Chairman annual letters

Fellow shareholders,

I begin this letter with a thank you to Irakli Gilauri, the founding Chair of GHG. While serving as CEO of the Bank of Georgia, he recognised the potential for building a modern healthcare company serving Georgia. He led the spinout in 2015 and attracted US$100 million in capital to create a first-class nationwide healthcare network. He assembled a management team and a board capable of delivering quality care and creating value in what is now the largest private employer in the Georgia. Irakli has stepped down as chair but remains an active board member. I am honoured to succeed him.

The overall economic picture in Georgia remains a promising one for our company. The economy grew at estimated rate of 4.7% in 2018, with annual average inflation at 2.6%. Per-capital GDP is estimated to have grown to US$4,345. The EU-Georgia Association Agreement and related Deep and Comprehensive Free Trade Agreement lay solid groundwork for more economic opportunities as Georgia continues to deepen its commitment to European standards and norms. Looking east, the Free Trade Agreements with China and Hong Kong should create export opportunities and increase FDI.

The country consistently ranks well on indicators of governance and doing business. It ranks just 6th out of 190 countries for the latter, up from 9th from last year. Strong anti-corruption policies and the Government’s active engagement to attract international investors with tax and legal incentives, positions the country on a par with many European Union member states.

Implementation of progressive healthcare policies and public health measures appears to command broad support. Georgia government has more than doubled its healthcare spending to 3% of GDP (total spending on healthcare at US$324 per capita). We see significant growth potential; government spending in most countries with a universal healthcare system are above 5% of GDP.

Against that backdrop, I’d like to highlight three of the ambitious goals we have for the company:

1. Fully realise the quality and financial performance potential of our hospital, clinic and retail networks.
We have created a modern healthcare and retail networks. Our priority now is to fully utilise that capacity, drive continuous improvement in clinical quality and productivity and generate cash. These networks provide important scale economies for procurement, operating productivity and platforms for patient/customer satisfaction and clinical quality performance. Nikoloz Gamkrelidze, our CEO, has modernised his management structure to ensure accountability for operating, quality and financial KPIs in each of our lines of business. He continues to deepen and develop our pool of general managers and functional leaders.

2. Grow profitably.
We have a promising portfolio of growth opportunities, most of which will be realised with minimal capital. Our retail pharmacy business is pioneering new product concepts and store formats. We are expanding the range of healthcare services to attractive markets, such as dental and diagnostic testing, in which our capabilities can deliver better care and create value. We have begun to build a medical tourism business, targeting consumers in the region for whom Georgia offers superior care at an affordable price in an attractive travel destination. This business, which we are building with a dedicated business model, can generate attractive returns and provide attractive opportunities for our best physicians. We believe the vigorous growth in Georgia’s tourism will be a helpful tailwind. Finally, our digital innovations will provide unmatched capabilities for our customers and patients across our retail, insurance and healthcare portfolio.

3. Contribute to a healthier Georgia.
Our management team is proud of the contributions we make to the healthcare capabilities and infrastructure of Georgia. Each year, we invest on average 11 hours of training per person across our 16,000 employees — mostly on our physicians, nurses, pharmacists and managers. Examples include the residency program designed to deepen the skills in important medical specialties and develop next generation of doctors. We partner broadly with the Georgian government on a variety of educational and public health programs such as screenings and vaccinations, including the recent deployment of a leading-edge e-prescribing capability.

I invite you to read this report to learn more about our company, its performance and its promise.

Dear Shareholders,

In this year’s letter to shareholders, I would like to talk about the Georgian macro environment, GHG’s strategy going forward and our management development programme. Let me address each of these topics separately.

The macro environment

The Georgian Government’s pro-business policies are paying back in terms of macro progress on all fronts. The country has been upgraded to 9th place in the latest World Bank Ease of Doing Business report, and also remains one of the least corrupt countries globally in different indices. The Government’s brave decision to slash corporate profit tax delivered positive results, as we witnessed record high inflows of foreign direct investment through 9M17. At the same time, the Government managed to decrease Georgia’s budget deficit to below 3% of GDP, while boosting infrastructure spending by 45% y-o-y to a record GEL 3.2 billion. Tourism posted a robust performance as tourist arrivals increased by an impressive 28% y-o-y reaching 3.5 million tourists in 2017, while the number of international arrivals was up 19% y-o-y totaling 7.6 million visitors. Goods exports also rose by 29% y-o-y. As a result, GDP grew by nearly 5% in real terms in 2017. Georgia’s free trade agreement with the EU has been instrumental for Georgia. Moreover, the Georgian Government signed a free trade agreement with China, effective from the 1st of January 2018. This means that Georgia can be said to have two new assets, which are not yet reflected in its macro numbers, and which are expected to be utilised more and more over the coming years to drive further growth: free trade agreement with the EU – the largest market globally in terms of GDP size; and free trade agreement with China – the largest market in the world by size of population.

Our strategy going forward

Nikoloz Gamkrelidze, the CEO of GHG, discusses strategic priorities in greater detail in his statement. I plan to emphasise two points: going forward, we would like to increase the utilisation of our services and to run a capex light business model.

A heavy capex programme has been implemented and many sophisticated services have been launched; at the same time the company has increased its market share to nearly 30%. Our current priority is to increase utilisation of these services by continuing to recruit Georgian doctors who work in Georgia or in developed economies. By matching state-of-the-art equipment with highquality doctors, we will be well positioned not only to attract patients locally, but also to export healthcare services to the region. GHG is well positioned to offer high-quality services that are many times cheaper than those of our regional competitors.

Going forward, we are aiming for a capex-light strategy, which has three legs: digitalisation of services, entering into management agreements with third-party hospitals and rolling out of outpatient clinics or what we call polyclinics.

• Digitalisation of services will enable us at the first stage to electronically store patient records, prescribe drugs electronically, and manage our patients’ needs digitally. This will enable us to provide the highest quality of service in a cost-efficient way. 
• GHG as an institution is well-positioned to manage more hospitals, which will give the company even more scale advantage. By managing third-party hospitals, GHG will be earning the fee without putting its balance sheet on the line. 
• Rolling out more polyclinics is another priority for turning capex light. Our polyclinic business is not only high margin, but it is also greatly synergistic with the rest of GHG’s businesses. The polyclinics segment itself is also very attractive because it is highly fragmented, and by scaling it up, we will be expanding our presence in the whole healthcare ecosystem. 

Management development

GHG is operating in multiple business lines and these businesses interact with each other in multiple ways, more than we can see from the top. It is important for management of all business lines to work together smoothly and to be proactive in taking initiatives as an integrated player. This way, management teams will be able to achieve more synergies and further enhance value creation. In order to promote a collaborative culture, together with other development projects, our CEO has initiated a programme encouraging management to give and receive feedback in a constructive manner. This initiative will enable the organisation to move towards a more decentralised decision-making system and will support a more proactive and creative culture across the organisation, building further value for the shareholders.

Finally, I would like to thank my colleagues on the Board, our management, and most importantly you, our shareholders, for your support and your dedication to GHG and to Georgia.

Dear Shareholders,
   I am honoured to report that GHG delivered an excellent year in 2016 in a number of important areas. I want to particularly emphasise three of those. First, GHG delivered an exceptional performance on the strategy announced at the time of its IPO in November 2015, building on an unprecedented period of growth over the past two years. Second, GHG diversified into the pharma business – an important move to unlock more value from our business, and solidify GHG’s leading position in the healthcare ecosystem in Georgia. Last, but certainly very important, GHG’s management team continued to get stronger at the senior and middle management level – growing our management team is a priority of ours and I am particularly proud to see such meaningful progress in this direction.
   You can see the details of the financial performance, execution perspective and business priorities at a granular level in the CEO letter later in this report. I would like to cover four important points in this letter:
- the key drivers of GHG’s growth in 2017 and beyond;
- GHG’s growth prospects are supported by attractive macro-economic performance and the Georgian Government’s healthcare policy;
- robust corporate governance drives our returns; and
- GHG’s management team is growing stronger than ever.

The key drivers of GHG’s growth in 2017 and beyond
   We will continue the development of new, high-quality medical services in Georgia, particularly focusing on elective care, to cover existing service gaps. Despite significant recent reforms in the Georgian healthcare system, there are still many service gaps in Georgia which, as the largest provider of healthcare services in the country, GHG is focused on covering. These are services which either do not exist or are currently of low quality. Patients often bridge this gap by travelling to hospitals abroad, the spending on which is estimated at approximately US$ 100 million. Covering medical service gaps in Georgia by developing new services and institutionalising improved quality makes us proud of the work we do for our patients. We strongly believe that by investing in the healthcare market in Georgia, we will support an increase in the quality of care for the Georgian population, throughout the country. During 2016, we have launched over 60 new services in different locations and many more are under development. You will have an opportunity to read more about the service gaps and what we do to cover them later in this report.

   We will continue the roll out of our outpatient clinics, because this is a highly fragmented and underserved market where we see a significant opportunity for growth. During Soviet times, we used to have “polyclinics” in Georgia. They were many – in neighbourhoods close to home. Citizens were assigned to one of those “polyclinics” for all kinds of outpatient services. With the collapse of the Soviet Union, many “polyclinics” closed, some significantly shrank and all became dilapidated. It may seem paradoxical that the Georgian healthcare services sector has seen much investment and development in recent years and yet the market of “polyclinics” or their equivalents is still so underdeveloped. This is because Georgia’s recent healthcare reforms and the subsequent investments were primarily targeted at hospitals to ensure the population had access to the much needed hospital level care. GHG is already the largest provider in this segment with the outpatient clinics that are the first of their kind in the country, but in a way our clinics are a modern version of the well-known concept of “polyclinics”. We see the same opportunity now in the fragmented outpatient sector that we saw in the hospital business a number of years ago. We aim to grow footprint and utilisation quickly, to achieve by 2018 c.5% market share of this market that is expected to be valued at approximately c.GEL 1 billion. We aim to significantly increase cross-referral synergies with our pharmacies and medical insurance to drive high utilisation of our “polyclinics”.

   Investing in information systems will be our next priority to identify ways in which we can provide better service to our patients and deliver more value to our shareholders. With the scale and diversity of GHG’s business, we are best positioned to lead the way in the digitalisation of patient records in Georgia. We have made this a key priority and are taking significant steps to make it happen. I am glad that we have a strong IT team that will lead this very important transformation throughout the organisation.

GHG’s growth prospects are supported by attractive macroeconomic performance and the Georgian Government’s healthcare policy:
   During 2016, Georgia once again demonstrated its commitment to European standards and norms by ensuring full and fair democratic parliamentary elections. Georgia has continued to deliver a remarkably resilient economic performance, with real GDP growth at 2.7% in 2016. In addition, Foreign Direct Investment continued to be strong, and tourist numbers – a significant driver of Dollar inflows for the country – continued to rise significantly.

   Georgia is an open and resilient emerging market with a realistic ambition to transform itself into a regional hub economy. Georgia is consistently ranked as a top performer in governance and "Doing Business" indicators, in economic policy and institutional assessments tracked by well-respected international institutions. Georgia was named a top performer globally over the past 12 years in the latest "WB-IFC Doing Business" report. The Government’s four-pillar reform programme, and its deepening economic integration with the European Union is expected to boost the economy’s productive capacity, support further economic diversification and attract more foreign investment. Access to healthcare remains one of the Government’s top priorities. Since the full rollout of UHC in mid-2014, government expenditure on healthcare has grown considerably, increasing to over 100% from GEL 487.9 million in 2013, to GEL 996.0 million in 2016.

Robust corporate governance drives our returns
   In my letter last year, I provided significant detail about the governance structure, the way the Board works and the composition of our Board. A year later, I am particularly proud about the important role that the GHG Board continues to play in growing the institution. Therefore, I would like to highlight several critical thoughts:

   At GHG, we remain strong believers that great institutions are only built with robust governance, and that without it they cannot deliver sustainable value for their shareholders. I am happy that at GHG we have built a Board that is independent, highly engaged, has diversity of thoughts, is able to provide strong oversight together with valuable advice, guidance and coaching to the top and middle-level management teams. I am proud that we continue to enrich the Board and management and continue to attract high quality people with relevant experience in the delivery of quality healthcare.

   We want our managers to act as shareholders, which they are. The remuneration structure that we have for the management at GHG naturally aligns the interests of shareholders and the management team. This is achieved by awarding, as part of their remuneration package, long-term vesting shares (up to five years) to the executive management team and ensuring that this share-based compensation makes up a large proportion (e.g. 80-85%) of total annual compensation. If shareholders make money, the management team makes money and if the shareholders lose money, the management team also loses money. In this way, we create a long-term alignment between the interests of the management team and the shareholders. This structure makes the Board’s job of oversight easier.


GHG’s management team is growing stronger than ever
   Attracting, growing and enabling the management team to perform at their best is our number one priority. Management makes things happen at GHG and I am proud that the majority of our management at GHG has been with us for several years, and the team has grown together with the organisation. From time to time, we also enhance our management team through hiring externally. Still, promoting internally is our preference. GHG’s team is young, motivated, capable and most importantly, eager to learn and do more, dedicated to the performance of the organisation and to helping each other to deliver. We get the benefit of a double effect from GHG attracting talent, and that strong talent attracting great new talent.

   At GHG we have a culture of delegation, accountability and coaching – cornerstones of people development in our organisation. We provide opportunities for our management to grow through challenging and diverse experiences. We do this through promotions and rotations. We are a meritocratic organisation. We value results and we also coach our management to unlock their best potential. Our senior team members have access to leadership coaching. Our middle management has access to targeted courses around management and leadership development, developing into the next tranche of leaders, and enhancing the management team at GHG.

   I am proud to recap 2016, which proved an excellent year for GHG. I am honoured to continue to serve as the Chairman of this great institution and the team, and I look confidently to the future growth of GHG.

I would like to thank all our new shareholders for their support throughout the process. The capital we raised supports our growth plans and our target to double 2015 healthcare revenues by 2018, while achieving c.30% EBITDA margin. This target will be achieved by expanding GHG’s market share in the hospital segment by number of beds from the current 27% level to c.30%. Following the IPO, GHG has already accelerated the complete renovation of two hospitals, and is in the process of rolling out a nationwide chain of ambulatory clinics – the first of its kind in the country – where GHG’s revenue market share is currently just 1% and its aim is to grow this to c.5% by the end of 2018. Introducing new services – treatments which are currently not available in Georgia – will be another contributor to this growth. The Company’s own growth plans are underpinned by the government’s ongoing initiatives to make healthcare more accessible to all Georgians. You will be able to read about how GHG aims to deliver on each of its strategic pillars later in this report.

In this letter I would like to focus on four key topics: 

1. Georgia turns 25;
2. Expansion into pharmaceutical retail and wholesale business;
3. Good governance leads to good returns; and
4. Management make things happen.

In 2015 Georgia celebrated its 25th anniversary as an independent state. Although the country is over three millennia old, it was reborn when the Soviet Union collapsed in 1991. In its recent history Georgia has managed to transform itself from a corrupt and failed state into a young democracy with a rapidly growing economy, supported by a pro-business reforms. Over this period of time, GDP per capita has increased from US$500 to US$3,700 and, over the last 12 years, on the back of the reforms, real GDP has grown by average of 6%. Let me give you a brief summary as to why and how this has happened. Georgia’s independence in 1991 turned out to be a very expensive economic exercise. By 1995, Georgia’s real GDP collapsed to 28% of its 1990 level. This resulted in desperately poor and lawless society with no electricity, no gas, no heating, no telecommunication, no roads and no healthcare. In the 1990s Georgia also fought three civil wars and ended up losing 20% of its land. The second half of the 1990s was marked by declining crime rates, but also widespread corruption, weak state institutions and continued poverty. Therefore, people of Georgia demanded radical change and after the Rose Revolution in 2003, the new government managed to eradicate corruption and initiate pro-business reforms, among which was a reduction of the number of taxes from 21 to only six currently. In addition, the government embarked on a mass privatisation process while building strong state institutions. In 2016, the World Bank named Georgia as the top reformer globally over the past 12 years in its Ease of Doing Business Survey. The country ranks as one of the least corrupt in surveys done by Transparency International, and Trace International and Georgia is consistently ranked as the top performer in country policy and institutional assessments compiled by different organisations. Supported by a corruption-free environment and Ease of Doing Business reforms, the flow of foreign direct investment (FDI) has remained strong, standing at 9.7% of GDP in 2015. In 2012, Georgia took yet another important step towards strengthening its democracy. Following parliamentary elections the country experienced a democratic and peaceful transfer of power – for the first time in recent history. The Georgian Dream coalition won the election and promised a more independent judiciary, an even better business environment, free media and healthcare for the entire population. In three years, the new government has managed to deliver on its promises and its healthcare reform is widely regarded as one of the government’s biggest achievements. The newly appointed Prime Minister has put forth new reform initiatives to boost growth and accelerate foreign investments. These new reforms aim to reduce corporate profit tax to zero, invest more in infrastructure, invest in labour market-driven education and create a single touchpoint for corporates to deal with the government institutions – making it even easier to do business in Georgia. The leading political parties recognise the need for a good business environment to attract FDI, which investment continues to play a crucial role in the country’s success. FDI (Foreign Direct investment) has averaged 10.0% of GDP in the past ten years, and with its businessfriendly environment – ease of doing business, professional and independent state institutions, and a corruption-free environment – Georgia is firmly on the path to becoming the investment and services hub of the region. With visitor numbers growing from 560,000 in 2007 to nearly 6 million in 2015, Georgia has the potential to also become the financial and healthcare services hub of the region. In this very short period of time, the Georgian population has managed to develop and grow the country. I have been closely observing this remarkable transformation and the key take-away for me is the following: unless a corrupt and dysfunctional state goes fully bust, it is difficult to transform it. Once a transformation starts, it is difficult to stop it.

In March 2016 we announced one of our largest acquisitions and a move that marked our expansion into pharmaceutical distribution business. Initially, we did not actively plan to go into the pharmaceutical business Instead we worked on projects to independently secure and optimize our pharmaceutical supply chain for the hospitals, the ambulatory clinics and our medical insurance business. However, when an opportunity to acquire a pharmaceutical distributor presented itself, GHG’s management team saw this as a strategic fit and since they were able to conclude it on very attractive terms, this was to me and the Board a “must-do” deal. Subject to regulatory approvals, GHG signed a binding Memorandum of Understanding to acquire GPC, the third largest pharmacy chain in Georgia. This move supports our aim of being the leading integrated player in the Georgian healthcare ecosystem – a GEL 3.4 billion market. It positions GHG as the major purchaser of pharmaceutical products in Georgia. The acquisition price of GPC implies 5.7 times EV/EBITDA before eliminating unnecessary costs and capturing further cost and revenue synergies. Post-synergy this is reduced to 3.3 times. The pharmacy business will be highly synergistic both to reduce the cost of pharmaceuticals for our hospitals and medical insurance business as well as to crosssell through GPC’s loyalty programme. GPC has c.12 million customer interactions per annum, and a strong brand. GHG will open GPC pharmacies on the premises of its c.40 hospitals and large ambulatory clinics, which is expected to significantly boost the revenue of GPC. The move is strategic and I strongly believe it will create huge shareholder value going forward.

We at GHG, strongly believe that great institutions are only built with robust governance, and that, without it, they cannot deliver sustainable value for their shareholders. We think that a highquality, diverse and independent Board is extremely important for the success of the Company. We see the Board as an institution, which is not only performing its fiduciary duties of management oversight and strategy setting, but also providing guidance and coaching to our top and mid-level executive management team. In the case of GHG, the Board’s role of oversight is made relatively straightforward by naturally aligning the interests of the shareholders and the management team. To achieve this, we award long-term vesting shares (up to five years) to the management team and ensure that share compensation makes up a large proportion (e.g. 80-90%) of total annual compensation. In this way, we create a long-term alignment between the interests of the management team and the shareholders. If shareholders make money, the management team makes money and if the shareholders lose money, the management team also loses money. With this simple approach, in addition to being executives, the management team feels and acts more like shareholders – because they are. Out of nine Board members, seven are independent and six are non-BGEO Group members. The Board meets every quarter to discuss and set strategy, to approve key projects and transactions and to review and approve recommendations from the committees: Audit, Clinical, Remuneration and Nomination. We have a diverse Board. David Morrison is our Senior Independent Board member, who also chairs our Audit Committee. He is well aware of our fiduciary responsibilities, and regulatory obligations, and knows very well how checks and balances work in a public company. His long tenure at Sullivan and Cromwell serves him well in this regard. Neil Janin heads our Nomination and Remuneration Committees. His management consulting work for 25 years with McKinsey serves the GHG Board and management team very well. Neil spends time with the management team to help them brainstorm on different strategic issues and provides invaluable guidance. Neil’s management coaching skills and out-of-the-box thinking serve both the Board and the management well. Both Neil and David have an in-depth understanding of Georgia, as they have been Board members at the BGEO Group for the past 6 years. Tim Elsigood is our hospital guru. He has extensive experience of running hospital businesses in Western, Central and Eastern Europe, as well as in North Africa. Tim knows very well what works and what does not work in the hospital business, which makes it easy for us to understand the strategic priorities for GHG. Dr. Michael Anderson heads our Clinical Quality and Safety Committee. As a doctor, he has great input into how to improve the quality of our services. Ingeborg Oie, a healthcare research analyst and MD at Jefferies and a research analyst at Goldman Sachs, helps us to better understand investors’ ways of thinking and the Company’s long-term strategy. Jacques Richier, another independent director, is CEO of Allianz France. His input in making strategic decisions for our medical insurance business is critical. Allan Hirst’s extensive experience as CEO of Citibank in multiple countries helps us to better understand our government relations strategy. The Board is extremely motivated and engaged in making GHG a successful institution and ultimately creating strong value for shareholders.

Back in 2010 after the global financial crisis, Bank of Georgia’s intention was to divest its insurance subsidiary to raise capital. At the time Nick Gamkrelidze was CEO of our insurance company, Aldagi. Before making the decision to sell, the Board called in Nick to understand his plans in more detail. Nick presented the strategy of entering into the healthcare services sector, consolidating it and integrating it with our existing medical insurance business. The healthcare sector was ten times larger than the insurance sector and totally fragmented. The Board was convinced by Nick that investing in the healthcare business presented a much bigger opportunity than raising money from its divestment. Indeed, after embarking on the healthcare strategy, in less than five years Nick successfully led the transformation of a loss making company into a business with a market capitalization of US$350 million following last year’s successful IPO. Nick is a visionary leader, with great execution skills. He learns fast and develops even faster, and he has not been shy to surround himself with a team of top class executives. The management team of GHG is young, smart, energetic, and gets things done in a fast and efficient manner. The management team has demonstrated that it can grow the business organically as well as through acquisitions. In the past five years the management team has completed over 30 successful acquisitions and integrations. Identifying and eliminating unnecessary costs and extracting synergies is in the DNA of this organisation. In Georgia, we do not have middle names, but if GHG’s management team had one it would be “efficiency”. The management team at GHG is extremely motivated to develop themselves, the Company and the country’s healthcare system. Together with all the employees of GHG, they are not only building a great Company, but more importantly raising the standard of healthcare in the country. I am extremely honoured to have the opportunity to serve as Chairman of this great institution – one that we aim soon to be a billion Dollar company.