Business Watch: December 10, 2002

The Russian Federal Property Fund (RFFI) floated a 5.9 percent stake in oil major LUKoil on the London Stock Exchange on 4 December, netting the state a tidy $775 million in one fell swoop, "Kommersant" reported on 5 December. The successful privatization followed an August attempt to sell off the same 5.9 percent stake that failed when investors proved willing to cough up only $703 million. The 4 December sale was the largest-ever Russian public equity offering, "The Moscow Times" reported on 5 December, outpacing the 1996 sale of a $429 million stake in Gazprom. Analysts felt that propitious circumstances and a surprise announcement allowed the government to cash in handsomely against a backdrop of Iraq-inspired uncertainty over the future of the oil market. "The government is acting wisely by offering this stake at this particular moment," a United Financial Group analyst told "Izvestiya" on 4 December. Troika Dialog analyst Valerii Nesterov told "Kommersant" on 5 December that LUKoil's encouraging third-quarter earnings and recent decision to sell its stake in the Azeri-Chirag-Guneshli consortium drove up share prices. "Nezavisimaya gazeta" sounded a contrarian note on 5 December, writing that RFFI hoped to get more than $810 million for the stake. The state retains a 7.6 percent stake in LUKoil, and while RFFI claims that no sale is in the works, the proceeds from this most recent privatization will still be fresh in officials' minds as they face a raft of payments on Russia's foreign debt in 2003. DK

With the 18 December privatization auction of Slavneft drawing closer, new auction participants and curious doings in Slavneft itself enlivened the proceedings this week. China National Petroleum Corporation (CNPC) applied to the Russian Antimonopoly Ministry for permission to acquire the soon-to-be-auctioned 74.95 percent stake in Slavneft, "Vedomosti" reported on 3 December. With market capitalization of $33.5 billion and a 2002 net profit of $2.4 billion, CNPC could bid the price of Slavneft up to $3 billion from the $1.7 billion starting price, one oil industry source told "Vedomosti." With China's oil consumption outstripping its reserves and the possibility that Yukos may cooperate with an as-yet-unnamed Chinese oil company to build a pipeline to China, the acquisition makes sense, "The Moscow Times" reported on 4 December. Meanwhile, LUKoil President Vagit Alekperov announced that his company will not take part in the auction, "Vedomosti" reported on 6 December. A LUKoil representative told the newspaper, "There are too many poison pills." The bitterest "poison pill" is Slavneft's incomplete control over its affiliates. Affiliate Megionneftegaz, which accounts for 90 percent of Slavneft's production, chalked up a 349.5 million-ruble ($10.97 million) loss in the first nine months of 2002, "Kommersant" reported on 3 December. If Megionneftegaz fails to earn a net profit for 2002, enough preferred shares will become voting shares to endanger Slavneft's control over its affiliate. The current situation benefits Sibneft, which in conjunction with Tyumen Oil Company (TNK) controls a trust company well positioned to destabilize Slavneft's relations with its important affiliate. Any other purchaser of Slavneft will be forced to spend $500 million-$600 million to gain full control over the company, industry analyst Vladislav Metnev told "Vedomosti" on 6 December. Sibneft recently strengthened its position further by purchasing Belarus's 10.83 percent stake in Slavneft for $207 million, Belapan reported on 6 December. DK

The tender for rights to the Eastern Siberian Talakan oil and gas field was officially canceled on 4 December, "Vremya novostei" reported on 5 December. According to "Oil and Gas International" on 13 September, the Talakan field, located some 240 kilometers north of Lake Baikal, contains reserves of approximately 900 million barrels of oil and 1.7 trillion cubic feet of natural gas. A bevy of heavy hitters -- Gazprom, Rosneft, Yukos, Surgutneftegaz, Sibneft, TNK, and TotalFinaElf -- had applied to take part in the tender, with a starting price of $56 million and investment conditions totaling $350 million over two years. Industry sources told "Vedomosti" on 5 December that the new tender, to be announced by year's end, will likely be reworked to benefit one of the state-owned participants. The official reason for the cancellation was the low starting price and unrealistic investment conditions, "Vremya novostei" reported. The Eastern Siberian region in which the Talakan field is located currently lacks an effective transportation infrastructure. Sources told "Vremya novostei" that some $30 billion in investments are needed to develop the region's reserves. The cancellation comes on the heels of public disagreements over the tender between the government, on the one hand, and the Economic Development and Natural Resources ministries, on the other. Behind-the-scenes efforts to coordinate the political aspects of Eastern Siberia's future development, and the state's role therein, are likely to ensue as officials contemplate a new date for the tender. DK

Gazprom CEO Aleksei Miller used a 3 December press conference to discuss a recent European jaunt to talk up potential investors in the company's $5.7 billion Northern European pipeline project, "The Moscow Times" reported on 4 December. Miller traveled through England, the Netherlands, and Finland, meeting with representatives of British Petroleum, Fortum, Gasunie, Royal Dutch/Shell, and Centrica. Tentatively slated for operational status in 2007, the North European Gas Pipeline will bring 30 billion cubic meters of gas annually to customers in Britain and Scandinavia. Miller also met with European Bank for Reconstruction and Development (EBRD) First Vice President Noreen Doyle to discuss EBRD financing for the project. "Vremya novostei" wrote on 4 December that Miller gave an unconvincing performance at the press conference, "answering questions rather irritably and constantly interrupting journalists." The newspaper commented that "for now, there's only an idea, and little concrete information." Gazprom currently faces a debt crunch, and talk of ambitious long-term projects inclines some observers to understandable skepticism. DK

The Yukos board of directors recommended that shareholders approve a $400 million interim dividend payment at a 31 December extraordinary shareholders' meeting, a 5 December press release on the company's website announced. Yukos dividends have been on the rise in recent years, totaling $107 million in 1999, $294 million in 2000, and $488 million in 2001, "Vedomosti" reported on 6 December. Analysts queried by "Kommersant" described the interim dividend payment -- which comes to 5.7 rubles (18 cents) per share -- as higher than expected, the newspaper reported on 6 December. Aton analyst Steven Dashevskii calculated the payment at 20 percent of an estimated annual net profit of $2 billion, telling "Vedomosti" on 6 December it was "an impressive figure." Although an October amendment passed by parliament allows companies to pay interim dividends with the permission of an extraordinary shareholders' meeting, Yukos appears to be one of the few companies prepared to do so. According to "Vedomosti," Russian business heavyweights Sibneft, Norilsk Nikel, Transneft, LUKoil, and Surgutneftegaz have no plans to pay interim dividends. DK

Prime Minister Mikhail Kasyanov announced on 3 December that the EBRD has agreed to acquire a 20 percent stake in state-owned Vneshtorgbank, "Vedomosti" reported on 4 December. Venshtorgbank, which handles foreign commerce, is Russia's second-largest bank. Officials estimated the worth of the 20 percent stake at some $300 million. The bank will issue additional shares to make the acquisition possible, since Russian privatization law stipulates that state-owned stakes can only be sold through tenders. Downplaying a potential sticking point, Kasyanov stressed that export sales of arms will be serviced solely by Vneshekonombank, "Kommersant" reported on 4 December. Vneshtorgbank had recently begun servicing Vneshekonombank's military business, raising issues of disclosure in the context of Venshtorgbank's planned cooperation with the EBRD. "Nezavisimaya gazeta" reported on 5 December that Vneshtorgbank is servicing weapons-export contracts and will now have to "return the military contracts (or the most savory of them) to Vneshekonombank." The acquisition is scheduled to take place within the next three to four months. It will pave the way for the full-fledged privatization of Vneshtorgbank. DK

Four years after the 1998 crisis laid it low, banker-turned-oilman Mikhail Khodorkovskii's Menatep bank is back with a plan to create a "financial supermarket," "Vremya MN" reported on 5 December.Interbank Financial Union (MFO) Menatep CEO Platon Lebedev announced at a 4 December press conference plans to unite Trust Investment Bank (DIB), Menatep St. Petersburg, and nonstate pension fund Progress-Trust -- all part of the Khodorkovskii empire -- into a single holding. Lebedev explained that it will take MFO Menatep until mid-2003 to consolidate the two banks' shares, which are currently divided between MFO Menatep and Yukos oil company, "The Moscow Times" reported on 5 December. With 67 billion rubles ($2.1 billion) in assets, the reconstituted Menatep would be the second-largest bank-holding company in Russia, "Kommersant" reported on 5 December. Still, memories of the 1998 crisis, when the original Menatep went bankrupt and lost its license, could cast a pall over the reincarnation. Interfax Rating Agency Deputy Director Mikhail Matovnikov told "The Moscow Times" that after "what happened to Menatep four years ago, it will take a lot of time and commitment to win back confidence." DK

U.S. financial-services powerhouse Citibank will seek to capitalize on its recent entrance to the Russian market by setting up automated banking centers at British Petroleum (BP) filling stations in Moscow, "Vedomosti" reported on 6 December. The centers will include ATM's, Internet kiosks, and a 24-hour hotline to the bank. In addition to filling up their cars, customers will be able to withdraw and deposit funds and perform other transactions. Five centers are now operational. Citibank plans to extend the network to all of BP's 39 stations. BP, for its part, intends to expand to 120 stations within the next five years, "The Moscow Times" reported on 6 December. The arrangement will allow Citibank to expand its market presence without sinking vast sums into new branches. According to "The Moscow Times," Citibank already has 1,200 customers -- just two weeks after arriving in Russia. Russia's leading foreign bank, Austrian Raiffeisenbank, has 32,000 customers. Raiffeisenbank retail Director Aleksandr Koloshenko seemed unimpressed with his competitor's move, telling "Vedomosti," "We maintain a 'personalized' approach to serving clients.... We're in Russia, after all, and our clients prefer to deal with a live person." DK

Tremors from the September acquisition of B/Com3 holding by French group Publicis have reached the Russian advertising market, "The Moscow Times" reported on 5 December. B/Com3 includes agencies D'Arcy, Leo Burnett, and Saatchi & Saatchi. Publicis's new strategy will eliminate D'Arcy as a brand, folding it into Leo Burnett. The decision created an odd situation in Russia, where D'Arcy is one of the country's top three advertising agencies. It posted 2001 revenues of $110 million, while Leo Burnett & Moradpour (the company's Russian branch) came in at only $19.7 million. The "new" Russian Leo Burnett will be part of a holding company that will include Rodnaya Rech advertising agency and media companies Starcom and MediaVest. Marco Milesi, who will manage Leo Burnett in Moscow, told "The Moscow Times" that the new Leo Burnett will have a staff of 80-110 people drawn from D'Arcy, Leo Burnett & Moradpour, and Leo Burnett International. Vladimir Estafev, head of advertising group Maksim, sounded a critical note to "Kommersant" on 5 December, telling the newspaper that the loss of Edward Moradpour, who was dismissed from Leo Burnett & Moradpour in the course of the merger, is "simply idiotic." Calling Moradpour "perhaps the main specialist on advertising in Russia," Estafev said that "now he might go to another company, maybe a competitor." DK

Boris Kuzyk's New Programs and Conception (NPK), which holds a controlling stake in St. Petersburg shipbuilder Severnaya Verf, won a vitally important $603 million appeal to save the enterprise from bankruptcy, "Vedomosti" reported on 3 December. In July, prosecutors acting on behalf of the Finance Ministry won a devastating $603 million arbitrage ruling against Severnaya Verf for two destroyers that were sold to China for $614 million. Severnaya Verf obtained the partially constructed destroyers in the course of a reformation after a 1997 bankruptcy. The prosecutors claimed the state, which owned the enterprise when the ships' hulls were constructed, was never fully compensated for its property. Severnaya Verf is willing to compensate the federal budget only 182 million rubles ($5.7 million). "We feel that in the course of privatization, the enterprise received only partially assembled metal constructions that cannot be considered warships," Severnaya Verf lawyer Dmitrii Zakhmatov was quoted as saying in "Vedomosti." While further appeals may be in the offing, "Kommersant" pointed on 3 December to sources in the military-industrial complex who say that negotiations over an amicable agreement have been ongoing since November and that only the final sum remains to be established. DK

President Vladimir Putin signed a decree on 4 December to liberalize the export of Russian diamonds, with far-reaching implications for the international market, "Kommersant" reported on 5 December. The decree leaves export quotas in place but will free national diamond monopoly Alrosa from exporting diamonds solely through South Africa's De Beers. Additionally, diamond-cutting companies will receive the right to export, or have cut abroad on commission, 15 percent of the raw material they obtain from Alrosa. Alrosa produces $1.5 billion worth of diamonds annually, half of which it exports, "Vedomosti" reported on 5 December. Opening the door to commission cutting could spur changes in the industry. According to "Kommersant," if the price of cutting small diamonds in Smolensk is $45-$50 per carat, it drops to $20 per carat in neighboring Belarus and $5-10 per carat in India. The decision to open up the diamond market may have been linked to Russia's ongoing bid to join the World Trade Organization, which frowns on market-throttling controls. Alrosa Vice President Sergei Ulin told "Vedomosti" that the decree will allow Alrosa and other Russian suppliers to develop their own ties to the world market and play a more active role in price formation. DK

In a move that will tie up and consolidate the last loose ends in Russia's aluminum industry, the Siberian-Ural Aluminum Company (SUAL), the country's second-largest aluminum producer, announced that it is merging with Sevzapprom, "Kommersant" reported on 5 December. Under the terms of the merger, which will boost SUAL's production of primary aluminum by 24.3 percent, Sevzapprom will receive an 18 percent stake in SUAL. SUAL will gain three plants that produce primary aluminum and alumina. The resultant holding will produce 2 million tons of alumina (65 percent of the Russian total) and 850,000 tons of primary aluminum (25 percent of the Russian total) annually, "Vremya novostei" reported on 5 December. Even so, it will remain in second place behind industry leader Russian Aluminum (RusAl). Commenting on the consolidation trend, Aton analyst Aleksandr Agibalov told "Vedomosti" on 5 December, "With such a powerful player as RusAl on the market, the consolidation of other enterprises makes sense." The deal raises the standing of SUAL President Viktor Vekselberg, who is also the CEO of Tyumen Oil Company. "Kommersant" succinctly summarized the deal's effect on the industry, commenting, "There's nothing left to divvy up in the Russian aluminum sector." DK

The lure of oil profits outweighed the danger of environmental catastrophe as Georgian President Eduard Shevardnadze announced on national radio an "optimal solution" to the difficult issues surrounding the Georgian leg of the Baku-Tbilisi-Ceyhan (BTC) oil pipeline, "Vremya MN" reported on 3 December. Talks with Ambassador Steven Mann, the U.S. State Department's senior adviser on Caspian Basin energy diplomacy, and British Petroleum-Azerbaijan President David Woodward convinced Shevardnadze that the potential benefits to Georgia from the $2.95 billion BTC pipeline are greater than the risks to the Borjomi-Karagauli National Park. The pipeline will pass within 15 kilometers of the park that lends its name to Georgia's Borjomi mineral water. Touted as both tasty and healthy, the popular beverage accounts for 10 percent of the country's exports. A July report by six NGOs (http://www.bankwatch.org/downloads/pipelines-factfinding-georgia.pdf) concluded that the "companies' baseline survey of the Borjomi district is wholly inadequate and must be conducted fully before the project goes any further." For its part, BP agreed to environmental protection measures that will cost the company $25 million-$30 million, "Kommersant" reported on 3 December. Georgian Glass and Mineral Water President Mamuka Khazaradze, who has been a vocal critic of the BTC project, told "Vremya MN" that, in the event of a disaster, BP "promises to help out with marketing specialists who will create a new legend for Borjomi." The newspaper did not specify the level of sarcasm. Construction on the BTC project is slated to begin in Georgia in the spring. DK

The Russian automotive industry at the close of 2002 presents a uniquely instructive picture of hybrid development. Weighed down by a classically Soviet imbalance between quantity and quality, the nation's largest carmaker finds that its only real solution to an overproduction crisis is to idle its conveyer belts and hope for better times. Yet elsewhere in the industry, the burgeoning development of consumer credit could have broad implications for the future of the nation's underdeveloped financial system.

Employing some 120,000 people and producing roughly three-quarters of a million cars annually, AvtoVAZ is the be-all and end-all of the Russian automotive industry. Konstantin Titov, governor of the Samara region in which AvtoVAZ is located, told "Volzhskaya kommuna" on 29 November that AvtoVAZ accounts for 76 percent of Russian passenger-car production. But this ungainly giant confronts the worst problem any carmaker can face: Consumers don't want to buy its cars. Industry observers estimate that in 2002, AvtoVAZ has produced 80,000-80,500 more cars than it can sell. With excess production clogging dealers' lots, the factory halted production from 26 October to 10 November, a period that normally would have seen AvtoVAZ churn out 27,000 cars. It wasn't enough. Starting on 26 November, the factory reduced its production week from 88 hours to 60 hours, cutting shifts down to six hours a day with two days off. With all of the stoppages and slowdowns, the 720,000 cars will roll off assembly lines by year's end, 8 percent less than the factory had planned to produce.

Emergency measures extend beyond production. AvtoVAZ is slashing social programs for workers and mulling cuts in management. There is talk of rationalizing a chaotic four-channel distribution system that wreaks havoc with price formation, and even introducing a standard 4.5 percent dealer markup throughout Russia. Management seems willing to try just about anything to get cars moving again. Anything but lower prices, that is. AvtoVAZ has stood firm throughout the crisis, refusing to cut consumers a deal. "Spros" wrote on 11 November that by August AvtoVAZ had raised prices five times in 2002 for a total hike of 12 percent.

AvtoVAZ's Achilles' heel might be summed up in one word: quality. Or lack thereof. A 26 August 1996 "Forbes" profile of the Russian automotive industry bore the unambiguous title "Would you drive a Lada? Russians make the world's worst cars..." Little has changed in the intervening six years. In a 28 November interview with "Ploshchad svobody," AvtoVAZagregat (the parts manufacturer for AvtoVAZ) General Director Sergei Sychev admitted that quality is the problem. "Over the last few decades," he explained, "no traditions of quality work were inculcated...so defects are an old tradition. This is what we have to eliminate."

While AvtoVAZ management ponders the fate of its unsold cars and contrives ways of freeing itself from the Soviet legacy of low-quality production, an entirely different sector of the Russian automotive industry is forging ahead into the uncharted territory. Auto financing, only recently seen as a newfangled innovation with dim prospects on the Russian market, is making significant inroads.

Though still limited primarily to purchases of higher-priced foreign cars in Moscow and Petersburg, a poll of auto dealerships conducted by "Konservator" in early December revealed that 10 percent of new cars are now bought on credit, a hefty increase from 5 percent at the beginning of the year. Statistics on the industry website http://www.carloan.ru indicate that in the third quarter of 2002, banks issued nearly $26 million in car loans. The two leading banks -- Raiffeisenbank and Rus-Bank -- are both foreign. Most car loans go for new and used foreign cars and cost borrowers 14 percent interest.

Foreign carmakers are the most active proponents of auto financing in Russia. "Konservator" reports that Toyota has an agreement with Raiffeisenbank to offer car buyers 11 percent financing on new Corollas. Ford, which recently began to assemble its Focus at a new facility in Vsevolozhsk, is cooperating with a Russian bank to make 11 percent financing available to its customers. For now, the trend appears limited to foreign manufacturers, however. "The Russian auto industry doesn't try to help banks sell its products," writes "Konservator," "and Russian cars rarely appear in auto-financing programs."

Granted, auto financing has a long way to go before it becomes part and parcel of how Russians buy cars. But the trend bears watching. Consumer credit is one of many missing links in today's Russian economy, and the increase in auto financing could presage significant future developments in this lagging sector. A February 1999 article in the "Quarterly Journal of Economics" by Martha L. Olney detailed the history of consumer credit in the United States, focusing on the 1930s. Reviewing the emergence of an institution that would come to dominate American economic life, Olney wrote that "the 1920s mark the crucial turning point in the history of consumer credit." For the first time, installment debt became an accepted way of acquiring big-ticket items. Like cars. Olney explained: "Automobiles were at the center of the 1920s expansion of installment debt."

Honore de Balzac's novel "Splendeurs et Miseres des Courtesans" has taken on a strange second life in Russian journalism. Shorn of its Parisian courtesans, the novel -- in the Russian translation of splendorous "blesk" and miserable "nishcheta" -- has inspired countless harried journalists penning articles about "something good, something bad": blesk and nishcheta. Hackneyed though it may be, the phrase's popularity points to a certain constant perceived by those who write about Russian life. As Russia's auto industry rides into the 21st century, burdened by a surplus of cars it cannot sell and yet buoyed by a new way of doing business, blesk and nishcheta are once again inseparable. DK