Is Innovation a Turks' Game to Create New Wealth?

A. Mete ÇakmakcıJ.P. Morgan Asset Management Breakfast Meeting

June 7th, 2011 - İstanbul

2

Making Sense of Turkey

… Raki led me to wonder why so much of its potential remains unrealized. Turkey is undoubtedly the country of the future, but will it always be? … … By the time they drain their final glasses and step out into the darkness, they have often concluded that their country is either the “golden nation” destined to shape world history or a hopeless mess certain to remain mired in wretched mediocrity…”

Reference: Stephen Kinzer, “Crescent and Star: Turkey between two Worlds", Farrar, Strauss and Girous, 2001.

“… After a glass or two, what at first seemed clear becomes obscure. By the time the bottle is empty, everything appears murky and confused. Yet through this evocative haze, truths about Turkey may be most profoundly understood …

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Source : Sak (2009) “Küreselleşmenin Türk KOBİ’lerine etkileri”, TEPAV

Innovation Mercenaries

4

A place of limitless exotic fun?A future mutual partnership?

An economic partner from a safe distance? A curious tease?

Where is the Brand Equity?

5

Catching up or Lagging Behind?

Source : European Innovation Scoreboard 2008

Turkey is labeled under “catching up with moderate growth”

6

In 2009, 2,731,878 students were registered in undergrad university programs. 397,884 graduated from undergrad programs.

28,681 master and 3,744 PhD degrees were awarded.

Source : US Census Bureau, 2010

In 2009, 13,263 Turkish students were enrolled in the US universities, (10,2% increase from 2008 and 8th most populous group)

Many return with business ideas.

The Story : Demographics

7

Emerging Middle Class

2003 2006 2008

Automobile Sales (in thousands) 359 622 494

White Good Sales (in millions) 3 5.5 5.2

Airline Passengers (in millions) 34 59 75

Mobile Phone Network Subscribers (in millions) 26.6 51.4 64

# of People Getting House Loans (thousands) 43 268 237

Consumer Credit + Credit Cards (billion TL) 12.8 67.7 114

Source: ODD, TURKBESD, DHYMI, TBB

8

Innovation Dynamics

Knowledge is GLOBAL, value is LOCALKnowledge is GLOBAL, value is LOCAL

9

Global Innovation : MIA 12 Turkish companies in 2010 edition of the «Forbes Global 2000» list (5 in Banking, 3 in Conglomerate, 2 in Telecommunications, 1 in Construction, 1 in Transportation)

BUT, in 2010 edition of Booz Allen’s «The Global Innovation 1000» list, there are only 3!

Global Ranking

Category Ranking

R&D investment(m EUR)

R&D / Net Sales Ratio (%)

R&D Investment per Employee (k EUR)

General Industries (272 companies in the category)

Koç 355 15 118,38 5,7 1,7

Category Ave. 773,13 3,2 3,4

Leisure Goods (25 companies in the category)

Vestel 786 24 42,92 2,0 3,5

Category Ave. 1783,98 2,4 2,7

Automobiles and parts (62 companies in the category)

Tofaş 370 35 111,22 4,4 15,9

Category Ave. 816,66 4,7 3,2

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Anatolian Tigers

2002 2003 2004 2005 2006 2007 2008 2009 2010 -

20,000,000

40,000,000

60,000,000

80,000,000

100,000,000

120,000,000

140,000,000

10%

15%

20%

25%

30%

35%

40%

Share in Exports by Anatolian Tigers

"Tigers"ShareTurkey

Expo

rts B

illio

n $

2004 2005 2006 2007 2008 -

50,000,000

100,000,000

150,000,000

200,000,000

250,000,000

55.0%

55.5%

56.0%

56.5%

57.0%

57.5%

58.0%

58.5%

59.0%

Anatolian Tigers' Share in Manufacturing GDP

"Tigers"TurkeyShare

Bill

ion

$

Source : TUIK, Ekonomist

Since 1980s, they represent the emerging conservative grass roots – TOBB

Culture very similar to East Asian examples.

Companies from fast growth regions outside İstanbul, İzmir and Ankara

Strong enterpreneurial family companies with very sophisticated skills set

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A Map of Technological Innovation

Companies from the regions are more financially conservative, reluctant to use external finance

Thin capital positions to support indigenous growth

12

European Benchmarking EU-27 Turkey Spain Poland

Life-long Learning 9,7 1,5 10,4 5,1

Pubic R&D Expenditures 0,65 0,37 0,55 0,38

Private Credit 1,31 0,29 1,83 0,4

Non-R&D Innovation Expenses 1,03 0,16 0,49 1,03

Public-private Co-Publications 31,4 0,3 10,6 1,3

EPO Patents 105,7 1 29,3 3

Technology Balance of Payments Flows 1,07 0,12 0,28 0,4

SMEs introducing product or process innovations 33,7 29,5 29,5 20,4

SMESs introducing marketing or organizational innovations 40 50,3 29,5 29,1

Employment in Medium-high & High-tech Manufacturing 6,69 3,6 4,47 5,5

Employment in knowledge-intensive services 14,51 5,53 14,22 10,33

Medium-tech and high-tech manufacturing exports 48,1 38 52,3 48,9

Knowledge-intensive Services Exports 48,7 12,9 27,9

New-to-market sales 8,6 4,65 7,37 4,56

New-to-firm sales 6,28 11,17 8,48 5,55

Source : European Innovation Scoreboard 2008

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Global Benchmarking

Source : www.worldbank.org/kam

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A Regional Production Specialist

Source : The World Bank

15

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%0%

5%

10%

15%

20%

25%

30%

35%

ArmeniaAzerbaycan

BulgariaEgypt

Georgia

Greece

Israel

Jordan

Kazakhstan

MaltaQatar Moldova

Romania

Russia

Sırbistan

Tunisia

Turkey

UAE

Country’s share in total manufacturing exports of the region (%)

Share of manufacturing in Country’s total exports (%)

Source: TEPAV, UN Comtrade data

Largest Manufacturer in the Region

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0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0%

-15%

-10%

-5%

0%

5%

10%

15%

20%

Automotive Clothing and Accessories

Iron-steel

Textiles

Electrical machinery

Fruit-Vegetables

Metal ProductsPetroleum Products

Non-metal mineral products

General Industrial Machinery

Other transport

Telecom and Sound Equipment

Note that bubble volumes indicate exports in 2009.

Ave

rage

ann

ual g

row

th ra

te (2

005-

2009

)

Star sectors

Traditional sectors

Rising sectors

Failing sectors

Market share in 2009

No «Star» Export Industries

Source: UN COMTRADE, TEPAV calculations

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Export Markets

1996 2000 2007 2008 2009 20100%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

otherEU-27Non-EU EuropeNear and Middle EastNorth AfricaNorth AmericaSh

are

in E

xpor

ts

Good news is, exports are diversifying from the EU

Bad news is, still high exposure to troubled regions and markets, not much exposure to Far East and South America

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Number of product groups with above $ 500 million exports(HS4 classification, 2 digit, 2008)

Turkey

Russia

Ukraine

RomaniaUAE

Greece

Israel

Saudi A

rabia

Kazakh

stan

Egypt

Tunisia

Moro

cco

Bulgaria Iran

Croatia

Jordan

Serb

iaQatar

Kuwait

Algeria Iraq

Syria

Azerb

aijan

Turkmenist

an

Armenia

Bosnia-H

.

Georgia

0

5

10

15

20

25

30

35

40

45

39

28

21 2017 16 15

1311 11

9 8 8 86 5 4 3 3

1 1 1 1 1 0 0 0

Source: TEPAV, UN Comtrade data

Export Diversification

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Diversification vs Sophistication

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 20099000

10000

11000

12000

13000

14000

15000

16000

Brazil

China

India

Russia

Turkey

Export Sophistication Index (EXPY) Turkey and selected countries (1995-2009)

Source: COMTRADE, TEPAV analysis

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Converting High-Tech to Low-Tech

Source : TUSİAD, (2008) “Türkiye Sanayiine Sektörel Bakış”

Source : OECD STI Scoreboard, 2008

Share of high-tech in manufacturing exports from 1992 to 2008 only increased from 1,2 % to 1,7 %. Poland’s increased from 3,7 % to 5,2 %; Brazil’s increased from 5,4 % to 12 %.

Turkey’s exports increased from 14,7 Billion USD in 1992 to 127 Billion USD in 2008. (2008 imports were 202 Billion USD )

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• Where does Turkey stand?– Turkey was a transition economy from efficiency-driven to innovation-

driven in 2009.– In 2010, WEF downgraded Turkey to efficiency-driven.

• Upgrade to an innovation-driven economy? – Need for a large set of reforms in a wide set of areas– Education, judiciary, public administration, infrastructure investments

• Risk: no-reform political climate– The period ahead will be even less conducive for reforms: elections in

2011, 2012, 2013, 2014, 2015 ….

Factor-driven economy

Efficiency-driven

economy

Innovation-driven

economy

low-cost inputs productivity unique-valueSource: WEF

Mid-Income Trap

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x 3,5 increase in TUBİTAK grants to private companies

1416 Million TL in Public R&D Investments

286 Million TL in Public R&D Investments

Investing in R&D

2002

2009

Source : State Planning Organization, 2010

Cheaper borrowing is trigerring more R&D investments & spending

2010

X 5

in p

rivat

e R&

D

spen

ding

23

Promoting Private Sector R&D Law # 4691 on Technology Development Zone and Law # 5746 on R&D Promotion grants generous tax deductions/exemptions for R&D activities.

28 active TDZs support 1515 firms employing 13,000 R&D staff generating 540 Million USD in exports. (mostly software companies)

76 R&D centers facilitated 1,9 Billion TL in R&D spending by the private sector

Source : OECD STI Scoreboard, 2008

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Cost of Innovation

8-10 yrs Experience6,000 – 7,000 TL

3-4 yrs Experience3,000 – 4,000 TL

O-1 yrs Experience1,600 – 2,000 TLIn

nova

tion

adde

d-va

lue

incr

ease

s

Cost of innovation (rather the cost of

failed innovations) is probably the single

most important barrier to innovation.

Recent tax incentives had limited

additionality for various reasons.

In spite of “unlimited” supply of youth,

talent and skills are limited.

Investment in development of skills is extremely limited and conservative.

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Source: EVCA

UK

Sweden

Belgium

Norway

Finland

Denmark

Switz

erland

Hungary

Luxe

mburg

European U

nion

Portugal

France

Poland

Netherlands

Germany

Spain

Greece

RomaniaIta

ly

Turkey

Austria

Czech

Rep.

Ireland

Bulgaria

Ukraine

0

0.1

0.2

0.3

0.4

0.5

0.6

European Countries Share of Private Equity Investments in GDP (2009)

A “Virgin” Market

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Funding for Innovation : VC

MANAGEMENT

INVESTORS

REGULATORYFRAMEWORK

INVESTEES

Turkey has an open capital regime, for most sophisticated institutional investors local context is irrelevant. But, with no historic data it is impossible to wager for risk of

investing in Turkey...

The regulator is not willing

Low skills to develop projectsStrong unregistered activities

Extremely sceptical of external finance

Local dept is non-existantNo tax incentives to investors

Mostly international institutions

Team profiles are genericOften chasing after same

investors and deals

27

Majority

Minority

Ow

ners

hip

Investment Size

Mega5 M EUR

INTERESTING

A Trivial Investment Radar

28

Current opportunity profile requires more “hands on” investments

People with people skills and a vision for the business are required

Management Skills

29

Most investor “driven” funds have problems with management

No question that there is ample supply of local talent with some international experience/exposure

Most team profiles have strong representation from I-Bank and consultancy careers

Job is more than deal making – it’s about growth and exit

Recently deal terms are shifting to more conservative (I-Bank)

Profession is more art than science – should look for diverse skill implants and spin-out teams – local empathy is important (“talk to talk, drink the tea”)

Another urgency to develop local Turkish investor base

A Few Good Men

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Crowding Radar

Turkish PE market is attracting many new players.

Deep talent pool is a strong enabler

Where is the deal flow?

1995 - 2002

2002 - 2010

Source : EIF

31

Where is the Beef?

Source : Deloitte, Ernst&Young, İş Girişim A.Ş.; Press

<2001 2002 2003 2004 2005 2006 2007 2008 2009 20100

5

10

15

20

25

30

0

500

1000

1500

2000

2500

3000

3500

4000

1

68

14

2

9

24

24

2

1

4

6

4

9

3

2

3

3

3

4

3

24

3

2

11 > 200 M USD

50-200 M USD

25-50 M USD

0-25 M USD

unspecifiedNum

ber

of D

eals

Am

ount

Inve

sted

(M U

SD)

As of April 2011, total number of transactions is 131 and number of total exits is 22.

71% of all transactions took place after 2006

Of 86 public transactions, 65% were within 0-25 M USD

32

Turkey has an expanding war chest of international investors

So far the largest private investor in PE/VC is the İş Group in İş Girişim

Garanti is an investor in İstanbul Venture Capital Initiative

Many Turkish Blue Chips (including big manufacturing and services conglomorates) expressed interest in setting up their own funds. (some are already recruiting management)

“Minority psyche” is big barrier for most to commit to a fund

Unrealistic expactations on representation in investment decisions

Concerns on branding

Too early to speak about “retirement funds” in Turkey

Investor Profile

33

Outlook New generation of young enterpreneurs (especially of top universities) have the proper skills and high capacity to learn fast. They ask and learn.

Second/third generation is taking over in the family owned SMEs. They mean business and are open to the world

Investors and Banks are quickly adopting to finance innovation. They need to ‘innovate’ to stay relevant

Big companies are still a big «?»

Capacity on the demand side is developing faster than the suppy side of policy and programs. Civil initiatives are mobilizing. Legacies are slug.

Innovation and related buzzwords are still crowding out the agenda.

Challenge : Can Turkey be the ‘California’ of Europe?

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A public private partnership built upon the market credibility of the investors

Fund size is 160 M EUR. As of June 2011, 41 M EUR have been committed; 71,5 M EUR are under negotiation (24 M EUR is anyday for signature)

Full commitment is expected before the end of investment period at the end of 2012 – «iVCi 2» is under discussion

iVCi helped create strong awareness in the market, providing a mentoring facility for new/emerging teams

Istanbul Venture Capital Initiative Turkey’s first and only fund of funds as a

Luxembourg SIF vehicle under EIF management (www.ivci.com.tr)

iVCi Strategic Network is currently chaired by Mr. Ali Sabancı, a highly visible enterpreneur and investor.

35

Sector needs a professional association

TurkVCA is MIA since 2004

Concerns over high visibility

Reliable data and strong representation is needed to develop a good conduct sector and market

Turkey has extensive experience on localization of special purpose administrative structures

It might be time to consider setting up a proper “free financial zone” with its own regulator in line with

other government priorities inside Istanbul

Future of PE in Turkey Recently, pe/VC has become a top policy priority. It is a learning process!