Kingsmen Creatives

Hi Nick,

With due respect, Kingsmen's reputation and talent pool can serve as a competitive moat though not in the strict sense of the word. It's an intangible asset which companies have and is not visible on the Balance Sheet, but contributes to enterprise value as well.

For your comment on gross margins, one year of declining gross margins (due to the huge USS contract) should not be used to conclude that gross margins on the whole for the industry are declining. If the work is of quality and the client is of sufficient reputation, they will be willing to pay premium dollar for the service.

As for companies such as Noble which you say have built up their empires worth billions of dollars, do note that this is as a result of a lot of debt and their net margins are even thinner than Kingsmen. The industry is also inherently cyclical and risky and it's like comparing apples to oranges when stating that these companies have a moat. Yes, this may indeed qualify as a moat, but what is their ROE and is it based more on debt rather than internal cash flows? This may not qualify such companies to be good investments.

So yes, I do beg to differ.

Hi wee,

No problem at all. I am glad to have a healthy exchange of ideas.

I am not saying a high return - high capex company is a good investment. I am just stating that there exist a moat which few companies can replicate unless they have billions of cash sitting in the bank.

Reputation exist as long as the reputable designers exist within the company. It wouldn't take billions of dollars or even months if a determined vulture seeks to enter the industry by poaching. A high return low capex biz will eventually attract poachers - it is pretty natural.

My question is hence whether can KC withstand such a threat ? I think yes but definitely with a price.

In my mind, I do not think Kingsmen has any individual great designers (although i'll be happy to be wrong). Considering the ME and ID business, i reckon most original master designs would have come from client side. That said, designers and other players are still necessary to bring concepts down to the local level and to execute. It's the team (and probably a few key players) there that makes the difference. Competitors can poach individuals, but its harder to poach a team. Quirky individuals may not want to just work for anybody either. Let's extrapolate options available to KC staff. Other than PICO, there are not many other close competitors who could offer the same potential. If he exists, a star could go anywhere, and that would be KC's challenge. Even so, that star has to built from a much smaller base, work with a smaller team and infrastructure.

As an investor, it has troubled me wondering if KC can keep their people. One quantifiable indicator could be their manpower turnover but that may not show for key personnel. I just looked at their AR 2004 vs 2009 senior management, the 2004 people are all still there, in an enlarged team.

From the active discussions in the last 2 days. I can see there are quite many forumers who are serious investors having an interest in and looking hard into Kingsmen. For such a high-quality and promising company as Kingsmen, I think this is perfectly understandable.

There must be some kind of "moat" within Kingsmen's business. Otherwise, how could the company (established in 1976) have lasted the last 35 years, built and kept such a high-quality customers base, and recorded the business growth and good financial numbers since its listing on SGX in 2003.

Perhaps Kingsmen's stated Corporate Philosophy (extracted from the company website) re-produced below will help all of us to better understand/appreciate its "moat"....

"Corporate Philosophy
The heart of quality at Kingsmen lies with the people who are totally absorbed in the notion that quality impacts the market.

Everyone has a role in Kingsmen because every member is a vital link in a chain of activities that produces customer satisfaction.

Based on cooperation and mutual respect, management and staff work hand-in-hand towards a common goal, focussing on customer's needs, priorities, competitiveness and ultimately, profitability.

After all, the customer's success is our success."

From the above, I can see Kingsmen's "moat" in their managers/supervisors/staff and, more importantly and specifically, how the senior management has trained and treated them, and directed them towards doing their daily work as an unified team to meet customer's needs and try to exceed their expectations.

I can also see the "moat" in Kingsmen's very strong customer focus - on their needs and a lot more, including their profitability. This to me means that Kingsmen - apart from just providing their services to customers at a competitive price - will also strive to provide good/effective solutions to help customers to achieve their own business objectives and profitability. I guess this smart business strategy has earned for Kingsmen the trust from customers, and many have chosen to stay with Kingsmen over the years.

(28-01-2011, 12:27 PM)Nick Wrote:

(28-01-2011, 10:12 AM)Musicwhiz Wrote:

(28-01-2011, 09:41 AM)Nick Wrote: I guess the main issue with KC is its lack of moat. There is no expensive asset, lock-in revenue period, human capital is the main asset (which can easily be poached) etc. I hope the industry's ROE tanks so that it doesn't attract larger vulture which can easily over-run KC position in this growing sector.

Just curious - why would expensive assets and lock-in revenue create a "moat"? Most probably if you have expensive assets they would be highly specialized and require constant maintenance & upgrading (i.e. capex). Lock-in revenue like charter contracts does give visibility but does not tell you much about the customer strength in repayment and the margins, so that is also a potential area of concern.

Human capital is not so easily poached as the Company may have built a culture of loyalty into their key employees by granting share options or other perks.

I find the OCBC report (as usual) too short-term. All 3 factors it mentions in "headwinds" relate to near-term (2011) earnings visbility and even the arbitration proceedings is a short-term consideration. It goes on to conclude that just because of these factors, Kingsmen's goal of doubling revenue in 5 years time "appears stretched". I rest my case.

I would classify KC's industry as one of high return - low capex. This is naturally one of the best industry to be in since the cash-generating ability should be in excellent shape. But let's not forget that such industries will not exist in such a shape for long if there is no viable moats.

Examples:

1) Specialized Service Companies - law firms, consultants etc

Why: The bulk of their asset lies in their human capital. There is no need to spend big $$$ to double their profits.

Moat: Size and prestige. Moreover, they tend to adopt a 'partner-associate' model which promises huge rewards to those who succeeds. Difficult for a small firm to attract talent.

2) Management firms - REIT Manager, Trust Manager etc

Why: There is no need to spend big $$$ to increase their AUM. Net-working is the key here.

Moat: Lock-in revenue. Very difficult to remove a REIT Manager from power.

3) Technology firms - Microsoft, Apple etc

Why: Patented software can generate huge amount of cash-flow.

Moat: Patents

I think you get the picture - there is a viable moat in each of these companies which ensures the situation can remain at it is.

In KC (and Pico etc) case, the moat lies solely in their human capital (their designers etc). The only way to retain human talent is through a good remuneration package. But this is one of the weakest moat since a larger and more established player can easily offer more $$$. A bidding war will reduce profits and hence ROE in the long run. We are already seeing this happening slowly - gross margins are declining slowly.

A high return - high capex companies offers an 'automatic' moat by virtue of its capex.

A good example would be the local commodity firms. I would consider the likes of Noble and Wilmar to have sizable moats. It would take billions of dollars and years before any competitor can achieve a similar scale as them. I can't build another mine in Japan but I can easily poach a few talented engineers to beef up my design company.

Naturally, you may wish to disagree. I don't mind buying KC (it is in my watch-list) due to its good cash-flow and yield. But to claim that KC has strong moat is hardly accurate.

I believe the moat in 2) is simply because in Singapore, trust manager or property manager charges too much for trust fee or property management fee. too high passive income for them.

if the manager does not do much, they do not deserve a high passive income. and the acquisition fee should be paid in years rather than one-time, so they will think twice when they acquire new assets.

I can’t help but notice the amount of interest generated. For argument sake I’ve decided to chip in some of my personal observations as well. The prevailing arguments here seem to revolve around the economic moat that Kingsmen seems to or seems not to be having.

What exactly is an economic moat? It refers to a business' ability to maintain competitive advantages over its competitors in order to protect its long-term profits and market share from competing firms. Having a strong talented team of salesmen + advertisers + designers + contractors etc does not equate to having an economic moat. Simply put, this is expected from any decent and well-managed company in any industry. If other competitors or even new entrants can easily put together a similar and functional team, this is as good as not having any moat at all. As to whether Kingsmen truly possess a quality team vastly different and superior to other similar players in the industry, I will leave it to those who follow the company more closely than I do.

There are 5 types of economic moats that we usually know of:
1. Product differentiation.
2. Branding.
3. Low costs or prices.
4. Locking in customers.
5. Locking out competitors.

Clearly, Kingsmen does not belong to an industry befitting of type 5. There seems to be varying degrees of arguments supporting or opposing the other categories.

1) Product Differentiation is when a company is able to produce or market a product with technology or features superior to others, thus allowing a premium fee to be charged. I do not not think Kingsmen belongs to such a category. In fact to attribute this characteristic to any event management company is pushing it a bit too hard.

2) Branding can be a wide and deep economic moat. People are often willing to pay much more for the branded designer goods compared to an identical item selling for less but without a brand. Though it may be argued that mega event organisers for instance, would want to look for reliable and reputable companies to handle such events, thus urging them to pay significantly higher for such services, I would contend that this would hardly be an appropriate case to establish. The challenge to branding services is to bring tangibility to what would otherwise be difficult to quantify, i.e. emotional experience, brand personality, soft-dollar benefits for instance. Personally, I have difficult appreciating how Kingsmen is able to do so in an effective and meaningful way.

3) Competing based on cost for similar or identical products is another type of moat, seen more commonly in industries where there is sense in obtaining cost benefits through economies of scale. From what I hear from industry players previously, Kingsmen seems pretty good at doing that. How exactly they are able to do so I’m not sure, but I’ve heard stories of how their sub-contractors are bullied in submission by virtue of their dependence on Kingsmen’s strong contractual flow. If that is true, such an unhealthy scenario would not be expected to last. Whether this is indeed true, I will leave it to those who are interested to dig up further.

4) Lastly, if an industry is able to lock in customers by virtue of a high switching cost in place, it can also be a valid economic moat. However it is far too easy to switch from one event company to another without any penalty. There is no retraining, no infrastructure to redevelop, no user experience to maintain. In essence, there is nothing preventing Kingsmen’s customer from switching to another competitor. Probably the only change is that the staff doing the costing might need to resubmit another proposal.

In essence, I would agree with Wee and Nick that human capital hardly qualifies as a valid case of economic moat. There may be specific business competences built up by Kingsmen over the years thus making it a more attractive investment proposition to some, but I would disagree that this can be claimed to be a form of “moat”.

Similarly, it would be unwise to claim there is an effective moat simply because a company may have lasted for the past few decades, as this is akin to saying any company established decades ago have some kind of “moat”. A simple illustration would be the case of “kacang puteh” peddlars, who exist till this very day. There would be businesses which exist just for existence, and not because they are holding some qualities that cannot be replaced.

That said, I do not have a vested interest.

May I invite all those who do not believe there is some kind of "moat" within Kingsmen's business, to spend some time looking into the history/business of Nebraska Furniture Mart (a Berkshire Hathaway company), and its famous founder Mrs B and her management style/practices.....
http://www.nfm.com/ourstory_history.aspx?ID=1a
and then try to guess/understand how kind of "moats" WB saw in this business before he bought it in 1983.

As I have said in my earlier post, there must be some kind of "moat" within Kingsmen's business. Otherwise, how could the company (established in 1976) have lasted the last 35 years, built and kept such a high-quality customers base, and recorded the business growth and good financial numbers since its listing on SGX in 2003.

Thanks for all the wonderful comments and analyses by fellow forumers, some of which are really detailed and insightful.

My point of view is much simpler, and not based on definitions of Economic Moat. For me, if I can observe that the business has decent growth prospects, is able to maintain good and regular FCF, has a clean Balance Sheet, and high ROE which is not due to leverage; all these factors come together to inform that it is a well-run company. Of course not everything can be "perfect" and there will be risks and competitive assaults occurring now and then, but the numbers do speak for themselves.

Another thing is the clientele and also projects and events which Kingsmen is engaged in. Many of the customers are very established global brands and the events are high profile ones. To me this signals that the Company has the core competence to execute and deliver quality work to their customers, which is why they continue to be sought by such an international clientele.

Of course, I am vested and cannot be fully objective. But just sharing what I have observed and the factors which influenced my purchase, plus adding in the numbers aspect too to bolster my case.

Thanks.

I recently renovated my place. I also compared notes with 2 other friends who renovated their place. Without reservation, I would have chosen the interior designer used by my friend, even though the premium was some 30% over mine (this is a rough gauge based on itemised billing).

Delivery on target, quality, lack of hassle - all these are intangibles. Kingsmen does not need to have the best designers. It may not even need to have good designers.

What it has, is its proven ability to deliver a quality product/service at the appropriate price. It has the relationship built up with major players.

These are not economic moats in the strict sense, as they may be ephemeral. But they are moats, nevertheless. My personal take is simply to see if (i) margins can be expanded in the future? and (ii) margins can be maintained?

I think the answer to (i) at this moment is clearly no. (ii) is a maybe, and we need to see how it pans out in this FY, when the impact of USS is taken out. The second thing to note is whether it can continue to expand its orderbook - failure to do so implies a static business. Not a bad business still at this price, but where will we find the drivers of the stock price from?

Vested

can someone with more money assemble a team of top designers to replace Kingsmen in the market place?

if can't, is this considered some kind of "moat"? there is not high barrier to entry, but there is high barrier to achive the scale of Kingsmen.

30+ years of industy experiance, good customer relationship and good reputation can't be replicated overnight.