The Oral Care Industry

Value investors love mundane sectors and what could be more mundane than brushing your teeth? Nobody ever talks about brushing their teeth, how they enjoy it or how they look forward to it every morning. Well basically I think nobody does, that’s why it’s never been talked about.

But as far as investing is concerned, this is one of the best business to be it. We will talk about a few important points:

Everyday Necessity (Consumer Staples)

Well, first of all, everyone brushes teeth at least twice a day right? Toothpaste runs out fast, and people just buy back the same brand without thinking too much. Even if prices were up like 20%, they will still buy it. After all it’s something going into your mouth. If it’s going from $5 to $6, most people wouldn't risk switching to something that doesn’t taste right.

And toothbrushes, they wear out fast too! Not to mention dentists keep recommending that you change yours every 2 months. So it’s a business with growing recurring demand, as long as world population grows.

This is also the beauty of consumer staples. Hence they usually trade at a higher multiple vs other cyclical sectors.

The Industry Structure

The business model may be great but if there are too many competitors, it drives margin down and there is little money to be made. The strange thing about the oral care industry is that globally, there really aren’t that many players. Basically there are only 5, and they control 70% of the world’s market. The top 2 guys alone, Colgate and P&G, controls 45%. So it’s an oligopoly.

When the industry structure is such, the top players have the pricing power and they call the shots and the 3 minor players will follow. Of course they are also cognizant that they can only raise prices to the extent that consumers won’t be put off. If toothpaste becomes $20, I think a lot of alternative brands will appear and most people will switch to them immediately.

However the top players would choose to raise prices just enough to keep people from switching. In fact, given their size, they can lower prices to kill competition when they see fit. That is the power of oligopolies and monopolies.

Well, it’s not so good for the consumers though.

Emerging Market Growth

As with most consumer staples, we can expect steady growth as long as consumption grows. Specifically for oral care, growth rate can actually be high single digit driven by volume increase (as global population increases) and price increase (which should keep in pace with inflation, if not more) over the long run.

It is worth noting that this high single digit growth is also mostly driven by emerging markets. The number actually breaks down to low single digit growth rate for developed markets and teens growth rate for emerging markets.

So having exposure to this industry is basically another way to bet on the growth in the emerging markets. The difference is that you probably pay a fraction of the multiple of the actual consumer staples in emerging markets. (Well the growth rate is also lower bcos the base includes developed markets)

Next, we look at the main player in the market!

Steel Industry

After 186 posts about value investment philosophy, I think it’s about time to write about something else. Well, after all, value philosophy can actually be surmised into just 3 words. So, I am actually quite amazed why I could write so much. So going forward, hopefully I can write about industries and individual stocks. As and when new ideas hit, I will still talk about value philosophy and the big picture. Ultimately, that is what’s most important and what will drive long term return for investors.

In this post, I would like to talk about the steel industry. Steel is a basic commodity used by humans and has been pretty integral throughout the development of our civilization. Sadly as a business, it sucks. The industry as a whole doesn’t really create much value for shareholders although there are periods where it churns out enough cash to whet some appetite.

Today, about 1 billion ton of steel is consumed every year. China accounts for half of the usage. Outside of China, Asia including Japan, accounts for bulk of the rest. Well, this is unsurprising as steel is mostly used in construction and infrastructure which Asia needs, a lot.

The business model is simple enough. Buy raw materials like iron ore and coking coal, throw it into a blast furnace, out comes molten steel, add some other metal to make it better (like nickel for stainless, or zinc coat it for shine) and process it into sheets or beams etc. This in itself is not bad. What is bad is:

1. Both the input and output prices are uncontrollable.
2. Competition is very, very tough
3. It is very capital intensive

Raw material prices are controlled by the ore majors: BHP, Rio Tinto and Vale. Specifically, they dominate the spot market and use the spot prices to determine contract pricing. So the steel makers have no say in pricing. The final product prices are also determined by the spot market. There are international market prices for a variety of steel products including the most famous hot rolled coil (or HRC), for H-beams used in construction, for pipes etc.

The reason why such spot markets developed is probably bcos there are simply so many players in the market that is just have to be done for the benefit of both the steelmakers and their buyers. With such markets, products could be standardized, distributors can handle them easily and lengthy negotiations could be avoided. But that’s bad for profits.

But why are there so many steelmakers globally? Well, in the past, it was a country’s ambition to have its own steel mill. It’s a symbol of strength for the nation. The western countries had it. Japan still has it. Korean has it and now China and India are building theirs. What’s worse is when the various provinces or prefectures also decided that they should have, hence you have all these few hundred steelmakers all over the world, each having less than 1% of the global market.

In the middle of this decade, someone decided to restructure the whole industry. His name was Lakshmi Mittal. So he started buying small steel mills all over the world. But he realized that wasn’t enough. There were just too many. In a move that shocked the industry, he decided to buy over one of the biggest steel players globally. Today, his company is called ArcelorMittal and it has capacity of 100mn tonnes or 10% of the market.

But still, 10% is nothing in a world where the suppliers and customers are much stronger and you still have over a few hundred competitors. ArcelorMittal, amazingly, has been able to generate good cashflow by squeezing cost and investment. Unfortunately, the money has to be used to pay down debt and it will take another 5-6 years to bring debt down to a comfortable level. Not to forget, by that time, it probably needs to resume its capex plans as well.

Which brings us to the 3rd point. Steel is insanely capital intensive. It takes USD 1,000 to bring 1 ton of new capacity on. For ArcelorMittal to increase capacity by 10%, it will cost USD 10bn! That’s one sixth of its equity base today. Most other steelmakers are not even that half its size and a new blast furnace project almost always means new financing.

So in short, the steel business, though integral to the development of our civilization, is bad business. There is usually nothing left for shareholders, after everything is said and done.

Well, that is the big picture. Value investors are also stock pickers and hence the dynamics can change for individual companies.

Buffett had a stake in the Korean steelmaker POSCO for the longest time. The story for POSCO is that the company is the No.1 leader in a country that is perpetually in short of steel despite being one of the biggest exporters of steel intensive products like ships, cars, and consumer electronics. What is more amazing is that POSCO is also one of the world’s lowest cost producers of steel. It can achieve this bcos it has the most integrated high capacity steel mill in the world and it also attracts the best talent in Korea to work for the firm. To that end, it even has its own university!

Hence the firm consistently generated free cashflow and paid dividends while having a clean balance sheet with no debt. Having said that, the wheels of fortune might be turning as Hyundai tries to break its monopoly in the Korean steel market while the company had also tried unsuccessfully to expand into the Indian market. In recent times, the dividend has fallen to 2% while free cashflow yield is also below 5%.

So that’s a short summary of one of the oldest industry on earth. In short, it’s best to avoid, as the industry had not been very profitable for shareholders except for the 5 years starting 2003 when the whole world got into a once in 30 year situation whereby there was a shortage of steel. This happens when a big country industrializes after a long drought and no new investment was made in steelmaking. The last country before China was Japan, which started the steel boom in 1970s.

Next on the list is India, but that might be 2030, if we use the once in 30 year rule.

The Vilification of Leisure: Death of the TV

There are a few major consequences with the vilification of home leisure activities

1. Growth of share of mind-time for new activities

We all have only 24 hours a day, and this is the amount of time that things can occupy our minds. In the past where there are only TVs, radios and print, we spend our mind-time on these things. In fact the world probably spends 80% of home leisure time watching TV during the 2nd half of the 20th century. However as we move to the 21st century, we are spending our mind-time differently.

Internet, Facebook, iPhone, iPad, Youtube, Gaming (Xbox, Wii, PS3, DS, PSP), Blogging, Twittering etc. Some youngster completely stopped watching TV since they can watch it on the internet. No doubt TV is still big. It is still the major portion of global advertising revenue and is likely to be so for some time. But the winds of change are blowing. TV as a % of our mind-time is dropping and will continue to do so until it is just another form of media in a whole spectrum of others.

2. Ad spending to traditional media to fall

The revenue sources for most media comes from advertising, sale of content and subscription, with advertising usually making the bulk of the money. As mentioned, TV has dominated that total media ad spending for the 2nd half of the 20th century as it has the widest reach as compared to print, radio, outdoor or other forms of advertising. This makes the absolute dollar amount huge, like $100,000 to $300,000 for a 30 sec TV commercial in the US, and in tune of millions for high-profile programs like Superbowl, but the cost per 1,000 impression (CPM) is actually comparable to other forms of advertising at $10-30 CPM. This means that even though a company spends $300,000 on a TV commercial, it reaches 15mn viewers in that 30 sec, while other forms of media probably reach only 1/10 or even 1/100 of that no. of viewers.

Now the total ad spending over the long run can only grow with the global economy or perhaps slightly faster. With more and more people spending time on Facebook and other internet sites, traditional media CPM has to come down. Maybe from $10-30 to $6-20 or something. This means that ad spending on TV and other traditional media will be a smaller % of the global ad pie. While blogs, Youtube, Facebook and iTunes grow to take their places.

3. Consumer leisure dollar gets vilified

Another form of impact of the Vilification of Leisure affects the consumer leisure dollar. Before the explosion of these 21st century leisure activities (ie Facebook, apps, Youtube etc), the consumer leisure dollar for the masses is actually pretty limited. There is Hollywood, ie going to the movies. Buying CDs and DVDs, buying games for Wii, Xbox. Pay TV or cable and maybe some magazine or radio subscription. And that's about it! Well we are not going to explore leisure dollar into hobbies like photography, collecting comics, going for concerts etc though.

So with the Vilification of Leisure, the leisure dollar now gets spread over thinly to buying apps, buying items for your avatar in some online game, downloading songs, buying e-books not to mention buying newer and newer devices like iPad, Kindle, netbooks, PSP, the new DS, iPhone 4 etc.

Now the total leisure dollar that can be spent has a limit. Just a wild guess, it's perhaps $200-300 per month per person in developed countries. It is not going to double unless global GDP doubles. So this means that what was used to pay Hollywood, cable TV, games etc now needs to spread to all these new gimmicks. Of course, these new gimmicks enjoy spectacular growth since they start from zero. Like apps, it was nothing 2 years ago. Now it's a billion dollar industry. But it would be wrong to assume that it can be a $10bn industry in 3 years bcos the leisure dollar can only stretch so far. This goes for social online games, songs, online subscription whatever.

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So there you have it, Vilification of Leisure will hit us strong and we should be aware of its various impact. In short, a slow death for TV and a quick growth and plateauing for a lot of these new entrants.

Facebook and the Vilification of Leisure

Ok time for a confession: I don't have a Facebook account.

Geez what kind of dinosaur doesn't have a Facebook account these days? Even my grandma has a Facebook account. Well the rationale was that I do not need to have a Facebook account bcos I meet my friends LIVE and those that I have lost touch, I am happy that the relationship stays that way.

Well the same argument can be used for cellphones. Who needs cellphones anyways? We have letters, land lines and if we wanted to link up with an old friend, we would just call them up for dinner using fixed line phones. When we want to meet outside, we determine the exact time and place to meet, before meeting up. If they are late, we would just wait until they show up! And we write letters to our penpals, who needs phones?

Well, I am just saying it. (Borrowed from RWJ, one of the funniest on Youtube, go Google "RWJ =3")

I guess Technology cannot help you manage your life if you don't want it to. Grandma just wouldn't use Skype even if she could use it to see her adorable grand-son playing happily on the other side of the globe, every day. Dad refuses to use the cellphone with a GPS even if it means that he never needs to read the map again, Evar (yep fr RWJ too!).

Does anything change? Well actually it doesn't. Grandma and Dad are still very happy, oblivious to what they are missing out. It's ok, life goes on. What's wrong with just seeing cute little Toby once a year? Or with reading maps anyways? Technology is not everything. Yes that is true. It is also true that we had horses, hence we didn't need cars and we had letters, hence we didn't need phones. In fact, if we had continue to use horses today, maybe the big environmental issue might be avoided! And the mailmen wouldn't have lost their jobs and contributed to the 10% unemployment.

Well, I am just saying it.

Okay, in the bigger scheme of things, technology ultimately leads to better productivity. However technology does not increase productivity overnight. It needs enough time and people to embrace it before the curve takes off. Not all technology becomes truly beneficial, like Segway or even Gaming. Technology also comes with side-effects: like carbon emission. But on the whole and over the long run, it has allowed humans to progress faster than otherwise.

Back of Facebook, how does it help improve our lives? Now that we are at it, how do we define Facebook anyways?

Well, according to most, Facebook is a social networking platform where you can link up with friends, share photos or music or interesting weblinks, or you can use it to chat with friends, play games or just surf around for interesting stuff. In one sentence: it is a leisure, edu-infotainment and networking hub. There are now close to 400mn users on Facebook, (ie about the whole of US plus 20 Singapores) which also makes it a super powerful marketing machine. Facebook has recently turned profitable, I expect it to make a few billions in revenue in a few years and profits might reach a couple hundreds of millions. However, if it ever gets listed, the PE would be like 80x ie there wont be a chance to buy it at a reasonable price.

So how does one's productivity increase with Facebook? Well the most compelling argument would be Photos. The age of digital cameras means that people no longer print out as many photos as in the past. Most photos are stored in hard drives and the only time we get to see friends photos now is, well, through Facebook! Unless you are talking about wedding glamour shots or specifically going to some friends' house and ask them to show their Hawaii photos (which would be in their PCs btw and the reason you would ask is bcos they don't have a Facebook account where they could upload it).

Other than that, Facebook just becomes this viral photosharing-networking-eduinfotainment hub that sucks away time from the TV, the phone, the radio and other forms of leisure. There might be some productivity increase bcos instead of passively receiving entertainment/leisure/knowledge you actively search for it. Well the argument works both for Facebook and for the internet.

But what is happening with Facebook is actually much bigger than Facebook or Internet or Dinosaurs with no Facebook account. I call it the Vilification of Leisure.

In the past, like say 30 years ago there are only about 3 forms of home leisure activity.

1. TV
2. Radio
3. Books/Newspaper

Well there is a fourth one involving kids: either playing with them or making them, but let's just leave this one aside for now.

Then. gaming consoles came along, followed by the internet, then American Idol (needing both TV and cellphone), then Youtube, iPod, Facebook, iPhones, Wii, Skype, World of Warcraft, iPad, Natal, Twitter, PPS etc etc. The whole home leisure scene just exploded. But sadly we still only have 24 hours per day. Even sadder, we probably spend only 2-3 hours of our day doing these things. So 30 yrs ago, we spend 2-3 hours every night in front of the TV. Now it's gonna be spread over this huge maelstrom of activities. (Of course it would be more like maybe Family A goes Facebook, Family B still watches TV, Family C goes Wii or Brother of D goes Warcraft, Sister of D goes iPad etc).

In any case, the home leisure which used to be dominated by just TV now becomes a million things. This is the Vilification of Leisure.

In the next post, we discuss its impact.

PS: Well I lied, I have a Facebook account since 2008.

Economics of YouTube Musicians

I have been spending some time watching Youtube recently and was amazed by the talents of all these YouTube Musicians all over the world.

Check out Sungha Jung
http://www.youtube.com/user/jwcfree#p/u/16/JykAgIVT6-s

And Singapore's own YouTube Sensation
http://www.youtube.com/user/ling86#p/u/8/bUY8iT525yQ

The analyst in me started wondering about the business economics of these musicians. So here I will simply share some random thoughts on how things can work.

First, as pointed out by Mary Meeker and her famous Price to Eyeballs, the no. of hits should have some value. Btw this is a crazy idea in finance and still draws laughter to this day. I guess Meeker's greatest mistake is to attribute the price of a stock directly to eyeballs, which grossly overstates the true profits that millions of hits actually generates.

It is surely quite a tough job to determine the true profits from millions of hits.  But it's been 10 years now and we have a history of stuff to help us. Also, I will stop short at revenue and not profits, which  requires another few levels of analysis. For a start, let's look at some online businesses out there:

Online social games: Zygna, revenue paying users: 5-10%
2nd Life: Revenue paying users 5% or less
Facebook: Revenue paying users probably 2% or less
Blog clicks: 8percentpa, monetize clicks 1% of all page views
Less than successful targeting online: e.g. selling Amazon books on personal websites, less than 1% of all page views

So with these historical no.s, we can roughly say that maybe 1% of the eyeballs, or hits can be converted to money. Obviously the kick comes from the per user revenue, or just to throw in a technical term: the ARPU or average revenue per unit/user. The ARPU varies widely depending on the nature of the online business. For Zygna, this is pretty high, at $4-5 or even more . For Blog clicks, unfortunately, it's more like 10c or less.

Back to YouTube Musicians, so a million hits converts to perhaps 10,000 potential revenue paying users and then if we put ARPU at $1, that's $10,000. That's the theoretical value of a Youtube Channel with a million hits.

In reality, we need some form of infrastructure to realize this $10,000. Specifically for YouTube Musicians would be distribution: like iTunes to sell the music via downloads, or record labels to sign them up, make albums and sell CDs through music stores like HMV, sponsors, experienced artists to help them (like with joint live performances), capable producers, good agents etc. And depending on many other factors, the realized value can be much greater (or smaller) than the theoretical value.

Now you might be thinking, this isn't all that attractive right? Even if we scale up the value by 10x, a million hit channel can only generate $100,000. That cannot even buy the cheapest HDB flat. I guess there are two points pertaining to this.

1. In the world of internet, the scale needs to be in 10-100 million or more

Sungha Jung has over 130mn hits for all his performances, going by my simple calculations above, his channel's theoretical value is $1.3mn, and in reality he has probably monetized even more. He succeeded with help for famous guitarists all over the world, supportive parents, perhaps generous sponsors and producers etc.

When we look at some old world artists with just one hit song, like Lisa Loeb with "Stay" or Berlin with "Take My Breath Away", CD sales are formidable at just a few millions, that is bcos the no.s left out people who listen half-heartedly and decided not to buy. Whereas the internet captures all these no.s as hits. To put it another way, if "Stay" started out as an internet song, it could have generated 100mn hits.

2. Longevity issue

A channel that can generate $10,000 in revenue one off might not be any good. But a channel that can generate $10,000 annually for say 10 years is something. Singapore's GDP per capita is $40,000. One channel that can year in year out gives $10,000 is worth a lot. But needless to stay, that can only be achieved with constant maintenance and updates. This in itself is a lot of hardwork.

Most musicians, if you ask me, don't really survive 10 to 20 years. Think of all the hits in the 80s and 90s, and where are the singers? Tiffany, Debbie Gibson, NKOTB, Jewel, Boyz To Men, Michael Learns to Rock, Cranberries etc. Well one might argue they made enough, called it a day. Or they might have drifted into oblivion against their will. Actually the pace of human civilization is so fast that most careers don't last that long as well. Guess that's why a lot of people in their 40s and 50s struggle with jobs and competition from the younger generations.

Back to YouTube Musicians, longevity is an issue, there is no two way about it. It would be quite a feat to last even just 10 years.

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To sum it all up, let's try to think about how to then maximize the full value of a popular channel.

I guess one logical answer would be tremendous hardwork and then promotional work in the first two years. This would include quick updates of new videos, selling via iTunes, finding sponsors and producers etc. This would then be accompanied by live performances, appearances in media, shows etc. Hopefully, with these, the revenue scaling really does go from $10k to $100k for a million hit channel. Of course, the better leverage factor would be generating more hits ie from million channel become 5 mn channel. This would in turn translate into more revenue down the road.

As the years progress, things will definitely slow down, so the focus might be on recycling the songs for other uses: awareness videos, commercials etc. And perhaps selling distribution rights but retaining a very small revenue share.

Thus the maximum absolute dollar value extracted could probably be somewhere between $300-400k. Well good enough to get a 3-4 room HDB in the suburbs, I guess.

Global industries and product market sizes and their implications

This is the 3rd installment of facts and figures around the world. (Don't we just love trilogies!) Not so useful for a lot of people, even value investors. Value investors just need to know enough about the companies they invest in order to do well. But hopefully, information here can help to widen your circle of competence.

We shall talk about a few industries and markets here: Steel, Automobile, PC, TV, Game console, Mobile phone.

The global steel industry is an estimated USD 600bn industry with global annual shipment of 1.2bn ton of steel. The No.1 leader in this industry is Mittal Steel with close to 10% market share. Interestingly, our hero, Warren Buffett has a stake in POSCO, a Korean Steel co. which is also one of the lowest cost producers of steel in the world.

To a layman looking at this 1.2bn ton for the first time, this may be just another no. and may not seem impressive at all so let’s translate this to something more powderful. 1.2bn ton of steel translates to 200kg of NEW steel being produced and used every yr for every person on Earth. This means enough steel to make 1 washing machine + 1 fridge + 1 aircon + 1 full set of stainless steel cutlery and 1 Ipod for every person on Earth EVERY YEAR! And this amt has been going up since humans walked this Earth (well it went up a lot more during the last 100 yrs as compared to the past 1000 yrs.)

Btw, consumption of all kinds of natural resources have only gone in one direction since, well, humans walked this Earth, and that is up. Environment fanatics talk about recycling and conservation but the way I see it: it’s a lost cause. Primarily bcos recycling comes at a price and it’s too high. Eg. it cost USD300-400 to produce 1 ton of steel and the truth is scrap steel (i.e. recycled steel) cost almost as much too! Anyways, that’s a topic for another day.

Ok, next. The global automobile industry is an estimated USD 2trn industry (Woah that’s huge! Remember global GDP is only 40trn!) with annual shipment of 70mn cars. Needless to say, the Japanese dominates this industry. 1 in 3 cars on global roads now are Japanese cars and Toyota now produces close to 10mn cars every year ie 1 in 7 cars is a Toyota. With China joining in the 5C’s race, we can expect even more cars and seems like the Japanese will win hands down bcos they are cheap and reliable, just what the masses want.

Fortunately or unfortunately, the rest of the industries/markets are all tech-related and most value investors hate tech bcos tech has never really created much value. No tech product ever stood the test of time, remember Polaroid? Or Walkman? Discman? SegaSaturn? So we may not see these products mention here 20yrs from now.

Anyways, the global PC market is USD 250bn market with annual shipment of 250mn units. This 250mn is an interesting no. bcos the global TV market is an estimated 220mn unit shipment. Hence it probably suggests the maximum ceiling for household products is around 200-300mn global unit shipment per year. This means that when analyzing the next killer household application, this may be a good no. to use as the maximum ceiling for unit shipment. Incidentally, the no. of households in the developed world is roughly 300mn as well.

The global game console market is a small one with a market size of USD 8bn and annual shipment of roughly 30mn units. Of course, if you include the revenue of the software (ie, the games), this market is already bigger than Hollywood. Most pple like to look at the market over its lifecycle though which is roughly cumulative shipment of 150mn units over 5-6yrs. During the last cycle, PlayStation 2 made by Sony shipped an incredible 120mn units over 5 yrs. But this time round, it’s Nintendo stealing the limelight with its Wii console. If you are not familiar with Wii, go google it up and be amazed! Sadly the PlayStation 3 has shipped only a miserable few million consoles to date.

The global mobile phone market is a USD 200bn market with annual shipment of 1bn mobile phones. If you are missing the impact of this, it’s 1,000,000,000 mobile phones! This means that 1 in 6 people globally buys a mobile phone every yr! If you take out the children and the old folks and those in not-so-privileged countries, we can even say that EVERYONE buys a mobile phone EVERY YEAR! If you think Ipod is big, think again! Ipod shipped a mere 100mn units over 4-5 yrs!

The mobile phone is definitely the most impactful killer application in the history of humankind although it may be at the tail-end of its growth. Wish you had bought a Finnish co. with a funny name some 15yrs ago huh!

So what’s the use of knowing all this? Well actually not very useful. It helps you to think about your co. (i.e. the co. you are investing in or planning to invest) in the global scheme of things. What is the market that your co. is competing in. How big is the market? Does your co. have a huge share of the market? These questions and more. With these no.s at the back of your mind, hopefully it will make the analysis easier. Doesn’t mean that you can make money though!