IPO’s, Liquidity, Bonds and Banking in Mongolia

Given our bullishness on Mongolia and our trusted relationship with Eric Zurrin from Rescap Securities, we wanted to reach out and get Eric’s current thoughts on the Mongolian equity market, liquidity, banking and upcoming deal flow.

Pertinent to this post was something that happened after our interview with Eric. Mongolia’s central bank cut interest rates for the first time since 2009 after determining that the outlook for inflation is benign and to support growth. The Bank of Mongolia reduced it’s policy rate to 12.5% from the previous 13.25%.

This should be bullish for Mongolian equities, and lends support to our bullish call from earlier in the month.

So, enjoy the interview; as usual Eric didn’t disappoint.


Mark: Eric, liquidity is still an issue on the MSE. Given that fact, what’s the current deal flow pipeline look like for domestic equities?

Eric: Lack of liquidity in listed MSE stocks has been an ongoing issue for the exchange. This is one of the key requirements for new investors (largely foreign) to consider prior to making an investment. As a result, the investor demographic on the MSE is overwhelmingly retail. The liquidity is adequate for retail investors but institutional investors to date have not had the ability to buy into the market without significantly distorting prices.

As this is an identified issue, it is also a priority that the London Stock Exchange (MSE’s partner) has at the top of its list to address. I understand that the LSE will tier listed companies according to minimum thresholds (ie liquidity being one of those) which I hope will improve the situation, but this will take time.

The deal pipeline on the MSE as a result has been somewhat dictated by the existing constraints: large offerings are non-existent because they can’t attract institutional money which means the funds cant be raised. The deals that we are seeing (that actually get done!) are those that have a liquidity profile and corresponding dollar size that fit the constraints of the MSE. One such deal that we are in the final steps of completing is the reverse takeover by Eurofeu Asia LLC.

Mark: Yeah, you guys have been working very hard to push through Eurofeu, which is the first reverse merger listing in Mongolia. We’ve been tracking that pretty closely. (Note: In full disclosure to our readers, Chris and I will be buying a position in Eurofeu, pre-IPO from the broker, as will our CPAN members.) What have you learned from that process, and will you be looking to do more of these?

Eric: The Eurofeu RTO (reverse takeover) has been an interesting process to be part of. We had the first formal shareholder meeting (of the shell company) in April 2012 and submitted our application to the FRC at the end of May. Here we are in January 2013 consummating the transaction and effecting the listing.

I have completed RTOs on international exchanges in the past. Incredibly, the required steps in having this one done in Mongolia are not at all different than say on the TSXV. Audited financials, shareholder approvals, listing document, regulatory review and approval and finally listing; it has been the required time to navigate locally which has been surprising. Interestingly enough, the listing document that we submitted to the FRC (Financial Regulatory Commission) in Mongolia was 263 pages (all Mongolian) vs an Offering Document to the TSXV that is much shorter.

Seeking out attractive, high-quality, private companies in Mongolia that are interested in listing (and raising capital…ie the basis of being listed) is something that we will continue to do. We have been in discussions with another private company in Mongolia, non-resources, 20+ years experience in the consumer products space (ie dairy) that has been exploring the idea of listing with us through RTO; we hope to bring that to investors in 2013. In fact, you and Chris accompanied us to the dairy operation during your Meet Up in Ulaanbaatar last July.

Mark: Yes, that was a very interesting, and smelly site visit!

Eric: (Laughs)

Mark: Free float is a very misunderstood thing on the MSE. For example, APU, the largest beverage producer in the country has a free float of 7%. Frankly, if the MSE wants to evolve and see liquidity again this will have to change. When Eurofeu lists, how can investors be sure that the stock remains liquid?

Eric: The success of an issuer is related to a number of factors, not simply limited to liquidity. It’s also company marketing, trading support, research, strong company results(!), sound management, good governance, free float (linked to liquidity), etc.

Many of the currently listed companies on the MSE have some but not all of the above characteristics. As Eurofeu comes to list and begins its life as a publicly-traded company, our objective is to assist and monitor all of the above ‘requirements’ of a successfully traded public company. Many of these factors are within our control and with our experience of listing companies internationally over the last 10 years, I think Eurofeu has the chance of a much stronger start as a listed company versus others on the MSE (and may even become the “one to own” in 2013).

Mark: Eric, You have a robust team of locals who have sourced some very exciting deals, though due to bureaucracy of various kinds it takes months do to an RTO or even an IPO. When passed, how will the Securities Law fix the inefficiencies in the system? Will we see a new, streamlined process for listing?

Eric: The ResCap team comprises a great group of individuals each bringing different strengths. We have spent a good deal of time over the last 2 years looking at various private companies in Mongolia as potential candidates for public listings. We are governed by the existing Securities Law (which is expected to be upgraded in the short term based on principles adopted from the London Stock Exchange) and as a result the process for listing companies is long and not well understood in Mongolia. However, this is changing. While the listing of Eurofeu has taken the better part of the last year to complete, ResCap Securities has been through the process and understands where it can become more efficient.

I expect the new Securities Law will theoretically have all of the right components (ie addressing minimum free float, independent directors, ongoing company disclosures, etc) to make the MSE an efficient trading venue, but it will take time to incorporate and expectations need to be managed.

Mark: It is no surprise to those of us focused on Mongolia that lending is expensive, 25+% in some cases. So when companies need capital it is absurd for them to go to a bank. With the passage of the securities law I have to assume that the corporate bond market will blossom, whether anyone wants to buy the paper is a different story. How could this potentially impact the MSE? Will people prefer debt over equity?

Eric: We have to note the difference between the bank lending market and corporate bond market. The headline rates that we have come to see in the past have been upwards of 25% (or higher), and as a result have constrained some of the ability of good projects to obtain financing. However, I would caution that on a risk adjusted basis, a 25% rate for illiquid, private opportunities may not always be unreasonable compared with the implicit cost of equity capital for the same project being much higher. The banks have protected themselves against risk as well as inflation, which is in the low teens (25% is a local currency rate).

The MSE has been upgrading its identity to include corporate debt trading. This has actually been a large dollar amount of issuance (ie tens of millions of USD), but it has nearly all been absorbed by the local commercial banks, and the issuer has been the government. I understand this is the starting point of the treasury management in country.  Corporate issuers are beginning to consider the local bond market, but again the liquidity and institutional depth is still an issue for them in being able to raise large enough pools of capital.

I expect the bond market will develop but again this will take time. One of the barriers to the bond market blossoming is around risk appetite: investors that we typically know who are seeking Mongolian exposure, are attracted by the risk/reward profile and usually see the balance of probabilities in the favour of outsized returns. A capped, single digit (or low teen) yielding corporate bond on the MSE may not be enough to entice foreign investors to participate, particularly in the face of similar (if not higher inflation rates) resulting in negative real returns.

Mark: The government recently auctioned off US $1.5 billion in bonds at (comparatively for Mongolia) really low interest rates. The offering was massively over-subscribed, so I guess it was a major success no matter how you look at it. Yet we think the success is more a statement of the lengths that money managers will go to for yield these days. This all just seems a bit surreal to us. What’s your take on it?

Eric: Without a doubt, the closing of any US$1.5 billion transaction is a success. This was a very large amount of money raised in a short amount of time, and it is commendable. The drivers behind this success should be looked at in closer detail and I believe that you have identified the most important one already – capital flows.

A Mongolian financing of US$1.5 billion will need to be raised in the international capital markets. In 2012, ongoing nervousness around the state of the global economy, US election and fiscal cliff, softening by China, etc all contributed to general investor angst for risk. Capital had been flowing into bonds from equities for an extended period of time. Consequently, a need to deploy this capital by international bond managers was only exacerbated as more dollars kept flowing into bonds. The phrase “chasing yield” was commonly used, and Mongolian was fortunate enough to find itself in a great period to be raising money through fixed income.

The rates on the sovereign bond were very low (and priced for perfection!), just below 5% on the shorter dated 5-year bond. As investors refocus towards risk in the future (maybe 2013?) we will see fund flows back to equities and the situation potentially reverse itself. The market has always cycled, and will cycle again.

Mark: Rescap, like a lot of Mongolian brokers and IB’s is pretty resource-focused. Given the issues with the OT contract and the as-of-yet unsettled foreign investment law, what are you telling your institutional clients?

Eric: The recent foreign investment law (May 2012) was a function of the ill-timed South Gobi attempted sale to Chinalco (April 2012), and lead up to the national election (June 2012) where nationalistic principles became the easiest platform to campaign on. The OT contract is the single most important contract in Mongolia and is the focus of public debate. As we gear up for the Presidential election (June 2013), I expect we will continue to see political jostling and rhetoric around supporting nationalistic principles.

I continue to have my clients focus on the long term fundamentals of the country and remind them that Mongolians are largely entrenched in the success of their own businesses and foreign investment. The technical strengths of the country are phenomenal vis a vis the geology. It is not unfeasible to see another “OT” be discovered in Mongolia. These are 60+ year mines with transformational effects on the country. A few months of political instability, knowingly tied to elections, is a short term impact of a highly contested democratic environment.

Mark: Eric, you also co-manage the MSE Liquidity Fund. The Tugrik has been struggling a bit, as have equities. We imagine it is tough running a fund with a mandate to generate yield and capital gains in that environment. How are you coping with market conditions that I would equate to the doldrums? (for those sailing types among our readership). I understand that the fund has returned approximately 10% in the face of a tough market?

Eric: The MSE fund is a hybrid of equities and fixed income. We don’t purport to know more than our investors regarding internationally listed equities, so we don’t (and are not mandated to) buy them. We focus only on MSE equities where we can add value to investors who are not on the ground on a day to day basis.
We also invest in commercial bank deposits and have negotiated what we consider incredible money market rates in the top Mongolian commercial banks.

Examples of some of the MSE Liquidity Fund’s holdings are positions in Remicon (where we negotiated an entry price 10% lower than the current traded day rate by doing a block trade), APU, commercial bank deposits at above 18% (local currency) and 10.8% in USD over 12 months. While the MSE was down approximately 25% in 2012 and many of our peer funds were down by between 20-60%, we returned approximately 13% net to investors (in USD) while also facing the headwind of a slightly weaker currency.

Since inception in October 2011, the MSE Liquidity Fund has had 14 out of 15 positive monthly returns. The fund has an NAV of approximately $7 million and redeemable on a quarterly basis with no front or back ended fees with subscriptions monthly.

We positioned the MSE Liquidity Fund to take advantage of very specific situations that we have identified and harnessed in Mongolia. The fund has a very strong balance sheet and we deploy capital in situations where we can closely monitor the investment, similar to a merchant banking type of approach.

Mark: In your video recording from our Mongolia: Boots on the Ground Meet Up you commented that Mongolia’s fundamentals are compelling. Given the political challenges, the slowing of China’s economy (and everyone else’s) and the seemingly ever-present tendency toward “nationalism”, do you still feel the story is unchanged?

Eric: I look at the fundamental aspects of the opportunity: Mongolia is rich in resources and largely unexplored. I look at the past discoveries made: Mongolia has the potential to host world class assets (Oyu Tolgoi and Tavan Tolgoi). Then I look at the playing field I am participating in: Mongolia is a democracy (for better or seemingly worse in this case) where the rule of law stands. The recent issues around nationalist views are related to the democracy that governs the country:  this is Mongolia’s “coming out” period and Mongolians are trying to do whatever it takes to be sitting at the top when it happens.

Mark: Thanks as usual Eric for your timely insights!

Eric: My pleasure Mark.


Chris and I realize we beat Mongolia’s drum a lot, but when something is working, or about to work, you stick with it.

The most spectacular wealth building investments are usually very narrowly-focused trades. Soros on the Pound, Paulson on China, Kyle Bass on the housing bubble, etc…

This is one of the core lessons we talk about in our Crash Course. When you’ve done your homework and you identify an opportunity, go for it. Hesitation is for losers.

That being said, don’t misunderstand us; Mongolia is not the only place we are suggesting investors should look for deploying capital. Cambodia, Myanmar, Nepal, Sri Lanka, Vietnam, Fiji, Georgia…all these places contain opportunities. It’s best to REALLY get to know a place, do your own exhaustive research and then pull the trigger.

For those that like the idea of Frontier Markets but can’t quite get their head around how to do the reasearch, check out funds from folks like our friends at Leopard Capital. We just interviewed Leopard Asia’s Thomas Hugger, in How to Invest in Frontier Markets.

Until next time…

– Mark

“I am just a nice, clean-cut Mongolian boy.” – Yul Brynner


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