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Sourajit Aiyer - www.MarketMoving.Info, UK - Investment in Frontier Markets Bhutan - Mar 2014
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Sourajit Aiyer - www.MarketMoving.Info, UK - Investment in Frontier Markets Bhutan - Mar 2014

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  • 1. Market Moving News and Views What moves stock prices, bonds, currencies and commodities. News and commentary. Asia’s final frontier in investment: Bhutan By Sourajit Aiyer Frontier markets have gotten remarkable attention in recent months. As an analyst is said to have summarised it during an investor roadshow in Nairobi: everyone and their dog seems to know something about frontier markets. Improving governance, positive demographics and reforms initiation at one side, the large population is a major rationale to look at economies like Vietnam, Argentina, Kenya, Colombia, Nigeria, Bangladesh, Romania, Pakistan or even Myanmar. But judging strictly on the population criterion, there would hardly seem a validation to think of countries like Bhutan. After all, it has a population of only around 750,000 and does not figure on the list of typical frontier markets (hence I have used the term ‘final frontier’). However, every economy is still an economy. Specific opportunities can exist for those enterprising enough to invest some time to sift through its threads, identify sector-specific micro stories (‘islands of proficiency’) and place emphasis on the profitability potential of opportunities rather than just the growth potential. One needs to look at such an economy with a granular/micro/sector-specific mindset rather than the broader/macro/‘country- story’ mindset with which most look at the large emerging/frontier markets. In January this year, I made a short trip to Bhutan (a country in the eastern Himalayas between India and China), and took that chance to make some observations on ‘Ground-Zero’. There are three basic reasons why I think there might be some rationale to look at this final frontier market. First, Bhutan is a country which has undergone political and economic transition. More importantly, it is phasing it in a gradual, step-by-step manner. That might seem an intelligent and mature way of managing transitions, given the numerous cases where countries have simply rushed head-first and often fallen nose-first in the process. Second, the attitudes and aspirations are changing with uptick in local income and media proliferation, fuelling demand in specific sectors. The strength of the ‘demographic attitude’ in this case offers the chance to help businesses benefit from ‘islands of proficiency’, especially as the competitive scenario is still nascent and there is scope to capture the first-mover advantage. Third, the debate between chasing profitability (or return on equity) or chasing growth has bitten the post-2008 business world, especially when it comes to a new market. The importance of maintaining profitability to avoid capital erosion and accumulated losses cannot be overemphasized. After all, not every venture by global businesses in the large emerging/frontier markets has shown rapid profitability. BHUTAN’S VISIBLE CHANGES Recent changes in the country are visible and perceptible. The monarchy paved the way for a parliamentary democracy in 2008 to institutionalize the governance system. Given its systematic planning, the economy itself has grown at rates of 7%, 12%, 9% and 5% in real terms, in the last four fiscal years. Secondary and tertiary sectors led the growth in the recent years, some large projects were initiated and public services expanded. The resultant growth in income is apparent, and the capital Thimphu has expanded with the urbanization flow.
  • 2. New buildings, both residential and commercial, are coming up along the Babesa highway just before the city starts. This stretch of around 5 kilometres on the southern side of Thimphu looks a major construction site. The real estate activity is more in this part of town because this is a stretch of flat land, whereas uphill mountains at the other end (north-west) of the city limit the scope of real estate expansion. Two senior professionals from the Bhutanese financial sector whom I met informally said some homeowners are trying out new interior designs inside their houses, a sign of changing times. While the building supply would be backed by demand, not everyone would have the capacity to buy new houses. It is easy to see cases of families living in strained/worn-out houses if one walks along the bylanes of the city, though their number seemed lower than other Asian developing countries. Nevertheless, how many of them are actual homeowners, how many are tenants on lease and how many can afford a home loan is something only the Census statisticians can say. While education enrolments have picked up, the job market has not kept up. Employment capacity of the public sector seems to be reaching saturation and the private sector is yet to expand in that respect. There were at least two taxi rides where I was surprised to find that the drivers (a man and a lady of the younger Gen-X/older Gen-Y age group) were actually qualified students working in a government office on-contract for part of the week, and were driving taxis in the remaining time to supplement their income. Both said they were lucky they were able to afford car loans, as not everyone is able to do so. So there did seem to be a sense of despair at the general lack of full-time job opportunities. Regarding low-income labour, either the Bhutanese have not built their skills or they seem not to like getting their hands dirty – a situation a bit similar to that in the Middle East, where there are a lot of migrant workers. Most of the labourers working on road and construction projects seemed to come from India, a fact made clear on hearing the music playing on their radios when one halts beside their work sites. WILLING TO SPEND Most of the boys of the older Gen-Z/younger Gen-Y are increasingly sporting the ‘punk’ look and most girls are sporting generous doses of chic-fashion/accessories. An expat working with an international organization in Thimphu told me that the young Bhutanese have become big fans of Korean television programmes. People are high on aspirations and desires, reflected in changes in attitude. Those who are earning well are willing to spend on new consumption, be it clothing accessories, cars, hang-out zones or department stores. Cars are larger and in more variety, whereas they used to be smaller and fewer till the 1990s. New coffee shops and restaurants are sprouting up in the city centre, and affluent local/expat crowds are thronging at all hours. Average prices in these establishments seem on the higher side as compared to levels in Thailand, India, etc. But then Bhutan has very few such outlets, hence, some element of monopolistic-type pricing by the first- entrants might be existing. While department stores used to store mostly ‘Made in India’ products earlier, nowadays one can see goods made in Thailand and elsewhere, also jostling for shelf space in most stores. In a future article, I will outline a dozen opportunities that these changes are bringing to investors. The author works with a leading capital markets company in India. Views are entirely personal. This entry was posted in In Depth, Views and tagged Asia, Bhutan, emerging markets, frontier markets, India, investing, investment on February 27, 2014 by Antonia.. Market Moving News and Views A dozen direct investment opportunities in Bhutan By Sourajit Aiyer What sector-specific micro opportunities for direct investment do the recent changes in Bhutan’s economy spell? Following are a dozen that came to my mind based on the observations made during my recent trip there.
  • 3. I emphasize these are not just products for global businesses to export to Bhutan. Most can also be produced locally in Bhutan over time. That can create production-oriented jobs for locals, instead of just trade/sales-related jobs. But for that, it depends on the country itself, whether it has the capabilities or desire to expand into ventures, albeit with foreign investment/foreign technical partnership. Some of these ideas use intellectual capital, some use physical capital, and some use a combination of the two. In most of them, I have tried to draw parallels to India using similar Indian companies as examples. Similarly, such examples of successful companies would exist globally in other countries as well. 1) ELECTRIC CARS Bhutan has been looking at the electric cars sector for some time, and has recently cut a deal with Nissan for its Leaf. Despite being a hydro-electricity producer, most of its internal energy consumption is fuelled by imported fuels as most of the hydro power is exported. Apart from environmental concerns, there are other justifications for electric cars. Thimphu is only as big as an average neighbourhood/borough of a city like Mumbai, Delhi or Bangalore. Hence, intra-city driving within a small city means drivers are never really too far from their homes, ie their charging points. The Bhutanese financial professionals remarked informally that young Bhutanese increasingly preferred to drive, rather than walk short distances. While it does not mean the population is becoming lazy, it does show a shift in people’s attitude. The vertical expansion in the city is yet to occur. Most buildings have few storeys which makes wire-charging practical if batteries are difficult to detach and carry. Mahindra & Mahindra also announced plans to launch its E-20 (formerly Reva). Entry strategies by electric car makers should be more aggressive if the price differential between the various models justifies it. Mahindra E-20 costs the equivalent of about 0.6 million Indian rupees in India. Through informal chats with local cabbies, I learnt that the average car imported from India costs about 20-25% more than its price in India. By that estimate, one can add 20-25% over the mark-up of the Mahindra E-20 for its cost on Thimphu’s roads. Public transport of choice in Thimphu is also the taxi. Most taxis are Maruti Suzuki WagonR/Alto or Hyundai Santro made in Indian factories, which cost 0.35-0.5 million rupees in India. The price point of electric cars keen to enter Bhutan has to be comparably affordable; otherwise the loans might be out of reach for most buyers unless they are subsidized. 2) PROCESSED FOOD PRODUCTS There seems to be demand for processed foods like meat products etc, as evidenced by the stocks in department stores. The population is able to pay and willing to pay. Hygiene in packaged foods might be one reason, as compared to the raw meat at the traditional shops. Another is the longevity of the processed/packed version. Daily cooking is not practical with a working population comprising both men and women due to lack of time and lack of hands, a feature also common in India. Bhutan itself has set-up a company in the agro-processing space, and there might be a rationale to invest into similar processing facilities given it has adequate supply of the raw materials. 3) MOBILE V.A.S. In a country where TV programming was banned till the 1990s, media proliferation has now grown in leaps and bounds. The latest phones are visible everywhere, and young faces are visibly busy peering into their various gimmicks. This suggests potential for Mobile VAS providers to tie up with local networks. Mobile VAS includes mobile gaming, tones, infotainment, live streaming, m-commerce, etc. A number of mobile VAS players in India like OnMobile, InMobi, CanvasM, Mahindra Comviva etc have made this segment a success story in the Indian telecom space.
  • 4. 4) SOLAR RENEWABLE ENERGY The sunlight is intense and clear for people in Bhutan, which is easy to understand given its altitude and low pollution. It was enough to tan a person within 3-4 days if most of the time is spent outdoors. Conversely, the sunlight hitting flat and polluted cities is more diffuse and mild. So is there a scope for solar renewable energy? Bhutan’s government does seem to have upheld environmental causes. Solar power would further reduce its dependence on oil imports. Being a mountainous terrain, the country has tracts of land which are not easy for real estate or agriculture development. This is visible in the eastern parts of the city across the river, on the western part near the TV Tower, and on the southern part around the Buddha view-point. These tracts can be useful areas to set up solar photo-voltaic panels to absorb sunlight and channelize the electricity into the national grid. Today, solar panels are easily set on roofs of buildings and large-scale solar panel farms are also being set up. Logic suggests that sunlight absorption would be higher where it is more intense and bright. Nevertheless, a limitation is that the movement of shadows owing to the position of nearby mountains versus the sun can restrict the amount of time sunlight hits a specific surface. 5) LOANS, I-BANKS, ONLINE TRADERS Bhutan’s government pays for the healthcare and higher education for its people in most cases – two key reasons why people globally save. The Bhutanese seem to be consumers by nature, rather than savers. Low interest rates historically have also not been much of a motivation. This can constrain the ability of the Bhutanese banks to lend to investible projects, if the supply of funds does not match the demand. Depending on the due diligence of local projects and regulatory requirements, there might be an opportunity for global commercial banks to look at lending to genuine, high-asset quality projects in Bhutan. To draw a parallel to India, commercial banks there have funds owing to the average Indian’s propensity to save. But the ability to lend is constrained due to asset quality concerns in the wake of the economic slowdown. The scope of capital markets also draws interesting observations. The local professionals told me the country’s stock market has only about 20 listed companies, but the appetite for those initial public offerings had been huge. One can argue the appetite is high due to the fledgling stage of the markets and novelty of the IPO product. But one can look at it from another angle – that cracking the first sale is often the toughest, and subsequent sales get accepted more easily, more so if the money in people’s wallets is only set to grow. Potential appetite of future listings might warrant the attention of boutique investment banks for sector-specific advisory service. Online trading in shares has also picked up, and might offer scope for technology service providers to partner with the four local brokerages to enhance their online offering to clients. 6) E-COMMERCE RETAIL PLATFORMS Indian e-commerce firms like Flipkart, MakeMyTrip, Rediff, Jabong, Myntra etc have garnered market share in India, and are employing large numbers of people. Bhutan has good internet connectivity and most young people are literate and computer-savvy. If investing in physical outlets poses viability concerns, then expanding the e- commerce offering might have potential, provided security of online payment gateways is maintained. There is hunger for products – evidenced by the variety of casual apparel, shoes, fashion accessories, electronic and entertainment gizmos, etc. used by the people on the streets. Formal clothes might have a limited market, since most locals wear traditional attires at work. I do not know the penetration/safety of online banking services in Bhutan, but there are also strategies to navigate that if it poses a constraint. For example: India’s Flipkart allowed cash-on-delivery option for clients in India who were unable to make payments online. 7) PREFABRICATED FURNITURE Given the real estate activity, there might be a rationale for pre-fabricated furniture. These are made from compressed ply, sawmill products, etc, and are easy to set-up/dismantle, easy to move and light-weight. They are increasingly favoured in India for its practical advantages, if the foot-fall seen in stores like Home Town or Reliance Living is an indicator. Bhutan, although rich in timber resources, restricted the export of timber to India a few years back to maintain its ecological balance and prevent excessive deforestation. In this context, the demand for furniture fuelled by the
  • 5. building boom might mean demand for more timber, something which the nation might want to avoid in order to maintain its ecology. Hence, usage of pre-fabricated furniture might actually serve a broader national interest. 8) COOL HANGOUTS Growing consumption and changing lifestyles mean changes in the way people spend their leisure time, be it in shopping plazas or socializing in ‘chic’ public spaces like coffee shops and restaurants. These are the current hang-out zones for the affluent locals, and the 1990s western music playing in some of them seems to target the younger Gen-X/older Gen-Y age group. There might be more appetite for such outlets if the number of high-income earners grows further, coupled with the fact that the number of such chic outlets is still limited in the city. 9) PROFESSIONAL COURSES Construction of the Knowledge Park on the Paro-Thimphu highway and the IT Park in Thimphu serves as evidence that the government is taking the objective of higher education and creating further jobs very seriously. But apart from universities/colleges, higher education also includes professional and vocational courses focused on specific streams which help build expertise in that specific area and make the students job-ready. It helps create ‘employability’ of the students. Successful examples in India are software/IT institutes, hotel management colleges, graphics designing, media and mass communication colleges, industrial training institutes etc. After all, there is a limit to the number of engineers, doctors and lawyers a country can employ. Any country needs professionals in other work areas as well, otherwise it needs to import that talent. Investing into education is also akin to investing into the country’s future, since the skills of its people are its biggest asset against competing nations in the global arena. India’s leadership in the global ITES and software sectors is a classic example. 10) ONLINE NEWSPAPERS Local newspapers were not really impressive, with dimensions of an afternoon tabloid paper and just a dozen pages. The small population size poses a constraint to set up a fully-fledged newspaper since the readership base is limited. So it might be worth looking at a digital/online newspaper with both news and infotainment content, which makes its revenue from either the advertising or subscription. There might be such products already existing in the country, unfortunately I did not spend much time in ‘Bhutanese cyberspace’. 11) ONLINE TRAVEL BOOKINGS Tourism is a major draw. But what is really missing is a good online booking platform if one is not travelling as part of large, package groups. Using my own experience, it was difficult to book Druk Air’s tickets online, and it has a limited number of travel agents. It was also tough to book hotels via phone/email. Of the dozen hotels in the Ngultrum 1,200-2,000 (1,200-2,000 Indian rupees, $19.3-$32.2) range that I contacted by phone/email, only two acknowledged. It was not the most straightforward booking experience. Hence, there might be scope for online booking platforms which make it convenient for individual budget travelers, like MakeMyTrip or Yatra in India. However, the number of tourist arrivals may not grow exponentially – the small tarmac bay of Paro airport can only fit a limited number of aircraft, road travel is time-consuming, Gelephu airport development is delayed, and the government itself is keen to limit the tourist inflows to maintain the country’s ecological balance. Hence, service providers need to manage costs within limited tourist volumes. Budget hotel chains might take a look at Bhutan. But why not 5-star chains? Most foreign visitors apparently pay a per-day fee which limits the number of days spent, most of the time in Bhutan is spent outdoors on day-trips, there is limited time to spend in the hotel to use its luxury services and the existing 5-star TAJ property might just be sufficient for the small number of high-end tourists.
  • 6. Therefore, the numbers might warrant only the attention of budget chains like Ibis, Ginger Hotels or Lemon Tree. 12) FITNESS CENTRES From the above observations, it is apparent that the Bhutanese society might be on the eventual path where people are walking less, not always eating healthy foods, too busy at work to take time off, etc. Such examples of societal transformations abound globally, where an increasing proportion of people fall prey to lifestyle issues like obesity, ‘bulging-waists’, etc. This might just interest fitness chains like Fitness First, etc. The third, and last article in this series will take a look at whether the profits justify the risks of investing in Bhutan. Pages: 1 2 3 4 The author works with a leading capital markets company in India. Views and ideas expressed are entirely personal. This entry was posted in In Depth, Views and tagged Asia, Bhutan, emerging markets, frontier markets, India, investing, investment on March 3, 2014 by Antonia. Market Moving News and Views Is it worth investing in a small, frontier country? By Sourajit Aiyer Is it justified to look at the investment opportunities listed in the second article of this series, given that Bhutan is such a small market? Here I would like to draw attention on the profitability vs. growth debate highlighted in the initial paragraph of the first article. The market of this frontier country might be small, but one needs to look at it from the perspective of a correspondingly lower capital outlay and the profit potential. For example, I might need 100 dollars of capital to set up 10 outlets in a large market where I might earn 20 dollars profit. A small market like Bhutan might warrant only 1-2 outlets, ie a limited outlay of 10-20 dollars. But as long as the project earns a profit of 2-4 dollars, the ROE is maintained. It has some ‘margin of safety’ since the absolute amount of capital is committed to an unknown market is lower. Even expansion into small areas within a large country requires breaking up of the larger business plan to examine the viability per location. Hence, one can compare a small market like Bhutan to a sub-portion of a larger economy. But it assumes the 2-4 dollars profit factors in the additional compliance/regulatory cost, given it is a separate country. The potential to earn that profit fast seems to exist because: (a) Competition is still limited and the first-mover advantage exists, to some extent. In comparison, competition is already high in large emerging/frontier markets. Bhutan might not be a demographic story, but it seems to hold potential to realize profitability faster vis-a-vis larger markets, which hold higher growth potential but are challenged due to sheer number of players competing, leading to capital erosion, delayed break-even and unrealistic price wars. (b) The government will also have to think about increasing economic opportunities for its jobless youth, otherwise restlessness and impatience will eventually rise as the supply of qualified youth increases each year. The monarchy seems pro-people, and its popularity among the local/foreign residents is clearly visible. The commitment of the establishment to create opportunities for its people seems to be concrete. The government has to delve how it can manage the economic needs of its youth within its much admired Gross National Happiness objective.
  • 7. THE CHALLENGES OF A FRONTIER COUNTRY Does this mean there are no challenges? The government has faced criticism in the international media for its handling of the situation of the Bhutanese people of Nepali origin who could not prove their residency as per the 1958 law, rendering them homeless in camps in Bhutan and Nepal. There have been some incidents of violence and situations of unrest associated with this issue. Any situation causing heterogeneity/ghettoisation of population segments is best avoided, especially in a small country like Bhutan where any demand leakage should be a concern. Also, when people and lifestyles mix, it is good for business as it enhances scope for products that one might not otherwise have demanded. Another challenge is the vacancy rate in the newly constructed buildings. If the demand continuously falls short of supply and prices do not reconcile, then vacancy rates will move northwards and remain sticky. This can eventually lead to a bubble and loss in invested capital. The supply of educated youngsters is only going to increase each year. Controlling the impatience and frustration of its educated yet jobless youth is a socio-economic challenge, especially to avoid those ill feelings getting targeted towards the government. Lastly, while some steps of the government might seem restrictive (like restricting car imports, etc), they were good from ensuring the nation’s long-term sustainability. But such uncertainties worry those who have committed capital. In conclusion, there might be some opportunity to extract profitability even in the ‘final frontier’ markets, despite the population size not being significantly large. One needs to look into the viable sector-specific micro ‘islands of proficiency’, study the strength of the ‘demographic attitude’ rather than just the ‘demographic quantum’, the existent competitors and scope of the first-mover advantage. In the end, profitable growth makes a valuable and sustainable business. In this case, the absolute value of potential profitability is low owing to the lower capital outlay in a small market. But the chances of achieving the potential profitability faster seem bright, especially when one recalls that a proportion of new businesses in large emerging/frontier markets are still struggling to achieve profitability due to the old adage – too many cooks spoiling the broth. The author works with a leading capital markets company in India. Views and ideas expressed are entirely personal. This entry was posted in In Depth, Views on March 18, 2014 by Antonia Oprita.