Frontier Investing – The Investors Podcast Network

On the latest ‘We Study Billionaires’ podcast from The Investors Podcast Network, Kiyan Zandiyeh speaks to Preston Pysh and Stig Brodersen about Frontier Markets Investing and Investment opportunities in Uzbekistan.

With discussions around the differences between Investing in Frontier Markets and Investing in Emerging Markets, how to assess the political and currency risk of a country, validating information collected and the advantages of conducting “boots-on-the-ground” research prior to deploying any investment capital.

Furthermore, Preston & Stig explore why Uzbekistan is the most interesting frontier market right now and how Sturgeon Capital is approaching investments in the country through their Uzbekistan Growth Equity Fund.

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Podcast Transcipt

TIP 306: Frontier Investing w/ Kiyan Zandiyeh

Stig
Hey everyone. Welcome to The Investors Podcast. On today’s show, we have an awesome guest that’s going to talk to us about frontier investing. His name is Kiyan Zandiyeh, and he’s the Chief Investment Officer for Sturgeon Capital. Kiyan has extensive experience with early stage business and pioneer investing. Throughout the show, we talk about different countries and how to assess equities inside of those countries. And then in the second half of the show, we specifically focus on the way he’s investing in Uzbekistan. This is a fascinating discussion, and I have no doubt you guys are going to really enjoy learning about this style of investing as much as I did. So with that, let’s go ahead and dive in.

Stig
Welcome to The Investors Podcast. I’m your host Stig Broderson and as always, I’m accompanied by my co-host Preston Pysh. Today’s guest is Kiyan Zandiyeh. Kiyan, welcome to our show.

Kiyan
Thank you very much, glad to be speaking with you.

Stig
Today’s topic is investing in frontier markets and that is not to be confused with investing in emerging markets. Kiyan, perhaps you could provide an overview of the difference between the two and what it really means to be investing in frontier markets.

Kiyan
So it’s an important question, actually, and I guess, to take the first step is, there’s no universal definition of frontier, emerging or even developed for that matter. And if you take the indices as they stand, and you invert the current indexes, let’s say by the country constituents, what you quickly find or infer is that there is no unifying theme that exists. And the difficulty of that is, let’s say for public market investors, is that for active investors, On a relative basis that performance is judged by the indexes, and passive investors are getting exposure to what would arguably not be frontier. And the issue of the indices, I think is that the lens of which they’re put together is capital market sophistication. That is, to what extent have the capital markets, these countries allow for international investors to access them. Now what that implicitly means that you have a whole host of countries that have simply skipped or missed, and investors are not getting access to. And so our focus is really on the private market, where we’re not beholden by these traditional definitions. And we can act as we see fit. And so what we’ve tried to do is create a simple definition of what we consider frontier and emerging.

And the way we look at it is a frontier country is effectively one that has substantially below average levels of private sector participation. And by virtue of that has very low levels of foreign investment, and emerging are countries that we see developing in the sense that either the government or some sort of catalyst is taking place to allow for private sector participation, and foreign investment to increase. And what we like to define, what we do is, investing in countries that are fronted by the definition I just provided, but are emerging in the sense that they are allowing for the private sector to play a larger role in the economy, and by virtue of that foreign investors to also participate. What that effectively means is that, because there has been a lack of, let’s say, true private capital, which is more incentivized to capitalize on opportunities in let’s say, government capital, that opportunities can be exploited or capitalized that the rest of the world has already seen, but that these countries haven’t yet experienced. And in terms of frontier markets, specifically, I think what has changed in the landscape over the past five to 10 years, has been that traditionally, the only way to really express a view, especially on the private side, was to invest in, let’s say, traditional businesses, let’s say a bottling factory or some sort of industrial business. And the difficulty with that is what you’re effectively doing is optimizing what has already been in the country, rather than creating or optimizing for what is best practice, or best business models. And the revenue side of that is implicitly linked with GDP.

Now what you have in these countries is that GDP is structurally higher but more volatile. And so your revenues and freedom from FX perspective, there’s more volatility. And what a lot of people focus on is, let’s say cost optimization. And let’s say your business has 20% operating margins but peak margins and industry are 30%. There’s not really that much room for you to optimize. And so again, you fall back to revenue growth. And revenue growth in a scenario where you have to make large tangible investments is difficult. But what has happened is the beauty of let’s say, developed markets is because of a base level technological infrastructure improvement, the speed with which companies can grow has been extremely accelerated, to an extent that base level of lots of digital infrastructures is there as well. So you have let’s say 70% to 80% internet penetration, you have 50 to 60% smartphone penetration. But none of these business models that we know have, let’s say, positive economic dynamics, positive unit economics that are scalable that have been implemented. And so our focus really is on this area where we believe it’s a secular trend that is de-correlated. It’s not too linked with the economy, but you’re taking advantage of all the benefits of what frontier markets typically present that haven’t been previously available to investors looking at this.

Stig
So Kiyan, when we hear about growth rates in frontier markets, we often hear about generous double-digit returns. However, the highest returns are often denominated in local currencies for that specific country. How do I as an investor assess the currency risk when I convert back into USD or euros or any other major established currency?

Kiyan
Let’s say on a macro basis, I would say country by country is different but there are tell-tale signs of structural dynamics of an economy that could be FX vulnerability. It could be current account deficit; it could be budget deficit could be high levels of external debt. And these are stuff that are easily available for an investor to observe and to choose whether to participate in the economy or in the markets or not. What we try and do is obviously stay away from those sort of economies. What we like our economies that have natural current account surpluses have very low levels of external debt. And so from a foundational perspective, you’re protected. Then there’s the portfolio or investment micro basis where on a company by company basis, you can build in, let’s say, implicit hedges. So what you want to avoid or let’s say companies where you’re importing your input factor, that is your cost or FX base, but your revenue is a local currency base, that will always leave the business vulnerable to FX shocks. The flip side of that is, you have companies that may export a product or a service whereby they’re getting hard currency revenues, but that costs a local currency and in a scenario where the currency weakens your model actually expand. What we also care a lot about is companies to have pricing power. So what you normally have, is let’s say, a weakening in currency, but then inflation coming. What we want to be able to see is that a company has demonstrated power or pricing above whatever inflation may be. So that what will happen is in the short term, yes, you’ll feel a nominal pain from the currency weakening but over the mid to long term, really, that pricing power comes to fruition and provides the hedge to the currency. And on a separate basis, what we try and do when we’re looking at investments is really stress test against worst possible FX scenarios. And if we find that we’re not comfortable with what the business will look like, in that scenario, then we simply pass. I mean, we like to think that we want in build resiliency within the business models from various different perspectives, but especially on the FX side of things.

Stig
Frontier markets is such an interesting type of investment. And typically, people don’t want to be 100% exposed into something like that, but perhaps they might take a small part of that portfolio and allocate into something that’s different. Could you please talk about the correlation and risk premium between specific frontier markets and a portfolio of global model weighted equities?

Kiyan
If we take a look at, let’s say, public markets when more data is available, on let’s say the MSCI frontier, what do you have actually found over the past 10 years is that they are pretty de-correlated. So I think you have a correlation of developed markets about 0.3. And only 3% of individual returns in countries can be explained by frontier markets. So you tick the box from the correlation perspective. From a risk premium perspective, Frontier Markets basically failed in this. So if we take MSCI frontier over the past 10 years, it’s annualized about 4% in dollars. What I think explains both the correlation dynamic and the risk premium dynamic in public markets, has been a drain of liquidity that you’ve seen from these markets over the past 10 years and for us is a structural flaw of public market investing in frontier markets. In that you may be right on your investment thesis, but for the validation of that investment thesis to be liquidity coming into the market, especially foreign liquidity in the absence of local sophisticated capital markets, you’re basically investing with a huge variable you have no control over. So maybe you’re right in five years, maybe you’re right in seven years. But as an investor where your career isn’t it, is the funds that you manage, it’s very difficult. Similarly, in private equity, I would argue that the risk premium side of things have failed as well.

So if you look at realized returns over the past 10 years on frontier market private equity funds, we are talking about 9.87%. Now, if we put that on the spectrum of emerging and develop emerging mean, let’s say realised within around 15%, developed markets have been 19%, upper quarter was 29%. So frontier, from a risk premium perspective in the private markets has really been the opposite end of the spectrum that one would normally want. And, again, going back to my previous answer, I really think that has been an issue of allocation as opposed to the fundamental benefits of frontier. In that, again, if you’re investing traditional businesses, it’s very difficult to unlock value. If you’re investing in previously owned state companies, because they’re nominally cheap, it’s very difficult to unlock value. And the way we think about it is, well, what is the return that investors should expect from frontier. And if we focus on the private side of things, if you take a look at develop market returns, they said, let’s take the upper quartile of 29% over the past 10 years, it would be rational to assume that investors would want to premium. And if we take that a GMO forecast of kind of what premium should be, it’s roughly 10%. So our target return is 40% annualized, which means roughly just above five x in five years on capital. Now, that may seem somewhat of an ambitious target. But our view is that if we cannot achieve it, there’s simply no reason for us to exist as a firm. And the way we think about it is when we’re appraising or looking at investments, 40% is simply a discount rate. And if it does pass that, then our whole job is making sure that the assumptions that go into how that return is achieved is validated, and that we have conviction.

Stig
So Kiyan, most investors like the certainty that there won’t be any major unexpected changes to the investment climate that’s different in frontier markets. So how do you assess the political risk in a frontier market?

Kiyan
I don’t think there’s anywhere in the world at the moment where there isn’t political risk. And I would argue that political risk in more developed countries is higher. Why? Because you have democratic political cycles that are every four years. And within that there are dynamics that unfold that drive markets. So if we take the US as an example, for tweets, Trump can move the market. The narrative of 2019 was the China trade deal. You’ve had examples of let’s say, Switzerland in 2015 when they abandoned the current FX floor, investors lost money. There are a lot of things that are happening around the world, especially in developed markets that present investors some form of political risk. With frontier markets is somewhat different. So what you have is there’s less democratic structures. And what you normally have is one political system that leads or operates for an extended period of time. Now, that doesn’t necessarily mean that that political system is positive or negative. But at least you’re comfortable with the lay of the land. And what you normally happen on momentous shifts every, let’s say, 10,15, 20 years, where the leadership structure of the country changes. And what we want to be is on the right side of that, if a country is just gone for a change, to observe that that change is positive, that there is stability to that change, and then we start to invest. So that’s on a macro level. On a micro level, what you have from political risk, is, let’s say if you’re involved in an industry where all of a sudden the regulation changes, the law changes that could affect the pricing of the product or service that you’re selling. And what you normally find is, especially if you’re involved in investments that are somewhat involved in the ecosystem of the government, from a strategic asset perspective, that there are potential risks there.

So let’s say a country is one of the biggest assets is, let’s say oil and gas. If you’re somewhere in the value chain of that you potentially fall foul of political risks. And so what we want to do is the way we think about it is, we don’t want to be involved in investments where we’re taking from the ecosystem, but we’re adding to it. So let’s say if a lot of people like the concept of investing in privatizations, I’ve seen success stories in other countries. But what you normally find in these companies that they have bloated workforces, and that the rational first thing to do would be to basically make redundant up to 50% of the workforce. Now, as a first step in an economy, which you’re doing, that doesn’t win you any favours. But if I flip it and say, well, let’s say we’re investing in e-commerce, what are you doing there? What you’re saying is the local logistic providers which aren’t really making money is, look like working with us your revenue will increase. You employ the youth population. Again, you’re tackling a problem of youth unemployment. You’re making it easy for people to access products which they otherwise wouldn’t be able to access to and at a lower cost so you’re adding value to the ecosystem. And the final point to kind of I would say that we really focus on is, is building intangible value as opposed to tangible value. tangible value is much easier to be expropriated. It’s much easier to criticize, but intangible value is something that is difficult to build. And it’s very difficult for someone to say, oh, well, we don’t like this business, we’re taking away the CEO and putting a new one, because there isn’t anyone that could run the business the same way that the incumbent is already doing. Whereas with a goldmine, you can easily take away the CEO and putting someone else to run it.

Stig
So I guess I would like to preface my next question and say that this might come from someone who hasn’t been invested ever in frontier markets, and only starting to invest in emerging markets recently. Again, knowing that there is no official definition between the two. One thing that I as an investor are always concerned about the information that I get, how do I validate if that’s true? And some of the data might even be hard to collect. So I guess that’s my way of saying, okay, so you have research process. But how do you validate the data you collect?

Kiyan
The benefit of investing let’s say in the US is, by law, by regulation, the quality and the quantity of information that is provided to investors allows for an appropriate judgment to be made as to an investment. Now, what that means is that, that information has effectively been commoditized. Now, the beauty of frontier markets is that it hasn’t. And so as an investor, if you have an edge in collecting valuable information, then that can really be valuable. So what we do is in any country that we invest in for us, it’s important to build a local team on the ground. And one of the reasons that’s important is that they have an understanding of the level of information that’s needed for us to make an investment appraisal. And what they actively do with the companies that we’re looking at. I’m focusing on the private market here is effectively handhold and actively work with the management to dig out the information that is necessary for us to appraise.

The other thing that’s important in these countries is that what you don’t want to be in a situation as well as a huge asymmetry of information. So you could go into a management meeting and the guy could be extremely charming, they could be charismatic. What we want to do is effectively flip that asymmetry. So when we’re looking at a business, what we initially do is identify the variables to say, what are the important variables that are driving this business? What are the data points that we can match to that? And what we request or what we insist on is that company having the data infrastructure within the business for us to be able to see it on basically a live basis, on a weekly basis, bi-weekly basis. We’re getting data inputs as to what factually is happening with the business and then for us to drive the discussion narrative management off of that. So we believe that’s important from let’s say, practical investment perspective. The other factor is, let’s say governance aspect, in that again, when it comes to develop markets, you’re reasonably confident that the laws and regulations provide for a base level of governance infrastructure that can make you comfortable. What we effectively do is we create what we call a stakeholder map. So that really is a map of all the factors that are driving the business. So you want to know if the guy’s, if he’s buying supplies, if he’s buying a datacentre, if he’s buying an office, is there any related parties in that transaction? If so, what is the incentive driving that? And that really basically brings to life any bottlenecks, any potential risks that we can address, even through the term sheets, even through direct discussions of management, or the way we structured investment.

Stig
So Kiyan, I know that you’re doing this and top authorities in the frontier market investing always talk about why you need to be having boots on the ground to conduct research? What are frontier market investors like you looking for when you travel to frontier markets like Albania, Bangladesh, Botswana, or any other kind of frontier market for that matter?

Kiyan
Well, the first question you want to answer is why does an opportunity exists in that country? Normally the answer is pretty simple. It comes back to my first point of saying, well, there just hasn’t been private capital. Make sure that the institutions, that is the laws and regulations will allow you to operate in a reasonably easy manner. The ultimate question I would say that we want to answer is what variant perception, let’s say what edge do we have in the country that not only foreign investors don’t have, but the locals don’t have? And one kind of hack that I think is a good way to go about it is when you go to a country meets with leading brokers meet to the local version of vessel banks, and ask them to simply show you the best deals that they have. The idea is not specifically to look for actionable investment ideas, but it’s to see what are the locals thinking about? How are they thinking about what the best opportunities are and why they think that and then around that you can see well, what are they missing? Now the aim there is not necessarily to look for actual investment opportunities offer that but it gives you the framework of how the locals are thinking about it.

What you ultimately want to do is define what your edge is within that country, whatever it may be. What is also important is that whatever that edge is to make sure that the institutions in the country, that is the legal system, the regulation allows for you to execute on whatever that particular focus may be. So one example that I can give as to what we’ve learned through this as to avoid what you normally find in frontier countries that investors, they say, well, let’s go and invest in the leading entrepreneur in the country. Why? Because well, obviously, he would probably be able to capitalize on the country opening up and expand his business. But if you think about the dynamics of that, as a trade, it’s an asymmetrical trade in the sense that whoever that individual is, a man or woman has been successful, they already have access to capital, they already have a profitable business. So what you’re saying to them, what you’re effectively doing is forcing capital to them. They’re saying take my capital, please because I want you to have it. And that capital may be in the form of saying, well, okay, if you’re producing 100 tons of glass for bottling this year, increase it to 150 times. Now again, if you’re certainly on the entrepreneurs perspective, what he’s saying is, well, this is a great trade, if it works out, it works out. If it doesn’t, I still have my core business, which is profitable. And what most likely will happen is that me as an investor, I have a liquidity window I have to get out at some point, so they buy me out at a discount. What also happens is that because everyone’s follows this narrative or this analogy, the price or the valuation of that company gets bid up to such a point that from a risk perspective, you don’t really getting returns commensurate with the risk that you’ll take.

Stig
Let’s transition into the second segment of the show. After talking about Frontier Markets asset investment class, I would like to be a bit more specific. Right now Sturgeon Capital is focusing on Uzbekistan specifically, I can’t help but wondering of all the frontier models you could invest in, why you space them, and why not any of the other frontier markets?

Kiyan
It’s worth a little bit of history on the firm. So, again, define what we do is looking at countries that are a frontier but emerging, and what that has naturally led us to is focusing on Central Asia. So you had Georgia in the first instance, which had went through a tremendous reform path Kazakhstan, which didn’t weren’t as aggressive as reforms would really allow the private sector to take shape. And the elephant in the room for us over the years has been as Becca song because relative to this region, it has a largest population, about 33 million people. Great demographics kind of 60 5% under the age of 35, unlike a lot of other countries as a really diversified economy, so whilst they have natural resources, the natural resource to an extent counter cyclical, so that the largest export is gold, they have uranium. But for all intents and purposes, it was very difficult to allocate meaningful capital. They’re under the previous administration. And the previous administration was there for about 25 years, you could argue is kind of, let’s say, a closed off socialist state. And so no one was really paying attention to it.

Now, having said that, we were actually involved in the country for about eight years on a small nominal level, because we believe that important to have a pulse of what’s actually going on. So what happened two and a half years ago affecting the previous president passed away, and ironically, his prime minister became president. And so the general consensus at the time, even amongst locals was that well, it would be a continuation of the previous policies. And then unbeknownst to everyone, what he effectively did was embark on a very ambitious and aggressive reform path. And what we define as I say, the falling Berlin Wall moment was really lifting the currency control. So they had two different currency exchange rates. One was a subsidized rate one was a free market rate. And overnight, they unified that they took a 50% hit on the currency. But as before where it was difficult or impossible to get money in and out, that changed overnight. What then followed was that the roster of let’s say, previous ministers were fired and replaced with a young Western educated Uzbek technocrats and then a series of other policies reforms took place so they’re now privatizing nearly every state assets. There are 1200 companies on the privatization list. They engage in serious tax reform. So they had a large part of the economy estimates are up to 50% that were in a black economy that was not paying taxes. Why because the tax system was complex, and probably arbitrarily high. And what they did is they reduced, let’s say, the corporate tax rate by 50%. And the irony is that tax revenues went up 70% year on year. So that’s a reflection of the black economy moving towards a formal economy.

Now, if I put the GDP per capita of the country in context view, we’re talking about a country of 33 million people that is 1500 dollars GDP per capita. Now comparing that to, let’s say, a country like Georgia, which has one fifth of the population, no natural resources, they’re about four and a half 5000. Kazakhstan, with, let’s say, half the population, but more natural resources is about eight to 9000. And you’re coming from such a low base, that if you want to add a value to it, you’re investing with a margin of safety, or with the wind behind your back. The second aspect that is important from an economic structural perspective is that the country basically has very little debt, both across the sovereign corporate and private sectors, the total debt to GDP is under 30%. And their reserves are a GDP of 60%. And a bulk of those reserves are of gold. And so what you will see I think, is a one-off leveraging. But the important point to that, unlike developed markets is that that leverage really is going into productive capacity, and that you have a lot of the economy which is already producing under capacity. And so what that capital is going into is really high return on investments projects. The final aspect that is positive and somewhat under looked by let’s say, the Western world is the Belton road from China. And the way we think about that is that it’s the Marshall Plan on steroids. It’s a 1 trillion investment plan. And effectively what it’s doing for the country is reducing the cost of doing business by building out base level infrastructure, and making it easier for the country to do business with the world. And I mean, Charlie Munger talks about these kind of lollapaloosa effects happening when you have a confluence of positive factors taking place, we believe you have a number of positive factors that are coming to fruition at a single point in time. And that at frankly, from an investment career perspective, there hasn’t been a country which has such a high conviction over undeposited funds.

Stig
So Kiyan, let’s assume that three of us go on a trip to Uzbekistan, what would it be like when we hit the ground and what might we expect to see from an investing standpoint?

Kiyan
A good way to think about it is so you have pre-Soviet infrastructure or order, that is, you have these wide roads, the roads are clean, everything’s quiet, but and you have pre-Soviet Union, human capital, right, in that the majority of the people, education levels are very high. And then the majority of the people are educated in the hard sciences, which is normally what you want, as opposed to the software, the social sciences, but you have post-Soviet GDP dynamics. So let’s say the normal amenities which you probably expect in a lot of countries are not there, although they’re, they’re really coming to place now. In terms of opportunities, I think we’re effectively at the moment, the only international firm providing private capital to the country. And I hope I’d like to think that that’s built up somewhat, a lot of goodwill. And when you meet local entrepreneurs, they’re very proud and they like the fact that you’re there. And they’re more than open to have a discussion with you. And so what we find fascinating and I think what investors that come with us to the country find fascinating is simply the breadth of people that you can meet so you can meet the leading entrepreneur in the retail space, you can meet the leading real estate developer, you Meet the leading tech entrepreneur. Similarly, on the public side, you can meet with ministers to really understand how are they thinking about the policies that they’re setting, what yardsticks they’re setting for themselves. And so they’re saying in the space of three to four days, you can leave the country, having experience of met with people that you would otherwise never be able to meet in any other country, and really probably get a good feel of what the reality on the ground is, as opposed to perception? Well, in most cases, there is simply no perception because as a country, most people haven’t really come across in their lifetime.

Stig
So it’s very interesting that you would say like, you’re the only foreign company providing capital. What kind of advantages and disadvantages does that entail?

Kiyan
One disadvantage, I think is and it’s something that could be managed on a personal level or a firm level, is that simply if you travel the you could be awed by the scale of opportunity, which you would see and I kind of want anecdotal evidence I would give you as a given example of the real estate sector. What will normally happen is that yes, demand is likely to go up because you have urbanization GDP is going up, but one factor that probably will more determine economic returns is the supply side. And on the real estate, it’s not too difficult to expand supply. Right? So an equilibrium will quickly be formed, which is what you want to stay away from, really where our focus is, as I mentioned earlier, is to try and capture these de correlating dynamics by investing in secular trends. Now, the biggest secular trend that we see amongst frontier markets, is the technological leapfrogging. Now what do I mean by that? It’s that if, let’s take the sector banking sector, and let’s take FinTech as an example. So if you look at the UK revenue, the US to an extent, there are very difficult pure play FinTech winners to see that are profitable at scale. Why? Because you have a legacy infrastructure in place. That is the majority of people hold their main deposit accounts at incumbent bank, and they will use FinTech companies for additional services, whether it be payments etc. In frontier countries it’s a completely different dynamic. So you already have a large part of the population that simply does not have a bank account and there is no legacy infrastructure. So when you’re going in there with a FinTech product, you have the ecosystem to allow you to build that business. But what you find is that the people will move directly towards the most optimal solution, as you add a capital deposit account for that customer, as opposed to just being an added functionality. And so our focus really is on looking at business models that we know work. What I mean by work is that they have positive unit economics, they build a moat as time goes by, and that they’re scalable. What we like to do is build or invest in businesses similar to that in these countries. I’m happy to go into a few examples if you would like.

Stig
That would be fantastic, because you already made a few positions in your space that are already. I’ll be very curious to hear if you can take us through like a step by step process from whenever one of or multiple of these companies came on your radar until today.

Kiyan
Yes, I think something that we’re kind of proud of is that all the investments that we’ve made have been, let’s say, organically sourced in the sense that either it’s been the entrepreneur that has contacted us esoteric ways. It may be a message through LinkedIn, it may be an email, it may be someone indirectly reaching out, or they’ve been sourced from us actively reaching out to entrepreneurs. We try not to rely on let’s say that outside of advisors where incentives can be flawed. But if I give a few examples of let’s say, one investment that is represents a significant portion of our portfolio today is a business that today is called Zudmo. And today is arguably the largest cross border e-commerce marketplace in Central Asia. Now, what do I mean by e-commerce marketplace? Think of the same business model as Alibaba or AliExpress. That is, you don’t hold product inventory. You’re not Amazon. You simply provide a platform for products to be placed, people buy it, and you take a commission. Now, if we think about what is needed for that business to be successful, effectively, it’s three main things. One is a logistical solution, right? That is, if you’re sending products from China to let’s say Uzbekistan or from Europe or anywhere in the world, you need to have a logistical solution. And what this company has done is they’ve partnered up with every National Post company and local postal companies, to the point where in every country it operates in, it has last mile delivery, something that just did not exist. And it provides that delivery at a cost lower than AliExpress and faster than AliExpress.

Why? Because for AliExpress, these countries on an individual basis are not large enough for them to want to do the heavy lifting needed to integrate it into their core platform. The second aspect they need to solve fourth payment solutions. So in Uzbekistan, less than 10% of the population have Visa or MasterCard, and which basically shuts them off from any international commerce. And what this business has done is they’ve integrated local payment solutions with international ones. They’ve added cash on delivery which today represents 80% of their orders, but they’ve also added instalment solutions and buy now pay later what buy now pay later is effective saying you buy a product today. You pay it in 60 days with zero interest and the supplier takes the hit on the interest and for the supply they will do it. Why? Because here you have a population of combined 400 million people, which no one from an e-commerce perspective is tackling. The final aspect is you actually have to have products on the platform that people can buy. As with that infrastructure that they have, they basically signed with JD.com in China, which is, I think, number three e-commerce, you’ll have Sibarad and Toof, which is number one e-commerce and a range of other service providers. The other kind of less direct positive is that all these countries have VAT and customs duty exemptions for cross border ecommerce, which basically means that all the products that would be available offline are cheaper for the platform. So if we summarize the totality of the value proposition is that you have the convenience of last mile delivery, you’re opening up people to buy products from around the world for integrating payment solutions.

You have a range of products that are implicitly cheaper than if they were available offline. And you have products that are simply not available offline in those countries. And so what the business did effectively launched them in November 2018. And I should say this as a management team that we’ve known for about five years, core management team has been together for about 20 years they produce at two successful exits. And since November 2018, effectively, the business has developed such that today in every country in operates in it’s the most downloaded shopping app. It has about 33.5 million downloads of the app up until Corona was growing at about 38% a month GMV wise, that is the value of transactions on the platform. And the way we see it as time goes on, the barriers to entry go up, the modes of the business increases. And what you’re seeing is that, for example, over the past two months, they’ve basically been given the exclusive online distribution for Samsung Huawei phones and even Apple products through this region, which is a huge win. But why is because they have that infrastructure, which is just kind of adding to that month. And the way we see it in terms of returns is if you mathematically compound GMV, from where it is today, let’s say at 4% a month, you get to about half a billion in value transactions in about four to five years. Bear in mind that the company is growing at about 30% a month at the moment. And if you look could exit multiples of these businesses over the past 5 to 10 years, let’s say from one and a half to three times GMV, let’s take the bottom threshold. This in our mind can be a plus billion business and at the moment we’re invested in the business at a valuation of 40 million.

Stig
So here in the US, when a company talks about an exit plan, it often involves an initial public offering, an IPO, or if you’re really small, maybe you’re trying to sell to a private equity firm. Are the rules any different in the frontier investing space?

Kiyan
That’s a very good question. And I guess it’s kind of reverting back to the public markets. Again, one of the reasons that I think it’s difficult to consistently make money there’s if we isolate the local capital market, you don’t have that impact. Do capital or the true free market capitalism mentality that you have in the US, whereby if something is cheap, even through private equity or through M&A, that value is unlocked. And so you’re really relying on foreign liquidity, again, which is very difficult to predict. What we want to be in is on the side of where we effectively are involved in situations whereby the value or the strength of the business creates its own liquidity ultimately. And that can come in a few forms. One is if we take Uzbekistan, we’re investing at a time where the public markets really are in their infancy, but there’s aggressive reforms, and there’s ambitious plans to develop that local capital market. So there is a scenario where I would probably rank order perspective, we’ll put it at the bottom that you could exit for the local capital markets. And by virtue of being invested in a company where none of the existing or incumbent constituents of the market represent that sort of dynamic that is a technology company that is relatively fast growing, it would relatively be easier to let’s say IP on a local basis. On international basis, I can point to at least a half a dozen examples of leading frontier businesses that have managed to IPO on international markets. If you take Georgia you have two of the leading banks that are trading on the stock exchange, you can have plus billion market caps and trading valuations at pairs with let’s say, Western multiples. If you take Russia, you have businesses like Yandex, your business like Tinkoff that are trading on the NASDAQ. In Africa, you have businesses like Jumia, which again is an e-commerce marketplace that that had a pretty successful IPO on the US market. And finally, again, what you’re ultimately doing in these countries is if you think of it through the lens of international players, whether it be multinationals, and let’s say companies like 10cents or Alibaba, is that what you’re saying is I’ve solved the issue of this country’s, I’ve solved the difficulty of operating in these countries for you. So if we look at 10 cents or Alibaba, a third of their income line is investment income and investment income comes from acquisitions. If you look at the number of acquisitions that Alibaba or 10 cents make combined, I think it reaches nearly 1000 over the past 10 years. Why? Because they have a cash cow and their core business. And they have FOMO that they don’t want to miss out on the next big thing, whether it be e-commerce, whether it be gaming, whatever it may be, and so they have the capital to acquire. And China already has this basically I SilkRoad which is the digital Silk Road project that they have. What we’re doing falls directly within to that so you also have the optionality of leaning towards these.

Stig
So talking a bit more about comparison for something like the Uzbekistan and to the west, which perhaps resonate a bit more with most our listeners, you know, you mentioned a pricing power before, that’s also something we talked about here on the show, Warren Buffett one on one. How are the quote unquote rules, different if ever have a good company in the that’s called the developed world, like you’re looking for something not just with a good pricing power, You might also be looking at a company that does need to have lower cap, whatever kind of things that we’ve been taught about all the businesses. Is that different now in any way, when you try to identify that in a country like Uzbekistan?

Kiyan
Yes and no. I mean, the question that I guess we’re ultimately trying to answer is, is twofold. One is, what is the value proposition of the business’s core product or service to the underlying user? That is, what utility is it providing it. And sometimes that utility is very high. And the ideal situation is that there’s high utility, but the economic structure that business or a sector also allows for economic gains to be made from that utility. And that’s basically, margins are indicative of that. So you have some businesses where there’s high utility to the customer, but the underlying dynamics maybe as a competitive factor, whatever it may be, doesn’t allow for you as an investor to capture economic benefits. And so what we really care about is investing in business models that have high customer utility, but also have high economic benefits to you as an investor. Another example I could give that is, let’s say a business we’ve invested in is Uzbekistan called Bills, which is the leading enterprise software of SAS business. I think probably you and the listeners are familiar with that business model, which in our mind is most elegant, beautiful business model, you have kind of plus 50% operating margins, you’re kind of high cashflow, high recurring revenue. And we can argue as in developed world, this is quite an unsaturated investment landscape and that everyone is investing in SAS. Now, if you flip them in the frontier market space, specifically in Uzbekistan, this is a business that is targeting the small to mid-size businesses where their alternative if let’s say we’re focusing on account management and inventory management is either paper or Excel. And the beauty is that the government has effectively mandated that that has to be digitalized, that businesses have to digitalize their account management imagery management process, not only for transparency, but for efficiency. And the beauty of this business is also that not only are you providing a service that is implicitly profitable, but by virtue of providing that service, you’re collecting unique data, which no one has in the country. Now what data is that? It’s working capital cycle cash cycle data on a range SME businesses which no one has, and that comes into the financial services angle, and that no one is really you’re talking about a country that is really at its infancy of financial services. So you’re 50% of the population that do not have a bank account, which by law, now they have. Now one of the issues there is, is credit quality, and that at the moment, credit scoring is binary. Either you have good credit in which you get a loan, or your bad credit in which you don’t get a loan or the rate at which you get it is astronomically high. And so what is really important to have an edge is to have good credit data. Why because it means that you can price your risk that is priced loans that are more appropriate, right? But also allows you to speed up the with the speed at which you can distribute that load. Now going back to the SAS business, what you’re effectively doing is you have a range of businesses where you have all the working capital like we have all the cash cycle data. And the business can either for your own balance sheet start to lend up or act as a platform to the banks to basically say, well, we act as a loan distribution for you and we take, introduce a few. The latter is a more capital like model. The former is you have more control over it. But either way, it’s still you’re adding value and there’s economic rent to be taken from it.

Stig
So Kiyan, what are the main red flags you look out for in Uzbekistan where if they materialized you would close down your whole Uzbekistan Growth Fund.

Kiyan
As a firm, what we’ve seen over the past 15 years by being in frontier markets, is a wide range of risks, be coming from government, be it kind of micro investment risks, and what I hope I like to think that we’ve built up as an investment framework offering mistakes, of seeing other investors mistakes, that really focuses on this concept of resiliency, and that, that we’re investing in business models and investing in a manner and constructing a portfolio that is inherently resilient, or the aim of being resilient. And one other anecdotal example I can give of a country that we’re not involved in at all anymore, but purely observe out of interest is Iran. So let’s look what happened in 2016 sanctions lifted. This is a whole rush for investors together. into the country, whether it be multinational financial investors. 2018 Trump comes in, the widest ranging sanctions that any country’s ever experienced, gets reinstated on the country, the currency devalues by 80%. The country goes into recession, what has happened over the past two years 2019 if the stock market goes up roughly 80% in dollars, this year, it’s up 120% in dollars. In similar period, you’ve had the local version of Uber be developed, where to the point that has two and a half million rides today, which is basically makes it the third or fourth largest ride hailing app in the world, as if it was a country that was normally open and this will be a plus 3 billion company. So the point is that there are red flags that I would say we have a responsibility and it’s incumbent upon us to be cautious of and to build a framework around them.

Stig
Kiyan, this was a fantastic interview. I cannot believe it would take us six years into the investors podcast to have the very first episode about frontier markets. I’m sure the audience would like to learn more. Where can I learn more about you and Sturgeon Capital?

Kiyan
I think the easiest way is to reach out to us. We believe we’re operating in markets and countries which are implicitly more unknown to the bulk of the investor population. And we have a responsibility. And again, it’s incumbent upon us to be actively communicating the opportunity set and what we do. So I would really encourage anyone that wants to reach out to us directly, you can find us on our website. And I hope once COVID goes away that we can encourage you and potential investors to come out of us Uzbekistan. There’s another way to go about it and really get a feel for what’s going on the ground. I can speak as much as I want, but it’s better always to get your own list of first principles.

Stig
Kiyan, we really appreciate that kind invite and we really appreciate you coming on the show today. I know I learned a ton. I’m sure the audience captured a ton of value out of this. And thanks for making time for us.

Kiyan
It’s a pleasure. Thank you again for the time.

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