Outside Looking In: Early Stage Private Equity

Thursday, Mar 22, 2018 09:02

Brian Spence

I like to use "Early Stage PE" here because "Venture Capital" has a connotation of high risk and/or tech investments which belong in Boston or Silicon Valley. Coming from the UK, I understand Venture Capital quite well and I believe the opportunities in Viet Nam do not have to be "high risk" nor "tech" to achieve the returns normally reserved for Venture Capital investments.

There is a gap in the early stage investment market in Viet Nam. I believe the reasons are twofold. First, local investors culturally have a short investment horizon, and therefore, lack the patience and long-term discipline to earn venture-type returns. Second, foreign investors, who have the patience and discipline but need to invest more money, cannot source the appropriate deals.

The solution, then, is to optimally compromise on the investment horizon as well as investment size. The goal here is to make more smaller deals work. As a result of doing more smaller deals, the investment size over the total number of deals does not necessarily decrease. Moreover, because Viet Nam is such a robust market, doing more deals will not decrease overall performance either.

This model doesn’t work economically in the US or other mature markets because labour is too expensive relative to growth. Consider GDP/capita of US$57,000 and growth of 1.5 per cent yields a cost of $38,000 for each 1 per cent of growth in the US. In Viet Nam, this number is only $350. Theoretically, because the US is 100x more expensive than Viet Nam, we could hire 100x more people in Viet Nam! Put another way, if we hired five people in Viet Nam at double the cost then we’d still be operating at a 90 per cent discount than the US. The lower cost of labour in Viet Nam allows us to do more (smaller) deals, assuming we can source them...

Sourcing deals anywhere is a matter of perspective and access. In Asia in general, and especially in Viet Nam, it is particularly difficult for foreigners to access local or regional deals. These deals are attractive because valuations are reasonable and sometimes depressed for no logical reason. Deals that come to Ha Noi or HCM City normally have a series of brokers, which increases costs. Furthermore, the array of competing buyers usually drive valuations to levels suitable for western investment markets.

To put everything together in an example, consider mining. Foreign investors usually like larger mines because investment sizes can be larger. However, larger mines face tougher regulatory requirements, where the majority of the risks lay. Smaller mines are not attractive due to their smaller investment sizes and therefore are usually invested by smaller local investors. Smaller investors are usually capital constrained and lack the experience to maximise financial gain. To compromise on both sides here, we could invest in a series of small mines at a lower cost than an equivalent larger mine. As a result, gains would also be higher. We have executed on this model and are currently considering several series of smaller mines and quarries around the country.

There are many other examples of exceptional early stage private equity investments in diverse industries including media, manufacturing, distribution, pharmaceuticals, medical services, IT & data analytics, energy, etc.

* Brian Spence is Managing Partner of S&P Investments. He has over 35 years’ experience in the UK financial services industry as an investment manager, financial planner, and M&A specialist. He is a regular contributor in the UK financial press and has a deep understanding of the financial services community. Brian’s column will reflect on all the challenges and opportunities within the Vietnamese market, bringing a fresh perspective to today’s hottest issues. The columnist’s email is brian@sandpinvestments.com.

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