The value of an investment, and any income from it, can fall as well as rise and investors may not get back the amount invested.
Van Gogh went through five potential careers before becoming a painter of idiosyncratic genius. Roger Federer’s sports included skiing, wrestling, badminton and football before, aged 12, he settled on tennis. These examples, cited in David Epstein's book Range: How Generalists Triumph in a Specialist World, demonstrate how hard it can be to predict success in a given field.
There are parallels here with investment in general, and with the portfolio in particular. As long term-growth investors in Japan, looking 10 years into the future, we often don’t know which endeavour, product or even which business segment will generate the most shareholder value. Early promise can end in failure, but failure that leads to another kind of success. What the world’s best businesses share with great artists and sports stars are certain traits or strengths that make ultimate success more likely.
In all these cases, positive outcomes come from deeply ingrained ambition, a culture that allows experimentation and failure and a commitment to stay the course in challenging times. As investors we rate these factors highly, while keeping an open mind over what path our holdings may follow. And we know not to over-extrapolate from the success of a hit product or service – it may prove ephemeral.
Amazon and Netflix are examples of businesses that flourished in unpredicted ways. It’s easy to forget that Amazon Prime and Amazon Web Services (the cloud infrastructure business) were only conceived over 12 years after the company was founded in 1994. Today’s Netflix bears little resemblance to the DVD sales and rental company launched in 1997. Video streaming didn’t arrive until a decade later and it wasn’t until 2013 that Netflix produced the original content that’s now its greatest strength.
Japan has many companies that, like Amazon and Netflix, have evolved by experimenting. Some are longstanding holdings, others more recent positions.
CyberAgent started out in online advertising, but it was its social blog Ameba Pigg which underpinned profits during its formative years. After Ameba Pigg amassed over a million users and began generating sustainable profits it launched a series of additional services: a foreign exchange (FX) margin business, a corporate venture capital business and a mobile advertising unit. At this point many would have challenged management for lacking focus and allocating capital to areas with no proven track record, instead of reinvesting ‘in franchise’. Indeed, we ourselves overlooked the company until 2013.
Fast forward to today and CyberAgent is Japan’s standout leader in mobile advertising. It has a formidable track record in online gaming and, more recently, has established a lead in streaming television and video content, boasting over 10 million weekly average users.
CyberAgent has had failures as well. Ameba Pigg fizzled out and the FX business was sold to Yahoo! Japan in 2013, having weighed on profits for years. Music subscription service AWA, launched in 2015, also failed to gain traction and been downplayed. But these disappointments pale into insignificance given the outstanding success of other business units. We argue that this willingness to experiment and to embrace failure has underpinned the company’s success. Back in 1998, and even 15 years after that, it was unclear what path CyberAgent would take and what would drive shareholder value. With hindsight, the components and traits of wealth creation are clear. Founder Susumu Fujita has instilled a culture in which employees are offered an attractive working environment and an opportunity to experiment.
The dominant C2C used goods platform Mercari is a more recent example of a business branching out. With its eponymous portal now the default platform for trading used goods online in Japan, and with operating margins consistently 30 per cent or higher and with room for online used goods penetration to grow to a multiple of current levels, this diversification might seem premature, even foolhardy.
Since listing on the Tokyo Stock Exchange First Section in 2018, Mercari has reinvested profits in its US business where it lacks scale and faces tough competition from eBay, Poshmark and others. We were sceptical of this plan, having seen Japanese companies struggle in the US, yet its recent growth there has been faster than at home. Reaching $100m dollars per month, the target for turning profitable, seems imminently achievable. Similarly, Mercari’s venture into online payment with Merpay seemed questionable, given the strength of PayPay and Rakuten Pay in Japan. Again investors have been proven wrong. Last time we checked, Merpay had amassed over 10 million users.
Mercari’s formative years looked very different from its recent forays into new areas. Dating from 2013, Mercari tried and failed with bicycle rentals, classified media and online travel before establishing the now successful online used goods service. Had we invested then, we might have criticised its scattergun approach. Instead we should have praised management for its culture of experimentation.
CyberAgent and Mercari have strengthened as they’ve grown. This is down to two factors: First, experimenting has provided great learning opportunities that have refined the core business. Second, connections between different business segments have strengthened the overall offering, creating natural synergies. For example, CyberAgent is now able to use reliable free cashflow from mobile advertising to fund its gaming studios, while Abema TV has proven excellent for advertising new games. Similarly, Merpay may not ultimately become Japan’s leading payment business, but it has greatly improved service on its used goods trading platform, improving its ‘stickiness’.
What does this all mean for our investment approach? That we should be open minded when investee companies experiment with new ventures: giving them the benefit of the doubt, provided they demonstrate the ambition and commitment to succeed. That when considering new investment, we should also resist our industry’s bias towards companies that specialise early and put all their eggs in that basket.
David Epstein’s book notes that when scientists study the early development of successful athletes, they often observe them spending less time practicing the sport in which they ultimately excel than lesser players of that sport. Instead they undergo what researchers call a ‘sampling period’. The same should go for businesses.
Risk Factors
The views expressed in this article are those of Andrew Brown and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved in March 2022 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
Potential for Profit and Loss
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
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The images used in this article are for illustrative purposes only.
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