#17 - JRL 7070
March 3, 2003
By Paul Klebnikov
When Russia's electricity monopoly is broken up, who will get the choicest pieces? Some Western shareholders are putting up a surprisingly effective squawk.
Another redistribution of Russia's industrial wealth is under way. After the privatization debauchery of the 1990s, when Boris Yeltsin sat by while insiders walked off with the country's best oil and metals companies, now comes the turn of Unified Energy System.
UES, 52% owned by the state and perhaps 20% by foreign portfolio investors, is the largest electric utility in the world. Including the plants of its partly owned subsidiaries, it controls 156 gigawatts of generating capacity, nearly the capacity of Germany and Britain combined. Today this sprawling empire is being broken up. At the center of the three-year-long fray stands Anatoly Chubais, 47, the architect of Russia's flawed transition to a market economy in the 1990s. Articulate, energetic and pragmatic, Chubais used to be the golden boy of Russia's emerging market. But the days when Western investment banks rushed to invest in the projects he championed and Western politicians and newspapers parroted his opinions are long gone. In 1998, after the Russian monetary system collapsed, Chubais was fired as first deputy prime minister.
But he landed in a position of extraordinary power. As general director of UES in Moscow, Chubais presides over most of Russia's big power plants and transmission lines. Following Western precedent, Chubais aims to split generating assets from the distribution of electricity and heat (a by-product of generation in cities). "The energy sector is the last remnant of the socialist economy," Chubais tells FORBES. "Here, you still have the old-fashioned production plans and government price controls. What I am doing is ensuring that a normal market develops in this sector."
These are words to warm any capitalist's heart. But anyone who thinks that Chubais is simply a free market crusader should listen to UES minority shareholders, who are complaining that Chubais' reform could degenerate into another series of corrupt insider deals. Fears of getting the short end of the transmission line have persuaded investors to mark down UES' market value to $5 billion. Add in debt, subtract the cash and divide by generating capacity (including only a pro rata share of subsidiaries' power), and the market says UES' system is worth 6 cents a watt. Comparable figure for Exelon Corp.: $1.12.
Chubais' first plan for breaking up UES, presented in March 2000, was to retain control of the national transmission grid but break up the rest of UES into hundreds of small companies and sell off the assets piece by piece. Shareholders raised a stink.
"This was a straightforward asset-stripping scheme," says Alexander Branis, a UES board member and director of Swedish funds group Prosperity Capital Management. "Together with other minority shareholders, we wrote a letter to President Putin, expressing our concerns that the assets of UES would be given away."
Putin set up a committee to study the matter. The committee came back with a plan resembling the 1984 breakup of AT&T. UES would be dismembered into some 30 companies (rather than hundreds), and UES shareholders would get shares in each.
But Chubais did not wait for the restructuring plan to take effect and began negotiations to sell off bits and pieces of UES. Russia's oligarchs smelled the blood in the water and began acquiring blocking stakes (25% plus one share) in at least a third of UES' regional subsidiaries; they have also been buying up the depressed shares of the parent. They evidently aim to swap these shares for powerhouses or other assets.
This is the kind of dealmaking Chubais excels at: Over the past year he promised the powerful mayor of Moscow the opportunity for the city to take control of the Moscow electricity and heat distribution grid. Oil giant Yukos was promised future control of the generating assets of the Tomsk regional utility. Russian Aluminum convinced Chubais to pledge a stake in the unfinished Boguchansk hydroelectric plant in Siberia (replacement cost: $1 billion) to secure a $10 million loan to the plant. In the southern region of Rostov a company linked to a UES manager bought a gas-fired power plant for zero cash down and $2.5 million over four years.
Last summer UES minority shareholders got wind of these negotiations. With government support, they passed a resolution that any deal worth more than $500,000 had to be approved by the board of directors. The board has since blocked the Yukos and Russian Aluminum deals.
Meanwhile, Chubais has plans to divide the biggest base-load plants among ten competing generating companies. At first he proposed outsourcing the management of these companies to other outfits, including the Italian utility Enel, and giving these management companies options to buy equity stakes in what they were managing. To UES shareholders it conjured up images of Russia's infamous loans-for-shares scheme of 1995-97, under which the oligarchs got a one-year contract to manage state-owned oil companies in a series of lopsided auctions, ran these companies in a way that made them unattractive to any outside bidders and then ended up buying them for a song. Shareholder pressure forced Chubais to back down on the idea of granting options, but he still wants to bring in outside management companies.
"A management company merely adds an extra buffer between shareholders and the operating companies," protests board member Branis. "It weakens the control of the shareholders over the company's assets."
Another point of contention is the pace of the electricity sector reform. Andrei Illarionov, chief economic adviser to President Putin, argues that the deregulation of wholesale electricity should be accompanied by the deregulation of retail electricity, as well as of natural gas and rents in municipal housing.
"Chubais is in a big hurry," Illarionov says. "He does not want to wait for the other parts of the reform package to be ready."
Why the rush?
"I don't see any reason to waste any time," answers Chubais. "My approach has always been to take decisive action whenever possible. I refuse to wait for someone else to make the decision for me."
Unlike some other Yeltsin-era politicians, Chubais did not line his own pockets during the first wave of privatization and is not doing so now. The complaining UES shareholders can only accuse him of trying to earn political favors that would boost his position as a power broker in the parliamentary elections later this year and the presidential elections of 2008.
"This is a way to grease the wheels and create a bunch of people who owe him a lot," says William Browder, chief executive of Moscow-based investment fund Hermitage Capital, a UES shareholder.
The government is currently working out a more detailed and transparent restructuring plan and a more gradual liberalization of the electricity sector. It could still go wrong and the oligarchs could end up taking over the assets of UES after all. But the mere fact that UES minority shareholders have managed to block Chubais' riskier proposals thus far--and the fact that the Putin administration has supported them so decisively--shows how much the country has changed since the Yeltsin years. Even in Moscow, shareholders have some rights.
Chubais wanted to break up $15 billion (revenue) UES into hundreds of companies and sell them off piece by piece, but minority shareholders forced him to change his plans. Here's how UES and its restructuring plan look today.
38 federal power plants
The biggest hydro and thermal plants in the UES portfolio.
UES ownership: 100%
Combine into ten independent generating companies, each with the capacity of a major world-class power company; provide pro rata distribution to UES shareholders.
National transmission grid
1.7 million miles of transmission lines (more than six times the distance to the moon).
UES ownership: 100%
Keep as a monopoly; provide pro rata distribution to UES shareholders, but the state may raise its stake from 52% to 75%.
73 regional utilities
Russia's regional utilities combine generation, transmission and distribution.
UES ownership: 49% (average)
Spin off transmission and distribution; combine generation into 30 regional companies; provide pro rata distribution to shareholders.