Czech crossroads

In 1991, the first time I visited Czechoslovakia, it was difficult to miss the remnants of communism. Aesthetically there was a drab feel to the country. Finding a working telephone required patience, a sense of humor and an impossible degree of optimism. Perhaps worst of all, at least at meal time, was the frustratingly shallow selection of restaurants and shops established without any apparent consideration for supply and demand, strategic placement, or the remote possibility the general public might desire culinary options beyond meat, potatoes and cabbage.

This is not the picture one encounters today, particularly in the capital, Prague. Levi’s, Big Macs and Coke quickly invaded and multiplied. One can now dine on Indian or Italian dishes, and in many cases, you wind up with something authentic, rather than a bowl of noodles, melted cheese and ketchup. The city itself has had a broad makeover and as in the rest of Europe, everyone has a cell phone.

That the Czech economy (in 1992, the country split into the Czech Republic and Slovakia) has done well by democracy and capitalism is quite visible in the cities and to a lesser but still notable extent, in the countryside. But although the transition from communism to capitalism has been smooth in comparison to some of the other former Soviet satellite states, it has come with bumps.

Privatization on a grand scale

In the early 1990s, the Czech government privatized industry through a system under which each citizen received a set number of vouchers.

The process transformed them into stockholders overnight, and in one fell swoop companies became publicly traded entities. Unfortunately, the grand visionary process had more than its fair share of flaws.

‘The privatization process initially looked intelligent and efficient, but it has not gone as well as one would have hoped,’ says Ernst & Young’s Petra Wendelova, who has one of the more authoritative perspectives having worked for the infamous Viktor Kozeny’s Harvard Fund. During the voucher privatization, the Harvard Fund, along with some other funds, offered to manage vouchers or buy them outright, promising fantastic returns. Today, they are accused of everything from fraud to piracy, although investors who took a pay-off did receive a premium.

‘The basic problem was a lack of corporate governance and laws. Some of the funds acquired companies and were literally stealing from minority shareholders, selling off assets and pocketing the profits. There were no corporate governance standards. Many of the companies were poorly managed, but the banks, which were still state-owned, continued providing financing for management buy-outs,’ says Wendelova.

Over the last few years, successive governments have taken steps to improve the environment for investors, including the creation of a securities commission, privatization of nearly all the state-owned banks, and the establishment and enhancement of laws to protect minority shareholders. The Prague Stock Exchange has tightened its listings and disclosure rules for its largest companies, and moved to improve transparency.

‘The situation has been improved – from a legal point of view as well as in terms of the transparency of securities trading on capital markets. The commercial code was amended, and the changes not only enhanced minority shareholder rights but also moved Czech law closer to EU law,’ says Petra Lapkova, an equity analyst at Credit Suisse First Boston.

But despite the improvements, longer-term problems remain, particularly with regard to the stock market and its ability to support both mature and emerging companies. Out of some 250 listed companies on the Prague Stock Exchange, the seven largest account for nearly all of the trading volume. ‘It’s a big problem, in that Western investors only have a few choices. So it’s a question of whether the stock market can survive,’ says Ondrej Datka, MD of Patria Finance in Prague.

Even for the seven blue-chip Czech companies, known as SPAD, volatility can be frustrating. ‘Our price movement usually has little to do with anything but speculation. We could announce great results, but if an investor sells, it will often send down our price – and that investor might be selling for reasons that have nothing to do with our performance. Maybe he just needs to buy a new house. With so little activity, it can push down our price,’ says Dagmar Franckova, external relations manager for Ceske Radiokomunikace, a SPAD company traded on the Prague Stock Exchange, and through GDRs listed on the London Stock Exchange.

Unfortunately, it doesn’t look as if Prague’s stock market is going to get much bigger. In fact, it’s set to shrink dramatically in the coming months as the exchange tightens listing requirements in an effort to improve the quality of the listed companies. But in order to increase liquidity, the exchange needs to attract new companies, something few believe it can do, especially since it has yet to pull off an IPO (its first is planned for late 2001).

Catch 22

The Czech equity market is in something of a bind, a victim of a privatization process that literally forced nearly 2,000 companies into public hands. Most have since delisted – under-capitalized, poorly managed, unprepared for the disclosure requirements expected of them. Worse, equity financing for all Czech companies holds little interest, which does not translate into a positive environment for IPOs.

‘Czech companies learned to rely on debt rather than equity financing, and that mentality remains. Over the recent economic recession, we’ve seen a positive, though partial, substitute of this mainly bank financing by foreign direct investments, which also laid the cornerstone for long-term sustainable growth of the Czech economy,’ says Lapkova.

But with companies putting no premium on shareholder value – if you don’t care about your share price, shareholder value isn’t a hot concept – the urge to improve disclosure isn’t a priority. ‘You basically have five companies practicing good investor relations. No-one else,’ says Martin Nejedly, director of Fincentrum, one of the country’s largest financial portals.

The scenario is not only a hindrance to the growth of the Czech capital market, but it drags on the reputation and valuations of the blue chips, which have made vast improvements to their businesses as well as their investor relations programs.

‘We coach smaller firms on conducting better IR, but they don’t see how it will help. They feel it doesn’t promote media coverage or lower the cost of bank loans, so they don’t see the value,’ says Franckova.

Leading by example

The upside is that the larger firms like Ceske Radiokomunikace are doing well, despite the lackluster stock market and the lagging state of the rest of the corporate sector. One of the key improvements they’ve made is in disclosure and accounting. The top SPAD companies not only report quarterly results, but they also provide results according to international accounting standards as well as local rules. This has moved them into step with peers in the EU, which the Czech Republic hopes to join.

‘The government is in the process of selling its remaining stake in our company, so we’ve had lots of meetings related to the privatization process. It has made us improve the quality of our internal communications systems, making sure we’re all working together. It’s been a positive experience,’ says Franckova, who started 18 months ago and has been working since then to reach out to the analyst community.

Because many of the largest Czech companies are majority foreign owned or are in the process of being sold off to foreign bidders, as is the case with Ceske Radiokomunikace, they’re exposed to the IR practices of these strategic investors. The Czech tobacco company, Tabak, has been renamed Philip Morris CZ, for example. Ceska Sporitelna, a Czech bank, is now majority held by Erste Bank of Austria.

‘We’ve been undergoing a large transformation, as there’s been a huge transfer of knowledge from Erste Bank to our company. This includes investor relations. We were doing three analyst presentations in Prague and one roadshow in Europe and the US. Now we are going to do a telephone conference for international investors when publishing our quarterly results and we will also travel twice a year with Erste Bank. This year’s spring roadshow is being organized by Goldman Sachs,’ says Zbynek Fiser, head of IR at Ceska Sporitelna.

As for the future of the Czech market, beyond the SPAD group of stocks, which can always list abroad, veteran Wendelova· says she remains optimistic. ‘I believe we can do quite well, but it’s really going to be a question of when. There are successful small markets, but it takes time, especially when you’re starting as late as we are.’

Source: Patria Finance