Bargains On The Baghdad Exchange

Courtesy of Barrons, an interesting article on why Geoff Batt and Grant Felgenhauer of the Euphrates Iraq Fund, the country’s largest non-Iraqi investors, like Bank of Baghdad, Al-Mamoura Real Estate, and Pepsi distributor Baghdad Soft Drinks, the country’s largest soft drink provider with 80% of the market:

Americans sacrificed lives and billions of dollars in Iraq. Geoffrey Batt, 35, is optimistic that those sacrifices weren’t in vain. In 2010, the investor started what is now the largest U.S.-managed hedge fund devoted to that recovering nation. Since inception, the $62 million Euphrates Iraq fund has returned about 30%, as the Iraqi people build a modern economy underwritten by record levels of oil production. Joined by his partner Grant Felgenhauer, 39, Batt told us why Iraq’s little stock market may be poised for a rally reminiscent of postwar Germany, 1990s Russia, Hong Kong, or South Korea.

Barron’s: How did you wind up in Iraq, Geoff ?

Batt: I didn’t know the distinction between a stock and a bond when I was an undergrad. My intention was to pursue a Ph.D. in philosophy and become a college professor. But junior year, I took a graduate seminar, and there was a third-year Ph.D. student who was the smartest guy in the class. He also looked like he may have routinely slept in his clothes. We would go to lunch after class and talk about philosophy and current events. After knowing him for a year, I told him that I had to leave school because I couldn’t afford to pay the following year’s tuition.

And he said, “Maybe I can help you.”

“Before I decided to pursue a Ph.D.,” he told me, “I created the first fund to invest in post-Soviet Russia, called Firebird. That’s how I made my fortune. I’m starting a new venture that will focus on Asia, ex-Japan. Why don’t you come work for me for a year and learn how the world works? The last thing we need is another philosopher who doesn’t know anything about the real world. If we do well, I’ll pay you a bonus that will cover your tuition.”

Who was this guy?

Batt: Daniel Cloud. If you could only see this guy telling you that he’d created the first fund to invest in Russia — I mean he looked, on certain days, like maybe he actually slept outside. It didn’t fit my conception of what a wealthy person looked like. I left the conversation a little scared. But I looked him up on Google, and sure enough, everything he’d said was true. There was a story and pictures of him and Firebird’s other founding partner in Barron’s in the mid-’90s.

Was he better dressed for Barron’s?

Batt: Oh yeah, he was in a suit and a tie. He cleans up well.

I was intrigued. I talked to my parents, and they said, “We think you’re nuts, but you can do what you want.” So I worked for Dan for a year. We focused on East Asian emerging markets like Thailand, Taiwan, Indonesia. They did very well that year. I got my bonus, and it paid my tuition.

Actually, I had money left over to invest. I went back to school and would sit in the lecture hall with my laptop reading 10-Qs and 10-Ks, rather than listening to the teacher. My heart simply wasn’t in it anymore. After a semester, I decided to go part-time so that I could focus more on markets. Eventually, I just dropped out, two classes short of graduation. Chalk it up to Latin. I just couldn’t pass Latin, no matter how I tried. In retrospect, a foolish decision. Maybe I was a bit mad myself.

Then I started looking for the next Russia, the next historic equity “rerating.” And I was a bit despondent because in the summer of 2007 just about everything that you can think of was in a bull market. Emerging markets were very fashionable. Commodities were in a fifth or sixth year of a big bull market. Even currencies had spectacular moves.

“Rerating” means what?

Batt: Think of a rerating as earnings growth and multiple expansion at the same time. You get this compounding effect.

Grant Felgenhauer: Successful reratings have three characteristics: No. 1, stable currency and prices; No. 2, the ability for the economy to grow into something significant; and No. 3, very low valuations.

Batt: In the summer of 2007, I happened to come across an article about how Iraq was increasing its oil production. I thought to myself this is a strange thing. All I knew was what I read in the newspapers or saw on television. I’d thought Iraq was a failed state, fighting a civil war. How on earth did a failed state increase oil production?

This was the sort of thing Dan taught me to look for — a very wide gap between perception and reality. The wider the gap, the bigger the opportunity to make money. So I looked more closely and saw that it wasn’t just oil that was increasing. Deposits in the banking sector had started to rise rapidly; electricity generation was rising. Their currency was stable. Violence from terrorism — which was around 4,000 fatalities a month at its peak in 2006 — had dropped to about 1,000 a month, down about 75%.

I went to the stock exchange Website in December 2007, got all the brokers’ addresses, and e-mailed everyone. Something like five responded…two in English…one in coherent English. I went with that guy. Opened an account, wired some $2,000, bought a stock, sold it the next day, and wired the money back to my bank in New York — all to see if I could get the money out.

There was no problem, and I just went from there. I told Dan about it, and he said something like, “You’ve come to me with 100 ideas, and 99 of them have been either average or bad. But I know this one is really good, because the very first thing I thought was, How can I steal it from you?”

Come 2010, I told Dan that there could be demand for a hedge fund, but none existed. We launched Euphrates with $5 million of our own money, in October. We didn’t start taking outside investment until late December 2010, after I published an article about Iraq in the Gloom, Boom & Doom Report.

The newsletter published by Barron’s Roundtable member Marc Faber.

Batt: Yes. He became an investor in our fund. A lot of high net-worth individuals read his newsletter. We went from $5 million to $27 million pretty quickly. That’s when I brought Grant in. Once Grant came on board, we really started to grow. Now we are up to $68 million, including managed accounts.

Where’d he find you, Grant ?

Felgenhauer: I started my career thinking that I would spend the rest of my life working in post-Soviet Russia. I made my first trip there during high school in 1991 and continued to go back every year during college. In 2004, I joined a firm called Hermitage Capital, which was the largest portfolio investor in the Russian equity market. I came to Hermitage because its manager Bill Browder had invested successfully in the treacherous operating environment of Moscow. Russia had been experiencing one of these historic equity reratings that happen once in a generation. Hermitage moved to London in 2007 and launched a global fund focused on frontier and emerging markets. We looked at Iraq, and in the course of that work, I met Geoff. When he described what was happening on the ground in Iraq, it sounded like Moscow in 1994-95. I invested in his fund individually, in the summer of 2011. Then I joined Euphrates in April 2012.

So how’s Baghdad these days?

Batt: It’s surprisingly normal, though all you see on TV are bullets and bomb blasts.

So it’s not like The Hurt Locker?

Batt: Nothing like that. The violence in Iraq is high-profile violence, sure, because there are bombs going off. But it’s concentrated in a few areas in the west and the north: some parts of Baghdad, but mostly places like Fallujah, Mosel, Kirkuk, Tikrit. Yet most of the oil is in the south, and that’s where it’s actually safest. In the main business district of Baghdad, you can walk around at night, window shop, and go to restaurants. You look out your hotel room window and see two guys playing tennis in the middle of the afternoon, other guys jogging down the street, kids playing in a playground.

Felgenhauer: Rising GDP per capita is going to overwhelm any kind of divide between the people, sectarian or otherwise. It also means that the guys setting off bombs have no following. Iraq has a terrorism problem now, not a civil-war problem.

Are there other foreign investors like yourselves in Iraq now?

Batt: In 2008, I was one of three or four people in the West investing more than a million dollars in the Iraqi stock market. There are a few more now.

Felgenhauer: The stock exchange keeps track of Iraqi trading and non-Iraqi trading. Non-Iraqis rarely reach 20% of daily turnover, and often much lower than that. If you consider non-Arab foreigners, it is basically us and a few other funds, none of which is larger than $30 million. That will change.

How big is the Baghdad market?

Batt: When I first invested in 2008, the exchange had a market cap of $1.8 billion, smaller than the Palestinian Stock Exchange. By 2013, it had a $5 billion market cap. Mid-February, it was $10 billion, because of a $5 billion IPO — the largest in the Middle East in five years, a mobile telecommunications operator called Asiacell [ticker: TASC.Iraq].You will have another $5 billion telecom IPO late this year or early next year.

OK. What’s in your portfolio?

Batt: A key difference between the Iraqi stock market and Russia is that in Russia you were investing directly in Lukoil or Gazprom. In Iraq, oil is state-owned.

Felgenhauer: A good analogy is Saudi Arabia. As an equity investor in Saudi Arabia, you never own a piece of Aramco. But you can own everything that benefits from the liquidity provided by Aramco.

So banks are about 45% of our portfolio, real estate is just over a quarter, consumer goods is about the same, and the rest is logistics, trucking, hotels.

Batt: We think of a bank as a leveraged investment on the growth of a country, particularly when a country goes from not having a banking system to having a banking system. The banks can go from being very, very tiny to colossal in a relatively short period of time, short being defined as 15 years. They can go from having $300 million to $40 billion to $50 billion in assets.


Company Ticker Price
Bank of Baghdad BBOB 1.97*
Baghdad Soft Drinks IBSD 2.36
Al-Mamoura Real Estate SMRI 3.75
Companies trade on the Iraq Stock Exchange. Prices in Iraqi dinars.
*As of 7/02/13. Source: Bloomberg

Felgenhauer: We own Bank of Baghdad [BBOB.Iraq]. It is Iraq’s No. 2 private bank, by assets, with a market cap of roughly $300 million. It’s inconceivable to me that in 10 years the market cap will be $300 million.

Batt: In Saudi Arabia, over the past 50 years, you’ve had a 114,000% increase in the assets of their banking system. Bank of Baghdad is now about $1.4 billion in assets. You could easily imagine this bank having $15 billion or $20 billion in assets in the next 10 years. Let’s say it has $20 billion in assets and a 2% return on those assets. It would earn $400 million, which is greater than its market cap right now.

We are also investing in consumer products. We own 7.5% of Baghdad Soft Drinks [IBSD.Iraq], which is the Pepsi bottling distribution company for Iraq. Pepsi is the No. 1 soft drink in Iraq, and the company has 80% of Baghdad’s soft-drink market. Iraq is one of the hottest places on earth. We have rising per-capita GDP and a young, rapidly growing population. So it is an ideal environment to be investing in the soft-drink business, particularly one as well managed as this company is.

Felgenhauer: And it is trading at seven-times earnings.

Tell us another of your holdings.

Felgenhauer: We own a real-estate company — Al-Mamoura Real Estate [SMRI.Iraq]. They own the single largest undeveloped plot of land in suburban Baghdad, which is an asset that is going to do great things in this kind of cycle that we are just starting. In the meantime, they just build seven-story apartment buildings over and over again, whose units sell like hot cakes.

What limits Iraq’s capital markets?

Felgenhauer: Illiquidity. The exchange’s daily trading volume is between $2 million and $4 million. You can have some days where you trade $30 million, but it is a small market.

What else is missing?

Batt: Major third-party custodians. Institutional investors invariably bring up custody as their No. 1 concern. Now, custody is via the stock exchange itself. But a large $50 billion regional bank, called National Bank of Kuwait, is thinking about offering custody.

Felgenhauer: Citibank just went into Iraq.

Batt: And JPMorgan announced that they are going back in. Standard Charter is going back in. You can easily imagine third-party custody put into place within a 12-to-18 month period. That could lead to a significant amount of foreign money coming in.

You must be optimists.

Batt: Iraq is a very diverse place. It is arguably the most important place for Shia Islam, but at the same time it is a cosmopolitan and progressive place. You have Sunni and Shia Muslims, Arab Christians, Kurdish Christians, Kurdish Sunnis, Syrians, even Zoroastrians. It’s a melting pot of ethnicities and religions. I met with the CEO of the stock exchange, and one assistant comes into his office dressed in traditional Arab clothing. She won’t even shake your hand. The next assistant comes in, and she’s wearing a black miniskirt with stiletto boots and a lot of makeup. She looks like she could be walking down the street in SoHo. And they are working together. The CEO of the largest bank in Iraq is a woman. Twenty-five percent of parliament is made up of women.

Felgenhauer: What’s happening there is reshaping the Middle East and affecting every neighbor. Saudi Arabia is terrified of Iraq. They see a country that is growing oil production and where a quarter of the parliament are women who can drive and do whatever they want. It scares them to death.

Batt: And they have regular elections.

This entry was posted on Tuesday, July 30th, 2013 at 7:36 pm and is filed under Iraq.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

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