2012.12.04 Occasional Paper - Financing Diversification on Local Market Between Wish and Necessity

Occasional Paper

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Financing diversification on local market between wish and necessity

1. Does optimal debt to equity matter? - Briefing on financing decision

related theories

Financing mix is an important decision for managers, and many academic papers discuss the

determinants of capital structure, the implications of firms capital structure on firms value and

on cost of capital (i.e.: Modigliani&Miller, 1963), as well as capital structure features across the

world. It might appear quite weird to talk about alternative financing methods given that banks

provide approx. 92% of the necessary resources of local corporations, whilst there is marginal

concern for the accomplishment of traditional objective of managers, namely firm value

maximization, especially in case of large state-owned companies. The effects of capital structure

on firms value become even more complicated to analyze, when costs of asymmetric

information, agency costs and costs of financial distress are taken into consideration.

The expansion of local banking system during the economic boom almost annulled any

discussion of financing decision aiming to reach optimal capital structure in relation with business

performance outlook. To this we add, lack of capital market depth, and poor capital market

reaction to releases of stocks value estimation, which created modest incentives for special

attention to value creation process of a firm.

The economic recession, orderly deleverage at banking system level seen in the past three years

reveal the negative effects of credit risk concentration at banks, through rising NPLs (17.34% as

of end-Sep12 vs. 14.18% as of end-Sep11) and the necessity of cautious approach in financing

companies and households already significant leveraged. Without taking banks out of the

financing game, well known alternative financing resources should be tapped.

Conventionally, a corporation can raise funds through internal and external sources. Internal

resources refer primarily to retained profit and depreciation, whilst external sources are debt

(loans or corporate bonds) and equity (issuance of new preferred & common equity). In our

paper, we will discuss these financing means, leaving out for the moment the hybrid financial

instruments (i.e.: convertible bonds) through which corporations may gather financial resources.

There are country-specific factors (please see table below) identified by academic literature

which should be considered when you analyze financing mix of a corporation.

Carmen Lipar [email protected] +4 021 301 4370

Laura Simion, CFA [email protected] +4 021 301 4461

Capital structure has an impact on firms value and on its cost of capital

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Country-Specific Factors and Their Assumed Impacts on the Companies Capital Structures

Source: Corporate Finance, CFA Program Curriculum, Volume III, Level II 2012, pg. 122, Pearson Publishing House, BRD-GSG Research

Moreover, Damodaran1 identified as macroeconomic factor influencing optimal debt ratio the

level of default spread. Thus, if default spread is higher the optimal debt ratio should be lower

and vice-versa.

Besides, country-specific factors, we can add firm-specific factors with impact on optimal debt

ratio as following2: corporate tax rate, pre-tax return on firm, and variance of earnings as listed

in the table below.

1 Damodaran A., Debt and value Beyond Miller-Modigliani, Stern School of Business, pages.stern.nyu.edu/~adamodar/pdfiles/country/levvalue.pdf 2 Ibid 1.

Country-Specific Factor If a Country Then D/E Ratio isPotentially

and Debt Maturity isPotentially

and our comments for Romania

Institutional framework

Legal system efficiency Is more efficient Lower Longer There is a great level of information asymmetry, especially for state-owned enterprises (SOEs) whose results are not made public on regularly basis, keeping transparency on SOEs operations at low levels.

Legal system origin Has common law as opposed tocivil law

Lower Longer Romania has civil law system, thus it doesn't recognize legal precedent as stare decisis. It is known that civil-law countries (where shareholders rights aren't that stronger in comparison with those in common-law countries) tend to be more bank-oriented.

Information intermediaries Has auditors and analysts Lower Longer Active presence of local analysts is rather pale given the undersized capital market as compared with auditors business. International empirical research confirmed that large number of auditors and analysts is associated with lower leverage of companies.

Taxation Has taxes that favor equity Lower not specified Currently, the dividend tax rate equals income tax rate at 16%. To our knowledge there is no empirical study on this topic for local companies.

Banking system, financial markets

Equity and bonds markets Has active bond and stock markets not specified Longer

The average daily turnover on shares segment declined by 25.8% ytd up to EUR 6.84m (as of 22 Nov'12), whilst corporate bonds market includes three issuers (out of which one has been listed on BSE on 20 Nov'12) with infrequent and rare tardes. So, we can assess that local capital market plays a minor role in financial intermediation.

Bank-based or market-based country Has a bank-based financial system Higher not specifiedAs we have already mentioned, local financial system is concentrated on banks, which are the main financial resources providers.

Investors Has large institutional investors Lower Longer Net assets of local pension funds, investment funds increased significantly in the past years, but are still low at approx. 6.57% of GDP in 2011 (vs. 4.4% GDP in 2008).

Macroeconomic environment

Inflation Has high inflation Lower Shorter

Romania HICP was 5% as of end-Oct'12, the second highest HICP in EU. Given the largest weight of volatile and administrated prices in consumption basket as compared with EU peers, we expect upside pressures to persist, unless changes in consumption basket might be made.

Growth Has high GDP growth Lower Longer

Some academic research found that companies in developing countries with high GDP growth rely more on equity financing. Local corporations preferred loans in the boom years given the easiness in contracting a loan (corporate loans (nominal terms) CAGR 2004-07 of 40.6% vs. CAGR 2004-07 GDP of 37.7% ; CAGR 2008-11 corporate loans of 6.08% vs. GDP CAGR 2008-11 of 3.98%). Also, on local market only 14 successful IPOs have been run between 2004 and 2010.

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Firm-Specific Determinants of Optimal Debt Ratios

Source: Damodaran A., Debt and value Beyond Miller-Modigliani, Stern School of Business, pages.stern.nyu.edu/~adamodar/pdfiles/country/levvalue.pdf

In relation with how corporations make financial decisions, the academic literature has

formulated two theories: pecking order theory and trade-off theory. According to pecking order

theory, firms prefer to use internal financing, then they prefer debt (loans and bonds), and

finally they prefer equity. This can be explained by the fact that managers prefer financing

methods with the least potential information content (internally generating funds) and have

lowest preference for means with greatest potential information content (public equity offering).

Costs of asymmetric information are caused by the uneven allocation of information between

managers and investors (creditors and/or shareholders), because always companys managers

have more information about future investments and companys performance compared with its

investors. For instance, companies with low transparency on their financial standing or

companies with lower levels of institutional ownership have higher level of asymmetry in

information. Furthermore, Myers&Majluf (1984) find that managers decide to issue new shares

when they believe the firm is overvalued by the market, because the stock price declines

following an equity offering. Agency costs are related to the fact that managers of the company

are not the owners of the company, and stockholders are different from creditors. Thus,

managers might not make their best efforts to run the company to maximize its value, but to

maximize their own wealth. The costs related to the minimization of this type of conflict of

interests were named agency costs.

The static trade-off theory of capital structure refers to the necessity of balancing the

expected costs of financial distress (i.e.: bankruptcy costs) with the positive benefits related to

the tax deductibility of interest expenses reflected in tax shields. Thus, there is an optimal

debt/equity ratio (leverage ratio) where any additional debt will create higher costs of financial

distress as compared with the positive effects of additional tax shields obtained. Optimal

debt/equity ratio is difficult to be specified exactly for any company. Consequently, we have

mentioned above some country-specific and firms specific factors influencing it.

1. Tax RateHigher tax rate Higher Optimal Debt RatioLower tax rate Lower Optimal Debt Ratio

2. Pre-tax Returns on Firm =(Operating Income)/Market Value of FirmHigher pre-tax returns Higher Optimal Debt RatioLower pre-tax returns Lower Optimal Debt Ratio

3. Variance in EarningsHigher Variance Lower Optimal Debt RatioLower Variance Higher Optimal Debt Ratio

Firms prefer internal financing, then debt, and finally equity

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Source: Corporate Finance, CFA Program Curriculum, Volume III, Level II 2012, pg. 122, Pearson Publishing House

The left chart shows the trade-off between

positive effects on firms value of tax shields

once leverage is increasing and negative effects

on firms value determined by costs of financial

distress or bankruptcy, agency costs of debt,

and asymmetric information.

VL=VU+tD-PV(Costs of financial distress), where

VL is value of levered firm; VU is value of unlevered firm (all-equity financed); t is tax rate; D is total debt; PV is present value of costs of financial distress.

There is a great level of information asymmetry on domestic market, especially for state-owned

enterprises (SOEs) whose results are not made public on regularly basis, making a decent level

of the transparency difficult to be achieved.

2. Debt financing Loans vs. Bonds

Debt can be raised from banks or from capital markets. Typically, banks enjoy information and

contract negotiation advantages compared with capital market participants, and this allows them

to better monitor and enforce the financial obligations of their clients. Thus, bond market

investor protection measures (including enhanced disclosure requirements and consistent cross-

country bankruptcy protection laws) need to be commensurate as debt capital market financing

is growing.

Bonds financing

Loans financing

Pros

Flexibility of the issuer in terms of redemptions, interest rates Usually, bonds are used to finance medium-long terms investments

Easy access to banks financial resources

Cons Higher transparency costs with the disclosure requirements Need for credit rating assessment and continuous monitoring

Generally, loans finance short-term projects The bank has high negotiating power regarding costs, payment schedule, loan size, setting negative or positive debt covenants

Financial intermediation provided by credit institutions in Romania remains below

neighboring peers and EU average. However, Romanian banks hold the largest amount of

net assets compared with other financial institutions, whilst capital market is significantly

undersized, as showed further.

PV of Interest Tax Shields

PV of Costs of Financial Distress

Mar

ket

Val

ue

of t

he

Firm

Optimal Debt/Equity RatioDebt/Equity

Value of the firm if all-equity financed (unlevered firm)

Maximum Value of Firm

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Credit institutions - Financial intermediation in 2011

Local net assets (% GDP) evolution (2009-11)

Source: 2012 NBR Financial Stability report, BRD-GSG Research

Source: 2012 NBR Financial Stability report, BRD-GSG Research

The preference for banking system isnt the feature of our country only, as shown below:

The authors of an IMF study3 (2005) stated that there is no definitive evidence that either

a market-based or bank-dominated financial system is better. Moreover, it has been

argued that a more diversified financial system would mitigate its vulnerability to systemic

risk. For instance, the effects of the Asian crisis and the recession in Japan during the 1990s

may well have been far more benign if the countries involved had had well-functioning

capital markets and correspondingly less heavy reliance on their troubled banking sectors

during this period (see, for example, Greenspan, 1999).

The paper also mentioned the factors weighing on demand and the supply of corporate

bonds:

a) the local institutional investor base; b) the foreign investor base; c) issuance costs and taxation; d) public versus private sector bonds.

a) The local institutional investor base is still undersized, as we have shown in the

top-left chart, in spite of positive evolution of investment funds and private pension

funds between 2009 and 2011. According to 2012 NBR Financial Stability Report, these

sectors increased their joint share in financial system only by 1.27 percentage points

between 2009 and 2011, compared with credit institutions increase of 0.87 percentage

3 Luengnaruemitchai P., Lian Ong L., (2005), An Anatomy of Corporate Bond Markets:Growing Pains and Knowledge Gains, IMF Working Paper

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

Romania Poland Czech Republic

Hungary EU27 (avg.)

Assets/GDP

Loans/GDP

Deposits/GDP

-

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

2009 2010 2011

Investment funds

Private Pension funds

Insurance companies

Non credit financial institutions

Credit institutions

Financial intermediation indicators in 2011

Source: Eurostat, BRD-GSG Research

2011 Debt securities issued by corporations (% GDP)

MFI credit to non-government residents (% GDP)

Stock market capitalisation (% GDP)

Czech 24.2 54.5 20Hungary 27.2 63.6 16.2Romania 0.2 38.6 8.6Poland 13.3 54.5 29EMU 103 134.7 41.5

The ultimate macroeconomic scope of corporate bond market is to mitigate credit risk in an economy

An active corporate bond market cant be developed without improvements in secondary Gov bonds market, more active local institutional investor, larger foreign investor base and favorable general regulation, low fees, commissions, and taxation

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points, and decline of insurance companies of 0.04 percentage points for the same

period, respectively.

b) The foreign investor base declined, mainly as a consequence of international

financial crisis and poor local economic growth prospects. The NSC foreign investments

data show that 2011 total foreigners inflows on local capital market amounted to EUR

399.21m, and were 23.1% below 2008.

c) Issuance costs and taxation

In this respect, we may mention the local market regulatory (NSC) decision on 21

Aug12 stating that NSC fee for local corporate bonds, T-bonds, municipal bonds to be

zero. Still, local capital market is more expensive compared with neighboring markets,

dragging on its development (please refer to our Appendix for a list with fees and

commissions for BSE and Warsaw Stock Exchange as of 28 Nov12).

d) Public versus private (corporate) sector bonds

Indeed, moderate development of local secondary T-bonds market (please see more

details in our report Developing the government securities market 4), and significant

issuance of T-bonds given the financial needs of Ministry of Finance (estimated by us at

approx. RON 90bn for 2013) which gather local savings might be significant obstacles in

promoting private sector bonds.

Since 2009, only one company issued corporate bonds and listed the issue on BSE, namely GDF

Suez Energy Romania. The other two issuers are two international financial institutions,

European Bank for Reconstruction and Development (EBRD) and European Investment Bank

(EIB) - Luxembourg, but trades with these bonds are few (i.e.: in the past 52 weeks no trade

has been recorded with EBRD bonds and only 3 trades with EIB bonds).

In comparison analysis regarding corporate bonds trades, Czech Republic stands out from the

selected peer countries, supported mainly by a large number of listed corporate bonds.

Shares and corporate bonds turnover

Source: Source: Warsaw, Prague, Bucharest, Budapest Stock Exchanges websites, BRD-GSG Research

Thus, GDF Suez Energy Romania raised RON 250m through 5-year corporate bond issuance,

with coupon rate of 7.4% p.a. We believe that a major influence in companys decision to issue

bonds might be related to the fact that GDF Suez SA, the majority shareholder of the GDF Suez

Energy Romania, has a tradition in issuing corporate bonds and notes. Please see below the list

of notes/bonds issued be GDF Suez and/or its affiliates, totaling EUR 30.88bn (46.9% of total

companys debt worth EUR 65.81bn) as of end-Jun12:

4 For more details on local government securities market, please refer to our Occasional Paper Developing the government securities market published on 28 Nov12.

2011 Shares turnover (EUR bn) Bonds turnover(EUR bn)

Poland 65.09 0.20

Czech Republic 15.09 25.55

Hungary 13.79 1.04

Romania 2.35 0.13

Local corporate bond market has only three issuers, out of which one listed in Nov12

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*As of 26 Nov12, # YTW is yield to worst; OAS is option-adjusted spread Source: FactSet, BRD-GSG Research

As we have already mentioned, another important criterion in deciding between loans and

bonds is the term for which financial resources are needed. Usually, corporations prefer

bank loans for short-term financing, whilst corporate bonds are issued to finance medium-

term investment projects. The maturity breakdown of corporate loans showed that locally

there is a preference for loans with the maturity between 1 and 5 years.

Some researchers and analysts questioned the evolution of lending criteria which seem to

be tightening, especially when NPLs experience a significant rise. Under current domestic

circumstances, we may see a propensity for corporate bonds issue, although regulatory

bodies should play their role in providing favorable legal framework.

Class/DescriptionAmount Outstanding (EURm)* Reported Coupon Rate Coupon Type Maturity Seniority

Latest Price

Latest YTW#

Latest OAS to LIBOR#

GDF SUEZ SA 6,387.6 -- -- -- Senior Unsecured -- -- --

Glow Energy Public Co Ltd - 3b THB 74.4 3.140% Fixed 2012 Senior Unsecured 100.01 2.80 --

Belgelec Finance SA - MTN 300.0 5.500% Fixed 2012 Senior Unsecured -- -- --

GDF SUEZ SA - 975m CHF - EMTN 811.7 3.500% Fixed 2012 Senior Unsecured 100.17 1.11 110.97

GDF SUEZ SA - MTN 910.3 4.750% Fixed 2013 Senior Unsecured 100.95 0.76 58.10

GDF SUEZ SA - 18b JPY - FRN 177.8 1.396% 3-month LIBOR+120 2014 Senior Unsecured -- -- --

Belgelec Finance SA - 340m CHF 283.1 3.250% Fixed 2014 Senior Unsecured 105.70 0.49 29.64

GDF SUEZ SA - 65b JPY 641.9 1.170% Fixed 2014 Senior Unsecured 100.00 1.17 56.09

GDF SUEZ SA - EMTN 1,400.0 6.250% Fixed 2014 Senior Unsecured 106.50 0.65 13.03

Electrabel SA - EMTN 600.0 4.750% Fixed 2015 Senior Unsecured 109.17 1.13 57.44


Belgelec Finance SA - Series B 750.0 5.125% Fixed 2015 Senior Unsecured -- -- --

GDF SUEZ SA 1,000.0 1.500% Fixed 2016 Senior Unsecured -- -- --

GDF SUEZ SA - MTN 1,500.0 5.625% Fixed 2016 Senior Unsecured 114.95 0.80 23.36

Glow Energy Public Co Ltd - 1600m THB 39.7 4.560% Fixed 2017 Senior Unsecured 103.20 3.84 --

GDF SUEZ SA - 300m CHF 249.8 1.500% Floating 2017 Senior Unsecured 103.65 0.74 37.71




Glow Energy Public Co Ltd - 1400m THB 34.7 4.770% Fixed 2019 Senior Unsecured 101.61 4.50 --

Glow Energy Public Co Ltd - 2b THB 49.6 4.720% Fixed 2019 Senior Unsecured 102.05 4.37 --

GDF SUEZ SA - EMTN 1,200.0 6.875% Fixed 2019 Senior Unsecured 130.53 1.62 53.54

GDF SUEZ SA - MTN 1,000.0 3.125% Floating 2020 Senior Unsecured 108.14 1.89 59.25

E-CL SA - 400m USD 315.2 5.625% Fixed 2021 Senior Unsecured 111.38 3.98 259.10

GDF SUEZ SA 500.0 4.078% -- 2021 Senior Unsecured -- -- --

GDF SUEZ SA - 700m GBP - EMTN 865.1 6.125% Fixed 2021 Senior Unsecured 123.31 2.87 129.90


SUEZ Environnement Co SA - MTN 750.0 4.125% Fixed 2022 Senior Unsecured 113.92 2.46 83.20



Belgelec Finance SA - Series C 1,000.0 5.750% Fixed 2023 Senior Unsecured 127.50 2.70 99.69

GDF SUEZ SA - 15b JPY 148.1 3.180% Fixed 2028 Senior Unsecured -- -- --

GDF SUEZ SA - 500m GBP - EMTN 618.0 7.000% Fixed 2028 Senior Unsecured 139.70 3.63 125.37

GDF SUEZ SA - 1.1b GBP - EMTN 1,359.5 5.000% Fixed 2060 Senior Unsecured 108.11 4.58 166.53


International Power Finance II Ltd 230.0 3.250% Fixed 2013 Senior Conv. 38.55 -- --

International Power Finance Jersey II Ltd 700.0 4.750% Fixed 2015 Senior Conv. 108.50 -- --

International Power Plc - 252.5m USD 180.4 3.750% Fixed 2023 Senior Conv. 38.55 -- --

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Corporate loans maturity breakdown Expectations for corporations lending criteria evolution

Source: NBR, BRD-GSG Research

Source: 2012 NBR Financial Stability Report, BRD-GSG Research

A major role in promoting corporate bonds on local market should be played by regulatory

authority. Locally, Private Pension System Supervisory Commission (CSSPP) published on 10

Oct12 a proposal to amend current regulation regarding the investments of private pension

funds. One of the amendments proposed refer to corporate bonds investments criteria, as

pension funds will acquire corporate bonds issued by investment grade issuers and/or

investment grade parent companies of the issuer. Few local corporations have credit rating

assigned, so in case local corporations would like to issue corporate bonds they should apply for

a credit rating with specialized rating agencies. This will translate in additional costs related to

rating assignment and monitoring. Although, the proposed amendment to regulation aims to

minimize the investment risk of private pension funds, this is expected to have a negative impact

on the enlargement of local corporate bonds market.

Probably, if incentives (e.g.: fiscal incentives) for those corporations looking for a rating

assignment are given, a pale support for private bonds is granted. Moreover, lower commission

and fees related to the issuance of bonds and/or equity, maintenance and listing of the issuance

that should be paid to different capital market authorities might be another motivation for

corporations to use capital market as financing method.

3. Equity financing

Beside own financing resources and debt, a company could use fresh equity as a third source for

financing growth. If the company decides to raise equity and goes listed also (IPO), the firm will

gain access to further resources. Moreover, once listed, companys majority shareholders might

decide to exit, an operation easy to be performed by launching an SPO (secondary public

offering).

As we mentioned above, Myers&Majluf (1984) suggested when formulated pecking order theory

that managers prefer financing methods with the least potential information content (internal

funds) and have the lowest preference for the form with the greatest potential information

content (public equity offerings). Also, once a company becomes public, it is expected to

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12

Maturity > 5 year Maturity > 1 year and < 5 year Maturity < 1 year-40.0

-20.0

0.0

20.0

40.0

60.0

80.0

100.0

Q4'07 Q2'08 Q4'08 Q2'09 Q4'09 Q2'10 Q4'10 Q2'11 Q4'11 Q2'12

Romania (%)

Eurozone (%)

Favorable fiscal and specific investment regulations should be supportive for developing local corporate bonds market

Generally, equity offerings are the least preferred method by corporations to raise financial resources

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improve corporate governance and transparency as they have to keep investors informed about

its projects and operations.

The advantages and disadvantages of equity and debt used as financing method for a firm are

summarized below:

Debt

Equity

Pros

Avoiding dilution of shareholders stake Predictable costs Lower issuing costs Interest expense is tax deductible resulting in lower tax income base, namely tax shields Lowering weighted average cost of capital (WACC)

No periodical cash outflow affecting companys cash flow Improving firms leverage

Cons Periodical payments of interest and principal affecting the free firm cash flow Higher firm leverage Higher business risk Lower financial flexibility

Higher issuing costs Capital dilution No tax shields Increasing WACC

Source: BRD-GSG Research

The first and easiest way to use equity as a financing source is to reinvest current profits, if the

shareholders accede to renounce at their annual dividend payment or to receive a smaller

amount. The second method is to raise new capital from old and/or new shareholders by issuing

new shares.

In the first case the costs and time consuming are limited, but also the amount that could be

raised. However, the method was frequently used by companies in early growth stage.

A relevant example from our local market is the case of Banca Transilvania (TLV) which

successfully used this method in the last 15 years and developed from a small bank up to the top

five league of Romanian banking system. Listed to Bucharest Stock Exchange back in 1997, the

bank used to capitalize its profits by distributing bonus shares, or issuing new shares at

preferred prices for its old shareholders and also attracting new ones. We have inserted Banca

Transilvania (TLV) stock price evolution chart and the history of share capital increase

information.

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Banca Transilvania (share price evolution), where s stands for the split operation

Source: FactSet Note: Banks share capital increased by RON 962.61m between 6 Apr04 and 22 Apr08 (shareholders meeting dates, 20 Sep04 and 16 Sep08 modification dates) followed by face value consolidation operation (from RON 0.1 to RON 1). Between 28 Dec09 and 13 Jul12 (modification dates) banks raised its share capital by RON 843.35m.

Source: FactSet

We notice that the downward adjustment of TLV stock price following share capital increase

operations was short-lived, and positive performance of the stock has been posted if general

market conditions allowed it. Moreover, cumulative return (please see table below) between 6

Apr04 and 22 Apr08 calculated for BET (+131.8%) and TLV (+439.7%) show that banks stock

performed better compared with BET for the period, in spite of several adjustments following

share capital increases. For the period 28 Dec09 and 13 Jul12 the banks stock earned less than

BET, but we believe risk aversion towards financial assets played a major role in obtaining this

result.

Cumulative return (%) for BET and TLV

Source: FactSet, BRD-GSG Research

For projects implying a significant capital injection the most appropriate method is to raise new

equity from current and/or new shareholders. Although, companies could use this financing

alternative by negotiating with specialized investors like private equity funds, usually the method

is associated with a company planning to go public or already listed companies. A company could

initially tap the equity market by launching an IPO and then floating its shares to a stock

exchange.

Splits - Cumulative Split Factor: 0.259

17-May-2012 (1.0729 For 1) Bonus Issue: 0.07294 new shares for1 existing share18-May-2011 (6 For 5) Bonus Issue: 0.200102 new shares for 1existing share12-May-2010 (1.2875 For 1) Rights Issue: 0.110463 new shares @1 RON for 1 existing share; Bonus Issue: 0.25 new shares for 1existing share17-Sep-2008 (1 For 10) 14-May-2008 (1.6915 For 1) Bonus Issue: 0.6841 new shares for1 existing share09-May-2007 (1.5038 For 1) Rights Issue: 100 new shares @ 0.35RON for 1000 existing shares10-May-2006 (1.6010 For 1) Rights Issue: 0.15 new shares @0.35 RON for 1 existing share; Bonus Issue: 0.509 new shares for1 existing share27-Apr-2005 (1.7220 For 1) Rights Issue: 100 new shares @ 4000ROL for 1000 existing shares; Bonus Issue: 673 new shares for

1000 existing shares19-Apr-2004 (51 For 40) 27.5% Stock Dividend22-Mar-2004 (1.0476 For 1) Rights Issue: 1 new share @ 3500ROL for 10 existing shares16-Apr-2003 (1.3615 For 1) 36.150002% Stock Dividend16-Aug-2002 (1.0133 For 1) Bonus Issue: 0.013 new shares for 1existing share13-Mar-2002 (9 For 5) 80% Stock Dividend

Ticker BET TLV Calculation period

Cumulative return (%) 131.8% 439.70% 6 Apr'04 - 22 Apr'08

Cumulative return (%) -1.2% -25.05% 28 Dec'09 - 13 Jul'12

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Out of the countries in CEE region, Polish capital market is by far the most successful story as

financing channel in the region. The Polish Government has chosen to privatize major state-

owned companies by selling minority stakes using the means of the stock exchange. Besides

successfully using raising equity method as a viable alternative for state-owned companies

financing, the decision had also several collateral benefits: constructed a solid local investors

base, encouraged also private companies to come to the stock exchange to seek financing and

contributed significantly to the development of the local stock exchange which now competes

with traditional European exchanges like London and Vienna to attract both issuers and

investors.

In 2009, other three CEE markets i.e. Prague, Budapest and Ljubljana grouped around Vienna

Stock Exchange and formed an alliance, CEE Stock Exchange Group (CEECEG) aiming to

coordinate efforts for strengthening their international positioning among regional capital

markets. The results were already visible in 2010 when the amounts raised using capital markets

means (IPOs, SPOs, and share capital increases) experienced a significant growth on all the

three markets, as is depicted in the charts below.

IPO value in Poland 2005-2011, EUR m:

Source: IPO Watch Europe reports - PwC, BRD-GSG Research

Total raised capital* in Czech Republic, Hungary and Slovenia, EUR m:

*Includes IPOs, SPOs, share capital increases Source: CEE Stock Exchanges Group, BRD-GSG Research

Romanian market didnt benefit either of a strong Government support in developing the equity

market as Poland, or of the alliance with a strong, developed neighbored market. The

Government program aimed to sustain the privatization of state owned companies through

capital market means had a modest start in 2006-2007 with two IPOs gathering EUR 100m,

representing the selling of 10% of the national monopoles for gas and power transport, then the

projects pipeline has been postponed one year after another. Additionally, the beginning of the

financial crisis in 2008 together with the unsuccessful closing of some IPO-s discouraged

potential private issuers. Currently, Romanian equity market stands a few steps behind its peers

from CEE region in terms of market capitalization related to GDP and transactions volume as

well.

1,740

1,045

2,021

2,502

1,594

3,770

2,067

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2005 2006 2007 2008 2009 2010 2011

EUR m

0

50

100

150

200

250

300

2009 2010 2011 H1'12

EUR m

Czech Republic

Hungary

Slovenia

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Mk capitalization as % of GDP:

*2012e GDP, Mk capitalization as of Oct12 Source: Stock Exchanges websites, Eurostat, BRD-GSG Research

IPO value in Romania, EUR m

Source: www.kmarket.ro, BRD-GSG Research

After a scarce capital raising in 2009 (EUR 3.3m) and 2010 (EUR 1.4m) and no offers in 2011,

this year started modestly with a SPO of Transelectrica placing shares of EUR 37m. However, in

2012 the state selected the managers for some major IPO/SPO projects (Romgaz, Hidroelectrica,

Nuclearelectrica, Transgaz) which will be probably launched in 2013. This might be the impulse

that local capital market needs to break the vicious circle from past few years when investors

base narrowed in the absence of a solid issuers pool leading to declining liquidity which also

discouraged potential private issuers.

Times are changing, as well as habits and needs, and many corporations dont have

the ability to make the necessary transformations to adapt their business to new

market and regulatory environment. In Europe, the deleveraging process of banks,

more restrictive lending criteria as a result of capital requirements regulations had

determined companies to issue bonds for financing their projects. What today might

seems to be only a wish, tomorrow might turn into a necessity. In some years we

might be forced to pay more attention to medium-long term financing decision.

2008 2009 2010 2011 2012e*

Bulgaria 17.94 17.27 15.25 16.04 9.32Czech Republic 26.57 34.64 36.85 26.54 28.51Hungary 12.72 23.08 21.49 14.65 17.39Poland 30.70 56.09 56.72 39.31 43.88Romania 8.32 16.12 19.26 12.01 14.27Slovenia 22.74 23.79 19.74 13.47 13.00Slovakia 6.02 5.65 4.72 5.28 4.89Average 17.86 25.23 24.86 18.19 18.75 0

10

20

30

40

50

60

70

2005 2006 2007 2008 2009 2010 2011

EUR m

Occasional Paper

Page 13 of 15

References

1. CFA Program Curriculum (2012), Corporate Finance, Level II, Volume III, pg. 122,

Pearson Publishing House.

2. Damodaran A. Debt and value Beyond Miller-Modigliani, Stern School of Business,

pages.stern.nyu.edu/~adamodar/pdfiles/country/levvalue.pdf.

3. Dragota V., Ciobanu A., Obreja L., Dragota M., (2003) Management financiar vol. 2 ,

Ed. Economica.

4. Dragota M., (2006), Decizia de investire pe piata de capital Ed. ASE

5. Fabozzi F., CFA, Peterson P., (2003) Financial Management and Analysis, John Wiley &

Sons.

6. Luengnaruemitchai P., Lian Ong L., (2005), An Anatomy of Corporate Bond Markets:

Growing Pains and Knowledge Gains, IMF Working Paper.

7. Modigliani F., Miller M., (1963), Corporate Income Taxes and the Cost of the Capital: a

Correction, American Economic Review, Vol 3:433-443.

8. Myers S., Majluf N., (1984) Corporate Financing and Investment Decisions when Firms

Have Information that Investors Do Not Have, Journal of Financial Economics no.

13:187-221.

Occasional Paper

Page 14 of 15 Appendix

Source: BSE, Warsaw Stock Exchange, NSC, Central Depository, Polish National Securities Depository, Polish National Securities Depository websites as of 28 Nov12

Polish market fees Romanian market fees

Warsaw Stock Exchange Bucharest Stock Exchange

One off fees for admision to trading One off fees for admision to trading

Shares IPOFixed fee for processing admision request, all instrument types RON 1200, exempted until 31.12.2012

- fixed fee PLN 6000 Admission to trading fixed fee

- variable fee 0.03% of issue value, min PLN 8000 - max PLN 96000 Shares

min RON 3000 max RON 21000, depending on shares category and share capital size, exempted until 31.12.2012

Bonds

min RON 1500 max RON 10500, depending on bonds category and issue size, exempted until 31.12.2012

Shares SPO Shares IPO and SPO - fixed fee PLN 1500 - variable fee 0.135% of issue value

- variable fee0.0075% of issue value, min PLN 5000 - max PLN 96000 Bonds IPO

- variable fee 0.007% of issue valueDebt instruments, other than TB Bonds SPO

- variable fee*0.0075% of issue value, min PLN 5000 - max PLN 30000 - variable fee 0.0216% of issue value

* reduced by 20% if the issuer has other instruments listed (shares or rights)

Rights to shares - fixed fee PLN 10000Pre-emptive rights - fixed fee PLN 3000

Annual fees Annual fees

Shares - First year after listing Shares

min RON 3000 max RON 21000, depending on shares category and share capital size, exempted until 31.12.2012

- variable fee0.015% of issue value, min PLN 4000 - max PLN 48000 Bonds

min RON 1500 max RON 10500, depending on bonds category and issue size, exempted until 31.12.2012

Shares- next years

- variable fee0.02% of market value, min PLN 9000 - max PLN 70000

Debt instruments, other than TB

- variable fee 0.002% of issue value, min PLN 500 - max PLN 7500

Polish National Securities Depository Central Depository

One off fees for securities registration One off fees for securities registrationShares Shares IPO

- variable fee0.01% of market value, min PLN 3000 - max PLN 100000 - variable fee 0.004% of offer value

Convertible bonds or rights to shares Shares of state owned companies SPOs


Bonds Fixed income instruments - IPO


Other securities Annual fee

- variable fee0.012% of market value, min PLN 3000 - max PLN 100000 - fixed fee

min RON 700 - max RON 120000, depending of shareholders number

Polish Financial Supervisory Commission NSC

One off fees for public offers One off fees for public sale offersShares and othe equity instruments -fixed fee for prospectus analysis RON 1000 - variable fee 0.06% of offer value, max EUR 25000 SharesNon equity securities - variable fee 0.5% of offer value - variable fee 0.03% of offer value, max EUR 25000 Bonds

- variable fee no fee - fixed fee for securities registration with NSC RON 1000

Occasional Paper

Page 15 of 15

BRD-GSG - Research +40 21 301 6850 [email protected]

Florian LIBOCOR Chief Economist Head of Research +40 21 301 6869 [email protected]

Carmen LIPAR Head of Financial Markets Research +40 21 301 4370 [email protected]

Laura SIMION, CFA Equity Analyst +40 21 301 4461 [email protected]

Roxana HULEA Economist +40 21 301 4472 [email protected]

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2012.12.04 Occasional Paper - Financing Diversification on Local Market Between Wish and Necessity

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