Vietnam feeling the pain of quick development

IFR Asia, May 2008

Vietnam is in the middle of a landmark shift: from being a frontier outpost of great potential, to a market sufficiently developed to have become an essential location for foreign banks and investors. Like all big transitions, it is involving some pain.

Vietnam’s economics are compelling. The country’s GDP grew by 8.5% in 2007, the third consecutive year in which it had done so. It has joined the World Trade Organisation and its path into the global economy seems assured. It has a population of 85 million people, all of them gradually growing in wealth, which supports industries from banking to retail to construction. What people love about it most is the idea that, as a Communist state, it’s the next China.

For foreigners seeking to take advantage, though, there are a number of challenges to consider. For mainstream commercial banks, there’s a clear opportunity: barely 10% of the country’s population has a bank account and 15,000 new foreign investment enterprises were set up last year alone, with US$20 billion of commitment. But there are plenty of people fighting for that prize: Vietnam has five state-owned lenders, 36 joint stock banks, 33 foreign banks, and there are new licences approved for more.

Several foreign banks, unperturbed, have decided to take on the market head-on and have opted for local incorporation. HSBC, for example, received its regulatory approval to go local in March, allowing it to offer a full range of local banking services alongside its strategic stakes in Techcombank and the insurer Bao Viet. HSBC’s Vietnam CEO Thomas Tobin speaks of being able to “reach new and existing customers through a broader distribution network.” ANZ (with a stake in Sacombank) and Standard Chartered (which is a strategic partner of Asia Commercial Bank) are also working on local incorporation. “We can open new branches in a more practical manner this way,” says Thuy Dam, ANZ’s CEO for Vietnam. “With incorporation you become a local bank and hopefully you can get your network more quickly.” Citibank has not opted for local incorporation at this stage, but its country head, Charly Madan, doesn’t doubt the appeal. “More than 90 players is a lot of people to serve a US$75 billion economy, but the fact is Vietnam is an under-served market in terms of its banking sector.”

On the commercial side, if growth continues at its current pace, they may all flourish. But for investment banks, it is a tougher call. Banks have been attracted for years by the prospect of so many landmark state assets coming to the capital markets. At the end of 2006 it was commonly said that as many as seven new listings of these companies, worth a billion dollars apiece, would follow in the next 12 months.

Progress has been considerably slower than that, and it hasn’t been particularly smooth. A few landmark listings have made it to the market, but each has had its own challenges, largely to do with structure and price expectation.

In Vietnam, the process of bringing state assets to the markets is called equitisation. It uses a Dutch auction system, where the state sets a minimum bid, and people then put in their own bids above that level, which will define the successful price. But in a particularly unusual step, successful bidders pay what they bid, not the median figure. Additionally, any strategic investor –seen as absolutely key to any successful equitisation, for reasons of both finance and expertise – must pay the same price as the one set in the auction, as opposed to most nations where a cornerstone investor will come in at an attractive discount.

Even when that’s done, it doesn’t mean the stock is listed on the country’s main exchanges, in Ho Chi Minh City and Hanoi. There is no set period of time within which a company must go from its equitisation (after which it trades on over the counter markets) to a full listing on a main board. Indeed, it can often take a year or more.

The first major state company to grapple with this framework was Bao Viet Insurance last year. Retail bidders showed such exuberance for the stock that some bid as much as 25 times book, pushing the price up way above the levels most foreign investors had bid at. Then, when shares started trading on the OTC markets, they fell so sharply that many investors, having paid only a 10% deposit on the shares, walked away rather than paying the balance to take them up. That meant a second auction had to be undertaken to place those stocks (accounting for about a quarter of the offer), but since the price had to be at least the level set in the first auction, few took any interest in it, with only 10% of that block selling. HSBC then came in as strategic investor, which at least concluded it on a positive note.

Next came Vietcombank, the first of the big state owned banks in Vietnam to be sold, and perhaps the most eagerly awaited offering in the country’s history. The problem here was expectation: the bid was set at a level equivalent to 87 times 2007 earnings, which appears to have scared off potential strategic investors (GE Capital was understood to be all but signed up). Next, Saigon Brewery Company (Sabeco) raised less than two thirds of its target – with overseas investors taking barely 5% of the offer despite being entitled to take up to 49% – with valuation once again the problem. The starting price for bids was set at 72 times 2007 earnings. Don Lam, chief executive officer of VinaCapital, would like to see “something left on the table for investors. If it’s at full value, there’s no upside.”

Since then, the markets have tanked anyway (22% in March alone, bringing the fall to 44% for the first quarter of 2008), which makes further issues unlikely in the short term. The pipeline is considerable: the three other big state-owned banks (two, BIDV and Incombank, have already appointed advisors on their privatisations, Morgan Stanley and JP Morgan respectively); several mobile phone companies, with Mobifone understood to have held a beauty parade; and other big assets. But it’s going to be a while before these deals hit the markets.

Even when they do, that’s just the domestic privatisation. What people are really jostling for in Vietnam is what comes next: the international listings of some of those assets. That’s where the fees are likely to come in. Credit Suisse was advisor on the Bao Viet and Vietcombank deals, but its role was not really to handle the domestic issue, so much as to find a strategic adviser and advise on a foreign listing of the stock in future, so even when deals hit the domestic markets that’s not really putting revenue in the pockets of foreign investment banks. It is believed that Morgan Stanley’s pitch for the BIDV mandate, covering finding a buyer and advising on an international IPO, was $1.8 million – not enough to make anybody rich.

There are some signs of movement, though; Vinamilk plans a listing in Singapore. “It is our firm believe that the success of Vinamilk’s dual listing will be a recognisable milestone for many Vietnamese businesses who are striving to access international capital markets, or more broadly to go global,” says Le Song Lai, deputy director general of State Capital Investment Corp, the closest thing Vietnam has to a sovereign wealth fund, and until recently part of a joint venture with Morgan Stanley. “Any of SCIC’s investee companies that are qualified to list overseas should be encouraged and helped to do so.”

There is a widespread feeling in the market that Vietnamese authorities are willing to listen to market opinion, and that structural changes will probably come to the equitisation process in time. And it is, undeniably, early days in a program which could see as much as US$40 billion in enterprise value hit the markets.

In the meantime, the opportunities are limited for foreign fund managers too, who have for some time been on the sidelines waiting for sufficiently large and liquid issues to hit the market so they can invest in them. Long-standing locally based fund managers like Dragon Capital, Mekong Capital and VinaCapital are doing fine, but the field is becoming crowded: Chris Freund, managing director at Mekong, reckons there are about 60 funds now exclusively focused on Vietnam. One hears talk of billions of dollars waiting to be deployed, although people on the ground tend to be rather sceptical about that.

Nevertheless, deploying any capital is challenging, partly because of the slow progress of the jumbo listings, partly because of foreign ownership limits on certain stocks (particularly banks), and partly because of this oddity where so many stocks don’t trade on the main boards but on the OTC market. This OTC market is not unsophisticated – it is reasonably liquid, for a start – but certainly lacks the transparency that a multinational fund manager is going to be comfortable with.

Still, recent falls in the stock market – accompanied by panicking retail investors selling out – have afforded foreign investors some opportunities to buy, and they put in US$249 million in March, the largest month of net buying in more than a year, according to HSBC. US$450 million went in in the first quarter. “We believe that country funds, which raised money last year but have been unable to deploy all of it, have taken advantage of cheaper valuations to put a higher percentage of their funds into the equity market,” notes Garry Evans, a regional strategist at HSBC.

And with a long term view, despite the growing pains, Vietnam’s future looks bright, as does foreign participation in its emerging story. “The fundamental story of Vietnam as the next major FDI destination is not over,” adds Evans. “Try asking companies in Taiwan, Japan and Thailand where they intend to invest next.”