FIELD OF DREAMS
Noble Group has a bold plan for global growth, but explaining its vision isn’t easy.
By Tom Leander

You would expect a man just back in Hong Kong from a hectic journey around the globe to crave luxury. Not Steve Marzo, the CFO of Noble Group, a global supply-chain manager based in Hong Kong but listed in Singapore. “Truffles – I don’t like ‘em,” says Marzo, and with a nod, chases off a waiter.

Marzo has an air of an executive whose business is too engaging, perhaps too nourishing, to care much about posh food. And Noble is certainly on a roll, boasting a return on equity, at 28%, more than twice its peers, as well as 36% year-on-year sales growth. Founded by a London entrepreneur more than 20 years ago, Noble has emerged in the last five to occupy a place in that relatively small elite of companies that have gone global from Asia.

But with dreams come responsibilities. Becoming a dynamo is one thing. Staying dynamic in perpetuity is another.

Marzo, by dint of being CFO, is a strategist in this transition. A former investment banker with trading company roots, he joined in 2003 as Noble settled comfortably into mid-tier status. His job is to build a finance structure that will support the company’s next evolution. Now worth US$12 bn in revenues and with US$1.7 bn market cap, Noble was cited as one of Asia’s ‘Global Challengers’ by Standard & Poor’s – in the company of others like India’s Bharat Forge and Hong Kong’s Techtronic Industries, which are preparing to sustain themselves into the next generation as major global players.

Noble was the top growth stock on the Singapore Stock Exchange between 2001 and 2005, but has been hit by a series of declines from its peak in February 2005 at S$1.64 to its trough of S$0.87 this June. At S$1.16 on October 30, the stock was trading at 11.22 times earnings. In comparison, global supply chain manager Olam, which listed in Singapore in February 2005, now trades at 33 times earnings. Li & Fung, which Noble compares itself to, trades at 34 times earnings.

Analysts still adore Noble. When Citibank initiated coverage in August, it called the company a buy – but a high-risk one. Like a critically acclaimed movie that nevertheless doesn’t draw huge crowds, Noble appears to be waiting to be discovered as the next generation’s classic. Its definition problem is part of its growth story – a problem likely to be encountered by Asian companies seeking to change from within and take the world by storm.

“Most companies from Asia can’t be said to have a business model,” says Stephen Brown of Kim Eng Securities, the Singapore research firm. “In Hong Kong this is true. Real estate companies buy on opportunity, and even Hutchison goes about its business opportunistically – selling Orange and pumping money into a money-losing business (Hutchison’s 3G investments). For a true business model, look to a Li & Fung or a Dell.” He adds: “Noble is at the point in which it’s trying to make the change from opportunistic business to a true, sustainable model.”
Explaining that model is another challenge again.

Some Assets, Please

Marzo’s travel schedule in October looks like a diplomat’s – or an investment banker’s. Over the course of 15 business days, he found himself giving a presentation on a Monday to investors in New York City with CEO and founder Richard Elman and chief operating officer Ricardo Leiman. He hopped on the night flight to Sao Paolo on Tuesday, where Noble has an office, from which it partly oversees a thriving grain and soybean supply-chain business in South America. The company recently built a US$51.2m state-of-the-art port terminal in Argentina, and is developing a fledgling business in ethanol in Brazil.

By Friday he was back in New York, looking over its US financial affairs from the company’s Connecticut office. Noble has been building its North American business in ethanol, setting up off-take agreements with plants in the US states of Iowa, Nebraska, and New York, and has invested in a production and storage unit in Indiana. Another overnight flight took Marzo to Lausanne and then back to Hong Kong for a weekend with his family before departing the following week to Sydney. The company bought a 10% equity stake in a vanadium mining operation worth US$16.5m in early October, and agreed to handle all distribution logistics for the mine worldwide. Noble has also recently commenced construction of a new coal-mining development in New South Wales.

The travel seems necessary. In part, Marzo’s job is to get out and check the company’s supply-chain businesses, testing for weaknesses and eyeing up new opportunities. He’s also overseeing the company’s selective shopping expeditions to invest in assets where it makes good economic sense. Noble is in transition, Marzo says, from a company with a strictly asset-light approach to one that regards some ownership as necessary to the next phase of growth.

So far, Noble is managing the transition with a remarkably lean balance sheet, even as it grew its businesses in energy, agriculture, metals, minerals and ores, logistics, and corporate financing operations to facilitate business in these areas. It has 3,223 employees working in 75 offices, from Hong Kong, where it was founded, to Xingang in western China and Sulawesi in remote Indonesia. In a very short time, the company has increased substantially in scale – sales leapt to US$2.96 bn in 2002 to US$11.7 bn in 2005. With large cash holdings after raising US$3 bn in the debt markets in the last three years, it has sighted more direct ownership as a key to a next stage of growth.

Soybean Shock

The South American agricultural trade, including grain and soybeans, illustrates the shift. Business there developed from early discussions before Marzo arrived in 2003, through the asset-light approach and now to direct investments.

“There was recognition early on,” says Marzo, “that China and India may be increasingly unable to feed themselves. Our view is that the Mato Grosso in western Brazil and Argentina will be cheaper producers than the US, Canada, and Russia, and will be the breadbasket for many importing countries.” He recalls: “We asked ourselves, ‘How can we take advantage of that investment and that opportunity?’”

The trick has always been to go far up the supply chain to maintain Noble’s efficiency and look for spots where value can be eked out. At the source, Noble helps arrange financing so that the farmers have the capital to raise the crops. It placed itself in the region as an aggregator, providing a central location for the farmers to deliver goods – and building economies of scale in the cost of onward delivery. It chartered barges to bring the goods 250 miles down the Parana to Buenos Aires, where they would be on-loaded at a port facility. Noble would then charter ships and deliver throughout the world.

This was simple enough, and lucrative, but as time progressed, Noble’s activity on this sourcing side of the supply chain has become broader in scope and more comprehensive. The company built its own facility further upriver on the Parana. Rather than pay the costs of the barging, it chartered a Panamax vessel to load the agricultural products directly at this site. It also integrated fertilizer deliveries at the facility. All of this cuts down operating costs, gives the company more direct control of the process, and improves timeliness and reduces operating risk.

Mitigating risk is one reason Noble has opted for an asset-heavier approach at the delivery end in China. The company – and other major traders – got seriously burned in 2005 when a glut in the soybean market prompted Chinese operators to collectively renege on delivery contracts. Noble lost US$25m, but it learned the powerful lesson that ownership can sometimes be beautiful. It has since bought a soybean crushing facility, taking the business away from local operators, and gaining value at the same time. “We crush the soybeans, sell off the oil and the meal,” says Marzo. “We added another profit point.”

“The commodity traders of the past,” he adds, “would buy free on board (FOB – a term that means that the price of goods includes delivery at the seller’s expense to a specified point and no further) at the load port and sell at the discharge port. This makes money on the product and transportation – two profit sources. But by selectively investing in that supply chain, you have the opportunity to add additional profit points – or reduce operating costs.”

The message is out: assets can be sweet, if invested in intelligently. “Four years ago,” says Marzo of its South American presence, “we had no offices, no ports, nothing. Today we have eight offices and four ports.”

The South American-to-China soybean gambit mirrors other major aggregation and supply-chain building operations that Noble has built, many in recent years. Marzo dubs the company’s approach, “going in by stealth.” The company’s main competitors – Glencore, a private company based in Switzerland, Bunge, and Cargill, two US suppliers – are much larger, having been in these businesses for a long time. Seeing that the delivery of iron ore would be crucial to China, Noble launched a supply-chain aggregation business in India, stitching together financing, services, and common delivery points for dozens of small operators who would otherwise not have access to markets outside the borders.

It has repeated this trick, most recently in Vietnam, where it is now the nation’s largest exporter of coffee. It applied the same principle in the coal mining business in Indonesia, bringing raw coal from dozens of mines to aggregation facilities, onward to ports and outward onto ships. Its latest, greatest push is to become a supplier of ethanol. In addition to investments and off-take agreements in ethanol plants, the company acts as a market maker for the Chicago Board of Trade’s ethanol futures market.

In each of these operations, Noble looks for the best way to handle the asset question. Should it own, or, as it does frequently, invest small amounts and arrange off-take agreements? “The important thing is having the flexibility to expand when we need to,” says Marzo.

What Are We?

The progress of companies can sometimes resemble that of governments moving from the cult of personality to a system of process, traditions, and laws. After a first entrepreneurial burst led by powerful founders, those founders must bring in mid-level management to bring sustainability to the business, while trying to retain some of that original, revolutionary culture.

Starting in 2001, Elman has brought in a new layer of senior management. Among the newcomers were Paul De Fries, group risk manager, who joined that year, followed by Wildrik de Blank, group treasurer, and by Leiman, who signed on as group operating officer in April. The company is upgrading its technology and building a global trading platform that incorporates a risk management system. The discussion of how to manage this change is ongoing, and like a company trying to find its way, professionals at Noble are big on mantras. They’re asset-light, like Li & Fung, the global supplier from Hong Kong. They’re a hands-on company – the tagline on a recent advertising campaign. This means staying on top of the details of the businesses and direct involvement in markets. But these mantras hint, but don’t necessarily define, what kind of global company Noble wants to grow into.

The firm in some ways is a 21st century version of a kind of company familiar in globalization’s first wave. Elman had worked for the legendary trading house Phillips Brothers, aka Phibro, in its declining years, when it bought Solomon Brothers, the Wall Street investment bank, and was in turn absorbed by it (Salomon was eventually bought by Citibank).

Much has been written about why Phibro, which was founded in 1901, lost its punch, but perhaps it was best put by Helmut Waszkis, in Phillip Brothers: The Rise and Fall of a Trading Giant (Metal Bulletin Books) in 1992. Waszkis described the company’s loss of its flexible, hard-working ethos and its turn to wasteful investment, loss of controls, and extravagance in this assessment: “An inner-company mystique, a synergy between management and the staff has to exist. Pragmatism and emphasis on the ‘bottom line’ must be of uppermost importance, but they alone will not allow a company to grow and succeed.” In a conversation in 2001 between CFO Asia and Elman, he made a veiled reference to his days at Phibro by saying he always wanted to take stab at running and growing a company himself, after watching mistakes hobble one of his previous firms.

As it happens, Marzo also worked at Phibro in treasury positions in the Asia Pacific and in Europe. He went on to Bear Stearns as Asia Pacific head of institutional credit and in 1996 undertook the role of executive director and head of credit risk management for non-Japan Asia at Goldman Sachs. He joined Noble in 2003, after a switch during the dotcom boom to two companies, SME Finance and Tom.com. “I thought it would take me three to five years to learn what I needed to become a CFO and land in the right place. It took me three,” he says.

It was at Tom that he observed a company that was having a hard time explaining itself properly to analysts. Tom.com set up a chart that described what the company was – and what it was not. Marzo has outlined the same distinctions for analysts in a presentation for Noble, and runs a chart called “Explaining Noble’s Business,” in earnings presentations. Under this tautology, Noble is a manager of physical delivery of goods, but not a screen trader; maintains a largely hedged book, and does not focus on speculative trading; a total supply chain management company, adding value at all stages, and not just a trading, shipping, or finance company, and so forth.

Marzo cites numbers (see chart, page 24) that, he says, belie the impression in the investment community that Noble’s stock tracks commodity prices, and therefore the company is, in essence, an opportunistic commodity trader or a shipping stock. The stock, in fact, doesn’t track the common benchmark for commodities, the GSCI commodity index, or the Baltic Dry Index, which tracks dry freight.

But the trouble with distinctions that define by saying what something is not, is that they frame the negative. Say “Don’t think about elephants,” and all you can think of is an elephant. It’s perhaps more instructive to hear what those inside the company say it is. “We’re a little like Fed Ex,” says Marzo. “Fed Ex owns its airline, but no one thinks of it as an airline. We’re more than a shipping company, more than a trading company, more than a finance company. We’re performing a series of value-added services, and if we’re successful, we’ll have an annuity type of income stream.”

He adds: “That’s the transformation. We’re more of an integrated operation that’s capable of producing more attractive returns on capital.”

And: “It’s the same trade flow. Now we’re making more money doing it, adding more value and services along the way.”

Black Box

But Noble has always had a way of making money on the trade flow, and at the center of market trepidation is a suspicion that entrepreneurial boldness – that Phibro-like dash – may still be more the operating mode than boring old process. Noble has almost – but not entirely – shrugged off the fallout from its most successful year. Citigroup analyst Peter Williamson writes that Noble has been punished by investors for its canny handling of the bulk shipping market in 2004, when the company’s sales increased 96% over the previous year, and profits jumped to US$293m from US$62m. But Williamson also says that the price-to-book ratio of 1.7 currently reflects the discount.

The problem may seem perverse, as if the company is being punished for making a phenomenally good bet. Seeing the white-heat growth in China, particularly in the steel industry, Noble’s traders were able to lock in capacity well ahead of the surge, a speculative move that amply paid off in 2004. One irony here is that Noble was able to generate this money from shipping, whereas many other suppliers simply regard shipping as a cost center.

Demand for iron ore has now subsided as long-term contracts began to ease supply concerns. Speculative trading in China has more or less stopped since the Chinese government imposed import licenses in May 2005. And charter rates for ships have increased. Noble’s extraordinary earnings now look like a one-year marvel. Earnings declined in 2005 year-on-year by 19% and investors punished the stock due to the earnings volatility, from a high of nearly S$1.80 in February 2005 to a trough of S$0.87 in June.

The volatility may be discounted, but analysts never fail to hint that the ‘black-box’ problem still dogs the stock. They fret that Noble is an aggressive, street-fighting trader, and that it doesn’t fully reveal the risks it takes to its investors. The emergence of a fraud case hasn’t improved matters. In the fourth quarter last year, company earnings declined again as it wrote off unspecified losses connected to alleged fraudulent trades involving two employees in its aluminum business.

With this impression still at large, it hasn’t helped that Noble has found a bright-eyed competitor on the Singapore Exchange in Olam. Even though Olam is much smaller, analysts give the company high marks in comparison to Noble in transparency and an articulated business model. Part of this is a matter of style. Ask Ravikumar Krishnan, CFO of Olam, what his company does, and he has an instant, almost show-biz response, “We manage, find, and create value in trade flows from the farm gate to the factory door, and sometimes within the factory itself.” Ask what goals the company has set and he answers, “Our goal is to achieve a profit margin of between 2% and 2.5% and a leverage ratio of 3.5 to 4.” The goal on ROE is between 20% and 25%, below Noble’s current sterling 28%.

Marzo has been fighting the speculator impression all along by fortifying the company’s financial discipline. Noble’s working capital performance would be the envy of any CFO. As sales rose astronomically in recent years, its working investment ratio remained steady, at 7.7% in 2003, 7.1% in 2004 and 7.7% again in 2005. The result, says Marzo, is that financing working investment requirements with debt or equity has remained consistently low.

Between 2004 and 2005, for example, only 20% of the company’s working-capital requirements needed to be funded through debt. It has done this by means that would win accolades in any reckoning of CFO discipline. Noble discounts accounts receivable to accelerate cash flow, and tracks inventory levels to ensure that it has no over-weighted physical positions. The effort on accounts receivable allows Noble to keep a lean balance sheet. This is particularly important since 90% of the balance sheet, as of June 2006, represents current assets.

Marzo points to the company’s sales, general, and administrative expenses (SG&A) as another example of a strong culture of process. If you divide gross profits by SG&A, you arrive at a proxy for income per employee because most of Noble’s SG&A expense is taken up by wages. As the company has grown, this metric has held more or less steady (see chart, page 28), save for the bonanza year of 2004. The point here is that actual SG&A spending is tailored to adjust to volatility in market conditions.

“Call it elasticity,” says Marzo. “People here accept the fact that if you don’t make as much money because of the market, you’re not going to get paid as much, either.” Noble does have a compensation scheme that resembles more the bonus structure of an investment bank, with stock options and a three-year bonus pool to encourage long-term thinking on the part of its managers. Elman holds 41% of its stock and has never sold a share.

The financial discipline and long-term thinking extend to the way Marzo handles the company’s war-chest of US$703.6m in cash, resulting from its profitable businesses and fund-raising activities in recent years. Marzo says that the firm’s strong emphasis on conservation is born of years of having to expand without access to easy capital. It puts a high bar on investments, and most of its investments have been highly selective and relatively small. Most recently, the company walked away from negotiations in July to buy 10% of Fortescue Metals Group, for reportedly between US$270m and US$300m. The talks collapsed after the two parties couldn’t agree on elements of a joint-venture arrangement to sell iron ore to China.

Given this probity in the way that it handles shareholders’ money, it seems perverse that analysts sometimes dub Noble as ‘underleveraged’. Noble’s ratio of net debt to capital, as of June 2006, stood at 44.4%, compared with 42.7% at Bunge, a US peer that is approximately twice Noble’s size, and 35.6% at Li & Fung, the Hong Kong supplier. However, when debt market analysts look at gearing, they typically adjust that figure, removing hedged and liquid assets. Using this adjustment, Noble’s gearing shrinks to 6.1%, compared to Bunge’s 38.4% and Li & Fung’s 35.6%. Not only does Noble maintain a largely hedged book, in other words, but because of its cash position, it sees no reason to add debt. The critique here is that Noble is not investing or returning cash to shareholders at a rate to inspire total confidence. Translation: that vision thing again.

It’s Model Time

So is Noble too cautious, or too wild? Neither, if you ask Marzo. It is simply keeping its options open, strengthening its internal controls, and trying like mad to hang onto the killer instincts that pushed it toward global success in the first place. This is reflected in Marzo’s views toward the future. He sees the company reaching US$25 bn in sales in the next three to five years. But success depends a lot on process. “We also have to fold out our own internal infrastructure,” he says. “It’s easy as you’re growing to neglect backfilling the support side of your business. You don’t want to be two miles ahead of your partner or your colleague.” Another challenge: experienced people with a mixture of physical trading and banking acumen are hard to come by.

But the primary challenges will be strategic and financial. “I look forward to monetizing the wealth creation that we’ve had,” he says, referring to a future that looks beyond organic growth and selective acquisitions to possible IPOs and spin-offs. In which case, that Goldman Sachs background will be put to the test. One thing’s for sure: he’ll have even less use for truffles.