation, having maintained No. 1 in the global semiconductor for decades. But its biggest drawback rests with its inexperience in the wafer foundry sector that highlights a service-oriented corporate culture, as Intel’s technology departments have long served the company’s own needs, totally different from the core culture of serving others seen in the pure-play foundry sector. With his 25-year experience at Texas Instruments before founding TSMC, Chang said he realized very well what kind of corporate culture was needed for the foundry sector. He said when establishing TSMC 30 years ago, he was able to easily inject the service-oriented culture into the TSMC at the very beginning.

TSMC is also holding its 30th Anniversary Celebration Forum and Concert in Taipei, Taiwan on October 23, inviting the many customers, colleagues, suppliers, investors, and partners from government and across society to mark the milestone together. Morris Chang commented: “In the last 30 years, we have joined hands with our partners to unleash numerous innovations in the semiconductor world whose products have been pervasively used in all parts of the world and have made many people’s lives more secure, comfortable and convenient. Through the process, we have also established long-term trusting relationship with not only our partners but also many of our major shareholders. At this 30th anniversary celebration for TSMC, we want to show our gratitude for all those who have been a part of our history.” The Hidden Champions Fund sends our heartiest congratulations to TSMC’s 30th anniversary.

Below is an article “Any Benjamin Franklins in Asia?” written back in May 2013 which is still relevant today in understanding why TSMC has succeeded in compounding value while Singapore learnt painfully, through the spectacular failure of its homegrown loss-making, debt-laden Chartered Semiconductor Manufacturing (CSM) which was started in the same year as TSMC in 1987 but sold in 2009 to GlobalFoundries for $1.8 billion, that the scalability and resilience of the business model is not about pouring ever more tangible resources and money with efficient centralized “leadership” to manage assets and people as costs but rather it’s about having a culture of values, trust and collaboration to foster innovation and customer service. And this indestructible intangible asset is the essence of deep moat competitive advantage found in the emerging underappreciated Hidden Champions that we invest in.

PS: An update on the 2nd anniversary of our Hidden Champions Fund – our YTD (January to September) 2017 returns (net after fees) is over 20%, with our Fund benefiting from the flight-to-quality effect as the overall market retreats while we see a 7.9% gain in the month of September, bringing our total absolute returns to over 37% since our inception in September 2015. We like our clients to ask us tough questions to make intelligent decisions. Our first HNW client who invested $1 million with the Fund in June 2017 after asking tough questions, and in the process appreciated the high-conviction investing approach to achieve investment resilience, is up over 18% in returns since our initial launch offering event that we held four months ago in June. We also have had existing clients subscribing additional capital into the Fund. We will be extending our Founding Partnership Cash Bonus till the end of October for both existing and prospective clients before our Fund soft closed. For investors who like to participate in the long-term non-linear growth of the underappreciated emerging Hidden Champions, please drop us an email at to find out about the subscription process.

Warm regards,

KEE Koon Boon | Chief Investment Officer & CEO
Hidden Champions Fund

Any Benjamin Franklins in Asia?

Why is Benjamin Franklin, Charlie Munger’s hero, the ubiquitous face on the hundred-dollar bill, the largest-denomination bill in circulation in the U.S. today? Why not a President – Abraham Lincoln or George Washington? And how does this “uncommon” insight help value investors to identify the resilient compounders globally and in Asia?

Even Americans who handled the familiar winking Benjamins daily are puzzled themselves when I asked them and there is no official answer as to why Franklin is honored, like a curious big blindspot. While Franklin is recognized as the only founding father who signed on all four major documents which led to the formation of the United States, including the Declaration of Independence and United States Constitution, Franklin is honored for contributing much to what is deemed most “American” about United States. He was a tireless inventor-entrepreneur solving the nation’s biggest problems and creating innovative solutions mostly from behind the scenes, having created the lightning rod, the first bifocal glasses, odometer, urinary catheter, the Franklin stove and yet he never filed for patent for all his inventions. He believed that “knowledge was not the personal property of its discoverer, but the common property of all.” Dean Kamen, the contemporary American inventor-entrepreneur of the infusion pumps for chemotherapy and treating newborn babies, the world’s first insulin pump, the technology used in portable home-use dialysis machine and many more, believe that solving problems and creating solutions create real wealth and is the essence of what makes America great for over two hundred years: “Real wealth is not a zero-sum game, like moving oil here or moving gold there.” In other words, inventor-entrepreneurs like Franklin and Kamen want to build and scale their ideas and inventions so that they can give or “empty” more. We need to “empty” ourselves before we become open to the possibilities to innovate. Only when we have the desire to “empty”, then can we want to persevere in building something meaningful. This urge to build in order to give is the magnetic north to scale a resilient compounder and they work obsessively to realize this vision. This “emptiness” is akin to the empty hollow center of a bamboo. The vitality and resilience of the bamboo growth revolves around its “emptiness”: the nutrients and moisture that would have been exhausted making and maintaining this empty center can be utilized for growth of other stems. It’s about having an intangible idea that is larger than our own individual self to provide useful products and services to benefit other people and in turn become a resilient compounder – the Bamboo Innovator.

Are there any Benjamin Franklins in Asia? In Part 1, we got acquainted with the insight that “entrepreneurship in Asia is usually driven not by a new idea but by the desire of being your own boss”. This comment was made by a Chinese entrepreneur who has built an Asian-listed global company that has multiplied over 26-fold in 19 years since its Sep 1994 listing to an all-time-high market value of $100 billion. He started the company at the young age of 55 in 1987 based on a “new idea” that he was laughed at and ridiculed everywhere. He is Morris Chang, recognized around the world as the creator of the world’s first pure-play dedicated semiconductor foundry, TSMC (2330 TT and TSM US [ADR]), the most valuable company in all of Taiwan and possibly the most valuable semiconductor in the world nearly on par with the mighty Intel in market value.

Recall how Franklin astonished the Europeans, who were accustomed to the solemn deliberations of royal academic societies, by venturing into a rainstorm with a kite to prove lightning was electrical, thus proving the resilience of the lightning rod? Without any strength in IP, circuit design, R&D, sales and marketing, Morris Chang also shocked his backers which include K.T. Li, the minister best known as the “Father of Taiwan’s Economic Miracle”, by boldly choosing a pure-play foundry business model that had a fatal problem then: “Where’s the market?” Who is TSMC going to manufacture the wafers for? The Intels and Texas Instruments are also manufacturers themselves and they would let TSMC manufacture their wafers only when they didn’t have the capacity, the leftovers, or didn’t want to manufacture the stuff themselves anymore. As soon as they got the capacity they would stop orders to TSMC, so it couldn’t be a stable market. And when they didn’t want to make the wafers anymore, the chances were that it was losing money for them. And so why would TSMC want to do it? Does TSMC want to take over the loss? And Taiwan is two generations behind in technological capabilities. As Morris Chang recalled, the experts all laughed, “What the hell is Morris Chang – and Taiwan – doing?”

The “lightning rod” that Morris Chang carried with him to bend and not break like the bamboo in the rainstorm with his “new idea” of a pure-play business model was this unusual insight that was a blindspot for everyone else. When he was a longtime executive at Texas Instruments, he saw that a lot of IC designers are unhappy at work and wanted to leave and set up their own business, but the only thing, or the biggest thing, that stopped them from leaving those companies was that they could not raise enough money to form their own company. Because at that time it was thought that every company needed wafer manufacturing and to build a wafer fab was the most capital-intensive part of a semiconductor IC company. With TSMC acting as a pure-play platform since the TIs are not interested in the success of their former employees by providing either fab capacity or important customer support services for them, TSMC could solve a major problem for these enterprising IC designers to strike out on their own. They will become TSMC’s customers, constituting a stable and growing market. Another thread that inspired and formed the foundation of the “new idea” for Morris was his reading of the academic writings of researcher Carver Mead who gave him the idea that the design part could be separated from the technology. CEOs or entrepreneurs or even value investors who pride themselves for being practical often scoffed at the term “academic” or “theory”. As Morris proved, nothing is more practical than “theory”! It is noteworthy to appreciate that Morris Chang returned to Taiwan as a relatively wealthy man and successful executive at 53 at K.T. Li’s invitation to head the think-tank ITRI (Industrial Technology Research Institute) at a much-reduced compensation. Yet his thirst for knowledge and learning never ceases. Morris reflected on his life path, “You need to follow your interests not where you think the big money is. Because, obviously, back in 1985 the big money was thought to be in financial venture capital, or maybe even continuing to manage a company in the U.S., but I felt that the Taiwan opportunity appealed to me from the interest point of view.”

As the fabless IC industry took off from 1991, its enabler TSMC became a powerful value compounder. The success of fabless innovators such as Qualcomm and UK’s ARM to leapfrog over their integrated rivals (known as IDMs, or integrated device manufacturers) such as TI was made possible because of TSMC. As Qualcomm President Steven Mollenkopf said, without ties to TSMC, “We wouldn’t have been here.” The IC designers are not able to trust that their proprietary work will not be copied by the IDMs if they outsourced manufacturing to them or to other foundries; they are able to trust TSMC. And Qualcomm is now as big as Intel in terms of market value, having compounded over 110-fold in 21 years since Dec 1991 to $112 billion! Naturally, the value investor in you might ask, what’s so moaty and innovative about this business model that others cannot replicate? Despite its capex-intensive nature, Bamboo Innovator TSMC has “emptiness” at its core that is rooted in a culture of trust and collaboration. One of the sources of “emptiness” is the indestructible intangibles that stem from having trust and support in the community. The exciting and important exchange at the market peak in Oct 2007 between Morris Chang and JH Huang, the founder of California-based gaming graphic chip designer Nvidia who is a TSMC customer, is worth reading over and over again whenever we are too caught up in the second- or third-order analysis of “technology curve” and geek-speak in looking at TSMC:

Huang: “In retrospect, most of the people who looked at the foundry industry thought that technology and capacity were important. It is important but they really missed what ultimately made TSMC extraordinary and more powerful in the end is this incredible focus on customer service. I remember, when you called and you said, and it was a phrase that I remembered then and that I’ve heard several thousand times since then, ‘We will jump through hoops for you.’ And one of the things that I really admired about that was that it wasn’t just what you told me that day. It was a phrase that drove through all of TSMC. Every employee believed in it and lived by it. People repeated it year over year. How did you do that? How did that start and how were you able to drive that through the culture?”

Morris: “In TSMC, we actually tailored everything in the company, the organization, the compensation system, the evaluation system, we tailored everything to customer service, to jumping through hoops. Let me tell you an anecdote. I was visited by a big company more than 10 years ago, and he was very big and we were still fairly small. We were couple billion dollars maybe and he was a lot more than that. His sales were several times that. He and I had dinner together and this CEO of this big company, he sort of intimidated me by saying, ‘Well, maybe I will go into your business and compete with you.’ So I let that go for the time being. Several minutes later, I asked him, innocently, ‘John, how do you evaluate your fab manager?’ So he gave me the list. ‘Well,’ he said, ‘yield, cycle time, productivity, ability to make billings every month,’ you know, all those things he told me. After he ran through his list of 10 or 12 factors, he said, ‘What else? Don’t you evaluate your fab managers the same way?’ I said, ‘No, no, no, John. I evaluate them according to how much complaints I get from customers about their fab.’ And that’s the honest truth. I really did that, have always done that, the evaluation of the fab managers. We don’t even keep P&L in each fab. We don’t. But we do keep very good track of how satisfied the customers are. If a fab manager has got very unsatisfied customers, he is in big trouble. I don’t care how much money he makes. He is in big trouble.”

The intense focus on providing superlative customer support services by jumping through the fire hoops for them is embedded into its open innovation business model. “Open innovation” is another source of “emptiness” in Bamboo Innovators as shared earlier. As demonstrated by the stunning success of Qualcomm, the largest fabless company, the chip industry is re-integrated in terms of knowledge flows rather than through integration within a single company. One industry insider puts it, “Design for manufacturing is a contact sport. You’ve got to be communicating closely, effectively, and systematically.” TSMC has become steadily involved with design. Although most of its customers rely on their own design teams or those at service providers allied with TSMC, the foundry has found it increasingly necessary to develop in-house expertise in order to help its customers create manufacturable designs and fill TSMC’s fabs. TSMC would develop and acquire technology files, process design kits (PDK), interface IPs, ERP and a rich portfolio of open libraries for use not only by its engineers but also by its customers. These reusable building blocks are essential for many design projects to help its customers complete their designs successfully and in less time, at lower cost. For instance, UK smartphone chip designer ARM and TSMC celebrated the completion of the implementation from RTL to tape out of the world’s first 20nm ARM Cortex-A15 MPCore processor in 2011 in six months, indicating the readiness of TSMC’s Open Innovation Platform® (OIP) 20nm design ecosystem. Thus, although ARM has 2,300 employees, it has a market cap of $23 billion and there are more than 35 billion ARM-based chips out there with the open innovation platform provided by TSMC.

Morris Chang was worried about being delayed by traffic in the TSMC’s shareholder meeting so the punctual down-to-earth Morris took the High Speed Rail from Hsinchu Science and Industrial Park to Taipei with the public in a photo taken in Oct 2012. Because a ‘big boss riding the train’ is truly too difficult to imagine, the photo was suspected to be doctored but later it was proven to be true. The female pictured in the photo sitting next to Morris was immersed in her study on the train and netizens jokingly said that if she would just raise her head and talk to Morris for ten minutes, it would be worth ten years of study.

The competitive edge in these design enablement via the open innovation technology platform is made sustainable because of focus on customer’s success carefully cultivated by Morris Chang: “All through the 1990s, and even now, really, the biggest joy I get out of this job was to see my customers grow and make money and succeed.” Interestingly, with the rise of the ARMs, once-proprietary chip design is increasingly commoditized. After all, nearly all mobile chips these days are centered on the ARM architecture. For the cost of a license fee, companies such as Apple can create their own modifications and hire a foundry to manufacture the resultant chip. The keen observers in the tech space would have noticed that the profits in the value chain, where the hockey puck is going as hockey legend Wayne Gretzsky would say, is shifting to manufacturers and there are only three or four manufacturers – Samsung, TSMC, Intel, GlobalFoundries – who have the capability and capacity to build the chips that are in every mobile device today and in everything tomorrow. Foundry price is about one-third of the final chip value. TSMC controls about half of the $39 to 40 billion market for contract-chip manufacturing. Morris Chang said that today about a third of industry sales is outsourced, a ratio that will continue to rise.

That’s why Intel, who prides itself as a design company, is eager to scale up its foundry business especially when Apple is dying to diversify out of Samsung’s supply chain in its smartphone and tablet chips. Apple’s transition will be complicated, because Samsung is involved in part of the processors’ design, in addition to fabricating the wafers that foundries normally handle. Intel has also recently promoted its COO Brian Krzanich to CEO in an apparent move to focus on manufacturing. It is noteworthy that Intel’s wafer cost is similar to TSMC’s wafer price and Intel’s fab arrangements is not as efficient as TSMC’s “mega fab” strategy. Intel’s fab ops are used to serving only internal customers and its corporate culture would have to change to a 24-hour customer service oriented one to compete effectively. Qualcomm, Nvidia, AMD, Altera, and Xilinx are currently the top five early adopters of technology at TSMC. Since Intel competes directly with Qualcomm, Nvidia, and AMD in PC microprocessor, smartphone, and tablet, Intel is unlikely to offer its leading-edge manufacturing technology to help these competitors. The exclusive contract between Intel and Altera also excludes Xilinx as a potential Intel customer. This leaves only Apple as the potential significant foundry customer for Intel. Yet, even Apple competes with Intel indirectly; Intel’s advanced technology could enable Apple’s SOC to replace Intel’s CPU on MacBook Air; and Intel is improving its own SOC to enable Apple’s competitors. The silent wisdom of Morris Chang in his “new idea” of building a pure play business model 25 years ago to be a partner to its customers and not a competing rival starts to ring louder, given the contradictions and limitations that Intel would face in its existing business model when it embarked upon scaling its internal foundry business for external customers. Interestingly, since the October 2007 market peak, TSMC is up 77% while its Taiwanese foundry rival UMC is down 37% and Intel is still down 5% as compared to the 20% rise for the Nasdaq index.

When fab managers at TSMC are measured and empowered to focus on customer service rather than P&L as Morris Chang shockingly points out, it rooted the corporate culture to treat employees as intangible assets to enable innovation at the customer level rather than as expenses to efficiently manage by the HQ “leaders”. As Singapore learnt painfully through the spectacular failure of its homegrown loss-making, debt-laden Chartered Semiconductor Manufacturing (CSM) which was started in the same year as TSMC in 1987 but sold in 2009 to GlobalFoundries for $1.8 billion, the scalability and resilience of the business model is not about pouring tangible resources with efficient centralized “leadership” to manage assets and people as costs but rather it’s about having “emptiness” at the core that is rooted in a culture of values, trust and collaboration. Nvidia’s founder JH Huang recalled with fondness that the first time when he visited Morris Chang in Taiwan, instead of a presentation about all the capabilities of TSMC, Morris gave him a brochure of the core values of TSMC. And Morris said, “And I do the same thing with a lot of visitors, with every customer, every potential customer.”

“I had decided at the start what the values of the company should be. Those values were very important to us, not only in the first phase of survival but from there on. We have maintained them. We have actually followed them. They are our compass, really. The values are pretty simple. At first, there were just three: integrity was number one; commitment, we really wanted our employees to be totally committed to TSMC but, in return, the company is committed to the employees, too. Also, commitment applies to customers. We want the customers to be committed to TSMC but we, in return, are totally committed to customers. Integrity is pretty simple, self-explanatory. Commitment works between employees and the company and between customers and the company. And then the third one is innovation. We knew that we couldn’t compete at all without constantly innovating. Those were our three values. The three values that we had at the beginning are still values today. Political candidates usually, before they start their campaigning, would call me so the presidential candidate came and told me all his big vision about Taiwan and I handed him our values: integrity, commitment and innovation. The presidential candidates from both parties saw that. In fact, I thought that I detected in each of them a little surprise? They don’t know what to do with it.”

Besides enabling the $300 to 400 billion fabless industry to sit on top of its resilient business model, TSMC has also played a pivotal role to Taiwan’s economy. As Acer’s founder Stan Shih commented in the Nov 2012 Forbes article on Morris Chang titled “Ageless and peerless in an era of fabless”, “TSMC buttresses Taiwan’s global competitiveness in industries ranging from machinery to auto parts because of the importance of chips in those businesses.” If all this is not enough, Morris Chang is also a bridge player who expresses a longtime interest to play with Warren Buffett and Bill Gates – and Nvidia’s JH Huang teases Morris jokingly that “he has quite a bit of confidence he would prevail.”

Sadly, if the comments by Morris Chang that “entrepreneurship in Asia is usually driven not by a new idea but by the desire of being your own boss” were shared with a number of wealthy and property-rich Asian and Singaporean businessmen without them knowing they were made by someone who built a $100 billion market-cap company and who started the firm at the age of 55, they are likely to react with scorn and disgust. “What new ideas?” Entrepreneurship to them is about “Can make money or not?” (a popular phrase in our local colloquial Singlish language which has deliberate grammatical errors). “If inventors were entrepreneurs, Thomas Edison would not have died a poor man,” a local expert commented in our local press two years ago in defending against well-intentioned observations on the award of the “Entrepreneur of the Year” to wealthy businessmen who can make good money largely for themselves but might not possess the “X-factor” in creating larger-than-self new business models or new ideas to benefit others.

At its best, entrepreneurship entails something far more important than mere money. The December 1949 issue of Fortune with the feature essay titled, “The Moral History of U.S. Business” was inspiring in its description of entrepreneurship: “An enterprising man not in haste to get rich, willing to run some risks, yet not willing to risk in hazardous enterprises the property of others entrusted to his keeping, careful to indulge in no extravagance and to be simple in his manner and unostentatious in his habit, not merely a merchant but a man, with a character to form, a mind to improve, and a heart to cultivate.” Ben Franklin, Charlie Munger, Morris Chang, Qualcomm’s founders Irwin Jacobs and Andrew Viterbi and ARM’s Warren East would add, “… and a new idea to innovate”.

Happy Diwali! The Inner Light of Asian Compounders

Dear Client and Partners,

Wishing you all a very happy Diwali! May this festival of lights awaken the Inner Light in all of us and bring with it inner joy and peace.

A Diwali-related business story that we find inspiring is from the fascinating book “The Resilience Dividend: Being Strong in a World Where Things Go Wrong”, in which Judith Rodin, president of The Rockefeller Foundation, recounted the well-known story of billionaire Anand Mahindra’s near death experience – and resilience – in the day before the Diwali festival in 1991.

Anand Mahindra was attempting to turn around the business with productivity improvements and broke down the barriers between the silos of manufacturing, marketing and sales, and finance in the company. On the day before Diwali, Anand Mahindra made an announcement to the factory floor that the traditional holiday bonus would be awarded differently than it had in the past. For the first time, it would be linked to the achievement of performance targets and negotiated through the labor unions. Not long after making the announcement, Anand Mahindra looked out of his window and saw a line of angry workers charging into the factory floor. Anand Mahindra and a group of union leaders he was with scrambled into Anand Mahindra’s inner office and locked the door. A four-hour standoff ensured. The union leaders advised Anand Mahindra to stay put until the workers left, but Anand Mahindra at last decided it would be best to have a direct conversation.

Anand Mahindra walked out of his office to the factory floor and asked everyone to sit down. “If you want to throw me over the railing, you can. But that won’t change anything. The world is changing and there’s not going to be a free lunch anymore.” The workers did not throw Anand Mahindra over the railing. The mood completely changed. They calmed down and waited to hear what he has to say. At the end of the “conversation”, there is a sense that “we’re-all-in-this-together” mentality and one of the workers even asked for Anand’s autograph!

We like to also share another Diwali-related article that we have written earlier: “The Inner Light of Asian Compounders: The Reborn of India’s Hero Motocorp”, also a tribute and remembrance to the wise leader Brijmohan Lall Munjal, the late billionaire founder of Hero Motocorp.

Warm regards,
KB and the team at Hidden Champions Fund
KEE Koon Boon | Chief Investment Officer & CEO
Hidden Champions Fund

The Inner Light of Asian Compounders: The Reborn of India’s Hero Motocorp

A Hero lights up this Diwali festival: Hero Motocorp (HMCL IN, MV $6.8 billion), the world’s largest two-wheeler manufacturer (by volume), announced on Nov 1, the first day of Diwali, that they achieved the highest-ever retail sales (625,420 units, +18.2% yoy) for any month in October in India. This is also the first time that any two-wheeler manufacturer has exceeded the landmark 6 lakh unit sales in a month. Hero sold 6.23 million units in the year ended March 31, and has a capacity to produce 7 million annually. Hero’s performance stood in contrast to the four-wheeler market in which the automakers from Maruti Suzuki, Tata Motor and Mahindra & Mahindra reported lower or nearly flat sales with the Indian economy growing at its slowest pace in a decade and accelerating inflation (onion prices has surged from Rs 16 a kg in Jun to Rs 100) leading the central bank to raise its lending rate twice in as many months. Interestingly, just three years ago on Dec 21, 2010, Hero hit a crisis and was thought to have problems surviving in India. Yet, Hero has emerged stronger from the crisis because of its “Inner Light”, just like the spiritual significance of Diwali.

Diwali, also called Deepavali or the “festival of lights”, is a five-day Hindu festival to celebrate the slaying of the evil demon Narakasura by Lord Krishna, the incarnation of Vishnu (the supreme god of Hinduism), signifying the victory of good over evil and light over darkness. The deeper spiritual meaning of Diwali celebrates the belief that there is something beyond the physical body and mind which is pure, infinite, and eternal, called the Atman or the Inner Light. With this awakening of the Inner Light comes compassion and the awareness of the oneness of higher knowledge which brings ananda (joy or peace).

Hero Motocorp (HMCL IN) – Stock Price Performance, 1995-2013

Hero Motocorp is an incarnation of Hero Honda, the JV formed between founder Brijmohan Lall Munjal and Japan’s Honda Motor (7267 JP) in 1984 in a country that did not think beyond scooters back then. By 2001, Hero Honda beat Bajaj Auto (BJAUT IN) to become India’s largest two-wheeler manufacturer – and also the world’s largest for 12 consecutive years. In the years between March 2000 and March 2011, Hero Honda’s revenue grew from Rs 2,118 crore to Rs 20,787 crore ($3.4 billion); profits increased from Rs 192 crore to Rs 1,927 crore ($314 million).

On Dec 21, 2010, Honda announced a bitter split up and Hero bought over their 26% stake for Rs 3,842 crore ($622 million), ending the 26 year-old JV which started with equity of Rs 16 crore, of which Honda contributed Rs 4 crore. Worse, Honda will be competing with Hero in India and Hero has to drop the Honda name from its brands, products, and distribution outlets after March 2014. How would customers know that the Hero bike is not Honda nad that the quality has not gone down? Dealers are thought to be stampeding out of Hero to join Honda. Prior to the termination of the joint venture, Honda supplies technology for products which Hero marketed in India and Hero’s right to use Honda’s new technology for Hero’s new products will end in 2017, though they can continue to use the existing technology. The 90 year-old Munjal commented, “They didn’t tell us that they want to leave. We told them that if they, themselves, are here to make motorcycles, then they become competitors. How can a competitor and principal be the same?” Since the split, Honda, the world’s biggest motorcycle maker, overtook Bajaj Auto to become India’s second biggest two-wheeler seller with around a 20% market share and vowed to overtake former partner Hero’s 43% leadership by 2020. “We want to be number one in every market we are in, it’s unacceptable at the company to not be number one,” said Tatsuhiro Oyama, senior managing officer in charge of Honda’s motorcycle operations.

The main reason for the split is the typical principal-agent case in Asia: Success. As Hero Honda grew enormously successful, it increased the aspirations of Hero to export and develop the products in-house with its own R&D. Honda, of course, refused any exports though they later modified the agreement to allow exports of limited products to a few countries, namely Sri Lanka, Bangladesh, Nepal, and Columbia. The second contentious issue was that of board representation. Hero felt that the four Honda representatives on the board had access to its plans and strategies, while they had access to none of Honda’s plans. This, Hero Honda had felt amounted to a conflict of interests when Honda decided to launch a 110cc motorcycle, the segment that formed over 70% of Hero Honda’s sales. The third issue was related to Hero Honda wanting to do its own independent R&D and manufacturing its own products. When it asked Honda to be allowed to do so, Honda’s response was “R&D is our heart and we can’t give our heart to anyone”. Honda in turn was unhappy with the Indian family for not injecting the lucrative spare parts business into the listed JV. When the split was announced, the share price fell from Rs 2,000 to Rs 1,500, which subsequently rebounded to over Rs 2,000. During the recent emerging market crunch with the sharp decline in rupee, share price again fell from Rs 2,000 to Rs 1,500 before rebounding to Rs 2,000. Even now, of the 66 analysts who track the stock, 27 rate it a sell, while 19 advise buying it, according to data compiled by Bloomberg.

So how did Hero survive the crisis? What are the lessons for value investors in assessing stocks in Asia beyond the quantitative financial numbers?

Munjal’s journey at Hero is an extraordinary story of entrepreneurship in the face of adversity. Importantly, it is the tale of a man who has lived his life on the principle that if you work hard and be good to people around you, success in business will, inevitably, follow. Munjal started off by manufacturing bicycle parts in 1944, travelling “across India carrying bicycle parts in a bag” and showing dealers the samples. In the initial phase, the dealers simply shoo off Munjal: ‘Sir, you’ll show something and send something completely different. This won’t work’.” Munjal never lose heart. Over a long chat, he would convince the dealer to place just one order; if it didn’t turn out to be as promised then the dealer was free to never order again. “Because we did that, our reputation, right from the first day, was very good. And then people stopped asking for samples. They would directly place the orders.” Munjal decided to manufacture bicycles, recalling that the bicycle-makers Raleigh, Hercules and Atlas mocked him, “They said they had got the technology from England, loans from banks and then started making bicycles. They would say, ‘Will you do it just like that?’ Within six months of us starting operations, they were all taken aback”.

What worked for Hero was simple – whatever was promised was delivered, and there was no attempt at profiteering. “Other people would show something and deliver something completely different. Or after one consignment, if sales were good, they would tell the dealer that the price of raw materials had gone up and then increase the prices. We never did anything like that, unless the Government of India announced that price of raw materials had gone up,” says Munjal. During his bicycle manufacturing days, while in search of machines, Munjal found inspiration from Germany. “People used to be surprised at why I would go to Germany so much. But I got the best technology, met such nice people and was very impressed with their working style,” he says. “I saw that if a person committed to something, even if it is a loss-making proposition for the company, he would go out of his way to keep his commitment. And the Germans would never do an incomplete or inferior job. That influenced me… that whatever I do, I should do it perfectly.” Those were the days of the ‘Licence Raj’. It was easy to get tempted and make money through a licence for a commodity in short supply, such as steel sheets, oil or even power. These could be traded in the market for a handsome profit. “We had a licence to buy steel sheets and if we were to just sell that, there would have been no need to make bicycles. But, with God’s grace, we never ever thought like that,” says Munjal.

These values helped Hero build a reputation where dealers and suppliers had unflinching trust in the company. Building a pan-India dealer and distribution network to reach out the rural consumers is critical for the business model to scale up sustainably. And reach is not just in terms of the sales touchpoint but importantly it’s about service and it is ultimately what determines how much one can sell. From day one, Munhal adopted a very personalized approach towards dealers. The final interview and selection of every dealer that the company has appointed in the last 30 years has been done by Munjal himself. At Hero, there are many such stories about Munjal – be it knowing the company’s thousands of dealers on a first-name basis or personally calling suppliers on their birthdays. But Munjal doesn’t find any of this surprising. “Wouldn’t you do that if it was your family?” he says. So people feel connected and engaged with the company. As a result, from December 2010, when the split happened to January 2012, only two dealers out of its vast network of 5,500 across the country have left Hero. This intangible quality in the trust and support from its community of customers, suppliers, employees, and partners is the Inner Light that helped Hero bend not break in the crisis like the bamboo.

Data from the Society of Indian Automobile Manufacturers show that sales of two-wheelers in India rose an astonishing 85% between 2007-2008 and 2011-2012, to 13.4 million units a year. Much of the growth was driven by demand for fuel-efficient transport in rural areas — where public transport is often poor or nonexistent — and from specific segments of the urban population such as students, office workers and working women. India’s rural spending was $67.57 billion between 2009-10 and 2011-12, compared to urban consumption of $53.95 billion in the same period, according to a November 2012 note by India Brand Equity Foundation. Rising incomes and low penetration of consumer durables are the reasons cited for the growth in spending. Nearly half of Hero’s sales come from rural markets where it has deep-rooted brand equity. Through its vast network of dealers, Hero organizes free vehicle servicing and free health checkups in medical camps in over 100,000 villages around the country to bolster its presence and attract new customers. Hero also has creative marketing campaigns over the years that have entered into the hearts of millions of consumers, ranging from “Fill It, Shut It, Forget It” emphasizing the low-maintenance fuel efficiency to “Why should boys have all the fun?” featuring the Bollywood film-star Priyanka Chopra to “Hum Main Hai Hero” (There is a hero in each one of us).

The company is still relying on technology from Honda for its best sellers, the 100-cc Splendor and Passion, and is struggling to introduce new independent models. Hero and Honda have signed a new licensing agreement under which Hero will pay Honda 45 billion yen ($458 million) or an annual royalty of $228 million till 2014. Since going solo, Hero has developed new engines of 100cc, 110cc and 250cc capacity with technical partners that include Austrian engine-developer AVL and Italian design firm Engines Engineering. Apart from the new engines, Hero is set to commercially launch its first motorcycle without the technology of Honda in the year ended March 31, 2014. “Our ultimate aim is to have our partners as an extended R&D arm for Hero MotoCorp. These partners have huge specifications available and we want to be known as a full-fledged global two-wheeler brand eventually,” Munjal has said. The company is investing Rs 450 crore ($73 million) to set up a R&D centre near Jaipur in Rajasthan. The facility would be commissioned in the first quarter of 2015. In July 2013, Hero acquired a 49.2% stake in US-based Erik Buell Racing (EBR) for $25 million after entering into a technology sourcing pact last year. The investment is part of the strategy to enhance its own technological prowess and have multiple technology sources for different segments. Erik Buell is one of the most revered names in the motorcycle industry Erik Buell has been instrumental in developing some highly advanced technologies for motorcycles over the years and is the only American sportbike maker in the world. Erik F. Buell (in photo with Hero’s Pawan Munjal) commented: “EBR is delighted to partner with a company as iconic as Hero MotoCorp. Both HMCL and EBR share the common commitment to manufacturing world-class two-wheelers with technology of the future. I have personally been deeply impressed with and inspired by Pawan’s vision. He has given us a challenging brief, and our highly-motivated team is working towards giving shape to that dream. We look forward to designing technology solutions which are in line with contemporary global standards and also futuristic in their appeal and utility.”

Hero also looked to expand in global markets to make up for lost time. In August this year, it had announced plans to enter 50 new markets by 2020 with a target of 20 manufacturing facilities across the globe and an overall annual turnover of Rs 60,000 crore ($9.8 billion). Hero currently exports about 200,000 two-wheelers annually while rival Bajaj sells more than 1 million, making significant progress in reaching out to emerging markets in the years Hero was restricted to South Asia. For instance, in Nigeria, Bajaj is the market leader and Bajaj has a significant presence in many Latin American markets and exports make up 35% of its two-wheeler revenue as compared to around 3% at Hero. Hero expects to export nearly 75% more (350,000 units) in 2013-14. Hero and EBR would also promote selling and marketing of motorcycles in the Western Countries, namely North America and Europe and Hero also plan to set up an assembly line for EBR.

The biggest challenge for Hero will be to allocate resources and capital. There is unprecedented demand for capital for initiatives ranging from R&D, spare parts capacity enhancement, developing exports markets, manufacturing capacity expansion, tying up with technology vendors and re-branding. These costs will put pressure on profitability as initiatives such as R&D and exports do not yield results immediately. However, it helps that Hero possess the three sources of “emptiness” in Bamboo Innovators: the indestructible intangible of the trust and support from its community of suppliers, dealers and partners; the core-periphery network of the 5,500-strong dealers, particularly in the rural areas; and the open innovation model that it now adopts in working with external technological partners such as EBR to co-develop new products. With this Inner Light lit up, value investors can see more clearly the uncertain path ahead for Hero in the face of the formidable partner-turned-rival Honda, just like how the lights of the oil lamps during the moonless night of Diwali are turned on to invite the blessings of Lakshmi, the goddess of prosperity and well-being.

Without the Inner Light to guide the path, it is easy for value investors relying on quant financials to always get overconfident and pick up “cheap”-stocks-turned-value-traps such as China’s largest two-wheeler Lifan Industries (601777 CH, MV $1.08 billion) or Vietnam Manufacturing and Export Processing (VMEP) (422 HK, MV $61 million), the third-largest manufacturer of scooters and motorbikes in Vietnam and 67% owned by Sanyang Industry (2006 TT, MV $884 million), not realizing that while the listed vehicles have some “net-net” tangible manufacturing assets, the lucrative intangible assets in distribution and spare parts are not injected into the listed companies which are just front vehicles to raise funds and pledge assets to finance the unlisted businesses in the group.

Even at 90, Munjal still clocks at least six hours in office every day. Ask him why and he informs you that everybody asks him the same question. And he doesn’t see the point of it. “When I am still on duty, what is the point of not coming to office? What will I do at home the whole day? You are being paid for this,” he points out. “What right do you have to not do a full day’s work and still draw a full salary? The biggest thing is that I enjoy working. I enjoy coming to the office and I look forward to the day. Till the time that I am capable of work, I will not think about retirement”. Munjal summed up:

“This company is going to last for a long, long time. Because it is neither in my heart nor my children’s hearts to become rich quickly. If we keep satisfying the customer, who pays money to purchase our products, there is no reason for us to fall behind. Our culture is not to overcommit and underdeliver. First, prove your capability and then talk. Not the other way around. I am very grateful to God that my kids Pawan and Sunil talk only about what they have accomplished or what they have the capability to deliver.”

Key Bamboo Takeaways:

  1. In emerging Asia, the growing rural consumer market is often overlooked because it is difficult to reach out to this group without the right business model.
  2. To assess whether companies can overcome a crisis, value investors would find it helpful to look for the three sources of “emptiness” in Bamboo Innovators: the indestructible intangible of the trust and support from its community of suppliers, dealers and partners; the core-periphery network; and the open innovation model in working with external partners to co-develop new products.
  3. The case of China’s Lifan and Vietnam’s VMEP highlights the extreme dangers of using the net-net approach in investing in “cheap” stocks that (usually) turn out to be scary value traps. While these listed vehicles have some “net-net” tangible manufacturing assets, the lucrative intangible assets in distribution/financing and spare parts are not injected into the listed companies which are just front vehicles to raise funds and pledge assets to finance the unlisted businesses in the group.
  4. In Asia, it is very likely that we will see more cases of the principal taking back their powers from their local partners and compete alongside. Other ways for MNCs to leverage their power include increasing the royalty payments. It is possible that some of the outperforming Asian-listed units of MNCs could start to reverse their earlier massive gains.
  5. The case of Hero also highlights that there is no perfect stock and value investors often commit the error of omission because of nitpicking the grains of sand. Confirmation bias can distort the view of focusing on the trees or “chess pieces” but missing the forest or the “chess board”. Investors need to keep away from the emotion of having to be right in spotting the negatives. The red flags include (1) the lucrative spare parts and financing business residing outside the listed vehicle and in the private pockets of the Munjal family – Hero Honda before the split and Hero Motocorp after the separation; (2) the Munjals, like almost all Indian business family, are also active in their private business interests ranging from renewable energy, financial services, education to retail in chocolate and clothing. However, the core intangible asset of the distribution and marketing that drives the value creation process is housed inside the listco. Often, only one or two questions really matter to the investment case.

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