Asset privatized: Svyazinvest
Percent sold: 25% of shares plus one
Amount paid: $1.9 billion
Date: July 25
Successful bidders: Uneximbank, Soros Quantum Fund, Deutsche Morgan Grenfell, Morgan Stanley Asset Management
In the last minutes before five o’clock one Friday this past summer, the biggest privatization deal in Russia came down to two envelopes. The atmosphere that day was electric.
At 20 minutes to five Moscow time, Leonid Rozhetskin arrived at Russia’s privatization committee offices with an envelope in his hand. The head of investment banking for Renaissance Capital in Moscow was carrying a top-secret billion-dollar bid for 25% of Svyazinvest, the country’s telecommunications network and the most eagerly awaited privatization deal to date.
Svyazinvest’s privatization had been dogged by controversy since 1995 when Italian operator Stet scrapped a strategic purchase at the eleventh hour after financing squabbles. And, following Russia’s well-publicized loans-for-shares scandals, cynicism was high that this latest round of privatization would be no less corrupt.
But now, in 1997, the Russian government was strapped for cash and determined to raise more funds with an open, competitive auction for the state’s reorganized sale of 25% of Svyazinvest. A mega-holding company for stakes in more than 85 regional telephone operators, Svyazinvest also includes a 38% chunk
of long-distance provider Rostelekom and shares in the ageing Central Telegraph and Giprosvyaz research institute.
In the stuffy hallways of Russia’s State Property Committee headquarters, Rozhetskin and his investment banking team eyed a rival bidder: Michael Friedman, president of Russia’s influential Alfa Bank.
Last autumn the Russian government had reportedly dumped western advisers ING Barings and Rothschild in favour of Alfa and Most banks, two of Russia’s rising financial-industrial powerhouses, to organize the sale of Svyazinvest.
“At about five minutes to the five o’clock deadline, it became clear there were only two of us,” Rozhetskin of Renaissance recalls of that day. In his envelope, Rozhetskin held the bid from the Cyprus-registered Mustcom, a powerful and star-studded bidding vehicle for some big players: Uneximbank, Russia’s third-largest bank by assets, headed by former cabinet officer and influential politician-cum-businessman Vladimir Potanin; George Soros, US-based billionaire financier and currency speculator with a mixed reputation in Russia; Deutsche Morgan Grenfell; and Morgan Stanley Asset Management.
Friedman had some serious fire power in his envelope as well. A Dutch-registered group calling itself Telefam BV Alfa put together the bid with the backing of old ally Most Bank, part of the Most Group headed by flamboyant and influential Russian banking and media tycoon Vladimir Gusinsky. Also in the group was aggressive Spanish telephone operator Telefonica, and Credit Suisse First Boston.
“It was clearly a 50-50 chance, since we’d discovered there were only two bidders by that time,” says Rozhetskin. He recalls that the corridors were packed with onlookers: nervous privatization officials with Russia’s State Property Committee, curious young fund managers, representatives for other western telephone operators, and jostling television cameramen. “I saw faces I knew from CSFB, Alfa Bank and Telefonica, and I even joked with Alex Knaster [CSFB managing director overseeing the rival consortium bid], that as far as numbers of people there, they had already won.
“Vladimir Malin, chairman of the State Property Committee, asked us whether we had any complaints or criticisms about the way the auction was run. Both Friedman and I responded: ‘no’. I unsealed my envelope; he unsealed his. We brought the contents of the unsealed envelopes up to the auction commissioner, and then we all sat there holding our breaths for about 30 seconds.”
The winner? Mustcom, with a bid of just over $1,875 million, a clear margin above both the rival Alfa-led bid of $1,710 million and the government-mandated minimum starting bid of $1,180 million. By 6:30pm, an air of triumph permeated the press conference as privatization officials announced the winner of over 4.8 billion common shares, or 25% plus one share, in Svyazinvest.
“Svyazinvest turned out to be a high-quality product, as the results of the auction have shown,” says Vladimir Bulgak, vice-premier and the former minister of telecommunications.
Analysts such as Merrill Lynch’s Jan Sudol had put the value of the stake at near $1.7 billion, and the winning price had logged in well above that.
But the feeling of triumph didn’t last. In fact, the seemingly transparent Svyazinvest auction was just the opening salvo of an impending bankers’ war which has since divided Russia’s elite business leaders into savagely belligerent camps. The war became public following the Svyazinvest results, pitting Gusinsky’s Most group and his allies, such as Logovaz chief Boris Berezovsky and prime minister Viktor Chernomyrdin, against Potanin’s politically well-connected Uneximbank and young reformers in Russia’s government such as first deputy prime minister Boris Nemtsov and privatization boss Anatoly Chubais.
Political analysts say Most and Alfa felt they were entitled to win the Svyazinvest auction after Uneximbank had earlier paid rock-bottom prices for key state assets such as Norilsk Nickel and oil giant Sidanco in the so-called robber capitalism days of privatization. Just hours after the Svyazinvest results, news reports on television channels owned by Gusinsky’s Most and his allies slammed Uneximbank for including a speculator such as Soros in its consortium and the federal government for being in Potanin’s pocket. Chernomyrdin intervened and called for an investigation into the legality of the Svyazinvest sale, while Potanin countered that Gusinsky himself had proposed a deal to buy Svyazinvest at a cut-rate price at an earlier, private meeting with Potanin and Chubais in France.
In fact, even bankers with the losing Alfa-Most-led consortium admit that the Uneximbank-led rivals won fair and square. Why?
“Potanin was probably as surprised as anyone that he won, because we actually had the bigger bid to begin with,” says a western banking source with the group. Spain’s Telefonica had contributed roughly half of the $1.71 billion bid, and had committed to roughly $200 million more. But at the last minute, “we lost some of our ammunition” when Telefonica cut back its commitment, the source says. With a higher $1.91 billion bid, the Alfa-Most consortium could have won Svyazinvest. Following the results, a Telefonica spokesman said only: “You win some, you lose some.”
Starting in late 1996, Renaissance had begun cobbling together investors in anticipation of the upcoming round of state auctions.
“Everyone knew about the failed attempt to sell Svyazinvest two years ago,” says Rozhetskin. “Everyone knew the government was preparing to re-offer that stake. We had anticipated bidding for it very early on and we spoke to the Soros Quantum Fund and to some other investors about putting a joint bid together. We knew Soros for a long time. We had worked with him before. So we had secured a preliminary agreement together if and when an auction came.” Soros had invested in Russian companies via Renaissance’s Sputnik Fund, but the billionaire had so far avoided taking any major position in Russia. Following the auction results, Soros said simply that he had changed his mind with the ascent of Nemtsov and other Russian government reformers, and chipped in $900 million of the winning $1,875 million bid. Uneximbank raised roughly $500 million, while DMG and Morgan Stanley raised the remainder.
Meanwhile, the privatization structure proved tricky. The Russian government hadn’t provided many guidelines, just the auction rules. Both Russian and foreign investors could bid for the first tranche of Svyazinvest, 25% plus one share, but consortia were not allowed. Potential buyers could bid only under a single corporate legal entity. Bidders had to deposit an initial $400 million a week before the final auction, and another transfer of $500 million would be made 15 days after the winner was announced. The remainder would be due within 75 days, and a total of 85% of the revenue would go directly into federal government coffers. Only 15% would be reinvested in the Svyazinvest holding company.
Meanwhile, the only benchmark on timing was a decree by president Yeltsin setting the Svyazinvest privatization in motion. Yeltsin signed the decree in April, “but even then there were no rules about the actual auction, whether there would be restrictions on resale. All of that was open”, Rozhetskin says.
By May, rumours about who would bid for Svyazinvest began to intensify. And it was Potanin himself who unexpectedly announced that Uneximbank would consider bidding for Svyazinvest. Potanin sprang the surprise on everyone at a press conference announcing the merger of Renaissance Capital, founded by the US-born Boris Jordan, and Uneximbank subsidiary MFK. “We had no idea he was going to say anything,” said one shocked Renaissance banker after the press conference.
Renaissance already had an agreement in principal with Uneximbank and Soros. Together they approached DMG and Morgan Stanley Asset Management in late May to get them on board the Svyazinvest bid.
Only weeks before the July 25 deadline, Rozhetskin sat down to figure out a structure that would make all parties happy. “The rules were written in a way that didn’t permit for a consortium to bid,” he says. “A specific company had to place a bid and we needed to form a special-purpose vehicle so all interests would be reconciled. Until then we had contemplated that a consortium could act as representatives. But all the money had to be transferred by a single corporate bidder, so that was when we went ahead and created Mustcom.”
An off-the-shelf name from one of two made available by auditors Coopers & Lybrand, Mustcom was selected by the deal architects because “the other one was even more stupid. We went ahead and formed it and began to give final structure to the financing”.
Some investors said the final terms of the financing for Mustcom were slanted too far in Uneximbank’s favour. “We would have ended up loaning money to Uneximbank for the privilege of buying derivatives in Svyazinvest,” says one local broker.
The Mustcom structure was designed to lock investors into Mustcom for a two-year period, but Rozhetskin says derivative certificates on units in Mustcom should still be traded to allow some liquidity. “We understood that the assignment was to raise debt for the benefit of Uneximbank and fill the remainder with equity investment,” he says. “So I sat at the computer and tried to devise the unit structure in proportion to the economics between us and the principal investors.”
Investors would buy units of Mustcom, which local Moscow brokers say divide into roughly two-thirds equity and one-third debt in the form of a loan to Uneximbank at annual interest of about 17% (or the current yield on Russian T-bills). Rozhetskin confirms the structure but not the exact figures, explaining that the derivative notes in Mustcom aren’t exchanged for Svyazinvest shares but for cash.
“There was a lot of excitement about these instruments,” he says. “We spoke to our closest investors and reached an agreement before the final bid, and as for the unallocated amount – the gap between commitments by existing investors and bidding investors – we closed that within a week. It was about 10 times oversubscribed.”
The equity component of buying into Mustcom was simple, says Rozhetskin. “As long as the auction bid was within the price range of investors, it was just straight equity,” he says. “On the debt component, this would be risky debt. We could not make Svyazinvest a balance-sheet risk for Uneximbank because of its requirements and Uneximbank isn’t in a position alone to raise $500 million in debt. If it did then it would block its path to further Eurobond issues. So we had to make the debt non-recourse to Uneximbank, and secured with stock of Svyazinvest.”
Currently, all of the roughly 4.8 billion Svyazinvest shares are owned by Mustcom. “We don’t expect an active market in the debt instruments but, as far as equity is concerned, people are very interested,” he adds.
The deal’s structure may also prove important to the political future of Mustcom’s winning bid in Svyazinvest. Analysts say it is far from clear whether Uneximbank and its partners are ready to pump in the billions of dollars needed to upgrade Russia’s telecommunications sector. “Indeed, the consortium is not bound by investment conditions and may simply be counting on a short-term capital appreciation on its new asset,” writes Aton brokerage firm in a research note.
In response to such accusations, Potanin promises that the Mustcom consortium would not sell its 25% holding in the telecommunications mega-holding company for at least two years. “Investment in Svyazinvest is of strategic importance for Uneximbank and goes beyond the two-year limit,” Potanin says.
Some critics say that the bid should also have lured in a western telephone operator with technological expertise to develop Svyazinvest’s ailing network and raise the value of the company. There are still questions about whether profits from long-distance provider Rostelekom will be steered away towards the poorer regional telephone companies, and whether portfolio investors – particularly controversial ones such as Soros – have the will and political backing to restructure the sector.
The Uneximbank-led consortium lacks a great deal of control, even though it has the power to block charter changes and will push for adoption of GAAP accounting standards. Mustcom also holds two board seats, although none of the investors has revealed who will act as representatives.
Meanwhile, Svyazinvest officials contend that the company has its own development plan in the offing, and that regional telephone companies could even make large-scale share issues in 1998. Svyazinvest general director Nail Izmailov says several candidates have already been chosen for additional issues, but that they will have to be organized in such a way that the federal government still holds a majority of shares in the individual operators.
But those equity issues will probably have to wait until the second Svyazinvest tender. That sale, of 24% minus one share of Svyazinvest, is tentatively scheduled for the autumn of 1997 and Potanin has not ruled out that Uneximbank or its subsidiaries would bid again. Only Russian investors are allowed to bid for the second tranche, and Izmailov said recently that this next auction should provide the company with about $600 million in funds.
And, in the meantime, Mustcom expects to complete a detailed business plan as part of a broader agreement at a shareholders’ meeting sometime later this month or in October. It should include financing and investment goals. Potanin and other officials have said Svyazinvest will probably have to adjust tariffs – they will most likely be raised at the local level.
In any case, a future strategic partner for Svyazinvest remains a possibility. “That’s the kind of deal a company does once in its lifetime, the kind of decision not made lightly, quickly or unilaterally by any one of the shareholders,” says Rozhetskin. “It wasn’t appropriate for us to foist a strategic partner on Svyazinvest until we secure the agreement of the telecommunications industry, and we didn’t want to negotiate. Now that we have won we’re not in any rush and the Russian ministry of communications understands what needs to be done.”
Any names in the pipeline? Rozhetskin won’t specify, but adds: “Our experience shows that companies with Russian management can be equally viable. Look at Vimpelcom, a company we took to the New York Stock Exchange.”
