The Coral Capital podcast recently hosted an interesting conversation with Jonathan Shih, the founder of Keyrock Capital Management. His firm is an active investor in Japan across public and private markets. He discusses Japan’s overlooked growth potential and how this came to be a key area of focus for the firm, some considerations for private companies which decide to go public, managing IR and investor expectations as a private vs. public company, and some of the differences between management communication styles in Japan versus other markets.
Some of my notes from the interview are included below. These are for personal reference only and not intended as a comprehensive transcript; any mistakes are also my own.
On the history of Keyrock Capital Management:
They were founded in 2018, with most of the team based in HK. They are a pan-Asian investment firm, but a lot of what they do is in Japan. They take fairly concentrated long-term bets on the companies they invest in. The fund typically won’t have more than 10 investment positions and that really helps to distil down to what they consider to be the best ideas, founders, companies etc. They have a public equity focused hedge fund and, within that, there is also an allocation they can utilize to invest in private companies. They have also raised a smaller, separate vehicle for dedicated private investments. When they invest in a private company, their intention is to be shareholders even post-IPO and to provide some stability in the shareholder base through that IPO process.
On Keyrock’s investment into Timee (a labour marketplace for spot workers):
They met Timee back in 2021 and, truth be told, the company has completely blown through their own forecasts of what they would be doing, which emphasizes to him that there is a tremendous opportunity for startups in Japan if you can get the product/market fit right. The company has been around for 6-7 years now. In 2020, their business got completely disrupted, because most of the clients they were serving were restaurants and retail stores, which themselves faced a lot of disruptions in their business and hence the demand for labour.
What he found really impressive was the company’s ability to quickly pivot away from those core industries that they were serving towards logistics, which is now more than 50% of their business. When they invested in 2021, they were still in this Covid-period, there were restrictions on going out, restaurants were closed etc. As long as they didn’t embed that normalization into their forecasts, it was free optionality on restaurants and retail demand coming back. That is really what has played out and over 2022/23, the momentum for the business really shifted, logistics was on fire and demand from restaurants and retail stores also came back very strongly.
On how they initially identified growth opportunity in the Japanese market:
For the first ~12 months of the fund, their Japan exposure was limited. Most of what they were doing was in China, as well as the rest of Asia. Then, in 2018, he got to meet the CEO of Money Forward and he was blown away with that meeting. Here was a founder who was Western-educated, who decided to quit his job at Monex to found Money Forward, and he was making really bold statements that he had never heard any Japanese management team talk about (e.g. wanting to revolutionize the accounting industry in Japan through software). That meeting became a pivotal moment for the firm and they began to ask how many more Money Forwards might there be in Japan.
So that is when they started to look for opportunities in Japan more closely. Between ~2018-2021, they did a lot of research on all the listed growth companies in Japan and what they found was that many of these companies had just gone public. Then they started to look at the upstream, to build up their research on companies prior to their IPO, so they would be in a good position to evaluate those companies at IPO or thereafter. His personal investment philosophy is that time is the best indicator of truth. Over time, you are going to be able to figure out whether a market, industry, management team is going to be great. So what he wanted to do was pre-pone a lot of that research. In 2021, they also started to look at private investment opportunities and that is when they met with Timee, subsequently invested in them along with 3 other private companies in Japan.
They didn’t have any crystal ball in terms of this focus on Japan but, generally speaking, success in the investment business is inversely correlated to competition and the supply of capital. You often need to go to the areas of the market that are underappreciated and where you can do some unique things. Back in 2018/19, nobody was talking about Japan growth. It has been a really productive and interesting journey over the last ~5-6 years and we are still only in the second or third innings.
His thoughts on whether companies should raise in the private markets or IPO:
This is something they about a lot with the founders of their portfolio companies, in terms of when is the right time to go public. There are two points to consider. 1) You need to be of sufficient scale in the public markets to attract institutional investors and you will typically need to be at least US$1bn in market cap for a Fidelity or Capital Group to really look at you seriously. Otherwise, the reality is that your shareholder base is probably going to be primarily domestic and retail. 2) The most important part of going public is you are now going to have to open the kimono, so to speak. You will attract a lot more attention and also have to disclose your unit economics to your competitors and prospective competitors. So the question is are you going to be able to defend your competitive position post-IPO, particularly when there are going to be certain expectations of you as a public company, including in terms of profitability.
On best practices for managing investor expectations and IR for private vs. public companies:
The IR activities for a private vs. a public company are completely different. He would use an analogy of a SaaS company, which may have direct sales, but they also may have channel partners. The way you manage those two channels are completely different. On the direct sales front, you employ, manage, train and have control over your direct sales team. That is similar to a private company’s IR activities. They basically control who the shareholders are, and what types of fundraising activities or share transactions go on.
Once you move on to public status, he would liken that more to channel partners. Your channel partners are not employed by you, they don’t have to do what you want them to do, they have other alternatives, they don’t have to sell your product. So, in order to be able to nurture, manage and grow through your channel partners, there has to be this delicate balance between how are you going to incentivize them but also how are you going to manage/influence them. Truth be told, when you go public, you have no control over the share price. From a private company standpoint, management teams are very good at and always have this mentality of wanting to get the highest valuation possible. From a public company standpoint, that might not always make sense. The activities and mentalities between IR for a private and public company are often very different.
When he was at business school, they had a Fortune 500 CEO speak to their class, and one of the things the CEO said was he didn’t get concerned when his company’s share price went down. If the share price goes down, he knows the shares are undervalued and he can demonstrate this. Rather, he got concerned when the share price went up a lot, because the fundamentals haven’t necessarily changed and so do the shares really deserve to be at that valuation? From a public company IR perspective, you have to not only be cognizant of when your shares go down and can you effectively communicate the story, but also when your shares are at peak levels, can you walk down expectations and manage that volatility.
On any contrasts in management communication styles between Japan and the US:
Very hard to generalize across all the founders and management teams he has met and interacted with. Instead, what he has found to be really helpful during the due diligence phase prior to investment is to really understand what is driving this founder’s motivation – do they care about money, their employees, is it ego, their position as a CEO etc. What is the most important thing? Then you have to communicate to that CEO or management team around that motivating factor. Being able to interact with and convince your portfolio companies to do what you think they should do is a really important thing, and he doesn’t think that is any different in or outside Japan.
Generally speaking, however, he has observed that Japanese management teams will manage down expectations on what they can achieve, versus outside Japan it can be more aggressive and they want to tell you how amazing they are, what they are going to achieve in the future. One other thing he has noticed in Japan is that there is a lot of consensus building in terms of the board, shareholders etc. Many times, you will find that any difficult conversations have already been had outside of the board meeting. Whereas outside Japan, shareholders and management teams are not afraid of disagreeing with each other in more of a public setting.
At Keyrock, they try to be as transparent as they can with the management teams they work with. Part of that is because he doesn’t speak Japanese and so, sometimes, he will have to rely on a translator. Therefore, he has to be as direct as possible, otherwise whatever nuances he is trying to communicate will not get through. If he thinks that a company or management team is doing poorly, that is what he has to say, otherwise they may not get the message. Part of what helps, however, is that management teams don’t expect that he knows Japanese customs and so he can perhaps say something that a Japanese person wouldn’t be able say. But generally speaking, he is trying to give them the story as straight as he can and in a very simple manner.
On their research process when evaluating a market and/or business:
They are kind of like a call center in that, every year, they do more than 500 reference calls across the portfolio and also on prospective companies. That is where they are going to be able to derive their insights on that company, industry etc. Of course, reference calls on management are a key part of that research. They also find that speaking to current clients of that product or service is really helpful in order to understand the pain point the company is solving, and also what the alternatives were (i.e., why did the client decide to onboard this service). Lastly, what they look for is the market. Growth solves all and if the market/company is growing, good things will happen and a lot of the issues you find with companies end up not being a problem. It is only a problem if there is no growth. So, they spend a lot of time thinking and assessing how big can this market be, and how big can this company be within this market.
On the key questions start-ups should address before going global:
Generally speaking, they are not underwriting for international growth. Often times, he will meet with entrepreneurs who have a global ambition and, even within their portfolio, some of their CEOs have said they do want to go global at some point of time. The most important question he would ask them is what is the pain point you are going to solve in the global market that is not being solved today. Why are you going to uniquely solve that problem? Usually, with that question, the CEO will pause and not really have a a great answer, because the going global ambition is really about them, and not about the customer or market. Whereas when they think about the Japanese market, it’s not about them, but about the pain point they are going to solve. It is not that he doesn’t want their companies to go global or discourage founders from having the ambition, but until you can answer that question, what is the point of going global because you are not going to add value to the global market.
On Keyrock’s sectors of focus:
They are open to investing in all types of sectors, but in the past they have gravitated towards SaaS. The opportunity for SaaS penetration in Japan is very large. The software market in Japan is 1/4 the size of the market in the US, and SaaS in Japan is still only 1/4 as penetrated as in the US (~10% vs. ~40%). So, the growth opportunity is very large and, also, if you wanted to create a SaaS company it tends not to be that capital intensive. Within SaaS, they have focused on back office software (e.g. LayerX, which does invoice management, or Nealle, which does software for parking lot management). The main thing they are looking for is some demonstrated track record of the company’s product/service being launched already. The company should have demonstrated a sizeable client list, that they are generating at least US$5-10mn of revenues etc. In turn, that enables them to go and do due diligence to assess whether there is that product/market fit.
On Japan’s overlooked growth potential:
To him, the biggest misconception about Japan is there is no growth. If you were to speak with 100 non-Japanese investors, when you talk about Japan, most of them are going to think about activism, corporate reforms etc. Growth and Japan are almost antonyms. But over the last ~5-6 years, what he has seen is that if you can get the product/market fit right, you have a tremendous amount of opportunity to grow (e.g., Timee has grown sales ~20x over the last 3 years).