Sunday, November 30, 2014

Now We're Cooking with Gas...New Jakarta Governor is Indonesian Chinese

In my research and investing I stress three things: people, structure and value.  I look for companies that are controlled and managed by quality people, have corporate structures that align minority and majority shareholder interests and trade at valuations that are below intrinsic levels if not outright cheap.

This article is about people.  More specifically it is a wee bit about Basuki Tjahaja Purnama who is better known by his nickname, “Ahok”.  But it is mostly about Indonesian Chinese and how they are becoming more integrated into Indonesian politics if not all of mainstream Indonesian society.

To be honest I don’t know much about Ahok.  His importance is due to him being the first ethnic Chinese Governor of Jakarta.  Jakarta is important, as it is the largest city in the world’s fourth largest country.  With an estimated population of 10.2m it is one of the largest cities in the world and bigger than New York, London, Paris, Munich... (props to "M"[1]).

Ahok was the running mate of Joko Widodo (better known as “Jokowi”) in the 2012 Jakarta gubernatorial election.  They won and Ahok became Lieutenant Governor in 2012 and acting Governor in June 2014 when Jokowi took leave to run for President.  Ahok was sworn in as Jakarta’s 17th governor a few weeks ago.

Although he filled his predecessor’s post rather than being appointed, his acceptance and support by some of the country’s largest Muslim organizations is very significant and worth taking note (article here).  Perhaps even more important was that it wasn’t made into such a big thing, which indicates to me that old racial divides have fallen and will continue to fall (like many Indonesian Chinese Ahok is Christian).

And its not just Ahok.  Other Indonesian Chinese are also getting involved in Indonesia’s politics. 

Perhaps the most high profile is Hary Tanoesoedibjo, an Indonesian Chinese tycoon who founded and heads the MNC group, Indonesia’s largest media conglomerate.  He’s on the opposite side of Indonesia’s political spectrum and closer to the ex-Suharto military men.  In this year’s election he threw money and media behind ex-Suharto general and son-in-law Probowo Subianto.  Earlier in the election season Hary Tanoesoedibjo was a vice-presidential candidate with ex-Suharto era general Wiranto.  He has even bolder ambitions and wants to establish a political party of his own according to a recent interview (article here)

Ahok and Hary Tanoesoedibjo think very differently about how Indonesia should be governed.  They are both ethnic Chinese but are diametrically opposed to each other’s ideology.

Compare this to Malaysia where political parties have a history of being based on race.  “UMNO” stands for United Malays National Organization, “MCA” stands for Malaysian Chinese Association.  In contrast to present day Indonesia, it seems like Malaysia’s political structure wastes too much time thinking about race rather than thinking about how to move the country ahead.  

Accepting Chinese into Indonesian society has been evolving rapidly since Jakarta's 1998 riots. Mandarin can now be taught, public displays of Chinese culture are allowed, and all people born in Indonesia – regardless of their ancestry – can run for President. None of these things were legally allowed just 15 years ago.

During my first trip to Jakarta, back in 1989, I was struck when I heard about the racial policies and customs that effectively banned ethic Chinese from many fields, mostly notably politics.

In my first or second trip I met a bright, U.S. educated Indonesian Chinese stockbroker who was clearly not into his job. Instead he was doing it because his dream job as a government policy wonk, or better yet diplomat, was essentially unavailable to Indonesian Chinese.  Despite his Ivy League education, intelligence and ability to talk-your-socks-off-about-everything-under-the-sun he would not be allowed to help his country, which he clearly loved.  His dream career had to be given up.  It simply was not available to him because of his race.  Instead he focused on helping people buy and sell blips-on-a-screen (Actually it was ink-on-white-boards as the Jakarta Stock Exchange did not have electronic trading at the time).  

In this instance Indonesia also lost out on who might very likely have been a star bureaucrat[2].  I suspect this story has been repeated many times across the country.

Having grown up in the USA, I see similarities with the American Jewish experience.  Two to four generations ago American Jews were all but excluded from politics, faced university quota restrictions, and many times outright bans at country clubs and other organizations.

Despite this, many excelled as academics, business people, and - when attitudes and regulations changed - as politicians.  Despite being 1.7 to 2.6% of the US population, some 6% of America’s upcoming congress is American Jewish.

Like American Jews, Indonesian Chinese tend to punch above their small percent of the population.  They control a large proportion of Indonesia’s monetary wealth despite being about 1.2% of its population. Just as they succeeded in business I suspect they will do well in politics and government.  And I suspect that Indonesia will be better off.

As an investor I like companies that hire across racial and ethnic backgrounds. To me this shows a desire to hire the best person for the job, rather than one who fits.

The company that stands out the most is Astra International, which I wrote about in a previous post (link here).  In the early 1990s Astra International was one of the few conglomerates that was known to hire and promote based on ability rather than ethnic background.   Although Indonesian Chinese owned it, many of its senior executives were ethnic Indonesian.  This was in contrast to most other businesses that were owned by ethnic Chinese and mostly hired Chinese from the same linguistic group as the founding family. Astra International was and remains one of the best managed companies in Indonesia.

I suspect that what is good at the corporate level is also good at the national level.  Why not get the best person for the job whether it’s for a government bureaucrat or a corporate executive position?

Indonesia has changed a lot since 1989 when I first went there. It is now far more developed, open and progressive. Ahok’s swearing in as Jakarta’s governor and the support he’s getting is an important symbol of the tremendous progress the country has made since the dark days of 1998. 

Indonesia has many hurdles to overcome if it is to continue to develop.  Many of its problems are directly related to the government - endemic corruption, inadequate infrastructure, and inefficient state-owned companies.  It needs good leaders from all walks of life that can solve these problems.

[1] Apologies.  Couldn't resist
[2] Assuming that “star bureaucrat” is not an oxymoron

Wednesday, November 19, 2014

Shenzhen: The World's Most Dynamic City

As this is being written in mid-November 2014 most stories on China and Hong Kong in the financial press are about the "through-train"  scheme that allows cross equity investments between Hong Kong and Shanghai.  There are a lot of articles that can be found on this by better writers so I won’t add my two cents about this except to say it’s about time. 

While this is a very important step toward a more open China I think investors should not forget about Shenzhen, which in my opinion is much like Shanghai during the latter’s 1860s to 1940s heyday.

I believe that Shenzhen is the most dynamic city in the world’s most dynamic country. Foreign investors would be well-served to spend more time skipping across the border rather than just following the herd to Shanghai and Beijing.

Despite its freewheeling history and reputation, Shanghai is very much a government-led growth story.  Huang Yasheng and Qian Yi came to this conclusion in their co-written chapter titled “Is Entrepreneurship Missing in Shanghai” [1].   In it they noted that: “The story of Shanghai is one of two extremes.  At one extreme, Shanghai is viewed as a model of economic development and as a symbol of a rising and prosperous China. At the other extreme, as we have shown, Shanghai appears to lack private-sector entrepreneurship – a microeconomic mechanism widely regarded as important for economic growth, competition, job creation and innovation” (full document available here).  

After China was liberated in 1949, one of the first things the new government did was to clean up what was then perceived to be the “whore of imperialism”[2]. They did a very thorough job and most of Shanghai’s famous entrepreneurial zeal either left or was extinguished. Many of the more successful entrepreneurs fled to HK, Taiwan or further (one of these is Sir YK Pao whose biography I reviewed and can be found here).

The World’s Most Dynamic City  

Shenzhen’s growth in the last 25 years has been amazing.  It has evolved from a sleepy agricultural town of some 300,000 people when I first crossed the border in 1985 and is now a thriving metropolis of some 14m. 

The catalyst for Shenzhen’s rapid development was its designation as a Special Economic Zone (SEZ) under Deng Xiaoping.  One of its key backers at the time was Xi Zhongxun, Xi Jinping’s father (my profile of XJP is here).  

Leading the charge was Hong Kong’s internationally famous entrepreneurs who quickly relocated factories and manufacturing facilities.  Like Shanghai at the turn of the nineteenth century, Shenzhen initially grew from textile and other labor intensive manufacturing before expanding into trade and financial services.   Also like Shanghai, its openness to ideas and information brought new ways of thinking and information previously unavailable. 

Shenzhen's population came from all over China for a variety of reasons. The most important being that there are more opportunities. Others come for the better weather, freer lifestyle, or youthful ramblings and ambition. 

But opportunity and the possibility of a better life make up the key reason. This is analogous to the ‘old’ Shanghai where people from all parts of China – particularly from the lower Yangtze River area - moved into what was arguably China’s first cosmopolitan city.  There – as in Shenzhen today – they could mostly leave behind the prejudices that engulfed their traditional hometowns and make a new start in a young, vibrant and diverse city.

Like many new cities Shenzhen is reaching for the stars.  When it was built in 1985 Shenzhen’s International Trade Center was China's tallest building.  Later the Shun Hing Square become Asia's tallest when it was completed in 1996. The KK Finance Centre Plaza is now the tallest building in the city with 100 floors and a St. Regis hotel.  Its title will be short-lived as the 115-story Ping An International Finance Center is due to be completed in 2016 (from Wikipedia link here).

The border between Shenzhen and Hong Kong is coming down.  I’ve met several people who commute into Hong Kong’s financial district from their cheaper, bigger and probably more comfortable apartments in Shenzhen.  I’ve also met people who commute to Shenzhen on a regular basis as that’s where the growth and opportunities are.  This is especially true for young Hong Kong professionals that don’t want to uproot their families.

I think many foreigners also tend to overlook Shenzhen’s growing investment and financial sector.  In addition to being the home of Ping An and China Merchants Bank, there are numerous fund management, banks and other financial firms based in Shenzhen. 

From personal experience several China focused fund managers have opened offices in Shenzhen to complement what they do in Hong Kong.  They are there not only because it is cheaper but also because it is actually China.  Which brings us to another topic.

Despite the growing links between the two, Shenzhen feels like it is China while HK maintains its separate system. Chinese nationals still need a passport and a permit to cross the narrow border into HK.  In Shenzhen one gets the pulse of modern China that eludes Hong Kong’s more international and ‘sophisticated’ population (or stuck-up depending on the circumstance).

Domestic brands that are big in China barely advertise or have made inroads into Hong Kong.  People in Hong Kong buy Daikin and Panasonic air conditioners.  People in Shenzhen buy Gree and Midea.  People in HK buy Japanese and German imported cars.  People in Shenzhen are just as likely to drive a Geely or Cherry.

Many of China’s largest and most successful privately-owned companies are located in or near Shenzhen.  These include Tencent (China’s largest internet portal), ZTE (mobile devices), Ping An (largest private insurance company), Huawei (telecom hardware), BYD (electronic vehicles), Konka (electronics and telecom hardware), and Skyworth (televisions).

But it is not the big companies that really contribute to growth and progress as it is the small and medium ones that are developing the next big thing.  

Stock Markets

The Shenzhen stock market seems to reflect the city’s youthful spirit and aspirations.  It has three ‘boards’ with different listing requirements: the Main Board, SME (small medium sized enterprises), and ChiNext (even smaller and younger companies). 

Altogether there are just over 1,600 companies listed in Shenzhen compared to 960 in Shanghai.  The average size of companies in Shanghai is much larger and includes some of the largest companies in the world such as China’s large SOE banks, telcos, and petroleum companies.  These super large SOEs account for close to 30% of Shanghai's total market capitalization. 

The Shanghai market is also more concentrated.  The five largest stocks in Shanghai account for 25% of the market value whereas the five largest stocks in Shenzhen account for just over 4%.

Shenzhen Stock Exchange

Main Board
Number of Companies
Total Market Cap (In RMB b)
Average PE Ratio
Source: Shenzhen Stock Exchange Website (17 Nov 2014)

Shanghai Stock Exchange
Number of Companies
Total Market Cap (In RMB b)
PE Ratio (weighted average)
SSE180 Index: 9.1
SSE 50 Index: 8.0
SSE 380 Index: 26.9
Source: Shanghai Stock Exchange Website (figures above from end Oct 2014)

A quick glance at the five biggest companies in each market reinforces Shanghai's government led development.  The five biggest companies listed in Shanghai are all majority stated-owned and controlled by either SASAC or Huijin.

However none of the five largest companies listed in Shenzhen are majority owned by the government.  Three have a distributed shareholder structure with no single entity controlling more than 20%.  The two privately-held companies – BYD and Midea – are owned and controlled by individuals.

Shenzhen’s listcos are not cheap however.  Its main board now trades at an average PE of 21x.  The SME and Chinext are even more expensive at 41x and 68x respectively.  It seems that investors are expecting tremendous growth from the smaller companies listed in Shenzhen.

Shenzhen Stock Exchange – Five Largest Listcos

Controlling Shareholder
Market Cap
% of SZSE’s Total Market Cap
Ping An Bank
China Vanke
Distributed; Central SASAC is largest shareholder
BYD Co. Ltd.
Private; Wang Chuan Fu and Lu Xiang-Yang family
Midea Group
Private; He Xiangjian
BOE Technology
Distributed; Beijing SASAC is largest shareholder
 Source: FactSet

Shanghai Stock Exchange – Five Largest Listcos

Controlling Shareholder
Market Cap
% of SSE’s Total Market Cap
Central SASAC
Industrial and Commercial Bank
China Construction Bank
Agricultural Bank
Bank of China
 Source: FactSet

Huge Caveat

Equity investors should tread carefully.  While there’s a lot going on just north of my Hong Kong base, valuations in Shenzhen are scary.  At 20x to 60x earnings much if not all of a firm’s growth is likely to already be reflected in its valuation.  Shenzhen is very dynamic, but no matter how dynamic things are, paying too much for any stream of future cash flows runs the risk of a permanent loss of capital.

And let’s not forget the skyscraper curse.  While not scientific its uncanny how economic decline often follows when tall, record-breaking building are announced or built. The Empire State Building was completed on the eve of the Great Depression, the Petronas Towers were finished just as the Asian Financial Crisis unfolded, and the Burj Khalifa was unveiled about the same time as Dubai/UAE economy faltered in 2010 (more info here).

Shenzhen Represents China's Future

Shenzhen has a lot going for. It is the headquarters of some of China's largest private companies. It has a lots of start ups and available funding.  Its population is relatively young and mostly composed of migrants from other parts of China.  Even its stock market has outperformed Shanghai year-to-date. 

While its equities are expensive investors could do worse than hopping across the border. With some 1,600 companies to choose from, I suspect there are many diamonds yet to be found.

Shanghai is not dead by any means, but in my mind it is more of a representation of China’s past.  Shenzhen is China's dynamic, private and entrepreneurial future. 

Shenzhen and Shanghai Composite Indices - 17 Nov 2014 YTD

Source: FactSet


[1] International Differences in Entrepreneurship; Edited by Josh Lerner and Antoinette Shoar, University of Chicago Press, 2010.
[2] Taken from “The Party”, Richard McGregor, Allen Lane, 2010