A New Frontier
In the blink of an eye, Iran is about to shift from international pariah nation to a key driving force in global economic growth. 1 year ago, Iran was led by a President who reveled in mischief. Then, in June 2013, President Rouhani took office with a dominant vote in the general election.
President Rouhani studied for a Ph.D in Scotland and his speeches illustrate a pragmatic and even liberal attitude that may have been influenced by his time living in the West. Despite the cynicism of many in the West who refuse to believe that such a change in attitude from Iran can be trusted, the reality is that the sentiments expressed by Rouhani are far more reflective of public opinion in Iran than his antagonistic predecessor.
Over the past 10 days, the strategic importance of Iran has come into focus like never before. The advances in Iraq of ISIS, a militant Sunni grouping aligned in spirit with the Taliban and Al Quaeda, runs the risk not just of destroying the efforts of the US and others to bring stability to Iraq, but in destablising the entire Middle East and Central Asia. Iran has emerged as a potential strategic partner with the US and Western Europe. Quite an extraordinary turn of events.
For investors, this marks an extraordinary opportunity to participate in an economy which, given its natural resources wealth, should be one of the richest in the world. Assuming that sanctions relief is granted next month (as now seems inevitable), an extraordinary level of potential energy will be released as billions of dollars of strategic and investment capital starts flowing into the country.
This capital will be attracted by the following key highlights:
- #1 in proven natural gas reserves (1,187 cubic feet and #4 in proven oil reserves (157 billion barrels) worth US$35 trillion at current market prices (Source: British Petroleum Statistical Review of World Energy).
- #1 in proven reserves of zinc, #2 in Copper, #9 in Iron Ore and plentiful gold, lead, and many other minerals estimated at representing over 7% of the world's mineral reserves (Source: Iran Parliament Research Centre)
- The largest fruit grower in the Middle East/North African region and a top 10 provider of Agricultural Products in the world. Despite suffering from very low productive efficiency, the country remains the largest producer of pomegranates and pistachios in the world, 2nd in dates, 3rd in Cherries and Figs and top 10 in oranges, grapes, and many other fruits (Source: FAO and Iran Agricultural Ministry)
- A young and highly educated workforce
- A population of 80 million with a large appetite for international consumer goods.
- Tourism potential driven by many historically important sites, skiing in the North and golden sandy beaches in the South.
Despite the recent collapse in the price of Iron Ore and the conversion of the US from energy importer to potential exporter, the world's demand for hydrocarbons, minerals and metals will remain high enough to attract enormous investment into Iran.
The country has already dramatically improved the commercial terms under which foreign oil companies can operate and companies such as TOTAL of France are rumoured to have agreed a re-entry strategy. The simple fact is that the country can more than double daily production on currently known resources. All it needs is access to technology, equipment and, of course capital. The oil ministry estimates a need for $170 billion in capital investment over the next 5 years which seems about right. Such an injection would drive not just this sector, but the entire Iranian economy into solid double digit economic growth.
Historically, Iran has been the dominant provider of food to the Middle East. It can reclaim this role rapidly and secure a role as a provider of food internationally. As soon as shipping links are reintroduced, the ability of the country to export fresh fruit and vegetables as well as meat and dairy will increase.
Some countries are already preparing for this expansion. Australia signed a new export agreement with Iran related to livestock exports. In the 1970's, Iran was Australia's largest buyer of livestock. As the world's demand for protein expands, Iran's production of lamb can fulfil a need in the Middle East and beyond.
However, as with Oil and Gas, the country requires an injection of new technology and processes in its agricultural industry. This is particularly the case in its use of water which is inefficiently managed. However, only last month, the country signed an agreement with Japan to upgrade its water management. Given the global food price inflation that has taken place over recent years, investment in agriculture and water management is likely to be significant.
Young Educated Workforce
The demographic advantage of Iran is perhaps best illustrated by the following comparison with Japan:
Source: Indexmundi and CIA
As can be seen, Iran's population is heavily dominated in the 15-44 year old category whereas Japan's age distribution is far more skewed towards the older generation. Iran's advantage here is similar when compared to most other industrialised countries hence its clear advantage.
The education system is comprehensive with a 97% literacy rate amongst 15-24 year olds (Source: ForUSA) Additionally, the country has retained a strong reputation for higher education hence the 'brain drain' problem that Iran has faced over recent years when there was little economic hope at home. Whilst the population has doubled since 1979, the university population has increased by 25 times and though employment equality for women remains a dream, literacy rates are equal between the sexes and indeed the majority of science and engineering graduates in Iran are female.
Despite economic sanctions, Iran's appetite for foreign brands has not been diminished nor has its population's knowledge of consumer goods. The Government estimates that 71% of Tehran's population has access to satellite TV. As such, the population has a solid knowledge of international fashions, styles and goods. A stroll around Tehran today will seem very normal to residents of the West. People are chatting on their iPhones, looking at the latest Samsung tablets, driving a BMW, drinking at a café and grabbing a burger on the go.
There is little doubt that in a short space of time, McDonalds, Starbucks, Apple Stores and other retail outlets common in Western society will be found across Iran.
The historic locations of Isfahan, Persepolis and Shiraz are on many traveler bucket lists, but there are many other areas of interest from the Merchant Houses of Kashan to the brick houses of Abyaneh. Also, the islands of the Persian Gulf were once feted for their beautiful beaches and only 40 minutes North from Tehran lies the ski resort of Tochal which offers snow for 7 months per year.
Today, the tourism infrastructure is understandably dated. Most hotels in Tehran have hardly changed cosmetically since the 1970s.However, the geographic position of Iran means that it is within non-stop flight range from New York, London, Beijing and Sydney. Iran Air was once regarded with the respect now reserved for the likes of Singapore Airlines and Emirates and even flew Concorde (if only on charter).
Immediate Investment Opportunities
Given the current sanctions regime, many international investors and all US investors are restricted from acquiring shares in Iranian companies. However, as expressed above, this may soon change.
There is a stock exchange in Iran. It has over 300 companies listed and a market capitalization over $100 billion. However, current sanctions and regulatory restrictions aside, passive direct investment here may be foolhardy. Corporate governance and reporting is tremendously weak compared to international standards and business planning and management information systems are similarly restricted in scope. This is hardly surprising given that for many/most Iranian companies, survival over recent years has been the focus.
1. Accounting and Corporate Governance
The levels of reporting certainly don't come up to international standards, but the principles are there and basic concepts of financial accounting are known and utilized. However, for many companies, 'survival' has been the order of the day and as such, the published accounts may not tell the full story. Note that debt has been used extensively over recent years and may come from multiple sources and be very expensive. It is also important to note that the Government has urged banks not to foreclose on Iranian businesses if at all possible. As such, it is likely that as soon as Iran has access to international capital once again, corporate restructuring will be widespread and many companies will find themselves forced to address their debt position.
2. Management Information Systems
A request for a business plan will generally deliver a narrative of the amazing potential that a company has if only it had access to more capital. When you ask for specific financial details of how this capital will be spent and how profits will be earned, the answers may be rather underwhelming. Equally, whilst a company may produce a daily report on its business activities, it may not think to provide a financial overlay which can highlight potential problems (or opportunities) ahead.
If there is one area where education has been lacking it has been in business. Iran has been short of MBA programmes compared to the US and Europe and hence financial management skills are in short supply.
Iranian companies access to international markets have been severely curtailed over recent years by sanctions. As such, international marketing has been very limited and the skills required have become rusty. Domestically, a similar situation pervades. A clear example is the oil and gas industry where NIOC has been the only customer for service companies. It is not uncommon for Iranian companies to believe that the process of offering a service or product is all that is required to secure sales.
4. Technology and Processes
Engineers and technologists around Iran are like kids in December waiting for Santa to arrive with presents at Christmas. They have been aware of new equipment and processes, but sanctions have restricted access. As such, there is a big wish list, but just as kids play with everything on Christmas morning and then forget about many of their new toys by the end of the day, the investment decisions of Iranian companies may not be as objective as one would like.
So corporate restructuring will be necessary and widespread but it would be a mistake to assume that this provides a clear opportunity for foreign companies to barge in and take advantage of the situation. There is a strong sense of national pride and a demand for respect that Iranians possess. This transcends religion and reflects the long cultural identity of the Persian peoples.
From this perspective, I believe that at least in the short term, Iranian companies supported by foreign capital and resources will be favoured over foreign companies going it alone. It will be important that foreigners are not seen to be taking advantage of Iran's situation but rather are contributing to its progress. Equally, there is a sense that Iran wants to balance the geographic origin of investment. Currently Chinese companies have remained actively involved, and hence, whilst there is little doubt about the continued need for access to Chinese capital and indeed capital goods, there is a clear impatience to balance this with European and North American involvement (and of course other parts of the world.
Today, investors need to be watching Iran and preparing for its re-integration into the economy rather than taking action. Only a few weeks ago, risk premiums for the region as represented in the credit and insurance markets were declining as relations between Iran and the Sunni nations were warming. Whilst the ISIS actions in Iraq have undoubtedly reversed this trend, it may also have accelerated the strategic rapprochement between the US and Iran which underpins Iran's re-entry into the global commercial arena
However, whilst the local stock market would undoubtedly rally following such an announcement of sanctions relaxation, hard work will be required. In many ways, this is a classic private equity model with additional M&A activity for foreign companies seeking to access the country through the negotiation of strategic relationships with Iranian groups.
Certain foreign companies will undoubtedly be early entrants. I already mentioned TOTAL and many French and German companies in particular are ready to return at short notice. Germany has enjoyed a historic relationship with Iran as have the likes of S. Korea and Japan and their ability to supply Iran with much needed upgrades of technology and equipment will mean that an 'Iranian Premium' may be built into the valuations of certain companies from these countries. However, care has to be taken as such benefits may be diluted elsewhere and do not represent a pure Iranian play.
Rather, it is more likely that private equity and listed country funds that are positioned in the reorganization and recapitalization of Iranian businesses will be the most suitable immediate route for portfolio investment seeking Iranian exposure.
The reintegration of Iran into the global economy may not be as important as the entry of China has been. However, it remains of major importance to the world given its prominent position in energy, minerals and agriculture and its potential elsewhere. Profits will be made, but as ever, losses will be common. Not just from uninformed or 'lazy' investment, but also because the impact of Iran's reintegration into the global economy was not tracked. Whether an investor in frontier markets or not, the impact of re-intregration of Iran should be noted and monitored.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.