Business Watch: September 3, 2003

Serbian Privatization Minister Aleksandar Vlahovic announced on 25 August that Russia's LUKoil made the winning bid to purchase a 79.5 percent stake in Serbian fuel retailer Beopetrol, Reuters reported the same day. LUKoil will pay Serbia 117 million euros ($128 million) for Beopetrol's 207 filling stations, invest 85 million euros to develop the company, and spend 8 million euros on social programs. Beopetrol's proximity to LUKoil's Burgas refinery in Bulgaria is an added benefit. The tender, in which LUKoil bested Hungary's MOL, came as a welcome success for the Russian oil company after recent failed attempts to acquire a 23.17 percent stake in Greece's Hellenic Petroleum and a 75 percent stake in Poland's Gdanska Rafineria. Some observers felt that LUKoil may have paid too much, however. Trust Bank's Vladislav Metnev told "Vedomosti" on 26 August, "It comes out to about $1 million per filling station. That's a bit much." Troika Dialog's Valerii Nesterov echoed Metnev in comments to "Vremya novostei" the same day, noting that Austria's OMV paid less for the filling stations it bought from BP in Bavaria, Germany. Steven Dashevskii, head of research at Aton Capital Markets, disagreed, telling "The Moscow Times," "The cash payment looks reasonable...[and] LUKoil will be investing in its own business."

The Ministry of Finance announced in a 27 August press release that the United Depository Company (ODK), a subsidiary of state-owned Vneshtorgbank, will hold the pension savings of Russian citizens who select an asset manager to look after their retirement money. In effect, the decision ensures some form of state control over all pension funds: Russians will soon have the option of selecting an asset manager to invest their pension savings, in which case ODK will be the depository for those funds; state-owned Vneshekonombank will be the default manager for all other pension savings. ODK bested two competitors, neither one state-owned, in a contest many saw as designed to favor ODK. Garegin Tosunyan, head of the Association of Russian Banks, described the tender conditions as set especially for Vneshtorgbank, "Gazeta.ru" reported on 25 August. Pyotr Lanskov, who heads the research division at a self-regulating depository organization, was bitterly critical of the Finance Ministry's decision, telling "The Moscow Times" on 28 August, "It's a farce and a slap in the face of [pension] reform." According to "Kommersant-Daily," ODK will service some $5 billion-$7 billion in assets, for which it will receive a 0.1 percent commission. The eventual amount is difficult to predict, as it remains unclear how many Russians will choose an asset manager other than the state pension fund. A recent poll by ROMIR Monitoring found that 66.5 percent of respondents have not yet made up their minds, "Nezavisimaya gazeta" reported on 28 August.

RosBusinessConsulting (RBC) announced on 28 August that it will launch Russia's first-ever business news channel on 2 September, Regions.ru reported the next day. Targeted at Russia's growing middle class, the channel will present original programming as well as news from CNN and CNBC and will broadcast live from 7 a.m. to 1 a.m., with rebroadcasts to fill late-night time slots. RBC is investing $20 million of its own money augmented by $6 million in loans. The channel, which will broadcast in Russia's 12 largest cities, will rely on advertising for revenue. RBC Director Yurii Rovenskii told "Kommersant-Daily" on 29 August that RBC-TV has already concluded $2.7 million in advertising contracts and should break even after two years. Others were less sure. Aleksandr Gerasimov, first deputy director of news broadcasting at NTV, told "Vedomosti" on 29 August that he gives RBC-TV a 50-50 chance of survival. Vladimir Evstafev, president of the Russian Association of Advertising Agencies, told the newspaper that RBC-TV will likely lose money because rates in Russia are too low for a pure news channel to turn a profit on advertising alone.

Prime Minister Mikhail Kasyanov announced during a visit to Perm on 26 August that the state supports the creation of a Federal Engine Building Center (FTsD) to bring together the myriad Perm-based aviation companies that went their separate ways during the privatization of the 1990s, "Vremya novostei" reported the next day. According to the prime minister, the state will not hold a controlling stake in the future holding company. But the number of companies and owners involved could make consolidation a complex task. For example, U.S.-based Pratt & Whitney owns blocking stakes in the Perm Motors Plant and Aviadvigatel design bureau, both of which are to be integrated into the new company. Yurii Koptev, director of Russian space agency Rosaviakosmos and coordinator of the group charged with creating the FTsD, told "Vedomosti" on 27 August that the FTsD will emerge in two stages, with a managing company to be created by September and a full-fledged holding company by year's end. Prime Minister Kasyanov promised foreign shareholders that their rights will be respected in the upcoming consolidation process. Thomas Hajek, Pratt & Whitney's vice president for the company's Russian operations, adopted a wait-and-see attitude, telling "Novye izvestiya" on 27 August, "We'll see what the government proposes to us."

Recent reports indicate that senior managers at the world's largest titanium producer have sold a 5 percent stake in the company to aluminum giant SUAL. "Vedomosti" reported on 28 August that four top managers at VSMPO together sold off a 5 percent stake in the titanium producer, approximately $15 million worth of stock. Other VSMPO managers allegedly learned of the sale on 10 August and took action to remove the four managers, who remain officially on leave. Top figures at VSMPO, which is owned by senior management through a complex arrangement intended to minimize the chances of a hostile takeover, see the handiwork of aluminum powerhouse SUAL and fear a bout of corporate raiding. "Kommersant-Daily" reported on 26 August that VSMPO Director Vladislav Tetyukhin found out about the share sale when a SUAL manager called him and asked, "Did you feel our first hit?" Experts queried by the newspaper noted that the acquisition of a stake in VSMPO fits in neatly with SUAL's avowed aim of becoming a transnational corporation with wide-ranging metals involvement. For its part, SUAL denies buying up any VSMPO shares. NIKoil analyst Vycheslav Smolyaninov told "Vedomosti" that no matter who stands behind the share buy-up, it indicates that "someone is seriously interested in VSMPO, and its top managers will have to fight to retain control over the enterprise."

Cellular operator VimpelCom announced in a 28 August press release that the company's board of directors approved VimpelCom's merger with regional subsidiary VimpelCom-Region. VimpelCom-Region was created to hold the company's regional licenses and oversee its expansion outside of Moscow. The merger involves a share exchange between VimpelCom's main shareholders -- Russia's Alfa Group and Norway's Telenor -- and values VimpelCom-Region's business at 91 percent of VimpelCom's Moscow business. Telenor will hold 26.6 percent of voting shares and 29.9 percent of ordinary shares in the new company; Alfa Group will hold stakes, respectively, of 32.9 percent and 24.5 percent. Deutsche Bank analyst Yulii Matevosov told "Vedomosti" on 29 August that the consolidation of VimpelCom's corporate structure makes it simpler for Alfa Group either to attempt a VimpelCom-MegFon merger or sell off some of its telecom holdings. VimpelCom also announced on 28 August that the board gave its blessing to Alfa Group's recent acquisition of a blocking stake in competitor MegaFon, adding that "the parties will seek possible ways of merging the business of MegaFon and VimpelCom in the future." Valerii Goldin, VimpelCom's vice president for investor relations, told "Gazeta.ru" on 28 August that he could not confirm any negotiations between MegaFon and VimpelCom; he did say, however, that a merger could be the subject of such talks.

VimpelCom and Mobile TeleSystems (MTS) both announced better-than-expected financial results for the second quarter of 2003 last week, although analysts were quick to note that the cellular operators are likely benefiting more from propitious macroeconomic conditions than their own competitive acumen. VimpelCom's second-quarter earnings rose 75.6 percent year-on-year to $304 million and net profit increased 139.9 percent to $53 million. MTS's second-quarter earnings jumped 92 percent year-on-year to $606 million, while net profit for the period rose 98 percent year-on-year to $128.5 million. (According to "Finansovye izvestiya," VimpelCom now has 8.54 million subscribers -- 4.84 million in Moscow, and 3.7 million in the rest of the country; MTS has 12.76 million subscribers -- 10.47 million in Russia, 4.135 million in Moscow, and 2.29 million in Ukraine.) Aton analyst Nadezhda Golubeva told "Vedomosti" on 29 August, "The macroeconomic situation favors both operators and the population is willing to spend money on cellular communications. Moreover, summer always brings with it an increase in traffic and income from roaming fees." Brunswick UBS analyst Dmitrii Vinogradov told "Kommersant" on 29 August, "The service is in demand and the macroeconomic situation is favorable. As a result, there are companies that will be able to advance that service." They may have considerable room to hawk their services in the future. Cellular penetration in Russia stands at a comparatively low 17 percent, and while the Moscow market may be nearing saturation, analysts foresee substantial regional growth. Finland's Nokia, for example, forecasts that by 2008 Russia will boast 60 million cellular subscribers, "Finansovye izvestiya" reported.

High-level Russian-Ukrainian talks in Kyiv on 26 August produced an agreement in principle to build a new gas pipeline but failed to clarify the future of a proposed gas consortium. The negotiations involved Russian Deputy Prime Minister Viktor Khristenko, Ukrainian Deputy Prime Minister Vitaliy Hayduk, two deputy chairmen from Russian gas monopolist Gazprom, and the chairman of Ukrainian state oil and gas company Naftohaz Ukrainy. Khristenko announced after the talks that the sides agreed to build a $2.5 billion, 1,700-kilometer gas pipeline across Ukraine from Novopskov in the east to Uzhhorod in the west, "Kommersant-Daily" reported on 27 August. The pipeline will take two years to build and will boost Ukraine's gas transport capacity by up to 30 billion cubic meters of gas a year (bcm/yr), "Nefte Compass" reported on 27 August. The country's entry capacity at the Russian border is now 290 bcm/yr, while exit capacity at the western border is only 175 bcm/yr. The added capacity means higher profits for Gazprom, which transports most of the gas it exports to Western Europe through Ukraine, which will benefit in turn from increased transit fees. Gazprom and Naftohaz Ukrainy are to present a final feasibility study and details on financing by 1 November. Meanwhile, the sides decided to put off a decision on the structure of a proposed gas consortium until 1 December, AP reported the same day. The consortium, which was conceived in 2002 as a means of providing a common framework for gas exports to Western Europe, has made slow progress thus far. According to Russian press reports, the sides are currently trying to hammer out a mutually acceptable concession arrangement in which Ukraine will retain ownership of its pipelines.

Russia's Antimonopoly Ministry announced in a 26 August press release that British-American BP and Russia's Tyumen Oil Company (TNK) are free to merge their Russian holdings and create the country's third-largest oil company. The announcement hardly came as a surprise -- Russian President Vladimir Putin and British Prime Minister Tony Blair were in beaming attendance when the two companies tied the knot in London, and antimonopoly authorities in Ukraine and the European Union have already given the merger the go-ahead.

Though the Yukos-Sibneft merger and Yukos' legal travails have drawn media attention away from TNK-BP since it was first announced in February, the joint undertaking is still a major development on the Russian business front. Bringing together assets in Russia and Ukraine worth some $16 billion, TNK-BP will pump 1.2 million barrels of oil a day from more than 5 billion barrels of proven reserves, according to RBC. Moreover, TNK-BP represents an unprecedented commingling of Russian and Western corporate clout that could serve as the model for future joint ventures.

With official approval secured, BP and TNK announced on 29 August that TNK-BP Ltd. is up and running. At the same time, a few adjustments to the parameters of the original deal emerged as well. First, BP will increase its cash payment to its Russian partners Alfa Group and Access/Renova (AAR) -- TNK's owners -- by $200 million to compensate for BP's holdings on Sakhalin, which will not be included in BP-TNK. The additional $200 million brings BP's cash contribution to $2.6 billion, with an additional $3.75 billion in BP stock to be paid out in three annual installments of $1.25 billion. According to "Vedomosti," the assets BP is stirring into the common pot are a 25 percent stake in oil company Sidanko, a 33 percent stake in Rusia Petroleum, and a network of filling stations in and around Moscow. AAR's contribution includes 97 percent of TNK, 92 percent of oil company Onako, 57.5 percent of Sidanko, and 29 percent of Rusia Petroleum, as well as a stake in Rospan International and Sakhalin-6.

The substitution of $200 million for BP's Sakhalin holdings hardly registers a blip on the deal's multi-billion-dollar backdrop. But that wasn't the only adjustment. AAR will also include its 50 percent stake in recently privatized oil company Slavneft in TNK-BP, and BP will pay AAR an additional $1.35 billion. That blip was bright enough to cast an eerie glow on the auction that landed half of Slavneft in AAR's lap.

TNK and Sibneft together acquired the state's 74.95 percent stake in Slavneft in a December 2002 privatization auction that lasted three minutes and nudged the $1.7 billion starting price up to $1.86 billion amid a marked lack of competitive bidding. The general consensus among observers both in Russia and the West was that the state had, at best, failed to maximize its gains and, at worst, turned a blind eye to collusion.

Just because BP is ready to pay AAR $1.35 billion for one-fourth of Slavneft doesn't automatically mean that Slavneft is worth $5.4 billion and the Russian government took a $2 billion hit on the privatization. (Theoretically, if Slavneft is worth $5.4 billion, 75 percent of it should have gone for $4 billion, or $2.2 billion more than it garnered at auction.) For one thing, it's not entirely clear -- publicly, at least -- exactly what BP is getting for its money. As Sibneft spokesman Aleksei Firsov confirmed to "Gazeta.ru" on 29 August, no final decision has yet been reached on the division of Slavneft's various assets between TNK-BP and Sibneft (itself merging with Yukos by the end of 2003). Still, BP's 29 August press release noted that "the Slavneft acquisition will increase TNK-BP's production by some 160,000 barrels a day," indicating that BP appears confident it is buying into roughly half of the company's production assets. (According to the same press release, Slavneft's 2002 production was 294,000 barrels per day.)

At least one analyst weighed in with a grumpy reaction to the news of Slavneft's inclusion in TNK-BP. Aleksandr Korchagin, head of information and analysis at Prospect Investment, told strana.ru on 29 August, "When the Slavneft auction took place in December 2002...they said that the state's stake should be worth between $2 billion and $3 billion...The price that BP is setting corresponds exactly to what the company should cost. Actually, you could say that, taking into account Slavneft's reserves by international standards, the price is low. As for why such auctions take place, well, that strikes me as a rhetorical question."

Rhetorical or not, the question is intriguing. Even more intriguing is whether BP's decision to put a concrete figure on a chunk of Slavneft will encourage other observers and analysts to look back at the Slavneft privatization with rhetorical questions of their own.

As summer fades to fall, persistent rumors that the Prosecutor-General's tussle with oil major Yukos would inflict a bear-mauling on Russian free enterprise, scatter foreign investors as chaff before the wind, and usher in a retro-Bolshevik redistribution of wealth appear to have been somewhat overblown. Instead, the standoff has produced a far stranger spectacle -- Russia's flagship corporation flourishes...even as one of its top lieutenants languishes in jail amid a raft of unresolved criminal cases.

The irony is probably lost on Platon Lebedev, the billionaire and core Yukos shareholder whose lot is languishing in jail. A Moscow court ruled on 28 August that he will stay put for the next two months, during which time he will be able to familiarize himself with the state's 146-volume case against him over the 1994 privatization of fertilizer producer Apatit. For his part, Lebedev was disdainful of the proceedings in comments reported by "Kommersant-Daily" the next day: "This isn't a trial, it's a kangaroo court, a farce, a set piece. My arrest is yet another attack on the constitution, human rights, and the free market, of which I am a representative. I forbid my lawyers to take part in this farce."

On other fronts, however, Yukos has had good news to report:

26 August: Yukos fights off an attempt by state-owned Rosneft to remove Yukos ally Mikhail Tetyushev from the director's chair at oil company Eniseineftegaz (ENG), "Vedomosti" reports the next day. Yukos is locked in a complex struggle for control of ENG, which holds a disputed stake in the company that owns the license to develop the rich Vankor oil field. One of the Yukos-related criminal cases currently open involves a Yukos affiliate's acquisition of a 19 percent stake in ENG. The Prosecutor-General's office opened the case in response to a request by Rosneft.

27 August: Yukos announces the appointment of Steven Michael Theede as chief operating officer and Thomas Wayne Nicewarner as chief information officer. A source at Yukos tells "Vedomosti" the next day that Theede is coming in as a neutral outsider to make "tough decisions about putting together management teams" in the course of the Yukos-Sibneft merger. The arrival of Theede and Nicewarner, who are both U.S. citizens, can also be seen as a possible hedge against future assaults by the Prosecutor-General's Office, which is likely to think twice -- or so the logic goes -- about throwing a Western executive into a Russian jail.

28 August: Reuters reports that a pool of Western banks led by France's Societe Generale will loan Yukos $1 billion -- $500 million for three years at 1.5 percent above the benchmark London Interbank Offered Rate (LIBOR), and another $500 million for five years at LIBOR plus 1.75 percent for the first three years and LIBOR plus 2 percent for the last two. No Russian company has ever borrowed so much or so cheaply.

In the two months since "the Yukos scandal" burst into the headlines, it has mimicked the trajectory of other Russian scandals over the last decade -- from a shocking event greeted with vocal dismay and frenzied speculation to a grudgingly accepted fact shrugged off with a wince. Privatization is perhaps the classic example of such a scandal and it is, fittingly enough, privatization's unquiet legacy that imbues l'affaire Yukos with such ambivalent overtones. The observer who seeks some sort of justice in Russia is as uncomfortable with the methods of the Prosecutor-General's Office as with the idea of mid-1990s privatization as the bedrock of capitalist practice.

For now, Yukos continues to flourish as a business, Lebedev is still in jail, and a number of criminal cases await either prosecution or procrastination. What started out as freewheeling boxing in early August has slowed to middle-game chess by early September, with pieces aplenty still on the board and no end game in sight.