We Study Billionaires - The Investor’s Podcast Network - TIP306: Frontier Investing w/ Kiyan Zandiyeh (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. Hey, everyone, welcome to the Investors podcast. On today's show, we have an awesome guest that's going to talk to us about frontier investing. His name is Kian Zandiyah, and he's the chief investment officer for Sturgeon Capital. Kian has extensive experience with early stage business and pioneer investing. Throughout the show, we talk about different countries and how to assess equities inside of those countries. And then in the second half of the show, we specifically focus on the way he's investing in Uzbekistan. This is a fascinating discussion.

Starting point is 00:00:30 and I have no doubt you guys are going to really enjoy learning about this style of investing as much as I did. So with that, let's go ahead and dive in. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to The Investors Podcast. I'm your host, Dick Bruterson, and as always, I'm accompanied by my co-host, Preston Pish. Today's guest is Kian Zandiyya. Kian, welcome to our show. Thank you very much.

Starting point is 00:01:14 Pleasure with you. Today's topic is investing in frontier markets. And that is not to be confused with investing in emerging markets. Kian, perhaps you could provide an overview of the difference between the two and what it really means to be investing in frontier markets. So it's an important question, actually. and I guess to take a first step is there's no universal definition of frontier emerging or even develop for that matter. And if you take the indices as they stand and you invert the current

Starting point is 00:01:48 indexes, let's say, by the country constituents, what do you quickly find or infer is that there is no unifying theme that exists. And the difficulty of that is, let's say, for public market investors, is that for active investors on a relative basis, their performance is judged by the indexes. and passive investors are getting exposure to what would arguably not be frontier. And the issue of the indices, I think, is that the lens of which they're put together is capital market sophistication. That is, to what extent have the capital markets of these countries allow for international investors to access to?

Starting point is 00:02:20 And what that implicitly means is that you have a whole host of countries that have simply skipped or missed than investors are not getting access to. And so our focus is really on the private market where we're not beholden by these traditional definitions, and we can act as we see fit. And so what we've tried to do is create a simple definition of what we consider frontier and emerging. And the way we look at it is a frontier country is effectively one that has substantially below average levels of private sector participation, and by virtue of that has very low levels of foreign investment. And emerging are countries that we see developing in the sense that either the government or some sort of catalyst has taken place

Starting point is 00:02:59 to allow for private sector participation and foreign investment to increase. And what we like to define what we do is investing in countries that are frontier, by the definition I just provided, but are emerging in a sense that they are allowing for the private sector to play a larger role in the economy and by virtue of that foreign investors to also participate. What that effectively means is that because there has been a lack of, let's say, true private capital, which is more incentivized to capitalize on opportunities in, let's say, government capital, that opportunities can be exploited or capitalized that the rest of the world has already seen, but that these countries haven't yet experienced. And in terms of

Starting point is 00:03:39 frontier markets specifically, I think what has changed in the landscape over the past five to 10 years has been that traditionally, the only way to really express a view, especially on the private side, was to invest in, let's say traditional businesses. Let's say, a bottling factory or some sort of industrial business. And the difficulty with that is, what you're effectively doing is you're optimizing what has already been in the country rather than creating or optimizing for what is best practice or best business models. And the revenue side of that is implicitly linked with GDP. Now, what you have in these countries is that GDP is structurally higher but more volatile. And so your revenues and even from an FX perspective, there's more volatility.

Starting point is 00:04:22 And what a lot of people focus on is, let's say, cost optimization. And let's say you have a business that has 20% operating margins, but peak margins in an industry of 30%. There's not really that much room for you to optimize. And so, again, you fall back to revenue growth. And revenue growth in a scenario where you have to make large, tangible investments is difficult. But what has happened is the beauty of, let's say, development markets is because of a base-level

Starting point is 00:04:45 technological infrastructure improvement, the speed of which companies can grow has been extremely accelerated. To an extent that base level of, let's say, digital infrastructure is there as well. So you have, let's say, 70% to 80% internet penetration. You have 50% to 60% smartphone penetration. But none of these business models that we know have, let's say, positive economic dynamics, positive unity economics that are scalable, have been implemented. And so our focus really is on this area where we believe it's a secular trend that is decorrelated. It's not too linked of the economy, but you're taking advantage of all the benefits of what frontier markets typically present that haven't been previously available to investors looking at this.

Starting point is 00:05:28 So, Kian, when we hear about growth rates in frontier markets, we often hear about generous double-digit returns. However, the highest returns are often denominated in local currencies for that specific country. How do I, as an investor, assess the currency risk when I convert back into USD or euros or any other major established currency? Let's say on a macro basis, I would say country by country is different, but there are tell-tale signs of the structural dynamics of an economy that could lead to FX vulnerability. It could be current account deficit, it could be budget deficit, could be high levels of external debt.

Starting point is 00:06:06 And these are stuff that are easily available for an investor to observe and to choose whether to participate in the economy or in the markets or not. What we're trying to do is obviously stay away from those sort of economy. economies, what we like our economies that have natural current account surpluses, have very low levels of external debt. And so from a, let's say, foundational perspective, you're protected. Then there's the portfolio or investment micro basis where on a company by company basis, you can build in, let's say, implicit hedges.

Starting point is 00:06:34 So what you want to avoid are, let's say, companies where you're importing your input factor, that is, your costs are FX based, but your revenues are local currency base. that will always leave the business vulnerable to FX shocks. The flip side of that is you have companies that may export a product or a service whereby they're getting hard currency revenues, but their costs are local currency. And in a scenario where the currency weakens, your margins actually expand. What we also care a lot about is companies to have pricing power. So what you normally have is, let's say, a weakening in currency, but then inflation coming.

Starting point is 00:07:09 What we want to be able to see is that a company has demonstrative power of pricing, whatever inflation may be. So that what will happen is in the short term, yes, you'll feel a nominal pain from the currency weakening, but over the mid to long term, really that pricing power comes to fruition and provides a hedge to that currency. And on a separate basis, what we try and do when we're looking at investments is really stress tests against worse possible FX scenarios. And if we find that we're not comfortable with what the business will look like in that scenario, then we simply pass. I mean, we like to think that we want inbuilt resiliency within the business models from various different perspectives, but especially on the FX side of thing.

Starting point is 00:07:48 Frontier markets is such an interesting type of investment. And typically, people don't want to be 100% exposed into something like that, but perhaps they might take a small part of that portfolio and allocate into something that's different. Could you please talk about the correlation and risk premium between specific frontier markets and a portfolio? of global market-weighted equities? If we'd take a look at, let's say, public markets where more data is available, let's say, MSCI frontier, what you've actually found over the past 10 years is that they are pretty decarrelated. So I think you have a correlation with developed markets about 0.3.

Starting point is 00:08:25 And only 3% of individual returns in countries can be explained by other frontier markets. So you take the box from a decarrelation perspective. From a risk premium perspective, frontier markets basically failed to invest. So if we take MSCI Frontier over the past 10 years, it's annualized about 4% in dollars. What I think explains both the correlation dynamic and the risk premium dynamic in public markets has been drain of liquidity that you've seen from these markets over the past 10 years. And for us, it's a structural flaw of public market investing in frontier markets, in that you may be right on your investment thesis,

Starting point is 00:09:01 but for the validation of that investment thesis to be liquidity coming into the market, especially foreign liquidity in the absence of local sophisticated capital markets, you're basically investing with a huge variable you have no control over. So maybe you're right in five years, maybe you're right in seven years. But as an investor where your career is in it, is the funds that you manage, it's very difficult. Similarly, in private equity, I would argue that the risk premium side of things have failed as well. So if you look at realized returns over the past 10 years from frontier market private equity funds, we talk on 9.87%. Now, if we put that on the spectrum of emerging and develop, emerging mean, let's say, realize it's been around 15%. Developed markets have

Starting point is 00:09:42 been 19%, upper quarter of was 29%. So frontier from a risk premium perspective, and the private market has really been the opposite end of the spectrum that one would normally want. And again, going back to my previous answer, I really think that has been an issue of allocation as opposed to the fundamental benefits of Frontier, in that again, if you're investing in traditional businesses, it's very difficult to unlock value. If you're investing in previously owned state companies because they're nominally cheap, it's very difficult to unlock value. And the way we think about it is, well, what is a return that investors should expect from Frontier? And if we're focusing on the private side of things, if you take a look at developed market returns, as I said,

Starting point is 00:10:23 let's take the upper quartile of 29% of the past 10 years. It would be rational. to assume that investors would want a premium. And if we take, let's a GMO forecast of kind of what premium should be, it's roughly 10%. So our target return is 40% annualized, which means roughly just above 5x in five years on capital. Now, that may seem somewhat of an ambitious target, but our view is that if we cannot achieve it, there's simply no reason for us to exist as a firm. And the way we think about it is when we're appraising or looking at investments, 40% is simply our discount. down rate. And if it does pass that, then our whole job is making sure that the assumptions that go into how that return is achieved is validated and that we have conviction.

Starting point is 00:11:08 So, Kian, most investors like the certainty that there won't be any major unexpected changes to the investment climate. That's different in frontier markets. So how do you assess the political risk in a frontier market? I don't think there's anywhere in the world at the moment where there is in political risk. And I would argue that political risk in more developed countries is higher. Why? Because you have democratic political cycles that are every four years. And within that, there are dynamics that unfold that drive markets. So if we take the U.S. as an example, for a tweet, Trump can move the market. The narrative of 2019 was the China trade deal. You've had examples of, let's say, Switzerland in 2015 when they abandoned the current FX floor investors lost money. There are a lot of things

Starting point is 00:11:56 that are happening around the world, but especially in developed markets, that present investors some form of political risk. With frontier markets is somewhat different. So what you have is there's less democratic structures and what you normally have is one political system that leads or operates for an extended period of time. Now, that doesn't necessarily mean that that political system is positive or negative, but at least you're comfortable of the lay of the land. And what you normally happen are momentous shifts every, let's say, 10, 15, 20 years, where the leadership structure of a country changes. And what we want to be is on the right side of that.

Starting point is 00:12:28 If a country has just gone through a change to observe that that change is positive, that there is stability to that change, and then we start to invest. So that's on a macro level. On a micro level, what you have from political risk is, let's say if you're involved in an industry where all of a sudden the regulation changes, the law changes, that could affect the pricing of the product or service at the last. selling. And what you normally find is, especially if you're involved in investments that are somewhat involved in the ecosystem of the government from a strategic asset perspective,

Starting point is 00:12:58 there are potential risks that. So let's say a country is one of the biggest assets is, let's say oil and gas. If you're somewhere in the value chain of that, you potentially fall of political risks. And so what we want to do is the way we think about it is we don't want to be involved in investments where we're taking from the ecosystem, but we're adding to it. So, let's say if a lot of people like the concept of investing in privatizations, they've seen success stories in other countries. But what you normally find in these companies that they have bloated workforces and that the rational first thing to do would be to basically make redundant up to 50% of the workforce.

Starting point is 00:13:34 Now, as a first step in an economy which you're going, that doesn't win you any favors. But if I flip it and say, well, let's say we're investing in e-commerce, what are you doing that? What you're saying to local logistic providers, which aren't really making money, is, look, by working with us, your revenue will increase. You employ the youth population. Again, you're tackling a problem of youth unemployment. You're making it easy for people to access products which they otherwise wouldn't be able to access to and at a lower cost. So you're adding value to the ecosystem. And the final point to kind of I would say that we really focus on is building intangible value as opposed to tangible value.

Starting point is 00:14:12 tangible value is much easier to be expropriated. It's much easier to criticize. But intangible value is something that is difficult to build and is very difficult for someone to say, oh, well, we don't like this business. We're taking away to CEO and putting a new one because there isn't anyone that could run that business the same way that the incumbent is already doing. Whereas with a gold mine, you can easily take away the CEO and put in someone else to run it. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:18:55 emerging markets recently, again knowing that there's no official definition between the two. One thing that I as an investor always concerned about, the information that I get, How do I validate if that's true? And some of the data might even be hard to collect. So I guess that's my way of saying, okay, so you have a research process, but how do you validate the data you collect? The benefit of investing, let's say in the U.S. is by law, by regulation, the quality and the quantity of information that's provided to investors allows for an appropriate judgment to be made as to an investment. Now, what that means is that that information has effectively

Starting point is 00:19:35 been commoditized. The beauty of frontier markets is that it hasn't. And so as an investor, if you have an edge in collecting valuable information, then that can really be valuable. So what we do is in any country that we invest in, for us, it's important to build a local team on the ground. And one of the reasons that's important is that they have an understanding of the level of information that's needed for us to make an investment appraisal. And what they actively do with the companies that we're looking at, and I'm focusing on the private market, here is they effectively handhold and actively work with the management to dig out the information that's necessary for us to appraise. The other thing that's important in these countries is that

Starting point is 00:20:15 what you don't want to be in a situation is where there's a huge asymmetry of information. So you could go into a management meeting and the guy could be extremely charming, that could be charismatic. What we want to do is effectively flip that asymmetry. So when we're looking in a business, what we initially do is identify the variables to say what are the important variables that are driving this business. What are the data points that we can match to that? And what we request or what we insist on is that company having the data infrastructure within the business for us to be able to see it on basically a live basis. So on a weekly basis, biweekly basis, we're getting data inputs as to what factually is happening with

Starting point is 00:20:51 the business and then for us to drive the discussion and narrative of management off of that. So we believe that's important from, let's say, practical investment perspective. The other factor is, let's say, governance aspect in that, again, when you're a discussion, when it comes to develop markets, you're reasonably confident that the laws and regulations provide for a base level of governance infrastructure that can make you comfortable. What we effectively do is what we create what we call a stakeholder map. So that really is a map of all the factors that are driving the business. So you want to know if the guy is, if he's buying supplies, if he's buying a data center,

Starting point is 00:21:25 if he's buying an office, is there any related parties in that transaction? If so, what is the incentive driving that? And that really basically brings to life any bottlenecks, any potential risks that we can address even through the term sheets, even through direct discussions of management, all the way we structured the investment. So, Kian, I know that you're doing this. And top authorities in the frontier market investing always talk about why you need to be having boots on the ground to conduct research.

Starting point is 00:21:54 What are frontier market investors like you looking for when you travel to frontier markets like Albania, Bangladesh, Botswana, or any other kind of frontier market for that matter? Well, the first question you want to answer is, why does an opportunity exist in that country? Normally, the answer is pretty simple. It comes back to my first point of saying, well, there just hasn't been private capital. Make sure that the institutions, that is the laws and regulations, will allow you to operate in a reasonably easy manner. The ultimate question I would say that we want to answer is what variant perception or, let's say, what edge do we have in the country that not only foreign investors don't have, but the locals don't have.

Starting point is 00:22:35 And one kind of hack that I think is a good way to go about it is when you go to a country, meet with leading brokers, meet with the local version of investment banks, and ask them to simply show you the best deals that they have. The idea is not specifically to look for actionable investment ideas, but is to see what are the locals thinking about, how are they thinking about what the best opportunities are and why they think that. And then around that, you can see, well, what are they missing? Now, the aim there is not necessarily to look for actionable investment opportunities off of that, but it gives you the framework of how the locals are thinking about it. What you ultimately want to do is define what your edge is within that

Starting point is 00:23:12 country, whatever it may be. What is also important is that whatever that edge is, is to make sure that the institutions in the country, that is the legal system, the regulation, allows for you to execute on whatever that particular focus may be. And so one example that I can give is to what we've learned through this as to avoid. What you normally find in frontier countries that investors, they say, well, let's go and invest in the leading entrepreneur in the country. Why? Because, well, obviously, he would probably be able to capitalize on the country opening up and expand his business. But if you think about the dynamics of that as a trade, it's an asymmetrical trade in the sense that whoever that individual is, a man or woman that's

Starting point is 00:23:52 been successful, they already have access to capital. They already have a profitable business. So what you're saying to them or what you're effectively doing is forcing capital to them. They're saying, take my capital, please, because I want you to have it. And that capital may be in the form of saying, well, okay, if you're producing 100 tons of glass for bottling this year, increases to 150 tons. Now, again, if you're sat in the entrepreneur's perspective, what are you saying is, well, this is a great trade. If it works out, it works out.

Starting point is 00:24:18 If it doesn't, I still have my core business, which is profitable. And what most likely will happen is that me as an investor, I have a liquidity window. I have to get out at some point, that they buy me out at a discount. What also happens is that because everyone follows this narrative or this analogy, the price or the valuation of that company gets bid up to such a point that from a risk perspective, you're not really getting returns commensurate with the risk that you'll take. Let's transition into the second segment of the show. After talking about Frontier Market's as an investment class, I would like to be a bit more specific.

Starting point is 00:24:53 Right now, sturgeon capital is focusing on. on Uzbekistan specifically. I can't help but wondering of all the frontier markets you could invest in why Uzbekistan and why not any of the other frontier markets? It's worth a little bit of history on the firm. So again, I defined what we do as looking at countries that are frontier but emerging. And what that has naturally led us to is focusing on Central Asia. So you had Georgia in the first instance, which had went through a tremendous reform path. Kazakhstan, which didn't, weren't as aggressive as reforms, but really allowed the private sector to take shape. And the elephant in the room for us over the years has been Uzbekistan,

Starting point is 00:25:33 because relative to this region, it has the largest population, about 33 million people, great demographics, kind of 65% under the age of 35. Unlike a lot of other countries, it has a really diversified economy. So whilst they have natural resources, the natural resource to an extent countercyclical, so the largest export is gold, they have uranium. But for all intents and purposes, it was very difficult to allocate meaningful capital there under the previous administration. And the previous administration was there for about 25 years. You could argue it was kind of, let's say, a closed-off socialist state. And so no one was really paying attention to it. Now, having said that, we were actually involved in a country for about eight years on a small,

Starting point is 00:26:12 non-long level because we believed it important to have a pulse of what's actually going on. So what happened? Two and a half years ago, effectively, the previous president passed away. And ironically, his prime minister became president. And so the general consensus at the time, even amongst locals, was that, well, it would be a continuation of the previous policies. And then unbeknownst to everyone, what he effectively did was embark on a very ambitious and aggressive reform path. And what we define as, let's say, the fall of the Berlin Wall moment was really lifting

Starting point is 00:26:42 the currency control. So they had two different currency exchange rates. One was a subsidized rate. One was a free market rate. And overnight, they unified that. that they took a 50% hit on the currency. But as before, where it was difficult or nearly impossible to get money in and out, that changed overnight. What then followed was that the roster of, let's say, previous ministers were fired and replaced with, let's say, young, Western-educated

Starting point is 00:27:05 Uzbek technocrats and then a series of other policies reforms took place. So they're now privatizing nearly every state assets. There's 1,200 companies on the privatization list. They engage in serious tax reform. So they had a large part of the economy estimates are up to 50% that were in a black economy that was not paying taxes. Why? Because the tax system was complex and probably arbitrarily high. What they did is they reduced, let's say, the corporate tax rate by 50%. And the irony is that tax revenues went up 70% year on year. So that's a reflection of the black economy moving towards a formal economy moving. Now, if I put the GDP per capita of the country in context view, we're talking about a country of 33 million people that has $1,500 GDP per capita.

Starting point is 00:27:47 Now, comparing that, let's say a country like Georgia, which has one-fifth of the population, no natural resources, they're at about four and a half, five thousand. Kazakhstan has a half the population, but more natural resources is about 8,000 to 9,000. And you're coming from such a low base that if you want to add a value tilt to it, you're investing with a margin of safety or with the wind behind your back. The second aspect that is important from an economic structural perspective is that the country basically has very little debt, both across the sovereign, corporate and private sector. So total debt to GDP is under 30 percent, and they reserves the GDP

Starting point is 00:28:22 of 60 percent. And that bulk of those reserves are of gold. And so what you will see, I think, is a one-off leveraging. But the important point to that, unlike developed markets, is that leverage really is going into productive capacity, in that you have a lot of the economy, which is already producing undercapacity. And so what that capital is going into is really the high return on investment projects. The final aspect that is positive and someone underlooked by, let's say the Western world is the Belt and Road from China. And the way we think about that is that it's the Marshall Plan on steroids. It's a one trillion investment plan. And effectively what it's doing for the country is reducing the cost of doing business by building out base

Starting point is 00:29:01 level infrastructure and making it easier for the country to do business with the world. And I mean, Charlie Munga talks about these kind of lulipalooza effects happening when you have a confluence of positive factors taking place. We believe you have a number of positive factors that are coming to fruition at a single point in time. And that, frankly, from our investment career perspective, there hasn't been a country which has such a high conviction over in the past 15 years. So, Kian, let's assume that three of us go on a trip to Uzbekistan. What would it be like when we hit the ground and what might we expect to see from an investing standpoint?

Starting point is 00:29:37 A good way to think about it is, so you have a pre-Soviet infrastructure or order. That is, you have these wide roads, the roads are clean, Everything's quiet. And you have pre-Soviet Union human capital, right? In that the majority of the education levels are very high, and then the majority of the people are educated in the hard sciences, which is normally what you want as opposed to the software that are social sciences. But you have post-Soviet GDP dynamics.

Starting point is 00:30:02 So, let's say the normal amenities, which you probably expect in a lot of countries, are not there, although they're really coming to place now. In terms of opportunities, I think we're effectively at the moment the only international firm providing private capital to the country. And I hope I like to think that that's built up somewhat a lot of goodwill. And when you meet local entrepreneurs, they're very proud and they like the fact that you're there and they're more than open to have a discussion of you. And so what we find fascinating and I think what investors that come with us to the country find fascinating is simply the breadth of people that you can meet. So you can meet the leading entrepreneur and the retail space.

Starting point is 00:30:38 You can meet the leading real estate developer. You can meet the leading tech entrepreneur. Similarly, on the public side, you can meet with ministers to really understand how are they thinking about the policies that they're setting, what yardsticks they're setting for themselves. And so they're saying the space of three to four days, you can leave the country to having experience and met with people that you would otherwise never be able to meet in any other country and really probably get a good feel of what the reality of the ground is as opposed to perception, where in most cases there is simply no perception because it's a country that most people haven't really come across in their lifetime.

Starting point is 00:31:10 So it's very interesting that you would say, like, you're the only foreign company providing capital. What kind of advantages and disadvantages does that entail? One disadvantage, I think, is, and it's something that can be managed on a personal level or a firm level, is that simply if you travel there, you can be awed by the scale of opportunity, which you would see. And one anecdotal evidence I would give you is a given example of the real estate sector. What will normally happen is that, yes, demand is likely to go up because you have urbanization, GDP is growing up, but one factor that probably will more determine economic returns is a supply side. And on the real estate, it's not too difficult to expand supply, right?

Starting point is 00:31:52 So an equilibrium will quickly be formed, which is what you want to stay away from. Really, where our focus is, as I mentioned earlier, is to try and capture these decorrelating dynamics by investing in secular trends. Now, the biggest secular trend that we see amongst frontier markets is the technological leapfrogging. Now, what do I mean by that? Let's take the banking sector. And let's take fintech as an example. So if you look at the UK or in the U.S. to an extent, there are very difficult pureplay

Starting point is 00:32:21 fintech winners to see that are profitable at scale. Why? Because you have a legacy infrastructure in place. That is, the majority of people hold their main deposit account at incumbent bank. and they use fintech companies for additional services, whether it would be payments, etc., etc. In frontier countries, it's a complete different dynamic. So you already have a large part of the population that simply does not have a bank account, and there is no legacy infrastructure.

Starting point is 00:32:46 So when you're going in there with a fintech product, you have the ecosystem to allow you to build that business, but what you find is that the people will move directly towards the most optimal solution. And so you are the captive deposit account for that customer as opposed to just being an added functionality. to. And so our focus really is on looking at business models that we know work. What I mean by work is that they have positive unity economics. They build the most as time goes by and that they're scalable. What we look to do is build or invest in businesses similar to that in these countries. I'm happy to go into a few examples if you would like. That would be fantastic because you already made a few positions in your space than already. I would be very curious to hear if you can take

Starting point is 00:33:28 is through like a step-by-step process from whenever one of or multiple of these companies came on your radar until today? Yes, I think something that we're kind of proud of is that all the investments that we've made have been, let's say, organically sourced in the sense that either it's been the entrepreneur that has contacted us esoteric ways. It may be a message for LinkedIn, it may be an email, it may be someone indirectly reaching out, or they have been sourced from us actively reaching out to entrepreneurs. We try not to rely on, let's say, outside of advisors where incentives can be flawed. But if I give a few examples, let's say one investment that represents a significant portion of portfolio today is a business that today is called Zudmore.

Starting point is 00:34:08 And today is arguably the largest cross-order e-commerce marketplace in Central Asia. Now, what do I mean by e-commerce marketplace? Think of the same business model as Alibaba or Alibaba Express. That is, you don't hold product inventory. You're not Amazon. You simply provide a platform for products to be placed, people buy it, and you take a commission. Now, if we think about what is needed for that business to be successful, effectively is three main things. One is a logistical solution, right? That is if you're sending products from China to, let's say, Uzbekistan or from Europe or anywhere in the world, you need to have a logistical solution. And what this company has done is they partner up with every national post company and local

Starting point is 00:34:47 postal companies to the point where in every country operates in, it has a last mile delivery, something that just did not exist. And it provides that delivery at a cost lower than AliExpress and faster than AliExpress. Why? Because for Ali Express, these countries on an individual basis are not large enough for them to want to do the heavy lifting needed to integrate it into their core platform. The second aspect they need to solve for is payment solutions. So in Uzbekistan, less than 10% of the population have Visa or MasterCard, which basically shuts them off from any international commerce. And what this business has done is they've integrated local payment solutions of international.

Starting point is 00:35:22 ones. They've added cash on delivery, which today represents 80% of their orders. But they've also added installment solutions and buy now, pay later. What buy now pay later is, is effectively saying you buy a product today, you pay it in 60 days with zero interest. And the supplier takes the hit on the interest. And for the supplier, they will do it. Why? Because here you have a population of combined 400 million people, which no one from an e-commerce perspective is tackling. The final aspect is you actually have to have products on the platform that people can buy. And so with that infrastructure that they have, they basically signed with JD.com and China, which is, I think, number three e-commerce.

Starting point is 00:35:57 You have Hepsi Barad and Turkey, which is number one e-commerce, and a range of other service providers. The other kind of less direct positive is that all these countries have VAT and customs duty exemptions for cross-border e-commerce, which basically means that all the products that would be available offline are cheaper for the platform. So if we summarize the totality of the value proposition is that you have the convenient of last mile delivery, you're opening up people to buy products from around the world through integrating payment solutions. You have a range of products that are implicitly cheaper than if they were available offline, and you have products that are simply not available offline

Starting point is 00:36:33 in those countries. And so what the business did effectively launched them in November 2018, and I should say this is a management team that we've known for about five years. The core management team has been together for about 20 years. They previously had two successful exits. And since November 2018, effectively, the businesses developed such that today in every country it operates in it's the most downloaded shopping app, has about 3.5 million downloads of the app. Up until Corona was growing at about 38% a month, GMV-wise, that is, value of transactions on the platform. And the way we see it is, as time goes on, the barriers to entry go up, the most of the business increases. And what you're seeing is that, for example, over the past

Starting point is 00:37:12 two months, they've basically been given the exclusive online distribution for Samsung, Huawei phones, and even Apple products through this region, which is a huge win. But why is because they have that infrastructure, which is just kind of adding to that month. And the way we see it in terms of returns is if you mathematically compound GMV from where it is today, let's say at 4% a month, you get to about half a billion in value of transactions in about 4 to 5 years. Bear in mind that the company is growing at about 30% a month at the moment. And if you look at exit multiples of these businesses over the past five to 10 years, let's say from one and a half to three times GMV, let's take the bottom threshold. This in our mind can be a plus billion

Starting point is 00:37:49 business and at the moment we're invested in the business at a valuation of 40 million. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up and customers now expect proof of security just to do business. That's why Vantta is a game changer. Vanta automates your compliance process. and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure and keeps your deals moving. Instead of chasing spreadsheets and screenshots, VANTA gives you continuous automation

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Starting point is 00:41:28 firm. Are the rules any different in the frontier investing space? That's a very good question. I guess it's kind of reverting back to the public markets. Again, one of the reasons that I think it's difficult to consistently make money there is if we isolate the local capital market, you don't have that intensity of capital or the true free market capitalism mentality that you have in the US, whereby if something is cheap, either through private equity or through M&A, that value is unlocked. And so you're really relying on foreign liquidity, again, which is very difficult to predict. What we want to be on the side of where we effectively are involved in a situation,

Starting point is 00:42:04 whereby the value or the strength of the business creates its own liquidity ultimately. And that can come in a few forms. One is if we take Uzbek as something, we're investing at a time where the public markets really are in their infancy, but there's aggressive reforms and there is ambitious plans to develop that local capital market. And so there is a scenario where I would probably rank all the perspective, we'll put it at the bottom that you could exit for the local capital markets and by virtue of being invested in a company where none of the existing or incumbent constituents of the market represent

Starting point is 00:42:38 that sort of dynamic that is a technology company that is relatively fast growing, it would relatively be easier to, let's say, IP on a local basis. On an international basis, I can point to at least a half a dozen examples of leading frontier businesses that have managed to IPO on international markets. If you take Georgia, you have two of the leading banks that are trading in the London Stock Exchange, kind of plus billion market caps and and trading on valuations at peers with, let's say, Western multiples. If you take Russia, you have businesses like Yandex, you have businesses like Tinkoff that are trading on a NASDAQ.

Starting point is 00:43:09 In Africa, you have businesses like Jumea, which, again, is an e-commerce marketplace that had a pretty successful IP on the U.S. market. And finally, again, what you're ultimately doing in these countries is, if you think of it through the lens of international players, whether it be multinationals or, let's say companies like 10-cent or Alibaba, is that what you're saying is, I've solved the issue of these countries, I've solved the difficulty of all. operating these countries for you. So if we look at Tencent or Alibaba, a third of their income line is investment income. That investment incomes comes from acquisitions. If you look at the number of

Starting point is 00:43:40 acquisitions that Alibaba or Tencent have made combined, I think it reaches nearly a thousand over the past 10 years. Why? Because they have a cash cow in their core business and they have FOMO that they don't want to miss out on the next big thing, whether it be e-commerce, whether it be gaming, whatever it may be. And so they have the capital to acquire. And China already has this basically I Silk Road, which is the digital Silk Road project that they have, what we're doing falls directly within to that. So you also have the optionality of leaning towards the East. So talking a bit more about comparison for something like Uzbekistan and to the West, which perhaps resonate a bit more with most of our listeners. You know, you mentioned a pricing

Starting point is 00:44:19 power before. That's also something we talked about here on the show, Warren Buffett one-on-one. How are the quote-unquote rules different, if ever, of a good company in the, let's call it the developed world? Like, you're looking for something not just with a good pricing power. You might also be looking at a company that needs to have lower capic, whatever kind of things that we've been taught about all the businesses. Is that different in any way whenever you try to identify that in a country like Uzbekistan? Yes and no. I mean, the question that I guess we're ultimately trying to answer is twofold. One is, what is the value proposition of the business's core product or service to the underlying user?

Starting point is 00:45:02 That is what utility is it providing it? And sometimes that utility is very high. And the ideal situation is that there's high utility, but the economic structure of that business or the sector also allows for economic gains to be made from that utility. And that's basically margins are indicative of that. So you have some businesses where there's high utility to the customer, but the underlying dynamics, maybe there's a competitive factor, whatever it may be, doesn't allow for you as an investor to capture economic benefits.

Starting point is 00:45:29 And so what we really care about is investing in business models that have high customer utility, but also have high economic benefits to you as an investor. And another example I could give of that is, let's say a business we've invested in Uzbekistan called Bills, which is the leading enterprise software of SaaS business. And I think probably you and the listeners are familiar with that business model, which in our mind is the most elegant, beautiful business model. You have kind of plus 50% operating margins. You have kind of high cash flow, high recurring revenue. And what you can argue is in a developed world, this is quite a now saturated investment landscape in that everyone is investing in SaaS.

Starting point is 00:46:04 Now, if you flip that in the frontier market space, and specifically in Uzbekistan, this is a business that is targeting the small to midsize businesses, where their alternative, let's say we're focusing on account management and inventory. management is either paper or Excel. And the beauty is that the government is effectively mandated that that has to be digitalized, that businesses have to digitalize their account management and inventory management process, not only for transparency but for efficiency. And the beauty of this business is also that not only are you providing a service that is implicitly profitable, but by virtue of providing that service, you're collecting unique data which no one has in the country.

Starting point is 00:46:40 Now, what data is that? It's working capital cycle, cash cycle data, on a range of, of SME businesses which no one has. And that comes into the financial services angle and that no one is really, you're talking about a country that is really at this infancy of financial services. So you have 50% of the population that do not have a bank account, which by law now they have to. Now, one of the issues there is credit quality in that at the moment credit scoring is binary. Either you are good credit in which you get a loan or your bad credit in which you don't get a loan or the rate at which you get it is astronomically high. And so what is really important

Starting point is 00:47:15 to have an edge is to have good credit data. Why? Because it means that you can apprise your risk that is price loans at a more appropriate rate, but also allows you to speed up the speed of which you can distribute that loan. And going back to the SaaS business, what you're effectively doing is you have a range of businesses where you have all the working capital cycle, you've all the cash cycle data, and the business can either, through their own balance sheet start to lend out or act as a platform to the banks to basically say, well, we act as a loan distribution for you and we take a introduce a fee. The latter is a more capital-light model. The former is you have more control over it.

Starting point is 00:47:47 But either way, it's still, you're adding value and there's economic rent to be taken from that. So, Keanu, what are the main red flags you look out for in Uzbekistan, where if they materialized, you would close down your Uzbekistan growth fund? As a firm, what we've seen over the past 15 years by being in front end markets is a wide range of risks, be it coming from government, be it kind of micro investment risks. And what I hope or I like to think that we've built up is an investment framework off our own mistakes, off seeing other investors' mistakes, that really focuses on this concept of resiliency and that we're investing in business models and investing in a manner and constructing a portfolio that is inherently resilient or the aim of being resilient. And one other anecdotal example I can give of a country that we're not involved in at all

Starting point is 00:48:36 anymore, but purely observe out of interest, is Iran. So let's look what happened there. 2016 sanctions lifted. There's this whole rush for investors to get into the country, whoever it be multinational financial investors. 2018, Trump comes in. The widest ranging sanctions that any country has ever experienced gets reinstated on the country.

Starting point is 00:48:56 The currency devalues by 80%. The country goes into recession. What has happened over the past two years? 2019, the stock market goes up roughly 80% in dollars. This year, it's up 120% in dollars. In the similar period, you've had the local version of Uber B development. where to the point it has two and a half million rights today, which basically makes it a third of fourth largest ride-hailing out in the world.

Starting point is 00:49:20 That is, if it was a country that was normally on, this would be a plus three billion company. So the point is that there are reflives that I would say we have a responsibility and it's incumbent upon us to be cautious of and to build a framework around of. Kian, this was a fantastic interview. I cannot believe it would take us six years into the Ammasters podcast to have the very first episode. about frontier markets.

Starting point is 00:49:44 I'm sure the audience would like to learn more. Where can I learn more about Jew and Sturton Capital? I think the easiest way is just to reach out to us. We believe we're operating in markets and countries which are implicitly more unknown to the bulk of the investor population. And we have a responsibility. And again, it's incumbent upon us to be actively communicating the opportunity set and what we do.

Starting point is 00:50:06 So I would really encourage anyone that wants to reach out to us directly. You can find us on our website. it. And I hope what's COVID goes away that we can encourage you and a potential investor is to come out of us to Uzbekistan. There's no other way to go about it and really get a feel for what's going on on the ground. I can speak as much as I want, but it's better always to get your own, let's say, first principles. Kehan, we really appreciate that kind invite, and we really appreciate you coming on the show today. I know I learned a ton. I'm sure the audience captured a ton of value out of this.

Starting point is 00:50:37 And thanks for making time for us. It's a pleasure. Thank you again for the time. All right, guys. That was all the press down I had for this week's episode of The Ambassadors Podcast. We'll see each other again next week. Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only.

Starting point is 00:51:00 Before making any decisions, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permissions must be granted before syndication or re-broadcast. Staying.

We Study Billionaires - The Investor’s Podcast Network - TIP306: Frontier Investing w/ Kiyan Zandiyeh (Business Podcast)

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