M&A in Ukraine: residents buy up assets
Despite the high level of corruption and poor economic growth, the insurgency on the Ukrainian M&A market is growing due to the low cost of assets and the presence of internal investors with enough money to enhance existing companies and diversify investments in different industries.
According to KPMG Ukraine, the size of Ukrainian M&A in 2017 increased by 37% to $1 billion, while their number — by 22% to 67 transactions. To that note, the market of M&A is far from being as active as in 2013. CIS companies were the most active foreign participants on the market with their key focus being centered around Ukrainian assets in Crimea, North America, and Europe. However, there are other estimates as to the size of the Ukrainian M&A. According to the financial intelligence and news service Mergermarket and legal firm Aequo, 2017 marked a 57% increase in M&A — up to €554 million. The number of transactions hit its four-year maximum with 44 transactions as compared to 30 and 41 of 2015 and 2016, respectively.
Some studies have other figures. According to Zephyr Global M&A Review 2017, the number of M&A transactions in Ukraine declined by 35% to $5.14 billion in 2017 ($7.95 billion — 2016). Ukraine ranked third by the size of M&A among the states of the Central and Western Europe being ahead of such countries as Romania, Czech Republic, and Hungary. The number of M&A increased by 33% to 60 transactions. Such a huge difference stems out of the research methodology.
The largest transactions in 2017 were (according to KPMG): an acquisition of 100% shares in Ukrainian Agrarian Investments from Onexim Group for $155 million by Kernel; an acquisition of 13% shares in Ferrerxpo Plc from CERCL Holdings Limited for $126 million by BlackRock Inc.; a sale of 100% shares in PJSC “Evraz Sukhaia Balka” to DCH Group for $110 million by Evraz Group; a sale of agricultural assets in Crimea to an anonymous buyer for $78 million by an agricultural holding MKhP; and a purchase of 75% shares in 10 agricultural companies from Glencore for US$55 million by Epicenter K.
All studies show that domestic investors set the tone. According to Zephyr Global M&A Review 2017, residents accounted for 41 transactions, whereas Russian companies — 4, and Cyprus — 3. According to Mergermarket, 75% of transactions involved Ukrainian companies and only 25% of transactions involved non-residents. That said, most transactions were structured through foreign jurisdictions.
“So far, internal investors lead the investment ratings both by size and number. Local companies have a better grip on the situation since they have already been here and factored in all the risks. For foreigners, the decision about the first investment is much more difficult to take. However, there is a positive trend. Since 2017, Ukrainian companies with local owners are have been facing competition from Ukrainian companies with foreign owners. Foreign companies that had invested in Ukraine before the crisis now compete with local companies for juicy assets, which has not been the case since 2014” — says Vladyslav Ostapenko, Head of Corporate Finance and M&A at EY in Ukraine.
Local investors have a good position too. With a plethora of investment opportunities, they use the momentum to reinforce their market position by acquiring affordable competitors or diversifying investments in various industries. Many transactions seek to enlarge the existing business, especially in agriculture and energy sectors. As far as domestic investors are concerned, the investment company Dragon Capital, business groups TAC, DCH, Burisma Holdings, and agricultural company Kernel are most active on the M&A market.
At the same time, experts note that foreign investors are becoming more active. “Based on our project portfolio, foreign companies, which had never been in Ukraine and who we proposed acquiring a profile asset here in Ukraine two years ago, always had the same response — a polite refusal due to the lack of interest in a region. Today, however, foreign investors are actively engaged in the process: they study materials, come to inspect assets, and meet with owners. This means there is interest and that we can expect foreign investors to return to the Ukrainian capital market. Non-residents are looking for assets to buy, but they are not the changing power on the market for now,” — says Vladyslav Ostapenko.
According to Ihor Dykyi, Director of Corporate Department at IBI-Rating, non-residents accounted for one-third of transactions. Most of them are strategic investors, who gradually build up their presence in Ukraine. However, little by little, there is interest from investors that do not hold any assets but are exploring the market actively.
“For now, a foreign investor is an oddity for the Ukrainian M&A. Foreigners see Ukraine as a toxic state. The country is too risky because of the military actions in Donbas, economic instability, and poor legislative base on investment security”, — says Oleg Kuznietsov, Partner at Kreston GCG. For the M&A market to grow further, certain risks should be addressed: slow pace of reforms, endemic corruption, presidential and parliamentary elections of 2019, and unfavorable macroeconomic situation.
However, Ukraine’s investment climate is far from perfect. According to the European Business Association, Ukraine’s investment attractiveness in July to December 2017 declined by 3.03 points of potential 5, which is 0.12 points less compared to the first six months. According to respondents, the Ukrainian business climate has had no significant changes. 25% of respondents saw no positive changes for their business, and almost one-half of the respondents pointed at a lack of any changes. Respondents also spoke on the issues that prevent their business from growing: the lack of results on the prevention of endemic corruption and creation of an anti-corruption court, a slow pace of reforms, political and economic instability, etc.
According to the American Chamber of Commerce, the Ukrainian business is facing corruption more often. In 2017, 91% of respondent businesses became victims of corruption, while in 2016 this figure was 81%. That said, 36% of respondents think that the level of corruption in 2017 decreased (47% in 2016). Corruption may take different forms, but the main ones were bribes and ‘contributions’ to stop pressure on the company. As a result, 40% of respondents speak about additional legal expenses due to corruption, 17% say international companies are unwilling to work with Ukrainian companies on that very reason, and 22% point at the unwillingness to develop their business.
At the same time, the surgent M&A market means the investment climate has improved in Ukraine. “According to domestic investors, there is some equilibrium in the political and economic environment, i.e. no significant shocks are anticipated and, therefore, investment projects can be implemented, including M&A. Our practice shows the increasing number of pre-investment analyses (due diligence) — a common prerequisite for M&A. However, their existence does not guarantee a successful M&A. It only means that an investor wants to prone the situation and considers entering the market. Therefore, the investment appeal of Ukraine has slightly grown in the eyes of investors” — says Oleg Kuznietsov.
Venture investments is another indicator of a vigorous investment market. According to the Ukrainian Venture and Private Equity Association (UVCA) in partnership with Deloitte Ukraine, it was following the fall in 2016 when the total size of venture investments in Ukrainian IT companies took a tumble and reached US$259 million, thus, being three times higher than the previous year. The last year also became successful for direct investments. In 2017, there were 14 private equity transactions accounting for $126.7 million in total.
Unfortunately, many IT startups are Ukrainian only by the citizenship of their founders and by office location for some employees. As far as legal matters are concerned, these companies are registered in the US and pay corporate taxes there.
Taking into account the macroeconomic trends, it is reasonable to assume that the number of M&A deals next year will top the figures of 2017. The prerequisites for this are a relative macroeconomic and monetary stability, attempts to kindle the privatization and continue improving the business climate. However, it is unlikely we will see the exploding growth.
According to KPMG Ukraine, the increased number and size of transactions will be facilitated through the growth of the Ukrainian economy and structural reforms supported by international financial institutions.
The M&A market is a reflection of the economy and performance of certain companies. It also stems from the geopolitical situation in Ukraine and war in the Donbas. Investors become more interested in Ukrainian property mainly because of the improved macroeconomic stability, cessation of hostilities in Donbas, and a relatively low cost of assets.
“The market worth of assets may differ depending on certain factors. These may be buyer’s preferences, revenue risks, time-to-revenue, liquidity, degree of control powers. The supply and demand are also an important factor” — says Larysa Poberezhniuk, managing partner at Poberezhniuk and Partners Law Group.
According to Oleg Kuznietsov, the economic situation made the cost of Ukrainian assets hit rock bottom and remain there still. Unfortunately, nothing promises drastic changes in this area. To that note, almost all the most promising assets have been already bought, and the remaining ones are of no serious interest for investors. Therefore, their value does not grow.
“Meanwhile, there is another peculiar trend on the market caused by the upcoming presidential elections. Some experts fear a military regime can be declared in Ukraine as a result. Such a forecast divided investors into two groups. Anticipating the worst, those rooting for the bad scenario hop on all assets they find interesting. Others take no serious actions preferring to wait until the situation unfolds itself. This fact should be also factored in when we look at the increasing number of M&A deals in Ukraine” — says Oleg Kuznietsov.
For his part, Vladyslav Ostapenko notes a gradual improvement for the sellers: “the market is slowly reviving, valuation multiples are growing steadily”.
Another trend was an en masse withdrawal of Russian owners from the Ukrainian market as a result of restrictions imposed on the Russian banks in Ukraine. Since 23 March 2017, five Russian banks working in Ukraine have been under sanctions. They are forbidden to conduct financial transactions for the benefit of affiliates, including parent entities. Even though there are potential bidders, no deal was struck for various reasons. It is most likely that Russian financial institutions will soon fold operations.
According to Zephyr Global M&A Review 2017, most deals fall for agriculture (12), banking (9), oil & gas (4), finance (4), and metallurgy (3).
At the same time, according to Mergermarket, the banking sector leads with 33% of the total number of transactions and 33% of the total size of transactions in 2016–2017. The buyers showed interest in other assets from the power generation and extractive industries (14%), FMCG (13%), telecommunications (11%), and agriculture (8%).
According to Vladyslav Ostapenko, the most popular industries for M&A are: agriculture (mainly crop farming, grain elevators), IT, commercial real estate in large cities. Other industries are characterized by a situational demand. Only leading companies are showing interest or have new technology/equipment.
“We are currently having a good situation on the commodity market, which only adds to the appeal of export-oriented industries. We expect no serious changes on the M&A market in the nearest future” — says Ihor Dykyi.
It bears mentioning that agriculture will remain one of the most attractive industries for M&A. According to KPMG, the appeal of agriculture owes to the steady growth of direct foreign investments in the industry and increased number of deals in the agriculture against the backdrop of higher yields and high export potential of the industry. Agriculture will have even more investment prospects once the land moratorium is lifted and the market becomes free as required by international donors, and that is what people and certain politics do not really want. That is a political question, and no politician would want to risk ratings in the run-up to elections.
The commercial property remains to be the most promising on the market. One of the most active internal investors in the market is Dragon Capital, which has recently added some good investments to their portfolio: Shopping Centers Pyramid in Kyiv and Victoria Gardens in Lviv, business centers Prime and Eurasia, some logistic assets and a TV and radio broadcaster Radio Era.
Foreign investors have a high interest in IT for its export-oriented nature and low susceptibility to the local economic environment. Investments were made both in startups and through large companies acquiring small companies. This trend is expected to continue in Ukraine for the next few years.
According to Larysa Poberezhniuk, the political situation we have now causes a gradual reduction of direct Russian investments, especially in the banking sector. Russian owners simply have no other way but to sell their assets to cease business activities.
With regulations imposed by the National Bank of Ukraine, Ukraine’s banking sector is likely to consolidate.
Mention should also be made of the alternative energy sources. “Ukraine has a unique situation where the green energy tariff is still high, thus, encouraging local investors to build wind and solar stations. All efforts center around the plant to commission it before 2018 and hold that beneficial tariff so then a foreign investor can be found and the implementation ends with premiums. In this regard, we can expect increasing M&As in alternative energy in 2-3 years” — says Oleg Kuznetsov. As far as the global situation is concerned, experts point that M&A will increase in such industries as oil & gas, telecommunications, transportation, FMCG and retail, including extractive industries and metallurgy (according to EY).
According to EY, the number of M&A deals entered in 2017 topped the peak of 2007. Over 52% of respondents — more than 2,500 executives from 43 countries — say that they plan M&A in 2018. Top managers are also full of optimism. The number of executives planning to conduct more deals in 2018 has increased by more than two times (67% in April 2018, 33% in April 2017). 80% of respondents expect a tougher competition for assets subject to M&A.
Positive macroeconomic and capital market situations are what raises interest in corporations to conclude M&A deals. Most top managers (73%) think that the global economy is on the mend. Three-fourths of respondents (77%) expect corporate revenue to increase.
However, owners acknowledge that the geopolitical uncertainty creates difficulties, and almost half of them (43%) consider it to be the main risk. More than one-third of respondents (36%) see changes in regulations and protectionism policies as risks that will only hamper the development.
More than three quarters of respondents (81%) plan transnational mergers and acquisitions within the next year because access to new markets in various regions is on top of their agenda.
The increasing number of M&A also owes to the government’s actions taken to invigorate privatization of state-owned companies. “Another important thing to upsurge M&A can be the start of a privatization of state-owned companies. If successful, many other investors will follow the example of pioneers” — says Ihor Dykyi.
January marked an adoption of a new privatization act designed to simplify the process greatly. The act stipulates regulations on privatization to be united under one law instead of seven and divide privatization lots into two groups (instead of five): small-scale privatization and large-scale privatization. The first pertains to state-owned companies worth more than ₴250. A privatization can be contested in international arbitrary courts within three years following the privatization. Buyers are eligible to demand a conclusion of any legal agreements under the law of England and Wales before January 1, 2021. Moreover, privatization lots will have a bankruptcy moratorium imposed. It is suggested to have two privatization procedures instead of five: bidding and purchase. If the first auction has not taken place yet, the second one will have the prices reduced. According to the Cabinet of Ministers of Ukraine, small lots will be sold in June 2018 at Prozorro.Sales.
At the beginning of May, the government adopted a list of 26 lots to be sold in 2018 as part of a large-scale privatization. Shortly after, 3 lots were removed from the list. It included 9 power facilities: Azovmash (almost inactive now), Turboatom (government has majority ownership), Centrenergo and other lots. The final flourish is Odesa Port Plant (OPZ — Ukrainian abbr.). Nothing changed since the previous year. The privatization competition for this lot has already been snapped twice and the initial price accounts for $54 million, which is 10 times less than three years ago. It is expected that Odesa Port Plant and other large lots will be privatized by November 2018.
Privatization is an excellent way to breath life into the Ukrainian M&A. That said, there is no issue with overpriced lots anymore. Investors are not willing to pay excess for an asset (especially when the government decreases the price). Alas, Ukraine is still risky to invest.
No doubt, some assets are interesting for investors, especially for the local ones. However, large investments are unlikely to enter the country. A classic example is Odesa Port Plant and the muddy waters surrounding its privatization. This case shows us only one thing — somebody particular really wants to put hands on the plant and with demand comes the supply. Authorities promised investors transparency in privatization and international creditors demanded it. Such a transparency does surround sales of various illiquid assets as part of a small-scale privatization. However, transparency in the large-scale privatization leaves much to be desired.
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