Final ADB IB Report, Beckwith January 2013

7/29/2019 Final ADB IB Report, Beckwith January 2013

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Final Report on the Prospects forEstablishing Inclusive Business

Facilities inSelected South-East Asian

andSouth Asian Markets

ADB Inclusive Business Fund Initiative

SUBMITTED BY NOAH BECKWITH


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ADB BOP INVESTMENT FUNDS INITIATIVEDATE: 19 JANUARY, 2013

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Table of Contents

Section Page

No.

Introductory Remarks

3

I. Cambodia 8

II. Vietnam

25

III. Thailand

43

IV. Laos 54

V. India and Sri Lanka

60

VI. Indonesia 84

VII. Philippines

94

VIII. Bangladesh

101

IX. Pakistan

107

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Introductory Remarks and Broad Conclusions from IB

Due Diligence

This report follows detailed due diligence undertaken between 2011-2012 in

Cambodia, Vietnam, Laos, Thailand, India, Sri Lanka, Indonesia, the

Philippines and Bangladesh, and an abbreviated desk study undertaken on

Pakistan. The focus of due diligence was to evaluate the prospects for

inclusive business (IB) in each of the markets, and to assess their suitability

to the establishment of several IB Facilities to provide finance to private

companies that do or might incorporate populations at the base of the

economic pyramid (BOP) into their activates as consumers, suppliers,

producers, distributors, or employees. The overriding conclusion of the due

diligence exercise is that there is a critical role for private sector investmentto play, accompanied by strategically-deployed technical assistance, in

addressing issues of access to, and affordability, choice, availability, quality

and price of key goods and services for the poor. Moreover, private sector

investment could be harnessed in the target countries to incorporate the poor

into supply chains in more sustainable ways thereby enabling them to

accumulate wealth and reduce insecurity and vulnerability, and drawing them

into production chains as producers and distributors. Finally, depending on

the size of investments made, in certain countries, the Facilities would havethe opportunity to affect the experience of BOP incumbents as employees by

focusing on issues such as wages, and improving skills and mobility through

training.

Whilst each market has its own particularities and unique set of challenges,

several overarching themes and commonalities have emerged through the

due diligence exercise, including:

1. A focus on the SME sector is required: Unsurprisingly, the lions

share of economic activity in all of the markets surveyed is attributable

to the small and medium-sized enterprise (SME) sector. This means

that drawing SMEs into supply chains, and helping them to capture

market share in the provision of key goods and services to lower

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income groups and the middle class alike must be a key component of

an inclusive business strategy;

2. Access to finance is a persistent challenge: The micro- small and

medium-sized enterprise (MSME) sector struggles to access finance

from formal institutions in every geography investigated. This

represents a significant bottleneck to their growth, which hampers the

ability of larger domestic companies and multinationals to draw SMEs

and micro-enterprises if feasibleinto their supply chains. In order

for ADB Facilities to be meaningful, to the extent that access to finance

issues can be addressed through targeted lending to financial

institutions, and complemented with concrete policy initiatives by

other parts of the bank, the effectiveness of the initiative will be

considerably enhanced;

3. Investing in financial institutions should be a prominent

theme: A corollary of point 2. above is that although microfinance has

made significant advances at the personal and, in some cases, micro-

enterprise levels in most of the target countries, access to finance

bottlenecks could be eased by helping financial institutions to develop

pro-poor products that enable SMEs and small entrepreneurs to

participate more effectively in the economy. Such products include

agricultural finance, micro-insurance, micro-health insurance, working

capital facilities and, more generally, the development of cash flow-

based lending expertise as a means of liberating SMEs from the

collateral trap which so often denies them finance;

4. Debt is preferable to equity: Given that financial and capital

markets are in their infancy in many of the markets considered, and

that entrepreneurs are generally not comfortable with opening their

shareholding structures to external ownership, in a first iteration, it is

advisable for the Facilities to focus on lending to businesses rather

than deploying equity. This significantly reduces exit risk, and will help

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to mitigate currency risk (somewhat) in that there would at least be

regular repayments back to the Facilities which could be transferred

back into hard currency at the earliest moment possible. In some

cases, as highlighted in the country analyses, there may be scope to

consider equity investment, but it is not a sine qua non for any of the

target geographies, and in some countries, such as India, it is debt

rather than equity the entrepreneurs desperately require;

5. Technical assistance is vital: The strategic use of technical

assistance funding will be critical to the success of the Facilities.

Investee companies desperately need hands-on engagement from fund

managers and technical and sectoral experts in the following key

areas, inter alia: corporate governance, management capacity-

building, management information systems implementation, strategic

planning, financial controls and accounting, preparation of information

and reporting, human resource management, talent retention and

incentivisation, marketing and customer-outreach. Technical

assistance packages should be conceived ex ante, i.e., as part and

parcel of the overall financial intervention in a company in order to

ensure that fund managers do not gain a reputation for providing

hand-outs. Additionally, recoverable grants and concessional loans

should be considered in larger, more advanced investees to ensure

that sponsors have skin in the game and do not view technical

assistance as free money;

6. Facility sizes should not be the focus: Facilities need not be

particularly large (i.e. greater than $100 million) in order to be

effective or meaningful. What matters is the establishment of proof of

concept, after which several things can transpire: additional

investment instruments can be introduced, larger facilities can be

raised, a broader range of investorsideally domesticcan be

attracted and more sectors can be tackled;

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7. Investment size is important: The Facilities must avoid the pitfall of

trying to be all things to all people, or in other words, attempting to

solve all access to finance and working capital issues in one initiative.

For this reason, loans (and especially equity injections) below $500,000

should be avoided, because the risks and intensity of engagement

increase vertiginously in such transactions. There is no question that

the void between the upper echelons of micro-credit and the floor of

the IB Facilities requires attention, but it must be acknowledged that

that is beyond their purview;

8. Dissemination of learnings is vital: Linked to the above two points

is the vital importance of disseminating learnings, especially across

Asia. It is important to engage governments, corporates and the

private sector more broadly in order for the concept of inclusive

business to take hold market by market;

9. ADB is particularly well placed to convene/facilitate the IB

Initiative: In all of the markets surveyed, ADB is perceived as a

natural convener of key stakeholdersgovernments, banks,

institutional investors and othersrequired to successfully launch

inclusive business initiatives and, critically, to secure buy-in at the

national, regional and local levels. This does not necessarily mean that

ADB must provide the largest amount of capital in any of the Facilities;

rather, that as the regions multilateral development bank, it is

naturally positioned to champion the initiative. In addition, it is well

placed to mobilise capital from development and donor partners based

in strategically-important member countries such as China, Japan and

Korea;

10. Partnerships with other multilaterals may be helpful: Some

multilateral development institutions, such as the Inter-American

Development Bank, the Corporacin Andina de Fomento and the

International Finance Corporation, among others, have been promoting

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inclusive business for some time. Partnership with such institutions,

leveraging their experiences and tailoring them to the Asian context

may be enormously helpful in avoiding some of the inevitable pitfalls

and teething problems;

11. Sub-regional Facilities are preferable: Due diligence revealed

that, in contrast to Latin America and Africa, there are no obvious fund

managers focused on Asia that would be able successfully to invest

one larger Facility across such a varied geography. In addition,

investors would likely consider a continent-wide Facility to be unwieldy,

and it would be extremely challenging to structure incentives across

such a range of target countries where considerable variations in

performance will inevitably emerge; and

12. Building fund manager capacity is vital: In addition to the above

point, few fund managers in the region, with the notable exception of

India, have been focused on inclusive business. This provides ADB with

the opportunity to achieve an additional development impact beyond

that of the funds deployed in helping to build capacity among fund

managers in the region so that they are better placed to invest to dual

(financial and social) and triple (financial, social and environmental)

purpose in future.

In conclusion, this compendium of due diligence reports presents a

compelling case for promoting a series of inclusive business facilities in

selected Asian countries. The Facilities would be well placed to demonstrate

that private sector can be mobilised by ADB and harnessed by domestic fund

managers both to address pressing social challenges, whilst also providing

attractive returns to investors. In the longer term, it is realistic to expect that

this initiative would stimulate greater flows of private-sector capital into

future IB vehicles as the concept becomes mainstreamed in the investor and

asset management community.

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I. Cambodia

Political LandscapeDespite the notional presence of political opposition in Cambodia, the

dominance of the Cambodian Peoples Party (CPP) effectively renders the

country a one-party state and the prime minister, Hun Sen, continues to

concentrate power in the executive branch of government unimpeded by any

significant checks and balances. Notwithstanding, the global financial crisis

and economic slowdown of 2009-2010, which led to factory closures and

redundancies, clearly demonstrated that Cambodia is not immune to social

tensions and unrest. On the one hand, this has encouraged Hun Sensauthoritarian instincts, leading the CPP to propose legislation to further

restrict organised labour. On the other hand, there is a growing realisation in

government that a thriving, market-driven private sector is critical to

maintaining rapid economic growth and, above all, to absorbing some, if not

all, of the 300,000 young Cambodians who enter the workforce yearly.

Despite the likelihood that trade unions in the all-important garment sector

will remain assertive and threaten strike action, emboldened by theredundancies in 2009-2010, and the fact that confidence in the judicial

system will fail to improvethe courts have upheld numerous convictions

against opposition figures in recent monthsfrom the perspective of the IB

Facility, Cambodia offers a relatively stable, very business-friendly

environment for investment. That said, three potential sources of political

and social instability should be noted:

1. Commodity prices: Ordinary Cambodians, many of whom live at thebase of the pyramid, are extremely vulnerable to commodity price

volatility. Increases in the cost of living hit the poor rapidly and very

hard, and renewed economic hardship could cause unrest and anti-

CPP sentiment.

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2. Land appropriations: Land grabs by large agricultural interests and

property developers with close connections to senior CPP figures will

continue. Many Cambodians are resentful of involuntary resettlement,

with de facto expulsions intermittently driving the poor from their

homes and communities.

3. Cross-border tensions with Thailand: The dispute over the sovereignty

of religious temples on the border with Thailand will continue. Some

dismiss the issue as a political diversion from domestic challenges

used by politicians on both sides of the border. Others argue that the

dispute is more substantial, and could flare up in a significant way if

left unchecked. Currently, there is little evidence that the issue has

slowed thriving cross-border trade, both formal and informal, and

Cambodias economic relationship with Thailand remains important.

However, an escalation of hostilities cannot be ruled out, which would

affect the Cambodian-Thai business corridor significantly.

Although it is important to note the key medium-term political and social risks

above, it should be emphasized that the business climate and operating

environment in Cambodia is extremely conducive to debt and equity

investments as envisaged by the IB Facility. Certain sectors, such as rice, are

politically sensitive because of their crucial contributions to GDP and social

stability, but the government will look favourably upon any investments that

strengthen them by boosting employment and exports.

Economic Policy and Performance

The Cambodian economy is extremely vulnerable to exogenous shocks:

fluctuations in commodity prices, volatile international oil prices, externaldemand for its exports and deteriorations in its terms of trade more

generally. The global economic crisis of 2009-2010 highlighted this

vulnerabilitythe United States accounts for 40% of Cambodian garment

exports, for exampleand it is unlikely that GDP growth will return to pre-

crisis levels of 10% for some time. According to Economist Intelligence Unit

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(EIU) data, economic growth rates will hover in the range of 6-6.5% in 2011

and 2012, underpinned by an increase in manufacturing activity and

strengthening demand for merchandise exports. Significant foreign direct

investment (FDI) from China, Vietnam and several north Asian countries, such

as Korea and Japan, will also drive GDP growth, and further increases in

garment sales to European countries can be expected, helped by the

Everything But Arms agreement which provides duty- and quota-free access

to European Union markets for least-developed countries (LDCs). Significant

expansion is also forecast in the agriculture, footwear, tourism and

construction sectors. Indeed, according to the World Bank, footwear exports

increased by 57% in 2010, creating 18,000 new jobs between December

2009 and February 2011. Similarly, tourism posted a strong recovery in 2010,

with a 16% increase in visitor arrivals on the previous year. From a socio-

economic and BOP perspective, it will be critical to boost expansion,

efficiency and value addition in the agriculture sector and, fortunately,

government policy is supportive in this regard.

There are several notable structural weaknesses in the Cambodian economy

which impede faster economic expansion and production efficiencies. It is

important for the IB Facility to take account of these because there is an

opportunity, through its investments in portfolio companies, to contribute to

redressing them to some degree:

1. Diversification: The diversification of the production and export base

is key. A supportive policy environment is critical in this area, as

evidenced by the near trebling of milled rice exports following the

governments policy to promote increased paddy rice production and

exports. Other sectors require similarly conducive policy regimes to

promote diversification and in order for Cambodian producers to

capture greater value domestically and move up the value chain.

2. Import reliance: The high import content of exports makes the latter

expensive, and augments producers vulnerability to price

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fluctuations of key factor inputs. Significant investment is required in

domestic capacity and production of inputs, especially in the

agriculture sector, to reduce import reliance and increase consistency

and quality of supply.

3. Dollarisation: The Cambodian economy is highly dollarised, which

undermines the effectiveness of monetary policy and leads to

systemic asymmetries that disproportionately affect small producers.

4. Limited Revenue Generation: The combination of increased

expenditure on defence and upward pressure on wages will keep the

budget in deficit for the foreseeable future. This prevents the

government from increasing spending on key social sectors.

On a more positive note, unlike neighbouring Vietnam, inflation has largely

been kept in check, and is well below double digits, hovering at 6%. The

government appears cognisant of the potential impact of inflationary

pressures on the economy from the Vietnamese experience, so it can be

expected to maintain its policy of keeping inflation under control.

Operating Environment for the IB Facility

As stated above, despite the pervasive presence of the CPP and the

politicisation of many business activities and relationships, especially in

larger companies, the business climate in Cambodia is extremely conducive

to the IB Facility as currently envisaged. Although the country remains

heavily dependent on donor funding, the conversation in the private sector

has become much more focused on entrepreneurship in recent years. Young

Cambodians with graduate degrees and MBAs from foreign universities arereturning to the country and infusing family-owned businesses with market-

orientated strategies. As one observer stated, whereas the employer of

choice among elite Cambodian graduates used to be the United Nations,

there is now a strong preference for banking and finance, and many are

starting their own businesses. Additionally, there is a realisation both within

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government and the private sector, that the country cannot rely on cost and

wage arbitrage as a long-term guarantor of export competitiveness in the

garment sector. Social instability and industrial action in China, coupled with

inflationary pressures in Vietnam, have highlighted the need for Cambodian

companies to move up the value chain asor ideally beforewages

inevitably rise.

A salient challenge for Cambodian businessesand an area where the IB

Facility can play a very active rolewill be their ability to create and capture

more value within the country. Domestic value creation and capture are

currently hampered by the modalities of available financing in Cambodia. The

banking system is awash with liquidity, and not only do banks compete

vigorously for opportunities to lend, but formal and informal loans from

Chinese and Vietnamese traders are abundant. The problem in many

instances is the quality, appropriateness and terms of the financing. In the

case of Vietnamese liquidity, the government is directing their state-owned

enterprises (SOEs) to lead the charge into Cambodia as a counter-weight to

the fear of growing Chinese influence in the region. Private Vietnamese

companies tend to follow SOEs thereafterpressured or of their own volition

but the short-term and often expensive nature of the financing they offer

impedes longer-term thinking in Cambodian businesses. Chinese lenders and

traders are also rapacious, and see no value in building long-term

relationships with Cambodian entrepreneurs and SMEs.

Another significant issue in the Cambodian context which, again, underscores

a vital role for the IB Facility, is land acquisition and tenure. Land in

Cambodia can be held under soft or hard title, the difference literally

reflected in a paper (soft) or cardboard (hard) deed, respectively. Whereas

few banks and lenders accept the former as collateral, the latter confers

permanence of title and is a recognised asset. The government is slowly

dealing with this highly-sensitive issue, but the disparity between espoused

policy measures and concrete change on the ground will continue for a

number of years. Hence the importance of financing mechanisms which

consider cash flow-based lending and quasi-equity or equity as opposed to

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just collateral-based financing. The latter represents a de facto poverty

penalty, because it is generally the poor who cannot afford to convert from

soft to hard title if the opportunity arises, and assuming that they understand

the arguments for and means of conversion. As mentioned earlier, forced

expulsions and involuntary resettlement are also rife, particularly when land

is required for commercial or industrial uses.

Debt and Equity Transactions in Cambodia: Prospects for the IB

Facility

Despite excess liquidity in the banking sector, a vibrant semi-formal and

informal financing community and the pervasive presence of Vietnamese and

Chinese lenders, there is a very strong case for establishing an investmentfund which provides debt and equity financing (where possible) to private

businesses in Cambodia, for four main reasons:

1. Businesses require long-term partnership: Although Cambodian

businesses are often under-geared, their reliance on debt and the lack

of familiarity with equity perpetuates short-term thinking and poor

strategic decision-making. Additionally, as competition intensifies

within and beyond the region, the need for business developmentservices (BDS), technology, know how, management information

systems (MIS) and professional management is becoming ever clearer.

Most banks and semi-formal lenders have neither the capacity nor the

expertise to provide this value addition and mentorship to Cambodian

businesses, which is central to the IB Facilitys relationship with its

portfolio companies.

2. A growing recognition of the importance of value creation:Traditionally, Cambodian business-owners have focused on short-term

cash generation and intermittent dividend issues to extract cash from

their companies. In the case of family-owned businesses, beyond

personal consumption, cash generation generally is directed towards

repaying bank loans, which are perpetually rolled over. However, the

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economic downturn of 2009-2010 and the pre-crisis construction boom

and subsequent bust have begun to shift this mind-set. During the

construction boom of the mid-2000s, many businessmen and

entrepreneurs were acquiring and flipping land primarily in the

greater Phnom Penh area. Siem Reap, the gateway to the temples of

Angkor Wat, was also vastly over-built, fuelled by heavy north Asian

investment in hotel and other construction projects. Cambodian

entrepreneurs have learned from the subsequent downturn that

speculation is no substitute for generating long-term value in their core

businesses.

3. The emergence of an equity culture:The forthcoming establishment of

the Cambodian Stock Exchange (CSE) has gripped the business

community. Whilst the CSE will likely remain nascent for many years,

with few listings and limited trading volumes after its founding,

curiously, it has provoked vibrant discussion of the benefits of listing

and the modalities of external ownership. Following the bubble and

fallout on the neighbouring stock exchanges in Hanoi and Ho Chi Minh

City (HCMC), Cambodian entrepreneurs are beginning to consider the

concept of underlying value in their businesses more carefully and,

even if only in incipient and theoretical terms, the improvements that

might be required if they were to list. The governments recent

announcement that companies will be required to publish audited

financial statements when they reach a certain size is also encouraging

formalisation and professionalisation.

4. Collateral constraints: The Cambodian financing culture is predicated

on collateral although, of course, in the subsistence, small-holder and

SME sectors, informal and semi-formal financiers provide un- or semi-

collateralised loans often at punitive monthly interest rates. Assuming

that the government maintains its policy of diversification and export

development, especially in the agriculture sector, Cambodian

businesses will require appropriately-priced, medium- and long-term

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financing which provides them access to more than just money. Slowly,

the absence of recognised collateral, counter-balanced by the need to

invest and build critical mass to take advantage of export opportunities

is forcing Cambodian business open.

Cambodia: Target Investment Sectors for the IB Facility

The Cambodian economy is not particularly diverse. It is heavily dependent

on agriculturemostly subsistence and small-holdertourism and garment

exports. Other than tourism, which is centred around Angkor Wat in Siem

Reap, there is little depth to Cambodias economic base which, in turn,

hampers commercial and export relationships because of inconsistency of

supply and questions over quality and reliability. Although this is verygradually beginning to change as competition intensifies among Mekong

countries, Cambodian businesses desperately require outside expertise and

capital to professionalise and compete more effectively. From the perspective

of the IB Facility, despite these challenges and the need to be cognisant of

just how challenging the operating environment in Cambodia can be, due

diligence confirmed encouraging prospects for investment in the following

sectors and sub-sectors:

1. Agriculture

Cambodian agriculture and aquaculture is diverse and a

broad range of crops and raw materials are produced,

including rice, cassava, pepper, cardamom, cashews, other

nuts and spices, rubber, sugar and seafood, among many

others.

Because fertilizers, pesticides and herbicidesif and when

availableare generally made from natural products, it is

very easy to acquire organic status in Cambodia because

most production is effectively organic to begin with.

The main constraints to increasing crop yields and quality

include:

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i. Lack of access to and/or inappropriate usage of key

inputs, such as seeds, fertilizer and pesticides;

ii. Absence of technology, know-how and in many cases,

modern farming techniques;

iii. Access to irrigation systems, especially secondary and

tertiary channels, is largely random. As a result, most

farmers only grow one crop per season and are

dependent on favourable rainfall patterns;

iv. Quality assurance and traceability mechanisms are

generally non-existent;

v. Relationships with aggregators and processors are

random, and there is little loyalty to purchasers among

farmers. Crops are generally sold to the purchaser

offering the highest price, whether an aggregator who

purchased from a farmer the previous year, or an

unexpected Chinese or Vietnamese trader.

Consistency and quality of supply reaching domestic

processors suffer as a result; and

vi. Limited social organisation and co-operation among

farmers, which compounds information asymmetries

and un-level playing fields when it comes to pricing.

Infrastructure constraints in Cambodia are also significant.

There is no cold chain, storage facilities are poor, road and

rail infrastructure are poor and no Cambodian port can

handle ships carrying more than 20,000 tonnes of product.

Although primary production in Cambodia is probably too

rudimentary to be suitable for direct investment by the IB

Facility and is politically sensitive for land-related reasonsdiscussed above, any investment in agro-processing (see 2.

below) will necessarily be confronted with these issues.

Importantly, and in line with the IB Facilitys core objectives,

supply chains will have to be strengthened in order for

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investment objectives in any aspect of Cambodian

agriculture to be realised.

2. Agro-processing

The long-term prospects for agro-processing in Cambodia are

extremely bright, particularly in the rice sector (see below).

The challenge is one of achieving scale: few processors have

significant production capacity due to the absence of

hardware and modern machinery, which means that

investment is urgently required.

The influence of Vietnamese investment and procurement is

also significant, and generally value-destructive. In order to

avoid domestic taxes and address supply shortages in

Vietnam, traders simply buy up Cambodian crops and raw

materials and smuggle them across the border for

processing. At a formal level, Vietnamese enterprises

pledged $1.3bn of investment in Cambodian agriculture in

2010it is difficult to know how much of this actually

materialisedbut their true interest lies in input acquisition

in Cambodia for processing and value addition in Vietnam.

The Cambodian government and private sector will welcome

any investment initiatives that help to counter this dynamic.

Rice is the cornerstone of the agriculture sector, and the

government has set an ambitious target of increasing rice

exports to 1m tonnes by 2015. Given just 60,000 tonnes of

rice were exported in 2010, the 1m tonne target is probably

unrealistic. However, boosting rice output, improving

processing and quality in order to compete within and

beyond the region will remain high on the agenda. According

to one source, there is US$700 million of investment pent up

in the rice sector.

Although some mills are state of the art and could do the

colour grading and polishing demanded by international

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markets, poor paddy quality and supply impedes mill

calibration for particular varieties. Massive investment is

therefore needed in various areas: mills require better inputs,

storage facilities, modernised production processes and,

above all, they need help to adopt more entrepreneurial

approaches to milling. This, in turn, opens the door for

investment partners like the IB Facility, willing to support the

professionalisation of their operations.

As with other crops, consistency and quality of paddy supply

to mills is problematic, because mills cannot compete with

the price arbitrage of Vietnamese and Chinese traders. There

is an opportunity, therefore, to invest in rice mills with a view

to strengthening the supply chain not just through price-

competitiveness, but mutual reliability: millers need to know

that they can count on supply, and farmers need assistance

in organising in order to bargain effectively, with loyalty

clearly reflected in the prices they command. The BOP

impact of engagement in the rice sector through portfolio

companies could be significant, especially supporting co-

operatisation among producers and millers.

The IB Facility may find agro-processing opportunities in

other sub-sectors such as cassava and sugar cane. Cassava

has been booming recently, but there is little domestic

processing capacity and cassava chips are generally

exported to Vietnam.

3. Agricultural Inputs and Infrastructure

Cambodian agriculture is desperately in need of good quality

agricultural inputs, ideally produced domestically. Soil,

fertilizer, pesticides, tools, tractors and the like are all in

short supply and expensive to import.

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Chinese, Singaporean, Vietnamese and European investors in

Cambodian agriculture have all spotted this opportunity and

are investing aggressively.

There will be opportunities for the IB Facility to invest in

manufacturing, wholesale and distribution of agricultural

inputs, whilst the Technical Assistance (TA) Facility can play

a critical role in outreach, education of farmers and extension

services.

Access to water and irrigation schemes may also produce

investment opportunities for the IB Facility. The government

is responsible for primary and secondary channels, but

tertiary channels can be provided by the private sector.

Currently, irrigation schemes are haphazard and need

upgrading and extension to vast areas without facilities.

Distribution and logistics, with respect to both factor inputs

and raw or semi-finished product, are desperately lacking.

The absence of a cold chain compounds the problem,

creating opportunities to invest in simply getting inputs to

farmers and getting goods to market and export facilities.

4. Financial Institutions and Access to Finance

As discussed above, Cambodian entrepreneurs and SMEs,

including some medium-sized enterprises of substance,

struggle to access appropriate financing, either due to

collateral constraints or because they are used to seeking the

cheapest debt available. Vast segments of Cambodian society and, crucially, of the

productive economy, remain under-banked or un-banked in

this cash-dependent economy. Many communities have no

formal banks or financial institutions at all. Although there is

no shortage of microfinance institutions (MFIs) in Cambodia,

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the sector is unregulated and dominated by non-

governmental organisations (NGOs). As regulation and

transition to deposit-taking institutions inevitably take hold,

there should be opportunities for the IB Facility to invest in

MFIs and other financial institutions looking to provide access

to finance to BOP populations in numerous ways:

i. Agricultural finance, including factoring, reverse

factoring, commodity-based finance, warehouse

finance;

ii. Disaster and catastrophe insurance for small-holder

farmers;

iii. Micro-insurance, micro-health insurance and

vulnerability schemes;

iv. Mobile banking.

Over-indebtedness has become a big issue in Cambodia,

exacerbated by excess liquidity, lack of regulation, the

governments openness to the establishment of any new

financial institutions and an entrenched mentality among

borrowers of perpetual refinancing.

There is an opportunity, therefore, to help mould responsibly-

managed financial institutions that are able significantly to

undercut interest rates of 2-3% per month offered by traders

and informal financiers and some MFIs by offering products

tailored to borrowers at the BOP that take into account the

challenges around land ownership and collateral.

5. Clean Energy

Bio-energy and renewable energy projects have begun to

spring up in Cambodia. There are opportunities for

gasification, or the use of rice husks, cassava husks or

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sugar cane by-products for conversion to energy, thereby

reducing reliance on fossil fuels.

Significant investment will be required in commercial

approaches to waste-to-energy initiatives. Moreover, given

that Cambodia lacks a national electricity grid, there is room

for private sector energy generation. Agricultural waste

conversion can therefore be used to power processing and

milling plants and also be sold to local communities. Bio-gas

production for domestic consumption and animal dung

conversion for household energy are two other opportunities

for the IB Facility to support.

Technology and know-how are lacking, along with investment

in capital goods needed for conversion.

6. Garments

Although the garment sector is a critical contributor to the

economy, and certainly involves the BOP from a production

perspective, it would probably be best avoided by the IB

Facility. Following large job losses 2009 and early 2010, the

sector has begun to recover, but it is subject to aggressive

and often unscrupulous investment from Taiwan, China and

Hong Kong. Of the estimated 300 garment factories in

Cambodia, only 15 are locally owned. Many foreign investors

establish highly-mobile, under-invested operations in

Cambodia to take advantage of cheap wages (wages are

significantly lower than in Vietnam). The result is that many

factories are literally little more than tin sheds that can be

closed within days if necessary.

Unless the IB Facility encounters local garment

manufacturers with a long-term vision of establishing lasting

relationships with foreign buyers predicated on a gradual

move up the value chain, this sector is best avoided.

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7. Tourism

As with the garment industry, the IB Facility will have to take

a cautious approach to tourism investments. In recent years,

Taiwanese, Korean and Chinese investment has been

plentiful and unscrupulous, and over-construction,

particularly in Siem Reap, has caused a market glut. Land

acquisition is complex, often with brutal consequences for

the poor, so selection of partners would have to be carefully

managed.

Opportunities could nevertheless emerge in support services

to tourism, such as catering, laundry, logistics and

transportation. As visitor numbers increase, drawn initially by

the Angkor Wat temples, but increasingly aware of stunning

beaches and varied flora and fauna, eco-tourism is

developing.

Again, tourism is generally not a sector that lends itself to

closed-ended investment funds because holding periods to

realise value are often incompatible.

Cambodia: Proposed Fund Design

Based on due diligence, there is scope to deploy up to $15m in private

Cambodian businesses, primarily in agro-processing, agricultural inputs and

logistics, clean energy, distribution and logistics more generally and, possibly

carefully-selected light manufacturing and tourism deals. The key features of

the proposed Fund design for Cambodia are presented below:

Fund allocation to Cambodia:Due diligence suggests that it would be

challenging to deploy more than $15m in Cambodia over a five-year

investment period, and that a realistic figure lies somewhere in the range

of $10m-$15m. The average transaction size is likely to be $2m, although

if the IB Facility is able to gain exposure to rice milling opportunities, it

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should be possible to deploy $4m-$5m in one or possibly two transactions.

It should be remembered that it may be possible to gain exposure in

Cambodia indirectly, through Thai companies that are expanding or

acquiring operations there, primarily in agriculture.

Transaction Profiles:As emphasized above, Cambodia is a cash-based

economy. Individuals and entrepreneurs are familiar with debt from both

formal and informal sources. They have little or no understanding of

equity. The notion of opening up the ownership structure of a business to

external participation is alien, and in many transactions, the financials will

be neither comprehensive nor accurate enough to get a clear enough

picture of the business on which to base a valuation. For this reason, most

transactions in Cambodia will be time consuming and will likely involve

debt, although, very slowly, quasi-equity and equity are gaining the

attention of local businessmen seeking foreign partners. Cambodian deals

will be growth plays, with financing largely used for working capital to

boost output and achieve efficiencies. There is no management buy-out

(MBO) culture in Cambodia, and rescues, restructurings and start-ups

should be studiously avoided. They are far too risky.

On a positive note, the government is very pro-business and hands-off

when it comes to the modalities of foreign investment. Convertible loans,

preference shares, preferred shares and redemption clauses are all

permissible in Cambodia, not that they will be used very often. Other

more complex equity structures will probably be similarly received when

introduced. The key risk factor, however, is that no such deals have ever

ended up in the courts, so enforceability in case of dispute remains an

open question.

Risk Mitigation and Currency Issues:Cambodia is a highly dollarised

economy and to a large extent, the US dollar remains the currency of

choice for trade and investment. Denominating the IB Facility in US dollars

makes sense in the Cambodian context, and indeed, the Cambodian riel is

expected to appreciate marginally against the dollar in 2011. Where risk

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mitigation strategies are concerned, unfortunately it will not be possible to

de-risk investments through complex transaction structuring and strategic

use of investment instruments. Cambodian sponsors will be intimidated by

unfamiliar structures.

A critical factor in Cambodian transactions will be for the IB Facility to

work with competent local investment partners who are sufficiently

connected to cross-reference prospective portfolio companies

management teams. Undertaking know your client (KYC) checks is

challenging because political connectedness abounds and larger

businesses generally require strong links with the CPP in order to operate

and grow.

Two additional risks will need to be addressed in all Cambodian

transactions. First, many will be family-owned businesses. Corporate

governance arrangements are weak or non-existent, management is

rudimentary, strategic planning is not systematic and often financials

simply will not exist or will certainly fall far short of international

standards. Faced with these risks, the opportunity for the IB Facility

manager will be to persuade sponsors of the value of formalisation and

transparency. If it is argued that this is a likely conduit to strong

relationships with foreign partners and, possibly, an eventual listing,

forward-looking Cambodian entrepreneurs have reached a point where

such a message will resonate.

The second risk is on the fiscal side. The relationship between most

businesses and the tax authorities consists of creating a plausible

scenario for turnover during the relevant period (generally vastly

understated), and paying the tax representative the amount required to

handle the situation. Most businessmen avoid making truthful

declarations because, as they see it, it translates into a significant cost

disadvantage vis--vis their competitors. Again, the IB Facility will have to

persuade investee companies that the benefits of partnership and faster

growth, and hence higher turnover, far outweigh the perceived short-term

disadvantage of greater tax liabilities.

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Exits:As discussed above, the advent of the CSE, soon to be launched,

has changed the conversation significantly in Cambodia, and forward-

looking businessmen are slowly focusing on building and realising long-

term value in their businesses. That said, it is unrealistic to expect that

trading volumes and the number of listings will be sufficient to provide a

viable exit avenue for Fund portfolio companies. In other words, the IB

Facility should avoid transactions where the exit thesis is predicated on

listing, although of course, should the opportunity arise it will be a

welcome boon. Most exits will take the form of strategic sales to regional

or foreign buyers and company buy-backs, or redemptions. The fact that

production and export from Cambodia, due to its LDC status, confers duty-

free entry to many export markets increases the attractiveness of

Cambodian acquisitions to foreign purchasersall the more so if, as a

result of the IB Facilitys investment, the companies are well-run and have

implemented proper corporate governance arrangements.

Fund Managers: Presently, there are only two independent fund

managers in Cambodia: Emerging Markets Investments (EMI) and Leopard

Capital. By their own admission, the two founding partners of EMI are new

to private equity although they do have strong backgrounds in investment

banking and corporate finance. EMI benefits from its strategic partnership

with Aureos Capital, which has a seat on the investment committee and

provides input on deal structuring. However, Aureos Capital does not have

sufficient time or resources to take a very active role in the EMI portfolio.

Leopard Capital was unavailable to meet during the due diligence

exercise. Anecdotal feedback suggests that Leopard is not especially

methodical in its transaction execution and, although more experienced

than EMI, it is, on balance, the weaker of the two. See Section IV below for

further discussion of fund management options.

BOP Impact:As one of the poorest countries in the world, it is difficult to

see how the IB Facility will not have a significant impact on Cambodians

living at the base of the pyramid. Any labourers employed by Fund

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portfolio companies will likely be earning $2-$3 dollars per day, if that,

and farmers involved in the supply chain of agricultural processors and

aggregators generally live at or below the poverty line. The main areas of

BOP impact that the IB Facility could achieve in Cambodia include:

Employment generation: Increasing job opportunities through

portfolio company growth;

Supply-chain strengthening: Building mutually-reinforcing

relationships between farmers and processors is key to

addressing the quality and consistency issues that hamper

certainty and reduced volatility for the former, and the ability to

boost output and secure more favourable trading relationships

for the latter;

Reduced income volatility: Smoothing income flows for poor

farmers by helping them to form co-operatives and associations

(where appropriate and possible) and strengthening their

relationships with aggregators and processors;

Reduced vulnerability: If the IB Facility can identify a well-

placed, creative partner financial institution to invest in, it could

build pro-poor financial products that may have an enormous

impact on rural farmers and the rural poor;

Access to finance: Far from any formal institutions, rural

agriculturalists struggle to access appropriate financing that

takes into account collateral constraints (land ownership),

seasonality issues, limited access to inputs (or poor

quality/inappropriate inputs when possible);

Value-addition and value-capture:Particularly in the rice sector,

but in fact in most transactions, the IB Facility can help

Cambodian producers to move up the value chain and captureand retain more value in Cambodia;

Business formalisation and professionalisation: Management

capacity and corporate governance in Cambodian companies is

rudimentary at best. The IB Facility can make a significant

contribution, particularly through strategic deployment of TA

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Facility resources, by providing training and mentorship in this

area. By leaving behind a cadre of well-run, well-managed

businesses, the IB Facility can have a meaningful demonstration

effect on non-portfolio companies.

_____________________________________

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II. Vietnam

Political LandscapeAlthough tensions and in-fighting have increased in recent months within the

Communist Party of Vietnam (CPV), fuelled by the urgency of taming inflation

and halting currency depreciation and contrasting approaches for doing so,

spats between conservative hard-liners and more reformist elements will not

undermine the partys grip on power. The government is more determined

than ever to keep political opposition in check, so despite the increasing

market orientation of the economy, the development of genuine democratic

opposition will not be tolerated. The economic hardship in urban and ruralVietnam in the wake of the global economic slowdown and financial crisis of

2009-2010 has made the government nervous of social tensions and the

possibility of uprisings or intermittent instability. In that context, the

diplomatic row with China over the sovereignty of the Spratly and Paracel

islands in the South China Sea has provided a useful pressure valve, and the

government, unusually, has allowed anti-Chinese demonstrations to take

place in Hanoi and HCMC. In the longer term, however, social unrest may re-

ignite unless the government is able to tackle inflation and reverse escalatingprices for staple foods. Resentment against the government is also caused by

haphazard and forced land acquisition for factories and large infrastructure

projects. Compensation is either woefully inadequate or simply not offered,

and the rural, urban and peri-urban poor affected are left with few means to

rebuild their livelihoods.

Such is the CPVs grip on power that the operating environment will likely

remain relatively stable throughout the life of the IB Facility, though themodalities of achieving stability may be heavy-handed. The government has

watched the industrial unrest and social upheavals in neighbouring China

with trepidation. It will use all means to avoid similar confrontations in

Vietnam, and from a strategic perspective, will seek to present Vietnam to

investors and major export markets as a contrasting oasis of stability. Again,

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in order to achieve this, inflation must be brought well below double-digits as

quickly as possible. Currency depreciation and the pressures of increasing

dollarisation will also need to be dealt with effectively.

Economic Policy and Performance

In this somewhat fragile political context, there is a question mark over

policymakers willingness to implement the hard-hitting austerity measures

required to stabilise the economy. The corporate sector has certainly felt the

full force of tightened monetary policy and interest rate hikes, and the

evidence suggests that it has been sufficient to quell the speculative activity

both corporate and personalwhich led to the boom and bust cycle of

2006-2009. Yet high oil prices have left the government little choice but to

increase subsidised retail prices for fuel and electricity which, naturally, affect

the poor most severely. A fundamental impediment to more effective policy

making is the governments fixation on a perceived binary relationship

between either achieving high growth rates or addressing fundamental

structural and systemic imbalances in the economy. Party dogma that

double-digit growth must be achieved at all costs and is critical to poverty

alleviationnot, in itself, untruemeans that price and currency stability are

foregone or not confronted vigorously enough. For example, domestic credit

creation has slowed somewhat since the economic downturn, but the

government has only reduced its target from 23% in 2010 to 20% in 2011,

not nearly tight enough to quell inflationary pressures. Further inflationary

pressures will be produced by consistent budget deficits in the region of 5%

of GDP over the next three-to-five years, and although the return to near-

double digit growth rates will boost government revenue, high oil prices and

expenditure on social welfare programmes and infrastructure projects will

keep the budget firmly in the red.

In the context of the IB Facilitys focus on people living at the base of the

pyramid, it is important to disaggregate Vietnamese inflation figures. They

can be misleading. Ironically, high inflation has actually benefited rural

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farmers because their products are commanding much higher prices. The

population segment that is being most affected by inflation are rural migrants

who generally are forced to accept the lowest-paid factory jobs in peri-urban

areas. With 41% of the Vietnamese inflation basket comprised of food, the

proportion of this demographics expenditure on food once in conurbations is

probably somewhere in the range of 40%-60%. In contrast, the rural poor and

less-vulnerable urban poor, even with marginally higher incomes, are

significantly less affected by high food prices.

To a worrying extent, given the export-dependence of the Vietnamese

economy and, further, the reliance on strong demand from two particular

trading partnersChina and the United Statesthe medium and long-term

GDP growth prospects are beyond the countrys control. Diplomatic sparring

with China certainly does not help matters, although to date this has not

significantly affected commercial and investment corridors. The salient

question is whether there is a significant slowdown in the Chinese and

American economies, which would rapidly reduce demand for Vietnamese

exports. For this reason, it will be important for the IB Facilitys investment

portfolio in Vietnam to be carefully balanced between domestic and external

sources of demand.

Operating Environment for the IB Facility

Business sentiment in Vietnam is at an all-time low. The real estate market

has fallen considerably and is expected to continue to do so, forcing some

real estate players to issue bonds with ludicrous coupons to raise capital, in

some cases 20% or higher. The speculative activity which caused the Ho Chi

Minh Stock Exchange Index to sky-rocket from 250 to 600 in 2008 has ended,

and the Index now hovers in the low 400s. It probably has further to fall.

Worryingly, during the boom, both corporate and individual speculators were

borrowing money from banks and interest rates of 10%-12% with a view to

making 40%-60% returns in short periods on the stock exchange. Although

the boom and bust cycle has been painful, four particular aspects of the

fallout are critical and, ironically, positive from the IB Facilitys perspective:

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1. An unprecedented focus on company value: Many businesses have

collapsed and continue to do so in the wake of the crisis. For the

first time, the government has allowed them to failincluding,

importantly, bloated SOEs. This unprecedented willingness to

tolerate bankruptcies has taught businessmen an essential lesson

in the difference between underlying company value and short-

term profit, a lesson not limited to public companies.

2. Recalibration of valuations: Historically, penetrating Vietnamese

businesses has been challenging for external shareholders not just

because of lack of transparency, but due to owners unrealistic

valuation expectations fuelled by the boom years. The challenges of

borrowing where once liquidity abounded have forced owners to

reconsider valuations and restructure in order to attract much-

needed capital.

3. Greater openness to equity: Vietnamese businesses have

traditionally used debt to fund growth. Equity is not as unfamiliar as

in Cambodia and Laos, but Vietnamese businesses owners are

generally much more comfortable with debt. The fallout on the

stock-exchange, combined with interest rate hikes and more

stringent lending conditions, is forcing companies to consider equity

participation where previously it would have been shunned. The IB

Facility will therefore be well placed to invest in businesses using

equity, quasi-equity and debt, which will provide a welcome

counter-balance to debt-based transactions in Cambodia and,

possibly, Laos.

4. The structure of post-crisis indebtedness is important: It is

noteworthy that indebtedness levels are much higher in the

corporate sector than in the personal sector. Speculative activity in

the latter was, by and large, confined to business people in HCMC

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and Hanoi who had significant disposable income to bet on stocks.

It will take a long time for banks to regain confidence in the

financial viability of all but their largest clients. This, again, will help

the IB Facility to access transactions which would have been almost

impossible pre-crisis.

Another feature of the current business climate in Vietnam is also significant.

The government is emphasising the importance of industrialisation both for

job creation and to reduce the import-content of exports, which remains

stubbornly high (see below). Given the structure of the Vietnamese economy,

successful industrialisation will necessarily require the inclusion of the SME

and sector and non-SOE sector more generally into the supply chains of

larger companies and public-sector projects. As the government has set

about achieving this, the degree of weakness of commercial and

infrastructural linkages between larger businesses and the SME sector,

mirroring similarly fragile linkages between the two largest conurbations,

HCMC and Hanoi, and rural areas, has been thrown into relief. As a result,

there is a growing realisation in government and the private sector that

supply chains, value chains and the interface between the SME sector and

larger businesses, let alone export markets, needs urgent attention and

strengthening. This dynamic is beneficial for the IB Facility because portfolio

companies will be much more minded than before to invest time and

resources into establishing robust supply chains and business relationships to

improve consistency and quality of product.

Transactions in Vietnam: Prospects for the IB Facility

The extent to which the economic downturn of 2009-2010 has shaken

Vietnams financial community, altered the financing landscape and affected

the business mind-set cannot be overstated. Access to cheap debt, unbridled

issuing of corporate bonds and their subsequent treatment as assets rather

than liabilities all helped to fuel the unsustainable boom of the mid-2000s.

Unsurprisingly, along with sharp increases in interest rates, commercial

banks have tightened lending policies, collateral requirements have become

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far more stringent and access to capital for the private sector is challenging

for all but the strongest companies. It is important to distinguish between this

dynamic and the SOE sector. Although the government has tolerated some

SOE failures, there is no question that politically-directed lending to SOEs

perceived to be strategic, regardless of their health, continues.

The salient point from the IB Facilitys perspective is that acute credit

constriction and the inability to raise funds from speculative investors on the

capital markets is forcing the creation of an equity culture in Vietnam. De-

listings from the bloated stock exchanges are common, as companies seek to

sell stakes at private equity-level valuations. The whole concept of company

value is subject to re-evaluation, and in addition to being compelled to open

their ownership structures to external partners, business owners have less

power to resist the critical managerial and operational changes that the

former introduce to increase transparency and drive efficiencies.

Unsurprisingly, it has become more difficult than ever for SMEs to access

financing from formal financial institutions in the post-crisis environment, let

alone larger companies.1

Collateral constraints:The smaller the company, the greater the

struggle to provide acceptable collateral. Proof of land ownership

can be especially challenging for small-holder farmers.

Poor accounting practices: Accounts are generally managed and

presented so as to minimise tax liabilities. Sales are heavily

discounted and costs are bloated to show little or no profit. It is

difficult to gain an accurate financial picture of a business.

Non-banked cash flows: Many SMEs route cash flows outside of

official bank accounts. Generally, a companys principal bank

1 For the purposes of this report, the term SME is used for convenience. Thereference is really to the medium-sized enterprises or lower mid-caps that the IBFacility will be targeting, or enterprise able to absorb $1m-$10m of debt, quasi-equityor equity.

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account is used to receive payments from customers, but not to

deposit revenues or pay suppliers and staff. As a result, banks are

even more reluctant to consider cash-flow based lending.

Lack of information:The pervasiveness of the debt culture means

that SMEs are often unfamiliar with financial products and which

might be appropriate for them.

Again, regardless of size, cash constraints are obliging companies to seek out

financing partners for the longer term, requiring, in turn, greater openness

and a willingness to professionalise.

Vietnam: Target Sectors for the IB Facility

Although the Vietnamese economy is largely export-driven, it is relatively

diverse, and the near 90 million-strong population translates into robust and

strengthening domestic consumption. As highlighted above, the salient

challenge to achieve more consistent, rapid economic growthand, crucially,

more balanced growthwill be to further unlock both the productive and

consumption forces of the domestic economy. In many parts of the country,

physical infrastructure still impedes access to inputs, markets, appropriate

financing and information. These shortcomings need to be addressed in order

for productive sectors as a whole to move up the value chain. Additionally,

there is much reputation building to be done by Vietnamese companies

domestically and internationally. Made in Vietnam is not synonymous with

quality as a brand. Domestically, this often leads consumers to choose more

expensive imports over Vietnamese product if they can afford to.

Internationally, some producers and importers are wary of significant

exposure to Vietnam because of poor reliability. That said, the backlash

against certain Chinese goods, such as toys and dairy products, within and

beyond China has been carefully watched by Vietnamese industry, and there

is an awareness of the opportunity to exploit increasing disenchantment with

Chinese producers and business relationships in some sectors. As the outline

of target sectors demonstrates below, many of the investment opportunities

for the IB Facility will be found in agriculture and light manufacturing, but

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there may be some interesting and very BOP-relevant opportunities in

services, including healthcare and education:

1. Agriculture

The base of agricultural products in Vietnam is much more

diverse than in Cambodia, with crops and raw materials ranging

from coffee, tea, cardamom, pepper, acacia, cassava, fresh

fruits and vegetables, to fisheries, horticulture and floriculture.

Indeed, as the worlds second-largest coffee producer, Vietnam

is on the map as an agricultural player in a way that Cambodia

is not. Nevertheless, significant challenges need to be overcome

for the agriculture sector to achieve more rapid and consistent

growth and, crucially, for small-holder farmers to capture more

of value and income from their output.

Given the likelihood of several Fund investments in agro-

processing, working through portfolio companies will provide

opportunities to address some key challenges to the sector, of

which the following should be highlighted:

i. Weak processing capacity: Resulting in many raw

materials and unfinished products being shipped to

Thailand for processing;

ii. Value chain dislocations: Due to poor logistics,

transportation and distribution networks. For example,

avocados sell for $0.20/kilo at harvest points, but $2/kilo

in Hanoi and HCMC, and often arrive spoiled;

iii. Weak supply chains: Medium-sized producers and

aggregators are realising the need to foster more

consistent supply chains by building lasting relationships

with individual farmers and co-operatives. Consistency

and quality of supply are enormous challenges in

Vietnam;

iv. Contract enforceability: In order to achieve iii above,

processors and aggregators must rely on relationships

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rather than contract enforcement. Farmers often have

little or no understanding of contracts and they are

certainly not enforceable through the courts. The only

way of preventing farmers from selling to the highest

bidder, regardless of signed contracts, is for purchasers to

build trust, price competitively and offer security and

reliability through repeat business;

v. Poor co-operation among farmers: Top-down

collectivisation and co-operatisation have generally been

unsuccessful in Vietnam. This leaves individual small-

holders more susceptible to predatory purchasers and

lenders. If, however, bottom-up organisation is

encouraged through Fund portfolio companies with a view

to establishing equitable, lasting relationships, the

chances of success could improve;

vi. Rudimentary growing techniques: Most Vietnamese

agriculture is un-mechanised, seed quality is often poor,

and hardware and machinery is lacking. Again, to

strengthen supply chains, processors need to offer

technology and know-how as part of their engagement

with farmers;

vii. Erratic land distribution: Land is distributed to farmers by

the government, but is often random and, when deemed

necessary for industrial plants or infrastructure projects,

simply appropriated. Because land is the only asset most

farmers holdand even that is tenuouspurchasing

relationships are random, production is inconsistent, crop

timing is variable and pricing fluctuates considerably.

2. Agro-processing

Not surprisingly, the demographics of Vietnam have fuelled

demand for processed fruits, vegetables and, above all, fish

sauces. Fish and agro-processors have realised that in order

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to compete with imported products, which often sell for ten

times more than domestic equivalents, they must improve

quality, presentation and packaging. This, in turn, means

addressing many of the challenges listed under 1. above.

In order to move up the value chain, increase market share

and develop export markets, agro-processors also need to

invest in compliance and traceability systems, certifications

and production best practices. Marketing, branding and

packaging also need improvement. Opportunities to provide

high-end niche and organic products have not gone

unnoticed by Vietnamese producers, but they require know-

how and, in some cases, technology.

From a transaction and exit perspective, consolidation in

agro-processing is slowly taking hold. Because of supply

chain constraints, larger players are looking to purchase

smaller players to increase market share. This is a significant

proxy indicator for pent up demand for processed goods,

suggesting enormous growth potential for the sector.

Downstream from agro-processing, there will be

opportunities for the IB Facility in fast moving consumer

goods (FMCG) in two particular areas: re-packaging and

distribution for export and for the domestic market.

3. Agricultural inputs

As in Cambodia, Vietnamese agriculture is hampered by poor

quality inputs, including seeds, fertilizer, pesticides, tools and

hardware. In some ways, the impact in Vietnam is more

serious because farmers are often tricked by intermediariesinto purchasing fake, adulterated or noxious products.

Traditional herbal medicines for animals and pesticides for

plants that are safe to use are in desperately short supply.

The demand for quality factor inputs is vast, and there are

opportunities for several players to aggressively grow

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companies who build reputations on high-quality, reliable

and, above all, safe products. Again, this will require portfolio

company engagement with farmers to establish

relationships, and provide training on usage and best

practices.

4. Fisheries

There is significant potential for fisheries and fish-processing

in Vietnam. Once again, however, consistency of supply and

quality control are significant obstacles for local producers.

Shrimp aggregators and processors tend to own their own

farms, but output is rarely sufficient so they are forced to

purchase from individual farmers and households.

With burgeoning demand for seafood, fish products and

sauces, there is an opportunity to work through investee

companies to develop new models of aggregation and

contract farming.

Moreover, the fact that two fish processors have gained pre-

approval status from the US Food and Drug Administration

(FDA), meaning that inspection is not required when product

arrives in the United States, has highlighted to the sector the

relationship between investment in technology and best

practices, and the development of export markets.

5. Healthcare

The Vietnamese are enormous consumers of healthcare and

pharmaceuticals, both in rural and urban areasindeed,

Vietnam is the second-highest self-medicating country in the

world. One of the main problems with the geography of

healthcare in Vietnam is that the best care is concentrated in

urban centres, particularly Hanoi and HCMC. There is

burgeoning demand for better healthcare at lower socio-

economic echelons and, of course, at the base of the

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pyramid. However, those reliant on free public healthcare

the vast majority of the populationhave little choice but to

wait for attention, sometimes for day. The quality of the care

they receive is highly variable.

Recent analysis of the Vietnamese healthcare sector

suggests that those in the upper segments of the BOP are

willing and able to apportion some of their disposable income

to quality healthcare. The three areas for which there is

particularly strong demand include:

i. Oncology consultancy and cancer treatment;

ii. Maternal healthcare; and

iii. Paediatric healthcare.

Because the public healthcare system is strained, and

medical professionals are not well paid, many doctors see

patients privately as a way of increasing their incomes.

Thriving groups of medical professionals have sprung up in

urban areas that are fully private. There is, however, vast

under-served, or entirely unattended, demand in the rural

areas. Due diligence suggests that the IB Facility will be well-

placed to help doctors and private clinics to formalise and

develop hub-and-spoke structures through which to serve

marginalised communities and the rural poor. Further, such

investments would probably require $5m-$10m, providing a

counterweight to smaller investments in the Vietnamese

portfolio.

The privatisation of primary healthcare as a strategy for

alleviating pressure on public resources has become topical.

In addition to hub-and-spoke approaches mentioned above,investment will be required in clinics serving mostly lower-

income groups in secondary and tertiary towns and cities.

As the healthcare conversation in Vietnam has started to

focus on affordability, new models for financing and delivery

of care have sprung up. Some financial institutions are

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realising that the market for pooled healthcare products and

risk-adjusted models for coverage provision to lower-income

groups could be a huge growth area. Tele-medicine and

remote diagnostics models are also emerging. The IB Facility

could well find opportunities to invest in financial institutions,

most likely MFIs, that are specifically targeting access for the

poor as their growth strategy.

Professionalisation of hospital management and clinic

administration, particularly childrens hospitals, may

generate additional deal flow.

6. Education

Demand for better quality education is burgeoning in

Vietnam, and not just among middle and upper classes, nor

only in urban centres. Particularly in the language school

segment, there are many cowboy institutions offering

appalling quality instruction, but the problem extends to

primary and secondary education and professional

education.

The standard of instruction is especially poor in the social

sciences, entrepreneurship and business education, with a

dearth of well-trained graduates coming through the ranks.

There are good prospects for the IB Facility to invest in

education franchises and school chains at various levels

primary, secondary, professionalin rural and urban areas

alike. A hub-and-spoke approach may also prove effective in

extending reach to rural areas and lower-income groups.

7. Sanitation

The government is very focused on the urgent need to

improve sanitation and waste-water management at the peri-

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urban and rural levels. Importantly, space is being created

for the private sector to participate through outsourcing.

Public-private partnerships (PPPs) would be complicated for

the IB Facility, because the government tends to retain

control of what it considers the most strategic or lucrative

parts of operations, but once full outsourcing begins, there

could be opportunities to invest up to $10m in this sector.

State-of-the-art machinery and know how are in short supply.

8. Small Hydro and Clean Energy

Whilst many small hydroelectricity opportunities will, in

themselves, be too large for the IB Facility, there will likely be

opportunities to deploy up to $10m, accompanied by project

finance in a consortium. Some aggregators have begun to

roll-up small hydro opportunities across communities.

The build-operate-transfer (BOT) approach could well prove

effective in this sector. The government needs additional

capacity and supply which, realistically, can only come from

the private sector.

In addition to opportunities in waste-to-energy, there may be

cleaner production plays possible in light manufacturing. An

example cited during due diligence was a lighting company

that needs $5m to modernise operations, introduce new

technology and reduce reliance on fossil fuels to reduce

costs.

9. Light Manufacturing

The manufacturing sector has not fully recovered from thedownturn of 2009-2010. Investment has dried up,

competition with Chinese producers is vigorous and the high

import-content of almost all manufactures makes the cost

base very high. The closure of a Sony assembly plant in 2010

dealt a strong blow to the sector: the closure was not

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attributed to poor labour quality, rather high import costs

vis--vis other South-East Asian countries.

The opportunity in Vietnamese manufacturing is to invest in

technology, know how, improve efficiency and productivity

and, above all, to focus on quality and reliability. Domestic

producers of components and parts are in desperately short

supply. Over time, manufacturing will also need to move up

the value chain in order to reduce import dependence.

The retail exports that Vietnam has gained a reputation for

may also provide prospects for the IB Facility, including

clothing, shoes and other leather goods, furniture, wooden

flooring and so on. Again, quality and reliability are the key to

developing entrenched export relationships. There are some

examples of Vietnamese exporters competing in South-East

Asia and beyond in flooring, press-board, and wood

composites such as MDF. However, establishing reliable

supply chains from sustainably-managed forests is

challenging, presenting an another opportunity for BOP-

orientated Fund involvement.

Manufacturing need not only be focused on export markets.

Differentiation among local brands is increasing and

consumers are becoming more discerning, causing local

producers to move up the value chain in order to compete.

Supply and service chains need strengthening, however, and

particularly in the case of furniture, the potential BOP impact

of investments could be significant as it relates to labour.

10. Packaging and Distribution

The quality of processing, packaging, branding, presentation

and marketing is very poor in Vietnam compared to many

other Asian countries. This puts Vietnamese products at a

disadvantage.

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As Vietnamese consumers become increasingly brand-

conscious, demand for good packaging and distribution

systems will increase. Companies can also achieve cost

savings by not having to ship product abroad for packaging.

11. Garments

The garment sector is clearly a significant contributor to GDP

and a very labour-intensive industry. Owing to volatile

demand in Vietnams main export market, the United States,

it is a risky sector.

That said, there may be selected opportunities to invest in

garments. In a $4bn industry of which the import content

accounts for $3.6bn, import substitution is badly needed to

reduce costs and boost competitiveness. Moving up the value

chain is also important in order to compete with China, which

has abundant domestic supply of materials and accessories.

The worst labour conditions and lowest wages in Vietnam are

probably found in its garment factories. Unskilled and semi-

skilled workers, many of whom migrate from rural areas, live

in atrocious conditions in industrial zones, often with little or

no access to affordable housing, clean water and nutritious

food.

On the IB Facilitys theme of improving peoples lives at the

base of the pyramid, there is clearly a win-win to be achieved

by changing the garment manufacturing model somewhat.

One problem for manufacturers is that the work is so tedious

that staff tend to move on after one year. If firms are serious

about moving up the value chain, they need to invest intraining and retain staff, which can translate into higher

wages and better conditions.

Again, investments in the Vietnamese garment sector are by

no means straightforward, but the IB Facility should be on

the lookout for opportunities to work with forward-looking,

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innovative management teams who come to recognise the

relationship between loyal, well-treated labour and the ability

to manufacture reliable, good-quality product.

12. Access to finance

As the lax, urban-centric lending which marked the boom has

dried up post-crisis, financial institutions are being forced to

innovate. They have begun to realise the value proposition of

providing tailored to financial products domestically.

The IB Facility could well find, or help to create, opportunities

to invest in MFIs and other financial institutions looking to

penetrate rural areas by developing the following products:

Agricultural finance products, such as factoring,

reverse-factoring, commodity-based finance,

warehouse finance and so on;

Crop insurance, disaster insurance and vulnerability

schemes;

Micro-health insurance; and

Mobile banking and tele-banking.

Vietnam: Proposed Fund Design

Due diligence in Vietnam highlighted the profound impact which the

economic slowdown of 2009-2010 has had on the business culture and

financing landscape. Given the depth of the Vietnamese economy compared

to Cambodia, the size of the population and extent to which domestic

demand for basic goods and services is under-served or entirely unattended

in many parts of the country, there is scope to deploy up to $50m in private

Vietnamese companies in the sectors discussed above. From the perspective

of risk diversification at the IB Facility level, it is fortuitous that openness to

equity is increasing, given that transactions in Cambodia and, possibly Laos,

will be almost entirely debt-based. The key features of suggested Fund

design for Vietnam follow below:

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Fund Allocation to Vietnam: The IB Facility will be able to consider a

broad range of transaction sizes in Vietnamroughly between $1m and

$10mwhich presents both an opportunity and a challenge. On the one

hand, sound portfolio management across all of the IB Facilitys target

countries would suggest several larger transactions of $5m-$10m should

be made as a counterbalance to smaller, riskier deals in other Mekong

countries. That said, the acute need for financing and partnership in the

$1m-$5m range should not be overlooked. Clearly, the IB Facility manager

should focus on the most financially viable and thematically-relevant

transactions, so to some extent, the ultimate average deal size in the

Vietnamese portfolio should only be pre-engineered up to a point.

Caution will be required, however, to ensure that the portfolio does not

become unwieldy with too many smaller transactions all requiring

extensive engagement from the manager.

Transaction Profiles:The range of transaction types open to th

Documents

Final ADB IB Report, Beckwith January 2013