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.”

Governance concerns remain despite cosmetic improvements

Jason Corcoran

Financial News: Focus on Russia

Companies chasing international investment are trying to improve their image

Hostile takeovers, asset stripping, threats of imprisonment and violence have long been unpalatable features of doing business in Russia. Corporate governance was a little known concept even five years ago.

Critics claim it remains a myth and that reforms are cosmetic. However, Russian companies seeking international investment say they are responding to demands for greater accountability, independent directors and transparent corporate structures.

Stanislav Vartanyan, former chief executive of the Investor Protection Association, a Russian shareholder group, said: “The corporate world and the stock exchange here have made a quantum leap from the wild days when it was the law of the jungle. We now have a more civilised investor oriented culture.”

Vartanyan, who heads investor relations at Russia’s largest shipping company Fesco, is realistic about the extent of change required, but points to the declining influence of Russia’s oligarchs as being key to reform. Fesco has seen its share of controversy.

It was accused of extortion by a British investor and board member, and it was alleged that its ships spied on the US Navy and blinded pilots with laser beams.

Fesco’s main shareholder, the investment vehicle of former Energy Minister Sergei Generalov, has made several changes since buying a controlling stake in 2002 after a two-year campaign by the state to end shareholder conflict and stabilise management.

Vartanyan said: “One of the first things the new owners had on their agenda when they accumulated the controlling stake was to improve the company’s corporate governance, which at that time was typical for most Russian companies of that era – meaning there was no corporate governance at all.

“The new owners hired a new chief executive and a new chief financial officer, they introduced internal control procedures reporting to shareholders, the decision-making process was streamlined and the board of directors has become an efficient element of the company’s governance.”

Further changes have been made ahead of the Fesco’s initial public offering planned next year in London. Generalov has diluted his group’s shareholding from 80% to 64% while William Owens, former Colorado Governor and a friend of US President George W Bush, joined the ranks of independent directors.

Investors also point to improvements at aluminium producer Rusal since its merger with Sual, and at steelmaker Severstal since its IPO last year, as evidence that governance is improving.

Elsewhere, mining company Suek has created a internal audit management structure and oil group TNK-BP is introducing an anti-corruption programme.

Progress remains slow. A report this year by Standard & Poor’s found its transparency index of Russia’s 50 largest companies had risen from 50% in 2005 to only 53% in 2006.

“Corporate governance in Russia is generally becoming more transparent and more information is being disclosed, thanks to increasing pressure from international investors. Improvements in these two categories are particularly imperative for Russian companies and banks that seek more foreign listings,” said S&P.

Western investors remain wary of Russian companies coming to market and argue that changes barely scratch the surface of the problem. Vadim Kleiner, head of research at Hermitage Capital, one of Russia’s biggest foreign investors, said: “From my experience with Russian IPOs, an investor always has to ask the question of why management has chosen to sell out and go public.

“In many cases there may be something negative lurking beneath the surface that makes it a good time for these people to cash out to the public markets.”

Indeed, negative western perception of Russian corporate standards prevails. Calpers, the California state pension fund known for its focus on governance, continues to exclude Russia from its permissible equity investments, while UK manager F&C Asset Management refuses to invest in the country.

The Edelman Trust Barometer for 2007 described Russian business as the least trusted in the world because of a lack of corporate governance, lack of transparency and poor business ethics.

Investors point to the incarceration of oil tycoon Mikhail Khodorkovsky, and the final dismantling of his oil company Yukos in May, as a sign that little has changed. They also highlight how Russian tax inspectors and environmental watchdogs are squeezing western energy companies from production-sharing agreements.

A recent reminder of the bad old days is the case being undertaken by Russian investigators against Mikhail Gutseriyev, the head of Russneft, the country’s largest privately held oil company.

In echoes of the Khodorkovsky case, the interior ministry has charged Gutseriyev and his colleagues with tax evasion and illegal business activities. Reports suggest the political pressure on Gutseriyev stems from his alleged refusal to negotiate on the sale of Russneft to a state-controlled entity.

Stephen Jennings, chief executive of Renaissance Capital, claimed such incidents were rare and had not dissuaded foreign investors.

Jennings said: “Most people believe the risks are quite low. Otherwise, you wouldn’t have seen the kind of investment and development that we have seen.

"There is a definite sense that these incidents can be quarantined. If those incidents had been broader or more random, they would have had a bigger economic consequence.” Article tags:

Local investor group fights for minority rights

Financial News: Focus on Russia

Jason Corcoran
30 July 2007

The Investors Protection Association was set up in 2000 to enable investors to join forces to protect their rights and improve corporate governance in Russia.

The association, little known outside Moscow’s financial community, is the only Russian investor group that backs the rights of minority shareholders. Its membership is drawn from Russian and international banks such as Alfa, Troika Dialog, Deutsche Bank and foreign fund managers such as Hermitage, Prosperity Capital and East Capital.

Former chief executive Stanislav Vartanyan said the association had scored notable victories in the energy and fixed-line telecommunications sectors by forcing companies to pay the dividends they had promised and demanding the election of independent directors.

Members have been elected to the electricity monopoly UES and seven regional subsidiaries of state-backed telecoms group Svyazinvest.

Vartanyan said: “Russian stocks are no longer cheap because investors are paying more and more attention to corporate governance. The Russian stock market has limited capital-raising ability so companies are subject to the stringent listing requirements of London or other exchanges.”

Shareholder activism has played a role in pushing for corporate reform but arguably a minor one. Two activist hedge funds, Hermitage and Prosperity Capital, operate on a regular basis in Russia.

Swedish-owned Prosperity continues to thrive but Hermitage has suffered outflows following the barring of its crusading founder Bill Browder from Russia.

Prosperity’s modus operandi is collaborative: to support a company’s management and give it a chance to perform. However, it can become aggressive when results disappoint and has filed several lawsuits against the Russian oil company Surgutneftegaz.

Prosperity is tangling with Lukoil, another oil company, over the legality of the merger of its subsidiary NGD with Ritek, in which Prosperity is the largest shareholder.

Mattias Westman, chief executive of Prosperity, said: “Ritek is a flashback to the bad old days but things have greatly improved. The enforcement of the tax codes and the abolition of complex corporate structures has helped. We have taken a lot of board seats in the power utilities sector.”

Hermitage has been a vocal critic of state-controlled entities such as Gazprom, Sberbank and Unified Energy Systems since it began investing in Russia in 1996. But Browder’s exclusion has led Hermitage to turn to other emerging markets in Latin America and the Middle East.

Hermitage did not field a candidate for election to Gazprom’s board on June 24, nor did it release its annual report highlighting alleged shady practices at the energy giant.

Moscow-based Vadim Kleiner, research director of Hermitage, declined to comment but other investors suggested there was little value in agitating for reform at Gazprom.