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Forget Everything You Think You Know About Mongolia - Part II

Yesterday we left you on the edge of your seat with Chris DeGruben from M.A.D. Investment Solutions with our post, Forget Everything You Think You Know About Mongolia.

Today we'll get a bit deeper into what Chris and his partner Joachim are doing on the ground in Mongolia, and how you can participate along side of them.

Mark: Tell us more about what your doing on the ground with Mongolian real estate. How can the "little guy" participate in Mongolia's real estate growth through your activities?

Chris: We really specialise in bringing foreign investment to the Mongolian Real Estate sector, regardless of the size of that investment. We have clients that invest as little as US$ 50k, while others invest US$ 5 million. We are here to assist all those clients regardless of how much they are working with.

We have developed a range of turn-key services for our clients that take into account our own remote location (not every client comes, or rather wants to come, to Mongolia on a regular basis), as well as the difficulties of navigating such an opaque and complicated market.

We offer origination services, due diligence, rentals and sales, relocation (mostly for mining companies), renovation / construction, project management, site visits and of course completion and exit strategy. We work with each investor to tailor make a strategy that suits their particular tolerance for risk, need for regular returns through rental yields or rather a strategy on longer term added value through capital growth.

You don't need to be rich to invest in the Mongolian real estate market, the majority of our clients invest around US$ 150k, but it is important to note that no financing is available in-country. Mongolia is still considered a medium to high risk environment and we always warn our investors that while we are positive and bullish on the market we always advise to invest only what they can afford to lose. A lot of the safety nets that exist in other countries, such as insurance or government guarantees, do not exist in Mongolia.

Mark: You mentioned Eric Zurrin from ResCap earlier. You work closely with him, and in fact we'll get into discussing what you're doing together in a moment, it's pretty exciting. Before we get into that give us your impressions of the Mongolian capital markets and where you think the bottlenecks are currently.

Chris: We work with ResCap on a daily basis and would certainly recommend them to any of our clients or anyone wishing to make a play on the MSE.

I outlined some of the general issues I see with the MSE above, but essentially it is not liquid enough, with too few players currently involved in the market. All notions of transparency go out of the window as soon as you invest, and only long term positions are possible. The real risk here is that if the LSE does not manage to turn the MSE around in a short space of time, the big Mongolian IPO's such as MIAT, TT and all the others will happen in HK, London and Canada, not in Mongolia. This would then be an effective death warrant for the MSE.

There is a limited window of opportunity for the MSE to become something great and a true institution in the country, but this window will close fast. The other relevant challenge faced by the MSE is that insider trading, instead of being a rarity is a fact of life and the majority of trades on the MSE are based on insider trading, as the business community is tiny and it will remain so for the foreseeable future.

Mark: How about the banks, are you confident in the strength of the financial system and the government's ability to manage the monetary growth?

Chris: It is clear that there are far too many banks currently in operations (18 retail banks for 3 million people, of which only about 1 million are "bankable"). I expect that over the coming years we will see an increasing amount of bank mergers to end up with the big four that we have today (Khan, Xac, Golomt and TDB) as the main market players. We have all our accounts in those four banks and have no doubt that they will survive anything that Mongolia will go through.

I have no trust in any of the other banks, as the government has not really put in place the guarantees needed to protect account holders. This became clear during the last crisis where 2 banks went bust (Zoos and Anod banks) and depositors are still waiting to get their deposits back from the Central Bank. I think the government is in its learning phase of how financial systems function, they are learning by putting two steps forward and one step back.

There is a very real risk of a "Dutch Disease" taking place, and also the potential for hyperinflation, but only time will tell how the country and its financial institutions move forward. So far the signs are positive, but corruption and politics have a way of putting the best of intentions to the test.

Mark: Tell us about what you're working on right now with ResCap.

Chris: We are currently preparing an investment vehicle called "Real Estate Mongolia" for those investors that want to invest in the Mongolian Real Estate sector, but don't want to have their risk exposure tied to a single asset or asset type, but rather want to be invested across the country and across asset classes while maintaining a solid exit strategy.

I will serve as the CEO of R.E.M., which will be a publicly-traded company in Canada and the US. We're doing this similarly to how Harris Kupperman set up his Mongolia Growth Group.

R.E.M. will hopefully be ready to start trading by the 2nd quarter.

Mark: Is there an opportunity to get involved now, prior to the listing?

Chris: Accredited investors can contact Eric Zurrin at ResCap to discuss details. There is an opportunity currently.

Mark: Tell us a bit more about R.E.M., and why it's unique.

Chris: We made the decision to make R.E.M. a listed company from the start. We also wanted it to be listed outside of Mongolia to take advantage of the liquidity available in more mature markets, like Canada and the U.S.

You have Mongolia Growth Group, Lee Cashell's APP, and of course Alisher Ali's Mongolia Development Resources (NYSE:MDR). We are different in a number of ways from all of these. Not to say that we are better, but just a bit different. Here's why...

First, all of M.A.D. Investment Solutions Real Estate Portfolio, estimated at US$ 2.5M in assets, including high yielding residential properties in Ulaanbaatar, as well as land and commercial assets in the South Gobi, will be placed into the Company.

In addition, all of M.A.D.'s operations and revenues will flow into the Company. R.E.M.'s operations will take priority, but maintaining all of the other operations drives liquidity for R.E.M., brings about opportunities and operational synergies, as well as contributes revenues and expertise to R.E.M. We're also throwing Research Squared (our dedicated Mongolia-focused research company) and its considerable IP, into the Company. A lot of high-quality assets are part of the equation from the start.

Further, M.A.D. is the only real estate company in Mongolia to maintain its own dedicated and independent research department. This means that we work with all the largest players that require market intelligence. This includes CBRE, Knight Frank and Jones Lang Lasalle. Arguably nice clients to have.

Through Research Squared we have published the ONLY comprehensive real estate report on Mongolia, and therefore we have incredible access to market information that no one else has. The report is 450 pages of in-depth analysis of all sectors of the real estate market, it was an incredible undertaking, with a team of 9 people taking 10 months to compile. It's nearly all proprietary research. If you're looking to put money to work in Mongolian real estate, especially anything substantial, it's a must-read in my opinion.

(Readers that are interested in obtaining a copy of this report should contact us directly here at Capex. Chris and Joachim have generously offered to extend our subscribers a nice discount. We'll put you directly in touch with Research Squared to discuss the report and get your copy.)

I also want to point out the unparalleled experience of our executive team and their robust Mongolian and international network. In my opinion we have some of the best Mongolian and expat Real Estate pros working with us. Joachim and I have been on the ground for the past 7 years, having closed over 1,000 deals, with exposure to over 6,000 verifiable transactions.

We just have an incredible level of on-the-ground expertise, and that translates into the success we've had at M.A.D. thus far. Our overall expertise and knowledge of the market is unmatched. Our position as "experts" also gives us access to what we believe are the absolute best opportunities at any given moment.

Mongolia is an extremely fast moving and dynamic market, things change quickly from month-to-month and year-to-year. We can adapt and be flexible. We also maintain liquidity to make sure we can move on opportunities quickly.

Mark: I'm glad you brought up Research Squared. We recently asked you to do some research for us on a project we are going to be launching in Mongolia. Tell us more about R2, as we call it.

Chris: Absolutely. Look, Mongolia is a very opaque country when it comes to the availability of reliable and unbiased information. This is how most frontier markets are, it's just a fact of life.

We noticed that this was a major obstacle for investors in Mongolia, and thus decided to diffirentiate ourselves from other agencies who operate on a "need to know" basis and only give out as little information as possible to their clients in the belief that too much information would only confuse clients or remove the added advantage of the agency.

We have taken a different approach, and so far it has truly paid off. We noticed about 8 months ago this enormous demand for information that no one was providing, this is when we set up Research Squared, with the mission of providing relevant, up-to-the-minute, unbiased information for investors.

The services were initially only tailor-made for clients by providing due diligence, market research, feasibility studies and business planning to those that required it. The Company has now started providing "off-the-shelf" reports, such as the Mongolian Real Estate Report 2012. It has become by far our best selling product, as it is the first and only report in the country that goes into so much depth about any sector. Your readers should contact you to get a discounted copy directly from us if they are interested.

It is truly unique and has taken our research team of 7 people over 6 months to compile and analyse all the data. We have placed Research Squared in a separate office to our own to maintain an unbiased aspect to them and the team is given no instructions about which products to push, or rather give a negative outlook on. On the contrary, today M.A.D. is basing its investment strategy on the findings of Research Squared and not the other way around.

Mark: That's a great approach. Let's move away from real estate for a bit. Talk to us about doing business in Mongolia. What is the bureaucracy like?

Chris: Bureaucracy in Mongolia is of course a part of every day life. We have decided to outsource as much of our "bureaucracy" as possible. All of our accounting and a lot of our administration has been outsourced to profesionnals outside of our firm. It costs a little more than doing it in-house, but at least it removes headaches and prevents us from losing valuable management time.

The biggest problem that any company in Mongolia faces today is the lack of qualified human resources. I think Harris Kupperman pointed this out in an interview he did with you a while back. Mining companies such as OT are recruiting massive amounts of Mongolians (17,000 workers at the last count) and this places an enormous drain on small businesses such as ours. Salaries have increased 5 fold in the past 2 years and are expected to keep growing at a similar rate for the foreseeable future.

Talented Mongolians continuously "job hop" between different companies until they reach the golden goose of the mining job, which pays way above market rates and provides considerable perks that we can't provide. Expats are too expensive and require too much baby sitting to be of real value, so we are forced to minimise those operations which are labour intensive, as we simply cannot get the man-power to carry them out, and if we do they are not economically feasible.

Like Harris said, if you come here and start an HR company and can manage to find talented workers to contract out, you'll do very, very well indeed.

Mark: How much do you think politics, and social pressures will influence Mongolia's growth going forward?

Chris: Enormously. The Mongolian political elite and the business elite are one and the same. There is no conflict of interest law in Mongolia, so there is nothing wrong with a member of parliament also owning an active interest in a business in Mongolia.

Essentially, the 76 members of parliament in Mongolia are also the 76 most prominent businessman in Mongolia. This actually contributes towards having a positive business environment, as the same people who pay corporate taxes also vote for them. Beyond that, there is no denying that there is an increasing populist agenda in Mongolia and we will see where this will lead. We have upcoming parliamentary elections in June 2012 and expect to see a lot of political volatility until then, which will of course translate into growing concerns to foreign investors, particularly those in Mining.

Mark: Chris and I plan to be on the ground for the elections at the end of June. We're actually thinking of organizing a Capitalist Exploits "meet up" in the country. If anyone is interested they should drop us a note or email us directly.

Chris: That sounds like a great idea. You'll get a lot out of seeing the elections process on the ground, it should be very interesting.

Mark: You're a young guy, what's Mongolian social life like?

Actually to be fair, while in Mongolia I lead a very boring and sedated life. There is very little to do socially beyond going out to bars and restaurants, and as I don't drink alcohol, this very much limits my social life.

The Mongolian business community is still reliant on copious amounts of alcohol to close deals, but this is something that I stay well clear of, for my own health as well as for the reputation of the Company. I believe that business is better served by being professional towards our clients, rather than by being drinking buddies.

I cook a lot and have a close group of friends, both Mongolian and expat, that I regularly see in cafes, restaurants and of course at home. UB life, despite it being a capital, is very much like a village, with everyone knowing each other (and gossiping about each other). The winters are long and cold (now -36) so the temptation to go out for walks goes out of the window, and we all tend to hibernate with books and good TV shows... Those play an important part in my life during winter.

Mark: I'm from the frigid north myself, so I know what you're talking about. Any advice for young entrepreneurs with some guts and a little bit of cash in their pockets?

Chris: I think that being an entrepreneur in Mongolia is an amazing opportunity, but it also comes filled with challenges. Mongolia is a tough environment where you will be challenged on a daily basis. It is also too easy to fall into the temptation of taking shortcuts and paying bribes or going out drinking too much.

I have seen an incredible amount of young expats come into Mongolia and rapidly crash and burn in an alcohol-fueled frenzy. While there are immense opportunities here, having the right Mongolian partner on the ground is essential, as well as having a solid head for business and not letting yourself be intimidated by the markets.

Mongolia is a very small market, and unlike China it is a very well educated and discerning market. If your strategy is not 100% on the spot, it is easy to fail. I would advise any young entrepreneur to first spend time in the country learning about how it functions, building up a network and truly researching the markets before launching yourself into the unknown. Make sure you understand the challenges of working here. Mongolia is neither Asian nor European, but a mix of the two with a very particular market dynamic. Never make the mistake of thinking that if it works in China it must work in Mongolia. Here everything is different, and if you become successful everyone will copy you, so you have to remain competitive at all times.

Mark: Those are great points Chris. You just cannot underestimate the challenges in frontier markets. I'm glad you pointed out that Mongolia is NOT China. I think too many people make that mistake and lump them together.

Finally, give our readers an overview of how they can work with you at M.A.D. or at Research Squared.

Chris: We really take each investor individually and work out the best strategy for them, so regardless of ticket size we always try to work out the best solution for each particular investor.

This ranges from smaller investors buying a US$ 40K or 50K apartment in the city, renovating it and renting it out to an expat, to the larger investor wishing to create a land-bank in secondary cities to build warehouses for the mining supply chain.

I think it is important to point out that our two strong company values are transparency and unbiased advise. We don't charge commissions based on percentages, as we think there is a conflict of interest with our clients in that system. We want to sell the properties at the lowest possible amount to bring the most value to our investors, not the other way around. We also believe that by giving unbiased advise about the markets, our investors are more likely to make the right decisions in the long term rather than the wrong decision in the short term, and thus are more likely to become long term clients of ours.

Mark: Thanks Chris, this has been a great interview, and one that I think our readers will really be able to extract value from.

Chris: You're welcome Mark, see you in June!

There you have it. Chris really does have his finger on the pulse of Mongolia, and his advice should be taken to heart.

We've said it a hundred times in these pages, Mongolia is a land of opportunity. However, nothing comes without a price. Those that think they can just Waltz on in and make a fortune really need to take a step back and give it some thought. Fortunes will be made, but they will also be lost.

If you want to participate you need to go and get on the ground and talk to guys like Chris and Joachim. This is exactly what Chris and I are doing with our venture in Mongolia. We've identified a niche, reached out to our network and are now laying the groundwork with guys like Chris and Joachim to insure our success. We'll write more on that later.

- Mark

"Fortune favours the bold" - Virgil

Disclosure: I am long OTCPK:MNGGF.