The following article is extracted from the Bamboo Innovator Insight weekly column about the process of generating investment ideas among wide-moat businesses in Asia. Each month, an in-depth presentation on one such business is featured in The Moat Report Asia.
“How do you decide how to invest with conviction in a company when sizing up the bet to become a Top 20 shareholder as disclosed in their annual report?”
We were asked this question by a fellow value investor when we shared that our largest portfolio stock at 35% of the NAV of our Hidden Champions Fund, a wide-moat innovator with dominant market leadership as the largest provider of nation-wide tourism and transportation services generating record profitability, is up over 15% from our cost during a period when markets were volatile and the MSCI Asia index is down around 15% over the past year.
“We follow the ‘OQ’, or the ‘Obsession Quotient’, to overcome the asset size barrier to investment performance in allocating funds productively and to mitigate potential concentration risk.”
Think of Steve Jobs famous obsession with the perfect screws on the inside of the original Mac.
Think of the early Bill Gates who would “be in the middle of a line of code when he’d gradually tilt forward until his nose touched the keyboard. After dozing an hour or two, he’d open his eyes, squint at the screen, blink twice, and resume precisely where he’d left off — a prodigious feat of concentration.”
Think of Ray Kroc’s obsession with quality and cleanliness with his oft-quoted motto: “If you have time to lean, you have time to clean”, leading to the automation of as many operations as possible and the institution of rigid training programs at “Hamburger University” for McDonald’s franchise owners, whom he required to manage their own stores.
Think of the late Mr Sim Kee Boon, one of Singapore’s pioneer top civil servants, best known for overseeing the construction of Changi Airport and turning around the fortunes of Keppel Corporation after succeeding the servant-leader Mr Chua Chor Teck, who was said to check toilets at Changi Airport at night.
We were also inspired by M.S. Oberoi, founder of the Oberoi Group, a chain of luxury hotels in India, who obsessed about every frontline detail in his hotels that might affect the customer experience and would scrawl responses on customer comment cards even at the age of 94 when he could barely see and had to hold the cards an inch away from his eyes. The elderly Oberoi would visit his hotels to make sure employees were getting everything right, and in doing so he established a culture by which all employees shared in his obsession.
The late Carl Elsener III (1922-2013), the entrepreneur perhaps most responsible for the unprecedented success of the Victorinox Group behind the world’s most recognizable Swiss Army knife, had lived close to the factory and, until age 86, rode his bicycle to the office every day, and was obsessed with preparing the 4th generation to be competent managers of this worldwide successful, traditional Swiss enterprise.
We have obsessed all along with identifying entrepreneurs with the focus and sense of urgency to build something with Purpose and commit to an idea larger than themselves to care for and serve others with love. “Wealth creation” would then take on a Purpose and meaning, as opposed to opportunistic money gathering through short-term business transactions, complex financial engineering schemes and worse, tunneling fraud that eventually unwind to harm others. While these people are able to make money, the wealth “created” is at the expense of others and benefits themselves. How to quickly tell them apart? They “energize” themselves not from work, but from the pursuit of short-term pleasures.
For Buffett-Munger, their idea larger than themselves is manifested in the creation of a focused vehicle Berkshire Hathaway, which compounds not only wealth for shareholders but more importantly, compounds values and virtues as an exemplary role model in the way business is conducted and how they live their life in a simple and frugal way. The Berkshire Hathaway Bus carries more passengers and supporters who get positively energized towards the right direction in the journey of Life in the increasingly harsh and pretentious world.
A true goal needs to become an obsession. We observe the following about “OQ”, or “Obsession Quotient”, over our years of interacting with entrepreneurs, innovators, and hidden champions.
- They view themselves as business insurgents, fighting on behalf of an underserved customer, a persistent idea, mission, duty, calling and vocation that preoccupy/absorb/dominate their every thought and dominate their desires every second of every day and make them approach each moment, decision, action and day with this level of fixation. They are completely captivated by an obsession that they simply cannot imagine conducting their life without. They always find their work more fulfilling than those who find themselves in a profession because it was expected of them. For those who are obsessed by this pursuit, there is no separation between life and work. It is much easier to endure all the setbacks, reversals and frustrations of management when you deeply enjoy your work.All of the High OQ entrepreneurs, innovators and hidden champions whom we observed have witnessed first-hand the problems that beset the masses and wanted to build a business to provide useful products and services. And they are not contented to stop at $10m, $100m, or even $1 billion, like most businesspeople who rush to buy fancy property and cars for themselves. They want to build and scale their businesses so that they can give more. Only when we have the desire to give, 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 business and they work obsessively to realise this vision.Imbued with a perception where everything from telephony to music distribution to consumers’ relationships with technology is being disrupted, Steve Jobs felt there was simply no time to lose. This understanding has fueled the rapid-fire pace of his actions and his obsession with “what’s next?” in products (although he would never rush to market a product he thought imperfect). It may have also fed his often harsh, dictatorial, and somehow still-inspiring management style.
- They have an obsession with the economics of customer loyalty and have this deep curiosity for what is going on at the front line, where the business meets the customer. They have an obsession to cultivating a culture of decentralization, trust and cooperation to foster innovative experimentations, including investing in a system to cascade decision rights throughout the organization;
- They foster an owner’s mindset, which keeps them fast, bold, and infused with a deep sense of responsibility for long-term results. They do things with a long-term approach because they strongly believe that is the only way to build a truly durable and excellent business.
- They are obsessed with staying grounded to their values. Carl Elsener Jr., the fourth-generation business leader and CEO of Victorinox commented of the values uphold by his beloved father Carl Elsener III: “Despite his success, my father has stayed grounded. The most important values in his life have always been mutual respect and trust, courage, gratitude and humility. I have also learned from my father that the company who wants to stay successful in the long-term basically needs to concentrate on three things: the people, the customers and the products. He embraced that concept very nicely.”
In essence, they are the single-minded monomaniacs with a mission to accomplish. They are ruled by spirited behavior, by the vigorous pursuit of a worthwhile competitive idea. Peter Drucker highlighted also the importance of being single-minded in the passionate pursuit of one’s quest in life:
“The single-minded ones, the monomaniacs, are the only true achievers. The rest, the ones like me, may have more fun, but they fritter themselves away. They carry out a ‘mission’; the rest of us have interests. Whenever anything is being accomplished, it is being done by a monomaniac with a mission.”
The interaction with their clear goal and single-mindedness is an essential factor for their stamina and perseverance. Success and the achievement of goals inject new energy into these leaders. Nothing energizes an individual or a company more than clear goals and a grand purpose.
They do not cling on to the idea that work should be fun, exciting, entertaining and invigorating – every day. Operating a business is a serious, rugged, flaw-ridden demanding task. The inevitable fluctuations and vicissitudes of an industry’s affairs, as well as in the general level of economic activity, often seem to compel painful decisions and trade-offs to meet the exigencies of the day. But operating a business is also thrilling, challenging, and rewarding. Work is like life: sometimes fun, sometimes moving, often frustrating, and defined by meaningful events. Those who found their place don’t talk about how exciting or how stimulating their work is. Their language invokes a different troika: meaningful, significant, fulfilling.
They pursue virtues rather than seek instant gratifications, not because such pursuits are pleasurable (they hardly are in fact!), but because they are meaningful. They have something significant yet to achieve in their lives. Without virtue, leadership is nothing. They epitomized what Benjamin Franklin echoes: “Industry and Frugality”:
“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 in his keeping, careful to indulge in no extravagance, and to live within his means. Simple in his manner and unostentatious in the habits of life, not merely a merchant but a man, with a character to form, a mind to improve, and a heart to cultivate.”
Work is the ultimate seduction in life, Picasso illuminated. Indeed, the High OQ entrepreneurs, Bamboo Innovators and Hidden Champions put their work, their will and their world in the services of others. They are lit by passion, make that extra effort and demonstrate that extra commitment. They want to engage in something grand and beautiful and noble (in their own interpretation), well worth the toil and anxiety.
In the month of March/April 2016, we investigate an Asian wide-moat innovator who commands a dominant 50-60% domestic market share leadership in a consumer healthcare device and is also the global #3 player and #2 in China (22% market share) where its first China plant in over 80 years is operational in March 2016 after building up strong demand from successful sales in leading online marketplaces JDmall and Alibaba’s Tmall. We like to share excerpts of the inspiring story of the founder Mr O, whose OQ has permeated into the corporate culture and ethos of the firm, as recounted by the second-generation business leader and current CEO of this wide-moat innovator:
Q: “[Company’s name] has achieved phenomenal success since it was established in 1934 by founder Mr O to command a dominant 60% domestic market share leadership in [flagship product] and also becoming the global number three player. Can you share with us how the wonderful story of [Company’s name] started, especially the tipping points and challenges along the way?”
Mr O: “…due to limitations of technology and material science, these [product] melted under hot weather and high temperature and ‘fresh’ [product] need to be produced. The [product] were also thick, 1mm thick, like a glove for the finger, and the consumer was not happy… Also, imported foreign-produced [product] cost ¥3 for a dozen; at an age when rice cost ¥0.30, these [product] are not affordable to the masses. Yet, while domestic-produced [product] are cheaper, they melt.
Our founder was a hardworking technician who started working at a rubber goods factory observing all these problems. He started working after primary school after both parents passed away when he was young. He resolved to solve this problem for the Japanese people and thought very hard how to produce a new safer and thinner [flagship product].
He also set the target of reducing the thickness of [flagship product] by ten times from 1mm to 0.1mm. It seemed an impossible task. But our founder never gave up. Our founder tried for more than seven years. For thin [flagship product] to have the strength, an intuition flashed in the mind of our founder when he was looking at the latex molecule under a microscope in the laboratory. Maybe a new binding molecule can be added? Our founder first tried the addition of branch-like resin to the molecule. However, the two do not stick at all. Since then, days and nights in the laboratory were spent in repeating countless experiments to find a catalyst material that can stick the two molecules.
A breakthrough came when our founder knocked on the door of German Bayer who had set up operations in Japan. The director representative at Bayer Japan was generous in sharing information. Our founder learnt new knowledge from the science magazines and journals at Bayer and he would experiment with new catalysts and chemicals. This repeated experimentation resulted in our founder’s knowledge to improve by leaps and bounds. This visit to Bayer took one year and a total of eight years have been spent on research. Finally, through trials and errors, the breakthrough happens and the highest quality [flagship product] was produced. Our founder was so happy that he took a [flagship product] and ran to the river to fill it up with water, which expanded many times bigger like a water balloon. He blew air into the [flagship product] balloon and watch it fly into the air.
He resigned from his work at the factory and sold off every of his possessions and furniture to establish [Company’s name]… Subsequently, he challenged the belief that the thinness of the [flagship product] has reached its limits at 0.04mm to produce 0.02mm and 0.01mm from a new material.
Through our founder’s experience and spirit, we understood that wealth earned through hard work, dedication and years of persistence, and through courageously correcting mistakes in trials in experiments and research, is the most valuable of all. He has inspired us to think that ‘work that is not profitable is the most lucrative’. If we persist in doing what people think is difficult or foolish or dislike to do, the road to sustainability will open up. Our founder believe in addressing seriously real-world customer problems and if there is a demand out there even without immediate profitability, we will still diligently tackle it with earnest. [Company’s name]’s mission is the use the power of science to build the future with our years of accumulated experience, our proprietary technology honed and accumulated over the decades, our trusted reliability, our ceaseless research, our development that constantly pushes boundaries and our inquisitive spirit that endlessly seeks out challenges.”
PS1: We like to share our presentation slides in Value Investing Shanghai on March 18-20, 2016 where we highlighted high-conviction investment in Hidden Champions to navigate the volatile markets and that such an investment approach has enabled us to outperform with positive absolute returns vs -15% for the MSCI Asia Index, and our highest portfolio-weighted stock at 36% of our portfolio NAV is up more than 16% in SGD:
PS2: We like to share our Investor Day Presentation held on 1 December 2015 for our shareholders. The presentation material is available for download on the ASX website:
http://www.asx.com.au/asxpdf/20151102/pdf/432nk9r3hhw4nf.pdf (pg 10-14)
and our Value Investing Summit 2016 presentation “Quietly Innovating Value with Hidden Champions”:
A new monthly issue of The Moat Report Asia is now available!
Access the in-depth idea presentation:
In the month of March/April 2016, we investigate an Asian wide-moat innovator who commands a dominant 50-60% domestic market share leadership in a consumer healthcare device and is also the global #3 player and #2 in China (22% market share) where its first China plant in over 80 years is operational in March 2016 after building up strong demand from successful sales in leading online marketplaces JDmall and Alibaba’s Tmall.
Since the launch of its game-changing innovative new consumer healthcare device premium product in April 2015, its TTM Dec 2015 (YE March) sales is up 7.2% and EBIT soared 67.6%. Under the motto of using science to enrich everyday lives, [Company’s name] is a quiet innovator in leveraging upon its accumulated deep material science and chemistry know-how to continuously launch innovative new products, from consumer healthcare device to a pad that helps heal wounds by absorbing moisture, a technology that it adapted from its popular food wrapping film household product, to protective film-coated lining for motorcycle seats where it commands a 90% market share in US.
ROE of this world-class hidden champion is 14.2% and it trades at EV/EBIT 11.7x, EV/EBITDA 8.8x, EV/Sales 1x, a steep discount to its local consumer goods peers who trade at an average of EV/Sales 2.1x, EV/EBIT 20.2x, EV/EBITDA 14.5x, a 64-110% premium over [Company’s name]. Its consumer healthcare device peers trade at an average of EV/Sales 4.36x, EV/EBIT 19.7x, EV/EBITDA 17.2x, a 69-96% premium over [Company’s name]. We think that this steep valuation discount is unjustified given the technical excellence and innovative profile of [Company’s name] and it deserves to trade at a higher premium once there is greater investor awareness when they continue to deliver quality earnings growth with higher ROE which has soared from 6.7% in FY13 (YE March) to 14.2% in the latest TTM Dec 2015 and is expected to climb higher from its underappreciated price premiumisation strategy.
Sales has increased 24% in the past 3-4 years since FY13 and EBIT and OCF (operating cashflow) growth is faster at 168% due to the price premiumisation strategy. With the upcoming China plant operational in March 2016 and the tipping point in its US factory in automotive interior material, we believe [Company’s name] can build on the momentum to generate $120m operating profits and OCF in the next 4-5 years, similar to the profit scale of its domestic consumer goods peers with market cap of $2.2-3.4bn, thus spurring an upward valuation re-rating towards a potential tripling in market cap to cross $2.4bn based on EV/EBIT 20x from its present $850m market cap.
[Company’s name] embodies the best of patient sacrifice and stable capital for longer-term profound investments in business and people, with relentless and eternal pursuit of excellence in perfecting its offering, institutionalizing its craftsmanship and codifying the knowledge to pass from one generation to another. We believe [Company’s name] has hit a tipping point in its business model transformation into a complete integrated global producer of innovative rubber and plastic products with long product lifecycle with both engines in household & lifestyle division and industrial division (automotive interior) revving up to compound growth in a long runway.