Shareholder Letters

Chairman’s Statement

Extract from 2016 Annual Report

Dear Shareholders,

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.                  

Neil Janin

CEO’s Statement

Extract from 2016 Annual Report

Dear Shareholders,

Georgia continued to achieve consistent improvements in its macroeconomic performance and improved levels of business confidence, and the Group delivered another year of strong business performance with over 30% basic earnings per share growth, and improved returns in both the banking business and the investment businesses. With the economy seemingly on the rebound in 2017 as measured by levels of business confidence, a number of recent strategic initiatives and acquisitions are expected to continue to deliver excellent performance in 2017 and beyond. In this annual letter, I will therefore update you on our medium-term strategic goals. 

The Group will continue to focus on capturing growth opportunities in the rapidly growing Georgian economy. Our ‘4x20’ strategy will continue to be targeted over the medium-term to deliver:

  • A return on average equity in the Banking Business of at least 20% 
  • Retail Banking customer lending growth of at least 20% per annum 
  • A minimum targeted Internal Rate of Return of 20% on investments in the Group’s investment businesses, and 
  • A maximum 20% profit contribution, of the Group’s profits, from our investment businesses 

The Group will continue to aim to maintain a regular dividend payout ratio from the Banking Business profits in the 25%-40% range. Since the introduction of dividends in 2010, the Group has managed to grow its annual dividend per share by 51.6% CAGR. At the 2017 Annual General Meeting the Board intends to recommend an annual regular dividend for 2016 of GEL 2.6 per share payable in British Pounds Sterling at the prevailing rate. This is within the range of our regular dividend payout ratio target of 25-40% paid from the Banking Business profits, and represents an 8.3% increase over the 2015 dividend. 

2016 marked the first ever issuance of Eurobonds at the holding company level, through which we raised US$ 350 million, with a coupon of 6.00%, due 2023. Overall, the Group’s capital and funding position continues to be very strong, with capital being held both in the regulated banking business and at the holding company level. Within the bank, the NBG (Basel 2/3) Tier 1 Capital Adequacy ratio was 10.1%1, comfortably ahead of the Bank’s minimum capital requirement. In addition, as of 31 March 2017, GEL 335.2 million liquid assets were held at the Group level. 

As a result of the Group’s strong capital position, excess levels of liquidity and high level of internal capital generation, in November 2016 the Board approved a $50 million share buyback and cancellation programme, to be completed over a two year period, in addition to the regular annual dividend to be paid to shareholders. Over the last few months, the Group Employee Benefits Trust has also purchased shares in the market totalling approximately US$ 20 million. 

A recent development in the Georgian Government’s tax policy is now effective, and applies the profit tax (currently set at 15%) only to distributed profits. Undistributed profits will no longer be subject to the profits tax. As a result, approximately GEL 500-600 million equity will be left to profit-generating corporates that are expected to profitably reinvest this capital. This tax policy amendment took effect for most companies on 1 January 2017, and for certain financial companies (including banks and insurance companies) it is expected to take effect from 1 January 2019. This will reduce the effective tax rate of the Group’s non-banking businesses in 2017, and the entire Group in 2019. In addition, the Bank expects to benefit from the general improved creditworthiness of its entire corporate portfolio. The impact of these changes has led to a number of deferred tax adjustments that increased profits in 2016 by GEL 63.8 million. 

Despite some regional headwinds, the Georgian economy remained resilient during 2016, with estimated GDP growth of 2.7% for the year. Foreign Direct Investments were solid at 11.5% of GDP and tourist numbers – a significant driver of US Dollar inflows for the country – continued to rise throughout the year. Inflation remained well controlled at 1.8% at the end of 2016. 

Turning to the business, let me talk about our two business lines – the Banking Business and the Investment Businesses – separately: 


The Bank delivered another very strong year in 2016, characterised by the expected strong growth in the retail bank, and a repositioning of the corporate bank to further reduce concentration risk. Customer lending increased by 24.5% during the year, with 39.5% growth in the retail bank and 8.3% growth in the corporate investment bank. The Return on Average Equity in the banking business increased from 21.7% in 2015, to 22.1% in 2016. 

Over the next few years, Bank of Georgia aims to shift the mix of its customer lending to become 65% retail and 35% corporate (currently 61% retail; 39% corporate) with the product per client ratio in the mass retail banking targeted to increase to 3.0 products, from a current 1.7 products. 

We are now running a client-centric, multi-brand strategy in our Retail Bank. Over the past decade, Retail Banking has delivered a stellar performance by reaching c.2.1 million clients, delivering exceptional loan book growth and achieving its ROAE targets. While we were targeting these milestones, the Bank was product-centric with an active client acquisition approach. Having over two million clients now, this phase is less prevalent and we target stronger growth through increasing the product to client ratio by introducing our client centric model while running a multi-brand strategy for different segments of population. 

Our Express brand caters to the emerging retail segment and offers predominantly transactional banking services to clients through small-format, Express branches, ATMs and Express Pay Terminals. In this segment, the Bank will aim to double the number of transactions over the next 2-3 years. 

Our Solo brand caters to the mass affluent segment and offers exclusive products and the finest lounge-style environment at our newly designed Solo lounges, together with new lifestyle opportunities, such as exclusive events and handpicked lifestyle products. Solo already has very encouraging early signs: we have invested only US$ 11.5 million in this new concept since its launch in April 2015 and we have almost doubled the annual net profit to GEL 25.3 million. In this segment, the Bank will aim to increase the number of Solo clients to 40,000 (19,267 as at 31 December 2016). 

Our Bank of Georgia brand caters to the mass retail segment. This is our flagship brand and our most significant profit contributor. We are currently transforming our service delivery to mass retail clients from a product-centric to a customer-centric one. The client centric approach has also had very encouraging early signs and in 24 pilot branches, sales have increased threefold. Going forward, expanding express branches will be very important to move out transaction focused clients from flagship branches and allow our universal bankers to cross-sell and increase the product to client ratio. We will be launching the first fully transformed branch in April 2017. 

The Bank will continue to reduce concentration risk in the corporate lending portfolio, with the support of the Investment Management business. The target is for the top ten borrowers to represent less than 10% of the total loan portfolio (currently 11.8%). Georgia is becoming the service hub of the region and Bank of Georgia is in a great position to capture wealth management clients from throughout the region. In 2016, we have attracted more than 150 clients from 68 countries and we plan to step up these efforts. The Bank’s aim is to develop a significant regional private banking franchise to reach AUM of GEL 2.5 billion (currently GEL 1.6 billion). In this regard, we leverage superior knowledge and capital markets capabilities in the Georgian and neighbouring markets both in terms of reach and the expertise that we have accumulated during the past several years through our corporate advisory, research and brokerage practices united under Galt & Taggart – a wholly-owned subsidiary of the Group, which is at the forefront of capital markets development in the county. 

At the end of 2016, we announced a number of appointments that further strengthened the management team of the Bank. 

We appointed Kaha Kiknavelidze as CEO of the Bank. Kaha has been on the BGEO board for 8 years and knows the Group and management very well. At the same time he brings new perspectives to the executive team who have worked together for a very long time – the mix of old/new blood is important to bring new topics for discussion to the table. Kaha has over 15 years of experience in financial services in a number of roles at UBS and Troika Dialog. Prior to his current role, he was the founder and Managing Partner of Rioni Capital Partners LLP, a London-based investment management company. 

We also have two new members in the executive management team of the Bank. David Tsiklauri was appointed to the position of Deputy CEO at the Bank, and leads the Bank’s Corporate Investment Banking Department. David has extensive experience in banking as well as the corporate segment in Georgia, having worked as the Deputy CEO in charge of Corporate Banking at TBC Bank and as Vice President of the Capital Markets and Treasury Solutions team at Deutsche Bank. Ramaz Kukuladze was appointed Deputy CEO at the Bank, and leads the Bank’s SME and Solo businesses. Ramaz has extensive experience in the financial services industry and wide experience with and a deep knowledge of the segments that he is leading. Prior to joining the Bank, Ramaz worked at Bank Republic Société Générale where he led the bank’s corporate and retail business as Deputy CEO. 

I am confident that the strengthened executive team of the Bank will deliver on the opportunity to build on the Bank’s recent strong growth by further developing its presence and profitability in both the retail and corporate banking sectors in Georgia. 


The Group’s Investment Businesses continued to deliver very strong earnings performances in 2016, with strong organic growth supported by the impact of recent acquisitions – specifically (1) the addition to our healthcare business Georgia Healthcare Group (GHG) of the GPC pharmacy business following its acquisition during the second quarter, and (2) the second half consolidation of our utility and energy business Georgia Global Utilities, GGU, following the acquisition of the remaining 75% equity stake in GGU for a cash consideration of $70 million in July 2016. EBITDA from the investment businesses increased by 71.1% to GEL 132.6 million in 2016. 

In the healthcare business, Georgia Healthcare Group, GHG, we are present in whole healthcare ecosystem, which in size is GEL 3.4bln, with a best in class management team and access to capital. We see three key opportunities in healthcare business: Firstly, continue the introduction of new services in our hospitals, which should further strengthen our leading market position. Secondly, expand in the outpatient segment where the market is highly fragmented. We see the same opportunity now in the fragmented outpatient sector that we saw in the hospital business number of years ago. Lastly, we see an opportunity in digitilisation of healthcare services by creating electronic patient records and advising our patients in maintaining a healthy lifestyle. Our scale is important to deliver on our targets of delivering good quality healthcare at affordable prices. 

In m2 Real Estate we are targeting an internal rate of return of c.40%+, whilst delivering a capital return to the Group of US$ 20-25 million in 2019/20. As we have previously declared, we are no longer buying land plots as our aim is to develop third party land. In essence our aim is to evolve m2 from a real estate developer into a real estate asset manager. 

In the beverage business, Teliani, we are launching beer production and will be opportunistically expanding the beverage business in order to penetrate the retail network by offering a diversified product base, as well as enlarging the business to achieve economies of scale and cost advantage. Our primary exit strategy is expected to be a trade sale. 

In the utility and energy business, GGU, we aim to achieve EBITDA of more than GEL 80 million in 2018, whilst establishing a renewable energy platform, targeting 200MW operating, 57MW ready-to-build,150MW in the pipeline for the hydro power plants; and 20-20MW ready-to-build wind farms and solar photovoltaic stations. All of this by 2019 with a targeted IRR in excess of 20%. GGU has a significant opportunity to increase its operational cash flow over the next few years from a combination of improving cash collection rates, increasing energy efficiency and reducing water loss rates, and by the development of renewable energy resources. We are aiming to prepare the combined utility and renewable energy business for an IPO in approximately 2-3 years. 

As we start to prepare GGU for an IPO, we have further strengthened the GGU team and appointed Archil Gachechiladze as the CEO of GGU. Having been with the Group for almost 8 years in various roles, Archil has an outstanding execution track record with the Bank and, just as importantly, he is very passionate about the business of GGU having initiated our investment in the utility and energy business. We are also consolidating the Group’s utilities and energy businesses under GGU, the two investments that the Group made separately. 

Last but not least, I would like to reiterate our commitment to the highest level of corporate governance which is a foundation for accessing management and capital. A key focus for me – and my board – is to grow and develop talent. Coaching and a feedback culture has become part of BGEO. Helping each other to succeed is the core principle of our management team. We understand very clearly that we are in the same boat as our shareholders and our mandate is very clear: to create sustainable shareholder value.

Irakli Gilauri
Chief Executive Officer