Russia Faces Spectre of Another Yukos

Prosperity Capital, a $3 billion international fund manager that invests in Russia and the CIS, is warning of another Yukos-type situation occurring because of a major dispute it has with two controversial “billionaire” oligarchs, Mikhail Prokhorov and Leonid Lebedev.

Prokhorov hit the headlines in 2007 when he was arrested in the ski resort of Courchevel, France, for hiring prostitutes, which he denied; he was not charged.

In 2002, Lebedev was facing an indictment by an Italian court for supplying weapons to the former Yugoslavia. He was acquitted for lack of evidence.

Both of them have been refusing to follow the letter of the law and buy out Prosperity’s minority stakes, worth hundreds of millions of dollars, in two regional power-generating companies known as TGK-2 and TGK-4.

That has led to Prosperity and other minority shareholders, including EOS Russia and East Capital, petitioning President Dmitry Medvedev to settle the ongoing dispute once and for all.

The situation has become so dire that Prosperity – whose client base is made up of Western pension funds, charities, endowments and private banks – has compared it to the Kremlin’s expropriation of Russian oil giant Yukos just a few years ago. Vladimir Putin – who was president at the time and is now the prime minister – threw Yukos’s billionaire owner, Mikhail Khodorkovsky, into a Siberian gulag on trumped up charges of tax evasion. In reality, Khodorkovsky had dared to challenge Putin politically.

“In our view, this dispute is Russia’s worst corporate governance abuse since the Yukos affair. It risks setting back the country’s reputation as a place to do business by at least a decade,” says Prosperity’s chief investment officer, Alexander Branis, who knows Putin personally from his days at the previously state-controlled electricity holding company, RAO UES (Unified Energy System).

From entry into the Russian market in 1996, Prosperity built up the biggest minority stakes in TGK-2 and TGK-4 as part of a two-step privatisation process of UES.

The final part of UES’s privatisation saw its US$60bn break-up last year and the spin-off of its gencos, which included 13 TGKs. Leonid Lebedev and Mikhail Prokhorov then saw an opportunity to launch a full takeover of TGK-2 and TGK-4 respectively.

At the start of 2008, they acquired significant equity holdings above the 30% mandatory takeover threshold, requiring them by law to buy out the minorities in each of the power companies.

But they are refusing to follow through, and have reneged on their financial commitments – although they dispute this – using questionable legal practices to do so. That has called into question, yet again, the rule of law in Russia, and the risk involved of foreign companies making acquisitions in Russia.

“In many ways, these TGK abuses are even worse than Yukos,” says Prosperity’s Branis. “While Yukos was terrible, it was a one-off political struggle between the Kremlin and an oligarch who didn’t play by the rules. It also led to changes in the tax law and compliance which improved Russia’s business environment.”

He adds: “But those gains are now in jeopardy. For what we have in the case of the TGKs are two private individuals who have decided they’re not going to fulfil their contractual obligations – because the market has gone against them.

“And, without too much effort, they’ve bent Russia’s regulatory and legal institutions to their will.”


In May, 2008, Prokhorov, who runs the Cyprus-based investment company Onexim Group – with investments in Polyus Gold and UC Rusal – acquired 48.4% of TGK-4 from the Russian government for around US$1.28bn. He now owns a non-controlling 50% stake in the company, having reduced it from 50.4%.

By October last year, when the buyback payment became due, Prokhorov pulled the deal to buy out the minorities, which also included Credit Suisse and Halcyon investments, in addition to the state-controlled Federal Grid Company, which controls Russia’s power transmission grid, and RusHydro, which generates Russia’s hydroelectric power.

The Federal Tariff Service – which sets the tariffs for monopolies – had labelled TGK-4 a natural monopoly, but only at the insistence of TGK-4.

According to Onexim, that meant the buyout was no longer legally possible. As a foreign registered company, Onexim said it could not own more than 50%, because that would be in breach of the Russian federal law that deals with foreign investment in the country’s strategic sectors.

Prosperity says this is poppycock: Onexim is a Russian company and Prokhorov is a Russian citizen, so he does not need permission to take control of TGK-4; he is merely manipulating the law to his own ends, so as not to buy out the minorities.

What’s more, Prosperity does not believe TGK-4 can even be considered a strategic asset, merely based on the ownership of a very minor gas pipeline, which supplies a mere ten customers and accounts for less than 0.01% of TGK’s revenue.

Prokhorov even has the cash to pay for all of TGK-4, having secured the financial backing of Rosbank, the Russian subsidiary of Societe Generale.

According to Prosperity, Prokhorov has bizarrely even sued himself for “allowing” Onexim to have got to a controlling 50.4% stake in September in an apparent breach of Russia’s new strategic law. Onexim has now reduced that holding to a “non-controlling” 50% stake; ironically, by doing so, that means it has probably violated its shareholder agreement with the Russian government.

“He has bent every rule in the book to avoid paying what he owes,” Branis adds, “and Russia’s regulatory and legal institutions have done nothing to stop him.”

Onexim would not comment on the situation.


In March 2008, Leonid Lebedev’s oil business, Syntez Group, acquired at auction a 44% stake in TGK-2 for about US$800m through an investment vehicle called Kores Invest. Kores, which is 99%-controlled by Syntez, fulfilled its obligation to launch a share offer in July.

Since then, however, Russian equity markets have dived and credit has dried up. By September, Germany’s energy utility, RWE, pulled out of a deal with Syntez to take joint control of the genco, citing the high cost involved.

While RWE went onto buy its Dutch counterpart, Essent, for €9.3bn, Syntez said it would sue RWE for US$1.41bn at the international arbitration court in London. RWE refused to comment on the current situation.

It all left Lebedev a bit out in the cold, leaving him no choice but to withdraw in October his legally binding buyout offer to the minorities.

According to Prosperity, his grounds for doing so rested on a “bogus lawsuit” filed against Kores by Syntez. The Russian courts will not hear the case until May, but it has given him breathing space until then to come up with the cash, despite having US$765m of financial guarantees from Russia’s largest and state-controlled bank, Sberbank.

“Lebedev doesn’t want to fulfil his buyout obligations, as to do so would expose the fact his business empire is fragile and grossly over-extended,” claims Branis.

Syntez could not be reached for comment.

Legal nihilism

Unless Medvedev and Putin facilitate an end to these disputes in a way that upholds the rule of law and pays the minority shareholders a fair price for their stakes in TGK-2 and TGK-4, the very “legal nihilism” that Medvedev wants to stamp out will continue.

“These TGK corporate governance abuses – once they’re understood by the rest of the world – will hinder domestic and foreign portfolio and direct investment in Russia for many years to come,” concludes Branis.

By Adam Durchslag

Source: Thomson Merger News