Cambodia – New Land of Opportunity (Part 2)

When we left off with our friend Doug Clayton of Leopard Capital, we were discussing how Cambodia is The New Emerging Market.

Doug commented that, “Cambodia has a very different approach to business than most of Asia. It forces prices down for consumers due to the free competition. The government also doesn’t intervene or distort the price signals by setting a lot of subsidies or minimum prices on things. It really is one of the most free market environments around.”

A “free market environment” huh? Let’s finish our chat with Doug, and then Mark and I will have some thoughts later in the week to discuss with our readers.


Chris: Doug, that free market environment you just described bodes pretty well for an economy on the whole. What are the things that you’re currently looking at, or feel have the most risk/reward potential in the country?

Doug: Our fund has a very broad mandate. It can invest in almost anything as long as it’s not harmful or too controversial.

Chris: No slave trading then!

Doug: Right, absolutely not. So, we’ve been able to try out various strategies and invest in quite a few different sectors. But, ultimately our portfolio is focused on three main themes. One is bringing financial services to the rural areas, because that is where there’s minimal competition and the margins are the best.

Chris: Right, that’s usually the case globally.

Doug: This also provides a nice social benefit, giving poor people access to finance. We’ve invested in both rural banking and micro-finance, and these have been good investments.

Even though there’s a lot of banks here, there’s scope to expand banking services into areas like trade finance, auto loans, leasing, and other things beyond property-based lending.

The second theme has been bringing basic utilities to rural areas. We’ve found there’s more affordability in the countryside than most people would expect. There’s a large underground economy, and being a farmer in the last few years has not been the worst profession, due to the higher crop prices.

Around 80% of Cambodians live in the countryside, and many are willing customers. They want electricity, cellphones, and bank accounts. We’ve invested in all these areas and are happy with the returns so far.

The third area has been the whole food production value chain, all the way from agriculture to producing branded food and beverage products.

That is an area that still has a lot of opportunity for growth, because when you go to a grocery store in Cambodia many of the labels are written either in Thai or Vietnamese since the products are being imported. Most of the local Cambodian consumers cannot read those languages, so they’re not really sure what they’re buying. It seemed to us that creating high-quality local products, with labels written in the local language, would be a good concept to invest in.

So far we’ve focused on beer, mineral water and shrimp. As for agriculture, you can see in the countryside that a lot of people are still farming the same way their ancestors did a thousand years ago, with cows pulling wooden plows on small lots.

Chris: That’s what we would have seen in places like in Chiang Mai as little as 10 or 15 years ago.

Doug: Exactly, when my wife came to Cambodia she said it reminded her of her childhood back home in Northern Thailand. Thais of her generation have watched their country leap from Cambodia’s current level, to middle-income country status.

The modernization process is now starting in Cambodia’s rural areas, and the people there are starting to get plugged into the rest of the country through better roads, cellphone networks, schools, and jobs for some family members in Phnom Penh’s garment factories. They start to use banks instead of money lenders. They watch TV. But still, Cambodia doesn’t have everything yet. It’s going to get much better over time, and the trend will play out for a couple decades as it did in Thailand.

So those three areas are our core investment themes and they are really applicable to all frontier markets in Asia.

Chris: This segues nicely into another question I’ve been pondering. When investing in early stage companies, how do you include those positions for the fund? From the perspective that your funds have a ten year lifespan, and you need some sort of exit strategy to be able to return the money to your investors, how do you deal with that?

Doug: With every investment we make, the first thing we have to consider is how could we get out of it.

We use different strategies. There’s no cookie cutter approach. One thing we look at is the unusual interest that multi-nationals have in accessing new emerging markets like Cambodia, where there’s still not a lot of brand awareness yet. The population is very young, so it is a tantalizing market to multi-nationals whose home countries are stagnating.

Pioneer investors like Leopard can front-run the multi-nationals by creating new businesses they will want to acquire later. You discussed Front-Running Liquidity in a recent post, it’s a great strategy.

For example we’ve started a small world-class beer company in Cambodia called Kingdom Breweries. If we look globally, the beer industry consolidates and independent local brands get bought out by multi-nationals. However, most of the beer giants are still not in Cambodia yet, so we’re creating a vehicle that they can buy later and gain instant access to the market whenever they decide to come in. There aren’t many other candidates for them to buy.

Chris: Savvy, very savvy!

Doug: That’s one of our pre-planned exit strategies, a trade sale to a strategic investor.

We’re also creating a bottled mineral water company to flip to a multi-national. We create a cool brand and build a factory with the same technology and equipment that a multi-national uses, and even hire retired managers that worked for the same multi-nationals that we aim to sell to later. We can create a company that will fit very nicely into a multi-national’s global portfolio later.

M&A is really our core exit strategy.

A second one is using the business’ cash flow to provide our returns, usually through high-yield debt, enhanced with an equity kicker so that we get both a fixed return plus a variable return based on performance.

That structure works best when the cash flow is predictable, usually not in a startup unless there’s a contract in place providing visibility into the cash flow generation. For example, we financed a new power grid this way, as their income is steady.

A third strategy is investing in companies just before they go public. Here the best approach is to take a small stake in a large company so that you are not subject to a lockup period. We invested in the biggest hydropower company in Laos, and the price doubled after it went public, allowing us to take some nice quick profits.

Chris: We love hydropower. Mark helped seed a run of river hydropower company in Nepal, which is another Frontier Market Worth Exploring.

Doug: Our fourth strategy is to sell our position back to the company’s promoters or co-investors. In some cases owners may want us in their company for a period of time while they are scaling up. So we can sometimes negotiate put options or pre-planned sales back to our co-investors.

Chris: Okay, interesting.

I was just thinking about some of these countries – the Philippines and Vietnam jump to mind – where the manner in which businesses tend to operate with regards to record keeping, is, shall we say, a bit “spotty.” Private companies often don’t keep reliable books, and there’s no receipts in terms of taxes paid or anything along those lines.

What they do is wait for the government tax official to show up and then sit down with the guy, have a beer and negotiate a “price.” This is why government numbers in these places are so skewed and unreliable.

This is incompatible with functioning capital markets and transparency for investors. In order to encourage private companies to go public, it means that the old way of doing things has to change regarding book keeping and taxes.

Mark feels this is the main reason the Chinese reverse mergers blew up so spectacularly. A good number of those companies were either fudging the numbers somewhat, or just out and out lying. They had no intention of changing.

Essentially, accessing the capital markets needs to be more productive and economic than fudging the books in order for the liquidity to come to these markets.

On the Cambodian exchange, which opened back in July of last year, one of the problems that they naturally had was there weren’t any national companies ready to go public yet. Do you think that the environment is getting better and more attractive for companies that are considering going public, and what is the state of play within the exchange now?

Doug: The “three sets of books,” which is what you are discussing, is something common to all Asian counties; it’s a traditional family business approach to running a company. In our case we tend to avoid the problem through the way we screen partners.

We don’t go to the big local tycoons and say, “We want to invest in your old-style family business and make you modernize it.” Rather, we tend to seek out younger companies and start-ups, and set the governance and accounting policies from early on.

100 percent foreign ownership is allowed in Cambodia, so often we are investing alongside other foreign investors who want transparency as much as we do. Or, we may invest with Diaspora returnees who learned the Western style of business while living abroad.

Companies that have multiple sets of books and underpay their taxes are not suitable investment targets for our fund.

Chris: Right, they just can’t be fixed that easily, it’s more hassle than it’s worth in most cases.

Doug: Developing a stock exchange is an important driver for the economy and for modernizing business practices. A listing gives a financial incentive for traditional companies to become more transparent because they will get a higher market valuation if they report all their profits. Competitors who choose to remain unlisted usually have higher financing costs than those who clean up their books and list.

In Cambodia they’ve launched the stock exchange as an organization, but haven’t listed any companies yet. The launch of trading has been delayed several times already, so no one really puts much faith on the planned start date, which always seems to be a moving target. But, I’m sure it will happen eventually, as the government really wants an exchange and some companies do want to list.

A few brokerage firms have set up trading floors and have hired analysts to write research. Two things are holding back the launch of trading. One is that not all the legislation has been finalized, like the ecommerce law and updating the share ownership registration procedures.

Secondly, only one company has applied and been approved to list their shares, and the Exchange wants to start with two. The Laos stock exchange opened with two companies last year.

Chris: And interestingly the demand for the shares of those companies was very strong.

Doug: Initially they were great fun. Since then trading has died down. They need some new listings to stimulate it.

Chris: They need to go further with those initial listings. But irrespective of the stock exchange, I think the critical point that you’ve made is that a stock exchange isn’t a prerequisite to investing in a particular country. It makes it a little bit tougher without one, and illiquidity is of course an issue without a smoothly functioning capital market.

The flipside of that is that price discovery is more difficult and buying assets at ridiculously cheap valuations is possible. In a fully-functioning, liquid capital market those opportunities are harder to find and usually priced in.

Doug: Right. Yes, the inefficiency can be your friend because it allows you to stumble across deals that shouldn’t be priced the way they are.

Chris: In terms of the growth in Cambodia the rate in 2010 was around 6% if I remember correctly. What do you see going forward?

Doug: I think Cambodia’s natural GDP growth rate is around 8%, and I believe we’ll see that rate going forward. If it goes above 8%, you start to draw unproductive real estate speculation. When the world economy lurches downward, Cambodia’s economy dips temporarily before bobbing back up to its natural growth rate.

The average age of Cambodia’s population is just 21, so roughly 300,000 people reach the working age every year, going from being dependents to economic contributors. So, the labor force is expanding by roughly 3% per year and its quality is continuously improving because education is getting better – from a very low base.

In the late 1970’s Cambodia’s school system was shut down by the Khmer Rouge who murdered a lot of its most educated people. They decimated the talent pool. But in the past two decades there has been a gradual re-normalization of the economy and the social system, and literacy rates are rising.

There isn’t a safety net or minimum wage, so everyone basically has to find work. You have this upgrading and expansion of the workforce, coupled with factors like higher commodity prices, rising foreign investments, better infrastructure and greater inter-regional trade. All of these things underpin an 8% baseline growth rate without much correlation to the world’s advanced economies.

Chris: Doug, thank you very much, it’s been fascinating!

Doug: My pleasure Chris, any time.


Chris again… Clearly Doug and his partners have executed on a thoughtful and prudent strategy for investing in frontier markets.

As an individual investor it can be tough to penetrate new, emerging capital markets, but Doug lays out some very good examples of how an investor should be “thinking” about ways to do so. There are myriad opportunities available for entrepreneurs, investors and speculators if you learn the patterns that occur in every developing market.

If you have questions for Doug just drop us a comment below, or an email and we’ll pass it along to him!

– Chris

“Having emerged from its dark 1970s past, Cambodia is solidifying the remarkable progress it had made since its 1990s embrace of free market economics. The country’s 9.8% GDP growth rate over the 1998-2007 decade ranked sixth in the world and fastest in the Far East, after China.” – Leopard Capital


This Post Has 3 Comments

  1. sagûm

    Ok nobody else seems to be asking anything, so I will throw a question out there for Doug Clayton.

    What does Doug see as the best investment opportunity in Burma?

    Coming off such a low base and with a population of 60 million there has to be some serious opportunity in the offing there.

    1. Chris MacIntosh

      Hi Sagum

      We (Mark and I) along with Doug and other friends of ours all have opinions on Burma and we will be delving more into this throughout this year. And since what we talk about here is what we’re doing with our own capital you can rest assured you’ve not heard the last of Burma from us.

      (BTW Doug is out of touch for a little bit as he is investigating Haiti)

  2. Douglas Clayton

    Dear Sagum,

    Myanmar offers so many opportunities that it is impossible to say which is the best. It depends on what you like to do. Our approach in frontier markets is to invest via a Fund across multiple key sectors to capture the overall economic growth. Consumer goods, electricity, Internet, financial services, real estate, tourism, agriculture…the list is long.

    Douglas Clayton

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