Why is Starbucks Interested in This Tiny War-torn Country?

When I first started developing our proprietary Asian Capital Development model for understanding Asian markets, I began by testing the major economies like China, Japan, and Hong Kong.
 
And I wondered... how would our model and thesis hold up in all economies, even the obscure ones?
 
To what degree could state policies impact growth, based on the natural and human capital of the country?
 
These questions led to our study of a small, little-known country in the archipelago of islands between Australia and Indonesia called Timor-Leste (or 'East Timor').
 
I don’t blame you if that doesn’t ring a bell, as it’s rarely covered in the mainstream financial media.

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Here’s what we uncovered:
 
1. It’s young
 
Timor-Leste officially became independent from Indonesia in 2002, so it’s quite a youthful nation.
 
Nonetheless, its leaders were able to establish a fairly stable democracy with a growing economy. In 2016, its GDP grew by more than 5%.
 
However, seeing as 1/3rd of Timor-Leste’s 1.2 million inhabitants are currently living below the poverty line, it’s still an incredibly poor country.
 
Our perspective: According to our Asian Capital Development model, Timor-Leste is just too underdeveloped for its people to have established the skills needed to drive the economy into the second phase of our ACD model, manufacturing.
 
2. Rising foreign investment
 
As a result, in order to give the economy a boost, the government is investing in a couple of mega-projects and initiatives like oil refineries, a special economic zone (SEZ), a massive port, and its very own tourism sector.
 
These projects are attracting a lot of foreign investors who are all looking to profit from this new frontier.
 
ConocoPhillips (NYSE:COP) is the largest investor with a 57.2% share in the Bayu-Undan gas condensate development.
 
Other companies active in the Timor-Leste/Australia Joint Petroleum Development Area (JPDA) include the likes of Shell (ADR) (NYSE:RDS.A), Woodside Petroleum (ADR) (OTCMKTS:WOPEY), BHP Petroleum (ADR) (NYSE:BHP), Marathon Petroleum (NYSE:MPC), and Enterprise Oil.
 
Private investors from Singapore, China, Indonesia and Australia are heavily investing in the country’s hospitality, tourism, export-import, logistics and consumer goods sectors.
 
The Indonesian state company Waskita Karya Tbk (IDX:WSKT) has a contract worth US$76 million to improve the airport.
 
Our perspective: Based on Timor-Leste’s current stage of development, we conclude that investing in their SEZ or tourism sector is not a safe bet. But, with great risks come great potential rewards... This all depends on whether the secret 'growth ingredient', Human Capital, can grow in tandem with GDP. Which brings us to the next point...
   
3. The workforce
 
Timor-Leste workforce is rather unskilled at the moment.
 
Currently, half of the country’s population is under 17-years-old and isn’t formally educated. About a quarter of them works in services, and the service sector accounts for about one-quarter of the country’s GDP.
 
The manufacturing sector, like food processing and oil refinery, only employs 1/10th of the workforce. But thanks to the oil industry, it accounts for 68% of the country’s GDP.
 
Then there’s the agricultural sector, which employs 64% of the workforce, but only accounts for 7.5% of its GDP.
 
Our perspective: The country’s human capital is vastly underskilled to move into services as most are still engaged with the agricultural sector. Without a solid manufacturing base established that could lift wages independently, the government will need to invest heavily in training the rural poor for work in the service sector.
 

4. Oil exports
 
Oil is one of the major export products of Timor-Leste, as the country sits on substantial oil reserves in the Timor Sea.
 
Its biggest oil and gas field is Bayu-Undan and is located in the Joint Petroleum Development Area (JPDA), an area in the Timor Sea. Since 2004, the oil field has yielded the country US$18 billion.
 
Our perspective: This is an impressive number for a practically forgotten country of over a little a million people. The oil industry in turn has potential, seeing as you only need a small number of skilled workers to turn a profit. However, if the government does not reinvest the profits from this industry in a smart way, it will be back where it started when it runs out.
 

5. Coffee exports
 
Another big export of Timor-Leste is coffee.
 
You may be having a cup of Timor coffee right now, as Starbucks is a major purchaser. Most of it is raw coffee, which has lower yields than processed coffee. But with the right investment, it could boost the rural economy, train the workforce to international standards, and slowly move the country up the value chain.
 
Our perspective: The coffee industry is desperate for investment. Harvests are dwindling and about 1/3rd of the coffee trees are not productive. It just makes sense from an economic development standpoint.

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The bottom line...
 
At the country’s current level of development and human capital, the agricultural sector would be your best bet.
 
The human capital and export-oriented supply chains that are needed are already in place. And given that both the government and the Asian Development Bank are already funding this sector, you can expect to see some profitable coffee processing plants to be there built soon.
 
For the more profitable industries in the manufacturing and service sectors, we suggest holding back for now and observing how the government manages its profits from the oil industry. If they are reinvested in ways to boost its human capital, Timor Leste could very well be Asia's next economic miracle.
 
We'll keep monitoring and will report back to you.

Peter Pham