15 October 2003, Volume 3, Number 38
LUKOIL PROFITS FAIL TO IMPRESSOil company LUKoil presented its consolidated financial results to U.S. accounting standards for the first half of 2003 on 9 October, a press release on the company's website (http://www.lukoil.com) reported the same day. Net profit for the period was $2.364 billion, although $1.13 billion came in the form of a one-time cash infusion from the sale of LUKoil's 10 percent stake in the Azeri-Guneshli-Chirag (AGC) oil project. The $2.364 billion figure represented a 181 percent increase on the company's first-half 2002 net profit of $0.84 billion (or a 47 percent increase without the AGC proceeds). Revenues for the period rose 53 percent year-on-year from $6.676 billion to $10.233 billion. Second-quarter net profit was $1.544 billion ($0.414 billion without AGC) as compared to $0.597 billion in 2002. Analysts were unimpressed with the results, with many noting that LUKoil's operating expenses rose 9.4 percent in the first half of 2003 to $1.361 billion. Zenit Bank analyst Sergei Suverov told "Kommersant-Daily" of 10 October that management's failure to keep its promises to reduce expenses is a bad sign. "LUKoil doesn't have a single center for monitoring expenses, but it has many centers for spending," Suverov told the newspaper. Aton analyst Steven Dashevskii told "Vedomosti" that investors were disappointed to see that LUKoil had spent more than $1 billion on new acquisitions in Russia and Eastern Europe. "Investors hoped that at least some of the money from the record profits would go toward dividends," the analyst noted. "But it didn't happen. Managers found a use for the money right away." DK
FRANCE'S EDF JOINS INTERROS FOR POWER VENTUREFrance's Electricite de France (EDF) and Russia's Interros signed a memorandum of understanding on 6 October with an eye to collaboration in the Russian power sector, "Kommersant-Daily" reported the next day. The two companies plan to study the possibility of participating in the tender to manage the Northwest heat and power plant. Interros deputy CEO Andrei Bugrov said that the companies might also join forces for the auctions of wholesale generating companies that are scheduled to take place in the course of power sector reforms, "The Moscow Times" reported on 7 October. "EDF's interest in the Russian energy sector isn't surprising. What was unexpected is the choice of Interros as a partner," Yulianna Slashcheva, PR director for managing company ESN Energo, told "Vedomosti" the same day. Controlled by Vladimir Potanin, Interros is one of Russia's largest financial-industrial groups. Its flagship asset, Norilsk Nickel, is in the metals sector, but Interros's holdings extend to manufacturing (Power Machines) and publishing (Prof Media) as well. EDF is one of the world's largest energy companies. It operates in 24 countries and generated revenues of $27.1 billion in the first half of 2003. The two giants might soon have a chance to test their compatibility, as the tender to run the Northwest power plant, a modern facility located close to Russia's European border, could take place before the end of 2003. DK
STRIKING MINERS WIN RAISE FROM SUAL...Striking miners at the North Urals Bauxite Mine (SUBR) scored a partial victory on 9 October, winning a roughly 20 percent pay raise from Russia's second-largest aluminum producer, Interfax reported the same day. About 500 miners at SUBR started a wildcat strike on 1 October, refusing to leave mineshafts unless Sual, which operates SUBR, agreed to raise their salaries to $1,000 a month. The miners agreed to come to the surface on the evening of 6 October after a conciliation commission brokered a deal for further talks between management and the Independent Miners' Union. "Vedomosti" reported on 8 October that miners' salaries were linked to production quotas, with miners who fulfilled 100 percent of the quota earning approximately 6,000 rubles ($200) a month. Miners who produced 40 percent more than the quota got 12,000 rubles ($400) a month. According to the newspaper, the average miner's salary at SUBR was 13,170 rubles ($436) a month, with most miners working weekends and overtime for the extra pay. Valerii Kuskov, deputy chairman of the Sverdlovsk local of the Russian Miners' and Metalworkers' Union (GMPR), told Interfax that management agreed to increase salaries for SUBR's 9,500 workers by an average 20 percent, with a 35 pay hike for the facility's 3,000 miners. A 10 October Sual press release stated only that the parties would discuss a new pay scale over the next month, however. According to Sual's website (http://www.sual-holding.com), SUBR brought in revenues of more than $80 million in 2000, the last year for which financial results are provided. DK
...AS SUAL, VSMPO CALL TITANIUM TRUCESual has ended its efforts to buy up shares in leading titanium producer VSMPO and will get a seat on the company's board, regions.ru reported on 7 October. According to Vladislav Tetyukhin, general director of VSMPO, the two companies have agreed after negotiations to cooperate with each other. In a move that was seen as a possible prelude to a hostile takeover bid, Sual had succeeded in buying up 5 percent of VSMPO from dissident managers in the company. A source told "Vedomosti" on 9 October that Sual ended up controlling 10-12 percent of VSMPO, after which the two companies decided to begin talks because "further confrontation promised nothing but trouble for both sides." Sual will now gain one seat on the boards of directors at both VSMPO and Avisma. (VSMPO owns 76 percent of Avisma, which supplies the titanium producer with most of its raw material.) Avisma shareholders will meet on 24 November; VSMPO shareholders on 5 December. Some observers suspect that Sual's plans might go beyond a seat on the board, "Vremya novostei" reported on 9 October, noting that VSMPO's profit margin is 54.59 percent as compared to Sual's 9.87 percent. Prospect Investment analyst Nikolai Ivanov told the newspaper, "What mattered to Sual was to gain a foothold at VSMPO, and it's done that." DK
WBD SALE RUMORS BOOST SHARESFrance's Danone is looking to acquire a controlling stake in Russian juice and dairy producer Wimm-Bill-Dann (WBD), the "Financial Times" reported on 7 October. Danone, which already owns 7 percent of WBD, is in talks to buy out WBD executives, who control two-thirds of the company's shares. According to the newspaper, the main stumbling block is price -- WBD is presently valued at some $900 million. News of the negotiations sent WBD's American depositary receipts on the New York Stock Exchange up 7.3 percent to close at $22.80, a record for the year. Analysts queried by "Vedomosti" on 9 October reacted cautiously, however, noting that rumors of a WBD buyout have swept the street before. Aleksandr Svinov of Alfa-Bank told the newspaper, "We're reading tea leaves here." Timothy McCutcheon of investment bank Aton was less equivocal in 9 October comments to "The Moscow Times": "You have to remember that WBD is just a bunch of guys who got together in the early 90s, didn't invest that much capital and created a billion-dollar company. So they look at it as a private equity fund that's done extremely well. For them it's not about bailing or not bailing -- it's a question of 'why not fix your profits and go on to something else?'" DK
EVRAZHOLDING GOES FISHINGIn an unusual expansion move, Metals giant EvrazHolding has acquired a controlling stake in the Nakhodkinskaya BAMR (NBAMR), one of Russia's largest commercial fishing companies, "Kommersant-Daily" reported on 9 October. The newspaper estimated that EvrazHolding paid $20 million for NBAMR, which posted revenues of $60 million in 2002, earning a net profit of $1.7 million. NBAMR Director Anatolii Kolesnichenko told Vladivostok's "Zolotoi rog" on 7 October that the company had been on the lookout for a strategic investor. "We were looking to establish contact with precisely this kind of large industrial structure," Kolesnichenko said. "I've retained my post, and I'll do everything I can to make sure that the company isn't broken up into pieces." An anonymous government source told "Vedomosti" on 9 October that a new system of distributing fishing quotas -- on the basis of past catches -- has made the $2 billion-a-year industry more transparent and attractive to investors. At the same time, EvrazHolding Vice President Timofei Khryapov told the newspaper, "If this experiment succeeds, we're ready to look at other fishing companies." DK
SHEREMETEVO TENDER NEARSPrime Minister Mikhail Kasyanov has approved the terms of a tender to manage Moscow's Sheremetevo International Airport and ordered that the tender be held by 1 December, "Vremya novostei" reported on 8 October. "Vedomosti" reported on 9 October that it had learned the tender terms -- companies must be Russian-registered with assets of at least 60 billion rubles ($2 billion), 15 billion rubles cash on hand, and a billion-ruble guarantee from a Russian bank with assets in excess of 60 billion rubles. The winner will manage the airport for three years, receiving 1 percent of Sheremetevo's annual revenues, 25 percent of annual revenue growth, and 2 percent of net profit. (The airport's 2002 revenues were 4.6 billion rubles, with a net profit of 689 million rubles.) The tender terms, which Sheremetevo's board is set to approve on 15 October, appear to favor the Russian financial-industrial groups Alfa Group and Sistema, both of which have expressed an interest in running the airport. Another would-be competitor, Aleksandr Lebedev's National Reserve Bank, likely falls short of the asset requirements. DK
SHELL GAINS REPRIEVE ON SALYM LICENSERoyal Dutch/Shell and Russia's Natural Resources Ministry have reached an amicable settlement in a dispute over the license to develop the Salym group of oil fields, "International Oil Daily" reported on 6 October. The ministry will suspend proceedings to revoke Shell's license for Salym, Shell will drop the protest lawsuits it has filed against the ministry, and the two parties will set up a working group on Salym's development. Salym consists of three oil fields in Western Siberia with total reserves of 1 billion barrels. The license to develop the fields is held by Salym Petroleum Development (SPD), a joint venture between Shell and Russia's Evikhon. (Evikhon, in turn, is a subsidiary of Moscow entrepreneur Shalva Chigirinskii's Sibir Energy.) Shell had hoped to develop the field under a production-sharing agreement, but those hopes faded in 2003, and development idled. Galled by the inactivity, the Natural Resources Ministry subsequently took steps to pull SPD's license, and a legal wrangle ensued. Finally, SPD shareholders approved a $1 billion budget for Salym in mid-September. The parties now hope for a rapid resolution of the remaining issues, "Kommersant-Daily" reported on 7 October. Aton analyst Timerbulat Karimov told "Vedomosti" the same day that the agreement is good news for Shell, which "is clearly trying to carve out a place for itself in Russia." DK
AROUND THE CIS
TNK-BP TO FILL UKRAINE PIPELINE?Ukrainian state-owned pipeline company Ukrtransnafta accepted an offer on 3 October from Russian-British TNK-BP to fill Ukraine's languishing Odesa-Brody pipeline, AP reported on 6 October. Constructed in 2001 at a cost of $200 million, the pipeline is still awaiting oil as debate rages over whether it will carry Russian oil from Brody (in Western Ukraine) to Odesa or Central Asian oil in the opposite direction. TNK-BP has offered to supply 450,000 metric tons of oil in the direction of Odesa. The oil comes as a loan valued at $90 million to be paid back over three years at an annual interest rate of 8 percent, "International Oil Daily" reported on 6 October. Russian oil producers are eager to see the pipeline begin working -- from Brody to Odesa -- so that they can benefit from the added export capacity. A LUKoil Ukrayina spokesman told "Vedomosti" on 6 October, "For Russian oilmen, this means the chance to export an extra 9 million tons a year, which is very important in conditions of rising production." More conflict might lie ahead, however. Ukrainian Prime Minister Viktor Yanukovich discussed the issue with U.S. Vice President Dick Cheney during a visit to Washington on 7 October. According to Ukrainian Deputy Minister of Foreign Affairs Volodymyr Yelchenko, Cheney voiced U.S. opposition to running the pipeline from Brody to Odesa and promised help in finding suppliers to ship oil in the opposite direction, "Vremya novostei" reported on 9 October. A final decision on the pipeline lies with the Ukrainian government. DK
TOTAL, ROSNEFT TO WORK TOGETHERFrance's Total and Russia's state-owned Rosneft have signed an agreement to explore and develop the Tuapse Depression in the Black Sea, Total announced in a 7 October press release. The two companies will create a joint venture to conduct seismic surveys. Total concluded a similar agreement with Yukos in 2002 to explore the Shatskii block, also on the Black Sea. With the prospects for finding oil in the Black Sea uncertain, analysts linked Total's move to a desire to gain a foothold in Russia, "Vedomosti" reported on 8 October. Others expressed fears for the area's famed resorts. Ivan Blokov, an expert with Greenpeace Russia, told "Gazeta" on 9 October that the search for oil on the Black Sea shelf would mean that "what happened this summer on the coast of Spain could be repeated here at any time." Cooperation between Total and Rosneft might extend to other areas as well. Total is in talks to acquire a stake in Kazakhstan's $10 billion Kurmangazy offshore project, "The Moscow Times" reported on 10 October. At present, Kazakhstan's KazMunaiGaz has a 50 percent stake in the project, Rosneft has a 25 percent stake, and a 25 percent option is reserved for Russia. Total is looking to acquire a 25 percent stake, Reuters reported. A "source close to the project" told "Vedomosti" of 10 October that the 25 percent stake will likely come from KazMunaiGaz's share. DK
CHINA TO FINANCE KAZAKH OIL LINKA senior official at KazMunaiGaz announced on 9 October that work will start in 2004 on the first stage of a projected 3,000-kilometer pipeline between Kazakhstan and China, AFP reported the next day. The first section of the pipeline will cover 1,100 kilometers from Atasu, Kazakhstan to Alashankou on the Chinese border. Kairgeldy Kabyldin, managing director for transportation infrastructure at KazMunaiGaz, told attendees at an industry gathering in Almaty that China will invest $800 million to construct the first leg of the pipeline. According to Kabyldin, the pipeline will carry 400,000 barrels per day (bpd) when it comes on line in 2006, with capacity eventually increasing to 1 million bpd, "International Oil Daily" reported on 10 October. Reuters quoted Kabyldin as saying, "It looks like the situation around Yukos has played its role," an apparent reference to the Russian government waffling over a Yukos-backed pipeline to link Siberia's oil fields to Daqing, China. DK
'BIG-BUCKS ORBIT'If you manage a pension fund with, say, $100 billion to invest under stringently conservative guidelines, last week was probably the first time that a large, cold country called Russia crossed your mind. For example, John Chartier, spokesman for the $105 billion New York State Common Retirement Fund, told "Vedomosti" on 9 October, "Our managers are always looking for new investment opportunities. Naturally, they're going to analyze Russia now."
Why Russia? Why now? The day before Chartier's comments, Moody's Investor Service raised its rating for Russian debt to investment-grade in a move that took analysts, investors, and officials alike by surprise. The international ratings agency upgraded Russia's foreign-currency bonds and notes, as well as the government's Eurobonds, boosting them a full two notches from Ba2 to Baa3. Moody's based its decision, which had been widely hoped-for if not widely expected, on Russia's rational tax policy, sound debt management, improving debt-to-liquidity ratio, decision to form a stabilization fund to cope with possible fluctuations in commodity prices, and political stability under President Vladimir Putin.
The move puts Russia on a par with such up-and-coming countries as Thailand, Croatia, and Slovakia. More importantly, it raises the prospect of substantial cash inflows from conservative institutional investors, who are usually prevented by their charters from putting money into anything riskier than an investment-grade opportunity. Finally, the upgrade sends a powerful symbolic message. Even if the decision technically applies only to the likelihood of a default on Russian sovereign debt, casual observers are bound to see it as a positive verdict on the nation's economy as a whole -- in effect, a clean bill of health after the economic meltdown of 1998.
For now, Moody's stands alone among the three major ratings agencies in its strongly bullish view. Russia is two steps below investment grade according to Standard & Poor's, and one step below according to Fitch. Konrad Reuss, managing director of sovereign ratings at S&P, and David Riley, his counterpart at Fitch, both told "The Moscow Times" of 9 October that their respective agencies have no plans to raise Russia's rating in the immediate future. "If oil prices were to drop, how well would the economy and public finance stand up to that kind of shock?" asked Riley. He continued, "Perhaps [Moody's] is less concerned than we are in that respect."
Russia's benchmark RTS stock exchange, already on a roll, responded to the news with a record high of 628.98 on 9 October. At the same time, analysts shared their excited first impressions. "This is a celebration for all of us," Troika Dialog president Ruben Vardanyan told "Vedomosti" of 9 October, "The attitude toward Russia, its economy, and its government has undergone a qualitative shift." An unnamed analyst told "Kommersant-Daily" the same day, "Russia is entering the big-bucks orbit."
Indeed, most of the initial positive commentary focused on the improved rating's allure for heavyweight institutional investors. Marlen Manasov, president of Brunswick UBS, told "Vedomosti" on 9 October that while emerging markets funds have around $100 billion to invest, global investment funds control a whopping $1 trillion. Deputy Premier and Finance Minister Aleksei Kudrin told "Kommersant-Daily" in an interview the same day that the higher rating means that an increasingly stable Russia will offer lower returns, sending smaller, more speculative investors elsewhere and clearing the way for "big, serious investors."
General skeptics weighed in as well, cautioning against the giddy logic that equates specific moneymaking opportunities with overall prosperity. An unnamed analyst told the "Financial Times" of 9 October: "So long as Russia has all these oligarchic structures you will not develop the political institutions and a middle class needed for a democratic society. There is still a very serious political dimension to the progress of Russian reform." A 13 October story in "Newsweek" noted sadly that "outside the oil industry, Russia's new boom is largely confined to Moscow. Even there the benefits go overwhelmingly to an elite stratum of the superrich. The vast majority of Russia's people live hand-to-mouth, often in near destitution, waiting perhaps fruitlessly for their lives to get better."
Still, Russia is clearly moving up on the international investment agenda. Management consultants AT Kearney listed Russia the world's 17th-most-desirable destination for foreign direct investment in 2002, but put the country in the top 10 for 2003, the "Financial Times" reported on 9 October. Venture capitalist Patricia Cloherty, whose private-equity fund has invested $260 million in 41 Russian companies, summed up the rationale for "Newsweek": "The good news is that you can only lose 100 cents on the dollar. The upside is that you can make multiples of that."
Proof of Moody's prescience, or foolhardiness, will come only during the next patch of stormy weather -- when falling oil prices starve the petroleum-fueled economy, or if the stability of Putin-era "managed democracy" proves less than iron-clad. For now, the question is one of emphasis. The man who has benefited the most, materially speaking, from Russia's market economy recently suggested one possible view. Mikhail Khodorkovskii is Russia's richest man and the CEO of an oil company embroiled in a confusing, possibly political, conflict with law-enforcement authorities. "Kommersant-Daily" quoted Khodorkovskii on 13 October as saying: "Russia is a good place to do business. I hope that one day it will also be a good place to live." DK