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Business Watch: October 9, 2001

9 October 2001, Volume 1, Number 13
Russia's oil-pipeline monopoly Transneft has received a $150 million two-year loan to complete the first stage of the Baltic Pipeline System, RosBusiness Consulting reported. Raiffeisen Zentralbank, the arranger of the loan, said in a statement that the debut international financing deal was based on ruble receivables. The loan, at a rate of 450 basis points over LIBOR, was also extended by Natexis Banques Populaires, Standard Bank London, Citibank, and Commerzbank.

In a joint effort to pave the way for hydrocarbon exports to China, Russian gas monopoly Gazprom is negotiating development of East Siberia's hydrocarbon reserves in partnership with Russian oil giant Yukos. "Gazprom doesn't have a very deep base in Siberia and the Far East," Gazprom board member Boris Fyodorov told investors. "Yukos can be one of the big partners with Gazprom in this area." Yukos's press service confirmed that the talks are under way. During the July visit of Chinese President Jiang Zemin to Moscow, Russia and China signed an agreement on a feasibility study for a 1,700-kilometer oil pipeline linking the two countries. Yukos's president, Mikhail Khodorkovsky, has fought tooth and nail for such a pipeline, and construction could start as soon as summer 2003. China National Petroleum Corporation in late September signed an agreement with Yukos and state-owned Rosneft to develop oil fields in the Irkustsk and Sakha regions. Gazprom is not so well-positioned. Its pipelines stop at Krasnoyarsk. However, the alliance with global energy major Shell has emerged as the front-runner in the bidding to build a gas pipeline to China. Gazprom also plans to participate in the development of the BP-operated Kovykta gas deposit in Eastern Siberia. Gazprom lacks capital to explore and develop Eastern Siberia on its own, as a result of under-investment and alleged asset-stripping by the former management, the "St. Petersburg Times" reported.

Russia's second-largest copper producer, the Urals Mining and Metals Co. (UMMC), has suspended a project to start zinc and lead output due to weak world copper prices, a company official said on 4 October. UMMC had planned to rearrange part of its facilities to start producing electrolytic zinc and lead cathodes as by-products of copper output at its Uralelectromed copper plant from September 2001. It had intended to use $70 million of its own money to launch production of up to 60,000 tons of zinc and 12,000 tons of lead per year. UMMC has shifted its resources to build a new copper refinery at Uralelectromed, which would be able to produce 300,000 tons per year when completed. It plans to commission the first stage of the plant with a capacity of 150,000 tons per year in 2003 and the second stage in 2005. The Uralelectromed plant produced 244,407 tons of copper in the period from January to September. This is a rise compared to 226,000 tons in the same period of 2000. "Around 70 percent of this volume is meant for exports and 30 percent will be consumed by domestic cable and pipe producers," UMMC's technical director, Konstantin Plekhanov, told Reuters.

Russian financial and industrial group Interros, owner of metal producer Norilsk Nickel, announced on 2 October that it was setting up an agricultural firm that will control a chunk of the grain, poultry, and pork markets. "We intend to create a vertically integrated firm with a high level of capitalization...encompassing production, processing, and sales of agricultural products," Dmitrii Ushakov, who will be the new company's president, told Reuters. Interros President Vladimir Potanin said the company will be registered in the next few weeks with a charter capital of $100 million. He said Interros plans to invest $50 million in the project by the end of 2001. "We hope to attract no less than $200 million to acquire modern technology and machinery for the project," Ushakov said. He added that the new company aimed to become the largest player on the poultry, meat, and pork market in Russia and control 6 percent to 7 percent of Russia's grains market within three years. Ushakov said that by the end of 2001, Interros plans to acquire one or two large Russian agricultural firms and thus gain access to its first agricultural assets. Interros will have a controlling stake in the new company, which has not been named. The remaining stake will be owned by the company's management. Interros includes a major bank, Rosbank, a number of machine-building plants, a stake in a large gas projects, and media holdings.

Moody's Investors Service has signed a strategic cooperation agreement with the Moscow-based Interfax Rating Agency, an affiliate of Interfax Information Services Group, Russia's largest and most prominent information-services provider. The agreement, effective immediately, will include the provision of technical assistance by Moody's, joint research, credit risk analysis in Russia through joint conferences, seminars, and workshops. "Interfax Rating Agency already enjoys a strong domestic market position and has a reputation for providing authoritative analytical services. These strengths, combined with Moody's long established track record and global expertise in credit analysis, will put the Interfax Rating Agency in an even better position in terms of providing the highest quality credit rating and research services available in the Russian marketplace," Chester Murray, group managing director for Europe, said in a written statement. The agreement with the Interfax Rating Agency marks the seventh rating agency with which Moody's has affiliated over the past three years. The Interfax Group provides business information and services from and about the emerging markets of Europe and Asia, Business Wire reported. It has a global operational network with companies and offices in about 30 countries, according to the same source.

The chief executive of Bema Gold Corporation, Clive Johnson, announced on 1 October that his gold-mining company expects to repay $35 million in bank loans in the next 20 months on the strength of production out of its Julietta gold mine in eastern Russia. Julietta, which is 79 percent owned by Bema, has "very, very strong project economics" including an eight-year mine life, Johnson said at the Denver Gold Group's Mining Investment Forum 2001. In the first year of production, the Julietta mine is expected to produce 140,000 ounces of gold and 2.4 million ounces of silver. Cash operating costs per ounce are projected at $25 while total cash costs per ounce are projected at $70, including a net credit for silver production. Johnson said there is also "excellent exploration potential" on the 225 square-kilometer property at Julietta, and he is "very confident" that the company can expand its gold reserves. Johnson said that, despite skepticism about investments in Russia, local and federal governments there are "very, very keen" on foreign investment. "This place is open for business," he said. Even if gold prices stay relatively low, Vancouver-based Bema has positioned itself for low-cost production that will enable it to survive, Johnson was quoted by FWN Financial as saying.

Kinross Gold Corporation Chairman Bob Buchan stated at the Denver Gold Group's Mining Investment Forum that with its highly educated work force, Russia is one of the best environments to mine for gold. Canada's Kinross has been developing the Kubaka mine in far eastern Russia since 1998. Kubaka is one of the world's lowest-cost mines to operate, Buchan said. In the first half of the year the company produced more than 106,000 ounces of gold for Kinross at a cash cost of $148 per ounce. The mine has the most educated work force of any mining operation in the world, Buchan said. Sixty percent of Kubaka's workforce is made up of university graduates. About 95 percent are high-school graduates. "The plant is currently running at 20 percent to 30 percent over capacity without any lost-time accidents." Buchan said there is not much more gold in the Kubaka deposit beyond the reserve, but Kinross hopes to conduct further exploration at another promising deposit, Birkachan, about 33 kilometers away.

Russian pipeline operator Transneft has put the Rodionovskaya-Suhodolnay oil pipeline into operation, A&G News reported. The pipeline is a 253-kilometer stretch around Ukraine. The estimated cost of the project is $180 million. According Semen Vineshtok, Transneft's head, his company expects to receive $70 million annually from the pipeline while transporting 26 million tons of oil per year.

Russian President Vladimir Putin called on the government to keep a cool head when considering state spending in 2002, saying resources should only be allocated when they have been gathered. The Russian State Duma approved the 2002 budget in its first reading, including a planned budget surplus. A more detailed second reading is expected to cause haggling between deputies and the government, Reuters reported. "We cannot allow ourselves a situation where we allocate what is not in the nation's coffers," Putin was quoted as saying. He said forecasts had to be based on reality. "There should be nothing that looks like being dizzy from success," he said. Russia's economy this year is growing faster than government forecasts, but prospects of a global recession and oil-price volatility have cast a shadow over what looked like a rosy picture for next year. The government, however, insists that forecasts for 2002 are realistic and that it will be able to meet foreign-debt payments, which reach a peak of $19 billion in 2003. The budget surplus has been set at 1.63 percent of gross domestic product (GDP), economic growth at 4.3 percent, and inflation at 10 percent to 13 percent.

Russia hopes to reach an agreement with Germany on billions of dollars in Soviet-era debts by spring 2002, Trade and Economic Development Minister German Gref was quoted by Reuters as saying on 1 October. Gref said that Russia was eyeing a deal by the next Russian-German forum, which will take place in Weimar in early 2002, and perhaps by the end of this year. "We have agreed to try to decide this problem somehow by the next Russian-German forum," Gref said. Germany is waiting for payment on the Soviet-era debt to East Germany that it assumed after German reunification in 1990. "During the last meeting of the working group on this question we gave the German side all documents relating to trade turnover with East Germany," Gref said. "Some documents were not known to the German side and they took a time out to study the situation. We agreed that by the end of the year we will call the working group together again." The sticking point in talks is the appropriate exchange rate for the debt of 6.4 billion transferable rubles, an artificial currency used for payments between Soviet-bloc countries. Berlin insists that 6.4 billion rubles are worth $6.4 billion, while Russia argues it should be significantly less.

The Russian government and electricity monopoly Unified Energy Systems (UES) are drafting a plan to divide the UES in an attempt to implement utility reforms in Russia. In a restructure blueprint approved in July, the government set a deadline for the creation of a national grid operator, the first stage in carving up UES and its subsidiaries, regional utilities. Currently, large chunks of the national grid are controlled by the regional utilities, most of which also generate and market electricity. Their functions are to be divided. Critics blasted government plans to concentrate all networks in a single national grid, saying it made no sense for a national company to control local networks. Investors have worried about compensation for grid assets. According to the state-monopoly-restructuring department at the Trade and Economic Development Ministry, a small part of regional utilities' current assets would be transferred to a national grid operator. The reform blueprint also says the grid operator must be created as a full subsidiary of UES by the end of 2001. The government wants to buy out the regional utilities' grid properties or exchange them for debts later on. UES spokesman Andrei Trapeznikov told Reuters UES would make proposals on dividing "monopoly from non-monopoly" functions to be piloted at about five regional utilities by the end of 2001. After the restructure, generation and distribution are to be spun off and privatized, while transmission is to remain a government monopoly.

Alexander Mamut, chairman of MDM-bank, is resigning from his position after his two-year contract expires, "Kommersant" reported. A company spokesman said the move was to be discussed at the shareholders' meeting on 1 October. "One of the main questions of the meeting is the re-election of the board," the spokesman said. Mamut was chairman of the board and gained prominence recently as the author of a plan sponsored by Russia's industrialists' union to shake up the banking system. The plan, a radical scheme aimed at a quick reform of Russia's banks, was rejected by the Central Bank, which favored a go-slow approach. Mamut has long been rumored in the Russian media to be one of the country's key political insiders, with close links to the Kremlin. He has also been dubbed an "oligarch," a term used to describe Russia's wealthy business elite with considerable political clout.

Alfa Bank's New York subsidiary Alfa Capital Markets has hired two sales directors for North America to join its rapidly expanding global-equities business, PR Newswire reported. Nick Beech joins as director of sales trading and Diana Imperatore as director of research sales. Beech was previously head of emerging markets trading at Schroder Salomon Smith Barney in London, and Imperatore was vice president for Emerging Europe equity research sales at ING Barings in New York. "These two high-caliber appointments are another key step in our strategy to create a global equities business," said Alfa Bank's head of equities, Dominic Gualtieri. Alfa Capital Markets is the New York arm of Alfa Bank's international-equities business. Alfa Capital Markets is regulated by the NASD and will operate on the same lines as Alfa Banks London FSA registered subsidiary Alfa Securities, providing brokerage and investment services for foreign investment in Russia. Alfa Bank is Russia's largest private bank and is active in investment banking, commercial banking, asset management, and insurance. It has more than 70 branches in Russia and subsidiaries in Ukraine, Kazakhstan, London, Amsterdam, and New York, according to PR Newswire.

Russia is planning to supply Afghan anti-Taliban forces with tanks, armored vehicles and other arms worth up to $45 million in the coming weeks, "Nezavisimaya Gazeta" reported. Russia's envoy to Tajikistan, Maxim Peshkov, said that no Russian arms have arrived. "Up to now there has been only humanitarian aid.... There have been no guns or machine guns," he said. Planeloads of food, blankets, and medical supplies have been sent to northern Afghanistan. Defense sources say the supplies would include 40-50 tanks, 60-80 armored personnel carriers, and ammunition. Russia would also supply Grad missile systems, artillery, mortars, anti-tank weapons, and sniper rifles, as well as Mi-24 attack helicopters and Mi-8 troop-carriers. President Vladimir Putin has set increased arms supplies to the Northern Alliance as one of the main ways in which Moscow will support Washington's operations against "terrorist" bases in Afghanistan. The Russian newspaper pointed out that it has not been decided who will pay for the weapons and it suggested Russian Defense Minister Sergei Ivanov might turn to Washington to settle the bill, Reuters reported.

Cranes clutter Moscow's skyline and construction workers toil around the clock, but industry officials say the city's real-estate market is still suffering from a lack of properties. "What was free after the [1998] crisis is occupied now and there is not enough new space to satisfy demand," said Polina Kondratenko, research and appraisal consultant at Colliers International. "What's on offer is quite limited." According to Mark Stiles, head of the representative office of Stiles and Ryabokobylko, top Moscow assets yield 17 percent to 22 percent returns -- much higher than Eastern Europe, where yields are sometimes below 10 percent. Investors need four years to see a return on their investment in Moscow real estate, which compares favorably to six or seven years in Eastern Europe. The period is starting to lengthen as risks diminish and competition rises. Amanda Spring, managing director at real-estate firm DTZ, pointed out the immaturity of the local market. "We actually see a lot of interest at the moment from overseas investors who are looking to purchase property with returns of 18 percent to 20 percent and above. The real problem is that there are very few buildings available for sale at that price," she told Reuters. "The product isn't really there."

Ferane, Vladimir Bryntsalov's pharmaceutical firm, has the reputation of being an aggressive company, able to survive in a difficult business environment by exploiting opportunities, including those outside its core business. According to "Intercon," Ferane represents a new brand of Russian companies born during the privatization of government property in the early 1990s. Naturally, it absorbed both the best and the worst aspects of privatization in Russia. With access to important political and business circles, Ferane has built a reputation as a solid and reliable partner. Ferane will act strongly to protect its interests.

Ferane was created during the first stage of privatization in 1990, on the basis of government-owned Karpov Medical Ingredients Plant, one of the largest producers of antibiotics in the USSR. The name of the company comes from Moscow's oldest and best-known drug store on Nikolskaya Street near the Kremlin, which was owned prior to the 1917 revolution by an individual named "Ferrane." The drug store was later bought by another pharmaceutical company that wanted to retain the old name of the drug store. This conflict was resolved by Ferane leaving only one "R" in its name and the drug store using two "R"s. The present owners of Ferane are Bryntsalov's company, Pchelka (Little Bee), and the Economic Association of Support for Handicapped Children, Youth, and Sport Veterans � ASID. There are strong indications that ASID's name was used to secure some tax exemptions from import duties, which were issued to non-profit and sports organizations.

Commercially, Ferane is a very successful company. It has passed through all the turbulence and economic hardships of perestroika without losing much of its highly qualified workforce or industrial potential. Observers believe the key to Ferane's success lies in its opportunistic, but well chosen, management strategy, which was developed and implemented by Bryntsalov himself.

When Bryntsalov came to Moscow in 1988, he rented industrial space at the Kulakov Pharmaceutical Plant to develop production of bee-based medications in Pchelka's name. Within two years, he was able to take over the plant and its privatization program, establish a new company -- Ferane -- and assume the position of president without opposition. It is thought that Bryntsalov has good contacts with powerful Moscow bureaucrats who helped him get through difficult privatization procedures. According to Ferane employees, he is an aggressive, authoritarian-style manager who keeps tight control over all business operations. He is respected for his business skills but feared by his subordinates. Security at Ferane is tight. Employees value their jobs and are easily manipulated by management. They are forbidden to discuss anything related to Ferane activities with outsiders.

Bryntsalov's initial strategy was to limit production, concentrate on the packaging of imported or Russian-made medications, and sell them through a chain of dealers in different part of Russia. He immediately created a separate commercial department, dealing with trading operations and other business ventures, which generated funds instrumental to the company's survival in 1991 and 1992. Ferane produces little, but buys a lot of cheap medicines in the West and packages them locally, putting Ferane's name on the label. By some estimates, this practice allowed Ferane to sell medications at up to 25 percent above the average market price. Another successful line of business, initially the company's most profitable, was the large-scale bottling of medical alcohol and its distribution through a network of drug stores. The alcohol was bought cheaply in Ukraine or Belarus, bottled by Ferane, and sold as medication. Back in the 1990s, medicinal alcohol was untouched by taxes imposed on consumer alcohol producers. However, it became popular among customers who used it for more than just medical purposes. Later, Ferane developed the capability to produce and bottle vodka.

Bryntsalov is perceived as skillfully utilizing, when necessary, the status of Ferane as a former government-owned company involved in a socially important industry. Ferane regularly pays taxes and completes records truthfully. Bryntsalov pursues a "closed-door" policy of self-containment and self-sufficiency. To support Ferane's operations and isolate it from outsiders, he has established several entities that are well integrated into Ferane's activities. These are Medinvestbank; insurance company Status-S; Bryntsalov, Yumanov, & Co; and consultancy Glossa Lawyers Bureau. All these entities are registered at Ferane's legal address and their primary purpose is to support Ferane's operations, making them hard for outsiders to monitor or control. It appears that the bank and the insurance company are increasingly becoming the most important assets within Bryntsalov's powerhouse. Bryntsalov's success is attributed both to his business acumen and his ability to deliver what he sets out to do and what he promises.

Russian oil giant LUKoil appears to have won a legal battle against its small and unprofitable business, TV-6 television network. In compliance with a Moscow Arbitration Court ruling announced on 27 September, the TV-6 network might be liquidated on account of its poor financial standing. In the past three years, TV-6's debts have exceeded its assets. According to Russian legislation, the failure of a business to post a profit for more than two years qualifies the company as eligible for liquidation.

TV-6 was sued by minority shareholder LUKoil-Garant pension fund, a LUKoil subsidiary with a 15 percent stake in the broadcaster. The fund demands the liquidation of TV-6. Prior to this lawsuit, the fund had filed four other lawsuits charging the network with preventing access to shareholders meetings and participating in the decision-making process, "Kommersant" reported on 28 September. TV-6 lawyers won all four claims in court. The liquidation suit, however, remained on the agenda as the court ordered a probe on 28 June into the company's financial status. According to an audit prepared by the Justice Ministry's center for court expertise, from January 1998 to July 2001 the network posted consecutive losses with the combined debt reaching $12 million at the beginning of 2001. The audit confirmed that TV-6 owed $8 million to a Moscow-based financial bank and the remaining $4 million to different TV content providers and to providers of transmission and communications services.

Analysts doubt that the plaintiff's motives are strictly commercial. This is because TV-6 came into the public spotlight after sheltering NTV's independent journalists following its takeover by Gazprom in a boardroom coup. NTV, formerly owned by Russian media mogul Vladimir Gusinskii, was a thorn in the Kremlin's side for its sharp criticism of Moscow's military campaign in Chechnya and alleged human rights abuses committed against civilians. Following the takeover, the defiant NTV staff, headed by its former director and noted anchorman Yevgenii Kiselev, teamed up with a former Gusinskii rival, Russian business tycoon Boris Berezovskii. With a 75 percent TV-6 share under his control, Berezovskii was eager to shelter the journalists. Once a Kremlin insider, Berezovskii, along with Gusinskii, found himself at loggerheads with the government for criticizing the clampdown on freedom of speech, conduct in Chechnya, and reversal of authoritarianism. Berezovskii pledged to build a "constructive opposition" to the Kremlin, and an independent-minded TV-6 network had an important role in his scenario. With renewed management and staff, TV-6 quickly gained popularity for NTV's trademark independence in reporting.

LUKoil-Garant moved quickly by filing lawsuits and demanding the closure of the station for its failure to post a profit. According to "Verdomosti," however, LUKoil cannot clearly explain why it wants to shut down TV-6. LUKoil-Garant's director general, Mikhail Berezhnoi, officially stated that his company "is not pursuing any political purposes. It just defends its shareholder's rights." TV-6 Press Secretary Tatyana Blinova told that LUKoil will get "only moral satisfaction" from liquidating the network. Analysts speculate that the Russian government as a minor shareholder in LUKoil could be behind this move, as some top cabinet officials are linked with LUKoil. Berezovskii and his closest ally, Badri Patarkatsishvili, stated that the Kremlin, through LUKoil, is trying to "strangle" the independent TV network. "I cannot understand how a shareholder can liquidate a company if it develops effectively and brings profit. I do not see here any other decisions, but political ones," Berezovskii told "Kommersant" in an interview. He added, "What else is there to say if [LUKoil Chairman] Vagit Alekperov told me himself that the presidential administration had put a task before him to buy my stake in TV-6."

TV-6 lawyer Anatolii Blinov argues that the allegations about the network's poor standing are premature. TV-6 posted a 186-million-ruble ($6.3 million) profit over the last six months. "I closely follow the company's financial standing," he said. "I guarantee that the network will post profits by the end of the year." Unfortunately, he added, the court reviews only annual balance sheets. "If the court is not satisfied with the positive balance, then our government needs an obedient, but not profit-making, television." If this is the case, he concluded, "The laws should be rewritten and I should leave the country, because my work here will not be needed." TV-6 officials were quoted by UPI as saying that they would appeal the court ruling and "find ways to legally defend television network and its viewers." reported on 28 September that Berezovskii reacted calmly by not publicly expressing his discontent and concerns over the network's troubles. It appears that Russia's biggest oil company, closely associated with the Kremlin, closed its eyes to TV-6 losses for three years while waiting for the best moment to act. The opportunity presented itself after Gusinskii's opposition media reporters aligned themselves with Berezovskii's TV-6. However, in these two wars against the oligarchs, there is a difference: The moral and judicial destruction of NTV was based on Gusinskii's factual bankruptcy. If you "can't pay off the debt -- give up your property," President Putin said. In this respect, TV-6 should feel secure. However, concludes that this small legal battle between a minority shareholder and a network could mushroom from a crackdown on press freedom into a complete repeal of the institution of private property.