Financeprofessional.com interviews Chris Freund, managing director at Mekong Capital, a private equity firm that invests in Vietnam, Laos and Cambodia. The firm is the investment manager of the $18.5 million Mekong Enterprise Fund.
Financeprofessional.com: Can you tell us about your background? Your professional development and how you ended up as a financial professional in the Mekong Region? Anything you can tell us briefly about your partners?
Chris Freund: I came out to Asia to study Buddhism in India in 1992 and backpacked around Southeast Asia, including Vietnam, for six months after that. In 1994 I was hired to do a six-month research project on the investment environment in Vietnam for a U.S. based fund manager called Harris Associates. At the time, all of the stock markets in Southeast Asia were booming, and it was widely believed that Vietnam would be the next Asian Tiger. There was a Vietnam euphoria, and many investors were in a hurry to get in early.
I joined Templeton in early 1995, shortly after the launch of the Templeton Vietnam Opportunities Fund and set up the office and operations for Templeton in Vietnam. Although Templeton only made three investments for that fund in Vietnam, I was able to watch as the market developed and learn from the experiences of the other Vietnam funds and investors that were investing in Vietnam in the 90�s.
In 1998, Templeton closed its office in Vietnam, and I was transferred to Templeton�s Singapore office where I became a technology analyst and portfolio manager covering technology companies in Taiwan and Israel. In early 2001, I left Templeton in order to form Mekong Capital and move back to Vietnam. I�ve always wanted to be in Vietnam due in part to the tremendous opportunity which I believe exists there as well as a very strong admiration for Vietnamese people.
One of my partners in Mekong Capital is Martin Adams, who is also Chairman and is a member of our fund�s Investment Committee. Martin launched and managed the Vietnam Fund beginning in 1991, which was the first Vietnam country fund. They made and divested 11 investments over the 11-year life of the fund. Martin has an extraordinary depth of experience--and a willingness to share that experience. He has really gone out of his way to help us.
Financeprofessional.com: How do you think your strategy differs from other current capital providers in the area?
Chris Freund: The key elements of Mekong Capital�s strategy are threefold: 1) focus on private entrepreneurial companies as opposed to equitized (privatized) companies or foreign invested companies; 2) focus on labor-intensive export-oriented businesses which leverage the region�s competitive advantages; and 3) provide very substantial levels of post-investment assistance to the companies in which the fund invests. Because of our focus on private entrepreneurial companies--and due to the small size of those companies--the average investment size of the deals in the Mekong Enterprise Fund�s pipeline is around $1 million, which is also smaller than what most other investors are willing to accept, particularly relative to the amount of work that goes into these deals.
Financeprofessional.com: What kind of interest are you seeing from investors in Mekong Capital and the Mekong Enterprise Fund? Can you tell us more about the involvement of some of the semi-governmentals in the Mekong Enterprise Fund? What goals do they have for their participation in your fund?
Chris Freund: Due to the generally poor record of the Vietnam funds and Mekong region funds in the 1990�s, investors are generally cautious, and with good reason since the risks in these markets continue to be very substantial, particularly corporate governance and transparency issues.
Most of the investors in the Mekong Enterprise Fund are fully or partially government funded and have development-impact objectives when investing in a fund such as the Mekong Enterprise Fund. They want the fund to have a positive impact on the development of the private sector such as by the companies in which the fund invests serving as role models for other private companies and government officials and by the fund acting as a catalyst in the development of capital markets such as by identifying and resolving problems that we encounter. For example, Mekong Capital maintains and regularly circulates an �Obstacle Status Report� which explains about 30 to 40 of the problems that face private companies or investors in private companies in Vietnam and then we coordinate with various government agencies or donor funded programs to get those issues resolved. We also try to provide a lot of useful information at our website, which is useful to private companies in general.
Although the Mekong Enterprise Fund operates on a commercial basis, due to the development impact objectives of the investors, the investors are willing to accept a higher level of risk than what most private sector investors would be willing to accept. Another issue is that in a fund like the Mekong Enterprise Fund, the expense load is very high due to the significant amount of time and work which needs to go into these deals relative to the investment size, including legal costs and time spent providing assistance to the portfolio companies. Although we believe this high expense load can be more than compensated by the value that Mekong Capital can add to the fund�s portfolio companies, this model is unproven in this region and is a point of concern for private sector investors.
Although it is still difficult to raise capital from foreign investors to invest in Vietnam or Mekong region funds, an interesting development is the rapid growth of life insurance companies in Vietnam, all funded by domestic capital, which now have significant money to invest but limited outlets in which to invest it. The stock market of Vietnam currently only has a total market capitalization of around $120 million.
Financeprofessional.com: Why the Mekong Region; why Vietnam, Laos and Cambodia? What is the growth potential for the area, and what attributes convince you that it is poised for growth? What sectors do you find most promising? What opportunities are you seeing there that you do not see in the rest of Southeast Asia?
Chris Freund: The people of Vietnam are generally hardworking, diligent, enthusiastic, eager to learn and highly cooperative--and combined with a cost of labor of around $50 per month, it is an attractive base for labor intensive manufacturing. Although there are a few exceptions, the depth of management expertise is low in general.
The growth of specific companies largely depends on their ability as organizations to attract and develop management expertise, particularly soft skills such as leadership, communication, proactiveness and attention to detail. Since local companies are usually competing largely based on their production costs, the success of specific companies depends to a significant degree on their ability to manage the production process with increasing levels of efficiency, which means low defect rates. We do see this trend happening but the big question is whether or not these companies will be more or less proactive about this than similar companies in China, which is the main competitor for Vietnam in most sectors.
Relative to the rest of Southeast Asia, Vietnam is often considered to have a more diligent and cost effective workforce. Furthermore, Vietnam is seen as having greater political stability and personal safety than some other countries such as Indonesia and Philippines.
For Vietnam we believe that the most attractive sectors are labor-intensive export-oriented sectors such as furniture, garments, footwear, ceramics, agricultural processing and some downstream plastics.
Due to the abundance of trees, Laos has a lot of potential in the wood products industry but so far that hasn�t been realized in any significant way. They also have a lot of potential in lower-temperature agriculture such as coffee and fruit plantations.
Cambodia�s potential seems to mostly be related to tourism. Of the three countries covered by the Mekong Enterprise Fund, this one seems to be the most difficult to find potentially attractive investments.
Financeprofessional.com: What are the challenges and difficulties of investing in the region? What sectors and businesses would you avoid?
Chris Freund: The biggest problem we face is transparency and corporate governance. In the current system, it is easy for companies to hide their profits and by doing this they can save a lot of money on taxes. Therefore, most private companies in the region are unwilling to meet the Mekong Enterprise Fund�s transparency requirements, particularly our requirement that they have their accounts audited.
A related risk is that even for companies that commit to meeting our transparency requirements, there is a risk of non-compliance after the Fund invests. Generally it is companies that plan to list on a stock exchange that are most willing to meet our transparency and corporate governance requirements because they realize that with good corporate governance practices and high levels of transparency, they will obtain higher valuations when they list on the stock market. We estimate that around one third of the companies we meet are willing to meet our transparency requirements.
The transparency situation is typically worse for domestic oriented business than it is for export oriented businesses because many domestic oriented businesses are sometimes prevented from issuing invoices by some customers (who want to hide the size of their business in order to avoid tax) and/or must pay unofficial commissions to generate sales. Since commissions are not tax deductible, it precipitates the use of slush funds, which again leads to poor transparency. Therefore, we are generally avoiding domestic-oriented businesses.
In broader strategic terms, the region�s competitive advantage derives from the low cost of labor and management as well as some environmental advantages. We would avoid industries where the region is at a competitive disadvantage, or industries which rely on government protections, including most capital intensive businesses. Those businesses often depend on large economies of scale and low capital costs which makes it difficult for this region to compete. Another issue is that investors have routinely overestimated domestic demand in these markets and we would avoid businesses that intend to sell into unproven domestic markets.
Financeprofessional.com: What would you tell people who wonder about the political stability of the region?
Chris Freund: Vietnam is often considered one of the most politically stable countries in Asia, and we would agree with this analysis. Reforms and economic growth are occurring at a reasonable speed, and the quality of living is the best it has ever been.
Laos also seems quite stable politically. Cambodia on the other hand seems to have higher levels of political risk as well as enforcement-related risks.
Financeprofessional.com: How does the average person on the street view foreign investors? What is the government doing to encourage foreign investment?
Chris Freund: In all three of these countries the people very much welcome foreign investment. They seem to recognize foreign investment as much for the jobs it creates and the skills that local employees develop when working for foreign invested companies as they do for the economic growth which it generates. There is a strong preference among people to work for foreign invested companies, which in fact is something of a problem for locally-owned companies which typically don�t have well developed employee value propositions.
Financeprofessional.com: What about the Vietnamese way of doing business would most surprise a Western investor?
Chris Freund: I would say the two biggest surprises are 1) the widespread use of the commission system among domestic transactions--for example, even many foreign invested companies have difficulty stopping their purchasing managers from receiving commissions; and 2) the time horizon of locally owned businesses is usually shorter.
For example, foreign investors are usually thinking about creating shareholder value over a three- to five-year time horizon whereas locally owned companies are often thinking about maximizing cash flows in the short term, which sometimes means investing less in the development of their businesses, particularly in the development of the capabilities of the management team, such as by paying higher salaries to attract higher quality managers. On the other hand, due to this emphasis on short-term cash flows, locally owned companies are less likely to be losing money than foreign invested companies and that often means they are more stable. [6/13/2003.]