Vietnam's Investing Landscape: A Conversation with SEAF Blue Waters' Keirn O’Connor

If entrepreneurs could time travel 10 years into the past, many would choose to create a business in China. A decade of rapid growth saw the country make huge strides toward becoming an economic powerhouse, with accompanying economic reforms that built upon the gains. China is planning for the full convertibility of its currency and wants to turn Shanghai into a global financial center to rival London, Tokyo and New York. While it is just a dream, according to some investment professionals, entrepreneurs and manufacturers, it is possible to go back in time by heading to Vietnam.

Vietnam did not embark on reforms as early as China, but the Communist Party in Vietnam is following the example set forth by the Communist Party in China. State-owned companies are being reformed, consolidated or privatized; financial reforms have led to the opening of a stock exchange and heavy inflows of foreign investment.

The global supply chain is already several years into a shift from China to Vietnam. It’s a mark of success for both countries. Capital investment in China has lifted wages, but some businesses can operate more efficiently with low-wage workers. As China moves up the value chain, Vietnam has successfully stepped into place and offers a new destination for low-cost manufacturing, which it, too, hopes to capitalize on.

Where Vietnam does not compare to China, it sometimes exceeds it. Though its smaller population of nearly 90 million means it will never grow to the earthshaking size of China’s economy, half of Vietnam’s population is under the age of 25. Whereas China is staring at a demographic stall in the next few decades, Vietnam’s demography will deliver a boost to economic growth for decades in the same way it delivered growth in Western Europe, Japan and the United States.

Market Vectors Vietnam (VNM) launched this year and offers the first opportunity for ETF investors to get in on the Vietnam story. Emerging markets are volatile, and this fund will be no exception. Investors should look to buy it on the drops and sell it near the tops. With a market capitalization in the neighborhood of $20 billion, there will be plenty of wild swings for years to come, though the country sees the need to meet foreign and domestic demand. Growth in market capitalization may be led by new listings rather than share price increases for the foreseeable future.

Coverage of Vietnam is limited in the press, and while there’s news and data to make a case for the country as an investment, I believe it is better to get an understanding of what’s happening at the ground level. As with China, it could take several years for profits to show up for public equity investors. China’s Shanghai market declined from 2001 until 2005 during a phase of rapid growth. Investors watching the stock market may have left China, but those in the country were buying up assets and positioning themselves for the inevitable rebound.

With that in mind, I interviewed Keirn O’Connor, the managing director of SEAF Blue Waters Growth Fund, which “is a commercial investment fund that provides growth capital combined with strategic and operational support to small and medium enterprises (SMEs) operating in Vietnam.” Small and medium businesses are the engine of vibrant, stable and prosperous economies, so there’s no better person to talk to about the prospects for the Vietnamese economy.

Don: What do you think the prospects are for economic growth in Vietnam?

Keirn: The prospects for growth in Vietnam are as good as almost anywhere in the world right now. Vietnam’s GDP is expected to grow at 5%+ this year. In many ways, Vietnam is a little China, and many of the factors that contribute to China’s success, like low-cost production, a stable political environment, a large population increasingly capable of supporting a domestic market, entrepreneurial business people and a successful short-term stimulus initiative, also bode well for Vietnam. Vietnam also benefits from the “China+1” strategy, where international manufacturers, who had been operating in China, are looking to open facilities in Vietnam as a political hedge and due to increasing production costs in China. Many people say that Vietnam is at the stage now that China was in ten years ago. Who doesn’t wish that they made a more significant investment in China in 1999?

Don: How have the real estate and stock markets performed? Did they participate in the global bubble?

Keirn: The real estate and stock markets were certainly in bubble territory in 2007 and early 2008. The markets corrected drastically in early 2008, even before the global correction, when the government reacted to high inflation by taking all liquidity out of the market. Since the bottom in March this year, The Vietnam Index is the best performing market in Asia. At the peak in June, it was up 117% from the low. The recent run-up has caused many to diversify into other assets, like property. Property prices have picked up recently, partly due to this and partly due to increased capital available for investment, largely from banks, due to the government stimulus package.

There is clearly significant long-term upside potential in the local stock markets. The flaw is the lack of liquidity, leading to drastic swings on the upside and on the downside. The small size of the market, and the difficulty of foreigners investing directly in the market due to capital controls, means that local liquidity levels often determine market performance more than the profitability and growth of the companies themselves. The stock market capitalization is still small, and there are only about 40 companies with a market cap over $200 million. It often seems like local speculators are the driving force.

Don: How is your own business doing, and what is your outlook?

Keirn: I am managing director of SEAF Blue Waters Growth Fund, which invests in small and medium-sized enterprises in Vietnam using private equity and mezzanine structures. This fund is part of Small Enterprise Assistance Funds (SEAF), a global investment firm focused on providing growth capital and operational support to businesses in emerging markets and those underserved by traditional sources of capital. SEAF invests in more than 30 countries around the world through an international network of 19 offices in Central and Eastern Europe, Latin America, and Asia.

Through our portfolio companies in Vietnam and because we have the opportunity to evaluate many new small companies for investment, we have a direct insight into the basic workings of the Vietnamese economy. Last year, after the end of the 2007 boom, we saw that many companies in Vietnam struggled due to decreased demand, increasing production costs and limited access to financing. This situation has slowly improved and now, especially in the last three to four months, companies are feeling optimistic again and re-implementing many of the growth plans that they had previously put on hold. This is due to continued strong domestic demand, increased bank lending spurred by government policy and even some positive signs in global demand.

One positive of Vietnam’s relatively isolated financial system is that consumers have little debt, and in fact, the majority of people here don’t even have bank accounts. Also, banks here were not exposed to things like securitized loans, so there was no need to unwind these sorts of situations, as has been necessary in so many other places. This certainly limited the impact of the global financial crisis in Vietnam and hurried the recovery.

Don: Have you seen any changes in spending/your business during the global economic downturn? Any reversal in these changes?

Keirn: Vietnam had its own “mini-crisis” in mid-2008, long before the severity of the global downturn was widely apparent. The crisis in Vietnam was caused by runaway inflation due to the booming economy and investment environment. The peak was August 2008 when year-overyear inflation reached 28%+. The Vietnam government addressed the inflation through drastic monetary measures, which slowed the economy then. When the global downturn came about last autumn, many Vietnamese companies and domestic consumers had already started to make adjustments, so they were more prepared for the situation. In a way, the downturn helped Vietnam because global commodity prices fell, helping to further control inflation.

Since last autumn, a dichotomy has developed in the economy. Exports have fallen drastically due to problems in destination markets like the US, Europe and Japan. Exports previously drove the country’s extraordinary growth, but, year to date, exports have fallen 13.9%, and some say more. While exports have fallen, domestic consumption has been resilient. Domestic retail sales have grown 18.3% year to date.

Most people think of Vietnam as a global low-cost producer whose economy is driven by exports. This is really only part of the story. The opportunity in the future may very well be investments that are based on increasing domestic demand. Vietnam has a fast-growing, young population of almost 90 million. They are becoming more prosperous, and the spending power of the middle class is increasing quickly. People are quick to adopt new products and are looking to improve their quality of life. So, we are actually focused on investing in companies that sell strong products or services to meet this growing domestic need.

Don: Do you think that sociopolitical factors could impact Vietnam investments?

Keirn: The political environment in Vietnam is tightly controlled, as is the economy. One factor that has a large impact on investment in Vietnam is the tight currency controls. Much of government policy revolves around keeping the Vietnamese dong stable in relation to the US dollar. As a result, capital flows are tightly controlled, as are the banks. Due to the current account deficit, the trade imbalance and the government’s need to keep a large reserve of dollars to keep the currency stable, it is often difficult for local businesses to purchase dollars to fund imports, which are necessary for many raw materials, machinery and technology. This can also mean problems with simple things, like a foreign investor having trouble repatriating an investment because it is not possible or prohibitively expensive to convert an investment in dong to US dollars to send home.

Don: The Asian Crisis is still fresh in many foreign investors’ minds. How do you see the currency situation?

Keirn: There is the remote, although scary, possibility that the government will not be able to prop up the currency for the long term. A severe currency devaluation would have far-reaching negative implications for business activity here. Most local people expect there to be at least some devaluation. Sometimes even the potential threat of devaluation can spook the market. For example, last year, Morgan Stanley released a research report predicting that the dong would devalue significantly. This caused an uproar in the market and actually resulted in severe short-term devaluation pressure.

Don: Any final thoughts?

Keirn: Although the Vietnamese economy’s growth is very attractive, anyone who is investing in the market should realize that economic development is still in its early stages. This is a positive, because many changes will naturally come that will make the economy more efficient in coming years. However, there is a lack of transparency in many aspects of the economy. Company financial reports are often unreliable, corporate governance is often weak and the legal framework is often unclear. This introduces an elevated level of risk into any investment.

Comments

[Mad Hedge F...:]

tyt Now that we have figured out that Vietnam is a great place to invest, we welcome the news that the Van Eck group is about to launch its own Vietnam Index Fund (VNM). The venture will invest in companies that get 50% or more of their earnings from that country, with an anticipated 37% exposure in finance, and 19% in energy. This will get you easily tradable exposure in the country where China does its offshoring. Vietnam has been one of the top performing stock markets this year, at its peak rising by an amazing 110%. It was a real basket case last year, when zero growth and a 25% inflation rate took it down 78% from 1,160 to 250. This is definitely your E-ticket ride. Vietnam is a classic emerging market play with a turbocharger. It offers lower labor costs than China, a growing middle class, and has been the target of large scale foreign direct investment. General Electric (GE) recently built a wind turbine factory there. You always want to follow the big, smart money. Its new membership in the World Trade Organization is definitely going to be a help. Until now, the only way to get involved with this country was to go through the tedious process of opening a local currency brokerage account, or buy a region sub emerging market ETF. I still set off metal detectors and my scars itch at night when the weather is turning, thanks to my last encounter with the Vietnamese, so it is with some trepidation that I revisit this enigmatic country. Throw this one into the hopper of ten year long plays you only buy on big dips, and go there on vacation in the meantime. Their green shoots are real. But watch out for the old land mines.

Sep 15 06:08 PM

[Brian O'Fla...:]

Nice post. Over the long-term, the economy will continue to open and its highly entrepreneurial people will drive extraordinary growth (like it or not, the people still admire America). Good point on the inflation concern, though. Adding VNM to my watch list.

Sep 15 08:11 PM

[Tony Roberts:]

Great article that gives us an insight into a possible great investment opportunity.

Sep 15 10:06 PM

[Paul Harper:]

nice work Don, am v bullish on Vietnam long term, mainly
due to the population demographic. One of my long term
stocks VIP has just entred the market there as mobile
penetration is sub 30% & all those budding capitalists will
be tech hungry going forward.

Having sat on the sidelines when VNM launched, I added
some to my long term portfolio last week.
Fly my pretties ... fly !

Sep 16 12:38 AM

[Nettligent:]

I would rather trust Viet Nam than China.

Sep 16 05:11 AM

[chap08:]

Firstly, I own listed investments in Vietnam, so I am on the positive side for all the well known reasons. But there are several things about this I don't like.

1. I just don't know enough. I have visited and done some research, but somehow I find it's a difficult place to get to know.
2. The danger in these "difficult to know" situations is that you are drawn in by the blue sky nature of the thing. You don't get the whole picture on the problems.
3. There's not much to invest in.
4. There is a lot of hot money around. The combination of blue sky, small market and hot money is not one I like.
5. I was initially attracted by the "China 10 years ago" story. But this is not China 10 years ago. If it was, it would not have a current account deficit and difficulty holding the currency up against the dollar. China was exactly the opposite.

Until these factors change, my Vietnam holdings will remain small. But don't let my ramblings put anyone else off. My perspectives are usually on the risk averse and cynical end of things.

Sep 19 07:25 AM