Vietnam's road to reform

"We are not investing in Vietnam," one Southeast Asia-focused private equity professional bluntly affirms. "We are not yet comfortable with the macro environment."

Given the country's recent economic upheavals, perhaps this attitude is unsurprising. Consumer prices in Vietnam climbed by more than 20% year-on-year in June, the fastest pace since November 2008, and the government expects 17% inflation for the year in full. Economic growth projections have also been cut, from 6.5% to 6%, after GDP grew 5.57% in the first half of the year.

The dong underwent its fourth one-off reduction in 15 months in February and, although it has since stabilized, Hai Pham, an economics analyst with ANZ, doesn't think it will stay that way. "The government's more-aggressive stance against inflation and changes in foreign exchange policy supported the dong in the last few months, but fundamental pressures for depreciation persist," Pham says, citing continued double-digit inflation and a fragile balance of payments.

Positive sentiment

Local private equity players admit raising money is difficult right now, but they remain positive about the market's long-term prospects. Indeed, foreign investors might find valuations especially to their liking.
"In the rest of Asia capital is abundant, but in Vietnam there is shortage due to a tighter monetary policy that is intended to fight off inflation," says Chris Freund, managing partner at Mekong Capital. "Domestic borrowing rates are over 20% so it's a very good environment for inbound trade sales – there is a much lower capital cost for overseas investors compared to domestic investors."

With stocks trading on the domestic market at price-to-earnings (P/E) ratios in the high single digits, the thinking is that private equity firms can buy in at low single digits. Investors were taking positions in Indonesian companies at much the same valuations five years ago and have since been able to exit at 15-20x, sparking massive private equity interest in the country.

For Vietnam, though, there is also a trust issue: much of the investment that arrived in 2007 – when fundraising and investment peaked at $1.4 billion and $900 million, respectively – did deals at P/E ratios of around 30 struggled as valuations subsequently fell. Fundraising activity reached $161.4 million last year, with investments reaching $230 million, according to AVCJ Research.

"It takes a lot of nerve for investors to go against the grain," says Andy Ho, managing director and head of investment at VinaCapital. "Everyone is piling into Indonesia and driving up valuations. Who has the guts to go to Vietnam? The fact that KKR put $159 million in Masan at 20x P/E is a great sign for the industry."

KKR's acquisition in April of a 10% stake in Masan Consumer Corp., a subsidiary of Masan Group and Vietnam's second-largest manufacturer of branded instant noodles, is the country's largest-ever private equity transaction. It stands out as a ringing endorsement of the consumer sector.

Economists are often keen to tout Vietnam as the China of 10 years ago – an odd comparison given the vast difference in size, but one that is very roughly borne out by the timing of the introduction of free market reforms as well as relative figures for GDP per capita, workers per dependent and urbanization. The paths diverge on the consumption share of GDP, which has been comfortably over 60% in Vietnam for some years, but in China has slipped from 45% to 36% during the last decade.
Freund and Ho are quick to talk up consumer plays and the link to the rising wealth of a young population. Mekong was an early investor in Masan – it exited last November with an IRR of 61% – and thinks it has the next big thing in Mobile World, which has grown from a five-store outfit in 2007 to become Vietnam's largest independent mobile phone retail chain with 110 branches.

Freund sees huge consolidation opportunities in convenience stores and restaurant chains. "When you are investing in retail now you are looking at companies with 10-15 stores, which is on the small side," he says. "With that the profit is probably about $2 million a year, so you are talking less than $20 million on the way in."

The long game

Deals of this size are unlikely to please global private equity firms, but they are a fact of life in an economy that remains largely dominated by state-owned enterprises (SOEs). This structure also points to fundamental inefficiencies that are the root cause of Vietnam's economic volatility – and therefore its long-term appeal to private equity investors.
Questions are being asked of the government's ability to persist with current austerity measures and bring inflation under control. While Philip Wyatt, an economist at UBS, believes price growth can be pulled back to 10-20%, he says bringing it even lower hinges on banking sector reform. Free-handed – and predominantly state-driven – lending in recent years has sparked concerns about banks' balance sheet quality and the possibility of government bailouts to prevent a crisis.
"Mismanagement of the economy is a product of its SOE legacy. If they can sort out the relationship between the central bank, the SOEs and the government then they have a chance of getting inflation down to around 10%," Wyatt says.

He draws comparisons between the Vietnam of today and Southeast Asia of the 1980s. Back then, the likes of Indonesia and the Philippines – more as a result of narrow, unstable leadership rather than Vietnam's command economy model – suffered from high inflation, current account deficits and an export-dependency that meant currencies came under pressure whenever the economy slowed.

These countries have since turned the situation on its head and private equity players are beating a path to their doors. 

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• Topics
• Southeast Asia
• KKR
• Mekong Capital