News from the Centre: Interview with Kiyan Zandiyeh

Sep 25, 2020

Thanks for taking time for this interview. Could you briefly present Sturgeon Capital?

We are an investment firm focussed on investing and building in technology and technology-enabled businesses in frontier countries that are yet to experience broad-based technological evolution.

We define frontier countries as those that have for an extended period of time had little in the way of private sector participation in their economy. This lack of private capital – which is usually well incentivised to capitalise on opportunities – means that these countries present an abundance of opportunities for investors to capitalise on.
We typically get interested in a country, where there is some sort of catalyst where private sector participation in a country goes up and by virtue of that foreign investment.

When observing these countries, they all have high levels of internet and smartphone penetration but haven’t yet seen technology-enabled business models being built, that we have become accustomed to in the developed world. Our favourite business models are those that have proven to be successful in other parts of the world and viewed through the lens of Mazlow’s hierarchy of needs provide products and services that address the basic needs of the general population.

Ultimately, they are monetising the efficiency gains they introduce. When finding these businesses, our job is to provide capital and work actively with the businesses to scale and be leaders in their respective business in their countries and regions of operations. for them to realise their full potential.

How to appreciate political and currency risks which are more likely in these markets?

Starting with political risk, one of the reasons we focus on technology-based businesses is that you would find it hard to find a country that has been able (whether they’ve wanted to or not) to get in the way of technological progress. Once the cat is out the bag, it’s out.

The second is that these businesses are primarily comprised of intangible assets, which are operationally complex to develop and difficult to expropriate. Historically, frontier market investors have often seen political pressure, when they’ve invested in companies that whilst nominally cheap, operate in an area that is strategically important for a country, or potentially tread on the toes of various power centres. Investing in technology stays away from this and has another factor which is important to us – whether a business adds or takes away from the eco-system. In e-commerce for example, we’re making it easier for consumers to buy a wider array of goods at cheaper prices, helping local logistics companies increase revenues and helping local offline retailers increase their sales through linking with the online platform. Here the whole eco-system wins. This is the opposite of investing in say a bottling company, where the main way to generate returns is by taking market share away from an incumbent and increasing the prices of the products, which is inflationary to the consumer.

As it relates to currency, each country has their own dynamics. We like countries like Uzbekistan which have natural current account surplus’s and low debt levels such that structurally the country is less vulnerable to currency shocks. Separately we our aiming to invest in businesses that have very high growth rates such that the net return to us as in investor minus any currency weakening (which we factor in) is still high

Isn’t possible to mitigate these risks with the performance of the funds?

Our return target for the fund is quite clear. To return 5x in USD in 5 years. From an investing perspective this means investing in businesses that are very scalable, have near zero marginal costs to growing and have clear product market fit. In e-commerce for example we’re seeing 50% month on month growth. Whilst growth rates at such levels won’t sustain, even a fraction of it compounded over five years outweighs currency risks.

Other countries we’ve invested in have seen severe currency shocks (over 80% weakening), and the environment has played in the favour of technology companies, providing their a product or service that is more efficient and cheaper than the offline alternative.

In such scenarios the cost of operating and market share go down, in line with the currency, yet your customer adoption goes up significantly, which again makes up for currency losses.

Ultimately, our investment framework has been borne out of investing in countries that are difficult to operate in, and so resiliency as a concept for the companies we invest in is very important.

Why is Sturgeon Capital focused on Uzbekistan and how is the situation different from the economic opening which occurred previously in other neighbouring countries ?

Uzbekistan is a country we’ve been involved in for about eight years. Within central Asia it has the largest population (35m people), 65% of which are under 35. The legacy of the Soviet Union is also a very educated population, focussed on the hard sciences. The issue was that under the previous administration the country was effectively closed off to foreign investors and so that talent didn’t have fertile grounds to thrive. Economically, the country generates revenue from diverse sources. Unlike other countries in the region, they’re not reliant on oil & gas. They’re largest natural resources are Gold and Uranium, which are counter cyclical assets. They also have very low levels of debt (under 30% to GDP) and high reserves (60% to GDP). So, the economy from a structural perspective has strong foundations. Separately from a GDP per capita perspective, the country currently is at $1,500. If you compare that with Georgia with 1/5 of the population and no natural resources, it’s at $4,500. So the country is coming from a very low base, and we believe can play catch up in the years ahead.

Since the new administration came to power, they’ve embarked on a series of reforms, which if put into the context of any other country would be considered astounding. Ministers now are young western educated technocrats, all state assets are to be privatised, corporate tax rates have been nearly halved, and the government is moving all government infrastructure to digital means (e.g. before if it took you 20 days to register a business, today it’s 20mins and all online).

So to sum up, it’s a country we know well, has the positive tailwind of reforms and economic growth and a blank canvas in terms of tech enabled businesses for us to use the strong digital infrastructure (70% internet and smartphone penetration) to invest and build the leading technology businesses in the country.

We have seen a wave of promising economic reforms in Uzbekistan from February 2017. However, the financial sector is far from being updated. Do you foresee any evolution to attract foreign banks and/or foreign investments in the soon-to-be privatized Uzbek banks?

We see the opportunity for foreign banks to enter the market, and this is happening. TBC from Georgia has entered along with Halyk in Kazakhstan. This will likely continue.

With that said, what we’re interested in, is being able to use non-bank technology companies to provide financial services. For example, we have a business – Billz – which provides inventory management and account management software to SME’s (which represent 60% of GDP). With the data generated from the software the company can partner with banks to provide working capital loans to SME’s. Similarly, with e-commerce, we have nearly a million users across the region including Uzbekistan. Here again, we can partner with banks to provide consumer loans to the platform’s customers.

Frontier countries don’t typically follow the route of more developed markets in the evolution of their financial industry, and China is a good example of this, where Ant Financial (Alibaba) has built one of the largest financial services businesses through their e-commerce business.

So far, sectors like microfinancing and consumer financing are not very developed despite the growing needs from consumers and SMEs. Do investments in such markets provide enough performance to mitigate the currency risk?

We believe they do. SME’s represent 60% of GDP in Uzbekistan and currently have no real access to financing. Their main source of financing is supply side financing with the costs being nearly +100%.

The issue is credit data, and being able to make an appropriate appraisal of risk, such that you can lend at more appropriate rates, whilst being profitable. Currently microfinance (MFI) businesses are small with limited balance sheets, and cater to a small group of businesses. Using the combination of digital distribution (through our software company), a team that has the track record of building successful MFI’s in frontier countries, and a strong balance sheet, we’re actively investing in the space to build the country’s leading microfinance businesses.

We see roughly $2bn of lending opportunity a year, and so far no one has built a business that can seriously challenge it. Similarly we’re building the lending functionality in our e-commerce business, where we know we already have access to a large customer base, and with the data being generated, can overlay lending to lend to a broader pool of customers that a bank typically would, through traditional distribution mechanisms.