Something big is happening in emerging markets

April 7, 2015 03:41 PM

Any investment professional that has spent even a small amount of time studying emerging markets knows that the key growth story in the developing world is the growth of the consumer class.  There are dozens of studies and reports published by investment banks, consulting firms and fund companies showing us how literally billions of humans are moving from subsistence income levels to levels where they begin to consume more and better food, clothing, appliances, cars, etc.  It’s a very good story.  It’s a big story.  In a report titled “Going for Gold in Emerging Markets” McKinsey & Co concludes:

“By 2025, annual consumption in emerging markets will reach $30 trillion—the biggest growth opportunity in the history of capitalism.”

That is a bold statement.  Not a “large opportunity” or “good opportunity” but the biggest growth opportunity in the history of capitalism.  And while it may sound like hyperbole, based on my personal research, analysis, travels, experience and logic I think it’s true.   Besides, even if it turns out to be only the 2nd or 3rd best opportunity in the history of capitalism it might be worth a closer look.

What did the Alibaba IPO Mean?

The IPO of Chinese Ecommerce giant Alibaba is fading in the memory of the investment community.  Though, with all the hype and coverage, it is more like the haze of a mild concussion.  I liked the assessment from popular financial pundit Josh Brown who wrote on “Alibaba day”:

“The truth is, today is a historic moment. It’s one of the largest IPOs in history – you’ve seen all the stats and superlatives I’m sure. But we won’t know just what it all means for weeks, months or years to come. The significance of this day will not be fully realized anytime soon – like most major market events. Sure, we can speculate.”

He was right.  It was, after all, the largest IPO everon the NYSE.  It was a big deal.  But what did it mean?

The Great Confluence

I suggest that what the Alibaba IPO “means” is that several powerful trends are coming together in a great confluence with staggering results.  Just as the massive population wave in emerging markets is joining the consumer class, the tools, methods and models of consumption are undergoing a once in a lifetime transformation as three other major trends take hold.

Trend 1 - Smartphones Are Becoming Ubiquitous and Affordable

When did you first have a phone with a touch screen?  For me the answer is 2009, just a few years ago.  And yet, now, the idea of not having one, seems implausible.  What would I do? Indeed, The Economist has recently labeled the smartphone “the defining technology of the age” adding a prediction that 80% of all adults “will have a supercomputer in their pocket” by 2020.

Fueling the spread of this technology are new competitors that are driving down prices for entry level smartphones making them affordable for more people.  Chinese smartphone maker Xiaomi – started less than 5 years ago - sold over 60 million units in 2014 and may sell 100 million in 2015.  Xiaomi is now the world’s most valuable private company.  In India, market leader MicroMax is selling smartphones for under $40.  And, it may still be the first inning of this game.  Consider for example that India has 1.25 billion people and only 150 million smartphones today.

Trend 2 - Mobile and Wi-Fi Broadband Internet Access are Surging

When was the first time you were able to reliably watch a video on your phone?  The answer for me is only in the past couple of years. I live 50 miles from where all of this stuff is being invented.  It seems logical that if I am just getting these things, most of the people in the developing world must not have them quite yet.  Indeed, estimates are that that only 6% of households in emerging markets have a fixed broadband connection like the one I have enjoyed for the past ten years.  And it’s highly unlikely they will ever receive broadband via a coaxial cable because there will be no need.  Just as smartphone prices have become affordable broadband mobile prices have fallen dramatically and access has exploded.  And, it is important to note that while our smartphones are a new and mobile alternative to access broadband internet, for most in the developing world, obtaining a smartphone likely means broadband access for the first time.

Trend 3 – The Globalization of the Capital Formation Process

Across the developing world, local entrepreneurs are partnering with U.S. venture capital investors to pour their hearts, sweat and billions of dollars from U.S. institutional investors into e-commerce startups.  In many cases – like Alibaba – these enterprises are enjoying tremendous success and creating significant value.  And while Chinese companies have received the majority of the funding and attention thus far, the trend is spreading. 

India, with its massive population and low penetration rates is the current hot spot for venture investors.  But it’s happening everywhere from Vietnam to Colombia to Turkey.  It’s even happening in Africa, which has been an economic and investment basket case for my entire lifetime.

The most successful of these companies will likely continue to IPO – like Alibaba – on U.S. stock exchanges.  For investors, this is important to note because if they are listed on the NYSE or NASDAQ these companies are left out of most Emerging Market ETFs for, frankly, dumb technical reasons. 

Results of the Great Confluence

Investors in Emerging Markets should make note of the following things that are happening as a result of The Great Confluence.

Result 1 - Serious Revenue Growth

The revenue growth of publicly traded Emerging Markets internet and ecommerce companies has been nothing short of sensational.  Total revenue of the companies in the EMQQ Index have grown from $13 billion in 2009 to $73 billion in 2014.  That’s an average annual growth rate in excess of 40%.  And while the growth rate is certain to decline, it still posted an impressive 39.9% gain in 2014.

Result 2 – Significant Value Creation

The growth in revenue has led to similar growth in the value of publicly traded Emerging Markets internet and ecommerce companies, especially versus the returns of the broader Emerging Markets indexes.  In fact, the EMQQ Index returned over 200% from inception on June 1, 2009 through December 31, 2014 vs. about 40% for the broad indexes.  That’s an average annual return in excess of 23% vs. about 7% for the major indexes.  This should be no surprise to those who have watched the markets closely.  Hong Kong listed ecommerce giant Tencent has grown from a company nobody had ever heard of to the most valuable brand in China and the third largest company in the MSCI Emerging Markets index.

Result 3 – Emerging Markets ETFs are NOT Participating in This Growth

Recently many investors have lamented the poor performance of Emerging Markets – especially relative to the U.S. market. In fact, as I write this on March 13, 2015 the Barron’s Emerging Markets Daily column begins with “Growth is missing from the emerging market story, and that makes EM assets unloved.”  There is growth in Emerging Markets, and it’s significant, but it’s largely left out of the indexes and the ETFs that track them.  In fact, only two of the forty four companies in the EMQQ Index are included in the largest Emerging Markets ETF.

The Great Confluence is Just Getting Started

By now most of you have heard of Alibaba founder Jack Ma.  But have you heard of Sachin and Binny Bansal?  They are the founders of FlipKart – “the Alibaba of India”.  They raised nearly $2 billion in venture capital last year from investors including the family office of Mark Zuckerberg.  FlipKart will likely file for an IPO on a U.S. exchange sometime in the next year and you will hear about it.  (Remember, you heard it here first.)  How about Sim Shagaya? Ever heard of him?  Don’t worry, you will.

EMQQ is an exchange-traded fund that invests in Internet and e-commerce companies operating in emerging markets.




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