Monday, 17 November 2008

Russian power plays highlight risks for minority investors

Financial News

Jason Corcoran in Moscow
17 November 2008

Energy company has been hit by governance failings

The crash in Russian equities has exposed serious risks for minority shareholders, despite an amelioration in the country’s corporate governance over the past few years.

The growth of Russian capital markets and the recent boom in initial public offerings has led to an improvement in corporate governance and accounting practices among the blue chips, but violations continue in the small to medium tier. A number of Russian utility companies that were spun off from the electricity monopoly have been particularly affected.

A group of 15 minority shareholders in power generator TGK-4 last month wrote to President Dmitry Medvedev claiming Onexim Group, an investment firm owned by Russian billionaire Mikhail Prokhorov, had exerted pressure on Russian officials to act in Prokhorov’s interest after Onexim agreed to buy it in May.

By law, as a majority shareholder, Onexim was required to offer to buy out minority investors. Investors said Prokhorov promised to do so.

However, following the slide in the Russian stock market, the required offer price for the buyout of TGK-4 shares stood at a 50% premium to the utility’s market price.

The group of minority shareholders, headed by Swedish investment firm Prosperity Capital and including a number of Russian and international hedge funds, claims Prokhorov reneged on his promise.

In an open letter to the President, the investors accused Prokohorov of “trying to avoid obligations by manipulating facts and using legal loopholes.

The shareholders wrote: “We appeal to you with a request to take immediate measures to protect the foundations of the Russian financial market and legal system, and to help set right these flagrant violations of the principles of corporate management.”

Alexander Branis, a director at Prosperity, which has about $4bn in funds under management, said the Kremlin had not replied. The Kremlin did not return calls inviting comment for this article.

James Fenkner, founder of Moscow hedge fund Red Star Invest and a local authority on corporate governance, added: “TGK-4 has been made into a strategic asset. The situation is borderline criminal, but you can see that corporate governance always gets worse at the bottom of a cycle.”

Onexim said it was no longer obliged to buy out the minority shareholders despite initially promising to do so when they acquired the majority sake in May.

Since its purchase of the stake, it had managed, in a way Prosperity questions, to lower its stake in TGK-4 below 50%, eliminating its obligation to buy the remainder of the shares.

TGK-4 also recently landed on a list of state “natural” monopolies, which prevents those companies from being bought. Investors claimed Onexim had applied pressure on the anti-monopoly regulator to include it on the list.

Prokhorov says he has a big capital investment programme, which will benefit the company and its shareholders who lost out from the buyout.

In a statement, he said: “I am certain that, once TGK-4 carries out its investment programme, the investors will earn a lot more than they would by pulling out their money now.”

Prosperity has sold down its original 18% stake of TGK-4, but remains a substantial shareholder. Other large investors include RusHydro and Federal Grid Company, which were spun off from the electricity monopoly UES. Fund sources suggested the latter two might come to a separate arrangement with Prokhorov in relation to their stakes in TGK-4.

Igor Goncharov, analyst at UBS in Moscow, said the market weakness had highlighted problems at energy companies TGK-2, TGK-4 and OGK-3 and could led to potential risks at OGK-2, 6, TGK-6, 7 and 9.

He said: “The most apparent risk is that the core shareholders may economically dilute minority shareholders by buying newly issued shares at current valuations, which we find to be substantially below intrinsic fair value for most of the companies.”

Branis of Prosperity said Russia’s main financial regulator, Federal Financial Markets Service was beginning to talk robustly about minority shareholders rights and had stepped in at OGK 3 and TGK-4 in a practical way. The free float in these other utilities is rather small and Goncharov is concerned that abuses could occur.

He said: “The regulator has mobilised itself to get involved in upholding the rule of the law and this is very encouraging.”

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