wide-moat investing in the asian capital jungle

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《竹经：经商经世离不得立根创新》

nnovator Bamboo

R.E.S.-ilience in Value Creation

(1) Mental Model: Bamboo Innovator (2) The Idea: Taiwan Microlife (4103 TT) (3) Biggest Mistake (4) Book Recommendation

KB Kee Managing Editor The Moat Report Asia

www.twitter.com/bambooinnovator

[email protected]

www.moatreport.com

Wide-Moat Investing In the Asian Capital Jungle Navigating with the Bamboo Innovator approach

11th Value Investing Seminar, Trani July 17-18, 2014

Marco Polo on bamboo: “… stronger than hemp… One of the engineering marvels of the world.”

The Da Vinci Flying Machine can be considered as Leonardo’s Magnum Opus in scientific design. Leonardo had designed the frame to be made with bamboo shoots.

SSRN: http://ssrn.com/author=1174940 Moat Report Asia publications: http://www.moatreport.com/updates/ BeyondProxy publications: http://www.beyondproxy.com/author/koon-boon-kee/ SMU profile: http://accountancy.smu.edu.sg/directory/Kee-Koon-boon

http://www.twitter.com/bambooinnovator





mailto:[email protected]



http://www.bambooinnovator.com/





http://ssrn.com/author=1174940

http://www.moatreport.com/updates/

http://www.beyondproxy.com/author/koon-boon-kee/





http://accountancy.smu.edu.sg/directory/Kee-Koon-boon





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[email protected]

www.moatreport.com

To Catch An Asian Snake: Detecting Accounting Frauds Ahead of the Curve

Value Unplugged, Naples July 14-16, 2014


Krishna dances over the subdued poisonous Kaliya snake in river Yamuna, where only one solitary Kadamba tree grew on the river bank. From a Bhagavata Purana manuscript, c. 1640.


























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Taiwan’s Bamboo Innovators 80: Who Are They?

Bamboo Innovators Watchlist: Taiwan 80

5%

Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.

Source: Bloomberg, 24 Jun 2014

Institutional subscribers get access to the Bamboo Innovator Index of 200+ companies and Watchlist of 500+ companies in Asia and the Database has eliminated companies with a higher probability of accounting frauds and misgovernance as well as the alluring value traps.

Index Big Mid Small Micro TOTAL %

Singapore 3 5 2 10 4.5%

HK 8 10 7 1 26 11.7%

Korea 2 9 14 1 26 11.7%

Taiwan 2 14 8 24 10.8%

Thailand 1 6 15 3 25 11.3%

Indonesia 2 8 5 2 17 7.7%

Malaysia 2 7 9 7 25 11.3%

Philippines 2 6 2 10 4.5%

India 2 14 9 25 11.3%

ANZ 4 15 12 3 34 15.3%

TOTAL 28 94 82 17 222 100.0%

Watchlist Big Mid Small Micro TOTAL %

Singapore 8 5 13 4.2%

HK 1 9 9 19 6.1%

Korea 3 14 19 4 40 12.8%

Taiwan 2 21 29 4 56 17.9%

Thailand 1 11 6 19 37 11.9%

Indonesia 4 9 11 3 27 8.7%

Malaysia 7 7 5 19 6.1%

Philippines 8 5 13 4.2%

India 5 28 25 2 60 19.2%

ANZ 12 13 3 28 9.0%

TOTAL 16 127 129 40 312 100.0%

The Taiwan stock market (TaiEx) has approximately 800 companies with total market cap of $870 billion, while the GreTai OTC market has around 700 companies with total market cap of $92 billion. TaiEx is ranked the #15 global stock exchange by trading value.

Big >$10bn, Mid $1-10bn, Small $200m-1bn, Micro <$200m

TaiEx

Market Cap

PE

GreTai

$880 billion

17.7x

$93 billion

31.2x

MXAPJ

$7.2 trillion

13.7x

Index 222 + Watchlist 312 = Bamboo Innovators 534

(1) Mental Model: Bamboo Innovator

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“If you gave me $100 billion and said, ‘Take away the soft-drink leadership of Coca-Cola in the world,' I’d give it back to you and say it can’t be done.” - Buffett

Robert Bosch (1861-1942) worked as apprentice at German companies, in US under Thomas Edison, in UK at Siemens

1st breakthrough: Magneto ignition device (1887) 2nd breakthrough: MID to vehicle engine (1897, 1902) Global expansion: 1898-1913 WWI (1914): Lost it all! Factories and plants all destroyed! Never give up: Electric horn (1921), windshield wiper

(1926), power brake system (1927) Boat engines, jet skis, garden and forestry equipment, gas

engines, water pumps and emergency generators… 2012: 11 billion spark plugs produced by Bosch Ownership: 8% Bosch family, 92% Foundation (1938 will)

Resilience: The Ability to Replicate & Scale from Scratch & The Indestructible Intangibles to Bounce Back From Crisis!

$68B Sales

>$150B Value

$48B Sales

$180B Mkt Cap

Burn and destroy all the tangible assets!


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“The first rule is that you can’t really know anything if you just remember isolated facts and try and bang them back. If the facts don’t hang together on a latticework of theory, you don’t have them in a usable form. You've got to have models in your head. And you've got to array your experience - both vicarious and direct - on this latticework of models.” – Charles Munger, “A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business ”, USC Business School, 1994

Mental Model: Bamboo Innovator Bamboos Bend, Not Break in the wildest storms that would snap the mighty resisting oak trees; it survives and therefore it conquers.

“Rootedness” in cultivating a culture of kindness, trust and cooperation to contend with and heal creative dissent and incentivize innovative experimentations R Rootedness

E Emptiness

S Sheath

A “Good-to-Great” checklist approach might overlook the resilient Bamboo Innovators. After all, there are much larger impressive trees in the forest. By comparison a bamboo looks smaller, thinner, and fragile. The list of Bamboo Innovators is a surprising one; many of them are not the typical ones that one would come across.

“Emptiness” like the empty hollow center of a bamboo in having (1) “indestructible intangibles” which in turn derives its strength from either a certain know-how or trust and support in the community; (2) a “core-periphery” network; and (3) an “open-innovation” business model in which both internal and external partners co-develop new products and creations.

“Sheath” in leadership to create the context, adaptive-govern, coordinate, synthesize and weave diverse networks and groups who might otherwise be excluded into a coherent whole, rather than the typical command-and-control “positional/title-based” leadership.

Empty hollow center

The nutrients and moisture that would have been exhausted making and maintaining this empty center can be utilized for growth of other culms. From a builder’s viewpoint, the architecture of the bamboo culm presents a powerful configuration: fibers of greatest strength occur in increasing concentration toward the periphery of the plant.


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Search Methodology for Bamboo Innovators: “Emptiness” in Business Model

Indestructible Intangibles

Proprietary know-how Trust and support from community of customers, suppliers, partners

220+ Bamboo

Innovators

U.S.

Europe

Asia

Core-Periphery Network

Open Innovation

Both internal and external partners co-develop new products and services

Scaling by empowerment and decision-rights beyond the founder Scaling by technology as an enabler and embedded into the business model design

RockTenn (RKT US) Balchem (BCPC US)

O’Reilly Automotive (ORLY US) Sherwin-Williams (SHW US) Fastenal (FAST US)

Qualcomm (QCOM US) Ecolab (ECL US)

Bosch, IMA SpA (IMA IM) Novo Nordisk (NVO DC)

Inditex (ITX SM) ASSA Abloy (ASSAB SS)

Luxottica (LUX US) Novozymes (NZYMB DC)

Yunnan Baiyao (000538 CH) Kewpie (2809 JP)

DKSH (DKSH MK) Major Cineplex (MAJOR TB) Home Product Center (HMPRO TB)

TSMC (2330 TT) CSL Limited (CSL AU)

530+ Watch List

~15,000* Listed Asian

Stocks

* Asia ex-Japan ex-China A-shares. Includes India, HK, Taiwan, Korea, Singapore, Malaysia, Thailand, Indonesia, Philippines, Australia, New Zealand, with a market value of over $8.5 trillion. If Japan and China A-shares were included, the investment universe is expanded to over 20,000 stocks with a market value of over $15 trillion.

3.7% 1.8%


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An Italian Bamboo Innovator: IMA SpA But the Asian Capital Jungle is Far More Complex….

Hidden global champion: Do you know that 70% of the tea filter bags in the world are made from IMA’s automatic packaging machines?

Intangible know-how in high-tech automatic machinery applications in packaging: World leader in the design and manufacture of automatic machines for the processing and packaging of pharmaceuticals (tablet, capsule filling, coating, freeze dry etc), cosmetics, tea, coffee and foods. IMA has filed about 1,200 patents worldwide and has launched many new machine models over the last years. Over 400 of its 3,600 workforce are designers committed to product innovation.

Established in 1961 in Bologna (Emilia Romagna – the “Packaging Valley”), listed in Milan Stock Exchange since 1995

760.9 million Euros for the fiscal year 2013 (export: 92%). Vacchi family 66.2%.

Quiet innovator until

exponential spurt

Q: Why is it that throughout the financial crisis, Italy has remained Europe’s second-largest export economy, after Germany, despite Italy being ranked as the 80th place in the World Bank’s “Ease of Doing Business” survey because of his strong labor unions, seemingly boundless bureaucracy, organized crime, and endemic tax evasion?

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Missing Cash in S-Chips (Singapore-Listed Chinese Companies): Left Side In, Right Side Out!

First, the controlling shareholders will engage in 'propping' activities to artificially inflate the sales and assets of the listed firms through related-party transactions (RPTs) to entice the funds of investors who did their 'fundamental analysis' of the firms. Artificial accrued sales are booked under 'other receivables', while the bogus cash-based sales stay hidden in the 'cash & cash equivalents‘. After 'propping', 'tunnelling' or expropriation of these assets out of the listed firm follows, engineered through related-lending and transfer activities which are rarely paid back by the controlling shareholders. These cash transfers are done artfully, often in short-term transactions in order to be qualified as 'cash equivalents'. That explains why most of the artificial cash balances in these firms typically earn low average interest rates, at below one per cent, when the typical bank rate in China varies between 5 and 10 per cent. In other words, there is left-side in via propping, and right-side out via tunnelling.


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The Case of Sino-Environment

Take the case of the high-profile and 'highly profitable' S-chip Sino-Environment. Footnote 12 of their 2008 Annual Report revealed that the average interest rate earned from their 728 million yuan (S$143 million) cash in the balance sheet is merely 0.56 per cent. In Footnote 13, the amount due and dividend receivable from its subsidiaries in the company accounts is 282 million yuan. In their group accounts, the amount of non-trade receivables is 240 million yuan out of the 276.5 million yuan in total receivables. From Footnote 12, Sino-Environment possibly made dubious related-party acquisitions, financed by the IPO and secondary equity offerings, to cancel the artificial receivables that were created in collusion with the related parties, and booking the set-off as goodwill and intangible assets which stood at 228 million yuan. In a Raju-deja vu fashion, property was involved. According to news articles reporting about the firm's situation, its chairman Sun Jiangrong reportedly tried to siphon away a 100 per cent stake in Chongqing Daqing Property, which owned properties in China worth 10 billion yuan, to his Hong Kong private firm called Top One Property Group, and later to a Chinese firm owned by his brother, Sun Shaofeng, the chairman of HK-listed China Green.

Wrote and submitted the article in Apr 2010. Published on 25 Nov 2010 in Business Times Singapore


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Left Side In, Right Side Out! Sino-Environment-China Green (904 HK) Connection

China Green

Wrote and submitted the article in Apr 2010. Published on 25 Nov 2010 in Business Times Singapore

Published article


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Egana (48 HK): HK$1.4 billion “cash and cash equivalents”; ~HK$1 billion are promissory

notes due from related investment companies

Peacemark (304 HK): HK$600 million net cash; HK$330 were “deposits” placed with related

parties

Egana (48 HK) and Peacemark (304 HK): Durable Consumer Franchise & Value Stocks With Lotsa Cash in Balance Sheet?

• Of the HK$1B, $693.7m was rolled over upon maturity for another one to three months. These promissory notes have been building up for years. This begs the question of how many times some of these notes have been rolled over, who the borrowers are, and what ability they have to repay.

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Q: Why are the faces and clothes of puppets in the wayang performance – a traditional Javanese show – painted with bright colors when the audience sitting behind the screen can only see their shadows? More importantly, why is the philosophy underlying the wayang performance critical for value investing in Asia?

A: Colors of the puppets are not meant to be seen by the common masses; only the audience behind the stage, those who are closer to the puppet master, the dalang, have the privilege of seeing the true colors of the faces and costumes of the puppets. When a warrior like Arjuna or Bima is about to appear, the dalang places on that puppet a golden mask. The privileged few behind the screen close to the dalang know in advance that a war is about to begin before the front audience sees it over the screen and they have a deeper understanding of the feelings and behavior of the manipulator.

Dalang-mite: The Primacy of Governance Pitfall in Value Investing in Asia

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Davomas was listed in the Jakarta Stock Exchange in 1994 and it grew to become the largest exporter of semi-processed chocolate products (cocoa powder and cocoa butter) in Indonesia with international trading houses and large chocolate manufacturers in Europe and US as their customers. Davomas became a darling stock with its growth prospects and technologically-advanced facilities. In Apr 2007, the main shareholders Tse Kam Bui and Husein Sutjiadi sold a 24.9% stake to a handful of investors at Rp400 per share, raising about IDR 610.2bn ($67m). Foreign institutional investors such as Templeton became significant shareholders. Davomas continues to enjoy glowing sell-side research reports such as the one on the right dated 25 Jan 2008.

On May 2009, Davomas shares were suspended because it defaulted on its $238m 11% guaranteed senior bonds due 2011. Shareholders agreed to a restructuring plan involving an exchange offer for the original bonds and a $33m shareholder loan. The shareholder loan was from the secretive majority owner Tse Kam Bui who controls five BVI-registered companies that together hold a 51% stake in Davomas. The debt to the BVI companies was immediately repaid via a rights offering for those shareholders. The original bondholders took a 50% haircut and exchanged for $119m variable interest rate guaranteed secured bonds due 2014 and retained security over the assets of Davomas and the BVI companies. In March 2012, Davomas once again defaulted on its debt due 2014. In June 2012, Davomas shockingly reported new debt of IDR 2.87tr to PT Aneka Surya Agro (PT ASA), allegedly a supplier to Davomas. Although the debt represented more than four times equity and more than double its IDR 1.32tr in revenue, no other information about the transaction was given.

The June 2012 debt restructuring called for the conversion of all outstanding debt into equity in Davomas. However, the debt-to-equity conversion requires the consent from the general meeting of shareholders and the shareholders’ meeting on Sep 2012 was cancelled due to confusion regarding the identity of the persons entitled to represent the majority shareholders, namely the secretive Tse Kam Bui. The irregularities in its financial statements remain unexplained. Later, it was suspected that PT ASA belongs to this secretive controlling owner, the dalang behind all the transactions. The aggrieved bondholders and shareholders are still demanding for justice.

The Case of PT Davomas, Indonesia’s Second-Largest Cocoa Processor with MNC Customers

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Why is Microlife underappreciated still?

Valuable Process IP/Know-How and Potential Takeover Target by Omron, J&J

(LifeScan), Bayer, Abbott

Microlife’s long-term terminal value and downside risk will be protected by giants such as Omron, J&J (LifeScan), Bayer, Abbott etc who wish to swallow it up to possess its valuable manufacturing technology platform and worldwide patents.

Durable Franchise Value in Boring and Resilient Patient Monitoring Device –

and a Quiet, Powerful Cost Consolidator

Microlife’s manufacturing technology platform has enabled it to build a global durable franchise in the niche patient monitoring device market that has stable resilient growth and yet is experiencing potential disruptions led by Microlife’s new innovation in blood pressure monitoring protected by worldwide patents. Microlife has the potential to consolidate the market further.

Worldwide Patents in Algorithm-Technology in Afib and MAM blood

pressure measurement

Microlife’s worldwide patents in algorithm-technology in blood pressure measurement has been commercialized into the WatchBP product series that is at the heart of its total solution service business model. This valuable intangible asset is not factored into long-term valuation.

Global #1 Market Share (Digital Thermometer)

50%

Worldwide Patents in Algorithm-Technology in Afib and MAM

The innovative WatchBP with the Afib detection and MAM technology are not merely additional features; it “forces”

the clinical community to adopt them as the standard, which in turn helps drive

home-use penetration. It transforms the BPM product into a unique strategy.

Microlife’s ROE 21% (Why?)

Total Solution Service Business Model

Incorporates software development to create

value-added services for health monitoring and

collaborating with hospitals and governments on tele-

healthcare projects.

Global #2 Market Share (Digital Blood Pressure

Monitor) 17-18%

Quiet, Powerful Cost Consolidator Reliable manufacturing platform for

over 30 years with in-house capabilities to combine Swiss design, high-precision

electronics with clinical healthcare to produce world-class products with cost

competitiveness.

Sticky ODM Partner to Reputable Customers

Diversified customer base to customers such as Wal-

Mart, Costco, CVS, Walgreen’s; none accounts

for >10% of sales.

EV/EBIT 9.7x EV/EBITDA 8.8x Dividend 5.6%

Net Cash 23% MV

US #1 Market Share (Electric Flexible

Heating Blankets) 50%

Microlife: Boring Global #1/#2 in Patient Monitoring Device (Digital Thermometer/Blood Pressure Monitor) ROE 21% with a unique solution-services business model protected by innovative worldwide patents

91% of Sales in Developed Markets

(54% US, 37% Europe)

Worldwide Patents in Afib and MAM

(2) The Idea: Taiwan Microlife (4103 TT)

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Salient Points See Appendix for the Full and Complimentary Version of The Moat Report Asia

(1) An undervalued hidden world champion: World’s #1 and #2 manufacturer of two healthcare equipment Decent valuation: EV/EBIT 9.7x, EV/EBITDA 8.8x Sustainable dividend yield: 5.6% Healthy net-cash balance sheet: 23% of market value Shareholder-friendly: Reduce 10% of shares outstanding in Sep 2012 to boost capital efficiency

(2) It’s boring! It’s misunderstood! Why wide-moat (Part 1)?:

Quiet powerful cost consolidator: Reliable manufacturing technology platform to build a global durable franchise in the niche patient monitoring device market that has stable resilient growth

In-house capabilities to combine Swiss design, high-precision electronics and sensor components Core competence of having an algorithm to allow fast reading/filtering of signals and outputting the accurate

results in a short period of time Worldwide patents in innovative algorithm technology in Afib and MAM to support its total solution service

business model Valuable intangible asset is not factored into long-term valuation


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“There’s big knowledge even in this seeming simple and boring digital and infrared thermometer products… As these techniques involve specialized knowledge and industry secrets, they are protected by patents. Microlife is one of the rare few in the whole world to have the capability to produce models with read time of 1 to 60 seconds. This is something that the rest of our rivals can never match… For infrared…It involves high-precision parts and complicated configuration and calculations before reaching an accurate standard. Thus, the barrier to entry is not low.”

Q: “What is the secret to Microlife’s success in maintaining such high profitability in relatively mature - and even boring! – products that are seemingly simple to manufacture with low barriers to entry?” KY: “There’s big knowledge even in this seeming simple and boring digital and infrared thermometer products. The speed in measuring body temperature is not limited to the sensitivity of the sensor device but rather how the thermometer can rapidly reach the calibration point of the body temperature with different physical principles of thermometry. As these techniques involve specialized knowledge and industry secrets, they are protected by patents. Microlife is one of the rare few in the whole world to have the capability to produce models with read time of 1 to 60 seconds. This is something that the rest of our rivals can never match. For infrared ear thermometers, after shooting out the infrared energy to measure the temperature, the sensory parts must receive the signal and convert the radiant power to an electrical signal that can be displayed in units of temperature after being compensated for ambient temperature. It involves high-precision parts and complicated configuration and calculations before reaching an accurate standard. Thus, the barrier to entry is not low. Our R&D in Taiwan concentrates on high-tech electronics parts and components, such as the in-house manufacture of sensors, establishing the high-precision measurement platform, temperature micro-controller design. Our Europe medical R&D and clinical trial center artfully combines high-precision electronics with healthcare to produce world-class high-quality products and new innovations. It’s not easy to manufacture quality thermometers with cost competitiveness. The various components are expensive. IC chips are the most expensive, accounting for 10-15% of the total cost. LCD 10%, sensor 10%, pump 10%. We have economies of scale in procurement and manufacturing. We will continue to consolidate this market, albeit gradually. Our market share is around 40% five years ago and about 50% now. Our market share is higher for higher-end products, especially for the range of infrared products.”

Conversation with Management: Microlife’s Founder and Chairman LIN Kin-yuan (KY Lin)

Chinese-to-English translation by KB Kee. Any translation errors are mine.


Microlife’s KY Lin, 61 years old

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Atrial Fibrillation (Afib) and Stroke Prevention Microlife has worldwide patents in Afib in BPM

http://well.blogs.nytimes.com/2014/06/25/longer-heart-monitoring-backed-for-stroke-patients/?_php=true&_type=blogs&_r=0 http://well.blogs.nytimes.com/2013/12/30/with-a-fib-rhythms-higher-odds-of-stroke/?_php=true&_type=blogs&_r=0


http://well.blogs.nytimes.com/2014/06/25/longer-heart-monitoring-backed-for-stroke-patients/?_php=true&_type=blogs&_r=0













http://well.blogs.nytimes.com/2013/12/30/with-a-fib-rhythms-higher-odds-of-stroke/?_php=true&_type=blogs&_r=0















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WatchBP is the only solution announced by Italy’s medical society SIMG (Società Italiana di Medicina Generale)


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Microlife: Why Wide Moat? Fundamental Dynamics Behind 21% ROE WatchBP as the potential disruptive technology

Disruptive Technology with Clinical Use: The WatchBP is the potential disruptive technology in the blood pressure monitor market as it has increasingly gained the acceptance as the preferred clinical use with implemented guidelines given its patented measurement of Afib with hypertension to detect stroke and hear diseases in advance. The WatchBP also has professional analytical software to enable easy and accurate diagnosis.

Logarithmic vs Exponential Growth: BPM has been a logarithmic growth market as incremental functional improvements are enhancers to the product. We believe that once the hospitals and clinics start to adopt WatchBP as the standard BPM, home-use could rise in an exponential manner.

Empowerment Tool as an Active Participant in Managing Health: Microlife developed the WatchBP solution as a way to help physicians accurately diagnose and treat hypertension and empower patients to be an active participant in managing their health. Two things drive effective care; good data and patient accountability. The best medical decisions are made with the best data. Patients also need to believe that the doctor’s advice and treatment is meaningful, understandable, and important to their well-being. Microlife provides accurate, reliable, patient-centered solutions that engage patients and empowers them to manage their health.


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Worldwide patents in algorithm in Afib: Not just a product, but a strategy! Why wide moat (Part 2): - “Forces” the clinical community to adopt them as the standard, which in turn helps drive home-use penetration. - Transforms the BPM product into a unique strategy that incorporates software development to create value-added services for

health monitoring and collaborating with hospitals and governments on tele-healthcare projects. - Watch BP Afib was soft-launched in 2010. 50,000 units are sold in 2011, and the number doubled to 100,000 units in 2012 and

around 250,000 in 2013, about 10% of group sales.

Sticky ODM Partner to Reputable Customers, Yet Is Able to Build Its Own Brand, Demonstrating Bargaining

Power! Why wide moat (Part 3):

- Microlife has a diversified customer base as the ODM partner to reputable companies including Wal-Mart, Costco, CVS and none of the customers account for more than 10% of Microlife’s sales.

- Microlife has demonstrated that it has bargaining power over its powerful customers with the ability to build its own brand since 1998 (44% of sales in DT/BPM, 62% of overall sales).

Long-term industry growth potentially switching gears from logarithmic to exponential growth: - Patient monitoring device (PMD) will be a niche resilient growth segment with the rise in aging population and chronic malady.

Patients are increasingly aware of the need to manage their own health and home-use of BPM will be a long-term growth trend. Nearly half of hypertensive patients are inaccurately diagnosed and accurate blood pressure measurement is increasingly difficult due to the complexities of modern diseases. Standard BPM are increasingly not effective. Microlife’s unique WatchBP has the potential to disrupt the market with the adoption led by the clinical community and possibility to spread to home-use as patients seek a consistent and integrated healthcare experience


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Long-term downside protection in terminal value as takeover target: - Microlife’s long-term terminal value and downside risk will be protected by giants such as Omron, J&J (LifeScan), Bayer, Abbott etc

who wish to swallow it up to possess its valuable manufacturing technology platform and worldwide patents in algorithm-technology in Afib and MAM blood pressure measurement.



Stable long-term shareholdings and patient capital foster innovation: - The stable long-term shareholdings and patient capital by the founder KY Lin and the management team

who together own around 48% of the equity has enabled Microlife to adopt a very long-term approach to building its business and cultivating new growth areas. While KY may sometimes be slightly over-optimistic and thinking too far ahead with his long-term opinions, this idealistic engineer-visionary-philosopher has done a fantastic job in continuously defying the odds of many skeptics by growing Microlife from a small startup into one of the world’s leading patient monitoring equipment company.

- KY is the rare Asian entrepreneur who was persistent in building his own brand despite the threat of offending his ODM customers. KY was also early in cultivating and coordinating a global network with high-tech component, R&D and manufacturing in Taiwan, manufacturing, assembly and packaging in Shenzhen, China and medical R&D and clinical testing and accreditation lab center in Europe, including making the difficult decision to establish a direct marketing sales force in Europe and North America given the high cost.

- Unlike most Asian business owners whose interest and focus in the core business starts to wane due to complacency from growing personal wealth and the inability to scale the core business, KY is genuinely passionate in the company’s ability to add value to the patients and society. The idea of the innovative WatchBP actually came from an in-depth conversation between European hypertension specialist Professor George Stergiou and KY.

- Microlife can effectively run without KY with the long-term corporate culture and management system in place, yet KY can inject great value as the steward in new innovations; we believe that this combination is rare for an Asian company and deserves a valuation premium.


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Microlife 10-Year Price Chart

Source: http://investing.businessweek.com/research/stocks/charts/charts.asp?ticker=4103:TT

Microlife is listed in GTSM (GreTai Securities Market) on Mar 29, 2001.

Microlife breaks into Wal-Mart

Anti-dumping saga in US against Chinese imports. Sales of Microlife’s

Made-in-China Biddeford was affected and Microlife shifted its production

facilities to Philippines.

Tipping Point: WatchBP soft-

launched in Switzerland and

Europe

Sep: Reduce share capital by 10% to boost capital efficiency Oct: New MAM series in blood

pressure monitors

UK’s NICE announces WatchBP to be used in

hospitals; 10th consecutive A award

for Most Transparent, Best Disclosure listed

company; Frost & Sullivan award.

WatchBP sales growth accelerated from 50,000 in 2011,

100,000 in 2012 to 250,000 in 2013.

Sales from Microlife brand exceeded

OEM/ODM business


http://investing.businessweek.com/research/stocks/charts/charts.asp?ticker=1565:TT

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Market Statistics and Financial Summary: PE 13x, EV/EBIT 9.7x, EV/EBITDA 8.8x, Dividend Yield 5.6%

Date: Jun 24, 2014 Share Price: TWD 74.2 Market Cap: US$272m Shares Outstanding: 110m FX Rate: USDTWD 30.0 Daily Liquidity: $0.3m 52 Week: TWD 73.4-91.9

P/E (FY13): 13.1x P/Book (FY13): 2.73x P/Sales (FY13): 1.40x P/CFO (FY13): 12.2x EV/EBIT (FY13): 9.7x EV/EBITDA (FY13): 8.8x ROA (FY13): 12.1% ROE (FY13): 20.9% Div Yield: 5.66%

Valuation Summary

YE Dec, TWD mil 2010 2011 2012 2013 US$M

Sales 5,622.9 5,124.4 5,367.8 5,896.7 196.7

GP 2,067.8 1,794.9 2,005.9 2,201.5 73.4

EBIT 582.3 464.1 676.0 705.9 23.5

EBITDA 636.4 507.5 721.5 778.0 26.0

Net Income 430.2 468.8 557.2 633.6 21.1

CFO (Op Cashflow) 230.1 321.0 769.0 677.0 22.6

Capex -92.9 -74.3 -41.0 -60.6 -2.0

Profitability

GP Margin 36.8% 35.0% 37.4% 37.3%

EBIT Margin 10.4% 9.1% 12.6% 12.0%

EBITDA Margin 11.3% 9.9% 13.4% 13.2%

Net Margin 7.7% 9.1% 10.4% 10.7%

GP/TA 46.4% 41.0% 44.4% 42.2%

ROA 9.6% 10.7% 12.3% 12.1%

CFO/Total Asset 5.2% 7.3% 17.0% 13.0%

ROE 16.3% 16.9% 19.9% 20.9%

Financial Summary

Cash vs Accruals 2010 2011 2012 2013

Capex% Sales -1.7% -1.4% -0.8% -1.0%

AR Day 77 100 99 112

Inventory Day 48 55 49 59

AP Day 74 68 62 80

CCC 51 87 86 91

Leverage

Mkt Value (TWD mil) 7,211 6,111 6,490 8,943

Shares Outstanding 122.2 122.2 110.0 110.0

Net Debt -1,424 -1,268 -1,371 -1,405

Debt/Book Equity -53.9% -45.8% -49.0% -46.3%

Ownership

Management & family 46.9% Foreign investors 14.4% (Franklin Resource 11.1%) Domestic funds & fin 12.5%

R = “Rootedness” in innovative culture? E = “Emptiness” in business model durability & scalability? (1) Indestructible intangibles in know-how and trust and support from community? (2) Core-periphery business model via technology and empowerment? (3) Open innovation business model?

S = “Sheath” leadership/ management quality?

R.E.S.-ilence Factors in Value Creation

Industry dynamics Business transparency Accounting quality Corporate governance Catalysts/ Tipping point Valuations Liquidity

Risk Factors

Microlife’s ROE has been steadily increasing from 16.3% to 20.9% due partly to better profit margin contribution from its innovative WatchBP products and rising net cash position.

Microlife has undertaken the unusual capital management program to retire 12.2m shares (10% of its shares outstanding) in Sep 2012 to boost capital efficiency by utilizing the comfortable net cash position. Share price has since spiked up over 25%. The proactive shareholder-friendly stance backed by its strong net cash position should limit any downside in share price.

Note that net cash in FY13 has grown from $47M to $65M in 1Q14

1Q04 sales +4.6% but OP -1.2% with GP margin maintained at 37.7-37.9%, mainly due to a 8.6% increase in selling and marketing expenses. During 1Q14, Microlife forex gain has fallen to $0.5m from $16m in FY13. It also suffered a hedging loss of $0.9m as opposed to a gain of $0.3m in FY13. Overall, other income has dropped from $2m profit in FY13 to -$0.2m in 1Q14

Market Stats

http://emops.twse.com.tw/server-java/t16sn02_e1?TYPEK=otc&step=current&co_id=4103





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Investors will always misunderstand inno-factures. They are distinct from the usual low-cost manufacturers in emerging markets because of their “manufacturing technology platform” that creates both that option value to break new grounds in new markets/customers and to widen the moat to fend off the typical distracted/complacent Asian emperor owners who need to indulge in luxury lifestyle and property/non-core investments to feel alive since the underlying core business cannot be institutionalized.

Increasing complexity and shorter design life-spans in a multitude of products mean that the “modular design” process of products requires plenty of technical interaction and tacit knowledge exchanges among brand companies, key component suppliers and formulation through their system integration and technological development abilities. ODMs have become an irreplaceable and integral part of the R&D and design process value chain.

“Skate to where the puck is going to be”: From “Brands” to Inno-Facturers Microlife is Part of the Long-Term Valuation Re-rating Trend from Brands to Inno-Facturers

Investors are always enamored by the brand story, sometimes right but often wrong, since, after all, there are few Coca Colas.

In our view, the profit and valuation premium in the value chain will start to skate to the “Inno-facturers” and the hidden ODM innovators (the brand behind brands) consolidating the industry with their unique business models, while the “brands” start to slug it out amongst themselves. Brands without their own distribution network in emerging markets to equitize end customer relationship will suffer de-rating given the explosion in advertising/ marketing and distribution/ logistics costs, the attack of private labels and too many me-too brands everywhere.


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ODM Vs Brand in Valuation = Inno-Facturers Will Always Be Misunderstood The case of TSMC (2330 TT, MV $117bn), the ultimate ODM now nearly as valuable as Intel

TSMC (2330 TT, MV $117bn) is now the largest ODM foundry in the world. When TSMC was established by Morris Chang in 1987, the market asked, “Who is TSMC going to manufacture the wafers for? The Intels and Texas Instruments are also manufacturers themselves and they would let TSMC manufacture their wafers only when they didn't have the capacity, the leftovers, or didn't want to manufacture the stuff themselves anymore. As soon as they got the capacity they would stop orders to TSMC, so it couldn't be a stable market. And when they didn't want to make the wafers anymore, the chances were that it was losing money for them. And so why would TSMC want to do it? Does TSMC want to take over the loss? And Taiwan is two generations behind in technological capabilities.” TSMC has the last laugh as it enabled fabless innovators such as Qualcomm and UK’s ARM to emerge.

The compounding effect of the neglected and misunderstood giant TSMC, a wide-moat ODM company with no “brand”, but enabler of fabless innovators such as Qualcomm and UK’s ARM. TSMC is up >25x since 1994 to a market value of $117bn.


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5 Examples of Inno-Facturers in Asia Besides Microlife

Example #1: Our Drinking Partner – The Asian Equivalent of Peter Lynch’s Multibagger Winner Crown Cork & Seal

Example #2: Our Digital Entertainment Partner – Hidden Global Consolidator with

Underappreciated GoPro Growth & More Example #3: Our Bakery Partner – The Middleby of Asia in Baking up Defensive Growth Example #4: Our Fashion Partner - Global #1 in Velcro fastener and “spec-in” partner to all top

20 sports shoe brands Example #5: Our Eyecare Partner - World’s #1 ODM in Soft Lens (Global #5) and Hidden

Champion in Color Lens That Giants Can’t Do Well


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Example #1: The Asian Equivalent of Peter Lynch’s Multibagger Winner Crown Cork & Seal?

if we can invest BEFORE the wide economic moat is obvious?”

Blossoms in the Desert: Great Companies in Lousy Industries

Peter Lynch: “Crown Cork & Seal makes soda cans, beer cans, paint cans, pet food containers, jugs for antifreeze, bottle caps, bottle washers, bottle rinsers, bottle crowners and can warmers. I probably don’t need to tell you that can making is a lousy industry with a thin margin… They never pay a dividend... Crown is a perfect company. A classic example of how to run an unexciting business and make it exciting for shareholders. We’d all be richer if we’d put all our money into Crown.”

Peter Lynch managed the obscure Magellan Fund from 1977-May 1990, growing AUM from $18m to $14bn with annualized return of 29%. Crown Cork & Seal is up over 670% for Peter Lynch.

John Connelly, a former Crown supplier, takes over as president in 1957 at a time when the company is reeling from a series of poor diversification and is on the verge of bankruptcy. In 32 years as chief executive of Crown, this blacksmith's son stubbornly went his own way. Other companies diversified with disastrous results but Connelly stuck single-mindedly to what he knew best: the manufacture of metal cans and caps. When he yielded to the infirmities of age in April 1989, it was an industry leader with 17,750 employees in 28 countries and annual revenues of $1.9 billion. Connelly passed away at age 85 in July 1990.

$1.6 billion market cap

? =

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Example #2: Hidden Global Consolidator With Underappreciated GoPro Growth & More

Why overlooked and underappreciated?

Association with PC Decline

Global PC sales tank to lowest since 2008. PC is disrupted by the twin terrors of tablet (iPad was launched on Apr 2010) and smartphone.

Despite industry slowdown, X has made market gains from further industry consolidation in PC peripherals.

Non-PC weighting in sales has grown from 22% in 2011 to 37% in 2Q13 and targeted at 40-42% in 2013, led by growth in tablet and consumer electronics (eg sports DV cam).

Keyboard Global #1

Market Share 33%

Webcam Global #1

Market Share 20%

Notebook Cam Global #1

Market Share 40%

Sports DV Cam

EV/EBIT 12x EV/EBITDA 9x

Operating Cashflow >$200M

Dividend Yield 5.75%

Spinoff (Listing Nov13):

#3 Global Player in Power Supply

(SPS/Adapter, LED Lighting); X owns

53%

Deep intangible know-how in design, development,

engineering and manufacture of keyboard

and camera modules

Complete global logistics system of 44 JIT

warehouses to deliver flexibility and speed in customer services and reduce inventory risk

Automotive Camera

IP Security Cam

Tablet DKB + Dual Cam

Wearable Sports DV Cam

Wearable sports phenomenon pioneered by GoPro is a niche that has grown from sports into multiple areas including military and defense.

DKB = Detachable keyboard

Global #1

Corporate Motto = No Quality, No Sales

“We are the ‘Red Ocean’ magicians focusing on three simple low-margin peripheral products.. Westerners do not want to do these “Red Ocean” products; we do them exceedingly well.. And we are the global #1 in market share in keyboard, NB cam/webcam/DV cam.” - CEO

Foundation for Cashflow and Growth

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Example #3: The Middleby of Asia In Baking Up Defensive Growth #1 in Asia in bakery equipment (80-90% of hypermarkets and 50% of bakery chains in China are X clients) = Strong cashflow foundation to expand to pizza and food service equipment

Why is X underappreciated still?

Structural Re-Rating of Niche Companies With Defensive Growth

Globally, business models with (1) diversified client base, (2) steady revenue streams, (3) lean capex requirements that creates ample free cashflow are underappreciated. One of such business models is boring niche FMCG/ food service equipment companies. They possess defensive investment characteristics and high competitive quality due to their dominant market positions in a niche which is sought after in the currently still uncertain macro environment.

Proven Unique Business Model to Consolidate Fragmented Market

X’s unique business model in finding, winning and binding new customers with its innovative bakery intelligence and a strong and unique distribution/ marketing network supported by bakers should protect X to continue to consolidate the fragmented market and provide ample opportunities to continue its profitable growth.

EV/EBIT 10.1x Earnings Yield 7%

(FY13e) Div 4%

Net Cash

When Selim Bassoul took over Middleby as COO in mid-1999 and as CEO in Jan 2001, revenue were $132m, which shrank to $100m by the start of the 2001-03 recession. “We had very limited resources and capital, we were running out of cash, and we were highly reliant on three customers that generated more than 60% of our sales. We lacked innovation, and the products we were generating or creating were very ‘me-too’ kitchen products across a very broad range, including mixers, refrigerators and ovens. Roughly 30% of the orders were not shipped on time. You could say we had a case study of a lousy company.” Middleby’s secret recipe in fueling growth in its kitchen gear even in recessions by creating and sustaining exceptional value for its customers: Love the customers, even the smallest ones. “At one time, McDonald’s was the small customer. This may sound basic but is not done by all our competitors.”

Middleby: Up 100X (1999-2014) to $5.7bn

“Whether you are a hypermarket or big bakery chain or a small independent artisan bakery shop, you can find the best equipment that you need at X. We are dedicated to making the best bakery machines since our establishment in 1983. We want to let more people eat the bread made from our bakery equipment. We want to represent Asia to become a global brand champion.”

Bassoul in 2004: “My biggest marketing problem is our products last forever”.

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Example #4: Velcro Up For Defensive Growth Global #1 in Velcro fastener and “spec-in” partner to all top 20 sports shoe brands Dedication to innovation in creating and scaling up new applications


Valuable Patent Portfolio and Potential Takeover Target by

Nike/Adidas/Pou Chen

X’s portfolio of over 110 patents and its deep know-how and experience over the past 30 years in manufacturing and R&D will prove valuable to the giants Nike/ Adidas and Pou Chen who might wish to acquire niche global champions to vertically integrate their business model and this intangible asset is not factored into the long-term valuation.

ODM with R&D capabilities and “spec-in” long-term

partnerships with all the top 20 athletic sports shoe

companies to develop new materials/designs and

provide patented solutions

Broad product offering protected by over 110

patents and continuous product innovations to break

out of price competition

Global #1 Market Share

>10%

Stable Margins, Strong Cashflow

and Div Yield

Pan-Asia production network (Taiwan, China, Viet, Isia)

with plants near brand clients to provide rapid delivery and

quality customer service

EV/EBIT 10.6x EV/EBITDA 7.1x

Div 3.9%

CEO : “Winning in a price war is a transient race; continuous innovation in product quality is like a marathon and the sustainable way to win.”

X

X: Growing together with its major customers Nike and Adidas

BUY Nike or Adidas or UnderArmor/ Lululemon/ Skechers? X supplies to all the top established and emerging brands

Proven Unique Business Model to Consolidate Fragmented Market

X has emerged from the financial crisis much stronger than before after investing in building up its Pan-Asia production network and creating new product innovations, improving its margins and consolidating the fragmented industry further with its comprehensive array of patents in materials and manufacturing technology and 30 years of manufacturing and R&D experience under its belt.

Globally, niche global champions with unique scalable business models, recurring revenue and cashflow from a quality clientele base and defensive growth features enjoy a structural re-rating in their valuation.

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Example #5: World’s #1 ODM in Soft Lens (Global #5) and Hidden Champion in Color Lens That Giants Can’t Do Well


Valuable Process IP/Know-How and Potential Takeover Target by Valeant-

Bausch&Lomb, Essilor, Hoya

X has been regarded as a “thorn in the flesh” by the Big Four giants for its role in feeding the hundreds of mid-tier brands competing with them, particularly in color lens. X’s terminal value and downside risk will be protected by giants who wish to swallow it up to possess its valuable flexible manufacturing system and know-how to fill their own missing competency gaps. Non Big Four giants such as Essilor and Hoya will also be keen to acquire X.

Proven Unique Flexible Manufacturing to Dominate Color Lens

X’s flexible manufacturing system and know-how enabled it to produce color lens and complex orders in large scale. X has the potential to consolidate and dominate color lens, a product that the Big Four giants are unable to manufacture large-scale..

The color lens penetration rate in Japan is only 15-18%, below Taiwan’s and Korea’s 25-30%, China’s 30-35%. This should provide solid foundation for X to grow .

ROE 41% (Why?)

(1) ROE (2) EV/EBIT (2)/(1)

X 41.1% 20.6x 0.50

Largan 31.5% 23.2 0.74

Ginko 17.9% 32.9 1.84

Interojo 16.3% 22.0 1.35

Essilor 14.7% 19.2 1.31

Carl Zeiss M 12.7% 13.6 1.07

Cooper 12.2% 19.8 1.62

Hoya 10.8% 12.7 1.18

Seed 5.5% 17.0 3.06

Q: Why can’t the giants (J&J, CibaVision, Cooper, Bausch & Lomb) mass-manufacture color lens but X is able to?

Among optical-related peers, X has the highest ROE at 41%. While its valuation is not cheap with EV/EBIT (FY13) at 20.6x, when we compare EV/EBIT relative to ROE, X is the cheapest, by as much as 130-220% when compared to giants Cooper, Hoya, Essilor.

Comparing EV/EBIT to ROE also makes good common sense since it is rare for wide-moat companies to sustain high ROEs and they deserve a valuation premium, while low EV/EBIT stocks ain’t cheap when their ROEs are even lower and value traps can be avoided.

Unique flexible production know-how in color lens and large-scale complex order that giants don’t have

Sticky ODM customer

relationship

Own brand is #2 in with

30% domestic

market share

(2)/

(1):

Lo

we

r =

Ch

eap

er

Expiry of patents in silicon hydrogel lens in 2014/15 (US/Worldwide)

With the impending expiry of patents in silicon hydrogel lens which make up 70% in US, 40% in Europe and below 20% in Asia, X will be able to better exploit the opportunity to penetrate deeper into this lucrative market segment to drive ASP/margin improvement. X has already shipped its first silicon lens to Italy in 2013 and 2 of its Japanese clients have applied for a 2015 launch.

ODM = Original Design Manufacturing

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X: Unique Leader In Anti-Malaria & Chronic Pain + Staying Power in Cost Efficiency = The Next Dr Reddy’s/Lupin (Market Value $1.5 Billion to $6 Billion)?


Governance

The pharmaceutical industry is complex and drug firms typically took advantage of informational asymmetry by engaging in aggressive accounting practices such as capitalizing R&D as intangibles or booking goodwill in M&As without proper impairment test to boost earnings.

Rare are firms with conservative accounting practices such as X and they deserve a valuation premium.

Supply Constraints in US Business

X’s Indore (SEZ) plant, built for US formulation exports, received US FDA approval on 20 Jun 2012 but X volunteered to report quality issues in Nov 2012, resulting in re-inspection in Apr 2013 and approval in Sep 2013. X management estimates that the Indore facility will contribute revenue of INR 4.5bn ($73m) per year (16% of FY13 revenue) at full capacity. This approval will resolve earlier uncertainty and pave the way for scaling up the important US business. X’s export formulations to US to potentially triple to $100 million by FY15, a decent size to trigger the next wave of sharp re-rating upwards, as had been observed when Sun Pharma, Lupin, Dr Reddy’s scaled up their US business and getting huge jumps in valuation multiples.

EV/EBIT 17.3x EV/EBITDA 15x

0%

5%

10%

15%

20%

25%

30%

IPC

A

Torr

ent

Cip

la

GSK

Lup

in

Dr

Red

dy'

s

Cad

ila

Sun

Gle

nm

ark

Step 1: Accounting Conservatism to Limit Downside Risk

Step 2: Staying Power in Cost Efficiency & Stability in Earnings

Step 3: Unique Business Model for Long-Term Upside

We used accounting conservatism rather than a misleading “cheap” PE ratio or EV/EBIT to limit downside risk in valuation. We measure “Goodwill + Intangibles + Long-Term Asset as % of Total Asset”; the lower the number, the more conservative the accounting figures.

Glenmark has continued to capitalize a significant part of R&D costs resulting in high intangible assets on the balance sheet.

X, Torrent and Cipla stood out; X is the only Indian drug firm which expenses, and does not capitalize, all R&D.

Goodwill, Intangibles, Long-Term Asset as % of Total Asset

145.5

95.3

78.4

64.8

44.1 36.5 35.8

0

20

40

60

80

100

120

140

160

IPC

A

Dr

Red

dy'

s

Lup

in

Cad

ila

Gle

nm

ark

Sun

Torr

ent

Cost efficiency provides the ability to stay competitive, have better control in the case of uncertain events like drug price controls and have stronger cashflow/balance sheet to strengthen the ability to carry out long-term R&D in higher value-added activities and seize inorganic growth opportunities.

DMF/ANDA* is a measure to assess the extent of fully-integrated capabilities of a manufacturer, whether the launch of drug formulation is backed by its own API for cost efficiency.

X, Dr Reddy’s and Lupin have the highest % of ANDAs backed by their own DMF filings. X also has 9 patent rights issued by the US Patent Office for its novel process of manufacturing of API, one of the few Indian drug firms with patents for its manufacturing process.

DMFs/ ANDAs filed

X has dominant market share in anti-malarial drug in India (~49% market share). ACT is the most common anti-malarial drug treatment and the AL drug accounts for 70% of ACT market.

X has grown the institutional malaria business from zero 5 years ago to INR 4bn ($65m), a feat made possible due to its fully-integrated capabilities. X is prequalified by WHO for six anti-malarial drugs. Of the five approved WHO players in AL drug segment, X is the only fully-integrated player, giving it >30% EBITDA margin, better pricing power compared to the competition, and significant advantage over other players in ramping up the business from the current 30% market share (vs Novartis 50%). X is also the only Indian player with substantial sales from Africa.

X management believes the institutional business can grow from guided sales of INR 4.6bn ($74m) in FY14 to INR 8bn ($129m) (28-30% of FY13 sales) over the next three to four years (FY17-18).

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

FY10 FY11 FY12 FY13

Institutional business revenue INR million

* DMF (Drug Master File) is submitted to US FDA containing complete information on API (active pharmaceutical ingredient) or drug formulation. ANDA (Abbreviated New Drug Application) is an application to US FDA for US generic drug approval.

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Tencent (700 HK, MV $150bn): Biggest Error of Omission! Market Value Compounded from $900M in 2004 to $150B in 2014

(3) Biggest Mistake

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Tencent’s Pony Ma ripped off Instant Messaging (IM) service, QQ, off Israel’s ICQ in 2000 as a free online download.

After burning US$1.1m, the two investors that Ma found were anxious to sell their shares. The company was shopped around for nearly any price to China’s largest portals, but no one wanted to waste money on a company doing IM. If the mighty AOL couldn’t make money off IM, who could?

Lucky break? China Mobile decided to share a portion of revenue to third-party companies who could boost the number of people buying data plans. Pony Ma offered IM chat messaging at RMB 6c per month per user. Viola! Tencent started to push anything that a mobile user would pay: ringtones, wall paper, horoscopes. Pennies over mobile phones earned Tencent US$6m sales and US$1.2m profits in 2001.

Tipping point came when Tencent offered virtual goods – avatars, outfits, pets, and emperor-kids spend pennies and hours collecting.

Naspers paid US$30m to buyout 50% of Tencent in 2005 before its listing and now its 35% stake in Tencent is worth >US$50B.

Tencent monetized IM when western giants failed and built chat not as a productivity tool but to be a community for bored kids to hang out.

Tencent (700 HK, MV $150bn): Biggest Error of Omission! Just Another Copycat? Tencent Monetized IM When Western Giants Failed; “Emptiness” in Know-How and Trust from Community

(3) Biggest Mistake

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“宁可不识字，不可不识人.”

“I would rather not be able to read words than not be able to read people.” - Zeng Guofan, Qing statesman, in “Icy Discernment”, a book ranked alongside “Three Kingdoms”, “Sun Tzu: Art of War” and “Water Margins”.

“以冰为镜，能查秋毫。”

“邪正看眼鼻，真假看嘴唇；功名看气概，富贵看精神；主意看指爪，风波看脚筋；若要看条理，全在语言中。”

梁启超：“五千年历史立德立言立功者只有两个人：范仲淹，曾国藩。五千年历史中事业有继衣钵得传者只有一个人：曾国藩。”

Assessment of Management Quality Linguistic/Textual Analysis and More…

Buffett: “Rittenhouse is still on the side of the angels.”

(4) Book Recommendation

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Two Little Stories from Decade-Plus Journey

Resilient Compounders

(2) Detecting Accounting

Frauds Ahead of the

Curve

(3) Tipping Point

Analysis

(4) Icy Discernment

(冰鉴) of Management

Quality

Inner Compass: Bamboo

Innovator, Values, Self-Awareness

(1) “Emptiness” in Business

Model & Wide Moat

Analysis

(1) Temasek invest S$500 million in services company with largest domestic market share in May 2007, followed by another S$30 million in Feb 2008. Darling stock, cannot go wrong? [Detecting Accounting Frauds Ahead of the Curve]

(2) The small-built Chinese entrepreneur. Can anyone name an “old” S-Chip that is untainted? [Icy Discernment]

Bamboo Innovators bend, not break, even in the most terrifying storm that snap the mighty resisting oak tree. It survives, therefore it conquers.

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R M C

Parents Govt

Developers eg 123, QMC

Questionable property owners, “special purpose vehicles” and trust

fund eg AET

M&As, via 123

Parents are not enrolling their kids in ABC due to poor service as costs are cut

Lease cost

Billions of dollars from bankers and investors go to paying “developers” (largely related-party) for questionable contracts in designing/ developing and refurbishing the centres, and to fund M&As

Fast Eddy: Education is a real sexy business in Australia and globally. Our govt supports education and especially us. There are also many cheap and good M&A targets lined up everywhere. Many of these centres are not well-run and the owners are not financially-savvy. But if they become part of our magic ABC brand and unique business system, they will be much more profitable. Also, after designing/ developing and refurbishing the centres (inc the acquired old haggard ones), they will be bright and sparkling, and parents will queue up for ABC – where else can they go? We have one-quarter of the market and that number can only go up and up., with or without your help, but together we can go faster and stronger.

Developers pay back quietly the funds to ABC and the RMCs to boost their revenue and profits and help them to achieve their “budgeted” numbers

Day care fees is AUD 62 a day. Childcare rebate on family’s put-of-pocket expenses is 50% up to AUD 7,500 a year which will be paid quarterly in arrears

Regional Management Companies (RMC) are “independent” entities employed by ABC to run the child care centres, inc collecting the fees from parents and government, and paying off the wages and other costs. RMC then pays back ABC license fees which ABC books as revenue.

Bankers and investors buy the story and lend/ invest billions of dollars in ABC via massive loans (many with market-based covenant terms) and new shares. ABC raised AUD 3.5b over 3.5 years

After “some time” when payments run into problems, the panicky bankers and investors cry: Where is our money?? ABC runs into cashflow problems in its periodic payments, and its going-concern status is threatened

Wages & other costs. Eddy says “Cut, cut, cut – we need to show them we make money fast”

2

6

7

8

Bankers, Investors

5

9

3

4

1

Until FY07, ABC submitted accounts that were net of RMC expenses. Things became shaky for Eddy after reporting standards changed and ABC reports gross revenue and breaks out the costs incurred by RMCs – Eddy sweats, a bit

Up Close & Personal With ABC Learning’s “Fast Eddy”


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“Resilience: Why Things Bounce Back” by Andrew Zolli

“This model posits moderate disruptions as a necessary, if painful mechanism by which systems are tempered, adapt, learn and reorganize. A resilient system isn’t one in which failures never occur; it’s one in which disruptions engender a healthy response— one which enables a system to “bounce forward” as much as bounce back. It is further assumed that there are epistemic constraints – limits to what we can know and prepare for in advance – and that surprises are inevitable, and that we’ll make mistakes.”


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All Books by Robert Greene

“The fools in life want things fast and easy – money, success, attention. Boredom is their great enemy and fear. Whatever they manage to get slips through their hands as fast as it comes in. You, on the other hand, want to outlast your rivals. You are building the foundation for something that can continue to expand. To make this happen, you will have to serve an apprenticeship. You must learn early on to endure the hours of practice and drudgery, knowing that in the end all of that time will translate into a higher pleasure – mastery of a craft and of yourself. Your goal is to reach the ultimate skill level – an intuitive feel for what must come next.”


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Appendix

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Why is Microlife underappreciated still?

Valuable Process IP/Know-How and Potential Takeover Target by Omron, J&J

(LifeScan), Bayer, Abbott

Microlife’s long-term terminal value and downside risk will be protected by giants such as Omron, J&J (LifeScan), Bayer, Abbott etc who wish to swallow it up to possess its valuable manufacturing technology platform and worldwide patents.

Durable Franchise Value in Boring and Resilient Patient Monitoring Device –

and a Quiet, Powerful Cost Consolidator

Microlife’s manufacturing technology platform has enabled it to build a global durable franchise in the niche patient monitoring device market that has stable resilient growth and yet is experiencing potential disruptions led by Microlife’s new innovation in blood pressure monitoring protected by worldwide patents. Microlife has the potential to consolidate the market further.

Worldwide Patents in Algorithm-Technology in Afib and MAM blood

pressure measurement

Microlife’s worldwide patents in algorithm-technology in blood pressure measurement has been commercialized into the WatchBP product series that is at the heart of its total solution service business model. This valuable intangible asset is not factored into long-term valuation.

Global #1 Market Share (Digital Thermometer)

50%

Worldwide Patents in Algorithm-Technology in Afib and MAM

The innovative WatchBP with the Afib detection and MAM technology are not merely additional features; it “forces”

the clinical community to adopt them as the standard, which in turn helps drive

home-use penetration. It transforms the BPM product into a unique strategy.

Microlife’s ROE 21% (Why?)

Total Solution Service Business Model

Incorporates software development to create

value-added services for health monitoring and

collaborating with hospitals and governments on tele-

healthcare projects.

Global #2 Market Share (Digital Blood Pressure

Monitor) 17-18%

Quiet, Powerful Cost Consolidator Reliable manufacturing platform for

over 30 years with in-house capabilities to combine Swiss design, high-precision

electronics with clinical healthcare to produce world-class products with cost

competitiveness.

Sticky ODM Partner to Reputable Customers

Diversified customer base to customers such as Wal-

Mart, Costco, CVS, Walgreen’s; none accounts

for >10% of sales.

EV/EBIT 9.7x EV/EBITDA 8.8x Dividend 5.6%

Net Cash 23% MV

US #1 Market Share (Electric Flexible

Heating Blankets) 50%

Microlife: Boring Global #1/#2 in Patient Monitoring Device (Digital Thermometer/Blood Pressure Monitor) ROE 21% with a unique solution-services business model protected by innovative worldwide patents

91% of Sales in Developed Markets

(54% US, 37% Europe)

Worldwide Patents in Afib and MAM


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Table of Contents

Executive Summary Price Chart, Market Statistics and Financial Summary Part 1: The Business Model Patient-monitoring device (PMD) industry Microlife’s major products Microlife: Background and tipping point Microlife: Revenue breakdown Microlife’s electrical flexible heating blanket business in America Microlife: Why wide moat? The fundamental dynamics behind it s21% ROE (1) Powerful cost consolidator; (2) Steady ODM partner; (3) Total solution-service (4) WatchBP as the potential disruptive technology Corporate developments and future roadmap Microlife Might Strike Potential Partnerships in Unconventional Channels Part 2: The Context: Why Now? Part 3: The Management Conversation with founder and chairman KY Lin Part 4: Valuation & Potential Risks Appendix “Alarm fatigue” from inaccurate blood pressure measurements Atrial fibrillation and stroke prevention WatchBP formally recommended by leading healthcare authority NICE Microlife’s other products Snapshot of Omron’s Healthcare Business Taiwan Bamboo Innovators 79

3-4 5-6 7-18 19-21 22-34 35-37 38-44



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Executive Summary

Microlife (GTSM: 4103 TT) is the world’s largest manufacturer of digital thermometer with 50% global market share (20% under its own brand Microlife), the world’s #2 maker of blood pressure monitors with 17-18% market share (60% under its own brand Microlife) and the largest maker of electric flexible heating blankets in US with 50% market share. Founded in 1981, Microlife was listed on the GTSM (GreTai Securities Market) on Mar 2001 and it has 2,400 employees. Key rivals include Japan’s Omron (6645 JP, MV $9.6bn), Germany’s medium-sized family-owned Beurer GmbH.

1) What Makes It a Wide-Moat Business? Quiet, Powerful Cost Consolidator: It’s not easy to manufacture quality digital thermometers and blood pressure monitors with cost

competitiveness. There’s big knowledge even in these boring and seemingly simple patient monitoring devices. Microlife’s reliable manufacturing technology platform for over 30 years has enabled it to build a global durable franchise in the niche patient monitoring device market that has stable resilient growth and yet is experiencing potential disruptions led by Microlife’s new innovation. A secret to Microlife’s success is its in-house capabilities to combine Swiss design, high-precision electronics and sensors components with clinical healthcare to produce world-class products with cost competitiveness. Microlife has competitive technology and patents especially its core competence of having an algorithm to allow fast reading/filtering of signals and outputting the accurate results in a short period of time. Microlife has the potential to consolidate the market further.

Sticky ODM Partner to Reputable Customers, Yet Is Able to Build Its Own Brand, Demonstrating Bargaining Power: Microlife has a diversified customer base as the ODM partner to reputable companies including Wal-Mart, Costco, CVS and none of the customers account for more than 10% of Microlife’s sales. Microlife has demonstrated that it has bargaining power over its powerful customers with the ability to build its own brand since 1998 (44% of sales in DT/BPM, 62% of overall sales).

Worldwide Patents in Algorithm-Technology in Afib and MAM to Support the Total Solution Service Business Model: Microlife’s worldwide patents in algorithm-technology in blood pressure measurement has been commercialized into the WatchBP product series that is at the heart of its total solution service business model. This valuable intangible asset is not factored into long-term valuation. The innovative WatchBP with the Afib detection and MAM technology are not merely additional features; it “forces” the clinical community to adopt them as the standard, which in turn helps drive home-use penetration. It transforms the BPM product into a unique strategy that incorporates software development to create value-added services for health monitoring and collaborating with hospitals and governments on tele-healthcare projects.

2) Genesis of the Idea – and Why It’s Featured This Month Long-term correlation with Omron: Microlife share price performance was closely correlated to Omron over the long-term until Abenomics in 4Q13

resulted in Omron to outperform Microlife by over 50% despite Microlife gaining stronger growth momentum in its patented WatchBP Afib technology. The New Taiwan Dollar did not appreciate much against the Japanese Yen, with the range between TWDJPY 3.3-3.4 since Abenomics.

Seasonality kicker: Microlife’s sales is traditionally the strongest during 3Q. The peak season for digital thermometers and blood pressure monitors is July-Oct and Aug-Oct for electric flexible heating technology blankets.

Recent correction: Microlife is down nearly 20% from its recent high in end March 2014 on profit-taking by short-term investors. Share price is back to May 2013 level, representing an attractive opportunity to take position in this long-term durable franchise which has wide-moat from its manufacturing technology platform and know-how developed for over 30 years and is now seeking to disrupt the industry with its new algorithm-based innovation in blood pressure measurement that’s protected by worldwide patents.


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4) Summary Investment Thesis The stable long-term shareholdings and patient capital by the founder KY Lin and the management team who together own around 48% of the

equity has enabled Microlife to adopt a very long-term approach to building its business and cultivating new growth areas. While KY may sometimes be slightly over-optimistic and thinking too far ahead with his long-term opinions, this idealistic engineer-visionary-philosopher has done a fantastic job in continuously defying the odds of many skeptics by growing Microlife from a small startup into one of the world’s leading patient monitoring equipment company. KY is the rare Asian entrepreneur who was persistent in building his own brand despite the threat of offending his ODM customers. KY was also early in cultivating and coordinating a global network with high-tech component, R&D and manufacturing in Taiwan, manufacturing, assembly and packaging in Shenzhen, China and medical R&D and clinical testing and accreditation lab center in Europe, including making the difficult decision to establish a direct marketing sales force in Europe and North America given the high cost. Unlike most Asian business owners whose interest and focus in the core business starts to wane due to complacency from growing personal wealth and the inability to scale the core business, KY is genuinely passionate in the company’s ability to add value to the patients and society. The idea of the innovative WatchBP actually came from an in-depth conversation between European hypertension specialist Professor George Stergiou and KY. Microlife can effectively run without KY with the long-term corporate culture and management system in place, yet KY can inject great value as the steward in new innovations; we believe that this combination is rare for an Asian company and deserves a valuation premium.

Patient monitoring device (PMD) will be a niche resilient growth segment with the rise in aging population and chronic malady. Patients are increasingly aware of the need to manage their own health and home-use of BPM will be a long-term growth trend. Nearly half of hypertensive patients are inaccurately diagnosed and accurate blood pressure measurement is increasingly difficult due to the complexities of modern diseases. Standard BPM are increasingly not effective. Microlife’s unique WatchBP has the potential to disrupt the market with the adoption led by the clinical community and possibility to spread to home-use as patients seek a consistent and integrated healthcare experience.

3) Why Is It Undervalued? Why Can It Double Over 4-5 Years? Microlife Vs Omron: In terms of EV/EBIT, Microlife is trading at 9.7x which is about 28% lower than Omron which is more diversified in industrial

automation and electronic components. Omron’s lucrative healthcare business contributes around 11.5% to group sales and operating income. Both Microlife and Omron are attractive in their valuations given their resilient business model and growth profile. Microlife, however, has a far superior ROE at 20.9% that is nearly double that of Omron at 10.7%. When we compare EV/EBIT relative to ROE and ROA, Microlife is cheaper by as much as 120-150% when compared to Omron.

Short-term downside protection with 5.6% dividend yield and healthy net-cash balance sheet to provide fillip to share reduction program: Microlife has an attractive dividend yield at 5.6% and a strong balance sheet with net cash as percentage of book equity at 47%. Note that net cash in FY13 has grown from $47M to $65M in 1Q14. Microlife has undertaken the unusual capital management program to retire 12.2m shares (10% of its shares outstanding) in Sep 2012 to boost capital efficiency by utilizing the comfortable net cash position. Share price has since spiked up over 25%. The proactive shareholder-friendly stance backed by its strong net cash position should limit any downside in share price.

Long-term downside protection in terminal value as takeover target: Microlife’s long-term terminal value and downside risk will be protected by giants such as Omron, J&J (LifeScan), Bayer, Abbott etc who wish to swallow it up to possess its valuable manufacturing technology platform and worldwide patents in algorithm-technology in Afib and MAM blood pressure measurement.

Executive Summary


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Microlife 10-Year Price Chart

Source: http://investing.businessweek.com/research/stocks/charts/charts.asp?ticker=4103:TT

Microlife is listed in GTSM (GreTai Securities Market) on Mar 29, 2001.

Microlife breaks into Wal-Mart

Anti-dumping saga in US against Chinese imports. Sales of Microlife’s

Made-in-China Biddeford was affected and Microlife shifted its production

facilities to Philippines.

Tipping Point: WatchBP soft-

launched in Switzerland and

Europe

Sep: Reduce share capital by 10% to boost capital efficiency Oct: New MAM series in blood

pressure monitors

UK’s NICE announces WatchBP to be used in

hospitals; 10th consecutive A award


company; Frost & Sullivan award.

WatchBP sales growth accelerated from 50,000 in 2011,

100,000 in 2012 to 250,000 in 2013.

Sales from Microlife brand exceeded

OEM/ODM business


http://investing.businessweek.com/research/stocks/charts/charts.asp?ticker=1565:TT

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Market Statistics and Financial Summary: PE 13x, EV/EBIT 9.7x, EV/EBITDA 8.8x, Dividend Yield 5.6%

Date: Jun 24, 2014 Share Price: TWD 74.2 Market Cap: US$272m Shares Outstanding: 110m FX Rate: USDTWD 30.0 Daily Liquidity: $0.3m 52 Week: TWD 73.4-91.9

P/E (FY13): 13.1x P/Book (FY13): 2.73x P/Sales (FY13): 1.40x P/CFO (FY13): 12.2x EV/EBIT (FY13): 9.7x EV/EBITDA (FY13): 8.8x ROA (FY13): 12.1% ROE (FY13): 20.9% Div Yield: 5.66%

Valuation Summary

YE Dec, TWD mil 2010 2011 2012 2013 US$M

Sales 5,622.9 5,124.4 5,367.8 5,896.7 196.7

GP 2,067.8 1,794.9 2,005.9 2,201.5 73.4

EBIT 582.3 464.1 676.0 705.9 23.5

EBITDA 636.4 507.5 721.5 778.0 26.0

Net Income 430.2 468.8 557.2 633.6 21.1

CFO (Op Cashflow) 230.1 321.0 769.0 677.0 22.6

Capex -92.9 -74.3 -41.0 -60.6 -2.0

Profitability

GP Margin 36.8% 35.0% 37.4% 37.3%

EBIT Margin 10.4% 9.1% 12.6% 12.0%

EBITDA Margin 11.3% 9.9% 13.4% 13.2%

Net Margin 7.7% 9.1% 10.4% 10.7%

GP/TA 46.4% 41.0% 44.4% 42.2%

ROA 9.6% 10.7% 12.3% 12.1%

CFO/Total Asset 5.2% 7.3% 17.0% 13.0%

ROE 16.3% 16.9% 19.9% 20.9%

Financial Summary

Cash vs Accruals 2010 2011 2012 2013

Capex% Sales -1.7% -1.4% -0.8% -1.0%

AR Day 77 100 99 112

Inventory Day 48 55 49 59

AP Day 74 68 62 80

CCC 51 87 86 91

Leverage

Mkt Value (TWD mil) 7,211 6,111 6,490 8,943

Shares Outstanding 122.2 122.2 110.0 110.0

Net Debt -1,424 -1,268 -1,371 -1,405

Debt/Book Equity -53.9% -45.8% -49.0% -46.3%

Ownership

Management & family 46.9% Foreign investors 14.4% (Franklin Resource 11.1%) Domestic funds & fin 12.5%

R = “Rootedness” in innovative culture? E = “Emptiness” in business model durability & scalability? (1) Indestructible intangibles in know-how and trust and support from community? (2) Core-periphery business model via technology and empowerment? (3) Open innovation business model?

S = “Sheath” leadership/ management quality?

R.E.S.-ilence Factors in Value Creation

Industry dynamics Business transparency Accounting quality Corporate governance Catalysts/ Tipping point Valuations Liquidity

Risk Factors

Microlife’s ROE has been steadily increasing from 16.3% to 20.9% due partly to better profit margin contribution from its innovative WatchBP products and rising net cash position.

Microlife has undertaken the unusual capital management program to retire 12.2m shares (10% of its shares outstanding) in Sep 2012 to boost capital efficiency by utilizing the comfortable net cash position. Share price has since spiked up over 25%. The proactive shareholder-friendly stance backed by its strong net cash position should limit any downside in share price.

Note that net cash in FY13 has grown from $47M to $65M in 1Q14

1Q04 sales +4.6% but OP -1.2% with GP margin maintained at 37.7-37.9%, mainly due to a 8.6% increase in selling and marketing expenses. During 1Q14, Microlife forex gain has fallen to $0.5m from $16m in FY13. It also suffered a hedging loss of $0.9m as opposed to a gain of $0.3m in FY13. Overall, other income has dropped from $2m profit in FY13 to -$0.2m in 1Q14

Market Stats






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Part 1: The Business Model


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Patient-Monitoring Device (PMD) Industry Nearly half of hypertensive patients are incorrectly diagnosed!

The global patient monitoring device (PMD) market is expected to grow from nearly $14.7 billion in 2013 to reach nearly $21.0 billion in 2018, a compound annual growth rate (CAGR) of 7.4% for the period of 2013 to 2018.

Factors behind the resilient growth of PMD: A decrease in the physical size of monitoring devices; enhanced utility, performance and sensitivity; usability and portability of devices; and increasing availability of remote/ wireless patient monitoring equipment and systems are factors leading to the growth of PMD. Other contributing factors include growth of aging population and that chronic malady has replaced infectious disease as the most common ailment faced by the populous.

Digital thermometers: 55m digital thermometers are sold, of which 7m are infrared. The continued threat of SARS/MERS, malaria and dengue fever makes the boring and seemingly simple digital thermometers a critical must-have product in a stable-yet-growing market. Environmental initiatives such as the decision of the US Environmental Protection Agency (EPA) and the American Hospital Association (AHA) to phase out the use of mercury diagnostic equipment by 2005 have resulted in a growing demand for infrared ear and pen-type digital thermometers. Infrared thermometers are increasingly popular due to their quick response, accuracy, safety and easy use as they are less invasive as compared to oral or anal procedures and are widely used by doctors and hospitals.

Blood pressure monitors (BPM): In 2013, 45m BPM are sold (N America 16m, Europe 15m, Asia 14m). ISH estimates that the CAGR of BPM is 6.7% as the number of people with hypertension will keep rising and home-use of BPM will be a long-term growth trend. Accurate blood pressure measurement is increasingly difficult due to the complexities of modern diseases. Standard BPM are increasingly not effective.

Types of PMD Blood pressure monitors; Digital thermometer Asthma monitoring device; Cardio monitoring device COPD device (chronic obstructive pulmonary disease) Blood gas analyzers; Glucose monitoring devices Respiratory and sleep disorder monitoring devices Fetal monitors; Neonatal monitors; Neuromonitors; Anaesthesia monitors

“Over 70m adults are affected by hypertension or obesity, costing the U.S. economy an estimated $170bn in lost productivity and medical expenditures. Less than 40% of hypertensive patients are under control and nearly 30m hypertensive patients are incorrectly diagnosed and are either over or under medicated.”

Market for Blood Pressure Monitors


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Microlife: Major Products

Sales 36.6%

Sales 24.4%

Global #2 (17% m/s)

Global #1 (50% m/s)

Sales 34.2%

US #1 (50% m/s)

OBM 20%

OBM 60%

OBM = Own Brand Manufacturing = 44% of sales in DT/BPM, 62% of overall sales


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Microlife: Background and Tipping Point

Microlife is the world’s largest manufacturer of digital thermometer with 50% global market share (20% under its own brand Microlife), the world’s #2 maker of blood pressure monitors with 17-18% market share (60% under its own brand Microlife) and the largest electric flexible heating blanket company in US with 50% market share (Microlife competes with Sunbeam which used to have 80% market share). Founded in 1981 by KY Lin, Microlife was listed on the GTSM (GreTai Securities Market) on Mar 2001 and it has 2,400 employees. Key rivals include Japan’s Omron (6645 JP, MV $9.6bn) whose healthcare business has FY13 sales of $810m and operating profit $68m, and Germany’s medium-sized family-owned Beurer GmbH (FY12 sales $208m) founded in 1919.

Tipping Point in 2008/10 in launching the innovative WatchBP: The WatchBP is the world’s first blood pressure monitor that is able to

detect atrial fibrillation (Afib) based on an embedded algorithm that calculates the irregularity index depending on the intervals between heartbeats, with the diagnosis further confirmed by performing an ECG. Hypertension with Afib is shown to be the most important risk factors of stroke development and heart disease. Microlife owns the worldwide patent for WatchBP and Afib detection. Microlife has managed to penetrate deeper into the institutional clients in hospitals, clinics and pharmaceutical companies such as Germany’s BI (Boehringer Ingelheim) and Bayer, Spain’s Lacer, Japan’s DS (Daiichi Sankyo), and France’s Servier, etc., who use the devices for improving clinical services. WatchBP was soft-launched in Switzerland in 2008 and the initial years were slow in sales with 50,000 units sold in 2011. With continued educational push and endorsement by reputable organizations to add credibility to the product and enhance its band value, sales have climbed to 100,000 units in 2012 and 250,000 units in 2013. Microlife’s “goal is like Intel to have ‘Powered by Microlife’ WatchBP solutions developed in partnership with the healthcare providers and regulators.”

Microlife’s 30-Years Journey to Become Global #1 in Digital Thermometer and #2 in Blood Pressure Monitor

1981 1985 1995 2000 2008/10

Founded by KY Lin

Digital thermometer;

US FDA

2001 1998 2012 2005 2013

Microlife brand; BP

received US FDA approval

Digital blood pressure monitor

began and received CE

Mark

Infrared ear thermometer gets FDA; 1-

second infrared ear

gun

ERP system; IPO on GTSM

2002

Acquires electric flexible heating blanket

Biddeford in US; launched

asthma monitoring

device

Obtain certification to manufacture

blood pressure monitors in

Japan, the first non-Jap firm.

Launch of iCare

WatchBP soft-launched

in Switzerland

Sep: Reduce share capital

to boost efficiency Oct: New

MAM series in blood pressure monitors

UK’s NICE announces WatchBP to be used

in hospitals; 10th consecutive A award


company; Frost & Sullivan award

2004

Sales from Microlife

brand exceeded

OEM/ODM business

2006 Microlife

breaks into Wal-

Mart


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Digital Blood

Pressure Monitor, 36.58%

Electric Flexible Heating

Blankets, 34.19%

Digital Thermometer, 24.43%

Others, 4.80%

US, 54% Europe,

37%

Other Countries,

7%

Taiwan, 1%

Revenue (by product segment and geography)

Sales GP Market Share OBM Share OBM

Digital Blood Pressure Monitor 36.6% 40% 17% 60% Microlife

Electric Flexible Heating Blankets and Green Products 34.2% 40% 40% (US) >90% Biddeford

Digital Thermometer 24.4% 25-30% 50% 20% Microlife

Others 4.8%

Overall 37.3%

- Product segment: Blood pressure monitor (BPM) contributes the most to revenue and profits at 36.6% of group sales with a GP margin of around 40% and its own brand Microlife accounts for 60% of BPM sales. The electric flexible heating blankets business, sold mainly in America under the brand name of Biddeford, accounts for 34% of sales with comparable GP margin of 40% (more on this later). Digital thermometers contributes 24% of sales with GP margin of 25-30%. With the rising sales of the innovative and higher-margin WatchBP series of products, overall margin is expected to be maintained or rise. OBM = Own Brand Manufacturing = 44% of sales in DT/BPM, 62% of overall sales - Geography: 91% of sales are in developed markets – US 54%, Europe 37%. Sales to other countries such as Asia and Middle East is 7%; Taiwan 1%. Microlife has been strong in the developed markets where the penetration rate of home-monitoring devices are higher due to higher health-consciousness and greater self-care. More importantly, Microlife has been successful in penetrating as the ODM partner for top retailers in America such as Wal-Mart, Costco, CVS, Walgreen’s etc. In Europe, Microlife sells its products both under ODM and their own brand. In contrast, Microlife is weak in emerging markets where Omron dominates, particularly in the vast China market in which Omron is very aggressive in offering high rebates to their customers. In the developed markets, Microlife is comparable to Omron: Omron’s sales in US and Europe are $127m and $177m vs Microlife’s $106m and $73m respectively.

Microlife: Revenue Breakdown


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The steady demand: In America, the demand for electric blankets is estimated at 3.6-4.2m units every year; in Europe, 2m pieces; in China, 10m.

Background on how Microlife break Sunbeam’s dominance: Microlife entered the electric flexible heating blanket market in 2002 after acquiring its bankrupt customer Biddeford Blankets for $2.5m and invested a further $5.7m in plants and equipment. However, the business lost $7.8m in 2002 with a $1.5m inventory write-off plus a $6.3m operation loss and another $5m loss in 2003. Microlife changed the cost structure of the company by shifting its production base from US to China in 2004 and competed head-on with Sunbeam whose market share plunged from 80% to 40%. Sunbeam is owned by Jarden Corp (JAH US, MV $7.8bn). Biddeford now has the #1 brand in US with 50% market share and sales of $67m and gross profit of $27m.

The anti-dumping saga in 2010 and the shift in manufacturing facilities to Philippines: An anti-dumping saga on China imports in 2010 hit Biddeford. Microlife made the bold decision to relocate the plant to Philippines, registering losses in 2010. The first year of operations in 2011 was modest. Since then, things are back on track with two good years of performance. Biddeford has plans to grow in Europe and China after achieving stable growth.

Why this simple small business has high barriers to entry: Biddeford is promoted as an energy saving alternative and supplement to the heater. They are designed with users’ safety in mind and have built-in temperature controllers that shuts off the heating coil and sensor wire automatically when a certain heat level is achieved. The key components in temperature controllers and sensor wire are manufactured in-house by Microlife and they are protected by patents, representing high barriers-to-entry and a wide moat. Even if one possesses the technology and cost efficiency, it’s not easy to penetrate into the supply chain of Wal-Mart and Costco and customer trust in the brand and safety is critical.

Seasonal risk: Note that the sales are highly seasonal and geared towards the autumn months in US (Sep to Nov) in order for customers to receive their inventory in winter.

Microlife’s Electric Flexible Heating Blanket Business in America


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Powerful Cost Consolidator: It’s not easy to manufacture quality thermometers and blood pressure monitors with cost competitiveness. - Microlife’s reliable manufacturing platform has in-house capabilities of module design, plastic

injection, surface processing, assembly and packaging. Microlife has competitive technology and patents especially its core competence of having an algorithm to allow fast reading/filtering of signals and outputting the accurate results in a short period of time.

- A secret to Microlife’s success is its in-house manufacture of high-tech electronic parts and components, particularly sensors, and establishing the high-precision measurement platform, temperature micro-controller design. With high-tech component R&D and manufacturing in Taiwan, manufacturing, assembly and packaging in Shenzhen, China and medical R&D and clinical testing and accreditation lab center in Europe, including establishing its own direct marketing sales force in Europe and North America, Microlife is able to artfully combine high-precision electronics with healthcare to produce AND sell world-class high-quality products.

- The various components are expensive. IC chips are the most expensive, accounting for 10-15% of the total cost. LCD 10%, sensor 10%, pump 10%. Microlife has economies of scale in procurement and manufacturing.

Sticky ODM Partner to Reputable Customers: Microlife has a diversified customer base as the

ODM partner to reputable companies including Wal-Mart, Costco, CVS and none of the customers account for more than 10% of Microlife’s sales. Major ODM customers include Wal-Mart, Costco, CVS, Walgreens, McKesson, Target, Sears, Medport, Kaz, Longs, KAC, Mabis Medical, Safety First-Dorel etc. Yet, none accounts for >10% of sales. Microlife has demonstrated that it has bargaining power over its powerful customers with the ability to build its own brand since 1998.

Total Solution Service Business Model: With the WatchBP, Microlife finally has a unique business model of incorporating software development to create value-added services for health monitoring and collaborating with hospitals and governments on tele-healthcare projects.

Microlife: Why Wide Moat? Fundamental Dynamics Behind 21% ROE Powerful cost consolidator, Steady ODM partner; Total solution service business model

“There’s big knowledge even in this seeming simple and boring digital and infrared thermometer products. The speed in measuring body temperature is not limited to the sensitivity of the sensor device but rather how the thermometer can rapidly reach the calibration point of the body temperature with different physical principles of thermometry. As these techniques involve specialized knowledge and industry secrets, they are protected by patents. Microlife is one of the rare few in the whole world to have the capability to produce models with read time of 1 to 60 seconds. This is something that the rest of our rivals can never match. For infrared ear thermometers, after shooting out the infrared energy to measure the temperature, the sensory parts must receive the signal and convert the radiant power to an electrical signal that can be displayed in units of temperature after being compensated for ambient temperature. It involves high-precision parts and complicated configuration and calculations before reaching an accurate standard. Thus, the barrier to entry is not low.” – KY Lin, Microlife’s founder and chairman


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Microlife: Why Wide Moat? Fundamental Dynamics Behind 21% ROE WatchBP as the potential disruptive technology

Disruptive Technology with Clinical Use: The WatchBP is the potential disruptive technology in the blood pressure monitor market as it has increasingly gained the acceptance as the preferred clinical use with implemented guidelines given its patented measurement of Afib with hypertension to detect stroke and hear diseases in advance. The WatchBP also has professional analytical software to enable easy and accurate diagnosis.

Logarithmic vs Exponential Growth: BPM has been a logarithmic growth market as incremental functional improvements are enhancers to the product. We believe that once the hospitals and clinics start to adopt WatchBP as the standard BPM, home-use could rise in an exponential manner.

Empowerment Tool as an Active Participant in Managing Health: Microlife developed the WatchBP solution as a way to help physicians accurately diagnose and treat hypertension and empower patients to be an active participant in managing their health. Two things drive effective care; good data and patient accountability. The best medical decisions are made with the best data. Patients also need to believe that the doctor’s advice and treatment is meaningful, understandable, and important to their well-being. Microlife provides accurate, reliable, patient-centered solutions that engage patients and empowers them to manage their health.


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"Microlife has astutely positioned the WatchBP Home A as a blood pressure monitor, with atrial fibrillation detection merely being an additional feature, it is this feature that has promoted its acceptance and adoption in the clinical community. Frost & Sullivan believes that in comparison to competitors, Microlife possesses an exceptional ability to understand market conditions and gaps. The Watch BP monitor is a manifestation of Microlife's best practices and has enhanced the company's market value.“ - Frost & Sullivan, in the Dec 2013 press release awarding Microlife the 2013 European Award for Competitive Strategy, Innovation & Leadership

WatchBP: “Forces” the Clinical Community To Sit Up – And Adopt; Not Merely An Additional Feature


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WatchBP Afib: Not Just a Product, But a Strategy! (Frost & Sullivan) Outperformed Omron and Beurer By a Wide Magnitude (9.5 Vs 8.4 and 7.6)

Omron

Beurer

Bamboo Innovator commentary For years, Microlife has lived under the shadow of Japan’s Omron who dominates the blood pressure monitor market. With the

WatchBP Afib and its worldwide patent protection, Microlife has a decent chance in the next decade to grab market share in chunks with its far superior performance as a patient-monitoring device and integration as a solution service to the hospitals and clinics.


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Product “MAM technology inside”: Microlife Average Mode (MAM) Technology (www.mamtechnology.net) is a

proprietary blood pressure measurement technology that reduces variation in measurements by calculating an average value based on several measurements taken with intermittent pauses of 15 seconds each. Human blood pressure is not static; blood pressure is a dynamic body parameter with significant changes over the day. Improved accuracy is achieved by the analysis of multiple successive measurements. Superior reliability gives important information to doctors and ensures that treatment plans meet healthcare needs. Like the WatchBP Afib, Microlife has worldwide patents for its MAM technology. Microlife has introduced the new MAM series of BPM in Oct 2012.

Blood glucose meter: Microlife has plans to develop blood glucose meter in 2013 but has been very quiet with no news on its progress. This is a crowded area with other Taiwanese players such as Taidoc (4736 TT, MV $250m), ApexBio (1733 TT, MV $202m) acting as ODM/OEM for Big Four giants such as Roche (29% market share), LifeScan (under J&J, 26%), Bayer (16%) and Abbott (14%). The commercialization of new products is not easy and will take time. We are somewhat disappointed that Microlife has squandered its opportunity in its existing asthma monitoring device, an area which Omron dominates. Omron has also introduced COPD (chronic obstructive pulmonary disease) to take advantage of the impact of rising pollution level on Asian population health. Total Solution-Service Business Model

Taiwan: Jan 2013, Microlife sets up the “Total Solution Service” in Hsinchu district of Taipei to link up 20 measurement stations in hospitals, clinics, pharmacies and now the cloud-based data platform is integrated with the hospital to provide tele-healthcare and information management. In Feb 2014, Microlife replicated the “Total Solution Service” in Yi Lan’s Bo Ai Hospital with 12 measurement stations, and to expand to 100 measurement points to strengthen stroke prevention and timely treatment.

China: Microlife has plans to expand the total solution-service business model to China. Potential Bolt-On M&A Opportunities with $47M Net Cash (1Q14: $65M) and Strong Balance Sheet

Potential bolt-on M&As might boost inorganic growth, though Microlife has been conservative in this area.

Microlife’s Corporate Developments and Future Roadmap


http://www.mamtechnology.net/





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Microlife Might Strike Potential Partnerships in Unconventional Channels Installing Blood Pressure Monitors in Convenience Stores Spark Sales by Elderly Consumers Licensing model in smartwatch/wearables and internet-of-things

Retail partnership to target elderly consumers Steps such as installing blood pressure

monitors in convenience stores in Japan turned out to be so popular they led to a 50% increase in store sales. Microlife is working towards integrating its WatchBP with hospitals, clinics, pharmacies into a total-solution service. The network might possibly include Uni-President’s 7-Eleven convenience chain stores – President Chain Stores (2912 TT, MV $8.2bn) - in the future.

Licensing Model in Smartwatch/Wearables, Internet-of-Things?

With the worldwide patent of Afib and MAM in blood pressure measurement, licensing fees from the analytics software and IP can be potentially generated when working in partnership with wearables and internet-of-things companies. Think “Afib and MAM Technology Inside”.


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Part 2: The Context: Why Now?


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Unfair Valuation Gap Despite Strong and Growing Fundamentals: Microlife Underperformed Omron by >50% since Abenomics/4Q13

Bamboo Innovator Commentary

Long-term correlation with Omron: Microlife share price performance was closely correlated to Omron over the long-term until Abenomics in 4Q13 resulted in Omron to outperform Microlife by over 50% despite Microlife gaining stronger growth momentum in its patented WatchBP Afib technology. Also, the New Taiwan Dollar did not appreciate much against the Japanese Yen, with the range between TWDJPY 3.3-3.4 since Abenomics. Microlife share price should catch up to Omron’s with continued progress in WatchBP and fundamentals.

Seasonality kicker: Microlife’s sales is traditionally the

strongest during 3Q. The peak season for digital thermometers and blood pressure monitors is July-Oct and Aug-Oct for electric flexible heating technology blankets.

Microlife

Omron

5-year chart of Microlife Vs Omron (6645 JP)

Microlife

Omron

TWDJPY

1-year chart of Microlife Vs Omron Vs TWDJPY


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1-year chart of Microlife Vs TWSE index and GreTai index

6-month chart of Microlife Vs TWSE index and GreTai index

Microlife Is Down Nearly 20% from Recent High and Has Underperformed Relative to the Taiwan Indexes

Bamboo Innovator Commentary Microlife is down nearly 20% from its recent high in end

March 2014 on profit-taking by short-term investors. Share price is back to May 2013 level, representing an attractive opportunity to take position in this long-term durable franchise which has wide-moat from its manufacturing technology platform and know-how developed for over 30 years and is now seeking to disrupt the industry with its new algorithm-based innovation in blood pressure measurement that’s protected by worldwide patents.

Microlife

GreTai index

TWSE index

Microlife

GreTai index

TWSE index


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Part 3: Management


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Q: “Can you share with us how Microlife started, especially in making the transition from OEM/ODM to building your own brand Microlife?” Chairman KY Lin: “33 years ago, the son of a fruit farmer in Taichung has just completed his Masters in Applied Physics at the National Tsing Hua University [one of the most prestigious universities in Taiwan]. By serendipity, he read an article in a magazine about how the women’s ovulation period might be related to changes in body temperature. He thought to himself: if there is a simple and precise measurement device that can capture the cycles, women need not eat contraceptive pills and can prevent abortion for unplanned and unwanted pregnancies. It will bring the biggest health welfare to women. As a result, he hide in his house and in the laboratory that he designed to conduct experiments after experiments. He succeeded in creating the world’s first diagnostic equipment that can let our women friends to use science to accurately calculate their own ovulation cycles and the time to avoid pregnancy by using the digital medical basal thermometer. Because of this invention, they can pursue their dreams. Together with my personal savings and my family’s, we raise TWD1m. My wife, my university friend and myself – the three of us started Microlife. Just like that, in Nov 1981, Microlife was born in Neihu district of Taipei. We started the research and manufacturing of high-precision digital medical thermometer and the basal thermometer for women. We even won the Gold Medal of Invention for the ‘Intelligent Woman Thermometer’ in Brussels and Taiwan in 1982. Within three to four years, with the support of two key customers, we sold 100,000 digital medical thermometers and basal thermometers, a pretty good result for a startup. We then decided to penetrate the US and Europe market. At that time, in 1980, Japan’s Omron was the first to introduce the pen-type digital thermometers to solve the problems of traditional mercury-based thermometers. It was the disruptive technology at that time. While we had a good start, in terms of expanding our customer base, we met with some bottlenecks and our sales growth started to decelerate. I sense a crisis even though we were doing quite well.”

“… succeeded in creating the world’s first diagnostic equipment that can let our women friends to use science to accurately calculate their own ovulation cycles and the time to avoid pregnancy by using the digital medical basal thermometer.”





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KY: “It was opportune then that I met with Syntek Semiconductor’s director Wang who is able to supply Microlife with transistor chips that were cheaper than the Japan-manufactured ones. This gave us some cost advantage. After our pen-type digital thermometer received the FDA approval in 1985, luck shine upon us. In the same year in 1985, there is the Plaza Accord, which resulted in the Japanese yen to appreciate sharply against the US dollar by 50%, eroding the cost competitiveness of Japanese goods and exports. Clients in US and Europe started to shift their orders away from Japanese products and Microlife was one of the beneficiaries. Subsequently, we introduced models with read time of 1-second to 60-seconds, the most advanced in the industry and we grew to become the global #1 leader with half of the market share. In the first ten years [1981-1991], our production base is in Taiwan. From 1990 onwards, Taiwan’s economy started to take off and the New Taiwan Dollar currency started to appreciate significantly. Our operations took a hit from the forex impact. In the second 10 years [1991-2001], we decided to boldly explore the idea of expanding our manufacturing facilities to China. In 1991, we set up a plant in Shenzhen. This was two years after the Tiananmen incident. In Taiwan, most of the technology-based companies are OEM/ODM and the situation is compounded in the area of medical device products as they require large amount of R&D investments and take a long time to see results, if any. Nevertheless, in 1998, we launched our own brand Microlife to sell worldwide. In the third 10 years [2001-2011], we wanted to really globalize our business model and brand and not simply export as OEM/ODM from China and Taiwan to Europe and North America markets. We decided to set up direct marketing and sales force in Europe and North America. This is a crazy decision back then because for the price of hiring one European, we can employ 200 people with good qualifications and skills in China. Because Microlife’s product and branding strategy is to go for the high value-add and high-quality segment, we specially collaborate with a Swiss marketing partner to establish a local sales and marketing team in Europe, leveraging upon the design capabilities of the Europeans and the branding image of the Swiss.”

“In Taiwan, most of the technology-based companies are OEM/ODM and the situation is compounded in the area of medical device products as they require large amount of R&D investments and take a long time to see results, if any. Nevertheless, in 1998, we launched our own brand Microlife to sell worldwide... We decided to set up direct marketing and sales force in Europe and North America. This is a crazy decision back then because for the price of hiring one European, we can employ 200 people with good qualifications and skills in China.”


KY with Acer’s founder Stan Shih


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KY: “We also set up a R&D and testing and accreditation lab in Switzerland and Germany. Shenzhen, China is responsible for our production and logistics delivery. Taiwan headquarters is our nerve center in charge of strategy, capital allocation and risk management. Our milestone year was in 2004 when our own brand sales in Microlife exceeded the sales of our OEM/ODM business. Interestingly, besides the CE mark in Europe and FDA certification in US, do you know that our digital blood pressure monitor devices are the only brand in the whole world to obtain the highest certification in Germany? As a result of our global network, in the world’s top 1,000 big diagnostic device companies in various categories, we are ranked 159. In particular, out of every two digital medical thermometer in the world, one of them is produced by us. We are the global number two in blood pressure monitor with a market share of around 17-18% [behind Japan’s Omron with around 50% market share]. Our Microlife brand has won numerous awards, including Frost & Sullivan Best Product Invention Award in 2006, Red Dot Design Award in 2007. Since its establishment in 1955, the Red Dot has been awarded to big tech companies such as Acer, ASUSTeK, so we are honored to win the award for our consumer healthcare devices. Recently, we won Frost & Sullivan Best Practices Award in 2013 for European Blood Pressure Monitoring: Competitive Strategy, Innovation & Leadership Award.*” [*Microlife’s overall score measured in five categories is 9.3 as compared to 8.4 and 7.6 for the #2 and #3 respectively]. You must be thinking, how about the fourth 10 years [2011-2021]? It will be the age of personalized medication, preventive healthcare, cloud-based health management, summed up by ‘lifeware’ and ‘total solution service’. Think Apple’s Steve Jobs who was thought to be insane when he made the bold claim that the personal computer will be on the desk of everyone’s home. He not only did it – he exceeded the initial vision. The other mega trend is energy-saving and energy-efficient consumer healthcare devices. For instance, our electrical blankets can bring warmth to the family in winter without expending so much energy as compared to a heater.”

“Interestingly, besides the CE mark in Europe and FDA certification in US, do you know that our digital blood pressure monitor devices are the only brand in the whole world to obtain the highest certification in Germany? As a result of our global network, in the world’s top 1,000 big diagnostic device companies in various categories, we are ranked 159. In particular, out of every two digital medical thermometer in the world, one of them is produced by us. We are the global number two in blood pressure monitor with a market share of around 17-18”




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Q: “What is the secret to Microlife’s success in maintaining such high profitability in relatively mature - and even boring! – products that are seemingly simple to manufacture with low barriers to entry?” KY: “There’s big knowledge even in this seeming simple and boring digital and infrared thermometer products. The speed in measuring body temperature is not limited to the sensitivity of the sensor device but rather how the thermometer can rapidly reach the calibration point of the body temperature with different physical principles of thermometry. As these techniques involve specialized knowledge and industry secrets, they are protected by patents. Microlife is one of the rare few in the whole world to have the capability to produce models with read time of 1 to 60 seconds. This is something that the rest of our rivals can never match. For infrared ear thermometers, after shooting out the infrared energy to measure the temperature, the sensory parts must receive the signal and convert the radiant power to an electrical signal that can be displayed in units of temperature after being compensated for ambient temperature. It involves high-precision parts and complicated configuration and calculations before reaching an accurate standard. Thus, the barrier to entry is not low. Our R&D in Taiwan concentrates on high-tech electronics parts and components, such as the in-house manufacture of sensors, establishing the high-precision measurement platform, temperature micro-controller design. Our Europe medical R&D and clinical trial center artfully combines high-precision electronics with healthcare to produce world-class high-quality products and new innovations. It’s not easy to manufacture quality thermometers with cost competitiveness. The various components are expensive. IC chips are the most expensive, accounting for 10-15% of the total cost. LCD 10%, sensor 10%, pump 10%. We have economies of scale in procurement and manufacturing. We will continue to consolidate this market, albeit gradually. Our market share is around 40% five years ago and about 50% now. Our market share is higher for higher-end products, especially for the range of infrared products.”




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“Microlife successfully developed the world's first blood pressure measurement devices equipped with patented atrial fibrillation (Afib) detectors – the WatchBP. We own the worldwide patent for this… The idea of WatchBP came from an in-depth conversation between European hypertension specialist Professor George Stergiou and myself… Our goal is like Intel to have ‘Powered by Microlife’ WatchBP solutions developed in partnership with the healthcare providers and regulators.”


KY: “Microlife successfully developed the world's first blood pressure measurement devices equipped with patented atrial fibrillation (Afib) detectors – the WatchBP (www.watchbp.com). We own the worldwide patent for this. Several studies have shown that atrial fibrillation and hypertension are the most important risk factors of stroke development and heart disease. Atrial fibrillation is often undetected and causes an estimated 75,000 strokes per year in America. Regularly, atrial fibrillation should be diagnosed by the electrocardiogram (ECG) devices and interpreted by clinically experienced specialists. With the WatchBP, atrial fibrillation can be diagnosed with high accuracy, as high as 97%, in a cost effective and time efficient manner. Another big secret to survive in this difficult business in which margin pressure is very real is our strong marketing channels. Many other companies may have some manufacturing capabilities but they are unable to sell their products! It’s not easy to break into Europe, Wal-Mart, Costco, CVS, Target etc. CVS alone has over 7,000 point-of-sales in America. Their accreditation process is very tough.” Q: “Given its growing importance , can you share with us how did the WatchBP started and how is the sales performance since its introduction? KY: “The idea of WatchBP came from an in-depth conversation between European hypertension specialist Professor George Stergiou and myself. We recognized that many aspects of the ESH blood pressure measurement protocol could be automated. This would eliminate many labor-intensive aspects and inaccurate reporting by physicians and patients. The WatchBP series is not like any other blood pressure measurement device on the market today. The WatchBP is physician-guided, designed for screening, diagnosis, and treatment follow-up. The WatchBP Home A detects atrial fibrillation based on an embedded algorithm that calculates the irregularity index (standard deviation divided by the mean), depending on the intervals between heartbeats. The diagnosis is further confirmed by performing a ECG. Our goal is like Intel to have ‘Powered by Microlife’ WatchBP solutions developed in partnership with the healthcare providers and regulators.”



http://www.watchbp.com/





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“Microlife Watch BP Afib was soft-launched in 2010, 50,000 units are sold in 2011, and the number doubled to 100,000 units in 2012 and around 250,000 in 2013. Although 250,000 units is only 0.5% of the overall blood pressure monitor device market, this new innovation contributes nearly 10% of our revenue… Despite selling at almost double the price of existing equipment, it is highly recognized by many leading European and American healthcare professionals.”


KY: “Some figures for you: Microlife Watch BP Afib was soft-launched in 2010, 50,000 units are sold in 2011, and the number doubled to 100,000 units in 2012 and around 250,000 in 2013. Although 250,000 units is only 0.5% of the overall blood pressure monitor device market, this new innovation contributes nearly 10% of our revenue. We expect around 30% growth for WatchBP in 2014. The profit margins are also higher. Despite selling at almost double the price of existing equipment, it is highly recognized by many leading European and American healthcare professionals. The WatchBP devices have special Cardiovascular Risk Assessment Software to monitor and analyze blood pressure profiles in and out of the office strictly according to European and American guidelines. Our strategic IT partner is IBM since Jan 2011. The WatchBP is the only blood pressure measurement tool on the market that has proven to meet professional medical demands and supported by scientific evidence. The WatchBP already has earned its reputation in the professional field. It is largely purchased by well-known pharmaceutical companies such as Germany’s BI (Boehringer Ingelheim) and Bayer, Spain’s Lacer, Japan’s DS (Daiichi Sankyo), and France’s Servier, etc., who use the devices for improving clinical services. To elaborate, the Watch BP Home A follows the European Society of Hypertension (ESH) and American Heart Association (AHA) recommendations for home blood pressure measurement, being the first of its kind. The Microlife brand received a huge boost with the world-renowned National Institute for Health and Care Excellence (NICE) recommending the device for routine blood pressure measurement and atrial fibrillation screening in primary care. In Jan 2013, UK’s NICE also recommended our WatchBP to be used in UK’s medical clinics. WatchBP is also the first solution to win the approval UK’s Hypertension Society A/A. WatchBP is also the only solution announced by Italy’s medical society SMG (Societa Italiano di Medicina Generale). Europe’s reputable magazine “Technology World” conducted a comparison test on the best blood pressure monitors based upon the scores given by nurses in top hospitals in the Nordic region in 2011. The judge is the famous Professor Anti Jula from Finland’s Turku University. Microlife’s blood pressure monitors scored far higher than all the rest of the other brands including Omron and Beurer.”



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“WatchBP is also the world’s first and only 24-hour solution partner to the ARTEMIS project (Ambulatory blood pressure Registry: TEleMonitoring of hypertension and cardiovascular… All these positive recommendations by reputed organizations add credibility to the product and clearly enhance its brand value and opens doors for our marketing team in Europe and North America to penetrate deeper into new and existing customers.”


KY: “WatchBP is also the world’s first and only 24-hour solution partner to the ARTEMIS project (Ambulatory blood pressure Registry: TEleMonitoring of hypertension and cardiovascular rISk project) in Jun 2010. ARTEMIS (www.artemisnet.org) is an international ambulatory blood pressure monitoring registry aiming at assessing the actual degree of blood pressure and cardiovascular risk control of hypertensive patients followed by doctors across Europe. In Europe, there are at least 4.5 million patients with atrial fibrillation; in America, 5.1 million. Research by leading health authorities estimate that by 2050, the figures will double. Because the long-term medical costs in heart diseases and strokes are very high to the caregivers, medical providers and the society, recently, governments around the world are paying far more attention to prevention measures with accurate diagnosis. All these positive recommendations by reputed organizations add credibility to the product and clearly enhance its brand value and opens doors for our marketing team in Europe and North America to penetrate deeper into new and existing customers. Continuous dialogue with leading authorities on blood pressure measurement, including Dr. Pickering in New York, Dr. O’Brien in Ireland, and Dr. Imai in Japan, has expanded the awareness of the importance of blood pressure in hypertension diagnosis and treatment. Microlife also continues to collaborate with prominent primary care physicians Dr. Jeff Yu in Taiwan and Dr. Scott Hammond in the U.S. to advance the implementation of WatchBP solutions into daily primary care practice. As the main force behind the initiative, Microlife has hosted and sponsored many events and dedicated its R&D resources to the development of new health care technology. A worldwide leader in the development, manufacturing, and branding of medical diagnostic equipment for institutional and home use, Microlife seeks to fulfil the demand, bridge the gap, and achieve the lofty goals of the WatchBP initiative. We have partnered with hospitals, medical colleges etc. In the second half of 2013, Microlife has partnered with 45,000 medical general practitioners doctors in Italy to introduce and promote an 18-month project ‘Measure BP, Test Afib’ to raise the awareness of stroke prevention. In Taiwan, we have donated 1,000 units in April 2014 to 30 medical centres,, regional hospitals, clinics and provide free testing services. The donated value is worth TWD4.5 million and it is expected to benefit 500,000 Taiwanese.”



http://www.artemisnet.org/





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“The healthcare ecosystem and healthcare economics in the coming decades will shift towards home-based care, back towards the patients, so as to reduce the use of government-funded healthcare insurance and expenditures. Prevention of diseases will be put at the forefront of the healthcare policies by the governments in various countries. This will spark a boom in home-based medical and patient self-monitoring businesses. And this will start from Asia.”


Q: “Can you elaborate more on Microlife’s ‘lifeware’ and ‘total solution service’ in hypertension and their related chronic medical problems in stroke and heart disease? Why do you see this as the next big thing for Microlife?” KY: “The ‘lifeware’ philosophy and ‘total solution service’ strategy originate from our company’s vision: To enable everyone to have the ability to manage and elevate their own health. In 2000, we try to advance the ‘lifeware’ philosophy, that we should proactively take charge of our health instead of reactively seeing the doctor only when we are sick. Lifeware is meant to swim towards the Blue Ocean – think Hardware + Software + Lifeware. We established a Microlife Education Fund to educate about healthy living. All three parties - the government/ hospitals/ healthcare providers, employers, and patients - are all trapped inside the ‘Red Ocean’ with huge losses. Nobody is winning with rising healthcare and medical bills. Because Microlife has an extensive global network, particularly in Europe and North America, we are able to observe at the front end of this battlefield the different healthcare system in different countries and we discovered that whether it is in UK, Germany, US or Canada, the system of medical payment will, consciously or subconsciously, create waste for both parties. Unless there is a new business model, the whole system will go bankrupt in the end. The ultimate reason is because everyone is used to entrusting their health to a healthcare provider, but the truth is that they can only contribute 10% of the healthcare needs of a person. Like a chair with only two legs, it will be unstable; we need to add one more leg, which is self-care. To save life, go see a doctor; but to keep healthy, we cannot depend on the doctor. The healthcare ecosystem and healthcare economics in the coming decades will shift towards home-based care, back towards the patients, so as to reduce the use of government-funded healthcare insurance and expenditures. Prevention of diseases will be put at the forefront of the healthcare policies by the governments in various countries. This will spark a boom in home-based medical and patient self-monitoring businesses. And this will start from Asia.”



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“…the ‘total solution service’ integrates top-notched medical technologies, world-class diagnostic and patient monitoring equipment, cutting-edge cloud-based IT platform, smartphone mobile system, medical professionals’ knowledge and channels to hospitals, pharmacies, clinics. From Bench to Bedside and Community, let’s work together to make it implementable!”


KY: “More than 970 million people worldwide are thought to be suffering from hypertension. In China, the figure is 220 million, yet only 1.5 to 2 million people know they have hypertension problems. Yet, only 1 million are undergoing drug treatment and 500,000 managed to control their hypertension. In Taiwan, with the aging population worsening, hypertension patients have been growing at least 5% every year and over 4.5 million Taiwanese are afflicted with hypertension. The health authorities have estimated that in ten years time, at least one out of five in Taiwan will suffer from hypertension. Those with hypertension easily develop further into heart disease and stroke with probability higher by 5 to 6 times as compared to normal people and mortality rate is 20%. But only in about 21 to 25% of patients is the disease being adequately managed. Globally, an increasing number of studies are showing numerous potential sources of error that arise when a patient is diagnosed and treated based on the conventional assessment. Thus, Microlife’s total solution for hypertension management entails a series of innovative professional blood pressure measurement devices designed for risk factor screening, diagnosis, and treatment follow-up. Microlife successfully developed several physician-guided blood pressure measurement devices totally adapted to the needs of physicians, patients, and home health care screening. This concept of Microlife shall enable government, industrial and academic sectors to control hypertension and prevent strokes in the future. We aspire to reduce the number of hypertension patients in Taiwan by half over the long-term with our total solution service. Although the journey is difficult, we will continue to push for this vision to contribute our small part in helping our local Taiwanese to be more healthy. Thus, the ‘total solution service’ integrates top-notched medical technologies, world-class diagnostic and patient monitoring equipment, cutting-edge cloud-based IT platform, smartphone mobile system, medical professionals’ knowledge and channels to hospitals, pharmacies, clinics. From Bench to Bedside and Community, let’s work together to make it implementable!”



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“I resolve for Microlife to grow to become the Alpha Primate!... Microlife has evolved to 4P, with Place (the marketing channels such as Wal-Mart, CVS) and Promotion. We are working towards 6P by multiplying People and Platform. 2P OEM are locked in price war and fierce battles, akin to reptilian-brained creatures… 4P means one has its own brands, like a mammalian-brained human capable of expressing emotions. 6P is the Alpha Primate, with the brain growing an additional special layer of intelligence, strategy and the ability to master one’s destiny.”


KY: “I have been standing behind the stage preparing things for a long time and we have been burning money more than anyone else, so we have accumulated more experience than anyone else*. Those who are early are very lonely. Now is finally the moment for one of human history’s greatest business opportunities in the next decade in home-based care and patient self-monitoring. Since I have not become a martyr, then I have a chance to become a pioneer in this megatrend! [*Microlife was criticized by its shareholders for thinking too far ahead when it introduced the Lifeware/iCare concept in 2005. Microlife had previously lost an accumulated TWD 500m ($16.7m) in investing in the iCare medical platform, the predecessor of the ‘total solution service’. KY himself had put in TWD 80m of his personal money.] I resolve for Microlife to grow to become the Alpha Primate! Let me share with you about our 6P evolution theory. The first stage is 2P, emphasizing Product and Price in the OEM contract manufacturing phase. Microlife has evolved to 4P, with Place (the marketing channels such as Wal-Mart, CVS) and Promotion. We are working towards 6P by multiplying People and Platform. 2P OEM are locked in price war and fierce battles, akin to reptilian-brained creatures crawling on the ground, with limited ability to control one’s destiny. 4P means one has its own brands, like a mammalian-brained human capable of expressing emotions. 6P is the Alpha Primate, with the brain growing an additional special layer of intelligence, strategy and the ability to master one’s destiny. To cross the chasm from 4P to 6P is not an easy task and we will continuously innovate new products to enhance our kungfu.”



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“Yes, at that time, the industry conditions was not ripe to embrace the ‘total solution service’ idea. The healthcare system at that time was too conservative in adhering to guidelines and rules. We walked too far ahead, that’s why we failed earlier. Previously, we were doing bits and pieces of this integrating platform, so it’s difficult to succeed. It’s just like for an aircraft to fly in the air, we need to prepare all the multiple parts, assemble them together, and most importantly, to have equanimity, to know what we are doing.”


Q: “Microlife has previously launched a similar total solution platform but it did not take off. Is there anything that we should know as to why it is likely to succeed this time round?” KY: “Yes, at that time, the industry conditions was not ripe to embrace the ‘total solution service’ idea. The healthcare system at that time was too conservative in adhering to guidelines and rules. We walked too far ahead, that’s why we failed earlier. Previously, we were doing bits and pieces of this integrating platform, so it’s difficult to succeed. It’s just like for an aircraft to fly in the air, we need to prepare all the multiple parts, assemble them together, and most importantly, to have equanimity, to know what we are doing. Once we have successfully implement this in Taiwan, we will replicate it in China.” Q: “What is your view of the major trends such as telemedicine, smartphone and smartwatch as patient-monitoring devices embedded with Big Data collection and analysis software and app?” KY: “Till now, it remains difficult to integrate healthcare information and in the medical consumer market, it is hard to see a unified single platform and business model that is successful. There’s also mobile app-based health monitoring. The key problem is that nobody likes to be watched and monitored everyday, even if it is beneficial to our health. Business operators usually go into the market from the path of hospitals, doctors, with selling drugs as the foundation, but they forget that the only sustainable way is People as the foundation. The future society is high-touch, not “high-tech” The “last mile” in medical management is self-care! With healthcare economics and the healthcare ecosystem going bankrupt, any long-term solution must incorporate preventive-based measures and Microlife will be an integral part of this megatrend.”



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“Culture is an operating system. At Microlife, it’s a trusting and self-discipline environment – all of us need not punch time cards like the typical Taiwanese firms. We tell our staff that if you want to grow to become a big tree, then you ought to treat Microlife as the fertile land. We want our Microlifers to think: ‘I want to be somebody, I don’t want to be nobody.’ Don’t be ordinary, passing the work day with mediocrity.”


Q: “Can you elaborate a bit further on the China opportunity?” KY: “The mainland Chinese authorities have opened up five provinces for Taiwan businesses to set up wholly-owned hospitals. In the near future, they could issue medical doctors’ licenses directly to the individual doctors, instead of the practice of issuing only to the hospitals and clinics. With the healthcare reforms, China has entered into the Medical Golden Age.” Q: “Can you talk about how the corporate culture is like at Microlife?” KY: “Culture is an operating system. At Microlife, it’s a trusting and self-discipline environment – all of us need not punch time cards like the typical Taiwanese firms. We tell our staff that if you want to grow to become a big tree, then you ought to treat Microlife as the fertile land. We want our Microlifers to think: ‘I want to be somebody, I don’t want to be nobody.’ Don’t be ordinary, passing the work day with mediocrity. We are also a Learning Organization and one of our unique welfare benefits is that we give books to our staff. We have an international culture. We are a global company with factories in China, sales in Europe, Switzerland, America and Asia – the cross-exchange of information flow is international. At every company major events, we will have colleagues from different countries gathering together to have interaction opportunities. We cultivate the habit of collecting information from many countries and to learn about the latest advanced healthcare management techniques.”


KY’s book in 2002《林金源：知識經營策略與知識管理》


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Part 4: Valuations

新竹雲端健康城市 - 雲端血壓量測站


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Microlife Vs Comparables

(1) Microlife Vs Omron: In terms of EV/EBIT, Microlife is trading at 9.7x which is about 28% lower than Omron which is more diversified in industrial automation and electronic components. Omron’s lucrative healthcare business contributes around 11.5% to group sales and operating income. Both Microlife and Omron are attractive in their valuations given their resilient business model and growth profile. Microlife, however, has a far superior ROE at 20.9% that is nearly double that of Omron at 10.7%. When we compare EV/EBIT relative to ROE and ROA, Microlife is cheaper by as much as 120-150% when compared to Omron. Comparing EV/EBIT to ROE also makes good common sense since it is rare for wide-moat companies to sustain high ROEs and they deserve a valuation premium, while low EV/EBIT stocks ain’t cheap when their ROEs are even lower and value traps can be avoided.

Microlife Omron

Taidoc (4736 TT)

Cowealth (4745 TT)

Excelsior (4104 TT)

ApexBio (1733 TT)

Bionime (4737 TT)

MV 272 9,230 250 236 226 202 99

EV 229 8,350 250 234 222 198 183

Sales 196.7 7,575.1 77 86 174.0 60.9 52

EBIT 23.5 666.9 7.9 10.8 10.3 11.6 4.8

Net Profit 21.1 452.6 11.4 9.1 10.0 12.4 3.0

Op Cashflow 22.6 774.6 12.5 -2.6 11.9 16.1 4.3

Capex -2.0 -308.0 -3.8 -7.2 -17.9 -7.7 -15.8

PE 13.1 17.1 17.4 21.0 31.4 15.2 33.0

P/Sales 1.40 1.22 3.26 2.75 1.30 3.32 1.90

PB 2.73 2.18 3.56 5.64 0.91 3.16 2.78

P/CFO 12.2 11.9 20.0 19.0 12.5 23.0

EV/EBIT 9.7 12.5 31.6 21.6 21.5 17.1 38.1

EV/EBITDA 8.8 9.1 19.1 19.0 15.9 13.5 22.6

EBITDA Margin 13.2% 12.1% 17.1% 14.3% 8.0% 24.1% 15.6%

EBIT Margin 12.0% 8.8% 10.3% 12.6% 5.9% 19.0% 9.2%

Net Margin 10.7% 6.0% 14.9% 10.6% 5.7% 20.4% 5.8%

GP/TA 42.2% 45.4% 32.0% 40.0% 8.1% 20.8% 13.9%

ROA 12.1% 7.1% 10.7% 12.1% 2.1% 13.7% 2.0%

ROE 20.9% 10.7% 16.2% 21.7% 4.0% 19.4% 8.4%

DE -46.3% -20.7% -0.7% -6.2% -1.8% -6.3% 236.0%

AR Day 112 81 89 161 411 83 79

Inventory Day 59 46 78 25 90 101 72

AP Day 80 70 68 38 95 45 29

CCC 91 57 100 148 405 139 122

Div Yield 5.66% 1.52% 3.36% 2.89% 3.33% 5.36% 2.63%

Taiwan medical device companies Taidoc (4736 TT): Blood glucose meter Cowealth (4745 TT): Diagnostic reagents, distributor

of Accuray’s CyberKnife system in China Excelsior (4104 TT): Dialysis machines ApexBio (1733 TT): Blood glucose meter, founded by

Dr Thomas YS Shen. Microlife trades at 50-75% cheaper than ApexBio (1733 TT); ApexBio has developed the world’s first biosensor-based blood glucose and cholesterol monitoring system.

Bionime (4737 TT): Blood glucose meter, OEM for GE

(2) Short-term downside protection with 5.6% dividend yield and healthy net-cash balance sheet to provide fillip to share reduction program: Microlife has an attractive dividend yield at 5.6% and a strong balance sheet with net cash as percentage of book equity at 47%. Note that net cash in FY13 has grown from $47M to $65M in 1Q14. Microlife has undertaken the unusual capital management program to retire 12.2m shares (10% of its shares outstanding) in Sep 2012 to boost capital efficiency by utilizing the comfortable net cash position. Share price has since spiked up over 25%. The proactive shareholder-friendly stance backed by its strong net cash position should limit any downside in share price.

(3) Long-term downside protection in terminal value as takeover target: Microlife’s long-term terminal value and downside risk will be protected by giants such as Omron, J&J (LifeScan), Bayer, Abbott etc who wish to swallow it up to possess its valuable manufacturing technology platform and worldwide patents in algorithm-technology in Afib and MAM blood pressure measurement.

Microlife Omron

(1) EV/EBIT 9.7 12.5

(2) ROE 20.9% 10.7%

(3) ROA 12.1% 7.1%

(1)/(2) 0.47 1.17

(1)/(3) 0.80 1.77


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Potential Risks

Forex risks Given that Microlife generates over 90% of its revenues in US (54%) and Europe (37%), significant appreciation

of the Taiwan dollar against the US dollar and Euro could have an adverse effect on the company. During 1Q14, Microlife forex gain has fallen to $0.5m from $16m in FY13. It also suffered a hedging loss of

$0.9m as opposed to a gain of $0.3m in FY13. Overall, other income has dropped from $2m profit in FY13 to -$0.2m in 1Q14. Liquidity risks

Microlife’s shares are relatively illiquid as they are tightly held by the management who have not sold their shares since the GTSM IPO ten years ago in 2004.


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Appendix


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“But most of the noises are false alarms or don’t require action. The sheer number of alarms — several hundred per patient per day — can cause alarm fatigue. Nurses and other workers, overwhelmed or desensitized by the constant barrage, sometimes respond by turning down the volume on the devices, shutting them off or simply ignoring them — actions that can have serious, potentially fatal consequences.” - Washington Post, July 7, 2013

“Alarm Fatigue” from Inaccurate Blood Pressure Measurements


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Atrial Fibrillation and Stroke Prevention

2-minute YouTube video by Microlife: www.youtube.com/watch?v=QOFk02VOQ9c

3-minute YouTube video by Dr Cal Shipley: http://www.youtube.com/watch?v=B3Lg4cuhtFQ


http://www.youtube.com/watch?v=QOFk02VOQ9c

http://www.youtube.com/watch?v=B3Lg4cuhtFQ

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WatchBP formally recommended by leading healthcare authority NICE after clinical research

http://publications.nice.org.uk/watchbp-home-a-for-opportunistically-detecting-atrial-fibrillation-during-diagnosis-and-monitoring-mtg13/recommendations




























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Other Microlife’s Products


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Snapshot of Omron’s Healthcare Business

Omron’s healthcare business generates an estimated $810m in sales and $68m in operating profit (OP margin 8.5%). By geography, Omron’s sales in US and Europe are $127m and $177m vs Microlife’s $106m and $73m respectively. Omron has started Medical Link, an IT-based blood pressure management service for medical institutions in May 2012. Home

measurement data are automatically transmitted to the doctor over 3G networks. Medical Link is employed at more than 1,500 medical institutions across Japan. Elderly citizens are able to earn points each time they measure their blood pressure. These points can be exchanged for gift certificates and other services in their town. This initiative has helped raise health awareness among citizens while simultaneously stimulating the local economy.


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Taiwan’s Bamboo Innovators 80: Who Are They?

Bamboo Innovators Watchlist: Taiwan 80

5%

Bamboo Innovators bend, not break, even in the most terrifying storm that would snap the mighty resisting oak tree. It survives, therefore it conquers.

Source: Bloomberg, 24 Jun 2014

Institutional subscribers get access to the Bamboo Innovator Index of 200+ companies and Watchlist of 500+ companies in Asia and the Database has eliminated companies with a higher probability of accounting frauds and misgovernance as well as the alluring value traps.

Index Big Mid Small Micro TOTAL %

Singapore 3 5 2 10 4.5%

HK 8 10 7 1 26 11.7%

Korea 2 9 14 1 26 11.7%

Taiwan 2 14 8 24 10.8%

Thailand 1 6 15 3 25 11.3%

Indonesia 2 8 5 2 17 7.7%

Malaysia 2 7 9 7 25 11.3%

Philippines 2 6 2 10 4.5%

India 2 14 9 25 11.3%

ANZ 4 15 12 3 34 15.3%

TOTAL 28 94 82 17 222 100.0%

Watchlist Big Mid Small Micro TOTAL %

Singapore 8 5 13 4.2%

HK 1 9 9 19 6.1%

Korea 3 14 19 4 40 12.8%

Taiwan 2 21 29 4 56 17.9%

Thailand 1 11 6 19 37 11.9%

Indonesia 4 9 11 3 27 8.7%

Malaysia 7 7 5 19 6.1%

Philippines 8 5 13 4.2%

India 5 28 25 2 60 19.2%

ANZ 12 13 3 28 9.0%

TOTAL 16 127 129 40 312 100.0%

The Taiwan stock market (TaiEx) has approximately 800 companies with total market cap of $870 billion, while the GreTai OTC market has around 700 companies with total market cap of $92 billion. TaiEx is ranked the #15 global stock exchange by trading value.

Big >$10bn, Mid $1-10bn, Small $200m-1bn, Micro <$200m

TaiEx

Market Cap

PE

GreTai

$880 billion

17.7x

$93 billion

31.2x

MXAPJ

$7.2 trillion

13.7x

Index 222 + Watchlist 312 = Bamboo Innovators 534

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Contact


KB Kee has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at Aegis Portfolio Managers, a Singapore-based value investment firm. As a member of Aegis’ investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Mirae Asset Global Investments, Korea’s largest mutual fund company. He holds a Masters in Finance and degrees in Accountancy and Business Management, summa cum laude, from Singapore Management University (SMU). KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, macroeconomic and industry trends in Singapore, HK and China. KB had also taught accounting at his alma mater in SMU and is currently an adjunct lecturer in accounting at SMU.


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