Privatisation: what's on offer?

In contrast to the prevailing hegemony further west, privatisation remains a dirty word for many Russians. The chaos following the collapse of the Soviet Union, the economic shocks of sudden market liberalisation, and the privatisation rackets that created the oligarch clans have left a nation traumatised. Yet it is only the latter – which saw state assets worth billions swapped for loose change in the Nineties – that still taunts from the TV and front page on a daily basis.

The current political leadership has always claimed that it believes private companies should dominate the economy, even as it has overseen expansion of state ownership. Hence, the announcement in late autumn of a wave of privatisation, kicking off in 2010, is consistent with stated intentions, even if it signals a distinct policy shift from the last decade.

In September, first deputy prime minister Igor Shuvalov predicted as many as 5,500 companies could be privatised (at least partially) over the coming years, with 449 due on the block in 2010. Last month, he announced that the privatisation plan for this year is to be substantially expanded.

It’s worth noting that the original numbers include a host of barely functioning enterprises that have been on the table for years – without any takers. While a selection of more interesting assets are now also about to come up for grabs, the investment community will have to wait to get their hands on a larger slice of the crown jewels they covet: the oil and gas, banking and other blue-chip companies.
Of the most attractive companies that are now definite privatisation targets (for example TGK-5 and three large insurers), the government will be relinquishing no more than minor interest or blocking stakes, suggesting the sales may do little to improve free floats or liquidity. Of those with full state ownership certain to go under the hammer, perhaps only construction company Mosmetrostroy will be able to provoke any great interest.

However, a second list of names has also been made public. This includes a handful of the largest shipping and transport infrastructure companies in Russia. The potential of this segment stems from the economy’s reliance on bulk exports – not only oil, but metals and mining products, grain and timber, to name but a few – and hence the stakes in Murmansk and Novorossiysk ports and the Sovcomflot shipping line are likely to provoke the most interest among investors. Yet these currently sit on the list of strategic assets in which foreign ownership is restricted. It’s the task of president Dmitry Medvedev to get these stricken from the list – a task he’s yet to achieve.
As ever, the gap between policy and implementation appears wide. Ivan Ivanchenko, chief strategist and economist at VTB Capital suggests the political leadership had to pause while it consolidated the breadth of political power needed to push through unpopular moves, such as privatisation.

“The crisis only strengthened the authorities’ urgency to escape the oil hook,” Mr Ivanchenko says. Hence, in February Mr Medvedev released a list of initiatives and deadlines aimed at improving the investment climate in Russia. This includes demands for penalties against officials who obstruct investment policy and projects, as well as a mid-March deadline for suggestions of further “major and strategic” companies to be included in the privatisation drive.

Privatisation is one of the few levers that can help attract FDI into Russia at the moment. This was not always the case: state ownership in Russia’s economy has increased substantially since 2004; from 25-30pc to over 50pc according to most estimates. To a large extent this has been the result of efforts to reclaim assets lost to the oligarchs – although the campaign was carried out ruthlessly and with little pretence of even-handedness.

This process accelerated during the recent economic crisis, as the government bailed out over-leveraged corporations. On a practical level, however, this action was little different to the bail-outs seen across the globe. Once again, prime minister Vladimir Putin insisted that the state had absolutely no interest in nationalising the assets. More recently, finance minister Alexei Kudrin has pledged that state interest in the enterprise sector will shrink to 30pc in the coming years. The challenge is to push this past vested interests in the Kremlin, bureaucracy and business world.

Some believe that rather than a commitment to loosen the state’s grip on the economy, it’s simply current financial straits fuelling the latest privatisation drive. Kudrin anticipates a budget deficit of around 6.8pc this year, following 5.9pc in 2009. While every little may help, the $2.4bn income targeted from privatisation in 2010 will not make much of a dent in the $100bn deficit. The theory looks even less convincing in the light of Russia’s preparations for its first overseas bond issue since 1998 (although few expect to see the full $18bn debt raised mentioned in the 2010 budget), while it also holds the third highest volume of sovereign wealth funds in the world, with around $400bn tucked away.

However, a need for cash looks like a viable driver for the inclusion of several transport assets from the strategic enterprises list. In the boom years immediately prior to the crisis, the state’s emphasis was fixed firmly on Russia’s ailing infrastructure, with promises of a gigantic $1tr investment. The electricity sector was the priority, with cash desperately needed to renew grid infrastructure and build extra capacity; lo and behold, the sector saw significant privatisation in 2007. While Russian and foreign corporations were tussling to get their hands on these power assets, the statements issuing from the authorities turned the spotlight onto transport.

The crisis turned these plans to dust. The private owners of power-sector assets are now facing increasing pressure from the state to honour the massive capex pledges they made at the time they bought; meanwhile, state spending has been diverted to ensure social, and therefore political, stability. Investors are to be invited to start the ball rolling again on rebuilding the country’s infrastructure.

At the same time, the political leadership knows that money on its own won’t be enough. As a government source told local media recently: “It’s obvious to everyone that they [the enterprises under government control] are excessive. It’s impossible to manage this huge mass effectively.”

Private management, as well as foreign expertise and technology, are cornerstones of the Kremlin’s struggle to diversify and modernise the economy.

This tallies with the speculation of Angelika Henkel of Alfa Bank that most of the named companies “are better candidates for buy-out by strategic investors that already have a significant interest in them”. The 25.1pc government stake in TGK-5 for instance is widely expected to end up in the hands of major stakeholder KES-Holding, while the 25pc stake in shipping company Sovcomflot is another likely to head to a working partner.

In fact, few of the named companies look set to float on the Russian or international bourses, despite Mr Kudrin’s claim in December that the majority of coming privatisations would be via IPO. For example, while a company such as Mosmetrostroy could prove attractive, the 100pc the government is looking to unload would stretch the capacity of fund inflows to Russia, and struggle to compete with established publicly traded companies.

Therefore, although the government clearly hopes to score PR points from its privatisation drive (the FT quotes a government official suggesting that the move will “show the world the liberalism of the government”), many in the international investment community apparently remain underwhelmed (see box).

How quickly the state will put the bigger prizes on the table is a major question. The invite to become more deeply involved in Russia’s state giants and other attractive assets will have to wait until the political leadership manages to push it past vested interests – including amongst their own ranks – as well as necessary restructuring. It also won’t come until investment flows and risk appetite perk up.

With governments across the globe now holding major assets, the Russian authorities have no intention of letting them go on the cheap.

What isn’t under discussion is that the government will give up majority control in the country’s largest companies in the near future. This issue gets commentators stewing like few others: indeed, minority shareholder rights are commonly ridden roughshod over in Russia.

In response, Mr Ivanchenko claims that legal action by investors is meeting more success recently: “Things are getting better, slowly.”

Russia’s state behemoths offer such steady and attractive returns that few fund mangers can summon the idealism to blacklist them. Besides, in a country in which businesses are often stalked by corruption and criminality, perhaps the safest place is in bed with the state.

Companies on sale in 2010

The Russian government has said it hopes to sell stakes of some $2.4bn in 2010. Despite a return to economic growth, the state engaged in heavy deficit spending (in the form of bailouts, subsidies and other stimulus programs) during the economic crisis and now hopes to cover a part of the financial losses.

Among the most interesting companies named thus far are the transport and shipping concerns – although these will need to be struck off the official list of "strategic assets" in which foriegn investment is limited. As Ivan Ivanchenko of VTB Capital points out, Russia hopes to develop its potential as a transport hub and bridge between Europe and the Far East.

Sovcomflot, Russia’s largest shipping company, has plans to invest $5.5 bn over the next six years – much of it intended for the oil and gas tanker fleet and offshore services to support Russia’s large-scale projects such as the Shtokman gas field in the Arctic.

At the end of 2008, the company claimed to own the largest icebreaker fleet in the world, a cornerstone in the state’s quest to open up an eastwards transport route along Russia’s Arctic coast in order to feed the energy hungry East Asian markets. With this in mind, there is little chance of the government relinquishing control over the coming years.

Overall, Sovcomflot could be viewed as a proxy for Russia’s giant energy projects – which have had global oil and gas majors battling to clamber aboard (or keep their seats in some cases) over the last five years. That said, Shtokman in particular poses an enormous challenge, the offshore Arctic location requiring the development of new technologies.

Novorossiysk Commercial Sea Port’s greatest advantage is its strategic posting on the Black Sea between southern Europe and Asia: most of Russia’s large ports are on the Baltic and Pacific shores. The company has strong links and partnerships with state-owned Russian Railways and Transneft (oil and gas pipelines), which dominate land-based transport, as well as exports.

However, with increasing numbers of pipeline routes in the area, the port’s heavy dependence on crude shipments (51pc of volume in 2009) may leave it exposed to increased risk in the coming years. A strong cargo mix in revenue terms (led by oil products, grain and metals) saw turnover remain resilient last year, despite the downturn in global commodities.

Given that it has an estimated free float of 30pc, and the stake to be privatised is no more than 20pc, the NCSP stake is one of the few heading for the public markets.

Russia’s fourth largest port (second in the north-west), Murmansk CSP, sits above the Arctic circle, but remains open year round. Traditionally an export route to north-west Europe, coal has always been king for this harbour.

However, shipments are now also headed east, with pipes being delivered to the Shtokman gas field and possibilities of expansion to serve the massive project are under scrutiny.

All rights reserved by Rossiyskaya Gazeta.