Cover story: Investing in Vietnam’s growth

This article first appeared in Personal Wealth, The Edge Malaysia Weekly, on December 9, 2019 - December 15, 2019.
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Investments in Vietnam have been gaining traction in recent years, but the biggest story may lie in its private markets. In just two short years, the country has jumped to the third most active start-up ecosystem from the second least active among the six largest Asean nations, only lagging behind Indonesia and Singapore, according to a report by Cento Ventures and ESP Capital in August.

More venture capitalists (VCs) are eyeing the market as they believe that is where the action is. “We see enormous potential in Vietnam, with strong socioeconomic macro [factors] driving the growth of a large, young, digital-first, consuming middle class. This alone would catch the attention of any investor. But coupled with the magic ingredient of a large, experienced, returning diaspora, these factors make the country super interesting,” says Justin Nguyen, partner at Monk’s Hill Ventures in Vietnam.

The country saw its first unicorn in 2016, when online entertainment and e-commerce portal VNG Corp reached a valuation of US$1 billion. It counts Singapore’s state investor Temasek and Tencent Holdings Ltd among its investors. Other notable and well-funded start-ups include e-commerce site Tiki, e-payments start-up VNpay and e-wallet service provider Momo.

According to the Cento Ventures and ESP Capital report, the amount of capital invested and number of technology deals done grew sixfold from 2017 to 1H2019. Foreign investors, especially those from South Korea and Singapore, have been pouring funds into Vietnam.

“The Singaporean and Malaysian markets are mature and saturated. Indonesia’s is not quite as saturated yet, but it is getting there. With the big influx of capital into Indonesia over the past few years, valuations have been frothy and deal flow has been difficult. So, Vietnam has become the ‘next’ market [to invest in] in Southeast Asia,” says Eddie Thai, partner at 500 Startups Vietnam, which launched a Vietnam-focused fund in 2016.

“Vietnam has a fairly unique place in the world in that there is a high quantity of STEM [science, technology, engineering and maths] talent in an emerging market context. That makes the country a potential innovation hub, not just for its own market but also for other emerging markets around the world.”

Another driving factor is the Vietnamese government, which has been actively supporting start-ups. Last year, it directed ministries to explore how regulations could accommodate new business models, such as those in the sharing economy.

“The government is very supportive of new business models because it understands these will be an integral part of the economic development going forward if it wants to sustain the 7% GDP growth. That is why I am very bullish on the country,” says Khanh Tran, a partner at Vietnam-based VinaCapital Ventures, which was set up last year.


Factors driving flood of private money

Many VCs point out that Vietnam’s huge pool of young talent is one of its unique features. The country has a large, educated talent base as well as a returning diaspora equipped with experience from abroad.

“Look at international maths and science competitions and you will find a disproportionate number of Vietnamese students on top. A lot of these students end up furthering their studies overseas. However, unlike a lot of countries, where the best and brightest go to school abroad and stay there, these Vietnamese students return,” says Monk’s Hill’s Nguyen.

“Along with them, people like me — who left as children — are returning to the country. And along with me, millennials who were born overseas are also returning to the land of their parents. They all bring rich experiences and perspectives from abroad.”

This group of people represent a generation of start-up founders that VinaCapital Ventures’ Tran likes. “These are young guys who come back with the awareness of the gap between Vietnam and the rest of the world. They are bringing their knowledge to fix the gap,” he says.

Another wave of start-up founders that he likes are those who founded companies five or seven years ago and most likely failed in building up their ventures. “They failed because the infrastructure and adoption of technology were not there. These guys are probably second or third timers in starting something new. To be honest, Vietnam five years ago was very different from what it is today,” says Tran.

VinaCapital Ventures comes under multi-asset investment firm VinaCapital, whose prominent funds include the London Stock Exchange-listed Vietnam Opportunity Fund. VinaCapital was among the first wave of investors in Vietnam’s private markets in the 2000s.

“Back when IDG Ventures Vietnam [the first venture capital firm in the country] came in, there were only about four million internet users, GDP per capita was US$1,000, e-commerce was virtually non-existent and Facebook had not expanded internationally. But when it did a couple of years later, it was blocked in Vietnam. There were few technology entrepreneurs and they were relatively inexperienced and disparate,” says 500 Startups’ Thai.

Now, there are 10 times the number of internet users and two times the GDP per capita, widespread use of technology and better founders, he adds.

When was the turning point? Tran thinks that was when Uber and Grab ventured into the country. For the first time, the Vietnamese started performing utility functions on their smartphones instead of just using their devices to text or scroll through the web.

“It was the first time people started to book rides via their smartphones. Very quickly after that, they started to pay [for things] with their phones. Then, many new business models came up in Vietnam, whether it was replicated from China or Southeast Asia. That is why this is the best time for these experienced founders to start [businesses] again,” says Tran.


Attractive sectors in private markets

There are a lot of inefficiencies in industries across Vietnam that can be solved with technology, according to the investors. For Tran, the biggest opportunities are in logistics, retail and financial technology (fintech).

“There is a huge asymmetry of information between supply and demand. For example, 70% of trucks will return empty [to their stations]. This creates pollution [and lost opportunities to maximise utilisation of resources]. The cost of logistics also becomes high, at about 25% of GDP. Compare that with Singapore or Malaysia, where it is about 10%, and China, where it is at 15%,” he says.

That is the reason he invested in Logivan. “It is like Uber for trucks. It matches supply and demand in the trucking business. Another company we invested in — An Vui — does the same for long-haul buses on which people commute,” he adds.

In retail, the opportunities lie in bringing modern trade to rural villages, many of which still rely on mom-and-pop stores. As for fintech, the more than 60% of unbanked population in Vietnam represents a prime target for tech solution providers.

One of Tran’s portfolio companies, Wee Digital, addresses this pain point by providing biometric solutions for banking services. Using this technology, the unbanked who live in rural areas no longer have to make long trips to bank branches just to open an account.

“They are working closely with the state bank to make sure biometrics is part of the know-your-customer methods. In the future, the farmers just need to take a picture [of themselves] using their phone and send it to the bank,” says Tran.

As at November, VinaCapital Ventures had US$100 million under management and 10 companies in its portfolio. It plans to start its second round of fundraising next year.

Healthcare is another major sector for investors in Vietnam. Most hospitals are located in big cities and the stretched healthcare system results in long commutes and crowded clinics.

Monk’s Hill invested in digital health start-up Jio Health to tackle this issue. The company’s app allows patients to input their symptoms, order a consultation and receive an in-home visit by a physician. Medicines can be prescribed and delivered immediately for simple diagnoses.

“Jio Health is one of our portfolio companies as its founder, Raghu Rai, is solving a big problem by bringing quality healthcare and convenience to a large population that is still paying high out-of-pocket costs,” says Nguyen.

While many of the investment themes in Vietnam are similar to those in the region, education is one sector that stands out, according to the Cento Ventures and ESP Capital report. For instance, ELSA (English Language Speaking Assistant) is a start-up that uses technology to help users improve their pronunciation and train them to modify their accents so as to be better understood. It was one of Monk’s Hill’s maiden investments in the country last year.

“We were very inspired by its founder, Vu Van. When she left Vietnam to study at Stanford’s Graduate School of Business, she realised that although she was extremely proficient in English, she had a difficult time being understood when she spoke because of her accent,” says Nguyen.

“She dug deeper and realised accents not only discouraged speaking and further learning but also —equally, if not more harmful — created disparities and distrust in the workplace. Dissatisfied with the only solution she found, which was one-on-one accent coaches, she set out to solve this huge problem using tech.”

Google’s artificial intelligence fund and 500 Startups Vietnam has also invested in ELSA.

Trusting Social, an alternative credit scoring start-up that also operates in Indonesia, India and several other emerging markets, is another of 500 Startups Vietnam’s portfolio companies. 500 Startups Vietnam closed its US$14 million fund last year. It had 50 portfolio companies and two exits as at September.

There are still many overlooked sectors in Vietnam, Thai observes. “This includes second-order business-to-consumer players in fintech that do lending, insurance and investment, as well as those in edtech, healthtech and business-to-business SaaS [software as a service].”


Looking for the next unicorn

The primary channel for exits in Vietnam is currently mergers and acquisitions (M&A). There is an appetite to acquire smaller businesses among the conglomerates in the country and the region, say the VCs.

“It is not just local conglomerates but also South Korean, Japanese and Singaporean companies. They want to penetrate the Vietnamese market and the only way they can get access and reach is through M&A,” says Tran.

There is also a growing number of regional investors who want to invest in later-stage start-ups.

VinaCapital’s first venture capital set-up — DFJ VinaCapital — delivered a gross internal rate of return of 24% for the 10 years since 2007, according to Tran. He thinks VCs in Vietnam can achieve similar returns in a shorter time frame and he hopes to achieve that target with the current fund.

But will the influx of money into the market distort the valuations of start-ups? Tran admits that there is currently a lot of hot capital. “Every time there is a foreign investor in my office, I tell them that they need a local partner. You can partner anyone local, just make sure you do not overvalue or overpay [for a start-up]. If you do, it is not good for anyone,” he says.

Similarly, Thai believes that VCs need to get on the ground by hiring local staff or visiting Vietnam frequently. They need to avoid the hype. “Valuations have got out of hand largely because foreign VCs are crowding towards just a handful of start-ups,” he says, adding that these are his personal views and not necessarily those of 500 Startups.

Regulations can also pose a risk to investors. Thai points out that the process to approve and close a foreign investment in a local company can take two to three months. The time frame is longer for companies in regulated industries.

Regardless, the Vietnamese market is considered to be at a nascent stage, with a small but growing number of exits and an increasing number of start-ups approaching later stages, says Thai. “Despite the recent influx of venture capital interest, it is still fairly early in Vietnam’s start-up scene with a lot of upside potential. And this is happening in the midst of a broader rising tide in the country. The minister of planning and investment has recognised this as a ‘once in a millennium opportunity’ for the economy.”


Opening up the equity market

Vietnam is said to be the biggest beneficiary of the US-China trade war, which boosted its economy by almost 8% year on year in the first quarter of 2019, according to some estimates. But the country had already experienced an economic boom in recent years and is offering attractive propositions to investors.

Some compare Vietnam’s growth to China’s in the 1980s and 1990s. The former is expected to be one of the fastest expanding economies in the next decade, with an average annual GDP growth rate of 7%, according to a Standard Chartered report in May. This will put it in the 7% club alongside countries such as India and Bangladesh.

“The Vietnam equity market is underpinned by robust economic growth. The economy expanded at an average growth rate of 6.1% per annum over the 10 years to 2018, with growth projected to exceed 6% per annum this year and next,” says Lum Ming Jang, chief investment officer at Public Mutual Bhd, which recently launched the Public Vietnam-Global Equity Fund (PVGEF).

A few factors are driving his confidence in Vietnam, he adds. This includes a healthy current account balance, relatively stable inflation and a young population. Up to 72% of the country’s population is between the age of 15 and 49, according to 2018 government data.

“Last year, Vietnam attracted foreign direct investment (FDI) inflows of US$15.5 billion, the third highest in Asean due to its business-friendly environment, attractive investment incentives and competitive labour costs,” says Lum.

Investors are paying attention. Vietnam’s main stock index — the Vietnam Ho Chi Minh Stock Index (VN-Index) — was among the top three performers in the region this year. “The VN-Index had gained 12.5% year to date [as at November]. Notably, the index managed to stay above the psychological level of 1,000 points for most of the trading days in November, with a greater probability of moving higher towards the end of the year as well as into 2020,” says Lien Le Hong, head of institutional research at Maybank Kim Eng Vietnam.

Lum observes that Vietnam’s equity market has seen its market capitalisation expand 26% per annum [as at October] over the past five years to US$194 billion (RM809.9 billion). The VN30 Index registered an annualised return of 11% (in ringgit) for the five-year period. According to Bloomberg, the annualised return was 6.9% (in ringgit) for the previous five-year period.

The positive growth numbers are expected to continue. “Given the positive developments of the macro picture, strengthened corporate earnings and positive momentum being built, we look forward to the VN-Index moving up higher. Returns for 2020 may be more positive than in 2019,” says Lien.

A potential driver of growth is a possible status reclassification. Vietnam is categorised as a frontier market by major global equity indices. But as the market’s size and liquidity has grown, the FTSE Russell and MSCI are considering reclassifying the country as an emerging market, which would attract more capital from global emerging market funds.

“Vietnam is one of the largest frontier markets in Asia and the sixth largest in Asean, with a market capitalisation of US$194 billion as at Oct 31. As Asean is the third largest trading bloc after the US and China, global investors will increasingly look for opportunities in Vietnam as its stock market continues to grow,” says Lum.

“Frontier markets generally suffer from a lack of investable stocks and investment research support as well as thin liquidity. Compared with other frontier markets in Asia such as Bangladesh, Sri Lanka and Kazakhstan, the Vietnam market has shown the most improvement in these aspects in recent years.”

On top of that, MSCI requires the country to liberalise its market as a criteria for an upgrade. This addresses a major pain point for foreign investors — the foreign ownership limit on companies. The cap varies depending on the industry, with sensitive sectors such as banking having a higher cap.

Since 2015, the limits imposed on many non-critical industries have been removed. Shareholders are allowed to decide on the cap for their company. Last month, the government passed the Revised Securities Law, extending the definition of securities to include depositary receipts and allowing regulations on non-voting depositary receipts to be set up, which increases the potential of the foreign ownership limit being raised.

But there have been challenges. Over the years, many companies have opted to not completely remove the cap as it could change their status to foreign companies and make them subject to stricter rules, according to reports. While the revised law takes effect in January 2021, there is no clear timeline for its implementation, says Lum.

“As a number of large index stocks in Vietnam have reached their foreign ownership limit and are not open to investment by foreign investors, our fund will complement its holdings in local stocks with exposure to the global markets to offset any volatility,” he says, adding that PGVEF will invest at least 30% of its net asset value in Vietnam markets.

The fund invests in the financial, consumer, real estate and industrial sectors, among others. Banks in Vietnam are poised to benefit from the greater demand for loans amid the country’s rising per capita income, Lum observes. The consumer sector is supported by the nation’s young and growing population.

“Real estate companies are set to benefit from the country’s growing population and increasing per capita income while retail mall players are poised to benefit from higher consumer spending. For industrials, selected companies may be well positioned to benefit from the shift in Chinese and multinational companies’ manufacturing facilities to Vietnam,” he says, adding that PGVEF will invest in sectors that are expected to outpace the broader markets outside of the country.

Lien recommends buying stocks of companies that uphold higher than average corporate governance standards and have diversified shareholder structures, where management’s interests are aligned with those of other shareholders. There are many companies that fulfil these criteria and still have reasonable or cheap valuations, she says. “For example, the top large blue chips in Vietnam are trading at a 10% discount to their five-year mean and a 20% discount to their regional peers while still holding superior market leadership.”

These companies include dairy industry leader Vinamilk, the Airports Corporation of Vietnam (ACV), which owns and operates most of the major airports in the country, and Petrolimex, which owns many petrol stations in premium locations. “Foreign investors can still find at least 15 mid caps that are trading at a 40% to 50% discount to their regional peers, yet being leaders in their respective industries or sub-industries,” says Lien.

The best and most common way for investors to access Vietnamese markets is to open an account with brokers to buy blocks of stocks directly, she observes. It is more challenging for foreign investors but, if chosen correctly, the investments will be worth it.

VinaCapital’s Vietnam Opportunity Fund, which invests in listed companies as well as private equity, has most of its asset allocation in real estate and construction (19.2%), food and beverage (16.6%) and construction materials (15.5%). Its top holdings as at October are Hoa Phat Group, Khang Dien House and ACV.

In the near term, any slowdown in global and regional trade as a result of the US-China trade tensions could negatively impact Vietnam’s growth outlook as its economy heavily relies on exports. However, in the long term, consumption expenditure is expected to chip away at that dependence, Lum observes.