Restart (trade talks) minus Reboot (rate cut expectations) = Greater market volatility?
Would pressing the “Restart” button in US-China trade talks, with no guarantee of a final agreement any time soon because fundamental differences still persist, reboot the aggressive rate cut expectations already impounded into the capital market pricing mechanism, and result in greater market volatility over a prolonged period of time despite a short-term relief rally? Due to a material worsening in economic outlook with the buckling of the China-US axis that has been the backbone of the world economy since the 1990s, markets are already expecting four rate cuts by the Fed over the coming year, starting with an aggressive cut of 50 basis points by end July.
The destabilizing force of easy money from the bet on central-bank easing had propped up the stock markets this year and pushed opportunistic traders into an ever-riskier frenzied grope for yields and into exotic investments. There is a long queue to buy the Austria’s 100-year bond with a 1.17% interest rate at 154% of face value – which means investors in the long-duration bond get back two-third of their money after interest in 2117. 40% of the world’s government bonds and US$13 trillion in fixed income bond yield less than zero, and a significant part are illiquid and with troubling underlying asset quality. So much debt has been sold at low yields that even a modest bump in yields near record lows could result in traders and banks to record mark-to-market losses on their bond portfolios. And the seemingly short-term favorable outcome from the G20 meeting could possibly send long-end yields rising to result in a possible VaR shock.
Perhaps it’s akin to the protagonist “Siddhartha” in the eponymous-titled profound book written by the German-Swiss author and Nobel laureate Hermann Hesse in 1922, the busy lostness experienced by Siddhartha before he attained enlightenment: “Whenever he awoke from this hateful spell, he fled further, seeking to escape in more exotic pleasures, seeking to numb himself back into the grind of hoarding and acquisition. For a long time he sought sleep in vain, his heart full of misery he felt he could no longer endure, full of a nausea that coursed through him like the vile, insipid taste of the wine, like the dreary all-too-sweet music, the all-too-soft smiles of the dancers, the all-too-sweet perfume of their hair. He felt nausea at his perfumed hair, the smell of wine on this breath, the wary slackness and reluctance of his skin. Just as someone who has eaten or drunk too much vomits it up again in agony and yet is glad for the relief, sleepless Siddhartha yearned for a monstrous wave of nausea that would rid him of these pleasures, these habits, this whole meaningless existence and himself along with it.”
Farsighted long-term investors such as the French Dassault family with over US$27 billion fortune are able to penetrate beyond the fog to continue to invest with conviction NOW (with emphasis) and serenity in the structural trend of a selected group of listed liquid and transparent under-the-radar high-quality quiet exponential innovators with highly-profitable recurring-revenue business models and strengthening fundamentals/ increasing returns-to-scale. Last week, it was reported that the US enterprise SaaS (software-as-a-service) revenue have passed the US$100 billion run rate this quarter, led by Microsoft, Salesforce and Adobe, and that SaaS revenue still accounts for just 20% of the overall enterprise software market despite the rapid overall CAGR growth of 30%, indicating buoyant growth for many years to come.
Unlike many of the emerging tech companies in the US or China or ASEAN or most of everywhere else that are still loss-making and cash-burning, a selected group of Japan’s and Oceania’s listed under-the-radar exponential innovators have quietly built highly profitable recurring-revenue business models generating positive free cashflow.
Consider the case of a listed Asian collaboration management and office automation (OA) software H.E.R.O. Innovator commanding the highest positive free cashflow margin (15.7%) and fastest total receivables period (34 days) in the entire software industry in its home country. Its “Rule of 40” — recurring revenue growth plus free cashflow margins should exceed 40% — also ranks as the best in the entire software industry in its home country.
This Asian SaaS/AI innovator is highly profitable with a healthy balance sheet and net cash (zero debt) in balance sheet is 49.5% of total assets. It is up over 14% since the trade war escalated from 6 May 2019, extending its YTD 2019 gains to 52%. On 26 April 2019, it announced a healthy set of results: sales grew 31% and profit rose 37.8%.
There is an increasing market demand for collaborative management software across industries and organizational size because the demand to complete work through multi-person, cross-department and multi-organization collaboration has increased. As organizations become more and more complex, information and systems are dispersed, resulting in more and more fragmented daily work. The daily work of employees needs to be switched between different platforms and systems. Many employees spend most of their daily work on different system data checks, administrative transactions, and various ineffective communication, while the effective time to create productive work is greatly reduced. There is an increasing need to coordinate resources and data in an orderly manner on a daily basis for increasingly knowledge-intensive work and establish a real-time, dynamic, and open collaborative operation system to streamline business processes, improve project workflow and management efficiency, and facilitate strategic and tactical business decisions to improve profitability.
Coupled with high employee coverage, frequency of use on a daily basis, and strong mobility attributes, collaborative management software is increasingly becoming the unified “gateway” platform for integration with multiple heterogeneous enterprise information applications (ERP/CRM/HRM/PM) through which worker interact with other business applications to improve workflow, and are increasingly having the same indispensable impact at work as a core fundamental platform that the FAANGs (Facebook, Amazon, Apple, Netflix and Google) had at home. Collaborative OA software has evolved from an app tool into a platform designed to capture and draw data from the different “silos” inside a business about how workers interact with corporate information, with different business apps, and with each other, combining and learning from them to give managers a new level of insight to make them more productive.
“Through our OA artificial intelligence voice assistant users can carry out instant completion of transactions that may take one or two days to complete in the past, such as travel application/booking/approval, expense reimbursement, voucher processing; quickly search related documents; quickly build approval processes without IT involvement etc, realizing automation in the daily processing of daily trivial work to make full use of the fragmentation in time to deal with administrative affairs and improve the efficiency in the daily management process,” comments Mr. W, founder and Chairman of this listed Asian innovator.
Chairman W adds: “If you encounter technical or product problems that you don’t understand at work, the AI voice assistant will give answers based on the relevant knowledge and experience accumulated by the system, and recommend which colleagues in the company are most suitable for such problems. When you are promoted or tasked to take over a new department and begin to formulate a new work plan, you can ask the AI voice assistant to give you a sales and operational performance overview, comparison of performance over the years, and other analysis report. The AI voice assistant will also tell you which sales employees have good performance in winning customers, which employees you need to be concerned with their performance. The AI voice assistant will also tell you the diligence, the learning ability and innovation ability of each person, how they spend their work time in office, and the possible risks of each item. At the end of the meeting, the AI voice assistant will quickly sort out the meeting minutes and automatically assign each person’s tasks.”
“If you tell the AI voice assistant that you want to visit the customer on a business trip in Beijing on Monday afternoon, the AI will automatically set up the day’s schedule, and whether there is a conflict, and remind the matter at the appropriate time. During the customer visit, the AI will automatically identify the path and identify other customers whom you can visit along the way. When you tell the AI voice assistant about your specific business trip to visit a customer or supplier and the return time, and tell the AI to book a flight ticket and hotel, the AI immediately registered you for business trips in the OA system, inquire about the best time and most cost-effective ticket, as well as the best location and the best value-for-money hotel, and recommend to you, and automatically handles all the backend travel expense and reimbursement and integration with the finance and accounting department in invoices, payments, reconciliations, audits and other matters with intelligent financial management and control services. The cost control system integrated with the OA system will carry out the pre-existing cost control throughout the whole process. After the activity is over, the name of the activity can be directly viewed in the system to visually check various budget usages and achieve accurate financial accounting.”
Consider another example in Asia’s leading online booking service specializing in local experience tours and activities which is up 150% YTD in 2019 amidst trade war uncertainties. On 14 May 2019, this listed Asian innovator announced a healthy and better-than-expected set of first quarter results for the fiscal year ended December with an operating profit margin of 25.8%, and it also revised upwards its first-half operating profit by 3.4X (OP margin 16%) from the previous forecast, while maintaining its previously conservative FY2019 estimate of operating profit to increase 43.9% with an OP margin of 14.8%, even as third quarter (July – September) is the peak period given the summer vacation period when it is more common for travelers to take longer vacations.
Unlike the typical low-margin business model of most OTA (online travel agency) marketplaces which have inventory of flight and hotel accommodation and hence very weak working capital dynamics and poor operating cashflow, this listed Asian innovator has an inventory-free business model. More than 13,000 experience tours and activities in 150 countries can be booked at the local price before travel, and it has a partnership agreement with more than 6,000 highly trained, professional tour guides & instructors who are active worldwide. Over 90% of its revenue are from outbound overseas travel services while the rest are the growing inbound sales of foreign tourists. The company’s value is enhanced by the posting of experiences only for customers who participated in the company’s service. As of the end of March 2019, the participation experiences reached a total of 410,000, and the posting rate is high. The content of the experience story is overwhelmingly many messages of appreciation to the local guide. Users are often repeaters, including hardcore loyal fans who use the online marketplace four to five times a year, and the number of members have been rising steadily every year. As at end March 2019, this Asian innovator had attracted 3.8 million monthly visitors and 2.9 million registered members, up from 2 million monthly visitors and 950,000 registered members in 2013. This Asian innovator has also been selected as the best company in the “Great Place to Work” survey for three consecutive years in 2017, 2018 and 2019.
“The memories of the journey are made by what you do there, rather than where and how to go. Tours and activities are the main travel experience and products. The majority of products currently require reservations before departure, but about 80% of the local tour market has been booked through offline procedures such as the concierge and free pamphlets at the destination hotel. There is high potential for growth by increasing the proportion of on-site tours that can be booked online. By providing overseas local activities, we maximize the experience and excitement of overseas travel that may last a lifetime of memories. That is the value that we pursue,” comments co-founder and CEO Mr. N.
Interestingly, this listed Asian innovator has also attracted the founder of Viator, the world’s first online marketplace in local experience tour activities, to join as an independent board director. After founder Rodney Cuthbert sold the then loss-making Viator to TripAdvisor (NASDAQ: TRIP) in 2014 for US$200m, Viator went on to compound its revenue multi-fold to over US$1 billion. We see good potential in this listed profitable Asian innovator to grow exponentially in the many years ahead.
Notably, this listed profitable Asian innovator, with its pure and singular focus in only local experience tours and activities and no flight ticket or hotel accommodation reservation or package tour, is generating around similar revenue to Indonesia’s loss-making unlisted online travel platform Traveloka, which generated a substantial part of its revenue from the generic flight and hotel accommodation reservations – and Traveloka is valued at US$4 billion, over 10X more than the highly profitable Asian innovator. HK-based unlisted loss-making travel activities marketplace Klook, which had quite similar revenue scale, command a valuation of over US$1 billion. Berlin-based unlisted loss-making tour booker GetYourGuide.com also had a valuation of over US$1 billion.
Our strategy remains: 0% in OEM/ODM + 0% in component makers + 0% in semiconductor & related sector + 0% in capital equipment, tech hardware & big-ticket items + 100% singular focus in a portfolio of highly-profitable listed Asia SMID-cap tech-focused exponential innovators = Higher probability of resiliency in both fundamentals and investment returns that are highly impervious to the US-China trade war risk and market volatility which have escalated since 6 May 2019.
The portfolio of 40 H.E.R.O. innovators, which has an average market cap of US$1.36bn (median market cap of US$868m), delivered strong interim results growth amidst the US-China trade tensions: overall weighted sales rose 30.6% YoY and operating profit grew faster with increasing returns to scale at 59.2% YoY, supporting the portfolio returns.
An overwhelming majority (82.5%) of the 40 H.E.R.O. portfolio stocks are highly profitable “SaaS (software-as-a-service), information & data analytics/AI” companies and “platform business models”, a group which we believe is highly impervious to trade war risks. 10% are indispensable medtech innovators with high recurring-revenue high-profitability business models. EC, cybersecurity and IoT highly-profitable companies account for the remainder 7.5%.
One of our focused portfolio stocks, the Korean SMID-cap tech innovator NICE Information Services (KOSDAQ: 030190) with a dominant 75% domestic market leadership in the recurring information & big data services in personal credit information, is up over 25% since the trade war escalated from 6 May 2019, extending its YTD 2019 gains to 66.7%.
With the impending “MY DATA” industry deregulation in Korea on big data business by revising currently the world’s most restrictive personal information protection law and a strengthening in loan reviews, market leader NICE is set to expand its decision analytics and big data marketing services revenue contribution from the current 8% to a potential 24% that its London-listed peer Experian is producing. NICE is also developing new artificial intelligence (AI) solutions with the convergence of financial and non-financial information to support loan decision-making, intelligent fraud bureau services and financial risk management.
Since we highlighted this Korean innovator about four months ago to one of our advisory clients, a business owner/CIO of an established Asia ex-Japan value fund management company in Singapore who manages sovereign wealth and pension/endowment money, the stock is up over 80% to a market value of US$930m. We are grateful to be able to deliver our recently operationalized bespoke investment solution for family offices, UNHW, corporates and long-term institutional investors with satisfactory results to this wise business owner/CIO client whom we like and respect and care for.
Farsighted investors and our clients are experiencing first-hand and benefitting from the flight-to-quality effect in the market to quality listed innovators that are most relevant in this exponential world, because each time the market corrects, the stronger hands of longer-term farsighted investors will accumulate more and more of these quality innovators, while the weaker short-term opportunistic hands sell out, creating a resiliency effect in these stocks. Listed profitable SMID-cap tech innovators with non-linear exponential growth potential are the most relevant and mispriced multi-year investment trend and opportunity.
Inspired by the Singapore’s Super H.E.R.O. Roundtable meaningful discussions, we are planning to organize a series of workshops on “100X: Exponential Innovators in the H.E.R.O.’s Journey to Navigate the Volatile World” on:
(1) July 11 (Thursday) at WeWork 380 Jalan Besar, 16th Floor, 6:30pm to 9pm:
- RSVP on Meetup: https://www.meetup.com/100X-Exponential-Innovators-in-the-H-E-R-O-s-Journey/events/262376448
- RSVP on EventBrite: https://www.eventbrite.com/e/100x-exponential-innovators-in-the-heros-journey-tickets-63190569695
(2) July 18 (Thursday) at WeWork 60 Anson Road, 6:30pm to 9pm:
- RSVP on Meetup: https://www.meetup.com/100X-Exponential-Innovators-in-the-H-E-R-O-s-Journey/events/262376470
- RSVP on Eventbrite: https://www.eventbrite.com/e/100x-exponential-innovators-in-the-heros-journey-tickets-63543841340
Due to the strict building management security rules, walk-ins are not possible and the venue location can only admit participants who have RSVP on the weblinks, thanks for understanding. Far-sighted adventurers who have RSVP’d are welcomed to bring along a plus-one friend to participate in the event.
We look forward to having you join us as a founding member and farsighted explorer in the H.E.R.O.’s Journey participating in the long-term exponential growth of a selected group of outstanding entrepreneurs.
Inspiration for CENTERED with H.E.R.O.: Our clients, just like our H.E.R.O. innovators and business owners, understood the profoundness that it’s not about a Maslow-type pyramid that they need to scale upwards in profits and returns; the H.E.R.O. journey is not upwards, but a deeper journey inwards and towards the center, about the kind of person you want to become through the work you build and invest in to serve those you care about.
Deeper and inwards towards the center. As Einstein elucidates: “Strive not to be a success, but rather to be of value” – Amid all of life’s chaos and challenges, a restorative balm to all of us to be Centered in values with focus and purpose to be of value in serving an idea larger than ourselves and the people we care deeply for.
Thus far, of the 72 entrepreneurs and CEOs whom we had highlighted in our previous weekly research brief HeartWare, less than one-third are in our focused portfolio of 40 HERO Innovators, while the rest (50+) are in our broader watchlist of 200+ stocks.
If you are not moving forward in this exponential world, you are going backwards. If you want to join us at the leading edge of opportunity, if you identify yourself in the values and bigger sense of purpose in H.E.R.O., or you wish to tell from your heart to your most important person, son, daughter, wife, husband, or best friend that you are a farsighted and thoughtful explorer in the H.E.R.O.’s Journey participating in the long-term exponential growth of a selected group of outstanding entrepreneurs, standing up for the embracement of the human spirit, please contact us via email or WhatsApp at +65 9695 1860. Thank you very much for your patience and support and we look forward to growing exponentially with you as we explore the H.E.R.O.’s Journey together.
It started with rethinking a few questions. Question No. 1: Can the megacap tech elephants still dance? Or is this the better question: Is there an alternative and better way to capture long-term investment returns created by disruptive forces and innovation without chasing the highly popular megacap tech stocks, or falling for the “Next-Big-Thing” trap in overpaying for “growth”, or investing in the fads, me-too imitators, or even in seemingly cutting-edge technologies without the ability to monetize and generate recurring revenue with a sustainable and scalable business model? How can we distinguish between the true innovators and the swarming imitators?
Question No. 2: What if the “non-disruptive” group of reasonably decent quality companies with seemingly “cheap” valuations, a fertile hunting ground of value investors, all need to have their longer-term profitability and balance sheet asset value to be “reset” by deducting a substantial amount of deferred innovation-related expenses and investments every year, given that they are persistently behind the innovation cycle against the disruptors, just to stay “relevant” to survive and compete? Let’s say this invisible expense and deferred liability in the balance sheet that need to be charged amount to 20 to 30% of the revenue (or likely more), its inexactitude is hidden; its wildness lurks and lies in wait. Would you still think that they are still “cheap” in valuation?
Consider the déjà vu case of Kmart vs Walmart in 2000s and now Walmart vs Amazon. It is easy to forget that Kmart spent US$2 billion in 2000/01 in IT and uses the same supplier as Walmart – IBM. The tangible assets and investments are there in the balance sheet and valuations are “cheap”. Yet Kmart failed to replicate to compound value the way it did for Walmart. Now Walmart is investing billions to “catch up” and stay relevant. Key word is “relevancy” to garner valuation.
We now live in an exponential world, and as the Baupost chief and super value investor Seth Klarman warns, disruption is accelerating “exponentially” and value investing has evolved. The paradigm shift to avoid the cheap-gets-cheaper “value traps”, to keep staying curious & humble, and to keep learning & adapting, has never been more critical for value investors. We believe there is a structural break in data in the market’s multi-year appraisal (as opposed to “mean reversion” in valuation over a time period of 2-5 years) on the type of recurring-revenue profitable business models, the “exponential innovators”, that can survive, compete and thrive in this challenging exponential world we now live in. Tech-focused innovators with non-linear exponential growth potential are the most relevant multi-year investment trend and opportunity.
During our value investing journey in the Asian capital jungles over the decade plus, we have observed that many entrepreneurs were successful at the beginning in growing their companies to a certain size, then growth seems to suddenly stall or even reverse, and they become misguided or even corrupted along the way in what they want out of their business and life, which led to a deteriorating tailspin, defeating the buy-and-hold strategy and giving currency to the practice of trading-in-and-out of stocks. On the other hand, there exists an exclusive, under-the-radar, group of innovators who are exceptional market leaders in their respective fields with unique scalable business models run by high-integrity, honorable and far-sighted entrepreneurs with a higher purpose in solving high-value problems for their customers and society whom we call H.E.R.O. – “Honorable. Exponential. Resilient. Organization.”.
The H.E.R.O. are governed by a greater purpose in their pursuit to contribute to the welfare of people and guided by an inner compass in choosing and focusing on what they are willing to struggle for and what pains they are willing to endure, in continuing to do their quiet inner innovation work, persevering day in and day out. There’s a tendency for us to think that to be a disruptive innovator or to do anything grand, you have to have a special gift, be someone called for. We think ultimately what really matters is the resolve — to want to do it, bring the future forward by throwing yourself into it, to give your life to that which you consider important. We aim to penetrate into the deeper order that whispers beneath the surface of tech innovations and to stand on the firmer ground of experience hard won through hearing and distilling the essence of the stories of our H.E.R.O. in overcoming their struggles and in understanding the origin of their quiet life of purpose, who opened their hearts to us that resilience and innovation is an art that can be learned, which can embolden all of us with more emotional courage and wisdom to go about our own value investing journey and daily life.
KB | email@example.com | WhatsApp +65 9695 1860