Business Watch: October 22, 2002

The owners of Tyumen Oil Co. (TNK) and Sibneft have decided to embark on a strategic partnership, "Vedomosti" reported on 15 October. Under the terms of a prospective deal announced by Alfa-Group head Mikhail Fridman on 14 October, Sibneft will receive up to a 7 percent stake in Alfa-Group's TNK International Ltd., an offshore vehicle that is the majority shareholder in TNK, and a seat on its board of directors. In return, Sibneft will grant TNK a 38 percent stake in the drilling company Orenburgneft (Onako). The deal, which is set to be closed in the next two to three months, ties up loose ends of Onako's privatization and will allow TNK to consolidate its holdings. The partnership should be viewed in the context of the upcoming privatization of Slavneft (see "In Focus" below). Sibneft is a prime contender for Slavneft, and TNK and Sibneft together own half of the trust company that controls 12.98 percent of Slavneft. DK

LUKoil's board of directors decided on 16 October to iron out the details of the company's restructuring within the next three months, "Kommersant" reported on 17 October. The restructuring plan, which is aimed at consolidating the holdings of Russia's leading oil producer and ridding it of noncore assets, is intended to raise the company's market value. The state tried to sell a 5.9 percent stake in LUKoil on the London Stock Exchange in August but backed away from the deal when it was unable to garner an offer of more than $703 million. With the government concentrating on the privatization of Slavneft (see "In Focus" below), the LUKoil sale has been postponed. Analysts, who currently value the stake at some $800 million, noted that the postponement could be risky. Valerii Nesterov of Troika-Dialogue commented in "Vedomosti" on 17 October that 2003 could be a year of unpleasant surprises: "For example, a war starts in Iraq and oil prices take a dive." DK

LUKoil is conducting talks with British Petroleum (BP) AG on acquiring a network of filling stations in Germany, the "Frankfurter Allgemeine Zeitung" reported on 18 October. German antitrust authorities ordered BP to unload some 750 Aral-brand filling stations when it acquired Veba Oil AG. LUKoil appears most interested in picking up the "southern packet" of 350 stations located in Bavaria and served by the nearby Ingolstadt refinery, which is supplied with Russian crude through the Transalpine Pipeline. RosBusiness Consulting reported on 18 October that LUKoil, which recently acquired a network of Getty filling stations in the United States, is also considering Poland as a staging ground for its international operations. LUKoil has expressed interest in a $300 million, 75 percent stake in the Polish Gdansk Refinery that is to be auctioned off in the near future. DK

The Financial Action Task Force (FATF) removed Russia from its blacklist of countries that exhibit insufficient zeal in the fight against money laundering, "The Wall Street Journal" international edition reported on 14 October. FATF lacks the authority impose sanctions on countries it deems money-laundering risks, but its recommendations can spur banks and companies to steer clear of cooperation with potential partners in blacklisted countries. Russia landed itself on the blacklist in 2000. Since then, Russia has introduced tougher legislation to combat money laundering and created a Financial Monitoring Committee, "The Moscow Times" reported on 14 October, all part of a successful effort to return to international fiscal respectability. Though Russian officials welcomed the decision as a vindication, other commentary was tepid. "Kommersant" wrote on 15 October that, "Many international officials have hinted on more than one occasion that the issue of removing Russia from the blacklist is a political question." And in a 14 October editorial entitled "Just PR," "Vedomosti" remarked that, "While there are as yet no concrete results, a law was passed and there are directives and instructions." The influential business daily concluded with a bit of world-weary wisdom: "The dogs bark, the caravan goes on." DK

In a move calculated to forestall major competitors, Moscow-based VimpelCom is expanding its Bee Line GSM network to the Krasnoyarsk region in Siberia, Gazeta.ru reported on 15 October. Bee Line GSM will initially be in competition with two regional operators, EniseiTelecom and SibChallenge, who together have some 100,000 subscribers. Experts see excellent growth potential in an area that could boast up to 1 million cellular customers, "Vedomosti" reported on 16 October, although VimpelCom competitor MTS may join the fray by acquiring a local operator. VimpelCom Vice President Nikolai Pryanishnikov touted the company's yearlong program of regional expansion in a 15 October press release, saying that, "Krasnoyarsk is the 34th region in the Bee Line GSM unified network, which the company began expanding actively a little more than a year ago." DK

U.S.-financed broadband network operator PentaCom has gone into an American-style, dot-com tailspin, "Vedomosti" reported on 17 October. The company, which planned to provide high-speed Internet access to the Moscow suburbs, failed to attract $250 million in investment needed for further development and is now embroiled in a lawsuit over unpaid back wages. According to its 2001 report, the U.S. Russia Investment Fund, which received $440 million from the U.S. government to "make equity capital...available to private businesses operating in Russia," sank $5 million into PentaCom in 2001. For his part, U.S. Russia Investment Fund President David Jones asserts that the fund is working "with other investors and company management" to rescue the ailing venture. DK

Dovgan GmbH Hamburg is set to begin placing Russian products on the shelves of such well-known retailers as Wal-Mart, Metro, Edeka, Kaufland, and Marktkauf, "Vedomosti" reported on 16 October. The Bystrov line of ready-to-eat food products will form the centerpiece of the Dovgan effort. Bystrov, a part of the Russian Si-Pro Group, posted sales of $35 million-$38 million last year. Dovgan was originally created to market the now defunct Dovgan brand products. Owners Andrei Kovalev and Viktor Srizhitskii have since made inroads on the German market distributing the production of Russia's Baltika brewery and Baltimor condiments manufacturer. Kovalev predicts that Dovgan's sales will reach 50 million euros ($48.6 million) this year, a twofold increase over last year's figures. "Vedomosti" reported, however, that Baltika, Baltimor, and Bystrov representatives are all seeking independent distribution channels to reach the German market. DK

With unhappy dealers overwhelmed by some 75,000 stockpiled cars still awaiting buyers, auto giant AvtoVAZ announced it will halt production for two weeks starting on 26 October, "The Moscow Times" reported on 14 October. A 17 October AvtoVAZ press release entitled "Reducing Production As Path To Market Recovery" blamed the vehicle surplus on a confluence of negative factors, including a delay in raising customs duties on used imported cars, flooding in southern Russia, and generally reduced consumer spending. According to "The Moscow Times," AvtoVAZ has produced almost 575,000 vehicles in 2002. "Kommersant" noted on 12 October that this is not the first production stoppage at AvtoVAZ; assembly lines also ground to a halt in December 2001, when 18,000 unsold vehicles cluttered dealers' lots. Commenting on the accusatory tone of AvtoVAZ press releases, "Kommersant" wrote that the automaker "preferred to remain silent about errors in its own marketing strategy." DK

The struggle for control over Moscow-based confectioner Babaevskii has produced a new director -- and new disputes -- "Kommersant" reported on 19 October. The Babaevskii concern consists of six enterprises and controls 7 percent of the Russian confectionary market. Babaevskii's current administration is in conflict with Gosinkor-Holding for control of the concern. The group's president, Sergei Nosenko, controls some 35 percent of Babaevskii's shares; Gosinkor-Holding 14 percent, and bankrupt Inkombank a controlling, and disputed, 51.06 percent stake slated to be auctioned off on 25 October. At a shareholders' meeting on 18 October, Gosinkor succeeded in electing a new director, Valerii Pyshnyak, and a friendly board. What happened next depends on the source. "Izvestiya," citing Gosinkor's PR director, Vasilii Borisov, reported on 19 October that, "Mr. Pyshnyak proceeded calmly to his office, where he signed an order about assuming the duties of director." "Kommersant," however, reported the same day that, "Mr. Pyshnyak was not allowed into the factory, and he departed after a long discussion with the enterprise's lawyers." Gosinkor, which hopes to create a consolidated confectionary holding by adding Babaevskii to its existing Red October and Rot-Front enterprises, is likely to continue its efforts to establish physical control over Babaevskii before Inkombank's controlling stake goes on the block on 25 October. DK

The owners of the Hot Tours Store, Russia's largest chain of travel agents, announced that they are selling Hot Tours to raise capital for future projects, "Kommersant" reported on 17 October. Bringing together some 200 travel agents in a franchising framework, Hot Tours boasts a 15 percent market share, annual revenues of $50 million-$60 million, and a profit of $1.5 million-$2 million. Hot Tours' owners hope to get as much as $10 million for the chain. But Igor Korepanov, who sits on the board of potential buyer Tantema, estimates Hot Tours' real value at closer to $2 million-$3.5 million. According to Korepanov, the chain is essentially a virtual entity, consisting of a recognizable brand but precious little in the way of tangible assets. DK

Russia's Alfa-Eco and Sweden's Vostok Nafta plan to build a $200 million direct-investment fund, "The Moscow Times" reported on 15 October. The fund's investment priorities will center on oil and gas, electrical energy, and mining concerns. Alfa-Eco is a subsidiary of Alfa-Group, which jointly owns Tyumen Oil Co., the fourth-largest producer of oil in Russia. Vostok Nafta, which boasted a $167.6 million investment portfolio in June, is the brainchild of Swedish energy baron Adolf Lundin. The Russia Resources Fund that Alfa-Eco and Vostok Nafta hope to create will be launched with $10 million contributions from each of the founders. Managers aim to attract $200 million by the end of 2003. Vladimir Andrienko, managing director of Russian Partners, told "Vedomosti" on 15 October, "Alfa-Group has wanted to create an international direct-investment fund for a long time." According to Andrienko, the presence of a large Western investor will add key management experience and enhance the fund's chances of attracting Western capital. DK

California venture fund Draper Fisher Jurvetson (DFJ) plans to invest as much as $100 million in Russian high-tech start-ups, "The Moscow Times" reported on 14 October. DFJ, which currently manages a portfolio of some $3 billion, played a role in the early days of current high-tech high rollers Hotmail and Yahoo!. Tim Draper, DFJ's founder and managing director, told reporters in Moscow that he sees "globally successful companies comparable with Microsoft or Intel coming out of Russia in the next two to three years." DFJ's plans to expand to the Russian market, however, come against a backdrop of shrinking tech-sector opportunities on its home turf. Industry tracker "TheDeal" (http://www.thedeal.com) noted on 11 October that a recent report by Milan-based CDB Web Tech SpA listed DFJ as one of 11 out of 54 venture funds whose write-offs exceeded new investments in 2001. DK

German tire manufacturer Continental acquired 76 percent of the Moscow Tire Factory on 16 October, the dpa reported. Continental hopes to produce some 3.5 million tires at the factory annually for the Russian market. According to a 17 October article in "Vedomosti," the German-Russian joint venture, which kicks off with $40 million in start-up capital, is slated to be converted into an integrated enterprise by late 2003. NIKoil analyst Vyacheslav Smolyanov speculated that the two-tiered approach might stem from Continental concerns that the Moscow tire manufacturer has "certain hidden obligations that are not immediately apparent." Meanwhile, the "Frankfurter Allgemeine Zeitung" reported on 17 October that Moscow's gain might be Germany's loss. Continental's Moscow move, which complements existing production joint ventures in the Czech Republic and Romania, is part of a general policy of shifting production to locations where labor is cheaper. Announcing Continental's eastward thrust, spokesman Manfred Wennemer would not rule out possible plant closures in Western Europe. DK

An Uzbek government resolution ended national Internet server UzPAK's monopoly on Internet access, Interfax reported on 14 October. Previously, all Uzbek Internet service providers were required to use UzPAK lines to reach the outside world. In a 17 October report, Internews Uzbekistan welcomed the resolution, which it described as aiming "to create a more favorable environment for providers to compete in the Uzbek Internet market." The resolution opens the door to the possibility of a more diversified IT market in Uzbekistan, where some 100 operators currently provide Internet services. DK

Kazakhstan's national oil company, KazMunaiGaz, and U.S.-based ExxonMobil plan in November to discuss the possibility of a joint venture, Interfax reported on 15 October. ExxonMobil, which initiated the talk of a joint venture, has shown an interest in exploring Kazakhstan's offshore oil deposits. KazMunaiGaz produced 3.593 million tons of oil in the first half of 2002. ExxonMobil is already involved in a number of projects in Kazakhstan, including the development of the Tengiz oil field. DK

Currency controls have been a touchy topic in Russia ever since the financial meltdown of August 1998. To prevent the ruble from launching into another unimpeded nosedive in the event of some future calamity, and to maintain a steady inflow into its own reserves, the Central Bank introduced regulations that required exporters to convert 75 percent of their hard-currency earnings into rubles (the figure was lowered to 50 percent last year). Now, with the cabinet set to review the law "On Currency Regulation And Currency Control" on 24 October, the issue of who controls hard currency and how is once again in the air.

Initially, three flowers bloomed on the field of currency regulation. The Finance Ministry and Central Bank, charged with drawing up the official text to be presented to the cabinet, were primarily concerned with staving off future crises by granting themselves the right to "halt various types of currency transactions and capital movement for a limited period," according to a draft published by Gazeta.ru on 15 October. In fact, their proposals were so restrictive that a dissatisfied Prime Minister Mikhail Kasyanov sent them back to the drawing board after getting a peek at the plan.

Economic Development and Trade Minister German Gref urged reducing mandatory foreign-currency sales to 25 percent in 2003 and abolishing them altogether in 2004, "The Moscow Times" reported on 15 October. Meanwhile, the Russian Union of Industrialists and Entrepreneurs (RSPP), a collective mouthpiece for Big Money, lobbied its own interests in the form of a complete removal of mandatory sales requirements and other administrative controls on capital movement. For his part, President Vladimir Putin has spoken out in favor of currency liberalization but avoided specifics.

A flurry of consultation produced a preliminary compromise by the end of the week. On 17 October, "Vedomosti" reported that the Central Bank and Economic Development Ministry agreed on the following hybrid proposal: 1) exporters will have to sell 30 percent of their hard-currency proceeds for rubles with no plans for future reductions; 2) companies will be able to open accounts abroad without obtaining individual permission, but only in banks in member countries of the Organization for Economic Cooperation and Development or the Financial Action Task Force on Money Laundering.

Even if implemented, none of these measures is likely to have a profound effect on Russian business. Exporters long ago learned how to circumvent inconvenient currency controls for their own needs while rendering enough unto the Central Bank to avoid its wrath. For its part, with hard-currency reserves standing at a record $45.6 billion, the Central Bank has little cause to put the squeeze on for dollars and euros.

Last week's currency-control debate did, however, illustrate the strength of group interests and institutional culture. Petr Aven pioneered the idea of forcing exporters to sell hard-currency proceeds to the Central Bank. But that was when he was minister of external economic ties; today he is the head of Alfa-Bank. On 14 October, he described himself to "Kommersant" as a "supporter of extremely liberal currency legislation" and called mandatory sales "an absolutely pointless quota." Sergei Ignatiev and Aleksei Kudrin entered Putin's cabinet with a reputation as liberals. Once ensconced in the Central Bank and Finance Ministry, however, they turned their attention to maintaining, and even increasing, the state's control over the movement of capital.

The discussion also showed that the 1998 financial crisis still casts a long shadow. Finance Minister Kudrin told Gazeta.ru on 15 October that in 1998 "rubles were tossed out [on the market] to buy several billion dollars that were taken out [of Russia] within a day or two." With oil prices and the revenues they generate low, catastrophe resulted. "This could happen again," the minister remarked darkly.

With oil prices high and the Central Bank's vaults bursting with dollars, the issue of anticrisis currency controls may seem largely technical. The watchword of the Russian economy, however, is still oil, oil, and oil again; and a host of geopolitical factors have conspired to cast a cloud of uncertainty over the future of oil prices. For all its apparently unwarranted pessimism, Kudrin's comment hints at an issue that is, while certainly tied to the specific policy of currency controls, a far, far larger question for Russia's future. DK

Prime Minister Kasyanov's recent announcement that the state will sell its 74.95 percent stake in Slavneft, Russia's ninth-largest oil producer, was more than just another billion-dollar news blip. An astonishing amount of the good, the bad, and the ugly in today's Russia traces its roots back to the divvying up and parceling out of the Soviet state's boundless fiefdom in the heady 1990s, and all were on display in the news of the Sibneft sale and reactions it evoked.

Before year's end, the Russian government will conduct a competitive sale of its 74.95 percent stake in Slavneft with a minimum price of $1.3 billion, the "Financial Times" reported on 14 October. Initial plans had called for a piecemeal auction starting with a much smaller stake, but the government apparently decided to collect as much as possible as soon as possible. Russia owes a $1.5 billion debt payment to the International Monetary Fund (IMF) in February, and an August auction of a 5.9 percent stake in LUKoil failed when investors were willing to pony up only $703 million for a chunk of the oil giant, $20 million less than the Russian State Property Fund had hoped for. Proceeds from the Slavneft sale will serve nicely to bridge the gap.

How much is Slavneft worth? Three expert opinions published in "Kompaniya" No. 235 set a price range from $1.5 billion-$2 billion. Andrei Vavilov, president of the Financial Research Fund, focused on management issues, saying that if the sale is prepared by management with a "Yukos mentality... it could be worth about $3 billion," but a "LUKoil mentality" would mean "no more than $1.5 billion." Kakha Kiknavelidze, senior oil and gas manager at Troika-Dialogue, valued Slavneft at $1.5 billion-$2 billion. And Stiven Dashevskii, director of stock analysis at Aton, estimated the company's worth at $3.15 billion, subtracted debts of $300 million and the holdings of minority shareholders, and arrived at $1.9 billion, adding that market considerations could push up the price.

Who's going to buy it? Analysts paint a picture of a star-studded cast lined up with wallets in hand. "The Moscow Times" on 14 October listed "No. 3 producer Surgutneftgaz and No. 5 Sibneft" as "front-runners," and described LUKoil, Yukos, and TNK as "mulling possible participation." Natalya Gotova, writing in "Kompaniya" No. 235, cited "certain analysts" who feel that Sibneft is the leading contender. "Expert" No. 38 tapped Surgutneftegaz, Yukos, and LUKoil as the top candidates.

What are the insider versions? Roman Abramovich's Sibneft would appear to have the advantage. Not only does Sibneft own 25 percent of the trust company that controls 13.17 percent of Slavneft, it recently entered into a "strategic partnership" with TNK, which owns another 25 percent of the same trust company. Gazeta.ru reported that President Yevgenii Shvidler reaffirmed Sibneft's intention to take part in the auction at a 17 October meeting with no less than President Putin, where the two "discussed the upcoming competitive sale of the state's stake in Slavneft." Not to be counted out, however, are Mikhail Khodorkovskii's Yukos, with its high capitalization and Eastern Siberian geographical proximity to Slavneft, and Surgutneftegaz, with its $4 billion in capital looking for a place to go.

What can we conclude from this?

First, Russia's upcoming payment to the IMF is as real as the state's need for money to make that payment, so cold, hard cash will change hands in this transfer of at least $1.3 billion of state property to the private sector. The mere fact that analysts can bandy about a bevy of contenders for such a costly purchase shows that at least one sector of the Russian economy -- oil and gas -- has more than a little financial muscle. The sector has built up its muscle by extracting a valuable commodity from the bowels of the earth and selling it, primarily abroad and most recently for prices that ensure a hefty profit margin.

Second, perceptions of Russian corporate entities have evolved sufficiently, especially in Western publications, to denude them of oligarchic affiliation and pair them with active verbs. Though the "Financial Times" included a reference to "influential politician and businessman Roman Abramovich" in its penultimate paragraph, it began by writing simply that "Sibneft, Yukos and Surgutneftegaz all expressed interest in the sale." Similarly, "The Moscow Times" ceded "oil majors" LUKoil, Yukos, and TNK their right to the verb "say," although editors may presume that their Russia-focused readers don't need to be reminded who controls what in the Russian energy business. And while most Russian articles went into considerably greater detail on the personal intrigues behind the corporate logos, the trend toward "corporate entity + active verb" was equally visible.

Finally, the fact of privatization has become unremarkable; only the mechanisms draw comment. On this count, the government's announcement that Slavneft will be sold at an open auction gave rise to fantastic rumors: the sale would be conducted on national television by Leonid Yakubovich, who gained fame as the host of Russia's equivalent of "Wheel of Fortune"; or, the auction would take place "by computer," opening the door to all manner of virtual chicanery.

To sum up, the state will sell Slavneft for real money to pay off its debts, a small group of Russian oil tycoons will participate in the auction, and, allowing for a brief flight of fantasy, it could all be carried on live television with scantily clad dancing girls and an emcee in a sequined vest. Only the good, the bad, and the ugly in this spectacle remain to be decided by the eye of the beholder. DK