Zarina Khasimova and Yana Galukhina

The Kalina Concern, makers of perfumes and cosmetics, recently floated its stock on the MICEX. The company is implementing a strategy to increase investment in order to compete with its foreign rivals.

Kalina’s IPO was the forth initial public offering in the history of the Russian stock market. Before the cosmetics company from the Urals, only RBK, 36.6 Drugstores, and Irkut have had the honor.
Kalina offered investors a 28-percent stake, of which almost half consisted of additional issue shares, while the rest were shares sold by company shareholders. At $19 a share, the company’s capitalization totaled $186 million. After the offering, the stake of majority shareholders, General Director Timur Goryaev and the European Bank of Reconstruction and Development, fell from 85.3% to 60.9%. Nonetheless, Goryaev retained his controlling stake.
According to experts, the IPO was more than successful: Kalina sold at practically the highest possible price. This was demonstrated by the fact that oversubscription for the additional issue shares was only 39%, while demand for the shares sold by shareholders exceeded supply by five times. Additional issue shares only come to market once regulators have registered the results of the IPO, while existing shares can be traded immediately. In addition, bids to acquire Kalina stopped ahead of schedule. All this, despite the fact that the market had fallen for the third week in a row!
According to Alexander Merzlenko, Director of Investment and Banking Services at Renaissance Capital Investment Company, which organized the IPO, more than seventy investors participated in the offering, and forty five of them were foreign funds. The issuer is more than happy with the results. “We achieved our goals in terms of investor profile and placement volume,” Alexander Petrov, Director of Economics and Finance at Kalina, told Expert.
The excitement surrounding the Russian cosmetic leader’s IPO was justified. Kalina’s success was due to the fact that its shares promise to grow in the future. Compared to its Western competitors, Kalina seems undervalued. “During the IPO, Kalina’s value coefficients such as EV/EBITDA (enterprise value versus earnings before interest, taxes, depreciation, and amortization) and P/E (the ratio of stock price to earnings per share) revealed a discount of 20-30% compared to analogous average values at Western companies,” argues Alexander Svinov, an analyst at Alfa-Bank. According to estimates from the United Financial Group analytical overview, in a year the fair price of Kalina stock should be $25.9 a share. Not all observers agree, however. Alexei Yazykov, analyst at Aton Investment Company, believes that the shares were sold at a price close to their fair market price and that their price is unlikely to go up in the future.
Regarding the goals the company set when entering the market, Alexander Petrov remarked that “The IPO was a logical continuation of Kalina’s activities. By means of the IPO, the concern has been qualitatively transformed. It turned from a private company, which it still is practically, into a public company with capital available to the market. We are striving to be an exemplary company, a public company with high growth rates.” To reach this goal, Kalina plans to issue top-level American or international depository receipts before the end of the year.
There is, however, a slightly more pragmatic version of the story. “It cannot be ruled out that the offering took place at the urging of the EBRD, because they needed to see some return on their investment. Shareholders from the company’s management could have had the same goal,” believes Alexei Yazykov.
The company’s directors, however, believe that the company will not disappoint its shareholders. Dividends for 2003 were 26 cents per share. The EBRD also appears to be in no hurry to withdraw from the concern.

Omnivore strategy

Kalina earned $25.4 million from the IPO and it plans to use most of these funds—around 65%—to strengthen its brand names. The concern always paid close attention to marketing, but is now tripling its efforts. Kalina hopes to ensure the “aggressive growth” foreseen by the company’s recently adopted strategy by concentrating on the brand component of its products. Kalina gained its leading position on the market thanks to a different, more omnivorous strategy, however. After new owners led by Timur Goryaev came to the failing Uralskie Samotsvety (Ural Gems) cosmetics factory in the mid-1990s, they began actively buying up other companies in the industry, including factories in Ukraine and Uzbekistan, which already had their well-known local brands.
By 1999, Kalina was already manufacturing more than 100 types of products and actively expanded its lines of toothpaste, moisturizers, and shampoos, increased its production of soaps and cleaning products, and set up diaper production. It covered practically the entire market both in terms of types of products and price ranges, as well as by consumer age group. Goryaev responded to his critics that the company was not falling to pieces, but was copying the practice of leading world producers. “We set ourselves the goal of getting into all market segments for products associated with beauty and health,” he stated. “We see our company as a Russian version of Procter & Gamble.”
This strategy yielded decent results. Between 1996 and 2000 the company’s earning increased by almost twelve times from $10 million to $118 million. The 1998 crisis, of course, also had a hand in this increase. The crisis temporarily cleared the market of foreign competition, giving Russian manufacturers an excellent opportunity for growth. However, by 2000, many foreign companies saw how attractive the Russian cosmetic market was. It was growing by 20-25% a year, while Western markets expanded by a mere 3%. Specialists estimate the market’s potential at $15-18 billion, while it is estimated at around $5 billion today.
Foreign and multinational companies brought hundreds of their brands to Russia. Heavyweights like Beiersdorf, L’Oreal, and Procter & Gamble hit the Russian market, taking over 3-5% a year. Foreign companies also began to open their own factories in Russia. The most unpleasant development, however, was that foreign companies began to move beyond the mid-price and expensive segments into the mass market, taking over Russian manufacturers’ main turf. Local companies saw that if they didn’t want to be shoved off the market by multinational giants, they would have to show a lot more muscle.

Brand focus

In 2003, Kalina sold its 84-percent stake in the Ukrainian company Alye Parusy. In the near future, there will be new owners at Pallada-Vostok in Uzbekistan and Novoplast, makers of plastic containers and packaging. Kalina seems to have learned this technique, related to its new strategy, of putting company assets in order from international practice. Since the 1970s and 80s, the world cosmetics industry has been based on contract manufacturing. The leading market players understood that it was not viable for one company to manage research labs, production facilities, and powerful marketing. Since then, the majority of well-known cosmetics companies have concentrated on marketing, or more precisely on brand management, which allows them to react more exactly to changes in the market and to keep production costs under tight control.
Kalina has also decided to focus on brands. “Our main activity will be developing brands,” Nikolai Geller, Kalina’s Director of Development, told Expert. For a start, the company got rid of assets not directly related to its business and sold off many local brands. Out of a hundred brands, Kalina has only kept around thirty (including Cherny Zhemchug, Chistaya Linia, MIA, 32, Lesnoi Balsam, and Anzhelika Varum). The concern will not completely get out of the manufacturing business, but it is heading toward contract production. “For the time being, most of our products will be made at our factories. With time, the share of contract production will increase and perhaps exceed half of all sales,” Goryaev states. Kalina has already made contract-based orders with factories in Poland, Germany, and Turkey.
Kalina also hopes to compensate for the weak spot among all Russian manufacturers due to a lack of resources, R & D and new products, via strong marketing. Geller, for instance, believes that in the mass-market segment, where most of Kalina’s products are positioned, the role of scientific breakthroughs is minimal.
Specialists think that in a few years, under pressure for foreign companies, Russian manufacturers’ market share on the domestic cosmetics market will fall from the current 50% to 20-30%, the same share as local producers on the European cosmetics market. Kalina currently holds a bit more than 3% of the market. By choosing a strategy innovative for Russia and concentrating on brands, the concern is trying to do more than earn a place in the Russian pool of market players. Kalina is aiming at a position equivalent to those of large international manufacturers with their market shares of 5-10%.

Kalina is undervalued compared to the majority of Western perfume and cosmetics manufacturers

	Stock Price/ Earnings per Share (P/E)	Enterprise Value/ Earnings before Interest, Taxes, Depreciation, and Amortization (EV/EBITDA)
Avon (USÀ)	27.8	16.6
L`Oreal (France)	30.6	20.7
Wella (Germany)	43.1	12.7
Colgate-Palmolive (USA)	21.4	13.5
Henkel (Germany)	11.8	7.4
Oriflame (Sweden)	17.7	13.9
Kalina (Russia, after IPO)	13.1	7.5
Source: data from UFG for 2003

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