5. How Political Access Adds Value

Traveling around the world, I am continually astounded by how many businesspeople know Ben Graham. Not just executives in places like Hong Kong and Dubai, but business students and investing enthusiasts in places like Bangalore, Chengdu, and Jeddah. Giving talks in these regions, I have found that if I put up a slide of Ben Graham, 10% to 20% of the group can identify him by his picture alone. And I suspect it is now only a matter of time before some large real estate developer in the Middle East or China builds two small twin cities and names them Graham and Doddsville.

It’s clear that Graham’s value approach is compatible with the government-infused markets described in the preceding chapter. Not only do the investors and deal-makers in these regions understand highly political systems and how to deal with active government actors, but they also understand and follow Graham. It’s really just a matter of adapting Graham’s Method and the well-known techniques to these politicized environments. This chapter is about how to do this, with a focus on private assets. Value strategies for companies on emerging market exchanges such as Hong Kong and Dubai are well known and are not repeated here.

Princes, SOEs, and Government Sachs

Seven ways political access can help investors

The large and persistent role of government in a multipolar world effectively guarantees the ongoing creation of large market inefficiencies. Fortunately, using political access is a fairly effective way to capture these opportunities. It is difficult to overemphasize the power of this approach in state capitalist and godfather capitalist economies. This approach explains the rise of many—sometimes I think all—of the wealthy investors from many regions.

Note in Figure 5.1, that politically created inefficiencies show up in Question 2, and political access is marked as a value key for constructing deals and securing a margin of safety. Recall that value keys both open the door to investments and add value with the primary goal of eliminating the current and long-term downside uncertainty.

Figure 5.1. The political access key and politically created inefficiencies

Question 1 asks whether a company is good, potentially great, or great. Government rules and the choices of government actors can positively and negatively impact the attractiveness of both individual companies and industry structures. Politically limited competition can create particularly sustainable competitive advantages. State-owned enterprises themselves can be very attractive companies for investment. And Mr. Government can directly increase the intrinsic value of many types of companies. So political factors are significant for Question 1.

Question 2 asks whether the company is cheap. As discussed in the preceding chapter, government-skewed markets are far more inefficient and can swing price far away from value. Both Mr. Market and Mr. Government can create mispricing opportunities. And if you are purchasing a company or asset directly from a government agency or state-owned enterprise (SOE), negotiated prices can be quite attractive. At the industry level, government-directed development activities, such as were described for China and Dubai, can generate large trends in which significant lags between value and price almost always exist. I have highlighted government-created inefficiencies under Question 2 as both “Mr. Government” and “Landscape Changes.”

Question 3 asks whether the margin of safety can be captured. But this middle section of the chart is also about deal advantages. Can you access the investment? Can you beat out competing bids? What is your advantage in bidding on companies in Dubai or Singapore? Is being a foreigner a disadvantage? Political access is a requirement in many of these situations and can be a very strong advantage in some. In the best-case scenario, you structure the deal such that you end up as the only bidder for a project or company.

Generally, if you are investing in politically infused markets then political access and government-skewed economics are significant determinants of company quality, price, and the margin of safety.

Although it is interesting to detail large investments involving high-level officials in Beijing, Doha, and Moscow, most political-type deals are actually at lower and smaller levels. Vancouver legal firms are doing mining deals with government officials in Kunming. Investment bankers in London are dealing with Saudi regulators for their corporate clients. And venture capitalists, private equity groups, and business development executives going global are rapidly building political expertise, if not capabilities, around the world.

In terms of the uncertainty language presented in Chapter 3, “Value Point,” political access can have seven significant effects on a value-focused transaction, as shown in Figure 5.2:

1. Increased access to deals. This is clearly the primary opportunity. And not just deals, but special deals. Getting land in China. Acquiring licenses in limited-competition situations in Latin America. Obtaining construction contracts in Qatar or oil and gas allocations in Saudi Arabia. Winning access to natural resources or state-owned assets or, in the case of the Russian oligarchs, getting actual ownership. The ideal situation is when you have preferential access to a company with politically limited competition.
2. Decreased entry price. This is occasionally possible. Whether it is assets or contracts, governments are often unskilled at setting prices, and this doesn’t seem to worry them much.
3. Increasing the intrinsic value of an asset or company. Buying a company and putting in place a significant government contract or benefiting from the actions of a state-owned entity can create a large increase in economic value.
4. Eliminating future downside uncertainty (stabilizing the margin of safety). This is most commonly done through a significant government contract or investing in a company with politically limited competition.
5. Creating an advantage when competing for deals. Politically connected locals typically are in a strong position relative to foreign companies. This is the reason for many foreign-local joint ventures in politicized markets.
6. Occasionally creating a long-term partnership with a company (strengthening a claim to the enterprise). Political access tends to be a short-term value-add for foreigners. It’s better for securing contracts or assets as opposed to creating long-term operating partnerships.
7. Eliminating nonmarket risks (defensibility). This is critical. The government is the primary nonmarket risk in many systems, and it’s better to be on the inside than the outside. This speaks to the long-term downside uncertainty.

Figure 5.2. The uses of political access

Figure 5.2 shows the net impact on the value framework.

These seven uses of political access are a different “value approach” than that taken by traditional value investors and private equity groups. Value investors have traditionally limited political connections to information gathering (particularly by event-driven short-term investors). Private equity firms have traditionally used political access both for information and for enhancing their management and operational efforts. It is a secondary consideration at best. Value point directly focuses on adding value with political access, which can be fairly powerful at the company and deal level in highly politicized markets. This approach is very common by local investors in these markets.

Political Access Success Stories

In 2010, Carlos Slim Helu became the world’s richest person, inching past Bill Gates at $53.5 billion. That Slim’s wealth increased by $19 billion in one year (averaging $2.2 million per hour) was particularly startling. He is also the first person from a developing economy to top the list, being propelled there by his Mexican telecommunications empire. Emerging-market giants like Carlos Slim are growing in number and offer important case studies in how to generate large wealth in economies with different politico-economic structures. You really cannot separate most of the emerging-market giants like Slim from such politicized economics.

Emerging-market giants most commonly are the result of exceedingly profitable industry positions in government-skewed economies. Typically, the individual or company captures a limited competition (very good) or monopoly position (phenomenal) at the regional or national level. And, given the rising wealth of many emerging markets, they become prominent and often highly liquid global investors fairly rapidly. The abnormally high domestic cash flows enable Western acquisitions so they are most often first noticed as bargain hunters for premier Western assets (see Figure 5.3). Whether it’s Slim into the United States or Russian oligarchs into the UK, we see this pattern repeatedly. A select few (such as Prince Waleed) then combine their developed and developing market assets to do global deal-making.

Figure 5.3. Government-skewed economics fuel the rise of many emerging-market giants

Emerging-market giants are one manifestation of the increasing wealth of government-skewed markets. There are many others such as state-owned enterprises, government-connected or -financed multinationals, and sovereign wealth funds. Understanding how political access is deployed in government-skewed economies is critical to understanding the wealth creation that is the engine of many rising companies and investors.

The Value of Political Access in State Capitalist Systems

In state capitalist China and Russia, political access is the number-one, -two, and -three strategy for investing and deal-making. I grew up with the idea that first you make your fortune in business, and then you serve in the government. In state capitalist systems, the approach is basically the reverse. People accumulate power through a government position, and then use that to make their fortune. This is not as Machiavellian as it sounds. It simply reflects the fact that state entities are the largest players in the economy, and that is where most of the economic opportunities are. Working in “politics” could mean working in a state-owned entity such as China Mobile or in a state-supported innovation hub such as Founder Group, a Beijing-based technology conglomerate. It can be building a private company with close ties to the government, such as Chinese search engine Baidu. But for those who invest in these environments, political access is part of most every successful company and therefore most deals.

A good example of one of China’s emerging-market giants is Vincent Lo, the chairman of Shui On Group and arguably the most famous Shanghai real estate developer. Lo was an aggressive early mover in large-scale Chinese real estate. In the 1990s, he successfully acquired and master-planned a very large section of downtown Shanghai, something unheard of at the time. The resulting now-quite-famous Xintiandi development covers approximately 129 acres of land in the central Luwan district of Shanghai and contains a historic shikumen district, residential housing, and premier office space. It is still a singular achievement in terms of Chinese real estate development. One can watch tour buses arrive at Xintiandi every morning filled with Chinese tourists who want to take pictures in front of its sign. When large numbers of tourists want to take photos in front of your Coffee Bean, that is a fairly good sign that you have succeeded.

When Lo first proposed the large master-planned development in 1997 to Han Zheng, then an up-and-coming Luwan officer (and a future Shanghai mayor), acquiring land in China was entirely a political process. Land is not even actually acquired as it belongs to the state; it is technically leased for 20 to 40 years. And typically, government departments master-plan the areas and then sell smaller sections to developers on a lot-by-lot basis. This unfortunately has resulted in most Chinese cities having very high-quality buildings but, as of yet, few memorable large developments. Shanghai has no Trafalgar Square or Champs d’Elysees. Within this highly political process, acquiring such a large space in central Shanghai and then being able to master-plan it was a demonstration of outstanding political access. To my knowledge such a thing has not been repeated since.

Over time, the land-acquisition process in China has become less political. Open bids are now held for most tracts in the major cities, but the bidding process is still influenced, and successful bids are sometimes “arranged.” Even today, such real estate deals, many of them politically connected, account for a large number of China’s emerging-market giants.

However, my favorite example of the use of political access in Chinese real estate is a developer I met in Changsha, Hunan, whom I will call Mr. Zhang. It is a good lesson in how even a small amount of political access can be leveraged into a fortune in such a system.

Changsha is the capital of Hunan, but it is certainly not a wealthy city. It has none of the economic scale or growth of Shanghai. So those with strong political connections typically focus on building hotels for visiting businessmen or luxury residential apartments for the still small local upper class. In starting his business, Mr. Zhang had little capital but some political access. He was able to leverage his political connections to buy some land far outside the city that nobody really wanted. As necessity is the mother of invention, he hit upon the idea of building private cemeteries. The land outside of town that nobody wanted was relatively cheap, and cemeteries don’t need central locations. There are also no real capital costs for building cemeteries, because there is really nothing to build. The only operating costs are for gardeners, which, as you can imagine, are pretty cheap in Hunan, and advertising space in downtown Changsha offering plots for people’s parents. Plus you can sign contracts and receive payments for the plots on a reservation basis almost immediately. In a respect-your-elders society, private cemeteries turned out to be a low-capital expenditure, low cost of growth, high cash-flow business. Within five years, Mr. Zhang became one of the most successful private cemetery owners.

Such success stories are fairly common in most of the state capitalist systems. A deal is done between a private business person and a government official or department (usually in construction, real estate, or infrastructure) and that propels the investor upward, often at astonishing speeds.

Still, the most spectacular example of the use of political access is without question the loans-for-shares deals in Russia in the mid-1990s. Relatively unknown individuals became billionaire oligarchs almost overnight by acquiring previously state-owned assets. This story is covered in fascinating detail in Chrystia Freeland’s book Sale of the Century and is not repeated here.

The Value of Political Access in Godfather Economies

In the godfather economies (Hong Kong, Qatar, Macau, the UAE, etc.), political access is a similarly powerful way to create wealth. The dynamics are also much easier to understand in these smaller and simple economies. A small number of individuals or families control much of the economy and local businesses in either strong or weak fashion, and they tend to be fairly easy to work with. Additionally, these economies are often not self-sufficient. They need foreign technology, products, brands, and business models, so the locals in power have a greater interest in working with foreign partners. A foreigner may have difficulty getting state approval for a deal in Moscow, but it is quite a natural thing in Singapore or Qatar.

Qatar is an interesting example because it is a rapidly growing economy and is controlled by a single group, the Al Thani family. Most of the country’s major projects are developed by entities controlled by his family. Additionally, as a small country, Qatar also lacks virtually all the capabilities required for domestic development (technology, management, businesses). So, unsurprisingly, Qatari Diar has launched a series of joint ventures with foreign partners. Qatari and the Saudi BinLadin group have launched a new construction and industrial services company. Qatari Diar and Deutsche Bahn, a leading passenger and logistics company, launched a joint venture to develop the country’s railways. Qatari Diar and Prince Waleed struck a hotel development and management deal in which Qatari Diar purchased 23% of Fairmont Raffles and then provided multiple hotel management contracts. And so on. Such deals are quite simply, and are mostly, and sometimes entirely, about political access.

You can see the same pattern across the godfather economies. A small group of individuals control significant parts of the economy and are quite comfortable with foreign partners. For example, in Dubai, most real estate is controlled by three state-owned companies—Emaar, Nakheel, and Jumeirah. And in Abu Dhabi, local real estate is developed by five primary real estate companies—coincidentally the same number of main members of the royal family.

From Mexico to China to the Middle East, companies and investors who leverage political access into returns are in ascension. Rising tycoons such as Slim in Mexico and Prince Waleed in Saudi Arabia; overnight billionaires such as the oligarchs in Russia; and family dynasty heads such as Li Kai Shing in Hong Kong and Stanley Ho in Macau are experts at understanding politically infused markets and at structuring political access into their deals. Understanding such political aspects at both the deal and company level is critical within a value approach in such systems.

Investment Strategies for Politicized Markets

The following sections detail two examples of particularly effective strategies for particularly government-skewed markets. These are both value-added strategies consistent with Graham’s Method previously outlined. You eliminate uncertainty, quantify risk, and invest surgically (and big). Again, the primary challenge is to eliminate the long-term downside uncertainty—through both company selection (the traditional value approach) and negotiated value-added deal-making (value point approach).

Strategy #1: “Bird on a Rhino”

A multipolar world contains many types of what I call corporate, government, and financial “rhinos.” These are the very large animals in the economy. They command large assets and large investment dollars and often they are focused on overriding strategic or government interests, as opposed to purely financial returns. They also tend to show herding effects, running in packs after various investment opportunities. Moving out of the West and into smaller and shallower economies, such rhinos can have a disproportionately large impact.

The state-owned enterprises of China, Russia, and the GCC countries are good examples of emerging-market rhinos. Their interests are a shifting mix of government and commercial priorities. And they regularly invest tens of billions of dollars with a long-term focus. Saudi Aramco, the Saudi government oil giant, routinely makes large strategic investments around the world in order to move downstream in the oil and gas industry. Chinese state-owned enterprises such as Baosteel operate like rhinos in places like Africa and Latin America, where they focus on making strategic acquisitions of natural resources and tend to be very large relative to the local economy. And they occasionally coordinate with government-backed commercial and development banks in these deals (another type of rhino). Similarly, Western-based multinationals often act like rhinos when going after the “must-win” markets of China and India. In all cases, the rhinos drive large flows of dollars without strict, or at least strict short-term, financial return requirements.

Continuing the analogy, real rhinos in the wilderness have symbiotic relationships with tick birds, the small white birds that ride on their backs, eating ticks and warning the rhinos of danger. In return, the birds have a safe place to stay, because no predators attack rhinos, and they receive free transportation.

Being a “bird on a rhino” is one of my favorite investment strategies in government-skewed economies. It entails making small investments in scalable, low cost-of-growth companies that directly benefit from, and often help, the commercial and government rhinos. They are also called “5 to 20” investments because they can go from $5 million to $20 million rapidly.

China’s financial sector includes some good recent examples of the “bird on a rhino” approach. The financial sector is evolving quickly with the recent addition of credit cards, wealth management, insurance, and securities subsectors. The sector is also teaming with rhinos, such as the state-owned banks, state-owned insurance companies, multinationals, and many others. Huge investment dollars are flooding into the sector at the current time.

One such “bird on a rhino” investment in this sector was undertaken by a friend I’ll call Mr. Lee. He invested in a communications platform that could connect commercial banks with smaller networks of independent ATMs, mostly in outlying regions. The investment was small and the service highly scalable, with a low cost of growth. Most importantly, it benefited directly from the actions of the large government-backed banks (it was a bird on a rhino). Immediately after investing, Mr. Lee could offer the large banks ATM access in areas in which they did not yet have it. Unsurprisingly, all the banks jumped at the chance to expand their ATM networks, and all quickly contracted with the company. One large bank offered to buy the company. The value of Mr. Lee’s small company jumped dramatically (5 to 20) based on the contracts.

This deal had all the basic qualities of a value point investment (see Figure 5.4). Mr. Lee found an opportunity to add value to both the investment (through several bank contracts) and the banks (offering them a regional ATM network). He targeted a large inefficiency—the capability gaps in the rapidly evolving financial services sector. He contacted the state-owned enterprises early on, invested surgically, and effectively made his returns at the time of investment. He also did not need to control the ATM company (minority share is OK), because the bank contracts gave him enough control for a secure investment. All in all, he entered with a healthy margin of safety, minimized the downside and maximized the upside.

Figure 5.4. “Bird on a rhino”—Shanghai Financial Services Company

However, the dominant factor was the government-skewed economics. Between government-backed banks, regulatory committees, and tightly controlled foreign banks, the entire development and evolution of the Chinese financial services industry are under political influence. Secondly, political access was the critical component in terms of securing the bank contracts and the value-add at the time of investment.

Occasionally, and in greatly entertaining fashion, the rhinos battle it out, as in present-day Macau. The rhinos of Macau are the foreign- and domestic-invested casinos. Western-invested and -operated casinos such as the Wynn and the Sands, as well as locally owned casinos, are competing for Chinese gamblers by pouring tens of billions of dollars into their facilities and offering luxurious services and facilities. The net result is a massive influx of money, people, construction, and other activity in a small city in the space of seven years.

This situation has all the qualities of an attractive investment environment. There is a large economic trend (a rising casino town). There are large capability gaps. And there are large cross-border inefficiencies. Moreover, Macau by definition is a government-skewed market in which casinos are licensed by the local government (a shifting mix of Beijing and Macau political interests) and land is tightly controlled on the small islands. Visas and other requirements for staff and just about everything else are government-controlled. It is a political environment from top to bottom.

Enter MKW Capital, a private equity firm that builds and buys scalable investments benefiting from casino growth and competition—often “bird on a rhino” strategies. For example, casinos need thousands of employees (the Las Vegas Sands Corporation has 28,500 employees), and Macau now has more than 30 casinos. So MKW opened the first online human resources company based in Macau and immediately contracted with many of the major casinos, adding large value rapidly at the time of investment. This approach also took advantage of cross-border inefficiencies (Western human resources companies don’t know much about Macau, and vice versa) and capability gaps (casinos need staff with specific skills), both of which I have argued are a type of market inefficiency. Their investment rose quickly on the backs of the competing rhinos. MKW also launched a locally based advertising company which directly benefits from the fiercely competing casinos that, unsurprisingly, spare no expense in this area. Multiple other “bird on a rhino” investments followed, and MKW quickly became known as the smartest investment group in Macau.

Strategy #2: Limited-Competition Situations

In the Macau scenario just described, the casinos were initially a politically limited-competition situation. Prior to the opening of the market, Stanley Ho had an effective monopoly for more than twenty years. Post-opening, the licenses remain controlled by the Macau authorities and are given to only select companies or individuals. Sheldon Adelson’s first Macau Sands Casino greatly benefited from the limited competition at that time. Opened in 2004 as a day trip destination across the border from China, the $240 million investment returned its capital and quite a bit more within only a few months. Although the licenses are no longer as strictly controlled today, there is a reason why Stanley Ho, and several of his children have casinos in prominent locations.

Another example of politically limited competition is Saudi Arabia, which has historically had nine banking licenses. Owning one of these licenses in the cash-rich oil kingdom was a guarantee of high profits. Prince Waleed’s first major investment in Saudi Arabia, after years of smaller, high-return real estate investments, was the acquisition of United Saudi Commercial Bank, at that time the weakest of the Saudi banks. Following a rapid turnaround, it returned to profitability, and Waleed became one of the Middle East’s major players. (This could be described as the bird taking over the rhino.) This also foreshadowed his 1991 investment in Citigroup three years later.

Limited-competition situations can take many forms, but they are overwhelmingly government-created and therefore are infused with politics. PetroChina is China’s biggest oil producer (the world’s second-largest company by market capitalization) and dominates the sector by size and political authority. Land and prime locations in places like China and Russia are effectively limited competition and are politically allocated (ie., Vincent Lo in Shanghai). Telecommunications networks usually are limited to two to three in a country and are politically controlled. And so on.

The challenge in pursuing this strategy as a value investor is acquiring such limited-competition companies. While long-term uncertainties are typically the primary problem in developing economy investing, in this case, it is deal access. A few of these companies are publicly listed and minority ownership can be acquired, but most are smaller and privately held. This is where offering to invest with a compelling addition to value is critical (that is, the search for the opportunity to add value). Pursuing this strategy usually means relying heavily on political access.

Live by Politics, Die by Politics

For foreign deal-makers, a political advantage often declines over time

Political access can be somewhat tricky if you are a foreigner and going long-term. It can be a very strong advantage in terms of getting some deals. In many situations it is a requirement for getting any deals. But political access for foreigners tends to be a particularly short-lived advantage.

For example, most search engines in China, Russia, and many other countries are both dependent on foreigners and highly political. This tends to put the local governments in the difficult position of balancing the foreign technology they need with the control of information they want.

Thus, when Google entered China in 2005, it was in a fairly strong political position. Approximately 100 million Mainland Chinese users were already searching online in various forms (the online population is now approaching 400 million), and Google had fairly unique search engine technology. To some degree, the government needed Google at that point. In a reasonably strong position, Google agreed to filter search results but avoided many of the joint venture and technology transfer requirements other foreign companies had faced. However, as time passed, Google’s political position grew weaker as domestic competitor Baidu increased its capabilities. Google’s technological expertise was no longer perceived as quite so necessary. In a highly political situation, its political strength was declining.

At a 2009 dinner with a Google executive in London, I made one of my better predictions: that Google would likely fail in China. Google was politically weak in a mostly political competition with Baidu. I predicted that it would be forced out, be forced to sell into a minority position in a state-controlled company, or be kept at a minority market share while the local competitors grew in strength. My argument was that the use of political access by foreigners tends to be strong in the short term but weak in the long term, particularly in hypercompetitive and hyperpolitical industries such as state capitalist search engines. Third-place search engine Yahoo! had already sold its China operations in 2005 to local competitor Alibaba. In March 2010, Google preemptively and very publicly exited China (sort of).

It is unclear what other decision Google could have made. In rapidly developing economies, foreign players can be very strong at certain key points, but political access is hard to sustain in an ongoing competition. For real estate or fixed-asset investments, a short-term advantage is usually sufficient. Once ownership of a building is acquired, it is pretty difficult to lose it. You need a political advantage on the day you buy the building. But for operating entities in highly competitive industries, such as Internet companies, it is difficult to survive with a declining advantage.

The case of Dubailand offers an interesting contrast. This massive Disneyland-type theme park under development in Dubai has similar political aspects. As originally planned, it will eventually cover 104 square miles, contain 24 separate projects (including an indoor ski dome and a Tiger Woods golf course), and cost $65 billion. The project is overwhelmingly strategic, with the objective of bringing 3 million tourists into Dubai. As with most every major strategic and symbolic project in Dubai, it is controlled by the Royal Family and is very political.

However, operating a theme park requires fairly specialized knowledge, and at the time the deal was negotiated, foreign theme park operators were in a strong position. The risk of a public failure of such a high-profile project would have been the primary consideration for the government developers. Additionally, theme parks have large up-front capital costs and high, ongoing, fixed costs. So as the market and demand ramp up, which is always the big unknown in emerging markets, large operating losses are likely. Euro Disney had this same early operating-loss problem after opening in France, which, as a developed market, had far less uncertainty in its demand projections than Dubai.

All these concerns would put an experienced foreign operator in a strong negotiating position with the government. The challenge, therefore, is how to utilize this strong political value-add in the short term and not get stuck in a weakening position in the long term (like Google did). In the Middle East, my typical approach is to target the returns on fixed assets and then take a private equity-type approach for high fixed-cost operating assets.

In the case of Dubailand, a foreign partner could have easily negotiated ownership of the ancillary fixed assets, such as adjacent hotels and residential towers, which would be both secure and profitable after being acquired (a traditional value investment). And for the riskier operating asset, the theme park, they could have put in place either a no-risk management contract (10% of revenue), preferred equity or an equity stake with an initial public offering (IPO) or sale set for two or three years in the future. Then, as their political value-add declined over time, they would still have control of the fixed assets and no risk on the operating assets.

Additionally, the absence of strong local management and local competition in Dubai meant that any political advantage would likely be much more sustainable than in China or Russia. Again, understanding the investment landscape is critical to plotting the investment strategy.

In this context, it is interesting to watch the current negotiations between Shanghai and Disney about creating a Shanghai Disneyland. The Shanghai Disneyland project, announced in November 2009, is set to cover only 3.86 square miles and will cost approximately $5 billion. The smaller size greatly reduces the risk of operating losses or a possible perceived failure of the project. Plus, it does not have the same strategic objective of bringing tourists into the country as Dubailand. Disney appears to be in a fairly weak political position already, and I would be on the lookout for a much larger, domestically owned theme park to be announced in the near future.

The key takeaway for foreign investors and deal-makers is that when you use primarily political access, it is important to determine if this is a long-term or short-term advantage. The fatal mistake is to try to maintain a political advantage as a foreigner in an industry with primarily operating assets and significant local competition. Foreign-owned Internet companies in China are an example of this. The government involvement that helps you at the time of entry can also hurt you later. Live by the sword, die by the sword.

Political Access by Locals

For local investors and deal-makers, political access can prove to be surprisingly resilient and profitable. In 2007, I penned an internal Kingdom Holding memo titled “Access Isn’t Enough” about the changing nature of competition for Middle Eastern investments. For 30 years, Prince Waleed’s company, Kingdom Holding, has had uniquely strong political and commercial deal access across the region and in other emerging markets, and it has used this access to great success. But in 2005 and 2006, private equity firms started to enter the region in force, with more than 30 Middle Eastern private equity firms being launched and more than 70 private equity funds being raised. These firms began operating with a partnership model, superior industry specialization, and more readily deployable funds, in stark contrast to the traditional Middle Eastern family office (one politically connected boss and two or three chief slaves).

I questioned how Kingdom Holding could compete for deals against teams of analysts who could both make decisions and deploy raised funds faster. We had superior access, but the winning formula seemed to be access plus specialized expertise. It appeared that access was no longer enough.

This turned out to be one of my weaker assessments. Most of the new private-equity firms were satellite offices of international firms and struggled to get access to good deals. A few firms such as Amwal Al-Khaleej built successful businesses by fusing private equity-type management expertise with politically connected owners, but most struggled. However, political access remains overwhelmingly the strongest deal advantage in the region. The dynamic, which I did not predict, was that in many emerging markets, getting a deal at an attractive price requires access to closely held deals. Any open-deal or open-bid situation attracts too much capital in markets where good deals are few and capital is plentiful. Great returns in the Middle East are still mostly about getting access to closed deals. Being a little stronger politically (or in other forms of access) continues to make all the difference.

There is one final comment on political access and government-skewed markets. The benefits in politically infused markets overwhelmingly stem from the fact that a free-market system is more efficient and, therefore, often a more difficult place in which to make abnormally high returns. Political economics create companies and industry structures that can be very profitable. They also enable investors to use political advantages when structuring deals. You can benefit at both the company and deal levels.

But this also means investors can be dependent on continued political largesse. Obviously this can change. If the government can make you rich, it can make you poor. Similarly, if it can create an attractive industry structure, it can create an unattractive one. This strikes at the key question of this book’s approach of how to be long-term and value-focused in uncertain and unstable environments. Again, the solution is to build an investment strategy based on where and when you add value.

Let me reiterate my original point about value point versus traditional value investing. You can see I am targeting the areas that most traditional value investors most strenuously avoid. I am presenting a value strategy for the opposite extreme. Instead of focusing on capturing a margin of safety for Hong Kong-listed shares of PetroChina, I focus on capturing and stabilizing a margin of safety for private illiquid assets in highly politicized markets. This does not mean this is the best target (although I do find these assets to have the largest mispricings), but if you can do these types of value-added private deals, everything else becomes easy by comparison and you can go almost anywhere.