What is the visibility and future ahead when markets are shrouded in a destabilizing and lulling yellow light instilled by the “Yellow Lantern” of fear?
Akin to the “Yellow Lantern” antagonist in the American comic book who gain power by feeding on fear, the creature of unabating lower bond yields and near-record stock market indexes has been boosted by fears of a global economic slowdown pushing central banks’ pre-emptive action into expectations of aggressive rate cuts to avert a sharper slowdown.
Yet, underneath the strength in aggregate asset prices, while the S&P 500 has risen 11% since January 2018, among the broader universe of U.S. stocks worth more than US$50 million, just over half are still in the red over that time. The median stock is down 0.7% over 18 months. The picture around the world is even starker. About two-thirds of global stocks are lower, measured in U.S. dollars, than they were 18 months ago. The median decline is 14%.
However, many of these battered “cheaper” laggards are disrupted cheap-gets-cheaper value traps – and they remain the biggest risk in the markets for the cashed-up bargain hunters priding themselves on their abstinence who continue to have a fatal temptation for these stocks, reminiscing for the previously comfortable mean reversion bounce despite a growing painful realization that there is an uncomfortable structural break in the market’s multi-year appraisal of businesses that can survive and compete in the exponential world. Turning to the “cheap” value traps and “defensives” is akin to the ever-riskier investment action of fighting fear with fear itself. Eventually, the Yellow Lantern is defeated by the Green Lantern hero who embody the positive energy of willpower to protect the planet from harm.
The structural rise 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 has been a Green Lantern-like force of positive energy protecting farsighted long-term investors. These investors include the French Dassault family with over US$27 billion fortune who continue to invest with conviction NOW (with emphasis) and serenity in these innovators quietly dedicating their lives to improving your own, guided by an inner compass and willpower in choosing and focusing on what they are willing to struggle for and what pains they are willing to endure. We like to briefly highlight two such listed profitable artificial intelligence (A.I.) innovators who also illuminated insights on the progress of A.I. applications.
What is the value of an A.I. that does not need a software programmer to tell them what to do? Traditional software is coded by an army of human programmers, which is expensive, fragile and difficult to maintain. Deep learning is software that’s not “written/coded” but rather, it “trained” itself using data under a learning framework, and it improves exponentially with more data and over time. Many AI algorithms and programs are custom developed for a specific company or an industry.
Consider the case of a listed profitable Asian SaaS (software-as-a-service) innovator who combines A.I. algorithm from seven areas: (1) image/video analysis module; (2) text understanding module; (3) dialogue & natural language processing module; (4) recommendation module according to user’s taste and preferences; (5) prediction module; (6) abnormality detection module; (7) reinforcement learning module – to create deep learning solutions for a wide range of customers who can immediately use in the business, including Toyota, NTT Docomo, Fanuc, Dentsu, Recruit Holdings, etc.
By incorporating the combined seven A.I. algorithms as a single system provided through the cloud into the software and hardware of the client, the accuracy improves more and more over time, and it becomes more indispensable with practically very little risk of cancellation of the subscription service, and sales will steady accumulate with high profit margin.
Advanced A.I. technology is a must for autonomous driving and connected cars, which demand rapid processing of massive volumes of data. After discovering its technical AI prowess in natural-language processing and image recognition, Toyota Motor took a strategic stake in the company and joined forces with the listed innovator in R&D in autonomous vehicles.
One of the uniqueness of the deep learning A.I. system of this innovator is that it can automatically recognize and track the behavior, emotions and expressions of “people in need” (such as looking around on the road, feeling unwell, etc) using the combined video/image recognition algorithm and abnormality detection module, thus differentiating from the general-purpose AI video analysis, and also going beyond the crime prevention and disaster prevention.
On 15 May 2019, this listed Asian innovator announced a healthy set of first half results (October 2018 – March 2019) for the fiscal year ended September with an operating profit margin of 35.8%, and management estimates its FY09/2019 (Oct 2018 – Sept 2019) sales to increase 66.3% yoy and operating profit to rise 51% yoy with an OP margin of 36%. This Asian SaaS/AI innovator is highly profitable with a healthy balance sheet and net cash (zero debt) is 65.6% of total assets. It is up over 9% since the trade war escalated from 6 May 2019, extending its YTD 2019 gains to 86%.
“Almost all (99.99%) of software have been deductively described by the engineer in a single code line, but it is now possible to embed the inductive reasoning ability to be added to software by deep learning technology, and that software is described by data, not humans. We believe that in the long run, most of the current software will be replaced by an intelligent embedded algorithm with inductive inference capability. In addition, the algorithm should promote better cooperation between software and human that enhances performance by learning knowledge and experience of people in each industry. We will continue to develop business to create value towards the post-digital information society of the near future in order to solve various social problems through our vision of ‘formulating software of the future’. We have developed several function-specific algorithm modules which can be used as core functions and sub functions of various software and hardware. By combining a plurality of algorithm modules, we can provide algorithms flexibly and quickly to meet diverse needs. We want A.I. to penetrate every corner of society,” comments founder and CEO Dr. U.
On 16 June 2019, this Asian innovator announced the 100% acquisition of a profitable MaaS (mobility-as-a-service) innovator who has deployed over 100,000 IoT devices throughout Japan with a stable recurring-revenue subscription service business model. The acquisition price of this MaaS company which generates over US$41.3m in sales is US$26m. Management view the acquisition as completing the last mile in the MaaS field since it can now better extend its AI software value chain to IoT terminals. It expects strong business synergies with its deep learning A.I. software combined with the smart IoT devices to create new solutions and “enable the development of various profit models”.
This acquisition reminds us of an earlier A.I. stock, which is the only listed pure-play profitable IoT-SaaS innovator in the world, that we had briefly discussed earlier in our Roundtable on 29 May 2019. Since the Roundtable discussion, it shot up 124%, extending its YTD 2019 gains to 197%. It has an operating profit margin 24.7% (1Q FY12/2019: 25.6%), ROE (= OP/Equity) 17.4%, ROA 13%, positive free cashflow margin 11.9%, net cash as % total assets is 32.3%.
IoT devices have long service life while unit prices are low, and the typical project-based OEM/ODM business model are vulnerable to the unpredictability in capex spending and orders from their customers. This listed Asian innovator’s A.I.-powered and multi cross-communication IoT platform supports continuous automatic IoT data control and monitoring and it has the largest AI-powered surveillance center in its country. The process of connecting sensors to the Internet is complicated. The innovator can complete complicated processes simply by installing a dedicated device, and users can easily and inexpensively introduce IoT utilization of various sensors (compatible with all sensors) into their business in a few days via recurring subscription service. It has very high customer retention rate of 98%.
Some specific application scenarios of its recurring-revenue subscription services include:
• Preventive maintenance of factory/robot equipment: Semiconductor giant Tokyo Electron’s equipment are equipped with sensors (vibration sensors, acceleration sensors etc) whose data are connected to Microsoft Azure cloud and this innovator’s AI/IoT cloud platform with its unique algorithm-cloud data-sensor connect service monitors abnormal vibrations and speed associated with equipment outages to prevent equipment malfunction in order to ensure the stable operation of plant facilities. Customers of Tokyo Electron equipment subscribe monthly for the monitoring services.
• Abnormality detection of commercial kitchen equipment (freezer/refrigerator): Temperature and humidity management is important for food companies. In addition to visual dashboard confirmation at regular intervals, there is real-time management and quick awareness and response to unexpected situations that will ensure safe hygiene management.
• Autonomous and operation control of construction equipment, forklift, etc: Sakai’s compact roller construction machine utilizes this innovator’s IoT/AI control & monitoring platform to realize joint human or full autonomous operation. The innovator’s automatic steering and emergency braking software technology improves efficiency and safety.
On 10 May 2019, this listed SaaS cloud innovator announced a healthy set of first-quarter results in which sales increased 28.3% and operating profit rose 40.3% with improving margin and record-high in monthly recurring subscription sales.
On 30 May 2019, this IoT-SaaS innovator was announced as one of the important partners in Amazon’s AWS new IoT-SaaS service for worldwide customers called “AWS IoT Events”, which is a fully managed IoT service that makes it easy to detect and respond to changes indicated by IoT sensors and applications. These event changes include malfunctioning machinery, a stuck conveyor belt, or a slowdown in production output – and automatically trigger actions or alerts in response. AWS IoT Events helps you gain visibility across your equipment, applications, and fleets of devices allowing you to do things like build a monitoring application that triggers customer support when assets fail.
Events are patterns of data that identify changes in equipment or facilities like a robotic arm being misaligned on the factory floor or a motion sensor detecting movement after business hours. Industrial companies such as manufacturers, energy utilities, and food processors want to be able to analyze their device data to detect and respond to events from many different IoT sensors and applications to drive faster and better-informed decisions.
Detecting events based on data from thousands of devices requires companies to write code to evaluate the data, deploy infrastructure to host the code, and secure the architecture from end-to-end, which is undifferentiated heavy lifting that customers want to avoid.
Using AWS IoT Events, customers can now easily detect events like this at scale by analyzing data from a single sensor or across thousands of IoT sensors and hundreds of equipment management applications in real time. With AWS IoT Events, you use a simple interface to create detectors that evaluate device data and trigger AWS Lambda functions or notifications via Amazon SNS in response to events. The detectors can evaluate tens of thousands of input messages from devices every second, identify events when they occur, and trigger actions. For example, when temperature changes indicate that a freezer door is not sealing properly, AWS IoT Events can automatically trigger a text message to a service technician to address the issue.
AWS IoT Events is priced per message evaluation. Message evaluations are metered each time the event detector logic evaluates an incoming message to determine whether an action or an alert should be triggered.
A pricing example: Over 30 days, a fleet of 500 trucks each has a single event detector which evaluates incoming messages every hour from the truck fuel gauge and every 15 minutes from a telematics application:
• Number of Messages Evaluated per truck: 30 days * (1 message / hour * 24 hour / day + 1 message / 15 minutes * 1440 minutes/day) = 3,600 message evaluations/truck
• Number of Messages Evaluated for all 500 trucks: 500 trucks * (3,600 message evaluations/truck) = 1,800,000 message evaluations
• Monthly Charges = 1,800,000 message evaluations in US East Region * $1.10/10,000 message evaluations = $198.00
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. In addition, we noted that of the 46 US-listed SaaS companies with positive operating cashflow, the weighted average margin is 16.6%; weighted ROA is 9%; over half have a weighted net debt as % of total assets at 17.3%; and weighted valuation is over 200X. The focused portfolio of 40 H.E.R.O. innovators have an operating profit margin of 23.8%, weighted ROA of 21.6%, weighted net cash as % of total asset at 39.6%, and is trading at a steep discount of over 4-5X less expensive than the US peers despite commanding stronger fundamentals.
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.
The portfolio of 40 H.E.R.O. innovators, which has an average market cap of US$1.41bn (median market cap of US$820m), 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%.
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.
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