Shareholder Letters

Chairman and CEO Statement

Extract from 2018 Annual Report

Dear Fellow Shareholders,

2018 was a historic year for our Group. As a result of the demerger of BGEO Group PLC, Georgia Capital PLC (“GCAP”) emerged as the only group of its size and scale focused on investing in and developing businesses in Georgia. GCAP intends to capitalise on its strong corporate governance to continue its superior access to capital and management. We have managed to attract a top class Board of global independent Directors, who are contributing substantially to the further development of GCAP as an institution. These pillars provide GCAP’s portfolio companies with clear and significant advantages in the local corporate market. Since Georgia, as we know it, is only 25 years old, many corporate sectors are in their early stage of development. GCAP therefore has a unique opportunity to participate in and shape the formation of a number of different corporate sectors, some of which are highly fragmented and/or with low penetration, providing strong opportunity for consolidation.

In addition to the demerger of the Group, 2018 will be remembered for the Group’s issuance of a US$ 300 million six-year Eurobond with a yield of 6.375%. This transaction once again demonstrated our strong capabilities to access international capital markets. In 2018, we also kick started our US$45 million buyback programme. At GCAP, we think of this buyback programme as an investment. We consider GCAP shares to be attractively priced and we are buying an asset we very well know and expect to be accretive. To date, we have invested more than US$21 million in GCAP shares.

After turning into dedicated developers and managers of assets, we have been enhancing our understanding of our new business and have started to institutionalise it by further developing our:

  • capital allocation framework – I will be describing this in greater detail below.
  • risk management procedures to better manage liquidity, capital and overall risk.
  • analytical framework of appraising investment cases.
  • reporting and monitoring framework for driving portfolio company value creation.
  • valuation framework to mark our portfolio companies at fair value. We identify listed peer groups for each private business that we own in order to value our portfolio companies at similar multiples. Peers are selected from frontier and emerging market economies. In a way, we are doing deep research of listed peer companies to make sure that they are comparable to our portfolio companies in aspects such as industry, business model, company size, economic and regulatory factors, growth prospects and risk profiles. This research helps us to learn and understand the key successful strategies of our peers, potentially to be adopted by our portfolio companies.
  • motivation system for GCAP and our portfolio company management that aligns the long-term interests of management and shareholders.
  • exit strategy framework. We are identifying complementary strategies of peer companies in the region with the desire and potential to buy our portfolio companies.

2018 was a year for us to get our house in order to prepare ourselves to execute our acquisition strategy, all the while monitoring and developing our current portfolio companies. We have developed the key principles for the acquisition and new business development side of our business model, which I would like to share in order to provide an insight into our way of thinking.

2018 was a year for us to get our house in order to prepare ourselves to execute our acquisition strategy, all the while monitoring and developing our current portfolio companies. We have developed the key principles for the acquisition and new business development side of our business model, which I would like to share in order to provide an insight into our way of thinking.

Who before What

Our key asset is the team of people working for GCAP and its portfolio companies. No matter how big the opportunity is, if we do not have the right people managing the company following the acquisition then it is impossible to capitalise on the opportunity. Therefore, before we invest in new opportunities, we make sure that we have the right management team in place. Clearly, developing management talent in GCAP and its portfolio companies is the number one priority for me. This is a key part of my KPIs – you should expect to see personal development as well as people development as part of that. Apart from allocating capital, my primary role has become to help the management of our portfolio companies to articulate their strategy and deliver on it. In a way, helping others to be successful has become very much my full-time job.

Personal development without a cultural shift within GCAP and its portfolio companies is difficult if not impossible. We are initiating a cultural shift throughout the business. We want to keep the good side of our culture intact, such as excellence in execution, having a clear vision, being entrepreneurial, opportunistic learners, and fostering loyalty to the organisation. In addition, we want to develop other qualities in order to shift our culture toward a constantly collaborative, creative context. A culture where multiple brains can work in tandem as one. The following cultural shift will happen in next couple of years:

  • giving and receiving feedback is considered an act of help, not criticism.
  • active listening to be encouraged in order to be open for different ideas and points of view.
  • mistakes are seen as an opportunity to learn, rather than a source of punishment.
  • developing successors will make managers stronger, not weaker, and this will allow further career development.

To summarise, because we refuse to invest in any new opportunity without having the right talent in place, we need to be proactive in developing talent internally. Otherwise, we will not be able to further grow and diversify our portfolio. Personal development combined with a cultural shift in the context of growing new leaders is becoming a critical success factor for growing and diversifying GCAP.

Think Twice Before Buying

Our main goal is to buy companies at affordable prices. Although I know we are not unique in this approach, I would stress that we have developed a framework to estimate the optimal price for any target. Before investing we absolutely need to understand at what level of discount we are buying an asset/company in relation to listed peers. At the same time, we want to understand at what level of discount/ premium GCAP is trading to its fair value. We would want to buy assets/companies at a higher discount to their listed peers than GCAP’s fair value discount. We also need to understand where our listed portfolio companies are trading. We call this 360-degree analysis.

We are always very mindful about the size of any deal. We may not shy away from a large investment if we are doing a bolt-on acquisition with a strong existing management team with a proven track record. However, if we are entering a new industry we would rather start with a small ticket size and test and develop a management track record before stepping up the investment size. We obviously want to make small investments in the sectors where we see the largest future opportunities. We also want to use GCAP shares as an acquisition currency when buying assets/companies at a higher discount to their listed peers than GCAP’s fair value discount. Utilising GCAP shares will preserve cash and at the same time align the interests of participants in corporate Georgia. In general we like the service industry as we believe that in the long-run Georgia will become the service hub of the region.

When investing, the following metrics are critically important for us:

  • MOIC1 combined with IRR2 : we want to know the money multiples we will achieve with all acquisitions; however we want to understand it in combination with the expected IRR. We prefer to have high MOIC with high IRR from our businesses. Realised and unrealised MOICs are equally important for us. We will start reporting MOICs for our businesses from 1H19.
  • ROIC3 : we want to measure our expected return on the total invested capital at each portfolio company level. Different yields will be appropriate for different industries.

To summarise, buying assets at affordable prices is part of our key investment philosophy and we want to be very disciplined in this regard. We are also comparing the discount level to the fair value multiple to listed peers with the NAV discount in GCAP. The ROIC, MOIC and IRR combination is the key decision making matrix used in our investment decision making process.

Cash is, was and will Always be King

We understand very well that our success will be measured by exits we will make from our portfolio companies/investments. An exit strategy review is becoming one of the key focuses of our investment decisions. However, we also realise that exits in a small frontier economy are not an easy exercise. Therefore, as outlined above, our investment entry point becomes very important, e.g. an acquisition with a low multiple ensures that we will be able to take money off the table by growing and leveraging our portfolio company. In a way, for each of our assets/investments we want to have two potential liquidity events. One with leverage to ensure the special dividend flow to GCAP, and another through a trade sale or IPO.

In this context, a key focus at the portfolio company level is the ability to grow operating cash. At the same time management is expected to be efficient in making capex investments by targeting an appropriate level of ROIC. From our perspective, monitoring of cash formation at both GCAP and portfolio company level is becoming the key metric to watch. We are developing cash monitoring tools which should ensure we have a single Group-wide cash view, enabling us to monitor and analyse cash generation across the Group as well as measure ROICs on cash investments for each of the projects within our portfolio companies.

To summarise, our thinking has very much shifted towards cash generation capabilities, not only for GCAP but also for our portfolio companies. Our ability to progressively grow and generate cash will be the critical ingredient for potential double exit routes, which in turn is the key measurement of our success.

As of 31 December 2018, net cash investment in listed and late stage companies was GEL (101) million against the fair value of GEL 1.6 billion, putting us in a strong position on both in-place cost multiples and IRR metrics, and, more importantly, creating optionality for our ultimate exits given the existing cash generation in these businesses. One key example is GHG, where our net cash investment was GEL 7.4 million against the fair value of our GHG holding of GEL 520 million.

Capital Allocation

During 2018 we allocated GEL 85 million of capital across our portfolio companies in order to make progress towards our established business goals. We allocated GEL 5 million to our renewable energy business and GEL 32.9 million to the hospitality business for our hotel pipeline development, while GEL 40.6 million went to our beverages business for bolt-on acquisitions to increase its scale. We also added an education business to our pipeline by investing GEL 6 million in land for high school development, where we expect to build a portfolio of affordable high schools to capitalise on our scale advantage in what is currently a very fragmented, private high school education market. We aim to invest GEL 140 million equity capital into our education business and aim to reach 30,000 pupils by the end of 2025.

We manage our capital needs such that we do not depend on potentially premature liquidation of our listed portfolio companies. Our ability to capitalise on the benefits of better capital allocation constitutes a pathway towards improving returns and therefore we constantly look for favourable investment opportunities in Georgia, preferably within capital light service industries. Based on our capital allocation outlook through the end of 2022, as described on page 23, we currently plan to invest approximately GEL 413 million and expect to receive dividends of approximately GEL 429 million, leading to net expected capital inflows of approximately GEL 16 million. This investment need will be comfortably funded by the existing liquidity of Georgia Capital, which stood at GEL 605 million at 31 December 2018.

Portfolio Valuation and Performance

Following the introduction of fair values for our private portfolio companies on a management account basis, our portfolio value reached GEL 2 billion at 31 December 2018, a 1.8% y-o-y increase. NAV per share increased by 0.9% to GEL 47.1, while NAV stood at GEL 1.7 billion, down 8.3% y-o-y. Given negative stock market conditions during 4Q18, valuations of our listed and unlisted companies were unfavourably affected; however, the underlying business performances were outstanding with double-digit revenue growth and strong operating cash flow generation supporting increased earnings. This leads us to be confident that the intrinsic values of our portfolio companies have increased at a much higher level than their underlying valuations at 31 December 2018. For a detailed performance review of each portfolio company please refer to pages 102 to 116 of the Annual Report 2018.

On an IFRS basis, revenue (at GEL 1.3 billion) and gross profit (at GEL 487 million) were up y-o-y largely as a result of the strong performance of GHG, our water utility and beverages businesses. Consolidated EBITDA remained flat at GEL 218 million. The lack of growth reflected, in particular, the cost of GCAP’s demerger from BGEO Group and the cost of the launch of our beer business. Net operating income before non-recurring expenses and IFRS net profit were both down for a mixture of reasons you can read about on page 92 of the Annual Report 2018.

Finally, I would like to thank you for your continued support for GCAP and for Georgia. I hope to see you all at our investor day in Tbilisi on 27 June. I am confident that the road ahead for GCAP will be interesting and, most importantly, enjoyable.

Irakli Gilauri
Chairman and Chief Executive Officer

3 April 2019

1 Multiple of invested capital.
2 Internal rate of return.
3 Return on invested capital.