19 July 2020

On today’s show, we have Kiyan Zandiyeh who talks to us about frontier investing. Kiyan has a growth fund that invests in Uzbekistan and other pioneering markets.

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  • How to invest in frontier markets from A-Z.
  • Why frontier market investing should have a place in any well-diversified portfolio.
  • How to assess the political and currency risk of a country.
  • How to do boots-on-the-ground-research and understanding lollapalooza effects.
  • Why Uzbekistan is the most interesting frontier market right now.


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

Intro  00:00

You’re listening to TIP.

Preston Pysh  00:02
Hey, everyone! Welcome to The Investor’s Podcast. On today’s show, we have an awesome guest who’s going to talk to us about frontier investing. His name is Kiyan Zandiyeh, and he’s the Chief Investment Officer for Sturgeon Capital. He 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. 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. With that, let’s go ahead and dive in.

Intro  00:40
You are listening to The Investor’s Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected.

Stig Brodersen  01:01
Welcome to The Investor’s Podcast! I’m your host, Stig Brodersen, and as always, I’m accompanied by my co-host, Preston Pysh. Today’s guest is Kiyan Zandiyeh. 

Kiyan, welcome to our show.

Kiyan Zandiyeh  01:14
Thank you very much. It’s a pleasure speaking with you. 

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Stig Brodersen  01:16
Today’s topic is investing in frontier markets. That is not to be confused with investing in emerging markets. Perhaps you could provide an overview of the difference between the two and what it really means to be investing in frontier markets.

Kiyan Zandiyeh  01:34
It’s an important question, actually. To take the first step, there’s no universal definition of frontier, emerging, or even developed, for that matter. If you take the indices as they stand and you invert the current indices, let’s say, by the country constituents, what you quickly find or infer is that there is no unifying theme that exists.

The difficulty of that is, let’s say, for active public market investors, is that, for active investors, on a relative basis, their performance is judged by the indices, and passive investors are getting exposure to what would arguably not be frontier. 

The issue of the indices, I think, is that the lens with which they’re put together is capital market sophistication. That is, to what extent have the capital markets of these countries allow for international investors to access? 

What that implicitly means is that you have a whole host of countries that have simply skipped or missed, and investors are not getting access to. That being the case, 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.

Therefore, what we’ve tried to do is create a simple definition of what we consider frontier and emerging. 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. 

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.

How we like to define what we do is we are investing in countries that are frontiered 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, opportunities can be exploited or capitalized that the rest of the world has already seen, but that these countries haven’t yet experienced.

In terms of frontier markets, specifically, I think what has changed the landscape over the past 5 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 like bottling factories or some sort of industrial business. 

The difficulty with that is what you’re effectively doing is you’re optimizing what has already been in the country rather than creating or optimizing for what is best practice or best business models. 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 an FX’s perspective is there’s more volatility.

What a lot of people focus on is, let’s say, cost optimization. Let’s say your business has 20% operating margins, but peak margins in an industry of 30%. There’s not really that much room for you to optimize, and so, again, you fall back to revenue growth. That said, revenue growth in a scenario where you have to make large tangible investments is difficult. 

But what has happened is the beauty of developed markets is that because of a base level technological infrastructure improvement, the speed with which companies can grow has been extremely accelerated to an extent that the base level of digital infrastructures is there as well. If you have, let’s say, 70-80% internet penetration, you have a 50-60% smartphone penetration.

However, none of these business models that we know have positive economic dynamics or 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 and not too linked to 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.

Preston Pysh  05:29
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 Zandiyeh  05:53
Let’s say, on a macro basis, I would say country by country is different, but there are telltale signs of structural dynamics of an economy that could lead to FX vulnerability. It could be a currency account deficit if we budget deficit. It could be high levels of external debt. 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 sorts of economies. It would be like our economies that have natural current account surpluses and 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. What you want to avoid are companies where you’re importing your input factor, that is your costs are FX-based, but your revenues are local currency based. 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 their costs are in the local currency. In a scenario where the currency weakens, your margins actually expand.

What we also care a lot about is companies to have pricing power. 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 demonstrative power pricing above whatever inflation may be. 

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, that pricing power comes to fruition and provides the hedge to that currency.

On a separate basis, what we try and do when we’re looking at investments is really stress test against worse possible FX scenarios. If we find that we’re not comfortable with what the business will look like in that scenario, we simply pass. We like to think that we want in-built resiliency within the business models from various different perspectives, but especially on the tech side of things.

Stig Brodersen  07:47
Frontier markets are such an interesting type of investment. Typically, people don’t want to be 100% exposed to something like that, but perhaps they might take a small part of their portfolio and allocate it 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 Zandiyeh  08:13
If we take a look at public markets where more data is available, let’s say, MSCI frontier, what you would 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 of 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. 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 drained of liquidity that you’ve seen from these markets over the past 10 years. 

For us, it’s 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 is in the funds that you manage, it’s very difficult.

Similarly, in private equity, I would argue that the risk premium side of things has failed, as well. If you look at realized returns over the past 10 years on frontier market private equity funds, we took on 9.87%. 

Now, if we put that on the spectrum of emerging and develop [an] emerging mean, let’s say, realized has been around 15%, developed markets have been 19%, the 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. Again, going back to my previous ones, I really think that has been an issue of allocation as opposed to the fundamental benefits of frontier, that if you’re investing in 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.

The way we think about it is, “What is the return that investors should expect from frontier?” Focusing on the private side of things, if you take a look at developed market returns, and they said, “Let’s take the upper quarter of 29% over the past 10 years,” it would be rational to assume that investors would want premium.

If we take, let’s say, GMO forecasts of kind of what premium should be, it’s roughly 10%. So, our target return is 40% annualized, which means roughly just above 5x in 5 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. 

The way we think about it is when we’re appraising or looking at investments, 40% is simply a discount rate. 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.

Preston Pysh  11:08
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. How do you assess the political risk in a frontier market?

Kiyan Zandiyeh  11:22
I don’t think there’s anywhere in the world at the moment where there isn’t political risk. I would argue that political risk in more developed countries is higher. Why? Because you have democratic political cycles that are every four years. Within that, there are dynamics that unfold that drive markets. 

If we take the US as an example, for a tweet, 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 flow, investors lost money. There are a lot of things that are happening around the world but especially in developed markets that present investors some form of political risk.

With frontier markets, it’s somewhat different. There are 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 the political system is positive or negative, but at least you’re comfortable with the lay of the land. 

Also, what you normally have are momentous shifts every, let’s say, 10-20 years, where the leadership structure of the country changes. What we want to be is on the right side of that. If a country has just gone through a change, to observe that that change is positive, that there is stability to that change, and then we start to invest. That’s on a macro level.

On a micro level, what you have from political risk is, 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. 

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. 

Let’s say among a country’s biggest assets are oil and gas. If you’re somewhere in the value chain of that, you potentially fall foul of political risks. Therefore, 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. 

Let’s say a lot of people like the concept of investing in privatizations. They’ve seen success stories in other countries. But what you normally find in these companies is that they have bloated workforces. The rational first thing to do would be to basically make redundant up to 50% of the workforce.

Now, as the first step in an economy, which you’re doing, that doesn’t win you any favors. But if I flip it and say, “We’re investing in e-commerce,” what are you doing now? What you’re saying to local logistic providers, which isn’t really making money is, “Look, by working with us, your revenue will increase.” 

If you employ the youth population, again, you’re tackling a problem of youth unemployment. You’re making it easy for people to access products that they otherwise wouldn’t be able to have access to and at a lower cost. So, you’re adding value to the ecosystem.

The final point, I would say, that we really focus on 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 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 put someone else to run it.

Stig Brodersen  14:35

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, am always concerned about the information that I get. How do I validate if that’s true? Some of the data might even be hard to collect. I guess that’s my way of saying, “Okay, so you have a research process. But how do you validate the data you collect?” 

Kiyan Zandiyeh  15:10

The benefit of investing in the US is that, by law, by regulation, the quality and the quantity of information provided to investors allows for an appropriate judgment to be made as to investment. 

Now, what that means is that that information has effectively been commoditized. The beauty of frontier markets is that it hasn’t. As an investor, if you have an edge in collecting valuable information, then that can really be valuable.

What we do is in any country that we invest in, for us, it’s important to build a local team on the ground. One of the reasons that are important is that they have an understanding of the level of information that’s needed for us to make an investment appraisal. 

What they actively do with the companies that we’re looking at, and I’m focusing on the private market here, are they effectively handhold and actively work with the management to dig out information that is necessary for us to appraise. 

The other thing that’s important in these countries is that you don’t want to be in a situation as well as a huge asymmetry of information. But you could go into a management meeting, and the guy could be extremely charming, could be charismatic. What we want to do is effectively flip that asymmetry.

So, when we’re looking at a business, we’ll initially identify the variables to say, “What are the important variables that are driving this business? What are the data points that we can match 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. Why a 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. We believe that’s important from a practical investment perspective.

The other factor is the governance aspect, in that, again, when it comes to developed 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 create what we call a stakeholder map. That really is a map of all the factors that are driving the business. 

So, you want to know if a guy is buying supplies, if he’s buying a data center, if he’s buying an office, are any related parties in that transaction? If so, what is the incentive driving them? That really basically brings to life any bottlenecks, any potential risks that we can address even for term sheets, even for direct discussions of management, or the way we structured investment.

Preston Pysh  17:33
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 Zandiyeh  17:56
The first question you want to answer is: Why does an opportunity exist 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, 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 [is] perceptional? What edge do we have in the country that not only foreign investors don’t have, but the locals don’t have? 

One hack that I think is a good way to go about it is when you go to a country, meet with leading brokers, meet with the local versions of Western 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?

Around that, you can see, well, what are they missing? The aim here is not necessarily to look for actual investment opportunities off of that, but it gives you the framework of how the locals are thinking about. 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, is to make sure that the institutions in the country, that is the legal system, the regulations, allows for you to execute whatever that particular focus may be.

One example that I can give as to what we’ve learned to avoid is what you normally find in frontier countries. Investors say, “Let’s go and invest in the leading entrepreneur in the country. Why? Because, obviously, he’ll 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 whomever that individual is, man or woman, has been successful. They already have access to capital, they already have a profitable business, so what you’re effectively doing is forcing capital to them. You’re saying, “Take my capital, please, because I want you to have it.” That capital may be in the form of, say, “If you’re producing 100 tonnes of glass for bottling this year, increase it to 150 tonnes.

Now again, if you’ve sat in the entrepreneur’s perspective, what he’s saying is, “This is a great trade. If it works out and 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 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 get returns commensurate with the risk that you’re taking.

Stig Brodersen  20:32
Let’s transition into the second segment of the show after talking about frontier markets as an investment class. I would like to be a bit more specific. 

Right now, Sturgeon Capital is focused on Uzbekistan, specifically. I can’t help but wonder, of all the frontier markets you could invest in, why Uzbekistan? Why not any of the other frontier markets?

Kiyan Zandiyeh  20:58
It’s worth a little bit of history on the firm. Again, I defined what we do as looking at countries that are a frontier, but emerging. That has naturally led us to focus on Central Asia. So, you had Georgia in the first instance, which had gone through a tremendous reform path. 

Kazakhstan, which wasn’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 Uzbekistan because relative to this region, it has the largest population of about 33 million people. They have great demographics, ~65% under the age of 35.

Unlike a lot of other countries, it has a really diversified economy. So, whilst they have natural resources, to an extent, they count as cyclical. Their largest export is gold. They have uranium, but for all intents and purposes, it was very difficult to allocate meaningful capital there under the previous administration, which was there for about 25 years. You could argue that it was a closed-off social estate, 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 it important to have a pulse of what’s actually going on. So, what happened? Two and a half years ago, effectively, the previous president passed away. Ironically, his prime minister became president.

The general consensus at the time, even amongst locals was that it would be a continuation of the previous policies. Then, unbeknownst to everyone, what he effectively did was embark on a very ambitious and aggressive reform path, defined as ‘The Fall of the Berlin Wall’ moment for really lifting the currency control. 

They had two different currency exchange rates. One was a subsidized rate. One was a free market rate. Overnight, they unified that. They took a 50% hit on the currency, but as before where it was difficult or nearly impossible to get money in and out, that changed overnight.

What then followed was that the roster of previous ministers was fired and replaced with young Western-educated Uzbek technocrats, and then a series of other policies and reforms took place. They’re now privatizing nearly every state asset. 

There are 1,200 companies on the privatization list. They engaged in serious tax reform. They had a large part of the economy, estimates of up to 50%, that were in the black economy that was not paying taxes. Why? Because the tax system was complex, and probably arbitrarily high. 

What they did is they reduced 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, we’re talking about a country of 33 million people. That is $1500 GDP per capita. Comparing that too, let’s say, a country like Georgia, which has one-fifth of the population, no natural resources, they’re at about $4500-5000. 

Kazakhstan with, let’s say, half the population but more natural resources are at about $8000-9000. Moreover, you’re coming from such a low base that if you want to add a value tilt 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%. Their reserves have a GDP of 60%, and a bulk of those reserves are of gold. 

And so, what you will see, I think, is the one-off leveraging. But the important point to that, unlike developed markets, is that that leverage really is going into productive capacity in that you have a lot of the economy producing under capacity. Therefore, what that capital is going into is really high-return-on-investment projects. 

The final aspect that is positive and somewhat underlooked by the Western world is The Belt and Road from China. The way we think about that is that it’s the Marshall Plan on steroids. It’s a $1 trillion investment plan. 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. 

Charlie Munger talks about this kind of lollapalooza effect 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. Frankly, from our investment career perspective, there hasn’t been a country that has such a high conviction over the past systems.

Preston Pysh  25:16
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 Zandiyeh  25:27
A good way to think about it is you have a pre-Soviet infrastructure order. You have these clean wide roads. Everything’s quiet, and you have a pre-Soviet Union human capital. Education levels are very high. The majority of the people are educated in the hard sciences, which is normally what you want, as opposed to the softer social sciences. 

The downside is you have post-Soviet GDP dynamics. The normal amenities, which you probably expect in a lot of countries are not there. Although, they’re really coming into place now. 

In terms of opportunities, I think we’re effectively, at the moment, the only international firm providing private capital to the country. I’d like to think that that’s built up a lot of goodwill. When you meet local entrepreneurs, they’re very proud, and they like the fact that you’re there. They’re more than open to have a discussion with you.

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. You can meet the leading entrepreneur in the retail space. You can meet the leading real estate developer. You can meet the leading tech entrepreneur. 

Similarly, on the public side, you can meet with ministers to really understand how they think about the policies that they’re setting, what yardsticks they’re setting for themselves. In the space of three to four days, you can leave the country having experienced and met with people that you would otherwise never be able to meet in any other country. 

By then, you’d probably get a good feel of what the reality on the ground is, as opposed to perception, where in most cases, there is simply no perception of the country as most people haven’t really come across it in their lifetime.

Stig Brodersen  27:00
It’s very interesting that you say it like you’re the only foreign company providing capital. What kind of advantages and disadvantages does that entail?

Kiyan Zandiyeh  27:10
One disadvantage, I think, is something that can be managed on a personal level or firm level. If you travel there, you could be awed by the scale of the opportunity, which you would see. An anecdotal evidence I would give you as an example is the real estate sector. What will normally happen is that, yes, demand is likely to go up because you have urbanization and GDP are growing up. 

But one factor that probably will more-determine economic returns is the supply side. On real estate, it’s not too difficult to expand supply, right? An equilibrium will quickly be formed, which is what you want to stay away from.

Really, as I mentioned earlier, our focus is to try and capture these decorrelated 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? Let’s take the banking sector and fintech as an example. If you look at the UK revenue to 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. The majority of people hold their main deposit accounts at incumbent banks, and they use fintech companies for additional services, whether it be payments, etc.

In frontier countries, it’s a completely different dynamic. You already have a large part of the population that simply does not have a bank account. Also, 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 are the capital deposit account for that customer, as opposed to just being added functionality.

That said, 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 the moats as time goes by and that they are scalable. What we look to do is build or invest in businesses similar to those in these countries. I’m happy to go into a few examples if you would like.

Stig Brodersen  29:09
That would be fantastic because you already made a few positions in your space already. I would be very curious to hear a step-by-step process from whenever one or multiple of these companies came on your radar until today.

Kiyan Zandiyeh  29:27
I think something that we’re proud of is that all the investments that we’ve made have been organically sourced in the sense that it’s been the entrepreneur that has contacted us via esoteric ways. It may be a message for LinkedIn, an email. It may be someone indirectly reaching out, or they have been sourced from us actively reaching out to entrepreneurs. We try not to rely on the outside advisors where incentives can be flawed.

However, if I could give a few examples, one investment that represents a significant portion of our portfolio today is a business that today is called *inaudible*. Today, it is arguably the largest cross-border e-commerce marketplace in Central Asia. 

Now, what do I mean by the e-commerce marketplace? Think of the same business model as Alibaba or AliExpress. 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, there are three main things.

One is a logistical solution. If you’re sending products from China or Europe or anywhere in the world too, let’s say, Pakistan, you need to have a logistical solution. What this company has done is they’ve partnered up with every national post company and local postal companies to the point wherein every country it operates, it has last-mile delivery. 

[It’s] something that just did not exist, and it provides that delivery at a cost lower 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 is payment solutions. In Uzbekistan, less than 10% of the population have Visa and MasterCard, which basically shuts them off from any international commerce. 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. They’ve also added installment solutions and Buy Now, Pay Later. Buy Now, Pay Later is effectively saying you buy a product today, you pay it in 60 days with zero interest, and the supplier takes the hit on the interest. For the supply, they will do it 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. With that infrastructure that they have, they basically signed up JD.com in China, which I think is #3 in e-commerce. You have Hepsiburada in Turkey, which is the number one e-commerce, and a range of other service providers.

The other less direct positive is that all these countries have VAT and customs duty exemptions for cross-border e-commerce, which basically simply 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, it’s 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.

What the business did effectively launched them in November 2018. This is a management team that we’ve known for about five years. The core management team has been together for about 20 years. They’ve produced two successful exits. 

Since November 2018, effectively, the business has developed such that, today, in every country it operates in, it’s the most downloaded shopping app. It has about 33.5 million downloads of the app. Up until the Coronavirus, it was growing at about 38% a month GMV-wise, which is the value of transactions on the platform.

The way we see it, as time goes on, the barriers to entry go up, the moats of the business increase, and what you’ll be 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. It’s because they have that infrastructure, which is just kind of adding to that month.

The way we see it, in terms of returns, is if you mathematically compound GMV from where it is today, which is at 4% a month, you get to about half a billion in value transactions in about 4-5 years. Bear in mind that the company is growing at about 30% a month, at the moment. 

If you look at exit multiples of these businesses over the past 5-10 years, let’s say from 1.5x to 3x 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.

Preston Pysh  33:44
Here, in the US, when a company talks about an exit plan, it often involves an initial public offering (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 Zandiyeh  34:00
That’s a very good question. It kind of reverts back to the public markets. Again, one of the reasons that I think it’s difficult to consistently make money there is if we isolate the local capital market, you don’t have that intensity of capital or the true free-market capitalism mentality that you have in the US. Whereby, if something is cheap, even for private equity, or for M&A, that value is unlocked, 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 where we effectively are involved in situations whereby the value or the strength of the business creates some liquidity, ultimately. That can come in a few forms.

One is, if we take Uzbekistan as an example, we’re investing at a time where the public markets really are in their infancy, but there are aggressive reforms and there are ambitious plans to develop that local capital market. 

There is a scenario where I would probably unranked all of the perspectives and 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 dynamic, that is a technology company that is relatively fast-growing. It would relatively be easier to IPO on a local basis.

On an 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. They have plus-billion market caps and trading on valuations at peers with, let’s say Western multiples. 

If you take Russia, you have businesses like Yandex and Tinkoff that are trading on the NASDAQ. In Africa, you have businesses like Jamia, which again is the e-commerce marketplace that had a pretty successful IPO in the US market.

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 Tencent or Alibaba, is that what you’re saying is, “I’ve solved the issue of these countries. I’ve solved the difficulty operating these countries for you.”

If we look at Tencent or Alibaba, a third of their income line is investment income. Investment income comes from acquisitions. If you look at the number of acquisitions that Alibaba tends to make combined, it reaches nearly 1000 over the past 10 years. Why? Because they have a cash cow in their core business, and they have FOMO. 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.

China already has this basically, i-Silk Road, which is the digital Silk Road project that they have. What we’re doing falls directly within that, so you also have the optionality of leaning towards the east.

Stig Brodersen  36:35
Talk a bit more about comparisons between Uzbekistan and the West, which perhaps resonate a bit more with most more listeners. You mentioned a pricing power before. That’s also something we talked about here on the show, Warren Buffett 101. 

How are the “rules” different, if ever, from a good company in the developed world? You may be looking for something other than having good pricing power, but you might also be looking at a company that does need to have lower CapEx or whatever we’ve been taught about with businesses. Is there a difference, in any way, whenever you try to identify that in a country like Uzbekistan? 

Kiyan Zandiyeh  37:17
Yes and no. The question that I guess we’re ultimately trying to answer is twofold. One is: What is the value proposition of the business’s core product or service to the underlying user? What utility is it providing? 

Sometimes that utility is very high. The ideal situation is that there’s high utility, but the economic structure of that business or a sector also allows for economic gains to be made from that utility. Basically, margins are indicative of that. 

So, you have some businesses where there’s a high utility to the customer, but the underlying dynamics maybe as a competitive factor or whatever it may be, doesn’t allow for you as an investor to capture economic benefits. Therefore, 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 is a business who’s invested in Uzbekistan, called Billz, which is the leading enterprise software of SaaS business. You and the listeners are probably familiar with that business model, which, in our mind, is a most elegant, beautiful business model as you have +50% operating margins, high cash flow, and high recurring revenue. What we can argue is that in a developed world, this is quite an unsaturated investment landscape and that everyone is investing in SaaS.

Now, if you flip that in the frontier market space, specifically in Uzbekistan, this is a business that is targeting the small to mid-sized businesses where their alternative, if they’re focusing on account management and inventory management, is either paper or Excel.

The beauty is that the government is effectively mandated that that has to be digitized. Businesses have to digitize their account management imagery management process not only for transparency but for efficiency. 

The beauty of this business is also that not only are you providing a service that is inclusive and profitable but, by virtue of providing that service, you’re collecting unique data that no one has in the country. 

Now, what data is that? It’s the working capital cycle, cash cycle data, on a range of SME businesses, which no one has. That comes into the financial services angle of a country that is really at its infancy of financial services. 50% of the population do not have a bank account, which by law, now they have.

Now one of the issues there is credit quality, in that at the moment, credit scoring is binary. Either you have good credit, in which you get a loan, or you have 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 risks. You can price loans that are at more appropriate rates, and also allows you to speed up the speed at which you can distribute that loan.

Going back to the SaaS business, what you’re effectively doing is having a range of businesses where you have all the working capital and all the cash cycle data. The business can either, through your own balance sheets, start to lend out or act as a platform to the banks to basically act as a loan distribution for you and to introduce a few. The latter is a more capitalized model. With the former, you have more control over it. Either way, you’re still adding value, and there’s economic rent to be taken from that.

Preston Pysh  40:20
Kiyan, what are the main red flags you look out for in Uzbekistan, where, if they materialized, you would close down your Uzbekistan growth fund?

Kiyan Zandiyeh  40:30
As a thumb, what we’ve seen over the past 15 years by being in frontier markets is a wide range of risks, be it coming from the government, be it coming from micro-investment risks. What I hope or like to think that we’ve built up as an investment framework off of our own mistakes, off seeing other investors’ mistakes that really focuses on this concept of resiliency, and that we’re investing in business models and investing in a manner in constructing a portfolio that is inherently resilient or having the aim of being resilient.

One other anecdotal example I can give of a country that was not involved in at all anymore but purely observes out of interest is Iran. Let’s look at what happened there. In 2016, sanctions lifted. There was a whole rush for investors to get into the country, whether it be multinational financial investors. 

In 2018, Trump comes in. The widest-ranging sanctions that any country’s ever experienced get reinstated on the country. The currency devalues by 80%. The country goes into recession. What has happened over the past two years? In 2019, the stock market goes up roughly 80% in dollars. 

This year, it’s up 120% in dollars. In a similar period, you’ve had the local version of Uber be developed to the point that it has two and a half million rides today, which basically makes it the third or fourth-largest ride-hailing app in the world. 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 Brodersen  42:00
Kiyan, this was a fantastic interview. I cannot believe it would take us six years into The Investor’s Podcast to have the very first episode about frontier markets. I’m sure the audience would like to learn more. Where can they learn more about you and Sturgeon Capital?

Kiyan Zandiyeh  42:17
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. Again, it’s incumbent upon us to be actively communicating the opportunity set and what we do. 

I would really encourage anyone that wants to reach out to us to directly find us on our website. I hope that once COVID goes away that we can encourage you and potential investors to come with us to Uzbekistan. There’s no other way to go about it and really get a feel for what’s going on on the ground. I can speak as much as I want, but it’s better always to get your own list of first principles.

Preston Pysh  42:53
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. Thanks for making time for us.

Kiyan Zandiyeh  43:06
It’s a pleasure. Thank you again for the time. 

Stig Brodersen  43:08
All right, guys. That was all that Preston and I had for this week’s episode of The Investor’s Podcast. We’ll see each other again next week. 

Outro 43:16
Thank you for listening to TIP. To access our show notes, courses, or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. 

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  • Sturgeon Capital’s website.
  • Learn more about Sturgeon Capital’s Uzbekistan Growth Equity Fund.


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