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04-09-2013, 04:58 PM
Frontier hedge fund investors eye Iraq

Author: Kris Devasabai (http://www.investorsiraq.com/author/412/kris-devasabai) Source: Hedge Funds Review (http://www.investorsiraq.com/hedge-funds-review) | 09 Apr 2013

Iraq is emerging as a surprise destination for frontier hedge funds

A slate of telecoms IPOs and efforts to modernise banking regulations have some frontier market hedge funds enthused about prospects for Iraqi equities as institutional investors sit on the sidelines

After a decade of war and destruction, efforts to restore Iraq’s economy and financial system are gaining traction.

The economy expanded 10.5% last year, more than any other Middle Eastern country, and the GDP growth forecast for 2013 is nearly 13%. The local equity market is also hitting its stride.

Asiacell, the second-largest mobile phone operator in Iraq and a subsidiary of Qatar Telecom, raised nearly $1.3 billion when it listed 25% of its stock on the Iraq Stock Exchange (ISX) in February. It was the largest public offering in the Middle East since 2008 and attracted tremendous interest from foreign investors in the region who purchased around 60% of the stock.

“A year ago no one would have believed the biggest IPO in the Middle East since 2008 was going to take place in Iraq,” says Grant Felgenhauer, a principal at Euphrates Advisors, which has been investing in Iraq since 2010.

There is more to come. The country’s foreign-owned telecoms are required to sell at least 25% of their shares on the ISX under the terms of government licences.

Zain Iraq, an affiliate of Kuwait’s Mobile Telecommunications Co., is expected to complete its public offering later this year, while France Telecom-owned Korek will also have to list on the exchange.

The telecoms IPOs could lift the ISX’s market capitalisation to over $15 billion from less than $5 billion at the start of the year. That would put Iraq on the radar of international investors that dabble in frontier markets and help attract more liquidity to the Iraqi exchange.

A few intrepid hedge funds are already active in Iraq. Euphrates runs around $54 million in its Iraq Fund, which it launched in October 2010.

Felgenhauer reckons Iraq is poised for “an historic economic renaissance” similar to other countries that emerged from major military and political conflicts such as Hong Kong in the 1960s, South Korea in the 1970s and post-Soviet Russia.

He identifies three factors Iraq shares with these countries: macro stability, scalable GDP growth and low asset valuations.

“Iraq has a stable currency, low inflation and normalised interest rates. GDP is growing rapidly and there is scope for the economy to grow to a meaningful size. Finally, the stockmarket is trading at four or five times earnings, which is cheaper than any mainstream emerging market,” says Felgenhauer.

“We’ve seen these circumstances before in post-war Germany and Italy, in Hong Kong and South Korea in the 1960s and Russia [after the fall of the Soviet Union]. Iraq appears to be on the same path.”

Prior to joining Euphrates, Felgenhauer was a partner and portfolio manager at Hermitage Capital Management, a hedge fund that made huge profits investing in equities in post-Soviet Russia.

Euphrates is not the only hedge fund with an eye on Iraq.

“There is a tremendous growth story in Iraq underpinned by rising oil production, a growing middle class and rapid credit expansion,” says Sanjay Motwani, president and founder of Sansar Capital, a hedge fund based in Singapore. “If you look past the politics and the security situation, which has improved dramatically, the macro picture is very exciting and company fundamentals are going gangbusters.”

Sansar has invested roughly $27 million in Iraq since early 2011, making it one of the largest foreign equity investors in the country.

Motwani established Sansar after leaving Kingdon Capital Management, where he managed an Asia portfolio from 1997 to 2005. He says Iraq is now a more attractive investment destination than many emerging markets.

“The Asian markets have become very crowded and correlated, which makes it difficult to have an edge,” he says. “Iraq is the opposite. There is a wealth of opportunity and very little competition.”

Swedish fund manager FMG and Invest AD in Abu Dhabi also have funds investing in Iraq.

Euphrates’ Felgenhauer says Iraq’s growth potential is unique among frontier markets. “People talk about places like Sri Lanka and Ghana. Those are interesting markets, but they will always remain small,” he says.

“Iraq is the only frontier market that has the potential to grow into something really meaningful. According to the IEA [International Energy Agency], Iraq will replace Russia as the world’s second-largest oil producer by 2030. It’s going to be a big economy,” he adds.

At present the oil sector is state controlled and off limits to investors. As a result hedge funds in Iraq are focusing on sectors that stand to benefit the most from rising income levels as the petro dollars begin to flow.

Consumer focus
The Euphrates Iraq Fund has the bulk of its capital invested in three sectors: consumer goods, financials and real estate. One of its biggest positions is Baghdad Soft Drinks, which holds the exclusive licence to distribute Pepsi and other soft drinks in Iraq. The company more than doubled its earnings in 2012 and is now priced at around five times earnings, excluding cash.

Despite its focus on the consumer class, the fund has only a minor position in Asiacell. “Mobile telecom in Iraq is an interesting business but we think the stock is pretty expensive. The multiple is about twice the market average,” says Felgenhauer.

Sansar is also bullish on Iraqi banks, which saw earnings rise more than 90% last year. “This is a leveraging economy with credit growth in the 30% range. Some of the banks in our portfolio have grown their earnings five times in the past couple of years,” says Motwani.

He also likes consumer businesses, including Baghdad Soft Drinks, and infrastructure-related companies. “There are lots of opportunities in areas like electricity generation and water purification as Iraq starts to address its infrastructure problems,” Motwani adds.

Despite the promise and enthusiasm, barriers to investment remain. None of the international custody banks has a presence in Iraq, which is a red flag for many institutional investors and traditional fund managers.

HSBC, which owns a majority stake in Dar Es Salaam Investment Bank of Iraq, was widely expected to offer a custody service in Iraq but this has failed to materialise. In February the National Bank of Kuwait was reported to have received authorisation from the ISX to provide custody services. However, it is still waiting for a custody licence from the regulator and it is not clear if the service will be launched any time soon.

That suits Euphrates just fine. “The lack of custodian banks keeps a lot of investors out of Iraq, which means we’re not competing with anyone else,” says Felgenhauer. He reckons it will be at least a couple of years before most institutional investors feel comfortable investing in Iraq. By then, the early investors could be sitting on a goldmine of cheap stocks.


04-09-2013, 06:33 PM
Thanks Babylon, this is why we play the game!

04-10-2013, 03:55 AM
For ISX stagnation , institutional investors are pointing to lack of custodian banks, I guess red tape on the Iraqi side will stay for a very long time.

04-10-2013, 12:11 PM
Thanks Babylon, this is why we play the game!

"He reckons it will be at least a couple of years before most institutional investors feel comfortable investing in Iraq. By then, the early investors could be sitting on a goldmine of cheap stocks."

ISX Junkie using Aljazera
04-10-2013, 12:41 PM
MMMMMM I am salivating.