<article>Value creation, and not financial engineering, will deliver results for private equity in the Vietnamese market, Chris Freund, founder and partner at Mekong Capital, said in an interaction.</article>

Value creation, and not financial engineering, will deliver results for private equity in the Vietnamese market, Chris Freund, founder and partner at Mekong Capital, said in an interaction.
&#8220;The traditional sense of financial engineering that global PE funds do, I don’t see much of that in Vietnam &#8211; like leveraged buyouts, or investors borrowing money to make investments; I don’t see them doing a lot to change the balance sheets of the investee companies, even though it is a common thing in the US and other more developed markets. From my perspective, everything has to do with value creation – how to build the management team, the culture, the infrastructure system, etc. Financial engineering is not a part of our playbook,&#8221; Freund emphasised.
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Vietnam-focused <a href="https://www.dealstreetasia.com/tag/mekong-capital/" target="_blank" rel="noopener">Mekong Capital</a> is set to raise its fifth fund this year after it completes 2-3 more investments from its Mekong Enterprise Fund III, but the firm says its success is partly driven by its <a href="https://www.dealstreetasia.com/stories/want-build-new-model-private-equity-investing-mekong-capitals-chris-freund-76599/" target="_blank" rel="noopener">Vision Driven Investing framework</a>, which is aimed at enabling portfolio companies to think long-term and deliver a minimum of 5x returns.
According to Freund, Mekong Capital had wanted to add value to its early portfolio but did not succeed. That led the firm to create its own value creation framework and transform at the corporate level.
“At first, most of our LPs did not even understand what we were doing. We tried to explain to them about transforming our culture; and eventually, once it worked out and was a success, everyone was happy and we got a lot of positive feedback from our LPs about our culture and the performance of the funds,” he added.
Last year, the firm was in the news when it exited retailer MobileWorld with 57x returns, following past successful exits such as restaurant operator Golden Gate and Vietnam Australia International School.
Edited excerpts:
Is doing middle-size deals in Vietnam challenging for you? How much of a factor is financial engineering when it comes to the companies that you have invested in?
Vietnam has seen a lot of regional and global PE firms searching for larger deals like TPG, KKR and CVC. Those are the deals funds like us don’t look at. There are also some who are doing small, incubator deals like 500 Startups, Cyberagent Ventures and other venture capital firms. For PE firms like us doing mid-market deals, at around $5-20 million, it is more of a country focus. There are a lot of opportunities in that space.
It seems to me that the LPs are interested in everything &#8211; so from an LP perspective, if it can make money, they are interested. We got feedback from some investors that they would like us to do some larger deal sizes, but it’s not a major consideration for them.
In the traditional sense of financial engineering that global PE funds do, I don’t see much of that in Vietnam, like leveraged buyouts, or investors borrowing money to make investments; I don’t see them doing a lot to change the balance sheets of the investee companies, even though it is a common thing in the US and other more developed markets. From my perspective, everything has to do with value creation – how to build the management team, the culture, the infrastructure system, etc. Financial engineering is not a part of our playbook.
Why is financial engineering not popular in Vietnam?
To some extent, the types of companies that PE firms focus on might be different. In a more developed market, they would normally focus on cash-flow generating businesses that they could borrow money (to invest) and have a lot of certainty that the companies will generate enough cash flow to pay back the loans. Or that could be a company that can generate cash but does not use the cash efficiently, so what they focus on is making it more efficient. A Brazilian PE firm called 3G Capital is a good example for this type of investment. They have a good track record, but their model is to invest in very matured businesses, find inefficiencies in them and remove the inefficiencies.
That is not the kind of deals we normally find in Vietnam. What we find tends to be small companies with a lot of growth potential, operating in very fragmented yet growing markets. So it is about how fast the companies can grow. It is a different skill set.
Do you think larger PE firms like TPG and KKR invest in more established businesses with high calibre management teams that do not require a lot of operational support like smaller PE firms do?
I could not speak for them, but I would say most companies in Vietnam need a lot of help building the management team, and elements in our Vision Driven Investing framework. All those things are opportunities for improvement for most companies in Vietnam. Often, PE firms want to find the most well-managed teams, but probably most investments by PE firms need a lot of help to achieve their potential. I don’t think they have a plan to be passive investors, but the intention to add value.
What are LPs betting on when it comes to the Vietnam market?
Each LP might be different but one thing they will generally look at is the track record in terms of the home market, strategies and specific PE firms. Once they see a lot of returns are generated, it definitely attracts them. If we have good successes, then they will see more potential for the future. The biggest thing is what the track record looks like both for the home market of Vietnam and for the specific PE firms. Some investors are interested in macro issues, some are not. Normally, LPs for private equity are very long term, so they don’t really focus on short-term macro factors.
In an interview with us in the past, you said that the track record of Vietnam was underestimated. How does it look like now?
It is hard to generalize. But there was a lot of money deployed in 2006 and 2007 but did not get to be invested well. LPs who invested in funds in that period normally lost money. The stock index lost 80 per cent of its value. For a while, investors lost a lot of money investing in Vietnam. It took a lot of time and evidence to rebuild confidence. But there have been more and more success stories like our past investee companies &#8211; Mobile World and Golden Gate &#8211; and good successes from other funds like VNG and Yeah1. Some have clearly been winners in various funds, and it helps validate that it is possible to have successful investments in Vietnam. In addition, there is a lot of data now &#8211; so there are a lot of patterns within fund managers of how and what will lead to successes.
What is the role of operational resources in mid-markets like Vietnam?
It is very critical. At least in Vietnam, I’d say in every investment we have made, with the exception of Masan Food, which was doing so well on their own, there was a big opportunity for us to contribute and add value. I don’t believe that in Vietnam, the passive investing style is a good idea.
About your own transformation, was it because you realized you had to change or was it an urge from the investors?
It was our internal decision. In 2007, there was a bubble and the performance of our first fund looked good at that time based on valuation. But valuation was high because of the bubble. I think the investors thought everything was going well. But I saw that the fundamentals of the companies were not very good, and we needed to do something to change. At first, most of our LPs did not even understand what we were doing. We tried to explain to them about transforming our culture, and eventually once it worked out and was a success, everyone was happy and we got a lot of positive feedback from our LPs about our culture and the performance of the funds.
The interesting pattern was that those who understood what we were doing were people who founded their own businesses. As they had run their businesses before, they saw the importance of having a strong culture and encouraged us to transform.
So is it fair to say now, with those proven success stories, PE firms with a value-added approach will find it easier to raise capital?
I believe so. If an investor is really good at adding value, it will show up in the results. They will have a better track record to show to the investors. Most funds claim they add value but a lot of them don’t. Some have the intention to add value but they are not effective like how we used to be. It is a separate issue that some funds spend a lot more time on marketing than others, and they can meet more investors, and be able to raise their funds.
Do you see the check sizes increasing in Vietnam?
It is gradually increasing, but slowly. Check sizes in Vietnam are generally small, compared to the rest of Asia. Most private companies in Vietnam are pretty young. They haven’t had a lot of time to grow &#8211;  so the deal size is often small. It’s definitely growing but not too fast, I’d say 10-15 per cent per year.
What is your projection for the deal flow in 2019?
I think it will be pretty much the same. In the absence of any major global events, it would be very similar, which means there will be more private companies, and SOE privatisation will continue to be behind schedule. The privatisation process has never happened as fast and easily as investors wanted. It is going to be slower than expected and harder to invest; maybe the percentage available is very small, making it unattractive.
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Vietnam-focused Mekong Capital is set to raise its fifth fund this year after it completes 2-3 more investments from its Mekong Enterprise Fund III.

Passive investment style not apt for markets like Vietnam: Mekong Capital's Freund

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