The stock of Mongolia Growth Group has been under pressure over the last several months. Consequently, this created lots of questions from the current and potential investors. Here is an interview with Harris Kupperman, CEO of Mongolia Growth Group. Also, the company released an update on January 14, 2015. I will be including Mongolia Growth Group in the February Issue of Ultimate Value Finder.
Interview with Harris Kupperman
Mariusz Skonieczny: Lots of things have changed since we talked last time and also lots of things have changed since MGG went public. I remember when I first learned about the company, the Mongolian economy was on fire. Lots of people were talking about it. However, recently people are not excited about the Mongolian economy and I am sure this some consequences on MGG. We will get to the details of MGG, but can you update us on what is going on with the Mongolian economy?
Harris Kupperman: When I first started MGG, I believed that Mongolia’s $2 trillion in resource wealth would ultimately come out of the ground and make Mongolia into a very wealthy place. I also knew that this wouldn’t be a seamless process and that there would be plenty of volatility along the way. In summary, we are witnessing some of that volatility today.
This is partly the result of lower coal prices, but the government has also made a number of critical mistakes in regards to foreign investment and that has discouraged investors. The good news is that this is all fixable. Furthermore, many frontier markets have made similar mistakes, recovered from them and then come out stronger. This is all part of a country maturing.
Mariusz Skonieczny: Because the Mongolian economy is so small in relation to the economies of other countries, single projects like the Cooper/Gold Oyu Tolgoi mine can by themselves grow the country’s GDP. From my understanding, the government of Mongolia and Rio Tinto are fighting over tax issues related to the project. Do you think that this disagreement has negative consequences on foreign investment in Mongolia?
Harris Kupperman: The disagreements between the Government of Mongolia and Rio Tinto over the Oyu Tolgoi mine are probably the largest single deterrence to foreign investment. Everyone knows that this will ultimately be resolved, but until it is, many large projects are on hold.
Mariusz Skonieczny: What is the status of the disagreement between Mongolian government and Rio Tinto?
Harris Kupperman: There are many issues, some are economic issues and some are simply related to egos. The biggest issue is that the project is over budget and Mongolia won’t be getting dividends until the project recoups its capital costs. The Mongolians want to understand why the project is so over budget and make sure that it won’t go even further over budget. In the end, this will get resolved—it is just a question of when.
Mariusz Skonieczny: Do you think once the conflict over tax issues is resolved, that foreign investment in Mongolia will recover?
Harris Kupperman: I think it will take some time for foreign investment to recover to prior levels. However, you want to be positioned for the eventual resolution as asset prices will jump substantially as soon as the resolution is finalized. We saw the same thing happen when the original stability agreement to develop the mine was signed. In the months after the announcement, asset prices increased by hundreds of percent—the MSE 20, the best benchmark for Mongolian asset prices increased by about six-fold in less than two years. No one will want to miss that sort of move.
Mariusz Skonieczny: Now, let’s move on to MGG. Last time we spoke, you hired a new CEO that had a plan to transform MGG into a CB Richard Ellis of Mongolia. He wanted to do a private REIT, development arm, etc. According to the most recent news from the company, the CEO is gone, several board members are gone, and huge cost cuts are on the table. This is obviously a completely different strategy from what was communicated to investors over the last four years. Please tell us what is going on?
Harris Kupperman: I am the largest shareholder and have a huge percentage of my net worth invested in this company. After I stepped away from daily responsibilities and looked at the model, I realized that it just wouldn’t work given the slow-down in the Mongolian economy. Not only were we not gaining traction with this model, but we were going backwards and adding to our costs. We should have been aggressively cutting costs and getting to cash flow positive. It’s great to talk about growth initiatives—but it’s much harder when investors are hesitant to invest in Mongolia. I think we will be doing many of the things that we talked about, but we need to first wait on a resolution of the Oyu Tolgoi mine dispute and an increase in foreign investment in Mongolia. I want to grow, but it needs to be from a much sounder base.
Mariusz Skonieczny: Can you give us an example of things that you are doing or planning on doing to bring your cost structure to a level that the company is profitable?
Harris Kupperman: A lot of it has to do with mentality. We were approaching this business like we were building a multi-billion dollar company. However, to get there, you first need to succeed at being a smaller business. This means cutting a lot of the unnecessary spending that has surrounded the company. There is just so much to cut and I’ve wanted to get cutting for a long time. I’m actually really excited to finally get the job done. There were impediments before, but now I’m finally free to act.
Mariusz Skonieczny: Investors always want to know “when.” So when do you anticipate the cost cutting initiative to be complete?
Harris Kupperman: The first round of cost-cutting is mostly complete. It will take a few months for it to work its way through the system, but the key was to identify the costs and then eliminate them. This is everything from terminating contracts that serve no purpose to re-negotiating contracts. Now I’m able to take out the chainsaw and get things in line with where they need to be.
There will be a second round of cuts, but this second round will take a bit longer as we are then looking at costs that are more difficult to simply eliminate. These are items that we need to re-tender and really analyze the costs and benefits of each service provider. I suspect that these costs will be much more under control by the middle of 2015.
Mariusz Skonieczny: Once the company is profitable, what are you going to do with the profits? Are you going to use it to buy other properties, retail it, or pay it out through a dividend?
Harris Kupperman: I think we will do a combination of the above, but there is so much opportunity in Mongolia that re-investment will be the main priority.
Mariusz Skonieczny: The company recently sold some properties to focus only on the core holdings. How was the money from the sale of these properties used?
Harris Kupperman: It was re-invested in Tuguldur. I believe that continuing to develop our Tuguldur asset is by far the best use of our capital resources. I suspect that we will continue to do this until Tuguldur is completed. We expect Tuguldur revenues to exceed the revenue of the rest of the company upon completion of the full project.
Mariusz Skonieczny: Are there more properties to be sold in the next few months?
Harris Kupperman: We have a few more that we are looking to sell. We’ve already sold most of the underperforming properties. We really don’t have many left that we don’t want—so it’s really a question of prioritizing what we want to keep and what we should dispose of to re-invest in Tuguldur.
Mariusz Skonieczny: What are the plans for the core real estate portfolio in terms of redevelopment?
Harris Kupperman: We have a great pipeline of projects. The first priority is Tuguldur. Then we will move on with other projects. We have enough to keep us busy for quite some time.
Mariusz Skonieczny: Now that you are the CEO again are you going to hold this position permanently or will you be looking for a new CEO?
Harris Kupperman: I do not plan to hold this position permanently. But today our number one priority, and the reason I’m back in the CEO role, is to slash costs. CEO’s are expensive and I’m willing to work for free, and know the business that I founded and grew as well as anyone. Once we are profitable and can focus on additional revenue generating opportunities, it will be more appropriate to bring in a real estate CEO who is more suited to run the company at that point in time. I think we will re-evaluate this as we see how things evolve at MGG. It was pretty obvious that I needed to step back in to dramatically cut costs and preserve the value of the company. Once the business stabilizes, I think we can once again go back to thinking about how to grow it.
Mariusz Skonieczny: I am done with my questions. I would now like to ask you questions that were submitted to me by readers of my blog and newsletter.
Anon: Does the termination of Paul Byrne mean that he is working independently rather than going to another firm full time?
Harris Kupperman: I don’t know of his current plans.
AAGold: The basic investment thesis for MGG, and for that matter most emerging/frontier market stocks, is that very high GDP growth leads to earnings/cash flow growth which eventually leads to stock price / dividend growth. I’ve seen this basic premise disproved in some research studies, and in the specific case of MGG something seems very out of whack.
If you consider the years 2012, 2013, and 2014, how much did Mongolia’s nominal GDP grow in US-dollar terms (i.e., 2014 GDP / 2011 GDP)? I think the growth over those three years was probably quite substantial – maybe 30% measured in USD? But now let’s take a look at MGG’s same-store rental growth over that period, also measured in USD so it’s an apples-to-apples comparison. I believe it’s the case that, on a same-store basic measured in USD, MGG’s rentals have actually *declined* over those 3 years. And if not an outright decline, MGG’s rentals are at best approximately flat, and there’s no way rentals in USD have grown anywhere near as much as Mongolia’s GDP. So, it would appear that Mongolia’s real estate businesses have gotten nowhere near their fair share of Mongolia’s GDP growth over the past 3 years. So what’s going on?
Harris Kupperman: Our rents are a lagging figure as we are signing 1-5 year leases. Hence, growth in rental rates only shows up in our numbers AFTER we re-sign the leases upon expiry. In addition, a decline in the USD/MNT exchange rate of approximately 50% since we started the company has further hurt our ability to show these rental increases in our numbers. That said; in USD terms, rents on Peace Avenue have gone from the low teens per meter a month to the high twenties per meter per month since we started the company. They’ve effectively more than doubled in four years. If the currency will stabilize for a year or two, that growth will show up in our numbers and it definitely has shown up in the valuation of the property assets that we own. So we are getting some of the advantage of this increase.
AAGold: Why has MGG’s management stopped disclosing same-store rental information? For a while they were disclosing rental information each month in the letter to shareholders, where they would give year-over-year growth rates in local currency terms. I notice they started doing this once the rentals started growing nicely, and now they’ve suddenly stopped for the past few months. That makes me think the more recent numbers are poor and they don’t want to talk about them anymore.
Harris Kupperman: I believe strongly in transparency and timely disclosure of important operating metrics. Now that I am now back as CEO, MGG will again disclose these key rental metrics, starting with the January, 2015 letter. The comparable numbers have remained consistent over the past few months
Mariusz Skonieczny: Harris, thank you very much for this interview. I hope that your answers will help investors understand what is going on within MGG.
Harris Kupperman: Mariusz, thanks for giving me a chance to further explain the changes that are happening at MGG. I think that these changes are both overdue and necessary. Now it is up to our management team to deliver on our cost cutting goals and put MGG into a stronger financial position to take advantage of the eventual rebound in the Mongolian economy.