The Opportunity and Challenge of Private Equity

in Vietnam: Mekong Capital’s Experience

Chris Freund, Founder and Managing Partner of Mekong Capital, shares Mekong Capital’s experience, having made 27
investments in Vietnamese companies since Mekong Capital’s establishment in 2001. Mekong Capital undertook a major
transformation in its value-addition framework and corporate culture commencing in late 2007, which eventually resulted
in major breakthroughs in the performance of Mekong Capital’s investee companies. Mekong Capital has raised three funds
to date—the first in 2002, the second in 2006 and the third in 2007. It has made 27 investments, and seven exits. Mekong
Capital has a team of around 35 people in Ho Chi Minh City and Hanoi.

In this article, Chris Freund shares aspects of Mekong Capital’s experience in Vietnam that have broader implications for
practitioners of private equity throughout emerging markets.

Introduction Exhibit 2: Vietnam’s Consumer Expenditure (US$B),

2006–2010
Vietnam is a market with consistently high growth in GDP and
consumer demand, yet a shortage of capable management $80 70.4
65.6
60.4
teams that can convert the market growth into shareholder value. $60 45.6

US$ Billions
38.3
Vietnam’s GDP growth rate has averaged 7.2% per year since $40
2000. Vietnam has not experienced a recession since the
$20
mid-1980’s when it commenced its market-oriented reform
process. The recent Global Financial Crisis had negligible $0
impact on Vietnam’s growth rates, with GDP growth falling 2006 2007 2008 2009 2010F
to a low of around 5.2% in 2009, hardly catastrophic levels. Note: The year 2010 is a forecast.
However, the crisis did involve a series of fluctuations in capi- Source: Euro Monitor.
tal markets and asset valuations in Vietnam, leading to the
current situation of capital scarcity and low asset valuations. manufacturing from China to lower cost countries such as Viet-
nam to continue as there is pressure on the Chinese currency to
Vietnam’s GDP growth has been driven by the ongoing appreciate and the Vietnam Dong to depreciate. Interestingly,
shift of business ownership from state-owned to privately- while Vietnam has a trade deficit with China, it is a net exporter
owned, a high percentage of the population in the work of commodities and agricultural products to China.
force, growing consumer demand, and substantial foreign
direct investment (FDI) into the manufacturing sector. Dis- Growth in retail sales and services has been strong since 2000,
bursed FDI is typically around 10% of GDP each year, making growing at an average rate of 18% per year, and expected to
it one of the highest FDI/GDP ratios in the world. grow at 20% in 2010. Meanwhile, the percentage of the popu-
lation in the upper-middle class and higher, defined as having
As a lower cost manufacturing base than China for labor- monthly household income above US$500 has increased from
intensive products, Vietnam attracts a lot of investment by 7% of the population in 1999 to 37% in 2008.
companies looking for a lower cost alternative to China, and
this has been accelerating recently due to the rapid increases in Retail is very fragmented in Vietnam, with modern trade chan-
production costs in China in USD terms. We expect the shift of nels only representing 18% of retail sales, but growing fast.
Successful retail chains typically
Exhibit 1: Vietnam’s Real GDP Growth, 2000–2010 have up to 100 outlets in Viet-
nam at present, or in the case
10 8.5 of super-stores or department
8.4 8.2
7.8 stores, up to around 10 outlets.
% Annual Change

8 6.8 6.9 7.1 7.3

6.2 6.7
6 5.2
In spite of all of this growth,
4 the business environment
remains fragmented, and few
2 companies have been success-
0 ful at converting this growth
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010F
into sustainable shareholder
value. The lessons below dis-
tinguish what’s worked best in
Note: Real GDP growth is the nominal growth of the GDP of Vietnam adjusted for inflation. The year 2010 is a forecast.
Source: Euro Monitor, World Bank. Mekong Capital’s experience.

EMPEA Quarterly Review Vol VI Issue 3, Q3 2010 1

 Private Equity in Vietnam, continued
Lesson 1: Companies Focused on Single
Businesses Have Achieved the Fastest Net
Profit Growth
We recently conducted an analysis of the performance of
the 26 investments we’ve made across our 3 funds (which
includes one spin-out) as of the end of 2009 based on the
number of business units. For this analysis, if companies
were investing cash into securities or real estate which was
unrelated to their core business, we counted that as one
extra business unit. Also, if a company was engaged in both
export and domestic sales of the same product, we counted
that as two separate business units because the key success
drivers for export and domestic sales are quite different.
Exhibit 3: Number of Business Units versus Net Profit
CAGR, from Year of Investment through 2009
300%
250%
200%
Net Profit CAGR
150%
100%
50%
0%
–50%
0 1 2 3 4 5
No. of Business Units
Note: Inclusive of all Mekong Capital investments held or exited as of 12/31/2009.
Companies for which data could not be computed are excluded from the analysis.
Source: Internal data of Mekong Capital.
While there is a lot of variation around the trend line, there is
nonetheless a clear pattern. Among our investee companies,
the number of business units is inversely correlated with the net
profit CAGR over the lifetime of the investment. The number
of business units is also inversely correlated with the degree to
which the companies achieved their cumulative net profit target
over the lifetime of the investment. In other words, the compa-
nies focused on a single business tend to both grow faster and
are more likely to achieve their net profit targets.
Of our eight investee companies that have achieved a CAGR
net profit growth rate above 50%, six of them have one
business unit, and two of them have two business units.
None have three or more business units. This contrasts with
some other Asian emerging markets such as India, Indone-
sia, Philippines and Malaysia, in which large family-owned
conglomerates tend to dominate the business landscape.
This pattern shows up so strongly in Vietnam due to the
relative youth of the private sector, and the shortage of
management sophistication necessary to successfully
manage multiple businesses. However, there are a few
exceptions in Vietnam, such as Masan Group and FPT Cor-
poration, which have successfully achieved rapid net profit
growth while managing multiple businesses.
2 Emerging Markets Private Equity Association
Lesson 2: Investments Made at Single-
Digit PEs Have Outperformed
Vietnam’s public equity market escalated dramatically in
2006 and early 2007, rising 280% over a 15-month period.
In 2008, the market started to collapse, losing 80% of its
value from the top to the subsequent bottom in early 2009.
In effect, Vietnam was in a bubble in 2006 and 2007. The
P/E ratios of listed companies increased from 8–15x in 2005
to a high of 30–40x in 2007 and back down to 6–12x at
present (this excludes real estate companies).
During 2007, we made several pre-IPO or PIPE investments at
30–50% discounts relative to comparable listed companies
at the time. While their net profit performance was generally
good, it’s taken several years to offset the negative impact of
having overpaid on the entry P/E for those deals.
Exhibit 4: Entry P/E Ratio versus Gross IRR
100%
80%
60%
40%
Gross IRR
20%
0%
–20%
–40%
–60%
6
–80%
0x 5x 10x 15x 20x 25x 30x 35x 40x
Entry P/E Ratio
Note: Inclusive of all investments held or exited until 12/31/2009. IRRs for exited com-
panies are as of the date of realization. IRRs for unrealized holdings are as of 6/30/2010.
Companies for which data could not be computed are excluded from the analysis.
Source: Internal data of Mekong Capital.
The above scatter diagram demonstrates that the IRRs of
our investments have been highest for the investments we
made at the lowest P/E multiples in the entry year.
Interestingly, some of our best investments were early
expansion-stage investments made at PEs of 4–9x during
the bubble period, demonstrating that it is possible to make
investments at attractive valuations during bubble markets.
This was achieved mainly by shifting to earlier stage compa-
nies during the bubble period.
In the earlier years we didn’t apply a ratchet or valuation
adjustment mechanism, and many investee companies under-
performed their net profit target in the entry year, leading to a
high entry P/E. Now we normally apply a valuation adjustment
mechanism of some kind to ensure our entry P/E is within an
acceptable range, which has been working well.
Discipline really matters in the entry valuations, especially for
investments that will be held for 3–5 years. As American-born
investor and philanthropist John Templeton said: “The four
most dangerous words in investing are: this time it’s different.”
 Private Equity in Vietnam, continued
Lesson 3: The New Generation of
Entrepreneurs Have Been Most Successful
Vietnam’s transformation from a centrally-planned system
into a market economy commenced in the mid-1980s, under
a program called Doi Moi. This, combined with the lifting of
the U.S. Trade Embargo on Vietnam in February 1994, led to
the birth of Vietnam’s private sector in the mid-1990s. The first
generation of private companies was established in the 1990s
by entrepreneurs with little or no international exposure, and
resembled family businesses. By around 2005, a new genera-
tion of entrepreneurs started to emerge, younger individuals
who had either studied and worked overseas and returned to
Vietnam, or who had been promoted up into management
roles at multinational companies in Vietnam before launching
their own businesses. Now, other than real estate companies,
most of the largest and fastest-growing private companies
in Vietnam are founded by this new generation of entrepre-
neurs, who are typically in their late-30s through mid-40s.
Our investments in companies led by the newer generation of
CEOs and entrepreneurs have been our most successful invest-
ments. While age alone doesn’t tell the whole story, there is
nonetheless a clear pattern that our investee companies with
younger CEOs have generated faster net profit growth. This
is attributable to their experience working in multinational
companies or overseas, as this younger generation has greater
awareness of international best practices, and has often been
more proactive about building robust management teams.
The median net profit CAGR of our companies whose average
CEO age was below 40 years old is 64%, while the median
net profit CAGR of our companies whose average CEO ago
was above 40 years old is 20%, a substantial difference.
Exhibit 5: Average CEO Age versus Net Profit CAGR,
from Year of Investment through 2009
300%
250%
Net Profit CAGR
200%
150%
100%
50%
0%
–50%
30 35 40 45
Average CEO Age
50
Note: Inclusive of all investments held by Mekong Capital’s funds as of the date of
this publication. Companies for which data could not be computed are excluded
from the analysis.
Source: Internal data of Mekong Capital.
For example, ICP is the largest locally-founded personal care
products company in Vietnam, and is #3 in the market after
Unilever and Procter & Gamble. ICP’s co-founders started
the company when in their early 30s. Both had previously
worked as managers at, or service providers to, multinational
companies such as Nestlé, Unilever and GlaxoSmithKline.
However, we certainly recognize that there are exceptions
and that several of the largest and most successful private
companies in Vietnam were founded and run by people
who are in their 50’s and 60’s.
Lesson 4: Consumer and Distribution Have
Generated the Highest Returns
Our first fund focused mainly on manufacturing and
export. After anecdotal observations that the domestic-
facing businesses tended to perform much better than the
export businesses, and operated in much less competitive
environments, by the launch of our second fund in early
2006, we had shifted our focus primarily to consumer
driven businesses such as retail, consumer products, dis-
tribution and education.
Our investments in consumer-driven businesses such as
retail, consumer products and distribution have con-
sistently outperformed other sectors. We see two key
takeaways here:
• Our investments in companies focusing primarily on
manufacturing have often not been effective at differ-
entiating themselves from their competitors, whereas
the consumer driven companies have been effective at
differentiating themselves through brands, distribution
networks, sales teams or retail presence.
• The consumer-driven businesses have been effective at
generating rapid top-line growth leading directly to net
profit growth, whereas the manufacturing companies
can’t normally grow their top-line as fast, and therefore
relied more on efficiency gains to generate net profit
growth, which often didn’t materialize.
For example, once of our most successful investments has
been MobileWorld (“The Gioi Di Dong” in Vietnamese),
which grew from five mobile phone retail stores when
we invested in 2007, to 55 mobile device stores by August
2010, becoming the market share leader in mobile phone
sales in Vietnam. They achieved this in part by developing
a highly scalable and repeatable system for stamping out
new stores in what is basically a very fragmented retail
wireless market.
“
55 60
The most reliable driver of the success (or
lack of success) of our investments has
been the degree to which the companies
proactively and effectively develop a strong
team of managers and leaders. Almost
“
every company says they are committed to
developing a strong team but few are really
effective at doing this.
EMPEA Quarterly Review Vol VI Issue 3, Q3 2010 3
 Private Equity in Vietnam, continued
Exhibit 6: Gross IRR by Broad Sector
100%
80%
60%
40%
Gross IRR
25.4%
15.3%
20%
0%
–20%
–40% Manufacturing
Consumer and Retail Distribution
Domestic
Lesson 5: Management and Leadership
Have Been the Most Critical Success Drivers
The most reliable driver of the success (or lack of success)
of our investments has been the degree to which the com-
panies proactively and effectively develop a strong team of
managers and leaders. Almost every company says they are
committed to developing a strong team but few are really
effective at doing this.
In Vietnam, the prevailing standard of management is quite
weak, so the opportunity is to identify those companies
most committed to developing strong management and
leadership on an ongoing basis, and to empower them
to do so. Those companies consistently capture a dispro-
portionate share of the growth opportunities presented
in Vietnam’s fast growing markets. While it’s not easy to
quantify the degree to which a company is developing a
strong management team, our most successful companies:
• Are very targeted, proactive and relentless about recruit-
ing senior people who can add a lot of value;
• Actively track key performance indicators (KPIs), espe-
cially net profit against year-to-date net profit targets,
and use those as a management tool;
• Set high targets and hold people accountable to achiev-
ing those;
• Invest extensively in training and link training to KPIs;
• Create a corporate culture, and corporate values, which
empower people to deliver results in a sustainable way;
• Implement bonus systems which are well aligned with
the most critical KPIs, especially net profit targets.
Mekong’s Transformation and New Model
of Value Creation
Realizing that many of our investee companies hadn’t been
achieving the net profit growth that we originally projected
when making those investments, particularly for our earlier
investments, Mekong Capital commenced a major transfor-
mation starting in November 2007. The transformation was
4 Emerging Markets Private Equity Association
Note: Inclusive of Mekong
Capital’s investments in
these categories, held or ex-
Average ited as of 12/31/2009. IRRs
for exited companies are as
of the date of realization.
IRRs for unrealized holdings
are as of 6/30/2010. Two
investee companies were
6.1% excluded as one was a spin-
1.1% out in which no new capital
was invested by Mekong
–5.5% Capital’s funds, and one
didn’t fit within these sector
classifications.
Manufacturing Real Source: Internal data of
Mekong Capital.
Export Estate
intended to lead to a significant breakthrough in the per-
formance of Mekong Capital’s funds, including each of the
investee companies held by those funds.
During our transformation process, we extensively and
repeatedly reviewed what was working, not working and/or
missing, and implemented a framework intended to lead to
breakthroughs in investment performance. The framework
is based on best practices in executive coaching, perfor-
mance, leadership and corporate transformation.
Mekong Capital’s new value creation framework inte-
grates technology developed by Landmark Education LLC,
a global training and development organization, and the
Barbados Group, a think-tank focused on breakthroughs
in performance and leadership. This framework extensively
incorporates A New Model of Leadership, which is captured
in a paper authored by two members of the Barbados Group,
Michael C. Jensen, a Professor Emeritus at Harvard Business
School, together with Allan L. Scherr, an IBM Fellow. Mekong
Capital’s value creation framework also draws on research
by John P. Kotter, a Professor Emeritus at Harvard Business
School, on leadership and corporate transformation.
The ways in which we interacted with investee companies
completely shifted from a piecemeal approach, or hodge-
podge of initiatives and projects, into a comprehensive
top-down approach called Vision Driven Investing. It involves
aligning around a shared vision with investee companies,
subsequently devising a shared plan with clear milestones
and measurable targets for achieving that vision, tracking
their performance against those targets, quickly identify-
ing when they are off-track for achieving the targets, and
providing the necessary coaching to ensure they get back
on-track, or at least avoid having the same breakdown
again. Through extensive training, we’ve built the capacity
of our Deal Partners to apply coaching tools to cause the
investee companies to distinguish the source whenever they
are off-track and to take appropriate action – often in ways
that represent breakthroughs in management and leader-
ship among the senior people at the investee companies.
 Private Equity in Vietnam, continued

Exhibit 7: Actual Net Profit versus Target Net Profit In conclusion, the rapid growth of consumer demand in
emerging countries such as Vietnam, combined with the gaps
10 in management and leadership which are common in these
markets, provides an opportunity for private equity inves-
8
tors to achieve sustainable investment success through their
US$ Millions

6 effectiveness at empowering and coaching their investee

companies to develop robust management and leadership
4
teams. The companies with a clear vision, robust manage-
2 ment and leadership, and a corporate culture which is well
aligned with delivering results, will be most effective at con-
0
2005 2006 2007 2008 2009
verting the market growth opportunities into rapid net profit
growth and sustainable shareholder value creation.
 Target Net Profit  Actual Net Profit

Note: Net profit is calculated on a pooled basis, which reflects the percentage Chris Freund is the founder and Manag-
ownership of Mekong Capital’s funds in each investee company as of 12/31/2010.
Source: Internal data of Mekong Capital. ing Partner of Mekong Capital, which
was established in 2001. Chris Freund
By 2009, after rolling out this new system, Mekong Capital has 16 years of direct investment man-
reported a dramatic improvement in the net profit perfor- agement experience, 13 of which were
mance of our investee companies. They achieved a weighted in Vietnam. Prior to forming Mekong
average net profit growth of 89% in 2009 — and this was Capital, Chris Freund was a Vice Presi-
the first year that they collectively exceeded their targets. dent and Portfolio Manager with
In the first half of 2010, our investee companies continued Templeton Asset Management, Ltd., the
to perform well, with weighted average net profit growth emerging markets arm of the Franklin/Templeton Group,
of 30% compared to the first half of 2009, and we remain which he joined in early 1995. Chris is also a co-founder,
committed to achieving our 2010 annual target of weighted and non-executive Director, of Navigos Group and Vietnam-
average net profit growth of 47% in 2010. Works.com, the largest recruitment services firm in Vietnam.

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EMPEA Quarterly Review Vol VI Issue 3, Q3 2010 5