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Scuttle-Butting in Seoul

 

The business grapevine is a remarkable thing. It is amazing what an accurate picture of the relative points of strength and weakness of each company in an industry can be obtained from a representative cross-section of the opinions of those who in one way or another are concerned with any particular company." — Phil Fisher, “Common Stocks and Uncommon Profits

 

EM Systems (“EMS”) is the largest software provider for dispensing pharmacies in Japan. In many ways, EMS embodies qualities that we look for in a company: a franchise business that benefits from a highly sticky customer base and a solid capital allocation track record.

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Einschätzung EM Systems

Background

After a roaring in 2017 where the KOSPI Index was up 22% -- driven largely by large-cap names such as Samsung Electronics and biotechnology companies such as Celltrion – the KOSPI ended 2018 down 18%. A major driver of this fear has been geopolitical risk with North Korea as well as the threat of a trade war between U.S. and China, which is a major business partner for Korean companies.

However, we find this backdrop to be especially interesting. In our view, Korea does not carry the same political risk as other countries caught up in the emerging market contagion (such as South Africa, Russia, Argentina, for example). From a capital allocation standpoint, KOSPI has returned to a ROE improvement environment since 2017 as management teams shifted away from holding cash to investing in their business. Additionally, Korea has made some improvements in investor transparency from an accounting standpoint and also in minority shareholder rights given the recent corporate developments. As such, we went bargain hunting in the Korean healthcare market, which has offered great investment opportunities in companies that were run by entrepreneurial management teams with innovative business model and were also trading at huge discounts to their intrinsic value.

However, it was also important for us to interface with the companies and hone-in on our network on the ground. Thus, two of our senior analysts packed their bags and hit the road to Seoul. Over one week they had 20 meetings with entrepreneurs, investors and brokers to perform due diligence, gather intelligence, build relationships.

Meet the CEOs

South Korea has a population of 50 million people with the national health protection scheme safeguarding their medical needs. Most of the businesses tend to be export oriented (as the domestic market is small) and target overseas markets such as China and Japan due to their proximity.

Perhaps the most dominant theme that ran through our meetings was the importance of cosmeceutical products, also known as the medical aesthetics space. We met with Hugel (which we have previously profiled here) and Medy-Tox at each company’s headquarters. Together, they account for >70% of the botox market in South Korea. While speaking with these companies, we noted the various game theory strategies that these players engage in within the duopolistic structure in their domestic market. We also emerged with a stronger understanding on the potential disruption of Allergan’s stronghold in the U.S. botox market. In the long-term, we maintain our belief that there is enough room in the market for both companies to grow.

Another notable company that falls within the cosmeceutical category is Caregen, one of our portfolio companies. We traveled to the city of Anyang approximately an hour out of Seoul. There, we were fortunate enough to visit Caregen’s plant and were impressed by the quality and range of products being manufactured at the facility. The company uses peptide-based technology to manufacture products for various therapies such as dermal, oral and hair care. We were quite excited to see their lineup of new products such as a diabetic energy drink and an anti-macular degeneration eye drop. The CEO is a first generation entrepreneur who has built the business from the ground up with passion and enthusiasm. There are very few academics who have crossed over so successfully to the other side of business, and he continues to navigate the capital markets space with a very competent CFO.

The second most important category of companies we met came from the medical devices sector. For instance:

  • A breast implant company, Hans Biomed, growing earnings at +13% p.a. over the last decade and earning gross margins of over 50%. The medical implants market is still tightly regulated, and the company operates in a primarily oligopolistic structure. It is also founder-run, and he owns >26% of the business.
  • A branded contact lens manufacturing company, Interojo, whose stock had recently corrected by 40% due. There have been excessive concerns about a slowdown in the domestic contact lens market; however, after meeting the CFO, we believe this is overblown especially since the domestic business accounts for only 30% of the total business, and as such, we have initiated a position in the company. We also did some scuttlebutting in contact lens shops throughout Seoul to gauge the popularity of the product.
  • A number of players in sensor space. We visited one of our portfolio companies, Rayence, formerly part of Vatech; in fact, we were even able to meet with both companies at the same headquarters. There, we learned more about the parent-subsidiary relationship and the rationale behind Rayence’s spin. We also met another publicly-traded competitor outside Seoul, and together we were able to put together a cohesive map of the competitive landscape and barriers to entry in this niche space.

Concluding Remarks

From companies performing cutting-edge personalized genomics to selling skin-moisturizers in pharmacies, we were able to cover a huge breadth of companies within the spectrum of Korean healthcare. Unfortunately, we are unable to profile every company that we visited in Seoul.

A final note: we were also able to further establish our network of befriended investors who share a similar investing philosophy. These conversations were especially important as we were able to further build up our checklist of “red flags” specific to the Korean market and also exchange investment ideas, especially about leading players in niche industries.

It is worth noting that with a market dominated by short-term traders, we value investors who find that such volatility provides interesting buying opportunities. Additionally, in most of these conversations with other investors, we are all equally wary of story stocks such as Samsung Biologics and Celltrion Healthcare. While journal headlines (and even books written by retail investors!) sang these companies high praises about leading the biosimilar race, the fact of the matter is that the multiples assigned to them are too lofty for logic.

We thank all the companies, brokers, and investors who made this trip possible. It has been an extremely rewarding week in Seoul, and we hope to provide more details on our next due diligence trip in Asia!

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