HIDDEN MENACE IN THE BALTIC ALCOHOL MARKET:THE SOCIAL AND ECONOMIC IMPACT OF UNDERGROUND ECONOMY

Valters KažeBusiness Development Director of Baltic Business Unit, SPI GroupBrand Director, Latvijas balzams JSC

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Global beverage industry leaderUSD 1bn assets, USD 0.4bn annual revenueOperations across 160 countries worldwide#1 in Baltic beverage production and distribution

#1 producer of alcohol

112 years of exellence

260 years for Riga Black Balsam, oldest Baltic TM

120 brands and products

>100 international awards

74m bottles produced annually

70m € annual revenue

>600 employees

35 direct export countries

160 Stolichnaya export markets via SPI Group

26% market share in Latvia

57% share from local producers in Latvia

#12 in National Reputation Top

Silver category in National Sustainability Index

Global SpiritsBusiness Unit

RussiaBusiness Unit

Wholesale distributionin 160 countries

Agriculture / raw spirits productionin Tambov, Perm, Kaliningrad etc.

BalticBusinessUnit

LV

LT

EE

Latvijasbalzams

52 LBoutlets

SPI Distribution(Latvia)

24 Bravo Alcooutlets

BennetDistributors

SPI Distribution(Estonia)

Real Estate & Private Equity Investment Business

Corporate HQ (Luxembourg)

WholesaleRetailProduction

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THE STORY TODAY IS ABOUT...

... DAYLIGHT

What are challenges for the legal alcohol industry in the Baltics?

Is there something called ‘scientific lobbying’ possible in the Baltics?

... TWILIGHT

What is the impact of illicit non-commercial alcohol market?

Do taxation decisions facilitate underground economy?

DAYLIGHT:THE LEGAL INDUSTRY CONTEXT

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ALCOHOL: INDUSTRY CONTEXT

SOCIAL CONTEXT

Produced since Neolithic era, 9,500BC

55% of adult population have ever consumed alcohol, 42% still do

Social interaction element

ECONOMIC IMPACT

Contribute around 2% to global GDP

Contribute on average 2-5% of state tax revenues

Strictly regulated industry

Non-commercial alcohol accounts for 50% of total

alcohol consumption worldwide

NEGATIVE ASPECTS

4% of total death are alcohol related

2.5m people die from harmful use annually

Heavy burden on social budget

NO BLACK AND NO WHITE, JUST IMPORTANT

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THE BALTICS: THE LEGAL ALCOHOL MARKET

LEGAL ALCOHOL MARKET 2011E, mn 9Lcs

Beer77%

Wine9%

Spirits8%

Cider/RTD6%

Beer76%

Wine11%

Spirits8%

Cider/RTD5%

ESTONIA

20

LATVIA

22

LITHUANIA

41

Sources: IWSR, WHO, government statistics offices, internal data

Beer70%

Wine7%

Spirits9%

Cider/RTD14%

Estonia Latvia Lithuania

0.8m

1.3m

2.2m

TOTAL CONSUMER POOL, 2012

BALTICS = 4.3m CONSUMERS

RECORDED ADULT PER CAPITA CONSUMPTION, abs l

Estonia Latvia Lithuania0

5

10

15

14.0 10.5 12.8 European average

9.5

SMALL MARKETS, YET CONSUMPTION ABOVE AVERAGE

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THE BALTICS: LARGEST MARKET PLAYERS

KEY FACTS

Latvijas Balzams Liviko Stumbras Alita Vilniaus Degtine

Located Riga, LV Tallinn, EE Kaunas, LT Alytus, LT Vilniaus, LTEstablished 1900 1898 1906 1963 1907Ownership Public Private Public Public PublicUltimate shareholder SPI Group: 90% NG Invest: 100% MG Baltic: 95% FR&R Invest IGA: 84% Belvedere: 68%Employees 634 378 236 228 179Revenue, EUR m 74.4 54.8 * 29.1 25.5 12.1EBIT, EUR m 6.6 1.5 * 5.6 -23.7 -0.2Local SOM, % volume 26% 23% 14% 8% 3%

EXPORT PORTFOLIO

Core brands Riga Black Balsam Riga Sparkling Wine

Grand Cavalier

Vana Tallinn Viru Valge vodka

999 Alita Sparkling Wine Sobieski vodka

Share of export 12% (LB only)74% (+SPI Group)

35% 11% 8% 8%

1

2

3

4

5

1 2 3 4 5

* - approximate as data is not public and integrated with distribution business

Sources: NASDAQ OMX, Baltic news agencies, internal data

ALL LARGEST PLAYERS ARE IMPORTANT EMPLOYERS AND TAX-PAYERS

TWILIGHT ZONE:HOW THE SHADOW MARKET IS BORN

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THE NON-COMMERCIAL ALCOHOL

LICITNON-COMMERCIAL ALCOHOL

Production: legalDistribution: might have minor issuesTaxation: mostly compliant

Traditional home beverages

Transnational trade

ILLICITNON-COMMERCIAL ALCOHOL

Production: illegal (apart from smuggled)Distribution: illegalTaxation: fully avoided

Smuggled product

Counterfeited product

Home brewed for commercial distribution exceeding restraints

Poor quality unknown product

Surrogate product

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THE BALTICS: WHAT HAS HAPPENED OVER LAST 5 YEARS?

THE RESULT: STATE TAX REVENUES DECLINE

INCOME OF HOUSEHOLDS HAS DECLINED

Household average monthly disposable income, €

2007 2008 2009 2010 2011E700

800

900

1000Estonia Latvia Lithuania

RECESSION HAS HIT ALL THE BALTIC MARKETS

Real GDP growth, % yoy

2007 2008 2009 2010 2011E

-20

-15

-10

-5

0

5

10

15

Estonia Latvia Lithuania

BALTIC POPULATION HAS DECLINED BY 0.7m

Estonia Latvia Lithuania0

500

1000

1500

2000

2500

3000

35002007 2011 official 2011 adjusted

Population, ‘000

-50

-280

-380

BALTIC ALCOHOL MARKET DECLINED BY OVER -33%

2007 2008 2009 2010 2011E4,000

6,000

8,000

10,000

12,000

14,000Estonia Latvia Lithuania

Wine & spirits market (w/o beer), ‘000 9Lcs

Sources: IWSR, Eurostat, government statistics offices, internal data

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POLICY MAKERS DESPERATELY SEEK

SOLUTIONS...

.

IF TAX REVENUES FALL...... LET US RAISE TAX RATES INSTEAD.

THAT SIMPLE

SOCIAL AND ECONOMIC IMPACT:CASE OF ILLICIT ALCOHOL IN LATVIA

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TAX RATES ON STRONG SPIRITS UP +49%

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3'00 '01 '02 '03 '04 '05 '06 '07 '08 2009 2010 2011

700

800

900

1,000

1,100

1,200

1,300

1,400

783

896

1,174

1,2661,337

Excise tax rate

+31%

+8%

+6%

Excise tax rate on strong spirits, €/l aa

LATVIA: ENTERING TWILIGHT ZONE

BITTER TRUTH: CONSUMERS SWITCH TO NON-COMMERCIAL ALCOHOL

+49%

EXCISE TAX REVENUE DOWN -15%

2004 2005 2006 2007 2008 2009 20100

20

40

60

80

100

44.3 57.6 72.6 89.9 91.0 84.0 77.3

Excise tax revenue, €

-8%-8%+1%

CONSUMPTION LEVEL REMAINS STABLE

2002 2003 2004 2005 2006 2007 2008 2009 2010E0

5

10

15

20

0

1

2

3

4

EUR

10.15

%3.7%

Household alcohol consumption

Expense for alcohol,EUR per capita annually

Share of alcoholin total household consumption, %

MORTALITY GROWS

Alcohol related mortality per 100,000 population

2005 2006 2007 2008 2009 2010E0

5

10

15

20

12.1 8.8 6.3 7.9 12.8 14.6

-29% +27%

+14%

Sources: WHO, Eurostat, Central Statistics Department, State Revenues Department, internal data

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LATVIA: IMMERSION INTO THE SHADOW

JOINT RESEARCH PROJECT

INTERNATIONALLY PROVEN METHODOLOGY

INDUSTRYLADRIA

GLOBAL PARTNERSEFRD, ICAP

ACADEMIC RESEARCHUniversity of Latvia

BUSINESS RESEARCHData Serviss, Ex Novo

1040respondents

in generalpopulation

152regular

non-commercialalcohol consumers

50non-commercial

alcohol producersand distributors

FACTS & FINDINGSFOR SHARING AND SUPPORTING

POLICY MAKERS

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FINDINGS: GENERAL POPULATION

52%admit that it is easy to buy non-commercial alcohol

50%have ever purchased counterfeit well-known alcohol brands

36%have friends or relatives among regular consumers

18%justify and raise voice in support of non-commercial alcohol

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FINDINGS: REGULAR CONSUMERS

56%are regular consumers for at least 10 years

34%plan their purchase well in advance

59%‘go shopping’ at least once a month

25%buy alcohol at ‘close to home outlets known to everybody’

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FINDINGS: HUSTLERS

58%are in business for at least 10 years

40%operate it as main source of income

80%do it at their residential address

62%of their customers are returning ones

20%smuggle products cross-

border or sell such

16%have arrangements with

somebody at law enforcement

32%say penalties are not

severe enough

20%know how to avoid being

punished

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FINDINGS: FACTS AND CONSEQUENCES

~40%from total alcohol market in Latviais illicit non-commercial alcohol

Growing mortalityrepresents a serious threat toalready declining population

>40m €annually are lost in a form of potentialtax revenues orextra burden to social budget...

If only we would cash it in for...1 year: enough to feed 5,000 average households2 years: enough to construct National Library3 years: enough to build all 100 required kindergartens

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LEARNINGS, FINALLY...

ANY CHANGES ALREADY?Priority to fighting shadow economy givenNo excise tax increase anticipated for couple of yearsIndustry association engaged as NGO partner in decision making

LEARNINGS FOR INDUSTRYScientific lobbying possible: build a case on proven argumentsIndustry power: get togetherBreak the box: pro-active resource mobilization beyond usual boundaries

LEARNINGS FOR POLICYMAKERSNo simple math: when dealing with consumersIndustry is a partner: legal business is willing to support most initiatives

NEW CHALLENGES AHEAD...New legislative initiatives underway across Europe and in the Baltics

THANK YOU!