In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor discuss:
- Reflections on Japan: Investing Culture & Net-Nets
- Capital Allocation & Tokyo Stock Exchange Reforms
- Buyout Firms in Japan: An Undervalued Opportunity
- Long-Only and Activist Investors in Japan
- Cultural Philosophy & Long-Term Thinking
- Transition to Shanghai: First Impressions & Cultural Contrast
- Venture Capital in China: AI, Robotics & Intensity
- Hard Tech vs Commercialization in China
- Consumer Culture and Competition in China
- China’s Tech Leap: Phones, TVs, and EVs
- 996 Work Ethic and Build Speed in China
- Payments, DeepSeek & Local AI Models
- China vs US: Manufacturing and Global Perception
- Mutual Misunderstandings: Media Bias and Cultural Perception
- Investing in China & Japan
You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:
Transcript
Tobias: It says it’s preparing a livestream. I think we’re live.
Jake: [laughs] Livestream.
Tobias: I’m Tobias Carlisle.
Jake: Oh, boy.
Tobias: This is The Acquirers Podcast. I’m joined as always by my co-host, Jake Taylor. JT, what’s news?
Jake: Welcome to the show, Toby. [laughs]
Tobias: Sorry for that intro, folks.
Jake: Yeah. We’ve set the bar at a new low for technical–
Tobias: JT and I, both still very jet lagged and I’m back on the road again.
Jake: Yeah. Just getting everyone caught up, we were in Asia for the last two weeks and so took a little break. Now, we’re back to do a debrief. While we were gone you guys decided to break the market on us. Much appreciated. [chuckles]
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Reflections on Japan: Investing Culture & Net-Nets
Tobias: Yeah. So, we were in Tokyo for a week and then Shanghai for a week. And interesting contrast I think between the two cities and the two investment styles in the two cities. I think it’s an interesting the way the energy of the cities matches the investment style a little bit.
Jake: Oh. Like, insane how they do that. It’s quite interesting to see how that manifests. One thing I wanted to start out with was I– The first observation that I really came away with was that you can’t get a sense of a foreign land I think without visiting it yourself. I was a little naive about that before– You could talk to lots of people and read the news, but I think it’s really not the same as seeing it close up for yourself. I think especially, I don’t think that I knew or that a lot of us in the US know what’s really happening in China unless you see it for yourself, especially.
Tobias: When you say that we are talking about China, because I think where you’d been to Japan unexpected?
Jake: Well, I think the part of Japan that was unexpected was that you knew it was going to be difficult to get management to do the capital allocation things you wanted to do to unlock some of those frozen and some might say bloated balance sheets. I think it’s going to be even harder than I thought it was going to be before seeing it up close.
Tobias: So, you’ve invested in Japan variously over the years. There was a net-net basket-basket from 2015?
Jake: 2011. Fukushima.
Tobias: 2011.
Jake: Yeah.
Tobias: So, everybody knows Japan has been in a bear market since 1993, earlier 1990? 1987?
Jake: It peaked in 1989, I think.
Tobias: 1989.
Jake: So, I think they just took that out what last year or something from 1989.
Tobias: So, they’ve been in this very long bear market. There have been a number of rallies along the way and there have been a number of these periods where it got very cheap.
Jake: Yeah.
Tobias: 2011, it was possible to buy a big basket of Japanese net-nets which is lots of balance sheet value, cash and so on trading at a big discount to the liquid portion of the balance sheet at a 2/3rd discount. How did that basket work out?
Jake: It worked out well. Like any typical net-net expectation where a few were clunkers, most did nothing and then a few really worked out well enough to carry the balance.
Tobias: The basic approach to.
Jake: Well, it is. It’s a power law driven outcome even though you’re starting off with equal aided, relatively junky. Although honestly the companies, they were low ROA, low ROE companies but they were all profitable. There was an R there. It could definitely be worse. I feel like a lot of times over the years trying to buy net-nets in the US and they would just be not only– Oh, they’d just be hemorrhaging cash too. So, you were like racing the clock it felt like to see if there was going to be an unlock.
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Capital Allocation & Tokyo Stock Exchange Reforms
Tobias: So, we flew into Japan first. A very large portion of the Japanese stock market trades at a discount to book value. Book value, everybody gets upset, because yeah, it doesn’t represent what you can take out, it’s what’s been put in and so on. But it does represent what has been invested in the company. And that’s a problem for these companies that they’re trading at a big discount to book value.
Jake: Yeah.
Tobias: And the reason is that those returns on equity, returns on assets remain very depressed. They’re trying to get them up to 5%. That’s the goal. Talked to one of the managers, they were like, “New projects looking at a 5% return on equity, return on investment.” So, we visited with multiple buyout firms, multiple activists,-
Jake: Yeah.
Tobias: -long only shops.
Jake: The Tokyo Stock Exchange which was interesting. Quite interesting.
Tobias: Because we wanted to hear from the horse’s mouth. There’s this directive regulation suggestion from the Tokyo Stock Exchange that companies have to get their price to book value above one, well, they face delisting. Not clear what they face.
Jake: Yeah, I don’t know if it’s a full– Like, it’s hinted at that’s the potential, but I think it’s more like well, we’re going to send you a strongly worded letter first or maybe 10 times before anything really happens. Not exactly clear what the teeth are there, but they’re working hard there and they’re pretty thoughtful about it. They know that things take time and they’re doing what they can to nudge in the right direction. So, I think they’re on the on the side of angels there.
Tobias: We met with the Tokyo Stock Exchange. Two guys from the Tokyo Stock Exchange. I’ve had lots of meetings with regulators over my life in Australia and the US.
Jake: Unfortunately.
Tobias: Unfortunately. I’ve never had a meeting like that though.
Jake: Yeah. They were surprisingly candid, weren’t they? I thought they were forthright.
Tobias: And helpful.
Jake: And helpful. Yeah.
Tobias: And so, they have this plan to move all of these Japanese companies that are under earning into a higher category– They’ve categorized them in terms of corporate governance and willingness to embrace more shareholder friendly practices. They’ve targeted these ones that have not responded at all, what they the group three or the third tier of this-
Jake: Yeah.
Tobias: -response to this directive. They’re trying to chase these guys. They do seem to be on the side of shareholders in Tokyo, which was refreshing, interesting to you?
Jake: Yeah. My hunch is that given the culture of wanting to you don’t really want to stand out on your own as much. Like, iconoclastic thinking doesn’t seem to be their strong suit. And so, my hunch is that it’ll be like that joke about bankruptcy, but it’ll be like, “How did you get rich in Japan buying cheap stocks?” Well, slowly and then all at once, which is to say that the companies may, once the sea change starts to happen, like there’s a momentum and it might be nonlinear.
I don’t know if you can time it very easily. Like, I think it’ll be one of those things where it’s like not working at all and you’re like, “Okay, I’m ready to throw in the towel.” And then, all of a sudden all of them will phase change and sell their cross shareholdings, maybe distribute cash, maybe buybacks. Lots of different levers to pull there. But it’s all like very simple stuff that’s required, like you don’t have to have a good sense of what’s the ROI going to be on AI cloud spend to get it right and maybe get paid. All they have to do is just figure out some real basic corporate capital allocation stuff. So simple, but so far proven to be not easy.
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Buyout Firms in Japan: An Undervalued Opportunity
Tobias: Well, the first groups of that we met with were the buyout funds. It sounds all of you young guys who are doing looking for HVAC businesses to search fund into and buyout, you need to get yourselves to Japan, because there are real businesses that are trading at ridiculously cheap prices. And the buyout firms are talking about taking stuff private at five to six times.
I think when we said five to six times to one of the other firms, they pushed back on it a little bit. Not one of the activist firms, this was one of the– It could have been one of the activists, and they said not five to six times, they said more like eight to nine times, which in the US context, that’s still pretty cheap. I think the US is currently like–
Jake: 13.
Tobias: It could be.
Jake: Yeah.
Tobias: Yeah. 12 to 15 on average, that kind of range, something like that, which is pushing me up edges of–
Jake: Allowing for a decent return?
Tobias: Yeah. Yeah. There’s been this giant buyout in Tokyo led by KKR.
Jake: KKR. Yeah.
Tobias: And they’ve paid 33 times. So, that’s at the very big end. The big end is just as competitive globally as it’s always been. So, Tokyo is no cheaper than New York in terms of the very biggest companies, because the big buyout firms from the US are over there chasing these companies. There’s just not many of them around. You’ve got to put in a very, very solid bid to get these things. And clearly, 33 times, that’s expensive. But at the lower end, all of these little– not little, but these buyout firms, middle market, lower market buyout firms, they say they pay five to six times. They’re borrowing at TIBOR, which is the Tokyo Interbank overnight rate. And it’s like 0.25%, 25 basis points, plus 200 or 300 basis points, so another 2% or 3%.
So, they say they’re borrowing at 2.5% to 3.5% and they’re able to borrow 70% LTV, that’s loan to value. So, they’re putting in 70% to 80% LTV, so they’re putting in 20% equity at five to six times EBITDA, borrowing at 2.5% to 3.5%. And if you plug that into a very simple little spreadsheet, then you get some pretty decent returns without having to do anything really. That’s old 1980s buyouts in the States. That’s what the level that they were done at– You’re going to get good returns at that level.
Jake: I remember you said at one point, “If you were 20 years younger,-
Tobias: Yeah.
Jake: -you might move to Tokyo and get out from here.”
Tobias: I would probably be going to do that anyway. [Jake laughs] I was thinking about doing it anyway.
Jake: Yeah.
Tobias: I think there’s a very big opportunity in Japan. It’s very, very obvious. It’s sitting right there. The challenge is how you move from– Well, some of the listed companies– Well, we’re going to talk about this a little bit more. There is a real challenge with these listed companies. But more than just what these buyout firms can pay, they also have investments from GPIF, which is the big government pension fund.
They have these brokers who contact them and give them these exclusive deals to buy these things. And the banks do the same thing. They’ve got backing from the banks. They’ve got equity from the banks. They’ve got lots of lenders. So, it seems like that the quantity that is short in Japan is the buyout firms themselves. We met with a few, but even those guys, they didn’t feel to me to be as experienced perhaps as the ones that I regularly run into in the States. Is that fair?
Jake: Yeah, I think that’s fair. I don’t want to–
Tobias: Sophisticated maybe?
Jake: Yeah, I was going to say that without saying it. Yeah.
Tobias: Just a little bit less aggressive maybe?
Jake: Yeah. The PE market now in the US has gotten so cutthroat that like you have to be aggressive to get a deal done. They’re picking through a big– And like you said, there’s these M&A brokers, advisory services, that go and find the businesses and they’ll go find the funding from the banks and they’ll show up and package it and deliver it to the PE firm. I think you just sign and [chuckles] start collecting checks. [laughs] I don’t know. I don’t know how it works.
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Long-Only and Activist Investors in Japan
Tobias: So, after the buyout firm, we went to see a long only firm.
Jake: Yeah, a few activists. Some of them a little bit more are probably– [crosstalk]
Tobias: I’m suing the activist guys into their own bucket. I’m just going to do the without activism. I don’t know if we should mention them. It was nice to meet this guy. He’s well known. He’s been around for a long time and get some of his perspectives on what was happening. I think he was able to find enough stuff where it was pretty well managed and where the balance sheet was pretty tidy. So, he was doing quite well without having to–
Jake: Find a little bit more quality too, I think. Like, that idea that it’s quite a bit easier to get the horse to go where you want to go if it’s already riding in that direction.
Tobias: They seem to be doing pretty well. And then, we visited with two activists. Well, I visited with two activists. JT wasn’t there for the second one. But the first one was an interesting perspective on what we had already been seeing that they thought that this approach of naming and shaming, which I think was the Tokyo Stock Exchange is tool to get them to get these companies to comply, they felt that wouldn’t be as effective. It might be a little bit what you’d expect an activist firm to say that.
Jake: Yeah.
Tobias: They felt that there needed to be a little bit more pressure applied for anything to happen.
Jake: Yeah. But then, meeting with an actual company was a little bit of a wet blanket, like cold water in the face, just as to what you’re up against if you were to try to do that. They’re perfectly nice. That’s not the issue. It’s when you talk to them and try to bring up some of the ways that they may unlock shareholder value, it just doesn’t feel like it’s really registering very much. I don’t know. How’d you feel about that? Of course, there’s the language barrier that were trying to jump over there.
Tobias: Without naming the company and without giving the exact proportions that these things are going on, but this is a very common problem. So, there are cross shareholdings where company A owns a shareholding in company B.
Jake: Which could be typically like a supplier.
Tobias: Yeah, customer or supplier. The customer owns shares in the supplier. The supplier owns shares in the customer. It has the effect that management is entrenched. There’s no external pressure that’s able to be applied by activists, or takeover firms, or buyout firms or anything like that. So, they just trade.
Jake: Or, just thoughtful owners of the business.
Tobias: Right. Said that’s about a third of their assets. They have another third in assets in cash. They justify that by saying that they feel like it’s an obligation to hold cash, because it’s not safe to not have enough cash. From the perspective of their customer or their supplier, they feel like they’re obliged to hold that cash.
Jake: Yeah. Shock absorber.
Tobias: Yeah, which I like that– I don’t know about the scale. And without having dug through the financial statements, you would have no idea whether that was an appropriate level of cash or not, but the sentiment is right. I just don’t know if it’s real or if it’s the sufficient justification for having that much cash.
Jake: Yeah.
Tobias: And then, just on the numbers that I’m making up there, it’s a third cross shareholdings, a third cash. And then, it’s trading at three times. So, it’s earning. It’s an EV/EBITDA of one or it’s EV net profit of one. And then, the concern with Japan was always that it was shrinking or it wasn’t growing, but I think it’s pretty clear that they’ve had inflation of 5% over the last 12 months. I think that inflation in that order looks like it’s here to stay for the foreseeable future.
Jake: Yeah. Starting to show up in wage growth as well, which once that can get sticky and now psychologically, it gets harder to have deflation.
Tobias: They’re very, very unwilling to raise prices. That’s a big deal to raise prices.
Jake: Yeah.
Tobias: So, we saw some ads where they’ve never raised their prices. That’s one of the things. That’s the way they advertise their services, which a little bit like the Costco hot dog, like it’s not been raised. Not going over a $50.
Jake: And don’t even think about it. We’ll effing kill you.
Tobias: At some point.
Jake: Yeah.
Tobias: I guess it’s a loss leader. I guess he can do that. But if it’s your whole business, you can’t be selling, you can’t ever not raise price in the business.
Jake: Yeah. [chuckles] It can’t be all hot dogs.
Tobias: But then, these things are growing 5% or 6% a year, trading at one times, that’s a pretty good setup. You’re going to make money at that level. Even passively, you’re going to make money at that level.
Jake: And even just imagine, if you effectively liquidated your cross shareholdings and bought back your own equipment for half of book value, half of what you spent on it, hugely accretive. You can’t really lose then.
Tobias: You just take over the supply, you vertically integrate, you take each other over at a big discount.
Jake: Well, that might actually be more of what how this gets solved. Actually, I was thinking about like, M&A might be the actual answer. Like, you can’t depend on them to find the right answer themselves necessarily. It might have to be like, “We’re taking the controls away from you. Sorry, we’re just going to buy this company and take it over and then fold it into whatever.”
Tobias: Shareholder laws are quite friendly in Japan. At 1%, you can call emergency general meetings, you can request lists of shareholders. At 5%, there’s something equivalent to a 13D filing where you have to be–
Jake: Yeah.
Tobias: You have to describe what you’re proposing to do.
Jake: Intensions known.
Tobias: And then, there’s another threshold of 20% where the company is effectively put into play. I think to actually to compel something to happen, you need to be at 20%. That’s not easy on some registers. They’re just not going to be able to get there, because they’re too locked up by GPIF and the cross shareholdings. And so, there’s going to have to be a different solution for some of those businesses.
Jake: Yeah.
Tobias: One thing that we talked about that I thought was interesting was that the Japanese companies really are high quality. They have this real focus on a high-end product. It’s going to be well made. The factories, everything’s well maintained. They’ve got this very long-term perspective. Maybe one of the criticisms of the US, is that the perspective isn’t long-term enough. It’s a little bit more throwaway.
Jake: Yeah.
Tobias: And they make this very high-quality product. They’re going to do it. Well, they look after that. It feels like they have many of the qualities that we would like more American companies to have.
Jake: Yeah. Yeah, that like capital Q quality, Zen in the art of motorcycle maintenance guys that get excited about that stuff. You think Japan would be like a hotbed for that just given the Kaizen continuous improvement. It’s all the same stuff, but yet for whatever reason, maybe it just doesn’t grow fast enough to get them excited. I wonder about that sometimes. But there’s a difference between growth and quality.
Tobias: One thing we didn’t talk about was just Japan. It was Tokyo itself.
Jake: Yeah.
Tobias: Tokyo is incredibly clean. It’s incredibly quiet. The people are very polite.
Jake: Yeah. No jaywalking at all. Even at 05:00 in the morning, and there’s not a car to be found and people are just standing there waiting for it to turn. [chuckles]
Tobias: I did do a little bit of jaywalking.
Jake: Oh.
Tobias: I couldn’t hold it in. It came out.
Jake: Arrest this man.
Tobias: I had to. But I think that same attitude applies in the business as well. They’re all really well maintained. All the taxi drivers got little white gloves on.
Jake: Yeah, isn’t that nice?
Tobias: The taxi driver saw me walk around a corner in the wrong direction, he jumped out and he called me back and he directed me to my hotel and then he waited until I got in the elevator and waved for me. It was really nice. It was really sweet.
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Cultural Philosophy & Long-Term Thinking
Jake: Can I tell you a little story of a place that I went to, because I went to Kyoto for the weekend when you went to Shanghai, I brought my wife along. So, I visited this temple. I’m going to mispronounce it obviously, but it’s Kiyomizu. K-I-Y-O-M-I-Z-U. Kiyomizu-dera temple in Kyoto. It was built in 778 AD, which is now, it’s over 1,200 years old. It’s constructed entirely without nails. It’s all joinery, and master level patience required to make all this wood fit together.
It actually intentionally uses impermanent materials, wood naturally ages. It’s so deftly assembled that can withstand all the– like being in a very seismic area for all these 1,200 years, and it’s because the joinery is so good and it has the flex in it. This preservation and maintenance and thoughtfully rebuilding things over generations to me feels very Japanese.
There’s this other place, it’s called the Grand Shrine of ISE, I think it is, I-S-E. It gets rebuilt every 20 years for the last 1,300 years. And so, the next rebuild scheduled for 2033. And the purpose is this continual renewal and it’s not permanence. I feel like corporate Japan has a lot of this same mentality to it, a very long-term thinking. But anyway, that’s as close as we’re probably going to get to veggies for this week. It’s all layered throughout.
Tobias: Well, I had a nice meeting. You were in Kyoto, I had a nice meeting where one of the managers who’s actually, who’s my favorite manager, and I’m going to talk to him. I hope he’ll come on the show. I don’t know. He’s got a good strategy you might not want to tell anybody about it.
Jake: Yeah, [chuckles] Smart.
Tobias: He was disappointed that Jake wasn’t there, because he had some veggies for Jake. I don’t want to butcher that, but he made the analogy that the lack of predators in the Japanese financial system had led to a change in the ecosystem there a little bit. And in the same way that they reintroduced wolves to Yellowstone, and that had an impact on the ecosystem of Yellowstone, and it brought back some rivers and some greenery that hadn’t existed previous–
Hadn’t been there since they’d taken the wolves out, because the wolves ate down the deer or whatever the ruminant animal, prey animal is in there, which then in turn ate all of the grass and changed the course of the rivers. And so, in the same way in Japan, the absence of predators in Japan had led to a suboptimal ecosystem. And reintroduction of wolves to Japan might bring that ecosystem back to life a little bit.
Jake: Yeah, that’s great. I think scavengers get a bad rap, because they’re tend to be ugly and they eat gross looking things to us, but they serve a really important purpose. Maybe not enough scavengers [crosstalk] cleaning up the– Well, both I guess. But now, we have dire wolves after 10,000 years we brought them back. And so, now, we’ll let bunch of guys–
Tobias: What supposedly can go wrong?
Jake: [laughs] Yeah. [laughs] let them run.
Tobias: If Jurassic Park teaches us anything, it’s really easy to keep those things in cages.
Jake: Yeah.
Tobias: There’s no chance of them getting in.
Jake: Although apparently, I read someone else was saying that it was– They’d only like changed 13 different DNA positionings or something within the normal wolf to get to the dire wolf. It was basically like it’s BS, like it wasn’t really that big of a breakthrough. [laughs]
Tobias: That’s pretty hard to me. I don’t know.
Jake: I don’t know.
Tobias: if you know the right 13 to change.
Jake: I guess.
Tobias: We share a lot of DNA with the banana. Share a lot of DNA with lots of animals, you just change a few little bits and pieces, you come up with a different animal.
Jake: Yeah, that’s true.
Tobias: Let me give some shoutouts, and then we’re going to do Shanghai. Petah Tikva, Israel. What’s up, Pants? Cleveland. Brandon, Mississippi. Tampa. Bendigo. Good start. Hamish, early stuff for you. Waterloo. What’s up? William, the wizard of Waterloo. Scottsdale, Arizona. Bethesda. Mac in Valparaiso. What’s up? Jerusalem, Palestine. Samson, good for you.
Nokia. Highland Park. Mendocino. Kennesaw. Jackson Hole. Jupiter, Florida. Oops, I skipped a whole lot. [chuckles] Austin’s in Mongolia. How are you? Lausanne, Switzerland. Santo Domingo. Bellevue. San Diego. Surbiton. Bremerton. Albion. Gothenburg. And I’m in Carmel on spring break with my kids. Gothenburg, Sweden. Tallahassee. San Diego. McDonald Island. Toronto. Wodonga. Dubai. Cool.
Jake: So, [crosstalk] China.
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Transition to Shanghai: First Impressions & Cultural Contrast
Tobias: We went straight from Tokyo to Shanghai.
Jake: The contrast–
Tobias: Went from Japan to Shanghai.
Jake: Yeah. The contrast was-
Tobias: Wow.
Jake: -immediate, wasn’t it? I took a taxi in Kyoto, and the driver’s wearing the white gloves and he’s apologizing that the traffic is bad and couldn’t have been nicer, like you said was helping. And then, I get to Shanghai and it’s like a total culture shock. I had to argue with the cab driver, because he was like the little toll machine, like quit halfway through the drive. And so, when we get there, he’s trying to stiff me and I was like, “Oh, God, here we go.” China just has this frenetic energy to it that I wasn’t expecting. There’s just a lot going on there.
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Venture Capital in China: AI, Robotics & Intensity
Tobias: Well, Shanghai, they say Shanghai is China’s New York.
Jake: Yeah.
Tobias: And super high energy. People are much, much louder. The traffic is insane. The traffic is like these little scooters that come up on the path. You can be hit walking along the sidewalk, you can be hit in the middle of the road, whether you’re on the crosswalk, if the lights on.
Jake: Yeah. Head on a swivel.
Tobias: Head on a swivel in Shanghai. [Jake laughs] All the time. The number of times that I nearly got run over– Actually after a while, and this is from coming from Tokyo, we’re not allowed to jaywalk.
Jake: Yeah.
Tobias: It got to the point where basically you’re as safe in the middle of the street as you are on the sidewalk. [Jake laughs] So, after a while, you get used to it, and it’s fine.
Jake: We were told several times by different people that the long-term in China is considered 18 months. So, if a concept a business hasn’t scaled by 18 months, basically it’s time to just shut it down and start something else.
Tobias: Yeah, boil it down.
Jake: I looked up later in 2023, 24 million new businesses registered in China. It’s launched fast, test quickly, pivot rapidly. The competition is crazy intense too. As soon as something is successful, there’s scores of these copycats who come drive the profits to zero. The way that as quick as businesses can grow, when we’d hear some of the numbers, honestly it boggled my mind. But I guess if 1.4 billion people who are searching for an ever-improving lifestyle, I think maybe it’s capable of that kind of growth. How do you feel about that?
Tobias: Yeah. So, we visited in contrast to Japan where we were at the buyout activist, and Shanghai was venture capital growthy managers. And in the VC, it was hard tech, which those are the VCs doing the real heavy lifting. That’s hard tech is AI.
Jake: Autonomous vehicles.
Tobias: And robotics.
Jake: Yeah, robotics manufacturing.
Tobias: [crosstalk] It’s like the robots that are like actually Optimus. So, Tesla fans, you’re going to love this. They all think that the Optimus is the most advanced robot.
Jake: Humanoid factor, right?
Tobias: I think they also think that Tesla’s ahead in autonomous driving.
Jake: Yeah.
Tobias: I asked one of them, because there’s a chart that does the rounds every now and again that shows that Waymo is way out in front and Tesla is way behind in terms of autonomous driving. But none of the VCs in Shanghai agreed with that. They all thought that it was Tesla, by virtue of their most recent rewrite of their code, combined with their cameras– They’re just the millions and millions of miles that they’ve driven on the roads, they’re ahead in terms of autonomous self-driving.
Jake: Yeah, best data, I guess.
Tobias: And the robotics. The robotics one was interesting, because what they’re saying is that we’re going to have these humanoid robots in three to five years. It seemed to me to be– I’m very skeptical of that. I think that’s a real stretch. But we’ve heard it so many times from so many different people that it makes me wonder if there is possibly something to.
Jake: This means like doing the laundry, folding clothes, like loading the dishwasher, I guess, like that kind of stuff.
Tobias: Yeah.
Jake: Rosie the Robot basically from Jetsons.
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Hard Tech vs Commercialization in China
Tobias: I said this to the last VC who was– We started with the hardest tech and then the firm that had the best reputation for really doing hard tech, the real hard tech guys. And then, we went increasingly further, a little bit broader without doing other things as well. And so, it’s a shame that I asked this to the last guy. But I said, “Has any of this been commercialized? Are there any commercial?”
Because I would have thought, like if you’ve got a humanoid robot that you’re going to put that in a mine or you’re going to put that deep sea diving, you’re going to stick it in someplace that’s very dangerous or very boring or both, and there’s no commercialization of any of this stuff. So, we’re a long way, I think, from commercial robotics.
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Consumer Culture and Competition in China
Jake: Did you, at any point in China, feel like there could be a moat in anything that would last more than 45 minutes?
Tobias: Well, I felt like there are so many firms chasing all of this stuff. Yeah, impossible. If it works, then there’s going to be– So, there are 100 EV companies in China. I don’t think we saw 100 different cars on the road, but there are lots of different cars on the road. There’s a car that’s reminiscent of Tesla. Looks exactly like a Tesla. There’s a car that’s reminiscent of the Porsche Panamera.
Jake: Yeah. Those are pretty nice looking, huh?
Tobias: They were. They were like 30 grand.
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China’s Tech Leap: Phones, TVs, and EVs
Jake: So, we should talk about our why we trip then while we’re getting into this. I think we both came away feeling like China has passed the US on some things. There was a phone that was like– it looked like a an iPad that could fold up four or five times on itself. I haven’t seen anything like that in the US.
Tobias: We had dinner in a restaurant in a mall, and then we walked around the mall and we walked into a Huawei store in the mall. It’s not like we were in the Huawei flagship or anything like that.
Jake: No, that was just–
Tobias: It was just in a random Huawei store in a random mall in Shanghai.
Jake: Yeah.
Tobias: In that, they have giant TVs on the wall.
Jake: Oh, my God. That TV was 110 inches, and it was the most clear picture I’ve ever seen in my life. I couldn’t look away from it. It was insane.
Tobias: And somehow, they use AI to take a less clear picture and make it into a more clear picture. They showed they had these blurry videos, blurry pictures of models and then they’d add in. And so, it was like putting your face up against a mirror. The detail was just incredible.
Jake: It was insane. And then, how about the cars in the Huawei store?
Tobias: And so, this is I think the most shocking thing. We went in, and the cars there are, they’re beautiful cars. They’ve got heaps of screens on the inside, leather seats. They’re luxury SUVs, luxury family cars, and they retail for about $30,000 US.
Jake: yeah. And they look better than $100,000 cars here honestly. I feel like pretty safely saying that.
Tobias: And they charge in five minutes.
Jake: Yeah. [laughs] What are we doing here?
Tobias: Somehow, they’ve figured out how to get these cars charged in five minutes. You plug them in and it charges.
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996 Work Ethic and Build Speed in China
Jake: Yeah. What do you think about this concept of 9-9-6 that we kept hearing about?
Tobias: Well, I think the Chinese are real capitalists and they’re very, very ambitious and they have this plan– China that they’re ambitious for China, but they’re personally ambitious as well. And to get what they want, they’re going to have to work 9-9-6, which is 09:00 AM to 09:00 PM six days a week. And so, that’s the way they work.
Jake: And it’s like a badge of honor. They all wear it proudly. Everyone just expects, like that’s what you’re going to work like that you want to like make your life better, you got 9-9-6.
Tobias: And if someone calls you at 01:00 AM in the morning, you just answer the call and you welcome the call. You don’t want to wait until tomorrow to hear whatever they’re going to say.
Jake: It’s true. [chuckles] One thing I did find interesting, and this goes back to the contrast between Japan and China and this 1,200-year-old Shrine. We toured a property developer in China, one of the few to survive this current real estate correction which has been quite the winnowing process. But we toured one of their building sites. The houses are nice looking, they’re expensive, they’re not much different than some luxury in price per square foot in the US, I felt like, but there’s like this brittle feeling of–
I just want to say cheapness to the built quality. Even though it looks nice, it hints at this impermanence. It needed to attract a high-end clientele who wanted to live there, but I wouldn’t expect it to still be there in 10 years. Maybe it won’t be. Maybe that’s just the expectation that they’ll need the land for something else. I don’t know. But you see this–
They can build, they’ll identify zone, get the permits, construct and sell a huge complex in less than two years. And here, I don’t even think you’d get the permits available in two years for the size of this project. They’re moving so much faster. It boggles the mind to be honest with you.
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Payments, DeepSeek & Local AI Models
Tobias: Well, we walked along the river.
Jake: The Bund?
Tobias: Is that the one? It was the Bund?
Jake: Yeah. Yeah.
Tobias: And our host said this was a cement factory three months ago. It was a mall with a whole lot of restaurants.
Jake: Yeah. Beautifully done.
Tobias: Art galleries. Yeah, it looked magnificent. Really impressive. You pay for everything. So, I think MasterCard and Visa are [chuckles] probably gone, I think, because you pay with– I use WeChat. You can pay Alipay. You can use Alipay. Every vendor has a cell phone. And if they don’t have a cell phone, they’ve got a sticker. You just scan the sticker with your app, and your app asks you if you want to make this payment. You click yes, you put in a little code and you’ve made a payment. It doesn’t run through MasterCard or Visa’s rails. It just charges your WeChat account. They say that they charge basis points for it. And in some instances, they charge nothing because they just want access to the vendor-
Jake: Yeah.
Tobias: -and the data. Yeah, so MasterCard and Visa are in trouble if that– Why isn’t somebody doing that here?
Jake: I don’t know.
Tobias: Facebook could do that here.
Jake: Because it just works right now and it’s low enough. I got the sense that DeepSeek was a pretty big moment for China, based on all the conversations, because obviously you talk about AI a lot, especially if you’re visiting VCs. But I think what it showed was that they weren’t as far behind as they worried that they were on AI. Really the CapEx that the US has been doing might who knows– If you’re able to get close to 80% of the result with 20% of the cost or less–
Tobias: Well, the numbers that they were quoting were 95% of the-
Jake: Yeah. Well, okay. [laughs]
Tobias: -quality with 5% of the cost.
Jake: Yeah.
Tobias: Which is bananas. I don’t know if it’s that either. But that’s the DeepSeek analogy that it’s like 95% of OpenAI’s 4.0 version, like their best version. And on the chart, it measures how smart these things are and how many questions it can answer. It’s right sitting, just underneath it for minimal cost.
Jake: Yeah.
Tobias: I don’t know if anybody could definitively say if that was real or if they had some training from– They had some advantage provided to them by the government, or they had spent more money than they had said that they had spent. But everybody seemed to think it was possible, because they were totally transparent with their model and their training data in the background.
Jake: Yeah. And the weightings.
Tobias: And the weightings. And so, it’s possible. One of the VCs who we talked to said– He interpreted this guy as being like an engineering type personality who just wanted to see this stuff out in the world, because he was making his money in a different– he’s making his money in the hedge fund. Yeah.
Jake: You know one thing I thought was interesting that a lot of the venture guys, I would have thought that there’d be something a little bit further out, like vision. Did you feel that same way?
Tobias: Yeah, 100%. The hard VC is like, they call it deep tech. It’s the stuff that’s like the cutting edge, the bleeding edge of tech. These guys try and put money into these really moonshotty type ideas. But then, when you come to hear what the moonshot type ideas are, they’re just what perhaps you’d expect them to be [Jake chuckles] just being a regular old– [crosstalk]
Jake: Yeah. Not even like a tech guy, right?
Tobias: They’re working on AI, they’re working on autonomous driving and they’re working on robotics.
Jake: Yeah.
Tobias: And so, they’re not working on cold fusion.
Jake: Yeah. [crosstalk] I guess some climate tech too, but I don’t even quite know what that battery.
Tobias: Yeah, we didn’t see– [crosstalk]
Jake: Yeah.
Tobias: We didn’t see what that meant.
Jake: Another thing that I noticed that I hadn’t really read anywhere else, is that it sounded like Chinese companies don’t want to use cloud-based AI solutions. Like, they want it on premises for data protection reasons. The US to me, I feel like they’re people are more comfortable, businesses are more comfortable with like “Okay, whatever. Microsoft’s got all our data.”
Tobias: Yeah, I don’t know. I just don’t know. My wife’s firm has its own internal AI, because they don’t want to share their data-
Jake: Yeah.
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China vs US: Manufacturing and Global Perception
Tobias: -and they’re a big consulting firm. So, it’s possible that it’s– I just don’t know. I haven’t heard otherwise. But DeepSeek is totally downloadable onto– So, they all use DeepSeek, the downloaded version, tuned up for their own stuff. I think one interesting thing that we should mention about– The next iteration of these models. So, the DeepSeek model and the OpenAI model, whatever the next one is going to be called.
They’re the two. So, the DeepSeek is just underneath OpenAI’s version at a fraction of the cost. And so, the next thing is to see, does DeepSeek leap OpenAI with its next update or does OpenAI leap ahead again? Well, they’re still ahead, but do they go further ahead. And the other question is, where are we on the S-curve of adoption of or the tech?
Jake: Not adoption, but the pace of innovation and the quality of the models and the output. If we’ve already used all the good quality data and now– They’re already using synthetic data, which to me sounds like you’re going to end up with some diminishing returns on that if you’re just making shit up to feed into it. Slowly breathing your own exhaust, isn’t it?
Tobias: I don’t know what synthetic data is, so I asked somebody what synthetic tech is. Synthetic tech is, if you ask it to solve a difficult math problem and it can’t figure it out, then you have somebody solve it and it shows the tech how to solve it, shows the AI how to solve it. But we’re at the point where all human knowledge has been fed into this AI, and it’s still not smart.
Jake: Oh.
Tobias: It’s pretty smart, but it’s not AGI. It’s human knowledge, it not AGI.
Jake: You would think that if you had every single book in your brain that you would beat any human at everything, right?
Tobias: Yeah.
Jake: But it’s still pretty magical. Just the idea of taking words and turning them into numbers, and then being able to perform mathematical derivations and expressions of things, and then turning that back into words from the math and it actually makes sense and like provide something useful, that’s fairly a pretty big miracle to me actually. I think that’s quite incredible.
Tobias: It is impressive. It does feel to me like it’s a little bit– I think that it takes the average of which I think is what– It does take the mid-point of like a–
Jake: Total mid. [laughs].
Tobias: I think the output is a little bit mid. That’s the feeling that I have at the moment. Then that’s pretty impressive I would say for where we are. And if we continue along this path for maybe a few more years or decades, maybe it’s writing it– maybe it’s Shakespeare. I don’t know, it’s not Shakespeare just yet. So, one of the things that–
Jake: It was the best of time than it was the worst of times? [laughs]
Tobias: I think we got a little bit of a shock in Shanghai, because we visited with another manager who’s a very famous manager in a Chinese context-
Jake: Mm. Yeah.
Tobias: -who has got some hundred bagger positions long-term record compounding of 44%, does these deep dives into companies, stays with ordinary Chinese folks to learn about their invest—[crosstalk]
Jake: Daily [crosstalk] habits. Yeah. It’s a she which probably went against all of your guys’ preconceived notions. [chuckles]
Tobias: Yeah. I came back and I wanted to investigate a little bit more, because I got a little bit of shock at how advanced I think the cars were, the charging. I found a website called Inside China Business. And this guy talks about business in China from the inside. I think that his impressions match my own.
Jake: So, he’s must be right. [laughs]
Tobias: Well, I think that the bits that I can verify of what he’s saying are true. And so, there’s bits that he’s saying that I don’t know, that I’m learning about. So, I don’t know. I think what he’s saying is the truth. He talked about a few things. This lady had mentioned that it’s hard for them to invest overseas in manufacturing type businesses, because they’ve got such great manufacturing in the Pearl Delta and another region that you mentioned which are just escaping my mind, but they have this density of factories.
Jake: Yeah.
Tobias: And these factories are so advanced that really China is the premier manufacturer in the world. It’s not that they’re the low-cost manufacturer. I think they’re the very best manufacturers in the world at the moment. They can turn out a lot of product.
And so, this Inside China Business guy, he talks about the dark factories that China has where there might be 10 engineers, and the factory itself is infinitely configurable and it might one day produce a demountable dwelling unit that looks like some space age car, and then they can retool the next day and punch out some Japanese autos over a couple of days later. I don’t know. The factory does this autonomously. They just change some settings with a dozen engineers, and the factories can punch these things out. I don’t think the US has anything like that.
There’s a guy in the US running a business called Hadrian. And that’s in Los Angeles. It’s in Torrance. I’ve driven around the location. I watched some YouTube videos about them. They’re trying to do some very advanced manufacturing, something similar, but they’re a long way behind what it sounds like these guys are doing.
So, I think it’s concerning for the US that manufacturing base has disappeared a little bit. I think it’s probably important for the US to get that back in some way. I don’t know how you do it, I don’t know if it’s possible or not, but it’s– I was a little bit scared, shocked when I saw the products that they’re punching out.
One of the things that this guy says, and he’s talking about US and German and Japanese auto OEMs buying these Chinese cars and tearing them down into parts, the component parts.
Jake: Reverse engineering.
Tobias: Yeah. What they’re saying is–
Jake: Wait, I thought the narrative was that all the IPs outside of China, they just steal it. Is that not true anymore?
Tobias: I don’t think so. Because these guys tore it down and they said these cars are better and they’re cheaper. I was shocked, because they said, “You can have better but not cheaper and you can have cheaper but not better.” But somehow these guys have got better and cheaper together, which was my impression too when we looked in those cars. They’ve got some technology that we don’t have, including the charging.
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Mutual Misunderstandings: Media Bias and Cultural Perception
Jake: I think in general, one of my main takeaways from the whole trip and especially China, but the view that we get from the US and the US media just really doesn’t do very good justice. The reciprocal of that is that talking to the Chinese people there and their views of the US are also pretty distorted. They’ve thought that we were on the verge of civil war here that all kinds of– If you only read the news and all the negative things, the sensationalism on both sides, you end up with this funhouse mirror version of what it looks like. I think that’s pretty toxic.
I’m not sure how to fix it other than to just travel and see for yourself. But I think at both places, both sides of the Pacific, there’s this universal human desire to which it transcends geopolitics completely. It’s just people, they’re striving for progress, they want a sense of agency in their lives, they want to feed their families, they want to do work that they think matters to them. It’s this human impulse. And I think we lose sight of that with the headlines a lot.
Tobias: Yeah. Yeah. I think you’re right. I think that some of the views that the Chinese have of the US are equally wrong. In their mind, they’ve already eclipsed the US. I think that may be true, in fact, but [Jake laughs] they think that America is doing a lot of dumb stuff. They call Trump the Nation Builder, but for China. I got the impression that they’re not at all worried about the tariffs, because they don’t feel like that’s going to impact them at all. If anything, that’s a benefit for them, because they already do a lot of business with the rest of the world. What was their justification for the benefit? Now, that I’m saying that, I can’t think what it was.
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Investing in China & Japan
Jake: I think it’s a combination of internal consumption, and rest of the world that wants to buy Chinese products and are happy to have better things that cost less. People like that.
Tobias: I’ve just gone blank on it. Sorry, I just read a line. Yeah, forget it.
Jake: Oh.
Tobias: I did have one more thing I wanted to mention, but it’s just slipped my mind. Yeah, I think my impression was that they’re very ambitious, which is understandable. The Chinese president said, “I’m not giving money to lazy men.”
Jake: Oh, yeah. And people seem to like that, huh?
Tobias: Yeah. The Chinese like what they’re doing. I got the impression that they like the government, they like what’s happening. They’re ambitious. There’s a lot of creative destruction in China.
Jake: Oh, my God. [crosstalk]
Tobias: Business doesn’t pop up and get torn down really quickly. Like, that’s what they say, the long run is 18 months. Somebody asked, “Is China investable?” So, this is interesting. I still don’t know the answer to that. I still have to think about that a little bit more. There’s a huge opportunity there, clearly, in terms of the rate of growth and the technological prowess that they have now. But then, the managers on the ground say, “If you pick the wrong manager–” The investors on the ground say “If you pick the wrong manager, they will kill you. They’ll just blow the company up.” And then, some of these businesses where you think it’s quite dominant, and one of our guys said, “Yeah, but it’s like Macy’s. JD.com, and now it’s like Macy’s.”
Jake: Yeah, he thought he was buying Amazon-
Tobias: Yeah.
Jake: -when he bought JD, but it turned out he was buying Macy’s. These are only like a year or two apart. That’s how fast the change is. The consumer preferences seem to shift. When people are done with a concept, they’re totally done with it and they’ve moved on.
Tobias: One thing I thought was interesting, the VC firms all said, “We’re doing AI robotics, autonomous driving and bubble tea.”
Jake: Yeah. [laughs] Yeah, exactly.
Tobias: And I thought it was a joke, but I think it’s real. Like, there’s this bubble–
Jake: No, no. Yeah, there was a bubble in bubble tea there, I think.
Tobias: Yeah, I thought that was funny.
Jake: The competitively advantaged periods and trying to map out what that would look like for any of these businesses seems incredibly difficult.
Tobias: I think in some sense, you probably need to be on the ground in China to do this. What do you think? Well, we’ve got three minutes. So, does a basket of Chinese stocks get you there? Does that work? And what are you selecting for? Are you trying to go value or are you just trying to find growthy value?
Jake: I have no idea. The concepts can scale in crazy ways. I don’t know the exact numbers. But something like Luckin Coffee, for instance, especially like a franchise model where there’s not capital slowing you down. These guys built, I think, 10,000 stores in one year. Just-
Tobias: Yeah. That’s crazy.
Jake: -incredible growth to some of these companies. When it goes sideways, like you have all that fixed cost going against you in the other direction, you could just see getting killed as well pretty easily. So, it’s quite difficult. Do you want like log jammed frozen balance sheets in Japan with no real change, or do you want just blood red churning oceans of competition in China? [laughs] Both quite difficult.
Tobias: The consumer surplus in China is huge.
Jake: True.
Tobias: Which is interesting. Well, in Shanghai– We should say Shanghai, because that’s where we were. We were staying in a very nice area in Shanghai too, which was pretty modestly priced. I thought like where were staying was pretty cheap for it was like a luxury hotel, but it was cheaper than a lot of places in the States.
Jake: Yeah.
Tobias: The coffees were–
Jake: Half priced.
Tobias: I like coffee. I went around and I tried a lot of coffee.
Jake: Yeah. [chuckles]
Tobias: Coffees were world class. Australians can go there and drink coffee. The coffees are good. They’re like two bucks each.
Jake: Yeah. Instead of five or six.
Tobias: Yeah. It’s easy to order everywhere. There’s a lot of English. And if there’s not, then you can mime your way to the right answer. We can use these translation apps. They’re not good enough, but they get you some of the way there. That was interesting. We sat in one of the Japanese manager meetings and we had a translator, but I also had my translation app on the phone. They’re not there yet. AI translation has a long way to go.
Jake: Yeah. It would be funny, because the manager would be talking for five minutes on something and then we’d get three sentences [Tobias laughs] given back to us from the translator. [laughs]
Tobias: I did see. That’s an American idea a few times.
Jake: Oh, yeah. Yeah. [laughs]
Tobias: Does a basket of Japanese stocks work, basket of undervalued Japanese stocks? Do you think you need the catalysts?
Jake: I think if you’re patient enough that that probably works. I don’t know if the IRR is off the charts necessarily. I bet if you picked the right scaling concept in China and caught hold of the rocket ship, you’re golden.
Tobias: China is cheap. China is undervalued. There’s a lot of–
Jake: It’s cheap too. Yeah.
Tobias: [crosstalk] four, five, six times for 30% ROE businesses.
Jake: And 30% growth. Top line too.
Tobias: Yeah. Yeah.
Jake: It’s insane, right?
Tobias: That might be shooting stars. That might be–
Jake: I know. I thought about it as like the energy equivalent is like China is shale oil drilling, where it’s like you pump all of the profits out in year one, and then after that it’s just the depletion rates are like off the charts. That might be what it is. It’s just a bunch of shale drilling, I don’t know. Or, maybe something coalesces around some brands that get some global scale and become the Proctor’s & Gamble’s of the world or Coca Cola’s of the world. Maybe there’s something that they do eventually that does find that. Quite difficult though to find one of those early.
Tobias: We’ve got a very interesting decade or so coming up here for China and Japan and the US, hopefully.
Jake: Yes. May you live in interesting times indeed.
Tobias: Live in interesting times. That’s time. Thanks, folks. We’ll be back next week. Same bat time, same bat channel. I’ll be back at the desk.
Jake: We’re going to have a guest back so we don’t have to talk so much?
[laughter]
Tobias: Thanks, amigos.
Jake: All right.
Tobias: We’ll see you.
[Transcript provided by SpeechDocs Podcast Transcription]
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