Ukraine: Ukrainian Wine Market: Prospects And Opportunities For Investors

By Olena Parkhomenko, Associated Partner and Dmytro Babaev - Financial Adviser

The experts appraised the market of wine in Ukraine at approximately 23 mln decalitres of wine or USD 800 million. 85% of wine is produced by Ukrainian companies and 15% is imported.

In 2008 10 largest wine manufacturers had 56,5% of all sales in the segment. In 2009 the stake increased up to 61,1%. Meanwhile, the national wine market is growing as well. Experts believe that potential annual growth of wine consumption in Ukraine for the next several years will be about 17.5%.

In 2009, 22 512 000 decalitres of wine were produced in Ukraine. While during the same period for the last year 20 901 000 decalitres. Increase in sales in 2009 of wine constituted 13% if compared to 2008. For 8 months of 2010 volume of grape wine production in Ukraine increased by 62.3% if compared to the corresponding period of last year, and export of grape wine by 25%.

WHO IS WHO AT THE MARKET

According to MEMRB's report there are several major wine manufacturers in Ukraine: The First National Winemaking Holding (INKERMAN^TM), "Massandra", "Koktebel", "Alef-Vinal" (Golden Amphora^TM), and "Koblevo". These trademarks cover 41,8% of all sales in Ukraine.

In 2010 the leaders of sales were the following: INKERMAN, Massandra and Koblevo.

The TOP-10 most sold trademarks are as:

Large wineries in Ukraine typically are vertically integrated holding companies, which consist of one or two wineries and a few collective farms with a total area of vineyards up to 5,000 hectares. For instance, INKERMAN, the leader of Ukrainian winemaking, has 5.5 thousand hectares of vineyards, Koblevo – 2.45 thousand hectares, Massandra – 4 thousand hectares. As a rule, winemakers try to use their own wine materials to avoid external purchases. Because of this the area of vineyards is directly proportional to a company's sales volume.

It is also common for the large wine makers to group with manufacturers of strong alcohol and to share their channels. INKERMAN (FNWH) is associated with the manufacturer of cognac – "Tavria", "Koblevo" (NAT) is a part of a holding company "Bayadera", which owns several leading brands of vodka, and "Koktebel" until recently was a part of Soyuz-Victan Group. At the same time "Massandra" and "Shabo" successfully do their wine business without any ties with strong alcohol manufacturing.

SUCCESS STORIES

Despite the long-lasting traditions of Ukrainian wine-making, the majority of domestic companies are very young. Only a few of them can boast more than a 10-year history. Let's look through some of examples of the current Ukrainian wine-makers development.

The history of the trade mark Shabo started in 2004. At that time the products under this brand were manufactured by a public company that included a state farm (area of vineyard was 1000 hectares) and a wine factory.

For five-year work there was renewed and completely modernized the workshop of primary wine-making. In addition, high-technological secondary production was introduced and modern workshops specialized in cool-bottling of wine. An expensive European equipment was installed for grapes recycling. The aggregate investments into the company made EUR 10 million.

Nowadays, Shabo is a vertically integrated wine-making holding company with the full-cycle production, that produces all types of alcoholic output from grapes.

Ukrainian consumers appreciated the efforts of Shabo winemakers, and, as a result, sales volume increase in 2004-2005 for more than 300 %. After the market reached saturation point in 2008-2009, sales volume increase was more than 150%. Currently, this index of sales increase is 1.7-1.9.

For five years the company managed to get a firm position in the market. Now Shabo wines are among the TOP 10 best-selling wines in Ukraine, and Shabo cognac falls into the TOP 3 best-selling cognacs.

Excellent management, five years and only one privatized public company.

The other example is The First Ukrainian Wine-Making Holding (FUWMH), that was established by the Logos Corporation in 2003. Initially, the Company was focused import and manufacturing of cognacs. Then the corporation obtained the exclusive distribution rights to the products of the Inkerman Factory of Vintage Wines (INKERMAN^TM).

In 2004 Logos started co-operation with the primary wine-growing and wine-making foundations "Chernomorets" and "Kachynskyi+" to create completed cycle of wine-growing and wine-making. In 2005 Logos acquired them both together with Closed Joint-Stock Company "Wine-Making Institute". Soon the manufacturer of cognacs under the brand "Tavriya" also became a part of the holding.

According to MEMBR in 2010 the share of FUWMH in the retail market of soft wines constituted 10.4%.

In 2011 50% of shares of the Holding's wine business were acquired by the Swedish investment funds Horizon Capital and Hartwall Capital for about USD 25 million. This was the first investment in the wine-business on the Ukrainian market. According to open sources Logos plans until 2016 to make IPO on one of the foreign stock-exchanges, obtain extra investments for the business development and become the major international wine holding in Ukraine.

Excellent management, six years and three privatized public companies.

PRIVATIZATION OF INDUSTRY & PUBLIC-PRIVATE PARTNERSHIP

Traditions, Experience and Prospects

Family winemaking for decades dominated in the wine industry in many European countries (France, Italy, Spain and Germany). Due to this, in these countries, for most, major wine companies are privately owned, those that "grew up" on the basis of those family businesses (in Italy, for example, Chianti, Barolo, the brands known throughout the world). In USSR countries state monopoly dominated in the market. After collapse of the Union, some countries got rid of publicly-owned assets in the wine sector of economy that helped to bring the industry to the new level.

For instance, in 1990 Hungary entered a new stage in the development of winemaking: state ownership of the vineyards was abolished. Large state wineries were privatized and assigned into private ownership. A number of modern wine-making companies with their own vineyards were launched and began to produce high-quality wines. Now the Hungarian wine industry is experiencing real growth.

European investments are implemented to study and develop the traditions of Hungarian wine industry with application of the latest technology of wine-making and modern equipment. International grape varieties are planted in Hungary to study their potential in the Hungarian lands.

Currently in Ukraine most of the company within the industry (wineries and farms) are owned by the state. Among the major players in the market are two state associations: Massandra that consolidates about 8 state wineries and Gosvinprom (previously known as Krymradgospvynprom) consisting of about 19 companies.

It ought to be mentioned that in most cases state-owned wine-making companies are prohibited for privatization and are in an extremely unstable situation. Main assets of these companies are significantly out of date, they have debts for salary payments before the employees, and some of them undergo bankruptcy procedure.

Despite these circumstances, the Ukrainian wine market is not completely saturated by the products and manufacturers yet, and is still very attractive for investments.

Representatives of Ukrainian authorities are also aware of the need for substantial restructuring and modernization of the industry and seriously think about beginning of mass privatization of the industry.

In 2010 the President of Ukraine Victor Yanukovych defined privatization as one of the key directions of the Economic Reform Program of Ukraine for 2010-2014 and as a wide-scale social and economic project. He emphasized that the majority of economy sectors would be privatized, except for those, which ensure the state's core functions, as well as national and economic security. Ukrainian wine market does not fall within the list of the exceptions. It is confirmed by the fact that at the end of April of 2011 the draft Act of Ukraine on delisting of 24 Crimean alcohol plants (wineries and farms, liquor companies) from the list of companies prohibited for privatization was registered with the Parliament.

According to experts, within the next year we should expect the mass privatization of the state wineries, which has all chances to completely change the Ukrainian wine market. However, transformation of the market needs strategic foreign or domestic investors. Investments, as well as the Western business experience and high technologies can make this sector very profitable and competitive in world markets and repeat the success of Ukrainian vodka giants.

Privatization and Alternatives

Privatization of state property is a lengthy and expensive procedure. In practice other options of assets acquisition are applied.

Under the laws of Ukraine the state-owned objects are managed by the Cabinet of Ministers of Ukraine and by the central and local executive authorities on its behalf. Therefore, implementation of any of the below options is possible only if a number of approvals and permits from the state authorities (Cabinet of Ministers, the Antimonopoly Committee of Ukraine, the State Property Fund of Ukraine, etc.) are in place.

Among the alternatives to privatization are the following:

1. Concession

It is a form of public-private partnership that prescribes for the right of investor to create (build) an object of concession and (or) manage (operate) it. Concession requires the following conditions to be met:

✓ the purpose of concession is to satisfy the social needs;

✓ concession agreement is made for a fixed time and must prescribe fees;

✓concessionaire undertakes to create (build) and (or) manage (operate) the object of concession, responsibility and possible business risks.

Concession activity in Ukraine is governed primarily by the Commercial Code of Ukraine dated 16 January 2003 No.436-IV, which stipulates the general provisions regarding concessions and the Act of Ukraine "On Concessions" dated 16 July 1999 No.997-XIV.

Peculiarities of concession:

• transfer of property into concession does not entail assignment of ownership rights to that property to the concessionaire, and does not terminate state or municipal ownership; assets created under a concession agreement go into state or municipal ownership;
• a foreign investor will need to establish a subsidiary in Ukraine that will become the tenant to the assets;
• concession agreement is concluded for a period that cannot be less than 10 and not more than 50 years;
• there is an approved standard-format concession agreement that is not subject to any significant amendments;
• concession agreement must be registered with the State Property Fund of Ukraine.

2. Lease of Going Concern (GC)

According to Ukrainian laws a GC includes fixed assets, current assets, cash, goods and securities (assets), which compose the commercial object with a complete cycle of production of goods (works, services) together with land, on which it is located, autonomous communications and system of energy supply. CG can be composed of all the assets of a publicly-owned company or of its structural subdivision.

Lease of state property is governed by the Act of Ukraine "On Lease of State and Municipal Property" dated 10 April 1992 No.2269-XII.

It is necessary to emphasize that the objects of state property, which produce excisable goods and which are forbidden to be privatized cannot be subject of lease.

Peculiarities of lease of GC:

• investor receives only the right of a long-term use of the object;
• a foreign investor will need to establish a subsidiary in Ukraine that will become the tenant to the assets;
• a tender is to be held, several bids for lease of the same object are filed;
• there is an approved standard-format concession agreement that is not subject to any significant amendments;
• lease agreement is to be notarized; the fee for notarization can be quite substantial.

3. Joint Venture Agreement (JVA)

This is a form of public-private partnership that implies consolidation of assets and/or business activity of two or more parties, one of which is a state company, without establishing a separate legal entity. Legal framework for JVAs is set forth in the Civil Code of Ukraine.

Peculiarities of JVAs:

• JVA must be approved by the Cabinet of Ministers of Ukraine;
• JVA must be registered with the state tax authorities;
• contribution of a participant to a joint activity can include cash assets, other property, professional and other knowledge, skills and abilities, as well as goodwill and business connections;
• affairs of joint activity are managed by the participants jointly, unless otherwise is stipulated by the JVA.

4. Trust Management

According to the trust management agreement one party (Trustor) assigns to another party (Trustee) for a fixed period of time assets for management, and the other party assumes obligations for a fee to manage these assets for the benefit of the Trustor or a specified third person (Beneficiary).

An object trust management agreement can be GC, real estate, securities, property rights and other assets.

Peculiarities of trust management:

• transfer of assets into trus management does not entail assignment of ownership rights to these assets to Trustee;
• trust management agreement must be notarized and approved by the Cabinet of Ministers of Ukraine;
• Trustee is entitled to a fee for managing the assets, as well as to reimbursement of all necessary expenses incurred while managing the assets;
• Assets in trust management must be accounted by a Trustor on a separate balance sheet and all the accounts must be kept separately as well.

The choice of form of public-private partnership depends on several factors that ranging from type and size of business and to those guarantees and obligations, which an investor is to provide/assume while investing in the state sector of economy.

Taking into account the market opportunities and prospects for mass privatization the Ukrainian market can give investors a unique opportunity: to enter the domestic market by investing in potentially attractive wineries and become the leader or one of the main players in the wine market of Ukraine .

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.