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Stealing steel in
Russia
By John Helmer
MOSCOW - Andrei Illarionov is a coward,
but President Vladimir Putin isn't strong enough
to say so. This makes the Illarionov case the very
opposite of what Putin's enemies in the media are
claiming.
Illarionov is one of the
leftovers of the laissez-faire, free-for-a-few
economics of the Boris Yeltsin era (1991-99).
Married to an American studying for a Harvard PhD,
the combination of Harvard economics faculty and
Russian privatization ought to have long ago
disqualified Illarionov from any public office
funded by the Russian taxpayer, let alone one at
the invitation of the Kremlin. However, since
Illarionov hasn't been invited to speak to the
president for a very long time, his function has
been that of a cheap lightning rod - to deflect
attacks on Putin himself; to unsettle Anatoly
Chubais, the electricity boss and another leftover
from Yeltsin privatization schemes still in
office; and to confound the doctrinaire
policymakers in Washington, who still have
influence on American public opinion toward Putin.
Accordingly, Illarionov has served as the
president's official economic adviser, and also
his emissary to the Group of Eight (G8) countries
dominated by the US. These are sub-ministerial
assignments in which protocol is more important
than power. But without the protocol he has
enjoyed, Illarionov would be one of dozens of
Russian chatterers seeking a perch in the Western
media. No one would pay him attention. In none of
the governments of the other seven G8 countries
would it be honorable for a man who advised the
head of government to stay in his post if he
opposed his leader. A ranking adviser in those
seven governments who finds himself at odds with
the policies and decisions of his superiors and
colleagues would resign. Illarionov, who has
repeatedly attacked President Putin's policies,
doesn't have the gumption to do that.
After Putin's end-of-the-year press
conference, Illarionov gave several media
interviews and took himself to a Moscow courtroom
to watch proceedings in the trial of Yukos bosses
Mikhail Khodorkovsky and Platon Lebedev. He was
there, said Khodorkovsky's lawyer, as an "ordinary
visitor". In his interviews, Illarionov did not
cover much economic policy ground. Instead, he
publicly condemned Putin's handling of the oil
company affair, calling Yukos "the best company in
Russia", and the dismantling of its shareholding
and corporate structure the "swindle of the year".
He added: "This entire affair regrettably
demonstrates that any of the official or
semi-official explanations given to the public
regarding the Yukos affair does not have a leg to
stand on." That remark included Putin; Illarionov
knows only too well that it was the president who
was the principal decision-maker in the Yukos
case.
Illarionov even went on to encourage
US intervention in the Yukos case. He endorsed
what he called the "victorious revolution" of
Ukrainian opposition leader Victor Yushchenko,
warning that Putin's policies are leading
"unavoidably" to a comparable revolution in Russia
itself. Illarionov said that on a Moscow radio
station on December 30. On January 3, a
presidential decree was released, announcing that
Illarionov had been relieved of his position as
Russia's G8 emissary and replaced by presidential
assistant Igor Shuvalov. There was no mention of
Illarionov's post as economic adviser, which he
retains, by default.
For this performance,
Illarionov has been treated as a hero in the
anti-Putin press at home and abroad, not because
he has enlightened anyone with the contents of his
economic portfolio or said anything that hasn't
been said dozens of times before. Rather, he is
the hero of the moment for having bitten the hand
that feeds him. Ekho Moskvy, a radio station that
used to be former US president Bill Clinton's
Moscow favorite, conducted a purported four-minute
poll, in which 9,200 listeners called in - that's
38 per second - indicating that 86% believe
Illarionov should stay in his job to influence the
president. The Anglo-American media then judged
Illarionov's removal as the G8 representative as
a fresh example of Putin's refusal to be
influenced and of the president's dictatorial
tendency.
If 38 Muscovites per second
believe Illarionov should keep his post, it would
behoove Illarionov to expose a little more of his
economics portfolio than the fistful of issues on
which he has expressed himself so plainly. Why,
for example, has he remained so conspicuously
silent - why indeed has the entire Russian
government, parliament, the judiciary, and the
press - been so indifferent to the privatization
auction of the state's shares in Russia's leading
steelmaker, Magnitogorsk Metallurgical Combine
(MMK), which took place the week before Illarionov
launched himself on behalf of Yukos and Ukraine.
Can Illarionov be a hero because he defends the
corrupt privatization of Yukos but as an adviser
to the president, has nothing to find fault in the
mysteriously under-priced privatization of
Magnitka?
On December 22, the government's
privatization agent, the Federal Property Fund,
put up for auction the state's 17.8% shareholding
(equal to 24% of the voting shares) in the steel
plant. Though there were 11 nominal bidders, there
was, in fact, no competitive bidding and the
auction was declared over as soon as it started,
with a sale price of US$790.15 million - this was
the government's starting price. This can be
estimated to represent a price of $0.42 per share.
The winner of the stake was a company called UFGIS
Structured Holdings Ltd, which represented the
management of the steel plant, headed by its chief
executive, Victor Rashnikov. The Rashnikov group
already controlled about 57% of Magnitogorsk
through a secretive web of onshore and offshore
companies that also manages the trade of the
plant's annual production of 10 million tonnes of
steel worth about $4 billion at current prices. A
report to Prime Minister Mikhail Fradkov by the
Tax Ministry in September indicated that
Magnitogorsk paid just 12% of its revenues in
taxes in 2003, a fraction less than its
steelmaking peers Severstal and Novolipetsk, but
well below the tax rates of the major Russian oil
companies. The report suggested that various tax
minimization schemes, including transfer pricing
between units of the same group, were at work.
Even if the Tax Ministry suspected
Magnitogorsk of paying the state less in taxes
than it should have, officials in other ministries
thought the state should receive even less in
value from the privatization than the balance
sheet suggested. In July, for example, an official
of the Ministry of Economic Development and Trade
announced that the sale of the Magnitogorsk
shareholding should fetch at least $275 million.
At that time, the plant management was still
trying to defer a date for the privatization to
enable them to accumulate enough cash to ensure
that they would be the highest bidder. In August,
Putin signed a decree removing the plant from the
list of strategic federal property barred from
privatization without express Kremlin approval.
Magnitogorsk had been thus listed as part of the
delaying tactics; its de-listing signaled that
Rashnikov was ready to bid. Then on September 30,
Prime Minister Fradkov signed a decree, adding the
sale of the Magnitogorsk stake to the
privatization schedule for 2004. This was the sign
that Rashnikov was keen to get the sale over with
as quickly as possible, before his rivals had time
to raise the cash for a counter-bid. After years
of red tape, the paperwork was rushed through to
fix the auction date on December 22.
There
was one last question the federal government had
to decide. That was the valuation of Magnitogorsk,
and the reserve price for the sale. It seemed that
$275 million was a visibly small number and had to
be increased, not least to keep it out of the
hands of Rashnikov's rivals. The price would have
to be just enough to deter speculators, but not
too high to create financing problems for the
Rashnikov group. On November 20, the Federal
Property Fund announced that the auction would
start at $790.15 million. This was small enough:
for the first six months of 2004, Magnitogorsk had
declared a pre-tax profit of $710 million on
revenues of $2.1 billion; after-tax income for the
period was $524 million. Most Russian investment
banks and brokers believed that rival bidding
would drive the auction to a figure of not less
than $950 million and perhaps as much as $1.5
billion.
What happened next is the tale of
how Rashnikov's rival, the Mechel Steel Group
controlled by Igor Zyuzin and Vladimir Iorikh, was
persuaded to abandon a challenge it had been
publicly preparing for more than a year. Mechel,
whose principal steelmaking asset is the
Chelyabinsk steel mill, but which also controls
rich iron ore and coal mines, generated $2.1
billion in revenues in 2003 and $1.6 billion in
the first half of 2004. Its annual steel output is
just under 6 million tonnes.
Though the
Rashnikov group was favored to win the
Magnitogorsk sale because it already held a
controlling interest that others were reluctant to
challenge, Mechel - which had acquired a 17.1%
stake for itself - announced that it intended to
bid against Rashnikov, either alone or with
another Russian steelmaker. But a challenger,
Iskander Makhmudov's Ural Mining and Metallurgy
group, claimed that it could break up Rashnikov's
shareholding control in court and then buy up the
pieces to achieve control with the state stake.
But Makhmudov's bid failed. Mechel pressed on and
in October, Zyuzin and Iorikh sold almost 12% of
their own stock on Wall Street in the form of
American Depositary Shares (ADS) to raise just
over $330 million. "In our view," reported Rob
Edwards, steel analyst for the Moscow investment
bank Renaissance Capital, "Mechel is gathering as
much cash as possible to take part in the auction
for a 17.8% stake in Magnitogorsk Iron and Steel
Works."
It was obvious that by itself,
Mechel didn't have enough cash to make the
government's reserve price, let alone compete
against the heftier cash pile of the Rashnikov
group. If Mechel were serious, then it would have
to recruit a more powerful partner than itself.
Various alliances between Russian steelmakers were
rumored. The Evraz group, with three Russian steel
mills, commands the largest steel production and
earns the largest revenues; but it decided to bow
out of the Magnitogorsk bidding when the Makhmudov
challenge failed. Severstal, ranked third in
output after Evraz and Magnitogorsk, had ample
cash to buy the Magnitogorsk stake from the
government. But the priority for Severstal's
spending, according to Alexei Mordashov, the
controlling shareholder, was pursuit of foreign
steel assets far from the reach of the Kremlin or
the Tax Ministry in Eastern Europe and North
America. Just one cash-rich Russian steelmaker was
left - Vladimir Lisin, who controls the
Novolipetsk Metallurgical Combine. For much of
2004, he had been spending an estimated $1.5
billion in free cash to take control of
strategically vital assets such as coking coal
supplies to his plant and ports that handle his
steel exports.
It was Lisin, then, whom
Iorikh meant when he announced on December 9: "It
is most likely that we will join up with someone."
Without saying exactly who, he had added: "We
expect to conclude an agreement on joint
participation in the auction in the very near
future." Over the next 10 days, Lisin made his own
moves, securing permission from the Federal
Anti-Monopoly Service to attempt to acquire up to
42% of Magnitogorsk's shares with up to $2.5
billion in cash. If this was the partnership
Iorikh had unveiled, it appeared that Mechel was
very much the junior player, if at all. According
to the detailed prospectus Mechel had presented to
US investors in October, the company's strategy
included a plan to expand its steel production by
up to 40% in the next three years. Among the asset
acquisitions planned, Mechel said it wanted to
"make selective acquisitions of coal and other
mining enterprises", and "to continue to
selectively acquire value-added downstream
businesses such as hardware, stampings and
forgings producers to help us reach our customer
base, including in new markets". Not a word was
said about Mechel's bid for control of
Magnitogorsk. Was Iorikh putting up a smokescreen
for Lisin? Or was Lisin trying to soften up
Rashnikov on Mechel's behalf?
According to
Mechel, during the weekend of December 4-5 and for
several days that followed, its offices in Moscow
were the target of an investigation by officers
from the Ministry of Interior. The federal Tax
Ministry said it wasn't involved and so did the
federal headquarters of the Interior Ministry.
Regional officials in Chelyabinsk added to the
denials. According to Mechel spokesman Alexei
Sotskov, the purpose was obvious: "Somebody is
insisting on checks at Mechel Trade House to
prevent its bid for Magnitogorsk Metallurgical
Combine," he said. A few days later, Edwards of
Renaissance Capital reported that Mechel had been
hit with a fresh charge that the valuation of the
company's key assets - the Chelyabinsk steel mill,
Beloretsk Metallurgical Plant, and Yuzhuralnickel
- had been intentionally understated in order to
limit the amount of cash subsidiary companies were
obliged to subscribe to the group's capital. "We
believe that the likely source of this allegation
is one of Mechel's main competitors in the auction
for the government stake in Magnitogorsk steel
mill," said Edwards. "We also think Mechel still
has a good chance of winning."
Mechel had
already admitted in its October 4 ADS prospectus
that it could face tax problems. The company's
lawyers had warned US investors that Mechel might
face "significant losses" if the Russian tax
authorities "challenge our prices and propose
adjustments". According to the consolidated
financial data presented in the prospectus, the
Mechel group paid income taxes of $74 million in
the first half of 2004, reflecting a rate of 4.5%
of revenues totaling $1.6 billion. In 2003,
according to the US data release, the income tax
payment rate was 2.3%, and in 2002, 0.2%.
According to the prospectus, there was a risk that
the financial statements might be subject to
revision. Mechel's accountant, Ernst & Young,
the prospectus stated, "reported material
weaknesses in our internal control and we may not
be able to remedy these material weaknesses or
prevent future weaknesses ... We may not be able
to accurately report our financial results or
prevent fraud."
In a listing of
risk factors associated with the offer of the
group's shares, Mechel said that Russian transfer
pricing rules, which took effect in 1999, empower the
tax authorities to impose additional tax on
companies when transfer pricing between related entities
or in foreign-trade transactions is found to differ
from market pricing by more than 20%. The rules,
according to Mechel, "are vaguely drafted, leaving
wide scope for interpretation by the Russian tax
authorities". Acknowledging the risk of a
challenge, the prospectus said: "If such price
adjustments are upheld by the Russian courts and
implemented, our future financial results could be
adversely affected. In addition, we could face
significant losses associated with the assessed
amount of prior tax under-paid and related
interest and penalties." According to the
prospectus, "widespread tax evasion" is noted as a
general factor in Russia's economic instability.
Mechel also suggested that the Tax Ministry's
"crackdown on certain Russian companies' use of
tax optimization schemes" may be "selective".
But when the crunch came, and officers of
an anonymous government agency fanned out through
the Moscow offices of its trading subsidiary,
Mechel claimed it was Rashnikov, not the Tax
Ministry, at work. As the value of his newly
minted ADSs started falling in New York, Iorikh
announced that he would fight off the challenge
with a heavyweight for a partner. This corrected
the fall in the value of Mechel's shares and led
the Russian market to anticipate a fierce and
expensive bidding contest on December 22.
But they were mistaken. On December 21,
Mechel announced that it had sold its 17.1% stake
to the Rashnikov group. Lisin's bid evaporated as
if it had never been, and by the time the sun came
up on auction day, there was no longer any
competition for Magnitogorsk. Rashnikov, according
to the Mechel disclosures, had paid Iorikh and
Zyuzin $870 million, which amounted to a price of
$0.52 per share. This was 10 cents, or 24%, higher
than the government's starting price for its stake
- a small premium for Rashnikov to avoid what
industry analysts had been expecting to be a final
price of at least $300 million more.
Renaissance Capital, which has been an
adviser to Lisin in the past, said it smelled a
rat. According to analyst Edwards, "The recent
probings by government organs into Mechel may have
caused the sudden transformation of Mechel from a
keen buyer of MMK, seemingly at any price, to a
willing and happy seller."
No one spoke up
for the Russian government, which had every reason
to believe that if the price Mechel had received
for its shares on December 21 was a fair one, the
Federal Property Fund had been badly short-changed
by the failure of the December 22 auction to raise
any money above the minimum price. Had Illarionov
the hero been focusing on his portfolio, he might
have advised the president or told the media that
by elementary calculation the privatization of
Russia's most famous steelmaker had failed to
realize a fair market price. All the extra value
in the Magnitogorsk shares had been quietly
transferred to the Rashnikov group, without a
murmur.
And who benefits? According to a
report by Alfa-Bank's Moscow brokerage after
the share sale, "We expect Magnitogorsk to
consider the listing and sale of its shares on a
foreign exchange (New York or London) as soon as
2005." It has been difficult enough for Putin to
manage the process of retrieving the ill-gotten
proceeds of the Yukos privatization. Had
Khodorkovsky not challenged Putin early in 2004 by
proposing to sell a large stake of his company to
the US, he might just have got away with it. If
Illarionov remains the economic adviser, the
process by which Magnitogorsk has just been
privatized and is about to be sold to Wall Street
will be just dandy - so long as Putin doesn't
learn what happened and doesn't interfere once
again.
(Copyright 2005 Asia Times Online
Ltd. All rights reserved. Please contact us for
information on sales, syndication and republishing.) |
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