- VARECS Partners Limited
Mr. Yasu founded Tokyo-based VARECS Partners, Ltd. in 2006. Jiro has served as portfolio manager for the VPL-I Trust since 2006. Previously, he worked at First Eagle Investment Management, LLC in New York. Currently, Jiro is a consultant for First Eagle’s business development and investments in Japan. Prior to First Eagle, he was an equity sales trader covering Japanese and U.S. accounts at Daiwa Securities America. Jiro holds a BA in Economics with a specialty in Econometrics from Keio University. Jiro is also a director of Jyujiya Holdings, Inc., his family’s holding company, and a director of Fujii Shuzo, a Japanese sake brewery in Hiroshima.
We employ a value investing philosophy and make long-term investments with medium-sized listed companies in Japan. We prefer companies with stable, high-margin businesses that we expect to grow steadily over time. In addition to talking to the company directly, we also talk to competitors, customers, and suppliers (both public and private) to understand the long-term competitive advantage of the company.
We calculate the intrinsic value of all the companies we research. We define intrinsic value as a price that a strategic acquirer would pay in cash to buy a company in its entirety. We calculate business value by applying conservative estimates of operating profit and a multiple based on our assessment of business risk. We tend to give higher multiples to low risk businesses and lower multiples to high risk businesses. We also look at multiples of similar companies in Japan and overseas and multiples paid in past M&A deals in the same industry. If there is a large enough margin of safety, we make an investment.
In addition, through active dialogue with management, we try to help the company to realize and grow its intrinsic value per share. We believe that appropriate capital allocation is essential to achieve this goal. We help the management team to understand their true value correctly and we guide them to implement rational capital allocation policies that allow them to take advantage of the difference between the stock price and the true value.
The most important thing in value investing is to properly understanding the true value of the company. Correct value recognition guides us to make correct investment decisions. Long holding periods allows us to develop better relationships with management teams. These relationships give us a constant flow of high-quality information, deepening our understanding of the value of the business. Creating this kind of virtuous cycle using our long-term approach is key to our investment strategy.
The biggest attraction of Japan's mid-sized listed companies where we invest is high business quality and low valuations.? Some mid-size companies in Japan are able to maintain attractively high operating margins by keeping high market share in niche areas. These kinds of high quality businesses often trade at more than 10 times annual operating profit in foreign markets.? However, we are still finding such companies in Japan trading at less than 5 times. As a result of years of accumulating profits, many of these Japanese companies tend to have large cash piles on their balance sheets.? This depresses ROE, which may be a reason the shares receive low valuations, but we believe such large cash piles provide us with downside protection.
If a company’s cash keeps growing in the future and ROE declines further, there is the possibility that valuations will never improve. However, we have started witnessing some smaller companies in Japan beginning to change capital allocation policies, while the Abe administration has been implementing policies such as Japan’s Corporate Governance Code, Japan’s Stewardship Code, etc.? We believe such changes will improve valuations of smaller companies in Japan and allow us to realize significant return over the coming years.
My family was running a brokerage company for about 80 years.? When I was a high school student, I was designated as successor of the business. After I graduated from college, I worked at Daiwa Securities’ New York office from 1996. That was during the heyday of major macro hedge funds run by people like George Soros and Julian Robertson, and I developed an interest in the buy-side. Then, in 1998, I was able to get a job with Arnhold and S. Bleichroeder (now First Eagle), and stepped into the world of investment .
However, at that time, to succeed as a fund manager like Soros, Robertson, or Tudor Jones, I thought I have to be a sort of genius. Therefore, I thought I have no such chance due to my own mediocrity. However, when Arnhold acquired the global value team from SocGen in 2000, I met with the philosophy of value investing. The team was led by Jean-Marie Eveillard, who is obviously quite different from star managers such as Soros. However, his long-term track record was as good as (if not better) than the star managers’ results. By reading Benjamin Graham’s books and Warren Buffett’s letters, I started thinking that it might be of doable even for me.
In 2005, I came back to Japan in order to succeed the family brokerage company. However, the business environment was much worse than I imagined as the entry of online brokers had forced commission rates down, while the cost of compliance increased. Therefore, we decided to exit from the brokerage business. Instead we launched VARECS to pursue value investing in 2006.
I think the most important thing for portfolio managers and analysts is to be "aware". The other day, I was reading a book of a founder of a large coffee chain in Japan. According to the book, his friend’s wife told the friend that she was going to see a doctor because she thought she might be pregnant. After that conversation, the husband drove to his office using the same route he had been commuting for years. But, that day was different since he noticed for the first time that there are five obstetrics hospitals along the way.? I thought it is a good example of how people can have completely different conclusions while looking at the same thing if they have different things on their mind.
I think great investment ideas can be found anywhere such as conversations with family and friends or in normal daily news if you have the ability to link such information to specific products, service, or companies that may benefit or be hurt.? I think such ability is essential for any fund manager or analyst. No matter how many books and articles you read or companies meetings you take, without such ability, it may be just a waste of time.? Therefore, I am always trying to link information to investment ideas.
One thing we try to avoid is deferring decision making and taking action.? As a portfolio manager, decisions are not so complicated: buying, selling, or doing nothing for existing holdings, and passing or buying for new ideas.? However, we have regretted in the past because we did not make a decision or we did not take immediate action. For example, we liked a company but did not buy immediately. Then we regretted our inaction because the share price went up a lot.? Similar things can happen with existing positions.? To not to repeat such mistakes, we are trying to draw clear conclusions on existing holdings and new opportunities and take immediate action accordingly.
Since our investment strategy is long-term investment in undervalued companies, our capital preservation depends on the quality of the business we invest in and the price we pay. We prefer to invest in high-quality companies, meaning companies that have stable business models, and maintain high profit margins over a long period of time. For example, we like software companies which have significant revenue from service and monthly charges. Or, we like machinery companies which have stable revenue streams from maintenance services, or sales of consumables and parts replacement.? If such companies have maintained high profit margin over years, we believe they are suitable for long-term investing while preserving capital in a tough environment.
In addition, it is important to invest in these companies at large discounts to our estimate of intrinsic value to preserve capital. Because assessing stability and competitive advantage of the company is qualitative, we cannot be 100% right. Therefore, investing at a large discount will give us a margin for error.? Even if the business value is zero, downside risk can be quite small if 90% of the market capitalization is in cash. To preserve capital, we only invest with companies which we believe have limited downside risk.
“The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success” William N. Thorndike
We give a copy of this book to CEOs of all of our portfolio companies.? The book introduces eight CEOs who grew corporate value per share at a surprisingly high rate during their tenure. The first characteristic that all 8 share was a focus on growing true value per share, instead of maximizing the size of the company. To achieve that goal, these CEOs delegate business operational responsibility to business managers as much as possible and focus on making capital allocation decisions. For example, when the share price is high, they acquire businesses using shares. When the share price is low, they buy back shares as much as they can. In addition, with respect to existing business, they allocate additional capital only when the expected return on the additional capital is higher than a hurdle rate. Conversely, if a business that cannot achieve the hurdle rate, the CEO would seek to sell the business.? By doing such rational capital allocation over the years, some of these CEOs have grown the value per share more than 100 times during their tenure.
The first chapter introduces Dr. Henry Singleton of Teradyne. He acquired more than 130 companies when his company’s shares were highly valued.? Then, he bought back 90% of its outstanding shares when the share price was deeply undervalued. As the result, he was able to grow the value per share over 180 times.????
I think the book did a great job to show the wealth creation power of proper capital allocation and compounding returns for the long term.?
We check following news and media:
Daily: Nikkei, FT, Wall Street Journal, and NY Times
Weekly: Economist, Barron’s, and Nikkei Veritas
Monthly: Grant’s Interest Rate Report
Annually: Berkeshire’s annual letter
This article originally appeared on March 7, 2016. Any views presented in this article are as of such date and are subject to change.
This article and the information provided therein are not a recommendation to purchase or sell any security, nor are they intended to constitute the marketing of, or a solicitation for investment in, any investment product.
VARECS Partners Limited is a Tokyo-based investment advisory firm which was founded in 2006. Since December of 2006, the company provided investment advisory service to VPL-I Trust, a Cayman fund.
VARECS Partners Limited employs a value investing philosophy and makes long-term investments with medium-sized listed companies in Japan. Through active dialogue with management, the company tries to help the company to realize and grow its intrinsic value per share over years.
March 7, 2016
by Investment in Japan