Opening the gates

Ukraine might be a country with a number of perceived problems, but its size – at least in a European context – means it is also a country which few can afford to ignore. Most important perhaps, it’s a young country. This is the main reason why savvy investors are being attracted to it, with foreign direct investment (FDI) reaching about $4.3bn in 2007, bringing the total since independence in 1991 to $21.2bn.

Figures show that the largest receiving end for FDI in 2007 was Ukraine’s financial sector. Much of the inflow activity in this sector came from a handful of merger and acquisition deals through which Ukrainian tycoons sold their banking operations to European financial groups for top dollar.

Increased FDI has also been seen in engineering, manufacturing, consumer goods, telecommunications, pharmaceuticals, and mining and processing.

Remarkably, FDI began to increase at the time of political upheaval. Ukraine’s turbulent politics notwithstanding, international investors remain highly confident in the market’s opportunities and seem to be willing to continue investing. In fact, political uncertainty in Ukraine has not had the impact on FDI that many might have expected. This is because FDI was at a low level to begin with and therefore has plenty of room for growth.

Anatole Klepatsky, chief executive officer and partner of Golden Gate Business, a Kiev-based firm which specialises in mergers and acquisitions (M&A) in Ukraine, says now is the time to consider getting a foot on the ladder in Ukraine. “It’s a big country with a population of 46 million. That means it’s a country of opportunities.” Until 2000 Ukraine underperformed, but is now in a position to play catch-up. “It’s the right time,” said Mr Klepatsky. “There’s no doubt that the growth potential is there.”

Mr Klepatsky is in an ideal position to judge. Golden Gate Business is a premier Ukrainian M&A advisory firm with proven execution capabilities. It provides objective and independent advice to help clients achieve their goals and increase the value of their businesses. In 2007, Golden Gate Business executed transactions with the total deal value over $800m.

“We try to provide a service in areas that we know such as telecommunications, consumer products and building materials. It’s only by handling the areas we are very familiar with that we can offer such a high level of service. We do not touch oil or gas, for instance. These areas are very difficult because so much of what happens is politically motivated.”

FDI is vital because the more Ukraine has, the better the country, said Mr Klepatsky. “Foreign investors bring their methods and their ideas and for a young country like Ukraine that can only be a positive development. The multinationals are active in Ukraine because they realise it’s a developing market. But there’s more to it than just making money. FDI also gives Ukraine a direct link to the way these companies operate.”

One cloud on the horizon is the effect that inflation, which topped 26 percent in March, might have on the economy and FDI. Ukrainian officials put much of the blame for the current spike in inflation on global food price rises, and also energy price rises caused by sharp hikes in charges for imported gas.

It’s a problem, said Mr Klepatsky, but while the risk of recession is there it’s very unlikely. There are reasons for this bullish view. The government has, in reality, done a solid fiscal job. State finances are generally in good shape, with public debt at just 11 percent of GDP. According to the National Bank of Ukraine, international reserves have grown steadily and now stand at $33bn. Gross domestic product (GDP) has been growing strongly at seven percent, while the exchange rate against the US dollar has remained almost unchanged. The average wage in the country has grown by more than 30 percent since October 2006 and grew by 5.2 percent in one month, September 2007.

New champions
The easing of restrictions on Ukraine’s economy and the resulting economic growth has been partly responsible for the rise of successful domestic companies, the so called “new champions.” These companies are changing the business landscape because they are innovative, they make the domestic market more competitive and are socially responsible in ways that communist-era behemoths were not. “It’s the same at Golden Gate,” said Mr Klepatsky. “We are privately owned, which means we are fast and quick, and not afraid to innovate.”

In previous years M&A market value was driven mainly by a small number of large deals over $1bn and a large number of small domestic deals under $5m. In 2008 there has been considerable growth in mid-market deals of between $50m and $500m.

As with any cross-border deal, investors need to weigh political and business risks. Political risks are always a concern for any cross-border transaction because regulatory issues can make or break the deal. However, given Ukraine’s growth potential, the question is not “should we enter the market?” – but rather “how can we manage the risks?”

For mid-sized and large deals, concerns over political risk highlight the need for a local partner. For more straightforward deals, a company still needs a local advisor, who knows how the government makes decisions and handles approvals and who can expedite the deal. Even multi-million-dollar investments can be delayed simply because a foreign investor does not know how to find his way through the maze of Ukrainian bureaucracy.

“A high standard of due diligence is absolutely vital, which is where Golden Gate can help,” Mr. Klepatsky said. “Our experience shows that several M&A deals in former Soviet countries delivers disappointing results due to poor due diligence. Good due diligence needs to look into strategic, operational, financial, legal and tax issues. It is critical to have a team of specialists who can carry through the whole process from pre∞deal negotiation to deal execution.”

Confident about the future
Golden Gate handles about 10 such M&A deals a year, concentrating on the business areas it knows and working with clients through the whole process from origination to closing. The company’s advantages include its in-depth understanding of local industries, markets and the regulatory environment, as well as its high level of access to key industry players.

“Clearly there are a number of economic areas where improvement would be welcome, but things are definitely changing and we feel very confident about the future,” Mr Klepatsky said. “Government stability is needed and new fiscal laws are needed to end some of the confusion that exists. But for a young country we have come a long way in a short time.”

The legal framework for FDI has improved and Ukrainian law now protects foreign direct investments in a variety of ways. Some allow for the full repatriation of profits, invested capital and the wages of expatriate employees in hard currency, once taxes and other debts have been paid. If nationalisation or expropriation takes place, Ukrainian law guarantees quick hard currency compensation of the full amount that was invested. It also provides a 10-year guarantee against changes in legislation that could damage foreign investors in any way.

Overall, Ukraine has taken significant steps, focusing on five main points to help in attracting FDI; admission and establishment, ownership and control, operational conditions, foreign exchange controls, and incentives. If the government succeeds in creating a lasting stable environment, and continues its policy of seeking closer integration with western Europe, Ukraine will see growth levels that will exceed anything that has gone before.

Further information: www.goldengate.com.ua