Issue 19 Kosovo November 12, 2010

Transcription

1 Issue 19 Kosovo November 12, 2010 Kosovo is it a country? Seventy-one countries 1 around the world say yes, but most of our Serbian friends would emphatically say no, and it would not take long for you to realize how emotionally charged this subject is. This is not the same as kidding your Southern relatives over the outcome of the US Civil War. The events are too recent; the experiences firsthand not something read from a textbook. To diffuse the situation, it might be best to steer the conversation in a different direction. Map: This map shows Kosovo as a separate state. 2 For us, Kosovo appears initially of little interest. There s no stock exchange yet; it s a small landlocked country slightly smaller than Connecticut with a population of only 2 million; and it s one of the poorest countries in Europe on a per capita basis. We examine it here because of an opportunistic experience that Frontaura associate Eric Dahl had in September and October. Eric spent three weeks in Kosovo as part of the Kosovo-America Emerging Leaders Program that the US State Department sponsored. He was one of 13 individuals to participate in this business exchange 1 Currently, 71 countries recognize Kosovo, including the US, Canada, and most of Western Europe. Notable countries that do not recognize Kosovo include China, Russia, and Serbia. Five EU member states Cyprus, Greece, Romania, Slovakia, and Spain also do not recognize Kosovo; some because of they do not want to create a precedent given separatist movements within their own countries. Because of China and Russia s permanent seats on the UN Security Council, the UN does not recognize Kosovo as a country. 2 Map source: Frontaura Capital LLC Frontaura Observer #19 November 12, 2010 Page 1

2 program exploring economic development in Kosovo and fostering business ties between the US and Kosovo. The countries in our portfolio are often post-conflict situations, where the country has emerged from war, or political or economic chaos. During their post-conflict transformations, most investors ignore these countries, misperceiving them as still too risky. The period from the end of the conflict to the point where normalization occurs can offer great rewards for early investors as valuations climb when investor perceptions slowly change. Therefore, while we cannot invest in Kosovo yet, it is a fascinating case study of the type of situation we like. Eric s program allowed us to get an earlier and more in-depth view than we otherwise would. We have found other countries of the former Yugoslavia to be fertile investing ground, with up to 10% of the Frontaura portfolio invested there. We own stocks in Macedonia, Montenegro, and Serbia, all trading on trailing PEs between 4 and 7, as they have not recovered fully from their selloff. Eric took side trips to Macedonia and to Albania, another interesting post-conflict country, having emerged from a half-century under an isolationist dictatorship. Kosovo is predominantly ethnic Albanian, and thus it identifies more with Albania on its southwestern border, than it does with Serbia. Picture: On the left, a statue of Bill Clinton, located on Bill Clinton Boulevard, constructed in On the right, the Newborn sculpture created to commemorate Kosovo s independence in Primer: 1999 Kosovo burst into international headlines in the late 1990s, when NATO intervened in the Kosovo War. Conflict between Orthodox Serbs and Muslim Albanians in Kosovo goes back at least to World War II, although its most recent incarnation has its roots in 1980s, when Slobodan Milosevic implemented anti-albanian laws in Kosovo, then an autonomous providence of Yugoslavia. Albanian resistance groups formed; Serbian nationalists retaliated; and by the late 1990s, Kosovo Albanian refugees began to stream into Albania and Macedonia. Popular sentiments in the US and 3 Picture sources: Frontaura Capital LLC Frontaura Observer #19 November 12, 2010 Page 2

3 Western Europe were with the ethnic Albanians, and in March 1999, NATO initiated a three-month bombing campaign against Serbia its humanitarian war. Kosovo Timeline 1389 Battle of Kosovo fought between Serbs and their allies against Ottoman Turk invaders. While the battle was inconclusive, eventually the Ottomans begin to rule Kosovo. Nevertheless, the battle becomes a symbol of Serbian national identity First Balkan War begins with Albanian uprising against Ottoman empire. The Balkan League of Bulgaria, Greece, Montenegro, and Serbia drives Ottomans from Balkans World War I ends. Treaty of London places Kosovo under Serbian control. Albania established as an independent state, ruled until 1941 by King Zog Albania and Kosovo occupied by Italian forces, who establish a fascist government that persecutes Serbs After fall of Nazi Germany, communist state of Yugoslavia incorporates Kosovo as a province of Serbia. Albania remains an independent communist nation ruled by Enver Hoxha Yugoslav economy falters. Albanians in Kosovo demand greater autonomy from Serbia. Anti-Serbian riots break out in Pristina Albanian ruler Enver Hoxha dies. New regime attempts to introduce liberal reforms Slobodan Milosevic expels Albanian ministers from Yugoslav government, and bans teaching of Albanian in schools. Parallel Albanian institutions begin to form in Kosovo Communist regime collapses in Albania Series of wars lead to creation of independent states of Bosnia and Herzegovina, Croatia, Macedonia, and Slovenia. NATO launches air strikes against Bosnian Serbs in Democratic government of Albania collapses amidst economic crisis. KLA (Kosovo Liberation Army) begins attacks on Serbian forces in Kosovo NATO launches air strikes against Serbian forces in Kosovo and Serbia, in reaction to reports of civilian massacres and growing refugee populations in neighboring countries. Serbia capitulates after three months, and Kosovo becomes a UN-administered region Anti-UN and anti-serbian riots break out in Mitrovica, at border of Kosovo and Serbia Assembly of Kosovo declares independence with backing from US. Table: Key events in Kosovo history. Because of NATO actions, Kosovo Albanians idolize all things American. In fact, Kosovo is likely the most pro-american, Muslim 4 country on the planet. American flags dot the capital. Bill Clinton remains a hero in Kosovo, along with Tony Blair and Madeleine Albright. The UN, however, does not get the same treatment. Albanian Kosovars generally view the ten years under UNMIK (United Nations Mission in Kosovo) rule as a lost decade. UN rule only ended in February 2008, when the Assembly of Kosovo declared independence from Serbia. Growing Pains Only two years old, the country is still very much in its infancy. To illustrate this, Eric s schedule changed twice due to unexpected cancellations. Originally planning to meet with Central Bank Governor Hashim Rexhepi, Eric instead had to meet with his deputy because authorities arrested Rexhepi in July on charges that included bribery and money laundering. Later, a second meeting this time, with Kosovo President Fatmir Sejdiu was cancelled because the Constitutional Court of Kosovo forced him to step down from office in September for violating the constitution! 5 4 Kosovar Albanians tend to be very secular Muslims. Calling themselves Muslim-lite, Kosovo Albanians only converted to Islam in 16 th century under Ottoman rule. Saudis financed construction of hundreds of mosques throughout Pristina after the war, but attendance is low. Alcohol flows freely at bars, nightlife is vibrant, and revenues are high (at least, by Kosovo standards) at Bier Peja, the country s largest brewery. 5 Sejdiu s departure actually precipitated the breakup of the ruling coalition government in October. The immediate consequences will be new elections in December, stalled negotiations with Serbia, and a possible halt to the privatization of PTK, Kosovo s state-owned telecom company, which could leave a major deficit in the 2011 budget. As we write this, events are still unfolding and outcomes are unclear. Frontaura Capital LLC Frontaura Observer #19 November 12, 2010 Page 3

4 Growing pains are evident in the capital as well. At first view, Pristina does not live up to its name. Yugoslav planners designed the city for an upper limit of 250,000 residents. In the aftermath of the war, however, the city grew to over half a million, and continues to grow. As a result, downtown is exceptionally badly organized. Traffic is endemic, and roads are at far beyond capacity. Zoning regulation is lax to the point that construction firms build first and obtain permits later if at all. Neighborhoods expand haphazardly, and short of bulldozing whole city blocks, the municipal government can do little about it. The underlying cause of the disorderliness is Pristina s extraordinary growth over the past decade. Precise figures are not available because the Kosovo government has not conducted a census since 1981, when Pristina had a population of 100,000. All accounts indicate however, that Pristina has grown (and improved) rapidly since This growth is due to two reasons. Waves of refugees returning from abroad after the war overwhelmingly relocated to the capital, rather than their familial villages. The second factor is the post-war population boom. The median age in Kosovo is 26, and nearly a quarter of the population enrolls in primary or secondary school. Kosovo Albanians buck the Eastern European trend, where populations are aging and shrinking. As a result, construction is booming in Pristina, and there are even whispers of an early real estate bubble. Those concerns aside, Pristina has a vibrancy that is difficult to quantify, and that defies the country s otherwise daunting macroeconomic indicators. Picture: View of construction in downtown Pristina. 6 The indicators, however, are indeed grim. The country suffers from a high unemployment rate. Figures are imprecise due to a large informal economy, but we ve seen estimates range from 16% to 45%. Kosovo is a net importer, and its net trade deficit is close to 45% of GDP. To close this gap, the economy relies on foreign aid and remittances, which combined make up over 20% of GDP. Unlike Albania, the country is landlocked, and transportation infrastructure is poor (but improving). Finally, there is the 800-pound gorilla in the room: Serbia. 6 Picture source: Frontaura Capital LLC Frontaura Observer #19 November 12, 2010 Page 4

5 A Tough Neighborhood When the Assembly of Kosovo declared independence in February 2008, the tone in Pristina was jubilant and euphoric. The reaction in Belgrade was anything but, where rioters responded by torching the US Embassy. The Serbian government refuses to recognize Kosovo as an independent state, and most Serbs regard Kosovo as their ancestral heartland. Serbia was historically the most powerful constituent of Yugoslavia, and today has a population of 7.4 million (excluding Kosovo), and a GDP of $39 billion, over six times that of Kosovo. Serbia should be Kosovo s biggest trade partner; instead, Serbia blocks the transit of vehicles and goods with Kosovo papers across its border. Passports (even American passports) with Kosovo stamps are denied entry, and flights to and from Pristina cannot pass through Serbian airspace. Serbia also has a powerful ally in Russia, which exercises its UN Security Council veto on Serbia s behalf. In private, most Serbian ministers admit that Belgrade s days of governing Pristina are over. Lingering border disputes, however, continue to stall negotiations between Serbia and Kosovo. Pictures: On the left, a sign giving instructions for crossing the Mitrovica Bridge in English, Serbian, and Albanian. On the right, a KFOR (Kosovo military) vehicle stationed on the ethnic Albanian side of the bridge, with a view of the ethnic Serbian side in the background. The epicenter of the conflict is Mitrovica, a former mining town to the north of Kosovo. In Yugoslav days, Mitrovica was one of the most dynamic cities in Kosovo due to its proximity to the Trepca mines. These days, the mines are closed, unemployment is close to 80%, and the city has become the de facto border between Serbia and Kosovo. Approximately 80,000 ethnic Albanians live in southern Mitrovica. North of the Ibar River, which divides the city, the population is predominately Serbian, and effectively governed by Serbia. Public servants in Northern Mitrovica receive salaries from Belgrade, and the official language is Serbian. For ethnic Albanians, it can be dangerous to cross the bridge to North Mitrovica, as violence between Serbs and Albanians has been commonplace since As an American, however, Eric was able to cross without incident. On the Serbian side of the Ibar River, the alphabet changes from Latin to Cyrillic, but the city is in the same state of disrepair. Poverty, it seems, transcends borders in Mitrovica. Frontaura Capital LLC Frontaura Observer #19 November 12, 2010 Page 5

6 One proposed solution is a territory swap. There are approximately 140,000 Serbs living in Kosovo proper, mostly in the northern region. There are also roughly 60,000 ethnic Albanians living in Serbia, mostly in the Presevo Valley near Kosovo s eastern border. A swap of North Mitrovica for the Presevo Valley could be part of a solution to normalize relations between the two countries. So far, Kosovo, Serbia, and the international community have balked at any kind of land swap. There are strong incentives, however, for both parties to negotiate. The benefits for Kosovo are obvious: better economic integration, easier transit to Central Europe, and legal legitimacy. For Serbia, recognizing Kosovo would clear its path to the EU. A number of EU member states demand that Serbia do a better job prosecuting its war criminals, and Serbia s ultimate accession to the EU may be contingent upon its recognition of Kosovo s independence. Incentives exist, but politicians must have the will to restart stalled diplomacy. 10% 8% 6% 4% 2% 0% -2% -4% -6% Kosovo Albania Pop. weighted GDP growth for former Yugoslavian states, excluding Kosovo Chart: Annual GDP growth rates for Kosovo, Albania, and the rest of the former Yugoslavia as weighted by population. Note that GDP data for Kosovo does not exist prior to Source: Frontaura Capital calculations using International Monetary Fund data. Greater Albania? As an isolated market, Kosovo is not especially compelling. Its close ties to Albania, however, bolster its long-term prospects. Kosovo and Albania share history, a language, and a sense of cultural identity. Both countries are emerging from Communist legacies, although unlike Kosovo, Albania was never a part of Yugoslavia. Instead, Albania spent the better part of the last half-century under the rule of Enver Hoxha, one of Communism s lesser-known megalomaniacal despots. Also unlike Kosovo, Albania boasts 362 kilometers of underdeveloped Mediterranean coastline, and a well-organized capital city in Tirana that features green public spaces, Parisian-style boulevards, international business headquarters, and a five-star Sheraton hotel. Although the IMF s future real GDP growth projections have slowed to a 3-5% pace through 2015, Albania averaged over 7% growth from Travel writer Paul Theroux visited Tirana in , and described a decrepit and apocalyptic city. 7 Less than two decades later, we found Tirana to be vibrant and surprisingly well functioning. 7 Theroux, Paul. The Pillars of Hercules: A Grand Tour of the Mediterranean. G. P. Putnam s Sons pages. Frontaura Capital LLC Frontaura Observer #19 November 12, 2010 Page 6

7 Between the two million Albanians in Kosovo, three million in Albania, and Albanian minorities in Serbia, Macedonia, and Montenegro, roughly seven million Albanians reside in the Balkans. For political reasons, a formal Pan-Albanian state is strictly off the table. Instead, integration will likely continue along informal lines. Most businesses in Kosovo see Albania and Macedonia as natural markets for expansion. Kosovo has free trade agreements in place with Albania, Macedonia, and Montenegro. While travel between Albania, Kosovo, and Macedonia remains difficult, distances are shrinking; new highways financed by privatization income will cut travel time from Pristina to Skopje, Macedonia from 90 minutes to less than one hour, and to the Albanian coast in four hours, not the six to seven it takes at present. Balkanized Exchanges Every country of the former Yugoslavia except Kosovo already has a stock exchange exchanges exist in Croatia, Bosnia and Herzegovina, Macedonia, Montenegro, Serbia, and Slovenia. A regional stock exchange across the Balkans, or even among the South Balkan countries of Albania, Kosovo, Macedonia, and Montenegro, could make the region more interesting to foreign investors. Often when trading volumes are low in frontier markets, talk of a regional exchange occurs. The problem is that every country thinks the regional exchange should locate within its borders. It would probably take a foreign player, such as Wiener Bourse in Vienna or the Warsaw Stock Exchange, to sidestep the location question, not to mention the ethnic, religious, cultural, language, and historical differences that are barriers to any regional Balkan exchange. So rather than a single regional exchange, we think a more likely outcome is increased cross-listings between exchanges or a common trading platform organized by Vienna or Warsaw. 8 Politicians want to pass legislation enabling a Kosovo stock exchange in 2010, but we think it may take several years longer for a proper exchange to exist. Most big business owners in Kosovo maintain a vice-like grip on ownership stake, and rely exclusively on bank loans to finance expansion. For a functional exchange to come to be, financial sophistication at upper-management levels must improve, as must accounting standards and transparency. A Kosovo stock exchange would be similar in size and activity to stock exchanges in Macedonia and Montenegro initially, with all the same liquidity and trading volume problems. Demand is unlikely to be especially high, however, which could lead to cheap valuations. As an example of the difficulties of an exchange taking root, one only need look at neighboring Albania. Albania s central bank established the Tirana Stock Exchange in 1996, but to date it only trades government fixed income securities not stocks. By sector, here are some of the larger Kosovar companies that could potentially list on a future exchange: Banking: As in many frontier markets, banking is very profitable in Kosovo, due in part to lending rates of 10-12%. The two largest banks, ProCredit and Raiffeisen, control 70% of the market. An increase in competition should 8 There is one successful regional exchange that proves an exception to our discussion here. Located in Abidjan, Cote d Ivoire, the Bourse Regionale des Valeurs Mobiliers (BRVM) serves French-speaking West Africa. Frontaura invests in Cote d Ivoire and Senegal through it, and stocks from other countries such as Burkina Faso and Togo also list on this exchange. Frontaura Capital LLC Frontaura Observer #19 November 12, 2010 Page 7

8 force rates down somewhat; for example, rates hover around 8% in neighboring Macedonia. ProCredit, the largest bank, ended 2009 with a notably high return on ending equity (ROEE) of 34%. Import and Distribution: Kosovo is heavily reliant on imports, and so import, distribution, and resale companies like Bucaj and ELKOS fill vital needs in the Kosovo economy. Both companies ended 2009 with revenue between EUR million, and are looking to expand into Macedonia and Albania in Telecom: PTK, the state-owned telecom, ended 2009 with revenue of EUR 145 million, ROEE of 19%, and market share of over 90%. A number of international telecom operators including Deutsche Telecom, Orascom Telecom, Telecom Albania, Telecom Austria, and Turkcell Telecom may bid for the government s 75% stake in PTK in Although not a member of the European Monetary Union, Kosovo has adopted the Euro as its official currency, which forces the Kosovo government to be fiscally conservative. Although the government will begin issuing debt in late 2011, its inability to print currency limits the amount of debt it can take on. Government ministers likely see this as a hindrance, but to prospective investors, this is a positive, preventing the government from monetizing its debt. Item Albania Kosovo Macedonia Montenegro Serbia GDP ($billions) GDP per capita ($) 3,616 3,156 4,634 5,825 5,262 GDP PPP per capita ($) 7,381 2,425 9,350 10,432 10,808 GDP % change 2.6% 4.6% 1.2% -1.8% 1.5% Inflation 3.4% 1.7% 1.9% 0.6% 4.6% Unemployment 12.5% 16.6% 32.0% 12.2% 18.2% Exchange rate (local currency per dollar) Population Annual population % change 0.5% na 0.3% na 0.2% Market capitalization ($billions) na na Market cap / GDP na na 7% 155% 30% Fiscal balance / GDP -7.0% -0.5% -2.7% na -3.7% Current account balance / GDP -9.2% -18.5% -3.9% -17.0% -9.6% Local currency public debt / GDP 58% na 32% 38% 31% External public and private debt / GDP 13% na 59% 16% 74% International reserves in months of imports 6.7 na 7.3 na 11.5 Net food exporter No na No na Yes Oil and gas production > consumption No No No No No Table: Economic statistics for Kosovo and bordering countries. 9 9 Exchange rates as of November 11, 2010 from Bloomberg. GDP, inflation, unemployment, population, and current account balance are 2010 values from International Monetary Fund (IMF) World Economic Outlook, October 2010, except for population figures for Kosovo and Montenegro and unemployment figures for Kosovo that come from the CIA World Factbook. Market cap data as of November 12 from stock exchange websites, except NEX Montenegro, which is from October 31. Other numerical data are actual figures or estimates for 2010 or latest available year from CIA World Factbook: Food export information from Who are the Net Food Importing Countries?", The World Bank Development Research Group Trade Team, Policy Research Working Paper 4457, January2008. Frontaura Capital LLC Frontaura Observer #19 November 12, 2010 Page 8

9 Looking Forward Kosovo ministers cite Ireland and South Korea as models for Kosovo. While we see the parallel in that both Ireland and South Korea emerged impoverished from painful conflicts, these comparisons only go so far as neither country is landlocked, and Korea has a much larger domestic population. However, that doesn t mean that Kosovo won t develop on its own terms. Kosovo s real strength is its young and multilingual population. It also has moderate (and underutilized) mineral resources; a productive (but again, underutilized) agricultural sector; and some tourism potential in the mountains of Peja and ski slopes of Brezovica. Gains in these sectors, coupled with income generated from privatization, could help to shore up current accounts deficits as foreign aid and remittances taper off over next decade. We ve said it before, and it bears repeating again: in the long term, we are bullish on Eastern Europe. We expect that over multiple decades living standards will converge toward the West. The specific case for Kosovo is both stronger and weaker: stronger because of favorable demographics; weaker for unresolved political issues. Relations between Kosovo and Serbia must normalize. Beyond that, Kosovo needs more value-generating businesses to employ its favorably young population; otherwise, it could squander its demographic advantage. About Frontaura Capital For those receiving this newsletter for the first time, this is an occasional publication on frontier markets investing. In 2007, we established a management company, Frontaura Capital, to invest in frontier markets. Frontier markets are stock markets, categorized by country, which leading index providers usually do not classify either as developed markets or, in most cases, emerging markets. Specifically, our universe is the 99 countries in the world whose stock markets each comprise 0.1% or less of aggregate market capitalization of the MSCI All-Country World Index. We believe these markets will provide investors with a net return series that over time exceeds that of the major US, international, and emerging market equity indices, while normally offering lower correlation to major global equity indices. Please us if you would like any materials from us, such as our investment presentation, monthly comments and fact sheets, quarterly letters, legal documents, or prior newsletters, or if you would like access to our web site, that also contains all of these materials plus media citations. Regards, Nick Padgett, CFA Stephen Mack Managing Directors Frontaura Capital LLC 180 North Stetson Avenue, Suite 1935 Chicago, Illinois USA info@frontauracapital.com For easier viewing and printing, we provide this newsletter in PDF form at: Frontaura Capital LLC Frontaura Observer #19 November 12, 2010 Page 9

10 This document does not constitute an offer to sell, or a solicitation of an offer to buy membership interests in Frontaura Global Frontier Fund LLC. We will not make such offer or solicitation prior to the delivery of a definitive offering memorandum and other materials relating to the matters herein. Before making an investment decision with respect to the LLC, we advise potential investors to read carefully the offering memorandum, the LLC operating agreement, and the related subscription documents, and to consult with their tax, legal, and financial advisors. We have compiled this information from sources we believe to be reliable, but we cannot guarantee its correctness. We present our opinions without warranty as of the publication date. Our opinion is subject to change at any time. Past performance is no guarantee of future results. To remove yourself from future mailings, please reply to this message with the word Remove in the e- mail subject. If you are not on our mailing list, but would like to be, please us with the word Add in the subject Frontaura Capital LLC. All rights reserved. Frontaura Capital LLC Frontaura Observer #19 November 12, 2010 Page 10