Retailers cannot afford to skip Asia’s youngest market. Here’s why.

Vietnam began to liberalize its economy in the 1980s, when the country’s leaders launched doi moi (or “renovation”). It was only after President Clinton lifted the U.S. trade embargo in 1994, though, that multinationals began to pile in. Since then, Vietnam has taken off. In 2007 it joined the World Trade Organization–just in time for the global financial crisis. The country weathered the storm well, posting 5% growth in 2009. This year should be even better.

For retailers and consumer goods companies, Vietnam is an attractive market: The economy is growing briskly and sustainably, and the population is adding a million people a year. Even more important, the country’s middle class is growing fast: from 7 million households in 2003 to an estimated 25 million in 2013. Vietnam’s literacy rate is 92.5%, and from 2003 to 2008 the number of college and university students nearly doubled. The cities, though mostly small, are expanding rapidly. Six of them–Can Tho, Da Nang, Haiphong, Hanoi, Ho Chi Minh City, and Nha Trang–account for 40% of the country’s sales, according to AC Nielsen estimates from 2007.

The Vietnamese government estimates that retail sales reached $39.1 billion in 2009–almost twice as high as five years earlier. And the country has room to grow: Per capita retail sales, at $450, are among the lowest in Asia. Setting up shop in Vietnam, however, isn’t easy. The market is fragmented and difficult to reach, and although 100% foreign-owned retailers can register for an operating license, they are generally allowed to open only one outlet. To expand further, they must pass an “economic needs test,” in which the government analyzes a new project’s economic impact. The test gives local governments an effective–and sometimes arbitrary — veto over new developments. Such regulations are legal and relatively common under WTO guidelines. Even so, they are more broadly applied in Vietnam than in most other countries, limiting access to the domestic market.

McKinsey has worked in Vietnam with a number of domestic and international companies. In June 2010 we spoke with a dozen executives who do business there. We offer the following observations, based on these interviews and our own experiences, about what it takes to succeed in this dynamic market.

Know Your Consumers

Vietnamese consumers want the same things others do–good, reliable products that enhance their daily lives. What makes Vietnam distinctive, though, is how quickly consumers are moving up the ladder–”leapfrogging,” in the words of Unilever Vietnam’s chairman, Marijn van Tiggelen. In personal care, for example, increasing numbers of people are buying more sophisticated products. Urban Vietnamese women aged 20 to 45, for example, spend 18% of their monthly income on apparel, according to the General Statistics Office of Vietnam. The Vietnam Ministry of Industry and Trade forecasts that the market for beauty products will grow 15% a year for the foreseeable future. Jean-Yves Romagnani, the chief operating officer of TamSon, a leading luxury-goods distributor in Vietnam, with brands such as Hermès and Kenzo, told us that the market for these products, though small, is growing dramatically.

“Vietnam’s policy is to speed up the process of equitization,” the state’s name for privatizations, said Nguyen Xuan Phuc, chairman of the Government Office, which oversees implementation of state plans. “The Vinashin case won’t slow the equitization program,” he said by phone on Aug. 6. The ex- chairman of Vietnam Shipbuilding Industry Group, known as Vinashin, was arrested last week amid a probe into losses.

Hastening the privatization push may boost management standards at local companies and help the South Asian nation pare a budget deficit that contributed to it being downgraded by Fitch Ratings last month. The government delayed plans to sell stakes in Bank for Investment & Development, Vietnam Airlines and other state-owned companies in the last two years as global stock markets plunged during the worldwide recession.

“Vinashin is a good example of why the equitization process needs to progress more quickly,” said Matt Hildebrandt, a Singapore-based economist at JPMorgan Chase & Co. It will “ensure that credible leaders run and grow Vietnam’s most important companies.”

Vinashin Investigation

Pham Thanh Binh, Vinashin’s ex-chairman, was accused of “intentional violations of state regulations on economic management that have resulted in serious consequences,” according to a statement posted on the government’s website on Aug. 4. He was suspended from Vinashin last month before being detained by an investigation agency under the Ministry of Public Security.

Binh, 57, had run Vinashin since the company’s formation in 1996, holding posts including general director, chairman and secretary of the group’s party unit, according to Thanh Nien newspaper. The government set up Vinashin by combining shipyards and related companies held by the Ministry of Transport, according to the shipbuilder’s website.

Fitch cut Vietnam’s long-term foreign and local-currency ratings by one level to B+ on July 29. That’s four steps below investment grade. The nation’s budget deficit will likely stay at 7.6 percent of gross domestic product this year, the ratings company said.

Smaller Privatizations

Vietnam has focused privatizations this year on smaller companies or units of larger groups. Last week, it raised 129.2 billion dong selling shares in BIDV Insurance Co., an arm of BIDV, the nation’s second-biggest lender by assets. Mekong Housing Bank, a state-owned commercial lender, said last week that it plans to finish its privatization this year.

The government intended to conduct an initial public offering of BIDV as early as 2007. The sale was delayed because of concerns about an oversupply of new shares and then because of the global financial crisis. Vietnam Airlines’ offering was planned for 2008. No date has been set yet for either sale.

Bao Viet Holdings, Vietnam’s biggest insurer, raised 4.3 trillion dong in an initial public offering in 2007 before listing shares on the exchange in 2009. Joint-Stock Commercial Bank for Foreign Trade of Vietnam and Vietnam Bank for Industry & Trade, the nation’s third-biggest and fourth-biggest bank by assets, also listed shares last year.

The benchmark Vietnam Stock Index, or VN Index, has dropped 4.5 percent this year, compared with a gain of 19 percent for the benchmark index in Thailand and of 21 percent in Indonesia. The MSCI Emerging Markets Index, which tracks 756 companies worldwide, has climbed 2.4 percent.

EVN, PetroVietnam

The government should prioritize selling stakes in some of the largest companies still fully under state control including the nation’s biggest power company, Electricity of Vietnam, or EVN, and oil producer Vietnam Oil & Gas Group, said Matthias Duehn, Ho Chi Minh City-based executive director of the European Chamber of Commerce in Vietnam, a business group.

“EVN is probably the most urgent one to address because Vietnam is experiencing serious energy problems in the medium- and long-term,” he said. “It is proven by many cases, most recently Vinashin, that state-owned enterprises are often lagging behind in efficiency, funds allocation and corporate governance.”

Vietnam plans to restructure Vinashin, which has already fired about 5,000 workers to cut costs and “was facing the risk of bankruptcy” in June, according to an Aug. 4 government statement. The company should focus on shipbuilding and maintenance, Deputy Prime Minister Nguyen Sinh Hung said last week. The shipyard had invested in projects including shipping, industrial zones and cement-making.

The government will likely save the shipbuilder as it employs skilled workers and generates export earnings, said Lawrence Wolfe, director of business development at DongA Securities Co. in Ho Chi Minh City.

“It’s a company and a group that the government would like to save,” he said. “It would also be an example of the need for equitization.”

Olivier will be speaking on the second day of the conference, which runs from October 27th – 28th at the New World Hotel in Ho Chi Minh City, Vietnam.

The 4th Alternative Investments Vietnam Conference will bring together industry leaders to uncover new investment opportunities and identify proven strategies to maximize investment returns in Vietnam. For more information or to buy tickets for the event go to the Alternative Investments Vietnam website.

More than 700,000 people will join Vietnam’s national workforce every year in the 2010-2015 period, an annual increase of 1.5%, said a recent report from the Institute of Labor Science and Social Affairs.

This makes the country one of the fastest growing labor markets in the Southeast Asia, just behind Indonesia and the Philippines.

The economy is thus under pressure to create jobs, the MoLISA added.

Between 2000 and 2007, agricultural jobs as a proportion of the total dropped from 65% to 52%, with many workers shifting to the industrial and service sectors.

Cheap labor will no longer provide the country a competitive edge when it shifts from a labor-intensive, export-driven economy to a high-tech, capital-intensive one to climb in the global value chain, the ministry admitted.

Vietnam now has more than 47 million people of working age with total workers in the state-owned sector accounting for 9.6%, those in the non-state-run sector 88.8 % and 1.6% in the foreign-invested sector

Shareholders in two funds valued at US$636 million run by Dragon Capital Group Ltd., Vietnam’s second- largest investment firm, on Monday voted down with a large majority a proposal to close them.

At the Vietnam Enterprise Investments Ltd. (VEIL) fund’s annual general meeting (AGM), 83.2 percent of shareholders and proxy voters said the fund should remain open, according to an announcement made by the company to the London stock exchange Monday.

At the AGM of the other fund belonging to the group – the Vietnam Growth Fund Ltd. (VGF), an even greater majority of 89.2 percent opposed a resolution to close the fund, the announcement said.

VR Capital Group Ltd., a Moscow-based hedge fund, had asked for the funds to be liquidated because of under-performance. VEIL recorded a 14 percent fall in returns last year while that of VGF declined 4.9 percent, according to data compiled by Bloomberg.

“The results reflect a clear sentiment that now is not the time to be exiting Vietnam, given strong market fundamentals combined with low equity valuations,” Dominic Scriven, Ho Chi Minh City-based chief executive officer of Dragon Capital, said in a statement.

The quality of macro-economic management has been improving, and the economy is expected to expand by 6.5 percent this year, the statement said.

VGF chairman Marc Faber said he was pleased with the confidence shareholders expressed “in the prospects for both Vietnam and the fund by voting overwhelmingly to continue.

“It’s clear that if there isn’t absolute transparency in the underlying holdings in a portfolio, then shareholders feel less comfortable with it,” Scriven said in an interview with Bloomberg. “We’ve spent the last year exiting the private-equity holdings that we had.”

VEIL’s low returns were partly because it is a closed-end fund, which means new shares aren’t usually issued once it is set up, and partly due to Dragon Capital’s investment in a mining venture, VR Capital president Richard Deitz said before the vote was taken.

Fund regulations

“I believe that the majority of shareholders (including many who did not support the winding up) would like to see the funds open-ended,” Deitz said by e-mail after the meetings. Without converting the funds to an open-ended structure, Dragon Capital “will not be able to raise any fresh capital to grow their business,” he said.

The State Securities Commission of Vietnam, the market regulator, is working on rules that may allow for open-ended funds, which typically allow new shares to be created and for redemptions to take place.

Dragon Capital is constitutionally required to hold a vote on closing the funds, and 75 percent of participants would have had to have supported the resolution for it to pass, Scriven said. “We had the biggest turnout that we’ve ever had (at such a meeting)”, he said.

The results have eased pressure on the market, which has been depressed since the proposal to close the funds was announced, said stock investor Nguyen Thi Ai Van.

Blue-chip stocks

Incorporated in the Cayman Islands and listed on the Irish Stock Exchange, VEIL, launched in 1995, is now the largest dedicated offshore listed Vietnam fund to invest in publicly or privately issued securities. VGF, introduced in 2004, has its investment mandate in listed and listable securities.

The $409 million strong VEIL’s biggest holding, as of May 27, was in Asia Commercial Bank, Vietnam’s third-largest listed bank. On the same date, the VGF’s largest investment was in Vietnam Dairy Products Joint-Stock Co., the nation’s second largest company. The fund is valued at $227 million, according to data compiled by Bloomberg.

Vietnam-focused funds need to build a track record and report good returns before they can attract investors, said Kelvin Chan, Singapore-based senior vice president of Partners Group, which invests in private-equity and hedge funds.

“There are a couple of cases of reported investments that made good returns, but on the whole there are not a lot,” Chan said. “Compared with other opportunities in more established markets in Asia like Korea and Australia, or even in Southeast Asia, investors don’t need to go to new frontier markets to take those type of risks.”

Dragon Capital in March 2007 paid an initial $225 million for a stake in Tiberon Minerals Ltd., a tungsten mining venture in northern Vietnam. The Ho Chi Minh City-based investment firm sold that holding in April to Masan Group Corp. for about $130 million.

“The key to our outlook on Vietnam has always been that the most predictable earnings exist in sectors related to the domestic economy, with businesses that we can understand, and with management that we can relate to,” Scriven said. “The question going forward is how we can have not just blue-chips in the portfolios, but how to find companies that are going to be blue-chips in the future.”

Other investment firms have wound up funds in Vietnam in recent years. Indochina Capital Advisors Ltd. last year decided to liquidate a London-listed Vietnam equity fund that had lost 50 percent of its value. In November, San Francisco-based hedge fund company Passport Capital LLC demanded the return of uninvested cash from a JSM Indochina fund that bought Vietnamese and Cambodian property.

The World Bank has approved four credits totaling US$456.5 million to help Vietnam’s transition to a middle-income country.
The bank said in a statement Thursday that with the latest credits, total World Bank lending to Vietnam this fiscal year has reached a record of $2.13 billion. The bank’s fiscal year ends on June 30.

The credits are all provided by the International Development Association, a World Bank arm that helps reduce poverty in poor countries.

One of the four approved credits – the Vietnam New Model Universities Project – aims to set up and pilot a new policy framework for the governance, financing and quality assurance of a new model university. “This will help Vietnam develop a model for a higher education system that is innovative and of high quality as well as geared towards developing marketable skills for young people entering the labor market,” the bank said.

Other credits will be used to assist reforms needed to transform Vietnam from a transition economy to a middle-income country, to help the country plan and prepare public investments efficiently, and to improve efficiency of the transmission system as well as rural energy access.

Vietnam’s annual GDP growth accelerated in the second quarter to between 6.2 percent and 6.4 percent from 5.83 percent in the first quarter, a government report estimated on Thursday.
The pick-up helped boost first-half GDP growth to between 6 percent and 6.1 percent over a year earlier, a Planning and Investment Ministry report said.

“The economy continued to recover relatively swiftly in the first six months of the year, with all sectors and fields reaching a higher growth rate than the same period last year”, the report seen by Reuters said.

Prime Minister Nguyen Tan Dung said on June 6 the economy was expected to grow between 6.5 percent and 7 percent this year, after expanding 5.32 percent in 2009. The government has targeted 2011 growth of between 7 percent and 7.5 percent next year.

Inflation slows

Inflation slowed for a third month in June as food prices eased, giving the government room to keep prodding banks to reduce borrowing costs.

Consumer prices rose 8.69 percent from a year earlier, after inflation exceeded 9 percent in each of the previous three months, according to figures from the General Statistics Office in Hanoi on Thursday. Prices rose 0.22 percent in June from May.

“The government must be relieved that inflation seems to be coming under control,” said Ayumi Konishi, the Hanoi-based Vietnam country director for the Asian Development Bank. “Food prices have been coming down and the relatively stable foreign-exchange environment must also be contributing to this.”

Prices in the category including rice dropped 0.83 percent from a month earlier, according to the figures.

New pledges for foreign direct investment into Vietnam rose 43 percent to US$7.9 billion in the January-to-June period from the same period last year, newswire VnEconomy reported, citing information from the Foreign Investment Agency.

Disbursed foreign investment in the period increased 6 percent to $5.4 billion, according to the report.

Olivier will be speaking on the second day of the conference, which runs from June 8th – 9th at the Park Hyatt Hotel in Ho Chi Minh City, Vietnam.

The Vietnam Investment Summit brings together industry leaders from Vietnam and throughout the region. For more information see the conference website or the Vietnam Investment Summit 2010 Brochure.

Q. What is your biggest challenge this year and how are you meeting it?

A. The changing global and regional landscape for property investors highlighted by the increased participation of domestic players in the Vietnamese property market. The local market is transforming as the increased presence of local developers, investors and retail buyers is taking significant market share from foreign competitors. By bringing international expertise to cater to the growing local demand we can offer a unique product in the Vietnamese market.

Q. What do you see as the biggest opportunity on the horizon?

The Vietnamese population is projected to grow by more than 30 million to 120 million before 2030. The population growth coupled with growing levels of personal wealth means that demand for the already supply constrained middle-income residential housing segment will continue to grow. For similar reasons, private equity investments, healthcare and education are also extremely attractive.

Q. To what extent do you think regional and international confidence is returning to the real estate market?

Over the last 18 months appetite for Vietnam has steadily increased although it has not reached the levels seen at the peak in 2007. Vietnam has had one of the better performing economies throughout Asia and the world, both before and after the credit crisis. Local developers have started moving forward with more and more projects throughout the country signaling that internal confidence of the recovery is underway. For international investors Vietnam provides an exciting alternative to adding additional exposure in China or India.

Q. Where in Asia would you invest $100m tomorrow?

In Vietnam of course! I would allocate the money to a portfolio of residential developments and private equity investments. The residential would be comprised of 10 – 20 middle-income projects in Southern Vietnam with a 3 – 5 year return horizon. The private equity investments would focus on healthcare and education as well as select infrastructure projects with a 5 – 10 year return horizon.

For better or for worse, Marinduque, Phu Quoc, Hainan and the Ho Tram Strip are being touted by developers and local governments as Asia’s next major tourist destinations. Here’s why

Marinduque, Phillippines

The lowdown: Pristine beaches, diving sites, a balmy climate. Marinduque has all the postcard charms of other Filipino hotspots such as Boracay and Tagaytay, but none of their tired tourist crowds.

The volcanic island of Marinduque is just a 45-minute flight from bustling Manila, but manages to elude the capital’s frenetic pace. There’s nary a nightclub or souvenir shack in sight. It has a generous sprinkling of hot springs and white sandy beaches, notably the sulphuric hot springs of Malbog, and Poctoy’s White Beach, which doubles as a community hangout. The uninhabited Tres Reyes Islands off the Gasan coast ranks among Marinduque’s best diving sites with azure waters, profuse corals and an underwater cave.

Come Holy Week, which is a week before Easter, Marinduqueños cover up with gaudy masks to make like Roman soldiers during the crucifixion of Christ for the famous Moriones Festival.

Why it’s next: For years, Marinduque has been under the foreign tripper’s radar, but not for long, if politicos and developers have their way. The laid-back island-province is now being touted as the Philippines’ next holiday haven, with the Bellarocca luxury resort set up last year, and new domestic flights on Zest Air and SEAIR connecting it to Manila.

Luzon officials are also on a crusade to raise the area’s public profile.

Ilocos Norte representative Ferdinand Marcos Jr. said earlier this month that “once the Marinduque air and sea ports are modernized, larger volume of local and foreign tourists can be lured to visit its little-known but awesome white sand beaches.” Marcos is also advocating the redevelopment of the abandoned Marcopper mining site into a 18-hole golf course and a hospital complex, to boost medical tourism.

Phu Quoc, Vietnam

The lowdown: The sprawling, tear-shaped island of Phu Quoc is being fashioned as the next Phuket, and with good reason. Not only does the southern Vietnam island have the routine beaches and diving spots, it’s also got a distinct regional character — the locals there produce the best fish sauce in the country and it’s lined with pearl farms.

To check out the renowned fish sauce factories and the night market scene, head down to Duong Dong town. The Ham Ninh fishing village is a picturesque alcove with kaleidoscopic boats at bay, while the Phu Quoc Pearl Farm down at Long Beach has a systematic pearl store with English signboards.

The palm-fringed strip of Long Beach is lined with spotless sandy bays and the An Thoi archipelago is a favorite among divers for its magnificent reefs.

When on the island, keep an eye out for the bizarre Mohawk-sporting dogs running around the island. The Phu Quoc ridgeback dog is native to the island and stands out for the ridge-like whorl running down its back, and its speckled tongue.

Why it’s next: It’s already a favorite domestic holiday destination among the Vietnamese, and the government is working furiously to flesh out the island’s tourist potential. In 2008, the Kien Giang province licensed out 21 infrastructural projects worth US$1.7 billion for the island, mostly for resorts along the coast. The island’s Duong To International Airport, worth VND16 trillion (around US$910 million) and with a capacity of three million passengers per year, is set to be completed in 2012, reports the Saigon Times Daily. Head down quickly if you want to see the retreat as it is, before the sun-tanning masses take over.

Hainan Island, China

The lowdown: Strictly speaking, to say that Hainan Island is one of tomorrow’s tourist hotspots doesn’t quite cut it. The temperate island attracted 20.6 million tourists in 2008, according to official statistics. Property prices and hotel rents have gone through the roof, and it’s already attaining the unsavory reputation of being a Chinese mass tourism locus.

But despite the rubberneck surge, the ‘Chinese Hawaii’ is still mostly overlooked by foreign travelers, with non-mainland Chinese tourists adding up to a pitiful 8.5 percent of the total in the boom city of Sanya, the South China Morning Post reports.

Perhaps foreign visitors are not giving the island its due. Hainan is China’s only tropical beach destination, and its 1,500km of sandy coastline and budding surf culture makes it a reprieve from garish city lights of the Chinese mainland.

It also has its share of unprocessed charm. For two millenniums Hainan was where subversive officials were exiled to, so it’s littered with historically significant sites, such as Temple of Five Lords (a memorial to, you guessed it, five shunned bureaucrats) and the Tomb of Hai Rui. The island has tens of thousands of hectares of primitive forests and homes the Li and Miao ethnic groups.

The poetically-named Tianya Haijiao, or “Edge of the Sky, Rim of the Sea,” is a beach so scenic it’s depicted on the two-dollar Yuan note.

Why it’s next: Earlier this year, Beijing announced its intentions for Hainan to become an international holiday destination by 2020. The official approval only sweetens the deal for Chinese and foreign developers, who had been eying the island as a goldmine for years. High end hotel operators such as Mandarin, Banyan Tree and Sheraton have already moved in, and Mission Hills recently unveiled a 22-course golf resort in the city of Haikou.

And the momentum is just starting. A space theme park that’s supposed to rival Disneyland is slated to open in three to four years, and duty-free shopping and tax-refund measures are on the cards. And although authorities dismissed old speculations of Hainan becoming the mainland’s first casino hub, provincial governor Luo Baoming said the island may be offering experimental sport lotteries in the future.

Ho Tram Strip, Vietnam

The lowdown: Unspoiled beaches in Asia probably won’t stay unspoiled for long. And if the examples above aren’t convincing enough, there’s always the idyllic beach town of Ho Tram in Vietnam to drive the point home.

Ho Tram sits 127 kilometres southeast of Ho Chi Minh City and has a 2.2 km stretch of coastline leading out to the South China Sea. Tourist exploitation is minimal — most vacationers stay at the quaint Ho Tram Beach Resort & Spa.

Why it’s next: It’s poised to become the next Asian Vegas following the success of Macau. The communist Vietnamese government issued its one and only gaming license to Canadian developer Asian Coast Development, and since then they’ve renamed their 169 hectare property Ho Tram Strip, and promised five Vegas-style casinos-resorts in a US$4.2 billion investment.

The first operator to sign on is MGM Mirage, who will be rolling out the first phase of the five-star, 1,114-room MGM Grand Ho Tram by 2012. When completed, MGM Grand Ho Tram will have 90 live table games and 1,000 electronic games, and will be flanked by an 18-hole, Greg Norman-designed championship golf course. The entire Ho Tram Strip is projected to be completely developed in ten year’s time.