Taiwan and Korea are both markets that are blessed with a number of companies for which potential change through engagement is central to the investment thesis, and in which there are therefore high-quality companies that are undervalued.
This is not because of core fundamental deficiencies, but due to a deficit in terms of governance, capital allocation, disclosure, their approach to material environmental issues and strategic urgencies, which are fixable.
Levers to achieve change range widely, including measures to enhance governance, improve strategic capital allocation, disclosure and investor relations, and introduce a material sustainability framework to each company. A combination of higher incremental returns alongside a lower implied cost of capital will drive higher economic value added, and in turn justify a valuation multiple re-rating.
For example, many companies in the semiconductor value chain represent good opportunities for value creation through more efficient capital allocation. Although the semiconductor industry has seen a sharp de-rating on account of slowing end market demand and inventory pressures, a number of companies (asset-light semiconductor IC design businesses) are backed by strong balance sheets with significant cash piles.
Alongside opportunistic buybacks to build book value per share, recent geopolitical concerns in Taiwan have created uncertainty surrounding many of these businesses’ main competitive advantage – their talent. Chinese chip IC design companies have been seeking to lure Taiwanese talent to develop their own nascent industry, with inflated proposed salaries. Were this ‘brain drain’ to accelerate, it would rapidly deteriorate the competitive positions of a number of semiconductor IC design and IP companies.
Engagement has focused on i) embarking on an inaugural buyback programme of material size; and ii) using the acquired shares to initiate a KPI-linked, share option incentive scheme to bolster talent retention. Having ownership in the business, rather than being mere employees, naturally inculcates a greater sense of belonging, pride and crucially, commitment.
The method of engagement matters. Aggressive activism framed by litigious threats, hostility and short termism have largely been ineffective in Taiwan and Korea. Cultural differences, less legal shareholder protection, tightly held ownership and fewer potentially supportive private fund managers blunt the effectiveness of such methods.
Instead, engagement should be defined by initially seeking friendly partnership with management teams. Interactions begin with humility while employing a significantly longer-term horizon with an unswerving ambition to first improve alignment. As a result, interactions are not shaped around public shareholder letters and shaming. Instead, conversations are private and supportive, communicated through bespoke presentation decks, recurring open discussions and whitepapers.
Such engagement showcases previous work with other portfolio companies and introduces a number of steps that can unlock significant shareholder value. It outlines the likely impact this can have on the businesses’ return profile and introduces comparisons with peer companies (both in emerging and developed markets) that can act as a reference. It is important to stress one is on the same side as portfolio companies. These engagement action points aim to provide helpful, material and actionable suggestions that lean on prior experience and outside perspective.