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Financial Frontiersman Touts African Stocks

Even Zimbabwe is not too risky a bet for broker Jon Auerbach

U.S. News and World Report web site
Posted April 1, 2008

Jon Auerbach, '64
Want to pick up some shares of a mining company in Mongolia? How about playing bonds in Bangladesh?

Available technology may let your average E-Trader play markets in China, but there are still plenty of places where trading requires some specialized assistance. Enter Jon Auerbach, cofounder of Auerbach Grayson, a boutique brokerage in New York that links up institutional clients with far-flung investments in more than 119 "frontier" markets around the globe.

Fresh off a three-week jaunt through Africa, Auerbach spoke with U.S. News about some overlooked opportunities, including why African pariah Zimbabwe might be a buying opportunity. Excerpts:

Why focus on the frontiers? Seems like a lot of work and uncertainty compared with running mutual funds or something.
It goes back to my belief that the historians will say our century was the beginning of the leveling of the global playing field. All of these people have aspirations to whatever their version of a middle class looks like.

Let's talk about some favorite markets.
Our most active are Bangladesh, Pakistan, and Sri Lanka. South Asia is attracting a lot of new money right now. What's interesting in all three is their valuations relative to India. That's what makes them cheap. Remember, at one point these were all part of greater India when it was part of the Raj and under the administration of colonial England. As a result, there is a stock market tradition that came with the English. There is a legacy of investment and a legacy of governance and rule of law which underpins the legitimacy of any stock market.

With the tremendous growth in India and valuations in that market, people neglected the others to the point where they were generally half that of India, depending on your metric. There's certainly a political overlay, but such low valuations led us to focus on local partners there.

Who's on the cusp of being a new India (or a new Brazil, Russia, or China, the other so-called BRICs)?
Well, the BRICs obviously have the size, but I would say Nigeria is an extraordinarily important market. Within five years or so, it will probably be the banking capital of Africa. It's a country of 160 million people and has done some very important banking restructuring. Its central bank really took charge, raised reserve requirements, and reduced the number of banks so they're all very well capitalized. A number are being actively invested in by major U.S. institutions now, plus it has a very liquid stock exchange.

If Nigeria's doing well, Zimbabwe is an obvious counterpoint. But you see opportunity there too ...
Like everybody else, I'm waiting to see how the election turns out. If indeed we find out in the next day or two that the voters have rejected [President Robert] Mugabe, I think it's going to be an extraordinary event and an opportunity to make some remunerative investments. The country has operated remarkably well through this hyperinflation, so change would be surprisingly fast—maybe just two or three years.

Now is the time you have to make those investments. For example, now's the time to buy Delta Corp., a brewer in Zimbabwe. It's operating at about 30 to 40 percent of capacity and still making money. Its market cap to a hectoliter of beer, which is the way brewers are valued in emerging markets, is $50. East Africa Breweries, the Kenyan brewery, is currently trading at $200 per hectoliter. That's four times the valuation. That should improve with a new government.

Market cap per hectoliters of beer? Not exactly a traditional valuation tool on Wall Street ...
I'm thinking of renaming the firm Auerbach Grayson: CSI. Take Econet (Wireless), the major cellular phone company in Zimbabwe. Last month I met with the [chief financial officer]. His revenue is cellular cards that are sold all over the place and people buy them as they can afford them. It's a cash business, but each day they're losing through inflation 15 to 20 percent. [Editor's note: Zimbabwe's annual inflation rate has topped 150,000 percent, according to some estimates, by far the world's highest].

So I asked him what he does with the cash. He said, "I put it in the stock market." And I asked if he was joking. So I asked the value of his portfolio, and he said it's the equivalent of about $150 million. The company only has a market cap of $125 million. He looked at me and said, "That's why we're a good buy!"

How are these markets faring as the American economy slows?
On a macro basis, we take a very positive view of the global economy right now. Given the [fund] flows we see and the amount of business we do in these markets, it's certainly where business is going. On a given day, I'll trade in 30 to 40 different countries and have turnover of $150 million to $200 million a day in order flow. Five years ago, 50 percent of our revenue came from G-20 markets and 50 from the rest of the world. Today, close to 65 percent is from the emerging and frontier world.

I also think global investing from people who are dollar-neutral, and that includes American managers, will continue to focus outside the United States, because the dollar will continue to be under more pressure than other currencies. Investing in most foreign markets is a natural hedge to short the dollar.

Is political leadership improving in Africa in a way that will help draw investment?
The postcolonial kleptocrats who assumed power when the British, French, and Portuguese took it on the lam in the '60s and early '70s are gone. You've got some really remarkable leaders in Africa like [President Yoweri] Museveni in Uganda, [Jakaya] Kikwete in Tanzania. In terms of privatizations, citizens becoming shareholders, publicizing investments, the improvements are there. They're politicians at the end of the day, but they're cognizant that there's something to improving people's lot.

But the political element is obviously still a concern in some of these spots. How do you invest in places where political risks are high and stability isn't a given?
The concerns people have, whether it's political corruption or governance, are generally overstated relative to the reality. Kenya had an electoral political crisis in January. I went there immediately afterwards because we have a lot of investments there for clients. Within two days—and I know what the headlines said—downtown Nairobi was busy.

We went around and picked up some fantastic, sizable, $10 million-range blocks of stock in some Kenyan companies. Our clients are up 10 to 15 percent on it on the recognition that what you could see on the evening news [was disruptive]—and I'm not minimizing what happened because there were people killed—but they resolved it. And things like tribalism are on the wane. I'm a great believer in Africa.

Any advice for average retail investors?
For the man on the street with a 401(k), realistic emerging market exposure is an absolute must. That means about 15 to 20 percent of a portfolio in emerging markets.
Read an earlier article about Auerbach on this site.