Rashmi Kwatra – Emerging Value, Value In South-East Asian Emerging MarketsThe Acquirer's Multiple
In this episode of The Acquirer’s Podcast, Tobias chats with Rashmi Kwatra. She is the founder and CIO of Sixteenth Street Capital, which invests in emerging markets using a Buffett-style approach. During the interview Rashmi provided some great insights into:
- How To Discover Compounders In Growth Emerging Markets (GEMs)
- The Leapfrog Effect – Fast-Growing Emerging Economies Can Take Advantage Of Technological Advances, Bypassing Outdated Infrastructure Building
- Investors Can Calculate Compounding Trajectory In Asian Companies, Based On The Disruption Created In Developed Markets
- How To Identify Moats In Early Stage Countries That Are Growing Rapidly
- What Are The Main Differences Between Investing In Developed Markets And Emerging Markets?
- India’s Larger, Deeper Market Provides Outstanding Opportunities For Foreign Investors
- Being Raised In A Small Family Business Provides A Great Platform For Investing
- Asia’s Projected Incremental Growth In Coming Years Provides A Sustainable Competitive Advantage Over Other Regions
- The Best Time To Sell Is When You Need Capital For Something Else
- Local Capital Investment Is Now One Of The Main Drivers In Emerging Markets
You can find out more about Tobias’ podcast here – The Acquirers Podcast. You can also listen to the podcast on your favorite podcast platforms here:
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Tobias Carlisle: All right. Are you ready?
Rashmi Kwatra: I guess.
Tobias Carlisle: Let’s do it. I’m Tobias Carlisle. This is the Acquirers Podcast. My special guest today is Rashmi Kwatra. She is the founder and CIO of Sixteenth Street Capital, which invests in emerging markets using a Buffett-style approach. She’s a 30 Under 30 Forbes Asia graduate of the Wharton School, the youngest partner ever at Prince Street Capital, which is a multibillion-dollar emerging markets investor. We’re going to talk to her right after this.
Speaker 3: Tobias Carlisle is the founder and principal of Acquirers Funds. For regulatory reasons, he will not discuss any of the Acquirers Funds on this podcast. All opinions expressed by podcast participants are solely their own and do not reflect the opinions of Acquirers Funds or affiliates. For more information, visit acquirersfunds.com.
Tobias Carlisle: Hi, Rashmi. How are you?
Rashmi Kwatra: Hi, Tobias. I’m good, thank you. How are you?
Tobias Carlisle: Very well, thank you. I think you’re the first guest who I’ve had on who speaks English, Thai, Hindi, and Punjabi. So how did you come to speak four languages?
Rashmi Kwatra: It’s a good mix. I guess, my heritage. I am ethnically South Asian, so I still have some roots in India, which is the Punjab region and Hindi. And then I grew up in Bangkok, Thailand, so Thai is actually my first language, and then picked up English along the way.
Tobias Carlisle: And I saw in your deck, that gives you some advantages when you’re visiting countries, you’re able to travel freely between India and Pakistan, and so on.
Rashmi Kwatra: Yeah. So being a Thai national, because there’s been a lot of discrepancies between some of the South Asian countries, et cetera, it’s not easy for people to get in and out of some of these markets. But for me, we travel freely, and I’ve been visiting these markets for over a decade.
Tobias Carlisle: So your pitch deck describes Sixteenth Street as a long-term investor in Asian growth markets, and the way that you describe it, Growth Emerging Markets, GEMs. So why the focus on GEMs?
Rashmi Kwatra: I think it’s what I know. So again, I grew up in Thailand, and ASEAN as the trading bloc is called, or Southeast Asia, was home. I traveled off into Indonesia, to the Philippines, and then I have a South Asian heritage, so travel to India often. And my first job with Prince Street that you mentioned, I started as an analyst covering this region.
Rashmi Kwatra: So I was fortunate that some of the competitive advantages we talked and where I was placed in my first job to allow me to focus on these markets, they happen to be some of the fastest growing countries in the world. So over time, there was no need to look elsewhere, because the tailwinds and rapid economic growth we’re seeing in my region of focus offers us quite a lot of opportunities for long-term compounding.
Tobias Carlisle: So let’s talk about your philosophy a little bit. What are you looking for when you’re examining these stocks?
Rashmi Kwatra: So as I mentioned, we’ve already narrowed down these markets that are in earlier stages of development than say the US, Europe. So they have certain things in their favor, including a younger demographic population that’s still entering the workforce. So these countries are already growing at GDP growth rates of 5%, 6%, 7%, 8%. One of our markets is touted to grow almost 10% in the next couple of years. So we already have economic growth in these markets.
Rashmi Kwatra: Now what we’re looking for is companies that are well set up in these markets run by talented management teams, who can not only grow with the tailwinds that these markets provide but take market share from perhaps the public sector or less well-run companies and grow multifold over time. So it’s really important to us to find companies that have a long runway for growth, and then really run by strong management teams.
Rashmi Kwatra: In these markets one thing is for certain is there’ll be volatility, there’ll be changes in regulations, but a really smart management team and an aligned management team can often navigate that very well, so that you come out ahead gaining market share in industries that already have quite a lot of room.
Tobias Carlisle: How do you characterize your investment style, is it growth in a value framework? Are you looking for compounders?
Rashmi Kwatra: Yeah. Yeah, I think that definitely looking for compounders. We have to understand what are the potential of these companies to really be able to value them accurately. So we do a lot of work in really understanding, what’s driving these companies, or they’re more sustainable, or they number two and number three player only in existence because they allow them to be?
Rashmi Kwatra: Certain things that really, first and foremost, we try to understand the business model and the competitive advantages of this business model, and then we do a lot of work to value that. I mean, we will always get in at a price much lower than the intrinsic value, whether that’s a single-digit P/E, not necessarily.
Tobias Carlisle: And when you’re constructing these portfolios, how concentrated do you get, how many positions do you like to hold, how do you think about geographic concentration and so on?
Rashmi Kwatra: So we have, in total, 25 holdings. Our top 10 holdings is roughly 60% of our portfolio. Our largest market is about 46% of the portfolio, and then in total we have about six countries represented in the portfolio. Again, I mentioned, these markets are fantastic if you have patient capital and a really long-term outlook because there will be volatility.
Rashmi Kwatra: So we like to have a portfolio that has some diversification in terms of country allocation, so that when India is going through a liquidity crisis we can fund from Thailand, or the Philippines has a change in the political party and we have an ability to fund from other places a portfolio to take advantage of that. So it’s important for us to have exposure in a few different markets, but we do get quite concentrated in our top 10 positions.
Tobias Carlisle: You say that you’re looking for sectors that can disrupt. How do you characterize disruption, and what does that mean?
Rashmi Kwatra: It doesn’t have to be sectors that can disrupt, but definitely the teams and the companies that are doing the right things to continue to disrupt what was normal practice before that didn’t work before. So it could be the sectors that we’re primarily invested in are traditional consumer companies and financial services company, where today we see low adoption rates in financial services companies, and for consumers we’re seeing household incomes continue to grow as the economies grow. So both these sectors will benefit along with the more digital economy, so e-commerce companies, fintech companies.
Rashmi Kwatra: So in terms of disruptors, we’re looking for the financial services company that is using mobile payments to address a segment of the population that historically could not be addressed before. We’re looking for the consumer company that is using e-commerce or the leader in e-commerce or classifieds businesses to reach, again, segments of the population that just five or 10 years ago could not be reached.
Rashmi Kwatra: Disruption also means management teams in the private sector that are disrupting the way the government used to do business, so the public sector. So we’re really looking for people who are thought leaders and using whatever technology is available today to increase their target audience.
Tobias Carlisle: When you’re going through your investment process you talk about finding the compounding trajectory of the business. How do you go about figuring that out?
Rashmi Kwatra: It comes from many avenues. One method is we’ve studied business models that have withstood time in more developed markets. So we’ve seen how retail businesses, for example, have been disrupted in most developed markets, but some formats have withstood even e-commerce, and why is that? And could the same dynamics play out in Asia where we were at a much earlier stage of growth, and therefore maybe have many more years of compounding?
Rashmi Kwatra: We might look at how similar Internet businesses have done in China or in the developed markets. And again, we have the luxury because these economies are 10 or 20 years back. So with some assumptions, we can triangulate as to what business models maybe will work in these markets as well.
Rashmi Kwatra: And then alongside that, really identifying where are the pockets. So adoption rates in banking are low. If you are using technology… and understanding that, well, people don’t have bank accounts or insurance, they do have cell phones. So which companies are using technology and cell phones to increase their reach. What is the trajectory look like from where they are today, and even the market growth that they can expect because of lower penetration or adoption rates?
Tobias Carlisle: When you talk about identifying the moat or identifying the sustainable competitive advantage, it must be a challenge when you’re looking at countries that are growing very rapidly and that are an earlier stage. How do you go about getting comfortable with the moats in these countries?
Rashmi Kwatra: You’re right. I mean, we can talk traditionally looking at, historically, what the companies have been able to do. So have they reinvested their capital in a way that incrementally brings more returns to all their stakeholders? We look at what is their return on investment, what is their incremental return on investment? How have they in times of crisises or when the economy has slowed or their segment has slowed, have they reinvested in R&D, have they been able to control costs so that their market share, even in tough times, continue to increase, those kinds of dynamics. What are we seeing in times of strain? Is there dominance, as in growing? And over time, how have they allocated capital and then shared it with their stakeholders?
Tobias Carlisle: Well, that was my next question. How do you get comfortable with the way that some of the controlling shareholders or the controlling entrepreneurs treat their shareholders and other investors?
Rashmi Kwatra: You really get ahead by partnering with entrepreneurs and shareholders that have large stakes in the companies. They are the ones that are doing it right, are very aligned. We do spend a lot of time looking at what their alignment is. Do they own a large part of the business, and is the business a large portion of their net worth or livelihood? And over time, how have they allocated capital? And whether it’s through dividends, or 5X, or just reinvestment, have they had arm’s length dealing, so no related party transactions? These are the kinds of things we look for in their historical behavior.
Rashmi Kwatra: And then we spend a lot of time on the ground as well getting to know these management teams. So unlike some more developed markets, I do believe in these markets… Actually, this is true irrelevant of market, but who you’re partnering with is very important. And so a lot of what we do is, I’ve been flying to these markets for over a decade, meeting the management teams, the business families, their customers, their suppliers.
Rashmi Kwatra: So we triangulate, if we’re looking at a management team, whether what they say they do is really what they do, by speaking to some of their peers and competitors. If they say they’re not very aggressive on pricing, is that true from the eye of a third party, and what do anybody in their ecosystem say about them? We do interviews with ex-employees. We really do think it’s important to assess the management quality, both in their historical actions and a reference check in terms of ensuring that what they’re projecting for the future is in alignment with at least what other stakeholders are saying about them.
Tobias Carlisle: What are the major differences between investing in more developed markets and investing in the areas where you’re invested?
Rashmi Kwatra: I mean, there are several differences, but there is often less published research. These markets are just less developed. There’s less capital going into the capital markets. The field of finance, the number of hedge funds, everything is lower in Asia. So that means that while a small cap company in the US may be covered by seven analysts and analysts who have been trained to think about the importance of different parts of the model, here that’s just not the case.
Rashmi Kwatra: That’s growing, and we’re seeing the financial field grow, so there’s more and more coverage, even of the less liquid or the smaller companies, but your access to published research will be lower. You also have to deal with… I mean, these are academics, but definitely much more volatility, the amount of retail investment in some of these markets. While some of the more developed markets, institutional capital makes up a lot of the trading liquidity, in some of these markets it’ll be the retail capital.
Rashmi Kwatra: So you will see volatility, which you really have to be prepared for in these markets, and it actually provides you great opportunities for the long-term because they trade on emotion. You can really if you have a long-term horizon take advantage of that, but those are a few things.
Rashmi Kwatra: In some of these markets you need regulatory licenses. So for me, setting up Sixteenth Street was very important that even when we set up and as we scale that we would have direct access to all of these markets, which means you need a foreign portfolio investment license in India. You need to have assigned tax regulators in Bangladesh, et cetera. So setting up, and having access is a little bit more difficult.
Rashmi Kwatra: But once you do the sophistication actually of the trading systems, and the exchanges are much stronger today. When it comes to repatriation of capital, et cetera, they’re almost like the West. You just have to do your own research, and be prepared to take advantage of some volatility along the way.
Tobias Carlisle: Just changing tact slightly, what’s it like going from a multibillion-dollar hedge fund to starting your own shop?
Rashmi Kwatra: I mean, it’s been a great journey. It’s only less than two years into it, but I think I learnt a lot from the fund that I was with; a lot of wonderful practices I’ve taken with me into Sixteenth Street, the importance of on-the-ground research. Some of the relationships that I’ve built over the years have allowed me to start this. And now, it’s really crafting what I think is sustainable for me for the very long haul. I mean, it’s a journey.
Tobias Carlisle: What’s the significance of the name?
Rashmi Kwatra: Sixteenth Street is where I grew up. So my mom lives on [Suai 00:18:21] 16. Suai means street in Thailand, and of course I worked for a fund called Prince Street Capital for many, many years. So Sixteenth Street is home for me.
Tobias Carlisle: I noticed when I was going through your pitch deck that you have a concentration in India. Is that because it’s a bigger market, or do you think that the opportunities there are particularly good?
Rashmi Kwatra: Both. I think the opportunities there are great but not necessarily better than some of the other markets I invest in, so they’re equally as good if not maybe more attractive as some of the other markets, but it is a much larger market with more depth. So again, we are focused on more bottoms-up process, which means we want to be invested with great companies run by great teams.
Rashmi Kwatra: In a market like India where there’s over 5,000 listed companies, finding a handful of companies is more plausible than in the Philippines when really you’re only looking at 40 companies that are in your investible universe. So it’s a combination of just being a larger, deeper market alongside the long-term opportunity we see in that market.
Tobias Carlisle: Do you develop relationships with local investors over local hedge funds when you’re looking to invest in these countries?
Rashmi Kwatra: Absolutely. I do, and I have some great relationships and great friends; solely Philippine managers, a Thai manager, Indian managers. Some of them are invested with me in my fund, and I think over the years I’ve cultivated a network to share ideas, and more so thought processes, and I think it is important to speak to everybody, whether it’s fund managers and peers, as I mentioned the businesses and their comps. So one of one part of the process is definitely building relationships with managers in these markets.
Tobias Carlisle: I ask because I think sometimes there’s an advantage to being a local, but then I think there’s also sometimes an advantage to being an outsider and being able to view the companies in a country in the context of the rest of the globe. So how do you weight those two considerations?
Rashmi Kwatra: I agree. And I think that we’re in the sweet spot because I am considered a local in these markets. And just by virtue of them being smaller markets at least Asia, et cetera, and the time I’ve spent in these markets I’ve probably visited Pakistan or Bangladesh more than any other manager.
Rashmi Kwatra: So I’m considered local, but then because of our process, first a more regional geographic focus, and then our process which looks at how things have developed; we have been in the global ecosystem, we’re able to zoom out, and yet get the access and the treatment as we do. And because so much of our focus is also being on the ground, I do think we see things like a local, and then step back and look at how it plays into things in the correlations and triangulate between different markets.
Tobias Carlisle: When you are looking at these companies, are you looking for something that can dominate geographically or dominate in the country, or do you think you’ll find some things that will potentially dominate on a global scale?
Rashmi Kwatra: Because these markets are in such earlier stages of development, there’s still quite a lot of growth within the markets themselves. So I find that the Home Depot of the Philippines, for example, they have so much growth in the Philippine market itself it would worry me if they went even to Indonesia. So it’s a combination, so not necessarily. Some of the companies we’re looking for we think that these markets provide growth for many years to come without stepping across borders.
Rashmi Kwatra: Then we have newer age companies that are building businesses afresh, and there are network effects in the e-commerce market, for example. So we have in our portfolio an e-commerce company that is dominating in several regions in Southeast Asia.
Rashmi Kwatra: Now I think Asia is also so far ahead when it comes to… we could talk about this, but leapfrogging in financial technology and mobile payments. I can open up a bank account in India, in Philippines in less than a minute. It took me forever to close my bank account in the US the other day. So I can’t do that in the US, I can’t do that in Singapore, I can in India. So some of these technologies and some of these businesses will be global.
Tobias Carlisle: I agree with you that there’s a very interesting phenomenon, and I’ve seen it in telecommunications in particular where it’s difficult to go out and run copper twisted pair to every single house. And so there are lots of parts of the world where that’s never happened, but it’s not as hard to run out mobile cell towers. And so where they haven’t ever had twisted pair coaxial cable, they’ve gone directly to fast cell phone data plans that some of the rest of the developed world doesn’t yet have.
Rashmi Kwatra: Exactly. So, some of what we’re seeing in that field especially. And this is because the infrastructure wasn’t laid out. So to the developed world’s credit, the mobile phone is less important when you have a bank branch and everybody already has access to credit.
Rashmi Kwatra: It’s very different in the developing world, which means with cell phone penetration and almost 5G network, 4G network, really great Internet across these markets which they’ve built out, what we’re seeing in terms of it definitely that interplay, how you’re connecting to a consumer using mobile is much ahead of what we’re seeing in the developed markets. So whether it’s those companies, those technologies or those ideas, that will be much more global, I think, going forward.
Tobias Carlisle: What does it do to a nation to move from being underbanked to being able to access financial services?
Rashmi Kwatra: I mean, it’s the multiplier effect. The effects are very large. I speak to two small businesses. I was just in Indonesia speaking to a small business. There’s a shop, they sell your everyday necessities, personal care, food and snacks. And their business today, because they have access to… firstly, they’re using their cell phone and services to provide their customers with more products. So you can now top up your mobile phone digitally at their store, you can buy travel tickets, you can send money to your mom using the payments network. So their businesses are growing because of technology.
Rashmi Kwatra: And now because we’re using technology to get better data on that shop’s economics and how much revenue they’re turning over, we could provide financing to them at a much more affordable rate than just a few years ago, which allows the shopkeeper then to think about expanding their business.
Rashmi Kwatra: So we’re talking about people getting credit at a much lower rate than they would historically been able to. So it’s either they didn’t have access to credit, or they were paying a loan shark or somebody in their village a much higher rate. And now we’re giving them access to credit and at a much lower rate, which allows them to scale their business, and doesn’t increase risk because we’re able to assess their business much more prudently because of the information that we’re able to get in this digital world.
Rashmi Kwatra: So I think this is a small, micro example, but the connectivity, the access to the rural villages that didn’t have an ability to scale their businesses, we’re seeing that take over, and small and medium enterprises in these markets are a much larger portion of the economy.
Tobias Carlisle: Just to change tack a little again, how did you personally get interested in investing? You did a Wharton undergrad, and then you did some postgrad… I’m sorry, I’ve just forgotten the name of the London…
Rashmi Kwatra: No, that was a semester abroad. So I went straight from undergrad at Wharton to working for Prince Street Capital, which is a fund that invest in emerging and frontier markets.
Tobias Carlisle: Why value investment?
Rashmi Kwatra: I was very fortunate, I think, to be taught a young. Going really back, I think for me, I grew up in a household with sisters and a mom who didn’t work, and I could see that she was financially very dependent. And for me, the idea of being self-sufficient and financially secure was always appealing. So I was always looking for a way to sell our books, or sell our lemonade or something. I enjoy being able to make money. That’s for sure.
Rashmi Kwatra: And I was fortunate because as I was growing up, my father ran a small business. He exported home decor from Thailand mostly to the US, so Pier 1 Imports was one of his largest customers. And I got to follow him around the office and ask him, what is his trade, who are his customers, how does he go about sourcing? Over the time, I got to learn about inventory, credit and things like that, and loved it. I would buy out any excess inventory. He had set up shop in my school, started a small business even back then.
Rashmi Kwatra: And maybe fortunately, again for me, maybe unfortunate or fortunate for him, his business got very competitive. The Indonesian rupiah depreciated during the Asian financial crisis, and exports from Thailand where the economy is slightly more developed than some of the other region was just not as competitive. And so he had saved up enough capital to send my sisters and I to any Ivy League school that we got into. He knew that he could provide that level of education, and then it was what we did next was up to us.
Rashmi Kwatra: And so he became a full-time passive investor in the Thai equities market. So that meant he would be handing me the intelligent investor and saying, “Rashmi, read chapters 8 and chapter 20.” Phil Fisher, Graham, Buffett, I was reading it and fortunate to be able to, and then have somebody to sit with on a Saturday or Sunday and say, “What businesses are you looking at, and why is that a good business?”
Rashmi Kwatra: And I think because he came from a business of his own and had made some earlier mistakes in investing, he was very much focused on finding great companies. Again, it was always instilled in me that the equity markets are just a proxy, that we were lucky that they existed because that meant that you could put $5,000, or $100, $200 in a business, and they’re just a proxy to investing in great businesses.
Rashmi Kwatra: Which meant I learnt, first and foremost, what makes a good business, how to think about business. I mean, I was intrigued. I enjoyed it. And it led me to think about, if I could master the skill, I’d have financial freedom for the very long haul. And so Wharton was touted as the best undergraduate business school. I applied, and went from there.
Tobias Carlisle: And when you got to Prince Street, how did that mold your investment process and change your philosophy, or not?
Rashmi Kwatra: When I got to Prince Street, I think, again, I was attracted to the opportunity because I thought that they were serious about some of the markets that I wanted to do more work in. So they were investing in Thailand, in Southeast Asia. But they didn’t have an analyst on the ground running around, meeting all of the companies and really doing some of the bottoms-up research from Asia, and I was willing to do that.
Rashmi Kwatra: So I spent the first few years of my career at Prince Street really just… If somebody mentioned a company in Asia and I didn’t know what they did and who was running it, it didn’t sit well with me. So I ran around these markets meeting the management teams, whether it’s through screens, through conferences, and getting to know the companies very well.
Rashmi Kwatra: So what Prince Street provided me, which I didn’t have as an earlier investor or as a novice learning, and even my father still doesn’t have is the access to these management team and I think the importance of understanding on-the-ground research, and the motivations behind some of these families is what I really took away from it and what I focused on, and then brought to them my focus on really diving deep and understanding the companies first and foremost. So they added to my process, but I think the fundamental grooming that I had earlier in stage or learnings, that really has stuck through till now.
Tobias Carlisle: I mean, it’s a hackneyed question, but I still want to ask it and I still want to understand, what do you regard as your edge?
Rashmi Kwatra: We talked about several of these things, but the ability to analyze a business first. Analyze a business first, and then understand why these businesses may or may not make sense in these markets, because I’ve grown up in them. I know when I go to the small shop owner what her problems are, what the threats are of modern retail. All of these things inherently make a lot of sense to me because I’ve lived through them, and then I spent a lot of time on the ground getting to know what’s changing.
Rashmi Kwatra: And it’s this ability to correlate what we’re seeing in terms of global trends or global changes with what’s happening on the ground, and being able to triangulate that and then have a focus on finding the right people to do it with for the veer, because of age at least the time to have a very long-term horizon. Those are the things I think are my competitive advantage.
Tobias Carlisle: I ask about the edge, and that’s sort of a personal question for you, but then the opportunity is what does the investment opportunity set look like for you where you can exploit that edge?
Rashmi Kwatra: I’m not sure I get your question, but the investment opportunity is then such a large part of Asia, where just in 2000, Asia made up less than a third of the world’s economy, less than a quarter now, it’s going to be 50% in 2040. 40% of consumption is going to come from Asia. So all the incremental growth we’re seeing in the world where companies do have an ability to grow very rapidly for many years to come are in the markets, that I believe I have a competitive advantage.
Tobias Carlisle: So when you’re examining a position and you invest in it, how do then whether the position is working or whether the thing that you’ve identified is working? How do you know if it’s wrong?
Rashmi Kwatra: I mean, that’s part of why we like a concentrated portfolio, and we really keep up to date with our holdings and their peer set. So we are on conference calls with the management teams of our companies once a quarter. I still traveled to visit them several times a year. My analyst team that I’ve built up is also traveling and on calls with them. So we keep track of where we think the businesses will go.
Rashmi Kwatra: For what it’s worth, we do model out what we think these businesses will look like three to five years. We check our assumptions, and whether what we believe is going to happen continues to unfold as we had assumed, or if there are variances what that means. And if something really changes, then then we analyze whether our thesis was broken, and if so, learn from it and move on.
Tobias Carlisle: And how do you make a sell decision? Is it your price has been reached, or are you waiting for some deterioration in the fundamental of the business?
Rashmi Kwatra: Often time it’s because I need to fund something else. So historically I sell because I have a better opportunity or I think it’s a better opportunity, and that’s more where the sell decisions come from. We don’t necessarily sell just because something has reached our medium term potential. We are investing in businesses that can be several times larger. And so while we do model out, where we think these businesses will be three to five years from now, and sometimes they overreach in the short term, that doesn’t necessarily lead to a sale decision.
Tobias Carlisle: Do you trade around positions? If they get too big, do you trim them back? And if they go in the short term they run against you, do you tend to add to them?
Rashmi Kwatra: It depends. If I have the capital and they go against me, I would add to it. On the other side, again, just because it runs, if I didn’t need the capital elsewhere it’s not necessary that I would trim it.
Tobias Carlisle: And how do you feel about the strategy now, the short-term, medium-term, long-term outlook? Is it a particularly good time to be looking at emerging markets?
Rashmi Kwatra: Absolutely. I think that some of what we’ve talked about has been true for these economies, the great demographics. Economy is growing at a more rapid place in the developed markets has been true for quite some time. But things are happening today and have been happening in the last couple of that are setting a stage for the next few years, in the next decade, Asia to be particularly strong. We’ve talked about some of the technological changes that just make the target addressable market for the private companies, companies run by private individuals that we really want to be invested alongside, expand exponentially.
Rashmi Kwatra: I believe that in the next few years we’re going to see a continued, really fast adoption, whether it’s e-commerce, whether it’s higher adoption rates in terms of financial services, leading to more consumers in the formal economy, and their ability to spend improving quite substantially. So for us, all of these changes are very positive for our economies, our markets, our companies, and we’re looking forward to the next several of years.
Tobias Carlisle: Emerging has underperformed the US in particular, almost everything in the world underperformed the S&P 500, but that has led to this unusually wide valuation discount for emerging versus developed. Does that make the opportunity set even better, do you think?
Rashmi Kwatra: I think so. To the credit of the US and some great entrepreneurs, we’ve seen several companies continue to make way for a strong market, but if you look historically at any point of time, it’s really a decade emerging market is outperformed, a decade SAP is outperformed. And I think we’re at the stage now where there’s enough going on in these economies for the world I think over the next couple of years to price some of these assets more accurately.
Tobias Carlisle: Do you see that on a company by company basis that they’re much, much cheaper than you would expect say something comparable in the US to be?
Rashmi Kwatra: Not necessarily. So in our markets, even some of our holdings, some of the best run companies in our markets are not necessarily very cheap, or there is price discovery and quality discovery. But the runway for growth in some of these companies is much, much longer.
Tobias Carlisle: What drives that so that they’re not unusually undervalued? What drives that? Is that locals finding that these are very good companies, or is that foreign investors finding that they can find an equivalent business to one that they might have looked at in the West and it’s maybe slightly undervalued, and then bidding that up to a level? Do you know? Is that possible to know?
Rashmi Kwatra: It’s much, much more the local institutions being more developed in these markets today. So 10 years ago, five years ago, some of these markets were foreign flow has really drove much of the market. But today we’re seeing the institutional capital domestically grow quite sustainably. So there has been a push by governments to have certain tax savings, et cetera, if they invest in funds that invest in the equity markets to promote the development of the equity markets, for example. And we’re seeing that some of the best companies in these markets, that their price is determined by the local capital and less foreign flows.
Tobias Carlisle: Your second largest holding is Sea Limited, S-E-A Limited. Could you just talk a little bit about how you found it? Tell us a little bit about the company and what’s happened since you’ve invested in it.
Rashmi Kwatra: So Sea has a strong gaming business. It’s a gaming distribution company, and it’s a market leader in e-commerce in Southeast Asia. So in markets like Taiwan, it’s competing for number one position, and in Indonesia, which is a very deep market. We’ve been studying this company since pre IPO. So pre IPO, we looked at Sea and Garena, which is their gaming arm, and thought about the presence they have in gaming, how underpenetrated gaming in Southeast Asia was, and really from an earlier stage liked that business.
Rashmi Kwatra: That business was a cash cow, just throwing strong cash flows. But what the management team was doing at the time was reinvesting in two other businesses; one was an e-commerce business and one was a payments business. In our analysis, both spaces, again, we think there are long runways for growth. E-Commerce is quite nascent in Southeast Asia, and so is the payment landscape.
Rashmi Kwatra: But to build a payment landscape that could be with some local strongholds in these markets would be difficult. However, there were signs that they could succeed in e-commerce. There was not yet one dominant e-commerce player. Again, I mentioned the market is quite nascent. But I was hesitant to invest earlier on because we weren’t sure whether good capital would be thrown at an industry that really would take a long time to break even.
Rashmi Kwatra: Over the last year, we’ve seen incredible developments in e-commerce platform. So they’ve continued to fire on all cylinders on their gaming business in Garena. And Shopee, which is their e-commerce portal, has gained traction and become a market leader in many of our markets. So they’re competing with some local players, but the way that they’ve been able to grow has caught our attention late last year.
Rashmi Kwatra: For us it was important to see whether that was sustainable, and what the competitive landscape was like. So we did a lot of interviews with, Tokopedia which is a competitor of theirs in Indonesia, Lazada which is owned by Alipay, and realize that both of their competitors had been funded and weren’t likely to get a new round of funding anytime soon, and recognize that the market was growing rapidly enough that they didn’t have to be competitive on pricing, and that everybody could grow with the market.
Rashmi Kwatra: That set a very good landscape or environment for Shopee to continue to grow where their take rates or the percentage that they take from the merchants that are signed on with them are still very low compared to regional or global peers. So Shopee takes about 2% from their merchants. Alibaba in China it takes closer to 8%. Amazon if you strip out AWS, et cetera, that progresses to something like 15%. So here you have an e-commerce market that is still very nascent. We think that it’s going to continue to grow very rapidly. Pricing power because they’re not yet being very aggressive on pricing, and then a competitive landscape that is benign, and so everybody can grow without cutting prices.
Rashmi Kwatra: So when we saw those dynamics, we recognized that what we were looking for in terms of the incremental execution of the business were tracking well. And then as importantly, the company because of just foreign flows out of Asia, out of China in these markets late last year, we were able to buy the company, where we would just have to price their gaming business at less than 10 times EBITDA, and we’d get their shopping business and anything else for free.
Rashmi Kwatra: Sometimes you do that and you can recognize that the other businesses can destroy value, but here we had comfort that this business was not going to destroy value. They were executing well and comps or peers in the markets had raised private equity capital at several times GMV. So we really had this option value of a business that could be much more valuable alongside a leader in the gaming business.
Tobias Carlisle: And where has Sea limited traded?
Rashmi Kwatra: It’s actually traded in the US, so it’s traded on the NASDAQ.
Tobias Carlisle: What’s the ticket?
Rashmi Kwatra: S-E-U-S.
Tobias Carlisle: S-E-U-S. Oh, that’s great.
Rashmi Kwatra: Yeah.
Tobias Carlisle: Rashmi, that’s just about coming up on time for us. But before we go, would you please let everybody know how they can get in contact with you if they’d like to do that?
Rashmi Kwatra: Sure. You can send us an email at [email protected]
Tobias Carlisle: Rashmi Kwatra of Sixteenth Street Capital, thank you very much.
Rashmi Kwatra: Thank you, Tobias. It’s been a pleasure.
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Article by The Acquirer’s Multiple