ASIA FOCUS : LONG VIEW

Notes from Kuala Lumpur

ISAAC SCHWARTZ

During my recent visit to Malaysia, newspapers chronicled the adventures - perhaps soon-to-be misadventures - of Lucky and Flo, two Labradors trained in Northern Ireland as the world's first specialists in sniffing out discs. The local police have them for one month, to scour areas of suspected piracy activity and locate the booty.

The dogs busted their first illegal disc-burning operation and became celebrities. Then, a few days ago, rumours began circulating that local mafia had put contracts out on the dogs' heads. Now they are being held in a safe house to avoid their assassination.

The disc bust had good timing. The Invest Malaysia conference was being held in Kuala Lumpur (I didn't attend). At least there were plenty of people around to notice the government efforts at intellectual property protection.

Who's the winner? In Penang ("Malaysia's Silicon Valley"; a beautiful, mountainous, mostly ethnic Chinese island of one million people), I visited a number of technology suppliers with very low valuations. They deserve at least fairly low valuations. Consider the competitive positioning of one, a supplier of parts for hard-disk drives (HDD).

An American HDD manufacturer is a major customer in Penang. HDD decided to open a Thai operation, so the supplier followed and opened a Thai operation too. This is not a scale business; it merely involves investing in some equipment based on your forecast production. (So it isn't a natural outsourcing candidate.) The reason HDD asked the supplier to come to Thailand was because HDD doesn't want to invest in the equipment itself. HDD is in a truly enviable position: its suppliers will make costly investments even though HDD knows their cost structures and will always squeeze them. Everything is priced in a spot market.

- urthermore, the supplier told me that the best customers are the western firms coming to Asia for the first time. They don't fully comprehend the cost savings of using Asian manufacturing, so they accept a deal that isn't as good as it should be because they're still rubbing their eyes over how much lower the costs are.

I'm reminded of tourists in a ripoff name-brand-goods market in Asia. They descend on the shops like wolves to buy a Lacoste shirt for US$20. But they're actually the sheep in the transaction; the margin and return on capital associated with this sale are typically enormous.

Nonetheless, being a merchant of fake Lacoste shirts is not ultimately a good business because, like any operation based on customer ignorance, it lacks scalability. Similarly, an industrial operation whose best customers are foreign first-timers is not a good one. With their stable customers, these suppliers are essentially acting as equipment financiers; the irony is that it's their customer whose balance sheet would elicit far more favourable terms for purchasing equipment. (HDD, meantime, is in a virtuous cycle of not needing to make capital investments.)

A buy call?I visited a dry-bulk shipper who owns smaller vessels. The executives were extremely optimistic about business, from three factors coming into play:

- The 10,000-15,000 deadweight ton (DWT) segment has experienced heavy net scrapping in recent years. In the quest for energy efficiency, people only wish to ship on larger vessels.

- Shipyards are backed up around the world for 24-30 months. (I'm aware we've all heard this juicy tidbit to exhaustion.)

- The owners of smaller ports have not made the capex outlays that dredging demands. So some ports are less usable. (Ports that might have been able to handle a slightly larger ship a year or two ago no longer can for physical reasons.)

But against this backdrop, regional economies are strong and demand is high. There will be lots of deliveries into smaller ports, with little addition of ships to service the segment and with ports that can no longer take as wide a range of ship sizes. (Is this a buy call on the dredgers?)

Isaac Schwartz is a New York-based analyst and portfolio manager at Robotti & Company, an investment adviser established in 1983. Robotti & Company (http://www.robotti.com) invests primarily in the US, but also in Norway, Canada, Thailand, and Korea. He can be reached at longview@bangkokpost.co.th

Bangkok Post

Saturday March 31, 2007