Octavian Report: What do you mean by the phrase “Asian capitalism” and what should it mean for investors?
Soo Chuen Tan: Most people think about Asian companies and about Asian stocks from a U.S.-centric perspective. For fundamental investors the perception is always that you’re owning a slice of the company.
You buy a common stock, you own X percent of the company and you have rights to X percent of the cashflow. If you take a step back and you look at Asia and how Asian businesses have evolved and developed over time, that’s often not how they think about it. They don’t think of someone who just bought their stock in the open market and owns two percent of the company or three percent of the stock as having that stake in the company.
OR: What are the two or three really crucial differences that stem from this?
Tan: If you look at publicly traded companies across Asia, there are a few common themes.
First, ownership concentration is significantly higher across the board. In many cases the publicly traded companies are controlled by a family group. Their control is often magnified through pyramid ownership structures, cross- shareholdings across different firms, or nested Russian-doll holding company structures where A controls B, B controls C, C controls D — and therefore A controls D. They’re really still family businesses where control is not up for grabs.
These groups are called different things in different countries: chaebol in Korea, klùm in Thailand, konglomerat in Indonesia.
Business within these groups and between them is really driven by personal networks. In certain Asian economies, the dominant business class is the Chinese, where guanxi networks are important.
Also, decision-making structures in many of these business groups are highly autocratic. The chain of command usually ends with a family member, instead of professional management.
The product and market scope of these businesses is often incredibly broad. I suspect that few of these groups subscribe to Michael Porter’s view about pursuing focused strategies based on identifying key sources of competitive advantage.
There is often relational contracting between these business groups and the politicians running the country. The relationships between these parties are often symbiotic and much more enmeshed than here in the U.S., for example.
Each of these characteristics has its own implications for how business is done.
OR: What do these characteristics imply?
Tan: First, which is where we started out at this conversation, when you own a stake in a publicly traded company in the Philippines or in Indonesia or Thailand or Malaysia, you don’t necessarily own the same proportion of control rights. As a minority shareholder, you often have few contractual and legal rights to begin with, and it’s hard to enforce even these rights.
Consequently, it’s important that you understand the incentives of the family or group that actually runs the company and rely on their rational self-interest.
It is also important to be vigilant. Is there a risk of tunneling? Have there been transactions that disadvantage minority shareholders? Are insiders paying themselves above the line? Are they overpaying to suppliers and contractors? Often these questions lead back to understanding the incentives of people who run the company.
Then there’s the fact that business is often done on relational grounds — ties based on circles of trust that, as an outsider, you might not appreciate. In the U.S., for example, we are used to putting a bid out for a contract and giving the job to the person who offers the lowest price and/or provides the best services. These impersonal rules of engagement are not necessarily adopted by certain Asian businesses. The key things to understand are questions like: What’s the relationship between Company A and other companies in its group? Why does this particular company have the contracts they do with a particular supplier, with a particular customer? What’s the relationship between that company and various government entities? Why does this business have an entrenched position in the ecosystem? Why does that one have a precarious position?
It is also important to consider that some of the underlying social principles governing Asian business dealings are influenced by Confucian thought.
According to the Confucian idea of relationships, there is no universal or universalizable moral precept that applies to all human relationships. Instead, in Confucian philosophy, the principles that underpin a relationship are governed by the nature of that particular relationship itself. So, for example, distinct social and moral principles underpin the relationship between a sovereign and a subject, a father and a son, an older friend and a younger friend.
The next challenge is understanding the circles of trust within which many Asian businesses operate. When folks do business in the U.S. for example, there’s a safety net: when you contract with someone and someone breaches the contract, you can go to court. You can say, “Look, you signed a contract and you breached it.” You have a bundle of legal rights, and the state plays the role of arbiter for private contracts between parties and help enforce those contracts. This allows the commoditization of business. It doesn’t matter whom you do business with, because if your counterparty reneges on an agreement the state will help you enforce it.
Now, if you move to a much less-developed legal jurisdiction where the laws themselves are not that clear and the institutions enforcing these laws are themselves not well developed, relying on informal circles of trust start to matter a lot more. It matters more whom you’re doing business with. Social vetting becomes crucial. Is that person related to your family? Is that person related to other people you know? Do the people that you’re dealing with come from the same village that your ancestors came from? Are they part of your “tribe”?
Hence, these often kinship-based circles of trust act as their own internal enforcement mechanisms, which are not legal, but cultural and social. While strong, these enforcement mechanisms are not applicable to all parties and therefore you can’t necessarily do business with all parties.
OR: Are there jurisdictions where shareholder rights are taken more seriously?
Tan: There are. Hong Kong is one example and Singapore is another. They tend to be the exceptions rather than the rule. But you have to also qualify those exceptions. Take Hong Kong, for example. The proportion of businesses in Hong Kong that are truly Hong Kong-only businesses has shrunk over time. Many Hong Kong businesses are really Chinese businesses run by mainland Chinese entrepreneurs. They may have their headquarters in Hong Kong, but have a whole bunch of business activities in China.
The rules of engagement in China are very different from the rules of engagement that applied in British-controlled Hong Kong. And so when you buy shares in a Hong Kong company, you have to ask the kind of questions I’ve been laying out. What are the roots of that business? Where did the entrepreneurs behind the business actually come from? What are the norms around the way the business operates? Sometimes it gets even more complicated than that. Some Asian conglomerate groups do business in Hong Kong, and in China, and in Indonesia. Often the ways the same group does business in different places differs. They abide by different rules depending on whom they do business with. You can’t just look at a company and say, “Okay, they have Western-style corporate governance.” The same group might adopt different business practices depending on context.
OR: How have the activists done in Asia?
Tan: Many have tried. I think, generally speaking, the strategy of buying a bunch of shares and then yelling and screaming at a management team often doesn’t end well, for a number of reasons. One, you often can’t acquire the majority stake in the company, so if you acquire a five percent stake the insider group controls 40 or 50 percent of the company and there’s only so much you can do. Your threat isn’t credible. There’s only so much a minority shareholder with a five percent stake can do. The rights you have to, say, call an extraordinary general meeting, to demand a statutory auditor — they’re often narrow.
Two, the court of public opinion is simply different in many parts of Asia. When U.S. activists say, “It’s crazy that this company is expanding into this unrelated business. It’s crazy that this company owns a golf course,” most domestic minority shareholders in a particular country may think that these things are perfectly normal. You can’t rally outrage for minority shareholders because people are not outraged.
There’s also a cultural component to it, which again is rooted in Confucian social principles. Society generally is more hierarchical in many places in Asia, where people are more used to deferring to authority. Here in the U.S. you can just make a really good rational argument about why something ought to be a certain way and that argument has a strength of its own. It doesn’t really matter who is making the argument.
In many societies in Asia that’s not true: if you are an outsider and you criticize the management team — socially, that’s just not done. That’s not perceived to be credible or acceptable. The person who’s in authority has ipso facto more social capital and more standing, regardless of how “strong” your argument is.
OR: Does Asia trade at a structural discount because of the issues you outline above? Do the companies that have more open shareholder bases trade at a premium? How does this end up playing out in the marketplace?
Tan: Many Asian companies do not, in fact, trade at a discount. It depends on the environment. Circa 2010, 2011, 2012, many Asian companies traded at premiums to the valuations here. Similar companies — with similar businesses, market positions, and structural business dynamics — would trade at a premium in the U.S. because Asia was at the time perceived to have a brighter future, because they benefited from longer growth windows, better demographics, and stronger balance sheets, and because their governments ran trade surpluses and didn’t borrow as much.
At other times, like today, companies in Asia will trade at lower valuations than similar companies here in the U.S.: people tend to invest using a rear-view mirror. American companies have done better, America is recovering, and so valuation multiples have flipped around, with U.S. companies trading at a premium.
Through-cycle, I think that Asian companies should trade at a discount because of the structural dynamics around the businesses we discussed, particularly around control.
There are very few widely held Asian businesses, so it’s hard to answer if they should be valued differently. People don’t realize just how few there are of those businesses.
Japan is an exception. Many Japanese companies do not have a single controlling shareholder. But even so, these businesses are often more tightly controlled than one might think, because of Japan’s keiretsu networks.
OR: Do you think that the planned economy is a better model than the Western model? How does this play into the way people should look at Asia in macro terms going forward?
Tan: If you look at various Asian economies, there’s a spectrum of the degree to which the economy is planned, to which the state is an active participant in the economy. In many countries, the state plays a big role, not just in China.
For example, if you roll back the clock, many states subscribed to a particular “Asian” developmental model. Countries like Japan and Korea pursued aggressive and specific industrial policies around import substitution, around creating national champions, and around export-led growth policies. Obviously you have countries like China where the state did own outright and directly controlled many businesses. There are several different shades of “planned economics” in Asia, but in most cases there remain much higher levels of state involvement in the economy.
Is that good or bad? The answer isn’t binary but depends on the end-goals of policies that the state pursues. If you’re trying to get certain groups of people out of poverty, then a particular policy around encouraging the development of industries that maximize the creation of jobs is a good thing. This policy may not necessarily be the greatest thing for shareholders — but then that wasn’t the premise of the policy. The goal of the policy wasn’t necessarily maximizing the return on capital for private entrepreneurs.