Adam Kutas | Portfolio Manager
Ever since I started looking at emerging and frontier markets, over 20 years ago, I have found the most commonly discussed investment thesis is a comparison-based product or service penetration story. For example, investors will highlight that approximately 90% of Canadians have a TV set, while the ownership statistic is 20% in Kenya. Accordingly, the growth opportunity for TV manufacturers in Kenya is much higher than in Canada, and Kenya can be expected to converge with the Canadian level over time as per-capita income grows. This kind of story can be applied to almost every company and sector. The basic idea is that frontier countries’ economic development path will exactly match the path set by developed and more advanced emerging markets over the past 50 to 100 years.
However, in certain sectors, with the tremendous advancements in technology, this matching is unlikely to happen: I see many frontier countries “leapfrogging” the market structures that existed in developed markets and moving straight to the most modern systems. This development should not only allow frontier countries to achieve faster productivity gains but also help them to avoid problems faced in developed countries, such as what to do with infrastructures that become outdated.
This leapfrog structural change is most apparent in three sectors: telecom, banking and power. What is enabling it? The main drivers are huge advancements in technology and the resulting collapse in the prices of that technology. As seen in Chart 1, the penetration of modern mobile phones is effectively equal in developed, emerging and frontier countries. Historically, most citizens in frontier markets would have had to wait for the government or a company to build out a traditional fixed-line telecom network like the ones built by Bell or Telus in Canada decades ago. But given that mobile phone towers are much easier and cheaper to install, and that Chinese-made handsets are available at a lower-income price point, frontier countries effectively leapfrog past the traditional telecom infrastructure built in developed markets, and are now reasonably at a par with people in Montreal or Vancouver in terms of mobile communications and mobile-based Internet access.
This change is extremely powerful for the productivity of a country earlier in its economic development.
For instance, think about the bank branch per-capita data shown in Chart 2. As you can see, developed markets have a huge footprint of brick-and-mortar bank branches – it used to be said about Toronto, “There is a bank and a church on every corner.” But with the advent of mobile banking (Kenya-based e-transfer giant Safaricom is case in point), frontier-based bank customers will leapfrog straight to Internet banking. Instead of fighting traffic across town on a scooter to pay utility bills at a bank branch, a customer will pay those bills on a phone, in seconds. Accordingly, that person is more productive, all those brick-and-mortar branches likely won’t be built, and frontier market commercial landlords will subsequently never have to deal with the challenges their developed market peers face in filling empty shops left vacant by bank branch closures.
Another example of leapfrogging applies to retail shopping. As seen in Chart 3, developed market consumers historically shopped at malls; accordingly, countries like the U.S. have very high mall penetration. With online shopping, frontier markets customers will leapfrog traditional mall shopping, preferring the offers of Amazon and Alibaba – and all those malls will likely never be built in countries such as Bangladesh.
The final leapfrogging is in the field of power. As outlined in a previous blog, solar panel prices have collapsed, driven by heavy Chinese investment, so power-generation costs from solar are now cheaper than from coal. Hence, given solar is “green tech” and there are no ongoing fuel input costs (which consumes a lot of corporate cash), frontier markets will leapfrog straight to solar power, and will not build out the massive coal-based power infrastructures seen in developed markets, as highlighted in Chart 4.
Please don’t misunderstand: malls will still be built, because families like to go out and see a movie; banks will still need some bank branches, to ensure customers trust their money is safe; and surfing the Internet is a much better experience using a fixed line, compared with wireless. But in frontier markets, the development path will be much different from the historical example set by countries such as Canada, given the fast adoption of effective, cheap technologies. This kind of development should lead to faster productivity gains in frontier markets and create exciting investment opportunities unique to these markets – opportunities that do not stem from the traditional “penetration” stock ideas familiar to most emerging and frontier investors.
Thanks for reading
Adam Kutas, CFA
Note: Data are as at December 31, 2017