1. Emerging Market Finance Bulgartabac Holding AD Tina Boyadjieva Rob Ferguson Renee Hartmann Jeff Walwyn

2. Agenda  Overview of Bulgaria  Bulgarian Tobacco Market History  Bulgartabac Overview  Opportunity Discussion  History of Past Deals  Current Opportunity  Cost of Capital  Valuation and Sensitivity Discussion  Proposed Solution  Real Options

3. Bulgaria – A Snapshot  Population: 7.8 million  32% rural; 68% urban  Currency: Lev  1.96 lev = 1 Euro  Communist govt. from 1944 – 1989  Ruling Party – National Movement for Simeon II  Next Election: 2005  Slated for 2007 EU entry  8.5% Turkish population  Bordering Countries: Turkey, Former Yugoslav Republic of Macedonia, Serbia, Romania

4. Bulgaria’s economy + Politically stable + Secure currency + Low inflation + Adopting EU laws + 4-5% GDP growth + Little ethnic or religious conflict + Low labor cost pool + Close relationship with IMF – Organized crime – Tension btwn. social and economic growth – 14% unemployment rate – Avg. wage < $100/month – Unsuccessful privatization efforts – Bureaucratic and slow

5. Bulgaria’s Tobacco Market  Leading grower of high quality tobacco  Tobacco and tobacco are 40% of agricultural exports and 5% of all exports  Cigarette smuggling an issue  Large black market for foreign brands  No anti-smoking movement yet  56% of men and 32% of women smoke  Accession into the EU will increase competition and lower import duties  Tobacco industry has been large employer of Turkish population  Bulgartabac has near local monopoly  85% market share

6. Bulgartabac - company  1947 – 1993 tobacco unit of BCP  1993 – becomes a Holding with 22 subsidiaries  2005 – one of largest tobacco companies in SE Europe  85% market share on the domestic market  One of largest tax payers and generates 4% of the BG revenues  Involves roughly 250,000 minority population in the production  Government purchases 13,000 tons/ year at determined prices  Owns around 50 trademarks  93% owned by the Ministry of Economics  60 bill cigarettes annual production, 75% produced at 3 plants

7. Privatization process  Essential to accession to EU – open market requirements for entry  Special government requirements: 1. Maintain tobacco production purchasing 2. Keep most of the current employees 3. Government has control over tobacco price until 2007 4. Government still maintains a stake in the company  Establish a “Tobacco fund” to transition minority workers

8. Failed BAT deal  October 2004 BAT: 1. Offers 200 million euro for 3 largest plants 2. Promises to keep purchasing 7,000 tons of production 3. Promises to use at least 30% Bulgarian tobacco in its production 4. Pledges to make Bulgaria tobacco production center of the region  Deal fails after 3 months: MRP and BSP don’t think it is in the strategic interests of the country

9. Cost of Capital  Using Institutional Investor country credit rating, Bulgaria is more risky than the United States (Rating – 51.6)  Cost of Capital Worksheet implies a 19.8% cost of equity  Organized Crime Expropriation  Creeping Expropriation  Operational Autonomy  Resource Risk

10. Valuation considerations  Three scenarios developed  EU membership could have various different effects  Increase imports of foreign brands  Open up new markets for Bulgarian made products  Growth is uncertain given previous government control  Labor costs are very high and government wishes to guarantee employment

11. Valuation considerations (cont’d)  Conservative case:  EU entrance reduces sales as imports increase competition  Slow reduction in labor expenses  Most likely case  Declining labor costs  Conservative growth  Best case  Significant labor savings  High growth in export sales

12. Sensitivity analysis  Cost of equity of 19.8%  Recent Offer suggests a lower cost of capital  Terminal Value could be understated

13. Real Options  Input/Output Mix Option  Current production mix  Inputs – 50% Burley, 33% Virginia, 17% Oriental  Outputs – 15% bargain brands, 42% premium  Create different mix of premium/bargain to match optimal profitability  Intensity/Operational Scale  Currently running at 30% of 140 thousand ton processing capacity  Valuation is also based on current capacity  Analogous to option to build additional plant, without the capital investment

14. Solutions/Recommendations  Government  Continue to pursue strategic investor  Continue to sell parts, rather than whole  ABC – Always Be Closing  Each year postponed is hurting potential accession to EU and ICCR  A sale gains FDI and will prove minority protection (Turkish)  Purchasing Party  Create social solution  Concessions to relieve social and political risk  Appease minority populations  Value is not the sticking point  Use past deals as a starting point - learn from the failures  Find flexibility around operational autonomy