A roller coaster ride

Vietnam’s stock market with its high level of volatility is not for the faint hearted. The VN-Index shot up over 100% in the first 4 months of this year to fall by more than a third between May and July. And just as many investors are hastily getting off the roller coaster ride fearing an imminent crash, the market made an impressive comeback, advancing 25% since August. The current recovery already ignited hopes that the hyper growth trajectory will soon be realized yet again.

The surest sign that the market has been revitalized is the intense interest shown in the IPO of the Petroleum Technical Service Company (PTSC), one of the leading companies in the petroleum sector.

On August 28, nearly 4,000 investors turned up to the auction of PTSC’s 37.3 million shares on Hanoi’s Trading floor. This is the biggest turn out ever, and together they bid for 220 million shares (almost 6 times the number put up for sale.)

All the stock was later bought at 37.256 VND/share, significantly higher than the expected price - each share has VND 10,000 face value.

PTSC is a good company, which will continue to enjoy its monopolistic position in the protected energy sector, but its successful IPO was guaranteed only by good timing. Between August 2nd and 31st, all the leading stocks enjoyed significant recovery - Vinamilk up 35%, Sacombank up 12%, VSH up 30.5%, and REE up 24.2%. Had the PTSC’s debut been made at the end of July instead, the result would have been very different.

The current rally was not unexpected.  In July, analysts had widely talked about the market bottoming out as the Index approached the 400 points. As well, good performance reports released in June also helped to cushion the fall. However, what is surprising is the strength of the upturn. Nearly 30% gain in August alone begs the question of what’s the force behind the emerging stock prices. 

The Merrill Lynch effect

Earlier in February, Merrill Lynch published a bullish report on the Vietnamese equity market, which called Vietnamese stocks a “10-year buy” and encouraged investors to have 3% of their Asian holding in Vietnam’s shares. The report was widely cited in the local press and fueled expectation of a capital inflow, which ultimately stimulated market fever.

Six months on, this same “Merrill Lynch effect” seems to be at work once again, propelling the rising tide of market optimism, as more reports of foreign investors’ interests in the local market spread like wild fire.

First, Merrill Lynch officially joined the market after acquiring a coveted "trading code" needed to buy and sell shares. The bank’s head of Asia Pacific equity called the move “a mile stone” for its equity franchise in Asia. Credit Suisse and JP Morgan are both reported to be in the queue, which will lengthen the list of Wall Street firms in the market. (Citygroup already obtained its trading code last year and is marketing its Vietnam portfolio actively). The move was not over-looked by the market’s observers and was quickly interpreted as a sign that “Wall street financiers are marching into Vietnam” (to use the local press’s phrase). With the big players now showing interest, despite the short-comings of the small and thinly traded market, local investors’ confidence was quickly restored and the market pulled itself up toward the 500 points level.
Asian investors are also joining the game. In the first 9 days of September, the State Security Commission (SSC) granted licenses to 3 companies - Blackhorse Asset Management Pte Ltd (Singapore), Nomura International Limited (Hong Kong) and Mirae Asset Maps Investment Management Co., Ltd (Korea) - to open their representative offices in the country.
Together with the news about more active foreign participation in the market is the high expectation of the much-awaited capital inflow. Dominic Scriven, Director of Dragon Capital was quoted as saying: “this year Vietnam could attract US$ 500 million Foreign Indirect Investment (FII), equivalent to 1/3 of the total inflow and 60% of the total money foreign investors have spent on the bourse to date.”

There are increasing talks about the “third wave of FII”, which is expected to follow Vietnam’s accession to the WTO.
The first wave of FII came when Vietnam first opened to the world in the early 1990s when the privatization process just kicked off and the Doi Moi program was bearing its first fruits as the economy grew at a rate near 10% a year. Seven foreign investment funds, including the Vietnam Lazard Fund, Templeton Vietnam, and Beta Fund, were set up in the country with a combined capital of US $700 million. However, most of these funds withdrew from the Vietnamese market after the 1997 Asian crisis.

In the early 2000s, foreign investors have resumed their interest in the Vietnamese market. The second wave of FII began in 2002 as the privatization process accelerated. However, the total FII attracted each year was still very small, as a ratio of FDI it rose slowly from 1.2% in 2002 to 2.3% in 2003 and then 3.7% in 2004 (compared to the regional average of 30-40%).

The low level of FII was mainly due to restrictions on foreign investors’ ownership of local companies, and the tight controls on current and capital accounts. The conditions have improved significantly over 2005 and 2006. Exchange controls have been greatly reduced; foreign ownership in the listed companies was raised from 30% to 49% and will soon be unlimited after Vietnam’s accession to the WTO. Unified Investment and Enterprise Laws were introduced in July this year, giving foreign investors and enterprises national treatments, creating a more favorable business environment.

By the end of June 2006, according to the Deputy Finance Minister, Tran Van Ta, there are 19 funds operating in the market with close to 2 billion capital in hand. Among those, the latest fund is Vietnam Holdings, capitalized at US $112 million, 60% of which was mobilized from Swiss investors.

In addition, some of the fund management companies operating in Vietnam plan to set up more funds to mobilize capital. Individual foreign investors are also reported to be on the rise. The SSC said on average it gives trading codes to about 40-50 foreign investors per month.

The right ‘love potion’

Despite growing rapidly this year, Vietnam’s equity market is still very small with only 48 stocks available for trading with daily turn over of US$ 500 million. The market capitalization is only US$ 3 billion, less than 4% of Merrill Lynch’s asset. It is a curious sight that the big boys are queuing up for such small pickings. What makes Vietnam so attractive?  What ‘love potion’ does it use?

The short answer is Vietnam’s potential as one of the fastest growing economies in the world and the privatization process which is reaching new depths. According to the head of Merrill Lynch Asian Pacific equity: "Vietnam presents one of the few truly untapped markets in the world, and has a great potential for investors for long-term growth."

Last year, VN grew 8.4%, the second fastest growing economy in Asia after China.

In September, the ADB in its ‘Asian Development Outlooks 2006 Updates’ saw the country’s economic performances remain robust with expected annual growth rate of between 7.8% and 8% in the next two years. Its resident director even called Vietnam “the Star of Southeast Asia”.

Banks are confident

HSBC also expressed its confidence in the government’s target of 7.5-8% annual growth rate in the next 5 years, saying: “the odds of achieving this are high”. Standard & Chartered bank is reported to be even more optimistic, estimating this year’s growth rate will reach 8.2% and even higher in 2007at 8.8%.

HSBC and Standard & Chartered are active foreign banks in Vietnam and both held 10% stakes at two of the three biggest local lenders.

And the fireworks continue with Standard & Poor’s recent decision to lift Vietnam’s long-term foreign currency rating one notch to BB, acknowledging the country’s effort and commitment to economic reforms and its steady transition to a market economy.  S&P also added that “measures to introduce foreign participation in the banking system have also laid the foundation for greater financial stability going forward”.

With this bright prospect, the small size of the equity market is no drawback as investors are betting on the privatization process to turn the country’s economic potential into investment opportunities. According to Credit Suisse, in the next 2 years Vietnam will privatize US$ 5-6 billion worth of the State’s assets. Bloomberg (31/8) also estimated the local stock market would grow eightfold to US$ 24 billion within 4 years after big conglomerates join the bourse (such as Vietcombank, BIDV, Techcombank, Vietnam Electricity Utilities, and Mekong Housing bank). The director of the SSC was also quoted saying  “22 companies will sell their shares in the next 4 months to increase market size to 10% of GDP by the end of this year.”

The speed of market expansion will be even faster as the companies currently traded in the unregulated OTC market find their way to the HCM Trading center. According to Merrill Lynch’s report, there are 2,400 joint-stock companies being traded in the grey market valued between 5 to 10 times the size of the official market. The bank also asserted that “the VN index will - in time - surpass 1,000 points” and privatizations and transfers from the OTC should raise the market cap to US$ 10 billion before the end of 2007.

Investors are ‘dipping their toes’

In its 25-page report on Vietnam’s equity market published in September 1, HSBC urges investors to “dip their toes” and test the market. According to the report, over time, Vietnam’s market capitalization (currently standing at 5% GDP) should reach a percentage of GDP similar to that in other Asian countries (an average of 71% for the Philippines, Thailand and Indonesia), equivalent to US$ 37 billion. “In five years’ time, if it were to grow at 8% a year, it would reach US$ 55 billion”. While it is true that even with this level of market cap, market liquidity is still too small for most institutional investors, HSBC however asserted its belief “that many (investors) will want to at least become familiar with its dynamics and will dip their toes into the water by opening a trading account and buying a few stocks”.  After all it will not hurt having a head start.

Yet another catalyst

Vietnam’s accession to the WTO (expected to be at the end of this year) is viewed as another catalyst. The WTO membership guarantees the country’s commitment to market rule, including pushing for stronger market reform and market liberalization, lifting the remaining restrictions on the capital account and flow of funds, giving foreign investors more freedom. All these factors create an attractive mix, which proves irresistible to foreign investors in their global strategy.

In November, as Vietnam hosts the APEC summit, hundreds of CEOs of the world’s leading businesses will meet in Hanoi. For many of them this would be their first opportunity to witness the country’s economic transformation close up, and some will surely return with business plans in mind.

What to make of the current rally?

There is visible similarity between the current rally and the stock fever earlier in the year. Both are fueled by the Merrill Lynch effect (i.e. market’s optimism about the coming flow of funds from abroad). However, the big and important difference is, that while the market sky rocketed in February from a low base (VN index was at 300 points), the current rally will meet much tougher resistance as the Index is already at 500.

So how sustainable is the current up-turn? Perhaps it is not going to be long lived because the supply constraint can be a difficult nut to crack.

On September 8, the Ministry of Finance (MOF) issued decision 1099/BTC-CST, which will scrap the tax incentive given to listed companies starting from next year. Currently, all joint stock companies, which list or register their stocks on the exchange, enjoy 50% corporate tax break for two years. This was seen as SSC’s main carrot to local firms to join the bourse. According to the new MOF decision, companies joining the bourse from January 1, 2007 will have to pay the full 28% corporate tax while those who listed before that date can still enjoy the tax rebate as specified by the existing regulation.
No doubt, many companies will try to speed up their preparation to join the market before the year-end helping to boost the number of listed companies significantly. If this happens, the market will follow up the momentum and the rally will be strong and sustained through to the end of this year. Some important blue chip companies waiting in line to join the bourse include ACB, the second largest private bank and the most profitable, which just received the go ahead from the State Bank of Vietnam for its listing plan and is now waiting for SSC’s approval.

However, there is not much time. The paper work might delay the listing of many companies.  According to the Stock Investment Weekly, there are about 30-40 companies able to join the bourse before the year-end, but there are no guarantees for them.

Thus, despite the bright long-term prospect, the short term is greatly dependent on development on the ‘supply side’.  But what is certain is that without significant increase in the number of stocks available for trading by the end of the year, there is nothing to feed the bon fire, which is being ignited by positive market sentiments. Already there are signs that the VN index is losing momentum in September and is most likely to trade around the 500 points waiting for the next good news.