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Business Watch: May 27, 2003

27 May 2003, Volume 3, Number 19
The cabinet reviewed and approved -- more or less -- Russia's long-awaited energy strategy to 2020 at a 22 May meeting, Interfax reported the same day. The strategy sets out a general framework for the development of the country's vitally important energy sector along with "optimistic, favorable, moderate, and critical" scenarios. Under the optimistic scenario, for example, rising oil production buttresses a threefold increase in GDP by 2020. Prime Minister Mikhail Kasyanov was careful to warn, however, that the strategy's ultimate goal is to cut the economy's energy dependence in half in order to stimulate manufacturing, "Kommersant" reported on 23 May. Official responses to the strategy ranged from the merely positive to the rapturous. Others were less impressed. Grigorii Vygon, a leading specialist at the Institute of Financial Research, told "Nezavisimaya gazeta" on 23 May, "In my view, there's virtually no practical benefit from this strategy." Some caught a whiff of the not-so-distant past in the planning project. Valentin Zavadnikov, head of the Federation Council committee on industrial policy, told "Gazeta" on 23 May, "Although it contains a large number of the right market words, the strategy doesn't presume actual market mechanisms. It was written by people whose thinking is still on Soviet standards." An unnamed source told "Kommersant" that the strategy is a "mix of market rhetoric and socialist mentality." The cabinet made its approval of the strategy contingent on certain statistical adjustments. Assuming the figures are tweaked to everyone's satisfaction, the contingent approval becomes final in one month. DK

Oil major Yukos announced consolidated financial results to U.S. Generally Accepted Accounting Practices (GAAP) standards for the fourth quarter of 2002 and the year as a whole on 19 May. Revenues rose 20.2 percent year-on-year to $11.4 billion, while net profits fell 3.1 percent to $3.05 billion. Fourth-quarter revenues rose to $3.42 billion from $1.93 billion in 2001, and net profits for the quarter jumped to $988 million from $423 million in 2001. But if revenue and profit results were largely in line with analysts' expectations, ballooning expenses raised concerns. Operational costs totaled $7.89 billion in 2002, as compared to $5.83 billion in 2001. Costs in the fourth quarter rocketed to $2.69 billion from $1.38 billion the year before. Deutsche Bank analyst Leonid Mirzoyan told "Vedomosti" on 20 May that the company is a victim of its own rapid growth. With output rising 19 percent in 2002 and Russia's pipeline export capacity already overtaxed, Yukos was forced to turn to costlier export alternatives such as the railways. Aton analyst Timerbulat Karimov seconded his colleague, telling RBC on 19 May that "the company's transportation expenses rose significantly." Not everyone found the results worrisome. Troika Dialog's John Warren remarked that Yukos' multibillion-dollar merger with Sibneft remains much bigger news, "The Moscow Times" reported on 21 May. As Warren put it, "I don't think that a couple of tens of millions of dollars in the fourth quarter is going to worry too much." DK

As Russian-U.K. TNK-BP puts together a business plan for 2004, the question of what to do with half of recently privatized oil company Slavneft remains unanswered. TNK-BP itself arose as a result of a February merger between Russia's Tyumen Oil Company (TNK) and Britain's British Petroleum (BP) that saw the latter agree to invest $6.75 billion in the joint venture. TNK and Sibneft together own 98.95 percent of Slavneft after jointly purchasing a 74.95 percent stake in the company for $1.86 billion at a December 2002 privatization auction. "Vedomosti" reported on 19 May that BP isn't interested in TNK's half of Slavneft, however. A BP representative told the newspaper, "We've studied the information on Slavneft...and decided not to continue working in that direction." Industry analysts Steven Dashevskii and Valerii Nesterov fingered Yukos, which recently agreed to acquire 92 percent of Sibneft, as the most likely buyer for Slavneft. Yukos CFO Bruce Misamore, however, said in a 19 May conference call that Yukos does not plan to acquire TNK's half of Slavneft, "Vremya novostei" reported the next day. Meanwhile, TNK Director German Khan said that while there is as yet no concrete timeframe for the division of Slavneft between his company and Sibneft, the matter should be put to rest by the end of the year, RusEnergy reported on 23 May. DK

The Russian Trading System (RTS) stock exchange spent the week of 19-23 May in record territory after surging past the 450 mark on 16 May for the first time since 1997. Leaders for the week were Unified Energy Systems, which climbed 31.46 percent to close at $0.234; ordinary shares of the Kostroma State District Electric Power Station, which rose 28.68 percent to close at $0.0875; and ordinary shares of Bashkirenergo, which rose 26.84 percent to close at $0.241. With the bull market in full swing, analysts' thoughts turned to the chances of an impending correction. "Vedomosti" wrote on 22 May, "There's no panic in the air, but virtually all analysts are talking about an inevitable correction." Andrei Bespalov, an analyst at Metropol Investment and Finance Company, told "Kommersant" on 20 May that the RTS could reach 500 in June, but he expects a correction by fall. But Aleksandr Baranov, vice president of the Russian Funds investment group, told "Gazeta" on 19 May that investors are readying their portfolios for an expected pre-election rally in the fall. Even so, Baranov allowed that the market might "sag" in the summer before picking up again. DK

Russia and Malaysia initialed a contract on 19 May for Malaysia to buy 18 Su-30MKM fighter planes for more than $900 million, Interfax reported the same day. The deal grabbed headlines in Russia not only because of the hefty price tag, but because Malaysia apparently chose the Su-30MKM over Boeing's F/A-18E/F Super Hornet fighter. Ruslan Pukhov, director of the Center for the Analysis of Strategies and Technologies, told "Gazeta" on 20 May, "It's nice to push Boeing out of such a promising market." The Irkut Corporation will produce the Su-30MKM's for delivery in 2006, "Vedomosti" reported on 20 May. Comments by Malaysian Defense Minister Najib Razak suggested that Malaysia might pay for the jets at least partially in kind, "Izvestiya" reported on 20 May. A precedent exists -- Malaysia paid part of a $600 million 1994 contact for 18 Mig-29 fighters in palm oil. Irkut is a rarity in the Russia's state-dominated defense industry, with management holding a majority stake and the state owning a mere 14.7 percent of the company, "The Moscow Times" reported on 20 May. According to "Gazeta," Russia exported $4.8 billion worth of arms in 2002 and controls 13 percent of the global arms market. DK

Cellular operator Mobile TeleSystems announced financial results on 20 May for the fourth quarter of 2002 and the entire year. The company's 2002 net profits rose to $277 million, a 34.6 percent year-on-year increase. Revenues rose 52.5 percent to $1.36 billion. Earnings before interest, taxes, depreciation, and amortization (EBITDA) rose 47.4 percent to $674 million. But fourth-quarter results were lower than expected, "Vedomosti" reported on 21 May, with EBITDA margin slipping to 44.6 percent from 53 percent in the third quarter. Fourth-quarter EBITDA was $182.7 million, lower than average expectations of $207 million, Reuters reported on 21 May. Average revenue per user (ARPU) dropped from $25.2 in the third quarter to $21.2 in the fourth quarter; overall, ARPU slipped from $36 in 2001 to $22.9 in 2002. Aton analyst Vadim Kotikov told "Vremya novostei" on 21 May, "It's rapidly become evident how much the entrance to the mass market cost MTS." The company launched its new Jeans tariff plan in November, targeting budget-minded subscribers. The MTS board of directors also recommended on 20 May that the company pay out $110 million in dividends from 2002 profits, RBC reported the same day. The dividend payment will be the first since the company's stock began trading. With nearly 10.5 million subscribers, MTS is the largest cellular operator in Eastern Europe. DK

A database with information on the customers of St. Petersburg's main telephone companies is available for sale, "Kommersant" reported on 20 May. A correspondent for the newspaper paid 1,650 rubles ($54) for a database on three compact disks with basic information on the subscribers of cellular operators Megafon (1.3 million entries), Mobile TeleSystems (MTS) (500,000 entries), Delta Telecom (120,000 entries), FORA Communications (15,000 entries), and fixed-line operator Northwest Telecom (2.5 million entries). Representatives of both Megafon and MTS told Interfax on 20 May that they are conducting investigations to determine the nature and source of the information on the black-market disks. Experts polled by "Nezavisimaya gazeta" agreed that law enforcement authorities were the most likely source for the simultaneous disclosure of such varied confidential information, the newspaper reported on 21 May. If confirmed, the theft would be the second largest of its kind. Earlier in the year, an MTS database with information on 5 million subscribers appeared on the black market. DK

Switzerland's Nestle announced on 22 May that it will spend $120 million to build a full-cycle factory to produce Nescafe coffee in Russia's Krasnodar Krai, Interfax reported the same day. According to Mark Sheperd, marketing director for Nestle's Russian subsidiary, when the factory is completed in 2005, it will employ 100 people and produce 99 percent of the Nescafe coffee sold in Russia. The Russian Association of Tea and Coffee Producers estimates that Nestle controls 30-40 percent of Russia's coffee market, "Vedomosti" reported on 23 May. That market has plenty of room for future growth -- the average Russian drinks 160 cups of coffee a year, while Scandinavians down over 1,000. As Natalya Zagvozdina, consumer goods analyst with Renaissance Capital, told "The Moscow Times" on 23 May, "If such a major international producer as Nestle is investing an additional $120 million in Russia then they are clearing seeing great potential." DK

The planned privatization of four petrochemical enterprises in Belarus failed to attract a single bidder, RBC reported on 21 May. Minsk had hoped to get at least $1.15 billion for 43 percent stakes in the Naftan oil refinery and Polimir, Azot, and Grodno Khimvolokno petrochemical plants. The government set stringent conditions for potential investors, requiring minimum bids, hefty investment programs, and even the retention of social infrastructure at the enterprises. Vladislav Metnyov, an analyst at Trust Investment Bank, told "Vedomosti" on 21 May that non-controlling stakes at high prices were unlikely to spark much interest. Surgutneftegaz had been cited as a possible buyer for the Naftan refinery, but CEO Vladimir Bogdanov told "Russkii focus" (No. 019) in a 19 May interview, "You could build a new refinery for the price they're asking. Not many people will agree to those conditions, I think." A source in the Belarusian Embassy in Moscow said that Minsk is now considering whether to postpone the privatization, cancel it, or change the investment conditions, RIA-Novosti reported on 23 May. DK

"It's a shame that the only thing a man can do for eight hours a day is work. He can't eat for eight hours; he can't drink for eight hours; he can't make love for eight hours. The only thing a man can do for eight hours is work." -- William Faulkner

Most people who have to work for a living leaven Faulkner's glum wisdom with the humble hope that they will, one day, be able to stop working and begin enjoying the fruits of their labor. But in a capitalist society, even retirees are expected to buy groceries and pay bills in the same valid coin as working stiffs. The pension's purpose is to bridge the gap between these two expectations.

The finite resources of a capitalist society set another condition -- the money for pensions must come from somewhere. Sadly, no fund of universal justice exists to pay the plowman's bills when he sets aside the plow. Either some of the plowman's earnings must be set aside for future bills, or someone must agree to provide for him when the time comes.

In the jargon of those whose profession is pensions, the aforementioned distinction is between funding and PAYG. Under a funded pension plan, workers set aside a portion of their wages and then draw on the accumulated funds when they retire. Under a pay-as-you-go (PAYG) system, taxes collected from workers go to pay the pensions of their elders; when those workers retire, they receive their pensions from the succeeding generation's taxes.

As John Shuttleworth explains in a 28 April article in "European Pensions & Investment News," Russia's Swedish-inspired pension reform is based on a three-tiered system: 1. a flat pension on a PAYG basis; 2. individual accounts, also on a PAYG basis; 3. a funded contribution to be invested. Starting on 1 January 2004, the money that comes out of each worker's paycheck will head in two basic directions. As "Profil" (No. 043) reported on 18 November, part of it (22-26 percent) will go to pay the pensions of current retirees; a smaller portion (2-6 percent) will be set aside and invested for the worker's own retirement. It is the setting aside and investing of the second, funded, part of pensions that is raising questions for some, and hopes for others.

According to "Rossiiskaya gazeta," men born in 1952 and women born in 1957 will be the first to receive pensions paid in part from funded 2012. But the money is already accumulating. The State Pension Fund (PFR) will have 85 billion rubles ($2.7 billion) ready for investment by 2004, "The Moscow Times" reported on 29 April. The amount of funded contributions will grow to $8.4 billion in 2005, and to $17.5 billion in 2008, "Vedomosti" reported on 23 May.

The next stage of pension reform will theoretically give employees the right to select a licensed fund manager to look after -- invest, in other words -- their funded contributions. "It's a revolution in the making," Roland Nash, chief economist at Moscow's Renaissance Bank, told the "Financial Times" of 24 March. "The knowledge that this money will be there has catalyzed a lot of ambitious young funds," he added.

Which brings us directly to a well-trodden crossroad on the path to reform -- where theory runs up against the practical details. A number of concrete events need to take place to get the funded part of the pension system up and running. Licensed fund managers must be licensed to manage funds. Employees must be made aware that they have a choice -- either to have the state invest their funded contributions or to have a fund manager invest them. Some employees must choose nonstate fund managers. (The funded contributions of those who make no choice will, by default, be invested by the state through Vneshekonombank.) Finally, fund managers must have investment opportunities that offer the right balance of risk and return.

The first problem is timing. The Finance Ministry, Economic Development and Trade Ministry, Federal Securities Commission (FKTsB), and PFR are still haggling over the requirements that fund managers must meet in order to handle funded contributions. Clearly, only stringent conditions can prevent fly-by-night operations from frittering away, or even flitting off with, citizens' hard-earned pension money. But overly stringent conditions will limit the market to a few players and prevent any real choice or competition.

Meanwhile, PFR is getting ready to send out 37 million letters by 1 August to inform participants in the new system how much money they have built up on their individual accounts and to give them a chance to choose a fund manager. First Deputy Minister of Economic Development and Trade Mikhail Dmitriev admitted to "Vedomosti" on 22 May, "It will be very difficult this year to synchronize the mailings and the competition [to determine licensed fund managers]." Employees are supposed to respond with their choice of a fund manager by 15 October. If the list of licensed fund managers is not ready on time, citizens will be expected to make their choice on the basis of information published later in newspapers and official Internet sites, almost certainly increasing the number of pensions defaulted to the state.

Even if everything goes smoothly, the question of the money remains. Ruben Vardanyan, head of the Troika Dialog investment company, told "Kompaniya" of 10 March: "It's not clear that the market can absorb the amount of funds that will emerge as a result of pension reform. Ask yourself how to invest $2 billion in Russia so that the investment is both secure and profitable." "Vedomosti" reported on 23 May that ratings agency Standard & Poor's predicts that Russian pension funds will face a shortage of sufficiently reliable investment opportunities by 2008.

Another concern is that the diversification of the pension system will serve to channel funds into the ubiquitous financial-industrial groups (FIGs) that control much of the Russian economy. Nonstate pension funds already exist in Russia alongside the state's pension system. As one might expect, the biggest of these belong to leading FIGs, and they are probably the only structures with the financial muscle to make the grade when government officials finalize requirements for fund managers. Edward Neugebauer, deputy director of the Prospekt investment company, told "Kommersant Dengi" of 12 May: "We can expect that the main players on the market for asset management will be companies affiliated with oligarchic structures. They will completely control all of the significant pension money."

The difficulty here is that, financial muscle aside, FIGs are primarily concerned with, well, their own primary concern -- making money for themselves. As Vitalii Plotnikov, president of the First National nonstate pension fund, explained to "Kommersant Dengi," "The founder of a large corporate fund is mainly interested in keeping the pension reserves of the nonstate pension fund he controls as close to himself as possible...since the founder uses these resources as borrowed funds to make a profit in his main line of business." In other words, pension funds could put all the nest eggs in one oligarchic basket, with decreasing returns and increasing risks for future retirees.

In the end, however, this might be the one reform that is truly in the hands of the people. As Dmitriev explained to "Vedomosti" of 23 May, the greatest peril is that, after all the planning and preparation, nothing at all will happen. If no one chooses private fund managers, funded contributions will go to the state for the state to invest in its own bonds. In Dmitriev's words: "The system isn't designed for all the funds to be invested in the national debt. Why go through all the trouble to do that? We risk getting not a funded pension system, but a more expensive version of pay-as-you-go." DK

Investors gave the board of Unified Energy Systems (EES) a billion-dollar backdrop for its 23 May meeting to approve a strategy for breaking up the monopoly over the next five years. On 21 May, EES shares soared 14.41 percent on the dollar-denominated RTS to close at $0.2175. By the end of the week, the stock was up 30 percent and the company's market capitalization had topped $10 billion. The Federal Securities Commission was so impressed it decided to open an investigation, "Kommersant" reported on 22 May.

While some investors might have been snapping up the shares on fundamentals, others had their eyes on the impending breakup of the state-run utility. The company's so-called 5+5 strategy envisages the creation of 10 generating companies, six of which will subsequently be privatized. And what does this have to do with EES shares? Yevgenii Malykhin, head of asset management at Guta Invest, told "Vedomosti" on 22 May, "Everyone thinks that EES shares will turn into something like a voucher that will allow you to acquire certain assets in the electrical energy sector, and this is driving up the share price."

And not without reason. The board approved the 5+5 strategy in a 14-1 vote at its 23 May meeting, "The Moscow Times" reported on 26 May. Dmitrii Akhanov, deputy director of EES's capital-management department, told "Izvestiya" on 27 May that EES shareholders will soon be able to convert their EES shares into direct stakes in the generating companies. The conversion will involve a two-stage process: pro rata distribution followed by shares-for-shares auctions. Additional details -- crucial details, if past privatizations are any indication -- will be hammered out in the five days leading up to the annual shareholders' meeting on 30 May, Interfax reported.

Independent board member Aleksandr Branis told "The Moscow Times," "I was the only one to vote against the plan because I am concerned about several things -- the sale of assets...and how the auctions will work. All the old concerns remain." High on the list of "old concerns" is that portfolio investors, among others, will end up with the short end of the stick as industrialists with a vested interest in the power sector muscle in on the privatization of generating assets.

Markets are roiling, industrialists prowling, and tasty morsels waiting to be privatized. With elections to the EES board looming on 30 May, the only possible conclusion is: To be continued. DK