Exotix pushes beyond the wild frontier

WHEN IN PYONGYANG, do as the North Koreans do. For business travellers, this involves the mandatory purchase of a large bunch of flowers on arrival at the airport on the twice-weekly flight from Beijing. It then involves a direct trip from the airport to the city-centre statue of Kim Il Sung, where you are obliged to lay your flowers and bow in deference to the deceased leader.

"Culturally, it is like going back to some strange eastern civilization," says Peter Bartlett (right in picture), managing director of Exotix, and a leading expert on North Korean and Cuban debt.

Exotix certainly lives up to its name. In Cuba and North Korea, two of the world’s last communist outposts, it could hardly have chosen more unusual settings from which to make money on the capital markets. There is only one other brokerage, after all, that deals in North Korean debt.

Exotix has seen immense change since its birth 10 years ago as an in-house subsidiary of London-based interdealer brokers Icap. In 1999, when the firm was registered with the UK Financial Services Authority, emerging markets were still recovering from the Asian and Russian financial crises of 1997 and 1998. "Esoteric markets" could still include such countries as Russia, Ukraine, Kazakhstan, and Thailand. "Exotix’s number one revenue generator used to be distressed debt in Indonesia, Thailand, and southeast Asia, but that has dropped down to a very insignificant percentage," says Bartlett.

Nowadays, even Iraqi debt is proving too mainstream for Exotix’s taste. According to Stuart Culverhouse (left in picture), the firm’s chief economist, Exotix was the main source for information on Iraqi debt after the 2003 invasion, when old letters of credit came back onto the market. Since the issuance of a restructured bond in 2006, however, more of the big investment banks have been trading Iraqi debt, and Exotix, says Culverhouse, "has gradually retreated from the market".

Without even an economic collapse in Argentina to provide the necessary offloads of near-worthless debt, Exotix is being forced to brave ever more uncharted lands to maintain a supply of sufficiently risky assets. Andrew Chappell, a director of Exotix with a background in emerging market debt sales at WestLB, says: "There is very little distressed emerging market debt any more. These days, it’s about frontier markets. It’s about helping fund managers find interesting, different assets, often in fairly new, fairly uncovered countries." If this is the case, it may then have come as no big surprise to Exotix that Standard & Poor’s announced at the beginning of August its first Frontier Equity Market index, covering stocks in countries as diverse as Bangladesh, Cambodia, Ghana, Ivory Coast, Pakistan and Zimbabwe. "Accelerating economic growth, increased government focus on privatizations and heightened IPO activity is luring foreign investors to frontier equity markets," the ratings agency said in the announcement of the index.

Development of a market, development of a company

The increasing stabilization of emerging markets over the past 10 years has gone hand in hand with the evolution and maturation of Exotix as a company. When Exotix was first set up, most of its business consisted of buying troubled debt from principal banks, and selling that on to speculative fund managers and investment banks. As its relationships with the fund managers became more established, however, it began to do less business directly with investment banks, and intermediated between fund managers instead. "We had to prove ourselves. But we also found that the fund managers we deal with have grown as we have grown," says Chappell.

In its new "frontier markets", meanwhile, Exotix is selling more assets from the primary markets, often helping local originators syndicate securities on a global platform. Here, with an access to global markets usually unavailable to local originators in countries with underdeveloped capital markets, Exotix effectively provides the sales force for a local financial institution partner.

"The locals have the best contacts with the borrowers but their distribution may not be up to the job. They may have no idea if there is a market outside their own country," says Chappell. Sometimes, he adds, it is Exotix itself that initiates an offering, by communicating the demand from the fund managers in London or New York to local bankers. "The fund managers tell us they are looking for a particular type of asset. We then act as an intermediary with a local financing firm, giving them feedback as to how a deal should be priced and structured in such a way that it is attractive," he says.

Over the past few years, Exotix has even begun to originate and structure its own deals independently of local arrangers. Since 2003, for example, when the first deal it distributed directly from the issuer took the form of repackaged foreign currency savings bonds from Serbia, Exotix has arranged $15 million of debt with equity warrants for a Turkish olive oil company in 2004. It has also helped a London publishing company issue a securitization of the Cuban non-performing loans it was holding (also in 2004). As Euromoney went to press, the firm was arranging financing for a biodiesel project in Paraguay, a bank in Nigeria, a holiday resort in the Dominican Republic, and a zinc oxide mine in Yemen (see box).

But in the past two years, Exotix’s focus has, more than anything, turned to Africa and, in particular, to equities in sub-Saharan Africa excluding South Africa. With that region accounting for about 5% of global emerging market GDP, and fund managers still spending well below 1% of their emerging market portfolios there, Bartlett thinks investors are still vastly under-exposed to sub-Saharan Africa (excluding South Africa). This is despite the fact that, according to Exotix research, companies there are "almost without exception, profitable, dividend paying, and with strong market positions, and good cashflows".

Bartlett says Exotix has been able to fill in a gap in the market in sub-Saharan African equity brokerage because it was previously difficult to compare the performance and cost of sectors in different countries. "Before we started dealing, the only option was to go to a Nigerian broker for a Nigerian stock, or a Kenyan broker for a Kenyan stock. We realized that our strength could be to provide a one-stop shop, based in London, with offices in New York, with research covering the whole of sub-Saharan Africa," he says.