Profit E-Magazine Issue 76

HOSPITALITY MORE THAN JUST A WORD True hospitality comes from the hea .

From a genuine desire to make sure our guests always feel totally at home.

CONTENTS

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10 News in Numbers 12 AkzoNobel in the mood to buy its way to growth in Pakistan 16 How Pakistani software exporters fared with the rupee

22 22 The bond market is signaling a recovery. But there is still reason to worry 28 Shifa International looks to expand its footprint in Punjab 30 Automotive industry feels the pinch Yousaf Nizami

32 32 Pakistan’s auto industry shows little sign of improvement 36 Can a MiniSo franchise make you a millionaire overnight?

40 How one Pakistani techie helped build a $20 million US-focused startup

welcome

Breathing room to act After months of speculation, at least we know where Pakistan stands: by the skin of our teeth, the country remains connected to the global financial system – for now. The Financial Action Task Force (FATF), the Paris-based global financial watchdog that enforces international standards on countries with respect to cracking down on money laundering, terrorism financing, and corruption, has concluded that Pakistan will remain on what is effectively a “grey list”, since the government and the banks have made the bare minimum amount of progress needed to ensure that the world takes the country’s attempts at reform and cleaning up seriously.

The problem, of course, is that the global body – and by extension, the whole world – can see that Pakistan did the very bare minimum, and hence Pakistan will be evaluated again in February 2020, just four short months away, to ensure that the government has made enough progress on combating terrorism financing. Of the 27 goals that Pakistan was given, the country has made reasonable progress on five, with the remainder at varying levels of completion.

This is the chance for the current administration, led

by Prime Minister Imran Khan, to show that they are serious when it comes to rooting out corruption in Pakistan and restoring global investors’ confidence in the country. Taking action against terrorism financing – which is in our own national interest to begin with – would go a long way towards earning the trust

of the global financial system, which wants to believe in the Pakistan story of growth and economic promise, but is reluctant owing to the government’s failures to implement the necessary controls against terrorism and money laundering, and address rule-oflaw concerns more broadly.

To their credit, the government does appear to grasp the seriousness of the problem, and – barring a few superfluous comments about Indian lobbying notwithstanding – appears to be at least willing to tackle the problem. We do not deny that the Indian Foreign Office has not had the most constructive of perspectives with respect to Pakistan of late, but that should hardly matter to the government: the only reason New Delhi’s lobbying means anything is because Islamabad has left itself vulnerable to attack. Close the loopholes in our laws and their implementation, and we eliminate an unnecessary headache from the financial system and the economy. What do we have to lose?

Farooq Tirmizi Managing Editor

Executive Editor: Babar Nizami l Managing Editor: Farooq Tirmizi l Joint Editor: Yousaf Nizami Reporters: Syeda Masooma l Muhammad Faran Bukhari l Taimoor Hassan l Abdullah Niazi l Ahmed Jamil Bilal Hussain l Director Marketing: Zahid Ali l Regional Heads of Marketing: Muddasir Alam (Khi) l Zulfiqar Butt (Lhr) l Mudassir Iqbal (Isl) l Layout: Rizwan Ahmad l Photographers: Zubair Mehfooz & Imran Gillani l Publishing Editor: Arif Nizami l Business, Economic & Financial news by 'Pakistan Today' Contact: profit@pakistantoday.com.pk

FROM THE MANAGING EDITOR

9

10

Contrary to the myths that may have been taught to most middle-class Pakistanis in either school or by their parents, this graph suggests one clear fact: Pakistan’s economy has not been competitive for over 50 years. While a trade deficit is not, strictly speaking, the sign of an uncompetitive economy, in the case of Pakistan, it reflects a bitter truth: that Pakistan has not invested in creating competitive enough export-oriented industries, which in turn has meant that the country has not been able to export its way into creating a large, robust middle class. Over the past five decades, there has been no period of greater than three months of trade surpluses, and even the surpluses tended to be small, inconsistent ones compared to the much more consistent trade deficits witnessed by the economy, particularly from the latter half of the Musharraf Administration, when the trade deficit just exploded

News IN NUMBERS

11

The graph of FDI into Pakistan shows a clear pattern: investment went up dramatically in the latter half of the Musharraf Administration, before tapering off during the Zardari Administration. It then took off again, albeit to lower heights, during the latter half of the Nawaz Administration, before tapering off again at the beginning of the Imran Khan Administration. The fact that investment usually does not take off in the beginning of any administration leads one to conclude the following: foreign investors still do not trust the institutions of the government of Pakistan and wait a few years to see a specific government’s track record before feeling comfortable enough to take the leap into investing into the country. While that creates opportunities for any incoming government, it does not reflect well on the society as a whole to be seen as so wholly without strong institutions.

News IN NUMBERS

AkzoNobel in the mood to buy its way to growth in Pakistan Nearly seven years after spinning off ICI Pakistan’s industrial chemicals business, AkzoNobel has struggled to grow its business in the country, and may be looking to buy a competitor as a way out of its current rut

By Bilal Hussain

A

kzoNobel Pakistan is stuck in a rut and may be looking to a combination of restructuring and acquisitions as a way to move into highgrowth gear.

The past few years have been challenging for the company, to say the least. Yes, the business is profitable, and still owns brands that command enormous respect in the market for paints, but there is no question that the company has failed to meet the expectations that management set for itself and investors when they first announced the spinoff of ICI Pakistan’s industrial chemicals business in 2012.

AkzoNobel Pakistan’s revenue has risen by a paltry average of 2.8% per year between 2012 and the second quarter of 2019, the latest for which financial statements are available.

Inflation during that time has averaged 6.0% per year, meaning that, in real terms, the company has shrunk its revenues. And that is before we

12

even begin to calculate the decline in revenue that has taken place once one measures revenue in euros, the reporting currency of its Netherlands-based parent company.

Needless to say, such results have not gone unnoticed by AkzoNobel global management. Sources tell Profit that the local workforce has shrunk somewhat at AkzoNobel Pakistan as employees have either been laid off or have left themselves amidst a restructuring exercise that has seen each local business unit become part of global business units rather than one cohesive national entity.

According to one former AkzoNobel employee who wished to remain anonymous to speak candidly, AkzoNobel’s verticals will now be led by their global headquarters typically located in other countries. For instance, metal coating will be led by the team based in the United Arab Emirates (UAE), while the decorative paints business will be led from the Netherlands.

In an interview with Profit, AkzoNobel Pakistan CEO Saad Mahmood Rashid acknowledged that the restructuring was underway,

and that the company has set itself ambitious targets that have resulted both in the creation of new roles as well as the elimination of ‘inefficiencies’.

“In order to ensure that we become the preferred provider in Pakistan’s paints and coatings market, the company is setting transformation targets and investing in people, processes and technologies to steer it forward,” said the CEO. “This has resulted in a few changes including creation of multiple new roles, that would help rebuild a more stable and effective framework to eliminate inefficiencies, in turn driving us forward.”

According to one source familiar with the matter, the restructuring exercise has led to the CEO of the local business entity – the publicly listed AkzoNobel Pakistan Ltd – with a significantly reduced role at the company.

Saad Rashid did not deny those reports in his interview with Profit.

“There are certain verticals and they do report to me but how to go about their specialized vertical comes from their superior from the same vertical or department, who is more

“AkzoNobel globally has always believed in both organic growth as well as through acquisitions. In 2018 alone, we acquired Fabryo in Romania, Xylazel in Spain and Colourland in Malaysia. The regional leadership at AkzoNobel considers Pakistan as a growth market. We continue to focus on organic growth here, while looking for bolt on acquisitions which would complement our portfolio and help us deliver on our strategy” Saad Mahmood Rashid, CEO of AkzoNobel Pakistan knowledgeable in that particular field,” he said.

“It’s a matrix organization.”

The context for the restructuring appears to have been the failed bid by the largest paints and coatings company in the world, the USbased PPG Industries, in early 2017. PPG is the largest paints company in the world and AkzoNobel the second-largest. While the merger failed, it nonetheless had a lasting impact on AkzoNobel.

At a time when PPG made its first bid of €83 per share, AkzoNobel’s shares were trading at approximately €60 a share on the Amsterdam-based Euronext stock exchange.

PPG subsequently raised its bid twice, first to €88.72 and then to €96.75 per share. AkzoNobel’s board rejected the bid on two grounds: the price was too low, and the merger of the largest and second largest paint companies in the world would likely attract significant antitrust regulatory scrutiny that would significantly complicate the benefits of any merger.

Having rejected the bid, however, AkzoNobel’s board was in a bind: they had to prove to their shareholders that they had the ability to create the same value for the company that PPG was offering through its acquisition offer.

“So the AkzoNobel management decided against selling the company to PPG and prom-

ised its shareholders that they will increase the share price to €90 within three years by increasing efficiency,” said Rashid.

“The reason PPG made such an offer was that it assessed some redundancy in the company and it believed that the company was overstaffed. By reducing the workforce etc. after acquisition, the company would then be worth €90 per share. So what PPG was supposed to do after acquisition, Akzo Nobel management started doing by restructuring itself globally.

Pakistan was among some of its markets, which were exposed less to the restructuring. And we actually ended up seeing much lesser downsizing as compared to what happened globally,” said Rashid.

The ICI spin-off

A

kzoNobel’s history in Pakistan starts with its January 2008 global acquisition of the UK-based Imperial Chemical Industries, better known by its acronym, ICI, the legendary industrial giant that was, for decades, the largest manufacturing company in the United Kingdom.

ICI’s history in Pakistan starts even before Partition, in 1944, when it started the production of soda ash, a precursor to several industrial

chemicals, in Khewra, in district Jhelum. Following independence and Partition, ICI incorporated its Pakistan assets under Khewra Soda Ash Company Ltd, set up in 1952. The company was renamed ICI Pakistan in 1966. At least one ICI subsidiary has been listed on the Karachi Stock Exchange since July 1957.

ICI has always grown in Pakistan through a combination of organic growth as well as acquisitions. For instance, in 1965, they acquired the Lahore-based Fuller Paints, which was later renamed Paintex. The company also created Pakistan PTA Ltd in 1998, which was then spun off into a separate entity in 2000.

In 2008, the global parent ICI was bought out by Dutch paints and chemicals giant AkzoNobel, following which ICI Pakistan became part of AkzoNobel worldwide. In 2010, the company made a decision to focus on the paints business, AkzoNobel’s global specialty, and spin off the chemicals business.

The spin-off, labelled a “demerger”, was completed in May 2012, creating two separate companies: AkzoNobel Pakistan and ICI Pakistan, though at the time, both were owned by the global AkzoNobel. The process to find a buyer for ICI Pakistan began in June 2012, and ended with the Yunus Brothers Group – the industrial conglomerate that owns Lucky Cement, Yunus

CHEMICALS

Textiles among others – won the bid to buy out the industrial chemicals business that was the new ICI Pakistan.

Coincidentally, ICI was the result of the 1926 merger of four companies, one of which was Nobel Explosives, which has its origins under Alfred Nobel, the Swedish explosives manufacturer. Another of Nobel’s subsidiaries became one of the component companies of AkzoNobel.

“ICI, ICI Roundel and Dulux are trademarks owned by Akzo Nobel and we still use them in Pakistan, hence retaining the brand equity that has been built over the past decades,” said Rashid. “It has happened globally that when AkzoNobel acquires some brands, it then keeps the paints business and sell the rest of the businesses to local players, like it did with ICI which it sold to Yunus Brothers.”

Buying its way to growth

A

s stated earlier, AkzoNobel Pakistan’s revenue has risen by a paltry average of 2.8% per year between 2012 and the second quarter of 2019. Inflation

14

during that time has averaged 6.0% per year.

And profits have not exactly kept pace, growth at an average of 3.2% per year.

When asked about the company’s performance, Saad Rashid had a somewhat optimistic spin on the matter. “Since the demerger in 2012, Akzo Nobel Pakistan has seen its sales value grow by 22% while its operating income has grown by 111%,” he said, an accurate, if somewhat incomplete way of describing the company’s financial performance.

“The higher change in the operating income as compared to sales revenue was due to the fact when businesses get focused, efficiency increases. Moreover, there were few one-off costs that also later translated into higher operating income,” Rashid explained.

Unlike business houses in Pakistan, which want their hands in every industry and prides in being called ‘conglomerates’ and lacks specialization, AkzoNobel is one of the companies that look to remain specialized in the paints business, he said.

Asked to explain why AkzoNobel’s business has struggled, Saad Rashid deflected and blamed macroeconomic factors, even though the

period in question included one of the longest booms in construction activity in the country’s history.

“Pakistan is a developing economy where economic upheavals and downturns can have a major impact on the overall business performance. Since its inception in 2012, AkzoNobel Pakistan has grown in terms of value and profitability,” he said.

“We intend to focus on medium and long-term deliverables. We believe that as long as the direction is correct, short-term challenges – for instance devaluation and raw material cost escalation – do not significantly impact the business.” Saad further said that AkzoNobel’s global parent sees Pakistan as a growing market and believe it to be attractive from a long-term perspective.

The reason for this outlook of Pakistan market because of the country’s population and expectation of growth. The industry is not saturated and paint usage is currently significantly under global levels. As Pakistan’s paint consumption levels converge with regional and global averages, that will create an opportunity for paint manufacturers to thrive.

“When the demand for paint increases, we are well-positioned to grab opportunities as we have the highest market share by value,” said Rashid. He added that AkzoNobel has invested Rs600 million during the period 2016-18.

It is unclear if that assertion is accurate, however. According to industry sources that Profit spoke to, AkzoNobel Pakistan has been losing its market share to other players, especially to Brighto Paints during the last decade.

But Saad Rashid does not quite agree on that.

“It depends if you are talking about volume or value because you will get different results of market share. Being a premium brand company, obviously our value market share will always be higher than our volume market share, simply because of where we play,” he said.

“In reality the market is quite competitive, with lots of players who are not very different from each other in terms of size. In a market with huge potential, our aim is to solidify our position and ensure a clear number one position in the next 5 to 10 years,” he added.

Sources familiar with industry trends who spoke to Profit said that AkzoNobel’s market share is highest in the southern half of the country and significantly lower in the northern half.

These sources added that AkzoNobel was in talks to acquire a local player that would allow the company to gain a greater market share in the northern part of the country.

Saad Rashid disagreed with the notion that the company does not have a substantial market share in Punjab and Khyber-Pakhtunkhwa. “Akzo Nobel prides itself on being a strong national player with substantial presence in all geographical areas of Pakistan. Other major players have limited geographical reach and drive their strength from a specific geography,” said Saad.

However, he did hint that talk of an acquisition were likely not out of place. “AkzoNobel globally has always believed in both organic growth as well as through acquisitions.

In 2018 alone, we acquired Fabryo in Romania,

SLOW GROWTH

2.8%

Average annual growth in AkzoNobel Pakistan’s revenues per year between 2012 and the second quarter of 2019, a time during which inflation averaged 6.0% per year

Xylazel in Spain and Colourland in Malaysia.

The regional leadership at AkzoNobel considers Pakistan as a growth market. We continue to focus on organic growth here, while looking for bolt on acquisitions which would complement our portfolio and help us deliver on our strategy,” he added.

Paint industry development phase

T

he Pakistani paint market, meanwhile, appears to be one that lags behind its peers in terms of sophistication and efficiency of the selling process.

“There are two types of paints. One is readymix and the other is POST (point-of-sale tinting) paints. Readymix is the paint which is readily available at paint shops. If there are 60 colors a company is offering and in three size containers (1kg, 4kg and 16kg), then its dealer has to keep at least 180 pieces at any given time to have the complete range. Then there has to be enough quantity to serve a big customer or multiple customers in a short period. Let’s assume, in order to have complete stock and quantity, a dealer may have to keep 10 containers of each paint. The dealer will have to keep a total of 1,800 containers: ten for each of the three sizes of each of the 60 colors,” explained Rashid.

“The POST paints are colors which can be made on demand from four basic colors at a dealer’s shop. What happens is that paint manufacturers install small machines at paint shops with four base paints. Whatever color of the paint a customer demands, it could be made right away. In this way, a dealer can work at a smaller place with less stock and the industry

becomes efficient.”

Saad said sales in the Indian paint industry consist of 70% POST paints and 30% readymix. But Pakistan is yet to evolve and the ratio here is 10% POST and 90% readymix.

‘Survival of the fittest’

M

eanwhile, Saad believes the paint industry will have a certain expected transformation due to the economic slowdown and it will move towards consolidation. As a result, certain large companies will become bigger.

“The economy has slowed down in the last couple of years and the same has had an impact on the paint industry. The Paints industry has over 600 manufacturers and most large retailers also have their shop-owned brands.

Due to the prevailing economic situation and growing size of certain large players, the industry will move towards consolidation in the coming years,” he said.

“We will see large players in the paints industry become larger by taking away share from smaller players and shop-owned brands. In medium to long term, the industry is expected to grow as Pakistan’s overall economy picks up traction,” he predicts.

“However, it has never been easy to predict accurately when the industry would evolve and how would it happen. There was a time when Macro came here and everyone was talking that retail business will evolve and only big supermarkets would operate. But it didn’t happen right away and it took time. And it didn’t happen the way people were assuming.

New players like Imtiaz and Al-Fateh brought that change,” he explained. n

CHEMICALS

NetSol, Avanceon, Systems and TRG earn a bulk of their revenues from exports which showed growth on the back of a strong greenback. Why, then, did the share prices of these companies plunge to historic lows? And does this present an opportunity to make a quick buck?

I

By Taimoor Hassan

t is 2019 and the Pakistani economy is a wreck. The stock market is in free fall with no signs yet of a recovery. The Pakistani rupee has hit its lowest against the dollar in the ongoing year, with the lowest recorded at Rs165.2 against the dollar in July 2019.

In theory, export businesses – that is to say those companies that earn all or a majority of their revenues in dollars – should be thriving in an economy like Pakistan. Why? Because it would increase their earnings in dollars, while their costs, which are local would not increase by much. This is particularly true for software exporting companies. Software companies do not need to source raw material like, for example, textiles that need cotton as a raw material, the price of which would go up as the dollar goes up, to manufacture a product. Information technology and its related products are a labour-intensive business and majority of the costs are associated with the size of the workforce.

With a weak rupee, revenues would most certainly go up for them while costs will not because a weaker rupee does not make the labour costly all of a sudden. Wages are more a function of supply and demand rather than exchange rate and in an economic recession, oversupply of labour due to unemployment would pull wages down instead of pushing it up.

It is true that investor sentiment drives stock prices but what drives investor sentiment

16

is fundamental company performance. Ideally, the stocks of these companies should be performing better than the stocks of other companies because higher revenues would drive the stocks up. It is, however, anomalous that the stock performance of these companies has been abysmal even though these businesses are flourishing on the back of strong dollar-based earnings.

So are the share prices of these companies truly reflective of their financial performance?

At Profit, we examined the case of four publicly listed software companies.

Avanceon Ltd

A

vanceon’s core business is automating industrial processes that have a significant software component. Its clients operate in the oil and gas sector, food and beverages, water and waste-water sectors; and other infrastructure projects such as rail and

Avanceon Limited Revenue (Rs in millions)

Share Price (Rs) 100

4,500 4,000

82.68

3,500

75

3,000 2,500

49.04 50

40.8

2,000

34.85

33.85

34.6

1,500 25

1,000 500 0

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019 (till June)

0

“Until the market starts appreciating [our work], we will see these kind of values but I am very confident that the market will soon see how we are evolving into a very high-value tech organisation and once the market starts seeing the additional work delivered by NetSol, we will see better values.

The market is overall down and that has affected us also but I believe that this is in the short run” Salim Ghauri, CEO of NetSol metro systems. The company has a considerable local presence with clients such as Nestle Pakistan, the state-owned Oil and Gas Development Corporation (OGDC), but the majority of its clientele is located in the United Arab Emirates (UAE), the Kingdom of Saudi Arabia, and Qatar, which provides it the bulk of its dollar-based revenues, approximately 60-70% of total sales.

For the half-year ended June 30, 2019, the latest for which financial data is available, Avanceon recorded revenue of Rs1.68 billion.

Compared to the same period last year, revenue grew by 16.3%. Company’s gross profit margin was 27.1%, down 383 basis points from last year, whereas operating margin was 35.2%, up 771 basis points from the same period last year. (One basis point is one hundredth of a percentage point.)

The growth is going to be even more because a bulk of Avanceon’s revenue is realised in the 3rd and 4th quarter of the year and historically, the 4th quarter has added revenue in excess of Rs1 billion for the company while the first two quarters are usually half or a little over that. For instance, out of its total revenue of Rs3.48 billion in 2018, the company added Rs1.47 billion in the fourth quarter of the year, giving a jump to its revenues of 42% in the last quarter.

Moreover, the company claims that they have $56 million worth of projects in the backlog.

Surprisingly though, Avanceon stock eroded by 39% in value for the six months of 2019 (from Rs80.61 on January 1, 2019 to Rs49.04 on June 28, 2019 at closing price), while the rupee depreciated by 34% during the same period. And for a little less than the 9 months of 2019, from January 1 to September 20, Avanceon’s stock price fell from Rs80.61 to Rs31.66 at closing price.

Between January 1, 2018 and December 31, 2018, Avanceon’s stock appreciated by 135% to Rs82.68 on December 31, 2018 from Rs35.18 on January 1, 2018. For the year 2018, its revenues increased by 23.7% from 2017. Avanceon’s financial year starts on January 1 and ends on December 31

each year. For the financial year 2018, the company realised revenues of Rs3.48 billion, against a revenue of Rs2.81 billion in 2017.

For the year 2018, the rupee lost 15.5% of its value and the company witnessed cost increases of 34.3% from the previous year, shrinking its gross profit margin by 558 basis points to 29.1% for 2018 compared to 34.7% in 2017.

The company said that in 2018, it witnessed a fixed cost increase of 36% due to Rs95 million in provisions for bad debts and earning in excess of billing and written-off of old balances. Other increases in costs include a 13% net increase in salaries and other administrative expenses and cost of selling due to inflation.

Meanwhile, Avanceon’s operating profit margin was at 26.3%, an increase of 258 basis points from the previous year.

Bakhtiar Wain, the CEO of Avanceon Ltd, attributes the lacklustre performance of the Avanceon stock to the bearish investor sentiment: “Everything is outstandingly good at the company but the market has been in a freefall,” Bakhtiar Wain tells Profit. “Our business and results couldn’t have been better. This is essentially a blip that will go away which will go away

automatically when the sentiment changes,” he says.

For a business like Avanceon, a bust in any of the sectors that it operates in abroad would not augur well for the company. A recession in Avanceon’s business would come if there is a recession in any of the sectors they operate in internationally, for instance in the oil and gas sector in the Middle East. But Bakhtiar says Avanceon is hedged from such dips in the business because of their diversification into other sectors.

NetSol Technologies Ltd

T

here is a great hype surrounding NetSol and a great deal of that comes from the very public profile of its founder Salim Ghauri. After returning to Pakistan from Australia after a 17-year stint as an IT consultant, Ghauri laid the foundation of NetSol in 1996 using seed funding from his brother Shahab Ghauri. For the 23 years it has been in existence, NetSol has remained an exporter of IT services to the asset finance and lease management, banking, insurance and information technology sectors. It

NetSol Technologies Limited Revenue (Rs in millions)

Share Price (Rs)

6000

125

97.28

100

4000 65.89

75

57.83 45.95 2000

32.49 25.01 17.86

0

2007-08

2008-09

50.1 50

29.22

20.46

25

13.73

2009-10

2010-11

2011-12

2012-13

2013-14

2014-15

2015-16

2016-17

2017-18

2018-19

0

INVESTING

is listed on the Pakistan Stock Exchange (PSX) and trades under the symbol ‘NETSOL’ and was the first and only Pakistani company to be listed on the NASDAQ in the United States.

NetSol’s business has a dominant share in the international automobile lease industry where it serves a diverse client base across the world through its core flagship and project the NetSol Financial Suite (NFS) – which is essentially an asset financing software application that helps lenders manage their lending. Almost all of its customers are international and that includes automakers Mercedes-Benz, Toyota, Volkswagen, BMW, Nissan and Hyundai among others.

The government of Sindh was its only Pakistani client according to its financial report for 2018.

For the full year ended June 30, 2019, the latest period for which financial information is available, NetSol posted revenue of Rs5.4 billion, a growth of 25.6% compared to last year. For the same period, the rupee depreciated by 34%. The company’s gross profit margins for fiscal year 2019 were 38.9% against 45.2% last year, while operating profit margins for fiscal 2019 were 25.2%, compared to 27.1% the previous year.

Meanwhile, over that fiscal year, NetSol stock fell by 48.1%, to Rs65.89 on June 28, 2019 from Rs126.84 on July 2, 2018.

Salim Ghauri, the CEO of NetSol, told Profit that the Pakistani stock market is not able to appreciate the work NetSol is doing and the domain it has built in the last 25 years.

“Until the market starts appreciating [our work], we will see these kind of values but I am very confident that the market will soon see how we are evolving into a very high-value tech organisation and once the market starts seeing the additional work delivered by NetSol, we will see better values,” he says. “The market is overall down and that has affected us also but I believe that this is in the short run,” he adds.

During fiscal year 2018, NetSol stock appre-

“The market is trading at a price-to-earnings (PE) ratio of 5 times latest earnings, and unfortunately they are also taking 30% growth of dollar based stocks in this category as well” Asif Peer, CEO of Systems Ltd

ciated by 116%, to Rs121.07 on June 29, 2018 from Rs56 on July 3, 2017. For the same period, the company reported a revenue of Rs4.3 billion, up by around 10% from the previous year. Its gross profit margin was 45.2% while the operating profit margin was 27.1%, an increase of 1,709 basis points from the previous fiscal year when it was a relatively smaller 9.98%.

Systems Ltd

S

ystems Ltd is a public limited company incorporated in Pakistan under the Companies Act, 2017, and listed on the PSX under its trading symbol ‘SYS’.

The Company is in the business of software development, trading of software and business process outsourcing services. The Group comprises of Systems Ltd (Holding Company) and its subsidiaries – TechVista Systems FZ LLC and E-Processing Systems (Private) Ltd. The company’s revenue is primarily from software development and IT services work subcontracted by its subsidiary TVS operating in the Middle East region and its associated company Visionet

Systems Limited Revenue (Rs in millions)

Share Price (Rs)

6000

125 109.87 95.97

100

84.6 4000

73.92 75

63.03

50 2000

25

0

18

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018 2019 (till June)

0

Systems operating in the North America region.

Over 73% of its revenue is export based. Systems Ltd’s financial year ends December 31.

For the year 2018, Systems Ltd’s stock appreciated by 46.5% to Rs109.87 on December 31, 2018 from Rs75 on January 1, 2018. While the dollar appreciated 15.5% against the rupee in 2018, the company revenues swelled by 38.9% to Rs5.3 billion from Rs3.8 billion in 2017. Systems’ gross profit margin was 28.7%, down 126 basis points from 2017 when it was 30.0%. Operating profit margin, on the other hand, was 20.17%, up 491 basis points from the previous year.

For the year 2019 through September 20, Systems’ stock lost value by 24%, down to Rs82.30 on September 20, 2019 from Rs108.70 on January 1, 2019.

The company has thus far posted half-yearly report for the period ended June 30, 2019. So for a fair comparison, we would look at the company’s stock performance for the 6-month period of 2019. For the period in consideration, the company’s stock shed 11.7% of its value to Rs95.97 on June 28, 2019 from Rs108.70 on January 1, 2019.

For the 6-month period that the currency depreciated by 34%, the company posted a 53.61% increase in revenues to Rs3.6 billion, from the same period in 2018 when the company posted revenues of Rs2.3 billion. Meanwhile costs increased by 47.6% in the first half of 2019 compared to the same period last year, whereas the gross profit margin increased to 30.8%, up 283 basis points from 28.0% in 2018 for the same period. The company had an operating profit margin of 25.5%, an increase of 530 basis points from 2018 when it was 20.2%.

When asked why the share price of Systems Ltd is down even though the business is flourishing, Asif Peer, the CEO of Systems Ltd, told Profit that the market is trading at a priceto-earnings (PE) ratio of 5 times latest earnings, and unfortunately they are also taking 30% growth of dollar based stocks in this category as well.

“Everything is outstandingly good at the company but the market has been in a freefall. Our business and results couldn’t have been better. This is essentially a blip that will go away which will go away automatically when the sentiment changes” Bakhtiar Wain, CEO of Avanceon Ltd

The Resource Group (TRG)

T

he Resource Group (TRG) is the brainchild of Zia Chishti – a US-based Pakistani businessman – who still serves as the CEO of the company. Zia’s entrepreneurial achievements are remarkable by all standards. The man single-handedly built two billion-dollar companies – with Align Technologies (the makers of the first ever brand of dental aligners called Invisalign) being the first one.

TRG Pakistan Ltd was incorporated in Pakistan as a public limited company and is listed at the Pakistan Stock Exchange (PSX) under its trading symbol TRG. Most in Pakistan know TRG as a call center company, but it is actually a holding company that acquires, invests in and manages operations relating to business process outsourcing, online customer acquisition, marketing of Medicare related products, and contact centre optimisation services through its subsidiary, The Resource Group International Ltd (TRGIL).

The bulk of the revenue for the company comes from its IBEX business, a subsidiary, which is essentially the call center business which has call centers in the USA, the UK, Canada, Jamaica, Nicaragua, Senegal and Pakistan.

The second cash cow for TRG is its Afiniti subsidiary which uses artificial intelligence (AI) to pair employees of the company with its customers to improve profitability.

TRG’s financial year starts July 1 each year

and ends on June 30 of the subsequent year.

The first nine months of FY19 was a period of highly significant growth for TRG as their consolidated revenues reached Rs51.3 billion, representing a 43.5% increase over the same period last year. The company said that the increase has been broad-based and took place across all of their major operating subsidiaries and was also aided by a weaker rupee against the US dollar.

The IBEX business alone was Rs42.7 billion. For the same period, the currency depreciated by 15.7%.

The company’s gross profit margin increased to 36.3% from 28.5% during the first nine months of 2018. The operating profit margin also increased by 983 basis points from -9.81% in 2018 to 0.02% in 2019. TRG stock lost 20.3% of its value, going to Rs23.06 on March 29, 2019 from Rs28.95 on July 2, 2018. However, from the start of this year TRG stock has lost 43.1% of its value, falling from Rs23.41 on January 1 to Rs13.31 on September 20.

Why? Because it was being dragged by the weight of the company’s bad financial performance, making billions in losses.

For the financial year 2018, TRG raked in revenues of Rs49.1 billion. It had a healthy gross profit margin of 29.2%, up 2,043 basis points from the previous year when it was just 8.8%.

However, the company made losses from operations of Rs3.5 billion, which was an improvement from 2017 when company made losses from operations of Rs8.0 billion before taxes and finance costs. And that is before taxes and finance costs.

The profit margin for 2018 was -7.2%, an im-

TRG Pakistan Limited Revenue (Rs in millions)

Share Price (Rs)

60,000

50 40.09

30.55

40,000

28.64

30

16.36

14.03

20,000

20

10.19 6.25 1.35

0

40

33.55

2007-08

2008-09

4.11

2009-10

2.56

3.42

2010-11

2011-12

10

2012-13

2013-14

2014-15

2015-16

2016-17

2017-18

2018-19 (till March 2019)

0

provement of 15.0% from the previous year (2017) when the operating profit margin was -22.2%.

TRG attributes its losses to investments for expansion of its Afiniti subsidiary. The Afiniti cost base during fiscal 2018 increased to Rs9.6 billion, up from Rs5.8 billion during fiscal 2017.

To fund its expansion, Afiniti closed a debt funding round in financial year 2018 for a total of $60 million, which included the refinancing of prior debt. The Afiniti subsidiary is also a significant source of revenue for the business. For the financial year 2018, Afiniti business added Rs7.5 billion in revenues.

How to approach these companies as an investor

I

t is evident that the companies are flourishing financially, even TRG, which even though it is currently making huge losses, it is on track to profitability with its operating profit margins in the positive after a plunge in the negative for a few years.

While it is certain that the overall economy has affected investor sentiment that has pulled the share prices of these companies down, when the dust settles, the share prices are going to adjust to their actual value based on the financial performance of these companies. But for now, however, even the best of these businesses are not correctly reflected in the stock market.

Maha Jafer Butt, director of research at Capital Stake, tells Profit that the overall sentiment in the equity market is low and concerns about the overall economy have kept investor confidence and participation low in the market.

“With the interest rates so high, institutional investors are more inclined towards investment in T-bills (treasury bills), which are low risk compared to equities,” she says, adding that when sentiments improve, it is expected that the overall market will pick up and share prices shall recover. n

INVESTING

22

L

By Farooq Tirmizi

adies and gentlemen, if we can get your attention for a moment, the bond market of Pakistan would like to make an announcement: the recession is over. We repeat, the recession is over. The economic recovery can now begin.

Unfortunately, while this good news has been telegraphed clearly throughout the country’s financial community for the last few weeks, the subtext appears to not be fully appreciated: the bond market is also signaling some serious causes for concern.

At this point, you may be thinking to yourself: what is the bond market and why should I care? Well, you should care because you are probably a more active participant in the bond market than you are in the better

CAPITAL MARKETS

known – but smaller – stock market. And, more importantly, the bond market can affect you in ways that the stock market – or most other markets – cannot.

In its simplest terms, a bond market is just that: a market to buy and sell bonds, which in the case of the Pakistani market, almost invariably means government bonds. Unlike stocks, which represent a share in the ownership of a company, a bond is a promise to pay; essentially a loan, with a fixed repayment date, and interest rate.

How big is the government bond market?

As of June 30, 2019, the total size of the domestic government bond market stood at Rs20.7 trillion, according to data from the State Bank of Pakistan. For comparison, as of October 17, 2019, the market capitalisation (the total value of all publicly listed stocks) of the Pakistan Stock Exchange stood at Rs6.7 trillion and has never gone higher than Rs11 trillion.

More importantly from the perspective of the ordinary person, government bonds are where over half of bank deposits are invested, and determine the cost of borrowing – and, therefore, the extent to which businesses have the ability to expand their operations.

So, what exactly is happening in the bond market? And what does it mean for the economy?

A brief introduction to bond mathematics

T

his article will use some concepts in bond mathematics, and while it is not necessary for most people to understand the details, it is helpful to understand directions of movements in bond prices and interest rates (which move in opposite directions from each other) and what that means.

If you know how bonds work, feel free to skip this section As we stated earlier, a bond is simply a loan: it has a fixed amount that needs to be paid back, at a specific time period, as well as interest payments (usually semi-annual) that need to be made.

Most corporate bonds in Pakistan are variable rate, meaning the interest rate resets every year. Most government bonds, however, are fixed rate, which means that they pay the exact same interest (as a percentage of their face value) every single year until maturity.

This matters because as interest rates change, investors’ willingness to buy certain bonds increases or decreases. For instance, if you own a bond that yields an 8% interest rate and you bought it for Rs1,000 per bond, and the interest rate reaches 12%, why would you want to continue owning that bond when you can buy a new one that yields so much higher?

If you then went out into the market to try to sell the bond, nobody would be willing to

24

“Price signals often fail in structurally distorted economies. A desperate borrower does not respond to price signals; this is especially the case with addictive goods/ services. While increasing interest rates is sufficient to deter an individual from borrowing more, in the case of a government with a short-term horizon, the rising cost of credit will not deter fresh borrowing, but only increase the government’s indebtedness and squeeze the fiscal accounts further.”

State Bank of Pakistan quarterly report, June 2013 pay Rs1,000 for it. They would be willing to pay a lower price which would make those interest payments (Rs40 every six months, in this example) be worth the same – in percentage terms – as the 12% interest rate they could receive on the new government bonds.

In other words, if interest rates go up, the price of existing bonds (which by definition have a lower interest rate) will go down to ensure that their yield-to-maturity becomes equal to a comparable new bond. Conversely, if interest rates go down, existing bonds become more valuable and therefore rise in prices.

We have skipped over several concepts, not least of which is yield-to-maturity, which is the effective interest rate on a bond until its maturity date, based on its face value, stated interest rate, and current market price. We will not delve into how yield-to-maturity is calculated, but it is the way to compare interest rates on bonds of different prices and different maturities.

The yield curve

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ne more key concept: in general, the longer the time to maturity of a bond (maturity meaning when the full repayment is due), the higher interest rates investors will demand, at least under normal circumstances. The reason: the longer the time to repayment, the more things can go wrong, and the more likely it is that the loan / bond will not be repaid.

That last point is particularly crucial, because it forms the basis of a concept known as the yield curve. The yield curve is a graph of the average yield-to-maturity of bonds against the time to maturity. Under normal circumstances, it should be an upward-sloping line: as time to maturity increases, so does yield-to-maturity of the bonds.

When the slope is curving upwards normally, there really is not much to say about the curve. It is only when the curve inverts that matters start to get interesting.

An inverted yield curve refers to the phenomenon, usually relatively brief and anomalous, of when short-term interest rates are higher than long-term interest rates. That signal is generally taken to mean something important in most

economies, though its interpretation can differ widely depending on the type of economy in question.

The inverted yield curve

I

n the United States, the economy where the very concept of a yield curve was invented, an inverted yield curve almost invariably means one thing: the onset of a recession.

Why? Because in the United States, an inverted yield curve happens when investors believe that the prospects for the economy have dimmed, and that the economy will be slower, with corresponding lower inflation, and thus lower interest rates than ones that currently prevail.

Here is how it works. Let us suppose that interest rates on a one-year bond are 4% and the interest rates on a 10-year bond are 6%. If you believe interest rates will go down, you will also believe that the value of both bonds will go up.

However, you also do not know when that will happen, making it less likely that you will want to buy the one-year bond, and making it a much safer bet for you to buy the 10-year bond.

As a result, investors start buying more long-term bonds under the assumption that they will gain more value as interest rates decline during a recession. That, in turn, becomes a self-fulfilling prophecy: as more investors buy those bonds, their prices rise, and hence their yields fall below short-term interest rates, even before the recession actually arrives, making an inverted yield curve a leading indicator of a recession.

However, as you can see, that phenomenon relies on a certain set of assumptions about the relationship between inflation, interest rates, and the nature of the economy.

Specifically, it assumes that the economy has a normal rate of inflation that slows down during a recession, and that the central bank, broadly speaking, sets interest rates to be positive in real (inflation-adjusted) terms. While that second assumption is mostly true in Pakistan, the first assumption is not. And that has to do with the particular dysfunctions of Pakistani society.

But before explore that, it may be helpful to figure out just when the yield curve inverts in

Pakistan, and what clues that might have as to what it means.

When and why yield curves invert in Pakistan

W

e must caveat our analysis by saying that our dataset – which relies on Business Recorder’s data on secondary market trading in government bonds – only goes back through to September 2007, so it only covers two major recessions in Pakistan’s economic history.

Nonetheless, the data from both of those recessions is very compelling and paints a logical, if somewhat counterintuitive, picture.

To conduct this analysis, Profit looked at the differences in the yield-to-maturity between the one-year government bond and the 10-year government bond and examined which periods that number turned negative (meaning when the 10-year bond started yielding less than the one-year bond).

There were two clear periods of when this happened: the first one started on April 9, 2009 and continued, with some minor interruptions, through October 3, 2009, a period of almost six months. The second significant period started on August 19, 2019 and appears to be continuing as of the writing of this article. There was one other

relatively brief period of negative yields which lasted from August 25, 2011 through October 7, 2011, which we will address later.

The two clearest periods of negative yields both have one thing in common: they both occurred shortly before or shortly after the end of a fiscal year of negative nominal growth in the gross domestic product (GDP) – the total size of the economy.

In other words, unlike in the United States, where the inverted yield curve is a leading indicator of a recession, in Pakistan, it is a lagging indicator of a recession and usually marks the beginning of a recovery.

GARGANTUAN

Rs20.7 trillion Total size of the government bond market in Pakistan as of June 30, 2019, according to data from the State Bank of Pakistan

How does an inverted yield curve in Pakistan mean completely the opposite of what it means in the United States? The answer lies in the differing structures of the two economies, and the role that currency crises play in both inflation and recessions in the case of Pakistan.

Pakistan’s recessions typically tend to be the product of a fundamentally insane policy decision that the country’s leadership has been repeating since 1949: a belief that, somehow, there is a magic number for the rupee’s exchange rate against the US dollar that must never change.

This, quite obviously, is not something that a country like Pakistan, with its perennial trade deficits and lack of significant foreign investment flows can keep up. As a result, periodically, the government’s attempts to control the price of the rupee fail miserably and it comes crashing down, not with a steady dribble of depreciation, but with a crash that frequently brings down with it the whole economy.

When the rupee crashes, that also causes a spike in the inflation rate, since Pakistan is now (and has been since at least the late 1990s) a net importer of energy. If the rupee price of energy goes up, so does the price of everything else, which causes a spike in inflation. In short, while in developed economies, a recession causes a decline in inflation as businesses maintain or even cut prices to try to stay competitive, in Pakistan, businesses are forced to raise prices because they

CAPITAL MARKETS

are facing a sharp rise in their cost of production or doing business.

So now put yourself in the shoes of a Pakistani bond investor: if you think the worst is over for the economy, and that the recovery has begun, what do you think will happen to inflation, and thus to interest rates? You will expect them to decline from their sharply high levels, which means that – in an economic recovery – you would expect interest rates to also decline.

Knowing what you know about expected interest rate movements, if the one-year bond is available at a yield-to-maturity of 12% and the 10-year bond is available at a yield-to-maturity of 14%, you would be better off buying that 10-year bond because its price would rise faster. So that explains why the yield curve inverts.

What it does not explain, however, is why the yield curve inverts after the recession is over, and not during it. After all, in the US, the inversion happens before the event it predicts happens. Why not the same for Pakistan, which

would mean that the inversion should happen before the recovery (and thus during the recession)?

The answer is both obvious and somewhat painful: data frequency. In the United States, bond traders have mountains upon mountains of data that tell them whether and when to expect a recession, and hence the market moves much more quickly. In Pakistan, unfortunately, while some economic indicators have frequent signals, most are issued on a very infrequent basis, almost invariably by a handful of government departments. Hence, Pakistani bond traders simply cannot have a clearer sense of when to expect an economic recovery until it has already started.

The 2011 inversion

S

o then why did the yield curve invert in 2011? The 2008 recession was long over and 2010, while not a great year, was not terrible either. Why the inversion?

That particular inversion had to do with an

While in developed economies, a recession causes a decline in inflation as businesses maintain or even cut prices to try to stay competitive, in Pakistan, businesses are forced to raise prices because they are facing a sharp rise in their cost of production or doing business.

26

experiment that had taken place in the first half of 2011 that died in the latter half of that year: a central bank that actually tried to rein in the federal government’s profligacy by raising interest rates.

But once Shahid Kardar, then the governor of the State Bank of Pakistan had reached his limits and was summarily fired from his job in July 2011, the bond market corrected for the expectations that interest rates would remain elevated. Once bond traders realized that Kardar’s departure meant a reduction in rates again, the yield curve inverted.

Yes, you read that correctly: the bond market gave Shahid Kardar his very own sendoff through the yield curve. He may have lasted less than ten months in office, but he may – quite possibly – be Pakistan’s only central bank governor with that distinction. Well played, sir.

Well played.

The longer-term impact of this ouster was that, by 2013, the State Bank of Pakistan had economists writing papers describing the federal finance ministry’s borrowing habits like one would ordinarily describe a heroine addict: twitchy, oblivious to pain, and making a series of poor life choices.

In a bit of subversive competence, in June 2013, the State Bank managed to publish their research as part of their more publicly well-known quarterly report and described the

finance ministry in the following way: “Price signals often fail in structurally distorted economies. A desperate borrower does not respond to price signals; this is especially the case with addictive goods/services. While increasing interest rates is sufficient to deter an individual from borrowing more, in the case of a government with a short-term horizon, the rising cost of credit will not deter fresh borrowing, but only increase the government’s indebtedness and squeeze the fiscal accounts further.”

No, ladies and gentlemen, that was not editorial comment about the heroin addict: that is language from official documents produced by the State Bank of Pakistan describing the Federal Ministry of Finance. What a glorious time to be alive!

So what if the yield curve inverted?

S

o the yield curve inverted because Pakistan’s economy is about to recover. Big whoop. Everyone knows that already.

Why should anyone care about the yield curve at all then?

Because of the reason as to why it is inverting this time: significant inflows into the rupee-denominated government bonds from foreign investors, which recent news reports suggest have reached $354 million since July

of this year. Yes, local bond market investors would have likely caused an inversion on their own too, but having foreign investors pump in money into the bond market is a somewhat bullish signal for the economy… up to a point.

While, in general, it is good for the country to receive investment from foreign sources, since it signals global confidence in the country’s macroeconomic indicators, the problem with the current flow into the rupee-denominated bond market is that all of this is what is known as “hot money”: temporary flows of cash chasing higher yields that will leave the second it can find something better elsewhere.

Given the fact that Pakistani economic crises tend to occur with a sudden collapse in the price of the rupee, does anyone seriously believe that having this hot money enter the country would do anything other than significantly worsen the next financial crisis in the country?

One suspects that a highly respected economist like State Bank Governor Reza Baqir is well aware of the nature of Pakistan’s economic distortions and how this flow of hot money is unlikely to be helpful in the medium to long run. Indeed, if the flows of this hot money investment were to continue to accumulate, they may well approach creating a crisis for Pakistan similar to the 1997 Asian Financial Crisis.

Unfortunately, the State Bank has no

good options here. If it lowers interest rates too soon, it risks encouraging government borrowing which would even further crowd out the private sector from the banking sector’s lending activities, and further slow down the economy. If it seeks to curb the flows of foreign money through regulatory means, it would be cutting off a source of dollars at a time when the economy can use all the foreign investment it can possibly get. The bank is damned if it does and damned if it is does not.

Ultimately, however, the country is likely better off without the flow of hot money and remaining a destination for a smaller, but more sophisticated set of foreign investors who would seek to business in Pakistan in the long run rather than seeking the quick buck to be made from the current set of high interest rates.

More importantly, given the fact that the finance ministry is best thought of as a heroin addict when it comes to borrowing, it is probably not a good idea to provide the addict with a new crack pipe (i.e. a new source of borrowing).

The situation is bad enough without the finance ministry getting even worse ideas about how to continue relying on flaky hedge funds for their more permanent needs for capital.

When it comes to suppliers of addictive substances to an addict, the State Bank should act like a responsible sponsor and just say no on behalf of their ward. n

CAPITAL MARKETS

Shifa International looks to expand its footprint in Punjab The company will fund the expansion through a combination of free cash flows and capital injections from the majority shareholders

S

hifa International Hospital Ltd, the country’s only publicly listed hospital company, is planning on building a brand new hospital in Faisalabad, the company’s first foray outside their home base in the Islamabad-Rawalpindi metropolitan area. The new Shifa National Hospital is expected to become operational over the next three to five years.

The new hospital in Faisalabad is not the only part of Shifa’s expansion drive, though.

During the same time period, Shifa is also planning on opening a new Shifa Ambulatory and Diagnostic Centre in Islamabad. The new center would focus on providing outpatient care, diagnostic and laboratory services, as well as minor surgeries that can be undertaken in the ambulatory (non-inpatient) setting.

The new center represents an expansion of the range of services for Shifa, which currently derives the bulk of its revenue from a single inpatient hospital in Islamabad, which also operates an outpatient department and an emergency room.

To fund both of these projects, Shifa is expected to raise Rs2.6 billion over the course of the next three years.

“Shifa is neither taking a loan nor issuing rights; instead it will raise equity from the directors’ and owners’ personal pockets,” said Sunny

28

Kumar, a research analyst at Topline Securities, an investment bank and securities brokerage firm, in a research note issued to clients earlier this month. At least part of the expansion will likely be financed by the company’s own free cash flows, though the cost of the new hospital is well beyond what the company normally spends on capital expenditures. Over the past few years, its annual capital expenditure was typically in the range of Rs600 - 700 million.

Nonetheless, despite its rising need for financing, the company is planning on keeping its dividend payout ratio unchanged during this period.

Currently, Shifa earns around 95% of its revenue from its main hospital in H-8, Islamabad. Its revenue for the financial year ending June 30, 2019 grew by 14.3%, from Rs10.3 billion to Rs.11.7 billion. Over the past five years, the company’s revenues have grown at an average annual rate of 12.8% per year.

The two projects will be managed by Shifa’s newly-named subsidiary Shifa Development Service Ltd (SDS). Shifa has applied for government approval for construction, and is expected to hear back within the next few days for the Faisalabad hospital, and two to three months for the Diagnostic Centre.

Markets have reacted favourably to the company’s expansion plans. The company’s

stock is up 17.9% over the past month when the announcement first came out.

According to Kumar, Shifa International Hospital is one of the largest hospitals in Islamabad, and has virtually no comparable competition in the city. The company’s foray into Faisalabad marks its ambitions to expand further in Punjab, while sidestepping exiting hospital competition in other large cities like Lahore. In its most recent annual report, the company’s management highlighted the potential it sees in Faisalabad as a growing urban centre of Pakistan, with a population three times that of Islamabad, and which an estimated metropolitan gross domestic product (GDP) of $20.5 billion.

Shifa does currently operate a much smaller hospital in Faisalabad, though, according to the company’s most recent financial statements, it is a much smaller hospital than the one in Islamabad, and one that operates at a much lower capacity utilization rate. While the much larger Islamabad hospital had a capacity utilization rate of 67.6% in financial year 2019, the Faisalabad presence only managed a 42.4% utilization rate.

Shifa International Hospital in Islamabad was first incorporated in 1987, and was converted into a publicly listed company in 1989. The Islamabad hospital currently offers 550 beds.

Once completed, the hospital in Faisalabad plans to offer 250 beds.

The hospital in Islamabad is also seeing some improvements; a new MRI machine has been installed that cuts test time from 45 min to 15 min, along with more neonatal intensive care unit (NICU) beds, and a new breast cancer clinic.

Growing interest in Pakistan’s healthcare

S

hifa Hospital’s expansion isn’t a complete surprise. It makes sense in the context of Pakistan’s booming healthcare landscape. The demand for health care services in the rapidly-growing country is rising, and companies are looking to invest.

Take Engro Corporation. The Pakistani conglomerate has been rumoured for almost a year now to be interested in the healthcare sector in the country. Profit has previously reported in December 2018 that sources familiar with the matter said that Engro was considering partnering with Ashmore, a London-based emerging-markets-focused investment management firm, and King’s College London Hospital to set up a chain of hospitals across Pakistan.

The proposed hospitals would cater to middle and upper-middle class consumers. Should the project actually materialize, it would be the first foreign healthcare brand to enter the Pakistani market.

And it is not just local companies like Engro that have taken an interest in this sector.

Before its spectacular collapse, Dubai-based private equity firm Abraaj managed a $1 billion healthcare fund, of which at least half was invested in hospitals and healthcare projects in Pakistan, India, Nigeria and Kenya. While Abraaj no longer exists, the health care fund still does. It was bought in May 2019 by US-based TPG Capital, the fifth largest private equity firm globally. The fund has been renamed Evercare Health Fund, and continues to operate at least 30 hospitals and 3,000 beds in Pakistan and other countries.

The increased interest in the country’s healthcare sector is not entirely surprising: since the passage of the 18th Amendment to the Constitution in 2010, and the 7th National Finance Commission Award, both of which granted provinces considerably more financial and political autonomy and granted them the ability to manage and spend on healthcare, total spending in Pakistan’s healthcare sector has exploded, led by the public sector.

Total spending on healthcare in Pakistan rose by an average of 18.3% per year since the passage of the 18th Amendment, led by a 33.9% per year average increase in government spending on healthcare, according to Profit’s analysis of data from the Federal Ministry of Finance, and the Pakistan Bureau of Statistics. Nearly all of that increase in spending comes from provincial governments spending more money on the country’s public health infrastructure.

By comparison, in the eight years prior to the 18th Amendment and 7th NFC Award,

healthcare spending rose by an average of just 9.5% per year, suggesting that the acceleration is quite real.

The rise in public spending has meant that more people have access to hospitals, including private ones. In Punjab and Khyber-Pakhtunkhwa, for instance, governments have instituted publicly funded, but privately operated, health insurance programs that allow most poor residents in the provinces to access high quality private hospitals on an equal footing with upper middle class residents of those provinces.

Those programs, which are similar to Managed Medicaid programs in the United States or publicly funded insurance programs in France, have greatly increased the demand for healthcare services, a demand that investors are increasingly looking to capitalise on. As the largest hospital in the nation’s capital, and the only publicly listed one, it is clear that Shifa International does not plan to be left out of the race on its home turf. n

HEALTHCARE

OPINION

Yousaf Nizami

Automotive industry feels the pinch

tax holiday available to Greenfield Projects. KIA is a revival project of sorts as Lucky Motors re-entered the market while the powerful Nishat group introduced Hyundai with much fanfare; a group that doesn’t enter a new market unless there is money to be made.

Hopes of a more competitive, right-priced and better quality automobile market, however, seem to be withering away as quickly as the World Bank, IMF and SBP are churning out worrisome projection reports on the country’s economy. The recession has set in and has hit the car industry hard.

Car sales have plummeted by a whopping 39.4 per cent to 31,107 units during the first quarter of this fiscal year compared to 51,221 units in the same period last year. Truck sales, considered a measure of trade and business Recessions don’t pick favourites (new or growing businesses purchase them for transportation etc.), also took a major hit with sales dropping from 1,738 to 874 on a year-on-year basis. Honda and Toyota sales dropped 68% and 57% year-on-year respecakistan’s auto industry is the quintessential oligopoly, tively during September, while Suzuki Motor Company sales contracted by with only three major players assembling a handful a relatively lower 18% year-on-year. This is despite the government putting of automobiles: Honda, Indus Motors (Toyota) and severe restrictions on used car imports that have also come down drastically Pak Suzuki Motors. For decades the ‘Big Three’ have as a result. dominated the market in their own right, each having Most of the damage has been done by the depreciation of the rupee; at least one USP over the other. roughly 27% against the greenback since August of 2018 to date. Two of the For example, Indus Motors’ Toyota Corolla has been the most important and expensive components of automobiles in here, the engine dependable low maintenance, mid-range featured resale market and transmission, are imported. That right there is a significant jump in cost. dominator while Honda’s Civic is the high-end offering for those Add to it the increase in Federal Excise Duty on cars and their registration expecting relatively better build quality and looks. Suzuki on cost, and all vehicles become unaffordable. The net effect has meant that a the other hand, with its Mehran (replaced by the Alto this year) 1.8L new Civic costing Rs 3.0 million on-road a year ago is now costing upand Bolan, caters to the lower end small-sized car customer and wards of Rs 4.5 million. A similar proportionate increase can be seen across business transportation vehicles. the range being offered by Indus Motors and Suzuki.

With the announcement of new entrants into the market Factory lots where previously cars right off the belt would not stay for under the PML-N’s auto policy, it seemed that a correction as a longer than a day, due to the high demand, are now full. Indus Motors even result of competition was imminent. KIA and Hyundai decided tried to absorb some of the price hike by offering to pay for the registration to set up shop in Pakistan taking advantage of the up to 5-year of its lower-end, lower displacement vehicles. With car inventories piling up, Honda and Indus have reduced their manufacturing by observing no-production days. New entrants such as Hyundai and KIA have also been compelled to revise their introductory prices upwards as they are importing CBUs (completely built units). HyundYousaf Nizami ai’s IONIQ for example has been launched at an eye-watering Rs6.4 million- a hybrid 1600cc hatchback. is a member of staff On the consumer side disposable incomes have decreased, so even the cheapest cars are now a luxury now ill afforded. Leasing cars is also no longer a financially viable option with the discount rate at 13.25%- add to that bank premium and you’re paying at least 15% mark-up, not to mention the higher down payment at a minimum rate of 33% of full price.

It is severe economic downturns like the current one that the true vulnerabilities of an industry become apparent. None of the so-called ‘Big three’ have invested their abundant retained earnings on reducing their dependence on imported parts in order to protect against currency shocks such as the current one. Price revisions owing to ever-changing economic conditions are not exclusive to Pakistan.

However, when the quality of the product does not meet international standards, because it doesn’t have to, then that product becomes even more unattractive to the consumer. There is simply no way to justify the asking price of cars right now. n

P

30

COMMENT

Pakistan’s

AUTO INDUSTRY shows little sign of improvement Expect more shutdowns and future layoffs, as Pakistan’s automobile sector struggles amidst declining sales

By Meiryum Ali

P

akistan’s automobile sector is showing no signs of halting its continued decline. The auto industry experienced a 39% decline in car sales in September 2019, compared to the same month in 2018.

The downward spiral in car sales in 2019 stands in sharp contrast to the relatively strong period of growth for the auto industry in the preceding four years. Car sales in the period between 2014 and 2018 grew at an average annual rate of 16.4% per year.

Now though, the decline that started in mid-June in 2019 has firmly taken root, with all three major automobile assemblers feeling the pinch. Honda Atlas Pakistan saw its sales drop by 68% year on year, while Indus Motors Company – the Toyota subsidiary in Pakistan – saw its car sales decline by 57% compared to last year. Only Pak Suzuki Motor Company fared a little better than its competitors, with its car sales dropping by 18% compared to the same period in the previous year. “[This] is yet another indication of how much demand has suffered over previous months due to price increases and interest rate hikes,” wrote Ahmed Lakhani, a research analyst at JS Global Capital, an investment bank, in a note sent to clients on October 14, 2019. “[Neither Indus Motors nor Honda Atlas] are good investment decisions, as volumes continue to suffer from current price levels and have led to temporary plant shutdowns...and might also lead to layoffs in the near future,” he added in the note.

So why is this happening?

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eclining car sales is just one from a series of depressing news from September. As many recall, Indus Motors shut down its Karachi plant

“The government’s ‘aggressive’ stance towards disclosure of income has caused fear among buyers” Muhammad Arsalan Siddiqui, co-head of research at Foundation Securities for 10 days in the latter half of the month (some news reports said it had unsold inventory of over 3,000 vehicles.) Both Indus Motors and Honda Atlas have seen dwindling sales since July, and have also had to shut down production for at least a few days each month.

But the multiple problems plaguing the auto industry are not simply confined to the events of September. What is behind the chaos? For one, most auto assemblers are facing exorbitantly high production costs, in part due to new customs duties on luxury items (like cars), and high federal excise duties.

Production costs have also increased due to an extremely weak rupee. Most Pakistanis are

simply unable to afford the new car prices.

Secondly, from a Pakistani consumer’s perspective, the rupee’s general decline, and the current economic slowdown, has affected their own buying power. A reduced personal disposable income will make people less inclined to make a large purchase like a car (particularly if that car is already priced exorbitantly high).

The auto industry is also being affected

by Naya Pakistan’s latest tax drive. A new government requirement states that people have to prove they filed tax returns before being able to buy a car. While seemingly a good idea on paper, the government's policies to in-

“[This] is yet another indication of how much demand has suffered over previous months due to price increases and interest rate hikes. [Neither Indus Motors nor Honda Atlas] are good investment decisions, as volumes continue to suffer from current price levels and have led to temporary plant shutdowns... and might also lead to layoffs in the near future” Ahmed Lakhani, research analyst at JS Global Capital crease documentation and grow the tax base is actually dampening sales, as consumers worry about potential complications caused by the notoriously difficult Federal Board of Revenue.

Muhammad Arsalan Siddiqui, an analyst from the investment bank Foundation Securities, wrote in a note on October 14, 2019 that the government’s ‘aggressive’ stance towards disclosure of income has caused ‘fear’ among buyers. Interestingly, the worst affected are not city-dwellers with their large cars, but in fact, new buyers in rural areas.

Auto assemblers’ specific gloom

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uch of the overall decline in the auto industry can be attributed to a huge fall in sales in both the 1,000 cubic centimeter (cc) engine and 1,300-cc cars. The decline in sales for those two categories compared to last year has been 60% and 65% respectively.

But this fall affected the three auto assemblers differently. The worst hit was Honda Atlas: sales for its flagship City and Civic car models fell by a whopping 66% in September compared to last year. This is despite Honda

trying to restructure federal excise duties and remove non-filer restrictions. The drop in demand has led to the Honda only operating 13 to 15 days a month, a trend that is expected to continue.

In a massive role reversal, Indus Motors’ star car, the Corolla, was most responsible for the company’s misfortunes this September.

Sales for Pakistan’s most popular sedan declined by 59% compared to the same month last year.

Meanwhile, Suzuki Motors saw a decline in sales across practically all of its major car models, with the Swift falling 59% year-on-year, the Cultus falling 38%, and the Wagon-R falling 75% compared to the same month last year.

The Bolan and the Ravi also dropped by 67% and 73% respectively. In fact, Suzuki Motors was only buoyed by its saving grace, the Alto (explained below).

The ‘Alto’ outlier

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ne surprising bright spot in this gloomy picture is the Alto. Suzuki Motors introduced the brand new Alto in June 2019, and car sales have exceeded expectations. Around 4,924 Alto cars were sold in September, which is the highest-ever monthly sales recorded for Suzuki

Motors for a single model.

In fact, Alto sales are what is behind Suzuki Motors performing somewhat healthier than Honda or Indus. Lakhani, in his note, singled out the Alto for preventing a temporary plant shutdown for Suzuki Motors, unlike rivals Indus and Honda.

While the Alto is providing some relief, a single car model is not enough to prop up any industry revival hopes. For one, the Alto is about to see a price increase of Rs70,000-85,000 in two of its variant models. Secondly, once the initial euphoria of the Alto fades, Suzuki Motors will have to scramble to find an alternative to boost its sales, considering that the classic Mehran was phased out in March 2019, and that sales for the other favourite Wagon-R declined sharply.

Worrisome vehicle indicators

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ne of the more alarming numbers from September is the sharp decline in sales for trucks and buses. No other vehicle sector has declined as significantly, with truck sales declining 61% in September compared to the same month last year, bus sales declining 67%, and tractors falling 35% respectively.

These vehicles serve as a proxy for understanding the health of the economy on a whole, since trucks and buses are what transport goods and people across Pakistan, while tractors indicate how the Pakistan’s agricultural sector is faring. Not surprisingly, the overall decline is attributed to a slowdown in the country’s economic activity.

There is hope among some analysts that these sales will eventually pick up, due to increased government spending in the agriculture sector, and the expected kick-off of the second phase of the China-Pakistan Economic Corridor. For the time being, however, those two hopeful events seem months, if not years, in the future, and it remains to be seen whether sales will actually improve. n

AUTOMOBILES

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By Taimoor Hassan

A

sk the scholars that spend decades obsessing over Japanese aesthetics and they will tell you tales of loft ideals and an ideology of beauty.

They will wax and wane philosophical about the transient and stark beauty of wabi, the beauty of natural ageing known as sabi, the profound grace in the subtlety of yugen.

The modern study of Japan, in particular Japanese aesthetics is perhaps the most understated yet currently most prevalent oriental enterprise in existence. Perhaps it is based in history, the fact that Japan remains uncolonised - the undiscovered pearl of the East that the great European empires failed to make their own. Whatever it is, there is a defined fascination with all things Japanese.

But where the scholars would prefer to be known as academics engaged in Japan studies, the overarching phenomena comes down to one word: Weebs. A weeb is a derisive term for a non-Japanese person who is so obsessed with Japanese culture that they wish they were actually Japanese.

More than anything else, a weeb is a category of people. It is greatly an American export, once again going back to history, perhaps because of the states’ latent guilt over their atomic adventures in Japan at the end of the second world war.

Weeaboos are usually characterised as a laughable counterculture. In a country like Pakistan, however, to be a weeb you need a certain level of exposure not just to Japanese cartoons, products and traditions, but also some understanding of the American subculture.

Why this small section of society is important to us is because they make up a market. A market that has a somewhat inelastic demand, because the product is something the consumers are passionate about and because they have the money to spare.

In Pakistan, MiniSo is the brand cashing in on the Japanese aesthetic. Walk into one of their stores, and you will feel like you have just been shoved by the Tokyo crowds into a Japanese outlet store. Their stores are sleek, all white walls with tinges and borders of red, set out like a sci-fi movie. They do not pander aggressively to the weeb crowd (you will find no anime posters or katana replicas), but it does have a very modern Japanese vibe. From the soap dish alarm clocks to their knock off earphones, keyboards, bottles, lego sets, towels, slippers, cutlery, speakers, stationary and all number of other products - everything is decidedly Japanese.

Everything, that is, except MiniSo itself.

For despite its Japanese name, design and branding, MiniSo is a Chinese mass retail brand, and they have successfully made inroads all over the international retail segment, and Pakistan is no different.

MiniSo entered the Pakistani market in 2017, but started its earlier operations in China in 2013. Thus far, MiniSo has operations in 60 countries and regions including the United States, Canada, Russia, Singapore, the United Arab Emirates (UAE), Korea, Malaysia, Hong Kong (China) and Macau (China), with an average monthly growth rate of 80 -100 stores.

According to the website of the company, MiniSo has opened over 3,500 stores worldwide in five years of operations, with business turnover reaching US $2.5 billion in 2018.

In Pakistan, MiniSo opened its first store in 2017 and reached to 45 stores in just 2 years.

And things are only getting started.

The Japense aesthetic

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iniSo is not the only entrant in the international retail segment and in Pakistan. Two more brands with similar concept have also jumped in to lay their claim on the pie, but are rather very small as compared to MiniSo. These other two brands are XimiVogue and Latt Liv. The story, however, is the same. Both of these brands also sell themselves as Japanese retailers, but they are headquartered in, you guessed it, China. They were started in, began their operations in and continue to have their major operations in China. They make their products in China, all or at least one of the cofounders are Chinese, and yet, all three of them insist that they are not Chinese.

In the retail business, especially designer retail as brands like MiniSo are, image is everything. And if you are a Chinese retailer, it is not going to be a same-noodle-different-sauce scenario. If you tell your customers you are a Chinese retailer that makes its products in China, they will immediately think cheap and perishable. If you sell it to them as Japanese, they will immediately think high end, high quality. This leads these retailers to adopt identities to best market themselves.

For instance, MiniSo portrays itself as a ‘Japan-based designer brand’, though the bulk of its operations are in China and their initial operations actually started in the Chinese market in 2013. In China, it operates over a thousand outlets opened in a span of a few years. The company was originally founded in Japan in September 2013 by Japanase designer Miyake Jyunya and his Chinese partner and

president of the company, Ye Guo Fu. In the month following the opening of their office in Japan, the founders moved on to China and set up an office in Guangzhou, which became the headquarters of the company. The initial Japanese branch, and designer, thus become simple tools to give legitimacy to their farcical illusion.

MiniSo has been criticised for masquerading as a Japanese brand even though it operates only a handful of stores in Japan while its stores in China are over 1,000. In an interview with Singaporean publication The Straits Times, MiniSo founders had to defend the company’s Japanese origin and insisted that it is actually a Japanese designer brand, even though media reports say that when MiniSo launched in China, it had no outlet in Japan. The founders even had to defend the name which sounded like Japanese retailer giant Daiso, and its logo which resembled that of Uniqlo - another Japanese retail brand.

Similarly, XimiVogue, also known as XimiSo, calls itself a ‘Korea-based designer brand’, while Latt Liv categorises itself as a Scandinavian concept brand.

The Chinese context is important. Given the reputation of Chinese retail products particularly in the lifestyle category, it’s not surprising that these brands would run away from their true origins and try to portray themselves as something which they are not. There is a lot of stigma around Chinese products which are shunned, at least by Pakistani consumers, for being low on quality. And as such, the stigma around Chinese products would kill the market even for the best of these products.

But an insider tells Profit that these brands are actually Chinese and their products are ‘made’ in China. Giving it a spin to make it look like a Japanese brand is a marketing strategy, or rather a gimmick of sorts, as Japanese products are well respected for their quality and well demanded in the international markets including Pakistan.

For these brands, courtesy the inexpensive product manufacturing value chain in China, it is the convenient prices that make the model attractive. Aesthetically pleasing, good quality lifestyle products ranging from kitchenware to health and fitness to fashion can be bought from any of these brands at a low price.

Imagine the customers you would pull if you had (supposedly) Japanese products to sell, for as low as Rs200-250 per item.

The business model

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iniSo’s business model is an innovation of the traditional retail business models that we are familiar with. Its strength are the low price products because of low-cost

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retailing model, but one that has been tweaked to keep customers coming back.

MiniSo keeps costs and consequently prices low because its products are designed in-house and it has an efficient supply chain.

More importantly, however, low prices are a result of low margins that the company earns for itself. Forbes reported citing MiniSo founder Ye Guofu’s interview with Cheung Kong Graduate School of Business in the spring of 2017, that the company’s gross margin was a tiny 8%.

So how does MiniSo keep customers coming back for its products?

At each MiniSo store, only a limited range of products is offered with a limited stock. This yields in a high inventory turnover. So if you like some products at MiniSo, which you surely will because the products are really nice in design and quality, you better rush to the store and buy it as quickly as possible because the stock is more limited, and if the stock depletes, the same range would not be available. It would be replaced with a new range though, with even better looking, high quality products, creating a treasure-hunt sort of an experience for the customers, who keep on coming back, fascinated by some of the best looking products at very low prices.

Making millions?

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iniSo, like most things Chinese in this century, likes to be in control.

All over the world, they run their vast array of shops themselves, preferring to micromanage everything. In Pakistan, however, the majority of the MiniSo stores you see are franchises.

In an interview with Aurora magazine in December 2018, MiniSo’s General Manager for Pakistan, Kezhi Jiang, had said that a majority of the stores worldwide were company operated but for further and a rather rapid expansion, MiniSo was putting stock in developing and implementing their franchising model.

If you were to get a MiniSo franchise in Pakistan, it would cost you a non-refundable management fee of $3,500, charged one time for 3 years, which comes to a total of $10,500.

In addition to this, there is a non-refundable franchise fee of $15,000 charged one time - both these are exclusive of taxes; another $15,000 as security deposit charged as a refundable amount.

MiniSo also charges $200 per metre square as advance renovation fee, $380 per metre square as advance furniture and fixture fee, $500 per metre square as advance first batch of goods fee and $8,000 for first batch of replenishment goods. All in all, the franchise cost, including the cost of the inventory for the first shipment, furniture and renovation, all of which depend on the size of the shop, the total

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Rs33-58 million plus tax

35-37% 12-18

MONTHS

Total cost of setting up a MiniSo franchise anywhere in Pakistan

Gross profit margin a franchise can potentially earn

The duration of recovery of investment from a franchise

7

The shortest an investment has been recovered from a franchise

36

The longest an investment has been recovered from a franchise

MONTHS MONTHS

for getting a MiniSo franchise for any location in Pakistan will cost you anywhere between $210,500-$372,500. That is obviously plus tax and that does not include rent for the outlet, which is to be borne by the franchisee.

That would be Rs33,048,500 to Rs58,482,500, at Rs157 for the dollar, plus taxes and rentals, for anyone who can foot the bill.

The return on investment is something MiniSo claims has the requisite bang for the many many bucks a franchise owner will have spent.

They claim to promise a gross profit margin of 35%-37% to all franchisees, while the return on investment is between 12-18 months.

For those with surplus money and looking to invest, MiniSo can be a gravy train. An industry expert told Profit that the margin offered by MiniSo to its franchisees is very lucrative and the shortest an investment has been recovered through a MiniSo franchise is seven months, while the longest it took to recover an investment has been three years.

Of course, MiniSo is not invulnerable to the calculus of foot fall and how certain locations bring more footfall to the store than

others, MiniSo is cautious about where its outlets are opened. The company has currently identified more than 100 locations where they want to open outlets. And while contracting a franchise, the location of the store is mutually decided by the company and the prospective franchisee.

An industry expert Profit talked to said that for a business like MiniSo, market of every location where a store is to be opened will be assessed, with the markets where the commercial activity is high is where an outlet should be opened.

Though both parties can propose markets, the franchisee shares multiple store options out of which Miniso finalises according to their criteria. And, as Profit got to know, MiniSo has rejected some franchises because of low commercial viability of the locations.

Franchises facilitate the company’s philosophy of rapid expansion. Multiple franchises would mean investment being mobilised quickly to open stores simultaneously. And many franchisees have contracted more franchises after opening their first outlet, which is

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a testament to the profitability of the business.

Another testament to the success of such outlets is that no franchise owner has shut down a shop or even relocated to a different place due to a lack of sales.

An industry expert told Profit that MiniSo’s marketing for the franchises is done primarily through store artwork and word of mouth as they want consumers who are already familiar with their brand to partner up with them.

Social Media platforms are used occasionally as well and more recently, MiniSo advertised discounts on social media for franchises to attract people to invest in MiniSo franchises despite a slowdown in the economy.

Giving its franchise model competition is XimiVogue. XimiVogue, also headquartered in China in the city of Guangzhou, has over 1,500 stores in 80 countries worldwide which it created in a span of 10 years, earning a total revenue of more than 2 billion RMB in 2018 (approximately US$297,876,140).

XimiVogue’s Pakistani presence is small with only 14 stores operational in major cities.

It plans to increase this number to 25 in a year’s time.

Now here’s what a XimiVogue franchise will cost you: for a three-year contract, a franchise fee of US $15,000, a management fee of $10,000, refundable security deposit of $10,000, basic store renovation at $200 per metre square and $600 per metre square for the initial stock of goods. All in all, for a 93 square metre store, XimiVogue would charge you a total of $132,560, that includes $76,850 for the complete store and $55,800 for the initial stock, exclusive of applicable taxes.

In rupee terms, at Rs157 for the dollar, it comes out to Rs16,835,120 or Rs16.83 million, plus tax. That is cheaper than a MiniSo franchise but the costs do not end there. A franchisee would also have to bear the costs for the shop rent, staff costs, utilities, taxes, registration and license fees etc.

Moreover, there are certain shopping malls in Pakistan with specific standard requirements and if a franchisee selects such a location, the cost of complete store renovation will increase by the additional costs incurred.

And for the cost that is apparently less than a MiniSo franchise, XimiVogue offers a higher margin of 45%-49% - 10-12% higher than what MiniSo offers.

However, Profit’s observations and conversations with the staff at the malls in Lahore where both these brands are present, revealed that though both the brands are considered hip and hot by customers, it was MiniSo that had a greater foot fall at its store in these malls as compared to XimiVogue. Even the staff at one of the outlets of XimiVogue admitted that where there is MiniSo, XimiVogue gets a beating. On the other hand, Latt Liv is too small and has only a handful of company-operated stores in Pakistan. And its franchising model is yet to start. n

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HOW ONE PAKISTANI TECHIE HELPED BUILD A $20 MILLION US-FOCUSED STARTUP

Fahad Aziz, co-founder of a $20 million healthcare startup, shares his insights into what makes makes investors heads turn

By Taimoor Hassan

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any startups do not even pass the first or second year of their existence.

And if they somehow do pass this phase, well, it was just their honeymoon period. Everything looks great at the time, your idea seems to be working, you might even have your first few customers and people might be wanting to join your team. But once you pass that phase and the startup becomes a business, that is when it becomes difficult to sustain, grow and succeed.

Fahad Aziz is the co-founder and chief technical officer of healthcare company CareAxiom, a subsidiary of US based compa-

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ny Caremerge, with offices in Chicago, San Francisco and Lahore. It was founded in 2012, and provides web and mobile-based solutions to improve coordinating care for senior citizens. It was named one of the fastest growing companies in the US by Inc5000 last year, and currently serves over 100,000 senior citizens.

How CareAxiom became a high-growth startup is a story of its own. Like all successful ventures, their journey had its period of tribulations. But one defining factor that allowed CareAxiom to achieve high growth was that they were able to raise investment whenever required. “You can grow organically but that is much slower. You have to raise money to grow. In the last five years, we [CareAxiom] raised $20 million in funding from various

CASH INFLUX

$20 million Amount of funds CareAxiom raised from investors in the last 5 years

investors. This, however, was not a one-time effort. It was an ongoing process. We raised $500,000 at first, then we did $2 million, and

For Google, that core action is ‘googling’. For Careem, that core action is booking, not just downloading the application and registering. In all of these cases, the core action should be the easiest to perform.

In his quest to raise investment for CareAxiom, Fahad sat in multiple sessions with over 135 investors. That precious time spent in fundraising rounds has given him an insight into what investors are looking for.

He outlined four crucial aspects to Profit that make or break an investor’s interest in any startup.

The Team

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then $4 million, $14 million and so on,” says Fahad.

He was speaking to Profit at a tech summit organised by CareAxiom and Open Lahore at Lahore’s Arfa Karim Tower - the same building that houses Plan9, the Punjab government’s incubation center for startups.

he investor looks at the team’s ability to deliver on what they are promising.

And that requires the team members to complement one another. Investors are watching out for any overlap in the team members’ skills, and will instead go for a team that possesses a diverse skill set.

“If you have two co-founders and both of them are technical [persons], it may not go very well [with the investor]. A technical co-founder and another one who has a business acumen would go rather well since the skill sets are diverse. Same would be true for someone in the team who has a background in marketing. They need to complement each other,” Fahad says.

According to him, investors are keen observers. They can decode the body language of a team and look for signs about whether the team has any contradictions among its members, or whether a team member negates what is said by his peers.

“They [the investors] want to make sure that those who are presenting before them can work together. They are looking at your body language. That you are not negating each other, not interrupting each other’s conversation.

This first conversation with the investors is going to tell them whether the team members are doers or will simply waste the money,” he adds.

The Product “Your product has to be good, it has to be

In his quest to raise funds for CareAxiom, Fahad sat in multiple sessions with over 135 investors. That precious time spent in fundraising rounds has given him an insight into what investors are looking for. He outlined four crucial aspects to Profit that make or break an investor’s interest in any startup

unique, it has to be 10 times better than what is in the market,” says Fahad.

If you want investors drooling over the money your startup could potentially earn them, just a good product won’t cut it (unless you are building something that doesn’t exist just yet). But if you are debuting in a market where there is already some competition, it is ideal that you build something that is at least 10 times better, and has the potential to significantly grow.

For instance, if you tell a potential investor that you are entering the ride-sharing startup space with a Careem or Uber-like app, you’ll only look absurd while pitching that idea. Copying the same model won’t cut it.

Of course, unless your investor is Softbank or something similar, and you have an idea so appealing that your investors can’t resist, they’ll probably still think twice before investing in your ride-sharing startup. Uber and Careem are established competitors, while your startup is on a shoestring.

“If you are building something that is already in the market and your solution is one or two times better, that might not go very well. It needs to have something that really affects that, so it has to be 10 times better,” says Fahad. In short, don’t build if you can’t build the best.

The Market

“I

f you are building a technology, you want to make sure it can grow,” says Fahad. “You are building a great product, but what if your market size is too small?” he questions.

The size of a market is an indicator of how much your startup can grow. Investors simply won’t spend money on a startup if they don’t see a potential for growth, unless your investors are philanthropists that seek no return.

Safwan Khan, the founder of Xgrid, an Islamabad-based tech firm, said that if you are building a product that has a market of millions of people, you are looking at a billion-dollar company, but if your market is of 10 people, you can’t achieve anything.

Let’s say you are a budding entrepreneur. You want to solve a problem in Pakistan, because let’s face it, we have a lot of them. You are also an educationist at heart, so you want to solve a problem in the field of education.

You have identified a problem and you build

STARTUPS

an application - a solution that allows doctoral candidates to do, let’s say, research more efficiently.

You have built a great product, but will you be able to grow it? Or put it this way: how much can you scale it?

The answer is obvious. No matter how amazing your product is, your target market is too small. Pakistan only produces a few thousand doctoral candidates every year, making it extremely unlikely that an investor would be interested.

“You are better off building an application for students who are in matriculation,” says Fahad.

“This first conversation with the investors is going to tell them whether the team members are doers or will simply waste the money”

Traction

downloading an application. That is a good matrix, but not good enough. For some people it can be that how many people are signing up on their application and registering on it. A good matrix but still not good enough. It has to be something that is a core action that you want them [users] to perform. And you need to measure on that core action. That’s what grows the business and that is what brings value to the user. Downloading an application or registering on your application, sadly, is not good enough,” he says.

Let’s understand what these core actions can be. For Google, that core action is ‘googling’.

They want more and more people to google and they make it very easy for the users to do it. For Careem, that core action is booking, not just downloading the application and registering.

The more rides you as a user book, the better it is for Careem’s business. For Twitter, this core action is tweeting. For Youtube, it is about generating content.

In all of these cases, the core action

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robably the most important component investors look at is traction. It’s one of the main reasons behind the failure of most startups. Fahad believes traction is often an afterthought for most startups.

What defines traction? Traction is having a measurable set of customers or users that can tell the progress of a startup. Every startup’s traction is different; for some, it is revenue, or how much how much money a startup is making. In some cases, it is about engagement: can you continue to engage your users over time?

This is what investors love, says Fahad.

They want to participate in your startup so that they can get a return on their investment, which is why your startup needs to have some traction.

There are a lot of misconceptions among startups [about what user engagement means], he says.

“It might mean the number of people

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Fahad Aziz, Cofounder of CareAxiom

should be the easiest to perform. Tweeting is hassle-free and uploading a video on Youtube is relatively seamless.

It is for this reason startups offer free goodies to prompt users to initiate these core actions on their applications to increase their user base. Airlift, a ride-sharing startup, offers five free rides to customers using it for the first time. By offering these free rides, Airlift is is increasing its user base ie. it’s initial traction. It is pulling customers to perform the core action that forms the basis of its traction: booking rides. For comparison, Airlift does not offer free rides on downloading the application or creating an account with them.

“The first problem, which is very difficult for the startup to figure out, is what is their core action. Then there is the ‘leaky bucket’.

That is what if you have people who do the core action but never come back,” says Fahad.

“We need to stop that and that is the next step: retaining your user base. There are two ways to do that. One is by giving so many benefits to the user that they don’t want to leave.

You have to get your users to when they use your system, they benefit from it so much, they use it more and more and more,” he says.

Does that ring a bell? Every now and then Uber and Careem offer discounts to its existing customers. Why? To retain their customers, of course.

Secondly, says Fahad, you need to build enough value around your product so that the more consumers use it, the harder it is for them to leave.

“An example of this is Evernote. It allows you to take notes. But more than taking notes, it allows you to send your PDF files and emails.

It becomes a repository of all your documents.

Imagine losing all your documents. But then you remember there is a repository where these are safe and you can find these documents there.

It would be impossible to stop using it. There is so much accruing benefit that leaving is not a choice anymore,” he says. n

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