Shareholder Letters

Extract from 2014 Annual Report 

In my Chairman’s letter to shareholders last year, I focused on the many aspects of progress made by Georgia over the last decade. I am pleased that this progress has continued throughout 2014, namely with the Government commitment to the continued effective implementation of the Association Agreement with the EU.

The bank has continued to deliver a strong earnings performance this year. You should also note that we have formalised an inflection of our strategy to capture further growth opportunities within Georgia over the medium term. At the same time, Georgia’s regional trading partners have faced significant geopolitical and economic challenges. 

In this letter, I will address the change in the Company’s strategy and the geopolitical issues, before concluding on dividend and governance matters. 

Strategy issues

Over the last decade, Bank of Georgia has evolved to become the market leader in what is a well regulated and competitive banking sector. In what was a year of substantial challenge, Bank of Georgia has delivered over 11% revenue growth, 15% earnings growth and a 19% return on shareholders’ equity. You will find all details on our performance in these assets in this report. 

In 2014, we decided to modify the strategy, structure and governance of the institution to profit from attractive investment opportunities in healthcare and beyond. Why did we choose to follow this strategy when we risked being called by one of the worst epithets possible, that of being a conglomerate? 

“One way to think about Bank of Georgia is in terms of capabilities. It has three macro skills: it knows how to execute well; it knows Georgia well; and it is disciplined in thinking in terms of capital allocation and return on capital, as op posed to market share and growth. Moreover, the institution attracts talent and capital beyond its needs.” 

Georgia has sectors of the economy which could be developed profitably with an infusion of capital and talent. The first one that we developed, and the closest one to our business of banking, was real estate. We noticed that as the economy picked up after the 2008 crisis, our mortgage portfolio did not keep up with this growth. The reason was that there was no supply of houses as builders/promoters had gone bust, and nobody was building housing any more. The builders had invested their capital in land purchases in a speculative drive, and were totally illiquid when the crisis of 2008 hit. We decided to enter this market as builders and promoters, and supplied the market with apartments. The result was the success of our subsidiary, m2 Real Estate, which provides affordable housing to a growing middle class. You can read all about its excellent performance in this report. 

Healthcare was another such sector where we were present through Aldagi, our insurance subsidiary. Universal healthcare was being introduced in the country, and the offering by providers was uneven, inefficient and fragmented. An injection of capital, talent, and best practice could change the industry structure in Georgia, and provide patients with a much higher quality of care. Good assets could be bought relatively cheaply. This made us invest in hospitals and create our wholly-owned subsidiary, GHG, Georgia Healthcare Group. It now has a 22% market share of hospital beds in the country and is currently planning its international stockmarket listing in the second half of 2015. 

Our strategy is one of buying potentially very high-quality, but currently underperforming assets, at a cheap price, bringing best practices to them, professionalising their management, and then selling them to the market at a higher price. Having access to top-quality management, corporate governance and capital in a fast-developing country like Georgia creates opportunities to achieve substantial value creation for shareholders. Our CEO Irakli Gilauri, describes in his letter why we can buy cheaply, what sectors look attractive to us today, and the discipline we bring to investment. 

“Let me reiterate that the banking businesses – retail, corporate and investment management – will remain our priority and a minimum of 80% of the Group’s earnings. Our goal this year is to prove to the market that this strategy delivers by selling to the market a major share of our healthcare subsidiary. Our shareholders will be free to own this business directly and we will attract new investors who specialise in healthcare.” 

The Bank’s structure has been modified to adapt to this strategy. In 2014, we established an investment arm to manage our non-banking businesses, which include our Healthcare operations, our Real Estate subsidiary and our recent pre-IPO purchase of a 25% minority interest in the leading Georgian water utility business. Irakli Gilauri goes into much more detail with regard to the implementation of this strategy later in this Annual Report. The Board is clear that our ability to continue leveraging our market-leading banking franchise, with an emphasis on the higher return retail business, together with a strategy to benefit from other carefully selected investments in the development of the Georgian corporate landscape, will provide clear and sustainable value creation for shareholders. 

There is significant information in the body of this Annual Report highlighting the Group’s strategic priorities for 2015 and beyond. This stems from a Board review of the Group’s strategy at the end of 2014 that aims to ensure that capital continues to be allocated effectively, to ensure the sustainability of the Group’s strong returns over the long term. Now let us turn to the context in which we operate. 

Geopolitical issues 

Georgia remains a steadfast Euro-Atlantic partner – a stance supported by most political parties and a significant majority of the population. In June 2014, Georgia signed an Association Agreement with the European Union, which included provision for a Deep and Comprehensive Free Trade Agreement that will underpin increased future trade growth for Georgia. Additionally, in March 2015, China and Georgia signed an agreement on co-operation for the development of the “New Silk Road Economic Belt”, which further highlights Georgia’s future economic potential. Georgia aims to protect itself from Russian regional dominance. This strategy has been costly in terms of territory lost (about 20%), but successful in terms of economic and standard of living growth (GDP per capita based on PPP more than doubled to $7,700 from 2003–2014). 

The current Government has succeeded in having a more open and pragmatic approach towards Russia, while moving the country towards greater integration with the West – a balancing act to say the least. This is not to say that all is done inside the country: the EU expects and civil society would be better served when the currently ongoing judiciary reform will be completed. Nevertheless, we should remember that only 4% of respondents admitted to having paid bribes in Georgia according to the Berlin-based Transparency International’s 2013 Global Corruption Barometer, well ahead of many European countries. In addition, the World Bank’s latest ranking shows Georgia as 15th in the list of countries where it is easiest to do business, between Germany and Canada. 

From a macroeconomic perspective, Georgia delivered strong GDP growth in 2014, at an estimated 4.8%. The Georgian Lari depreciated 7.3% against the US Dollar, but appreciated by 5.3% against the Euro, the single largest trading partner currency of Georgia. In early 2015 there has been some further currency weakness, but this now seems to have stabilised. This performance was to be expected and was managed skillfully by the Central Bank, which proved once again its independence. Overall, 2014 saw a particularly robust performance against the backdrop of ongoing geopolitical concerns and macroeconomic and currency devaluation pressures in many of Georgia’s trading partners, and demonstrates the resilience of the Georgian economy. The section on macroeconomics covers our prediction on GDP growth next year, in the face of the situation of Georgia’s trading partners and the country’s attractiveness to foreign investment and tourism. I hope that you will conclude, as we do, that this country, which has transformed itself into an economically liberal, market-oriented democracy, remains very promising. 

In conclusion, I want to highlight and acknowledge the significant efforts of the senior management team and the excellent leadership of our Chief Executive – Irakli Gilauri. In addition to their clear delivery against the existing strategy, having nearly tripled earnings and generated substantial returns for shareholders over the last five years, in December 2014 they worked with the Board to update the strategy for the Group and have established a clear strategic direction for the future. 

Shareholders should take note of 2 key governance features of the institution: the alignment of interest between management and shareholders, and the division of roles between the Board and management. I will summarise our philosophy below. 

Our incentive package to top management features a high percentage of stock vested over a long period of time. This scheme creates a sharply upward sloping wealth curve – the more a company’s stock price improves, the higher the percentage increase to the CEO and his top team’s total wealth. It encourages intelligent risk taking, as it heavily rewards the CEO and his top team to create long-term value, and punishes them if they do not deliver returns to shareholders. In summary, it discourages short-term thinking and risky behaviour, and encourages thinking like an owner manager. 

My role as a Chair is to run the Board, and the role of the CEO is to run the Company. One of the Board’s main roles is to be involved in setting the strategy and to monitor the operations of the Company to ensure that it is being run to the benefit of all stakeholders and as mandated. The second important role of the Board is to determine the pay of the CEO and the main executives. 

Finally, the Audit Committee, although composed of independent members, reports to the Chair – a further guarantee of independence. It should be clear that having the CEO be also the Chairman of the Board, opens the door for potential abuse in all three cases above. All depends on the quality of the Board. The Group now has a first-class Board of Directors. Their combined experience and support is invaluable to the organisation. The Governance section of this Annual Report highlights, amongst other things, our Board Diversity Policy. Within this policy the Board has stated its aim to increase the number of women on the Board to two within the next two years. To end, I would like to thank the members for their ongoing support and the provision of guidance and mentoring to executive management, at a time of significant economic and geopolitical uncertainty. 

At the 2015 Annual General Meeting, the Board intends to recommend an annual dividend of GEL 2.1 per share payable in British Sterling at the prevailing rate. This represents an increase of 5%, compared to an annual dividend of GEL 2.0 last year. 

2014 was clearly a year of demonstrable delivery and progress. The Board is pleased with this progress and is confident about the Group’s prospects for 2015 and beyond. 

Neil Janin
Chairman

Extract from 2014 Annual Report 

Dear shareholders, 

We have posted yet another record year in terms of profit and Earnings Per Share in 2014. You can read about our strong financial performance in this Annual Report. In this letter, rather than focusing on the past, in view of our upgraded strategy and recent regional currency tensions, I would like to focus on three key issues: 

1. Regional macro tensions and our response to it. 
2. Our upgraded strategy. 
3. The way we want to conduct our investment business. 

We stay disciplined in the light of a weaker 2015 macro outlook With the oil price decrease and the strength of the US Dollar, we are witnessing significant changes in the region. In particular, capital flows from remittances to Georgia and revenue from exports to regional countries are decreasing. Even though the Georgian economy is well diversified and resilient to external shocks, we believe growth in 2015 will be affected by the weak regional economies. Therefore, we have revised our GDP growth targets for 2015 to be within the 1.5%–3% range. In our view there are three key takeaways from the current environment in the region: 

1. Subdued capital flows in the region have had a short-term negative impact on both the Lari and the Georgian economy. The Georgian economy is getting rebased in order to stay competitive in the new reality. However, in the medium to longer term we see lower oil prices as a big positive for Georgia as the country will be saving c.US$450 million from oil imports and on the back of lower oil prices we will witness efficiency pick-ups in a number of different sectors within the economy – making Georgia more competitive. 

2. Our view is that this rebasing will not be significant – in the short term, Georgia will weather reduced capital flows better than oil producing countries in the region as due to lower oil prices we are experiencing much lower inflation than our neighbours. Lower inflation is also an outcome of the country’s disciplined fiscal and monetary policies. 

3. As dollar capital has been reduced in the region, it seems that Georgia and the Lari are getting more dependent on Eurozone economies and the Euro respectively. Two points can be highlighted in this regard: firstly, the European Union (EU) is our largest trading partner representing more than 26% of trade; and secondly, Georgia recently signed a free trade agreement with the EU. 

Our response to this changing and challenging environment in 2015 is to stay disciplined, until we get some clarity in terms of Lari stability and economic growth picking up. 

1. Credit and liquidity risk management: On the credit risk side, we are applying stricter underwriting standards and will be slightly increasing interest rates on loans. At the same time, we are proactively re-profiling US Dollar loans to clients with non-US Dollar income. Re-profiling implies effectively increasing the tenor of the loan so that monthly payment in Lari stays at the same level as it was prior to the recent devaluation of the Lari. When re-profiling, we do not change the interest rate of the loan. In Retail Banking, our mortgage loan clients are most likely to apply for re-profiling, as in total we have 7,500 mortgage loans worth of GEL 400 million which are US Dollar loans to Retail Banking clients with non-US Dollar income. We consider re-profiling applications from our corporate, SME and micro borrowers on a case-by-case basis. So far 413 loans totalling GEL 35 million have been re-profiled. 

Even though Bank of Georgia enjoys high liquidity and its positive liquidity gap up to six months is GEL 1 billion, we are now working with a number of Development Financial Institutions (DFI) to arrange further long-term loans to improve our Net Loan to Deposits + DFI funding ratio. Because the Euro influence on Lari is increasing and the Lari is effectively becoming a Euro proxy, we will be targeting to raise Euro funding and try to shift US Dollar loans into Euros. 

2. Costs: Being extra cost conscious in a volatile environment is the right thing to do. At the same time we are accelerating the integration of the merger with Privatbank in order to start extracting cost synergies sooner than originally planned. 

3. Investments: Even though we believe that the Lari has found its new equilibrium, we will further observe the Lari’s stability over a period of time, before we step up investment activities. During this period, we will remain vigilant and will continue to actively analyse and consider different opportunities. 

4. Capital expenditure: For our banking operations we are targeting capital expenditure at a lower level than our depreciation charge. Our key projects for 2015 are Privatbank integration (which is not taking much capital expenditure), our Solo roll out (a key driver for our capex budget) and further investment in our IT infrastructure, to increase the reliability of our system. In the Healthcare Business, we will be pursuing a quite aggressive capex programme, and will concentrate most of it on new equipment purchases and developing high-margin businesses. 

We upgraded our strategy from 3x20 to 4x20 

In December 2014 we upgraded our strategy from 3x20 to 4x20 – the 4th 20% being the minimum level of IRR we target from investments in Georgian corporates. The goal with this upgraded strategy is to create sustainable high returns and high growth generating a strong platform for our shareholders. With this model we are targeting to generate ordinary dividends from the Banking Business and continuous special dividends from the Investment Business. Both businesses are Georgia focused, where average real GDP growth rate was 6.3% from 2003–2014. Most importantly the current management team knows Georgia extremely well as a result of running the largest bank in the country for the past 10 years and the team has demonstrated a track record of successful growth in non-banking businesses such as healthcare and real estate. 

Why we upgraded our strategy to 4x20, when at first glance all looked good with a 3x20 strategy? 

Our key goal is to continue producing high returns in the long run for our shareholders. Currently, we see that Retail Banking is producing over 30% ROAE while Corporate Banking is producing c.10% ROAE. We do not think that in the long run it is possible for Retail Banking to keep producing 30% ROAE. Therefore, we see the risk of high returns for the Group decreasing over the longer term. At the same time we do not want to be forced to lend to Corporates in order to show you growth of 20% in the total loan book, while growing a business line with an unattractive risk return profile. This is why we announced the 20% growth target for the retail loan book only. It is noteworthy that penetration of retail loans is half of that of corporate loans (when counting in DFI funding and outstanding Eurobonds) at 21% of GDP. Due to the superior returns in Retail Banking, we expect our Retail Business to continue to drive the banking business ROAE. The recent acquisition of Privatbank is in line with our updated strategy to further strengthen our retail franchise by adding c.400,000 clients, stepping up our payments business as well as capturing synergies by merging Privatbank with our existing Express Banking franchise. Our other two pillars of banking business strategy remain unchanged: ROAE at c.20% and Tier I Capital c.20%. 

Due to the limited access to capital and management in a small frontier economy such as Georgia, we see a much better risk return profile when investing in Georgian companies than when lending to those same corporates. We also believe that the Group will be adding value for our shareholders by investing in opportunities, which currently are not accessible to our shareholders, changing management and governance, institutionalising and scaling up the companies, and most importantly, unlocking value by exiting from these companies over time. Our Plan A in exit is to take the company public. This way, as far as possible it is our firm intention to create an opportunity for our shareholders to participate in such offerings. 

Strategy going forward for the Banking Business 

Banking is the crown jewel in our Group and the key driver of profitability. We have three segments in the banking business, of which Retail Banking will drive most of our banking business growth, Corporate Banking and Investment Management will improve our ROAE, with the latter also contributing an increasing share of our fee and commission income. 

1. Retail Banking 

In our retail business we are covering 1.6 million individual clients and 90,000 SME and Micro clients. In order to capture different segments of our retail client base we are pursuing a multi-brand strategy for mass affluent, mass retail and the emerging bankable population. 

a. Under the Solo brand, we are targeting the mass affluent segment. Currently, we have only 8,000 individual clients under the Solo brand. In April, we launched a new strategy, where we will be providing clients with a superior customer experience by giving them access to newly designed Solo lounges and providing them with new lifestyle opportunities. Solo personal bankers will be offering tailor-made solutions for our Solo clients and introducing new financial products such as bonds and other capital market products developed by our investment management team. We estimate that our current market share in this segment is less than 15% and our goal with the new strategy is to significantly increase this market share in the next three to four years. 

b. Under the Bank of Georgia brand we target the mass retail segment. This is our flagship brand and most significant profit contributor, with 1.1 million individual clients and 90,000 SME and Micro clients. This segment is very much product driven and our biggest challenge is to change the business model to become more client centric and therefore increase the 1.7 current product to client ratio over time. 

c. Under the Express Banking brand we target the emerging bankable population. We are currently estimating the market of a 1.5 million emerging bankable population, which either do not have interaction with a bank or use a limited number of banking products. Privatbank clients are part of the latter and we would like to integrate the majority of 400,000 Privatbank clients within the Express Banking franchise. After the integration we expect the number of Express Banking clients to increase to c.500,000. Under the Express Banking franchise we are scaling up our payments business, which currently is in its nascent stage, by increasing our lower-end merchant footprint and thus giving more people access to card payments. Through Privatbank we will be increasing our footprint from 6,300 merchants to more than 7,500 merchants, increasing our coverage ratio to nearly 85% of the total number of merchants. Also, we are scaling up self-service terminals under the Express Banking franchise. This way, we plan to introduce a more efficient way to access the mass retail segment and allow easy transactional banking to the country’s under-banked population. Currently, country-wide we operate more than 2,200 self-service terminals. 

2. Corporate Banking 

One critical goal in the Corporate Banking business is to increase ROAE and we plan to do this by de-concentrating our loan book and decreasing the cost of risk. Our experience shows that if, in any given year, one of our top 20 clients has some problems, the Corporate Banking business ROAE gets depressed. Therefore our key goal is to de-concentrate the loan book by: 

a. Syndicating loans out. 

b. Selling risk. 

c. Helping our large corporate clients to access capital by issuing debt securities on the local capital market. 

We will focus on further building our fee business through the trade finance franchise, which we believe is the strongest in the region. 

3. Investment Management 

We expect to grow our fee income by building our local debt capital markets and M&A advisory franchise. As we would like to de-concentrate the corporate loan book in corporate banking, local debt issuance is one way to go in combination with our advisory business enhancing ROAE by generating more offbalance sheet business. On the M&A side we see the need for some sectors to consolidate and Galt & Taggart plans to take a leading role in this consolidation process. 

As Georgia has a pay-as-you-go pension system, we believe that our international wealth management franchise can benefit by focusing on the distribution of local debt. So far we see that c.70% of the demand in local paper issuances comes from our international wealth management clients. Further enlargement of the footprint of our international wealth management franchise will be critical for the success of our strategy to build local capital markets. Therefore, we will be investing more in this area.

To summarise our Investment Management strategy, we need to do the following: 

a. Enhance ROAE through our investment in the issuance of more debt paper in the local market. 

b. Enlarge our wealth management footprint internationally to further strengthen our distribution channels. 

The way we invest and manage 

As our Investment Strategy is new for our shareholders, I would like to spend more of your time and provide you with more insight into how we plan to conduct investments and manage companies. Let me outline our key principles, which are derived from our experience in running Bank of Georgia: 1. Be opportunistic and disciplined. 2. In scale we trust. 3. Getting our hands dirty. 4. Good governance makes good returns. 5. Liquidity is the king.

Let me expand on each of these points to give you more flavour on how we see our job in investing and managing the companies. 

1. Be opportunistic and disciplined 

We want to be opportunistic and disciplined when investing, by buying cheaply and in small ticket sizes. 

For us buying assets cheaply is the first and most important postulate in our investment strategy. It is difficult to go wrong when you buy assets cheaply. The key questions are: 

a. How do we define cheap in a small illiquid market? 

b. How do we manage to buy cheaply? 

When considering an acquisition, whether it’s pre-IPO or otherwise, we look at multiples of listed peers in the same sector and apply at least a 40% discount. This is our definition of cheap. 

Georgia is a small frontier economy and access to capital is limited. It is difficult to find liquidity for any single asset worth more than US$10 million. At the same time, owners of assets are often asset rich but cash poor. Georgia’s GDP has grown on average 12% in nominal terms over the past 10 years and local businesses have been reinvesting over that time to stay competitive. 

We like paying dividends to our shareholders as it creates natural self-discipline in buying assets cheaply. Therefore, before investing we will always ask ourselves the question: is it worth investing this money in this company or opportunity or better to pay/increase dividends? 

Another reason for us being disciplined is that we are under no pressure to make any new investment as Bank of Georgia is producing good returns. If we do not find a good opportunity we may not invest for two to three years. We are always following different sectors of the economy and if a good opportunity arises we would want to capture it. To this end, we would like to sit on at least US$30 million of cash (under the current market cap) at the holding company level to make sure that cash is available as opportunities arise in our existing business lines or new ones. Also cash is very handy in slower business cycles and can help to buy assets cheaply. 

We plan to be disciplined not only in terms of finding new opportunities through investment appraisals and understanding the risk return profile, cyclicality of the business and quality of revenue, but also in terms of the size of the initial investment in any new sector. We believe that our initial investment in any new sector should not exceed c.US$25 million. When and if we get comfortable with the sector, only after that would we allow ourselves to increase the ticket size of the investment. The small size of the investment is important as we are human beings and we may make a mistake. By investing in small ticket sizes we will be far away from betting the house. Making a small mistake is OK, just learn from it – do not bet the house. 

To summarise, Georgia was born 10 years ago and different sectors and businesses are in the process of formation, access to capital and management is limited, owners of businesses are cash poor and therefore good opportunities can be captured cheaply. At the same time, we are under no pressure to make new investments and we will be extremely selective and opportunistic and will not commit more than US$25 million in a single investment in a sector where we are not already present. Our dividend policy is the natural self-discipline mechanism for our investment business. 

2. In scale we trust 

We strongly believe that any investee company and/or sector in which we invest in should be large and scalable. In case of pre-IPO opportunities, EBITDA of the existing business should be at least US$25-50 million – depending on the sector. In the case of greenfield investment, we need to see an opportunity to scale up and achieve US$25-50 million in EBITDA over the next five to six years. 

We like to hold and/or target large market shares in any given sector. Our sweet spot is 30% market share in any given sector. This way we will have the scale to be efficient and competitive and at the same time not be overly dominant to attract the attention of regulators. We should be mindful not to abuse the power of a large market share and we should be open to share the benefits of scale with our customers. In a nutshell, we do not mind sharing success with our clients. 

We like large, but fragmented, sectors to have an opportunity to consolidate it – like we are doing in the healthcare sector. We also like natural monopolies like GGU. We would consider sectors where you have one dominant player with 50%+ market share. We like simple business models. 

We had a bad experience of acquiring small companies in 2005-2007. In a small period of time we acquired 10+ companies in total. The good thing was that capital commitment was limited, but it took too much senior management time and because of the limited size of company we were unable to hire good management teams. The strategy proved to be wrong due to the limited size of the investee companies. 

To summarise, achieving superior economies of scale in a small frontier economy is an essential part of the success. It actually significantly diminishes the risk of failure. 

3. Getting our hands dirty 

Before we undertake an investment we like to take time and get our hands dirty to understand inside out the sector and business we are targeting. Diligence and modelling in excel is the key before entering any business. 

Getting things done is the single most important task for our executives. No matter how great our strategy is, we strongly believe that execution is the key. No matter how good the investment opportunity is, we will not pursue it if we do not think that we have a first-class management team to put in place. 

At Bank of Georgia we have spent a lot of time building a top-class management team and we have a deep bench of people who have grown and are ready to take bigger responsibilities. One of the reasons we are confident in our strategy is that we have human capital available both on the top and mid-management levels. We spend a lot of time coaching and mentoring our talent and our Board’s role in this process is invaluable. 

Along with selling the companies, we will be selling the management team and saying goodbye to our management team, therefore we fully understand that our machine of producing new executives should not stop. Furthermore, for our top talent we have introduced a self-development programme by hiring coaches to help them to better understand their strengths and weaknesses. According to our policy, no matter how good the performance of our top executive is they may get limited bonuses if we do not see progress in executive’s self-development and growing their successor(s). 

You have observed rotations in our top management every two to three years. In December 2014, we announced another round of rotation. We would like our top talent to receive experience in different roles and learn and grow. Rotations will continue in the future. 

In some of the sectors where we have limited operational experience we would put together a complementary team of talent from our Group and sector specialists from outside the Group. We are confident that talent from within our Group can learn the sector in a short period of time. In the early stage of the investment cycle, the management from the holding company level will spend more time on coaching and guiding the management team. That is exactly what we are doing at Georgian Global Utilities now.

The question we need to ask before entering the new sector is not whether we are the best, but whether our management team is better than that of the next player. This is a relative play game. 

At this stage, we do not want to hold more than four investments at any given time, as we are limited in terms of oversight as well as management resources to put in place in more than four companies. 

To summarise, similarly to limited access to capital in this country, the availability of management is limited and by being a machine of producing top talent in the country we can add value for our shareholders. We understand that great management teams make great companies, and investing time in growing people continues to be critical for the success of our strategy. 

4. Good governance makes good returns 

We have already learned that great institutions are not built without robust governance and ultimately without it one cannot deliver sustainable value creation for its shareholders. 

We like to institutionalise companies by putting good governance in place. We do not like to bet on one person’s judgement and do not believe that one person can perform magic. Therefore, we believe that first of all the CEO should be surrounded with an outstanding management team from below and a first-class Board from above. Meritocracy, loyalty to institution rather than to individuals is our approach. To this end, our approach is to separate the roles of Chairman and CEO. We operate like this at Bank of Georgia and we truly believe in healthy checks and balances between the Board of Directors and executives. Having separate individuals for the top job on both levels is the key signal we are sending to our shareholders on governance. 

We think that a high-quality, diversified independent Board is extremely important for the success of the Company. We see the Board not only as an institution, which is doing its duty of oversight of the management and setting strategy, but also the Board is providing guidance and coaching of our top and mid-level management team. 

In our case, the Board’s role of oversight is made relatively straightforward by creating a natural alignment of interest between shareholders and management. For that we award long-term vesting shares (up to five years) to management and make compensation in shares a large proportion of total annual compensation (e.g. 85-90%). This way we create long-term alignment of interest between management and shareholders. If shareholders make money, management makes money and if shareholders lose money, management also loses money. With this simple approach, on top of being executives, the management team feels and acts more like shareholders – because they are. 

Even though this compensation structure has a lot of positives as outlined above, it has one main drawback: when share prices rise too rapidly the risk of management becoming arrogant and complacent is high. This is another reason why we think a strong Board is essential to bring management back to reality. 

The Nomination Committee is always searching for professionals around the world to make sure that we have all the skill-set available on the Board. For example, currently we are searching for an experienced potential Board member with background in Energy and Utilities to give us more guidance for our GGU investment. 

To summarise, we are big believers that robust governance is the source of value creation for our shareholders. The natural and simple alignment of interest between shareholders and management by awarding long-term stock works well for value creation and, finally, we want to have good balance by having separate people as the Chairman and CEO of the Company. 

5. Liquidity is the king 

According to our investment policy, we target to exit from our investment through a trade sale (full or partial) or IPO in up to six years from the initial investment. Because we are a publicly held company our preferred option is to take the Company public to give the market the opportunity to participate in the future upside. 

No matter how well our companies do in terms of operating results, we want to see their exit to unlock the value and with the generated profit pay special dividends and pursue new opportunities – in the event that we see one. According to our strategy we will be targeting three special dividends in the next five years. Our aim for the size of aggregate special dividends is to be at least 50% of ordinary dividends paid by the banking business during these five years. 

Because we aim for high returns and not for control, we do not mind selling below the 50% shareholding level at the IPO. We fully understand that liquidity for both incoming investors and our Group is the key. We have learned that increased liquidity of shares itself creates value as shares become accessible to a wider investor universe. This was indeed the case when we converted from our GDR listing to the London Stock Exchange Premium listing in 2012. As shares of Bank of Georgia became more accessible, their value increased while fundamentals did not change. 

Unlocking the value through IPO is more critical for us than any money we leave on the table at the IPO. At the end of the day and as far as possible it is our firm intention to create an opportunity for our shareholders to participate in the newly IPO’d company by buying its shares. 

As many of you know we are in the process of preparation to IPO our healthcare subsidiary Georgia Healthcare Group. The Board and I have complete confidence that the management will deliver on our stated strategy of doubling 2015 revenue by 2018. Some would argue that we might be better off to take the Company public in two to three years’ time, as more profits are expected to be generated by then. But we want to be disciplined in terms of unlocking value for our shareholders, as set out in our 4x20 strategy, and are targeting an IPO in 2015. I personally am extremely excited about the prospects of the Company. As far as possible, it is our firm intention to allow our shareholders to participate in the IPO and I, for one, will definitely be placing an order. 

To summarise, in order for our strategy to work we need to be disciplined in unlocking the value of companies in which we invest and manage. Taking companies public is our preferred option for exit, as it is our intention to give our shareholders an opportunity to participate. 

In the end, I would encourage you to visit Georgia and meet our management team. You can meet and get to know our Board members at our annual investor day. We have a saying in Georgia: “It is better to see the place once than hear about it 100 times”. What I promise you is dinner at a restaurant overlooking beautiful old Tbilisi – the place where East meets West at the old Silk Road, from where you will be able to feel the future. 

Irakli Gilauri
Chief Executive Officer