The great Ukrainian agricultural sell-off

As detailed previously, Ukrainian agribusiness has been one of the few success stories during the course of the country’s recent woes. And it’s a good thing that it is, as it is hard to understate the importance of agribusiness to Ukraine. A third of all exports from Ukraine last year were agricultural. Some 16.3% of total GDP comes from the sector. One in five employed adults work in a role connected to agriculture.

But there are also some drawbacks. The Ukrainian government is engaged in a costly and disruptive fight over territory in the east of the country. This requires cash, and with Ukraine already struggling to pay the bills, none of its newly-found friends in the EU, the US, Canada and the IMF — let alone its nervous private creditors — seem willing to contribute to a war fund in any meaningful way.

So, what is to be done?

Well, some 734 agricultural holdings remain owned by state. A legacy of Ukraine’s soviet history, the current situation creates two problems. First, the argument goes, focusing on managing these enterprises distracts the state from building the institutions that would attract foreign investment and build a positive business environment and attract much-needed capital.

Second, it costs a small fortune that the country can ill afford right now. In 2014, Ukraine’s 100 biggest state-owned firms combined to produce a loss of UAH116.6 billion ($5.48 billion at today’s exchange rate). And it looks to be getting worse. Data published on earlier in October by the Economic Development and Trade Ministry showed Q1 losses growing from UAH5.1 billion in 2014 to UAH9.7 billion in 2015.

As a result, over the coming months and years the State Property Fund plans to sell off or partially privatize 100 of its agricultural firms — which include grain producers, traders and elevators (as well as the more exotic tobacco growers, horse abattoirs and a few silkworm breeders).

In order to drum up interest in the selloff, a few weeks back the Ukrainian Ministry of Agriculture rolled into London to meet the European Bank of Reconstruction and Development (EBRD) and host a summit aimed at attracting foreign investment in the sector. While enlightening, the event also exposed some of the tensions at the heart of the issue.

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Notably, the overriding message from the government seems to be at odds with that heard from local companies. Rather than requiring investment from outside partners, many of the private Ukrainian firms represented at the forum had a somewhat different agenda.

Credit facilities, not foreign partnership, are what private Ukrainian agricultural companies are looking for. Is this much of a surprise? If you are a large Ukrainian agricultural holding or trading firm, operating with profit margins that have been estimated to be as high as 25-30% by some, why would you ever want to water down your stake or open yourself up to further competition from outsiders?

There was a telling moment when the EBRD’s moderator politely asked Oleksiy Vadaturskyy, owner of local success story Nibulon, about the potential for opening his company up to equity investment. The question and response, although delayed as they passed via interpreter, were deftly sidestepped and ignored by Vadaturskyy as he turned to plead directly with the audience for working capital.

In fact, the EBRD’s recent work is a notable example of the lengths that Ukrainian companies have been forced to by the current situation. Nibulon recently secured at $130m working capital loan from the bank. While the interest rate for a loan from a development bank will be significantly higher than those offered by your typical investment bank, they are likely to be significantly lower — and somewhat more feasible, given that they actually exist — than those offered by local banks.

So, while the private sector may have to become increasingly inventive in the ways that it secures working capital, the government does not seem to have much choice. It is probably going to have to find investors with a very high risk appetite. Failing this, it will be forced to offer its agriculture assets at bargain basement prices.

But it will not get rid of these assets at any cost. When asked about Chinese interest in Ukraine, Pavlenko was clear. Happily running off examples of Chinese state-owned firms eyeing up port, rail and grain storage infrastructure as part of Beijing’s New Silk Road initiative, the minister was at pains to explicitly rule out land purchases by foreign state-owned companies such as those seen in sub-Saharan Africa. Given Ukraine’s recent experience of keeping foreign powers’ hands off its territory, this policy should not come as a complete surprise.

What happens over the coming months will be interesting, to say the least. There are some tempting assets on offer to those willing to bear the cost of investing in Ukraine at the moment. But given — among other things — the geopolitical situation, banking solvency and capitalization requirements, the state of Ukraine's currency, falling commodity prices, and an only partially-reformed business environment, these costs may remain prohibitively expensive.