Episode #266: Best Idea Show – Kiyan Zandiyeh, Sturgeon Capital, “We Have A Blank Canvas To Potentially Create What The Technology Ecosystem Of That Country Will Look Like Over The Next 5-10 Years”
Guest: Kiyan Zandiyeh is the Chief Investment Officer for Sturgeon Capital, a leading frontier markets investment boutique focused on technology-enabled businesses that offer a product or service which solves an unserved, acute pain point for a large addressable market.
Date Recorded: 10/28/2020 | Run-Time: 52:16
Summary: We’re covering Kiyan’s best idea: frontier markets. With the U.S. markets near all-time highs, investors may want to look around the globe for other opportunities and frontier markets offer a unique risk/reward. Kiyan walks us through the current landscape and what countries he’s most interested in. He covers the most common risks investors need to be aware of, and why he’s focused on private companies utilizing technology in the ecommerce and enterprise SaaS spaces.
As we wind down, he walks us through a couple real examples of investments he’s made in countries like Iran and Uzbekistan.
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Links from the Episode:
- 0:40 – Intro
- 1:43 – Welcome to our guest, Kiyan Zandiyeh
- 2:42 – His background
- 4:27 – Defining frontier markets and an overview of the space
- 4:33 – Adventure Capitalist: The Ultimate Road Trip (Rogers)
- 4:38 – Investment Biker: Around the World with Jim Rogers (Rogers)
- 4:41 – Market Wizards, Updated: Interviews with Top Traders (Schwager)
- 9:39 – Biggest investor concerns in frontier markets
- 14:39 – Countries and sectors they focus on
- 15:19 – His interest in former soviet countries
- 15:24 – Red Notice: A True Story of High Finance, Murder, and One Man’s Fight for Justice (Browder)
- 17:30 – How frontier market investing works for them
- 20:34 – How they source deals
- 23:17 – Overview of their portfolio
- 27:50 – The interest of governments to boost investments
- 29:33 – How they exit their 7-year investment
- 30:35 – Investor appetite in frontier markets
- 33:43 – Exciting frontiers and ones that raise immediate red flags
- 34:59 – Environment for incubators and other start-up ventures in frontier markets
- 36:49 – Investing in Iran
- 38:01 – How the pandemic has impacted their strategy
- 41:42 – Most memorable experiences in their investment time
- 43:29 – The ‘Credit Suisse Family 1000: Post the Pandemic’
- 43:56 – Capacity for them to invest in
- 45:34 – How much local government is involved in their deals
- 46:53 – Traditional investor in funds
- 47:14 – Their focus for the future
- 48:48 – The low hanging fruit in frontier markets
- 49:47 – Most memorable investment
- 51:19 – Connect with them: twitter @k_zandiyeh & @sturgeoncapital, Sturgeon Capital, Email them to get on the distribution list: email@example.com
- Additional resources
- An introduction to Sturgeon’s impact investing approach (Sturgeon Capital)
- Laying the groundwork for investing in frontier markets (Sturgeon Capital)
- A ‘new economy’ approach to frontier market investing (Sturgeon Capital)
- Why are frontier challenger banks outperforming their developed market peers? (Sturgeon Capital)
Transcript of Episode 266:
Welcome Message: Welcome to “The Meb Faber Show,” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the Co-Founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com
Meb: Hello, friends. Today, we have another instalment of our Best Ideas series. We’ve had some really fun episodes already on long Japanese stocks, ins and outs of SPAC arbitrage, and how to launch an ETF. Today’s guest is the Chief Investment Officer at Sturgeon Capital, where they invest in technology-enabled businesses in frontier markets.
In today’s episode, we’re crossing the map and covering our guest’s best idea, long frontier markets. With U.S. markets near all-time highs, investors may wanna look around the globe for other opportunities, and our guest believes frontier markets offer a unique risk-reward setup.
Our guest walks us through the current landscape and what countries he’s most interested in. We cover the most common risks investors need to be aware of and why he’s focused on private companies utilising technology and the e-commerce and enterprise SaaS spaces. Please enjoy this special Best Ideas episode with Sturgeon Capital’s Kiyan Zandiyeh. Kiyan, welcome to the show.
Kiyan: Thank you. A pleasure to be here.
Meb: Where’s here?
Kiyan: London for me.
Meb: How long you been in London town? One of my favourite places in the world. I haven’t been able to get back. I was supposed to be in Europe and London this month, but sadly it didn’t happen. It’s not as much fun to do a virtual meeting with your Madrid friends from California. It’s a lot more fun to be doing it in person.
Kiyan: Typically, we travel about a week or two weeks a month, and this is the longest period I’ve been stuck in London, so I’m getting COVID fever.
Meb: We’re doing the best idea show today, which people seem to love. And this one I know will be particularly fascinating. What’s your concept for Best Idea now here in the fall of 2020?
Kiyan: Well, it is frontier markets. I think it’s an area of the investment world which is misunderstood. We think that historic performance has been quite terrible so it’s put off a lot of investors. But we like to think that we’ve developed some sort of investment framework that captures the benefits that frontier presents whilst also being cognisant of the risks that are also there.
Meb: That makes me salivate a little bit, something that no one understands but also that is at a terrible performance. That’s usually something where all the struggling value investors listening to this can probably sympathise a little too much. Tell me a little bit about your background. You worked with Dr Doom for a while, is that correct?
Kiyan: That is correct. I have a bit of an esoteric background. I was one of these weird kids that was obsessed with business and investing from a young age. I kind of bought my first stock when I was 13, started an investment partnership in my late teens.
Meb: Do you remember what it was?
Kiyan: Yeah, it was Yahoo! for no other reason that I just kind of recognised the name. And it is a steep learning curve from there. But coming out of the investment partnership, kind of adopting the old value methodology, it’s kind of sacrilege to think about macro or kind of take it as an investment consideration. But coming out of 2008, I thought that probably was quite an ignorant view. And so then I worked with Roubini, aka Dr Doom, covering effectively emerging markets and frontier markets.
And whilst fascinating, the paradox I came across was you had these really interesting positive dynamics, specifically in frontier markets that is high GDP growth, great demographics, and all that sort of stuff. I hadn’t seen any investor that had built up a good long-term track record. And so as a side intellectual project, it was to try and understand why and to see if an investment framework could be developed to tackle that problem.
And so I was lucky to ultimately then join Sturgeon, which is a London-based frontier manager. And we launched a fund using that framework, where, effectively, we seeded it predominantly with our own capital. And that fund has gone on to do quite well. It’s set to return about 5x on capital in just over 5 years. And since then, I’ve kind of honed in that investment framework and tried to refine it as much as possible in the fund launches that we’ve done since then, but all focused on frontier.
Meb: It’s funny talking about your early investments. I mean, I certainly grew up on the Jim Rogers books, “Adventure Capitalist” and “Investment Biker” I think was the first one. It was so much fun. And “The Market Wizard” books, too. I know there’s a new one coming out this winter or even fall, where they profile this concept of, like, the swashbuckling fund manager from the ’70s and ’80s back when he was at Omega, with Soros.
In many ways, it’s still similar to that. I think the struggle so many people have with…forget frontier markets. I mean, just emerging markets in general. My audience is global, but still, mostly Americans, even developed markets is a struggle largely because U.S. stocks have done so well over the past decade, but frontier markets is even tinier relative to emerging markets. So, walk us through the general case. And what do you even mean by frontier markets? I think a lot of people don’t even know what that designation even means.
Kiyan: There is no standardised definition of frontier. And if you were to take a look at let’s say MSCI Frontier, which is the broadest definition of frontier countries. Look at the country constituents. There’s no unifying theme bringing together. You have countries like Argentina, Vietnam, and Kuwait. Effectively, the variable of the lens of which they’ve been put together is capital market sophistication, not any dynamics relating to GDP, not only dynamics relating to underpenetrated consumer and all this sort of stuff. And so when you’re investing through the public markets in frontier, arguably, you’re not actually getting frontier exposure.
Even if you look at that MSCI Frontier track record over the past 10 years, it’s annualised about 5%, which is the opposite of the risk spectrum one would want from frontier, which is considered the most risky. At the same time, private equity funds in frontier, they’ve been the worst performing relative to emerging or developed in the sense that if you look at the spectrum of returns, frontier has been about 9%, emerging 15%, developed somewhere between 19% to 25%.
And our read of that is more that it’s an allocation function. So if you take private to start with, what has typically happened, or the approach that has typically been taken, is to optimise for how business has been done historically in the country. That is to invest in the leading local entrepreneur or to invest in state privatisations because they’re nominally cheap.
If you take those two examples, the leading entrepreneur, effectively, you’re entering in a really asymmetrical trade. That individual already has plenty of capital. What you’re effectively doing is forcing them capital saying, “Look, take my money. Increase capacity, whatever you do, so I can ride the wave of hopeful positive GDP growth going forward.” The difficulty of that is that revenue growth is intrinsically linked to the economy. And what you have in frontier countries is structurally higher GDP growth but much more volatile. And to add to that, FX volatility, it makes it very difficult to actually generate returns.
On the public side, when you travel to these countries, you realise that the stock markets are actually comprised of legacy state assets. That is the quality companies really are not on the local stock markets. So you’re investing in a small carveout of sub-optimal management cultures, sub-optimal business models, and again not really taking advantage of the dynamics that frontier presents.
But what has changed over the past five years is whilst in the more developed countries, you’ve seen the development of really great technology-based business models off of base-level digital infrastructure. That has seen the speed of which companies can grow to be accelerated. And if you take that to frontier, they also have that digital infrastructure. There’s kind of plus 70% smartphone penetration, plus 80% internet penetration.
But people have been lost in this wave of poor returns and have not seen that the opportunity is present to build and invest in similar technology-based business models in these countries. That is, you’re taking the blueprint for what has worked, business models that you know are proven to be profitable that is positive unit economics, they’re scalable, they address the broad public needs. If you think of it through Maslow’s hierarchy of needs, it’s really addressing the basic needs. And investing in those sort of businesses captures the positive dynamics of frontier, but also allows you to be resilient in the face of the risks, right?
So one risk that investors typically come across in frontier is political risk. And political risk, there’s normally a positive correlation between the success of a simple business, let’s take a gold mine, and the propensity for the government to let’s say want to be aggressive and potentially taking it off you. Why? Because a gold mine, on a relative base, is operationally simple to run, and so it’s very easy to replace the CEO with someone else. But if I’m running a tech company, not only I don’t have any tangible assets. I have intangible assets. So there’s nothing really to take. But they’re operationally complex. They’re difficult to take away from you.
And if you think of it through the lens of adding or taking away from the ecosystem, most of these businesses are adding to the ecosystem, so it’s a win-win for everyone, including the government. If you take e-commerce, you’re working with a local logistics provider to help them increase revenues. You’re helping local offline retailers have an online presence to increase their revenues. You’re helping people to access products at a cheaper price. And so the whole ecosystem wins. And that’s why I think the totality of focusing on technology in the frontier allows you to really capture the positive dynamics whilst being cognisant of the risks.
Meb: All right, man. We got about three hours of stuff to unpack here. As you think about the challenges of limitless choices and opportunities. Just in developed markets, there’s tens of thousands of securities, same thing for emerging. And then you get to frontier where there’s a whole slew of more countries. I pulled up the MSCI Frontier Index, and even then, you got to say how representative is that because you have one stock that’s 20% of the index. It’s so arbitrary that you have probably a dozen or two dozen countries.
For the listeners, foreign developed for the indices usually has about 22 countries and foreign emerging about the same. So a bunch of countries, and this is a problem with a lot of the regional indices, like Africa, if you have an African fund, it’s like you just basically have South Africa. So you always got to be really careful about these public market-cap-weighted.
A lot of the things that you talked about, I kind of smile about, because on the list of investor concerns, what do you say the big three are? When people talk to you, is it geopolitical risk, legal risk, FX? What are the main, like, top couple that… And then also comment, are they justified? And which ones are not? Which one is the non-issue and which ones are actual you got to take it serious?
Kiyan: So the top three probably are political risk, macro risk, including currency, and the ability to be able to actually exit your investments, I mean, if you’re focused on the private markets as we are. And all to an extent are justified by precedent. So you’ve had, in countries such as let’s say Mongolia, which was a decade ago sold as the next big frontier, which didn’t perform for a number of reasons, but political risk was one of them.
Macro risk as well because a lot of these frontier countries see a lot of volatility in their currency. And exit risk as well, because, again, if you go back to the idea that most investments in private space have been done in industrial old-age businesses, and if you can’t unlock value, it’s very difficult to actually exit.
But I would say that on all three points, that’s changed. My view as it relates to frontier is if you’re able to build and invest in a great business model that captures a large customer base, then you will be able to exit. And kind of one good example of that is a company that IPOed last week called Kaspi, which operates in Kazakhstan. Kazakhstan is a country of 18 million people, a very small country. And the basics of this business is e-commerce marketplace with fintech overlay on top of it. That is to provide consumer loans to individuals to be able to buy on this e-commerce marketplace. In 10 years, they went from $0 to about $500 million net income. And last week IPOed at $6.5 billion. Again, only operating in Kazakhstan with a population of 18 million. You’ve seen similar cases in Africa. I think two weeks ago you had Stripe, which acquired a payment provider at Nigeria called Paystack.
Meb: it was like $200 million, right? I think that’s their biggest acquisition yet.
Kiyan: Great for the ecosystem, yeah. The point is that on the business model, specifically, in the absence of technology, there has been no business models that has been able to capture large enough customer base to really make it interesting as an investor in frontier. But now I would argue, with technology, it’s possible.
And with political risk as well, again, if you look at the precedent, what has typically happened is if I invest in a previously state-owned asset, you have a legacy culture, you have a legacy way of doing things, you have embedded interests, and the only way for me to unlock value is to destroy all of that. Then, those embedded interests start to talk to one another, and then you can get screwed.
Similarly, if I’m investing in an area which is considered a strategic asset for the government, there you have risk as well. But going back to my point earlier, in technology, you’re doing nothing but adding to the ecosystem. And our experience is that the governments actually like to work with you in accelerating that because you bring youth employment, you bring jobs, you bring prosperity to the broad economy.
On the economic side as well, I mean, what I would like to say is, to define exactly what frontier is in our mind, which I didn’t do in the previous question, we define frontier as a country that has a very low level of private sector participation relative to the total investment in the economy. That has historically had that the state has been the largest provider of capital in the economy. And that we really become interested in a country where that’s changing, has become emerging in the sense that there’s some sort of catalyst that allows for private sector participation to go up. And as a result of that, foreign investment.
And what that effectively means is because there’s been an absence of private capital that is better incentivised to capitalise on opportunity, in theory, there’s an abundance of opportunity that an investor can look at. And what we like of countries that effectively are coming from a very low base on a few perspectives, that they have very little external debt, they have a natural current account surplus, they normally have high reserves to GDP.
From a foundational balance sheet perspective for the economy, you’re going into a situation where there’s much more resilience to the economy relative to a country, let’s say like Turkey, where you have a budget deficit, fiscal deficit, current account debts, and a really high external debt. And so we try to tend to avoid those countries that are in those situations.
Meb: Who’s on the list of countries in your universe? Do you guys focus exclusively on private, by the way, or is it public and private? And then what countries are in the universe that fall into at least a potential investment choices?
Kiyan: So we exclusively focus on private at the moment. And the countries that we’ve typically focused on are ex-Soviet Union countries. Right now, our favourite and the most probably esoteric to your listeners is Uzbekistan, and we can go into why. We also invest in Kazakhstan, but broadly look at opportunities in frontier, specifically viewing it through the lens of which business models that we know to be great haven’t yet been developed in a particular country, and then look to invest in that business model.
Meb: There’s a lot. Okay. So walk us through kind of how you settled on the former Soviets. You look back at the Bill Browder book, is it “Red Notice,” where he talks about investing in the privatisation of a lot of the former Soviet Union. What were they called? Not the stubs.
Kiyan: The vouchers.
Meb: Vouchers, thank you. Fascinating story. Why 20 years later are those countries particularly attractive, do you think?
Kiyan: If we take Uzbekistan as an example, effectively for… Well, out of Central Asia, that ex-Soviet Union block, it has the largest population, so about 35 million people. For 25 years, considered effectively a closed-end dictatorship, was basically shut off to foreign capital.
At the same time, had really interesting dynamics. You had 70% of the population under the age of 35. A very diversified economy, so not natural-resource-intense like a lot of other countries. Their biggest resources actually uranium and gold to counter-cyclical assets. No external debt, very low total debt to GDP, so under 30%, reserves to GDP of about 60%, and a general entrepreneurial culture, but basically was uninvestable because of the previous government that had certain capital controls.
And then what happened was that previous president died two and a half years ago, was replaced by his prime minister, and the general consensus was, well, it would be a continuation of what was there before. Unbeknownst to everyone, he starts on a reform rampage. And that’s what? He basically gets rid of all the old ministers, replaces them with young, Western-educated technocrats, continues to privatise nearly all state assets, cuts the corporate tax rate by half. Ironically, year-on-year, tax revenues go up 70%, so it shows you the size of the black economy. You have 70%, 80% smartphone internet penetration. And it’s a country which no investor has been looking at seriously.
So for us, it’s kind of the perfect sweet spot. We know the region. We know the country quite well. It’s kind of prime time to invest there now. They’re really going out to their way to attract foreign investment. And in our area of focus, which is technology, we basically have none of the standard business models that me and you are used to, let’s say in the UK or U.S. being developed there yet. But yet you have very good entrepreneurs that just need capital to be able to develop these businesses. And that’s where we come in.
Meb: There’s a lot of misunderstanding when I talk to investors consistently about looking to emerging frontier markets, even developed markets. There’s amazing entrepreneurs everywhere. And you think about people, particularly, we have a friend Tyrone Ross, who uses the phrase, “They have a PhD. Being poor hungry and driven, the incentives to be an entrepreneur are all around the world.” So, walk me through how it actually works. What kind of companies are you looking for when you say, like, put it in U.S. dollar terms, market cap sort of targets, you mentioned broad sector themes? But just give us kind of the whole overview of how do you guys go about it.
Kiyan: Effectively, our area of focus for us is between seed and let’s say series B. Often, for the whole financing of the company, we’re the only investor up until series B, because really there is no one else to plug that gap for capital for the company to develop to the point that it can start accepting more, let’s say, sophisticated investors.
But the business models that we like are effectively e-commerce, enterprise software, so SaaS, but focused on small to mid-sized businesses, and the hybrid between software and commerce. An example that I can give of a company in Uzbekistan that we’re investing in is exactly the hybrid between software and e-commerce but for the pharmaceutical market.
So if you take the structure of the pharmaceutical market in the country, they basically produce zero medicine or drugs themselves. Everything is imported through 200 distributors. And so this company was founded by someone that was in the pharmaceutical business about 20 years. His granddad was the Minister of Health back in the day, knows the industry inside out, and then came up with a basic inventory management software for the distributors. And in one year, sold it to 95% of them.
The next leg of the value chain is obviously the pharmacies. Again, came up with the basic inventory management software for pharmacies. In 6 months, sold it to 50% of them. And then added two other modules to that software for procurement. So if you’re a pharmacy, typically, you would have two to three people calling up the distributors for the different medicines or drugs that you need. Given you have the data on both sides, you can automatically match it. Just that part of the value chain, you have a nice enterprise SaaS-type business, high margin, high recurring revenue.
And the next leg of the value chain is the consumer. So the consumer typically would have to go around different pharmacies, whatever it is. But here because you have all the data from the value chain, you have already a million users on the application, where they can see which drug is cheapest to buy from which pharmacy, they can have subscription packages, and all of that sort of stuff.
The business is already, in a capital-like way, captured the whole pharmaceutical value chain. And it just so happens the value of transactions across that value chain is about $7.2 billion a year. Now we’re investing in this company, which is already operation cash flow breakeven at a pre-money valuation of $10 million. That dynamic, you wouldn’t be able to find in any other country.
And so what we really try and do once we’ve made an investment is really help the management to scale up, but also bring in best standards so that one day when they want to raise more capital or they want to exit, everything from the infrastructure perspective, from the governance perspective is done to international best standards to make it as easy as possible to exit.
Meb: It seems one of the benefits of the last 10 years of both VC and Angel sort of becoming much more commonplace, and as you mentioned, things like the success of a startup in Nigeria, is it then populates an entire future of entrepreneurs, but also the standardisation of contracts.
Twenty years ago, if you try to go raise money or invest in a private company, and you’re not working at a traditional VC firm, I mean, all the terms are negotiated. It’s just a big mess. But now that you’ve had tech stars and many of these others kind of post-YCombinator, these standardised contracts, at least you have a world where it’s not like a used car dealership anymore. I mean, I’m sure it still is in places.
Kiyan: It’s more plug-and-play approach when it comes to that sort of aspect of it.
Meb: How do you guys source deals? It seems to me many emerging frontier countries, because there’s not a history and foundation of entrepreneurship in the traditional sense that there is in Silicon Valley or London, how do you find the deals? Walk us through the whole process.
Kiyan: One prerequisite before we operate in any country is, for us, before we launch a fund, is to have a local team in place. And the idea behind that local team is that they’re individuals that arguably have the most track record of investing in private capital in that country.
And so as an example, in Uzbekistan, we hired basically the founder and CEO of the previous sovereign funder, so has the most track record in deploying private capital. And given we’ve been in the region for quite a while, I would hope to think that our kind of name is synonymous for anyone that’s looking for capital within the technology space. And so we have an on-the-ground effort for deal flow, but also we regularly get inbound requests or opportunities presented to us as well.
So from that perspective, it’s super interesting to see the spectrum of opportunities that come up just to understand the mentality of what entrepreneurs think are the opportunities set in their own country. But that’s the basic way we get our deal flow. And then the way we think about it is, what typically happens especially in frontier and emerging markets, is a lot of these companies don’t have the necessary infrastructure or data rooms for you as an investor to make an appropriate appraisal as to whether to invest or not. That’s almost become commoditised because of regulation in a more developed world but hasn’t been in frontier. So if you have an edge in gathering information, it really is a kind of competitive edge.
And then what we do there, which is easier with technology companies, is we ask ourselves, What are the most important variables driving the success of a business? Look for data points that match those variables. And then we insist on the company having the data infrastructure in place even before we invest so that we can monitor what is happening on a neutral basis with that business, and then let that drive our discussion on narrative with management as opposed to being charmed by management or the entrepreneurs without having any informational dates to work from them.
Meb: So what does the actual portfolio end up looking like? You mentioned two of the names that you kind of invested in. Are those companies traditionally almost always focused just within their borders or the region? Have you actually seen any companies develop that are actually global in nature or more than just regional? And then how does it work?
Kiyan: So the portfolio is structured such that the large position would be the one that we have let’s say the highest conviction about, that has a proven track record, has the largest TAMs or total addressable market in our mind, and effectively one that we believe will be relatively easier to exit.
And so our largest investment at the moment is a business called Zoodmall, which is today the largest cross-border e-commerce business in Central Asia. And that operates now in five countries and now has even expanded to the Middle East. It’s an interesting question to say, “Well, why should this business exist when you have the likes of Alibaba in the world?”
What’s interesting is if you look at these countries on an individual basis, they’re too small for the likes of Alibaba and too difficult from a localisation perspective to integrate for them to even make a meaningful effort. So they just haven’t done it. It’s kind of fair game for anyone to try and build an e-commerce business.
But what’s really important is that localisation. And you need to solve effectively for three main things. The first is logistics. So if you wanna get goods from let’s say China or Turkey to any of these countries, you need to have a logistical solution. And so there are the companies solved for basically being the first provider of last-mile delivery every single country of operation.
The second is payment solution. So if you take a country like Uzbekistan, less than 10% of the people have Visa or MasterCard, so they can’t make international payments. And there they’ve integrated local payments on international ones. They’ve added cash on delivery, which is a very important functionality, and so made it as easy as possible for people to pay for products.
And then with that base-level infrastructure, they approach the likes of jd.com and have a large e-commerce place to bring a product catalogue. Today, it has four million products that people can buy or sell and effectively went live in November 2018. And at the time, if you spoke to investors that were looking at the company, they’re like, “Jesus, this is the kind of really operationally complex business,” but it was necessary to be operationally complex for it to actually be able to operate in multiple countries.
In every country today, it operates, and it’s the most downloaded application, it has over 5 million downloads. It’s been growing GMV, that is Gross Merchandise Value at about 36% a month, which has just been accelerated with COVID. So back in March, before COVID, the company had an annualised GMV run rate of about $3 million. That today is $50 million. Why? Because not only have they added the cross border, but during the pandemic, you had a bunch of the local offline retailers that just had no way of selling their products. Quickly, they’ve basically brought their product catalogues online, made it as easy as possible for them to also sell, and in our view, it’s on its way to becoming a really sizable business.
The beauty of this business model, and what you see in developing countries, is the business models that I think we like the best are the ones that can capture a large customer base that is quite sticky. That is, they haven’t so many touchpoints for the business that you can add further services onto that to monetise further.
And to give you an example, now that we have a certain user base, let’s say roughly a million users that are actively using the application, we can now add consumer loans because we have the data on those underlying consumers. If you look at Ant Financial, which is kind of a recent IPO out of China, that beast of a finance business really was born out of Alibaba as an e-commerce company. Why? Because they had a captive customer base that from a customer-acquisition-cost perspective was extremely cheap to then start selling other services to. That’s when you then see the development of super apps, off of that concept of selling one service. Once you’ve captured the customer base and then start selling other services to them as well.
Meb: Your portfolio, I imagine you guys as a traditional private equity investor. How many names you guys looking to allocate to, and what’s the period?
Kiyan: We typically don’t invest in more than 10 companies in a fund. Our period for investment is a maximum of seven years. And our return target is…the way we think about it is quite formulaic. So we look at any point in time, what is the upper quartile of developed market returns in private? And then, obviously, given we’re investing in frontier, we believe we should be generating a premium today. And so if you take the upper quartile over the past 10 years of developed markets period returns, it’s been about 29%.
We take the GMO forecast of frontier, add 10% to them. And so our target IRR is 40%, which is effectively 5x on capital in 5 years. Obviously, it’s quite ambitious. But in our mind, if we cannot achieve that, then there’s simply no reason for us to exist as a fund.
Meb: That’s an honest assessment. So you have the tailwinds of a friendly government. I was reading that the public market is still pretty small there, like $5 billion, $10 billion, is that ballpark correct? And small relative to GDP. So there’s kind of two parts to that. There’s, it’s small on absolute level, but really, as a percentage to GDP, it’s way smaller than it could be.
Many countries around the world, just for listener sort of knowledge reference, the U.S. often ends up 200% of GDP. Many countries are 50% of GDP, the market cap of the stock markets. So if you have one that, say, at 5% or 10%, that public market could easily 10x from there in terms of size and capacity. And it seems like, from what I’ve read, the government is pretty intent on developing that as well.
So if you think that, typically in these countries, the capital formation has been through debt and that equity is a new concept to them, specifically for capital markets. When developing a capital market, you have the chicken-and-the-egg situation in the sense that you want the incentives for private companies to want to be able to IPO, but at the same time, you need the local capital to be able to match it.
And what typically has happened is that the real quality companies always IPO abroad. And so it’s actually very difficult. I can think of one example, actually. We’ve yet to see a frontier country that has really developed a deep ecosystem of capital markets. The one exception, ironically, is Iran. Why? Because you’ve had sanctions on the country for so long that they’ve really had to develop a stock market. There you have a stock market of about $250 billion, $200 million daily average trading volume. But non-sanctioned, normal frontier countries, they actually have a very difficult time in developing their capital market for the reasons I said.
Meb: You mentioned a seven-year period. What happens at the end of seven years? Traditionally, most VC firms, it’s IPO, it’s acquisition. They just monetise their position or sell it. What’s the traditional path for you guys? Is it similar, or is it different?
Kiyan: It’s mostly strategic acquisition. So the benefit of this region, you have quite successful large Russian technology players, which obviously this is a natural area for them to operate and compete in. At the same time, you have China, which has the One Belt One Road initiative, which for your listeners which aren’t aware of it, effectively, think of it as the Marshall Plan on steroids.
It’s like a $1 trillion investment program to offload excess capacity from China and to be able to invest excess capacity outside of China. And this region falls centre of that. And you have the very large kind of Chinese tech players which are also looking to expand, and they’ve been serial acquirers. And so, typically, that’s the route that we go down. If the company is large enough, then we would look at a foreign IPO, but, typically, it’s a strategic acquisition.
Meb: I feel like most investors are gonna probably have to take to Google Maps as we’re talking about some of these discussions. What is sort of the investor appetite? You mentioned we go through these cycles. Everyone, all they want to talk about in the U.S. now is probably tech, Amazon, Apple, Tesla, what’s going on with markets. You have this dual challenge of negative interest rates. What’s sort of the appetite for frontier markets currently that you’re having conversations? Are people interested? Are they cautious, wait and see?
I know last time I was in London, at some of the pubs, chatting with all my local friends, no one had any idea what’s going on with Brexit, still seems to be the case. But what’s the appetite for people being invested in some of the frontier categories?
Kiyan: If you look at the flows of liquidity, if we focus on the public side of things, you basically had a significant withdrawal of liquidity from international investors from frontier. And that goes back to that concept where I theoretically believe it’s just very difficult to make money on the public markets.
On the private side, you’ve had niche players which have looked at more traditional assets in frontier as we’ve discussed. There isn’t a player, let’s say, similar to us that is focused on technology within frontier. And so what we often find is that we’re going through an education process, and that either people have a perception which is somewhat distant from reality as it relates to a bunch of different aspects of these countries, or they simply have no perception at all.
And so it’s really an education process, and defining what the opportunity set is, why that opportunity set can meaningfully in a realistic manner generate returns. And then if you have that time or space to make that argument, normally, you get positive feedback. But given the pain that investors have experienced in frontier, there’s still a big hurdle you have to jump to get investors on board with the concept relative to obviously let’s say U.S. tech and everything else that’s going on in the world.
Meb: I say this with a smile on my face, and only half-serious, but actually half-joking, this new Borat movie out, does that actually drive any interest in the region? I mean, I saw Kazakhstan had, like, a tourism promotion where they said, “Kazakhstan, very nice.” Does that actually, I mean, in a weird way, generate some interest in this category?
Kiyan: Probably not the interest that you want to have. Kind of as a side discussion, why Kazakhstan was chosen as the country. It’s esoteric enough. People don’t really have enough knowledge about it that you can pick it to make fun out of, which goes back to that point that I was saying is this kind of this either a lack of perception or no perception of the countries and you have to go for the education process.
The point to come back to is that there are people that are alive in these countries. They’re extremely smart. I mean, you have the hangover of Soviet-level education, so that they’re trained in the hard sciences, which is the best education you want. They’re naturally entrepreneurial because you’ve never had a formal job market. There is GDP being generated, and yet these great business models aren’t built there yet. So someone has to come in and plug that gap. And now you’re seeing a company that I said, Kaspi, with their IPO last week, really showing that investors can make money and can capitalise on opportunities within these countries.
Meb: Let’s go beyond Uzbekistan’s borders. What other frontiers do you think are interesting? Are there ones that you’re like, “Oh my God, absolutely stay away from?” Are you guys investing in any outside Uzbekistan right now? What are some of the other opportunities out there?
Kiyan: The lens that we see more through is business models. So we’re looking at countries that, let’s say, they don’t have an e-commerce leader, they don’t have an enterprise software leader. I mean, Kazakhstan is a neighbour, so that’s a country we’re looking at. Ukraine is extremely interesting because they have a depth of talent pool, specifically within technology and development. Mongolia is a smaller country. Russia as well is yet to see really a lot of the business models that we’ve come accustomed to being developed. And so I think there’s plenty to go around.
I mean, if you take China as an example over the past 20 years, they shifted basically from the copycat economy to becoming arguably the tech leader in the world. Now, that was done in a very large population, so you’re seeing these really significant large businesses being developed. But that’s really a case study of what happens when you focus on technology and focus on building innovative business models of capable people and what the outcome of that is. Arguably, Africa has yet to see that and certain countries of Southeast Asia. And so if you see it for the lens of business models, it’s more interesting and is more insightful I think than if you go on a country level.
Meb: What’s the status in sort of the region of incubators, accelerators? I know Techstars has done a lot to sort of take it international. But being an entrepreneur is such a cultural challenging venture. It attracts a certain crazy person. We can all relate of the agony and ecstasy of being someone who worked at a startup or started one. Is that something that’s developing? Is it mostly infancy, or is it actually, like, starting to take hold in many of these countries?
Kiyan: No, actually, surprisingly, they’re really taking hold. So in all the countries that we’ve discussed so far, you have government-backed, let’s say, call them IT parks, where, effectively, as a startup, you can pay no taxes, you have an office, you have some basic funding to start your business. And then you have people that are trying to match you with international advisors or investors. And it goes back to that point that it’s a win-win, and the government really tries to promote, again, because you get youth employment, you bring efficiency to the whole economy, and you allow for the broader population to get access to services which they otherwise wouldn’t. And so what we also do is two separate things. For each business vertical, we have an advisor which is a very experienced entrepreneur in that particular domain to match with the businesses that we invest in to effectively act as a neutral feedback board to get advice.
The second thing is to actually have a funnel of talented people to go and work in these startups. So what we do is we partner with the leading universities where they give us profiles of talented students that don’t have the financial means to pay for their education. We give them a scholarship. Their internships are within the portfolio companies we invest in. And when they finish their university, they then join the portfolio companies. And that gives us a great funnel of talents within these countries to be able to put into the companies that we’re investing in as well. Surprisingly, there is a very good ecosystem developing around startups and venture.
Meb: You made a reference to Iran earlier. What’s the status of that market? I have a hard time trying to distinguish between just general news flow in the media and what’s kind of actually going on as from an investor standpoint. Is that a land of opportunity? Is it a minefield? Is it somewhere in the middle?
Kiyan: I’d say it’s a land of opportunity, and I’ll give you two numbers, which probably you won’t believe. 2019 and 2018 was the best stock market in the world, up over 100% year on year. And if you look at it from 1998 till now, the stock market has compounded in dollar terms of 16% a year. Now, why? Because you basically have, for an extended period of time, sanctions on the country. You’ve had extreme currency volatility. But if you look at the composition of the stock market, effectively, 60% of the companies are exporters, right? So they have dollar revenues, local currency costs.
When you have inflation, the stock market is the best liquid hedge for both institutional retail investors in the country. You have average P/S of about 4 dividend yields above 10%. Just an abundance of opportunity in the private space. But, obviously, given the situation, it’s very difficult to access at the moment, but we can see how that may change.
Meb: The geopolitical legal side is always, I think, a concern, often unfounded, but sometimes it becomes a very real issue. I know Argentina put some capital controls on. And then, like, you have investors, like, their biggest nightmare is money just getting stuck. So, like, “I can’t access it.” Any other opportunities you’re seeing in countries? We’ve touched on a lot so far. Anything else that you think is particularly interesting? And what has this year been like? How does this affect a lot of the companies, countries that you’ve been looking into?
Kiyan: I mean, touching on the last question first, I mean, serendipitously, I think around the world you’ve seen this development of things moving from offline to online. That’s just been accelerated probably by five years. And not that we had any foresight that there would be a pandemic and that this would be a result, but we’re really seeing that in the companies that we’re investing in.
So if you consider that for a lot of the population, these countries, they’re not used to the online services. The question that we always have is how much has to be spent in marketing dollars to convert those customers? What effectively COVID has done is accelerated that shift from consumers moving from offline to online, which is a great base-level shift upwards for the types of businesses that we’re investing in.
And for us, the most interesting opportunity is the amazing way that the addressable market of the businesses that we’re investing in expands. So I can give you another example. If you take Uzbekistan, 60% of GDP is SMEs, so small to mid-sized businesses. And if you look at all their back-end infrastructure for account management, inventory management, it’s typically either paper or Excel. And so here we’re investing in a business called Bills, which basically provides basic inventory software and account management software to these companies, which, again, has a 40% to 50% operating margin business, high-recurring revenue. We were happy as an investment thesis with that.
But then what has happened is interesting. Through the provision of that software, you’re collecting all the data on the inventory management cycle, cash cycle of all these underlying businesses, and the businesses managed to add on another service. Now, what is that service? It’s matching with the banking system to provide working capital loans to the merchants. It’s matching with the merchants to providing consumer loans to their customers. But also working with them to put all their offline products onto online commerce as well.
So, effectively, the revenue that the businesses will generate from the non-core services that we originally invested in will be much more than a software business. And what we see, which is extremely interesting in all these businesses is just, by capturing a core customer base, again, going to a concept that is just sticky, the ability to add on more and more services to generate revenue is always increasing as time goes by.
And I don’t think you have a similar dynamic in developed markets. So, for example, if I was Amazon, Amazon today could probably have the biggest consumer lending business in the U.S. But from a regulatory perspective, it will never be allowed. But we don’t face those difficulties in developing markets in the absence of competitors to even consider competition or regulatory dynamics in the same way that you have in the U.S.
Meb: I was smiling as you were talking because I was thinking ahead as we tend to do. My favourite thing as a public market guy is reserve tickers. And so, I was like, “All right, do we have STAN available? What are the tickers we can have for the first Uzbekistan or a former Soviet ETF?” But I said that’s the sign that a theme had its run is when you finally get a U.S.-based run in or STAN ETF, you’ll know that the markets have developed.
But, honestly, I don’t know how that doesn’t play out over a decade or two. I mean, many of these stories, thematic in nature, are a lifetime story. This isn’t a 2020 story. This is really a story of 10, 20 years.
Kiyan: Yeah, it’s a kind of secular trend that will take shape over the next 5 to 10 years.
Meb: I imagine you guys have a lot of stories over the years having been out this for a while. Anything that’s come that’s sort of the more memorable experiences from been doing boots-on-the-ground security analysis in these countries for a while?
Kiyan: One interesting case was the pharmaceutical company that we were looking at. And this was actually a private equity approach but executed for the public markets. This was a company in Kazakhstan, which was an extremely illiquid stock that no one was really looking at. What they produce is effectively the equipment that a hospital needs to be able to function, was tightly held by the family, and, again, when you spoke to the brokers, they’re like, “Just don’t look at this company. There’s no way to buy it.”
And so, silly old me, I bought one or two stocks, went to the AGM, which was in the middle of nowhere, surrounded by a boardroom. Everyone is sitting in lab coats. And I was trying to be semi-civilised and sensible and wear a suit. There’s a picture of it still somewhere. And this was a business that was running 40% operating margins consistently, free cash flow, always in excess of net income. I was growing top line at about 20%.
And then what that perspired effectively to be a five-hour conversation with the management, where you know when you kind of tap down some business strategy and all that, so we kind of made a very good connection. Convinced the part of the family to sell us some shares and worked with them to actively increase free float, actively communicate with the market, and ultimately the stock did quite well.
So that’s an interesting case of when not only foreign investors aren’t looking at it, but the local investors aren’t looking at it. And that by really being on the ground and doing the work, it’s beneficial.
Meb: You talk about this concept, which I think is interesting, which is in many cases of businesses around the world, state-owned businesses, but you also have the sort of family businesses, where they are just printing money, they have amazing cash flow. Credit Suisse actually has, our listeners, we’ll add it to the show note links, an index and report they update yearly that’s about sort of this concept of family-owned businesses.
And it’s not surprising they do well because who do you entrust more with your money than it being your own money as opposed to a somewhat detached board of directors or maybe CEO, that short term isn’t aligned with a family that may be generational. That’s an interesting concept. You know, it’s under this like umbrella of insiders and everything else. What’s the capacity? Do you start to bump your head against the ceiling if you get to a certain size? Is it $100 million, billion?
Kiyan: So before we launch a fund, we spend about a year just looking at opportunities, just looking at deal flow, to the point where we do the research, we’ve done the diligence, and we even have term sheets signed before the fund is launched. To know exactly what the opportunity said is in front of us, the benchmark of returns for those opportunities is the 5x on capital that I kind of mentioned earlier in a sense that if we think an opportunity can’t meet that, we simply pass. If we think it can meet that, then the whole work goes into building conviction about it.
The benefit of operating like that is, when it comes to fund launch, you know exactly what your fund size should be. And once the fund is launched, you can allocate very quickly. So, for example, in June, we launched the fund, and within three months we’d already had invested in five companies. Our capacity for our funds are extremely limited for the very reason that if we were to raise half a billion fund, we would have a difficult time deploying it.
So, for example, the fund we raised dedicated to Uzbekistan, that’s a $40-million fund. And it’s the reason why the opportunity exists for us. We’re an investment team of six people. On $40 million, the management fees don’t really push the needle, but if we meet our return target from a carrier perspective amongst five people, that’s quite meaningful.
But if I’m a large firm, if I’m a plus-billion-dollar asset manager, again, it doesn’t make sense for me to go and do a fund of that size, which is why, for us, it’s a sweet spot of raising limited capacity funds on a specific target set of opportunities where we have conviction about the types of businesses we’re investing and having conviction about the returns that we think we can generate.
Meb: What tends to be this sort of involvement with local government? I imagine many of these countries, particularly the ones like Uzbekistan, that are receptive to developing entrepreneurship and capital markets, is it ever the situation where the governments are helpful, meaning they’re like, “Hey, look, we’ll introduce you deal flow. There’s maybe some tax or incentive programs that they’re promoting.” I mean, I imagine there’s a lot.
Kiyan: Both governments have effectively, as I said, government-backed tech parks, which are a natural source of deal flow. They also have their own, if you take Kazakhstan, a government-backed fund of funds, which is there to seed international investment managers to invest in their country, which, again, you don’t have in a lot of countries. But it is a great initiative to promote investment in these countries.
And in Uzbekistan, we’re actively in discussion with the government for them effectively to be as a co-investor with us. Again, going back to that concept that you’re increasing employment and bringing a bunch of benefits to the economy, for them, it makes a lot of sense to do so. Particularly, they don’t have the domain expertise themselves within government to understand how to invest and develop these businesses. And so they very much like to work alongside firms like ourselves in developing that ecosystem and developing that investment basis for the companies in the country.
Meb: What’s your traditional investor? Is it a family office? Is it pension funds?
Kiyan: Family office, high net worth. I mean, we’re pretty big investors in all the funds that we manage ourselves. To an extent, development banks as well. So development banks usually have a mandate to invest in these sort of countries. They’re active direct investors themselves, but also they allocate the funds as well.
Meb: If you look out, so it’s 2020 winding down, been a weird year, but the decade is just starting, as you look out to the horizon for Sturgeon, what are you guys brainstorming about? What are you excited about as far as what y’all plan on doing in the future? Is it exploring into new regions as opportunities present themselves? Is it growing certain other new ideas? What’s on the brain?
Kiyan: The way I see it is, in a lot of the countries that we invest in, you have this interesting dynamic. So if I was to ask you, “How many tech entrepreneurs are there in the U.S. which shape the future of that country?” It’s probably in the hundreds, maybe thousands. Thousands are probably extending. If I look at a country like Uzbekistan, it’s probably a dozen, a dozen which we know very well, and together with the government, we have a blank canvas to potentially create what the technology ecosystem of that country will look like over the next 5 to 10 years.
The intellectual challenge of that, and getting to that stage, which we think is beneficial from an investment perspective, from a returns perspective, from a societal perspective, is extremely interesting. Thinking through which business models are the best business models to not only generate returns but also to target and influence the largest part of the population is very interesting.
What we’re really focused on are what are the business models that are the best way in a profitable manner to capture as large a population in these countries as possible. And that constant challenge and the way that develops, given the businesses within the country are developing as well, is what I find fascinating. And I think it’s a never-ending game.
Meb: I mean, I imagine there’s just so much low-hanging fruit. I was thinking about the European conglomerate that just, like, copies all the internet ideas. German guys, I think. Thinking about that applied to so many frontier markets, I imagine. Is that an accurate sort of assessment that there is a fair amount of low-hanging fruit in local regions?
Kiyan: Think of it for this framework. You have the blueprint for successful business models. They’ve been developed in the U.S. and developed in emerging countries even. You’ve seen what has worked, what hasn’t. Ultimately, the question you ask yourself is, why wouldn’t this business model work in this particular country? If the answer is that it will work, the question is, well, how do you do it in a localised manner to be effective?
So it’s that intellectual exercise that you constantly have to ask yourself. Because, again, you have a young population. They have the necessary digital infrastructure for these companies to be built. The capital is there for our firms. So how do you go about building it? And that’s the game of what we’re involved in over the next 5 to 10 years, which I personally find fascinating.
Meb: What’s been your most memorable investment over the years? Anything come to mind?
Kiyan: Our largest investment at the moment, going back to that e-commerce company called Zoodmall. Back in late 2015, I got a random LinkedIn message from a guy called Michael telling me about this business idea that he had. We ended up randomly meeting in a conference in Switzerland, became very close friends. We became the first outside investors in that company.
And what I serendipitously came across was, in my eyes, one of the best entrepreneurs I’ve met in my life, I’ve learned a hell of a lot just by being close to him, by seeing the development of the business. I think we’re on our way from seeing that business basically be $0 to probably over $1-billion business over the next 5 years. And that experience and that process of seeing it from ground zero to where it will be for me is fascinating, and I enjoy it every day.
Meb: There’s a lesson in there, listeners, is to check your LinkedIn messages. Once a week I log in, read 10 spam messages, delete them, log back off. I’m not sure what to do with LinkedIn, but if you’re telling me I can find a billion-dollar investment opportunity, you may have just changed my mind.
Kiyan: It should be an advert for LinkedIn, actually.
Meb: LinkedIn, are you listening? You can sponsor the show. Kiyan, if people wanna find out about you guys, what you’re up to… What’s the minimum subscription size, by the way, if somebody wants to send you some money?
Kiyan: For individuals, $100,000. For institutions, it’s $1 million, which is a legal requirement, unfortunately. And the easiest way to reach out to us is simply by email. I feel like we have a responsibility to communicate what is going on in this part of the world, which not a lot of people are aware of. And always more than happy to speak to people that are interested in what we do.
Meb: Do you guys publish any sort of…Is it only client-focused notes? Do you do any sort of research that people can read?
Kiyan: Yeah. We do two things. So every month, we have a business model that we as a team do a deep dive on. And then, normally, the results of that deep dive we started to now publish. And we have four pieces. For example, last week, you had this IPO of Kaspi, we’ve written a whole piece around that, which we add to our distribution list, and people can just email us to request access to it.
Meb: Awesome. I’d love to check some of those out. Kiyan, it’s been a blast. Thanks so much for joining us today.
Kiyan: Thank you very much.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us firstname.lastname@example.org. We love to read the reviews. Please review us on iTunes and subscribe the show anywhere good podcasts are found. My current favourite is Breaker. Thanks for listening, friends, and good investing.