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By the Highest Standards
The year 2003 was a year of large-scale mergers and acquisitions for Russia. They included the formation of the BP–TNK alliance, the buy-up of the Georgian power industry by Russian natural monopolies, and Shell’s commitment to invest $10 billion in the Sakhalin-2 project. However, the volume of failed deals is even more telling.
British Petroleum–Tyumen Oil Company
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| Photo: Aleksei Kudenko |
| Under the leadership of Sergei Bogdanchikov (in the photo), Rosneft acquired AO Northern Oil for $600 million (one of its co-owners, Andrei Vavilov, is shown in the photo on the lower right) |
On February 11, the owners of Tyumen Oil Company (TNK) announced that they were merging their assets with those of British Petroleum (BP) in Russia and Ukraine to form a single company. The final agreement between the shareholders was signed in London on June 26. The amount BP paid for its share in BP–TNK was reduced by $600 million to $2.4 billion. TNK’s shareholders received $6.85 billion from the Anglo-American British Petroleum for the right to set up a joint oil company with TNK. In order to do this, TNK’s largest owners, Mikhail Friedman and Viktor Vekselberg, had to give up the title of oil magnate, since TNK shareholders receive only 50% in the new company, called BP–TNK. Friedman believes that the next deal of this size involving Russian businessmen will have to wait for at least two or three years.
In many respects, the deal with BP stemmed from the Anglo-American company’s less than successful development in the mid-1990’s, particularly the muddled and complicated business with SIDANKO, which bankrupted TNK. However, TNK made no secret of its intentions to form a partnership with BP by any possible means. The deal will probably enter textbooks on strategic management: it was the first time a Russian company had successfully convinced a Western partner that it was more advantageous to work with it than to expand in Russia independently.
Rosneft–Northern Oil
On February 12, Rosneft announced the acquisition of AO Northern Oil (Severnaya neft) for $600 million.
The oil industry was the leader in the number of large deals at the beginning of the year, although in January everyone expected problems in this sector: it was assumed that war in Iraq would lead to a drop in prices. Nevertheless, Russian oil became a very attractive asset in the first quarter of 2003. For example, the owners of Northern Oil, who included former deputy finance minister Andrei Vavilov, sold the company to Rosneft for an even $600 million. In a departure from Russian business tradition, the parties paid for Northern Oil through Sberbank of Russia rather than through offshore or Western banks.
With this deal, Northern Oil set still another record as the only relatively large oil company to increase its market value approximately ten times between 1999 and 2003, while increasing oil production on the same scale. It was rumored that after the head of Rosneft, Sergei Bogdanchikov, had familiarized himself with Northern Oil’s operations, he gave orders not to make any major changes, but to turn the company into a model subdivision of the state company that they could show to foreign delegations and visiting government officials.
The Northern Oil deal sparked a lot of hearsay and false rumors. In particular, there was talk about a huge kickback received by structures of the presidential administration for supporting it. Nevertheless, this deal was important primarily because it gave the entire market an excellent reference point. A company that had grown from zero to $600 million in only a few years was worth that much for Rosneft as a business, not as a source of oil reserves or as a means of increasing capitalization.
Mechel–Korshunov Ore Mining and Processing Plant
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| Photo: Valery Melnikov |
| The main event in the area of railway reform was the formation of AO Russian Railways, headed by Minister of Railways Gennady Fadeev |
Mechel’s acquisition of Korshunov Ore Mining and Processing Plant (Koshunovsky GOK) was the last big old-style deal in the metallurgical industry. The history of the sale by SUAL-Ruda GOK, which supplied raw materials to Siberian steel plants, began with the standard Russian scandal: the Korshunov plant was bankrupt, and Mechel’s rivals from Evrazholding made no secret of their intentions to fight for Korshunov GOK using all available means, including force.
Nevertheless, Mechel obtained a final decision on the question at the negotiating table and in the arbitration court, although during the struggle for Korshunov GOK, the company had used more habitual means of fighting for industrial facilities, e.g., legal actions, police officers, “dropping in” on the plant’s management, and other romantic stuff of the mid-1990s. The question cost Mechel 2.4 billion rubles, a sum that included the amount of the deal along with Korshunov’s debts, which the owner assumed in order to get the company out of receivership.
The Korshunov plant was the last large ore mining and processing company without a major corporate partner. The other ore companies had long ago become part of Russian metallurgical companies. Not everyone was lucky: some Russian steel companies were left without their own raw material sources. Their only option is to buy mining assets from other owners. Therefore, both metallurgists and analysts believe that the investment attractiveness of Russian ore mining and processing companies will increase.
The tension is heightened by the rapid increase in world prices for steel raw materials resulting from increased demand for ore in Southeastern Europe. Another source of raw materials for steelmakers, scrap iron and steel, is inadequately collected in Russia and cannot be relied upon.
It is not surprising that the last ore mining and processing company went to Mechel. In 2003, Mechel had already expanded its operations beyond Russia and the CIS and had started buying companies of its profile in Romania and Slovakia. Thus, the company had an acute need for a raw material base, and it had to buy this base in a way that would not raise doubts among future partners and investors in Europe and in other parts of the world. A reputation is worth money, so there was simply no question of settling the situation with Korshunov GOK by force.
Troika Dialog–Rosgosstrakh
Troika Dialog Investment Company (IG Troika Dialog) paid 661 million rubles for the right to control Rosgosstrakh, one of the best known brand names of Soviet times. On the results of three auctions, Troika Dialog became the owner of 49% of Russia’s oldest insurance company at the end of 2001. The government owned a block of 26% minus one share of Rosgosstrakh, which it also put up for auction. Bidding for the share package of the former Soviet insurance monopoly took all of three minutes, beating the record set at the Slavneft auction by one minute. As a result, Troika Dialog became the owner of 75% minus one share of Rosgosstrakh.
The amount collected from the sale of the former giant hardly disturbed anyone except Duma deputies, who even tried to annul the auction. “The winning consortium of investors led by Troika Dialog has to solve the very urgent problem of attracting investments to the Rosgosstrakh system, “ the system’s press secretary, Igor Ignatev, told Kommersant. According to Ignatev, Rosgosstrakh will require about $50 million to develop automobile liability insurance programs alone.
The government intends to keep a blocking parcel of Rosgosstrakh shares at least until 2004, according to Kirill Tomashchuk, deputy head of the State Property Fund. The Ministry of Property Relations wants to use the blocking parcel as a guarantee of debt payments under policies written by Gosstrakh (Rosgosstrakh’s Soviet-era predecessor). However, at Rosgosstrakh, they told Kommersant that judging from the pace of the debt offset program, it will take at least ten years to pay off all the debt.
National Reserve Bank–Aeroflot
Monopolies, both past and present, are becoming more and more attractive to Russian businessmen. National Reserve Bank (NRB), which was once closely connected with both Gazprom and RAO UES of Russia (RAO EES Rossii), turned its attention to former Soviet monopoly Aeroflot and bought 26% of the company’s shares for $135 million, a record amount for the Russian airline industry.
It is not hard to understand why the bank headed by Aleksandr Lebedev wanted the shares. Aeroflot flatly refuses to buy Il-86 airplanes, and NRB is actively involved in an Il-86 production program. Now that it has seats on Aeroflot’s board of directors, NRB is counting on convincing the company of the undeniable advantages of Russian aircraft over Airbus and Boeing. A scandal is anticipated. Aeroflot has repeatedly stated that problems with access to Western airplanes are having a negative impact on the company’s business. Despite some improvements in Aeroflot’s financial indicators, the company’s situation is far from ideal. At the end of the year, Aeroflot began a “rebranding” campaign to bring its image more in line with its Western competitors.
Ministry of Railways–Russian Railways
AO Russian Railways (Rossiyskie zheleznye dorogi; RZhD), perhaps the largest Russian company in terms of assets, was formed in Russia at the end of September. Anna Belova, who at the time was still Deputy Minister of Railways, announced that the ministry would be transferring property worth 1600 billion rubles to Russian Railways. RF Minister of Railways, Gennady Fadeev, was appointed president of the company split off from the Ministry of Railways. The Ministry is expected to be eliminated by combining it with the RF Ministry of Transport, but Russian Railways has already started operating. It is still difficult assess the results of the deal, since there are no noticeable practical differences in Russian Railways’ operations compared with the Ministry of Railways.
Georgia--Russia
The business calm in Russia did not prevent two Russian economic giants, Gazprom and RAO UES of Russia, from carrying out an economic blitz with record speed in a country that was previously not very welcoming to Russian investors. The two unreformed monopolies captured Georgia’s power industry in about a month.
On July 1, Aleksei Miller, chairman of the board of Gazprom, signed a cooperation agreement with Georgia’s Minister of Fuel and Energy, David Mirtskhulava, which gives Gazprom the prospect of acquiring up to 100% of the Georgian gas market. Then in early August, RAO UES of Russia bought 75% of the shares of the Telasi power distribution network in Tbilisi and two power-generating units of the Tbilisi Thermal Power Plant with a total capacity of 600 MW (this represents a large part of Georgia’s power industry) from the American company AES Silk Road and its partners.
On August 1, RAO Nordic, a subsidiary of RAO UES of Russia, bought all of the American group AES’s Georgian business, which amounted to nearly 50% of Georgia’s power facilities. RAO Nordic paid $70 million for the assets; the only reason for such a low price was that the assets were burdened with monstrous (by Russian standards) debts, both payable and receivable.
The Georgian opposition accused President Eduard Shevardnadze of betraying national interests, but neither RAO UES of Russia nor Gazprom seems to have had any particular political aims. Although accusations of “selling the homeland” played a certain role in the Georgian president’s resignation, immediately after the coup, contrary to expectations, the new Georgian leaders said nothing about a possible review of the deals. Gazprom’s only actual interests in Georgia are the long-distance gas pipeline to Armenia and replacing Itera Oil and Gas Company (NGK Itera) on the Russian domestic market. This second aim is already succeeding in a way: the first thing the new managers of Tbilisi’s gas supply systems did was to cancel the contract with Itera.
Russian natural monopolies had never carried out this sort of blitz before, but RAO UES of Russia did not stop there. In keeping with chairman Anatoly Chubais’ political policy of creating a “liberal empire” through economic domination of the entire CIS, the company bought 33% of the shares of a Ukrainian company owned by ten regional power companies. RAO UES of Russia intends to continue expanding into Ukraine next year. Gazprom’s plans include the formation of a joint venture with the Belarussian company Beltransgaz, investments in Central Asian gas pipelines, and a whole set of “imperial deals”.
SUAL--Fleming Family & Partners
In February 2003, OAO SUAL announced the formation of a transnational corporation that included SUAL’s aluminum assets, the coal company Access Industries (Eurasia), and two facilities of the English company Fleming Family & Partners in Cuba and Mozambique. Chris Norval, former vice-president of strategic planning of the South African company BHP Billiton, was appointed general manager of the SUAL International industrial group and president of SUAL Holding.
Despite of its lack of publicity, the deal between SUAL and the large English private fund was one of the signal events of 2003. SUAL is a company able to compete with Russian Aluminum (Russky alyuminii), which has a virtual monopoly on the aluminum market, and Viktor Vekselberg is one of biggest players of the “oligarchic” political scene, which increases the investors’ risks. Nevertheless, the Flemings approved the deal, which made similar investments in Russia an acceptable risk for other serious partners. After all, the matter concerns a resolutely nonpolitical deal that is also one of the year’s ten largest transactions, which in theory should form the basis for an increase in foreign investments in Russia and globalization of the Russian economy.
Shell--Sakhalin-2
On May 15, 2003, the Sakhalin Energy (SE) consortium, shareholder of the Sakhalin-2 project, decided to begin the second phase of the project. The partners, the main one of which is Shell, committed to invest $10 billion in Sakhalin-2.
SE had planned to make the decision to start the second phase of Sakhalin-2 in the first half of 2003; but after SE’s management expressed a number of complaints about legislative guarantees of the safety of future investments (particularly the inconclusive settlement of SE’s rights to set tariffs for oil and gas pipelines from fields offshore Sakhalin to ports on the southern part of the island), there was talk of suspending the project. According to unofficial versions, SE and its shareholders (Shell, 55%; Mitsui, 25%; and Mitsubishi, 20%) wanted to postpone the decision on starting the second phase until fall 2003 or even later.
The main factor in making the decision to start the project was apparently a contract concluded between SE and the Japanese company Tokyo Gas for delivery of 1.1 million tons of liquefied natural gas (LNG) per year for 24 years. Philip Watts, Shell’s CEO, recently announced that the company plans to conclude similar contracts for LNG deliveries to Japan, South Korea, Taiwan, and the United States in the near future. However, it is not inconceivable that Shell decided to speed things up as a result of unofficial statements from Gazprom to the effect that if something happened, Gazprom’s status as coordinator of gas field development in Eastern Siberia and the Far East and gas exports from Russia to countries in the Asia-Pacific region might be extended to Sakhalin-2 as well. Shell decided not to wait until Gazprom’s hints turned into concrete actions and announced the start of the largest investments in Russia’s history.
No Deal
Despite the impressive appearance of the first ten deals, the list would have been much more impressive if a number of large deals in Russia’s most important economic sector, the fuel and energy complex, had taken place or been concluded.
First of all, the future of the merger of YUKOS and Sibneft into the unified company YukosSibneft, the largest deal in Russian business history, is still unknown at present. On April 22, 2003, YUKOS and Sibneft announced the start of the merger into YukosSibneft. In the first phase, Sibneft shareholders were to sell 20% of their shares to YUKOS for $3 billion; and then in the second stage, they would exchange their remaining Sibneft shares for about 26% of YukosSibneft’s securities. However, after the head of YUKOS, Mikhail Khodorkovsky, was arrested, Sibneft announced a suspension of the deal that might have formed a company worth $50–55 billion, making it the largest company in Russia in terms of capitalization and giving it control of nearly one-third of Russian oil production.
Two other failed megadeals also have a chance of taking place in 2004. The first is a deal to give a consortium made up of Gazprom and the Ukrainian company Naftogaz of Ukraine control of all of Ukraine’s gas pipeline infrastructure (for an estimated cost of no less than $25 billion). One of the main reasons for the holdup is Kiev’s obstinate insistence on including Kazakhstan, Uzbekistan, and Turkmenistan in the gas transport consortium (gas from these countries is exported through Ukrainian pipelines, but their membership in the consortium means that Gazprom would lose its monopoly position as natural gas exporter to Europe.
The second is the creeping privatization of Bashkortostan’s oil production and oil refining industries. In early August, the government of Bashkortostan reorganized the property structure of AO Bashneft and Bashneftekhim, which had previously belonged to it in an ownership chain, with the aim of protecting them from possible privatization. Now the companies control their own capital according to a complex scheme. The problem is that as a result of the deal the republican budget lost assets worth at least $2 billion. The deal is also being contested and is directly dependent on the outcome of the pre-election fight between President of Bashkortostan Murtaza Rakhimov and his rivals.
The last two deals are the attempted acquisition of Surgutneftegaz by Sibneft shareholders, which led to an unprecedented increase in Surgut shares in spring 2003, and the would-be sale of a large package (25 to 40%) of YUKOS shares to either ExxonMobil or ChevronTexaco. Based on estimates of the company’s market value, the deal should have been worth $20–35 billion, which beats the record set by BP–TNK by several times. Strangely enough, President Putin was the first to officially announce that negotiations were going on. The company itself is keeping dead silent; and Lee Raymond of ExxonMobil, who met with nearly all members of the government and oil and gas industry elite in Russia last October, has not said a word about the results of these meetings.
It is certain that three of these five deals have not taken place because of active interference of the Russian authorities. The YUKOS affair in particular, which arose as a result of the initial efforts to form YukosSibneft, became the determinant for businessmen who had been planning deals two or three orders of magnitude smaller. By the end of 2003, there were noticeably fewer of them than at the beginning of the year; and this should be considered one of the year’s main results.
Dmitry Tatarinov
All the Article in Russian as of Jan. 12, 2004
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