Understanding the growth opportunity for today’s top emerging-market companies
- Favorable demographics, rapid technological innovation, and progressive economic reform have offered unique equity investment opportunities in a select group of leading emerging-market (EM) companies.
- Many of these companies possess nuanced local understanding of these trends, leading to sustainable competitive advantages within their domestic markets in the face of competition from regional and multinational players.
- Developments in wireless technology and in fintech applications, such as mobile payments, support a wealth of growth opportunities within EM for select domestic companies.
Investors in today’s emerging markets (EM) face a host of risks, ranging from rising trade tensions to cyclical challenges stemming from the prospect of any slowdown in the global economy. Against this difficult backdrop, however, a number of powerful fundamental trends are converging to create a potent set of dynamics that could continue to define medium-term opportunities within EM equities. An understanding of these trends is critical in identifying those companies that we believe may succeed in becoming tomorrow’s domestically grown stars across EM broadly.
The intersection of favorable demographics, rapid technological innovation, and progressive economic reform with the scale of EM creates a unique environment. Which critical factors should be considered to help identify the EM companies that are best positioned to exploit these dynamics? How are these companies strategically positioned to take advantage of these opportunities profitably and sustainably? What differentiates their competitive positioning and creates the potential to generate persistent superior returns?
In addressing these questions, we describe the structural trends that define the framework for the global EM equity market, show how these trends influence investment decisions, and explore elements of the trends that could reshape the investment landscape for a range of EM companies, using financial technology—or fintech—as a case study.
Favorable demographics and the emerging-market growth opportunity
The broader context of demographic trends in EM is well known. The most powerful among them is the growth of middle-class and related consumer disposable income, with the 12 largest emerging economies expected to account for as much as 33% of global consumer spending by 2030.¹ Understanding the nuances of these trends as they evolve is vital in anticipating how they may influence the underlying investment case for individual companies.
For example, it’s widely understood that China is an aging society. Less recognized is the significant size both of its millennial population and female labor market participation, all contributing to shrinking household size. These characteristics result in incremental spending power—both in the hands of empty nesters as their one child grows up and of a generation of young affluent adults.
On the one hand, lengthening life expectancy for China’s growing “silver generation” exerts pressure on this cohort of aging citizens to ensure they don’t outlive their savings as state support diminishes—a new dynamic of self-reliance that gives rise to increased individual retirement savings and growing needs for insurance protection and healthcare. (It’s notable that healthcare spending in China makes up a mere 5.5% share of GDP, compared with 17.2% in the United States.²)
"Just as members of the post-war baby boom generation in the United States and Europe powered economic activity as they entered their prime earning years, today’s younger generations will drive consumption patterns in China and elsewhere in EM."
However, China’s consumption patterns are evolving most rapidly among the generations born after 1980. Just as members of the post-war baby boom generation in the United States and Europe powered economic activity as they entered their prime earning years, today’s younger generations will drive consumption patterns in China and elsewhere in EM. These young people are predominantly urban dwellers and technology literate, having grown up with smartphones and always-accessible data. In China, younger generations are relatively optimistic, having entered adulthood on a reasonably secure footing as financial beneficiaries of the government’s former one-child policy. With increasing discretionary income comes the propensity to trade up—to buy better-quality food and fashion, spend more on lifestyle and experiences, and invest in property and savings products, even while China’s official GDP growth rate may be slowing.
As these demographics play out and reshape patterns of consumer behavior, it’s important for investors to understand the defining characteristics of the businesses—which may be domestic, regional, or multinational—that appear most likely to compete successfully. Leading EM regional companies as well as multinational corporations are naturally attracted by the large scale of EM growth opportunities, but face challenges from locally established names, which may enjoy an edge in terms of domestic distribution networks, brand recognition, and on-the-ground knowledge of their domestic markets— advantages that may create effective barriers to entry.
By way of illustration, sportswear giants Nike and adidas compete with dominant domestic brands such as Anta and Li-Ning in China. Cosmetics brand Whoo, owned by South Korean consumer goods company LG Household & Health Care, has enjoyed considerable success in its home market and has extended its reach to China. The opportunity for China Resources Beer lies in its ability to develop premium brands that compete with major international brands by exploiting the advantage of the company’s knowledge of local consumer tastes and its extensive distribution network.
An understanding of how consumers spend is also critical. Consumer technology has become a powerful catalyst as the exponential growth of e-commerce gives rise to the ability to supply and monetize previously untapped consumer demand. These developments have opened tremendous opportunities for internet service companies, payment processors, and technology platforms, as well as created the potential for consolidation across highly fragmented markets.
Transformative technology as a catalyst
Asia has long been the manufacturing base for the world’s high-tech equipment, with smartphones and other electronic devices relying on a complex supply chain that spans China, South Korea, and Taiwan. Notably, ongoing investment in research and development has generated significant intellectual property, which is enabling companies involved to capture an increasing share of overall value.
A standard bearer for this trend is Taiwan Semiconductor Manufacturing Company (TSMC), a semiconductor foundry that makes chips for companies that lack semiconductor manufacturing facilities of their own. TSMC produces the application processors for Apple’s iPhones, AMD’s server chips, and many other high-end electronic devices. While Intel has long held a technology lead in this space, recent difficulties at Intel have enabled TSMC to take a leading position at the most advanced node of semiconductor manufacturing. South Korea’s Samsung also has capabilities on par with those of Intel and TSMC.
Asia’s rise up the technology curve is also reflected in key patents for next-generation 5G wireless technology, which holds the promise of radically changing how people, businesses, and devices connect. Chinese companies had applied for 34% of the world’s major 5G patents as of March 2019, compared with South Korea’s 25% and 14% apiece for the United States and Finland.³ Versus 4G standards, China and South Korea have notably improved their positions, while the United States and Japan have fallen behind.
Emerging-market companies are leaders in 5G intellectual property
Top 10 companies ranked by number of standard-essential patent filings in 5G wireless technology, as of April 2019
These patent positions give Asian companies a seat at the table to decide 5G standards, putting them in prime position to benefit as 5G begins to be rolled out across a range of applications. Initially, 5G will offer much faster smartphone speeds and a cost-effective alternative to fiber broadband in some rural areas. In the more distant future, 5G may be adopted for machine-to-machine communications such as automotive applications, where cars will connect to other vehicles and allow better traffic control. 5G is also expected to be used in the Internet of Things to connect machines on smart factory floors and transmit data to the cloud for analysis.
EM companies that are becoming globally competitive technology leaders range from large companies with deep financial resources and activities straddling a host of 5G applications to smaller firms that have carved attractive positions in the value chain. On the large corporate side, Samsung has a strong 5G patent position that creates advantages for its smartphone business; its memory division could see increased demand for its products as a result of the vast amounts of data generated by 5G-connected sensors. Another example is MediaTek, a Taiwanese company that was late with 3G/4G smartphone baseband chips but has significantly closed the technology gap with market leader Qualcomm and is in a better position as 5G is implemented. Lesser in size, LandMark Optoelectronics has established a niche position in semiconductor lasers, which will be essential in both 5G backhaul and data center communications.
Case study: fintech and the emerging-market growth opportunity
Innovation has powered the financial services sector across the developed world for many years and is now rapidly gaining traction across EM. The ability to process information seamlessly is reducing administrative costs, and specialist services and products that were previously available only to a limited number of customers through narrow distribution channels are becoming commonplace and widely accessible. Financial inclusion of segments of society that previously had little access to banking and other financial services has become a powerful economic and social phenomenon.
Companies leading the adoption of fintech and the provision of new products range from traditional but innovative banks and insurance companies to new sources of competitive disruption such as social media companies, telecom operators, and e-commerce businesses. The related ecosystem has further driven growth and profitability for specialist software and hardware providers, including manufacturers of smartphones, PCs, and servers. Early adopters of fintech include companies as diverse as Apple, provider of the Apple Pay payments platform, and Safaricom, a Kenyan company that provides a mobile money transfer service called M-Pesa. Other payment platforms include Alibaba’s Alipay and TenCent’s WeChat, which dominate online payments in China.
These new players in the payments industry have managed to break into and disrupt a marketplace previously controlled by slow-moving financial incumbents. Their success can be attributed to the confluence of demographic change, economic reform, and the accessibility of leading technological advances, allied with corporate commitments and strategic vision.
"Financial inclusion of segments of society that previously had little access to banking and other financial services has become a powerful economic and social phenomenon."
The example of Network International illustrates the potential. The relatively young United Arab Emirates-based company has grown over the last 20 years into the leading enabler of digital commerce across the Middle East and Africa (MEA), which remains the world’s most underpenetrated payments markets.⁴ Digital payments technology is established both in developed markets and faster-growing economies, providing a blueprint for the untapped MEA region, where Network International is the only pan-regional provider of payment solutions with scale across the entire payments value chain.
Network International’s experience with leading payment solution companies in North America and Europe means that its senior management team has a deep understanding of the application of technology as cash-based societies transition to digital solutions.⁴ These capabilities reduce the cost of doing business and provide the opportunity for rapidly developing economies to innovate by offering services previously unavailable to small businesses and individuals.
Most of the 1.5 billion population of MEA still prefers to use cash to settle transactions; across the region, it’s estimated that 85% of all transactions is based on notes and coins, compared with rates of 20% and 30% in the United States and the United Kingdom, respectively.⁴
Cash on delivery remains the primary settlement practice for e-commerce—as it was in China until five years ago—which partially explains the relatively slow adoption of digital payments across many of the economies of MEA. Savings associated with improved market knowledge and logistics costs are evident in many other developing regions, but have yet to materialize significantly in MEA.
We believe that the scale of Network International’s reach across MEA, combined with the first-mover advantage that the company enjoys in the region, places it in a leading position as business practices change and digital payments become the norm, as has occurred elsewhere in EM.
Where cash is still king: the Middle East-Africa (MEA) region is still underpenetrated when it comes to payment cards
Payment cards per adult, by region, and a sampling of countries
Source: Edgar, Dunn & Company, September 2018.
With the largest footprint across MEA and a customer base of over 65,000 merchants and 220 financial institutions, Network International has seen transactions and volumes compound at annual rates in excess of 30% and 15%, respectively, over the last 10 years.⁴ These trends appear likely to continue as important initiatives take hold, often driven by governments keen to capture tax revenue or distribute subsidies efficiently, or by local financial institutions seeking to lower costs and provide new services.
Partnerships with governments and central banks play an important role. In Egypt, for example, the company launched such a platform in 2017, and it now enables 40 million Egyptians to receive payments and subsidies electronically.⁴ The success of this relationship may, in turn, pave the way for commercial opportunities, as has been the case for Network International in the United Arab Emirates and Jordan.
On the commercial front, there’s room for considerable consolidation, as the limited digital payment solutions currently available are largely insourced by local banks. As a result, digital payment solutions in MEA have historically yielded little in the way of savings from economies of scale, with operators having to bear potentially large information technology costs. In contrast, the shift to outsourcing is almost complete in developed markets, with few major financial institutions remaining active in the payment solutions space.
Network International appears to have key elements in place to exploit a nascent growth opportunity. Experienced management and state-of-the-art systems are essential to operate in an underdeveloped growth region with material barriers to entry for potential rivals. The backing of major international private equity firms and local partners provides critical funding resources; at the time of the company’s initial public offering in the spring of 2019, the U.S.-based payments company Mastercard invested $300 million for a nearly 10% equity stake.⁴
1 “The New Global Middle Class: A Cross-Over from West to East,” The Brookings Institution, 2010. 2 China figure: World Health Organization Global Health Expenditure Database, May 2019; U.S. figure: “Spending on Health: Latest Trends,” Organisation for Economic Co-operation and Development, June 2018. 3 IPlytics, May 2019. 4 Network International initial public offering prospectus, April 1, 2019.
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