Makar Paseniuk: The IMF is not rescuing anyone. It’s allowing Ukraine to buy time (Part II)
Exclusive interview with Makar Paseniuk, managing partner of ICU, for Interfax-Ukraine News Agency (Part I)
What is the total amount of assets under ICU management?
Over $500 mln at the moment.
What does this represent?
If we speak in terms of assets under our management over the past five years, annual growth has averaged around 25%. This was driven by positive investment results, new products, and successful M&A deals.
Let’s move on to the macroeconomic outlook. Do you think Ukraine could jump from GDP growth of 2% and see stronger increases while preserving macroeconomic stability?
I think 3–4% is the maximum. Unfortunately, Ukraine will remain hostage to world macroeconomic trends until it takes proactive action to boost its economic growth. Ukraine is a commodity-dependent country. In our view, most commodities will grow against the dollar this year. Some suggest this will be a result of the weakening of the dollar, but I prefer to speak about the strengthening of key commodity markets. This will drive the growth of non-dollar currencies, first and foremost in developing markets, since they rely so heavily on commodities. Developing markets will benefit greatly from this growth. This is a global macro-trend that will become the key theme of 2018 for investors.
Do you expect the hryvnia to get stronger against the dollar?
Against the current rate, yes (the official rate was UAH 28.775 per USD 1 when the interview was done - IF). This will be accompanied by growing prices for metal and iron ore. We forecast that oil prices will continue to grow, resulting in an average of USD 65-70 per barrel for the year.
What is the role of the IMF in your projections? Do you assume continued IMF funding and support from other international financial organizations?
As far as I can see, this is the key issue for the country’s survival. Let’s not forget that the IMF is not rescuing anyone. It’s just buying time for Ukraine to start rescuing itself. The IMF simply provides Ukraine with some stability and predictability in the short term.
Do you believe that Ukraine will get the IMF loan tranche in the first six months of 2018?
I hope so. At least this is the scenario we hope for, and which we take into account in our investment decisions.
Based on this vision of the macro-economic landscape, what are the key investment themes you see for Ukraine in 2018?
Assuming that we receive the IMF loan, we can expect lower returns on corporate bonds? by Ukrainian issuers against the backdrop of two trends: the dollar curve and changes in the price of money.
Down to what? The government places bonds at 16.5% annually.
I’m talking about Eurobonds. The yield on Metinvest Eurobonds is around 9% and it is nearly 9.5% for DTEK, so they are close. The return on Kernel Eurobonds is 5.6% and MHP is at 3.7%.
I think they will now be quite close by equity valuation.
It’s better to think beyond equity valuation. Kernel is a super business that’s making money and has a great business model. But its land is rented. In my view, Metinvest’s credit rating should be comparable to that of Kernel because, from a business-model perspective, one trades in grain and the other one trades in metal. All of this is exported and is tied to commodities which are now growing. The prime cost of the products will hopefully not go up too much. There is a small difference in leverage between the two companies—two for Metinvest compared with 1.5 for Kernel—but that’s not very important. For creditors, a 3 to 5 difference in leverage matters. The 1 to 3 difference is not too big as it is affordable at both levels.
The difference in yield between these stocks is four percentage points. The yield spread between Kernel and Metinvest, or Kernel and DTEK will shrink. Even a two-percentage point yield decline for five-year stocks is not a bad rally compared with the current price.
This is for Ukrainian stocks. In terms of global markets, as I said, it’s the currencies of the developing markets plus commodities-driven companies, from Glencore to Rio Tinto, Vale, and so on.
Given your forecast for a strengthening hryvnia, do you believe that the purchase of hryvnia-denominated government bonds by foreign banks last autumn was the right decision?
Yes, I do. Moreover, the demand for long-term hryvnia-denominated bonds is still fairly high today. Yes, it will be volatile, and its owners will feel somewhat uncomfortable in terms of mark-to-market for some time. But these banks buy in order to hold the bonds; they have a mid-term vision that takes into account the IMF program and other positive trends.
There will be no new restructuring of Ukraine’s external public debt?
I don’t think so. It’s not serious. Of course, a comparison of Ukraine’s foreign-exchange reserves to the upcoming payments and potential payments Ukraine might have to make under the disputes with Russia over the USD 3bn Eurobonds and USD 2bn gas supply looks frightening. Everyone is now talking about tactical solutions when a strategy is what we need.
Still, you don’t take into account any political factors?
Why we should take it into account? As far as I understand, this investment idea works unless things explode macro-economically. Debt and debt securities are a very old business. It doesn’t produce any space technologies, but it could fund it. Perhaps I could create these space technologies, but I do what I know. I’ve been working with the distressed debt market for a very long time; I’ve done many deals there. Look at Velyka Kyshenia [supermarket chain], Nadra bank, CreditPromBank, PUMB and many others.
What about DonetskSteel? It has exploded—quite literally—as a result of war, not politics.
It has exploded partially.
So, is there still a chance to have some debts paid in such a case?
Yes, we look at this proactively.
Can investors accept war-related risks?
This is a matter of price and negotiation. Of course, when a debtor says, “we won’t pay our debts because we don’t want to,” this is wrong position. However, when the debtor says “that’s because of the macro-economic situation. Our business was in hryvnia while our liabilities were in dollars, and we were too optimistic, but we still want to restore our business,” so, you can talk to them.
We can contribute to their equity and help them restructure their business. But at the end of the day, we need just a return on our capital that has been invested, not someone’s business. Sadly, in some cases, there is no alternative but to seize the asset. But that’s the worst-case scenario.
Why does the American economy recover from crises much faster than the European or Japanese economies? Because their reboot process is automated. If you don't pay your debt, you go bankrupt. Everything is sold and you go on. That’s how it works, straightforward. When you start dragging out the process with courts, unpaid debts, and debt restructuring at 1% for a hundred years . . . What is all that about?
For instance, a state-owned bank restructures debt at 1%. But its liabilities cost 17%! Formally, it has not written off anything for the Prosecutor’s Office. But it loses 16% annually on that asset!
So, the Prosecutor’s Office should be sent to the US?! It’s a joke. You have been working with distressed assets, studying them and buying credit portfolios. One was Erste Bank.
We have bought many portfolios.
But these have been private transactions so far. Are you working with the state as represented by the Deposit Guarantee Fund?
We have applied to bid at asset sale auctions organized by American platforms at the Fund’s instruction.
What was the process like?
We signed all the documents, paid the fees, and spent months studying it all. As a result, we concluded that we were not interested because the minimum price was too steep. They are selling some land plots for construction, small stores and so on. Someone who gets involved in portfolios like this should understand that they will have to restore the value of the property, meet the people, and negotiate. If the properties had been priced much cheaper, we might have said yes. As they weren’t, it wasn’t worth the effort. We wrote back saying “thank you” and gave detailed feedback about why we were not interested after doing all the initial work. After that, we got a phone call and were told that we were the only company to say in detail why we opted not to place a bid. Still, we continue to watch this space, and will wait for a straightforward process.
Whose private portfolios have you bought? Can you name any big deals?
We have bought different portfolios. One was the Ukrainian portfolio of corporate loans from Erste Bank. Our partners in syndicated loans include the biggest international institutions, such as the EBRD and the World Bank.
You must own a certain amount of debt in order to be taken seriously by the borrower or your co-lenders in this business. Whenever you come to a big industrial group and tell them “give me back three pennies” they don’t react. If you come and say “give me back 300 pennies,” that’s a different matter. These transactions are rarely closed individually; they normally go into a pool.
We have a Ukraine Recovery Fund set up to buy distressed assets. It contains our own money, and a pool of capital from hedge funds. Why do they come to us? Because we are probably the only company in Ukraine dealing in this space. You can trade in it from London or New York. But, at the end of the day, you need someone to go to places, talk to people, and have expertise in the local situation. We do the same thing when we buy distressed assets in other countries. We speak to the local people with expertise.
How do you structure the Ukraine Recovery fund?
It’s a chicken and egg situation. Unlike a typical hedge fund, this one has the structure of a direct investment fund in which the money is not funded, but is instead provided under an obligation to transfer to a specific deal within five days. We already have agreements with a number of investors. The deals are being processed now and there are ongoing, prospective negotiations.
What other businesses are you interested in? Renewable energy, for instance?
Yes, we are looking into renewable energy.
But you have been in that state for three years probably.
I have been looking into the direct investment business since 2001 or 2002. I have even done one co-investment with ING. ING invested its own money. That investment failed, but it was a good experience. Throughout my career as an investment banker, I have not seen a single investment on the mid-sized business level in which I would invest my own money. Clearly, Kernel and similar companies are in a different situation, but nobody there ever plans to do such deals.
In terms of direct investment now, in terms of the risk/income ratio, very few deals actually count. When you come to a good company and say “we could buy a large block of shares from you at 5 times EBITDA since you are not a public company, and public companies trade at 6-7 times EBITDA”, the company thinks, why would I sell at 5 when everything is down and nobody is investing into this country? Shareholders were making USD 20mn annually before, now they make USD 10mn. They are generally happy with this. The company is right to think that it doesn’t have to do the deal now.
That’s what direct investment funds, including Horizon Capital, have faced. You have to pay more in order to buy a good business. But you can’t allow yourself to pay more in this business since the entry price is the most effective hedge. So, you don’t do anything or you pay extra.
What is different about working in distressed debt in Ukraine and other countries is that the terms and the deals are driven by banks and investors that are cleaning their balance sheets. Hopefully, the Deposit Guarantee Fund will soon start selling off its assets in large amounts. This is not to say that the deals are not already taking place. The debtors have no choice. They have to negotiate with the buyers of their debt. But let me say this, we rarely ask for it back immediately. We are prepared to support companies and inject working and share capital. If, say, they lack USD 5mn to finance the working capital, we provide that USD 5mn as a loan or in another form, but we also ask something for it.
Do you do these deals as well?
That’s what work with distressed assets is all about.
You are actively expanding the non-state pension fund (NPF) business. What is the reason for this?
Yes, the amount of NPF assets under our management grew 163% to UAH 406.5mn in 2017. The reasoning behind the expansion is pretty standard in asset management businesses—fixed expenses are distributed over more assets. That is what it is all about in the consolidation business: you buy additional cash flow and cut operating expenses. In this way, whatever has been bought begins to yield more under your management. We believe that this business will grow organically. If pension reform speeds up, we hope to participate in it too.
You mean to participate in asset management for the second pillar pension funds?
Yes, these are normal, reasonable expectations.
What is your forecast for the domestic market of corporate bonds?
We expect it to become more active.
The first banks have already gone into it . . .
It always happens like that. I don’t monitor this market, but it would be reasonable to assume that this would happen, as it does around the world, and as it has so many times in Ukraine. Banks are the first borrowers, followed by local corporations.
The problem with corporations is that big companies prefer to borrow in the international markets or take short-term loans denominated in hryvnia. It’s all about cost of funds. That’s why the first wave of corporate bond issues was not entirely successful. However, you also have retail businesses that have to be funded in local currency just because they only have goods to use as collateral. In most cases, bonds are the best way to draw the funding.
How much cheaper do government bonds have to get before investors see any sense in buying corporate securities?
This is about the cost of money. The NBU’s refinancing rate is 16%. It can still grow this year given the inflation expectations. When the rate grows and the banks have the NBU’s bonds or certificates of deposit as risk-free instruments, everything else will be evaluated against that potential return. The borrowers should ask themselves whether their business generates sufficient cash flow to service the debt.
How much can government bond rates go down by the end of the year?
I wouldn’t exclude a scenario where bond rates go up. Even if the first quarter is not always indicative, we’re talking about inflation, and that always pushes bond rates up. However, inflation expectations go down if the hryvnia strengthens. Therefore, I would assume that the rates will be more or less stable throughout the year, and government bond yields will be stable as well.
Do you believe that the commodities market will develop in Ukraine?
I do. We are prepared to invest in it and support the initiatives of the National Securities and Stock Exchange Commission. It is now important that the opinion of the regulator and the market participants are heard in parliament. Passing law No7055 will be the starting point.
Do you invest in bitcoin?
We don’t invest in bitcoin or cryptocurrencies. They are something very non-typical for institutional investors. We would not be able to justify it to ourselves or our investors, for example, when your IT person comes and says that your USD 1mn invested in bitcoins has been stolen? The infrastructure does not exist to meet the demands of international institutional investors who need facilities for saving, security, speed of settlement and the like.
With this in mind, the smarter people have made cryptocurrency-tracking Exchange Traded Funds, ETFs. Today, over USD 1bn of ETFs exists for one or two cryptocurrencies, like Bitcoin and Ethereum. That’s what we trade in. Also, we used to trade in futures at CME.
Do you understand the behaviour of prices for cryptocurrencies?
No. We trade with a trend in this particular case. Many books have been published on what drives the process of investing. One is crowd psychology. We take this into account when we trade.
I’ll tell you why we entered this area. It was an example of event-driven trading for the launch of CME futures. When deciding on a purchase at our various investment committee meetings every week, we discuss amounts, cause and effect, why we do this, and when we will be exiting it—based on the events that are supposed to take place or based on the price levels.
When you trade with a general trend, it’s important to set the stop-loss and take-profit points. Let’s assume that the price plunges 40% (it’s very volatile, but not as much at the ETF level). You have to realize that you will lose an amount X on this position. You have to close it no matter what. It’s more complex with the growing trend. We’ve had different opinions here on what profit to set. I suggested 50% of the entry level, while my colleagues offered 100%.
One-hundred percent is not really a lot for cryptocurrencies.
Greed leads to poverty.
Has crypto fever reached your clients? Are you getting requests to buy Bitcoins or to recommend the best cryptocurrencies to invest in?
One of our investors has withdrawn part of his capital from the fund to re-invest in Bitcoin. I see a trend where the demand for cryptocurrencies will keep growing. The question is which of the cryptocurrencies will grow and be adopted universally. It can be a self-fulfilling prophecy; whenever one of these assets becomes critically massive, it will happen.
In my view, Bitcoin has technological flaws. Ethereum is, essentially, better structured and more interesting. We bought the ETF for this reason. It is used to settle in most ICOs. But I don’t think either Ethereum or Bitcoin will be the currency at the end of the day.
Is a new Ukrainian IPO possible?It is if someone wants to buy agriculture. But Kernel, MHP, and IMC have already issued shares. Otherwise, whatever is offered for an IPO should be very cheap. But then why sell it?
Could one of the issues that has already been traded undermine Ukraine’s market? Like Mriya’s default and the fraud that hit agricultural companies before?
If you think that everyone has already forgotten about Mriya and provides trade finance to Ukrainian companies easily, you are wrong. This is not the case. It really is a problem.
The last question on the structure of ICU’s share capital: do you have plans to change it or are you all comfortable working with it?
What do you mean?
Would you like to involve more partners, or maybe some have had enough of this pressure?
Anything can happen at any time. But we have to have conviction in what we can do with capital if we want to draw more. For now, we have sufficient working and investment income to implement our ideas. If a hedge fund or an asset manager comes and says that they want to buy 25% of our share capital at a double price, we will certainly think about it. When we first started, 25% of the company was owned by a global hedge fund. Could one of our minority shareholders say that they have had enough? I suppose so.
Volodymyr Demchyshyn never did, even after he became Minister of Energy and the Coal Industry.
He wanted to quit his share, but we didn’t want him to: and that’s because our resources are not endless. When Valeria Hontareva [NBU Chair – IF] was leaving, it was a very painful process because our capital was shrinking. We are in the financial business. This means that we have complex contracts signed with financial institutions. They include certain credit-event triggers. A one-time capital drawdown is one of those triggers. That’s first reason.
Secondly, we did not create our business for it to collapse at the behest of one individual. We have commitments to our employees and clients, and ultimately to our families.