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FRONTAURA CAPITAL LLC
FRONTAURA GLOBAL FRONTIER FUND LLC
FRONTAURA GLOBAL FRONTIER FUND OFFSHORE LIMITED
Managing Frontier Market Portfolios
Nick Padgett, Managing Director, Frontaura CapitalCFA InstituteInvesting in Africa Traveling Conference SeriesFebruary 2013
Frontaura Capital LLC180 North Stetson Avenue, Suite 1935Chicago, Illinois 60601 USATel: +1 312 777 1500Fax: +1 312 268 [email protected]
© 2007 - 2013 Frontaura Capital LLC
Most of the world’s stock exchanges are frontier
2
70% of countries with stock exchanges are not represented in the
MSCI All-Country World Index
Frontier markets are stock markets, categorized by country, that leading index providers typically do not classify as either “developed markets” or “emerging markets”
MSCI World Countries
MSCI Emerging Countries
MSCI Frontier Countries
Other countries with stock exchange
Countries with no stock exchange
Frontier = 30% of world’s population;13% of world’s GDP, but <3% of global market cap
Source: IMF World Economic Outlook October 2012 for 2012 population and GDP estimates.
Market capitalization data through 11 October 2012 if present on Bloomberg. World Bank World Development Indicators database 2011 used to supplement Bloomberg.
Market cap shown is the total market cap for all of the countries in each group, not just the total market cap for the companies within the MSCI index.
3
MSCI Developed Countries
MSCI Emerging Countries
MSCI Frontier Countries
Other Countries w/ Stock Exchanges
Countries w/ No Stock Exchanges
14%
56%
12%
13%
5%
World Population(6.9 billion total)
46%
41%
6%6% 1%
World GDP ($83 trillion total, PPP)
75%
23%
1% 1%
World Market Capitalization($50 trillion total)
Frontier Potential
Why invest in frontier markets?
4
Participate in the world’s fastest growing economies 23 of 25 fastest growing countries over next 5 years are frontier
Capture additional returns by exploiting market inefficiencies Volatility and inefficiency allow for favorable entry and exit points
Benefit from favorable return characteristics Dividend yields are high Low PEs are plentiful as there is a wide dispersion in valuations
between and within countries High Return on Invested Capital companies with favorable earnings
growth exist
Complement existing developed and emerging market positions Frontier countries comprise 30% of the world’s population, 13% of the
world’s GDP, but <3% of the world’s market capitalization
Today’s frontier markets are tomorrow’s emerging markets
The fastest growing economies are frontier countries
The end of the Cold War, a step change in communications infrastructure, and significant cost advantages are allowing the least developed countries to grow the fastest
5
Of the 25 countries with local stock markets that are projected to grow fastest in 2012 - 2017, the MSCI All-Country World Index only captures 2
Source: International Monetary Fund October 2012
UzbekistanMyanmarVietnam
IndonesiaSri Lanka
BangladeshNigeria
PanamaTanzania
Burkina FasoCambodia
RwandaCôte d'Ivoire
ZambiaGhana
MozambiqueNigerLaos
Papua New GuineaChina
Sierra LeoneIraq
BhutanMongolia
Libya
0% 5% 10% 15% 20% 25%
25 Fastest Growing Economies 2012 - 2017
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
Real GDP Growth and Trends
Advanced economies
Polynomial (Advanced economies)
Emerging and developing economies
Polynomial (Emerging and developing economies)
MSCI Emerging Countries
MSCI Frontier Countries
Other countries with stock exchanges
Frontier markets are inefficient
Frontier markets are inefficient. Limited information coupled with limited liquidity drive major price / valuation swings.
6Volatility presents favorable entry and exit opportunities
Source: Bloomberg
Jan-
04
Apr-0
4
Jul-0
4
Oct-0
4
Jan-
05
Apr-0
5
Jul-0
5
Oct-0
5
Jan-
06
Apr-0
6
Jul-0
6
Oct-0
6
Jan-
07
Apr-0
7
Jul-0
7
Oct-0
7
Jan-
08
Apr-0
8
Jul-0
8
Oct-0
8-30.0%
-20.0%
-10.0%
0.0%
10.0%
20.0%
30.0%
40.0%
Monthly Returns
Ghana
Croatia
Vietnam
Bangladesh
S&P 500 Index
Frontier markets have favorable return components
7
Stock market returns are attributed to capital appreciation due to earnings growth and change in valuation multiples, plus dividend yield
Total Return = ∆ Earnings + ∆ P/E + Dividend Yield
Return Component
Frontier Market Attributes
∆ Earnings High GDP growth Growing middle class and integration of informal economy can provide
market growth > GDP growth for listed companies
∆ P/E Inefficient security pricing provides excellent entry and exit opportunities
High risk-free rates limit P/E ratios, but over time these rates will decline and P/E ratios will rise
Dividend Yield Frontier markets feature high dividend yields Frontier market companies often have high ROIC/ROE, allowing for
both high earnings growth AND good dividend yields
Frontier Markets offer potential for outsized returns
Frontier PEs often lower than emerging, developed
8
Source: MSCI data on Bloomberg
Jul-0
8
Sep
-08
Nov
-08
Jan-
09
Mar
-09
May
-09
Jul-0
9
Sep
-09
Nov
-09
Jan-
10
Mar
-10
May
-10
Jul-1
0
Sep
-10
Nov
-10
Jan-
11
Mar
-11
May
-11
Jul-1
1
Sep
-11
Nov
-11
Jan-
12
Mar
-12
May
-12
Jul-1
2
Sep
-12
Nov
-12
Jan-
13
0
5
10
15
20
25
30
Trailing Price to Earnings
MSCI Frontier MSCI Emerging MSCI World (Developed)
Frontier price/book ratios also lower
9
Source: MSCI data on Bloomberg
Jul-0
8
Sep
-08
Nov
-08
Jan-
09
Mar
-09
May
-09
Jul-0
9
Sep
-09
Nov
-09
Jan-
10
Mar
-10
May
-10
Jul-1
0
Sep
-10
Nov
-10
Jan-
11
Mar
-11
May
-11
Jul-1
1
Sep
-11
Nov
-11
Jan-
12
Mar
-12
May
-12
Jul-1
2
Sep
-12
Nov
-12
Jan-
13
0.0
0.5
1.0
1.5
2.0
2.5
3.0
Trailing Price to Book
MSCI Frontier MSCI Emerging MSCI World (Developed)
Frontier companies pay much higher dividends
10
Source: MSCI data on Bloomberg
Jul-0
8
Sep
-08
Nov
-08
Jan-
09
Mar
-09
May
-09
Jul-0
9
Sep
-09
Nov
-09
Jan-
10
Mar
-10
May
-10
Jul-1
0
Sep
-10
Nov
-10
Jan-
11
Mar
-11
May
-11
Jul-1
1
Sep
-11
Nov
-11
Jan-
12
Mar
-12
May
-12
Jul-1
2
Sep
-12
Nov
-12
Jan-
13
0
1
2
3
4
5
6
7
8
9
Trailing Dividend Yield
MSCI Frontier MSCI Emerging MSCI World (Developed)
%
Highest ROEs in emerging, frontier
11
Source: MSCI data on Bloomberg
Jul-0
8
Sep
-08
Nov
-08
Jan-
09
Mar
-09
May
-09
Jul-0
9
Sep
-09
Nov
-09
Jan-
10
Mar
-10
May
-10
Jul-1
0
Sep
-10
Nov
-10
Jan-
11
Mar
-11
May
-11
Jul-1
1
Sep
-11
Nov
-11
Jan-
12
Mar
-12
May
-12
Jul-1
2
Sep
-12
Nov
-12
Jan-
13
0
2
4
6
8
10
12
14
16
18
20
Trailing Return on Equity
MSCI Frontier MSCI Emerging MSCI World (Developed)
Frontier markets total return 2.4x since 2003
12Source: MSCI
Jan-
03
May
-03
Sep
-03
Jan-
04
May
-04
Sep
-04
Jan-
05
May
-05
Sep
-05
Jan-
06
May
-06
Sep
-06
Jan-
07
May
-07
Sep
-07
Jan-
08
May
-08
Sep
-08
Jan-
09
May
-09
Sep
-09
Jan-
10
May
-10
Sep
-10
Jan-
11
May
-11
Sep
-11
Jan-
12
May
-12
Sep
-12
Jan-
13
0
100
200
300
400
500
600
MSCI FM, EM, and Developed Returns(Monthly, USD, Total Return Net Dividend)
MSCI Frontier MSCI Emerging MSCI World (Developed)
Frontier markets underperforming since GFC
13Source: MSCI
Nov
-07
Jan-
08
Mar
-08
May
-08
Jul-0
8
Sep
-08
Nov
-08
Jan-
09
Mar
-09
May
-09
Jul-0
9
Sep
-09
Nov
-09
Jan-
10
Mar
-10
May
-10
Jul-1
0
Sep
-10
Nov
-10
Jan-
11
Mar
-11
May
-11
Jul-1
1
Sep
-11
Nov
-11
Jan-
12
Mar
-12
May
-12
Jul-1
2
Sep
-12
Nov
-12
Jan-
13
0
20
40
60
80
100
120
MSCI FM, EM, and Developed Returns(Monthly, USD, Total Return Net Dividend)
MSCI Frontier MSCI Emerging MSCI World (Developed)
Current environment may provide additional benefits
Developed world macro events will continue to impact frontier markets, but frontier markets have some structural advantages:
Corporate Deleveraging Reduced ROE as capital structures
are normalized Drag on GDP growth as banks
normalize balance sheets
Low corporate leverage ROEs are high due to competitive
advantage, not unsustainable leverage Banks in many frontier countries are well
capitalized and conservatively run
Consumer retrenchment Falling asset values, economic fears,
and reduced credit likely lead to a thrift mindset
Emergence of consumers Growing middle class becoming first
time consumers Consumer credit is in its infancy
Increased government role in private sector Increased government ownership in
the financial services industry coupled with fiscal policy could reduce innovation and productivity
Privatization & growth of free enterprise In most frontier markets, governments
are adopting free market policies and privatizing state-owned companies
Developed Markets Frontier Markets
14
How do we think about and manage risk?
15
We aim to invest in countries that are stable or improving; however, country diversification is ultimately the main tool to manage general market risk.
The two specific risks we actively manage are sudden currency devaluation and incorrect securities valuation.
Risk Mitigating Action
Currency devaluation Country Score of macroeconomic indicators helps identify high-risk countries
Company valuation models account for projected devaluations based on inflation differentials
Incorrect securities valuation
We select only securities trading at a discount to intrinsic value, providing a margin of safety
We strongly prefer relatively simple businesses that we are confident in valuing
Investors have these common concerns…
16
Concern Factors to consider
Corruption, political, and macro risks We monitor a number of indices that quantify macro risks. Generally, the risk metrics for frontier markets are similar to, not worse than, emerging markets.
Financial information quality; fraud Many countries have adopted or are in the process of adopting the IFRS standard for financial reporting.
Most of the publicly traded firms we invest in are audited by the Big 4.
Counterparty risk Most of our securities are held through our global custodian or local subsidiaries of leading global banks. We do not use a prime broker, and thus do not have prime broker counterparty risk.
Taxation and capital controls Frontier markets are similar to, but perhaps slightly better than, emerging markets in this area. Frontier markets typically do not have capital controls or levy taxes on capital gains. Many frontier countries have no dividend withholding taxes, but if dividend taxes are withheld, rates tend to be 10% – 15%.
Risks and investor issues faced in frontier markets are generally no worse than emerging markets
Frontier investors must choose a fund type…
Pros Brand name manager; safe choice
No performance fee Frequent fund liquidity Often available without high minimum
Cons Unless you know manager personally, you
probably have not heard of them High fee Lockups May have high minimum Business continuity of manager less certain
Cons The trade off for large fund size, superior
liquidity terms are investing liquidity constraints that eliminate many countries and shrink universe to a few hundred stocks
The most-liquid stocks often trade at higher PEs Manager may need to buy what they can
instead of what they want Personnel not always exclusive to fund
Pros Investable universe is a few thousand stocks
A broad range of valuations is available within universe
Best values and opportunities more likely to be investable
Managers live and breathe frontier markets
Conclusion Larger frontier funds may behave similar to
frontier index, for better or for worse
Conclusion Boutique frontier funds can perform significantly
different from an index, for better or for worse Outperformance necessary to overcome high
fees
Larger Funds Boutiques
17
Frontier markets are illiquid; a potential source of return
18
Recent Ibbotson research shows: Illiquid stocks outperform liquid stocks significantly (see table) This liquidity effect is present in every size quartile and every value quartile (not shown) The liquidity effect appears stronger than the well-known small-cap effect The liquidity effect exists globally (US, UK, Europe, and Japan) Not only do illiquid stocks outperform, they do so with less volatility
Quartile Geometric Mean Standard Deviation
1 – Illiquid 15.46% 19.81%
2 13.57% 20.08%
3 11.66% 22.91%
4 – Liquid 7.11% 27.32%
US data from 1972-2008. Source: Zhiwu Chen and Roger G. Ibbotson, Zebra Capital Management, LLC. All rights reserved. www.zebracapm.com. Cited in Ibbotson SBBI 2009 Classic Yearbook, Chapter 9.Liquidity Investing. Chicago: Morningstar, 2009.
We experience this liquidity effect firsthand in frontier markets and it can work for us or against us. Double-digit percentage discounts or premiums are common
when no one else is willing buy or sell.
Example of an actively managed frontier portfolio
Market, portfolio, and most recent 12 months of reported fundamental data as of January 31, 2013. Portfolio PE and PB are the harmonic means of all positions, weighted by position size. Portfolio dividend yield and return on ending equity (ROEE) are the means of all positions, weighted by position size. The yield on Frontaura Global Frontier Fund is less than our portfolio dividend yield due to cash held, withholding taxes, management fees, and operating expenses. At present, we retain all income, rather than distribute it.
19
Portfolio Statistics
Portfolio Price to Earnings 6.2
Portfolio Price to Book 1.1
Portfolio Dividend Yield 5.1%
Return on Ending Equity 21.7%
Country Holding
Vietnam 13%
Nigeria 13%
USA (cash only) 8%
Tanzania 7%
Zimbabwe 5%
Iraq 5%
Ukraine 5%
Serbia 4%
United Arab Emirates 4%
Pakistan 4%
Cambodia 4%
Estonia 3%
Botswana 3%
Senegal 3%
Industry Holding
Banks 32%
Consumer Staples 17%
Industrials 15%
Consumer Discretionary 12%
Cash 9%
Telecommunication Services 6%
Specialty Finance 3%
Materials 2%
Energy 2%
Diversified 1%
Country Holding
Qatar 3%
Lebanon 3%
Rwanda 2%
Romania 2%
Kazakhstan 2%
Cote d’Ivoire 1%
Ghana 1%
Oman 1%
Laos 1%
Papua New Guinea 1%
Montenegro 1%
Cyprus 1%
Zambia <1%
Kenya <1%
Characteristics of companies we invest in
20
Intelligent capital allocation – High return on invested capital– Track record of using free cash flow wisely
Reasonable growth prospects– Ample expansion opportunities– Product or service that benefits from growing middle class
Franchise characteristics– High market share or growing market share in fragmented market– Low competition and low threat of new entrants – Reasonable pricing power over customers
Low risk– Positive free cash flow, often in excess of net income– Predictable business model that can be forecasted easily– Margin of safety: valuation at a discount of our estimate of intrinsic value
Past Investment Example: Millat Tractors
21
Business Description:
Leading tractor assembler in Pakistan, selling Massey Ferguson brand.
Thesis: • In 2008, relatively unknown. No research on the company; local brokers had never met management.
• Management buyout during privatization
• Favorable cash cycle; 100% upfront cash payment required when order placed.
• At time of initial purchase: - LTM P/E: 8.2 - Dividend Yield: 8.8% - 5-year ROE: 25%
Source: Bloomberg
MTL PA price and running sum of dividends received
MTL PA price
Jan-
08
Mar
-08
Jun-
08
Sep-0
8
Dec-0
8
Mar
-09
Jun-
09
Sep-0
9
Dec-0
9
Mar
-10
Jun-
10
Sep-1
0
Dec-1
0
Mar
-11
Jun-
11
Sep-1
1
Dec-1
10
100
200
300
400
500
600
700
800
900
Buy
DPS: 10
DPS: 13
Partial Sale DPS: 16
DPS: 24
DPS: 28
DPS: 33
Exit
MTL PA Price and Dividend Chart
Pa
kist
an
i Ru
pe
es
Past Investment Example: Kingdom Hotels
22
Business Description:
Owns and operates luxury hotels in primarily emerging and frontier markets.
Thesis: • Unlike many real estate investments:
- Low debt - Book stated at cost - Portfolio largely complete and generating revenue• Stock oversold in 2008 due
to misperceived exposure to Dubai real estate due to HQ location. Over 90% of operations actually outside Dubai.
• At low, traded at $1.00 (0.15 book)• Acquired at $5.00
Source: Bloomberg
0
1
2
3
4
5
6
7
8
9
10
Weighted avg. purchase price
Frontaura accumulates position
Acquisition and delist-ing
KHI LI Price Chart*
US
Dol
lars
*Kingdom Hotels was listed in Dubai as KHI DU and also in London as KHI LI.
Current Investment Example: Swissport Tanzania
23
Business Description:
Leading airport baggage and air cargo handling service in country of 47 million.
Valuation Price: 1,740 TZS
Intrinsic Value: 2,821 TZS
Market Cap: $39 million
LTM P/E: 8.4
Price / Book: 6.3
Dividend Yield 9.4%
ROE: 74.6%
Debt / Equity: 35%
Investment Thesis:
• Global carriers gradually increasing flights to Tanzania.
• High returns on capital and oversight of multinational parent.
Source: Bloomberg
Market data current through 31 January 2013, and fundamental data current through 30 June 2012.
SWISSPOR TZ price and running sum of dividends received
SWISSPOR TZ price
Jul-0
7
Nov-0
7
Mar
-08
Jul-0
8
Nov-0
8
Mar
-09
Jul-0
9
Nov-0
9
Mar
-10
Jul-1
0
Dec-1
0
Apr-1
1
Aug-1
1
Dec-1
1
Apr-1
2
Aug-1
2
Dec-1
2400
600
800
1000
1200
1400
1600
1800
2000
2200
2400
Frontaura accumulates position
DPS: 40
DPS: 33 DPS: 40
DPS: 50
DPS: 43
DPS: 55
DPS: 62
DPS: 95
DPS: 68
SWISSPOR TZ Price and Dividend Chart
Ta
nza
nia
n S
chill
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FRONTAURA CAPITAL LLC
FRONTAURA GLOBAL FRONTIER FUND LLC
Disclaimer
This document is confidential and is for the exclusive use of the original recipient only. No portion of this document may be reproduced without the written permission of Frontaura Capital LLC.
This document does not constitute an offer to sell, or a solicitation of an offer to buy the membership interests described herein. No such offer or solicitation will be made prior to the delivery of a definitive offering memorandum and other materials relating to the matters herein. Before making an investment decision with respect to the LLC, potential investors are advised to read carefully the offering memorandum, the LLC operating agreement and the related subscription documents, and to consult with their tax, legal, and financial advisors.
This document contains a preliminary summary of the purpose and principal business terms of the LLC; this summary does not purport to be complete and is qualified in its entirety by reference to the more detailed discussion contained in the private offering memorandum and the actual text of the LLC operating agreement. The LLC managing member has the ability in its sole discretion to change the strategy described herein.
This document is being provided to you on a confidential basis solely to assist you in deciding whether or not to proceed with a further investigation of an investment in Frontaura Global Frontier Fund LLC. Accordingly, this document may not be reproduced in whole or in part, and may not be delivered to any person without prior written consent of Frontaura Capital LLC.
24© 2007-2013 Frontaura Capital LLC