The election of Shavkat Mirziyoyev as president in December 2016 provided and massive and long-awaited change for Uzbekistan. It drew a welcome line under the regime of Islam Karimov who had guided the country to independence in the early 1990s but whose isolationist stance had seen the land-locked Central Asian state overtaken by peers like Kazakhstan.
Under Mirziyoyev, the country has opened up financially to the world. It sold its first international sovereign bond last year and a pipeline of initial public offerings from domestic companies has been growing. With a privatisation programme kicked into gear, some of the crown jewels of the Uzbek economy are even expected to hit the markets before the end of the year.
As well as the headline-grabbing super-deals, Uzbekistan’s private equity market has also woken up.
Kiyan Zandiyeh, chief executive of Sturgeon Capital, points out that it is a no brainer to invest in such a diversified economy – the largest country in Central Asia – with a population of 33 million people, 65% of whom are under the age of 35.
The privately owned investment boutique, which has been investing in Central Asia for the past 15 years, announced the first close of its Uzbekistan Growth Equity Fund, its first fund in the country, in March this year with an expected return of 40%.
Its investment focus is on technology and finance and to date, it has made three investments: in online e-commerce marketplace Zoodmall; in Billz, an enterprise software company providing a SaaS solution for retailers to manage their stores digitally; and in digital service developer Finmedia.
Zandiyeh talks to FinanceAsia about his approach to frontier market investing, how he works with the companies in which Sturgeon Capital has invested, and how the Covid-19 pandemic has provided the impetus for companies to move online.
The following transcript of FinanceAsia’s interview with Kiyan Zandiyeh has been edited for brevity and clarity.
Q What is your approach to frontier market investing?
A It’s important to define what frontier means. In our mind, these are countries that have historically, a below-average level of private sector participation in the economy, and a significantly below-average level of foreign investment. The catalyst that makes it interesting for us is that the private sector is being allowed to participate more than the economy.
Our focus over the past 15 years has been countries in Central Asia – in the first instance Georgia, which was going through tremendous reforms, and Kazakhstan, where there were less aggressive reforms but the private sector was allowed to play a larger role.
The elephant in the room for us was always Uzbekistan. Why? Because it has the largest population; 33 million people, 65% under the age of 35 and, unlike a lot of countries in the region, a really diversified economy.
Q Your first fund – the Uzbekistan Growth Equity Fund – is going to be capped at US$40 million? Could you have done more?
A The target is $40 million and we have raised about half of that so far. We have another 14 months to raise the rest. The way we think about what we do is pretty formulaic, in the sense that if you look at frontier market returns, particularly in private equity, they have not lived up to the promise of what they would have said originally. Our job is to ask “what is the appropriate rate of return for an investor to achieve in a country like this?”
Developed market private equity returns over the past 10 years have been about 29%. What that means is that if you’re investing in a country which is considered frontier there should a 10% premium to that. Our target rate of return is 40%.
That may seem ambitious, but the way we see it is that if we cannot achieve it there’s practically no reason for our existence.
We don’t go out and raise a fund and then look for opportunities. We spend about a year, looking for opportunities. When we have enough ideas for which the fund can be used, we know exactly how much capital needs to be raised. The numbers are a function of performance and a reflection of the opportunities that we have in front of us.
Should we find larger investments, we would then go and raise a larger fund. For us, fund size doesn’t matter. Performance matters.
Q The Covid-19 pandemic has helped the technological transition in many countries especially the move to online shopping. Have you seen this with Zoodmall?
A Our portfolio is related to online businesses. The question that we always had with the incumbent offline market was “how long would it take for it to go online and how much would it cost us in marketing dollars?”
In the absence of any offline alternative, the only solutions have been online. What you’ve had is an acceleration of online solutions with basically zero to minimal marketing cost. From that perspective, it’s benefiting us.
The other perspective is in terms of the valuations with which we were investing in companies – we have managed to renegotiate them down on average by about 30%.
But obviously, for the underlying businesses to pick up from a meaningful perspective, you need to see the economy returning to some sort of normality.
Q You have taken comparatively small stakes in Billz and Finmedia. Given how much time you spend on due diligence, is it worth the effort?
A What you normally have is a seed round of funding, then Series A and Series B. The company has to go through this mental and physical effort of every round going out to speak to people. What we have said to each of the companies is that we don’t want you to have to do that and that we, as investors, are here for all the different financing rounds that you need. This allows the management to focus on the operational management of the business. This also means that over the life of the investment, the total ticket size will be larger.
$150,000 is representative of the capital that they need today. We baby feed capital as and when, relative to the stage of the business. Once they reach a certain stage and once they’ve met certain KPIs, we can release more capital.
Q When you move to the next stage of the funding do you see yourself bringing in other investors or are you agnostic on that?
A If you think of Zoodmall, over the life of the investment, they will need $80 million. That’s double the size of our fund. Our job there is to build a core position in the business at the best investment we can within the capacity of the fund. And then we will reach out in a way so that it stays within our ecosystem.
With companies Billz and Finmedia, there is no practical reason why we will need to reach out to co-investors.
Q Political reforms are always a challenge in Central Asia. Has president Shavkat Mirziyoyev modernised and liberalised Uzbekistan’s economy as you expected?
A As an investor, what you fundamentally want from an economy is that the incentives that are driving capital and behaviours are as rational as possible. You will always have institutions or areas of business where it’s difficult because it’s embedded interests, and there are strategic assets which are important for every country. We try and simply stay away from it. We want to avoid investing in situations where we could be treading on people’s toes.
We invest in e-commerce. What we are effectively doing is bringing value to the whole ecosystem. We’re not taking market share from anyone. What we’re saying to offline retailers is that we can take their products online and maximise their revenues.
On top of that, the part of the local population from which [our investee companies] are employing is predominantly young people, which is where you have the highest rates of unemployment. The message from this is only positive.
Q What happens if the reforms slow down?
A It’s very easy to be critical of positive momentum. But if you put it through the lens of if it were done in any other country it would just be completely monumental.
Let’s take the worst-case scenario and look at Georgia. I would argue that the way that the country completely changed itself and reformed itself is just amazing. It shows the fickleness of democracy that the government was voted out. But if you look at the business landscape, there were still two banks which were so embedded within the business ecosystem that they were allowed to grow into what are now billion-plus market cap banks. You still have Georgia Healthcare, one of the best healthcare companies in the region and you have the holding company Georgia Capital. Although that reform trajectory was to all intents and purposes rewound, these businesses and the business eco-system had been built up so that they had become normalised. It allowed business to do well.
Q When do you expect to make your next investments?
A Over this period [the Covid lockdown] we’ve actually closed another investment. We got through the due diligence that we wanted, and we came to an agreement on terms. What we always do in every country in which we invest is to build a team. That also helped us in that we’ve managed to be able to work with the companies in which we are already invested in a normal manner.
We’re actively looking at new opportunities and we come across them, then we’re in a position to allocate funds.