Extract from 2020 Annual Report
Dear Fellow Shareholders,
I have written this, only my third letter to Georgia Capital shareholders, against the backdrop of what has been the most challenging year for the world in modern times. In every conceivable way, the global COVID-19 pandemic in 2020 created a uniquely difficult environment that tested countries, governments and business leaders in ways we had never previously imagined. However, difficult times also create opportunities. We therefore need to be vigilant, tapping into the opportunities while at the same time being mindful of the risks – balancing these two is the critical task for Georgia Capital in 2021 and beyond.
Despite a number of important measures taken by the Government of Georgia, an unprecedented fiscal stimulus around the globe and strong international support, the pandemic quickly affected many businesses in Georgia and the country’s GDP declined significantly, particularly as a result of the necessity to close international borders, with the consequent reduction in tourism-related income. Notwithstanding the pandemic-driven headwinds, with the majority of our capital allocated to defensive industries and sectors, Georgia Capital demonstrated great resilience and delivered a strong performance in 2020. This was delivered predominantly as a result of the work the Board and management team have put in over the last few years on our core business enablers – strong corporate governance; the development of highly talented management teams; and access to both domestic and international capital markets. Our strength in each of these areas was tested and our foundations proved rock solid.
From a macroeconomic perspective, Georgia was one of the first countries to utilise the Extended Fund Facility with the International Monetary Fund (IMF), unlocking US$ 200 million immediately and swiftly gaining access to a total of US$ 3 billion of external funding, split equally between the public and private sectors. The Georgian Lari has performed relatively well compared to other regional currencies, stabilising after some initial volatility, against the background of the economic slowdown. The National Bank of Georgia (NBG) continued to accumulate reserves which grew by nearly US$ 570 million from 2019 until the end of February 2021, reaching a record high of over US$ 4.1 billion in early 2021.
Real GDP growth in the economy fell by 6.2% during 2020, higher than initially forecast, reflecting the impact of the two significant economic lockdowns during the year. The restrictions under the second of these lockdowns are, however, currently in the process of being lifted. The IMF estimates that economic growth will be 4.3% in 2021, while their medium-term (2022-2025) growth forecast stands at 5.4%, representing one of the highest economic growth expectations in the region. With Georgia’s expected return to economic growth in 2021, and Georgia Capital’s available cash resources and balance sheet strength, we are open to seize any potential investment opportunities that may arise.
Delivering on our strategic priorities
This Annual Report will go into greater detail later, but first let me signpost how we continued to deliver on our strategic priorities in 2020.
- Against the backdrop of this difficult macroeconomic environment, the management of our private portfolio companies successfully executed the cash accumulation strategy introduced at the beginning of the pandemic. As a result, the aggregated cash balances of our private portfolio companies more than doubled to GEL 392 million in 2020.
- We delivered strong operating results across our private portfolio, despite the pandemic impact, with aggregate revenues up 6.4%, and EBITDA up 4.1% year-on-year.
- In August 2020, we bought out the GHG minority shareholders following a shareholder-approved share exchange offer. This substantially strengthened our private portfolio by adding GHG’s existing three market-leading, high cash flow generating businesses. It also resulted in our achieving a previously announced strategic objective – reducing our listed assets to below 20% of our portfolio – way earlier than previously expected.
- In July 2020, Georgian Global Utilities, the holding company of our water utility business and operational renewable assets, successfully issued US$ 250 million 7.75% 5-year green bonds, demonstrating our superior access to capital even during challenging times. • In line with our expectations, the Georgian regulator increased the tariffs for our water utility business, translating into an approximately 38% growth in allowed water revenues for the 2021-2023 three-year regulatory period.
- We completed a 34.4% minority shareholder buy-out in our high-margin renewable energy business, increasing our share in its growing US dollar linked cash flows.
- GHG divested the low-return HTMC hospital at an attractive valuation for US$ 12 million, resulting in a 90bps improvement in GHG’s ROIC, on a pro forma basis.
- The Net Asset Value (NAV) per share allocated to our private portfolio, which we track as “controllable” NAV per share, increased by 54.4% during the year to GEL 39.32.
- Despite the significant impact of the pandemic on the value of our Hospitality and Commercial Real Estate business and our listed assets, particularly in the first half of the year, our overall NAV per share increased by 2.7% during the year, to GEL 48.12.
Enhancing our portfolio strategy
During 2020, we updated our portfolio strategy to ensure that we more clearly delineate, and therefore prioritise, our key investee businesses. Georgia Capital has always, with a clear focus on Georgia, invested to develop and grow our businesses and, as our investments mature, to realise proceeds via suitable business exits – but we have not previously focused on the respective size of individual businesses.
Our updated strategy, which we announced in November 2020, seeks to ensure that we invest only in sectors or corporate opportunities that have the potential to grow to an equity value of GEL 0.5 billion or more over a 3-5 year period. In our experience, these larger companies are more attractive to international strategic and financial buyers, which increase their liquidity. Management’s time will also be more efficiently and effectively utilised by focusing on larger, more scalable businesses.
With this in mind, our prioritised private assets, with the capability of growing to an equity value of GEL 0.5 billion or greater, will be the large portfolio companies – Healthcare Services; Retail (pharmacy); Water Utility; and our P&C and Medical Insurance businesses – and our key investment stage portfolio companies – Renewable Energy and Education. We have highlighted the strengths of and opportunities for these businesses in significant detail throughout this Annual Report.
As we continue to manage through the impact of the pandemic and grow and develop every single one of our businesses, the implementation and evolution of our updated strategy over the next few years will focus on two key themes:
- Realising the value of one large portfolio investment, by way of a sale, before the end of next year. This is most likely to be a trade sale to an international strategic buyer. We believe that realising the value of one of our large portfolio companies will go a long way to demonstrating and validating the value of our portfolio, and thereby support our desire to reduce the discount to NAV of our share price. In essence, we are targeting to complete the full investment cycle with one of our businesses – invest, grow, monetise.
- Secondly, at the right time and for the right price, we are considering the divestment of the smaller private companies within our portfolio. These are the companies that we believe have limited potential to achieve our desired GEL 0.5 billion equity value. We expect to complete this exercise over the next 2-3 years, with likely potential interest from both local and regional buyers.
Capital allocation and dividends
During the pandemic, we implemented a cash accumulation and preservation strategy and put many capital allocations on hold, making only limited investments. The following capital allocations were made during the year:
- GEL 138 million equity capital allocation was related to the buy-out of the minority shareholders in GHG. This was paid for by the exchange of 7.7 million newly issued GCAP shares for GHG shares.
- GEL 44.4 million was allocated to Renewable Energy, of which, GEL 38.7 million was for the buy-out of the minority shareholder in February 2020 and GEL 5.6 million for the development of pipeline HPPs.
- GEL 5.0 million was allocated to Beverages to finance working capital needs of the beer business.
- GEL 4.2 million was allocated to Auto Service, for working capital financing and the buy-out of an additional 10% equity stake in Amboli, increasing GCAP’s total ownership to 90%.
During 2020, Georgia Capital collected GEL 30 million dividends, of which GEL 5 million was received from Renewable Energy, GEL 10 million from P&C Insurance and GEL 15 million from Water Utility. Looking forward to 2021, we currently expect approximately GEL 60-70 million in dividends during the year from our private portfolio companies.
At the end of 2020, the Group held GEL 284 million (US$ 87 million) in cash, liquid funds and loans – a robust position that has deliberately been maintained throughout the COVID-19 pandemic. Since the year-end, on 9 March 2021, the Group further enhanced this position via a raise of a further US$ 65 million on the Group’s existing Eurobond, which positions the Group strongly for our planned investments in the renewable energy and education businesses – the two key sectors for our planned investments of approximately US$ 50 million over the next 3-5 years. In addition, as noted above, the aggregated cash balances of our portfolio companies more than doubled in 2020 to GEL 392 million.
NAV per share, in GEL, increased 2.7% in 2020 to GEL 48.12, despite a significant reduction of 35.6% in NAV per share in the first quarter of the year, as global markets responded negatively to the evolving pandemic-related economic challenges. Robust underlying operating performances across our private portfolio companies, supported by some recovery in market sentiment, enabled us to finish the year in positive territory. This increase in 2020 was primarily driven by the first-time valuations of GHG, now a wholly-owned private company following the minority buy-out, and by our investment stage portfolio companies. These strong positives were partly offset by losses in our hospitality and real estate businesses, a 24.9% decrease in the BoG share price, and an FX loss reflecting the impact of the GEL devaluation in the year on our net debt.
I was particularly pleased with the resilience of the operating companies throughout the portfolio. Our listed investment – Bank of Georgia – delivered a 13% return on equity in 2020, a remarkable achievement compared to local and international banking peers, with a 20%+ return on equity in each of the last three quarters of the year. Throughout 2020, BoG’s balance sheet remained strong, with better than expected levels of growth in both customer lending and deposits, loan loss reserves remained strong in the face of the economic impact of the pandemic, and its capital position remains robust. Perhaps BoG’s most impressive achievement in 2020 was to grow its shareholder equity by 18.6% during the year, despite the significant pandemic-related challenges faced by BoG and its customers. Looking to 2021 and beyond, I see BoG as extremely well positioned to benefit from Georgia’s expected return to economic growth.
Our private portfolio companies also delivered strong results, against the economic headwinds, with aggregated revenues and EBITDA both increasing during the year. In addition, the private portfolio companies increased their aggregate net operating cash flows by an outstanding 63% year-on-year, to GEL 375.7 million. The individual performances of these businesses are described in greater detail later in this report.
Who before what – the strength of our people
In every letter to our shareholders, I reiterate that our team of people continues to be the main asset of Georgia Capital. Our portfolio businesses are all managed by the best talent available in their respective sectors, but we do not rest on our laurels – we are always seeking to nurture, develop and acquire the very best talent. We do not invest in businesses unless we are certain they are run by the highest quality managers available in their respective sectors, and in many cases our managers are also shareholders. Importantly, throughout the pandemic crisis over the last 12 months we have avoided mass lay-offs and have retained and further enhanced the bench strength of our existing management team.
At the Georgia Capital level, and in each of the operating companies, managing through 2020 has been a considerable challenge for all of our management teams and colleagues – on both a personal and professional level. Across the Group, however, our people have stood up exceptionally well to all of the external challenges they have encountered and continued to deliver strong results. I want to thank all of our colleagues for such steadfast commitment.
Overall, I continue to be extremely impressed by the leadership teams of our portfolio companies and how successfully they have handled this challenging year, with strong support from our Board members. Entering 2021, while the range of possible economic outcomes remains wide, we see positive factors; vaccines are being rolled out to manage the pandemic impact, markets and businesses are adapting to the new environment, and the recent gradual reopening of Georgia’s international borders should spur a rapid return to economic growth.
We have created a high-quality and defensive portfolio of business investments with significantly reduced dependence on tourism inflows, a clear and proven governance model, an extensive network of top-quality talent, and strong financial flexibility. These are the foundations for consistent future NAV per share growth. While continuing to support our portfolio companies in delivering on their strategies and remaining alert to compelling new investment opportunities, we will be placing particular focus on the monetise element of our cycle over the next few years so that we can realise the value of one large private portfolio investment and divest our sub-scale portfolio companies. Achieving this should, we believe, support a reduction in the current discount of the market value of your shares to our per share NAV.
Chairman and Chief Executive Officer
25 March 2021