Renowned value investor Tom Russo gave a wonderful talk at Google again earlier this year. Most of our readers are probably already very familiar with Russo’s investment philosophy, especially with regards to his relentless focus on management team and the capacity to suffer and capacity to reinvest. What stood out in his speech this time, to me, was his mistake of omission in not buying Kweichow Maotai – one of my favorite brands in the world. I’ve also written a few articles on Maotai over the past few years. Given Russo’s deep understanding in the alcohol space, it’s amazing that he didn’t pick up Maotai when the shares were trading at roughly 10 times earnings a few years ago. Below is Russo’s brief summary of why he didn’t buy Maotai.
"The shares collapsed when President Xi cracked down on luxury banquet and gift giving in his attempt to get rid of corruption. Maotai’s shares collapsed and have advanced eight-fold over the past four years. It’s a brand that Russo didn’t buy because he assumed that as China becomes more open and as more Chinese people travel abroad, they will leave the brand because non-Chinese would not drink Maotai. He also felt that the controlling stake by the army and communist party would be a high level of agency cost."
Readers would find this interesting that Russo is absolutely right that Maotai’s taste doesn’t travel outside of China. In fact, I have personally tried to have my American friends drink Maotai and almost all of them hated the taste. Only one of them is still willing to drink it but he never thought of drinking it without me. None of them understands why a bottle of Maotai would cost so much.
It’s also interesting that I visited Russo in 2015 in his Lancaster office and asked him specifically about Maotai. As I recall, he actually visited Maotai (maybe even more than once) in China before. That was remarkable because the headquarters of Maotai are located in a very remote area of China. I would assume very few non-Chinese investors ever want to visit Maotai’s headquarter. Russo also said that he was concerned that management team at Maotai was assigned by the Communist Party so he didn’t think their interest aligns with that of the investor. And he was probably also right because there were some pretty large capital expenditure items that were questionable including a very large spending to build a hotel named after the brand.
The same concern was shared by the analysts at First Eagle Capital Management. It was in 2014 that I visited Jean-Marie Eveillard. During our conversation I brought up Maotai and why I thought it was so obviously cheap. Eveillard immediately became interested because he knew a lot about the French wine business. So he connected me with one of First Eagle’s analysts who covered alcoholic drinks. I spoke to the analysts a few days later and he inundated me with questions on Maotai’s capital expenditure. In the end, he passed on the investment and wished me good luck.
What’s more interesting in my opinion, is that all the best Chinese value investors I know, bought Maotai when the shares tank in 2014. Some bought the shares even earlier (one of them has held the shares since early 2000s).
The sharp contrast between the best U.S. value investors and the best Chinese value investors on Maotai is intriguing – two most experienced U.S value investors didn’t invest in Maotai even though they are both experts in the worldwide alcoholic drink market, while without exception, the Chinese value investors picked up Maotai’s shares like when they found gold.
I don’t think Russo or Eveillard were wrong in omitting of Maotai. It’s almost impossible to understand the power of the brand if you are not a Chinese. And understanding the power of the brand is a pre-requisite to recognize that Maotai was a bargain at 10-11 times earnings. In that sense, both Russo and Eveillard were perhaps just sticking to their cultural circle of competence. The Chinese value investors understand perfectly why Maotai’s brand is so valuable to they can act confidently with the shares were unbelievable discounted.
