On a rainy day in April, while the panel "Infrastructural Development in Silesia", part of a real estate conference organised in Warsaw by Spanish developers, was reaching its climax, joy suddenly erupted and the debate was put on hold. The UEFA committee had just announced that Poland and Ukraine had been selected over Italy and Croatia-Hungary to host the European football championship for 2012. The excitement in the room was worth thousands of figures and projections - a precise, although emotional, indication of the impact the verdict will have on the two countries' progress.
The choice was clearly a mixture of politics and economics and a good hint of Europe's new attitude towards this part of the CEE region.
Whereas Poland, in spite of its often messy politics, already represents a safe bet, the decision shows that Europe does not anticipate long-term negative effects from the recent political turmoil in Kiev and has a positive outlook for the country's five-year future.
The selection was made five months ago, at the time of a standoff between the president and the coalition government. New elections are due in September.
Contractors, developers, building materials producers, banks, insurance companies and retailers are all poised to benefit from the promised windfall.
As Igor Mazepa, managing director of Concorde Capital, a leading brokerage house headquartered in Kiev, admits: "The news definitely means acceleration in investments. Remember, in the year after the announcement that Portugal would host Euro 2004, FDI into the country doubled." In Ukraine, as stated in the draft law for the organisation of Euro 2012, $4.3bn (€3.1bn) has been already set aside by public and private investors for projects related to the tournament.
On top of that, continues Mazepa, "Major investments will flow into the transportation infrastructure - some $20bn, as planned by the ministry of transportation. Poland and Ukraine are the least developed countries in terms of their transportation network of any country ever to host the event."
Preliminary estimates confirm that investments in infrastructure, housing and hotels are scheduled to be much higher than those directly linked to the tournament, translating into a more significant impact of Euro 2012 on their economies than on any previous host country.
That said, a reader might still ask what these facts mean from the point of view of our survey. In short: opportunities across the board. Funds will converge into sport facilities, transport and hotel construction. According to projections made by Concorde Capital, some 30 new hotels will be built in Kiev by 2012. At present the hotel market in Ukraine is the laggard of Europe, and in Kiev the only international company operating is Radisson SAS.
High demand in construction is likely to spread out into other sectors of the economy, notably building materials, transportation and heavy equipment manufacturing. Banks will reap the fruits of a strong inflow of capital into the national economy.
With more than $24bn needed for renovation and construction projects over the next four to five years, Ukraine's banking sector is set to prosper a great deal on the route towards 2012. This will help the country in several ways. Money will have to go through local bank accounts, constituting a precious source of funding and an opportunity to earn on the liability side of the balance sheet.
Large-scale projects to be launched in the next few years offer numerous lending opportunities for banks - around 40% of total capital spending might be covered by borrowing according to Concorde Capital - and finally, new jobs and increases in wages will spur private consumption and, therefore, consumer credit and mortgages.
Ukraine closed 2006 with an enviable 7.1% GDP growth.
In the first quarter 2007 Poland grew slightly above 7% too. These two countries offer opportunities that investors and analysts can no longer ignore.
Poland: in search of a deadline
When talking about the current economic situation of his country, Marcin Dyl, president of the Chamber of Fund and Asset Management of Poland, exudes confidence: "I'm convinced that the actual pace of growth can continue without the economy overheating. The fiscal situation is sound: public debt is under control, the currency is stable. At the Warsaw Stock Exchange [WSE] valuations are historically high, true, but still pretty much in line with underlying fundamentals."
Dyl continues: "What we really need now is a dramatic improvement in the area of infrastructure. The upgrading will be chiefly financed by European Union funds, funds that we should deploy rapidly and efficiently. Poland's road transport system is one of the worst I've ever seen. Hopefully, EU plans to increase its structural funding for the period 2007 to 2013 will boost our government's effectiveness. In this respect, Euro 2012 provides us with a clear deadline - something that, by nature or maybe culture, we usually need in order to get things done. In my view, this is very positive."
Grzegorz Zawada, board member of Erste Securities Polska, echoes his words: "Infrastructure is a key part, but far from being all we need, I'd certainly add the simplification of red-tape-related impediments, so as to pave the way for the creation of new enterprises. We still have a lot of work to do in this field; our achievement here, although remarkable, could have been much better. New business creation is an all-important component of employment creation. We also feel that there's a major issue in the energy sector, both in terms of restructuring in order
to encourage competition, and privatisation."
That said, the general consensus sees Poland growing well above 6% in the present year and readings indicate that it has one of the lowest inflation rates among the EU countries and a steadily improving official unemployment rate. However, since it is not unusual to find working people registered as unemployed to qualify for state benefits, nobody seems to afford much importance to officially released figures. Otherwise said, the unemployment rate is considerably lower than the official 14%.
Today Poland is fast becoming the financial hub of reference for the entire CEE: a double digit increase in mortgages and consumer lending, an aggressive and skyrocketing stock exchange, numerous IPOs in the pipeline at the WSE, a booming asset management industry, a young population willing to save and invest - in a business of volume, a precious resource.
They all hint at the same direction. But the country appears to be much more than this. Part of the secret lies far from Warsaw in Krakow, Katowice, Wroclaw and Poznan.
Once second-ranked cities, they are now rapidly developing, turning the south west of Poland into a powerful economic engine able to propel the whole country.
Real estate is the underlying force, but the leading trends are outsourcing and near-shoring. Two years ago, Thomas Friedman, the columnist of the New York Times, in his book "The World is Flat", vividly drew attention to these processes, portraying back-offices of American insurance companies in Mumbai and call centres of European financial institutions in Manila.
The recent friendly takeover attempt (still far from being accomplished) of the Dutch ABN Amro by the British Barclays informed us about their plans to transfer thousands of jobs to India in a hypothetical post-merger scenario. Who would suspect, then, that Poland is rising as the country of preference for the same kind of activities, in certain cases already outstripping the success enjoyed by the Far East?
Who would think that a customer calling Sun Microsystems from Denver might very well receive help from a Pole speaking perfect English seated at his desk in Katowice? Or that the captain of a troubled ship insured with Lloyds, before launching the customarily mayday (so the procedure goes), may be put through to Krakow and not to London?
Indeed, Cap Gemini, the French consulting firm specialised in outsourcing and near-shoring, has doubled the number of its employees in the last 14 months and the figure is still on the way up. Jaap van Zweeden, its Dutch President, proudly affirms: "We were among the first to believe in the potential of Poland. Companies interested in reducing their costs, but worried about risks and cultural barriers normally involved in off-shore outsourcing have found a very appealing proposition in near-shoring. Rising costs in traditional centres, such as India, coupled with a deeper cultural affinity and more sophisticated services is pushing the country more and more towards the front stage."
This article has already mentioned that real estate is oiling the entire mechanism. Nevertheless, the astounding growth of the market in recent years and the furious pace of development have had some long-lasting repercussions.
These include a fast compression of yields - now, at least for commercial real estate, similar in Warsaw to those one can find in Berlin - and, in the coming years, possibly with the exception of the hotel investment market which is still in its maturing stage, achieving relatively high rates of return on investment will definitely become more difficult than in the recent past. In turn, this sort of stabilization might represent a very good opportunity for pension funds.
At the same time, Poland is interesting not merely as a standalone investment destination, but as a potential launch pad to pursuing further expansion in the region.
In this respect, the case of Unicredit Group is quite interesting. After having spent years turning itself into the biggest player of the CEE region and building a very solid position in Poland through the acquisition of Bank Pekao and Bank BPH (now involved in the latest stages of their merger process), Unicredit started to look at Ukraine, the only market where the group was lagging behind in the region.
The bank began by opening its own branches and branches of HVB (the German Bank acquired in 2005) in the country.
Then, very recently, Unicredit purchased the country's fourth largest bank in terms of asset value, Ukrsotsbank. The acquisition of the latter, in particular, says a lot about the ambitions of Italian banks, but even more about the potential they see in Ukraine - just consider the price Unicredit agreed to pay to Interpipe, the group owning the bank, a price 41 times the trailing price-to-earnings ratio, which has raised eyebrows among analysts following Unicredit stock. Meanwhile, as we have said, using Polish soil to complete this very intricate operation is a sign of the degree of complexity reached in the Polish financial sector and of the contribution by foreign players in bringing it into its adulthood.
This is the first operation of its kind ever carried out in Europe: the spin-off of part of the old Bank BPH and its contextual integration in Bank Pekao. As Jan Bielecki, now at the helm of Pekao, but formerly prime minister of Poland in the early nineties, points out: "At the beginning we struggled a little bit, trying to fend off some resistance and widespread scepticism, but I'm confident we'll be able to complete this unprecedented operation smoothly. In the meantime, we did not loose focus, delivering strong financial results. Moreover, in 2006 we added a significant piece to our expansion plan, building our second market, Ukraine. We have consistently invested in Ukraine and we'll continue to go down that path, creating a good platform for further strengthening our position in this very promising market."
The assumption is the following: even if I pay a little bit too much for an acquisition, if the firm then manages to grow its assets by at least 25%, it will then be able to significantly decrease that initial price. "The idea is that the assets will be growing impressively over the next years, due to the very low current rate of penetration in the market," concludes Bielecki.
Ukraine: the banking sector as a flagship
Forecasts for Ukrainian GDP growth in 2007 vary from 5% (IMF) up to 6.5% (on the part of the Ukrainian Government). Of course, external factors, such as commodity prices and price hikes of Russian gas will be crucial determinants. But, as it stands, what can we expect from Ukraine in the future?
In the words of Vladislav Ostapenko, head of the investment banking department of Sokrat, an investment boutique based in Kiev: "If we don't count Turkey in for a moment, our country is the last big thing in the entire region: 48m people, a very young population, impressive potential and very attractive figures in terms of banking penetration (loans to GDP, mortgages to GDP, credit cards to GDP). That's why you have people ready to pay good prices for assets. They are betting on these figures catching up with those in other parts of the CEE region and, ultimately, with Europe. Over time, they surely will."
In the last 2 to 3 years the banking sector has enjoyed the same dynamism as Ukraine's more traditional industries such as steel that have also witnessed a profound shake-up.
Since 2004 more than 30 acquisitions have taken place. The main drivers behind this phenomenon that widely replicates the pattern already seen in the region - in Poland, for instance, almost 80% of former local banks are now in foreign hands - are projected growth, a low level of penetration and, accordingly, high hopes of profitability.
Wages, real income and property prices have also increased quite dramatically, thus exerting an effect on both sides of bank's balance sheets, respectively in the form of growing deposits and a skyrocketing volume of loans on the books.
In addition, foreign currency inflow, stemming from some underlying dynamics such as still high steel prices, has risen dramatically, forcing the national bank to buy dollars in order to maintain the fixed UAH/USD exchange rate (the UAH is a non-convertible currency pegged to the dollar). The consequence has been an expansion of money supply, stimulating further growth and confidence in the sector.
Of course, some severe limitations persist, well summarised in the word of Jacques Mounier, president of Calyon Ukraine, a subsidiary of Crédit Agricole): "Ukrainian banks still have a very limited capacity to take a foreign exchange position… They also have no capacity to do foreign exchange swaps, that is to sell hard currencies today in order to create UAH and to purchase back those hard currencies at a later date and at an agreed price."
Actually, the only way, although plagued with drawbacks, such as some inflationary pressure on banks' books and residual market risks, would be so called synthetic swaps, consisting of reciprocal lending (borrowing) the currency against local currency equivalent at actual FX spot rate.
Ukraine has some 160 banks, of which only two, Oschadny and Ukreximbank, are state-owned. Western capital controls almost 40% of the sector's assets and, given the fragmentation of the landscape and the growth rate recently recorded, that figure will doubtless increase. Observers are unanimous on one issue: over time, and particularly in the retail sector, the presence of international players will force it to become more efficient and to move progressively towards Western best practice. Overall, banks' total balance sheet stood at $26bn in January 2005, $43bn the following year, and reached $66bn by 1 January this year. From 2001 to 2005 total assets grew at a rate close to 40% per year, and in 2006 alone their rise went beyond 58.3%. Loans as a percentage of GDP were 20% in 2002 and hit 51% in 2006. Profitability and efficiency showed some improvements too. The sector's cost/income ratio went down from 68% in 2002 to a healthier 52% in 2006 and during the same period return on equity climbed from 7% up to 10%.
Another interesting aspect, particularly from a Western point of view, is the almost universal lack of securitisation; to date only one MBS has been carried out. In 2006 total lending was equal to 54% of GDP, close to the Russian average, but still very far from the numbers seen in Western Europe. Retail banking has been the most powerful engine of the success and will continue to be so for quite a while. Nevertheless, if the lending boom does not run out of steam (and everything tells us it won't), funding could become a serious issue if it is to keep pace.
Expectations are bullish for the future as well and Euro 2012 will provide a further boost. Growth in assets is expected to come out at some 50% in 2007 and an additional 30% in 2008.
This kind of development raises the issue of credit quality, a critical element for every bank, but even more important in any emerging credit market in order to avoid future problems. Many operators in the field tend to underline the lack of credit data and the general weakness of procedures now in place to asses the creditworthiness of their clients. New, imported scoring systems and the future adoption of Basel II will slowly change the picture. That said, in a booming environment the percentage of non-performing loans is low and might encourage reckless behaviour (the meltdown of the American sub-prime mortgage market docet) with banks reluctant to let risk prevent their growth. The sustainability of the entire system will only be proved over time and will depend a great deal on the overall health of the economy.
On the other side of the balance sheet, it's worth noticing that households have little alternative when it comes to investing their savings. The asset management industry, although very promising, is still in its infancy, there are no significant outstanding products in life insurance, a very illiquid stock market and a not less illiquid fixed income one. Deposits are still hovering around 20% of GDP, a figure light years away from the minimum standard of developed countries. For Ukraine, growth seems to be inescapable.
Focus on stock exchanges: WSE and PFTS
"The Warsaw Stock Exchange was founded by the state treasury. We have a share capital of PLN41.97m (€11.09m), divided into 59,960 registered shares. At the end of 2006 we had some 38 major shareholders, among them banks, brokerage houses, another exchange and…the state treasury, our controlling shareholder with a stake of 98.81%. We have been growing rapidly over the last three years, in terms of total market capitalisation and in terms of our offer. Even though some instruments are not very liquid yet, we pride ourselves on having improved and widened the range of available investment solutions in the Polish capital market. Nowadays, with us one can trade shares, bonds, subscription rights, allotment certificates, investment certificates, and derivative instruments: futures, options and index participation units."
Concise as they may be, the words of Ludwig Sobolewski, its president, put forward the key elements needed to understand the most interesting stock exchange of the whole CEE. The state is the prevailing shareholder (which stokes the flames whenever Warsaw is rumoured to be targeting other exchanges in the region, the lack of reciprocity being the constant casus belli). Ambitious expansion plans, huge liquidity in the market and growing financial sophistication are the basic characteristics of the WSE.
Its appeal is on the rise and well deserved. There are several reasons justifying this: a booming economy, a greater deal of stability brought about by the accession to the European Union, an overall decrease of perceived systemic risk related to Poland and its pension fund system that, due to restrictions in capital allocation abroad, fuels prices and valuations and has to be fed with new opportunities, such as new companies issuing tradeable stock.
Last November Sobolewski launched the WSE IPO Partner Programme, under which brokers in Estonia, Ukraine
and the Czech Republic trawl for local companies wanting to list in Warsaw. "We already have some major listings in the pipeline for the months ahead," he adds, "including the Dutch real estate developer Orco Property Group, possibly a couple of Estonian companies and a Bulgarian one".
At the same time, he concludes: "We are now co-operating with other exchanges in the region, notably the PTFS of Ukraine. We want to share information and, most importantly, we want to encourage dual listings of companies in Warsaw and Kiev. Along the same line, we are looking for acquisitions in the rest of the CEE, with Ljubljana and Sofia (the Bulgarian government is planning to sell a 40% stake of the national stock exchange) being among the most mouth-watering options as far as I can see."
The agreement with the PFTS is of particular interest. There are several stock exchanges in Ukraine, but the main one is the PFTS. Generally, brokers and operators have mixed feelings about it. They appreciate the work of Irina Zarya, its energetic president, but they are unhappy with lots of things, such as the absence of clearing, understandably a relevant drawback; the extremely low liquidity of many securities; the limited presence of instruments very common elsewhere; the impossibility of getting intraday quotations for the blue chips index; poor corporate governance and an overall lack of transparency.
Indeed, it is a widespread conviction that Ukraine cannot teach lessons about transparency issues.
Nevertheless, not everybody sees weaker-than-average corporate governance standards and disclosure requirements necessarily as a bad thing. Alexander Sandul, managing director of Foyil Securities, is quite categorical: "At Foyil, we consider lower required standards as a sort of teaser, a way to attract companies into the orbit of a regulated market. Once you succeed in doing this, then, step-by-step, you manage to ‘educate' them and improve their reporting and openness. At this stage, it would be nonsense to raise the bar, since for some companies this would more than outweigh any economic advantage provided by the listing."
In Ukraine overall turnover figures are small, amounting to $68bn in 2006 (96% of which is at the PFTS), whereas in the country there are over 700 licensed brokers included banks, 143 licensed custodians, and roughly 100 investments boutiques and advisers. "I often ask myself," says Jacques Mounier provocatively, "what are they doing all day?" clearly hinting at the disproportion between the activity registered in the market and the mushrooming numbers of operators.
Against this backdrop, the number of private placements and IPOs completed in 2006 was four times greater than in 2005. The number and size of new equity offerings scheduled to take place in 2007 should make 2006's numbers pale in comparison.
This widening and maturing of the market, slowly but effectively, with new stocks on the supply side and new investors on the demand side, will affect the whole system with an epochal impact on corporate governance and disclosure policies. Over time, the need for detailed, reliable, updated information will be impossible to ignore. "Where are we on the Darwin scale?" asked Concorde Capital in a recent report on corporate governance, whose title was "From Ape to Man".
According to operators, the agree-ment mentioned above will help to improve the situation. It includes information exchange, joint information policy and, probably the most relevant part, shared actions in order to encourage dual listings of firms.
Additionally, the WSE will open its representative office in Kiev by 2008. Sobolewski expects some 10 new
Ukrainian companies to place their stocks in Warsaw within 2009. XXI Century, one of the biggest real estate developers in the country, has already publicised its desire to float its shares on the WSE by the end of the current year.
No doubt, as bumpy as the road might be, Sobolewski and his counterparts in Kiev have the strong support and the cheering endorsement of the local financial communities, already jockeying for position and hopeful to intercept a slice as big as possible of the cake to come.
As the CEO of Deutsche Bank Securities in Poland, Krzysztof Kalicki, puts it: "We are looking for remote membership in other stock exchanges of the region which can speed up and better our execution capabilities. We are already and independently active in our regional expansion.
"That said, I really wish Ludwig [Sobolewski] great success in his effort to turn Warsaw into the main financial centre of the region and, who knows, even beyond the region.
"It would provide us with easier access to other markets, even though the same would be true for our competitors." Right now, a total of 270 companies are listed in Poland, but only nine of them are foreign. Time will tell if a former communist country will succeed, in less than 20 years from the fall of the iron curtain, in affirming itself as a shining star of capitalism.
Poland and Ukraine at a glance
"We are now experiencing good market growth stemming from several different contributors: exports, foreign investments and internal demand. These key factors are boosting the general sentiment and providing what I think is a sustainable platform for long-term growth. Throw in the huge inflow of EU funds and you'll have plenty of reasons to be optimistic."
These days, the words of Pawel Wojciechowski, president of PAIIZ (the Polish Information and Foreign Investment Agency) are a conviction commonly resonating both in Poland and in Ukraine, and deservedly so. Although certainly very different in many respects, such as in GDP per capita, the degree of economic development, financial transparency, soundness of the respective legal systems, and a higher level of scepticism when it comes to Ukraine, Poland and Ukraine nonetheless share some structural similarities. These include a huge infrastructural gap that needs to be rapidly filled, two booming stock markets (whose Presidents have started to cooperate closely), a very competitive cost of labour - the average hourly salary in Ukraine stands at $0.65 (€0.47) according to Eurocar. Foreign companies are also willing to pay up for assets on the basis of the expected growth that should more than offset the initial layouts of money, and there is in both countries a widespread focus and commitment to shorten the so called catch-up process.
Among their similarities, probably the most discussed and worrisome has been and still is the two countries' precarious politics, which casts a cloud over any notions of certainty or predictability, elements that investors rightly deem all-important. This is a knot we should extricate at the beginning: local people are not much concerned about politics and that not simply because they are accustomed to its vagaries. After a few months spent interviewing managers and professionals in the field, one has the disturbing impression that reading what the (Western) press writes daily is not only insufficient in order to gain a good grasp of what is really going on in these countries, but might even be considered misleading. Nobody wants to be in denial: some basic problems, both in Poland and in Ukraine still remain to be solved and will probably require years to sort out.
But the good news is that development, investments, and improvements of every sort are happening, politics notwithstanding. An average businessman, in Warsaw as well as in Kiev, if asked his opinion about politics, most probably would shrug the issue off: "Let's talk about what really matters" would be his answer. And this suggests two main things. Firstly, when politicians are busy elsewhere they are less likely to interfere with business life. Secondly, prospering despite politics is a sign of maturity. These are two important lessons one can learn while living and working in Poland and Ukraine.
No comments yet