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Grahamites
Grahamites
Articles (293) 

Clash of Cultures - Why the Best US Value Investors Passed on Kweichow Maotai

Cultural barriers prevented Russo and Eveillard from investing in one of China's most valuable brands

April 07, 2018

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.

About the author:

Grahamites
A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

Rating: 4.7/5 (7 votes)

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Comments

snowballbuilder
Snowballbuilder - 5 months ago    Report SPAM
hi grahamites intersting and well written article (as usual)

first i dont own maotai or any other chinese stocks

that sayd also Pabrai had spoken a lot about it recently

Mohnish Pabrai (Trades, Portfolio) Lecture at Peking University (Guanghua School of Mgmt) - Dec 22, 2017



https://www.youtube.com/watch?time_continue=6546&v=z74NaYRyMJo

he has invested hevily in it , also interesting that he has tried to bring in Guy Spier describing Maotai as an "raining gold opportunity" but depite his confident and the fact that he and Guy are close friend ... Spier was not confident so he only take a 0,2% position.

I dont think that this is an error.... anyone has (should have) his circle of competence and anyone has his lists of big opportunities missed... and that is natural and perfectly ok if (until) your long term return (in your circle of competence and with the opportunity you take) is still way better than the average (and i think Guy Spier well fit this spot) .

That sayd i think Pabrai with his Maotai and his FCA / Ferrari incredible investment will be one of the best performing investor of these decade (good for him and well done).

Curiosity... Of much of your portfolio have you allocate to Maotai ?

Have a good day. Best Snow

yesudeep
Yesudeep premium member - 5 months ago

I'd call BS on Russo's decision-making if that's why he didn't pick it up. Alcohol is a matter of taste. If someone likes a particular brand of rum, they're going to stick with it. I drink Old Monk Rum even if it is not the best and the manufacturer is in its last legs (because of negligence). Yes, I might on occasion try something else entirely, but given that I have access to every kind of rum there is, that is the only bottle of rum I grab if I see it on the shelves. Same with smoking. Got to be a consumer to understand smoking and drinking. You can't explain what sex feels like to a virgin. Also cigarates and alcohol are products that can travel. I like products that travel with the customer. All Maotai has to do is export its products and get it within the reach of its loyal customers to fix the traveling-customer problem. In fact, if I can't find a single bottle of Old Monk rum on the shelves, I ask friends and family who are traveling to get me some bottles of that exact brand. Taste is extremely important to a consumer—my uncle, for instance, can /smell/ the difference between adulterated Old monk and regular Old Monk—that is how much he loves Old Monk. Smokers can tell cigarette brands apart from just the odor of the smoke. I'd suggest not underestimating taste/smell at all. Also, China has a very large population—not all of it is going to travel abroad. Given that situation, I think Maotai is a virtual monopoly. The only question one has left to answer with alcohol and cigarettes is: does this product own a piece of the consumer's mind? That has more value than the nominal price/worth of a business. The consumer is the ultimate guarantor of the safety of an investor's capital, and as Graham would put it, safety of capital is the pre-requisite of investing. Will Maotai have loyal customers in the future? I bet yes.

On matters of taste and travel, most people West of Asia don't have the same taste buds as those in Asia anyway. You could add a spoonful of pepper in my food and I'd relish it but it would pinch most non-Asians and turn them red. The taste of a certain region comes from its culinary culture and will persist as it has for eons. Only now people are writing papers about the use of turmeric to prevent cancer for example, but people in the East have been using it for such a long time that it is part of the taste. A consumer doesn't leave his tongue behind in the country of his origin—taste travels with him/her.

You'd have to understand the consumer to understand the value of the business more than you have to understand the business. In my rather straightforward opinion, I'd conclude that these very experienced value investors are underestimating Maotai.

Customer is king.

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