Asia Insight

May 2007

Vietnam: Appealing in Theory, Challenging in Practice

David Harding, CFA, Managing Director
Matthews International Capital Management, LLC

A fundamental appeal of investing in emerging economies is the ability to participate in economic growth rates that can be considerably higher than those experienced in the developed world. The challenge for investors is that, despite the proliferation of exotic derivative products, nobody has yet invented a warrant on economic growth. Some current alternatives are to start a local business, invest in property or other assets in the country, or participate through the capital markets. But stock markets can be an inadequate and imperfect reflection of the overall real economy. Nowhere is that more evident today than in Vietnam.

Just as nightclubs long ago discovered that a doorman and a velvet rope could enhance appeal simply by restricting access, one could argue that part of Vietnam's status as today's hot new emerging market is based on the limited ability to participate in its growth. As described in more detail below, the stock market is relatively small, difficult to access and illiquid.

Vietnam's status as the 'next big market' inevitably draws comparisons to its neighbors – is it the next China, or the next Thailand? Participating in a recent investment conference in Hanoi and Ho Chi Minh City, I found economic and development parallels to those countries, but also to Malaysia, Singapore and the Philippines; meanwhile the parabolic direction of its stock market draws comparison to Taiwan and Indonesia in the late 1980s. Those parallels are instructive, but can also be misleading – Vietnam is its own country, with its own set of opportunities and challenges. Recent growth has been impressive; GDP growth over the last ten years averaged 7.1%. A word on this and all subsequent statistics: the old saw about lies and damn lies has particular relevance to emerging markets. Consider carefully the accuracy of the statistics given the paucity of reliable data and speed of change.

Certainly the country appears to have all the ingredients for success; a domestic population of 85 million, shifting from rural areas into the cities, a young growing workforce (half the population is under 30), natural resources (crude oil is more than 20% of exports), and a labor cost advantage over many of its wealthier neighbors. In addition, there have been several catalysts for positive change; the original Doi Moi reforms begun in 1986, the removal of the trade embargo with the U.S. in 1994, and most recently accession to WTO in January 2007. The last brings comparison to China, whose accession to WTO in 2001 has been seen as a major driver of reform, especially in the financial sector. The political environment is also positive; President Triet and Prime Minister Dung are from the South, youthful by the standards of Vietnamese politics, and both considered pro-reform.

As the economy moves down the path of development what are some of the key challenges? There are many, but two worth noting have parallels with India and China respectively; infrastructure and State Owned Enterprise (SOE) reform. Infrastructure is being upgraded, especially in the South. Ho Chi Minh City is expected to have a new international airport in 2011 (assuming it is built on time), and a deep water port is being expanded to the southeast of the city. With those projects and light industry development, the city is gravitating eastwards. But eight million scooter riding residents aspiring to cars will make Bangkok's legendary traffic jams pale in comparison. In addition, property appears staggeringly expensive for a relatively poor nation. We heard prices for older houses in central Ho Chi Minh City range between $1 and $3 million. The fundamental problem is lack of supply, and solving the housing needs of the future means greater density. Foreign developers, including Singaporean and Korean firms, are capitalizing on the trend with condos and planned townships.

Vietnam is already making strides toward SOE reform. Beginning in 1991 the 12,000 SOEs were restructured, with most liquidated. Progress stalled in the late '90s, only to resume again in 2001. Today there are around 2,200 accounting for 31% of GDP. Last year the government established the State Capital Investment Corporation (SCIC) modeled in part on Temasek, the Singapore government investment company. While the plan is to retain complete control of 554 enterprises, SCIC will now take a central role in the next stage of reform, restructuring the other SOEs through a mixture of liquidation and equitization.

If the foregoing piques your interest, understand that accessing the market as a foreign investor remains a challenge. Ownership of property by non-resident aliens is not permitted. The country has nearly 3,000 quoted companies, which sounds impressive, but then imagine a version of the pink sheets in the U.S. with few trades and even fewer published financials. There are 100+ companies listed on the Ho Chi Minh City Trading Center, but the great majority have a market cap less than $100 million. Foreigners investing directly have to trade exclusively through one broker, a system ripe for poor execution and front running abuse. In 2001 there were only five listed stocks and seven brokers. Today there are 35 brokers, with licenses for 20 more, so it is hoped that the one broker rule will be eliminated in the future. Finally, value buyers will quickly lose interest: the market trades on over 30 times 2007 earnings, with banks on 6-10 times book value.

The good news is the government's ambitious equitization plan and the currently insatiable foreign demand for Vietnamese equities should combine to result in a market that by the end of this decade will be several times larger than today (don't forget that size is one measure, performance of individual companies something entirely different). SCIC's plan for 2007 assumes a pipeline of companies including banks, breweries, insurance, construction, sugar and fisheries worth about $10 billion, close to the total current capitalization of the market. In fact, a key risk is that companies listed today could be derated and liquidity dry up as interest shifts to more exciting listings in the next few years, as happened in Indonesia between 1989 and 1992.

It's hard not to be optimistic about Vietnam as an economy – it has rates of growth and fixed capital formation close to China, a young and growing workforce with higher standards of basic education than India, natural resources like Malaysia and Indonesia, and an expanding manufacturing base. But it's important to temper this enthusiasm with the reality of the challenges of investing in this nascent stock market. Key companies aren't even listed, those that are have a substantial scarcity premium, and transparency and corporate governance are limited.

May 2, 2007

The view and information discussed in this article are as of the date of publication, are subject to change and may not reflect the writer's current views. The views expressed represent an assessment of market conditions at a specific point in time, are opinions only and should not be relied upon as investment advice regarding a particular investment or markets in general. Such information does not constitute a recommendation to buy or sell specific securities or investments vehicles.