What has made the Slovenian market interesting is that after briefly coming on the radar in 2010, it fell off again, hitting 2009 lows, in contrast to the rest of the world’s stock markets. I can honestly say that at the time I knew nothing about Slovenian stocks and the Slovenian economy, but I thought it might be worth the time to get to know them.
Where joining the EU is considered a disadvantage
After doing some reading, it was immediately obvious that Slovenia was different from the other Central European countries: their 2007 accession to the Eurozone had come with consequences. More than likely they regret the decision today! Domestic interest rates converged, which is to say, fell to the very low Western European level, a boon to the participants of the Slovenian economy. Slovenian companies took on debt hand over fist, not so much to expand capacity, but to buy each other out. The economy boomed and the stock market soared. In just a few years, so much debt was taken on that by the start of the crisis, the Slovenian corporate sector had become by far the most indebted in the region. At exactly the worst time. Reviewing the balance sheets of some of the listed companies, it was plain to see that their capital structures were indebted much more than was typical. So the post-crisis poor performance of the Slovenian stock market began to make sense, since the banking sector made up such a large percentage of the index, and it became quite apparent that the problem was severe.
When bad results can be a positive
Among all the falling stocks there were some that were not in such bad shape. Among these Telekom Slovenije was the one in which we were most interested. At the time, it was trading around 80 EUR / share, and had just had a huge write-off (approximately 200 million EUR, about 40% of its market cap) related to a bad Macedonian acquisition. On the surface the numbers were horrifying, but these were all related to a one-off in the past; they had no bearing on what would happen in the future. In the meantime, just under the surface the company was making a ton of money, which was hidden by the loss of value resulting from the unnecessarily huge capital expenditures. Looking at industry standards, we suspected that the company could make major cuts to capital investments and still remain viable. Taking all this into consideration, the company seemed capable of producing euro cash-flow of around 20%, while the market at the time was pricing its regional competitors at around 10%.
When cheap defines real value
The more time we spent analyzing the company, the more we could not believe what we were seeing. How could this company be so cheaply valued? I paid a visit to the management team and also spoke to local analysts. They were down on the company out of sheer apathy, but they could not say anything drastic that negatively influenced our opinion. Thus there was nothing left for us to do but to start buying the stock, which actually was not an easy thing to do because of low liquidity. We developed a good relationship with a local brokerage that would call us anytime someone was looking to sell. For eighteen months this was the manner in which we bought the stock; in the meantime the stock price dropped to 60 euros / share. There were months when it seemed we were the only ones buying. We did not always sleep well at night at the time, but the company operated exactly as we expected them to: keeping capital expenditures low (that is, at a normal level), making sizable sums of cash and paying down its not necessarily high debt. At some point other investors must take note of all this, so we thought.
The Slovenian state intervenes
Help arrived unexpectedly: Investors discovered the company while taking a look at the country in which it operates, and the attendant troubles associated with all that bad debt in Slovenia. It was becoming evident that the only way to save the banking sector from a total collapse was for the state to prevent it, which would with a massive price tag (estimated at 10-20% of GDP). In the meantime as a result of the unceasing recession, the national debt rose sharply (currently at approximately 67% of GDP), which earlier had been maintained at an enviously low level. Adding all this to the bank bailout, and all of a sudden Slovenia was making headlines as the next Eurozone country predicted to go bankrupt.
The Slovenian state, struggling with liquidity issues, began making demands (as the majority owner) on Telekom Slovenije to pay ever larger dividends. It was at this time that investors took note of just how strong the telecom company’s cash flow position was. Over the previous roughly two-year period, the company had paid out something like 20 EUR in dividends to its owners. Finally succumbing to international pressure, the Slovenian state was forced to announce the company’s privatization, along with several others.
Buying at depressed prices
By the time fears of Slovenia’s bankruptcy peaked (first in summer 2012, then again in spring 2013), we had well-nigh familiarized ourselves with the country’s economy, had been making regular visits to the largest companies and had been regularly holding discussions with the local macro-analysts. We believed that Slovenia’s problems were serious, but not beyond hope. Even with the reorganization of their banking system, their national debt would remain within the bounds of Eurozone acceptability. Moreover, it seemed unrealistic to us that the mandarins of Europe would allow a moderately indebted, small Eurozone country with a “rounding error”-sized level of debt to go under. And so it was that, taking advantage of the panic mentality, we purchased euro-denominated 8-year Slovenian treasuries yielding 7 percent. Sellers also dominated the stock market as well, where we successfully added shares of KRKA, a drug maker, to our growing Telekom position, all at depressed prices.
Under immense pressure, the Slovenian government had no choice but to initiate market-induced reforms. The retirement age was upped; labor market laws were liberalized for greater employment flexibility; a “bad bank” was established, where those banks on the brink of bankruptcy could transfer the better part of their defaulted loans; the banking system was recapitalized; and a dozen or so companies’ privatization was announced.
International investors have also arrived
Combined with improving sentiment towards European capital markets, this was more than enough for Slovenian assets to be looked at in a whole new light. Today yields on Slovenian treasuries are only 2.7% (even though the problem of the national debt has not gone away, it appears to be more manageable), while the share price of Telekom Slovenije has doubled, as can be seen in the chart above. (Although EBITDA is much lower now than when we began to buy it). KRKA’s shares have also gone up, by nearly 50% (although most of its profits come from Russia, where the ruble has lost much of its value). These assets are no longer as undervalued as before. The last time I visited Ljubljana was in December 2013, to attend a conference of the companies listed on the exchange. I noticed two striking changes: the valuation of assets and the heightened interest of international investors in them.
Original date of Hungarian publication: June 13th, 2014