Asia Frontier Capital Newsletter – Country Report: Iraq

To mark the upcoming launch of the AFC Iraq Fund and to follow up on our recent in-depth coverage of Iraq in our previous newsletter (click here), this month we will be covering the post-conflict opportunity of Iraq.

Country snapshots for all of AFC’s markets can be found on our website at www.asiafrontiercapital.com

In the past few months there have been a number of significant local/regional developments that are taking place that bolster our positive stance on Iraq and support our thesis of the impending end of the recent conflict. This should then begin the multi-year wholesale reconstruction of the country and economy of Iraq after 35 years of conflict.

Recent Key Developments

The Iraqi forces (made up of the regular army, popular mobilization units (militias organized under the command of the government) and local tribal fighters) recently liberated Tikrit with the help of some unlikely bedfellows in the form of Iran & the US (see below). This is the first military major victory for Iraq’s new inclusive government in rolling back ISIS and is a precursor for the liberation of Anbar (which fell in early 2014) and Mosul (which fell in mid 2014).

Another incredibly important breakthrough was the solidification of the US-Iran détente in the form of the preliminary nuclear accord. The interests of the US & Iran have recently become significantly aligned, not only with the emergence of ISIS as a military threat, but also in addressing the conditions that gave rise to extremism. While the two are vocal in expressing their differences and non-cooperation, the actions on the ground show a high degree of de-facto coordination: the formation of the inclusive Federal Government of Iraq (FGI), the reconciliations between the autonomous Kurdish Regional Government (KRG) and the FGI, the containment of ISIS, and now the liberation of Tikrit. This alignment is in stark contrast to the conditions after 2003, in which the two sides fought a bitter proxy war in Iraq that contributed a great deal to the instability of the country.

This détente extended further to relations with Turkey with last week’s visit of Turkish president Tayyib Erdogan to Iran and the drive to increase bilateral trade between the two from USD14bn to USD30bn. Moreover, the Turkish president argued that the two should resolve their differences and work together toward resolutions of conflicts in Syria and Iraq. The two countries are significant powers in the region and in spite of trade relations they fought bitter proxy wars in Iraq and Syria.

Billions of dollars are pouring into Egypt, notably from the GCC, for the country’s reconstruction (a parallel Suez canal, a new proposed administrative capital city of up to 7m residents over 700 sq km plus a large number of mega housing projects). Many of these projects are intended to address the deep rooted needs of resource poor Egypt, with a young population of 85m people, 50% of whom are under the age of 25 whose needs for jobs and housing are extreme. These unaddressed needs gave rise to the Arab spring and were fertile grounds for the rise of extremism. This Marshall plan for Egypt is the region’s response to roll back the tide of extremism and would very likely be repeated in Iraq.

Closer to home, our previous Iraq country report from November 2014 (click here) focused on the significance of the deal between the KRG and the FGI as a game changer and a precursor for unlocking the country’s potential. The agreement was forged as both parties realized, with the help of the international coalition, that they needed each other both in the fight against ISIS and for the eventual reconstruction of the country as a whole. The deal has faced many challenges since being signed, as neither side appears capable of delivering on all of its commitments. Production from the Kurdish controlled areas has fallen short of the agreed levels, while FGI doesn’t have enough cash to keep up with all the payments owed to the KRG. However, both parties are fully committed to the agreement and continue to collaborate.

These challenges are unavoidable given the recent history of mistrust in Iraq and the actual logistical challenges of implementing both parts of the agreement in the difficult operating environment in the country. Further impetus for both parties to continue to work together is the stronger mutual benefits within the framework of détente in the region vs. the prior conditions which encouraged and fed their differences.

Lower oil prices have proved to be a blessing in disguise for the Iraqi private sector, as they are forcing the government to adopt market friendly policies to encourage much greater private sector involvement in the economy with the most far reaching policies benefiting the private banking sector which will be the subject of a future report on Iraq.

Finally, oil price prices, after collapsing in 2014, seem to have made a noteworthy bottom in early 2015. Although the short term rallies in Feb and early April were mostly for technical reasons and not sustainable, they have nevertheless established the floor for oil prices, as can been in the chart below.

Source: Financial Times

The cuts announced by the oil majors and most US shale companies should be felt in decreased supply towards the later part of the year while world demand should look better as we look towards 2016. However, the Iranian nuclear accord will tentatively see Iranian oil return to the world market in 2016 and increase supply meaningfully. Overall developments are likely to keep medium and long term oil prices in a range of USD60-70 as measured by ICE Brent Crude.

The positives cited above bode well for the medium to long term outlook for Iraq, however near term challenges loom as the economy faces a number of hurdles in 2015 as it deals with multiple conflicting challenges. Chief among them is sharply increased military spending, which is forcing a diversion of economic resources, which are already strained by the significant drop in the budget as a result of lower oil prices. At the same time, the non-oil economy is struggling to deal with sharply decreased government spending, as it is the largest player in economy, while the need is for increased spending. In response the underdeveloped equity market has undergone a significant correction of around 27% as measured by the drop in total market capitalization from pre-crisis high as it discounts the near term effects on corporate earnings with the result that current depressed market valuations fail to reflect the medium and longer term potential of the country.

ISX total market cap vs the RSISX Index developed by Rabee Securities

Iraq’s Stock Market
The Iraq Stock Exchange (ISX) is located in Baghdad, launched operations in 2004 and opened to foreign investors in 2007. The ISX is a self-regulatory organization and is governed by the Iraqi Securities Commission (ISC) which was modelled on the US’s SEC. The exchange operates an electronic trading platform provided by NASDAQ-OMX and the ISX currently lists over 80 companies in a variety of industries including financial services, agriculture, hotels and food processing.


Iraq Stock Exchange website: www.isx-iq.net

Total market capitalization was USD 7.5 billion as of March 2015 and the market cap to GDP ratio is under 4%.  This is significantly lower than countries in the MENA region which have the same ratio at levels between 25%-90%, which highlights the scope of potential developments for Iraq’s capital markets over the coming years.

Iraq’s Economy

Iraq’s economy witnessed significant growth following 2003, contracted by 2% in 2014, and is now on track to recover in 2015 with 1% growth and projected growth above 7% until 2018. Iraq is still a country with enormous potential for wealth in spite of the devastation of over 35 years of terrible conflicts, crippling sanctions, ugly civil strife, and the ISIS conflict.

Energy lies at the heart of the Iraq’s wealth and this will be a key impetus for growth in the future. It has the world’s 5th largest proven oil reserves at approximately 9% of total reserves, which could potentially rise to as much as 15% as further oil fields are explored and developed. Iraq also has world’s 12th largest gas reserves with about 2% total resources. On top of this there is also a wealth of minerals resources including phosphate, crucial to modern agriculture, in which it has the world’s second largest reserves at 9% of total resources. When this is combined with its significant human capital advantages when compared regionally, Iraq’s population of 35.9 million will certainly benefit.  The local population is growing by over 3% per annum and is extremely young, with 56% under 25 years of age, which will be a key driver of growth.

About AFC Iraq Fund

All of the aforementioned factors have created a situation in which current market prices in Iraq are significantly below their future potential offering an incredibly opportunity for forward looking investors.  The AFC Iraq Fund will execute an actively managed niche strategy that gives investors access to the upcoming recovery in Iraq via a compliant fund structure that offers monthly liquidity to investors.

The AFC Iraq Fund will be launched on the 14th May 2015 and will build on AFC’s core strengths, excellent track record investing in frontier markets as well as our history of launching innovative, successful funds. The AFC Iraq Fund is managed under the executive leadership team of Thomas Hugger (CEO & Fund Manager) and Ahmed Tabaqchali (CIO) who between them have more than 47 years of investment experience as well as extensive background covering emerging, frontier, and MENA markets.

AFC is a strong advocate for the potential of frontier markets and our new Iraq offering holds incredible value for risk-conscious investors looking for high long-term investment returns.  Our core thesis is that post-conflict countries are unique phenomena for investors offering large potential returns as the countries begin to reap the benefits of the peace dividend as they transition from conflict to economic growth with the peace dividend proportional to the resources at hand and the rebuilding required. Iraq’s attractiveness within these phenomena is its vast resources (hydrocarbons, minerals, agricultural & sizeable human capital) and the rebuilding required after over 35 years of conflict as the country has gone through wars, crippling sanctions, civil strife, and the ISIS conflict. Moreover, we are positive about the confluence of major regional developments that are currently taking place just as Iraq emerges from conflict, chief among them being the detente between the West and Iran, that will boost and sustain Iraq’s transformation.

The AFC Iraq fund will be positioned to take advantage of this situation to capture the upside of Iraq’s wealth of natural resources and strong underlying fundamentals. The fund will invest in companies leveraged to Iraq’s recovery and seek to arbitrage the perceived risk gap, which we see as being significantly higher than the actual risk.

Equity markets in post-conflict Sri Lanka saw a rally of +250% in the 18 months after the end of its civil war even without the significant resources to rebuild that Iraq has on offer. Other post-conflict country stock markets have also seen significant rallies in the immediate years after conflict. Iraq’s equity markets are at their infancy, at under 4% of GDP, with potentially a significant catch up to peers in the region in years to come. The underlying fundamentals for Iraq are strong and improving, and any slowdown or halt to conflict will have a significant positive impact on the domestic market in the next economic cycle. Being positioned to capture the opportunities of post-conflict Iraq could mean a potential increase of several hundred percent in local terms and even greater upside when coupled with extremely depressed valuations that exist at present.

AFC’s Asia Frontier Fund has been building its Iraqi expertise through its equity investments in Iraq for over two years and has significantly expanded this expertise with the addition of Ahmed Tabaqchali, an Iraqi/British national, who has extensively covered the MENA & global equity markets for over 22 years and leveraged this experience through coverage of Iraq’s investment prospects from the ground.

AFC Travel Report: Vietnam Investor Tour

In line with our process of being on the ground in the countries we invest in, AFC’s research team of Thomas Hugger, Andreas Karall, Andreas Vogelsanger, and Scott Osheroff spent a week visiting companies across Vietnam in March 2015.

During the final week of March, Asia Frontier Capital organized a five day Investment Tour to Ho Chi Minh City (HCMC) and Hanoi, Vietnam. We held this tour to showcase to existing and prospective investors the reality and great prospect of Vietnam’s economic prowess and the real possibility of it becoming the next “Tiger Economy”.

Our gathering started on a Sunday’s eve where we had drinks followed by dinner at the Majestic Hotel, a luxurious French colonial hotel overlooking the Saigon river and the city’s new metro project under construction. Since Vietnam is a former French colony, there still exists plenty of French colonial architecture all over the country making Vietnam a unique place to visit. In addition to the Majestic Hotel, a dinner several days later was held at La Villa French Restaurant in a refurbished French Villa in the outskirt of Saigon – the colonial name of Ho Chi Minh City.


Construction work going on along with the new underground system in HCMC


The upcoming underground station map in HCMC

At the onset of the business leg of our trip, Michel Tosto, Head of Institutional Sales & Brokerage of VietCapital Securities, provided us with valuable insights about the general state of the economy and its future outlook. The majority consensus is that the economy will continue to expand at a pace of over 6% in 2015 due to a low inflation environment and stable currency. Non-performing loans (NPL) on bank’s balance sheets will continue to decrease as the government purchases additional NPL’s through the state owned Vietnam Asset Management Company. Additionally, mergers in the banking sector and the first signs of a recovery in the real estate sector will lead to increased foreign investment and an easing of the current strain on banks.

Andy Karall, Fund Manager of the AFC Vietnam Fund, briefed the participants in detail about the fund’s investment strategy and investment outlook. The fund strategy is – contrary to big fund houses – to search for undervalued and overlooked companies in the small- and mid-cap space, which are normally not researched by brokerage houses and global institutions. Andy has successfully demonstrated during the last 16 months that this strategy can provide a significant investment return.

We also invited Marc Townsend, Managing Director of CBRE Vietnam, to provide an overview about the real estate market. While it is mainly the affordable housing segment showing robust signs of improvement, there are other positive indicators including the rise in newly registered real estate companies increasing 88% during 2014. Increasing discretionary spending will lead to an absorption of excess real estate supply and also see international retailers enter the market. Some of the more recent entrants to Vietnam include Gucci, Prada, Brooks Brothers, etc.  According to CBRE, approximately 80% of foreign direct investments in the first 2 months of 2015 went into the manufacturing sector while the next biggest allocation was real estate at roughly 9%.

Several listed companies also showcased their operations to us. Some of the companies we met, such as Mobile World (MWG), an electronics retail chain with a strong focus on mobile phones, demonstrated their ability to control a significant market national share as they have developed an in-house logistics network and have paid particular attention to customer service. This has helped drive growth and will enable the company to move into new industries with their integrated network and understanding of the Vietnamese consumer.

Another listed company from the consumer sector was Phu Nhuan Jewelry (PNJ), a jewellery company producing for their domestic brand as well as offering OEM to select major international retailers like Tiffany & Co. PNJ outlined their strategy for continued robust growth by offering customer friendly service together with a high quality product portfolio at competitive prices. Having also visited several factories, one of the standouts was Vinamilk (VNM), the largest dairy company in Vietnam. Visiting a state-of-the-art facility, our group suited up with food safety uniforms providing a fun photo opportunity. During the tour we saw a highly mechanized operation comprised of multiple ABB robots and high-tech Swedish packaging equipment.

We also visited Thien Long Group (TLG), a leading office supplies manufacturer with an international reach. Their main product is the fabrication of pens, something we all use in our daily lives and which won’t be disappearing even as we enter this digital age, a point the CEO of the company highlighted pointedly. Having seen their vertical integration from dye manufacturing to pen production, a pen is a sophisticated object TLG has become an expert at producing. This is a company with a bright future as they continue to grow rapidly.


TLG, office supply manufacturer

Mid-week we flew north to Vietnam’s capital, Hanoi, where we visited several other companies. Comparing the North and South is always interesting as of today, there still exists a divide between the two due to historical reasons dating back to when the US supported the South in the Vietnam War. While the South hosts a larger population and thus more manufacturing, the North is home to a significant portion of the country’s wealth and elite. This wealth is quite prevalent as we stayed in the Old Quarter of Hanoi where not more than a few meters from our hotel were Vertu, Prada, Pandora, and several other luxury stores.

On the last day of our trip we decided it best to take a break from company visits and reflect on our experiences from the past four days. We therefore drove four hours north-east of Hanoi to Halong Bay, a UNESCO World Heritage site, where we boarded a junk and absorbed the beautiful landscape over a wonderful seafood lunch. Boating through the waterways between over 1,000 limestone islands was an ideal way to conclude our journey and discuss the real potential Vietnam has to become a regional economic powerhouse.


Halong Bay

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