Description

Georgia Capital - Emerging Compounder

You can read the formatted presentation of Georgia Capital's investment thesis in the following link

- https://drive.google.com/file/d/1RByHrk_IliA1JCjDxzR07cKh1_oKDJ05/view?usp=sharing

Disclaimer - I have used information, extracts, and images from Edison Research, Georgia Capital, Bank of Georgia, TBC Bank, Vanshap Capital, Lacuna and other public reports. 

Brief - Investment Thesis 

Georgia Capital is an investment holding firm listed in London that was spun out of Bank of Georgia in 2018. The  key parameters that we generally look to judge the attractiveness of an investment firm, or a holding  conglomerate are as follows in the same order of importance: 

1.) Do we trust the ability and the character of the management team to compound shareholder value? Do they  have an investment edge to deliver strong returns? 

2.) Do they invest in an asset class that has attractive opportunities and are difficult to access for us directly? 

3.) Does the firm have high quality assets that would compound in value by continuously reinvesting cash flows  at attractive rates that we would anyways love to own? 

4.) Are the underlying assets reasonably valued? Is there a significant discount to NAV? Is the cost base and tax  leakage at the holding level reasonable? 

5.) Is the management team rightly incentivized to unlock shareholder value? Are there clear catalysts for  valuation re-rating?

As you can see below, we believe that Georgia Capital ticks all the above boxes positively and hence provide an  attractive investment opportunity. 

1.) CEO and team have a 20-year track record of delivering 18%+ compounded shareholder returns. They have  the best deal flow in Georgia across sectors and a clear edge to attract top class management teams because of  access to permanent capital and dominance in the local market (the pre-spin group used to control 15% of the  country's GDP). 

2.) Georgia is a high growth country with limited long term capital availability. It is an attractive investment pool  for growth investments because of a low per capita base and a progressive macro regime. Less than 20% of  Georgia Capital's portfolio is publicly listed and the remaining portfolio is made up of difficult to access private  assets with good economic characteristics. 

3.) The portfolio of the firm is well diversified with strong defensive businesses in financial services, healthcare,  energy, education etc which have a combined ROE profile of 20% and provide long runway for growth. Most  importantly, Georgia has a 0% corporate tax regime if the capital gets reinvested in the country and has a 0%  capital gains tax. This allows the management team to allocate capital wisely across their businesses with zero  tax leakage, making the firm a mix of conglomerate and a private equity holding business.

4.) The discount to NAV is 50% even when you mark the portfolio conservatively on look through earnings or  cash flows (levered cash flow yield on their non-banking operating business is above 25%). The net management  cash cost is less than 0.7% of AUM and less than 2% of AUM when you include share options. The firm aspires to  grow NAV by 10X over the next 10 years. 

5.) The CEO takes no salary as cash and is paid in shares that vest over 6 years. His incentives are rightly aligned  with us, and the management team is clear about the need to reduce the NAV discount. They want to sell one of  their medium sized portfolio firms to buy back stock aggressively at the current levels, providing a clear catalyst.

Georgia - Macro Overview

Management’s - Value Creation Track Record

In 1994, Binstosbank was privatized and became Bank of Georgia. The bank listed on the Georgian Stock Exchange in 2000 and in 2004, a new, western-educated management team, including the current CEO of Georgia Capital, replaced the prior management team. This new team set the bank on course to becoming a strongly performing, market-leading institution in a reforming and growing market.

 Since new management took control in 2004, assets at the bank have grown 34x and book value per share (inclusive of private equity operations) compounded at 18.8% and shareholder value at 25% CAGR through Q1 2018 before the demerger. In 2006, BoG listed on the LSE and in 2012 the group graduated to a premium listing.

Good Portfolio of Diversified Businesses

Bank of Georgia - Leader in a duopoly market

Bank of Georgia, along with TBC Bank Group are the two duopoly banks in Georgia. The two banks collectively hold approximately 74% of loans and 75% of deposits and those shares have generally been rising since 2005. Both banks are listed on the LSE.

• 51% of total POS payments transactions are executed in BOG POS terminals. 

• 40% market share in deposits of individuals & 38% market share in loans to individuals.

• 1.4 million active loyalty program members, providing a strong base to build a super app that encompasses multiple services. 

• Foreign currency loans exposed to foreign currency risks is 35% of the book and is a risk to note. 

• The fee income for the bank is 28% of the overall income, total capital adequacy is 17% and cost to income ratio at 35% and CASA ratio of 44%. 

Georgia Healthcare Group (Hospitals, Pharmacies & Medical Insurance)

Georgia Healthcare is a dominant healthcare services company in Georgia. It owns the largest hospital operator (23% market share), pharmacy chain (32% market share) and health insurance provider (32% market share) in the country. Within the healthcare services, the business is a mix of tertiary hospitals, clinics, and diagnostic labs. These are all long gestation assets whose returns improve overtime as utilization goes up with maturity. 

Georgia Healthcare has the best hospital assets in the region and is the only scaled up organized player in the country. The small Mom & Pop single hospitals have been suffering through the COVID phase which is accelerating the industry consolidation. Georgia is a big medical tourism hub to its neighbouring countries because of well invested assets and low-cost structure. GCAP with its integrated model (Clinics + Medical Insurance + Hospitals + Diagnostics + Pharmacy) is competitively well positioned. Well run emerging market healthcare assets tend to trade at premium valuations

Pharmacy (High ROE Business) - The pharmacy retailing business in Georgia is consolidated between 3 players with GCAP in leadership position at 32% market share. This business should be recession proof and provide stable cash flows in which the moat comes from scale advantages. The business has consistently generated over 30% ROE and is a cash cow. Management believed that this platform can also be used to enter other modern retail segments where there are opportunities to consolidate. 

Others – Insurance, Education, Renewables

P&C Insurance - Well Run & Profitable business

Water Utility - High Regulated Returns - Almost 1/3rd of the country’s population lives in their capital city, Tbilisi. Georgia Capital has the monopoly rights for the water utility business in the capital city and its surrounding areas. GCAP’s ability to access debt and equity capital is a significant competitive advantage in this business as the business runs with a Debt: Equity of almost 4: 1. The government allows for a regulated WACC return of 16% and because of the high leverage, the equity IRRs in local currency terms are above 20%. The post-maintenance CAPEX cash flows will improve significantly over the next decade. 

Renewables - Attractive Capital Deployment Opportunities - Georgia has a lot of untapped wind and hydroelectric potential. GCAP has been the first company to tap cheap green bonds from the London market to facilitate the development of these renewable assets. The whole energy market in Georgia runs on Dollar basis and the firm can get 11% to 13% in USD terms on their assets. With optimal leverage (2: 1 of Debt: Equity), they make a 15%+ equity IRR on these projects on USD basis. The renewable energy platform with its long pipeline of attractive projects provides attractive reinvestment opportunities.

Education - Investing for Growth 

Attractive Valuation - Discount to NAV 

Clear Catalysts & Aligned Incentives

Share Buybacks are clear catalysts

Total Insider Ownership - 18.65% (CEO & executives directly – 5.75%, Georgia Capital executive trust – 7.5% and Bank of Georgia Holdings management trust – 5.35%), valued at 59 million Euros compared with the yearly cash cost of less than 5 million Euros. So we are well aligned with the management team.  The management has done 55 million USD in buybacks since the demerger and have also bought shares from the open market.

Around 56% of its management expenses (or c 0.73% of NAV) in the 12 months to end June 2021 were share-based (i.e. non-cash) in the form of zero-cost options. The maximum number of guaranteed and discretionary shares that can be awarded to the executive director and key senior managers in a given year are set out in five-year agreements (which were signed in 2018). In the past, GCAP secured the share awards entirely through buybacks and presently GCAP has enough shares in its management trust (a subset of treasury shares) to cover awards over the remaining 2.5 years. Each award will vest over six (guaranteed) or four (discretionary) years. The share-based remuneration for other staff members is discretionary and has no particular limit, but is a minor part of their remuneration. The cost leakage is reasonable. 

In addition to the management quality, I believe that investing at the Holdco gives us access to leverage at reasonable terms. With the largest bank in the country being a related party, the holding firm will always have access to liquidity which could be a competitive advantage during a crisis. The Holdco has a net debt of 714 Million GEL and their stake in BGEO provides them a dividend of 26 Million GEL per year and thus covers at least 35 to 40% of the interest expenditure. 

Potential Risks

Macroeconomic Risk on Dollar dependency - Georgia is a highly dollarized economy. While the government and the banking regulator seem to be shifting the economy into the local currency, I believe that it would take 10+ years to reduce the dependency on US Dollar. 

The country also runs high deficits on the fiscal and current account front consistently. This is being financed by FDI investments into the country. If there is a sentiment change towards Georgia and the country loses attracting investment capital, the depreciation pressure on the local currency would increase structurally. 

Remittances are a stable source of foreign currency for Georgia that could help the economy during a crisis. A proper EU integration in the long term might solve some of these issues. 

Geopolitical Risks – Georgia is in a volatile neighbourhood. Russia has invaded Georgia in the past and continues to occupy parts of the country. In 2019 Russia also suspended flights to the country impacting inbound tourism. A large percentage of the country’s state-owned power generation is located in occupied territory. While there are always risks of Russia becoming more aggressive, it seems Russia now controls the most strategic and culturally relevant regions and may be focused on larger geo-political concerns.

Georgia is a small country with a nominal GDP of 16.5 billion USD. So despite backing the best management team in the country, there is a limit to the upside unless the country itself grows sustainably over the long term. The small size also means limited exit opportunities for portfolio investments as seen from the delisting of the Georgian Healthcare Group. This would mean that the valuation multiples will continue to be subdued. 

The current debt or leverage at Georgia Capital is 27.3% of NAV and 59.5% of Market Cap. The leverage and liquidity risk are manageable, but do pose a threat in an extremely bad macroeconomic scenario. Since a large part of Georgia Capital’s portfolio are in capital intensive businesses, a high cost of debt will have a doubly whammy as the valuations of both operating firms and the holding firm would be de-rated. All the subsidiaries are properly ring fenced and there is no corporate guarantees from CGEO.

Final Summary 

Emerging markets assets have massively underperformed the US equities over the last decade. The sentiment and fund flows continues to be negative. Georgia specifically has macro economic and geo political issues that are for real and their currency is volatile. In such a scenario, despite the underlying business being extremely attractive, an investor should always manage risk through appropriate position sizing and holding tenure. 

As an investor who spends mostly fishing in compounders in Emerging markets, I believe that it is very hard to see a 350 million USD market cap business with the governance standards and portfolio quality of Georgia Capital. The management team is credible and focused on growing per share NAV over the next decade. We can always adjust our position size based on the management execution going forward. 

I believe that the current NAV discount is not sustainable as the strong operating cash flows from the underlying subsidiaries along with any portfolio divestments will provide an opportunity to buyback shares aggressively. The long term risk-reward in investing in Georgia Capital shares is asymmetric in our view. 

Catalyst

Share Buybacks, Disposal of a medium sized asset