Investors who have already had their fill of China and India are now looking closely at the opportunities to invest in Vietnam. Currently the second fastest growing country in Asia, is this a good time to grab a piece of the action? Richard Newell reports.

The run-up to November’s APEC meeting in Hanoi was met with predictable hype about the host country’s status as Asia’s latest economic powerhouse. It’s a compelling story, supported by the beauty of the country and its people. Vietnam is a country of 85 million people with a growing reputation as one of the most dynamic and cost-efficient manufacturing bases in the whole of Asia. The country has a young and highly literate population and an economy that, despite being still largely agrarian, is growing at a steady 8% a year.

The Doi Moi reforms of the mid 1980s and the radical reform of 1989 marked the turning point in Vietnam’s economic fortunes. The unshackling of excessive government grip on industry, cuts in trade barriers and agricultural reform has transformed Vietnam from a centrally planned to a more market-based economy. Indeed, Government reforms and the abundant human capital have really underpinned the transformation of Vietnam’s economy. The Communist government had a firm grip on the political future of Vietnam and their support for market liberalization and IT development was of paramount importance. Being a communist country obviously does no harm at a certain point in your development. Jim O’Neill of Goldman Sachs says “it’s a complex issue, but it can be seen that in the early stages of development, being democratic is not necessarily key.” The only thing that could undermine this resurgence would be a sudden unwillingness by the Government to maintain the pace of liberalisation, which would negatively impact on foreign direct investment.

Vietnam is still a poor nation by the standards of the region. GDP per capita, $636 in 2005, is a quarter of the Asean average. But if the 8% annual growth can be sustained, Vietnam could become a middle income country, with GDP per capita of $1,000, as early as 2010. WTO entry should ensure Vietnam continues on the path of reform, particularly in banking and state-owned enterprises. In May, a plan for banking reform was issued, under which ownership role of the State Bank of Vietnam in the country’s commercial banks will be separated from the supervision functions. In addition, a younger generation of leaders was appointed in June, with Nguyen Minh Triet as president and Nguyen Tan Dung as the prime minister. Both are seen as supporters of continued reform.
It is sensible to question whether this level of growth is sustainable. At least for now, there is no sign of a slowdown. FDI growth continues to be strong, led by Taiwanese, Korean, Japanese and Singaporean and investors. Total FDI into Vietnam will hit the $7bn mark for 2006. Large private sector investors such as the World Bank’s IFC have committed over $100m over next three years. Chip maker Intel is just one of the high profile groups to have set up operations, with plans to expand three-fold between now and 2010.

Citigroup’s Singapore-based analyst Moh Siong Sim says Vietnam’s increasing success in integrating with the global economy, marked by FDI inflows and rapid trade growth, could genuinely turn it into a new powerhouse of south-east Asia.

Vietnam has been the best performing equity market in Asia this year. Much of the market growth has come from the handful of dominant large caps such as Vinamilk, a former state-owned dairy producer. The company’s listing doubled the market cap overnight. Since then the stock has risen 50%, now accounting for about 23% of the index.

Since the mid 1990s when fund managers began packaging vehicles for foreign investors, the market has never been able to grow fast enough to meet the demand for investment opportunities. In reality, while the scope for investment in China has improved significantly in the last five years, progress in Vietnam has been less remarkable. The economic developments have outpaced the broadening of the capital markets. Progress in equitising the larger SOEs has been slow. The Ho Chi Minh City stock exchange is immature and while the number of listings is growing all the time, the average trading volume is insufficient to draw widespread international investor participation.

As a visitor to Ho Chi Minh City in 1995, researching the latest emerging markets fund boom, it was clear there were few meaningful investment opportunities. While it was possible that some of the smaller fund groups like Dragon Capital, Beta and Indochina Partners were finding local projects to fund, it was also clear that Templeton’s decision to raise money for a New York listed Vietnam fund was spectacularly premature. The fund had to invest the majority of its assets in listed securities. At that time, Vietnam had no stock market and there were only so many Vietnam ‘plays’ to be found. Templeton was forced to retreat from its original investment policy and was eventually sued by disgruntled investors. Mark Mobius and his team weren’t alone though; many investments were made between 1994 and 1997 in anticipation of the Bilateral Trade Agreement with the US, and the opening of the stock exchange, events that did not occur until July 2000. Even now, with so much focus on Vietnam as it gains WTO entry and hosts the APEC summit in Hanoi, the pace of reform will disappoint those who expect to see Vietnam awash with investment opportunities suitable for a conservative foreign investor’s portfolio.

Chart:
Major Privatisations in the next 12-24 months

While recognising that the mid year correction was a sharp reminder that this market is prone to short-term shocks, CLSA recommends investors should start building their exposure to Vietnam through established specialist country funds that are able to buy holdings via placements and rights issues offered at a discount prior to listing.

CLSA’s Momchil Durlev says, “We believe the best way for an investor to buy into the market is through established specialist funds that have holdings in: i) companies traded on the over-the –counter market, which remain undervalued relative to their listed peers, or ii) banks, which are among the biggest beneficiaries of the economic growth and are expected to list in increasing numbers in the near term.”

Dragon Capital is probably the best known fund manager in Vietnam, having stuck around after the first Vietnam boom came to nothing 10 years ago. Dragon’s Managing Director Dominic Scriven has been raising capital for investment in Vietnam since the early 1990s. His firm now manages around $750m. Dragon has taken the view that focusing on small cap opportunities is too problematic and has focused on larger listed stocks such as Vinamilk, Vinh Son, the power company and banking stocks such as Sacombank and Asia Commercial Bank. Dragon and the other local fund managers such VinaCapital and PXP are also active in the OTC market, targeting key plays in mining, oil and gas, tourism, healthcare and industrials. Dragon has two fund listed on the Irish Stock Exchange and traded OTC. The Vietnam Enterprise Investment Ltd was launched in 1995 and has a heavy focus on banks. The more recent (2004) Vietnam Growth Fund Limited includes Vietnam plays not necessarily listed in Vietnam and has more of a focus on natural resources, food and beverage companies.

VinaCapital offers a mix of investment banking and fund management services. It has two publicly marketed funds focusing on the broad opportunities and technology areas, plus a real estate fund aiming to capitalise on a new land law encouraging foreign investment. Private equity groups are also targeting the real estate market, which is growing from a low base and seeing increasing demand via tourism, urbanisation and the growing middle class. VinaCapital’s Vietnam Opportunity raised another $300m in late 2006, earmarked for investment in the forthcoming IPOs.

Foreign investors are allowed to own up to 30% of a non-listed (OTC) Vietnamese company, while for listed companies the limit is 49%, and 30% for bank stocks. Central Bank governor Le Luc Thuy has indicated that Vietnam could double the ownership limit now that WTO entry has been secured.

Daily trading on the HCMC exchange is currently around the $10m level, with the number of stocks is increasing all the time. With the impending share flotation of large state-owned banks, telecom and mining companies following WTO entry approval, the market cap should comfortably push through the $10bn mark. As many as 1500 SOEs are expected to be privatized by 2010, with an official book value of $20bn.

However, to put the limited supply of opportunities into perspective, when ANZ Bank paid $27m for a 10% stake in Sacombank, that represented 28 times Sacombank’s 2004 earnings. ANZ justified the bid by stating its long term view and the strategy of getting into a narrowly held banking market ahead of its rivals. The IFC and Dragon Capital are also major shareholders in Sacombank

CLSA strategist Christopher Wood believes that Vietnam’s macro story is one of the most interesting in Asia. In his opinion, only India has similar dynamics to Vietnam. He thinks it would not be outrageous for earnings multiples of listed companies to reach 20x, given the country is running a nominal GDP growth at 15-20% and and top-line growth of 20% and higher.

VinaCapital expects the market to end the year strongly, possibly breaking through the 600 barrier. It believes institutional funds will continue to flow into the market until the first quarter of 2007. With this in mind its strategy is to consolidate on listed holdings by taking profits into market strength at year end.

According to VinaCapital’s Fiachra Maccana, WTO entry will boost the consumer sector: “Over half the population are under 24 years old, so their major spending years are ahead of them. WTO entry also means tariff reductions to 15% or less for most manufactured and agricultural imports. Pharmaceuticals, medical equipment and aviation related products will also see sharp falls, making these key sectors for increased foreign competition. Insurance, banking and telecoms will also be de-regulated.” Vietnam companies have yet to subject themselves to international accounting and audit standards, although the opening up of the local industry to international firms should advance this process.

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Key points:

• With a continuation of successful economic reforms, favourable demographics and huge surplus labour in the countryside, Vietnam may be able to maintain 8% growth annually over the next five years.
• The need to cope with problems posed by urbanisation means that the burden is on policymakers to mobilise adequate fiscal revenue for infrastructure spending
• While inflation has been stubborn in coming down, medium-term inflation risk appears contained amid decelerating credit growth.
• Despite rising capital inflows attracted by Vietnam’s strong economic prospects, the central bank is unlikely to loosen its grip on the currency and give in to appreciation pressures, given the precautionary motive to accumulate foreign reserves and the desire to retain export competitiveness.