Bulgartabac Holding AD

1
Bulgartabac Holding AD

• Tina Boyadjieva
• Rob Ferguson
• Renee Hartmann
• Jeff Walwyn

2
Agenda

• Overview of Bulgaria
• Bulgarian Tobacco Market History
• Bulgartabac Overview
• Opportunity Discussion
• History of Past Deals
• Current Opportunity
• Cost of Capital
• Valuation and Sensitivity Discussion
• Proposed Solution
• Real Options

3
Bulgaria A Snapshot

• Population 7.8 million
• 32 rural 68 urban
• Currency Lev
• 1.96 lev 1 Euro
• Communist govt. from 1944 1989
• Ruling Party National Movement for Simeon II
• Next Election 2005
• Slated for 2007 EU entry
• 8.5 Turkish population
• Bordering Countries Turkey, Former Yugoslav
  Republic of Macedonia, Serbia, Romania

4
Bulgarias economy

• Organized crime
• Tension btwn. social and economic growth
• 14 unemployment rate
• Avg. wage lt 100/month
• Unsuccessful privatization efforts
• Bureaucratic and slow

• Politically stable
• Secure currency
• Low inflation
• Adopting EU laws
• 4-5 GDP growth
• Little ethnic or religious conflict
• Low labor cost pool
• Close relationship with IMF

5
Bulgarias Tobacco Market

• Leading grower of high quality tobacco
• Tobacco and tobacco are 40 of agricultural
  exports and 5 of all exports
• Cigarette smuggling an issue
• Large black market for foreign brands
• No anti-smoking movement yet
• 56 of men and 32 of women smoke
• Accession into the EU will increase competition
  and lower import duties
• Tobacco industry has been large employer of
  Turkish population
• Bulgartabac has near local monopoly
• 85 market share

6
Bulgartabac - company

• 1947 1993 tobacco unit of BCP
• 1993 becomes a Holding with 22 subsidiaries
• 2005 one of largest tobacco companies in SE
  Europe
• 85 market share on the domestic market
• One of largest tax payers and generates 4 of the
  BG revenues
• Involves roughly 250,000 minority population in
  the production
• Government purchases 13,000 tons/ year at
  determined prices
• Owns around 50 trademarks
• 93 owned by the Ministry of Economics
• 60 bill cigarettes annual production, 75
  produced at 3 plants

7
Privatization process

• Essential to accession to EU open market
  requirements for entry
• Special government requirements
• Maintain tobacco production purchasing
• Keep most of the current employees
• Government has control over tobacco price until
  2007
• Government still maintains a stake in the company
• Establish a Tobacco fund to transition minority
  workers

8
Failed BAT deal

• October 2004 BAT
• Offers 200 million euro for 3 largest plants
• Promises to keep purchasing 7,000 tons of
  production
• Promises to use at least 30 Bulgarian tobacco in
  its production
• Pledges to make Bulgaria tobacco production
  center of the region
• Deal fails after 3 months MRP and BSP dont
  think it is in the strategic interests of the
  country

9
Cost of Capital

• Using Institutional Investor country credit
  rating, Bulgaria is more risky than the United
  States (Rating 51.6)
• Cost of Capital Worksheet implies a 19.8 cost of
  equity
• Organized Crime Expropriation
• Creeping Expropriation
• Operational Autonomy
• Resource Risk

10
Valuation considerations

• Three scenarios developed
• EU membership could have various different
  effects
• Increase imports of foreign brands
• Open up new markets for Bulgarian made products
• Growth is uncertain given previous government
  control
• Labor costs are very high and government wishes
  to guarantee employment

11
Valuation considerations (contd)

• Conservative case
• EU entrance reduces sales as imports increase
  competition
• Slow reduction in labor expenses
• Most likely case
• Declining labor costs
• Conservative growth
• Best case
• Significant labor savings
• High growth in export sales

12
Sensitivity analysis

• Cost of equity of 19.8
• Recent Offer suggests a lower cost of capital
• Terminal Value could be understated

13
Real Options

• Input/Output Mix Option
• Current production mix
• Inputs 50 Burley, 33 Virginia, 17 Oriental
• Outputs 15 bargain brands, 42 premium
• Create different mix of premium/bargain to match
  optimal profitability
• Intensity/Operational Scale
• Currently running at 30 of 140 thousand ton
  processing capacity
• Valuation is also based on current capacity
• Analogous to option to build additional plant,
  without the capital investment

14
Solutions/Recommendations

• Government
• Continue to pursue strategic investor
• Continue to sell parts, rather than whole
• ABC Always Be Closing
• Each year postponed is hurting potential
  accession to EU and ICCR
• A sale gains FDI and will prove minority
  protection (Turkish)
• Purchasing Party
• Create social solution
• Concessions to relieve social and political risk
• Appease minority populations
• Value is not the sticking point
• Use past deals as a starting point - learn from
  the failures
• Find flexibility around operational autonomy