Armenia: is the time to invest NOW?


Last week, on January 15th 2015, Moody’s downgraded Armenia’s issuer and government bond rating from Ba2 to Ba3 shortly after the company downgraded Russian government bond rating from Baa2 to Baa3 or as Reuters puts it “just above junk level” (Source: Reuters; Jan 16, 2015). The reasons given by Moody’s for downgrading Armenia’s bond rating are the following:

“1) Armenia’s increased external vulnerability due to declining remittances from Russia, an uncertain outlook for foreign direct investment (FDI), an elevated susceptibility to exchange rate volatility, and expected pressure on foreign exchange (FX) reserves;

2) The country’s impaired growth outlook, compounded by negative growth spillovers from Russia, weak investment activity, and constraints on trade with countries outside the Eurasian Economic Union (EEU) that are expected from Armenia’s recent EEU accession.” (Source: Moody’s Investors Service, Inc. Global Credit Research; Jan 15, 2015)

The World Bank estimates that personal remittances received by Armenians constituted 21.0% of the entire Armenian GDP in 2013 (Source: Personal Remittances; The World Bank Data). According to the International Monetary Fund approximately 89% of those remittances come from Russia. As IMF points out, the remittances from Russia are “a critical source of FX inflows for Armenia, averaging 38% higher than total exports, twice higher than FDI, eight times higher than bank flows, and four times higher than official government inflows to Armenia”(Source: IMF, Remittances in Armenia: Dynamic Patterns and Drivers; 2012). The European Bank for Reconstruction and Development indicates that remittances from Russia shrank in 2014 for the first time since 2009 noting in particular that the remittances to Armenia “slowed down significantly.” (Source: EBRD, Remittances from Russia shrink for first time in 5 years; Sept 18, 2014).

Furthermore, Russia is Armenia’s most important trading partner with roughly 19.6% of the total exports from Armenia going to Russia in 2012 (Source: CIA World Factbook, Armenia). Thus, it is clear that as the Russian economy shrinks – EBRD estimates Russian economy will shrink by as much as 5% in 2015, (Source Financial Times, “Russian economy to shrink 5%, says EBRD”; Jan 19, 2015)- a strong pressure is created on Armenian economy through declining remittances and lower export levels. This in turn explains the Armenian “impaired growth outlook and increased external vulnerability” stated by Moody’s.

However, it is important to also consider the other side of the coin and analyze the opportunities that are created by these recent developments for companies and individuals looking to invest in Armenia. In January 2015 Armenian currency, DRAM, reached its lowest level since August 2006, dropping by almost 10% within December 2014 alone (Source: OANDA Corporation). This makes Armenian assets historically cheap at the moment.

Oil prices, which also reached a historical 6-year-low at the beginning of 2015, are undoubtedly responsible to a substantial degree for the plunge in the Russian economy. However, how long can oil prices remain at such a low level? Speculations behind the reasons for the declining oil price include the current weak demand in Europe, surging US production, Saudi Arabia cutting prices to defend its market share etc. (Sources: Forbes “Why Are Oil Prices Dropping? Nov 11, 2014; BBC, “Falling oil prices: Who are the winners and losers?”; Jan 19, 2015). If we assume the historical cyclicality of the oil price will hold true this time again, we can count on a two year recovery period for the oil price: after the last drop in 2009, the oil price grew by more than 200% within roughly two years (Source: Nasdaq Crude Oil Price Chart). Such a price increase will almost certainly help the economies of major oil producers, including Russia, completely recover. Finally, for the reasons stated above, a recovery in the Russian economy will in turn lead to a recovery in Armenian economy. Therefore, the current situation could present a unique opportunity for an investor to enter the Armenian market at historically low price levels and exit just a few years later when the economy and subsequently the currency recovers. Alternatively, an investor with long-term investment goals could simply keep his investment and benefit from the growing Armenian economy. Furthermore, given the current low interest rates in Europe an investor could secure a “historical bargain” by borrowing cheaply in Western Europe and investing in Eastern Europe, specifically in Armenia.


Armenia Startup Models

Last fall I had the honor of speaking at State Engineering University of Armenia and Yerevan State University during my visit to Armenia. During my talk on entrepreneurship we went over the basics of creating a new startups and the process of financing. As I learned during my trip, I would have better served the students by discussing “Lean Startup” principles instead. As with many parts of the developing world, there is an acute shortage of investment capital in Armenia. Although during my trip the Armenian government announced a cooperation with the Granatus Fund, making $6 Million available as seed financing for high tech startups, the fact remains that Armenian founders will still face a difficult time in convincing investors (both foreign and domestic) to make a high risk bet on their startup.

While that will limit the number of potential “go big or go home” born-global startups coming out of the caucus region, it makes the funding decision for founder’s quite simple: keep your costs as low as possible for as long as possible and go for an immediate revenue model. The founder in this situation needs to find ways of generating money for his product or technology from day one. That lends itself to a project-based business plan, where some kind of service is sold and the entrepreneur’s innovation is how to reduce the costs of that service, typically through a new technology.

For example, a founder may be an expert on the logistics of import/export with Georgia and want to offer software for sale to companies that reduce their logistics costs or more effectively move their goods over the border by matching cargo needs to capacity. Instead of approaching large cargo companies and trying to sell the software (which likely has a long sales cycle), this founder could instead offer his services as a consultant. Then he uses his software himself, refines it and improves on it, and still has revenue coming in from the consulting project. This model is very slow growth, so most venture capitalists are against investing in such companies, but it has two huge advantages for frugal founders: i) the company can survive without outside financing based on the consulting revenues until the software is complete, and ii) the founder has excellent insight into the market he is trying to sell to, since he is working for them and knows what their problems are which need to be solved. Eventually, the software becomes effective enough that he can say to his customers “I’ve developed something very easy to use, which allows you to do what I have been doing but without needing to pay me to work for you as a consultant”. Now the founder is no longer receiving the consulting revenue, but can instead sell this finished software to the entire market of potential customers, bringing in much more profit (since the software is already complete he can sell it without incurring more costs per sale (as opposed to consulting where his time was a cost factor– each new project brought both more revenue as well as more costs). At this point the business model becomes scalable, meaning he can continue selling to ever larger numbers of customers without having his costs increase proportionally.

This model of course hinges on keeping the costs so incredible low in the beginning that the very small amount of revenue can cover them – so the company is profitable from day one as well. That doesn’t mean it is generating tons of money immediately, but rather that at the end of the month revenue ends up greater than costs, even if only by a few dram. If a founder is able to do that, and show that each month the profits grow, then he may have the makings of a successful and self-sustaining startup.

-Guest Post by Curtis MacDonald

Look back at the lectures in Armenian Universities

The lectures organised in Yerevan in October were a great opportunity for Armenia Tomorrow to cooperate with the leading Armenian universities – State Engineering University of Armenia (SEUA) and Yerevan State University. Our first two lectures were organised in SEUA. We were greeted by Prof. Dr. Gagik Kirakossian who helped to organise the events. After a small excursion through the university we preceded to the building #9 where our lecture auditorium was and I started with my lecture on the topic of “Mergers & Acquisitions”. This was a thrilling experience not only becaPicture3use of the great atmosphere and the enthusiasm of the students but also because I could finally see my dream of going back to Armenia and being able to do something useful starting to come true! Also, thanks to these lectures, I discovered how I like teaching. After my first lecture I got a lot of questions ranging from “What place has the goodwill in the valuation of the company” to “What is the revenue structure of the M&A Advisory Business”. After this, Curtis MacDonald talked about “Entrepreneurship and Startups” giving the shorter version of his lecture aimed at non-IT students. His lecture also drew a lot of attention.

Later that daDownloady we were greeted in the Yerevan State University. Our lectures were scheduled to be held for the
students pursuing Master’s Degrees in Business Administration as well as Master’s Degrees in Finance. However, shortly before the lecture stared the first and second semester Bachelor students joined us as well. After the lecture there was an open, public discussion with the Professors of Economics on how to adapt the classical valuation methodologies (DCF Valuation, Comparables, etc.) to the Armenian market. We believe this adaptation is important for the future development not only of the Armenian but also of similar Eastern European markets. Armenia Tomorrow considers this one of its core future projects and will be happy to work together with economists in Armenia and abroad also interested by this topic.

DownloadFinally, on Thursday we gave lectures to IT and Systems Engineering Master students in the State Engineering University of Armenia. Curtis MacDonald gave an outsiders perspective on the startup environment in Armenia and presented some inspiring examples of worldly renowned IT products developed with limited original financial backing –such as the Wikipedia Foundation or Craigslist.

Armenia Tomorrow is thankful to both universities and the organisation “PROFESSIONAL AND ENTREPRENEURIAL ORIENTATION UNION” for organising these inspiring events and is looking forward to the future cooperation.

Lectures on Startups at Yerevan Universities – October 2013

(Guest Post by Curtis MacDonald)

Now that the lectures have finished, I’d like to review the key points a bit.  At all three events I broke down the lectures into a basic explanation of startups and the process of value creation, then went into an example using Facebook.  (The slides are available for download if you contact Julia Melikyan.)

Section 1 explains the difference in lifestyle startup (like a restaurant) and a venture startup (like a high-tech, high-growth company).  The stages of this startup of course go from the original idea to the successful exit (where the value is unlocked for the investors and founders), with a wide range of events in between.  We managed to cover i) where the idea comes from, ii) why the idea is not the most important component of the startup, iii) building up the founder team, iv) financing (for Armenia this is probably best done through boot-strapping), v) growth and competition, vi) then value-unlocking (IPO, exit, on-going successful company, etc.

It was great to spend a lot of time with the students on Section 2, looking at Facebook as a concrete example and tracking the value of the company over time and important milestones like launch and revenue generation.  The big take away from that discussion was how quickly the company’s value grew and tracked the number of users, something you only see with social networks.  The investors also showed a lot of nerve by not pressing to hard for the quick exit to Yahoo or forcing the revenue too early.  This was clearly an exceptional case and doesn’t work for many or most companies, but makes for a good case study.

facebook Valuation overtime

Image Credit: Flickr/ User: mushman1970 (CC License)