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Custom-made shoes to fit your feet? Live in the shop?
In this presentation Century Management’s founder Arnold van den Berg explains why 3D printing is going to lead to an improvement in productivity and how this increased productivity leads to wealth creation. But this time, I believe the consumers will benefit.
The Wealth Creation Cycle according to Century Management
Century Management’s definition of Wealth
Obsolete manufacturing facilities
The drawbacks of this coming whirlwind of change to manufacturing companies is job losses and obsolete manufacturing facilities. Even though in Europe and the US many manufacturing jobs were outsourced in the last decade, there are still many plants left, employing still significant numbers of low-skilled laborers.
For example, what will happen with a bicycle factory in France which is now protected by EU import barriers against cheap Chinese bicycles?
If it doesn’t want to lose out against competition, it will have to start buying 3D printers, hiring engineers and designers and will have to start closing factories, firing production line workers and set up 3D printing hubs in every corner of the country, perhaps in every other bicycle shop.
Competition will be higher, competitive advantages short-lived
However as 3D printers will become cheaper every year, competitors will start appearing and key competitive battlegrounds will be intellectual property, safeguarding access to the latest 3D printers, materials, retaining the best engineers and most original designers and have a fine-mazed distribution network (bicycle shops with production facility?)
This will lead to very thin profitability margins and business models being turned upside down, there’s no EU import barrier to prevent this development.
What does this mean for investors?
After the technology sector, the heavy capital intensive manufacturing sectors will have their business models constantly turned upside down.
Owning a traditional factory could very well turn into a liability as competition turns abundant and profits turn into losses.
Subsequently fixed assets will have to be impaired and the debt used to finance these assets will be uncovered, leading to restructuring and losses for equity holders.
But debt is not the only liability, think expensive pensions, severance pay for redundant employees and more. Remember what happened to US car manufacturers with uncompetitive labor costs and obsolete car models?
Who will profit from this productivity gains?
For investors, productivity is a great gain, however 3D productivity will not be limited to the company you’ve invested in. It will rather be the new normal and if your company is not flexible enough to adapt…well forget all those stable cash flows you’ve counted on.
So run this scenario when you decide paying for a company’s future cash flows. How will 3D printing affect the business model? How much is current management thinking about or already applying 3D printing techniques?
Thanks to free competition in the end most productivity gains from 3D printing will go probably to the consumer. Manufacturers should prepare for an open competitive landscape and move first to safeguard their competitive position for the years to come.
Beware Myopic Politicians
A significant unknown are protective measures by myopic politicians to avoid 3D competition from destroying jobs. Pursuing this path will lead to temporary job protection, but uncompetitiveness and a dis-incentive to innovate and forcing their citizens to pay more than their peers in other countries. Leaving less money to productively invest in the economy. But unfortunately, career risk is also a strong incentive for politicians to make bad decisions.
See for a sad example Brazil’s expensive clothing prices and inferior textile industries. Ever bought clothes in Brazil? 4 times US prices and inferior quality fabrics. Middle and upper class Brazilians travel to US to buy furniture, electronics, wedding dresses, clothes and more. Hardly a sustainable and fair situation for the country’s population.
Often we read and experience M&A leads to value destruction and complex organisations, because companies are not integrated fast enough, cultures clash and management is not sufficiently involved in the acquisition process.
In a recent study by McKinsey, they identify common critical success factors for value creation in M&A processes. Their findings were earlier acknowledged by Schweiger and Lippert (2005) and Sitkin and Pablo (2005). Although not original I found them quite insightful and wanted to share them with you.
Three factors of key importance:
- After the acquisition performance targets should be set higher than due diligence synergy estimates;
- Reject adopting two cultures approach, also called best of both worlds approach;
- Focused involvement of the CEO in a few critical areas.
1. After the acquisition performance targets should be set higher than due diligence synergy estimates
Expected synergies based on due diligence shouldn’t be targets of the post-acquisition integration process, they should be the baseline because:
- In due diligence processes time and data is highly limited so the identified synergies can be merely considered hypotheses;
- Often synergies focus on the cost side (e.g. staff redundancies) not revenues;
- There’s hardly any focus on the opportunities for growth and sales synergies;
- Due to performance risk, management involved will be inclined to articulate on easy achievable synergies.
Considering this, a careful reassessment of synergies for the forward integration and business plan makes a lot of sense.
Some examples of best practices
Acquirers reset aspirations and build them bottom-up by identifying opportunities to transform the business.
Acquirers build a well documented fact-base to support the development of those opportunities
The common areas of opportunity that need discussion and fact-gathering are:
- Fundamental changes to operations;
- Offering of new products and services to customers;
- Overlap in customer space and suppliers;
- Importing best practices – this realizes synergies 75% higher than expected from due diligence estimates.
Uncomfortable leaders needed!
The target setting process requires leaders to leave their comfort zones and share aspirations. This is highly difficult in the general corporate environment, where managing expectations and avoiding surprises is the modus operandi of successful managers.
A successful technique are off-site workshops, where executives jointly pursue idea generation. End products should be:
- A list of growth opportunities:
- assessment of each opportunity
- ranking them by size and priority.
- A high level implementation plan;
- Additional synergy discovery;
- Cooperative formulation of targets (increasing motivation)
Surely as always there’s a catch. In an ideal world this would work like a dream, however aspirational performance targets require:
- a special breed of managers;
- higher than average sense of accountability (Think 90/10*);
- inspirational and authoritative leadership.
Now attracting these kind of managers and stimulating their behavior takes time and leadership. According to McKinsey, you should first develop this environment before you conduct acquisitions. This is the dreamworld part.
So what should 99% of the company’s do, which don’t have this culture, but see an opportunity to acquire a long time competitor? I’d say buy-in against a large margin of safety, so they’re not overpaying for the hope of synergies they’ll never get. Of course this also sounds more easy than it is.
Special managers require a special culture
If an organization would have the meanwhile the organization should start building a behavioral set of competences:
- Encouraging managers tot take calculated risks
- Giving management confidence to aim beyond original scope and size of synergy targets:
- encourage to develop ambitious business plans
- provide resources to pursue these plans
- Clearly defined managerial roles
- Strong links between individual performance and consequences (+ and -)
- Incentives for high performance – reaching the business plan goals
- Consequences for low performance – 3 strikes and you’re out
2. Asserting control of future company culture is key
McKinsey finds, mergers of equals – or the best of both worlds posture – creates confusion and reduces accountability, hindering integration, lengthening the time of integration, leading to lack of focus on doing business.
To prevent this situation, companies should recognize that one culture tends to dominate.
They should start building a fact-base to identify cultural differences and supporting the integration process. The fact-base should lead to extremely targeted improvements to the company culture, explaining cultural differences clearly and should better help acquired employees understand what to do and how to migrate to the culture of the new organization.
The integration should be managed aggressively, otherwise an unfair playing field will emerge for acquired employees.
A practical example
- Start with survey of: cultural performance, management practices & outcomes
- Identifying different cultural dimensions
- This provides a benchmark on each company’s position and performance
- Discuss this data with integration leaders so everyone understands differences in cultures
- Identify very targeted improvements
- Shape the language of messaging to the merged company
- Develop a Boarding-program to help employees understand how to succeed, performance reviews, financial planning and accountability
3. Focused involvement of the CEO in a few critical areas
During an M&A process the demand on the CEO’s time can be quite overwhelming or too hand-off. The CEO’s involvement should be carefully balanced to have a great process outcome.
The involvement of the CEO is critical for the deal team to remain focused and continue their high energy process. However the CEO should be merely involved in the two areas that matter most, for a couple of hours every two weeks. The remaining decisions should be taken by senior management.
Again thanks to McKinsey for the knowledge sharing, the most difficult part of their advice is overcoming the cultural hurdles to make managers take responsibility for ambitious targets. Career risk is a significant driver for bad decisions and most managers are not risk takers, at least when it comes to their own wallets.
*the 90/10 rule is an approach (which I try to apply) to get things really done. In any circumstance, project, work assignment or else, we should assume 90% of the responsibility and just expect 10% from others.
Some well meant advice, also use Pareto’s 80/20 principle in selecting the 20% activities that add 80% of the value otherwise you’ll drown in work!
Schweiger and Lippert (2005) and Sitkin and Pablo (2005)were both published in the book: Mergers and Acquisitions: Managing Culture and Human Resources edited by Gunter Stahl, Mark Mendenhall.
McKinsey’s findings can be found at http://www.mckinseyquarterly.com/Corporate_Finance/M_A
Anyone of you who is interested in the experience of the most successful value investor in Russia: Bill Browder, and how his success backfired heavily, leading to his prosecution and death of his lawyer. Take the opportunity to see his guest lecture at Columbia University with Robert Heilbrunn Professor of Finance and Asset Management, Bruce Greenwald.
I believe this scenario should be more explicit in our emerging market valuations and not be tucked away in a political risk premium in the discount rate.
Investors and valuation advisers have to consider what happens to valuations if Turkey’s government changes, what happens if Russia will re-nationalize financial institutions, what is the valuation impact of an ‘Arabic Spring’ inspired regime change in Angola, what happens when Greece exits the Euro zone and becomes the Mediterranean Argentina?
See per below a summary of the most interesting viewpoints, tips & tricks I got out of this lecture.
Getting to a proper valuation for an emerging market starts with taking a macro view, working your way down to the micro
- If the macro environment is favorable it doesn’t mean the companies on offer are great investments
- Stop thinking of getting exposure to an emerging market, that’s a sure way of losing money
- Start thinking about identifying undiscovered deep value opportunities – cheap/mispriced assets on an absolute and relative basis
- Privatization programs could offer great value opportunities, but ask yourself:
- Is there an investor friendly government?
- Why is government friendly? What is their incentive?
- Why are oligarchs friendly? What is their incentive?
- How could a change in this incentive and attitude affect your holdings?
- If not friendly? Stay out. Or realize, your market entry is a speculative bet, not an investment
- Is there an investor friendly government?
- Analyze economic fundamentals:
- Is the country a large oil producer? Timber? Diamonds?
- Are there other fundamentals supporting growth?
- Who profits from GDP growth? Don’t automatically assume GDP growth will translate in higher household consumption and revenue growth
- Be skeptical
- Look for fact based analyses to uncover lies
Note from Bruce Greenwald (the interviewer): “..keep in mind that every time you are buying and think an asset is going to perform well, somebody is selling it and one of you is always wrong. Who do you think is wrong when you‘re flying in and they are local?”
Before making any investment, conduct very thorough due diligence on the ground
- Depreciated assets often harbor hidden value, go there, determine reproduction value with you own eyes
- Being a local specialist on the ground gives you a competitive advantage in the valuation process
- Signals of conflicts of interest or worse fraud:
- Find out who owns the company
- What else do the owners do?
- How much do they own?
- How much do they own of other things?
- If you’re investing in an agricultural company and the owner also owns the fertilizer supplier, that’s not a good thing.
- A company that has switched auditors, is not a good thing
- A company where the majority shareholder is a politician
- Do a stealing analyses: Interview customers, consumers, competitors, employees etc. whether there is any stealing going on, check the facts with local registry offices (real estate, land holdings)
- Generally only companies that have stock options tend to overstate earnings, so reported earnings and assets are generally accurate. Implying they are earnings after stealing. Accounting generally counts what’s there.
Once uncovered fraud, what to do?
Fraud, can be also an opportunity: if you can stamp it out, your earnings will increase and so will the value of the companies.
- To get back leaked assets and stolen earnings: involve the press and government in your findings
- Make sure you do all this complying with local and international regulations
- As soon as you get invited for yacht-parties by your clients/investors and get awash with more cash to invest, it’s a sign you should liquidate your holdings (and those of your clients) It’s too much money chasing deals
- Think hard about what your contingency plan is, when relations with government or oligarch relations turn sour. If you see it happening: act fast!
- Think hard about what your contingency plan is, when relations with government or oligarch relations turn aggressive, towards you. If you see it happening: act fast!
Comparative attractiveness of emerging markets vs. free democracies
- Emerging market growth is all fine and nice however there’s huge economic value to fuzzy stuff like democracy and free press, so companies trading in markets without political checks and balances should be bought into against a higher discount than their comparable peers in democratic countries.
- Bill Browder: “…my single biggest lesson learned is that we undervalue what makes America and other democratic countries great, and we shouldn’t, because that plays a real role in valuation and what something’s worth..”
On country diversification:
- Country focus makes you better in knowing all that’s going on, but when political risk becomes unfavorable, that’s the only country you know
- Covering more countries costs more time and effort to figure out what’s going on locally
- However there is a 80/20 rule to this all. With 20% of the effort you can get 80% of the value reasonably estimated. As long as you buy-in cheap enough, and your downside is limited on an earnings or asset basis you can make the investment
Bill Browder on current attractiveness of emerging markets (November 2010)
Bill Browder: “…emerging markets are not attractive on a valuation basis, however they are a bubble about to be inflated due to all the completely absurd money printing that’s going on. We all know this will end in tears, but in the meanwhile there’s money to be made..” Bruce Greenwald’s warning: “…if we try to do what Bill describes it will end in tears for all of us, including Bill, the first time he invested in Russia.”
Disclaimer: this is a limited excerpt of the interview mixed with my personal notes and interpretations. This is not an exhaustive summary. Interpretation errors are mine and the quotes are not a literal transcript of the statements of the speakers. This is no investment advice.
Bill Browder has recently written down his experiences in a worthwile read: