Monday, May 19, 2014

Trip Report - Kiev, Ukraine; Feb 2014; Part II - Stock Market and Business Structure

Stock Market

My interest in Ukraine began in July 2013, when it appeared on a list of one of the world's worst performing stock markets.  The PFTS index and the narrower UX index had fallen over 70% from their March 2011 highs.  Many stocks were trading at very low valuations based on ratios commonly used by the financial community such as Price / Earnings, and Price / Book Value.  

Surprisingly Ukraine's equity markets held their own after November 2013 when the Maidan protests in central Kiev started.  During its December 2013 market lows the PFTS index was down less than 10% from where it was in the preceding July.

I haven't seen any research to support this, but a rule of thumb is that markets tend to hit bottom when they do not decrease on bad news.  Give all the problems and chaos a 10% decrease did not seem so bad.

With the local markets somewhat resilient despite months of protests in Kiev’s city center I thought it made sense to see for myself what was going on. 

Another thing I liked about the country is that it already seemed like it was in the middle of a political crisis.  Protests in the center of the city had been going on for close to three months and seemed to get bigger despite the chill of winter.

“…the crisis occurs at the end of the problem – not the beginning.  The crisis actually initiates the process of repairing whatever problem created the crisis”, wrote Frederick K. Martin in, ‘Benjamin Graham and the Power of Growth Stocks’. 

But who knows where and when things bottom until after the fact? 

Dead Market. Several people I met in Kiev told me that Ukraine’s stock market is dead.  Turnover has dried-up, prices are way down, and most companies are listing abroad if they list at all.  

Bid/ask spreads can be 100% or even higher. Free-float is small and declining.  Corporate governance is weak and minority shareholder rights are virtually non-existent.  Very few companies pay dividends.  

Brokers in Ukraine don't seem to make money from trading local shares.  Instead they earn their keep by trading fixed income, equity of Ukrainian companies listed outside Kiev, and helping local clients trade foreign stocks and bonds. 

Most managements don’t want to meet with investors, don’t post their accounts on their website, and don’t respond to emails.

It sounds like it was never much of a market to begin with.  From what I was told and read there has never been more than a handful of IPOs, rights issues or other equity funding in Ukraine. 

The market was set up to trade shares that were given to the general public after the USSR’s fall and many 'listed' companies don’t want on be on the exchange.  Even when they are some don’t consider themselves to be 'public'.  It is a very strange feeling when the management of a listed company whose shareyou've just bought says that they are looking forward to an IPO. 

Ukraine’s budding entrepreneurs have instead raised equity capital outside of the country, mostly in  Warsaw and London. There are at least twelve Ukrainian companies listed in Poland and at least six in the UK.   

BusinessWeek Cover
13 August 1979
Ultimate contrarian play?  If one needed a contrarian ‘buy’ signal Ukraine has more than enough.  And that’s before getting into domestic, regional and geopolitics which are seem to grow more uncertain day-by-day as I write this in mid-May 2014.  (These were discussed in the first part of this two part blog and can be accessed here).

The situation reminds me of what I've read about Wall Street in 1932 and 1979 when equities were all but given up by the general public in America.

It also reminds me of Indonesia during the 1997/98 Asian financial crisis. Indonesia is my base case emerging and frontier market as I've been following it off-and-on since it opened up for foreign investment in 1989.

But there are a lot of differences between Ukraine now and historic US and Indonesia.  Notably neither of the latter two were facing the possibility of invasion by a bigger and aggressive neighbor.  Then US President Carter was seen as weak, but nobody wanted to invade the US in 1979.  And who wanted to take over the chaos that was Indonesia during and after the 1997-1998 Asian financial crises?

One part of Ukraine’s financial chicken-and-egg problem is the lack of local institutional investors.  Except for the National Bank of Ukraine, financial industry contacts had difficulty naming any local pension funds or other institutional investors.  Many funds sprang up in the 2000s during the local market’s two rallies, but from what I can tell, the few that survived are but a shadow of what they once were.

Hope springs eternal.  I learned on my trip that the exchanges and bankers are not taking things sitting down.  In addition to plans to merge the country's two exchanges later this year (UX and PFTS), I was told of additional initiatives to reform and strengthen Ukraine’s financial sector:   
  • The exchange and I-banks are working on a program to list younger, financially hungry, and fast growing entrepreneurial firms. 
  • Laws strengthening corporate governance and minority shareholder rights were supposedly winding their way through parliament before they were side tracked by Maidan protests.  
  • One of the exchanges is working with the government to strengthen the local pension system, which – outside of the government and a few large banks - appears to be non-existent. 
  • Dual listings are also a possibility and one of the exchanges is talking to Ukrainian companies listed on other exchanges to have a secondary listing in Ukraine
The Ukraine equity markets have held up pretty well despite the all-too-obvious headwinds.  The broader PFTS index is up some 30% YTD, but flat in US dollars given the Hryvnia’s 30% fall.  The narrower UX index has not performed as well rising some 16% YTD.

Depending on what index is used this is in line or better than the Russian index and currency.  The Micex and Rouble are both down some 8% YTD.  In US dollar terms this is about the same drop as the UX index, but worse then the PFTS index.


Like most non-Anglo-Saxon countries, most of Ukraine’s business is split between powerful families and the government. In fact the entire structure is very similar to Suharto-era Indonesia. 

In Ukraine large business owners are known as “oligarchs”.  They are analogous to Asian tycoons in many respects as their business empires typically consist of several loosely related businesses. 

The key difference is that oligarchs are also politically powerful.  In Indonesia and South-East Asia business groups are typically owned by ethnic Chinese.  Their owners - due to racial reasons - have largely been excluded from political positions. 

The biggest.  The largest business group in Ukraine is Systems Capital Management (SCM).  Formed and owned 100% by Rinat Akhmetov, SCM controls some 17 listed companies, 40% of Ukraine’s power distribution (DTEK), its largest telecommunications company, and a large chunk of its steel making capacity (Metinvest).  

He and his group are similar to Sudono Salim and his Salim Group, which was the largest business group in pre-Asian Crisis Indonesia. SCM’s revenue accounts for some 5% of Ukraine's GDP according to SCM literature, or about the same proportion as the Salim group did in Indonesia in the early 1990s.  Their leaders Akhmetov and Salim, are and were the richest individuals in their respective countries.

Unlike Salim, Akhmetov is directly active in politics as he is Member of Parliament and a key backer of the Party-of-Regions. In Kiev I was told that he bankrolls a not-too-insignificant number of MPs in Ukraine's 450-seat unicameral parliament (known as Verkhovna Rada).  

This likely makes him the most powerful person in Ukraine, as he has both financial and political power.  

Assembling his conglomerate under murky and possibly criminal circumstances, Akhmetov is increasingly moving SCM and its companies toward international business standards (see Wikipedia entry here).  To keep growing, SCM needs access to international capital markets and several of the group’s companies have issued Euro bonds.  The senior managers I met at one SCM subsidiary were about as polished as any US/UK/EU MBA educated 30-something as they come.  

Interestingly Akhmetov has openly stated that he favors a unified Ukraine and seems to be backing this up according to one insightful report.  In an open letter posted on SCM's website four days after Russian forces moved into Crimea, he wrote:

“I state with all due responsibility that SCM Group, which today employs 300,000" people and represents Ukraine from west to east and from north to south, will do everything possible to maintain the integrity of our country.” Signed Rinat Akhmetov, President, System Capital Management, 2 March 2014. 

Another "First Family". The fastest growing business ‘group’ in Ukraine since 2006 was ex-President Yanukovich's family.  According to the fascinating “The Oligarchic Democracy", Yanukovich’s interests are represented by his sons, Oleksandr and Victor.  Oleksandr was in charge of business and Viktor was an MP and a member of the Party of Regions. The report calls them and their associates whom they put into powerful positions, ‘the family’.  It notes that ‘the family’, ‘…is currently the most aggressively operating group in Ukraine’.

In yet another case of history rhyming, during the last 10-15 years of Suharto’s presidency his sons become amongst the most aggressive businessmen in Indonesia, and many referred to the extended Suharto family and their associated business groups as the “First Family”

Independents and Red Directors.   Not all businesses in Ukraine are part of large conglomerates.  In fact some of the companies that do want to be listed, have good investor relations and more progressive management are many times independent.

Not all, but most seem to be led by true entrepreneurs.  They've built up businesses over many years and deftly navigated through Ukraine's rapidly shifting business and political environment. 

To the far left of these self-made entrepreneurs are Ukraine’s ‘Red Directors’.  ‘Red Directors’ is a term used in Ukraine to describe the controlling shareholders and senior management that think and act as if the USSR was still intact.  In general they are seen as keen to get business, but are not keen to share information about their company.  They would be somewhat analogous to the secretive, trust no-one-but-family-member groups that are increasingly rare in the Internet age.  


My 10-day trip to Kiev was an eye-opener.  It was my first time in Ukraine and the first time in the former USSR.  It was also just my third trip to the European continent, so there was a lot to learn. 

Like virtually all trips, it was a humbling experience. The more I travel the more I realize how little I know.  While I feel better informed about Ukraine than before the trip, I'm sure that the last two blog posts barely scratch the surface.  

Also like other trips, I was lucky to meet many smart, switched on, and helpful people that very kindly took their time to help me better understand the country and its investment prospects.  This was even more appreciated given that I was in Kiev during such an eventful week.  It takes a strong will to remain focused, when just a short distance away, one's fellow citizens are standing in harm's way. 

1 comment:

  1. It is great to know that you were lucky to meet many smart, switched on, and helpful people. Informative post written by you. Keep it up!
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