Zhihu is the no.1 platform for posting questions and answers in China’s internet space. The company was formed in 2010, almost two years after Quora and has since then grown to over 76 million monthly average users (33% yoy) and 315 million cumulative questions and answers and over 43 million cumulative content creators. Zhihu was recently included on BrandZ Top 100 Brands in China on 91st spot.1 Revenue grew 94% in 2020 and reached $207 million.

The company was founded by Zhou Yuan, a former reporter from Guizhou. His first software business failed2, however he continued pushing and eventually formed Zhihu. The site was invite-only for first 2 years, and started really monetizing its users in 2016. By being an “exclusive” site, it attracted a lot of high quality creators, who posted great content which in turn attracted more users and allowed them to beat their competition.

Users can register and ask questions, or they can answer questions posted by others. Similar to Quora, they get upvotes, shares or likes. Content can be posted in text form, audio, livestreams or videos (generally longer than one minute).

According to an analysis posted on Zhihu3, out of posts that received more than 1000 upvotes, only 19% were written by influencers with more than 200k followers, suggesting that there is a large distribution of quality content that is not concentrated in a few hands. In addition, the Zhihu highly upvoted (received for great answers) badge represents significant prestige in the Chinese online community.

Content creators get rewarded either through creating commercial or premium content, paid consulting or commissions from Recommended goodies (e-commerce feature).

The platform is widely used by various experts from a wide array of industries to write and post high-quality insights. You can get a lot of great answers on a diverse range of topics from career development to sports, politics or technology. In fact the site covers 1,000 verticals and 571,000 topics according to their F-1.

They went public in March, raising $523 million at $9.5, or the bottom of its IPO range.4 They raised an additional $250 million through private placements to Alibaba and JD.com affiliates. The company expects to use the proceeds for R&D purposes, marketing and potential acquisitions.

While the core still remains Q&A, Zhihu has expanded to several other areas over the years such as short videos, livestreaming and online education. The company uses artificial intelligence extensively to assess the quality of content posted by users (TopicRank), question routing to relevant users, feed recommendation and search functions.

According to their prospectus, 53% of users are based in Tier 1 cities, 43% are female and 79% are less than 30 years old. Zhihu has a very young and educated user base from largest cities, which is a valuable target group for advertisers. Daily active users open the Zhihu app up to 6 times per day.

The company generates revenue from 4 sources:

Advertising (62.4% of revenue; $129m): Advertising revenue was up 50% in 2020, despite growing only 23% during the first half of the year. Advertising is driven mainly by the number of MAUs and (average MAUs up 42% in 2020 to 68 million) and revenue per user, which was up 2.3% to 12.3 RMB. Performance (CPC) or display based ads can be placed either on Zhihu app or on their website.


Paid membership (23.7%; $49m): Called Yan Selection provides paying users access to a premium content library available exclusively on Zhihu. The average number of paying users went from 0.6 million to 2.4 million during 2020 (paying ratio went from 1.2% to 3.4%), and paid membership revenue increased by 160% in 2020.


Content-Commerce Solutions (10.1%; $21m): Posts and content published by companies, generating service fees for Zhihu. Increased by 135x due to their recent launch. Companies can either produce their own high-quality commercial content or they can invite existing and popular creators to produce content for them.


This seems to be a great monetization tool, due to higher click-through rates: “our content commerce-solutions have proven to be a highly effective marketing approach for merchants and brands, evidenced by an overall click-through rate multiple times higher than that of traditional advertising.”5 Zhihu is a great avenue for brands to build their reputation online, get closer to customers and explain the benefits of their products or services.6

Others (3.9%; $8m): Consists of commissions from sale of merchandise and third party online education courses. Content creators can place recommendations for products (on third-party e-commerce sites) and if a user purchases them, Zhihu gets a cut from that GMV and pays a part of it to creators. During 2020, the GMV of products sold through Zhihu reached 4.4b RMB ($672m).

Zhihu was initially slow to monetize its users, very similar to Quora. They are still relatively early on their monetization journey, advertising was introduced in 2016, paid content in 2018 and Yan Selection program in first half of 2020. Online education and e-commerce services were expanded significantly during 2020, hence the sharp increase in revenue. Zhihu has tried several monetization methods in the past, some of which were unsuccessful7, but eventually found their way and the company is on a clear growth trajectory.

Initially, users criticized the launch of advertising on the platform, citing lower quality answers and a lot of cluttered content. However, the company overcame these issues and Zhihu remains a thriving platform today.

Financials
Zhihu lost $79m during 2020 due to expenditures on marketing ($112.6m) and R&D ($50m), both of which actually declined compared to 2019. Zhihu acquires users mainly organically thanks to the rich content they have, but also through paid campaigns such as app installs, brand campaigns, celebrity marketing and TV ads.

The loss was smaller compared to 2019 thanks to a jump in revenues and improved gross margin (56% from 46.6%). The margins are still quite low given the nature of the business, the company must pay a significant chunk of revenue to its content creators as well as for acquiring new users. Content and operational costs (a part of cost of revenue) increased by 166% in 2020 to $31m, suggesting Zhihu has increased investments in content creators. 

Zhihu had $475m in cash and short-term investments at the end of 2020 and no debt. The mezzanine equity was probably converted to common stock as is usual in IPOs, therefore they have more than $1.2b of liquidity available for further investments in their platform. I always like to focus on companies with little debt, it gives them plenty of options when times get tough. As the saying goes, it’s hard to go bankrupt if you don’t owe anything to anyone.


One drawback is their negative operating cash flow of $37.4m. I prefer to invest in companies that do not need any external capital and generate plenty of cash themselves. In this case they have a lot of cash on their balance sheet, but it’s always better to see positive cash flow, as it proves that their business model is valid.


Capital expenditures were only $300k during the year, as Zhihu spends money onR&D and marketing, which are expensed immediately and not capitalized.
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Zhihu had 1,651 employees at the end of 2020 and 41% of them were employed in research and development.

Market size and growthThe online community in China is massive, hitting 773 million in 2019 and expected to reach 1 trillion by 2025.8 The online content market reached 276 billion yuan ($42 billion) in 2019 and is expected to reach 1.3 trillion yuan ($198 billion). A large part of that are videos and video sharing sites, which take the lion’s share of revenue and Zhihu is currently a drop in the ocean with revenues of 1.4 billion yuan ($207 million).


According to a CIC survey, the number of users who pay for content at least once a year is expected to hit 588 million in 2025, a 17% CAGR from 2019.
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China’s online advertising market is forecasted to hit 762 billion RMB ($116b) in 2020, out of which online content communities represent 21%. This is expected to increase to 28% (511b RMB) by 2025 at a CAGR of 26%.

Similarly, the content commerce market is expected to quintuple, growing at a CAGR of 38% from 2020 levels.

Content is king, the primary way in which the company can grow in the future is to increase the number of users and the amount of content generated. This will in turn attract more users, creating a strong flywheel that feeds itself over time. Zhihu was long considered a platform for intellectuals in China, but in order to grow it must go more mainstream to attract a wider variety of users. It’s hard to say whether this will cause the quality of content to deteriorate, but it’s one risk to keep in mind.

According to an analysis from 20179 by CNNIC, 74% of Zhihu users had at least a bachelor’s degree, as a result the platform is perceived as having a lot of educated and young people on it. Zhihu is also popular with advertisers, as it helps build trust in your brand and also can improve your SEO, as Zhihu similarly to Quora is highly ranked by search engines.

Zhihu recently launched an online conferencing feature10, which seems to have been met with positive reception from users.

Currently they resell third-party online education courses, but plan offer their own in the future according to F-1: “For instance, through capitalizing on our deep pool of education content and knowledge-oriented user base, we intend to ramp up our online education service through effectively enhancing the penetration of education products among our current user base, and offering a diverse course portfolio that satisfies our users’ growing needs for educational content”.

​Zhihu is very early on their monetization path and I believe they can grow revenues several times from current levels. Only 4% (at the end of 2020) of their user base are paying for subscriptions, ad revenue is growing by high double-digits and the content commerce monetization has just begun.


If the company can also attract a higher amount of users, becoming more mainstream the potential to grow further and achieve $1 billion in revenue is very real.

Competition
Zhihu has emerged as the top Q&A platform in the country, after beating Baidu’s Baidu Tieba and Zhidao, as well as Tianya, what used to be the largest Chinese forum. Bytedance also shutdown its similar site Wuking Wenda11. Kuaishou’s rivalry with Bytedance is one of the reasons why the company invested $434m in Zhihu along with Baidu.

Major Shareholders
​Founder Zhou Yuan holds 7% of shares after the IPO, with 43% voting power. The largest shareholder (11.3%) remains Innovation Works, which is the venture fund of Kai-Fu Lee, the Chinese AI expert who was an early investor in Zhihu. Tencent is the second largest investor with a 11.1% stake. Kuaishou holds 7.1% through Cosmic Blue Investments.

Even though Kuaishou, Tencent and Baidu own stakes in the company, the related transactions are mostly hosting fees and marketing fees paid to Tencent and Kuaishou and represent less than 7% of their total costs. Revenue from Tencent, Baidu and Kuaishou is insignificant at this point.

ValuationBased on data from Yahoo Finance12, the company has 561 million shares outstanding, resulting in a market cap of $5.03 billion. If the preferred shares were converted and summing together the cash raised from IPO with their current cash balances, the resulting enterprise value is below $4 billion. This implies an LTM EV/Sales multiple of 20, and a forward EV/Sales of only 13 assuming revenues grow 45% this year.


Assuming a revenue CAGR of 40% for the next 5 years, the company would hit $1.2 billion in revenue by 2025. I believe their margins will improve significantly over the next few years, with gross margins heading toward 65-70% and with long-term free cash flow margins of at least 20% given the nature of the business.


If these assumptions turn out to be true, an investor is essentially paying 20x free cash flow a few years out for one of the most respected brands in China, with a dominant position, massive library of high quality content and plenty of monetization options.


I expect they will hit positive operating cash flow this year and will probably start generating free cash flow by the end of 2021. I am not buying the shares right now, but I will wait for their first quarter of positive operating cash flow and enter at the inflection point.


RisksCompetition: The primary risk comes from video platforms like Kuaishou, Douyin or Bilibili, which themselves have expanded into educational videos delivered by influencers with a large following. Short video is the dominant form of information consumption in China right now, whereas Zhihu relies mostly on text posts.


Delisting: US Congress recently passed a law requiring Chinese companies to open up their books for examination by PCAOB, the organization that oversees accounting practices of publicly listed companies in US. Failure to comply with this regulation would result in a delisting.


Ownership structure: As is common for Chinese ADRs, the holding company in which shareholders hold equity is merely a conduit and conducts business in China through various agreements with subsidiaries, without directly owning them. This poses a large risk in case management transfers assets between the subsidiaries or conducts fraudulent transactions.
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COVID-19 impact
Their business has taken a hit from COVID during the first half of 2020, as many businesses in China paused their ad campaigns and Zhihu’s advertising revenue grew only 23% (to $45m) during the period. On the other hand, they likely beenfited from an increased number of monthly users, as people were forced to stay at home and spend time online.
COVID also delayed the launch of their content-commerce offering. The company decreased its marketing spend during the year, mainly due to the absence of offline events that they use to drive people to their platform.

I have initiated a new position in NARI last week representing 6% of my portfolio. The company is a medical device manufacturer focused on patients suffering from venous diseases. Thier main products are two minimally-invasive, single-use, novel catheter-based mechanical thrombectomy (removal of blood clots) devices. ClotTriever product is FDA-cleared for the treatment of  deep vein thrombosis, or DVT; FlowTriever is the first thrombectomy system FDA-cleared for the treatment of pulmonary embolism (PE). FlowTriever System was the first mechanical thrombectomy device to be awarded an FDA indication for treatment of Pulmonary Embolism.​

The company IPO'd on May 27th with a ticker NARI raising $179 million before investment banking commissions and fees. The proceeds from the IPO will be mainly used for research and development and clinical trials. 

Historically, development efforts for mechanical thrombectomy devices have focused on arterial devices, which are then repurposed for use in the venous system. Given the significant differences between the arterial and venous systems and the clot that forms in each system, these devices have difficulty removing venous clot, which is often adhered to the vessel wall and is older, firmer and substantially larger than arterial clot.

Venous thrombosis (VTE) causes 296,000 deaths per year in US, with approx. 1 million patients diagnosed with the disease each year. Out of those 242,000 DVT and 200,000 PE patients could potentially benefit from Inari Medical's products. Most of these patients are currently treated with coagulants, which are chemical drugs that cause blood thinning. The most common adverse effect of these is increased bleeding.

Pulmonary embolism is a blockage in one of the pulmonary arteries in lungs. It is primarily caused by blood clots that travel to the lungs from deep veins in the legs or, rarely, from veins in other parts of the body (DVT).

Mechanical thrombectomy (a catherer is inserted into the body) is also used on patients suffering from VTE but it has its drawbacks such as a limited ability to remove large clots or clots from vessel wall, as well as the need to undergo multiple procedures.

In addition, VTE patients are also treated with thrombolytic drugs, which have demonstrated an ability to prevent new clots from forming. However, the disadvantage is that older clots often remain in the body and this treatment can be quite expensive and time consuming.

Inari has treated more than 8,500 patients since their commercial launch in the third quarter of 2018. The company estimates their addressable market to be approx. $3.6 billion per year. In addition, there are 465,000 cases of DVT and 295,000 cases of PE in the European Union each year.

The company is currently evaluating long-term effects of their products in studies with 500 enrolled patients.

Advantages of Inari's products:

- designed specifically to treat larger blood clots
- they can replace the need to use thrombolytic drugs
- better safety profile than alternatives according to their studies and actual procedures performed on more than 8,500 patients
- short and mostly single session visits to the hospital, which decreases overall healthcare expenditures

Covid impact
The company was negatively affected by COVID-19, due to stay at home orders in Q1 and Q2, which negatively affected the number of venous procedures in hospitals. During mid-April the number of procedures was down 40% from peaks, but recovered in later months. 

There is also an increasing incidence of VTE in COVID-19 patients, as high as 26% in according to the National Center for Biotechnology Information. This might have provided a short-term tailwind for the company, although they didn't cite it specifically in their earnings releases or conference calls.

Financials (USDm)

Inari Medical recorded $51m in revenue in 2019, and $110.9m TTM in 2020, despite hospital closures. In their latest quarter, revenue increased 172% to $38.7m, with operating income up more than 10-fold. They have paid down their debt and have $168m in cash on their balance sheet. The company is solidly profitable with a TTM gross margin of 90% and ability to significantly expand their revenue.

The company employs its own salesforce and targets primarily interventional cardiologists, interventional radiologists and vascular surgeons. Their front-line sales employees attend up 80% of procedures performed, which allows them to gather valuable feedback from patients and surgeons. The products are sold to hospitals and reimbursed through various third-party payors. As of the date of their IPO, the company sold to 600 out of 1,500 US hospitals with a catherization laboratory.

Risks

• Despite hospital closures, COVID-19 might have positively impacted their revenue as many covid patients are hospitalized with blood clots or pulmonary embolism
• Competitors like Penumbra or Medtronic might come up with similar or better solutions
• Valuation is very steep at 30x 2020 forward sales, any slowdown in their growth rate could be severly punished by the market

Management
The company is run by CEO Bill Hoffman, a veteran manager who has spent decades at various medical device companies. He was previously the CEO at Visualase Inc., which was sold to Medtronic for $105m in 2014. Largest shareholders are U.S. Venture Partners (17%) and Coöperatieve Gilde Healthcare (17%) and  Versant Venture Capital (13%). CEO Bill Hoffman owns approx. 3.5% of shares.

​Sources:

https://en.wikipedia.org/wiki/Anticoagulant#:~:text=Anticoagulants%2C%20commonly%20known%20as%20blood,blood%2C%20prolonging%20the%20clotting%20time.

https://ir.inarimedical.com/static-files/82618a0a-0122-4e86-9309-3b1b21380cd9

https://en.wikipedia.org/wiki/Pulmonary_embolism

https://www.hematology.org/covid-19/covid-19-and-vte-anticoagulation

https://www.ncbi.nlm.nih.gov/pmc/articles/PMC7420982/

https://www.medscape.com/answers/1267714-124044/what-is-the-annual-international-incidence-of-venous-thromboembolism-vte
https://ir.inarimedical.com/news-releases/news-release-details/inari-medical-reports-third-quarter-2020-financial-results

Li Lu is one of the best value investors in the world. He once was considered to be a portfolio manager for Berkshire Hathaway's investment portfolios. He recently sat down with students at Peking University to talk about business and investing.

On selling a stock: 

"Usually I sell a stock on one of three occasions. First, I sell a security if I make a mistake. The second occasion when to sell is when you find something that's better. By better I mean a better risk and return combination. You do that by constantly improving your portfolio's opportunity cost. And the third occasion when to sell is when the valuation swings way too much to the extreme high, or when the market price deviates too much from the intrinsic value. When this happens your opportunity cost becomes cash. Essentially it's all about opportunity cost. But it's not that easy because everyone's opportunity cost is different and everyone's understanding of opportunity cost is different."

On value investing in today's market:

I've been in the market for 26 or 27 years. What I've observed is that authentic value investors have always been the minority. But today, at least in China, I see more and more investors call themselves value investors. But they may not understand the essence of value investing. As Ben Graham said, in the short term the stock market is a voting machine and in the long term it's a weighing machine. If you are a true value investor, you shouldn't care about the voting results because ultimately intrinsic value is determined by the long term profitability and growth. It has nothing to do with how market participants vote. 

What to focus on when analyzing a business:
So if you are interested in a business, you'll find out that you should focus on the long term competitive advantages of this business. What would the business look like in 10 years or longer? Can it sustain its competitive advantages in 10 years? Can it sustainably grow? Will it continuously earn a high return on capital?

The full interview is here ​https://www.gurufocus.com/news/1232294
​https://www.gurufocus.com/news/1234114

Danoff talks about his investment strategy, analytical process and the investing culture at Fidelity. Here is one important message: "So, here’s the lesson to your listeners, Barry. The stock pops on day one or day two and it was always very expensive for what it was. It was like 35 — 30 times the year estimate. But the company continued to grow and grow and it stayed expensive for like 15 years but it was a great stock."

"So, that’s helped me a lot and so, I’ve tried to stay in companies and not be faked out and sort of — again, what is sort of market noise, worried about some tweets or some concern about inflation or the dollar moving this way or that way, which is sort of irrelevant in most cases to the strength and long-term profitability of a company.

I would say and I’d urge your listeners and I’d urge you to think about this idea of when in doubt, check the fundamentals. When in doubt, listen to the latest quarterly webcast. When in doubt, look at the latest presentation to investors."

I remember meeting the great Herb Kelleher and I think one of my questions, one — again, Fidelity is a great place to manage money. For whatever reason, Herb came in and everybody was at a tech conference or everybody was at a healthcare conference. I think there were two other investors and me in the meeting and I was like, Herb, the great Warren Buffett says he got — he lost a lot of money in U.S. Air. How can you make money in the airline industry? And he said, Warren bet at the wrong airline.

​— a lot of times when I’m talking to management, they’re like, why don’t you guys own more stock and I’ve got to say, I made a mistake.
But one of the great lessons over 30 years, Barry, and this is important for all your listeners, if a stock has doubled or even tripled, you have not missed it. And I don’t like to give …

RITHOLTZ: Really?

DANOFF: … all my secrets but if a stock has doubled or tripled, you have not missed it. You have to say — have the mental wideout that Peter Lynch always talks about for the past and say, what is going to happen in the future because let’s step back, Bill Gates, Michael Dell, they didn’t sell after the first double. They didn’t sell after the first triple.


The full interview is here https://ritholtz.com/2020/09/transcript-will-danoff/

Bought  a new stock today for 5% of my portfolio with a stop loss as usual.

The company specializes in the design, development and manufacture of autoclavable, battery-powered and electric, multi-function surgical drivers and shavers used primarily in the orthopedic, maxocranial, and thoracic markets. They have patented adaptive torque-limiting software and proprietary sealing solution. Their customers are mainly primarily medical device distributors and OEMs (original equipment manufacturers). Large companies like Medtronic often outsource their manufacturing of specialized equipment to third-party companies as it's cheaper than developing it in-house.

PDEX has a market cap of $81 million and generated sales of $34 million in the year ending June 2020, with net income of $6.1 million and free cash flow of $5.4 million. The company has no debt, $9 million in cash and short-term investments and equity of $19 million. Its ROE Is therefore 31.6% and its ROIC is above 60%. Medical device companies can be quite profitable, once they pass all FDA tests they can keep customers for a long time and charge premium prices.

The company derives the majority of its revenue from sales of medical devices, however repairs have become a major part of business, increasing from 4% of revenue in FY19 to 17% in Q3 2020 (ending March 2020). Pro-Dex released two new products in Q2, a thoracic driver to one of their existing craniomaxillofacial ("CMF") customers and next generation CMF driver for an existing customer. These products contributed $1.6 million in Q4 revenue which increased their growth to 60% y-o-y. Excluding these new products, revenues would be up 36%. According to their earnings release, customers usually buy  larger quantities upfront, which means that Q4 revenues of new products might not be indicative of their sales in next few quarters: "Additionally, as described above, we released two new products in the second half of fiscal 2020 and while we expect to have future orders for these new products, often the launch or initial quantities are such that our customer can comfortably fill its distribution network and follow on orders may not occur for many months. As a result, fiscal 2020 sales of these products may not be indicative of what sales of these products may be in the future."

The organic growth of the business is still quite impressive and it's a great thing that their R&D efforts are bearing fruit and they are coming up with new products. 

The major shareholder and chairman is Nicholas Swenson, who owns just over 1 million shares translating into 26% of the company. He along with Raymond Cabillot (who owns 10.7% of shares) fought a proxy fight for the company in 2013. Back then, it was a struggling and unprofitable business which lost an important customer and was on its way to bankruptcy. They managed to turn it around by bringing in Richard van Kirk as CEO. Here is an interesting writeup on the past of PDEX on VIC: https://www.valueinvestorsclub.com/idea/PRO-DEX_INCCO/7443796112

Found an interesting stock last week called Viva Biotech. The company is a CRO (contract research organization) that does pre-clinical research for global pharmaceutical companies and biotechs. They claim that 9 out of top 10 global pharma companeis are their clients, as well as 400 biotech companies in various countries. Around 75% of revenue comes from US, 23% from China and the rest from other countries.

The company has grown rapidly in recent years, revenue was RMB 96.5m in 2016 but grew to RMB 323m ($45m) by the end of 2019. The Chinese CRO market is fairly large and expected to hit $27 billion by 2024, at a CAGR of 27%. Viva Biotech is a very small player compared to larger companies like Wuxi Apptec (which is another good business by the way) and Genscript BIotech.

Viva Biotech has a very unique business model, which is what really caught my eye. The vast majority of revenue (76%) comes from their Cash for Service model, which is just another name for regular fees that their customers pay for their services. They usually hire a whole team of scientists on a particular project and the company bills by the hour, just like in any other service business. The remainder of their revenue comes from EFS (Equity for service) where they take direct equity stakes in their customers. Because many of their customers are cash-strapped biotech upstarts, the company offers them the option to pay with their equity.

This is where the business becomes really scalable. The company evaluates roughly 600 various biotech startups every year, and picks c.5% of them, which become a part of their incubator and can use Viva's services in exchanges for equity in their startup. Over the years, management has built a solid reputation and network among many of the world's leading pharmaceutical organizations, which helps them discover promising technologies or ideas very early. The company employed 731 people at the end of 2019, out of which 614 work in R&D. This gives them a solid base with which to evaluate these startups and determine which are promising and which are not. The company added 15 startups to its portfolio since April 2019, and sold small stakes in two of them at the beginning of 2020. In January, the company sold a 4% stake in Proviva Therapeutics, one of their incubator companies for $4m, and still retaining their 31% stake, valuing the entire company at $100m. They originally bought their stake in June 2019 for $12.6m, so the valuation has roughly tripled since then. There is one red flag, some of the bidders who bought the stake are people related persons of Viva Biotech, which makes the deal look a bit strange.

At the end of 2019, the company had little debt and RMB 904m in cash ($127m) but they recently raised a further $180m in convertible bond offering. Viva intends to use the money for business development and expansion, which is pretty vague. The interest rate is 2.5% fixed, which is very low for such a company. I never invest in indebted companies, but this time I made an exception since they have a lot o cash on the balance sheet and their investments (startups) were valued at RMB 623m at the end of 2019. 

If the convertibles are converted, they will result in 15.6% dilution to common stockholders, which is pretty heavy. Some of the money will go their new drug incubation center in Sichuan, which is expected to cost c. RMB 150m. They provided no update regarding COVID-19, which means it's hard to tell the impact on their business. But since they are going ahead with all these investments, I expect they are increasing capacity due to increasing demand for their services. 

Since Viva records the revaluation of their financials assets in P&L, the resulting net income is subject to wild swings as the prices of their incubated companies are adjusted each time a report comes out. Excluding these movements, the operating pre-tax income was RMB 63m ($10m) in 2019, up 68% from RMB 37m a year ago. Market cap is HKD 9.8b ($1.26b) which is pretty steep for a company with $10 million in operating income and $9m in operating cash flow. The bulk of the valuation is assigned to their incubator investments, some of which have already shown promise. 

The CEO Mao Chen Cheney is a respected scientist, wiwth degrees from Fudan university and Cornell university. He owns roughly 30% of the shares outstanding and is the driving force behind the incubator investments. 

Although there are some red flags in Viva, I really like their business model with a biotech venture fund attached, it's very scalable and can lead to some big wins in the future. I'm a huge believer in the Chinese biotech industry, which will perhaps one day rival the one in United States. Viva gives me exposure to some early stage Chinese biotechs, which I could never invest in as a private investor. Given the small size of the company, their debt load and somewhat speculative business model, I have put on only a small position.

PAGS reported solid results after market close on Thursday last week.
- For the three months ended June 30, revenue grew 39%, while earnings before tax increased by 47%
- Luis Frias, the majority owner of UOL and PAGS joined the call with a few comments: The banking market in Brazil is 14 times larger than the payments market. The company has significant room for growth has a first mover advantage
- PagSeguro platform has 9.4 million active users, 4.7 million merchants and 4.7 million customers with PAGS digital wallet and PagBank consumers
- PagBank had 2.5 million downloads in the quarter and 1.4 million active customers. Average customer balance grew by 58% YoY
- The company sees competitors engaging in a "useless struggle", they didn't mention NuBank though, which seems to have a larger customer base than PagBank
- The company mentioned that PagBank is the largest digital bank according to Google Trends and the largest prepaid card issuer. Hard to say if Google Trends is a relevant benchmarking tool in this case, NuBank seems to be larger than PagBank, as it has 8.5 million customers according to https://www.vox.com/recode/2019/6/5/18654454/nubank-softbank-valuation-brazil-banking-funding and it's seeking a 8-10 billion valuation, vs 15.5 billion for PAGS. Other competitors include MercadoLibre (MELI) at $30 billion and Stone Co. with a  $9 billion market cap.
- Net take rate was 3.23% (up 0.11% QoQ, but down 0.13% YoY), GAAP net margin 23.2%, up from 22.7% in Q22018
- BRL26.8 billion, up 59% year-over-year, closing the quarter with 4.7 million active merchants, adding 1.2 million when compared to the second quarter 2018 (up 34%)
- According to IBGE and Brazilian Central Bank, there are 68 million unbanked people in Brazil. Additionally, 28 million of the low-income population do not have a bank account and 57% of the population are interested in adopting digital banks. Still, 40% of the paychecks are paid in cash, 65% of the bill payments are also made in cash and, finally, 51% of the new bank accounts are opened just to receive payroll checks.
- Total costs and expenses as a % of TPV declined from 4.1% in Q22018 to 3.5% in Q22019
- Company launched Pag Credit, which are loans advanced to merchants. Their focus is not on volume but on deliquencies, to have the lowest deliquencies possible. Credit is easy to advance but hard to collect.
- The company is aiming to get 30% of its revenue from PagBank in 3-5 years
- PagSeguro is constantly evaluating international expansion opportunities, nothing decided yet. The room to grow in Brazil is still huge

Overall very solid results and I haven't sold a single share yet, I would add more if I didn't have ARCE in my portfolio already.

I always like to follow upstarts in the investment management business and Alta Fox Capital looks very interesting. The fund is up 52% YTD, and has beaten its benchmarks since inception in 2018. I know that's a very short and insignificant timeframe, but the founder Connor Haley posts some very interesting investment ideas with long term potential. It looks like his focus is on high quality small caps that grow at above market rates, which is kind of what I'm doing as well.

Here is the letter:
https://static1.squarespace.com/static/5aaacb57506fbe4636414126/t/5d3a2ee5c694120001688a00/1564094184541/Q2+2019+Alta+Fox+Capital+Quarterly+Letter.pdf

He discusses positions in PaySign (PAYS), Nintendo (NTDOY) and Keyword Solutions (KWS).

Just read a great interview with the co-founder of GWRE, a P&C insurance software company. He talks about how difficult it was to build to business, and how once you surpass a certain level, you build very powerful barriers to entry. There is also a video at the end of the article https://community.intelligentfanatics.com/t/the-amazing-story-of-guidewire-software/2039

Bought a new stock today called Union Medical Healthcare (UMH) listed on the Hong Kong main board under ticker 2138. The company operates 54 medical clinics in Hong Kong (45), China (7) and Macau (2) as of January 2019. The group is the no.1 private healthcare provider in Hong Kong. UMH has several business segments (numbers are from last interim report ending September 2018):

• Medical services (55%) - aesthetic surgical procedures, minimally invasive procedures, eye treatments, orthopaedic and chiropractic treatments
• Quasi-medical services (8%) - energy-based procedures 
• Health management services (8%)
• Traditional beauty services (16%) - facials, massages and other non-invasive procedures
• Sale of beauty and skin-care products (5%) - they sell private label products like PRODERMA LAB and Suissebeaute
• Other (8%)

The company released their annual results for the year ending March 2019, but they haven't released an annual report yet so I'm using these numbers.

Here is a list of brands owned by UMH. Their focus is on aesthetic services, orthopaedic, eye and dental clinics. Also they have several diagnostics centers that provide health management services, radiology and MRI scans.

The company is growing at a brisk pace. Revenues have grown at a CAGR of 30% over the past 5 years and were actually up by 40% in the year ended March 2019, while net income increased by 30%. Net profit margin reached a peak of 28% after which it declined to 20% currently. According to morningstar, UMH had HK$ 967 million in cash and marketable securities, HK$498 million in short-term debt and zero long-term debt, thus having a HK$467 millon net debt position. Their ROE has averaged 29% over the past 4 years.

UMH has financed their expansion mainly by internal cash flow and their IPO proceeds. EPS has increased from 0.24 in 2015 to 0.36 in March 2019, a CAGR of 11% mainly due to dilution of shares in IPO. The company has c. 1 billion shares outstanding at a price of HK$6.7 , giving us a market cap of HK$6.7 billion (US$858 million). According to morningstar.com, the stock is selling for a P/E of 19, forward P/E of 13.6 and P/S of 3.6 which is pretty cheap if we look at their historical growth and future potential.

The business was started by Eddy Tang in 2005 with one clinic and one practicing doctor, the founder still owns 73% of shares and remains at the helm of the company. Here is a short interview with Tang from 2016. He drives the entire company towards excellent customer service and high quality medical care, which results in high patient satisfaction scores, with customer retention of 89% (not sure how this is measured). Also the company has introduced a 14-day cooling-off period, during which customers can request a refund without giving a reason. This helps cement their loyalty and trust in the brand. 

​The second largest shareholder is a US healthcare investment fund called Orbimed advisors with a 6.5% stake. 

The public system in Hong Kong has 43 hospitals and treats around 90% of inpatients, there is a chronic shortage of qualified doctors (around 350) and patients sometimes wait for more than 150 weeks for certain procedures (scmp.com). As a result, people who can afford it rather go to private healthcare institutions. The vast majority of UMH revenue is funded by out of pocket expenditures from patients, and not through insurance reimbursement, which makes them less susceptible to regulation and state intervention.

UMH focuses mainly on aesthetic services (plastic operations, botox treatments, facial and skin-care) through their brand Dr. Reborn which has won several awards in Hong Kong. 

​2019 has been a fruitful year for the group, as they increased the number of specialty clinics, oncology centres, day surgery
centres, and diagnostic and imaging centres. UMH increased their presence in radiology, cardiothoracic surgery, treatment of disorders of the ear, nose and throat (ENT), plastic surgery, neurosurgery, orthopaedics and urology.

Around 84% of their customers are women, and the company treated 81,000 patients in the year ended March 2018. In 2015, the vast majority of revenue came from Hong Kong and only 9% was from mainland Chinese patients, who travelled to Hong Kong for treatment. UMH opened their first clinic in China (Guangzhou) in June 2015 with a capex of HK$3.1 million. The clinic achieved HK$8.9 million in revenue in first 9 months of its operation, suggesting the payback period can be pretty short and that opening new ones is a very lucrative business. 6 more clinics in China followed. In February 2019 the company bought a clinic in Beijing that holds a medical license and practices aesthetic services. 

Pearl River Delta

The company wants to focus their expansion plans mainly on the Pearl River Delta (PRD) region and Tier 1 Chinese cities. They have stated, that instead of pursuing aggressive expansion, they will target selective locations high GDP per capita areas. The Pearl River Delta is comprised of 9 large cities and 2 administrative regions, with a population of c. 70 million people. PRD economic growth has been 3% above national average for the past 30 years, mainly due to the fact that 30% of foreign direct investment in China flows right here (wiki). 

​The Chinese government recently opened a new rail link between Hong Kong and mainland China, as well as the Hong Kong- Zhuhai-Macau Bridge, which connects the island with the continent. This has caused a large increase in the number of tourists from China, many of them seeking quality healthcare. As a result, I think the number of patients visiting their facilities can grow organically for the next several years, and the share of revenue from mainland Chinese will rise as well.

Tencent collaboration

UMH has opened two clinics in Hong Kong as a JV with Tencent (chinadailyhk), and plans to open 18 more within 2-3 years. Tencent will provide their IT systems, artifical intelligence expertise in diagnostics and advertising on WeChat app, which has over 1 billion users in China. This is a big boost for UMH and the stock initially jumped 61% when the deal was announced. Theoretically, Tencent could help the company expand on the mainland as well. But that's just my theory.

Hong Kong private healthcare market

According to their latest press release the private HC market in Hong Kong is expected to grow to HK$100 billion by 2024/2025 which is a 6% CAGR from HK$68 billion in 2017 (Dh.gov). Out of total healthcare expenditures in HK, 49% are funded through public insurance schemes, 34% are through out of pocket payments by patients and only 16% are paid for through private insurance (fhb.gov.hk). In addition, the government has launched a new private insurance scheme with extra incentives, to drive an estimated 1.5 million people towards private healthcare institutions, to reduce the burden on strained public healthcare system (scmp). This will benefit UMH, as the company can get approvals for reimbursements from insurance companies, which should increase the number of patients being treated at their clinics.

Healthcare in China

The Chinese market is very fragmented with over 31,000 hospitals with various levels of services and prices. According to ResearchandMarkets, the most profitable segments are ophthalmology, dental care and plastic surgery clinics with margins above 10%. Which is basically the majority of UMH business. There is plenty of room for industry consolidation to achieve economies of scale. Through acquisitions or developing their own clinics, UMH can achieve scale especially in purchasing (medical materials and equipment), IT systems and marketing. Large hospital chains like Aier Eye Clinic have around 200 units in the country, which is still less than 1% of the total market (although a higher % of private healthcare market).

I really like the business and its potential for future growth. The company will most likely expand its collaboration with Tencent, can open or acquire more clinics in PRC and their existing clinics will likely get more traffic thanks to the new bridge and railway terminal. GDP growth rate in China has slowed, but it's still several times higher than in many developed markets. The demand for quality healthcare will likely only increase, and UMH will be one of the beneficiaries of this trend. Union Medical can be one of those rare 10x stocks in the next few years.

I have put 7% of my portfolio in Union Medical stock, and I'm using a stop loss as always, in case something goes wrong.

A new stock popped up on my screener recently called Shake Shack (SHAK). It is a chain of upscale burger restaurants, with operations in 26 US states and several foreign countries. As of March 2019, they operated 218 stores.

​The company is expecting revenues of 580 million for 2019, which represents 26% growth YoY. That's down from Q1 growth rate of 33% and slightly down from 27% achieved in 2018. Despite that, Shake shack still has lot of potential for future growth. the company is targeting 450 domestically owned stores, which is almost 4x the current amount.

After several quarters, same store sales finally ticked up to 3.6%, comprised of 1.6% traffic increase and 2% price increase. While the company is growing pretty fast, the same store sales numbers are still pretty weak.

In Q1, the company opened five domestic company-operated Shacks and seven licensed Shacks. They are expanding this year to China, Singapore, Mexico and Philippines, 

The company has grown a lot over the past few years, but mainly thanks to opening new stores, not same store sales (same-Shack sales). SSS grew by 4.1% in 2014 and 13.3% in 2015, but decelerated to a growth of 1% in 2018. Average weekly sales are down from $89k to $84k. Average unit volumes, which are basically unit sales were down to $4.4 million in 2018 from $4.6 million in 2014. International sales per unit have also gone down to $3.05 mil. from $4.6 mil. in 2014.

Now this might be quite understandable, as their first Shacks were in New York City, which have very high sales per sqm, and as the company expands to more and cheaper locations, the sales per unit will naturally trend down. The decline in international licensed Shacks is a bit alarming though, as it also shows that the concept is not selling as well abroad as in US. Shake Shack has gone from 84 stores in 2015 (44 domestic company-operated) to 208 stores (124 company-operated) and 218 stores as of the end of March 2019.

The company was founded by Dan Meyer, an entrepreneur who owns several upscale restaurants in New York City. Here are a few articles about him:
https://fortune.com/2019/04/06/danny-meyer-tipping-shake-shack/
https://www.forbes.com/sites/briansolomon/2015/05/20/as-shake-shack-reopens-flagship-danny-meyer-becomes-600-million-man/#5df4894b5ccb
https://www.forbes.com/sites/lorenfeldman/2018/01/14/danny-meyer-on-eliminating-tipping-it-takes-a-year-to-get-the-math-right/#3f1df421431f

Dan Meyer is known for several controversial moves such as eliminating tipping (instead they incorporated it into menu prices) and going completely cash-less in several of his restaurants. Shake Shack was originally a single hot dog and burger stand at Madison Square Garden but thanks to its popularity quickly expanded to other locations and cities.

Financials

Shake Shack recognizes revenue from its own stores and licensing fees 
Operating and gross margin
Balance sheet items

Summary

I have looked at Shake Shack before when it was in low 40s, but didn't buy it back then. Now the stock price is 70% higher. I don't mind the valuation that much, as the multiples are a bit elevated but still reasonable given their large potential. What I mind is that SSS are growing so slowly, and also that it's a restaurant business, which is not something I'm an expert at. I don't understand their competitive advantage, it might be taste, but to it seems like that there are so many competitive options available that I just don't see their edge. 

PagSeguro is a Brazilian payment company, that sells POS devices, provides online banking services and payment solutions to small and medium sized merchants. The company has over 4.4 million merchants in their network, up 43% in Q12019 over the same period in 2018. 

The company makes money from 3 sources: Transactions, sales and working capital loans. 

Transactions represented 57% of revenue in Q12019 (713  million reais) and grew by 61% YoY. Total transaction volume grew even faster by 70% (to 24.4 billion reais), while the take rate declined slightly to 2.9% due to lower margin transactions making up a larger part of volume. The current exchange rate for USD/BRL is 3.84. 

Another part of revenue is sales of POS devices, which amounted to 68 million reais, down 28% from 94 million reais in Q12018. This was mainly due to lower prices (company sells some of their devices for only $1 and makes it up on transactions). 

The last part of revenue is Financial income, which represents the discount fees they withhold from credit card
transactions in installments for the early payment of receivables. It amounted to R$430.5 million in Q12019, up 56% YoY. This is basically when someone buys an item on installments from a merchant, the merchant doesn't have to wait until the customers pays over many months, PagSeguro provides them the money instantly or within 14 days and for that they charge a fee. 

Other financial income includes interest received on bank deposits and the impact of foreign exchange fluctuations on assets and liabilities.

Net income was up 109% in Q12019 to R$310 million, with a net margin of 25%. The stock spots a P/E of 44 and P/S ratio of 10, with a forward P/E of 25. 

The company is owned by Universo Online (UOL), one of the largest internet portals in Brazil, which is in turn owned by billionaire Luiz Frias. UOL originally bought PagSeguro as a startup and developed it into a business worth $12 billion today with $1.2 billion in TTM revenues (c. R$ 4,6 billion). The partnership with UOL can be seen as a competitive advantage, as it is one of the most visited sites in Brazil, which gives PagSeguro great exposure to millions of users as well as SEO benefits.

PagSeguro also recently launched PagBank app, which is an online bank app that allows customers to deposit, withdraw and send money for free. The company aims to capture the margin on payments, when users use PagBank to purchase products at merchant registered with PagSeguro. It will create a closed loop ecosystem and the company will not have to share revenues with banks. PagBank has already been downloaded more than 5 million times and has an average rating of 4.8 on Google Play.

Brazil is a nascent market for online payments, with competitors like MercadoPago and Stone co. fighting for market share. In addition legacy banks have announced 0% fees for working capital payments to merchants, which means PagSeguro's Financial income revenue stream is endangered. I am counting on their online bank to more than make up for this loss, as the consumer banking market is huge compared to merchant payment processing. In addition, it appears that Brazilian fintech companies are leaders in the region, and they should be able to expand their solutions to neighbouring countries. 

Around 60 million of Brazilians still don't have a bank account and 85% of PagSeguro merchants didn't accept credit cards before using their platform. So there is tremendous potential for growth both within the country and abroad. 

I have put 6% of my portfolio into the stock, with a clear stop loss in case things go wrong.

Bought a new stock last week called Hypebeast (HK:150). The company is an online media business, that owns several successful blogs (hypebeast.com, popbee.com, hypebae.com) and an e-commerce platform (hbx.com). The company also operates a creative marketing agency called HypeMaker. It was founded by Kevin Ma in 2005 as a blog about sneakers, and over the past 14 years grew to revenues of $86 million a market cap of $270 million USD. The site was initially focused on sneakers, but later expanded to fashion, streetwear, cars, watches, phones and everything that's "cool".

The company has experienced remarkable growth since 2014, going from HK$79 million to HK$672 million, a 56% compounded annual growth rate. Gross profit margin and operating margins have declined, as a larger share of revenue is represented by lower margin e-commerce activities, but operating income still grew by a CAGR of 42% over the 5-year period.

As of this writing, the stock is selling for 3.15 times sales and 33 times earnings. These multiples are not exactly what a value inevstor seeks, but their growth is really remarkable. In the year ended March 2019, e-commerce sales grew by 98%, online advertisting revenue was up 50% and creative agency revenue more than doubled. 

Approximately 33% of revenue comes from United States, 30% is from China and the rest from other countries around the world. The company has 21 million fans across WeChat, Instagram, Facebook, Weibo and other social media. Their sites attract 12 million unique visitors per month with over 70 million pageviews.

Hypebeast founder

Hypebeast.com was launched by Kevin Ma in 2005 as a side project, as he had intense passion for sneakers and fashion and wanted to put some information out there. Here are several interviews with the founder:
https://www.forbes.com/sites/carolinejones/2018/10/22/best-under-a-billion-founder-kevin-ma-wants-hypebeast-to-last-100-years/#1b9167b0678f
https://qz.com/quartzy/1399479/hypebeasts-kevin-ma-doesnt-care-about-sneakers-anymore-he-wants-to-start-a-book-club-instead/
https://www.forbes.com/sites/bishopjordan/2016/06/28/hypebeast-founder-kevin-ma-on-innovation-learning-and-hong-kong/#3331dd54a608

He has stated several times that he has a long-term view and wants to build a durable and sustainable business. They usually try many different things on a small scale, keep what works and shut down businesses that don't. That's how they came up with the creative agency idea and e-commerce site. The growth in e-commerce was initially slow, as they signed only a few dozen brands, but once they learned the game the business took off and now they offer merchandise from more than 300 selected brands.

Future growth
Many media companies have tried to establish e-commerce sites but have failed in recent years (Conde Nast is an example). Hypebeast has done a very good job at monetizing their pageviews and driving users to HBX.com. Total e-commerce revenues for 2019 were HK$238 million or US$30 million, which is a drop in the ocean of online retail sales. There is huge potential for expansion.

The company has launched creative agency services in China in March 2019, and is planning to open a physical fashion store in New York in 2020 (they already have one store in Hong Kong). Also e-commerce activities are growing at a brisk pace and the company wants to target Latin America next.

​I think the founder and Hypebeast team have done a tremendous job and built a really enviable business and they will probably be a much larger company a few years from now. 

Risks
- Other retail giants like Amazon, JD, Pinduoduo or Alibaba could start attacking their niche and drive margins down
- Trade war between US and China is still ongoing, tariffs on clothes imported into US might be increased at any point
- Their fashion sites might have a limited audience of streetwear enthusiasts, which will make it harder to attract mainstream fashion visitors or shoppers
- Creative agency business is likely going to be lumpy, they might get larger or smaller contracts across several years
- Future growth depends mainly on launching new online media platforms and driving more visitors to their sites

Summary
I like the business and the founder seems to be very passionate about it, he owns 75% of the company and bought 2 million shares recently on the open market. They are growing fast and while the valuation multiples seem a bit higher, if they deliver the stock will look like a huge bargain in a few years. They can grow in many areas including offline shops, e-commerce, creative agency, advertising and by launching new sites. I have put 6% of my portfolio in Hypebeast a price of 0.99 and I'm using a stop loss as always.

Found two more interesting stocks today: ARCE and DLHC.

ARCE (Arco Platform) provides education software to hundreds of private schools in Brazil. It's used for online student exams, student benchmarking, displaying individualized content and syllabus based on a student's progress, managing school administration and much more. The company has contracted over 1,100 schools with revenues of $87 million TTM.  Revenue in latest quarter grew by 70%, the stock looks a bit pricey at 15 times sales, but based on estimated sales of $100 million for 2018 and taking out the net cash position, the stock is selling for less than 10 times sales. Definitely worth a closed look.

The next stock is DLH Holdings (DLHC) a company that provides health care benefits, software solutions and other services to government institutions. They are growing by around 10% per year, but what caught my interest was a P/FCF multiple of only 5, which is very hard to find these days. It has a market cap of only $74 million and sales of $133 million, with earnings depressed last year due to some one-time effects. Their business description is pretty vague, I don't understand yet how they make money but will try to figure it out. In the latest quarter, they had 7 million in debt and 4.3 million in cash. With a Piotroski score of 8, the balance sheet looks pretty solid. Margins are low because it's a government contracting business, returns on invested capital are likely to be low as well in the future. The valuation multple is too low to ignore, have to look further into it.

  

China offers incredible investing opportunities and is often overlooked by investment professionals in developed markets. Many investors avoid the country, because of a lack of transparency, protectionism of domestic companies, previous accounting scandals and general distrust. But the fact is, that China is the second largest economy in the world and will surpass United States to become no.1 sooner or later. Despite general misconceptions about China in the West, there are many honest and hard-working entrepreneurs there who have built successful and lasting companies, and I believe JNBY is one of them.

JNBY Design sells apparel, footwear and accessories to women, men and children primarily in China. The name "JNBY" is derived from Jiang Nan Bu Yi (or Just naturally be yourself"). It was started by a group of design students in 1994 as a single clothing shop in Hangzhou China. In 1997, as the number of stores expanded the founders Li Lin and Wu Jian (who are married) established Hangzhou JNBY with a focus on women's clothing. More than 20 years later, the group is still going strong and expanding across China and into developed markets.

Mrs. Li Lin (Chief creative office) started designing clothes at the early age of 12 and her passion continues even today. Mr. Wu Jian (Chairman and Chief executive officer) is mostly responsible for the operations of the company and further development. Together, they both own 61% of the company according to the latest annual report. JNBY is not a brand that is riding the wave of recent popularity, rather the company has churned out successful designs and products for more than 20 years and launched several well-known brands for women, men and children. The company is repeatedly ranked among top 10 women designer brands in China according to Fung Business Intelligence report. Between years 2005-2011 the company launched the brands CROQUIS, jnby by JNBY and less. In 2016, they have expanded their portfolio by introducing Pomme de terre, an apparel brand targeted at younger generations. In the same year, JNBYHOME was born, a designer brand for furniture and household products. The company primarily targets middle to high-income customers, which means their products cost somewhere between $15 to $1000. The company gives significant leeway to its team of experienced designers, who are lead to come up with their own original designs, instead of responding to latest fashion trends.

The main driver of revenue is their loyal fan base, which as of December 2017 had 1.9 million subscribers on WeChat (up 27% since July 2017), 800,000 followers on Weibo (up from 200,000) and 2.3 million followers on their Tmall store (up 28% in the same period). Active membership accounts (those that made at least two purchases in last 12 months) reached 290,000, up 26% since December 2016. You might say, that every fashion brand has its followers and members, but those at JNBY contributed 67% of revenue in the 6 months ending December 2017. That's a significant number and the company collects a lot of data points about their purchases, spending patterns, online visitation and shopping frequency. 

In addition, the company has been very smart with their expansion, focusing mostly on lower-tier cities, where competition is limited and foreign brands are less dominant. Only 12.4% of their stores are located in Tier 1 cities (Beijing, Shanghai, Chengdu, Hangzhou, Shenzhen etc.) and 87% are in Tier 2 or smaller ones. As a result, they have been able to build a very large reach and position in smaller cities, and now can expand from a position of strength to the larger ones. The company sells their products in 3 ways: self-operated stores (557), distributor operated stores (1211) and online. Revenue from the online channel grew 31% in fiscal 2017, and 45% over the 6 months ending December 2017 but still represents only 8.5% of total sales. There is significant room to expand their online presence thanks to a large and growing fan base on WeChat and Tmall. Self operated stores are usually stand alone shops, but can also be smaller shops located within department stores in shopping malls. 

The company's fiscal year ends in June instead of December, and here are their financial results since 2014:

As we can see, revenue has almost doubled over this period, reaching 2.67 billion RMB ($420 million) and net income has almost tripled to 416 million RMB ($65 million). Net income margin has improved by 4.7%, thanks to better cost management, an omnichannel inventory system and higher gross margins. I expect this trend to continue, especially with regard to gross margins, as the company gets bigger and gains more leverage over suppliers. The company previously had a separate inventory management system for online channels and retail stores and now they have unified it, which resulted in faster delivery times and lower operating costs.  Revenue grew 22.6% in fiscal 2017, and accelerated to 26% over the last 6 months ending December 2017.

Now I'm no fashion expert but JNBY's numbers just make me salivate. Their 4-year average ROA is 19%, while 4-year average ROE is 50%. You won't find such returns in many companies, let alone in the retail industry. This one is truly exceptional. Their return on equity actually went down in 2017 to 26%, because the company raised a lot of cash in the IPO, which hasn't been used yet. If we look at return on invested capital, the number is even more staggering. In fiscal 2017, their equity reached 1.26 billion RMB, while they had 828 million in cash and short-term investments with no debt, which means their invested capital was only 429 million RMB. Dividing net income by this figure, we get a 77% return on capital, that is just outstanding.

Growth has been driven primarily by opening new stores around China and abroad, but also by rising same-store sales as evidenced in this chart. An expanding fan base is the main reason for the increase in traffic in stores, while their customers generally spent more per visit in 2017 than 2016. Rising discretionary income is helping fuel a boom in China's apparel industry, which grew approximately 5% in 2017.

JNBY started primarily as a brand for women, but later expanded to children and menswear. While the brands for women (JNBY and less) represented 80% of sales in 2014, this number was down to 68%, thanks to high growth at CROQUIS (men), Pomme de terre and jnby by JNBY (children). All their product categories are growing strongly, with JNBY up 23% in the 6 months ending December, CROQUIS up 19.5%, jnby by JNBY up 34%, less up by 45% and Pomme de terre up by a staggering 201%. I believe that each of these brands has potential for at least several hundred standalone stores. The company has proven very adept at designing and expanding new brands and I believe this trend will continue way into the future.

Pomme de terre is the fastest growing brand in terms of the number of stores, up 19% in the last 6 months. Less and jnby by JNBY both grew 18%, while CROQUIS stores expanded by 11% over the same period. The company actually closed one JNBYHOME store and ended the year with 2 stores. The pace of expansion is really staggering and JNBY plans to add at least 200-250  stores per year over the next several years, which is roughly in-line with the 270 stores added over the past 12 months. Out of the 1768 stores they operated at the end of calendar year 2017, 40 of them are located overseas, mainly in Hong Kong, Taiwan but also United States, where they have one store in Seattle and two in San Francisco. Also the CEO Wu Jian announced in February, that they are looking for distributors in Europe, and the company is preparing for international expansion. 

The exact size of the apparel market in China remains unknown, as various consulting companies or regulatory bodies report conflicting numbers. The only thing we can say for sure is that the market is really huge and expanding faster than those of Europe or United States. According to the Hong Kong Trade and Development Council (HKTDC), the overall apparel market for adults in China was worth 1,144 billion RMB ($180 billion) in 2016 and the market for children was worth 145 billion RMB ($23 billion). The apparel market for women grew 5% during 2016, and is expected to continue on this trajectory at least until 2019. The menswear market was up 4%, while the market for children's apparel grew 7%.  The sportswear market was the fastest growing segment, up by 12% in 2016. This compares to growth of 1% for the European clothing market (Source: Euratex) and 3% growth for the U.S. apparel industry. China is growing faster simply because they started at a lower base and still have many years to go. If we assume that it will grow in-line with GDP at 5-6% per year, that's still double the rate of US and nearly 6 times that of Europe.

The Chinese apparel market is highly fragmented with over 10,000 brands fighting for customer's attention. According to Fung Business Intelligence, JNBY had a market share of 0.4% in 2015 and was the 38th most popular womenswear brand in China. JNBY brand is visible only in the womenswear category, as shown in the table below. Brands like CROQUIS, less or Pomme de terre and not yet so popular or known around China, and I believe there is significant room to expand them.

As we can see the industry is still consolidating, as the best brands have around 1% of market share, and 6 out of 10 most popular ones are foreign. JNBY has its own unique style that targets mainly women between 25-30 and is growing faster than most of their competitors. The company has also set-up their own fabric development team to provide unique and original designs for women clothing. The group also buys environmentally friendly materials for garment manufacturing like organic cotton jersey, recycled nylon or VITA fabric. JNBY also has their own teams, that inspect third-party supplier factories before and during the textile manufacturing process, to ensure the highest quality of their end products.

The company's primary competitors are Koradior Holdings, La Chapelle, China Lilang, Heilan Home (menswear) and Giordano. 

Heilan Home is the elephant in the room. Their revenue and market cap just outmatches others, according to estimates Heilan (and their brand HLA) hold around 4% of the menswear market in China. Tencent and JD.com both bought a minority stake in Heilan Home recently, which is a part of their online to offline e-commerce strategy. Given their large size, growth has slowed down but is still a respectable 7%. Their net profit margin is 18%, second to only China Lilang which has 25%. JNBY is the third most profitable retailer, It's also the second fastest growing company in the group, behind only Koradior Holdings, which increased revenues by 38%.

It seems that JNBY is the most expensive from the group based on their P/E ratio alone. That might be a bit misleading as it's growing way faster than average and taking market share from competitors. It's also still small compared to Heilan Home or La Chapelle, based on their revenue. In addition, the company has room to improve profit margins further (although it already has the highest gross margin from the group), thanks to better cost control and increasing leverage over suppliers, which would reduce their P/E further. I am so optimistic on JNBY primarily because they earn very high returns on capital, are continuously launching new successful brands and have recently begun their international expansion. I don't think they will be very successful in Europe, as their designs are very different from those popular here, but I might be wrong in the end. On the other hand, United States has a very large Chinese population, and they might capture some market share there.

JNBY is a very well managed and fine business with lots of growth potential. The valuation is on the high end of its historical range now, but I don't mind paying a bit more for such a good company. I think they are on the verge of a major expansion phase and even though I'm a bit late to the party, with their shares up almost 200% over the past year, there is still plenty of upside left. I believe the company will grow revenues by at least 25% over the next several years, and net income should grow even faster thanks to economies of scale, which means revenues would hit around 8 billion RMB in 2023. I have put  8% of my portfolio in the stock at a price of 17.6 HKD. Good luck in investing!