Monday, May 19, 2014

Trip Report - Kiev, Ukraine; Feb 2014; Part II - Stock Market and Business Structure

Stock Market

My interest in Ukraine began in July 2013, when it appeared on a list of one of the world's worst performing stock markets.  The PFTS index and the narrower UX index had fallen over 70% from their March 2011 highs.  Many stocks were trading at very low valuations based on ratios commonly used by the financial community such as Price / Earnings, and Price / Book Value.  

Surprisingly Ukraine's equity markets held their own after November 2013 when the Maidan protests in central Kiev started.  During its December 2013 market lows the PFTS index was down less than 10% from where it was in the preceding July.

I haven't seen any research to support this, but a rule of thumb is that markets tend to hit bottom when they do not decrease on bad news.  Give all the problems and chaos a 10% decrease did not seem so bad.

With the local markets somewhat resilient despite months of protests in Kiev’s city center I thought it made sense to see for myself what was going on. 

Another thing I liked about the country is that it already seemed like it was in the middle of a political crisis.  Protests in the center of the city had been going on for close to three months and seemed to get bigger despite the chill of winter.

“…the crisis occurs at the end of the problem – not the beginning.  The crisis actually initiates the process of repairing whatever problem created the crisis”, wrote Frederick K. Martin in, ‘Benjamin Graham and the Power of Growth Stocks’. 

But who knows where and when things bottom until after the fact? 

Dead Market. Several people I met in Kiev told me that Ukraine’s stock market is dead.  Turnover has dried-up, prices are way down, and most companies are listing abroad if they list at all.  

Bid/ask spreads can be 100% or even higher. Free-float is small and declining.  Corporate governance is weak and minority shareholder rights are virtually non-existent.  Very few companies pay dividends.  

Brokers in Ukraine don't seem to make money from trading local shares.  Instead they earn their keep by trading fixed income, equity of Ukrainian companies listed outside Kiev, and helping local clients trade foreign stocks and bonds. 

Most managements don’t want to meet with investors, don’t post their accounts on their website, and don’t respond to emails.

It sounds like it was never much of a market to begin with.  From what I was told and read there has never been more than a handful of IPOs, rights issues or other equity funding in Ukraine. 

The market was set up to trade shares that were given to the general public after the USSR’s fall and many 'listed' companies don’t want on be on the exchange.  Even when they are some don’t consider themselves to be 'public'.  It is a very strange feeling when the management of a listed company whose shareyou've just bought says that they are looking forward to an IPO. 

Ukraine’s budding entrepreneurs have instead raised equity capital outside of the country, mostly in  Warsaw and London. There are at least twelve Ukrainian companies listed in Poland and at least six in the UK.   

BusinessWeek Cover
13 August 1979
Ultimate contrarian play?  If one needed a contrarian ‘buy’ signal Ukraine has more than enough.  And that’s before getting into domestic, regional and geopolitics which are seem to grow more uncertain day-by-day as I write this in mid-May 2014.  (These were discussed in the first part of this two part blog and can be accessed here).

The situation reminds me of what I've read about Wall Street in 1932 and 1979 when equities were all but given up by the general public in America.

It also reminds me of Indonesia during the 1997/98 Asian financial crisis. Indonesia is my base case emerging and frontier market as I've been following it off-and-on since it opened up for foreign investment in 1989.

But there are a lot of differences between Ukraine now and historic US and Indonesia.  Notably neither of the latter two were facing the possibility of invasion by a bigger and aggressive neighbor.  Then US President Carter was seen as weak, but nobody wanted to invade the US in 1979.  And who wanted to take over the chaos that was Indonesia during and after the 1997-1998 Asian financial crises?

One part of Ukraine’s financial chicken-and-egg problem is the lack of local institutional investors.  Except for the National Bank of Ukraine, financial industry contacts had difficulty naming any local pension funds or other institutional investors.  Many funds sprang up in the 2000s during the local market’s two rallies, but from what I can tell, the few that survived are but a shadow of what they once were.

Hope springs eternal.  I learned on my trip that the exchanges and bankers are not taking things sitting down.  In addition to plans to merge the country's two exchanges later this year (UX and PFTS), I was told of additional initiatives to reform and strengthen Ukraine’s financial sector:   
  • The exchange and I-banks are working on a program to list younger, financially hungry, and fast growing entrepreneurial firms. 
  • Laws strengthening corporate governance and minority shareholder rights were supposedly winding their way through parliament before they were side tracked by Maidan protests.  
  • One of the exchanges is working with the government to strengthen the local pension system, which – outside of the government and a few large banks - appears to be non-existent. 
  • Dual listings are also a possibility and one of the exchanges is talking to Ukrainian companies listed on other exchanges to have a secondary listing in Ukraine
The Ukraine equity markets have held up pretty well despite the all-too-obvious headwinds.  The broader PFTS index is up some 30% YTD, but flat in US dollars given the Hryvnia’s 30% fall.  The narrower UX index has not performed as well rising some 16% YTD.

Depending on what index is used this is in line or better than the Russian index and currency.  The Micex and Rouble are both down some 8% YTD.  In US dollar terms this is about the same drop as the UX index, but worse then the PFTS index.


Like most non-Anglo-Saxon countries, most of Ukraine’s business is split between powerful families and the government. In fact the entire structure is very similar to Suharto-era Indonesia. 

In Ukraine large business owners are known as “oligarchs”.  They are analogous to Asian tycoons in many respects as their business empires typically consist of several loosely related businesses. 

The key difference is that oligarchs are also politically powerful.  In Indonesia and South-East Asia business groups are typically owned by ethnic Chinese.  Their owners - due to racial reasons - have largely been excluded from political positions. 

The biggest.  The largest business group in Ukraine is Systems Capital Management (SCM).  Formed and owned 100% by Rinat Akhmetov, SCM controls some 17 listed companies, 40% of Ukraine’s power distribution (DTEK), its largest telecommunications company, and a large chunk of its steel making capacity (Metinvest).  

He and his group are similar to Sudono Salim and his Salim Group, which was the largest business group in pre-Asian Crisis Indonesia. SCM’s revenue accounts for some 5% of Ukraine's GDP according to SCM literature, or about the same proportion as the Salim group did in Indonesia in the early 1990s.  Their leaders Akhmetov and Salim, are and were the richest individuals in their respective countries.

Unlike Salim, Akhmetov is directly active in politics as he is Member of Parliament and a key backer of the Party-of-Regions. In Kiev I was told that he bankrolls a not-too-insignificant number of MPs in Ukraine's 450-seat unicameral parliament (known as Verkhovna Rada).  

This likely makes him the most powerful person in Ukraine, as he has both financial and political power.  

Assembling his conglomerate under murky and possibly criminal circumstances, Akhmetov is increasingly moving SCM and its companies toward international business standards (see Wikipedia entry here).  To keep growing, SCM needs access to international capital markets and several of the group’s companies have issued Euro bonds.  The senior managers I met at one SCM subsidiary were about as polished as any US/UK/EU MBA educated 30-something as they come.  

Interestingly Akhmetov has openly stated that he favors a unified Ukraine and seems to be backing this up according to one insightful report.  In an open letter posted on SCM's website four days after Russian forces moved into Crimea, he wrote:

“I state with all due responsibility that SCM Group, which today employs 300,000" people and represents Ukraine from west to east and from north to south, will do everything possible to maintain the integrity of our country.” Signed Rinat Akhmetov, President, System Capital Management, 2 March 2014. 

Another "First Family". The fastest growing business ‘group’ in Ukraine since 2006 was ex-President Yanukovich's family.  According to the fascinating “The Oligarchic Democracy", Yanukovich’s interests are represented by his sons, Oleksandr and Victor.  Oleksandr was in charge of business and Viktor was an MP and a member of the Party of Regions. The report calls them and their associates whom they put into powerful positions, ‘the family’.  It notes that ‘the family’, ‘…is currently the most aggressively operating group in Ukraine’.

In yet another case of history rhyming, during the last 10-15 years of Suharto’s presidency his sons become amongst the most aggressive businessmen in Indonesia, and many referred to the extended Suharto family and their associated business groups as the “First Family”

Independents and Red Directors.   Not all businesses in Ukraine are part of large conglomerates.  In fact some of the companies that do want to be listed, have good investor relations and more progressive management are many times independent.

Not all, but most seem to be led by true entrepreneurs.  They've built up businesses over many years and deftly navigated through Ukraine's rapidly shifting business and political environment. 

To the far left of these self-made entrepreneurs are Ukraine’s ‘Red Directors’.  ‘Red Directors’ is a term used in Ukraine to describe the controlling shareholders and senior management that think and act as if the USSR was still intact.  In general they are seen as keen to get business, but are not keen to share information about their company.  They would be somewhat analogous to the secretive, trust no-one-but-family-member groups that are increasingly rare in the Internet age.  


My 10-day trip to Kiev was an eye-opener.  It was my first time in Ukraine and the first time in the former USSR.  It was also just my third trip to the European continent, so there was a lot to learn. 

Like virtually all trips, it was a humbling experience. The more I travel the more I realize how little I know.  While I feel better informed about Ukraine than before the trip, I'm sure that the last two blog posts barely scratch the surface.  

Also like other trips, I was lucky to meet many smart, switched on, and helpful people that very kindly took their time to help me better understand the country and its investment prospects.  This was even more appreciated given that I was in Kiev during such an eventful week.  It takes a strong will to remain focused, when just a short distance away, one's fellow citizens are standing in harm's way. 

Saturday, May 17, 2014

Trip Report - Kiev, Ukraine; Feb 2014; Part I - Economy, Politics and A Bit of History

In planning my February 2014 trip to Kiev, I envisioned the Beatles' ‘Back in the USSR’, looping in my head as I visited companies, brokers and took in the odd tourist site.  

However I was there when the Maidan protesters were shot in central Kiev (13–22 February 2014) and the Talking Head's ‘Life During Wartime’ became the trip's soundtrack.   "A van, loaded with weapons, packed up and ready to go"is much more sobering and not nearly as much fun as “The Ukraine girls really knock me out.” 

Politics, Geopolitics, and a Bit of History

I’m not a big fan of politics.  Even less so of geopolitics.  But as this is being written in May 2014, Ukraine is front and centre in what seems like the beginnings of “Cold War 2.0” so politics is hard not to comment on.

Its eastern regions are holding referendums to break away, the press is writing that Ukraine may descend into  civil war, and Russian influence in the region seems apparent looking at pictures of the uniforms and flak jackets that pro-Russian protesters/soldiers are wearing.

Political uncertainty many times create good opportunities to invest in companies that may have been oversold. I've written a bit about this before (link here).  The Ukraine market had held up very well in the three months between when the Maidan protests started and I finally got my act together and went there. 

The Internet is flooded now with lots of writings about Ukraine, Russia, and how the EU and the US will react.  Most predictions will turn out to be false if the past is anything to go on (see Nate Silver's very good book The Signal and The Noise).  The article that best describes the situation after my week in Kiev was published by and can be found here.

I left Kiev with the impression that the West-East divide is not as serious as the press makes it out to be.  While most press reports – and most of the world – have escalated the Maidan protests and their aftermath into a Russia vs. the EU/US confrontation, I came away from my trip thinking that it was mostly a protest against 20-years of corrupt, power-hungry leaders of which Ukraine seems to have had more than its fair share of.  (for a better summary see here).  

A recent and very good Al Jezeera video report by Michael Anderson called Ukraine: A Dangerous Game added additional insight into the current situation.  The video references a (Ukraine) National University poll which indicates that in eastern Ukraine, less than 1 in 10 young people want eastern Ukraine to become part of Russia.  It also notes that most young people don't really care which language is spoken.  

He also believes that both Russian and EU/US journalists are irresponsible in the way they are reporting the current situation.  He notes that there is heavy propaganda in Eastern Ukraine that is stoking the conflict, and that most Western journalists are playing up a conflict that is not really there. 

My largest concern is that the democratic process was sidelined when Yanukovich lost his position and Ukraine moved form a presidential to parliamentary system.  It all happened in an extremely short period of time and seems too good to be true. I’m not really sure if it all went down by the book and the quickness may come back to haunt Ukraine in the future.  As I've written before, I think it is important for the process of democracy to be respected even if the current actors in that process are not great (link is here).

Brothers.  Another takeaway from the Kiev trip is that it will be hard for Russia and Ukraine to separate.  The two seem like the US and Canada; the US and Mexico; or Indonesia and Malaysia.  They are neighbors, speak the same language, more or less and share common histories and are amongst each other’s largest trading partners and investors.  I came away feeling that Ukrainians and Russians are basically brothers and sisters.

But I'm biased as I tend to see more similarities between people and nations than I do differences.  It is very likely that I am minimizing some fundamental differences.  As a CEO of an agricultural company I met in Kiev said, “Ukrainians are farmers. Russians are warriors”. 

Not to be forgotten is that siblings tend to fight the hardest. And the longest.  Protestant and Catholic Ireland, Sunni vs. Shia in the Middle East, North and South Vietnam, North and South Korea, America’s Civil War.  

However there is a lot of cross-border business that will keep the less politically involved Ukrainians and Russians interacting.  Some of this directly affects equity and bond investors.

This is because the largest shareholder of both financial exchanges in Kiev is the Government of Russia.  The Moscow Exchange owns 43% of the more equity-centric Ukrainian Exchange  ( and just over 50% of the more bond-centric PFTS (   The Moscow Exchange, is ultimately controlled by the Government of Russia through five entities the make up more than 50% of its ownership.  

Many companies that I met in Kiev either sell to or have investments in Russia.  Russians own controlling stakes in many Ukrainian listcos, and numerous Ukrainian listcos do significant business and have investments in Russia.

This includes the leading presidential candidate, Petro Poroshenko.  He owns Roshen, Eastern Europe’s fifth largest confectionery company.  In addition to Ukraine it has factories and outlets in Russia.  Sales of Roshen chocolates and other products were suspended in Russia for several months in 2013 with the reason suspected to be his political support for the Maidan protesters.  Earlier this year his factory in Lipetsk, Russia was closed down after it was taken over by riot police (link here).

Russia sometimes makes it hard for Ukraine to love it.  According to an insightful article in the International Edition of The Ukrainian Week by the very talented ex-buy-side analyst turned financial journalist Lyubomyr Shavalyuk, “Russia is proactively substituting (several) products with those made domestically and protecting its domestic market”.  The article points out that Russia has introduced many non-tariff trade barriers that effectively shut out many Ukrainian made goods that were previously exported to Russia. (For additional information on Russia, my review of the book Russians: The People Behind the Power, by Gregory Feifer is here)

This fact was brought home when meeting with an executive of a listed car manufacturer.  Soon after building a car factory, Russia changed some non-tariff regulations that effectively shut down Russia as an export market.  The new regulations were a way to protect Russian car makers at the expense of the new Ukrainian plant.  Now the plant is operating at some 20% of designed capacity and needless to say is losing money. 

Language. Some press articles have said that language is an issue between East and West Ukraine, but I think this is overplayed.  According to my hosts, all meetings in Kiev that weren't in English were in Russian.  My one word of Russian, "dos vidanya" or thank-you, was met with smiles from everybody I said it to; taxi drivers, hotel staff, CEOs/CFOs, etc.  

Stockbroker contacts in Kiev - two very proud Ukrainians - admitted that they never really speak Ukrainian - but they can understand it.  Others were proud of their native Russian heritage, but admitted they did not want to be part of Russia, and felt 'Ukrainian'.  This included a few that grew up and/or spent time in Kharkov and Donetsk, two of the larger cities in Eastern Ukraine that are pegged as pro-Russian.

Ukraine is in fact more than a bilingual place, which makes sense given its central location. In 2012 none other than Victor Yanukovich signed into law a ruling that regional languages will be recognized by the government if 10% of more of the total population of the region speaks it.  Soon after, Romanian became an official language in the Village of Bila Tserkva.  In addition to Russian and Romanian, Hungarian has been made a regional language in two regional towns (article here).

History.  There are two key takeaways from my trip to the National Museum of the History of Ukraine . I learned that modern and independent Ukraine has a very short history and virtually no period when it was not very close to or under Russia / USSR influence.  

Given its short history and the previous days’ discussion about Russia’s strategic interest in Ukraine, I left the museum feeling that there is a non-zero chance that Ukraine could break apart and/or the country could face a very nasty conflict or possibly war with Russia.

Modern Ukraine owns its very existence to Russia and the forming of the USSR.  A plaque in the sparsely visited museum noted that modern Ukraine only really came about in 1939 after being put together under the Russia led USSR.  

“In the second half of the 19th century and beginning of the 20th century Ukraine was split between parts of the Russian Empire and the Austrian-Hungarian Empire.”  “In the second half of the 19th century the Ukrainian national-liberation movement has gained momentum”.  (Source: Hall No. 15; Ukraine in the Second Half of the 19th century and the Beginning of the 20th century; National Historical Museum of Ukraine)  

“In September 1939, the Soviet Union annexed the Western Ukraine using the Molotov-Ribbentrop Pact.”  “Sovietization of western regions was realized with cruel methods and was attended by a mass repression. But the unification of all Ukrainian lands as members of the USSR was historically important.  For the first time in a few centuries of its history the Ukrainians lived in one state.” (Source: Hall No. 26; Ukraine During the Second World War (1939-1945), National Historical Museum of Ukraine)  

National Historical Museum of Ukraine
Hall No. 26
National Historical Museum of Ukraine
Hall No. 15
There is some historical baggage between the Ukraine and Russia.  From the museum trip I learned about the 1932-33 man-made famine which occurred in many of the USSR’s agricultural areas.  Ukraine was the hardest hit.  Like China’s 1958-61 Great Leap Forward, many historians believe that forced collectivization of agriculture was the key reason in which an estimated 6-8 million people starved. 

Called the "Holodomor" in Ukraine one estimate puts the total loss in Ukraine alone at 10m - 4m from famine and 6m from birth defects. (see Wikipedia entry on the “Holodomor”).  Several Internet websites claim that it was a genocide perpetuated on Ukrainian agricultural peasants by the USSR.  (More information and gruesome pictures and video can be found using a Google search on “Holodomor".)

(See link here for a more complete, and more critical, history of modern Ukraine – especially under Nazi Germany and the USSR.)


From my trip, I was told that Ukraine's economy never really recovered from the global financial crisis and that it has been stagnating for years.  

This is very evident in comparison with their western-bordered neighbor Poland.  In 1991, about the time the iron curtain fell, Poland’s per capita GDP was 47% higher than in Ukraine's.  It is now more than 3x higher. 

People living in eastern Ukraine may be making the same point but using Russia as a base for their comparison.  Per capita GDP has not grown as much in Russia as in Poland, but is still almost double Ukraine's over the last 20-years.

Ukraine’s slow growth also stands in sharp contrast to countries in my neck of the woods.  Twenty years ago the average Ukrainian was more than 3x richer than the average citizen of Mainland China.  Now he/she produces almost half as much.

On a GDP per capita basis the average Ukrainian is now on par with the average Indonesian.  But their lifestyle is not likely as good as people who live near the equator don't have to worry about staying warm in the harsh northern European winter. 

GDP/Capita 2012
GDP/Capita 1991
% change

Source: World Bank; GDP/Capita (at current USD)

As in other under performing economies, poor leadership seems to be the root of the problem.  Locals complain that the country has a lot of positives but has been led by people who are more interested in taking what they can from their powerful positions, rather than strengthening the government, institutions and infrastructure that Ukraine and its people need.

Widespread corruption, a compromised judiciary, and weak legal property protection add to the long list of problems. (More information about Ukraine’s corruption and economic problems can be found here).

Another big problem is that nearly half of Ukraine’s GDP is generated by imported energy-intensive industries.  Ukraine depends on subsidised energy imported from Russia as it is only 7% self-sufficient in oil and 40% in gas according to local brokers. The situation is rapidly changing and Ukraine can no longer depend on this going forward.  

Ukraine does have quite a lot of things going for it.  Its legendary ‘black soil’ gives it a natural competitive advantage in agriculture.  According to one Kiev-based broker, it is the second largest country in Europe by size with 15% of the continent’s arable land.  It is the world’s sixth largest exporter of grains (excluding rice) with most of this heading to the Middle East and Northern Africa.  It is the largest global supplier of sunflower oil and one of its largest exporters of walnuts.

It also has industry.  Ukraine is one of the key producers of railway cars in the CIS. It also has one of the largest aviation engine manufacturers in the CIS and is the center of the former USSR's aviation industry.  It supplies engines to 90% of helicopters produced by Russia.

It can also develop talent locally.  Many graduates from Kharkov’s top universities end up in Silicon Valley and other tech centers much like smart graduates from India’s famous technical universities. Only a few of the people I met in Kiev had studied abroad, but almost everybody I met spoke some if not very good English.  

I met many switched-on and forward-thinking people during my 10-days in Kiev.  I was especially impressed with those below 40 who likely grew-up in a freer environment than their communist / Soviet-thinking parents and grandparents.

In a very encouraging sign, Ukraine was listed as the world’s top reformer in the World Bank's 2012/13 Doing Business report. This report ranks countries by their support for laws that favor small and medium businesses. It praised Ukraine for implementing more pro-small and medium business reforms than any other country.  These include making it easier to start a business, dealing with construction permits, strengthening property rights, and improving credit information available to collectors and debtors. 

Travel notes

Kiev reminded me of my native DC.  The wide Dnieper river runs through the center of the city, there are lots of trees and not many tall buildings.  

There is also a lot to see.  Very impressive orthodox churches, national museums, and many historical tourist sites.  Kiev was the origin of the Russian culture and the city takes pride in this fact. 

It must be beautiful in May, when the locals say is the best month to come.  I was there in mid-February and had a very pleasant, albeit overcast and cold, weekend playing tourist.

Kiev's road system seemed like DC when I was growing up.  Roads are good and traffic seemed to flow most days, but I did experience a few very serious traffic jams and lots of potholes.  

The city has lots of cafes and prices are reasonable.  The menu selection can be eclectic though. Several restaurants have Japanese, Italian and Mexican on the same menu and likely cooked by the same chef. Lovers of spicy food may not be too impressed, but if picked vegetables, chicken and a good beer selection is your thing, you’ll probably like Kiev. 

Good Beer Selection
Roadside Market, Outside Central Kiev
Feb 2014 

Despite being there during the same week as the Maidan shootings, I never felt unsafe.  All the action took place in central Kiev.  Everyplace else I went seemed peaceful, although my contacts were concerned about my and their own safety.  After the Maidan shootings, I was told that Russians and Eastern Ukrainians thugs were travelling or already in Kiev.  These don't seem to have been substantiated as I did not hear of anything violent outside the city centre. 

I was obviously unlucky with my timing. Meetings on two of the six weekdays I was there were basically cancelled when the subway was shut and bridges into the city were closed.  On those days, staff went home early or worked from home.

Despite it being possibly one of the most important weeks in the country’s history, I was just plain bored.  With meetings cancelled and not wanting to get involved in a domestic dispute I watched all  of the action from my hotel room with walks to the restaurants and grocery store breaking up the day.

Lastly, despite the chill of winter, lack of sunshine and gloomy political mood I found that the people I met are smart, proud of their country and city, and keen to see Ukraine 'reboot' and move forward.  While outsiders seen Ukraine as a country torn between Western Europe and Russia, many people I met also saw this as an advantage as it has large markets at its doorstep and is a traditional bridge between Russian and the rest of Europe. 

On my last full day in Kiev violence in the square had stopped, the sun had broken through the clouds and I had a full day of meetings.  The last was with one of the smartest - and certainly best looking - CEOs I've ever met.  It was refreshing to get back to business.   

“The Ukraine girls really knock me out" was finally ringing in my head.