Tingyi (322 HK)

Joshua Kennedy, Sonian Capital Management

jtk@soniancapital.com
June 2014

Would you have bought Coca-Cola in 1988?

Imagine for a moment, rather than reading this recommendation in 2014, you are instead reading a
writeup recommending the purchase of shares of Coke in 1988.
You read this recommendation and you say to yourself: is this a contrarian idea? Coke was already
enormous, with a $20 billion market cap. It cannot be said to have been undiscovered in any sense.
And it certainly had not been underperforming: the stock price had appreciated every year between
1980 and 1988.
Well, you say to yourself: is it cheap? Umm not in any obvious way, no. At the time Coke sold for
approximately 15x earnings, 5x book value and 12x cash flow. This was a 30% premium to the sector
average on earnings, and a 50% premium on cash flow.
But the investor saw something, because he bought enough of the stock for it to be, in effect, a 25%
position. He filled his boots. With a stock everybody knew about. And with the benefit of hindsight we
know this was one of the greatest investments by one of the greatest investors of the modern era: the
then-59-year-old Chairman of Berkshire Hathaway, Warren Buffett. The stock was a 10-bagger 10 years
later. A $1 billion investment became $10 billion.
What he saw and Im reducing here -- was the combination of two factors:
1) A durable competitive advantage. In Cokes case this was comprised of its brand, customer
loyalty, and global distribution system.
2) A long runway of growth. In Cokes case, in 1988, this was characterized by the fact that
the average American consumed 290 servings of Coke per year, while in most global
emerging markets, the per capita consumption could be counted on one hand.
There are many companies with a durable competitive advantage. And there are many long runways of
growth. But the combination of the two is rare and if you think you can name more than a few, you
may need to re-think your assumptions on one or both factors. It is the combination that is critical,
because the company in question needs to be able to re-invest the extraordinary profits that accrue
from its competitive advantage into that same competitive advantage, and it needs to do so for a long
time.
Buffett looked at Coke and concluded he could be almost certain that Coke would still be making money
the same way, many years down the road. And he looked at the international penetration of Coca-Cola
and concluded he could be almost certain that consumption would be higher, probably much higher,
many years into the future.
In his 1989 annual report -- which is a tour-de-force -- Buffett would call the cigar-butt investing that he
had practiced for much of his career up to that point foolish, and would pen several of his mostquoted investing aphorisms, including: Its far better to buy a wonderful company at a fair price than a
fair company at a wonderful price.
1

I include this rather lengthy prologue not because I am recommending Coke, but because I am
recommending what I believe to be the closest thing to Coke in 1988 that is available today. A company
that dominates its growing market with a durable competitive advantage and will do so for many years
to come, and that is available for a price that today is fair, but in 10 years will appear to have been a
steal: Hong Kong-listed consumer packaged goods maker Tingyi.

Background
Tingyi is both Chinas largest maker of instant noodles and Chinas largest beverage company. The
Tianjin-based company was founded in 1991 by the four Taiwanese Wei brothers, and 61-year-old Ing
Chou Wei remains Chairman and Chief Executive today. The companys products utilize the Master
Kong brand1 (image below), esteemed in China for quality and value. Tingyis sales in 2013 totaled
$10.9 billion, and the companys market capitalization is approximately $15 billion.

Tingyis Noodle Business

Its our snack, its our peanut butter and jelly sandwich, its our bowl of cereal. Its something that has
been a part of my life forever. -Korean-American chef Roy Choi on instant noodles in Asian culture
Tingyi is the worlds largest maker of instant noodles, a $44 billion market that analysts expect to grow
to $61 billion by 2017, an 8.5% CAGR. China is the largest market for instant noodles and Tingyi really
controls it, with volume market share of 44% and value market share of 56%.

Master Kong is an adaptation of the name Kongzi, of which the anglicanization is Confucius. Thus, Master
Kongs brand representation is consistent with traditional Confucian values: frugality, duty, honesty, cleanliness.

Tingyi makes about 2/3s of its profits from noodles, although noodles only represent about 40% of
sales. Noodles is a more mature category than beverages sales growth has slowed to 9% in each of
2012 and 2013, from approximately 25% in 2010 and 2011. But noodles is a big cash generator for
Tingyi; the segment has earned an 11% operating margin each of the last 4 years. If Tingyis noodles
business were to stand alone, and you were to value it at half of Tingyis market cap, it would be a 4.5%
FCF yield business.
Tingyi started their instant noodle business in 1992, and sold a stake to Japanese noodle maker Sanyo
Foods in 1999. Today, the founding family owns 33% of the shares, Sanyo owns 33% of the shares, and
33% float freely. While 9% annual sales growth is still robust, Tingyis noodle business appears in most
regards to be a cash cow, throwing off investment capital for the beverages business that is both larger
and more fragmented.
Chinas market for noodles is enormous. 43% of all instant noodles sold in the world are sold in China:
42.5 billion units in 2012 thats 100 million units a day. But this is not a sunset industry. Per capita
consumption in China remains relatively low. China only consumes 32 packets per capita annually, while
South Korea consumes 69 packets, Indonesia consumes 63 and Japan and Taiwan each consume 40
packets/capita.
In addition, and more promising, is the potential for growth in average selling price. Chinese in Taiwan
and Hong Kong spend 2x as much on instant noodles as their mainland counterparts. Cup noodles and
bowl noodles, instant noodles which come packaged in the Styrofoam vessel in which the noodles will
be cooked, tend to sell for 3-4x the price of packet noodles, which must be cooked on a stovetop. In
China, cup and bowl noodles only account for 17% of consumption, compared with 47% in Taiwan. Cup
and bowl noodles, where Tingyis share is a towering 67%, are still growing strongly due to demand from
time-poor city dwellers.
Tingyis competitive advantage in noodles is based on its enormous scale (edible oil, flour and PET are
big inputs), a trusted brand, and superior distribution.
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Tingyis Beverage Business

The next decade is still a golden stage for the development of the food and beverage
industry in the PRC Tingyi Chairman Wei, 2012 Annual Report
In 2015, China will become the worlds largest beverage market. Chinas beverage market
is currently 4x the size of the noodle market and growing at a faster rate. The largest
component of the beverage market is bottled water at 32%, followed by carbonated drinks
at 23%, then juice at 17% and RTD (ready-to-drink) tea at 16%. Tingyis beverage
business is a joint venture with Japanese drinks giant Asahi, of which Tingyi owns a
controlling stake of 47.5%2.

Tingyi has leading share in the bottled water market at 26%, but it is RTD tea that is
Tingyis stronghold. Approximately half of Tingyis beverage sales come from RTD tea and
Tingyi controls approximately half of that market. Tingyis beverage sales make up 57% of
total sales having grown 27% in 2013 but so far only generate 30% of operating profits.
The beverage business currently generates only 3.5% operating margins for several reasons
which are discussed below. It is a growing market where competition is fierce and
characterized by aggressive promotional spending. Tingyis sources of advantage in
beverages, like in noodles, are its scale, brand, and a laboriously built distribution system,
which allows it to introduce new products efficiently.

Pepsi and Competitive Advantage in China

2

Ting Hsin is the Taiwanese investment vehicle of the founding Wei family, so Tingyi management controls a
majority of the Tingyi-Asahi JV in conjunction with Ting Hsin.

In late 2012, Pepsi, struggling with losses in its China business3, finally admitted to the
stark reality of beverage competition in China: distribution matters most. In exchange for a
5% stake in the Tingyi-Asahi beverage joint venture (TAB), plus an option to raise the stake
in the future, Tingyi acquired the right to manufacture, bottle and distribute all of Pepsis
beverages in China, royalty-free.
It is a remarkable deal, and I think it heavily underscores the width of Tingyis moat when it
comes to distribution. Pepsi had 24 bottling operations in China, with a combined book
value of $600m. Pepsis option allows it to pay cash to increase its stake to 20% of TAB
before 2015, at valuations that escalate periodically.
But consider for a moment what Tingyi gets in this transaction. With their distribution
network and scale in bottling, Tingyi was able to eliminate Pepsis incumbent losses by end
2013. The company describes the integration as halfway done, hinting that the Pepsi
management pay scale was higher than Tingyi and can be brought down. Tingyi
management believes this can be an 8% net margin business in the next few years, so in
terms of turning a loss-making business into a nicely profitable one, its basically a cinch.
To put some numbers on this: the market for carbonated soft drinks in China is
approximately $12 billion USD. If Pepsi has 30% share and earns an 8% net margin, this
could ultimately add $250-$300 million USD in profits to TABs bottom line in addition to
the $155 million the beverages business earned in 2013.
Thats not the whole story, however, because Tingyis distribution system is now flush with
Pepsi product portfolio. Today, Tingyi commands one of the only two brands that matter in
carbonated soft-drinks4. Then there is the Tropicana brand: 100% juice only represents 5%
of market share in the Chinese juice segment (Tingyi already has 23% share in diluted
juice). Sports and energy drinks are less than 3% of all beverage sales, but growing
swiftly, and Tingyi now controls Gatorade. These are outstanding brands, now in the hands
of a company that has the tools to leverage them.
What is really remarkable to me about this is that Pepsi is a globally dominant company that
has been spending tens of billions of dollars buying back its bottling operations around the
world. Pepsi had invested $1 billion in China since 2008 and in 2011 ear-marked an
additional $2.5 billion of capital spending there over the following three years, albeit for
both drinks and snacks. And then in 2012, looking at the remaining challenges of
competing in beverage distribution in China, Pepsi basically threw up its hands and said:
forget it. It reminds me of Boromir explaining that one does not simply walk into Mordor.

Pepsis bottling unit reported after-tax losses of $46m in 2009 and $176m in 2010.
Pepsi has 31.8% market share in carbonated soft drinks in China, #2 behind Coke, with approximately 50%. Pepsi
actually has nearly 50% share in cola flavor, but Coca-Colas Sprite brand has significant share. Tingyi may be able
to promote Pepsis 7-Up to steal share from Sprite.
4

One does not simply build a distribution network in China. It is folly.

Although it can be hard to make meaning of these numbers, here is what youd have to do
to build a production and distribution system to rival Tingyis: open 566 sales offices, 75
warehouses serving 33,504 wholesalers and 110,355 direct retailers. Youd need 80,541
employees, 654 production lines, and 119 production centers. As Boromir said: Not with
10,000 men could you do this

Chinese Consumption and the Runway of Growth

The image above comes from Coca-Cola5. The message is clear: what was true for Buffett
in 1989 remains true today. Coke and by extension all carbonated soft drinks -- are still

Just a comment on the slide: what is that guy doing? Is he speed-skating? Break-dancing with a Coke in his
hand? I know Coke is the master of consumer branding, but images like this make me wonder.

underpenetrated internationally, particularly in the emerging world. Im not sure anyone

can imagine Chinese consumers ever drinking 400+ servings of Coke every year like the
US, (let alone matching the jaw-dropping Mexican levels!), but I expect that Chinese
consumption grows inexorably toward levels currently exhibited by other developing
nations. For China to reach the average of just Russia, Turkey and Brazil would suggest 4x
growth.
The penetration of Coke products referred to in the chart above is simply meant to illustrate
the broader Chinese beverage market. In terms of non-carbonated soft-drinks and water,
growth opportunities are also ample. In 2011, Chinas per capita beverage consumption
was 52.6 liters less than half of Taiwans 113 liters, and only 15% of the USA at 342
liters. Regarding RTD tea, Japan and Taiwan each have per capita consumption of over 40
liters, while Chinas is 11.5. For bottled water, already the largest component of the
beverage market, Chinas per capita consumption remains below the global average, and
just 1/5th of Hong Kong.

The Price War Or,

How Long Does It Take to Drown Your Competitor in the Bathtub?
In order to properly value Tingyi, it is essential to understand the competitive landscape, in both noodles
and beverages. While the entire marketplace is extremely competitive, the most straightforward way to
understand it is to examine the battle between Tingyi and its fiercest competitor in both noodles and
RTD tea: Uni-President China.

Tingyi, as discussed above, absolutely dominates the instant noodle industry in China. But like a great
sports franchise accustomed to winning championships, Tingyis expectation is domination and nothing
less. A simplified version of the price war goes like this: Uni-President gained substantial share in 2010
by launching a differentiated and very successful flavor: Lao Tan Pickled Cabbage and Beef Flavored
Noodles6. Tingyi responded with its own pickled cabbage flavor and in the way Tingyi does
methodically set about reclaiming lost market share by leveraging its distribution and amping up
advertising and promotional spend. And of course it worked, blunting the advance of UPCs market
share.
In 2012, sensing the inevitable, UPC launched an aggressive promotional war, known in the industry as
the sausage war because of the dehydrated ham sausages included in packs of noodles as a free bonus.
Tingyi responded with its own sausages and settled into a siege mentality. Tingyi is methodically
drowning UPC.

Do you hear that, Mr. Anderson? That is the sound of inevitability.

The two companies compete in beverages, as well as noodles. And while the sausage war has been
more widely reported and watched, a similar story has played out in the milk tea category on the
beverage side. Uni-President launched a breakthrough product, Tingyi matched it and methodically
staunched the advance and then reclaimed share. In beverages, however, the damage to margins has
been more observable. Critically, what this means is that when the sausage war eventually ends, the
impact will not be limited to noodles. It will reverberate throughout Tingyis business.
There are signs that the war is nearing an end. Tingyi has clearly stated its parameters: when the
company has 70% share in pickled cabbage noodles, it will cease sausage inclusion. In some
geographies, the promotions have already been withdrawn, and Uni-President has signaled its appetite
for a truce.
In addition to the observed changes in UPCs market behavior, here is why I think Tingyi has won this
war and that it will end soon:

Pickled cabbage flavor sounds crazy but, seriously, its delicious.

The chart above is UPCs free cash flow. They are losing a lot of blood. UPC made an operating loss in
2013, for the first time in its history. Meanwhile Tingyi is still making profits and generating free cash.
How much longer can this go on? Well, the chart below is the net debt as a percentage of total equity
on UPCs balance sheet:

Sure enough, in May 2014, UPC announced a 1-for-5 rights issue, raising $3.3 billion HKD to repay debt.
This is actually less money than went out the door in 2013, so the company clearly will not tolerate a
much higher debt load than it currently bears. UPC is majority owned by a well-financed parent,
Taiwanese retail giant Uni-President Enterprises. But reportedly, headquarters tolerance for a long,
bloody war and its associated cash burn is limited.
Finally, below is why I think it will be so important to Tingyi when competition rationalizes, whether next
year, three years or five years from now:

This chart is Tingyis SG&A/Sales ratio for the last 15 quarters. The increase is, in essence, the burden of
a heightened competitive environment. Lets call it 4 points of SG&A/Sales. If Tingyi is able to reduce
this spend at some point in the future, those 4 points drop pretty much straight to the operating line. In
Tingyis case, this would nearly double its current operating margin, which for the drinks business in
2013 was a paltry 3.5% and for the group was 5.3%.
Tingyi management have a reputation for meticulous cost control. From the years 2005 through 2009,
Tingyis beverages business earned double-digit operating margins, averaging 13.2%. Managements
guidance for 8% net margins in the Pepsi business suggest a return to double digit operating margins for
the beverages business overall is achievable. With noodles currently earning an 11% operating margin
in a challenging environment, that segment appears capable of contributing 12-13% or higher. Overall,
my expectation is that Tingyi can achieve a 10% overall operating margin by 2016.

And At Last The Stock Price

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Tingyis stock price first breached $20/share in the second quarter of 2009, five years ago. Today, the
stock sells for $21.25. During that time, Tingyis sales have more than doubled, growing double-digits
every single year. The companys gross margin has remained steadily around 30%, which is Tingyis
long-term average in both noodles and beverage.

Gross profits double over five years but the stock consolidates

But in that time, the company has not grown operating profits, because its operating margin has fallen
from 10.8% in 2009 to 5.3% in 2013. This makes Tingyi look expensive on an earnings basis: nearly 25x
2015 consensus earnings. Eye-watering for a company that hasnt grown its bottom line in 5 years, to
be sure. But while the stock has consolidated, Tingyi has chosen to endure short-term pain in order to
position itself to dominate longer-term. That era is about to begin.
This is why I believe Tingyi can only be understood in the context of its market position and the
competitive dynamic in food and beverage in China. Consider that Tingyis Pepsi business made no
profits in 2013, but will contribute significant profits in the future7. In a more rational competitive
environment, Tingyis operating margin can return to 8-10%, and its net margin can return to 6-7%8.
Tingyi has historically sold for approximately 25x earnings, and thats what youre paying today. But
Tingyi today is under-earning, and so I believe you are getting fantastic assets for a much cheaper than
historical price.

A Wonderful Company at a Fair Price

Circling back to Buffett and his Coke investment: he paid 15x earnings, 5x book value and 12x cash flow.
Tingyi today? Also 5x book value, also 12x cash flow. What matters, in this case, with this type of
business, is not necessarily what headline multiples you pay, but rather how certain you can be that the
competitive advantage you perceive will remain in place for years to come, and how many dollars can
7

$250 million USD annually from the Pepsi business -- $119m after minority interest -- would represent 30% of
2013 total group core net profits.
8
On this I differ from consensus, which projects a net margin under 5% through the end of 2016. Here is
something I believe: forecasts based on valuation models are not very good at capturing operating leverage.

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ultimately be reinvested within the moat that the competitive advantage creates. This is a classic serial
compounder.
The advantage allotted from the distribution system Tingyi has built is, in the eyes of a competitor as
fearsome as Pepsi, basically insurmountable. And the growth implied by Chinese beverage consumption
levels is virtually inevitable.
Tingyi, then, with $11 billion in sales today, is set to grow to 3-4x its current size in the next decade.9 It
seems to me, with the growth of the market, the addition of the Pepsi portfolio, already established JVs
in snacks, frozen foods and infant dairy, and with nearly $2 billion USD in cash on hand for potential
acquisitions, that this scale is far more likely to come to pass than not.
My valuation: By growing sales 13% in each of 2014-2016, and by achieving a 10% OPM, the stock can
reach $32 HKD in 2016, an IRR of 17%, not including dividends. At that point the stock would sell for a
22x trailing multiple; it has not sold below 25x since 2005. At the end of 2016, I believe that Tingyi will
still be a company with a durable competitive advantage and a long runway of growth, capable of
compounding appreciated capital for years to come. It will be a $25 billion USD company, net cash,
generating $1 billion USD annually in free cash, paying out $500 million in dividends.
I am using 3-year numbers here. But I really think this is a 10-year idea.

Other Valuation Considerations

Below are some valuation comparisons for Tingyi. Want Want China Holdings is a useful one in some
regards: it is a comparably-sized, China-focused food and beverage manufacturer started by a
Taiwanese entrepreneur. But it competes directly with Tingyi only in bottled water, and its presence in
dairy products and its utter domination of the uniquely Chinese (and high-margin!) market for rice
crackers makes margin comparisons somewhat less valid. However, it is instructive to know that low
margins are not the inevitable fate of Chinese F&B companies: Want Want earned 18% net margins in
2013.
Regarding Coke and Pepsi, I would highlight a few things. 1) They are approximately 10x the size of
Tingyi. 2) Tingyi looks cheap on sales multiples but of course Coke and Pepsi do extremely high gross
margins (50-60%). This is in part a feature of their business models but I would emphasize that Coke and
Pepsi have both been buying back their bottling operations in important markets in the last few years.10
3) On EV/EBITDA, Tingyi, Coke and Pepsi are about in line. Tingyi does not have a global brand like Coke
or Pepsi, but also is not exposed to any mature markets, only the swiftly-growing Chinese market.

To triple sales from 2013 levels in 10 years requires compounded annual sales growth of 11.6%. The companys
trailing 5-year average sales CAGR is 20.6%.
10
Tingyi also looks cheap on multiples higher up the income statement because it consolidates TABs results and
pays a large minority interest line item to its JV partners.

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Tingyis balance sheet is appropriate for a steadily-growing but cash-generative business, with net
debt/equity at 15% and $1.9 billion USD of cash-on-hand. Despite the difficult business environment,
the company has generated approximately $500m USD in free cash flow each of the last two years,
despite spending nearly $1.7 billion USD on capex over that time.11 The company pays half of its
earnings out as a dividend, today yielding 1.3%.

Tingyis Brand
Coca-Cola is often cited as the single best example of the value of a brand. Indeed, many people believe
that there is in fact no discernable difference at all between Coke and Pepsi, except that people seem to
feel better about Coke. What better description of the value of a brand could there be? One of the
stories about why Buffett and Munger decided to bet so heavily on Coke in 1989 is that in their own
estimation, the value of the Coca-Cola brand was $100 billion, based on the amount you would have to
spend in advertising to replicate it. And the whole company, at the time, was selling for $20 billion.
Tingyis Master Kong brand is not like Coke or Pepsi. It is virtually unknown outside China. But the
Chinese market is so large, so much potential, that Tingyi doesnt need to be known outside China. The
Master Kong brand must be evaluated for what it is: an indigenously Chinese brand for Chinese
consumers. I am not going to assert that it is worth some multiple of the market value of the company.
But it is quite a valuable thing, and it may indeed be undervalued.
In Tingyis 2012 annual report, the company cites awards by the German Brands association for Best
Product Brand and Best F&B Brand in China. The association approximates the value of the Master
Kong brand at $1.5 billion.
Master Kong is the single most frequently chosen brand by consumers in China. According to brand
consultants Kantar Worldpanel, the brand is bought by more than 91% of households in China the
highest penetration of any consumer brand. It is also purchased the most often, at an average of
9x/year. Master Kong products were purchased 1.3 billion times in the last year.

11

This is a capex/sales ratio of 8.7%, which I expect to decline toward 6% with scale, boosting FCF

13

In 2011, market research firm TNS ranked the most valued brands in China12. Japanese electronics firm
Sony was #1. Master Kong was #2. Here is what I think is the most impressive illustration of the Master
Kong brand position, from Kantar and Bain Consulting:

The chart above demonstrates that not only is the penetration of Master Kongs brand extraordinarily
high in noodles and tea, but it also shows a critical factor about the approach that Chinese consumers
take to brands in the packaged goods categories. The most penetrated brands utterly dwarf the average
penetration of the top 20 brands in that category. The conclusion then is that once Chinese consumers
find something they like and trust, they choose it again and again and are not particularly apt to try out
new brands. To me, that is the basis of a brand-based, and therefore durable, competitive advantage.

Why Does this Opportunity Exist?

No discussion of an investment idea is complete without asking to paraphrase Howard Marks OK,
but who doesnt already see that?
12

Not valued in the sense of valuation, but rather a ranking of brands that consumers highly value.

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And yet, while that question is intrinsic to our stock-picking methodology, I have largely argued that
Tingyi is hiding in plain sight. It is not undiscovered not at a $15 billion valuation and with literally
dozens of analysts covering it. It is not the product of a restructuring, it is not under new management,
it does not employ disruptive technology.
Rather, my contention is that Tingyi is right there for everyone to see, but investors seem to not quite
understand what it is they are looking at. Why? A few possibilities:
1) Only by watching Tingyis main competitor Uni-President, can we conclude that the
promotional war of attrition is nearing an end. Tingyi, which has maintained growth and
gross profitability during this period, will benefit substantially from operating leverage.
2) Only by watching Pepsis decision-making in China are we are able to put a conceptual value
on Tingyis greatest asset: its distribution network. Tingyi is further under-earning by
absorbing Pepsis loss-making operations, but will leverage Pepsis product portfolio for
years to come.
3) Only by understanding Master Kongs brand for what it is: a Chinese brand for Chinese
consumers, can Western investors appreciate what a powerful asset it is for Tingyi.
Finally, Tingyi is currently a bit of a tweener. Value investors cannot get past the PE multiple, despite
the reality that Tingyi has been under-earning. Growth investors cannot get excited about a company
that hasnt grown its bottom line substantially since 2009. And momentum investors cannot get excited
about a stock price that has consolidated for 5 years.
To appreciate Tingyi for what it is, no matter what type of investor you are, you must be willing step
outside your style box. I hope this document, to some small degree, helps make that possible.

Catalyst
Fundamentally, nothing represents more of a paradigm shift for this company than a change in the
competitive environment. But there are some more technical catalysts in the near future, in particular
related to the ownership of the beverages JV.
First, Pepsi must decide whether or not to exercise its option to increase its stake in Tingyi-Asahi
Beverages by October 31, 2015. Pepsi must pay cash at a pre-determined and escalating valuation to
take its stake from 5% to 20%, on a fully-diluted basis. If Pepsi exercises the option, Tingyi would hold
40%, Pepsi 20%, and Asahi and the Wei family ownership vehicle Ting Hsin would own the remaining
40% between them.13 The initial deal valued TAB at $15 billion, which has grown by 15% in 2014 and
will grow by another 15% in 2015.
By October 2015, Pepsi will have to decide whether to pay approximately $3 billion in cash to increase
its stake in TAB. $3 billion in cash is a spicy meatball, even for Pepsi. So Pepsi is in a tough spot, either
they pay the cash which confirms the value of the JV at $20b, or they deem the valuation too high, save

13

Thus, Tingyi management would maintain control

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the $3 billion presumably to spend on their snacks business in China, and leave Tingyi with a larger share
of TAB.
Either way, once it is settled, Tingyi will begin the process of IPOing the drinks business, probably in
2016. While it is currently difficult to determine without a lot of subjectivity what the value of the
noodles and drinks businesses are separately, a listing of the drinks business will provide clarity.

Risks
Tingyi is a large buyer of flour, palm oil, PET and sugar. There can be no question that as these costs
rise, Tingyis gross margin suffers it hit a 10-year low of 26.5% in 2011. I think this risk is manageable
because Tingyis scale makes it the lowest-cost producer with the strongest buying power. In fact, the
promotional environment in both noodles and beverages that we currently see is enabled by the current
benign input price environment. When the tide rises, the tallest man is still breathing while others
drown. For its part, management refers to current input prices as still at a high level.

This input price risk is intertwined with the question of whether or not Tingyis market position implies
pricing power. Doing business in a centrally planned economy, Tingyi and its competitors need
government approval to raise prices, and somewhat infamously this request was denied in 2007 as
inflation surged in China. This is a knock on Tingyi, but I tend to see it differently. First, it has created
the environment we see today where no competitors are willing to cut prices, rather all the price
competition is conducted through promotions. I think this plays to Tingyis advantage in that it has the
greatest scale and most respected brand. Second, while the market tends to view this restraint as a lack
of pricing power, I think it is more like what Charlie Munger likes to identify as unexploited pricing
power, as Tingyi has learned to live with a stable price environment, but Chinas market is only
becoming more open over time. Finally, Tingyi has effectively been able to raise prices in the past by
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introducing new, higher-value products and exiting the lowest end of the noodle market. The noodle
value upgrade cycle represents considerable pricing opportunity for Tingyi.

Conclusion
Several times every year, a weighty and serious investor looks long and with profound respect at CocaColas record, but comes regretfully to the conclusion that he is looking too late. The specters of
saturation and competition rise before him. Forbes Magazine, 1938
While I have made an admittedly lengthy argument here, I have left out many factors that should
influence an investment decision. For instance: I believe strongly in Tingyis management, its depth, its
approach to the brand and to maximizing shareholder value. I have largely omitted discussion of
Tingyis other growth opportunities in snack foods, its capex requirements, efficiency programs for the
companys operating cycle, the list goes on. It is possible, in a report like this, to blur the readers eyes,
to practically go on forever
Rather I have tried to streamline to what I think is essential and in the process try to illuminate a
broader question about investing in general: when do you pay up? If you are a value investor you buy
cheap stocks, and if you are a growth investor you buy growth stories you think are underestimated.
But what do you do with the 10-year money? How do you decide the right value for the wonderful
business?
I think it looks something like Tingyi. Tingyi is in two businesses that will not be disrupted. Noodles are
part of the essential fabric of Chinese life, the very definition of a staple. Beverage consumption can
only grow in China. Whatever happens to Chinese socio-political life in the next decade and the
changes could range from meaningless to significant noodles, water and tea will be consumed. And
Tingyi will not be moved from its position. Growth may be lumpy, profitability may vary, but Tingyi will
be a productive asset, supplying essential goods to loyal customers in ever greater numbers.
The dilemma is highlighted by the quote above from Forbes. I dont think a company like Tingyi ever
looks cheap in real time. It only looks cheap in hindsight.

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