Extract from 2017 Annual Report
Dear Shareholders,
This is expected to be the last BGEO annual report. The forthcoming demerger of the Group, announced in July 2017, reflects both the end of an era and the start of a new one. The Board and management team are convinced that we are on the right strategic path. In fulfilling our fiduciary duties to you, the Board regularly examines strategic options. We elected to split the Group into two independent businesses: the Bank and an investment vehicle, which we call Georgia Capital.
If we do it right, we could be at the eve of a major jump in value creation. We will have created three large groups, all quoted on the London Stock Exchange, each with their own Board, management, and strategic logic. It is an opportunity to deliver better service to our clients, better development to our employees, more growth of the corporate sector of the country, and finally significant financial return to our shareholders. Each management team and the Boards will focus on the development of one kind of business.
In my letter, I have traditionally followed a set structure. First, a few words on Georgia; then on the strategy of the Group; and then on people – Board and top management. Irakli Gilauri, our CEO, and others will expand on the detail of the businesses.
Economically, Georgia is doing exceptionally well in a difficult region and world. I believe three key factors make the Georgian situation positive in the long term:
1. Macroeconomic stability. Prudent monetary and fiscal policies have led to almost 5% real GDP growth during 2017. This has allowed the first ever issuance of offshore local currency bonds by Bank of Georgia.
2. Many healthy and developing sectors, in line with Government policies:
a. The financial sector, of which we are part
b. Infrastructure development, especially in the power sector
c. Healthcare, where we participate in the universal healthcare access policies of Government
d. Finally, and more long term, the Government has a programme to improve education, and to make the public sector more efficient.
3. Good Government
a. Strong anti-corruption policies. According to Transparency International, Georgia has maintained its ranking as a low bribery environment — on a par with many European Union member states
b. Georgia’s ease of doing business ranking was 9th out of 190 countries in the world, in 2018, up from 16th last year. Here again an excellent result
c. Fiscal development. The corporate tax reforms, effectively eliminating corporate income tax for all re-invested or retained earnings, started at the beginning of the year and have already yielded GEL 600-650 million cash buffer for corporate re-investment in the first year on the policy’s adoption. The reform efforts also envisage capital market development and pension reform. Georgia is on the right path, and these are developments which take time
d. Reduction of the fiscal deficit. The Government is determined to reduce its fiscal deficit, on the back of reducing non-essential current spending. The 2018 draft budget is an illustration that Government delivers on its commitments; as was the case in 2017.
The proof of this economic progress lies in the fact that we were able do the first ever Lari Eurobond issuance and that Moody’s has upgraded both Georgia and Bank of Georgia to a level two notches below investment grade. The strategy of creating a “mini Singapore” within the region is moving forward day by day. Singapore was not created in one day.
Politically, things are as calm as they can be with Russia. The New York Times reported last year on Russia’s attempts to provoke Georgia on the boundaries of Abkhazia and South Ossetia – all true; but we also see that Russia is doing more business with Georgia, specifically in terms of transport links and increased tourism flows. Elsewhere, Turkey remains Georgia’s largest trade partner, whilst the development of trading links with Iran are likely to take more time than we originally thought. At the same time, Georgia signed a free trade agreement with China and now has access to a market of 1.4 billion consumers, with zero tariffs, without additional customs fees and without any transition period.
Internally, it is important to remember that Georgia is still a pluralist and free country. It is taking the habits of democracies, albeit with one party dominance: historically the UNM party, and Georgian Dream now. We have a Government which is supportive and has very competent public servants. Finally, investors should not forget that the United States and the European Union exercise strong external checks and balances – they do not want to lose Georgia as a rare democratic success story. They showed their confidence in the country by granting Georgia visa-free entry to the 26 countries of the Schengen Area.
The thinking behind our decision to break-up the Group into two separate businesses, each expected to be quoted on the premium segment of the London Stock Exchange, deserves to be explained.
It did not come from the analysis of a conglomerate discount, and the expectation that we would see a valuation bump because of the transaction. The value creation boost for the two entities is derived from our belief that we will run them better— with higher ROE and higher growth. The logic is simple: first, complexity creates confusion, simplicity creates focus. Second, each entity will be freer to pursue its own growth strategy without worrying about “the Group”. We can already see the effects of this decision. One example is our insurance subsidiary which has already signed a number of distribution agreements with banks other than the Bank of Georgia. This might not have happened if we had decided to stay in the “previous structure”.
Both entities have substantial potential of earnings and sales growth.
The Bank is repositioning its portfolio away from straight lending to corporates which require capital and see their margins diminishing. It behooves us to find innovative ways to serve the corporate segment much more profitably. We are also moving into the high net-worth segments, where we can attract wealth from the region. We will continue to reduce costs. Finally, digital technologies offer us an opportunity that we have not yet exploited. The Bank has a very good management team with Kaha Kiknavelidze as its leader, and they are at work on this strategy. I will become Chairman of the Bank and this will be my only Board appointment.
The non-banking business within BGEO will become an investment company — Georgia Capital — which will include real estate, energy, utility, beverages, and insurance. It will also have listed stakes in the healthcare business and the Bank. The value proposition to investors is “the best vehicle for emerging growth opportunities in Georgia, selected by people with unsurpassed understanding of the local landscape, and managers/entrepreneurs”. Georgia Capital will be run like a private equity fund with one exception. The interest of its investors will be aligned with those of its “Partners”. In fact, its CEO will be paid exclusively in shares vesting over six years, and his executive team will have a similar compensation structure. Irakli Gilauri will leave the Group and the Bank, to head this company as Chairman and CEO. The Board is made up of old hands, such as David Morrison and Kim Bradley and a number of new recruits: Caroline Brown, William Huyett, Massimo Salvadori and Jyrki Talvitie.
The healthcare company, GHG, is a stand-alone entity today, with its own Board and separate stock market listing. It has much potential that you can read about in its own annual report.
Board quality and composition have been one of my main preoccupations: we have an opportunity to build a new Board for Georgia Capital and to reinforce the Boards of the Bank and the healthcare company. We have tried to prioritise skills and experience as well as gender diversity. We need Board members who will spend time on the ground in Georgia. We have attracted Cecil Quillen to the Bank’s Board and are actively seeking an additional member. All of our Board members are T-shaped, capable of broad judgement and all bring a speciality to the company. The composition of the two new Boards and the experience and qualifications of their members are set forth on page 19 of this Report.
Unfortunately, at the outset, we will still have only one woman on each of our boards. Our goal is to correct that yesterday. We are still seeking to achieve the diversity targets at board level expected of a company of our size, and as chairman, I make this a personal priority. It has been a war for talent.
Corporate culture and human capital have increasingly become the cornerstone of our success. We would not be able to breakup if we had not developed capable leaders to take over. 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: more than 85% of management’s compensation is in shares that vest over a three-to-five-year period – discouraging quick earnings temptations.
This year we have moved further into changing our corporate culture in every one of the entities. We want to go from solo performance executives to executives who thrive on teamwork. We have instituted personal development programmes starting at the very top and cascading to the lower level of the hierarchy. Meritocracy and trust are what we aim to achieve. This starts with top managers’ behaviour and talk. It is reinforced by training programmes which teach both self-development, how to give and receive feedback, as well as how to dialogue rather than impose. All this will not be enough if good behaviour is not encouraged and bad behaviour not tolerated. The Board and I take a particular interest in seeing this through.
Before closing, I would like to thank Irakli Gilauri for his leadership as Chief Executive Officer. During his tenure at BGEO, Irakli has taken a Georgia quoted bank and transformed it into the organisation with multiple businesses which we have today. He did not do it alone. He attracted and developed many executives who all lead their own businesses today, and are developing in turn a set of new leaders. His final act will be to achieve the break-up successfully. The Board of Directors and I are truly grateful for his leadership over the years he has been with the company.
Neil Janin
Chairman