Privatization update…….we have been here before
A report by ING provides some significant information about Russia’s privatization program.
ING report that the state’s revised privatization plan aims to raise at least $120 bln over a five year period according to media reports.
The sheer volume of planned State sales will present a considerable challenge. But it also raises hopes that the government will continue to aggressively pursue improvements in the financial infrastructure and efforts to improve the perception of Russia risk by foreign portfolio and strategic investors. Otherwise such an ambitious program will hardly be successful.
Despite the overhang of new issuance, the program is a potential major positive for the market because state companies will be under pressure to make themselves more attractive to investors in the coming years.
Apart from the expected greatly expanded plan, the other big difference between the previous and this revised plan is that the state is ready to give up control, or sell outright, in most state companies in exchange for retaining a so-called ‘golden share” veto. That is a very big change in government strategy and suggests that the Law on Investing in Strategic Industries is also about to be radically changed. That is another big step in the proposed reform agenda.
Management will be more accountable. Cutting the state’s position below a controlling stake is, in general, also a big positive for valuations as management will be accountable to a wider base of shareholders.
Regrettably, we rather doubt that this is good news, less golden, more bronze.
On the surface this is a positive development and goes a long way to confirming our belief that the government well understands the nature of the Russia discount and that it is on an inexorable path to reform.
It is also encouraging that the Economy Ministry has listened to President Medvedev and met his August 1 deadline for a revised and more ambitious privatization program.
But we have been here before, several times, including last year, and the only progress so far has been the sale of a 10% stake in VTB, half of the expected sale.
$120 billion over five years is also a massive amount of equity for the markets to absorb, perhaps more than they will have an appetite for.
The golden share concept is not new. It was used in the United Kingdom 3 decades ago. There are different ways to interpret golden shares. The British model was to have a genuinely independent management, with the share in place purely as a blocking tool in the event of an unwanted takeover. The French and German models have been more interventionist. We suspect that the Russian version may be positioned along the lines of the British model, but in practice will be highly interventionist, though likely in non-obvious ways. We also suspect that, in many cases, the golden share concept is beside the point.
As one example, we will take the Federal Grid, which has a monopoly on electricity transmission. The Grid has a relatively new and workable regulatory model which generates a rate of return that allows the company to service what are anticipated to massively rising levels of debt, to pay dividends and to deliver a predictable return on capital for shareholders.
The increase in debt is to improve the Grid’s infrastructure, long overdue and much needed. As part of the model the Grid will substantially raise electricity tariffs, which should be surprising to no one. In recent weeks we have been hearing that pressure is being put on the company to reduce its infrastructure plans which, in turn, will reduce its debt requirements which, in turn, will ease the pressure on tariff prices. In an election year it is the price rises that concern the government. Could the Grid ignore such pressures if it were 100% independently owned, with the government retaining only a golden share. We very much doubt it, not least because the current regulatory expires next year and will need to be renegotiated.
The government can sell all the shares it wants, in any company it chooses. It can retain a golden share, but it can also manipulate the regulatory infrastructure, and we are quite sure it will.
What this means is that a golden share implies a much lower price for the stock of privatized assets or, alternatively, a higher cost of capital. It remains to be seen whether the government understands this or will accept it.
There is, as the saying goes, more than one way to skin a cat. This is one more of those skins. We think there will be even further skins before this game is played out, and we doubt that anything significant will occur until after the Duma election.
While we remain confident that Russia is reforming, and that investor appetite for Russian equity and debt will increase, we suggest that any five year timeframe will end up being loaded to the latter of those years and that, five years from now, seven will not seem much longer than five.
Put more bluntly, these forthcoming announcements are a nice PR exercise. It remains to be seen whether there is meat behind the fluff. We would also watch carefully for anything Prime Minister Putin says.