Extract from 2016 Annual Report
The business and political mood is upbeat in Georgia, and my coverage of the four topics of this letter reflects these positive conditions. I will start with the economic and political overview, followed by a discussion on our Group strategy, talent development, and then board development. The CEO letter that follows will go into more specific details on each of our businesses.
Economics and Politics: A few months ago, Georgia once again demonstrated its commitment to European standards and norms by ensuring the successful delivery of 2016’s democratic parliamentary elections. As expected, the Georgian people overwhelmingly supported the incumbent government. The elections turned out to be open, clean, and transparent with a very clear mandate for the incoming government. Most of the population believe that economic development is the way to prosperity and progress and this national consensus is the key to political stability.
After the elections, Georgia’s ruling Georgian Dream party introduced a package of legislative changes to support the implementation of the Government’s four-pillar reform programme (introduced in February 2016) to boost growth and enhance the economy’s resilience to external shocks. The programme includes new tax benefits, infrastructure schemes, governance reforms and the modernisation of the education system. Corporate tax reform was enacted and effective as of January 2017, undistributed profits are tax free, ensuring a significant potential boost to Georgia’s investments and economic growth.
The country continues to be very business friendly. The World Bank ranks Georgia 16th out 189 economies in terms of ease of doing business, up from 23rd position a year ago. With its business-friendly environment, stable Government, developed infrastructure, stable energy supply, flexible labour legislation, stable and profitable banking sector, strategic geography and a Government committed to addressing structural improvements in the economy through its four-pillar reform programme, Georgia is well positioned to become a significant regional hub economy.
In fact, we expect GDP to grow 4.3% in 2017 compared to 2.7% in 2016. The number of visitors to Georgia increased at a 22.1% CAGR over 2007-2016 and tourism inflows stood at US$ 2.2 billion (15.1% of GDP) in 2016. The Government plans to enhance Georgia’s positioning as a four season tourism location through improving the connectivity of different regions with an aim to enhance their untapped potential. Despite the fact that many countries faced reduced capital inflows during the recent economic turbulence, FDI into Georgia has remained relatively secure thanks to the business-friendly environment as well as strategic infrastructure projects. In 2016 FDI inflow to Georgia was up 5.2% y-o-y and totalled US$1.6 billion (11.5% of GDP).
International relations are on the right track. Georgia’s accession to the visa free programme with the EU was a concrete benefit for all to see. Moreover, the Government continues to constructively manage its relation with Russia. Tourists from, and exports to, Russia have increased 12.0% to 1.0 million persons and 26.6% to US$ 206.2 million last year, respectively, while the share in Georgia’s total still remains low at 16.3% for tourists and 9.8% for exports. On the regional front, Turkey’s situation has had some effect on Georgian economy. In contrast, recovery in other regional economies, particularly in Russia through its positive spillovers on Georgia’s major trading partners, is strengthening Georgia’s growth outlook. To summarise the situation: Georgia is boringly tranquil, in a neighborhood in turmoil. This bodes well for Georgia’s strategy to become a regional business hub.
Group strategy: Last year, we informed you of our new two-pronged strategy. Firstly, we would continue to make Bank of Georgia an excellent institution, and secondly, we would buy assets in Georgia cheaply, grow them, and then sell them to investors at a higher price.
We continue to view BGEO as a vehicle whose goal is to maximise the value of its assets for its shareholders. This means that we will continue to pursue our “buy low, sell high” asset strategy. GHG is a very good example of how we want to execute this strategy. Importantly, we don’t consider any of our activities “core” anymore – including the Bank. This is why we call ourselves: a Georgia Focused Investment Platform.
Let me give you a review of our main strategic priorities, while Irakli, our CEO, will talk in more detail about the strategic goals for each of our businesses in his letter.
- The Bank has become an excellent institution both in terms of innovation and cost management. We aim to become the best in class when the transformation of our retail bank is completed. In addition, we believe that regional wealth management holds a potential that we have not yet exploited. We believe Galt and Taggart and the corporate bank have the best investment banking capabilities in the country. These capabilities should translate into a more dynamic and profitable corporate banking segment. Today, the banking market is a two-player market – a market we share with a good competitor.
- GHG has three main strategic priorities: launch new services at hospitals to grow revenue from planned treatments, grow market share in outpatient clinics – a market which is highly fragmented, and digitalise healthcare system to accomplish further efficiency and more importantly, better quality of care. We are leading the improvement of healthcare in the country, by establishing new standards and developing new operating models and procedures which don’t exist in Georgia yet. Additionally, we have an open dialogue with the regulatory authorities to establish rules and regulations to reach significantly improved health care practice for the population of Georgia. Finally, we believe that our presence in hospitals, policlinics, pharmacies, and insurance holds enormous profitably, especially using digital technologies. GHG does not have the same market value as our Bank yet, but it holds much promise.
- In the utility and energy arena, we bought, at a good price, a water utility with many improvement opportunities. This year and next, we will be on the lookout for more acquisition opportunities in the areas of energy and utilities. Additionally, we aim to develop hydro, solar and wind energy production. Georgia could become a clean energy producer, and should become an electricity trading hub. We intend to be a major player in this emergent market. Again, we will follow our usual investment strategy, and seek to realise the value created through an IPO in a few years’ time.
It should be clear that we are continuing to pursue and expand a strategy announced in the past. We believe Georgia is too small to attract private equity investment. This is where we can play a significant role, providing capital and management talent, our two traditional strengths. At BGEO, our new slogan, Georgia Focused Investment Platform, reflects this mindset.
Talent development: For many years, we have defined our key assets as access to capital and to Georgian talent. We have built the credibility to tap capital markets, having raised over US$ 1.4 billion up until now. Now we must make an even more concerted effort to develop talent. We need that talent to develop the “cheap” assets that we are acquiring. Our CEOs at GHG, m2 and GGU, as well as many other top executives at the Group, came out of the Bank’s management pool, but we need to accelerate the growth of this talent pool if we want to continue to grow and develop staff properly. We need to continue to align our talent strategy with our business objectives.
One of the key components of our talent or human resource development strategy has been our incentive system. Its intent is to incentivise management to create value on a long term basis: c.85% of management’s compensation is in shares that vest over 3-5 year period – discouraging quick earnings temptations. The unvested shares are normally “clawed-back” if a manager is fired for cause which includes a broad range of misconduct and this fully aligns shareholders’ and managements’ interests in the long-term. This system also encourages teamwork. Shareholders’ interests are perfectly aligned with those of top management.
Incentive systems are important but don’t create talent. Until now, we have brought back talent who had trained abroad and developed others on the job. Today, we want our talent strategy to provide a supply of leader/managers to newly created positions. In effect, we need to build a pipeline of talent. We have named a new Chief Talent Officer, whose background is not personnel management, and given him this mission. He will ensure that BGEO further strengthens its culture of meritocracy, teamwork, and that it continues to develop a strong pipeline of capable managers ready to take the available positions.
The essence of a meritocracy is having employees feeling free to share their ideas and being evaluated and rewarded for their performance. This requires dialogue which we will promote by the spreading of the habit of coaching – up and down the hierarchy. We would like to see constructive feedback and frequent developmental discussions between managers and their direct reports. This is not an idle talk. Most of our top managers have chosen to be coached by external coaches in the past years. We believe that a coaching culture starts at the top. Our top managers are urged to coach their direct reports, and to encourage such behaviour to cascade down through the organisation.
This effort is reinforced by the development of a teamwork culture. This is a culture that is characterised within and across functions for the greater good of the institution. Our incentive system encourages that and we have started to implement a leadership development programme whose aim is to foster trust across horizontal managers.
We already see the results of these efforts in a few of our business units, namely, Bank of Georgia, m2, GHG, and elsewhere. Our next step is to align our HR systems and integrate such habits throughout the organisation. We would like our leadership programmes to initially cover 60 of our top managers, followed by the next 400. We believe that no other private institution is as large or as professional in Georgia as BGEO. We must become the talent development engine of the country. Georgian institutions and corporates need managerial talent. If we don’t lead, then who will?
The Board. Our board is constituted of capable individuals who are T shaped. They all were chosen for the quality of their analysis and their judgment, the horizontal T, and for their deep specialty, the vertical of the T. I described their talent in my letter to shareholders last year. As our businesses diversify across the industries in the Georgian economy, the talent pool to supervise them must adapt. In the case of GHG, we have built a separate board with the requisite talent and continue to enrich it.
We will also be adding two new board and/or committee members with IFRS experience – one to each of the BGEO and GHG boards. As we continue to refresh our Board, increasing female Board representation remains a priority. We were not successful in advancing that priority in 2016, but aim to make good on our promise this year and next.
Attracting talent to our boards remains key. We must build the capacity of the board to guide and supervise all our business entities. It is not economical at this stage to build full-fledged boards for the smaller ones, but in the fullness of time, we will need to do so. As Chairman, I am keenly aware that the Board’s responsibilities and capabilities must evolve to adapt and support our strategy.
I would like to thank investors who have given us their confidence and money from early on. I speak on the boards’ and managements’ behalf when I assure you that we are committed aiming to offer you a good return on your investment. I would like to also underline that your investment continues to develop BGEO Group, the country of Georgia and its population through better healthcare, housing, utilities, banking services, and economic development in general. It is also providing strong support to the people employed by all our companies.