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Slovenia is the most developed economy in eastern Europe, and provides perhaps the most interesting test of whether the region's industry can reorganize to survive the rigours of the free market. Unlike the rest of eastern Europe, Slovenia rejected the notion that multinational investment was a prerequisite for restructuring. Instead, employees and management were allowed to decide how their companies were privatized, and were allocated shares at big discounts. The government believed that restructuring and recapitalization should take place in the secondary market with the employees and other domestic shareholders playing the leading role.
Yet the scheme remains incomplete, two and a half years after its formal launch. Evidence is growing that it was over-ambitious and that the after-effects could stifle growth, which fell from 5% in 1994 to 3.5% in 1995.
The decision to put employees at the centre of privatization reflects Slovenia's inheritance. The 1,500 factories being sold were not state-owned under communism; they operated instead under the Yugoslav system of self-management, which gave employees and management free rein in deciding how they were run. Many Slovenian companies obtained western technology through licensing agreements in the 1970s and 1980s, and by the end of the 1980s the EU was already the Slovenian republic's main export market. Most companies had marketing departments and a finance function notions unheard of in the rest of eastern Europe. All this engendered a spirit of free enterprise and understanding of consumer needs that was wholly absent in the rest of eastern Europe at the fall of communism. It meant that Slovenian companies were in theory the best placed of all in the region to survive without foreign partners.
These advantages were eroded during the first half of the 1990s because most companies ceased investing: partly because of the uncertainties created by the break-up of Yugoslavia and partly because of the sudden loss of markets at independence in 1991. Past success bred complacency among Slovenian companies while rapid restructuring in the rest of eastern Europe pinning its future on exporting a similar range of products to the EU eroded their competitive position. The terms of trade worsened between 1993 and 1995 when the tolar appreciated nearly 30% in real terms against the dollar. Slovenia's average wage of just under $535 per month (nearly double Hungary's or the Czech Republic's), combined with employer social security contributions of 100%, made life particularly difficult for labour-intensive industries.
In the first half of the 1990s there was also a confusing debate about the best way to conduct privatization. Managers and employees lobbied for total control, but the privatization law that resulted from two years of bitter argument was a compromise that gave all Slovenians a chance to buy shares. The scheme relied on vouchers given free of charge to everyone, including children, with face value indexed to age. Employees and their families could use them to buy into companies where they worked. Vouchers could also be invested in voucher investment funds or used to purchase shares in the 100-plus companies that opted for public share issues as part of their privatization programmes. Implementation was delayed several times, but by mid-1996 virtually all companies had either completed the process or had nearly done so.
A handful of companies have pressed ahead with modernization. Leading the way is Krka, a pharmaceuticals manufacturer with sales of $300 million in 1995. According to deputy chief executive Joze Colaric, Krka maintained its investment programme despite the distractions of the first half of the 1990s. Its aim was to cement its position in its core market the former USSR and other eastern European markets by restructuring and developing its sales force in those areas. It is planning to move a step further by opening production facilities in countries where it has big export sales. Next year it will open a greenfield production and packaging plant in Poland costing $10 million, to be followed by similar investments in the Czech Republic and Croatia.
Krka's share structure post-privatization is typical of larger Slovenian companies. Management and employees own 23.6%, while other individual investors bought 33.4% through a public share issue. Investment funds were allotted 40.25% and the remaining shares are controlled by suppliers. There is already grey-market trading in Krka shares, which should be listed on the Ljubljana Stock Exchange later this year or in early 1997.
Krka is one of more than 100 large companies that completed public share issues as part of privatization and which will eventually be listed on the stock exchange or be traded over the counter. Kolinska, a food processor, was the first to be listed and another 10 companies followed its lead. These companies seem to have continued to operate as they did under socialism, with management remaining uneasy about outside shareholders.
Typical of this approach is Mercator, Slovenia's leading supermarket chain, which has a group turnover of more than $1 billion. It sold 60% of its stock through a public offering in exchange for vouchers and had just over 60,000 shareholders at privatization. Its shares are exchange-traded and have risen from Tr900 ($7.50) to over Tr5,000. "They have to be considered by any international investor looking at Slovenia. It is a big company and retail trade is important here," says Gregor Kastelic, analyst at Banka Creditanstalt in Ljubljana.
But Mercator has problems. Its stores are dowdy and its goods predominantly domestically produced many by its subsidiaries. It needs to invest heavily to fend off competition from the large number of private shops that have opened in the past five years or indeed to win back the custom of Slovenians who drive to Austria or Italy to buy their groceries. This year, Mercator has improved efficiency by rationalizing its trading divisions, but how it intends to modernize is not publicly known. "It is very hard to get information management do not like talking about their strategic plans," says Kastelic. "This is quite typical of Slovenian companies, although things are better than they were a year ago."
Deterrents
The reluctance to reveal information is one of several features of Slovenian companies that have deterred foreign portfolio investors. Observers warn that since domestic investors are likely to be net sellers of stock over the coming years, industry could be starved of capital. "Some Slovenian companies have been paying extremely high dividends instead of investing, and they could run into liquidity problems," says Leonardo Peklar, general manager of consultancy company Socius. "Their dividend policy should not jeopardize the future of the company. Dividends should be within the margins of free cashflow: the difference between net income of the company and necessary investments."
Another turn-off for foreign investors is gaps in Slovenian legislation. There are no rules on mergers and takeovers; a law on this was promised in 1994 but has been continually delayed. Some companies, such as pharmaceuticals maker Lek, have reacted by amending their statutes to place a cap on the maximum vote of any one shareholder.
Worst of all, it is not even clear whether foreign portfolio investors can repatriate earnings: Slovenia's foreign investment legislation dates to 1988 and was drawn up with direct investors in mind. This issue is the responsibility of the central bank in public it praises free markets but in private it brands foreign portfolio investment as a threat to sovereignty.
In the seven years since the stock exchange opened, there has been only one attempt to attract foreign portfolio investment and only one rights issue. In late 1994, SKB Banka, Slovenia's largest private bank, raised new capital through a share issue that brought in the European Bank for Reconstruction and Development and western portfolio investors. The shares trade offshore in the form of depositary receipts issued by Merrill Lynch.
Although analysts expect larger companies to become more investor-friendly when they realize they can raise new capital on the stock exchange, most are likely to rely on debt finance for immediate needs. Many companies entered the private sector with no debt at all or low gearing. With inflation below 10%, domestic bank loans are much cheaper than they were two years ago, while Slovenia's single-A long-term debt rating means the largest corporates can borrow abroad at less than 100 basis points over Libor. Mercator and Petrol, the Slovenian oil distribution company, have held talks about issuing bonds.
There are much bigger problems for the small and medium-sized companies which make up most of Slovenian industry. Most have had no public share issue and management and employees control 60% of the stock, which they paid for partly with vouchers and partly with cash (they were allowed to buy shares at a 50% discount to face value by instalments over five years). Most companies have shareholder agreements whereby management and employees elect a proxy before the general meeting and vote their combined 60% stake as one block. In practice, this makes management power near absolute. Of the remaining stock in any particular company, 10% is held by a state restitution fund, 10% by the state pension fund and 20% by private investment funds, which collected vouchers. These passive investors are natural sellers of stock. The restitution fund needs to service bonds issued to the owners of properties nationalized after World War II. The pension fund has said it intends to reduce its portfolio from over 1,500 companies to hundreds. The private voucher funds inherited abnormally diverse portfolios they want to slim down, and they need cash to pay their costs and earn their fees.
According to Socius's Peklar, these companies' greatest immediate need is simply basic administrative know-how: "They need to have an appropriate structure for their supervisory boards, with experts who would complement the knowledge and experience available within the company. Such a supervisory board could put reasonable pressure on management, rather than friends of the general manager."
In theory, private investment funds should do part of this. But they constitute the most controversial aspect of privatization and are a disappointment for government and ordinary Slovenians alike. Some 1.2 million people 60% of the population opted to entrust all or part of their certificates to funds run by 20-plus management companies with a combined book value of Tr250 billion. Two years after the first marketing campaigns, the funds still have teething problems. They were due to be allocated shares through auctions, but these were botched and most funds are still capitalized mainly by vouchers rather than equity.
Voucher funds short-changed
This problem will not go away, because bankruptcies over the past three years have wiped out $1 billion of equity that was due to be allocated to vouchers. The funds have lobbied to be allocated the government's stakes in the two largest banks, Nova Ljubljanska Banka and Nova Kreditna Banka Maribor, and in public utilities such as telecoms. The government, however, would prefer to sell these shares for cash. Most funds now expect that they will be exchange-listed in late 1997 or 1998 at the earliest. Analysts are predicting that they will open for trading at big discounts to book value, while the original investors dominated by pensioners, the unemployed and the poor are furious that the process is taking so long.
"The funds in Slovenia are not like those in the west, because they have a huge number of securities that are not listed anywhere," says Peklar. "The funds which restructure their portfolios and start to act as consulting companies and provide know-how will be much more successful than those that push for high dividends or launch lawsuits."
The funds have liquidity problems and managements think they hinder rather than help restructuring. The law requires 75% of shareholders to be in favour of a capital increase, and investment, pension and restitution funds have successfully blocked attempts to carry out rights issues.
One of the few management companies to have restructured its portfolio is Aktiva Avant, which was established by a local trading company and Vienna-based investment bank EPIC. Aktiva set up three funds with a combined book value of Dm140 million ($95 million). Aktiva director Ales Okorn says these funds acquired stakes in 35 companies: three have been sold for cash; the stakes in four companies have been consolidated; and four have been sold by swapping equity with the state pension fund or other private investment funds. Aktiva has also initiated the restructuring of a smaller company in its portfolio, a Ljubljana-based firm that trades optical equipment. "We increased our stake from 20% to 51% by buying out the other funds and acquiring some shares from the employees," says Okorn. "We changed the management and the company has been reorganized. Since then, sales have risen 70% and profits are up 300%. We hope to repeat this at one of the larger companies in which we have a stake."
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