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Business Watch: May 6, 2003


6 May 2003, Volume 3, Number 16
ENERGY
YUKOS GETS OFFICIAL BLESSING FOR DAQING PIPELINE
Prime Minister Mikhail Kasyanov announced on 29 April that the Russian government has decided to support a pipeline project from Angarsk in eastern Siberia to Daqing in China, regions.ru reported the next day. The choice of Angarsk-Daqing as a priority project puts a proposed pipeline from Angarsk to Nakhodka on hold. The decision comes as a victory for oil major Yukos, which proposed Angarsk-Daqing in 1999 and touted the route over Angarsk-Nakhodka. Once the $2.5 billion project goes on line in 2005, it will ship 20 million metric tons of oil to China annually. According to Kasyanov, the feasibility of the subsequent Nakhodka leg will depend on whether there is sufficient oil to fill the pipeline, AP reported. Supporters of the Nakhodka pipeline had stressed that it would provide access to markets in Japan, Korea, China, and the United States, while the Daqing route leads only to the Chinese market. Sergei Grigorev, vice president of state-owned pipeline monopolist Transneft, stated simply, "First we'll build the pipeline to Daqing, and when it starts to earn money, we'll use that money to lay the leg to Nakhodka," "Vedomosti" reported on 30 April. In a 30 April article for "RusEnergy," Aleksei Nedogonov noted that Angarsk-Daqing was originally premised on a booming Chinese economy's thirst for oil. With economists revising growth forecasts for China downward against the backdrop of the ongoing SARS outbreak, the decision to focus solely on the Chinese market now appears somewhat riskier. DK

ASOC SHAREHOLDERS APPROVE ROSNEFT OFFER
State-owned oil company Rosneft announced in a 28 April press release on the company's website (http://www.rosneft.ru) that more than 97 percent of shareholders in the Anglo-Siberian Oil Company (ASOC) have agreed to a buyout offer Rosneft made on 4 April. Under the terms of the offer, Rosneft will pay $72.7 million for 100 percent of ASOC, a 100 percent premium on the stock's market price as of 3 April. ASOC's main selling point for Rosneft is its 59 percent stake in Eniseineft, which holds the rights to the Vankor oil field and its 906 million barrels of oil. The horizon is not entirely clear for Rosneft, however. France's TotalFinaElf has an option to acquire a controlling stake in ASOC. Jean-Marc Fontaine, TotalFinaElf's vice president of exploration and production for continental Europe and Central Asia, told Reuters, "We expect Rosneft will respect the agreement we had with Anglo-Siberian." Rosneft representative Dmitrii Panteleev told "Vedomosti" on 29 April that, although his company concluded a partnership agreement with TotalFinaElf in 2001, "It is premature to discuss TotalFina's involvement in the Vankor project." Rosneft moved quickly to take control of ASOC, placing Rosneft representatives in three of five spots on the ASOC board of directors at a 28 April meeting, RBC reported the next day. DK

CONOCO, GAZPROM MULL $10 BILLION GAS PLANT
Gazprom deputy CEO Aleksandr Ryazanov told reporters on 28 April that U.S.-based ConocoPhillips is interested in joining forces with Gazprom to build a liquefied-natural-gas (LNG) plant in the Russian port of Murmansk, Reuters reported the same day. The $10 billion project would also include a platform on the Shtokman gas field in the Barents Sea, a 500-kilometer pipeline to the port, a tanker fleet to ship LNG to markets in North America, and a receiving terminal in the United States, "World Gas Intelligence" reported on 29 April. According to "World Gas Intelligence," Conoco and Gazprom are considering various storage and regasification systems to improve the efficiency of LNG imports to the United States. LNG is easier to transport than natural gas, but no facilities for its production currently exist in Russia. Gazprom will make a decision on the project in late May. DK

TURKEY HALTS BLUE STREAM IMPORTS
A mid-March decision by Turkey to halt gas purchases through Gazprom's Blue Stream pipeline under the Black Sea has given rise to speculation about both the reasons for the Turkish move and the $3 billion project's commercial viability. A representative of Botas, Turkey's state-owned pipeline company, told industry publication "Nefte Compass" on 30 April that the 12 March decision was motivated by demand concerns, not technical difficulties or price disagreements. A Gazprom official contradicted that in a 28 April comment to Reuters, explaining, "Turkey halted gas purchases in mid-March saying gas prices were too high." Energy Minister Hilmi Guler recently told the Turkish parliament that the country plans to reduce its dependence on Russian gas from 70 percent to 30 percent over the next five years, RFE/RL reported on 29 April. Faced with a slack economy and high gas prices, Turkey might be hoping to change the terms of its 25-year contract to buy 365 billion cubic meters of gas from Gazprom, "Vremya novostei" reported on 28 April, noting that Poland succeeded in renegotiating a long-term gas contract with Russia earlier this year. In the second half of 2003, Turkey will be obligated to buy gas under a take-or-pay arrangement, giving it only a few more months to exert pressure on Russia by halting shipments before contractually stipulated fines kick in. The two sides might try to work out their differences at the eighth meeting of the Turkish-Russian Economic Commission, slated to take place no later than 15 July, "GazetaSNG" reported on 28 April. DK

FINANCE
ALROSA FLOATS $500 MILLION EUROBOND ISSUE
State-owned diamond monopolist Alrosa successfully completed a $500 million Eurobond issue on 29 April, Prime-TASS reported the same day. The five-year bonds carry an annual coupon of 8.125 percent. The company had initially planned a $300 million bond offering but revised the amount upward in response to demand that topped $900 million, "Vedomosti" reported on 30 April. Aleksandr Ovchinnikov, head of the debt-market research department at Trust Investment Bank, told the newspaper, "Getting more money more cheaply is the main objective in a bond issue, and Alrosa did that." Money from the bond issue will go toward paying off $559 million in short-term debt, "Kommersant" reported on 29 April. More broadly, the Eurobond issue is part of $1 billion in borrowing the monopolist plans for 2003, "Izvestiya" reported on 27 March. Alrosa needs funds to finance the construction of two new diamond mines -- Mir and Udachnaya -- at a total cost of $2 billion in order to maintain current production levels as yield from older mines decreases. DK

COMPANIES
MEAT CONFLICT RESOLVED
Two warring food-industry concerns have agreed to settle their differences over one of Russia's largest meat-processing plants. The players are Rusagrokapital, a part of the Interros holding company, and Agros, created by the investment group Russian Funds. Rusagrokapital will cede Agros a controlling stake in a bread factory in exchange for control over Smolensk meat company Smolmyaso, "Vedomosti" reported on 28 April. The conflict began as a classic battle for control of a disputed enterprise, with Agros holding a 57 percent stake in Smolmyaso and Rusagrokapital 43 percent, "Izvestiya" reported on 27 March. "Kommersant" reported on 7 March that on 17 February Rusagrokapital gained physical control over Smolmyaso, usually a crucial factor in ownership disputes. Industry sources told "Vedomosti" on 28 April that Agros's 57 percent stake in Smolmyaso is worth approximately $5 million, while Rusagrokapital's 51 percent stake in the Smolensk Bread Factory is worth around $3 million. Parties close to the deal, however, told the newspaper that the actual financial arrangements are complex and "multilayered." With 61,000 pigs, a factory that can produce 3.5 million units of tinned meat a year, and 50 stores in the region, Smolmyaso is one of the largest meat-processing plants in central Russia. DK

INVESTMENT
PHILIP MORRIS TO INVEST $240 MILLION IN PETERSBURG PLANT
U.S.-based cigarette manufacturer Philip Morris announced on 29 April that it will invest $240 million in its plant outside St. Petersburg to boost production from 40 billion cigarettes a year to 70 billion cigarettes a year by 2005, Reuters reported the same day. The company's two factories, Philip Morris Izhora near St. Petersburg and Philip Morris Kuban in the south of Russia, accounted for 24.2 percent of the Russian market in the first quarter of 2003. Demand for cigarettes in Russia is stable at 280 billion-300 billion a year, while production currently stands at around 400 billion, "Kommersant" reported on 30 April. Mark Duerst, director of Philip Morris's Russian operations, told "Izvestiya" on 29 April that the specter of an overproduction crisis does not scare the company: "Sales of our products are increasing. In 2001, we sold 51 billion cigarettes, and 68.5 billion last year. That's fantastic growth." If Russian smokers cannot puff enough, export could prove a viable alternative. Viktor Stefashin, director of the analytical department at the Grandtabak Association, told "Vedomosti" on 30 April, "We have cheap labor and energy, so it's advantageous for international companies to locate production here." DK

AROUND THE CIS
AZERBAIJAN, LUKOIL SETTLE TAX CONFLICT
LUKoil has settled its differences with Azerbaijan over taxes due from the Russian oil major's sale of its 10 percent stake in the Azeri, Chirag, and Guneshli fields (ACG) to Japan's Inpex for $1.354 billion, "Nezavisimaya gazeta" reported on 29 April. Natik Aliev, president of Azerbaijan's state oil company, announced on 25 April that LUKoil will pay a total of $156 million to the Azerbaijani treasury -- $40 million to expand its interest in the D-222 project and the remainder in taxes on the ACG sale. LUKoil had denied any tax obligation, claiming that a production-sharing agreement exempted the sale from tax payments. A LUKoil representative told "Vedomosti" on 25 April, "We agreed to a certain increase in our obligations on the Yalama [D-222] project in order to avoid damaging relations with the Azeri authorities." DK

IN FOCUS
DEJA VU ALL OVER AGAIN
"RFE/RL Business Watch" reported on 25 March that timber-industry holding Ilim Pulp Enterprise (IPE) had bested its opponents in a long-running corporate conflict and was ready to consolidate its assets with an eye to a public offering. IPE's recent attempt to move ahead with the consolidation showed that both our conclusions and the company's plans were somewhat premature.

Registered in 1992, St. Petersburg-based IPE is one of the world's 10 largest timber, logging, and pulp-and-paper concerns, with overall sales estimated at nearly $1 billion in 2002. The leading Russian producer, exporter, and seller of pulp, paper, and board, it exports primarily to Eastern Europe, the Middle East, and China. Employing some 49,000 workers, IPE owns Russia's three largest pulp-and-paper mills, 42 logging companies, and separate firms for trading and logistics. Impressive as all this sounds, it still would not be news but for a long-running conflict that has been a case study in the vagaries of Russian shareholder rights, corporate litigation, and -- most importantly -- ownership of property.

The conflict broke out in April 2002. Previously, Zakhar Smushkin, chairman of the board of directors of IPE, was Russia's undisputed master of pulp and paper. But on 26 April, a minority shareholder in the Kotlas pulp and paper mill, the jewel in IPE's crown, obtained a ruling from a regional court in distant Kemerovo, several thousand kilometers removed from Kotlas, to freeze the shares that make up IPE's 61 percent stake in the mill. The suit charged that IPE had failed to carry out investments in the mill stipulated by a 1994 privatization agreement; IPE's shares were frozen "because of a lack of funds in the enterprise's accounts" and placed in state receivership.

By June, the 61 percent stake in the Kotlas mill had been snapped up by commercial structures controlled by aluminum baron Oleg Deripaska and high-profile banker Vladimir Kogan. By August, the battle for control of the mill was raging in the grandest tradition of post-Soviet takeovers, with mutually contradictory court decisions, two claimants for the director's chair, rival security details separated by makeshift barricades, heavy-handed media muckraking, and pained sighs in the international press at the malleability of Russian property law and its dampening effect on Western investment in the country.

Behind the ruckus stood an almost perversely simple mechanism for forcibly transferring ownership: A minority shareholder uses a minor violation to dispute the legality of a controlling stake, preferably filing the claim in a distant provincial court. If the court decides in favor of the minority shareholder, the controlling stake glides through receivership into new hands, which promptly fashion a new board of directors to decree new management. A court order, perhaps a scuffle at the entrance to the director's office, and the deal is done.

The practice is pervasive. An April 2002 report by Yegor Gaidar's Institute of the Economy in Transition (http://www.iet.ru/trend/2001/index.htm) presents an imposing list of takeovers in 2001 and 2002: Moscow-based Kristall (vodka) and Moskhimfarmpreparaty (pharmaceuticals), Babayevskii (a confectionery producer), the Kachkanarskii Iron Ore Dressing Works, Uralkhimmash, the Kamyshlovskii Construction Materials Factory (Sverdlovsk Oblast), the Saldinskii Metallurgical Works (rail-production monopolist, Sverdlovsk Oblast), Ust Ilim LPK (one-third of Russian pulp production, Irkutsk Oblast), the Stupinskii Metallurgical Works (nonferrous metals and heat-resistant-steel production, Moscow Oblast), the Alstom-Sverdlovskii Electromechanical Factory (energy equipment, Sverdlovsk Oblast), the Pskovsk Heavy Electric Arc Welding Equipment Plant, the Karabash Copper Smelting Integrated Works (blister copper, Chelyabinsk Oblast)...and so on and so forth.

Takeover after takeover has driven home the lesson that the best defense against the perverse simplicity of the minority-shareholder ploy is mulish obstinacy -- maintain physical control of the enterprise no matter what the courts say. Two mutually contradictory court decisions can happily coexist on two separate pieces of paper; only one party can control the ground. IPE took note, battling Deripaska and Kogan's Continental Management in court even as it manned the barricades at its facilities in the north.

In the 18 March 2003 court decision that spurred IPE to declare victory over its opponents, a Moscow arbitration court ruled that the registration companies that recorded the initial stock transfer -- the one that started the controversy -- did not have the authority to register the transaction. RBC closed its report on the ruling with the following remark:

"Today's court decision ended the suit over shares in the Kotlas pulp and paper mill and established that organizations linked to the companies Continental Management and Basic Element cannot claim that they acquired shares in the Kotlas mill -- the transaction was not recorded in the appropriate register of the enterprise's shareholders."

In other words, the deal never really took place. IPE prepared to consolidate its assets. But Continental Management, which did not accept the validity of the Moscow arbitration-court ruling and continues to consider itself the holder of a controlling stake in IPE's choice assets, was not ready to give up.

The assets IPE wants to consolidate are: the Kotlas pulp and paper mill and the Ust-Ilim and Bratsk timber mills. IPE claims to own controlling stakes in all of the enterprises, which together did $970 million worth of business last year, "Vedomosti" reported on 21 April. IPE scheduled annual shareholders' meetings at the mills in late April to approve its plan to move them to a single share. Continental Management scheduled alternate shareholders' meetings on the same dates in St. Petersburg to assert its own claim to the mills.

Armed with the above-mentioned court decision and firmly in control of the situation on the ground, IPE seemed poised to shrug off the parallel shareholders' meetings and press on with its consolidation. A sudden turn of events put IPE in conflict with a more serious opponent -- the state.

A so-called "golden share" grants its holder veto power over changes to a company's charter. The Russian state holds just such a share in Bratskkomplekskholding, one of two companies that control the Bratsk timber mill. Aleksandr Krivenkov, a representative of the Industry and Science Ministry, duly arrived in Bratsk for the annual meeting of shareholders in Bratskkomplekskholding. Krivenkov was unable to register for the meeting, "Kommersant" reported on 22 April, putting the legality of the proceedings in doubt. (IPE representatives told "Vedomosti" that Krivenkov presented insufficient identification; Property Relations Ministry officials vigorously disputed the claim.) To make matters worse for IPE, Krivenkov told "Vremya novostei" on 23 April that he had explicit instructions to vote against the consolidation. And as though that were not bad enough, the Property Relations Ministry is threatening to have the Prosecutor-General's Office investigate how and why IPE prevented a representative of the state from carrying out his appointed duties, "Vedomosti" reported on 23 April.

As the conflict burst back into the limelight, the press split. Russia's two main business dailies -- "Kommersant" and "Vedomosti" -- presented Ilim Pulp as the legally recognized owner and Continental Management as the challenger (a practice we have followed here); "Gazeta," "Nezavisimaya gazeta," and "Vremya novostei" described Continental Management as the rightful owner and IPE as the usurper.

So what happens next? "It's your usual corporate war, the outcome of which is impossible to foresee," Aton analyst Aleksandr Agibalov told "Gazeta" on 22 April, adding that IPE's physical control over the assets in question gives it the edge for now.

Whoever wins the war, the two sides seem determined to trot out the full arsenal of the modern-day Russian corporate warrior -- litigious minority shareholders, offsetting court decisions, parallel shareholders' meetings, and newspapers willing to take up the cudgel for a cause (or client). Recent hints of ministerial involvement suggest that heavier weaponry might be on the verge of deployment.

We remind readers that a little more than a month after reporting the legal resolution of this dispute, we find ourselves mulling its renewed escalation. The mere fact that such a reversal was possible might prove to be more important than the eventual outcome of the conflict. DK

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