Over the last decade of investing I’ve literally visited hundreds of companies. You never really know what you’re going to see, but there is a standard pattern to these visits. Usually it starts with some pleasantries followed by a pile of marketing materials being tossed at you. You go through the pitch book followed by a few questions. The CEO often has his CFO at his side to answer questions while the investor relations guy pushes the discussion away from unpleasant topics. We usually get a highly sanitized tour of the facility complete with safety gear and introductions to key employees. Once the tour is complete, we head back and ask a few more detailed questions and leave. More often than not, we get dinner later that night and I try to probe the CEO on his ‘vision’ for the company and where it really sits in the industry. If possible, we drink a lot of beers and see if the answers remain the same at 2am. We part ways at some point and then the IR guy calls me once a week like a good used car salesman. Maybe they give me a corporate hat to remember the visit. It’s pretty standard fare. I enjoy frontier companies because they are so raw.
I remember a company visit in Ivory Coast where the CEO told me that he was looking for a better company to work for. A CEO in Ghana said we shouldn’t invest because ‘this company sucks.’ Mongolia has not disappointed. They rarely meet investors; there are no IR guys to sleaze the meeting up. There is no PowerPoint to review. Heck, there aren’t even financials—just honest answers to honest questions.
These guys weren’t trying to sell me anything—they had nothing to hide. They didn’t particularly care if I bought shares. At most Western companies, the CEO has a 5 year tenure during which he needs to do something creative to get his shares up and cash in his stock options. It’s a very promotional mindset. In Mongolia, most of the executives have been there for decades. A surprisingly large number of them were floor workers during the Soviet times and earned their current jobs. They are here for the long run, want to build real businesses and don’t care where the shares trade tomorrow. I think this leads to more honest answers. It also means that a lot of the accounting I saw was less aggressive than in the States. Where else can you see multi-year cap-ex programs get expensed instead of depreciated? No one here cares to beat estimates by a penny. There aren’t even broker estimates, and it shows. With that in mind, let’s walk through a typical meeting.
How's business doing? Count the crates....
After the pleasantries are over, management always starts with the history of the facility. I have piles of notes on which 5-year plan the facility was built during and what percentage of total Soviet production it was at its peak. In particular, the CEOs are proud of past production awards. Very few plants hit their 5-year plan targets, but those that did were awarded medals. One plant even got consecutive 5-year plan awards—which was almost unheard of—their prize, a Lenin statue. We saw black and white pictures of happy Mongolian workers and Czech engineers working side by side. We saw workers awarded medals by proud Russian generals. Most companies spent a good 20 minutes going over 1960’s production nostalgia. You may ask why anyone would care, but this was important to these management teams. Many of the executives have worked their entire lives in these facilities and it’s obvious that they take great pride in them. There is also the subtle notion that if an investor (me) puts capital in to refurbish things, the factory can once again set records.
Once we transitioned into the modern time, the CEO would talk about the business for a while before I would finally interrupt him and ask for financials so I could follow the story. There would be some confusion, a bit of hesitation and occasionally, the CEO would refuse to show us any numbers at all. Often, the best that we could get were the statements handed to the exchange (literally). These were stamped by the exchange and bound in an official looking document. It was a starting point. Unfortunately, they are never in English and they aren’t quite in GAAP format. Put it this way, standard Mongolian GAAP has a line item for livestock—even for a financial firm. Every quarter the various line entries change. Even with a skilled translator, I was exasperated trying to figure out the financials. Fortunately, most CEOs will round off revenues and income to the nearest hundred thousand US dollars for discussion sake. Heck, it really doesn’t matter what earnings are. All these companies are in such states of flux that the past doesn’t matter anyway.
That's literally the set of financials turned into the exchange. You cannot take them with you. You cannot photocopy them. If you want to know how the business is doing, you go to the factory and look at the numbers.
If you have huge market share and transition from archaic Soviet equipment to modern machines, your income should increase considerably. Along the way, there are piles of charges and expenses. It’s not even worth deciphering it all. You need to stare into your crystal ball and visualize where the facility will be 5 years and millions in cap-ex from here. Fortunately, I’ve spent my whole investing life learning about companies undergoing dynamic change. Will $3 million in cap-ex really double income? What would pro-forma income look like if the production line had not been down for 6 months of upgrades? Eventually, you get a sixth sense for these things. So let’s forget the financials and see what these companies are doing. Everything up to this point is the past—I’m investing in the future.
A few hours outside of Ulaanbaatar is Silika. Built in 1966, it was at one time, one of the largest producers of cinder blocks in Mongolia. Time has not been very kind to the facility. Roughly $7 million has thus far been spent modernizing it. They are looking to do an IPO to finance the completion of repairs. How much will it take to modernize the facility? Will it be a good investment? Further research is needed. However, we have plenty of examples of companies successfully undergoing the modernization process.
Cinder block plant modernization phase I.
What will it cost to complete the modernization?
Consider Atar Urguu, the Mongolian bread company. At one point, it had 100% market share. That number has now declined somewhat due to competition. Two years ago, the company started a modernization process.The new equipment is faster and more efficient than old production. The company now has over USD $1 million of run-rate cash flow from bread production. However, it is hard to look at past financials and see this. The production line has been down a few times in the past two years for upgrades. You just need to trust the CEOs estimates—which I do. They have now paid off the debt from their bread machine and intend to buy new cookie machines. This will modernize the other half of their factory.
Top: New bread equipment. Below: The CEO explains how he makes the dough.
What’s this company worth? There’s no debt and over USD $1 million in cash flow from bread production. There’s no way to know what the changes in cookie production will do, but it’s safe to say that it will increase profitability. The current market cap is USD $4 million. That clearly is too low. I cannot see how you lose money on an investment like this. Even without the cookie upgrades, it should be worth ten times cash flow. If the upgrade to the cookies is successful, maybe it’s worth USD $20 million, or five times the current quote. Of course, this is all kind of silly to discuss. In the past year, less than USD $10,000 of stock has traded. Back when I was starting out, I’d stick a bid in there and hope to get some stock—even if it was just a few thousand dollars worth. Now the exercise is more academic than financial for me—there’s no stock for sale. However, it showcases the upside from factory improvements in Mongolia.
Cookie Plant: First they weigh the dough (top) then they make each cookie using a wooden mold. A more efficient cookie production line is desperately needed.
Portfolio manager Isaac Schwartz is breaking bread with the CEO. I tried to explain the concept of the bagel, but it was lost in translation--literally. It's a shame. Ulaanbaatar desperately needs a good bagel shop, or any bagel shop for that matter.
Everywhere you go, you can see Mongolian businesses modernizing and going up-market. Anyone can slaughter and slice goats; the real money is in high margin finished products.
Ever wonder where dumplings came from?
They say you should never watch sausage or CDOs being made. Sausage seems pretty sanitary, I'm far more scared of CDOs.
No trip to a former Soviet country could be complete without a trip to the biggest vodka plant. Our gracious tour guide gave me a bottle for the road. Quite good stuff. This is a fully modernized, highly efficient facility.
To be continued....