Podcast: Daye Deng

I spoke with ⁠Daye Deng (邓达业)⁠, author of the ⁠East Asia Stock Insights⁠ substack, about the Chinese sportswear industry and two of its leading players, Anta and Li Ning.

We began with Daye's background as a Chinese person growing up in Japan and then Canada; his career as a buy-side investor; and why he's now devoting his time to companies in Northeast Asia, using the Chinese sportswear companies Anta and Li Ning to illustrate his approach. We touched on the trends driving Chinese consumers' interest in sportswear; what makes sportswear companies good businesses (see the chart below); the rise and travails of China's homegrown sportswear companies; Li Ning and Anta's origin stories; Anta's success with a multi-brand strategy; the two companies’ distinct cultures; their corporate governance issues; the persistence of fierce inventory cycles in the Chinese market; and Anta's investment in Amer Sports, a holding company which owns Arc'teryx, Salomon, Wilson and other brands.

The following transcript has been lightly edited with ChatGPT:

Graham Rhodes: Welcome to the Long River Podcast. My name is Graham Rhodes, and I'm delighted to be here today with Daye Deng, author of the East Asia Stock Insights on Substack. Hey Daye, welcome to the podcast.

Daye Deng: Hi, Graham. Great to be here. How are you?

I'm doing good, and I'm excited to speak with you today. We're going to talk about two of the companies you profiled on your Substack recently, Anta and Li Ning, as a window into the Chinese sportswear industry.

But before we go any further, I have to give the usual disclaimer. None of what we go on to talk about is investment advice, so please don't treat it as such. Everyone should always do their own homework. Is that right?

That's right.

Okay, Daye, why don't you begin by giving us a quick recap of your CV?

Yeah, okay. Let me just give you a quick personal background. The thing is, people are often confused. I usually need a minute to explain because I'm Chinese by background. So my parents are Chinese, but I was born in Japan, and at the age of 9, my family and I immigrated to Canada where I went to school, did my undergrad at the University of Toronto, and worked in Toronto for five or six years after I graduated. Then, I moved to Hong Kong, worked there for three years, and now I'm in South Korea. So, I've been all over the place.

In terms of my career, I've spent almost 10 years on the buy side, covering East Asia, actually, at two firms, and they were both long-only. I had the chance to work on a number of different mandates during this time, which included a Japan-only mandate, a Pan Asia mandate, and I also had the chance to look at Asia as part of a global fund, along with some colleagues that looked at other parts of the globe. So, I was in the industry until 2021, and now I'm an independent analyst operating my own research platform called East Asia Stock Insights.

And until, I think, late last year, earlier this year, you were writing in partnership on another Substack, but you launched the East Asia Stocks Insight Substack because, in your words, you think this is the most exciting region in the world for investors today. Can you tell us why?

Just speaking from the perspective of allocating my own capital as an investor myself, I'm really excited about the region today. And I think it's going to draw more investor attention going forward. Just quickly on that, so like, by East Asia, I mean just three countries, basically: Japan, China, and Korea.

With Japan, it's the most well-known among the three here, the investor interest is really high right now, and I think, mostly for great reasons. As people know, like governance improvements, Warren Buffett has recently made some investments, right? And the macro situation is also very interesting with kind of inflation insight, right? With all the wage increases and whatnot. I think the story here is not over, and there's a lot of interesting things going on.

Today, I guess we're going to talk more about China, and that's a lot more controversial, I suppose. The risks here are, you know, basically well-known right now, political, regulatory, all that stuff, but at the same time, the markets. Valuations are at a historic low, and I just can't help but think that there are opportunities here in some names and just also starting to see actually more value investors start picking away at things too.

And then there's Korea, the last one. That's the least well-known to global investors, I think. And for myself too, it's a region where I'm doing the most to actually ramp up myself, but it's super cheap. And it's also like a Western-aligned democracy with the rule of law, just like Japan. I think maybe the market will still need some reforms, but I'm just watching it closely to see if it could become the next Japan, so to speak.

If you're going to spend time anywhere in the world, I think you've chosen a good spot. So, who is your target audience, do you think, and what kind of content do you plan to publish?

Most of my subscribers are professional investors, portfolio managers, and analysts on the buy-side, I would say about 80%. As for the content I publish, most of it will be stock write-ups. Given my own career experience working at long-only shops, my focus is really on understanding the businesses, the industries, and the drivers from a long-term perspective. I think what I write will cater to the long-only crowd. Regarding my regional focus, I'm currently spending about 70% of my time on Japan, which is reflective of the content I'm putting out. However, depending on investor interest, market valuations, and other factors, this could change in the future.

And do you think you'll address geopolitical or macroeconomic risks in your writing? Or do you think you'll assume that your subscribers are comfortable with those risks?

The short answer is no. I feel like when it comes to topics like geopolitics, people have already made up their minds, or at the very least, it takes too much effort to change one's view, and I'd rather spend that time elsewhere. I think platforms like Twitter or X are better places for expressing these opinions, especially since no one is paying me for them.

Fair enough. And how do you pick the companies you profile?

There are broadly two kinds of companies that I choose to profile. One is companies that I believe are actionable and can make money, although, obviously, nothing I say is investment advice. I'm never going to make any guarantees in my write-ups. However, it will be fairly obvious to my readers when they see an idea that I'm bullish on or that I find actionable for myself.

The other category includes companies that might not present an immediate value proposition due to high valuations or unfavorable risk-reward ratios, but are important for investors to know about because of their size, position in the value chain, or exceptional business qualities. Examples include Recruit Holdings in Japan or key companies in Japan. I alternate between these two categories.

The first time you came onto my radar was with your excellent write-up of the Japanese trading companies. I thought you did a wonderful job busting some myths. For example, one thing I learned from you is that they're among the top choices for graduates to work at because of the entrepreneurial autonomy they offer. I had no idea about that, so I thought you did a really good job with that one.

Oh, I appreciate it. Thank you.

So, we're here today to talk about Anta and Li Ning, just to illustrate the kind of companies you choose and how you think about them. You wrote about Anta and Li Ning earlier this month, along with a primer on the Chinese sportswear industry at large. Why did you choose to begin with these companies in this industry?

First of all, that choice implicitly hints at how much I like these companies as investment ideas. I own these myself, although this is not investment advice. Nothing I say is a recommendation. There's also a trend that I'm trying to explore with these companies, which is the fact that the landscape in China has changed a lot over the years. Local brands like these are thriving and Chinese companies have really moved up the value chain. If you're a quality, long-term biased investor, I feel like a lot of these Chinese companies have become champions and should be more interesting to these groups of investors.

On the other hand, while we're going to talk about Nike and Adidas, I don't think it means multinationals are doomed in China. However, many investors have perhaps relied too heavily on these multinationals for their China exposure in the past. I think it's worth questioning whether that's still the best strategy, especially as these Chinese companies become industry champions. I just wanted to explore this and use sportswear companies as an example.

So, your first piece on the industry gave us a macro view. Why don't you set the scene with that?

Over the years, China's spending on sportswear and all things sports has grown, with the 2008 Beijing Olympics serving as a significant turning point, which we'll discuss more later. One of the major drivers has been government policy, a topic I delved into in my report. While many are familiar with the concept of the Five-Year Plans, it might surprise some to learn that sports are explicitly mentioned in these plans by the highest levels of the Chinese government. Efforts have been made to increase the number of sports facilities and the sporting population. Interestingly, the government has even targeted very specific areas, such as aiming for 2.5 percent of disposable income to be spent on sports consumption, which directly benefits companies like sportswear makers due to the detailed and precise nature of these targets.

If I can just jump in there, why is the government targeting sports?

I've often wondered why they care so much about sports. Is it just about promoting healthy living among its citizens? While that's a significant part, there's also the concept of cultural soft power and national unity, especially given the rise in nationalism in recent years. Sports unite people like few other things can, which is why China places so much importance on the Olympics and winning gold medals. Athletes are among the most admired individuals worldwide, transcending skin color and religious beliefs, making them a powerful tool for China to gain global soft power by producing star athletes. This strategy is far more strategic than many realize.

And what about the quality of the companies or the industry itself from a business viewpoint?

I really like it, for several reasons. Brand importance in sportswear cannot be underestimated, as it's a category of self-expression. Emotional attachments to favorite athletes drive people to pay premium prices for branded products. Building a sustainably strong brand in this industry is challenging, which is why there are so few companies like Nike. It's a complex industry, often underestimated, but I'm amazed at what it takes for these companies to continue succeeding in this game.

I would just add, and perhaps I'll include this in the show notes, that market caps in this industry follow a power law, suggesting increasing returns to scale. This manifests in continuous technical product improvements by financially capable companies, maintaining a distinctive edge over competitors and compelling consumers to return. Additionally, the nature of endorsements, due to their high cost, tends to be oligopolistic, allowing only a few companies to afford them, further reinforcing the dominance of leading brands.

Yes, I agree. It seems to be an industry where having scale is a real advantage. Another benefit is the breadth of the product lineup. For instance, Nike is strong in both apparel and footwear, and the same goes for a company like Anta, as we'll discuss later. It's very hard to achieve this, but once you do, it becomes difficult for competitors to emulate.

Why don't you give us a history of the Chinese sportswear industry from the bottom up? How did these companies begin? What are their origins? And it's interesting how you chose Anta and Li Ning because they have such different backgrounds. Could you start with that?

Chinese brands didn't actually exist until the early nineties. All these Western brands make their products in China, right? So, Chinese brands started as contract manufacturers for the big Western brands after China opened up. Eventually, some smart entrepreneurs in China realized that the real money wasn't in contract manufacturing but in owning the brands. Li Ning was one of the first brands to develop in 1990, followed by many brands in the mid to late nineties, including Anta. However, the genesis of these two companies is very different because Li Ning was started by the Olympic legend himself, Mr. Li Ning, while Ding Shizhong, the founder of Anta, came from the contract manufacturing side. We can get into more of this later, but just on the history itself, from the nineties to the two thousands, growth was really strong, especially leading up to the Beijing Olympics.

But this was a classic China boom and bust story because after the Olympics, all the brands got carried away, started opening stores like crazy, and overproduced, leading to a huge downturn from 2011 to 2014. This was a painful period for all the Chinese brands. Interestingly, it was also a time when many Chinese brands reflected on what was wrong with their business and tried to improve it. Many firms invested a lot during this period so that they could gather and analyze more data in their operations, for example. They also really professionalized their operations during this time. I think the ones that survived and came out of this became stronger, but it was also a period when foreign brands started becoming really big in China, from 2010 to 2019, which could be called the golden years for foreign brands like Nike and Adidas, whose market share went from 10 percent to 20 percent each in just eight or nine years.

Regarding the distinction between foreign and domestic brands, which segments of the market are they targeting?

Foreign brands are obviously more premium, but even among the Chinese brands, there is some delineation. Not all are the same. Among the Chinese brands, Li Ning is considered the most premium and is primarily in tier 1 to 2 cities, whereas Anta is more of a true mass market brand, with wider price points and geographic coverage.

You mentioned the golden years for foreign brands being from 2010 to 2019. What has happened in the last five years?

The last five years have seen the industry enter a new phase, which you could call the post-COVID phase. Foreign brands have been losing share. Adidas, for example, went through a significant downturn, and even Nike lost a few percentage points, while Chinese brands have been rising. Many attribute this shift to politics, like the Xinjiang cotton incident, where accusations of forced labor led many foreign brands to stop procuring cotton from Xinjiang, a major cotton-producing province. This had a huge impact on sales, with Adidas experiencing a 30 to 40 percent drop in one quarter.

While geopolitical events like this are certainly important and have influenced the competitive dynamics between Chinese and foreign brands, attributing the entire shift to politics misses the bigger picture. Chinese makers have been improving across all business aspects, like product design, marketing, and retail experience. The shift was already happening but wasn't reflected in the numbers until incidents like Xinjiang served as a catalyst. The trend has been long in the making.

And just in the same way that rising consumer nationalism was a trend that started many years before the Xinjiang cotton incident, you can see that with the rise of leading house brand Zhong Guo Li Ning, how popular it was.

Exactly. So, I guess there are two trends here that might be helpful to clarify. Some people use the term patriotic buying, which could actually mean one of two things. The first is a trend where Chinese people are more willing to support Chinese brands, especially since these brands have significantly improved. It's not like they're willing to buy inferior products just to show support, but it's this support for their homegrown brands. The other kind of patriotic buying is related to the Guo Chao trend, which is essentially a fashion trend. You might have seen hoodies that are yellow and red, inspired by the colors of the Chinese flag, or having huge Chinese letters printed on a T-shirt. These are fashion trends, and the former is a real, structural long-term trend, whereas the latter is cyclical.

Yeah, I see. But you'd have to think that for someone who's coming of age today, their impression of a domestic brand is going to be so different from someone who came of age in the early 2000s, in terms of quality, perception, and endorsements. They probably consider these brands as on par with Nike or Adidas in some ways.

Exactly. To understand consumption in the Chinese market, you've got to look at the Gen Z customers, those in their 20s and late teens. To these people, foreign brands don't mean as much as they did to their parents' generation. The stigma associated with Chinese products and brands is shrinking with the newer generation. This is partly due to the patriotic education, media, and social narratives focusing on the great rejuvenation of China and Chinese achievements globally, which have played a role in changing perceptions among younger people.

Or even just in simpler ways, like seeing the logo at the Beijing Winter Olympics or seeing athletes like Gu Ailing wearing Anta clothes. It's a huge endorsement.

Huge. That's a great point.

Let's shift gears again and move to compare and contrast Anta and Li Ning again, as you hinted at earlier, they have very different origin stories and their business development has also been quite distinct. Could you tell us in more detail about their origin stories and where you think they're distinct?

Sure, they have very different backgrounds. Li Ning and the founder of Anta are not similar. For those not familiar, Mr. Li Ning is an Olympic gymnast who gained stardom at the 1984 Olympics, where he won six medals, three of which were gold. He's a legend, and in China, saying Li Ning is almost like saying Michael Jordan in the U.S., that's the kind of weight his name carries. On the other hand, Ding Shizhong, the founder of Anta, was essentially a factory owner from Fujian province, a hub for contract manufacturing in China. Even though Anta is the largest sportswear maker today, Ding would recount how they were a latecomer and operated in the shadows of Li Ning for a very long time. It's a battle between an athletic legend and what I perceive to be a very astute business builder in Ding Shizhong.

One of the most interesting differences between them is their strategies regarding multiple brands versus a single brand. Can you tell us a bit about that?

Yes, it's a significant distinction. Anta operates multiple brands, and nearly all of Anta's brands have been highly successful, contributing meaningfully to Anta's financials. Li Ning, on the other hand, is largely just Li Ning. Even though Li Ning has other brands, they're not as impactful, and I don't think they're the company's focus.

So, just remind us, what are Anta's brands? What's in its portfolio?

There's Anta the brand, which focuses on core performance sports like basketball, training, and running. Then there's Fila, which originated in Italy and is considered a leisure or fashion brand, occupying the high-end segment. Financially, Fila is also very significant, making up about 40% of the revenue, with Anta's brand at about 50% and all others around 10%. Within that 'all others,' one brand that's becoming really big is Descente, a Japanese brand.

And that's run in partnership with a listed company in Japan, controlled by Itochu, right?

That's correct. Anta holds a 56% stake in Descente China, and the Descente company, listed in Tokyo, holds about 40%, with Itochu having a mid-single-digit percent.

The case study with Fila is really interesting because it was not a successful brand when Anta acquired it. Could you tell us about that story?

Sure. Anta acquired Fila right after the global financial crisis at a significant discount, paying only 300 million RMB for the China operations. Today, Anta generates the amount they originally paid for Fila in just 17 days. The impressive part is how they've developed Fila into a high-end premium brand in China, starting from scratch. Fila in China is now more expensive than Nike or Adidas, and while it's big in Korea and Taiwan, China is the most expensive region for Fila products.

That's interesting. So, it's kind of like streetwear, not quite leisure, not quite fashion, but a blend of the two, occupying a premium segment in the market. Would you say it's popular with middle-aged people and older?

I think that's accurate. Fila used to be more of a sports brand, but it shifted towards leisure under Anta's guidance, leveraging its sports heritage to become a premium mass brand in China.

This was the genesis of Anta's portfolio approach, then, because Fila operates very independently from Anta, even though they share a lot of backend resources, allowing the two brands to coexist independently.

Exactly.

You mentioned that 10 percent of Other brands. Could you tell us a bit about those? I think it's quite interesting what Anta's trying to do there as well.

Anta has a segment called 'others,' and most of that comes from Descente. What's incredible about Descente is that they launched Descente China in 2016, and it only took them three years to reach 1 billion RMB in sales and reach profitability, which is half the time it took Fila. Fast forward to today, they're doing 5 billion RMB in revenue this year, and the profitability has also soared. This is a very premium brand with a high price point, occupying the 'all other' segment and now making a 30 percent operating margin, most of which is from Descente.

For those who don't know, what is Descente? What kind of person does it target?

They call it functional sportswear. It differentiates itself through the fabric and functional design, originally being big in ski wear like functional ski jackets. They're also in niche sports like endurance sports, triathlon, cycling, and rowing, where athletes wear unique, spandex-like material. Descente excels at these kinds of niche designs and materials.

What do you think the advantages and disadvantages are of a portfolio strategy like Anta's and a more focused, almost single-brand strategy like Li Ning's?

One advantage of the multi-brand strategy is the clear delineation between the brands. Anta covers core sports, Fila is more leisure fashion, allowing them to remain separate. This is crucial because sportswear makers often face trouble when they stray too far into fashion, causing brand confusion. This is the struggle Li Ning is currently facing. Anta, however, has managed to keep each brand distinct.

But Nike operates across many different sports and categories as a single brand, even spending the nineties and two thousands unwinding a multi-brand portfolio. Any thoughts on that?

Actually, this discussion on multi-brand versus single-brand strategies is interesting because every Chinese sportswear maker, including Li Ning, pursued a multi-brand strategy at one point. Li Ning acquired several brands, including the Italian brand Lotto in 2008, which was once bigger than Fila in China, but struggled. Even smaller players like Xtep, which is the third Chinese brand after Anta, bought K-Swiss and Merrill, an outdoor trekking shoe brand. China is unique in this aspect due to joint ventures with local companies by global brands to operate their China business. Interestingly, Li Ning management now emphasizes their single-brand strategy as if it was deliberate, but in reality, it resulted from the failure of their multi-brand efforts.

It also reflects how these companies wanted to escape the perception of being lower quality, lower-priced products, and adopting a foreign brand with its associated prestige was one way to achieve this.

I think so, exactly.

But I love how you highlighted Anta's history because it emphasizes that Anta is doing something right. It has made Fila into a huge success where others have not had as much to show for their efforts.

So far, it's been proven that Anta's multi-brand strategy seems to be the winning strategy in China, at the very least.

Let's talk about the cultures of the two different companies. Could you introduce us to the cultures of Anta and Li Ning?

Going back to the origin stories of Mr. Li Ning and Mr. Ding Shizhong, the founders of these companies, let's look at Anta. They were a latecomer and didn't have the Li Ning name on their products, which was a huge advantage. If you Google Ding Shizhong, you'll see he doesn't look like someone you'd expect to head a sportswear company. He's very smart, maybe a bit nerdy, which made me question if this is the guy running China's largest sportswear company. Unlike Li Ning, which had success from day one due to its founder's fame, Anta had to earn its place in the market. This achievement is largely due to Ding Shizhong and the culture of hard work he fostered, creating a performance-driven organization. While Li Ning is the champion athlete, Ding is a champion business builder.

It seems Mr. Li is very hands-on, and the organization reflects his operational style.

Actually, Mr. Li Ning's involvement has varied between being hands-off and hands-on. In the early nineties, Li Ning had an external CEO, and Mr. Li Ning mentioned in an interview that he barely came to the office during those early days. It wasn't until the industry downturn from 2011 to 2014, when the CEO quit, that Mr. Li Ning had to return to manage the business more directly. Since hiring a co-CEO from Uniqlo in 2018, Mr. Li Ning appears to be more hands-off, reportedly living in Hong Kong and focusing on his family investment vehicle, Viva Goods.

I know you wanted to discuss corporate governance as another dimension for comparison. Could you share your observations?

Before discussing governance, I'd like to add to my earlier points about the culture and leadership. One criticism of Li Ning is its management quality. I believe this stems from Mr. Li Ning being a part-time and somewhat reluctant owner, juggling multiple interests. This is evident in the M&A activities with Viva, which raises governance concerns, such as leading two listed companies simultaneously and related party transactions. In contrast, Anta has benefited from the continuous, dedicated leadership of Mr. Ding, who is deeply committed to the business. This difference in management style and dedication significantly impacts corporate governance.

And OK. So I guess you were just asking about the governance part, right?

Yes.

Okay, honestly, I think there are issues at both Anta and Li Ning. They're not the cleanest. Let's start with Anta. A situation that stands out to me is in 2019, when they acquired Amer, a few months after which they sold 5% of the shares to Anta's insiders, including Mr. Ding, at a 40% discount. The disclosure on this was cryptic and poorly explained, which left a bad impression on me.

Just to clarify, Amer, which was recently listed on the New York Stock Exchange, previously listed in Finland, held a portfolio of niche sporting brands like Salomon and others.

That's right, including Arc'teryx, Salomon, and Wilson. A few months after purchasing Amer, they sold 5% of the shares to insiders at a significant discount, without providing a clear rationale, which was concerning.

Regarding Li Ning, there have been some questionable related party transactions between it and Mr. Li Ning's other company, Viva, which is essentially his family holding company owning smaller brands that own factories in China. These factories also produce shoes for Li Ning, which, although not material, raises governance concerns.

Another aspect to highlight is Anta's distributorship, which has been scrutinized over the years for its margins and cash flow. Could you elaborate on Anta's distribution model and its evolution?

Anta has faced several short-seller attacks, notably from Muddy Waters in 2019, accusing the company of offloading inventory to secretly controlled distributors to inflate profits. This practice is likely true, given Ding's background in Fujian province, known for its clan business culture, which likely involved close associates or family members as distributors. However, this structure wasn't designed to defraud shareholders but was logical in the early, cutthroat years of the industry. This structure helped Anta survive and thrive during the cyclical downturns by mutualizing the inventory burden. As Anta grew, it shifted towards a direct-to-consumer model, reducing its reliance on wholesale channels from 60% of sales to just 10%, making the short sellers' argument less relevant today.

Understanding the context of the Chinese market in the 1990s and early 2000s is crucial, as it was fragmented without modern retail or e-commerce. Trusting family members as distributors was a natural choice for Anta, but as it outgrew this model, it adapted, showing a professionalism that sets it apart.

Oh, yeah, I agree.

To round out our discussion on governance, I think capital allocation is also really interesting, especially when considering how these companies envision their future. Li Ning recently invested in Hong Kong real estate, whereas Anta invested in a portfolio of global brands five years ago. Could you share your thoughts on this divergence?

It's evident by now, but I must say, Anta has a much stronger track record with capital allocation. What they've achieved, especially with the growth of acquired brands in China, is impressive. For instance, they bought Amer for 5.6 billion in 2019, and it listed on the New York Stock Exchange earlier this year, now trading at about 8 to 8.5 billion. Beyond financial returns, it's remarkable how they've managed brands like Arc'teryx, increasing its sales significantly in China from a mid-single digit percentage of total sales to 20-25%. I'm keen on seeing how they'll expand Salomon and Wilson in China as well.

Conversely, Li Ning has a poor track record with acquisitions, leading to a lack of trust in their ability to effectively buy brands. This might be why Mr. Li Ning opts to pursue small brand acquisitions through his family holding company rather than through Li Ning. Yet, they still managed to upset shareholders by spending 2 billion Hong Kong dollars on a commercial building, only to follow up with an announcement to repurchase their own shares for the same amount, which was more positively received.

This issue of capital allocation is crucial since these businesses generate significant cash.

Indeed. Both Anta and Li Ning have sizeable cash reserves, but the difference in how they're managed is stark. Anta has demonstrated its competence in utilizing its cash effectively, and while some criticize the company for its cash balance, having dry powder isn't bad, especially for a company that has shown it knows how to capitalize on good deals. On the other hand, Li Ning's management of its cash could be improved, though it's positive to see shareholder returns increasing.

Let's shift focus to the current state of the industry, particularly regarding inventory cycles. Why are inventory cycles such a significant and recurring aspect of the Chinese sportswear industry?

Certainly, post the 2008 Olympics period was a time when every player in the industry was vying for higher market share, leading to overproduction. It was really ugly, but the market has since consolidated, and management has improved. I believe that was the peak in terms of the magnitude of the cycle, and I don't expect a repeat of that. Recently, we did see some cycle; for example, Fila has struggled a bit, although it wasn't huge. I think the current cycle is more limited to a firm-specific issue at Li Ning rather than the entire industry. Also, the retail structure today is quite different, with a shift from wholesaler-dominated sales to more direct-to-consumer sales.

Can you tell us about what happened at Li Ning?

Li Ning overplayed the Guochao fashion trend, which became very popular around 2018, during the China-US trade war. They tried to capitalize on this trend by launching a new line of sportswear with China-style designs, even showcasing it at New York and Paris fashion shows. While it initially did well, being a fashion trend, the interest eventually cooled down, leaving Li Ning with overproduction and excess inventories.

Because Anta has moved towards more direct-to-consumer sales, its balance sheet provides a clearer view of inventory since it essentially is the channel. However, with Li Ning, even though its inventory days appear to be decreasing, you don't really have insight into the inventory days of its wholesalers.

That's exactly right. Li Ning's inventory days seem to be decreasing, but there's no visibility into the inventory days in the wholesale channel.

My impression is that domestic brands received a boost after the Xinjiang cotton incident, with wholesalers expecting another good year in 2022. However, due to COVID, demand was weak, and they were caught with too much inventory.

You mentioned being in Beijing recently; how did this excess inventory manifest?

Yes, I was in Beijing in February and took the opportunity to visit some stores. I was particularly interested in the discounting practices of various brands. Remarkably, Anta showed little to no discounting, aligning with its strong rebound in Fila margins as recently reported. In contrast, foreign brands like Nike and Adidas offered discounts around 10 to 15%, with Adidas marking down some items by 30%, indicating they were still facing challenges. Li Ning, on the other hand, had significant discounts on streetwear items, ranging from 30 to 50%, while their core sports products were barely discounted. This suggests that Li Ning's expansion into streetwear might have been premature, especially considering the high prices of items like hoodies.

Considering the near-term inventory cycle and looking ahead, where do you see growth coming from in the domestic market?

Despite concerns about the Chinese economy, both Anta and Li Ning have shown growth, with Anta's top line growing by 16% and Li Ning by 7% in 2023. The growth story is far from over, especially with emerging categories like outdoor and winter sports beginning to gain traction. Fila, primarily present in tier one and two cities, along with other high-end brands, has potential for expansion into lower-tier cities. However, with the abundance of brands in China, there's speculation about the necessity for more premium brands. My hypothesis is that the decrease in overseas travel and spending, coupled with crackdowns on cross-border e-commerce, might create more opportunities for brand expansion in China, as more money is spent domestically.

Yeah, I totally agree. Looking at how Anta is building the portfolio of Amer brands and Descente, they are really reinventing the in-store experience. Instead of being part of a multi-brand store, you can now enter a dedicated Arc'teryx store and have a much deeper connection with the brand, offering a wider range of apparel and footwear. This approach is beginning to build that emotional connection, which, I think, has so far proven to be quite successful.

Operating a multi-brand, we've discussed the pros and cons, right? One thing people often bring up is how companies can get into trouble by over diversifying. It dilutes their focus, but what’s really impressive about Anta is that they are diversifying yet executing really well in each area. They don't seem to have lost focus.

Looking at the international markets, Daye, do you think these brands can sell elsewhere? Do you think Anta and Li Ning have appeal in other countries too?

I think so. It really depends on the region we're talking about because, for obvious reasons, the US and Europe will be very difficult. I'd be very surprised if they decide to invest heavily there. Amer is a different story since it's already present in Western markets. I think the biggest opportunity for Chinese brands today is probably Southeast Asia, something I'm monitoring with a lot of interest. The body shape and style there are more similar to the Chinese, making apparel more adaptable across geographies. Additionally, the price point in Southeast Asia is much more similar to China, if not lower. So, I think they'll have a pretty good chance overseas against brands like Nike and Adidas.

Are you referring to the core Anta brand?

Yes, the core sports sportswear brand.

Okay. And how do Amer, Salomon, Arc'teryx, Wilson, and the other brands fit into Anta's strategy?

As I mentioned, outdoor and winter sports are key areas, and Amer has given Anta the best portfolio in China for this. The interesting part about the Amer acquisition is that it broke Anta's usual strategy of buying only the China carve-out, like they did with Fila and Descente. This time, with Amer, they bought the entire overseas company, which indicates Anta's global ambitions. If they just wanted to focus on China, they could have simply carved out Arc'teryx and focused on that, but they seem to believe they can add value to Amer, not just by bringing Amer to China but possibly the other way around.

Why didn't Anta take a full controlling stake in Amer?

They did take a controlling stake, but if you mean why didn't they buy the entire company, it's because the buyout was unprecedented in scale and it was their first time buying an overseas company, with no prior experience. Partnering in a consortium was a smart decision. Look at who they partnered with—Chip Wilson, Lululemon's founder, holds a 20% stake in that consortium. It shows the self-awareness and humility of Anta's founder, Ding, to approach this acquisition under a consortium.

That's a good point. And now one of Chip Wilson's lieutenants is leading Arc'teryx.

Yes, that likely wouldn’t have happened without Chip Wilson's influence.

Exactly. And I understand that Amer is somewhat of a side business, but do you have any idea what it needs to do to become profitable?

So, don't quote me on this because I still need to review the recent results, but I believe once you account for the interest rate that Amer is paying, as well as some impairments related to one of their smaller brands, the business is already profitable. The question then becomes how they can grow this profitability. For instance, Arc'teryx is quite profitable, and there's a significant effort to reinvent Salomon for the Chinese market, which is something to watch. I believe Wilson might be their segment with the lowest profitability, although it operates in a completely different sport category—both sports and equipment. However, I don't know enough about that to say for sure.

Yeah, and it's primarily wholesale, not direct-to-consumer (DTC).

Okay, all right. It's been really interesting speaking with you. Do you have any closing thoughts as we wrap up?

One thing I might add, because this is a question I often receive, is regarding the struggling Chinese economy. How is it possible for these brands to do well, right? If you look at the sales of Descente, Arc'teryx, and Lululemon, for example, Lululemon is growing incredibly fast in China—by 40%, 50%, even 60% per year. It's very counterintuitive. However, not all premium brands are succeeding. For instance, Li Ning has been attempting to go premium with their 1990 series and is really struggling. I was just discussing this with a reader, and we concluded that premium brands can still succeed, but the hurdle is higher than before. The value proposition of these brands needs to be even clearer than before.

One of my readers brought up a fascinating point about the bifurcation dynamics in the market. For example, you see people wearing a basic white T-shirt that could be bought from Temu or Shein, paired with Chanel bags or other high-end fashion items. In the West, brands like Hugo Boss, which sit in the middle, might not have as clear of a value proposition, which is why some of these brands are struggling. In conclusion, premium brands can do well, but we're seeing a market bifurcation, and the hurdle for premium brands is higher today than ever before. That's how I see it.

I think sportswear is so interesting because of the technical factor, and technical excellence can become its own form of luxury in many ways.

Yeah, every brand loves to talk about their technology, right? Like their sole technology, cushioning, all these things. I do think they're real, but I've always found it hard, both as a consumer and an investor, to really know what the difference is between Li Ning soles and Nike soles. But clearly, sneakerheads are paying attention. I have another friend who is a huge sneakerhead, and he's currently living in Hong Kong. He originally came from Canada. He was just telling me that he's been so impressed with Anta's basketball shoes. He told me he owns five pairs. Wow, so he's like, everything's on point—the design, the endorsements of these players. He's just raving about Anta's execution there. So, I thought that was interesting.

That's a good data point. Okay, just to wrap it up and to remind everyone, it's the East Asia Stocks Insight substack, Daye Deng. And Daye, how can people reach you if they want to get in touch?

Yeah, my substack is www.eastasiastocks.com. I'm also on Twitter or X a lot, and the handle there is again East Asia Stocks. So, message me anything. Oh, by the way, I'm also offering a free trial now on my substack, so you can access all the articles for free, including this one we talked about on Chinese sportswear. Check it out. And yeah, thank you, Graham, for having me.

It's been a pleasure. Thank you for sharing. It's great to speak with you.