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Southeast Asia E-Commerce: Opportunity and Optimism Abound

Southeast Asia digital spend by category, 2016 (US$ billions)

Rising internet penetration, a young population, and rising incomes are pushing Southeast Asian shoppers online, thereby opening exciting opportunities for business and investment.

Southeast Asia’s 655 million plus population is increasingly migrating towards a digital-centric lifestyle, going online to conduct day-to-day activities such as shopping, entertainment, payments, and transport. Driven by an expanding middle class and a youthful, tech savvy population (about 43% of Southeast Asia’s inhabitants are aged 24 years and below according to data from the CIA), this evolution of consumer culture is expected to drive the region’s internet economy in the years ahead and e-commerce has emerged as one of the top categories for digital spending according to Bain & Company; of the region’s estimated US$ 50 billion internet economy in 2016, e-commerce accounted for US$ 15 billion or 30%, second only to travel and tourism which accounted for US$ 22 billion (equal to about 44%) of digital spending.

Southeast Asia digital spend by category, 2016 (US$ billions)

The dynamism is reflected in the growth numbers with Southeast Asia’s e-commerce sales of first-hand goods reaching US$ 10.9 billion in 2017, up from US$ 5.5 billion in 2015, representing a CAGR of 41% according to data from Google and Temasek’s “e-Conomy SEA Spotlight 2017” report.

Yet, there is still plenty of growth potential. With just about 390 million people in Southeast Asia connected to the internet, (making it the world’s third biggest internet population), internet penetration in the region stands at about 59%, thereby offering an untapped market of over 200 million people.

Bar chart showing the population of internet users and non-internet users in Southeast Asia by country as at December 2017. Indonesia had the highest number of internet users (143.26 million people) as well as the highest number of non-internet users (123.53 million people). After Indonesia, countries with the highest number of internet users are as follows: Philippines (67 million), Vietnam (64 million), Thailand (57 million), Malaysia (25.08 million), Myanmar (18 million), Cambodia (8.01 million), Singapore (4.84 million), Laos (2.44 million), Brunei (0.41 million) and Timor Leste (0.41 million).

And among this army of internet users, just a handful of them are active online shoppers and e-commerce accounts for just about 1% of total retail sales for most countries in Southeast Asia according to a report by ResearchAndMarkets. In Singapore, one of the region’s most mature e-commerce markets, online sales made up just 2.1% of total retail sales in 2015 – the highest proportion among Southeast Asian countries according to a report by Google and Temasek. This compared with China where e-commerce accounted for about 12.1% of total retail sales in 2015, according to the National Bureau of Statistics.

Unsurprisingly, there is an air of optimism about Southeast Asia’s e-commerce growth prospects and the region is expected to be the next rising star of e-commerce in Asia. Asia-Pacific e-commerce sales grew 31.1% in 2017, according to data from eMarketer, however nearly 83% of those sales came from China alone, the world’s biggest e-commerce market. Japan, South Korea and India make up the top four e-commerce markets in Asia-Pacific, which leaves Southeast Asia as the next frontier for e-commerce growth thereby opening opportunities for business and investment in the region. BMI Research projects Southeast Asia’s e-commerce sales to explode from US$ 37.7 billion in 2017 to US$ 64.8 billion by 2021, representing a CAGR of 14.5%.

Indonesia

Boasting the fourth largest population in the world, the largest population of internet users and the largest economy in Southeast Asia, Indonesia is often touted as one of the most promising e-commerce markets in the region.

Indonesia’s e-commerce market was valued at US$ 8 billion in 2017 according to McKinsey and the market is forecast to grow eight-fold to US$ 55-65 billion by 2022, representing a grand CAGR of over 45% driven by increasing internet penetration and a growing consumer class; just about 53% of the country’s 260 million plus population is connected to the internet, leaving an unconnected population of over 120 million, and the country’s consumer class is projected to grow from 45 million in 2010 to 135 million by 2030 according to analysis by McKinsey Global Institute which represents huge potential for internet retailers.

With e-commerce accounting for 1.6% of Indonesia’s total retail sales as of 2016 (compared with 13% in China the same year) according to a report by AusTrade, and with just 15% (equal to about 30 million) of Indonesia’s adult population of 195 million being active online shoppers as of 2017, Indonesia’s e-commerce market, already the largest in Southeast Asia, is still at an infant stage of development and these driving forces are expected to propel the number of Indonesian online shoppers to 43.9 million people by 2022 and Indonesia’s online sales are expected to make up about 20% of total retail sales by 2020 according to estimates by Indonesia’s Trade Ministry. ResearchAndMarkets released a year 2018 report which foresees Indonesia to have the highest e-commerce growth rate in the region through 2025, and the potential has lured the likes of e-commerce giants Amazon, Alibaba who are aiming to capture a slice of this ever-growing pie which is currently dominated by homegrown head honcho Tokopedia with a 14% market share according to data from CLSA. Tokopedia is followed by Singapore-rebased Shopee with a market share of 11%, Bukalapak and Alibaba-backed Lazada with 6% each. 28% is taken up by other e-commerce platforms (such as Zalora, Blibli, MatahariMall and China’s JD.com-owned JD.id) while 36% of Indonesian online sales is generated by social media platforms, (notably Facebook and Instagram) and messaging apps (such as Whatsapp).

Part of the reason for the rise of social commerce in Indonesia could be attributed to a few factors; Indonesians are avid social media users (according to Hootsuite, Indonesia has the world’s fourth biggest population of Facebook users, and the world’s fourth biggest population of Instagram users, and according to Twitter, Indonesia has the world’s fifth biggest population of Twitter users), and Indonesian online shoppers seem to have a preference for interacting one-on-one with the seller prior to making a purchase. Banking on this consumer culture, a number of Indonesian SMEs began selling their wares online using available online channels such as social media, way before e-commerce platforms became ubiquitous. As a result, social commerce developed before e-commerce websites became mainstream with social commerce accounting for as much as 50% of online sales in Indonesia before dropping to 36% in 2017 as e-commerce websites gained traction.

While e-commerce is gathering momentum among Indonesian online shoppers, quite the opposite is taking place in China, the world’s biggest e-commerce market, where social commerce is gradually taking root and finding its place alongside well-entrenched e-tailing websites. Barely three years old, Pinduoduo, a Chinese social commerce platform launched in 2015, filed for an IPO this year, raising US$ 1.6 billion in what was the second-biggest Chinese IPO in the United States.

Hence, if the ongoing evolution of the relatively more mature Chinese e-commerce is anything to by, social commerce is likely to remain a formidable channel in Indonesia’s e-commerce sector going forward. However, the growth opportunity for dedicated e-commerce platforms could be more exciting as they potentially continue taking up market share from social media platforms. According to McKinsey, Indonesian online sales through e-commerce websites is forecast to grow eight-fold from US$ 5 billion in 2017 to US$ 40 billion by 2022 while online sales from social media is expected to rise about five-fold or so from US$ 3 billion in 2017 to US$ 15-25 billion by 2022.

Bar chart showing Gross Merchandise Volume (GMV) in Indonesia’s e-commerce market in 2017 and 2022 (forecast) (US$ billions). In 2017, Indonesia’s total GMV was estimated at over US$ 8 billion with about US$ 5 billion being generated by e-tailing websites and over US$ 3 billion being generated by social commerce channels. By 2022, Indonesia’s GMV is forecast to grow to US$ 55065 billion with US$ 40 billion being generated by e-tailing websites and US$ 15-25 billion being generated by social commerce channels.

So far, certain categories have been high flyers in Indonesia’s e-commerce growth wave. Much like in other Asian e-commerce markets such as India, Indonesian online shopping baskets tend to contain products in Fashion (the leading product category as per one market survey); Electronics & Media; Furniture & Appliances; Food & Personal Care; and Toys, Hobby & DIY product categories.

Although integrated e-commerce platforms such as Tokopedia, Lazada, and Blibli have been taking the limelight, specialist e-commerce websites that cater to these popular product niches are also showing promise. Seven-year old Islamic fashion e-tailing startup Hijup for instance, was ranked 20th in the number of visits to e-commerce sites in Indonesia in the second quarter of 2018 with a monthly average of 930,000 visits and has topped the list as the most followed e-commerce business on Instagram.

Much like the ongoing evolution of mature e-commerce markets such as China and India, where a proliferation of specialist e-tailing websites such as China’s Gome and Vipshop (which specialize in home ware and fashion respectively), and India’s Pepperfry and Ajio.com (which specialize in furniture and fashion respectively) take market share from integrated e-commerce bigwigs such as Alibaba in China and Flipkart in India, there is tremendous long term growth opportunity for such specialist sites in Indonesia as the country’s e-commerce market matures.

Indonesia’s largest luxury retailer, Masari Group appears to have spotted one such gap; luxury fashion. Although Indonesia isn’t particularly noted for its affluent class (unlike India or China for instance where swelling high income consumers has given birth to a burgeoning luxury fashion e-commerce market), the country is seeing a steady growth in its population of affluent consumers. And yet, there is no clear e-commerce platform for luxury fashion and unlike in India or China where existing e-commerce players are adding a luxury fashion component to their respective websites (Indian e-commerce giant Flipkart’s fashion arm Jabong for instance is piloting a ‘Jabong Luxe Store’ while Chinese e-commerce behemoth Alibaba launched ‘Luxury Pavilion’, an invite-only platform for premium and luxury brands to strut their stuff) so far there has yet to be such a move towards a dedicated platform for luxury brands by Indonesian e-commerce websites. Sensing an opportunity to offer an avenue for the country’s affluent demographic to shop online for high-end fashion wear, accessories, and shoes, Masari Group launched an e-commerce website showcasing products from brands such as Les Petits Joueurs, Rodo, Dorateymur to name a few.

Malaysia

A young, tech-savvy population with relatively high incomes, and a strong infrastructure make Malaysia a potentially lucrative e-commerce market.

As Malaysians increasingly turn to online channels for their shopping needs, e-commerce has been steadily growing its share of Malaysia’s GDP; e-commerce’s share of Malaysia’s GDP stood at 6.1% or RM 74.6 billion in 2016 according to Malaysia’s Statistics Department, up from 5.9% or RM 68.3 billion of in 2015. Online sales made up about 2.5% of Malaysia’s total retail sales in 2015 and the figure is expected to reach 4%-5% this year according to online deal website 11street. A 2016 report by yStats foresees Malaysia’s e-commerce sales jumping five-fold by 2025.

Several factors suggest that Malaysia, Southeast Asia’s fourth-largest economy according to data from the IMF is at an inflection point of e-commerce growth; internet penetration stands at about 78% as at December 2017, according to data from Internet World Stats, the country’s middle class is expanding (Malaysia, ranked third among Southeast Asian nations in terms of GDP per capita by PPP as of 2017 according to figures from the CIA, and incomes are rising among Malaysia’s youthful population (the median age of the country’s population is 28.5 as of 2017 according to the CIA, making it the country with the sixth-youngest population in Southeast Asia, younger than Thailand (median age: 37.7), Singapore (34.6), Indonesia (30.2), Vietnam (30.5), and Brunei (30.2). And with about 45% of the country’s population aged 24 and below according to data from the CIA, the long term outlook for Malaysia’s online sales growth is bright as these tech-savvy youngsters rise up the income ladder.

Although pundits point out that Malaysia’s logistic infrastructure may pose a bottleneck to the country’s burgeoning e-commerce sector, it is still worth noting that regionally Malaysia’s infrastructure is second only to Singapore according to the World Economic Forum’s Global Competitiveness Index 2017-2018. This could make delivery quality, speed and costs relatively more competitive in Malaysia compared to regional peers, which could better enable Malaysian e-tailers to profitably offer free shipping (an important advantage in an era where free shipping is increasingly becoming a competitive necessity) which incentivizes buyers to spend more money shopping online and thereby propel the domestic e-commerce market forward.

Bar chart showing the World Economic Forum's Global Competitiveness Index, 2017-2018 Infrastructure score for selected Southeast Asian nations. Singapore ranks highest with a score of 6.5, followed by Malaysia (5.5), Thailand (4.7), Indonesia (4.5), Brunei (4.3), Vietnam (3.9), Philippines (3.4), Laos (3.3) and Cambodia (3.1)

With the e-commerce space in Malaysia seemingly ripe for the taking, competition is heating up among e-tailers both foreign and local for a share of the pie. The horizontal e-commerce space is crowded with well-established players dominating the arena such as Alibaba-backed Lazada, Singapore-based Shopee, and homegrown e-commerce pioneer Lelong. Competition could get stiffer in the years ahead with deep-pocketed e-commerce heavyweights such as Amazon (which has already established operations in neighboring Singapore) and Chinese e-tailer JD.com (which has tied up with retail giant Walmart to tackle the Southeast Asian market) potentially setting up shop in Malaysia.

Vertical e-commerce however offers ample opportunity. Similar to most e-commerce markets, Fashion is the leading online shopping category in Malaysia, and there has been a blossoming of a number of local and international fashion and fashion-related platforms, the success of which minted a fair number of millionaire founders. Homegrown online beauty store Hermo was acquired by Japanese beauty portal iStyle, netting Gobi Partners (Hermo’s ex-investors) a 91% Internal Rate of Return (IRR) in just one and a half years. Meanwhile Fashion Valet, another homegrown fashion e-commerce platform successfully closed its Series C round this year with an investment from Malaysia’s main sovereign fund Khazanah.

Apart from Fashion, other popular categories include Electronics; and Sports & Hobbies. Opportunities exist in other verticals which are tremendously popular offline but have yet to established online. Furniture is one example; Malaysia’s furniture market has grown in along with the growth of the country’s middle class and the country’s has a vibrant furniture industry, currently ranked as the world’s eighth largest furniture exporter as of 2017 and has a target of being among the world’s top five furniture exporters by 2022.

While horizontal e-marketplaces such as Lazada and Rakuten sell furniture online, specialist online furniture marketplaces are a relatively new concept in Malaysia and there is so far no dominant specialist furniture e-commerce site in Malaysia as is found in other countries such as Pepperfy and Urban Ladder in India, and Wayfair(NYSE:W) in the United States. Malaysian furniture online stores iHias and Apver could be poised to ride this potential.

Vietnam

With its relatively high internet penetration rate, youthful, tech-savvy workforce, and rising status as a low-cost manufacturing hotspot, Vietnam’s e-commerce sector could be one of the hottest growth stories in the region propelled by domestic as well as cross-border e-commerce.

With about 64 million of its approximately 96 million population connected to the internet (reflecting an internet penetration of about 67% according to data from Internet World Stats) and about 40% of the population aged 24 and below (the median age is 30.5) according to the CIA, Vietnam’s e-commerce market, which accounts for a meager 1% of the country’s total retail sales is a growth opportunity. Online sales grew 25% in 2017 to US$ 1.75 billion up from US$ 1.4 billion in 2016 according to data from Statista, driven by its young, tech-savvy workforce who happen to be among the most frequent online shoppers in Southeast Asia. According to the Visa Consumer Payment Attitudes Study 2017, Vietnamese were the second most frequent online shoppers with 84% of the 517 Vietnamese respondents saying they shopped online at least once a month, behind only the Thai respondents, 85% of which shopped online at least once a month.

And although challenges such as a relatively weak logistics weak infrastructure network (Vietnam ranks sixth out of nine selected Southeast Asian countries in terms of infrastructure according to the world Economic Forum’s Global Competitiveness Index, and logistics costs account for about 21% of Vietnam’s GDP as of 2016 according to figures from the World Bank) and low online payments penetration continue to dog Vietnam’s e-commerce sector, they have not deterred e-commerce behemoths such as Lazada, Amazon, JD.com and Shopee who, clearly playing the long game, continue to invest heavily as they race to capture market share in the Vietnam’s burgeoning online retail market. Euromonitor projects Vietnam’s e-commerce market to expand from US$ 1 billion in 2016 to US$ 2.3 billion by 2020, representing a CAGR of over 23%.

Like most other e-commerce markets around the world, fashion is the leading product category, with Vietnam’s working class women who have money to spend but little time to stop by every store, instead peruse a variety of online stores at the convenience of their internet-enabled devices to hunt for clothes, handbags, shoes and fashion accessories. Fashion is the most product popular category not just on e-commerce portals but also on social commerce channels such as Facebook.

Bar chart showing the most popular categories among online shoppers in e-commerce platforms and social commerce platforms according to a 2017 survey by Q&Me Vietnam Market Research. Fashion was the most popular category with 73% of e-commerce shoppers and 68% of social commerce shoppers spending the most on fashion products over the past 12 months. Fashion was followed by IT / Mobile phones, Food and beverage, Cosmetics, Kitchen appliances, Books / Stationery, Sports goods, Ticketing, Supplements / Functional foods, Consumer electronics, SPA / Beauty services, Flowers and plants, Music / Video.

After fashion, IT products, cosmetics, food and beverages, and books and stationery according to a 2017 survey conducted by Vietnamese market research firm Q&Me. While there is clearly tremendous potential for Vietnam’s domestic e-commerce market going forward, the more exciting part of the story however is Vietnam’s rising status as a manufacturing hotspot and the implications this status has on e-commerce. As manufacturing costs rise in China as result of rising costs of labor and land among others, a number of China-based manufacturers are shifting some or all of their manufacturing facilities away to other countries, a strategy known as the “China+1” production model. Thanks to its geographical advantage of being located close to China, Vietnam (particularly northern Vietnamese provinces such as Hai Phong) has been a major beneficiary of this trend, which has had the effect of widening the country’s manufacturing base, and boosting the area’s GDP and real estate demand. Vietnam’s ascent has a manufacturing hotspot gives the country’s local businesses an advantage in selling to the global market, which suggests bright prospects for Vietnam’s cross-border e-commerce sector.

Global e-tailing giant Amazon has clearly noticed Vietnam’s potential in this space. This year, Amazon announced a partnership with the Vietnam E-Commerce Association (VECOM) to allow local and small and medium-sized enterprises to sell and export Vietnamese-made goods through the platform. Alibaba-backed Lazada has also jumped into the ring with the company revealing that it was developing tools to help sellers peddle their wares to Southeast Asian countries in which Lazada has operations such as Malaysia. Tiki.vn, backed by Chinese e-tailer JD.com has launched a cross-border e-commerce channel, “Tiki Global”, to enable consumers to purchase foreign products directly from foreign manufacturers.

Philippines

In a country where logistics infrastructure is lacking and shopping malls function as “destinations” whereby they represent more than just places to shop, dine and entertain friends, but also serve as places of worship, workout classes and more, e-commerce may not necessarily displace Philippines’s plethora of shopping malls in the near term. The long term outlook however for online retailing in Southeast Asia’s second most populous country is a lot more exciting.

Retailing is big business in the Philippines with the country being home to three of the top 10 largest malls in the world in terms of Gross Leasable Area according to a ranking compiled by WorldAtlas. For Filippinos however, shopping malls are not just places to shop, dine, watch movies and hang out with friends; shopping malls also function as places to pay bills, worship, workout (such as Zumba classes), conduct government transactions (such as applying for driver’s licenses and business permits) and more.

With shopping malls performing an ever-growing list of functions to cater to a shopping lifestyle somewhat unique to the Philippines, the rise of e-commerce may not necessarily spell the demise of the country’s shopping malls (at least in the near term) as has been the case in the west. Furthermore with Philippines being a notable infrastructure laggard (the country’s logistics infrastructure network that is among the weakest among Southeast Asian nations), the resulting relatively uncompetitive delivery charges could be a turn off to the country’s price conscious shoppers (at about US$ 8,300 per person Philippines’ income per capita is also among the lowest in the ASEAN region according to data from the CIA) which means online retailers may be compelled to absorb bulk of the delivery cost at the expense of their bottom lines. This challenge may impede Philippines’ e-commerce sector from achieving its fullest potential going forward.

Bar chart showing the 2017 GDP per capita (Purchasing Power Parity) among Southeast Asian nations according to data from the Central Intelligence Agency. At US$ 93,900 per person, Singapore had the highest GDP per capita. Singapore was followed by Brunei (US$ 78,200), Malaysia (US$ 29,000), Thailand (US$ 17,900), Indonesia (US$ 12,400), Philippines (US$ 8,300), Laos (US$ 7,400), Vietnam (US$ 6,900), Myanmar (US$ 6,200), Timor Leste (US$ 5,400) and Cambodia (US$ 4,000).

Although the near term view for Philippines’s online retail market may not appear to be as potentially lucrative compared to regional peers such as Indonesia or Vietnam, that however does not necessarily reflect a lack of long term potential. With just about 1% of Philippines’s total retail sales coming from e-commerce in 2017 according to The Philippine Retailers Association, and with the country expected to overcome its infrastructure inadequacies over the next decade through development programs such as the ‘Build, Build, Build’ program, Philippines’ e-commerce businesses could be set to ride a wave of growth in the long term in a market that could prove to be one of the biggest in Southeast Asia; among Southeast Asian nations, Philippines has the second largest population (estimated at over 100 million in 2017 according to data from the CIA), the second largest population of internet users (estimated at 67 million in 2017 according to Internet World Stats), and the second-youngest population with a median age of 23.5 (behind Timor Leste where the median age is 18.9 according to data from the CIA).

Like many other e-commerce markets in Southeast Asia, Philippines’ online retail sector is driven by its youth and as this tech-savvy generation climbs up the income ladder in the years ahead, there is tremendous growth potential for online consumption growth. Unsurprisingly, a report by Google and Temasek projects Philippines’ e-commerce sector to be worth US$ 19 billion by 2025, overtaking Malaysia and Singapore.

 

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Malayan United Industries (MUI Group): An Asset Rich, Undervalued Opportunity?

Bar chart showing domestic holidays in Great Britain during 2008-2017 (in millions of trips). In 2017, there were a total of 59.149 million recorded domestic holiday trips made in Great Britain, the highest since 2008.

Wielding a collection of renowned brands such as Laura Ashley and Metrojaya in the retail sector, Corus Hotels in the hospitality sector, Kandos and Tudor in the food sector, and Bandar Springhill in the property development sector, could asset-rich Malaysian conglomerate Malayan United Industries prove to be a diamond in the rough?

Malayan United Industries (KLSE:MUIIND) once a corporate powerhouse has under-performed over the past several years and has consequently lost its charm among investors. However, with MUI founder Tan Sri Khoo Kay Peng relinquishing his role as Chief Executive Officer in December last year, and paving the way for his son Andew Khoo Boo Yeow to take over the reins, changes are already underway with the new CEO spearheading a restructuring exercise aimed at building a sustainable business in the long run.

Key restructuring initiatives include corporate restructuring, business transformation (which involves transforming MUI’s key brands such as Laura Ashley into a lifestyle brand) and deleveraging (which will see the company’s debt burden being reduced through divestitures among other options). With such measures to unlock shareholder value being implemented, can the asset-rich long-time laggard turn its fortunes around, and regain its former glory?

Laura Ashley (LON:ALY)

Plans are underway to transform Britain’s iconic Laura Ashley brand (and one of MUI’s crown jewels) into a lifestyle concept by expanding from the current fashion, accessories and home furnishings business into other areas such as hotels (currently the company owns two hotels – Laura Ashley The Manor, and Laura Ashley The Belsfield – both located in the UK) and cafés (the company’s opened its first café – Laura Ashley The Tea Room – in June 2017). Future plans will see the brand expand into the spa business as well. The idea of transforming a brand into a lifestyle concept is nothing new and while some brands such as Missoni and Moschino have fallen off the runway (the fashion houses checked out of the hotel business a few years ago) a number of others, such as Bulgari, Mercedes Benz, Armani, Fendi, and Versace are still continuing the show. Buglari extended their famous jewelry brand into the now famous Bulgari Hotels and Resorts; Mercedes Benz steered their automobile brand into perfumes; Armani elevated the fashion brand towards luxury hotels and luxury furnishings; Versace strutted their fashion brand into fashion hotels; Jaguar took the auto brand up a notch with its lifestyle products ranging from clothing to accessories; Godiva sweetened their chocolate brand with its chain of lifestyle chocolatier cafés; and Fendi took the fashion brand to new heights with their hotel venture.

So can ailing Laura Ashley, which is struggling financially (profits have been falling over the past few years) as well on the stock market (its languishing share price has been a long time under-performer and is currently trading at a fraction of its value during its heyday decades ago in the mid-1990s), get back in vogue with a similar push?

While much would depend on strategy and execution, fundamentally, the idea holds potential. And if history is any guide, Laura Ashley appears to have had a reasonably fair track record in extending the brand beyond its core products. Starting out as a clothing brand, famous for its floral, billowy dresses typical of English fashion in the 1970s, which were in vogue up until the 1990s, Laura Ashley subsequently stumbled due to a combination of factors such as an ill-executed overseas expansion and a failure to adapt appropriately to changing fashions. The failed expansion dented the company’s finances while the failure to evolve meant the brand’s classic style gradually became more and more classic, which later on ended up looking completely outdated altogether. And although years later Laura Ashley made an effort to update its chintzy image, customer perceptions are hard to change, contributing to flagging financials.

Despite these setbacks, it is noteworthy that the company successfully made great strides in transforming the brand’s product offering from one limited to just clothing to one spanning furniture, decorating items and home accessories. A few years ago clothing accounted for 50% of sales, but now it accounts for just 17% and is the smallest revenue generator of all of Laura Ashley’s four business segments according to its latest annual report. The biggest revenue earner, Home Accessories (which includes products such as lighting, gifts, bed linen, rugs, cushions, and children’s accessories), accounts for 34% of UK sales followed by the Furniture segment (cabinets, beds, and mirrors) which accounts for 29%. The balance 20% comes from the Decorating segment (fabric, curtains, wallpaper, paint and decorative accessories).

So could the new hotel venture be the key to unlock the brand’s value and reverse the company’s sagging financials?

Laura Ashley is an upscale brand synonymous with British heritage and the company’s new hotel and café brands are clearly positioned in similar fashion with all three Laura Ashley hotels (Laura Ashley The Manor Elstree, Laura Ashley Belsfield Hotel, and the upcoming Laura Ashley Burnham Beeches) and its two cafés (Laura Ashley The Tea Room in Solihull and Buckinghamshire) offering quintessentially British experiences to their well-heeled guests.

Britain has no shortage of hotels offering “quintessentially British” experiences such as The Savoy, and The Langham London. However, Laura Ashley hotels differentiated themselves by offering their upscale iconic British-style getaways in some of England’s endeared countryside locations. Laura Ashley Hotel The Belsfield for instance, is located along Lake Windermere in Lake District which is a World Heritage Site in North West England. Although plenty of travellers visit to enjoy the lake’s shimmering water and picturesque surroundings, there is little traveller spend in the area. Sensing an opportunity, in 2014 Laura Ashley acquired a Victorian-era mansion (it was built in 1845) overlooking Lake Windermere, and spent millions of pounds on refurbishment (with décor and furnishings from Laura Ashley of course) to offer a classic English-style countryside retreat, ideal for corporate events and weddings (in fact winter weddings bookings were reportedly up 75% during 2017). The strategy seems to be working with revenues and operating profits at the hotel reportedly increasing three-fold since being converted to a Laura Ashley hotel.

Banking on the success of this approach, plans are underway to convert Corus Hotels’ Burnham Beeches hotel which is located in the rolling Buckinghamshire countryside, into a Laura Ashley Hotel, which could potentially emerge as a promising top-line contributor going forward.

Yet, with Laura Ashley’s hotel segment accounting for just a fraction of group revenue (revenues from Laura Ashley’s hotel segment made up about 1% of total group sales according to Laura Ashley’s latest annual report), the rosy numbers may not be enough to move the needle at Laura Ashley in the near term.

The long view seems more promising. With Laura Ashley hotels being located in England’s countryside which tend to draw local travellers (as opposed to locations such as London, Manchester and Birmingham which are among UK’s most popular tourist destinations), the company is positioned to tap the UK’s domestic travel market which accounted for 80% of the UK visitor economy according to data from VisitBritain’s 2016/2017 annual review.

In 2017, Brits took 59 million domestic holidays in Great Britain, a 6% increase from the previous year, spending £14.1billion on domestic holidays in Great Britain, also a 6% increase over the previous year according to VisitEngland’s Trip-Tracker Survey.

Bar chart showing domestic holidays in Great Britain during 2008-2017 (in millions of trips). In 2017, there were a total of 59.149 million recorded domestic holiday trips made in Great Britain, the highest since 2008.

Furthermore, there is considerable potential for the Laura Ashley hotel brand to expand internationally, and the management seems keen to exploit this opportunity having announced plans to increase the number of domestic and international hotels to 100 over the next five years through licensing agreements.

There exists clear demand for British heritage brands outside the UK, particularly in countries such as Japan, South Korea, Hong Kong, South Asia and Southeast Asia with British-style brands Burberry, Church’s and Harrod’s cashing in on enthusiastic customers in these regions. This market could be an opportunity for Laura Ashley and with the brand’s planned hotels serving as a showcase for Laura Ashley products, they could potentially draw shoppers to Laura Ashley’s product offering.

Towards this end, Laura Ashley is taking steps to export the brand worldwide; Laura Ashley derives much of its sales from the UK and with international sales making up just 7.4% of group revenue according to the company’s latest annual report, the Laura Ashley brand is strongest among UK customers and appears to have relatively little recognition outside the UK. Laura Ashley has expanded into India with a signing of a licensing deal with India’s leading fashion retailer, Future Group. The company has also tied up with a partner in Thailand to tackle the Southeast Asian market.

Growing its international customer base could help the brand reduce reliance on sales from the UK, its primary market, insulating its financials from geographical shocks and thereby smoothening out revenues over the longer term. According to the company’s latest financial data, all business segments except Fashion suffered revenue declines, partly due to the impact of Brexit which saw UK consumers reigning in on big-ticket purchases. And with UK consumer spending not expected to recover as the uncertainty of Brexit’s impact on jobs and income hit hard on consumer confidence, British brands with a heavy reliance on the UK market such as Laura Ashley may find themselves in challenging conditions in the coming years. Keeping a long term view in mind, an international expansion could Laura Ashley minimize such geographical risks.

Since Laura Ashley was thrown a lifeline by MUI about two decades ago, MUI has yet to see a return on its investment, with Laura Ashley trading at just a fraction of its market value in the mid-1990s when it was looking its prettiest. Will this time be different? Only time will tell, but the company could be worth watching.

Corus Hotels

MUI Group’s hotel subsidiary Corus Hotels which operates a portfolio of hotels across the UK and Malaysia and is also the owner and operator of Laura Ashley Hotels has returned to profitability in its latest financial year with pre-tax profit of £1.7m on a turnover of £27.8m in the year to 30 June 2017 which is a 5.7% increase from the £26.3 million turnover recorded the previous year.

Having disposed of two “non-core” hotels in the UK (namely The Old Golfhouse Hotel in Huddersfield, and The Imperial Crown hotel in Halifax), Corus Hotels’ UK portfolio comprises Corus Hyde Park in London, Burnham Beeches in Buckinghamshire, The Chace Hotel in Coventry, The Hillcrest Hotel in Widnes, Grimsby’s The St James Hotel and The Regency Hotel in Solihull. Corus Hotels also operates two Laura Ashley Hotels namely The Belsfield and The Manor Elstree, while a third hotel will be added to the Laura Ashley Hotel portfolio soon with the rebranding of Corus Hotels’ Burnham Beeches in Buckinghamshire.

Corus Hotels’ flagship hotel Corus Hotel Hyde Park (in London) which generated revenue of £11.9 million (accounting for over 40% of Corus Hotels’ revenue) recorded an average room occupancy of 75.8% for the year ended 30 June 2017. Although this is lower than the 2017 average room occupancy rate of 81.7% in London according to data from Colliers International, it is reportedly an improvement over the hotel’s average room occupancy rate last year according to its latest annual report.

Bar chart showing the top 5 cities with the highest hotel occupancy rates in the UK, 2017 (%). At 83.7%, Edinburgh had the highest hotel occupancy rate in the UK in 2017, followed by Oxford (82.6%), Glasgow (82.1%), London (81.7%) and Belfast (81.6%)

Over in Malaysia, for the year ended 30 June 2017, Corus Hotels Kuala Lumpur, which is strategically located within walking distance to Malaysia’s major tourist attraction KLCC, recorded an average room occupancy rate of 61% (lower than the 66.1% hotel occupancy rate recorded for Kuala Lumpur in 2017 according to data from CEIC) while Corus Hotels Port Dickson recorded an average room occupancy of 64.1% (considerably higher than the 55.7% hotel occupancy rate recorded for Negeri Sembilan in 2017 according to data from CEIC).

It is not clear how well the other hotels in Corus Hotels’ portfolio performed, however, what is known is that business has reportedly improved since two hotels, The Belsfield and The Manor Elstree were converted into Laura Ashley-themed hotels. The conversion of Burnham Beeches into a Laura Ashley Hotel is a continuation of this strategy and with more hotels under the Corus Hotels umbrella likely to follow the same path, Corus Hotels’ bottom line could get a much needed lift, benefiting MUI Group as well; Laura Ashley hotels target upper middle class travelers and are positioned as boutique hotels with fewer rooms (often less than 100, compared to Corus Hotel Hyde Park which has over 300 rooms) and higher room rates (for instance room rates at Laura Ashley The Belsfield is almost double that of Corus Hotel Hyde Park), which makes Laura Ashley Hotels a higher-margin and less capital-intensive business.

While this potentially profitable strategy gives reason to be optimistic about Corus Hotels’ future valuation, there is reason to be optimistic on its present valuation as well; many of Corus Hotels’ properties have been valued decades ago and their current market values could be considerably higher than their current net book values (NBV). For instance, Corus Hotel Kuala Lumpur, which occupies prime freehold land in Jalan Ampang less than half a kilometer away from KLCC, was last valued in 1982, and its current NBV is just Malaysian Ringgit (RM) 54.5 million according to MUI Group’s latest annual report. That values the property at about RM 843 per square foot. By comparison, an empty development land also along Jalan Ampang, about 2 kilometers away from KLCC and less than 2 kilometers away from Corus Hotels is currently seeking a buyer at about RM 2,300 per square foot, nearly three times the current NBV of Corus Hotels’ Kuala Lumpur. That would suggest Corus Hotels Kuala Lumpur could command a value of at least RM 200 million (some reports have put the figure as high as RM 300 million), and this property alone would thereby make up about 40% of MUI Group’s entire market capitalization of about RM 500 million currently.

Corus Hotels’ other Malaysian property, Corus Paradise Resort in Port Dickson, currently carries a NBV of RM 24.5 million according to MUI Group’s latest annual report, equivalent to about RM 41 per square foot. By comparison, a plot of land for sale along the same road as Corus Paradise Resort, was listed at a sale price of RM 45 per square foot. Meanwhile, hotel operator Avillion Berhad’s (KLSE:AVI) Avillion Port Dickson hotel which occupies a mix of freehold and leasehold land about two kilometers away from Corus Paradise Resort, is valued at RM 236 per square foot according to the company’s latest annual report.

Part 3 of this series (Metrojaya) will be coming soon. Sign up for the newsletter to get the article delivered to your inbox.

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Blockchain Startups Disrupting The Real Estate Industry

Bar chart showing Asia Pacific cross border commercial real estate investments, capital outflows by source (in US$ billions), in 2017. China was the biggest source of outbound capital into commercial real estate, with US$ 31.5 billion of cross border commercial real estate investments originating from China. China was followed by Hong Kong (US$ 20.5 billion), Singapore (US$ 19.9 billion), South Korea (US$ 8.6 billion), Japan (US$ 3.1 billion), Taiwan (US$ 1.7 billion)< Australia (US$ 1.7 billion), Thailand (US$ 1.1 billion), Malaysia (US$ 0.5 billion), and India (US$ 0.3 billion).

Having revolutionized banking, blockchain, the underlying technology behind Bitcoin, is set to bring change to the multi-trillion dollar real estate industry.

The global real estate industry, estimated to be worth trillions of dollars, could prove to be a lucrative industry to disrupt considering the current systems related to land titling which involves mountains of documents into which data and information on land transactions are manually inputted, is a time-consuming process that is susceptible to fraud and clerical errors. The inefficiencies and inadequacies in the current land titling system is the driving force behind the multi-billion dollar title insurance industry; IBIS World estimates the US title insurance industry is worth about US$ 17 billion while data from the American Land Title Association (ALTA) reveal that nearly US$ 4 billion in title insurance premiums were generated in the US during the third quarter of 2017 alone.

Propy

Country: United States of America

California-based real estate marketplace startup Propy uses blockchain to maintain a decentralized title registry in an effort to enable people to buy and sell real estate in any location, from anywhere without the problems associated with international real estate transactions such as fraud.

Properties listed on Propy can be purchased using regular fiat currency or cryptocurrency; using the latter enables the usage of smart contracts and a blockchain-powered decentralized, immutable registry which ensures that all aspects of the transaction, as well as title deeds and property rights, are stored forever, in a tamper-proof database. In 2017, Propy made headlines when it announced it had completed the world’s first real estate purchase on Ethereum blockchain, when TechCrunch founder Michael Arrington purchased an apartment in Ukraine using smart contracts, in Ethereum cryptocurrency and PRO (Propy) tokens.

Cross border real estate has been on an upward trend and is likely to continue doing so. According to a report by Knight Frank, cross border real estate transactions accounted for 32% of all real estate transactions by volume, up from 25% during 2009-2011.

In Asia, cross border real estate transactions are at a 10 year high according to Real Capital Analytics and according to Knight Frank, 2017 marked the first time since tracking the markets in 2007 where Asia-Pacific has overtaken Europe and North America as the top source of cross border capital outflow. Real estate buyers from China were the biggest source of cross border capital, followed by Hong Kong and Singapore according to Knight Frank while the US, UK and Germany were the top destinations for inbound capital.

Bar chart showing Asia Pacific cross border commercial real estate investments, capital outflows by source (in US$ billions), in 2017. China was the biggest source of outbound capital into commercial real estate, with US$ 31.5 billion of cross border commercial real estate investments originating from China. China was followed by Hong Kong (US$ 20.5 billion), Singapore (US$ 19.9 billion), South Korea (US$ 8.6 billion), Japan (US$ 3.1 billion), Taiwan (US$ 1.7 billion)< Australia (US$ 1.7 billion), Thailand (US$ 1.1 billion), Malaysia (US$ 0.5 billion), and India (US$ 0.3 billion).

Propy is positioned to capitalize on this lucrative trend; of Propy’s approximately 50,000 monthly website views, about half come from China, from prospects looking to invest in real estate outside their home country.

Furthermore, according to Propy’s whitepaper, initially, the Propy Registry will mirror the records in local land registries in which land transfers are recorded. Going forward however, the startup aims to have the Propy Registry as the official ledger of record for the relevant land registry department. Propy earns a percentage of the final purchase price of every transaction completed using Propy’s platform.

If Propy does succeed in its ambition of getting jurisdictions to adopt the Propy Registry, then Propy’s PRO tokens could potentially hold more value since the Propy platform will be required (as opposed to being merely an option) to conduct real estate transactions. Whether this ambition actually materializes however, remains to be seen.

Zebi

Country: India

Having been selected by Andhra Pradesh to deploy its blockhain-based solution to digitize the state’s land registry, Indian blockchain-based big data solutions startup Zebi is now reportedly in talks with several other state governments to introduce its blockchain-based big data solution to digitize their land records easing buyer concerns over real estate fraud such as fake land certificates, a very real problem considering India has a 69% bribery rate (the highest in Asia Pacific) according to a survey by Transparency International and was ranked the most corrupt nation in Asia in 2017.

According to Indian government official J.A. Chowdary, an estimated US$ 700 million is paid in bribes to land registrars across India and about two-thirds of all civil cases in India are disputes related to land and property.

With transactions rising in India’s real estate sector and projected to continue rising over the next decade driven by the country’s young population reaching home buying age and rising disposable incomes (Morgan Stanley forecasts India’s property market sales to grow at a 14% CAGR during 2016-2020 and 18% during 2020-2025), Zebi’s Ethereum-based technology solution as well as its token (ZCO) could grow more important as it increases the reliability and transparency of India’s land registry, thereby reducing potential problems such as property related fraud.

ChromaWay

Country: Sweden

Swedish blockchain startup ChromaWay has tied up with the Swedish Land Authority (Lantmäteriet), consultancy group Kairso Future, real estate search portal Svensk Fastighetsförmedling, telecom Telai Sverige, IT firm Evry. and a group of participating banks namely SBAB and Landshypotek Bank to conduct a pilot program to demonstrate how a private blockchain network could carry out real estate transactions. Each step in the transaction process is verified, and stored securely and immutably on the blockchain, and all participants in the real estate transaction – the banks, the government, buyers, sellers – will be able to securely track and trace the state of the transaction as it progresses from start to completion.

Consultancy firm Jairso Future estimates the blockchain solution could save Swedish taxpayers US$ 106 million a year by eliminating paperwork, cutting transaction times and reducing fraud.

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Optimistic Outlook For Malaysia’s Industrial Property Sector

Bar chart showing Malaysia’s property transaction volume in 2017 (in number of units). In 2017, Malaysia property transactions in number of units were as follows: Residential 194,684 units, Commercial 22,162 units, Industrial 5,725 units, Agriculture 70,290 units, and Development Land and Others 18,963 units.

Demand for Malaysian industrial real estate could rise further driven by a resilient manufacturing sector and ASEAN’s growing e-commerce market.

Accounting for just 1.8% of Malaysian property transaction volume and 8.3% of transaction value, industrial properties contribute the least to Malaysia’s property transactions by volume and value according to data from Malaysia’s National Valuation and Property Services Department’s (JPPH) Property Market Report 2017.

Bar chart showing Malaysia’s property transaction volume in 2017 (in number of units). In 2017, Malaysia property transactions in number of units were as follows: Residential 194,684 units, Commercial 22,162 units, Industrial 5,725 units, Agriculture 70,290 units, and Development Land and Others 18,963 units.

Bar chart showing Malaysia’s property transaction value in 2017 (in millions of Malaysian Ringgit). In 2017, Malaysia property transactions by value were as follows: Residential RM 68,467, Commercial RM 25,439, Industrial RM 11,642, Agriculture RM 13,501, and Development Land and Others RM 20,794.

However, with Malaysia’s residential and commercial property sectors facing oversupply issues, the country’s industrial property sector may offer better prospects; Malaysia’s manufacturing sector is resilient (contributing 23% to GDP in 2017 and accounting for 15% of 2017 FDI inflows) which suggests industrial properties for manufacturing and warehousing could offer investment potential, and the country’s ecommerce market is booming which could open opportunities for industrial real estate in areas such as logistics and warehousing. In particular, larger storage space near ports and airports, and smaller warehouses located close to urban areas could see an uptick in demand, as distributors look to establish fulfillment centers close to their customer base in an effort to shorten parcel delivery times to online shoppers.

An example of this is when real estate private equity and advisory firm Area Management Sdn Bhd announced its plan to set up an inner city distribution hub in Kuala Lumpur. The warehouse which will have 1.2 million sq ft of warehouse space will be located in Hulu Kelang, in the town of Ampang, just about 10 minutes away from KLCC.

Such investments in industrial property could be just the beginning. ASEAN’s e-commerce market is booming, yet with e-commerce accounting for just 2% of the region’s total retail sales, (this is lower than the average worldwide which saw 10.2% of total retail sales coming from online sales in 2017 according to eMarketer). Singapore has the highest e-commerce penetration with 5.4% f total retail sales being made online, followed by Malaysia at 2.7% according to a report by Maybank Kim Eng Research suggesting ample room for growth. Research by Google and Temasek forecasts the region’s e-commerce sales to grow at a CAGR of 32% from US$ 5.5 billion in 2015 to reach US$ 88 billion in 2025, when they will make up 6% of total retail sales in the region. Management consulting firm A.T. Kearney expects Malaysia’s e-commerce market to grow 23% annually until 2021 according to a 2017 report.

Furthermore, as intra-ASEAN trade grows and consumption increases stimulated by rising incomes among ASEAN’s 600 million plus population (larger than that of North America and the European Union), logistics demand in the region is poised to grow. Malaysia’s strategic geographical location, and its strong infrastructure network puts it in prime position to emerge as a logistics hub for the ASEAN region. Malaysia’s infrastructure is second only to Singapore among ASEAN countries according to a report by the World Economic Forum.

Bar chart showing the World Economic Forum's Global Competitiveness Index, 2017-2018 Infrastructure score for selected Southeast Asian nations. Singapore ranks highest with a score of 6.5, followed by Malaysia (5.5), Thailand (4.7), Indonesia (4.5), Brunei (4.3), Vietnam (3.9), Philippines (3.4), Laos (3.3) and Cambodia (3.1)

A number of multinationals looking to capitalize on Southeast Asia’s emerging markets have already spotted Malaysia’s logistics potential. Swedish furniture company IKEA has selected Malaysia to be its ASEAN logistics hub and the company will be investing nearly a billion Malaysian ringgit to establish a regional distribution and supply chain in the country in what would be among its 10 biggest regional distribution centers globally. E-retailer Zalora has invested RM 20 million building a regional e-fulfillment hub in Malaysia and Chinese e-commerce giant Alibaba (NYSE:BABA) has selected Malaysia’s commercial capital Kuala Lumpur as one of the company’s five global hubs with the others being Hangzhou, Dubai, Liege and Moscow. French automaker Groupe PSA has selected Malaysia to be its ASEAN hub and Chinese tech giant Tencent (HKG:0700) has selected Malaysia as its ASEAN data center hub.

West Malaysia – Central Region

Selangor, Malaysia’s most prosperous state and the top contributor to Malaysia’s GDP (accounting for 22.7% of Malaysia’s GDP), dominates Malaysia’s industrial property market, boasting about 35% (or 39,139 units) of Malaysia’s industrial properties. Selangor is followed by southern region state Johor (16,117 units) and northern region state Penang (9,057 units).

Boasting logistics hubs such as Port Klang (Malaysia’s busiest container port), Shah Alam, and the upcoming KLIA Aeropolis, the state of Selangor, Malaysia’s richest state, shows potential to be developed into a regional logistics gateway to the ASEAN region thereby supporting ASEAN international trade. For instance, Swedish furniture retailer IKEA set up a new regional distribution and supply chain center in Pulau Indah Industrial Park in Port Klang, which will serve IKEA stores throughout the ASEAN region.

Port Klang is Malaysia’s busiest port and the world’s 11th busiest port according to the World Shipping Council. Although the formation of a new global shipping alliance, the Ocean Alliance, in April 2017 saw a number of carriers shifting from Malaysian ports to Singapore ports, resulting in a 10% drop in Port Klang’s container throughput, and with the rise of competing ports in the region such as Ho Chi Minh City and Jakarta further eating into Port Klang’s share of transshipment volumes (which account for over 60% of Port Klang’s volume according to data from the Port Klang Authority), Port Klang, ASEAN’s second biggest port, is still expected to remain as a secondary transshipment hub, second only to Singapore.

Thus, the current limited supply and higher prices of industrial land in Port Klang townships such as Pulau Indah is likely to persist. Last year, a land transaction in Pulau Indah topped the list of Malaysia’s highest industrial real estate transactions by value when a 274,413 sqm vacant plot in Pulau Indah Industrial Park sold for RM 112 million according to data from the National Property Information Centre (NAPIC).

With Malaysia’s first Digital Free Trade Zone being set up in KLIA Aeropolis, Port Klang has been identified as a potential location for another new Digital Free Trade Zone, industrial real estate demand in Port Klang as well as the surrounding area could see further increases.

Companies moving in to capitalize on the opportunity include Sime Darby (KLSE:SIME) and Japan’s Mitsui (TYO:8031) which have announced a partnership that would see the development of industrial facilities on 39 acres of land at Bandar Bukit Raja in Klang (about 20 kilometers away from Port Klang) with an estimated gross development value of RM 530 million.

Malaysian aluminum products manufacturer Alcom Group Berhad (KLSE:ALCOM) has announced its plans to diversify into property development with a RM 500 million gross development value industrial park project in Sungai Buloh (a district in Selangor, about 45 kilometers away from Port Klang) which will see a 9.4 acre vacant industrial land being developed into a gated and guarded industrial park.

Selangor is among the fastest growing states in Malaysia, with much of that growth driven manufacturing, services and agriculture (this compares with Kuala Lumpur where growth is driven by services).

Bar chart Malaysia’s economic growth by state in 2017. Sabah was Malaysia’s fastest growing state with a growth rate of 8.2%. Sabah was followed by Melaka (8.1%), Pahang (7.8%), Federal Territory of Kuala Lumpur (7.4%), Selangor (7.1%), Johor (6.2%), Labuan (6.1%), Terengganu (5.9%), Perak (5.5%), Penang (5.3%), Kelantan (5.0%), Kedah (5.0%), Negeri Sembilan (4.9%), Sarawak (4.7%), and Perlis (2.3%). Malaysia as a whole registered a GDP growth rate of 5.9% in 2017.

Shah Alam, the state capital of Selangor, is a popular manufacturing hub, located about 20 kilometers away from Malaysia’s biggest container port, Port Klang, 50 kilometers away from Kuala Lumpur International Airport and about 30 kilometers away from Malaysia’s vibrant city center Kuala Lumpur. This makes Shah Alam an attractive location for manufacturing, warehousing and distribution activities, and the city already boasts a number of high profile occupants including German logistics company DHL which maintains a supply chain logistics hub in Shah Alam,

Yet, as Malaysia’s burgeoning e-commerce market continues to grow, Shah Alam could see rising industrial real estate demand as its advantage of being strategically located close to Selangor’s key airport (KLIA), sea port (Port Klang) and being located within Malaysia’s Klang Valley (one of Malaysia’s most advanced retail markets) lure multinationals and e-commerce companies looking to establish warehousing, e-fulfillment and distribution facilities to tap into ASEAN’s growing army of online shoppers.

Suggestive of this potential, Singapore-based property developer Aspen (Group) Holdings Limited (SGX:1F3), has diversified into logistics, having acquired a 71 acre industrial land in Shah Alam which will be developed into an integrated logistics, warehousing and e-commerce hub.

FM Global Logistics (M) Sdn Bhd, a subsidiary of Malaysian freight services provider Freight Management Holdings Bhd (KLSE:FREIGHT) is developing an e-commerce fulfillment hub in Shah Alam.

Axis Real Estate Investment Trust (REIT) has acquired two parcels of industrial land in Shah Alam, for RM87 million.

Meanwhile DRB-HICOM (KLSE:DRBHCOM) has disposed of its non-industrial real estate assets in an effort to focus on industrial property development.

Fashion e-retailer Zalora selected Shah Alam to establish its e-fulfillment hub, fancying the industrial city’s merits of being close to the airport, the seaport and close to Kuala Lumpur where it has a large customer base.

Volvo, the Sweden-based subsidiary of China’s emerging automotive giant Geely (HKG:0175) announced that it is looking at making Shah Alam its export hub to serve the ASEAN market.

Malaysia’s KL International Airport is a 45 minute drive away from Malaysia’s leading container port, Port Klang, a 45 minute flight away from Singapore, a one and a half hour flight away from Bankok, Jakarta and Ho Chi Minh City.

Malaysian airport operator Malaysia Airports Holdings Berhad (KLSE:AIRPORT) is developing an air logistics hub, named KLIA Aeropolis, in a 404.7 hectare site surrounding the Kuala Lumpur International Airport. The airport city project is expected to attract RM 7 billion in foreign and domestic investments.

Having selected Kuala Lumpur to be its global hub along with five other cities, namely Hangzhou, Dubai, Liege and Moscow, Cainiao Network, the logistics arm of Chinese ecommerce giant Alibaba, is constructing the company’s first regional e-fulfillment hub outside China – a new distribution center in KLIA Aeropolis near the KL International Airport, as part of a wider agreement to build a Digital Free Trade Zone (DFTZ) which aims to facilitate SMEs to engage in cross-border trade. The DFTZ is scheduled to begin operations in 2020.

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Vietnam’s Industrial Real Estate Sector Holds Potential For Growth

Pie chart showing 2017 Foreign Direct Investment (FDI) into Vietnam by industry (% share). In 2017, 44.2% of FDI into Vietnam went into the Manufacturing and processing Sector, 23.3% into Power production and distribution, 8.5% into Real estate and 24% into other sectors.

With labor costs rising and regulatory requirements increasing in China (the current Factory of the World), Vietnam is rising as a manufacturing hub and is poised to continue doing soas the country’s advantages of being geographically located close to China and relatively lower production costs entice multinationals as well as Chinese manufacturing companies to relocate production facilities to Vietnam enabling them to serve the enormous and lucrative domestic Chinese market while reducing costs. In 2017, Vietnam’s manufacturing output rose 14.4% and 44% of FDI investment into Vietnam were channeled towards the manufacturing and processing sector according to data from the Vietnam Foreign Investment Agency (FIA).

Pie chart showing 2017 Foreign Direct Investment (FDI) into Vietnam by industry (% share). In 2017, 44.2% of FDI into Vietnam went into the Manufacturing and processing Sector, 23.3% into Power production and distribution, 8.5% into Real estate and 24% into other sectors.

The trend is likely to continue. China’s labor force is dwindling, (the country’s working age population, defined as those between 16-59 fell by 5.5 million last year to 901.99 million according to the National Bureau of Statistics), wages are rising (according to a study by Euromonitor, manufacturing wages in China have risen steadily over the past decade and are now on par with high-income economies such as Portugal and Greece), and changing policies (such as the government’s effort to move to high end manufacturing) have made regulations more stringent and subsidy programs reduced.

However, with China boasting top-notch infrastructure, a large talent pool, and extensive sourcing options among other reasons, the Middle Kingdom still retains its appeal as a manufacturing base for multinational and Chinese manufacturing companies; the trend is not of abandoning China altogether but either of moving production towards China’s interior where wages are lower, or of supplementing Chinese production facilities with outsourced facilities (particularly for labor-intensive, low-end manufacturing operations such as product assembly) from lower-cost countries such as Vietnam, a production model known as China+1.

For China, the world’s largest exporter, exports account for about 19% of the country’s economy. The United States is the single largest export destination of Chinese-made products absorbing about 20% of Chinese exports in 2017, and Asian countries such as Hong Kong, South Korea, Japan, Vietnam and India collectively account for about 45% of China’s exports. Unsurprisingly, the vast majority of China’s factories are strategically located in the coast, in areas such as Shanghai, Shenzhen, Ningbo, Qingdao, Guangzhou, and Tianjin where the majority of China’s key ports are located such as the Port of Shanghai, Port of Shenzhen, Port of Ningbo, Port of Qingdao, Port of Guangzhou and Port of Tianjin which are among the world’s busiest and largest ports. Much of China’s export products are transported via sea through these ports which are the origin points of key shipping routes such as the Pacific route, one of the world’s busiest shipping routes, which goes through the Pacific Ocean.

Thus, relocating to inner provinces may make sense for some manufacturers such as those with substantial domestic sales or for those with major exports to countries such as Central Asia or Europe as goods can be transported via a growing rail system which is part of China’s ambitious “Silk Road” logistics network. Chongqing for instance, an inland Chinese province which is gaining prominence as a hub for railroad shipments across Central Asia and Europe, has lured the likes of Hewlett Packard which shifted production to Chongqing as part of China’s Go West initiative and transports products such as motherboards and laptops to Europe via the China-Duisburg rail line which connects China to Germany. The railway line which originates in China, crosses Kazakhstan, Russia, Belarus and Poland before finally entering Germany, a distance of over 10,000 kilometers taking about 16 days to complete, considerably less than the 3 months or so transport time for container ships. Add in the lower transport cost, and the rail option beings to look very favorable for companies such as HP. Duisburg-China traffic has reportedly quadrupled since the service was established in 2011.

For others however, such as Intel, the Chine+1 production model whereby some production facilities are relocated to another country to supplement existing Chinese manufacturing bases may make more sense. Vietnam’s close proximity to China (port city Hai Phong in northern Vietnam is about 865 km away from Shenzhen, considerably closer than Vientiane which is 1,200km away, Bangkok which is 1,700km away, Jakarta which is 3,300km away, and Kuala Lumpur which is 3,025km away) low wages, relatively young population (the median age is 30), and improving infrastructure (including ports enabling access to Vietnam’s East Seam, one of the major shipping routes in the world), make it an attractive option for manufacturers migrating away from China. According to the World Economic Forum’s latest Global Competitiveness Index, Vietnam ranked 79th out of 137 nations in terms of infrastructure, ahead of Southeast Asian peers Philippines, Laos and Cambodia.

Bar chart showing the World Economic Forum's Global Competitiveness Index, 2017-2018 Infrastructure score for selected Southeast Asian nations. Singapore ranks highest with a score of 6.5, followed by Malaysia (5.5), Thailand (4.7), Indonesia (4.5), Brunei (4.3), Vietnam (3.9), Philippines (3.4), Laos (3.3) and Cambodia (3.1)

This opens an opportunity for Vietnamese industrial real estate in the years to come. Vietnam’s industrial real estate market is at a nascent stage of development, and as Vietnam continues to grow its position as a new industrial powerhouse, the market holds considerably potential to expand as well. In 1986, just 335 hectares of land in Vietnam were dedicated to industrial parks. By 2018, this had grown to 80,000 ha a CAGR of over 18%.

Northern Vietnam in prime position to benefit from China+1 production model

Considered to be the ‘Number 1 option’ for manufacturers looking to move away from China, Northern Vietnam is poised to be among the biggest beneficiaries of the China+1 production model, which should drive demand for industrial property in the area. The China+ 1 model has been noted to be a major reason for Vietnam’s growing presence in global electronics supply chains with manufacturers such as LG, Samsung, and Nokia to name a few, maintaining substantial manufacturing operations in northern Vietnamese provinces such as Haiphong. This explains why manufacturers of computers, electronic and optical products account for the largest occupiers of industrial property in northern Vietnam according to JLL.

Pie chart showing Northern Vietnam industrial property, key occupiers by sector (%). By sector, the biggest occupiers of industrial property in Northern Vietnam were Computer, Electronic and Optical Products 25%, Machinery and Equipment 15%, Fabricated Metal Products except Machinery and Equipment 12%, Rubber and Plastic Products 7%, Chemicals and Chemical Products 6%, Other 35%.

According to CBRE Vietnam, rents in the northern region of Vietnam are expected to increase by 2% in 2018 and 1.5% in 2019 and 2020 while the vacancy rate is expected to drop to 19% in 2020 from 22% in 2018.

The North key economic zon (NKEZ) comprises seven cities/provinces; Hanoi, Hai Phong, Bac Ninh, Hai Duong, Hung Yen, Vinh Phuc, Quang Ninh. Of the seven provinces, Hai Phong and Bac Ninh boast the highest number of industrial parks in the country; according to JLL, as of March 2018, these two provinces accounted for 46% of total industrial land in Northern Vietnam and given their geographically advantageous location of being close to Vietnam’s seaports, these two cities are likely to continue seeing greater supply of industrial land.

Vietnamese city Hai Phong (located in northern Vietnam, 865 km away from China’s manufacturing hub of Shenzhen and about 100km away from Vietnam’s capital Hanoi) is increasingly emerging as a manufacturing and logistics hub with its increasing number of industrial zones (such as the VSIP Hai Phong Industrial Zone, the Nomura-Hai Phong Industrial Zone, and the Trang Due Industrial Zone), growing presence in Vietnam’s port system, and its direct rail line, the Kunming-Hai Phong railway, which connects Vietnam with China, with a transport time of about 9 hours.

Such economic merits have helped the city notch a 14.01% GDP growth rate in 2017, the highest since 1994, and twice the national average of 6.81%. During the first six months of 2018, exports turnover reached US$ 9.3 billion, a 25.34% increase compared to the same period in 2017. With numerous infrastructure developments taking place, from highways and bridges to port expansion projects, the city is actively working to increase grows its appeal as an alternative for manufacturers looking to shift production to Southeast Asia, potentially benefiting Hai Phong’s industrial property market.

Haiphong, already known for its existing port (which however is not a deep water port) is set to further strengthen its position as a rising logistics hub with its new Lach Huyen International Gateway Port (also known as the Hai Phong International Gateway Port) which was opened in May 2018; the new deep water port can handle around 300,000 20-foot equivalent units (TEUs) currently, and capacity is expected to expand going forward enabling the port to handle between 2 million TEUs and 3 million TEUs by 2019. Haiphong’s existing port handled 4.10 million TEUs in 2016 according to data from the World Shipping Council. Coupled with the new port’s capacity, Haiphong will be able to handle about 5 million TEUs, placing Haiphong on the same level as Vietnam’s leading port Ho Chi Minh City in south Vietnam which handled 5.99 million TEUs in 2016 according to data from the World Shipping Council.

Southern Vietnam

With its relatively well-developed infrastructure and favorable investment policies such as tax breaks, industrial property in southern Vietnam (the area surrounding Ho Chi Minh City which includes popular investment provinces such as Binh Duong, Long An and Dong Nai) have long been Vietnam’s industrial growth engine and remain as favored destinations for investors in Vietnam. Companies maintaining manufacturing operations in Southern Vietnam include Samsung, and Intel.

Companies adopting a China+1 production model may find southern Vietnam to be less appealing compared to northern Vietnam, particularly for time-sensitive manufacturing operations that require speedy transport of components between Vietnam and China.

Others however find value the area’s merits such as close proximity to Ho Chi Minh City, which boasts Vietnam’s largest commercial port – the port of Ho Chi Minh City, and Vietnam’s highest-earning consumer base (according to a 2017 report by VietnamWorks, employees in HCMC earn the highest average salaries in Vietnam at about 38% higher than the national average). This explains why a fair proportion of industrial occupiers in Southern Vietnam are in consumer-related businesses such as apparel, textiles and food processing.

Pie chart showing Southern Vietnam industrial property, key occupiers by sector (%) as follows: Machinery and Equipment 15%, Textile and Apparel 11%, Fabricated Metal Products (except Machinery and Equipment) 9%, Rubber and Plastic Products 9%, Chemicals and Chemical Products 8%, Food Processing 7% and Other 41%.

Yet, there is still potential for expansion. Southern Vietnam is general the preferred “launch market” for consumer products companies and as the country’s middle class population expands, demand for warehousing, distribution centers and manufacturing facilities should grow thereby driving industrial property demand. Already enjoying strong occupancy rates (occupancy rates in HCMC, Dong Nai and Bunh Duong Binh Phuoc stood at 77%, 85%, 88% and 85% as of June 2018 according to JLL) strong economic growth and continued growth in manufacturing activity is expected to continue driving industrial property demand with JLL forecasting industrial property in southern Vietnam to enjoy higher occupancy and rental growth over the next few years.

This year, US private equity investment firm Warburg Pincus formed a JV with Vietnam’s state-owned Investment & Industrial Development Corp (known as Becamex IDC, one of the largest industrial real estate developers in Vietnam owned by the government of Binh Duong province in Southern Vietnam) to develop industrial properties in Vietnam. The JV, known as BW Industrial Development JSC, was seeded with eight industrial property development projects across five cities in the North and South of Vietnam, including Binh Duong, Dong Nai, Hai Phong, Hai Duong and Bac Ninh. Warburg Pincus owns 70% of the JV.

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India Hotel Market: Long Term Growth And Opportunity

Bar chart showing India hotel transaction volume (in Indian Rupees millions), 2001-2017. In 2017, hotel transaction volume in India reached Indian Rupees 9,709 million, a four year low.

India’s hotel market is a growth market, and the country’s tourism and hospitality industry which contributed about 9.6% to India’s GDP in 2016, has emerged as a key growth driver of India’s service sector and thereby the Indian economy.

India’s hotel industry as a whole has been going through a relatively rough patch over the past few years with distressed loans from the sector jumping 63% over the past three years as a result of overinvestment, cost overruns, and high interest rates among other reasons, which have restricted capital flow into the industry and reduced hotel real estate transactions in the past few years.

 

Bar chart showing India hotel transaction volume (in Indian Rupees millions), 2001-2017. In 2017, hotel transaction volume in India reached Indian Rupees 9,709 million, a four year low.

However, there are numerous fundamental reasons to be optimistic on the industry’s long term prospects, particularly in the mid-scale and budget segment which have not been affected by the financial woes plaguing the luxury and upscale hotel segment. The Development Cost Per Key declines considerably the lower the hotel class, and coupled with robust demand from India’s growing wave of middle class domestic travelers, India’s mid-scale and budget hotel segments have been doing brisk business, a boon to their bottom lines.

Line chart showing the Average Development Cost Per Key in India (in India Rupees millions) by hotel positioning. The Average Development Cost Per Key in India for hotels in the Luxury, Upper Midscale, Upscale, Upper Mid Market, Mid Market, Budget, and Economy categories are INR 22.3 million, INR 14 million, INR 9.8 million, INR 7.2 million, INR 5.6 million, INR 3.5 million, and INR 1.7 million respectively.

India’s expanding population of middle class travelers have also helped boost Indian hotel occupancy rates which have been on an uptrend over the past few years, rising to 66% in 2017, the highest since 2007-2008, according to a report by hospitality consulting firm Horwath HTL.

Bar chart showing all-India hotel occupancy rates, FY 2013 - FY 2017 (E). Occupancy rates have been rising in India; during FY 2013, FY 2014, FY 2015, FY 2016 and FY 2017 (E) hotel occupancy rates were 58%, 59%, 61%, 64% and 66% respectively.

The momentum is expected to continue. However, with hotel demand exceeding supply (according to data from Hotelivate, Indian hotel demand is growing at around 12% while new supply is growing by up to 6% annually) and with hotel rooms per capita in India standing at just 18 per 100,000 people, considerably lower than China where there are 307 hotel rooms per 100,000 people, there is ample potential for expansion in India’s hotel sector driven by a growing middle class, rising disposable incomes, a growing fleet of low cost airlines and government measures to boost the country’s tourism industry such as the UDAN Regional Connectivity Scheme, and incentives such as the five year tax holiday offered for 2, 3 and 4 star category hotels located around UNESCO World Heritage sites (except Delhi and Mumbai) and the establishment of Special Tourism Zones. Further encouraging measures may be expected in the country’s upcoming Tourism Policy as the Indian government works towards its target of attracting 20 million Foreign Tourist Arrivals by 2020 and thereby addressing the country’s imbalance of outbound tourists being four times more than inbound tourists.

India is expected to be one of the fastest growing tourism economies over the next decade and the country is forecast to emerge as the world’s 3rd biggest tourism economy by 2028 according to a 2018 report by the World Travel and Tourism Council. According to forecasts by CARE Ratings, India’s hotel industry is expected to see an increase of 11-13% CAGR in room revenues during FY2017-FY2021. The Indian hotel market is projected to reach US$ 13 billion by 2020 according to a paper by FICCI-Yes Bank titled ‘Tourism Infrastructure Investments: Leveraging Partnerships for Exponential Growth’.

Unsurprisingly, global hotel operators are increasingly keen on expanding into India to grab a slice of the growing pie. International hotel brands already account for about half of India’s 123,000 branded hotel rooms, a dramatic increase in market share since 2002 when international hotel brands accounted for less than 20% of the 25,000 branded hotel rooms in India. By 2020, international hotel brands are expected to account for about 76% of India’s branded hotel room supply according to Patu Keswani, chairman and managing director, Lemon Tree Hotels.

Land scarcity and high development costs in Delhi and Mumbai are likely to encourage upscale hotel developers to focus on Tier II and Tier III markets

For several years after the global financial crisis in 2008, India’s luxury hotel sector struggled with an oversupply of hotel inventory and poor demand leading to lower occupancy and Revenue Per Available Room (RevPAR).

However, the tide may be turning as signs of a demand recovery and a limited supply pipeline push up occupancy levels, particularly in India’s top two hotel markets, Delhi and Mumbai where occupancy rates reached 75% and 70% respectively during 2016-2017, thanks to increasing business and leisure travellers, and a muted hotel room supply.

During the year ended March 2017, new hotel rooms in Delhi increased by just 1.1% compared to a CAGR of 5.3% over the past decade. The situation is the same in Mumbai where new hotel rooms increased 3.4% in 2016-2017, compared to a 5.3% growth over the past decade.

Bar chart showing the number of hotel rooms in Mumbai and Delhi during 2007-2008 and 2016-2017. During the CY 2007-2008, Mumbai and Delhi had 8,454 and 9,019 rooms respectively. By FY 2016-2017, Mumbai and Delhi had 13,494 and 14,296 hotel rooms, reflecting a CAGR of 5.3% in hotel room growth during the decade.

Yet, while rising demand in India’s top cities of Mumbai and Delhi may lure hotel developers, problems such as land scarcity, and zoning laws among other reasons are likely to continue restricting new hotel room supply going forward. While the difficulties may not hinder the expansion plans of some luxury hotel operators such as Jumeirah (which is planning to launch an upscale business hotel in Mumbai), other hotel operators may go down the acquisition route instead, which could drive up acquisition demand for existing hotel assets in these two cities, as high development costs may compel players looking to ride the tourist boom in Delhi and Mumbai to pay a premium for brownfield and existing hotel assets rather than developing new hotels.

With much of India’s luxury hotel room inventory concentrated in NCR, Mumbai and Bengaluru, developers are also likely to explore untapped opportunities in Tier II and Tier III cities such as Jaipur, Goa and Ahmedabad where occupancy rates and RevPAR have shown strong growth. According to JLL India’s 2017 report, Goa remained India’s most expensive hotel market for the second consecutive year, while Ahmedabad enjoyed the strongest RevPAR of 21% followed by Jaipur at 12.2%.

Marriott, currently India’s largest hotel by room inventory, appears to have spotted the potential; the hotel group has plans to expand its current Indian hotel portfolio of around 120 with the addition of 50 new hotels, which will add another 12,000 rooms to its current tally of more than 22,000 rooms in India. In addition to Tier I cities, the company is looking at opportunities in Tier II cities such as Ahmedabad, Jaipur and Kerala.

Ashmi Holdings, which manages the Bristol Hotel, an upscale business hotel in the business city of Gurgaon, (recently renamed Gurugram), has plans to lunch upscale, midmarket and budget hotels in Tier III and Tier IV cities with a target of 1,000 keys by 2020.

Significant upside potential in the midscale and budget hotel segment

India has welcomed rising numbers of foreign tourists, with Foreign Tourist Arrivals exceeding 10 million last year, and the number is expected to grow in the coming years as the government rolls out favorable measures as part of its effort to double Foreign Tourist Arrivals to 20 million by 2020.

However, the country’s tourism and hospitality sector is largely driven by domestic travelers and domestic hotel demand has historically been higher than inbound demand as domestic travelers account for a larger share of India’s travelers.

During the period 1991-2016, domestic visits to all Indian states grew at a CAGR of 13.03%, far outpacing foreign visits which increased at a CAGR of 8.25% during the same period according to data from India’s Ministry of Tourism driven by rising domestic travel among India’s swelling numbers of travel-hungry middle class citizens – a relatively price-sensitive and value conscious demographic who opt for hotels in the mid-scale and budget categories.

This trend is likely to continue as India’s middle class rise grows and their disposable incomes increase, which should increase their propensity to travel as well as their travel spend which currently accounts for about 88% of the tourism sector’s contribution to India’s GDP.

The opportunity in India’s midrange hotel sector has attracted the likes of companies such as Lemon Tree Hotels (NSE:LEMONTREE) and Royal Orchid Hotels (NSE:ROHLTD) which expanded their midscale offerings, thereby driving up the country’s midscale room inventory over the past several years; in 2002, some 6,000 of the 26,000 branded hotel rooms in India – less than 25% percent – were mid-market hotel rooms. By 2017, mid-market hotel rooms jumped nine-fold to 53,200, accounting for 43% of the total branded hotel rooms in the country which increased five-fold to 125,000 according to data from hospitality consulting firm Horwath HTL.

Apeejay Surendra, plans to expand its ‘Zone by the Park’ midscale hotel brand in Tier II and Tier III towns, positioning the hotel as a price and design conscious offering.

Goldman Sachs-backed hotel investment firm SAMHI Hotels Ltd plans has plans to acquire hotel assets around the country, mostly in Tier I and Tier II cities.

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Opportunities In Philippines’s Multi-Billion Dollar Infrastructure Bonanza

Pie chart showing 2017 FDI inflow into the Philippines, share by industry (%). The largest share of FDI inflows to the Philippines went to the electricity, gas, steam and AC industry (42.4%), followed by Manufacturing (35.2%), Real estate activities (7.6%), Construction (4.9%), and Finance and insurance (4.2%) while the balance 5.6% was taken up by other industries.

President Duterte’s ‘Build, Build, Build’ (BBB) project, an ambitious infrastructure program that will see US$ 180 billion being spent over the next decade towards building much needed roads, dams, bridges, airports, seaports and more in the Philippines is expected to push Philippines’s infrastructure spending from 6.3% of GDP this year to 7.3% by 2022 helping close the infrastructure gap between the Philippines and other countries; in the World Economic Forum’s latest Global Competitiveness Index, the Philippines ranks 97th out of 137 nations in terms of infrastructure ranking, lagging behind most of its Southeast Asian neighbors according to the World Economic Forum’s latest Global Competitiveness Report.

Bar chart showing the World Economic Forum's Global Competitiveness Index, 2017-2018 Infrastructure score for selected Southeast Asian nations. Singapore ranks highest with a score of 6.5, followed by Malaysia (5.5), Thailand (4.7), Indonesia (4.5), Brunei (4.3), Vietnam (3.9), Philippines (3.4), Laos (3.3) and Cambodia (3.1)

The latest World Economic Forum’s Executive Opinion Survey also revealed that inadequate supply of infrastructure is considered to be the second most problematic factor for doing business in the Philippines (inefficient government bureaucracy was rated as the number one problematic factor for doing business).

Philippines’s infrastructure challenge and the government’s ‘Build, Build, Build’ initiative which aims to usher in a “golden age of infrastructure” opens numerous avenues for business and investment for locals as well as foreigners. Business and investment opportunities in Philippines’s ‘Build, Build, Build’ program is attracting foreign investor interest, with the country enjoying record high FDI in 2017 which reached US$ 10.05 billion, a 21% YoY increase. Direct equity investment for local companies which made up 32% total FDI inflows, increased 26% YoY, much of which were channeled towards electricity, gas, steam and air-conditioning supply; construction; manufacturing; and real estate activities.

Pie chart showing 2017 FDI inflow into the Philippines, share by industry (%). The largest share of FDI inflows to the Philippines went to the electricity, gas, steam and AC industry (42.4%), followed by Manufacturing (35.2%), Real estate activities (7.6%), Construction (4.9%), and Finance and insurance (4.2%) while the balance 5.6% was taken up by other industries.

Numerous opportunities exist for local and foreign players in areas such as design engineering, cement and construction equipment, noteworthy opportunities are discussed below.

Cement

At about 212 kilograms per person (as of 2014), Philippines has one of the lowest per capita cement consumption compared to its ASEAN counterparts, and is about half the global average per capita cement consumption. However, that figure is set to improve as President Duterte’s Golden Age of Infrastructure which includes building six airports, 32 roads and bridges and a number of other developments such as bus rapid transits, industrial estates, and seaports drives domestic cement demand which is estimated to exceed 40 million metric tons by 2021, according to estimates from the Philippines’s Department of Trade and Industry. This is about double the quantity of Philippines’s current cement consumption which stood at 25.9 million metric tons in 2016.

This is a growth opportunity for cement firms such as LafargeHolcim, Cemex Holdings Philippines, Republic Cement and Eagle Cement Corporation. These four cement industry players account for about 80% and 82% of total clinker and cement domestic production, respectively.

German industrial giant Thyssenkrupp AG (ETR:TKA) expects its Philippines revenues to rise three-fold as a result of the country’s BBB initiative with much of that being driven by cement.

Cement producers are actively building capacity to capture a share of the country’s anticipated increase in cement demand. As of December 2016, the Philippine cement industry has an estimated annual clinker and cement capacity of 20.6 and 28.63 million tons, respectively, according to the 2017 Cement Market Report. The Philippine cement industry is estimated to need over 10 million tons of additional cement capacity to meet domestic cement demand until 2025. Unless local cement manufacturers increase capacity, the Philippines will have to fill the deficit through imports.

Construction equipment

According to BMI Research, Philippines’s construction industry is forecast to expand at an average real rate of 9.8% between 2017 and 2026, and the firm expects Philippines to be one of the fastest growing construction markets in Asia, which is expected to create heavy demand for construction equipment such as cranes, excavators and other heavy machinery, an opportunity companies such as Korean automotive firm Hyundai, Swedish auto firm Volvo, American heavy machinery giant Caterpillar (NYSE:CAT) among others are aiming to capitalize on.

Hyundai Heavy Machineries dominates Philippines’s excavator market and is expanding capacity to participate in the government’s BBB program.

Volvo Construction Equipment, the second largest player in Philippines’s excavators market according to a 2016 report by Ken Research is aiming to supply construction equipment as well as trucks, and buses to help with the program.

American heavy machinery giant Caterpillar is bullish on heavy machinery opportunities from the BBB initiative such as supplying excavators.

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High-Flying Growth Prospects In India’s Domestic Travel Market

Bar chart showing domestic and foreign visits to Indian states, 2006-2016 (in millions of visits). Domestic visits to Indian states grew from 462.4 million in 2006 to 1,613.6 million in 2016 while foreign visits grew from 11.7 million in 2006 to 24.7 million in 2016.

Tourism is booming in India, and the industry is emerging as a key growth driver in India’s service sector. Much of the growth stems from India’s domestic tourism sector which has seen a steady increase in visits from domestic travelers over the past decade; domestic tourist visits (DTVs)  increased 12.7% to 1.613 billion in FY 2016, (the latest year for which data is available) according to statistics from India’s Ministry of Tourism.

Domestic tourist visits have consistently registered positive growth rates over the past decade; during 2006-2016 domestic tourist visits grew at double digit rates every year except in years 2008 and 2013 when growth was at single digits. This compares with foreign tourist visits which mostly saw single-digit growth and sometimes zero or negative growth. In 2012 for instance, foreign tourist visits registered negative 6% growth while domestic tourist visits jumped 20%.

The rise of India’s domestic visitor numbers has been a long term trend; during the period 1991-2016, domestic visits to all Indian states grew at a CAGR of 13.03%, far outpacing foreign visits which grew at a CAGR of 8.25% during the same period according to data from India’s Ministry of Tourism.

Bar chart showing domestic and foreign visits to Indian states, 2006-2016 (in millions of visits). Domestic visits to Indian states grew from 462.4 million in 2006 to 1,613.6 million in 2016 while foreign visits grew from 11.7 million in 2006 to 24.7 million in 2016.

Domestic travelers also account for the lion’s share of tourism earnings; India’s tourism industry contributes about 7% to India’s GDP, and domestic travelers accounted for 88% of the sector’s contribution to GDP in 2016.

India’s rising numbers of domestic tourists have largely been driven by an expanding middle class with rapidly increasing purchasing power (currently estimated at 250 million Indians and counting), infrastructure development, a growing fleet of low cost airlines, and initiatives such as the UDAN Regional Connectivity Scheme.

Yet, there is considerable potential for further growth as a result of demographic, regulatory and economic factors. The number of middle class Indians is small compared to China and their purchasing power is considerably lower than their Chinese counterparts. However, India continues to be the fastest growing major economy in the world and this is likely to remain so in the foreseeable future; the International Monetary Fund (IMF) predicts India’s Gross domestic Product (GDP) will grow at an average of more than 8% every year over the next five years and this should drive income growth. According to Global Insight Inc, some 150 million additional Indian households are due to achieve real PPP incomes of more than US$ 20,000 by 2026, almost triple the amount in 2016 and according to Steelcase Growth Market Research, India’s middle class population is expected to grow to around 475 million people by 2030.

India’s expanding middle class citizens are expected to drive India’s consumption expenditures to reach US$ 4 trillion by 2025, helping India emerge as the world’s third biggest consumer market by 2025 according to consultancy firm Boston Consulting Group.

India’s domestic tourism sector is also benefiting from an encouraging regulatory environment; the Indian government is planning to turbocharge the tourism sector with tax cuts, incentives, infrastructure development and more. The Union Budget 2018 focuses on expansion of airport infrastructure (a key constraint limiting air traffic growth in the country) and there are expectations of a reduction in hotel tariffs and tax exemptions on investments in new hotels.

Thus, with several growth drivers in place from favorable demographics to a supportive policy environment, India’s domestic tourism sector is poised for greater expansion in the future. Domestic tourism is expected to maintain its dominance in India’s tourism industry through 2021. A report by Google India and Boston Consulting Group projects India’s domestic travel market to grow at a five-year CAGR of 11.2% to US$ 48 billion by 2020 from US$ 27 billion in 2015 opening numerous opportunities for businesses and investors.

 

Airlines

India’s domestic air traffic crossed the 100 million mark for the first time with 117 million passengers flying in 2017, up 18% from 99.88 million passengers in 2016 according to data from India’s Directorate General of Civil Aviation (DGCA) making India the world’s fastest growing domestic aviation market for the third consecutive year according to IATA. India was followed by China and Russia where domestic air passenger numbers increased 13.3% and 10.1% respectively in 2017.

Bar chart showing India’s domestic air traffic, 2013-2017 (in millions of passengers). India’s domestic air traffic grew from 61,426 million passengers in 2013 to 117,176 passengers in 2017, representing a CAGR of 17.5% between 2013 and 2017.

The boom in domestic air travel was a boon to local airlines such as Indigo (NSE:INDIGO), Jet Airways (NSE:JETAIRWAYS), Spice Jet (BOM:500285) and Vistara (a joint venture between Tata Group and Singapore Airlines) which enjoyed higher passenger load factors.

In 2017, market leader Indigo commanded a market share of 39.6%, Jet Airways had 17.8%, Air India 13.3%, Spice Jet 13.2%, Go Air 8.5%, Air Asia 3.7%, and Vistara 3.5%.

Yet the growth potential is still enormous; less than 10% of Indians take to flying and at around 0.08 annual domestic seats per capita, India’s penetration rate is relatively low compared to other developing markets such as Brazil (0.6) and China (0.4) according to data from flight information and data company OAG. By comparison, the United States has around 2.8 annual domestic seats per capita.

Rising incomes particularly among India’s tech-savvy millennial generation (those born between 1981 and 1996) which have a greater affinity to travel could propel India’s domestic aviation sector in the years to come. India has about 400 million millenials which account for about a third of the country’s one billion plus population and India is expected to be the youngest nation in the world by 2020 with a median age of 29. A survey by Phocuswright and ixigo revealed that Indian millenials take more trips per year compared to seniors and they also spend more.

The Indian government is also taking encouraging measures to boost efficiency and reduce flying costs. For instance, India is mulling the prospect of breaking the monopoly held by public sector oil companies in the supply of Aviation Turbine Fuel (ATF) at the Mumbai airport by allowing private refiners to enter the market, thereby improving operating costs and increasing efficiency. Mumbai airport, India’s busiest airport, accounts for about 20% of India’s ATF consumption. With ATF costs making up about 40% of the operating costs of airlines, the move could be a boon for India’s aviation industry, benefiting airlines as well as private refiners such as Reliance Industries (NSE:RELIANCE).

The International Air Transport Association expects India to overtake the United Kingdom to emerge as the third largest aviation market by 2025 (China will be the biggest market followed by the United States).

Morgan Stanley forecasts India to witness a CAGR of 13% in domestic air traffic during 2016-2026.

According to a report by Google India and Boston Consulting Group, air travel is expected to be the biggest contributor to the India’s travel market, registering a CAGR of 15% reaching a market value of US$ 30 billion by 2020, making up over 50% of the projected value of India’s domestic travel market which is forecast to reach US$ 48 billion by 2020.

Hotels

Overinvestment, cost overruns and high interest rates have hampered the financial performance of India’s hotel industry with stressed loans jumping 63% over the past three years.

Much of the industry’s woes appear to be concentrated on branded, full-service hotels in the luxury and upscale segment in Tier I and Tier II cities.

On the other hand, India’s mid-market hotel segment (i.e., two, three and four star hotels) is booming, driven by both domestic and overseas tourists, encouraging brands such as Lemon Tree Hotels (NSE:LEMONTREE), and Royal Orchid Hotels (NSE:ROHLTD) to expand into the sector pushing up the supply of mid-market hotel rooms over the past several years; in 2002, some 6,000 of the 26,000 branded hotel rooms in India – less than 25% percent – were mid-market hotel rooms. By 2017, mid-market hotel rooms jumped nine-fold to 53,200, accounting for 43% of the total branded hotel rooms in the country which increased five-fold to 125,000 according to data from hospitality consulting firm Horwath HTL.

However, there are signs of recovery in India’s hotel industry with occupancy rates rising to 66% in 2017 – the highest in nine years according to a report by Horwath HTL – and average room rates growing by 8% since 2008 according to hotel consultant firm Hotelivate.

Bar chart showing all-India hotel occupancy rates, FY 2013 - FY 2017 (E). Occupancy rates have been rising in India; during FY 2013, FY 2014, FY 2015, FY 2016 and FY 2017 (E) hotel occupancy rates were 58%, 59%, 61%, 64% and 66% respectively.

The momentum is expected to continue going forward driven by a muted hotel room supply pipeline, an increasingly travel-hungry Indian middle class population, and favorable policies such as the Indian government’s UDAN scheme Phase-II which is expected to open new opportunities benefiting domestic mid-tier hotels in particular. Horwath HTL anticipates all-India occupancy rates to be more than 70% next year and mid-market segment occupancy rates will hit 82%.

The annual average leisure hotel spend per household is expected to grow 7% to US$ 18 by 2020 compared with US$ 13 in 2015.

A report by Google India and Boston Consulting Group expects hotels to grow at CAGR of 13% to US$ 13 billion by 2020, making up slightly more than a quarter of the overall domestic travel industry which is expected to be valued at US$ 48 billion. Much of the demand will be fueled by domestic travelers who are expected to account for over 60% of hotel spend in India. The mid-scale segment is expected to retain its dominant share, accounting for about 44% of India’s branded hotel rooms in 2020.

Bar chart showing India hotel spend by domestic and foreign tourists in 2010, 2015 and 2020 (forecast) (in US$ billions). India’s hotel market was valued at US$ 4 billion in 2010, US$ 7 billion in 2015 and is expected to grow to US$ 13 billion by 2020. At about US$ 9 billion - US$ 10 billion, domestic travelers will account for more than 60% of hotel spend in India by 2020.

Online travel portals

According to consulting firm Praxis, India’s online travel market was valued at US$ 5.71 billion at the end of 2015, and is expected to more than double to US$ 13.6 billion by 2021, representing a CAGR of over about 16% driven by increasing penetration of international hotel and flight bookings from travel portals such as MakeMyTrip (NASDAQ:MMYT) (India’s largest online travel agency), Yatra (NASDAQ:YTRA), and Cleartrip to name a few.

Increasing internet penetration and rising incomes among India’s tech savvy millenials as they increasingly climb up the income ladder are some of the tailwinds that are expected to drive India’s online hotel market. The country’s internet user base stood at 481 million in December 2017, up 11.34% from a year earlier, representing an internet penetration rate of less than 40% indicating ample potential for growth. Much of India’s offline population resides in rural India. However, even in urban India where incomes are higher and residents generally have a higher propensity to travel, there is potential for higher internet penetration; about 295 million (equal to about 64%) of India’s 455 million urban population are connected to the internet leaving a potential market of about 160 million internet users in urban India alone. This is equal to nearly one half of the entire population of the United States.

Indian millenials are expected to be a key driving force in India’s online travel market going forward. According to booking data from India’s largest online travel company MakeMyTrip which is often touted as India’s answer to Ctrip  (NASDAQ:CTRP) and Expedia (NASDAQ:EXPE), the majority of the platform’s customers were millenials; over half of travelers who made bookings through MakemyTrip were under 35 years of age.

India has the world’s largest millenial population and as their disposable incomes grow, they are likely to travel more and thereby drive the country’s online travel market as they plan their itineraries online, presenting a major growth opportunity for online travel companies.

Online hotel bookings in particular presents a major growth opportunity in India’s online travel market. According to a report by Morgan Stanley, Indian millenials have shifted a large part of their activities online, for instance through the adoption of digital entertainment channels (to the detriment of traditional channels such as radio) and online shopping. However, online travel booking is an exception to the trend with 63% of all hotel bookings being reportedly made by walking into hotels. Less than 20% of hotels were booked online, and only one third of those were booked using travel agencies indicating tremendous potential for growth.

One third of all hotels are expected to be booked online helping the sector grow at a CAGR of 25% to be worth US$ 4 billion by 2020 according to a report by BCG and Google India.

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Healthy Opportunities In China’s Blossoming Healthcare Market

Bar chart showing the top 10 countries by health expenditure per capita and China’s health expenditure per capita (in US dollars), 2000, 2005, 2015 according to data from the World Health Organization. The top countries by per capita health spend as at 2015 are: Switzerland (US$ 9,818), U.S.A. (US$ 9,536), Norway (US$ 7,464), Luxembourg (US$ 6,236), Sweden (US$ 5,600), Denmark (US$ 5,497), Australia (US$ 4,934), Ireland (US$ 4,757), Netherlands (US$ 4,746), and Germany (US$ 4,592). By comparison, China’s per capita health expenditure in 2015 amounted to just US$ 426.

China, the world’s second largest healthcare market in the world after the United States, is growing rapidly driven by an ageing population, government support,  and rising urbanization (which is contributing to an increase in lifestyle diseases such as diabetes and cancer.

China is currently the fastest growing major healthcare market in the world with a five-year compound annual growth rate (CAGR) of 17% compared with just 4% for the United States and -2% in Japan according to 2015 information from the World Bank. Healthcare spending in China has risen four-fold from about CNY 1 trillion (US$ 126 billion) in 2006 to CNY 4.6 trillion in 2016 (US$ 698 billion).

Yet, the Chinese healthcare market is still relatively immature compared to developed economies such as the United States and Germany. China holds nearly 20% of the world’s population but the country accounts for just about 3% of the world’s healthcare spend.

As a percentage of GDP, China’s healthcare expenditure is about 5.6% of the country’s GDP compared with 17.1% for the United States, 11.3% for Germany and 10.3% for Japan according to 2013 data from the World Health Organization.

Furthermore, despite being the world’s second biggest healthcare market, China’s per capita healthcare spending is only a fraction of mature markets such as the United States, Luxembourg and Germany. China does not even make it to the list of the world’s top 10 countries with the highest per capita health expenditure indicating huge potential for spending increases.

Bar chart showing the top 10 countries by health expenditure per capita and China’s health expenditure per capita (in US dollars), 2000, 2005, 2015 according to data from the World Health Organization. The top countries by per capita health spend as at 2015 are: Switzerland (US$ 9,818), U.S.A. (US$ 9,536), Norway (US$ 7,464), Luxembourg (US$ 6,236), Sweden (US$ 5,600), Denmark (US$ 5,497), Australia (US$ 4,934), Ireland (US$ 4,757), Netherlands (US$ 4,746), and Germany (US$ 4,592). By comparison, China’s per capita health expenditure in 2015 amounted to just US$ 426.

China’s healthcare market is expected to continue its rapid growth in the years to come propelled by growth drivers such as an greying population, increasing lifestyle diseases as a result of increasing urbanization and government support.

China’s population is ageing with the country’s over-65 year olds accounting for 11.4% of the total population in 2017, up from 10.8% in 2016 and less than 8% in 2000 according to data from the statistics bureau. That equates to over 150 million Chinese over the age of 65 which is slightly less than half of the entire population of the United States. This number is expected to grow with the State Council expecting 25% of China’s population to be aged 60 and over by 2030, up from 13% in 2010 which is expected to drive healthcare costs going forward.

China’s urbanization rate has been on the rise and it currently stands at 59% according to the National Statistics Bureau. This compares with the United States which is at 82%, the United Kingdom which is at 83% and South Korea which is at 83%. China’s increasing urbanization has contributed to a greater incidence of lifestyle diseases such as diabetes and cancer. China has the most number of obese children in the world and has the world’s second -biggest population of obese adults after the United States according to the Global Burden of Disease report by a team at the University of Washington.

The urbanization process is continuing in China and thus as Chinese get increasingly wealthier and urbanized which leads to unhealthy diets and sedentary lives, the country’s lifestyle disease burden is expected to increase thereby driving China’s healthcare market.

Recognizing the need for a robust healthcare industry to meet the country’s increasing healthcare needs, the Chinese government has undertaken a series of reforms and supportive government policies such as the blueprint “Healthy China 2030” which aims to improve the level of health throughout the country by improving health services, expanding the medical industry and encouraging private investment in the local healthcare sector.

By 2030, the National Health and Family Planning Commission (NHFPC) estimates China’s health-related industries will reach CNY 16 trillion (approximately US$ 2.4 trillion).

These factors are expected to drive China’s healthcare industry going forward. According to a 2017 report by Research ad Markets, China’s healthcare market is poised to expand from around US$ 710 billion in 2016 to over US$ 1.11 trillion in 2020 creating numerous opportunities.

 

Pharmaceuticals

Pharmaceuticals is the largest sector of China’s healthcare market and China’s pharmaceuticals industry has been growing rapidly; the Chinese pharmaceutical market grew at a CAGR of 9.4% from 2013 to 2017 helping China overtake Japan to emerge as the world’s second largest pharmaceutical in the world after the United States.

Bar chart showing the world’s top 10 pharmaceutical markets in 2016 by market value (US$ billion). The top 10 markets are U.S.A. (US$ 461.7 billion), China (US$ 116.7 billion), Japan (US$ 90.1 billion), Germany (US$ 43.1 billion), France (US$32.1 billion), Italy (US$ 28.8 billion), U.K. (US$ 27 billion), Brazil (US$ 26.9 billion), Spain (US$ 20.7 billion), and Canada (US$19.3 billion).

 

Yet, China’s pharmaceutical market lags far behind the United States in sales; despite having a population that is three times the size of the United States, at US$ 122.6 billion in 2017, China’s pharmaceutical market was worth less than a quarter of the United States’ which was valued at US$ 466.6 billion the same year according to data from health information vendor IQVIA. However, with drug demand expected to grow due to factors such as a greater incidence of lifestyle diseases and faster drug approvals, IQVIA forecasts China’s pharmaceutical market to expand from US$ 122.6 billion in 2017 to reach US$ 145 billion to US$ 175 billion by 2022.

In 2017, China announced new rules aimed at speeding up the country’s inefficient drug approval process, which could be a revenue boost for pharmaceutical companies.

Foreign pharmaceutical companies in particular stand to benefit as the new rules allow foreign drug makers to file for drug approval in China using data from international, multinational trials (provided China is included as a study site) which enables them to gain greater inroads into the Chinese market and eliminates the necessity of conducting additional costly and often time-consuming clinical trials in China after receiving approval overseas.

Swiss pharmaceutical giant Novartis AG (VTX: NOVN) aims to double China sales over the next five years.

AstraZeneca (LON:AZN) has deepened its substantial China business with the announcement of a new company Dizal Pharmaceutical, which is a drug development joint venture with the Chinese Future Industry Investment Fund (FIIF).

French pharma giant Sanofi (EPA:SAN), one of the leading insulin providers in the world and in China, expects to maintain double-digit sales growth in China thanks to China’s growing diabetes population. One third of the world’s approximately 420 million diabetic population live in China which amounts to over 100 million diabetic Chinese, accounting for about 11% of Chinese adults as of 2015 up from less than 1% in 1980, a dramatic increase over the past 35 years. China’s growing insulin demand has been a boon to Sanofi’s rival insulin makers as well, Novo Nordisk (CPH:NOVO-B) and Eli Lilly (NYSE:LLY).

Local drug makers also stand to benefit from accelerated drug approvals.

Hutchison MediPharma, a subsidiary of Hutchison Meditech (LON:HCM) is expected to receive approval this year for its fruquintinib capsule for colorectal cancer, the second-most common prevalent cancer in China with about 380,000 new cases annually according to the National Central Cancer Registry of China. The market potential for cancer drugs in China is substantial with cancer rates rising nationwide as a result of aging, and environmental factors among other reasons. With China seeing approximately 700,000 new cancer cases annually, the country has one-third of new cancer patients in the world.

While China is the world’s biggest producer of APIs, the country lags behind the U.S. and other developed markets in drug innovation, and most innovative drugs are produced by foreign pharmaceutical companies. To help its pharmaceutical industry move up the global value chain, the Chinese government has been actively creating a supportive regulatory framework to galvanize homegrown pharmaceutical companies through grants and tax breaks for research, and through initiatives such as the ‘Made in China 2025’ plan which mentions innovation in pharmaceuticals, among 10 other key sectors, a national priority.

With the results of such initiatives likely to bear fruit in the long term, in the shorter term Chinese pharmaceutical companies’ expansion efforts are likely to remain focused on capturing market share in the global generic drugs market. China’s drugs market is dominated by generics, accounting for 85% of total drug sales as of 2016 according to data from Fitch, and over 95% of the 170,000 drug approvals by the China FDA according to data from the National Health Commission. China’s generics market is dominated by a large number of low-cost domestic pharmaceutical companies, and these Chinese pharmaceutical companies are now venturing out to overseas markets. In the United States, the world’s largest generics market, Chinese generic drug manufacturers have reportedly won approval for 38 generic drugs from the U.S. Food & Drug Administration in 2017, up from 22 in 2016. Jiangsu Hengrui (SHA;600276), Zhejiang Huahai Pharmaceutical (SHA:600521), Zhejiang Hisun Pharmaceutical (SHA:600267) are among the Chinese pharmas that received U.S. FDA approval.

Meanwhile the world’s largest exporter of generic drugs, India, (which won U.S. FDA approval for 300 drugs, roughly one third of the 927 generic drugs granted U.S. FDA approval in 2016)  has seen its imports of Chinese generic drugs soar 50% in dollar terms over the past four years (2012/2013 – 2016/2017) according to data from the Pharmaceuticals Export Promotion Council (Pharmexcil).

 

Medical devices

One of China’s fastest growing sectors, the Chinese medical device industry has grown in leaps and bounds, with the industry maintaining double digit growth for over a decade. According to data from China Medical Pharmaceutical Material Association, China’s medical device market expanded from CNY 53.5 billion in 2007 to CNY 370 billion in 2016, representing a CAGR of 23.97%, which is three times faster than the global average growth rate of 8%.

Bar chart showing China’s medical device market size (US$ billions) in 2014, 2015, 2016 and 2017 (estimate). China’s medical device industry has been growing at double digits over the past few years with the market valued at US$ 39.32 billion in 2014, US$ 47.38 billion in 2015, US$ 53.62 billion in 2016 and an estimated US$ 58.63 billion in 2017.

The stellar growth has helped boost sales of multinational medical device manufacturers such as Siemens (ETR:SIE), J&J (NYSE:JNJ), Philips, and General Electric (NYSE:GE).

Yet the Chinese medical device market is still at a relatively immature stage considering the fact that globally, the medical device market is about 42% the size of the pharmaceutical market but in China however, the percentage is considerably lower at about 14%, indicating an attractive growth opportunity for medical device manufacturers.

China is Johnson & Johnson’s second largest market after the United States and the company expects China to remain as a key growth engine in the years to come.

Carlyle Group (NASDAQ:CG) owned American in-vitro diagnostics company, Ortho Clinical Diagnostics plans to build manufacturing facilities in China, as it banks on the mainland to be its “No. 1 growth country”. China’s in-vitro diagnostics (IVD) market is expected to grow at a CAGR of over 14% by 2021 according to research firm Technavio, which could be a boon for Swiss healthcare giant Roche Holdings (VTX:ROG), which is the dominant player in China’s IVD market.

But much like China’s pharmaceutical industry, foreign-made medical device brands are perceived to be of superior quality compared to those produced by domestic manufacturers. Consequently, while Chinese medical device manufacturers dominate the local market in general, the vast majority of them compete in the low to mid-range medical device product categories (according to figures from the International Trade Administration, more than 80% of Chinese medical device manufacturers compete in the low to mid-end medical device categories).

Meanwhile foreign medical device manufacturers such as those from the United States, Germany and Japan tend to dominate the higher-end, high-value medical device product category; medical device brands from the United States, which is the number one foreign supplier of medical devices in China, rake in nearly 75% of their local revenue from China’s top tier i.e., Tier III hospitals with the rest from Tier II hospitals according to figures from the International Trade Administration.

In an effort to help local medical device manufacturers play a greater role in the higher-end medical device segment, the Chinese government unveiled its ‘Made in China 2025’ plan which focuses on domestic high-end medical devices in sectors such as diagnostic imaging, medical robots, wearable devices and telemedicine.

Under the plan, China hopes to increase the use of domestically produced medical devices in hospitals to 50% by 2020 and 75% by 2025. The move could further accelerate the rise of local device manufacturers which have been growing faster than multinationals, (albeit from a smaller revenue base), and as a result of continuous product improvement, they have been increasingly taking market share from foreign rivals in medium-level segments of the country’s medical device sector.

For instance, multinationals’ share of China’s orthopedic implant market has dropped from 80% to less than 50% over the past five years, multinationals’ share of China’s drug-eluting stents market (which stood at about 90% as recently as 2004), has declined considerably with local manufacturers such as Biosensors International, Lepu Medical, and MicroPort selling about 80% of China’s drug-eluting stents and multinationals’ share of China’s direct radiography market has dropped from 100% in 2004 to about 50% currently according to data from Boston Consulting Group.

Buoyed by their growing financial, technological and R&D capabilities and supportive government initiatives, Chinese medical device manufacturers appear poised to take further market share in more of China’s medical device sectors in the long term.

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China’s $150 Billion AI Ambition Opens New Growth Opportunities

Line and bar chart showing facial technology investment value and deal volume (including grants) in China 2013-2017. Disclosed funding in facial recognition in China grew from US$ 2 million in 2013 to US$ 41 million in 2017 while the number of deals increased from 3 in 2013 to 41 in 2017.

China is aiming be the world’s leading player in artificial intelligence (人工智能) by 2030 and by some measures, the country appears to be on track.

According to a report by CB Insights, Chinese companies seem to be overtaking their US counterparts in AI-related patent applications; the number of patents published in China containing the words “artificial intelligence” and “deep learning” have grown rapidly over the past few years, and the middle Kingdom finished 2017 with six times more patent publications containing those words than the United States in 2017.

Line graph showing the number of AI related patent publications published in China and the United States, 2013-2017.

While the United States continues to lead in terms of the number of AI startups and equity deal volume, it has seen its share of global AI equity deal volume shrink from 77% in 2013 to 50% in 2017. By comparison, China accounts for a mere 9% share of the world’s AI equity deal volume.

Bar chart showing global AI equity deal share (US vs Non-US deal share), 2013-2017.

However, in terms of global AI funding value, China is the dominant player accounting for 48% of global equity funding in 2017 representing a major increase from the 10% share China held in 2016 and surpassing the United States for the first time. By comparison, the United States accounted for 38% while the rest of the world accounted for the balance 13% of global AI funding value in 2017.

The numbers are likely to be just the beginning for China’s AI industry expansion which, driven by government funding, an encouraging regulatory environment, and the natural advantage of having the world’s largest population yielding unrivaled quantities of data (AI systems need to be “trained” with real-world data and the more data fed into a system, the more accurate it is) positions China as a hotbed of AI opportunities for investors and entrepreneurs.

The Chinese government has set forth a plan for the Development of a New Generation of Artificial Intelligence Industry, which runs in three stages during which the country’s AI capabilities will be steadily developed through 2020 and 2025 and conclude in 2030 when the government aims China will be the leading player in artificial intelligence.

Towards this end, the Ministry of Industry and Information Technology (MIIT) unveiled the first stage of the plan in December 2017, a detailed Three-Year Action Plan (2018-2020) which supports the local AI sector as a strategic area by developing AI-related technologies, bolstering AI talent and investing in AI research through various initiatives, incentives, grants, and funding commitments. The plan focuses on the development of some key AI areas namely,

  1. Intelligent Networked Vehicles (智能网联汽车)
  2. Intelligent Service Robots (智能服务机器人)
  3. Intelligent Drones (智能无人机)
  4. Medical Imaging Diagnostic Systems (医疗影像辅助诊断系统)
  5. Video Image Recognition (视频图像识别)
  6. Intelligent Voice Systems (智能语音)
  7. Intelligent Translation Systems (智能翻译)

 

This creates tremendous business opportunities. By 2030, the Chinese government expects China’s AI sector to blossom into a CNY 1 trillion (US$ 150 billion) industry which could stimulate as much as CNY 10 trillion in related businesses.

The opportunity has attracted local and foreign tech giants eager to profit from China’s burgeoning AI industry. Google (NASDAQ:GOOGL) for instance has opened an AI research facility, Google AI China Center, in Beijing to hire China’s top talent in artificial intelligence while homegrown tech giants such as Alibaba (NYSE:BABA), Baidu (NASDAQ:BIDU), Tencent (HKG:0700), Xiaomi, Huawei and JD.com (NASDAQ:JD) are making hefty investments in AI technologies.

 

Artificial Intelligence chips

AI systems depend on powerful AI chips to run and while numerous Chinese tech giants such as Alibaba, Baidu and Tencent are actively deploying AI technologies to improve their core offerings, much of the AI chips that power their systems are made by foreign suppliers such as Nvidia (NASDAQ:NVDA) and Intel (NASDAQ:INTC).

Although China is the world’s largest semiconductor market, accounting for about 45% of the world’s demand for chips (also known as integrated circuits), much of the country’s demand for chips is met through imports which account for about 90% of China’s total consumption of integrated circuits.

AI chips make up the basic infrastructure of AI systems and having a greater presence in the supply of such strategic components could potentially facilitate the Chinese government to achieve its goal of becoming an AI powerhouse.

Furthermore, as the global AI industry expands at a rapid clip, the global AI chips market is expected to witness extraordinary growth as well. According to research from ResearchAndMarkets, the AI chipset market is poised to expand from US$ 7.06 billion in 2018 to US$ 59.26 billion by 2025, representing a CAGR of 35.5% during 2018-2025.

Globally, chip startups have raised more than US$ 1.5 billion from in venture capital funding last year, nearly double the amount the year before according to CB Insights.

The Chinese government appears intent on capturing some of that profit potential too; in its Three Year Action Plan (2018-2020), the Chinese government aims to mass-produce neural network processing chips by 2020. China’s previous attempts to build the local semiconductor sector (from as way back as the 1990s) had mixed results partly due to the fact that government incentives and funds were concentrated on research and academia than on business.

This time however, Chinese AI chip businesses seeing greater government support, putting them in good position to participate in the growing global AI chip market.

Within 18 months of its founding by scientists at the Chinese Academy of Sciences (CAS), Chinese AI chip developer Cambricon Technologies raised US$ 100 million in Series A funding making it China’s first AI unicorn. Led by SDIC Chuangye Investment Management which is a subsidiary of China’s State Development and Investment Corporation, the funding round attracted prominent investors including e-commerce giant Alibaba Group, computer manufacturer Lenovo (HKG:0992), robotics company Zhongke Tuling Century Beijing Technology and the investment arm of the Chinese Academy of Sciences (CAS).

Scientists and engineers from Beijing’s Tsinghua University (which is known as China’s ‘MIT’) have developed “Thinker” a multi-purpose AI chip that can support any neural network and is extremely energy efficient. Beijing-based chip manufacturer Tsinghua Unigroup, a subsidiary of Tsinghua Holdings which is owned by Tsinghua University received up to US$ 22 billion in state financing in early 2017.

Chinese e-commerce goliath Alibaba is also reportedly developing its own chips, joining global tech giants such as Google, Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB) which are already working building their own AI chips. Called the Ali-NPU, Alibaba’s AI chips will be made available for anyone to use through its Alibaba Cloud service.

 

Facial recognition

 Over the past few years, China’s facial recognition market has seen a rapid growth in investment in terms of deal value and volume.

Line and bar chart showing facial technology investment value and deal volume (including grants) in China 2013-2017. Disclosed funding in facial recognition in China grew from US$ 2 million in 2013 to US$ 41 million in 2017 while the number of deals increased from 3 in 2013 to 41 in 2017.

According to CB Insights, of all countries in the world, China appears to be making the greatest use of facial recognition software with the technology being widely used throughout the country from supermarkets, airports, streets, office buildings, apartments, hotels, bank counters and ATMs.

The business opportunity has given birth to a number of Chinese facial recognition startups such as Alibaba-backed AI unicorn SenseTime (the most valuable AI startup in the world as if April 2018), Megvii (which develops Face++, one of China’s most common facial recognition platforms used for applications such as to manage entry in places such as Beijing’s train stations and Alibaba’s office building, and to enable Alipay customers to authenticate payment), CloudWalk Technology (a facial recognition software developer whose clients include the Zimbabwean government and Bank of China), DeepGlint, Zoloz and Yitu Technology (which counts the Malaysian Police as a client).

Chinese police are already using facial recognition sunglasses to track its citizens and the Chinese government is reportedly aiming to build a national database that will recognize any of the 1.3 billion citizens in China (the world’s most populous country) in three seconds. Already, more than 4,000 people have been arrested by Chinese authorities, helped by facial recognition technology.

Alipay, China’s most popular mobile payment app owned Alibaba affiliate Ant Financial has rolled out the world’s first payment system that uses facial recognition to enable customers to authenticate payments using just their face and a second authentication using their mobile phones.

In spite of China seeing rapid advancements in facial recognition, there is still considerable potential for the industry to grow driven by the growth of intelligent vehicles in China.

 

Intelligent vehicles

While autonomous cars are gathering momentum worldwide, China, the world’s largest car market is speeding towards intelligent vehicles with the country’s top economic planning agency, the National Development and Reform Commission naming intelligent vehicles as a national priority in a three year action plan unveiled in December 2017.

Autonomous cars refer to vehicles that are equipped with sensors and GPS while intelligent vehicles (the so called “smartphones on wheels”) refer to cars with technologies such as road safety monitoring, interactive entertainment, facial recognition, voice interaction systems and in-vehicle payment systems.

By 2020, the Chinese government expects the market share of smart vehicles to reach 50% of total new vehicles sold in China. Towards that end, the Chinese authorities have taken steps to boost the country’s intelligent and connected vehicle industry such as through talent training and research, encouraging investment, and encouraging cross-border mergers and acquisitions.

Strong regulatory support coupled with Chinese car buyers’ seemingly high enthusiasm for connected vehicles which presents a potentially sizeable market for smart cars suggests the government’s target could be within reach. According to a survey conducted by McKinsey in 2017, 64% of Chinese consumers would switch brands for better in-car connectivity. By comparison, 37% of Americans would switch brands for better in-car connectivity and just 19% of Germans would do the same.

Bar chart showing desire for in-car connectivity from consumers in China, United States and Germany. 64% of Chinese consumers surveyed were willing to switch brands for better in-car connectivity compared with just 37% of American consumers and 19% of German consumers. For 33% of Chinese consumers, having in-car connectivity is critical while 20% of American consumers and 18% of German consumers felt the same. 62% of Chinese consumers were willing to pay a subscription for in-car connectivity while just 29% of American consumers and 13% of German consumers were willing to do the same.

The opportunity has turned China’s intelligent connected vehicle market into a hot sector attracting a raft of companies, from established tech giants to smaller startups, keen to participate.

Alibaba has signed agreements with auto companies such as Ford (NYSE:F), Dongfeng Peugeot Citroen and SAIC Motor (SHA:600104) to develop connected vehicles which use its AliOS automotive operating system which was unveiled in 2016.

Chinese social media behemoth Tencent has teamed up with Changan Automobile, while Chinese internet giant Baidu has partnered with Great Wall Motors towards develop intelligent connected vehicles.