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Leopard Capital founder and CEO Douglas Clayton’s latest investment commentary and newsletter opines on what the future holds for foreign direct investment into Cambodia:

“There are some hopeful signs for future FDI, mainly from Asia.  New foreign business registrations surged 42% in 1H10, led by investors from China, Vietnam and Korea.  Vietnam officials said their businesses intend to invest $1.3 billion in Cambodia over the next two years in seven industries, including oil, power, mining, and rubber.  China’s cumulative investments in Cambodia have now reportedly reached $8 billion, making it by far the largest investor.  China has been the dominant infrastructure banker and contractor here, like in most frontier economies, and recent news suggests no change to that policy.  China has just agreed to finance and construct the $26 million first phase of Phnom Penh’s second river port, which will triple the port’s capacity.  China’s Ex-Im Bank will also finance Huadian Power’s US$412mn, 338-MW hydropower project in Koh Kong province, which when completed in 2014 will nearly double Cambodia’s current generation capacity.”

Per this latter point, electricty prices in Cambodia (the average price of electricity in Cambodia is approximately $0.16 per kilowatt/hour and as high as $0.90 per kilowatt-hour in remote rural areas) remain the highest in the ASEAN region.  Moreover, the Koh Kong project is one of fourteen similar plans associated with the government’s efforts (all being developed by Chinese firms) to triple the country’s energy output from around 808 megawatts in 2009 to nearly 4,000 megawatts by 2020 (equal to estimated consumption) and supply 70 percent of the population with electricity.  That said, however, because hydropower can only be used at full capacity for the duration of Cambodia’s rainy season, and can only be run at one-third capacity the remainder of the year, private funds are also being channeled to the development of coal-fired power plants (per analysts, Cambodia features extensive hydropower resources and poentially large coal and natural gas deposits which have yet to be fully developed). 

A relatively mature energy industry is a fundamental catalyst to ensuring an ensuing flow of foreign capital and investment, not to mention its role in helping the government provide services to rural communities.  According to the ‘Energy Outlook for Asia and the Pacific’ report released in November 2009 by the Asian Development Bank (ADB) and Asia-Pacific Economic Cooperation (APEC), Cambodia’s primary energy demand – driven primarily by the increasing demand for electricity – is expected to grow at 3.7 per cent per year from 2005 to 2030, outpacing the regional average of 2.4 per cent.  In March, the government noted that Cambodia had spent $59m USD on electricity imports from Thailand and Vietnam in 2009.  By 2017, however, it says it hopes to be a net-exporter.


Linked herein an interesting McKinsey video from the 2010 Fortune Global Forum in Cape Town, South Africa where McKinsey Publishing’s Rik Kirkland spoke with Absa’s Maria Ramos, Coca-Cola’s Bill Egbe, and McKinsey’s Norbert Dörr about the sustainability of African growth and its related, underpinning fundamentals.  One primary founding factor supporting output remains the African consumer; 80 million households earn at least the equivalent of $5,000 annually, the point where discretionary spending commences—an increase of 60 percent in eight years and trending towards an eventual target of 125 million.  Moreover, continued urbanization will see an increase from 40 to 50 percent of Africans living in big cities by 2030. 

Ramos, for one, pointed out the poential depth of the continent’s untapped potenial:

“There are 20 companies in Africa with revenues of over $3 billion.  For the size of our continent, we need many more companies with revenues of $3 billion or more. Additionally, there are millions more small- and medium-sized entrepreneurs. They, too, need access to finance. Now, if we are able to do that and to open up those markets, you unlock economic value and entrepreneurship.  And Africa is a place of entrepreneurship.”

These points fit in nicely with some of those made by Manoj Kohli, head of Bharti Airtel Ltd’s international operations, in a recent intervuew.  Looking forward, he said, the African population will double to two billion people whereas India will go up to 1.6 billion and China, up to 1.4 billion.  Moreover, “[Africa] has consumer spending of $1.4 trillion, which is far higher than India’s; a middle class of half a billion. T he median age is 17-18 (which is much lower than the Indian median age of around 24-25); and 25% of global youth will be in Africa.

The following is a piece I wrote last summer in response to a question about what global issue I felt “deserved greater attention.”  This correlates perfectly with frontier markets and moreover frontier or emerging market investing, given the issue’s inherent demographic angle (i.e. continued growth, and changes to a more meat-based diet as per capita incomes invariably rise).  Diary of a Mad Hedge Fund Trader reminded me just how pressing this problem is when he trotted out the following several weeks back:

“One theory about the endless wars in the Middle East since 1918 is that they have really been over water rights.  Although Earth is often referred to as the water planet, only 2.5% is fresh, and three quarters of that is locked up in ice at the North and South poles.  In places like China, with a quarter of the world’s population, up to 90% of the fresh water is already polluted, some irretrievably so.  Some 18% of the world population lacks access to potable water, and demand is expected to rise by 40% in the next 20 years.  Aquifers in the U.S., which took nature millennia to create, are approaching exhaustion.  While membrane osmosis technologies exist to convert sea water into fresh, they use ten times more energy than current treatment processes, a real problem if you don’t have any, and will easily double the end cost to consumers. While it may take 16 pounds of grain to produce a pound of beef, it takes a staggering 2,416 gallons of water to do the same.  The UN says that $11 billion a year is needed for water infrastructure investment, and $15 billion of  last year’s  U.S. stimulus package was similarly spent.”

Herewith the piece, which I hope to use as a springboard for a more thorough and bona fide investment thesis going forward:

Global population growth, pollution and climate change are combining with technological advances in medicine, increased migration and concentration of population clusters, and growing demand and changing dietary habits from the world’s emerging middle-classes, to exert unsustainable pressures on scarce resources such as fossil energy, agricultural land, fresh water and even fish.  In particular, the dearth of clean water should garner more concern.  A few years ago, the International Water Management Institute (IWMI) demonstrated that many countries are facing severe water scarcity, either as a result of a lack of available freshwater, or as a consequence of a lack of investment in infrastructure such as dams and reservoirs.  Making matters worse, this scarcity predominantly affects developing countries where the majority of the planet’s 840 million undernourished people live.  “Water is the oil of the 21st century,” declared Andrew Liveris, chief executive of Dow, a chemical company.  Yes and no.  While oil prices are subject to fluctuations in supply and demand, and thus prone to relatively swift and volatile swings in price, the consumption of, and demand for water continues to grow unabated.  Goldman Sachs, an investment bank, estimated that global water consumption is doubling every 20 years–an “unsustainable” rate of growth.  And The Economist observed that “water, unlike oil, has no substitute.”  However, like oil, new supplies of fresh water are harder to find.  “It’s increasingly obvious that we’re running up against limits to new [fresh water] supplies,” says Peter Gleick, president of the Pacific In­­­sti­­tute for Studies in Development, En­­vi­­­ron­­ment, and Sec­­ur­­ity. “It’s no long­­er cheap and easy to drill another well or dam another river.” 

The oil analogy also fails because unlike oil, water is never actually used up.  It only changes forms. According to NASA the world still has the same 326 quintillion gallons.  However, 97 percent of it is salty.  The remaining 3 percent of accessible, fresh-water supply is divided among industry (20 percent), agriculture (70 per­­cent), and domestic use (10 percent).  Theoretically, there should be enough water, even taking into account a global population increase of 6 to 9 billion by 2050.  However, pollution, waste and climate change have left clean water supplies approaching alarmingly low levels.  This drives up its cost.  In China the overall price of water scarcity is estimated to be 147 billion yuan ($21.4 billion) a year. And in 2007 poor water-quality cost China some $12 billion in lost industrial output alone.  Pollution especially is rampant in emerging economies where industrialization is growing but environmental concerns are often ignored.  The World Bank stated earlier this year that 90% of the rivers in China near urban areas are seriously polluted because of industrial waste dumping.  Waste takes on myriad forms across both developed and developing countries.  The Economist noted that “America’s generous subsidies for biofuel have increased the harvest of water-intensive crops that are now used for energy as well as food. And heavy subsidies for water in most parts of the world mean it is often grossly underpriced—and hence squandered.”  This is not to mention the growing “legitimate” use by industry, including firms not associated with agriculture.  Everything from chipmaking to energy production uses up water.  Anheuser-Busch operations suffered in late 2001 from a temporary drought in the Pacific Northwest, which affected not only its barley supplies, but also lowered its stores of aluminum whose production relies on cheap hydroelectric energy. Water scarcity thus affects not only core business operations, but also less obvious areas such as the supply chain.  Global climate change is more difficult to evaluate on net, though most pundits argue that its negative effects are already quite explicit.  In Kashmir, the Kolahoi glacier, which feeds a fertile Kashmir valley’s abundance in rice, wheat and corn, apple orchards and saffron fields, is melting so rapidly that some expect the glacier to be gone within a decade–an event which would threaten millions.

Solutions to address the scarcity of fresh water supplies will be multi-faceted and must involve both the public and private sectors.  They include more water storage, improved management of irrigation systems, increasing water productivity in irrigated and rain-fed farming systems, desalination, the risk-free re-use of wastewater from growing cities, the development of drought-tolerant crops, and the provision of infrastructure and facilities to get fresh food to markets.  This is not to mention actually cutting water consumption. Using less water reduces spending on water acquisition and treatment, and on the clean-up of wastewater.  Governments must begin to make significant investment in both research and development and water infrastructure development as needed.  And water buyback schemes, such as the one recently implemented by Kevin Rudd’s Labor Government in Australia to buy water entitlements from farmers in Queensland, are also necessary, no matter how unpopular they are with farm lobbies.  Furthermore, both short and long term measures must be addressed on both regional and national levels.   In many African nations there is a need for new large and medium-sized dams to deal with the critical lack of storage, as well as for the construction of small reservoirs, more sustainable use of groundwater systems including artificial groundwater recharge, and for rainwater harvesting of small-holder vegetable gardens.  Improved year-round access to water will help farmers maintain their own food security using simple supplementary irrigation techniques.  And the redesign of both the physical and institutional arrangements of some large and often dysfunctional irrigation schemes will also bring the required productivity increases.  All of these measures, opines Dr. Colin Chartres, director-general of the Sri Lanka-based International Water Management Institute (IWMI), “will require investment in knowledge, infrastructure and human capacity.”  To this extent, individual companies in the private sector are already taking strident measures.  Dow has continued to reduce the amount of water it uses per ton of output by over a third since 1995.  Nestlé slashed its consumption of water by 29% between 1997 and 2006, even while doubling the volume of food it produced. And Coca-Cola is maintaining its commitment to clean all of its wastewater at its various bottling plants by 2010, stating that it is already 84% of the way there.  The beverage firm has also initiated programs to monitor water-use efficiency in its plants, improve treatment of wastewater, and engage with stakeholders on water-related issues. According to its own environmental reports, it now  saves over 10 billion liters of water annually by improving it water-use efficiency.  However, is this enough?  Both Coca-Cola and PepsiCo have received the brunt of criticism from activists and NGOs in developing nations concerned that the companies monopolize freshwater in areas where it is scarce.   To help assuage such concerns, Coca-Cola is backing schemes like the one in Kaladera (Jaipur, India) where it is teaching villagers how to harvest rainwater and irrigate crops more efficiently.  It also speaks of a “social license”–an OK from the community to operate. 

Long-term solutions can afford to be a bit more grandiose.  Desalination, for example, is currently an expensive process that removes dissolved salts from sea and brackish water.  But economies of scale, better membranes and improved energy-recovery have helped to bring down the cost of reverse-osmosis seawater-desalination.  In Kumasi, Ghana, GE installed several water scarcity solutions to assist a local hospital.  The new equipment included reverse osmosis filtration technology, which removed impurities from the hospital’s water supply and also created an ultra-pure water source–a critical element in the hospital’s dialysis machines.  GE’s actions are hopefully the start of a trend.  Individual companies should implement strategies that not only make sense to them on a cost-basis, but also ones that utilize technologies and means already at their disposal.  They should also be mindful of working with communities, activists and NGOs alike to develop shared visions.  There are enough possible strategies listed above for a variety of industries to do just that, and given the global spread and influence of multinational firms, reaching even the most obscure and impoverished communities should not be out of the question.  Procter & Gamble is constantly reminding its product development teams that as they improve current products, or develop new-to-the-world products and services, they should think about how one could apply technologies to use less water, use water differently, or use no water at all.  Companies should also consult with organizations like the Pacific Institute, a nonpartisan environmental think tank, which regularly publishes reports identifying the main water-related issues facing business, as well as offers steps companies can take to help solve water-related issues, including measuring current water use; establishing water policies with specific goals and performance targets; improving water efficiency and conservation efforts; and engaging suppliers, community groups, and outside partners in an open dialogue.  Finally, one solution to the water problem may involve first tackling another issue: energy. “Water and energy are linked,” observed one commentator.  “Water can be used to generate electricity and energy can be used to convert contaminated water into fresh water.  Solve the energy problem and you also solve the water problem, provided a reliable source of contaminated water exists.”

Per yesterday’s Phnom Penh Post

Private equity fund manager Leopard Capital is in talks with investors to launch a $50 million Cambodia-Laos investment group by the first quarter of next year.  It will be the second Cambodia-centred fund for the firm, which manages a $34 million Kingdom-only fund it expects to have fully invested by the end of the year.  However, the new fund will have about a 30 percent tilt towards Laos and a stronger development mandate, according to Leopard’s chief investment officer, Scott Lewis.  “I think it will be more targeted than our first fund,” he said.  “It won’t change focus materially – it will still be agriculture, food products, light manufacturing, financial services, renewable energy – but we expect to have investors [such as development institutions] in the second fund that have more requirements for industries they want to avoid, such as extractive industries, mining, forestry, gaming [and] alcohol.”  The new fund would avoid real estate, unlike its first, which invested in Siem Reap residential property development Angkor Residences before the global financial crisis, he said.  

Leopard’s first fund has six investments, also including stakes in processing plant Nautisco Seafood, micro-brewery Kingdom Breweries, and indirect ownership of 1.47 percent of ACLEDA Bank, as well as outstanding loans to CamGSM and Greenside Holdings power transmission.  The development focus of its second fund might lower its returns, although targets for the new fund had not yet been established, Lewis said.  “It may be different to the first fund [which targeted 25 to 30 percent returns] given it’s going to have more emphasis on different industries where it’s difficult to achieve those returns,” he said.  “Laos is too small to have a fund by itself, but it’s a priority country for certain investors, so it makes sense to put Cambodia and Laos together – there’s a lot of parallels between the two.”  The fund will have a larger target size per investment – upwards of $5 million – than the first, which had an average goal size of $3 million, starting at $1 million.  Lewis does not expect Leopard to face the same challenges in fundraising that it did when it launched a potential $100 million fund in 2008, only to close with $34 million.  “I think we had some difficulty not only because it was a challenging time for fundraising [during the global financial crisis], but also it was a first-time fund – a lot of investors are reluctant to invest in a fund where the managers are yet to establish a track record.” 

On this latter point, the New York Times ran an interesting piece back in June detailing the fundraising travails of Leopard’s CEO, Douglas Clayton, who ultimately managed to collect roughly one-third of his desired seed capital for the initial fund from international investors, as well as referencing Peter Brimble’s Cambodia Emerald Fund, which was not so lucky and hitherto has been put on hiatus.   

But Clayton remains optimistic about the country’s return profile, especially for those willing to “blaze their own trails.”  One principal barrier facing local firms is lack of capital, for example, and the article mentions that in 2008, Cambodian bank lending was worth “about 25 percent of GDP, compared with more than 90 percent in Vietnam and Thailand.”  Moreover, many companies lack the proper “internal processes” (i.e. corporate governance, accounting and auditing standards), creating in effect a chicken-and-egg problem that hampers liquidity and growth.  Hence the enormous gap whereby private equity managers like Clayton can both theoretically realize enormous returns, or utterly flounder.

Kuwait-based NBK Capital’s recent commitment of $20 million in mezzanine financing to Metito Utilities, a water and wastewater treatment solution provider with over 50 years operating history in the water industry and a wholly owned subsidiary of Sharjah, UAE-based Metito Holdings Limited (MHL), comes less than one month after the International Finance Corporation (IFC), a member of the World Bank Group, agreed to invest $20 million in the firm in order to “support access to basic water supply and sanitation services in water-stressed regions of China and the Middle East and North Africa.”  Per Rami Ghandour, Executive Director of Metito Utilities, “This unique deal confirms the strength of Metito’s business model and supports our progress toward becoming a listed company, demonstrating the expansion of our investor base.”  MHL operates in over 22 countries and is the largest privately owned water treatment company in the region.  Its portfolio of wastewater treatment and desalination projects consists of nine concession-based projects and nine plants across the UAE, Bahrain, Egypt and China.  Meanwhile, the Middle East, which has roughly five percent of the global population, has just one percent of the world’s accessible fresh water and thus Gulf countries have hitherto relied on desalination, which provides almost 80 percent of the region’s potable water. 

While the IFC, per reports, has sought to extend reach and access while reducing scarcity in the water sector since 1993, MHL began its operations in 1958 in Beirut and now works across the Middle East with clients ranging from Saudi Basic Industries to Emaar Properties.  In the past several years it has increasingly talked about going public against the backdrop of not only rising demand for its desalination, water and wastewater treatment services, but also its own technological breakthroughs.  In July 2008, for instance, the firm announced the completion of an advanced, international-standard reverse osmosis polishing plant that it said would process 18,000 cubic metres of treated sewage effluent (TSE) every day and drastically reduce the water requirements of the UAE’s Palm Jumeirah’s cooling system.  The plant takes treated effluent and converts it into high quality, organics-free industrial water that is suitable for feeding the district cooling system and per officials would reduce district cooling water requirements by around 6.5 million cubic metres per year.

MHL realized doubled revenue and EBITDA during 2008-2009, and the future looks even brighter per some analysts, if for no other reason than burgeoning population increases across the Middle East and North Africa (MENA) region.  In particular, said its Managing Director, Fady Juez, “Libya has been closed to new projects for a long time – especially due to the Lockerbie incident.  But Tripoli is now opening up. It has huge amount of projects and Libya has one of the best beaches in the world.  So there will be a need for more projects such as in real estate.”  Moreover, “Algeria has a very large population and it is expected to build the highest number of desalination and water treatment plants in the near and medium term.  They have the money and they have the stability now.  Egypt on the other hand is stable and it has a high population as well.”  Investors keen on the firm will have to wait, however, as a public launch is not expected until sometime in 2011 at the earliest (Gulf Capital currently owns around 56 percent of shares, and the IFC/World Bank around 7 percent).  But water may indeed be a low-beta proxy on frontier population growth, and the firm’s geographical diversification into China and Indonesia as well as its expertise across the Gulf is also attractive as both a growth and a value holding.

That said, myriad hurdles remain.  Gary Becker, economist and Nobel laureate, writes:

“Africa still gets too much foreign aid that raises government spending at the expense of the private sector.  Net official aid to Africa has risen sharply since 1970 as shares of both government spending and GDP.  In 2008, such aid constituted more than 30% of government spending and 4% of African GDP.  India discovered during its first 40 years of independence that foreign aid (India used to be the world’s largest recipient of foreign aid) only slowed down the necessary adjustments toward a smaller government sector and a larger competitive private sector.  Africa needs to learn the same lesson.”

The Economist noted last week that “a shortage of premium Arabica beans from Colombia (the world’s second largest producer behind Brazil) and Central America has sent coffee prices shooting up by 25% since the beginning of this year, and traders expect wholesale coffee prices to increase further before the arrival of the new Brazilian crop later this year.”  Bloomberg reported yesterday that “persistent wet weather in Colombia may hamper a recovery from last year’s 33-year production low by depriving plants of sunlight,” according to Jorge Lozano, head of the National Association of Coffee Exporters.  Meanwhile, inventories of arabica coffee in warehouses monitored by ICE Futures U.S. have dropped to the lowest level since May 2000.  Yet Sudakshina Unnikrishnan, a commodities analyst with Barclays, maintains that the price spikes in Arabica and Robusta coffee are not linked to underlying supply and demand issues.  “There is no fundamental reason for coffee prices to have increased so much in recent weeks,” she said back in June.  “Although global inventories have come off over the last few years for the 2010-2011 marketing year we are expecting Brazilian production to be very high.”

Interesting column about Indonesia from last week’s NYT.  Aubrey Belford writes:

“Its low debt, high growth and a sense of optimism compare favorably with a mood of despondency in developed markets like the United States, Japan and Europe.  The huge consumer market in the country, accounting for more than two-thirds of G.D.P., has largely been credited for maintaining growth.  Although the global economic crisis crimped confidence, Indonesia’s relatively young population of 240 million and government stimulus policies, as well as a popular program of direct cash transfers to the poor, have kept consumption humming.”

While aiming to increase its FDI by almost three-fold in the next five years by in-part relaxing investment rules, the central bank is also engaged in a delicate balancing act of inviting capital inflows (its benchmark rate is 6.5 percent) while tempering potential outflows.  With Japan’s 0.1 percent borrowing rate looming nearby, for instance, the negative carry is the largest in the region, per Morgan Stanley.  The investment bank is in fact one of the country’s biggest cheerleaders at the moment (“Indonesia and India remain two of our long-term favourite selections,” gushed Henry H. McVey, Managing Director and Head of Global Macro and Asset Allocation for Morgan Stanley Investment Management, last month). 

To that extent, per Chetan Ahya and Sumeet Kariwala, two of the firm’s economists, Indonesia has myriad similarities with India apart from the trend in macro balance sheet changes (namely, its ratio of public debt to GDP declined to 35% in 2008, from a peak of 93% in 1999).  Like India, it has a benign trend in demographics with a falling age dependency ratio.  It also has a democratic political set-up, which implies that the role of government and state-owned enterprises would be low.  Specifically, they note:

“We are very confident in our view that Indonesia will see a trend similar to India’s in terms of the cost of capital and rise of the private corporate sector.  We do believe, however, that Indonesia has some structural deficiencies compared to India, which means that its growth will accelerate more slowly.”

While frontier assets are among the riskiest, they are still an extension of the safest.  According to the anonymous “currency specialist” in Steven Drobny’s Inside The House Of Money, “there is [thus] only one true macro trade and that’s the price of money.  Everything else is a function of the price of money. . . in actual practice, the price of money is not the Fed’s overnight rate but the interest rate that corporations use to evaluate investment opportunities.  I would argue that’s the eighteen month to two-year interest rate.”  While two-years have returned 2.1% YTD, tens have returned 7% and per John Riggs, an interest rate strategist with RBS, this flattening yield curve (the extra yield Treasury investors demand to hold 10-year notes over 2-year securities) may get even flatter in the near-term.  “With the Fed on hold, low inflation expectations and weak economic data, the front end has been anchored, which has led to the flattening,” Riggs told Bloomberg earlier today.  Last week the difference between yields on 10-year notes and TIPS, a gauge of trader expectations for consumer prices, narrowed to 184 points from the year’s high of 249 points back in January.  That said, the continuing downward trend of the TED spread, the difference between the three-month LIBOR and three-month T-bills and a proxy on the default risk of commercial lenders, indicates a continuing embrace of risk since June.  It seems one of these trends–flattening yield curve or narrowing TED–will ultimately have to give.

There’s nothing really new in today’s brief, Wall Street Journal piece on investing in frontier markets, though the point about certain funds tracking benchmarks in this field (i.e., the MSCI Frontier Index) and thus leaving investors particularly exposed to certain countries and certain sectors is worth repeating.  If you’re in a “frontier markets” fund that lives and dies basically by how Kuwait does, or how financials do, are you really as optimally invested in “frontier markets” as you could/want to be?  Silk Invest’s Food Fund, for example, is a private equity vehicle that seeks to capture the growing demands on Africa’s food processing and sales industries.  Yet this strategy is more or less absent from a Fund concentrating solely on banks or, say, telecoms.   So while retail investing in frontier markets may continue to be, in the words of Christopher Bliss, portfolio manager of the BlackRock Frontier Markets Fund, “like vermouth in a martini–just a splash is enough,” it’s worth considering that not all martinis are alike and likewise, the top-down dynamics and fundamentals underlying the slew of frontier markets are diverse as well.  Thus, it’s in this frontier sphere more than in any other sector of the investment world, I’d argue, that the range of alpha that can be generated by managers is most considerable relative to more liquid markets.  It pays to really be discerning in what kind of manager you’re investing with, what his or her vision is, and how that vision is being represented in the Fund’s holdings.  Save the index-based investing for the developed markets.


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