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«“In America, the best people go into the private sector. In Singapore, the best people go into government. In Vietnam, the best people leave the ...»

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“In America, the best people go into the private sector. In Singapore, the best people go into

government. In Vietnam, the best people leave the country.” - Long time Vietnam observer

I am just returned after a very interesting trip to Vietnam where I met movers and shakers in the

corporate and government world in Hanoi and Ho Chi Minh City. My first visit to the country was 14

years ago and I have been several times over the years witnessing a curious form of development. China seems to develop in a more or less linear fashion whereas Vietnam’s path to modernity is much more erratic. Last month The World Bank published a report titled thrillingly, “Vietnam Solidifies Macroeconomic Stability, but Economic Growth Continues to Perform Below its Potential.” Vietnam is a country with incredible promise and it is just that promise that blinds investors because China, it ain’t.

I have to admit having had this blind spot about the country for many years mislead by the “surface positives,” which are indeed very impressive. Vietnam is a Confucian culture (they use chopsticks) with a long history of literacy, tenacity and a national determination which has shaken off invaders one by one from the Chinese, to the French and most recently the Americans. Nearly 70% of its 90 mn residents are of “working age” with over half of the population under 30 years old. That large youthful work force is expected to grow at least by 1 mn every year. Other growth drivers include the paltry 35% urbanization rate, vs. 55% for China - a lot more people will be leaving the rice paddies and moving to the big smoke looking to better their lot. Inward remittances from overseas workers of almost $1 bn a month should not be overlooked either. All this helps explain why Vietnam’s consumer goods sector is the fastest growing in Asia, expanding by 23% in 2012, vs. 13% for China. Only 20% of the population has a bank account and nominal GDP per capita is just under $2,000: the consumer boom in Vietnam is barely getting started. That is the exciting bit.

Encouragingly, statistics show the country has upgraded its export mix from underwear and raw materials to high tech smartphones and electronics. Samsung Electronics is investing another $2 bn in building its second mobile phone factory in Thai Nguyen. The move up the value chain has helped transform Vietnam’s trade and current account deficits to surplus with the SBV (State Bank of Vietnam) now sitting on $35 bn in f/x reserves, a record high. Vietnam’s PMI reached 51.7 in July, an 11 month expansion and inflation, as measured by the CPI – long the major threat to the economy – is now just 5%; a ten-year low. Interest rates have come down with deposit rates falling from 12-14% to 7-8% now.

All this explains why the equity market has recovered – and will continue to do well, in my opinion.

Current equity market capitalization is $55 bn with trading on a good day reaching $100 mn. Foreign investors own almost a quarter of the market. There are no local pension funds or large insurance funds investing in the equity market which would deepen liquidity. Capital market development in Vietnam is still infantile. The main board (as there are two) is the HOSE (Ho Chi Minh Stock Exchange) and the index is up 18% YTD, so clearly everything is hunky dory, right? Well, not really.

GDP growth this year will likely be just above 5% and credit growth is dead at just over 2%. Much like China, the banking sector is crippled by a staggering amount of NPLs, with Moody’s estimating one in seven loans are rotten while the real number is a state secret (officially it is 5%). M2 growth averaged 20-35% from 2007 to 2010 with the majority of loans going to real estate projects. Banks were encouraged to lend to support economic growth. While an AMC was created a year ago which issued bonds to banks leading to a drop in NPLs and helping systemic liquidity, the dead loan problem is still hanging over the economy like an overweight, unwanted aunt with bad breath.

“With 2/3 of Vietnam’s exports by value coming from FIEs and most of the rest of it oil, it’s almost as if the Vietnamese can’t export anything.” – 15-year resident of HCMC While manufacturing has contributed 31% to GDP growth, 68% of exports are from FIEs – foreign invested entities. It is this FIE sector which is responsible for posting an $8.5 bn trade surplus ytd.

Vietnam is still a destination of low value-add export manufacturing with little indigenous technology offering a low-skilled, low-wage workforce. Unlike Korea and Taiwan, the country has not developed any process technology, nor do they look like they are very busy doing so.

SOE reform and the “equitization” (listing) of state owned enterprises has long been eyed greedily by foreign bankers and suspiciously by the local political elite. After spending a week on the ground in Hanoi and HCMC, it seems to me we are a very long way from any progress here. And the reasons for this are interesting.

“The less government ownership in a company the cleaner it is. Anything less than 50% state ownership means they are making an effort to clean it up.” – PE fund partner Any large company with the word “Vina” in it is almost always a state owned enterprise. SOEs control the commanding heights of the economy and are loath to give up their privileged position to a grubby but up and coming private sector. The main reason is less ideological rather than financial. The patronage system has deep roots in a country with over 2,000 years of recorded history. In short, working for an SOEs can be very profitable. In one example explained to me, suppliers to state owned enterprises on average over-invoice by 25-30%. That largesse is then spread among the various VIPs within the group. Privatizing such an organization would mean shining bright unwanted light into dark and currently lucrative corners. This isn’t to say the whole system is static and change is not coming but rather change for Vietnam – and this is the main message of my visit – will be slower than most investors expect.

“There are no rules in Vietnam. This is GOOD for investors. If you want rules – go to the United States!” – Director of a large SOE in Hanoi We met the chairman of one large SOE which operates directly under one of the major ministries of the government. He was at pains to explain to us in pretty decent English that while his company was an SOE, “We are internationalized and flexible and we compete against foreign firms, not Vietnamese ones.” Yet, we also learned they are forced to participate in projects they do not want and he told us, “With government projects NO project is on time. Always delay!” This may be true everywhere not just Vietnam. What is obvious, however, is SOEs by their very nature are told by politicians what to invest in and how much. This makes them less attractive destinations for investment.

“Why would I want to do that?” Our meeting was focused on assets, not earnings. The idea with state owned companies is to maximize the asset side of the balance sheet; an income statement is pretty irrelevant. When asked why this particular SOE didn’t monetize some of their vast land holdings by selling the rights off my innocent question was met with a loud laugh, “Then I would have to give the money to the government! Why would I want to do that?” I thought, uh, because that is your job? It was clear I had much to learn about incentives within the SOE structure.

One company I visited was VinGroup (VIC VN), the largest developer in Vietnam with a local brand name that is recognized nationwide. Chairman Pham Nhat Vuong is also Vietnam’s first official billionaire. The company has a market cap of $3.3 bn and trades about $1 mn a day. With unrivalled access to capital and powerful political connections, VinGroup has managed to acquire a land bank of 90 mn square meters, slightly larger than the island of Manhattan and four times the size of its nearest competitor.

Eighty percent of the land bank is tagged for resorts and is scattered up and down the coastline of this narrow country, while another 16% is in Hanoi and the remaining 4% in HCMC. Despite the heavy weighting in resorts, the real money is in urban development and urban retail which is to become the focus of the company going forward.

The street forecasts EPS CAGR of around 33% for the next five years, driven by residential asset sales and a growing recurring retail income. Along with the political connections, VinGroup enjoys a lower cost of capital than smaller local competitors having tapped the international debt markets with a $300 mn CB in 2012 and a $200 mn “International Bond” in 2013. Warburg Pincus has also made a $200 mn strategic investment for a 20% stake in the group’s unlisted subsidiary, Vincom Retail.

While the company is highly geared, with a D/E ratio of almost 3 times, they do have some flexibility on when they pay the government LURs which helps balance operating cash flows. All land is owned by the Socialist Republic of Vietnam but land use rights of 45-48 years can be had for a stiff fee.

Developers by the nature of their business are usually highly geared (except in Hong Kong where they enjoy a rigged system) and earnings are lumpy as projects are completed and sold off en masse.

VinGroup’s recurring income can help balance this out. The company has several large retail malls that produce income and is completing another one, the Times City Mega Mall by the end of the year.

Does this make VinGroup a Hang Lung (101 HK)?

No. Way. Building a mall is very different from designing a mall and both exercises are very different skill sets than running one successfully. Unfortunately, VinGroup does not see it that way. We spent a morning exploring their prized retail asset, the Royal City Mega Mall in Hanoi. To be frank, it was less than beautiful and less than full.

Actually, it was ghastly and deserted. Reminiscent of an underground bunker large enough to drive fuel trucks through, Royal City Mega Mall is cavernous, poorly lit and poorly maintained. It was designed unimaginatively with zero natural light and is made up of countless awkward passageways which only compound the feeling of isolation and even alienation one feels marching endlessly down miles of rather empty corridors. Shops imprisoned there are mainly no-name Chinese brands such as Anta, Li Ning, etc. The photo I took above perhaps illustrates some of this. One foreign commercial real estate broker I spoke with in HCMC described VinGroup’s retail ventures as “horribly designed,” and even more to the point, “a disaster.” Sitting atop Royal City are towering white blocks of concrete of 4,500 apartments. Stolidly bearing witness to zero aesthetic, these monstrosities have been ripped right out of the old Soviet Union playbook on how to house the workers. The buildings are ugly now and will only get uglier as newer and more modern buildings in the area are built (by other developers). The company has been able to achieve gross margins of 65% from leasing commercial space and margins half that from selling apartments. According to the company’s Q1 2014 financial statements, real estate operations are 80% of total revenue with leasing contributing just 8% but that amount is expected to reach 40% over time.

Lastly, the company has a stated goal “to become a major player in e-commerce.” When I asked them just what the heck that meant I was told it meant dumping $50 mn into an “internet project” to see what happens. Yikes. Tread with care.

Masan Group (MSN VN) is an interesting holding company which has a market cap of $3 bn and trades about $ 1mn a day. The company’s annual report begins with the telling statement, “Five years ago, we were primarily a sauce company.” Reading ahead with great foreboding I learned today, however, if you buy Masan not only do you get sauce but you also get a troubled bank, a capital-sucking tungsten mine, and a bucolic animal feed producer. The financial statements are rather confusingly split between “the Group” and “the Company.” The Group has the assets and the cash while the company has the accounts receivables and the long-term investments. In reality, the listco is “the Group” and the listco’s external financing department is “the Company.” The most interesting part of the group is their unlisted consumer business (Masan Consumer Holdings) which includes, sauces, seasonings, and instant noodles. MCH has over a 70% market share in fish sauce – the essential ingredient in Vietnamese cuisine. In the instant noodle segment, the company has gone from nowhere to owning 30% of the market.

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