Few US investors have the insight on Egypt that hedge fund manager Karim Sawabini does. Don’t take our word for it: We’ve included him in our inaugural CEO poll because his name has come up consistently in discussions with some of the smartest guys we know on the global investment circuit. Moon Capital has a 20-year track record and spun out of Oaktree Capital — the largest high-yield distressed debt player in the world, where founder John Moon ran the equities business until spinning out in March 2005. Headquartered in New York, Moon has offices in Singapore and Dubai and takes a long / short approach focusing largely on global emerging markets, where it is predominantly a public markets specialist with some private equity investments. Edited excerpts from our conversation:
2017 will be the year of progress. Stop-and-go progress, but ultimately progress in the right direction.
The biggest challenge of the year will be in the potential for disconnect between market expectations and the reality of how long it will take for Egypt to really get going. The market is now frontrunning news that is yet to come, and there will be some setbacks along the way. The risk in the near term comes down to execution. In the long term, it will be about improving education and skilled job opportunities, but that’s a common issue across emerging markets.
Consumer will underperform in 2017. It’s already suffering in the downdraft now, but it will start to recover in the second half.
Real estate has historically been a great place to invest after a large devaluation, but I suspect that this time might be the exception. Prices have already run up considerably. Egyptians have traditionally seen safety in real estate and turned to it when they couldn’t get money out of the country, resulting in increased speculation through multiple home purchases. Look at the very significant increase in prices of North Coast homes over the past four to five years. So whereas you would normally say, “Buy the heck out of real estate stocks” post a devaluation, I don’t expect real estate to lead the rally. The industry ran ahead of itself and affordability is substantially lower than in previous years.
Industrials will outperform in 2017, posting gains because they’re getting access to natural gas. You’re going to see a large positive impact from improved utilization. I’d look, too, at other sectors where natural gas is an input. Financials have done well, but the currency needs to strengthen a bit for them to really grow their loan books — I don’t like the implications for capital adequacy with the EGP at 18-19. If I saw it at 15, I’d like them a lot more.
What’s going to knock us off our horse? People are being patient now because they think the economy is going to get better, so there’s risk that continued weakening of the currency and continued high inflation could lead to social discontent / unrest. I don’t expect that, but you’re asking about the dark horse. The other thing would be oil going to USD 80 or USD 90 per barrel along with a commodities spike. Egypt’s a large importer of commodities, so that’s another dark horse. Again, I don’t expect it to happen. And the last thing would be if tourism doesn’t come back — if we see more Turkey-style security episodes.
Your view on where the EGP closes the year has to also factor in where you see the USD moving in 2017. I wouldn’t be surprised to see 16.00, 16.50. It could strengthen more, but that would demand solid execution on the reform program and a weakening of the USD in the back half of the year. If the US Fed does go for three rate hikes in 2017, it will hit the US economy negatively, and the USD will start to weaken. At any rate, the USD is at a 14-year high, and a strong USD isn’t good for US exports; it’s not good for bringing jobs back to the US. I see the USD strengthening in the near term and then it will turn, which will be positive for emerging-market currencies.
Other stock markets we like right now? It’s about valuations for us. We still like Russia, but it’s starting to get crowded by fast money. Turkey could get interesting in the next few months given skepticism is high — and rightfully so — and there’s pessimism on the street, so valuations could get interesting if the currency weakens further. Argentina could be interesting given the recent pullback. We’ve been out of Nigeria for three years now, and I would love to get involved. But I need a sense that something is going to happen on the currency front, that they’ll really float it. I could get interested again.
It’s not really a top-down thing for us, though. It is a focus when there are economic imbalances that would likely lead to large FX rate adjustments. Egypt is top-down, maybe, but we also look for great businesses. We’re invested in 40 countries now, but we don’t choose the countries as much as we look for great businesses at very attractive valuations, and that usually coincides with an economic shock and currency devaluation. We often take large stakes in businesses others haven’t heard of before, but which are market leaders and which have outperformed GDP growth over the long term and/or are at an inflection point underappreciated by the market.
What are we asking the companies in which we invest? Same as always: What are your opportunities? What are you doing with your capital? What challenges do you see? What pricing power do you have? What does demand look like? What about supply? It all comes down to the basics, and we’re typically much more interested in free cash than the income statement. We definitely want to understand the mindsets of management and of the owners, and we’ll go talk with their competitors, with their regulators, and with government officials.
What do we hold? Go look at the filings. We filed EK Holding last year — we have a large holding there. We’ve been very large holders of Global Telecom Holding over the past year, year and a half and have been buying industrial names since the devaluation.
It’s not what everyone on Wall Street gets wrong about Egypt, it’s what they get wrong about emerging markets. EM are the most interesting when there’s uncertainty — that’s when the risk-reward tradeoff gets interesting. When valuations collapse and the balance changes. You want to assemble a portfolio of assets that are dispersed geographically and that offer great risk tradeoffs — think tradeoffs of 4:1 or 6:1. Do that consistently, and you’ll generate attractive risk-adjusted returns.
What the “masses” get wrong about violent moves is that they want to buy when it looks like everything is getting better. They miss the massive initial move — that’s why we plowed money into Egypt in February when it got crushed, took profits in the summer, and then bought again after 3 November. We have seen stocks that have already moved 50% in USD terms since the devaluation. Anyone coming in now has missed the initial move, even though stocks remain relatively cheap on a two-year view.
There’s not a lot of attention being paid to Egypt by Wall Street, but there’s a growing awareness the currency looks cheap and that typically what you want to do in EMs is buy economies where there’s going to be improvement after a collapse, where currency and valuations are cheap and where earnings growth is in the cards. This is why Egypt should be interesting.
The big thing is going to be repatriation, where some investment firms are hamstrung by compliance and so I have less competition.
I think the IPO outlook should be good. It comes down to valuation, and there’s a lot of cash on the sidelines. It will come down to how good the companies are and what are the valuations.
I see M&A activity picking up as the year goes on. It will be slow initially because strategics will want to see where the currency settles and they’ll need comfort on repatriation. But three to four months from now, you should see an uptick in both M&A and FDI.
If I were going to start a new business in Egypt today, I would look at import substitutes and exports, particularly exports in any industry that’s really labor-intensive. Also, anything of which the country is a large importer, which involves natural gas and it’s a product sold in USD.
On the policy front, I get worried any time the government comes in and says it’s going to dictate prices or the amount of natural gas a company can get. That changes the economics of the business and makes it really difficult to forecast the business. I don’t like hearing things such as, “I’ll give you all the natural gas you need, but you need to bring your prices down.” The ideal is to get market rates on everything.
What the government needs to do is give the private sector what it needs to grow and prosper. The private sector is, by definition, the most efficient allocator of capital. They need to not crowd out the private sector. When disincentivized capital leaves a market, it takes time for it to come back.
The biggest challenge for the hedge fund industry in 2017? Ten or fifteen years ago, people paid you for beta. You would lever up your portfolio and if the market did well, you did well. Investors have become more sophisticated these days. They can create their own beta. What they want is people who create alpha. If you can create alpha and mitigate risk, that’s ideal. The challenge for asset managers generally is alpha. If I can buy a low-cost passive ETF that captures most of the market move in a rising market, why am I paying two and 20 [two percent management fee and 20% of profits earned, the standard hedge fund compensation structure]?
Egypt is fun in some respects because the market is still overrun by retail investors. You want to be the only professional at a poker table so that it’s not all professional fund managers slugging it out. You can make a lot of money when you know the companies and the facts, when you can talk to government.
Why would I buy equities when interest rates on deposits in Egypt are at 18%? Here’s my advantage: I don’t look at where interest rates are now, I look at where they will be and thus, ultimately, where the discount rate will fall. The sell-side says the discount rate is 18%, but if the EGP stabilizes over the next 12 months, inflation will fall. And as it comes down and currency stabilizes and there are inflows and a strong reserves base at the CBE, they can cut rates. That’s when debt investments start to become less attractive. So what happens when you look beyond the spot rate the sell-side people are using today and see rates coming down 400 bps over the next 12-18 months? Valuations go up significantly. Interest rates come down, the weighted average cost of capital comes down, and these highly levered industrial businesses suddenly have access to natural gas? When they’re paying 12% on their variable-rate facilities and their EBITDA and earnings are dramatically improving because they have access to gas, their valuations change massively.
It’s all about the ability to look forward and see a different environment. I like industrials, and I’ve liked them from the day of the devaluation. I knew that was the space I wanted to target.
What I love about our business at Moon is that we focus largely on global emerging markets, and we’re not afraid of illiquid markets, so you don’t have all of the quant funds, the large hedge funds, the global funds. They tend not to play in emerging markets, and in illiquid EM even less, because they need to be able to liquidate and get out of a market fast. I can live with less liquidity and get paid for it.