Ukrtelecom could be privatized by May-June

February 5, 2009

According to government officials, including Transportation and Communications Minister Yosyp Vinsky, acting State Property Fund head Dmitri Parfenenko and Prime Minister Yulia Tymoshenko, a controlling stake in fixed line operator Ukrtelecom could be privatized as early as February/March.

The Minister of Transport confirmed that the conditions for auctioning off a 67.79% controlling stake in Ukrtelecom have been finalized and they may be published as early as next week if parliament votes for the new head of the State Property Fund. The tender couldl then take place in May-June 2009 (75 days after publication of conditions, according to the minister).

The expected selling price, according to the Vinsky, should exceed UAH 25 bln, ($3 bln).

Prime Minister Yulia Tymoshenko commented that Ukrtelecom’s privatization will take place at “decent” prices in a well ordered process and with no hurry.

Tymoshenko’s also named two further conditions that significantly narrow the field of potential bidders: that only private companies with a global brand will be considered. Previous attempts to privatize Ukrtelecom have excluded companies from bidding with over 25% state ownership, which rules out European majors such as Telenor, Telecom France, TeliaSonera andTelekom Austria. The ‘global brand’ requirement would also seem to rule out purely Ukrainian telecom companies.

In 2008, System Capital Management (SCM), Turkcell (Life, together with SCM), Sistema (MTS and Comstar_UTS), and Telecominvest (MegaFon) expressed interest in Ukrtelecom’s privatization. Analysts also name Vodafone, VimpelCom and Telefonica as potential strategic investors.

The blocking stake in Ukrtelecom, which constitutes 25%+1 share, will remain in state hands.

The SPF also wants to privatize blocking stakes in five energy distributing companies (oblenergos).

According to Galt & Taggart’s Danylo Spolsky “owing to worrying budgetary shortfalls in January the latest attempt to privatize government stakes in Ukrtelecom and the five DisCos holds a higher measure of credence than past, failed attempts. Add to that the recent, but disputed, change in SPF leadership, and the unconfirmed report even verges on believability.”

Spolsky however notes that President Viktor Yushchenko may seek to boost his ratings by blocking efforts to pad the state coffers at the expense of Tymoshenko.

Dragon’s Andriy Bespyatov writes, “the current market capitalization of Ukrtelecom, at $609m, is also down 85% y-o-y. We think chances to privatize Ukrtelecom are very low as the government may require an unreasonably high valuation.”

Troika’s Peter Keller sees “significant political risk that could delay or even halt the now-resumed process that aims to privatize Ukrtelecom in 2Q09. However, it is now supported by the current economic situation with tough budget constraints and the IMF’s recommendation to resume the privatization process.”

According to Troika, Ukrtelecom’s target equity value as close to $1.1 bln ($0.058 per share), and with a control premium of assumed 30%, its value could even reach $1.4 bln ($0.075 per share).

Concorde’s Aleksandr Paraschiy says, “we consider the probability of a successful privatization as low – first, President Yushchenko is likely to ban the privatization, as he did in 2008; second, it seems like it will be difficult to find an investor for the company today.”

According to Paraschiy, “Vinsky’s price looks too high for a company that will report losses for FY2008. We believe the price for the stake will not exceed UAH 15 bln. The only thing that raises the chance of privatization this year is need to fill the stabilization fund of the state budget, which is planned to be UAH 20 bln: Ukrtelecom’s sale could raise up to 60% of that amount. Given this, the government may agree to lower the starting price.”

Prior to the privatization of Ukrtelecom, the SPF is expected to sell controlling stakes in electricity DisCos, Chernihiv-, Sumy-, Prykarpattya-, Lviv- Odessa-, and Poltavaoblenergo.

Paraschiy also sees difficulties here: “Actual privatization of these companies looks problematic this year. First of all, the tenders are sure to be banned by the President, as he did twice in 2008. Second, we believe the main candidates to buy the companies (Kolomoiskiy, Grigoryshyn and VS Energy) are not ready to spend money now to raise their stakes in the Oblenergos.”

Dragon’s Bespyatov estimates the asking price for the distribution companies at $130m, much lower than their 2008 valuation of $500m.

MTS Ukraine head says MTS could bid for Ukrtelecom

Graham Stack in Kyiv for business new europe
February 5, 2009

The announcement on February 4 by Ukraine’s Transport and Communications Ministry that a tender for fixed-line operator Ukrtelecom could take place this month was no surprise to Andrei Dubovskov, CEO of MTS Ukraine, Ukraine’s second-largest mobile operator.

“Everyone is waiting for Ukrtelecom’s privatization,” says 42-year-old Dubovskov. “The government and regulatory authorities are seriously pursuing this. We expect it will finally happen this year.”

Ukrtelekom’s fate, and the country’s privatization plans in general, have long been a political football. Ukraine’s parliament, the Rada, and the presidential administration cannot even agree over who should run the State Property Committee that’s responsible for privatization. President Viktor Yushchenko has in the past blocked the privatization of major companies, partly for fear Russian companies could buy strategic Ukrainian concerns, and partly over worries that his bitter rival Prime Minister Yulia Tymoshenko would use privatisation revenues to boost social spending, and thus her own ratings, in the run-up to presidential elections in January 2010.

But now privatisation is a last option to fund a budget predicated on a 2% deficit and 0.4% GDP growth, when consensus forecasts have now fallen to minus 5% GDP growth. The International Monetary Fund (IMF) is also demanding privatization. An IMF mission is currently in Kyiv and said to be unhappy with Ukraine’s patchy implementation of conditions for a second tranche of a $15.5bn stabilization credit agreed in November.

Speaking on February 4 about the Ukrtelekom privatization, PM Tymoshenko said that the tender would only take place if a decent price were offered by a “global brand.” She said talks were ongoing with interested parties about the exact terms of the tender.

Dubovskov says, “We have already expressed our interest, and have submitted our preferences for the conditions of tender. Nothing has changed from our point of view. We are already involved in the process.”

MTS is certainly among the most likely candidates to participate in a tender. Dubovskov adds. “But the decision on whether we participate or not, while not situative, will nevertheless depend on the specific conditions of the tender,” he warns.

In fact, proposed tender conditions for Ukrtelecom in the past have favoured MTS, by excluding any companies from bidding that have over 25% state ownership, thus ruling out several European majors such as Telenor, TeliaSonera, Telekom Austria and France Telecom. The Russian state has no stake in MTS. Tymoshenko, speaking Wednesday, February 4, reiterated that only private telecom firms would be allowed to participate.

Yevgeny Yevtushenkov, main shareholder in AFK Sistema, the Russian conglomerate that owns 52.8% of MTS, was quoted February 2 as saying that Sistema was planning some acquisitions, after securing financing facilities with Russian and foreign banks for several billion dollars. He made the comment while attending the Davos Economic Forum, according to Moscow Times.

Ukraine’s Minister of Transport and Communications Iosif Vinskii said February 4 that he expected Ukrtelecom to go for at least UAH25bn, currently just under €2.5bn.

Talking about devaluation

Regarding MTS Ukraine and the economic crisis, Dubovskov says the massive 60% devaluation has torn strips off Ukraine’s previously booming mobile telecom sector, and MTS Ukraine is no exception. “The strain on our budget has increased, our equipment comes from abroad and we have to buy hard currency at a significantly different level from earlier. Much of our expenditure is denominated in dollars, not only capex, but also [operating expenditure] such as international roaming. But our revenue of course is in hryvnia.”

Now the highly competitive Ukraine mobile telecom market is waiting to see who will take the plunge first and raise prices and/or switch to a dollar peg. “We will definitely not be the first to do so, and we have not yet made any decision,” says Dubovskov. “But when it does happen, the whole market will follow.”

Dubovskov is optimistic about demand staying stable, despite the crisis cutting into Ukrainian pockets in the form of inflation, hard currency credits turning into millstones, salary cuts and unemployment. Even with the crisis on everyone’s lips in Kyiv, Dubovsksov does not anticipate any drop in minutes of use. “MTS has the highest minutes of use per user in Ukraine, and our subscribers will not be talking any less in 2009.” But this could be speaking too soon: State Statistics reported for November a drop in the mobile sector’s revenues by 4.7% on the month, followed by stagnation in December.

Without providing any figures, Dubovskov says that MTS Ukraine’s debt situation remains stable despite the devaluation. “Our finances are sustainable, and our debt burden is manageable. Margin calls are absolutely excluded.”

Dubovskov points out that MTS Ukraine is a fully-owned subsidiary of Russian mobile giant MTS, “and thus is fully integrated into parent company financial flows.” The Russian parent has access to Russia’s emergency funds held by state bank VEB to refinance debt. And Russian Prime Minister Vladimir Putin recently included MTS on a list of 250 system-forming Russian companies that can qualify for direct financial help.

Dubovskov says MTS Ukraine does not need any such formal status in Ukraine itself- because the company already de facto enjoys such status: “On account of the size of our tax payments, we are already de facto a system-forming company in Ukraine. We have been the leader in tax payment growth in recent years. The government take good account of us as it is.”

Business as usual ‘in three to six years time’

Despite the crisis, MTS will continue to invest in its network. MTS Ukraine’s corporate governance director Andrei Bereznyi stated January 23 that the company would invest $323m in 2009.

Dubovskov himself is cautious about committing to specific figures, saying capex would be “restrained” in 2009. However, he stressed that the company will not abandon any major projects. This includes the rollout of its CDMA-based wireless internet network, already covering 100 cities and towns, 2G services and participation in any UMTS tender. “We will continue to pursue our plans, slowly, step by step,” says Dubovskov. Dubovskov rules out any adventures such as moving into handset retail, the current trend among Russian mobile operators.

MTS Ukraine’s CEO is downbeat about when business will return to normal. “I’m not one of the optimists who say that things will revive in the second half of 2009. I think it will take from three to six years to return to previous levels.”

Dubovskov relativises the shock of the massive hryvnia devaluation, saying he has been through similar traumas in 1991, 1994 and 1998. But he sees one important difference to the current crisis. “Those were local crises, affecting one country or a group of countries. This one is a global crisis.”

Belarus stock exchange is finally in the starting blocks

Graham Stack for business new europe (www.businessneweurope.eu)

Belarus is staying true to its tradition of bucking trends. In the 1990s, Belarus stuck to state ownership and dirigism, while its neighbours embraced privatization and the free market. And in 2008, with the world’s stock markets in freefall, Belarus is about to finally launch its stock market, and expects share prices to soar when trading takes off.

“Stock market participants here are like sprinters waiting on their starting blocks,” says Valery Kalazhenko, deputy head of the Belarus Ministry of Finance’s Securities Department, responsible for regulating the stock market. “Everything is ready and in place, all they are waiting for is the starting gun.”

An equity market has been a long time in coming in Belarus. The Belarus Currency and Securities Exchange (BSCE) is 16 years old, but in 2007 share trading comprised a miniscule 0.7% of trading volume, with the lion’s share trading in state securities. And yet, says Kalazhenko, there are formally over 3,000 public companies in Belarus as a result of the mass privatisation launched in 1992.

But that privatization effort was mothballed just as it began to roll. The state imposed a moratorium on the selling of shares obtained by the public for their privatization cheques. And following a backlash against market reforms symbolised by Alexander Lukashenko’s rise to power in 1994, the state introduced a “golden share” rule for privatized companies, giving it the right to intervene in company management in a wide range of scenarios. As a result of these two measures, says Kalazhenko, “although all the necessary infrastructure for the stock market has been created, there has until now been nothing to trade.”

This all changed in 2008. On January 23, the government passed a programme on “Development of the Equity Market 2008-2011,” envisaging the emergence of a fully-fledged stock exchange. Implementation of the programme started almost immediately, says Kalazhenko, with a presidential decree in February abolishing the state’s golden shares, which he calls “a revolutionary step.”

The government followed up by slashing capital gains tax from a prohibitive 42% to a profit tax level of 24%, and then with the abolition of the moratorium on alienation of shares held by the population as of June 1. “These measures will ensure development of a Belarusian stock market,” claims Sergei Tinnikov, deputy head of the BCSE. “All that is required is for them to be fully implemented.”

False start

Instead of a big bang, however, the June date proved to be a false start. Similar to the hesitant steps it is making toward some democratization, the Lukashenko administration, while liberalizing the economy, is also intending to keep control of its “commanding heights.” As a result, a list is still being drawn up of around 150 strategic companies that will be excluded from exchange trading, at least in the initial phases. And until the list appears, the moratorium remains in effect. “We’re all waiting for this list to appear,” says Tinnikov. “Only when it does, will the market will take off.”

However, even when the list does appear, it will only mark the start of phasing out the moratorium over three stages. Firstly, this year the moratorium will only be lifted on companies where there is either no state stake, or the state owns over 75%. Then in 2009, shares will be admitted to trading for companies where the state owns over 50%. Only in 2011 will the shares of companies where the state is only a minority shareholder start to trade. “This is to allow our colleagues in the State Property Fund time to optimize the state holdings,” explains Kalazhenko, indicating the state is likely to increase its stake to a majority one in companies it wishes to retain control over.

Added to this is the fact that key Belarusian companies such as petrochemical giant Belneftekhim and potash giant Belaruskali, accounting together for around 40% of budget revenues, are state unitary companies yet to be corporatised. “But there remain a huge number of companies where the state is already a majority shareholder,” says Tinnikov, “and these will be free for trading very shortly.”

In fact, according to Tinnikov, while potential blue chips remain in state hands, too many run-of-the-mill companies will list on the exchange, many of them of little interest to investors. This is partly a legacy of the mass privatization in the 1990s. It is also due to the government’s decision in the interest of transparency to close the over-the-counter (OTC) market. As of June, all share trading must take place via the exchange. “We don’t need 1000 companies, we only need 100 good companies that are interesting for investors,” Tinnikov says. “We are not very happy about the decision to end OTC trading, since it means we will have far too many companies on the exchange.”

Not only will there be a huge number of companies, but also a huge number of shareholders. According to Kalazhenko, a legacy of the 1990s mass privatization is that there are around 1.5m shareholders in Belarus, out of a population of just 10m. “Our stockbrokers are currently occupied fulltime with entering shareholder data into their systems,” says Tinnikov.

The government is thus not only concerned with retaining control over strategic companies, but is also intent on avoiding a rerun of the chaotic Russian mass privatization of the 1990s that saw companies bought for pennies. Banning OTC trading is intended to stop the workers selling company shares too cheaply, especially to company management, says Kalazhenko.

Another problem is that over the last decade and a half, many shareholders have forgotten they have shares deposited at the central depository. Former workers may have died without their heirs knowing about their shares, and many Belarusians have emigrated. “Companies may find it difficult to get a quorum for their shareholders’ meetings,” says Kalazhenko.

In addition, with such an overhang of shares, Kalazhenko and Tinnikov are concerned lest punters divest their shares too quickly and too cheaply in the initial phase, before the market has formed realistic prices. “We say – wait, don’t be in any rush to sell. Prices will rise,” says Tinnikov. “But many people will think ‘a bird in the hand is worth two in the bush,’ and sell their shares straight off for easy money. In general, people here have no experience with the share market, and do not regard shares as a form of investment that will grow in value over the long term.”

Bluish chips

Most analysts say that share prices will be way undervalued at the start and are set to soar initially. With the Belarusian economy powering ahead at 8-10% growth per year, and seemingly immune to the global financial crisis so far, most companies are profitable.

However, with around 1.5m small shareholders looking to sell, it is still not very clear who is going to be buying. “We have very few structures that are potential investors,” admits Tinnikov. “Banks and insurance companies are not allowed to work on the stock market because of the risks, and the population is used to keeping money in the banks. And, most significantly, in Belarus there is still simply no such thing as a collective investor, although legislation is being considered.”

Tinnikov also expects Belarusian private capital to buy heavily into public companies. “Belarusian oligarchs will emerge – this is simply how business develops, capital concentrates. Up to now, the state has held this development back, but, as we say in Russian, ‘money goes to where money is’.”

Management ownership is also a possibility – but, as Kalazhenko emphasizes, management can buy shares in “their” companies only via the exchange and after six months notice to ensure transparency. Far from welcoming the development, Tinnikov says Belarusian factory directors are often disconcerted by the process. “Factory directors have little experience in dealing with minorities, and they are worried about what will happen with such a wide dispersion of shareholders. If large groups compete for control of the company, will they change management?”

Moreover, state companies still get cheap credits from state banks, meaning the stock market does not figure in their plans for raising finance. “But,” says Tinnikov, “the state will stop or restrict cheap credits, and then the only option is to IPO, change communication with shareholders, do everything that is completely natural in the West, and even in Russia.”

Tinnikov is expecting foreign investors to arrive. “Russians, Ukrainians, our neighbours, will buy stakes in companies they know because they work with them.” Kalazhenko emphasizes that foreign investors are also perfectly free to trade on the exchange. “The system is totally open for non-residents. You just need to open an account in the depository, and buy shares and bonds. There’s no need for approval, except when buying banks. There are only questions of tax and currency to handle, and there is very good earning potential.”

Neither Tinnikov nor Kalazhenko believe that the Belarus stock market is going to be a major regional player in the near future. But they believe it will be interesting for foreign investors as a safe haven as Russia and Ukraine nosedive. “In five years time, it won’t not a large market here, even compared to Ukraine, but there we should reach $2bn-3bn annual turnover.” says Tinnikov. “There will be 20-30 companies with good trading volume. Not fully blue chips, but certainly somewhat blueish.”

Belarus coming in from the cold?

Graham Stack for Russia Profile

In a deep-reaching move, but still little noticed in the West, Belarus, aka ‘Europe’s last dictatorship’, has shifted the tenets of its economic strategy and is actively looking to attract foreign investment – and targeting the West.

Many analysts in Minsk see the energy dispute with Moscow at the start of 2007 over subsidized gas prices and customs-free oil exports as marking a caesura in Belarus economic strategy. In 2007, Russia put Belarus on a one way track to paying European prices for its gas by 2011, and also ended duty-free oil exports that allowed its small neighbour to earn millions by refining and exporting oil to Europe.

The booming Belarus economy, running at full capacity, with 8% annual GDP growth par for the course, was urgently demanding capital investment to stop bursting at the seams. The price rises punctured the idea the state could do it all itself.

Moreover, the Kremlin actively backed liberalization in Belarus – in the hope that Russian capital would move in powerfully.

Having learnt bitterly from the Ukrainian experience under Kutchma, where Russia subsidized Ukraine with cheap gas, but Russian companies were cut out of the privatization process, Russia has step-by-step shifted to a ‘non-ideological’ approach to dealing with its neighbours.

New president Dmitry Medvedev confirmed this shift July 15th in his first major speech on foreign policy principles:

“We are fed up with ideological investments. As you know, they were made in the previous period, and it is absolutely clear how they were paid back. And there should be no clawing at our money, which was inefficiently spent to support corrupted regimes, in the future,” Medvedev told the Russian diplomatic corps, as quoted by Interfax.

So if bumping up energy prices forced Belarus to open its economy to investors, it was a win-win game for Russia.

In fact, new head of the World Bank mission to Belarus as of July 2008, Martin Raiser, dates the Russia-prompted shift in Belarus policy even further back than January 2007.

“Key aspects of economic policy changed already a few years back. In particular, the unification of the exchange rate and the customs union with Russia meant that key market signals have already been in operation for some time,” says Raiser in emailed comments.

“With the rise in energy import prices from Russia, there has been an additional push for greater efficiency and competitiveness,” according to Raiser, “and this has led to a renewed emphasis on private investment and initiative in Belarus. This is new and it is welcome.”

Reform moves

It was in 2007 that the Belarus administration startled analysts by announcing and launching implementation of a raft of reforms aimed at improving the investment climate.

There was and is a lot to improve. Pro-private sector measures introduced in 2007 saw Belarus leap up thirteen places on the World Bank’s ‘Ease of doing business index’ – from 123rd place to an only slightly less embarrassing 110th place in the world.

But this is only the start, say analysts. According to the World Bank’s Doing Business blog, “in February 2008 the Doing Business team met with 45 government officials from 17 different agencies of the Republic of Belarus. Every single one of these representatives expressed their absolute commitment to ease business regulation in the country. Their aim is to be among the top 25 countries in the ease of doing business and top 10 reformers in the World Bank’s Doing Business 2009 report.”

In 2007, Belarus also took crucial steps such as acquiring a credit rating, and launching large-scale privatization – with the sale of second largest mobile operator, Velcom, to Telecom Austria, for over 500m euros.

An indication of the dominant state role in the Belarus economy until 2007 was that all three mobile phone operators were joint ventures with the state. But in 2008 the state is looking to sell its remaining stakes in operators MTS and BeST. Bank privatization is also in the cards, with Germany’s Commerzbank looking set to acquire fifth-largest Belinvestbank. Austria’s Raiffeisen International already owns the country’s third largest bank, Prior Bank.

This burst of reform activity in 2008 has caught many observers by surprise.
Many expected the reform drive to slow, as energy prices in 2008 have shifted back in Belarus’ favour: the country looks likely to run in a record trade surplus instead of the feared deficit this year. But, according to Dmitry Kruk of Minsk’s Institute of Privatisation and Management, the government has redoubled its liberalization efforts this year, indicating that ‘a strategic decision’ has been taken by the president.

Key challenges

World Bank’s Martin Raiser sees three key challenges facing the government:

“Belarus in some sense benefits from the fact that several of its key industrial assets are relatively new (built in the late 1980s) and that government-led efforts have achieved some success in modernizing the flagship companies.”

“But a lot of inefficient often state-owned enterprises still exist in smaller towns which will need to attract private strategic investment if they are to survive.”

“Secondly, Belarus needs to make better use of its key assets – an educated labor force and strategic location as a bridge between Russia and western Europe. For this, it needs to encourage innovation and entrepreneurship to complement the high human capital and it needs to reorient trade and transport links towards Europe and make it easier and cheaper to transit across its territory.”

“Thirdly, Belarus will need to cope with a deteriorating demographic outlook and the implications this has for the social inclusiveness of future economic growth. As the labor force declines due to aging and migration, the financing of generous social transfers through high levels of payroll taxes will come under pressure and the need to improve targeting of social assistance to the truly vulnerable and to encourage greater labor force participation will become ever more pressing.”

The question facing Belarus is whether the top-down approach pursued by the government is sufficient to master these challenges. World Bank’s Raiser notes that, while the government has “the ambition to tackle these challenges broadly”, the authorities “are aiming at efficiency improvements rather than wholehearted institutional change.”

Between Europe and a hard place

Nevertheless, the logic of reform in Belarus might yet kick-start some political liberalization, to make the country more acceptable in the West.

If economic reform in Belarus was initially prompted by relations with Russia shifting to market principles, then reforms now seem to target West European investors, according to Viktar Strachuk of Deloitte, precisely to avoid Russian capital predominating in the country.

So the government wants Western investors to counterbalance Russian influence. But Western investors are still wary of Belarus, because of the stigma attached to ‘Europe’s last dictatorship.’ So ultimately, economic reform will require some degree of political liberalization at least as window-dressing. Lukashenko seems to have recognized himself that image is important: in early 2008 he hired famous British spin doctor Lord Tim Bell, who has worked for General Pinochet, Boris Berezovsky and the British Conservative Party.

Lukashenko has even promised that the upcoming parliamentary elections in September 2008 will be a ‘model of democracy.’ The claim has met with understandable skepticism from opponents. However, there is considerable room for Lukashenko to liberalise and allow opposition, without losing his iron grip on power, since he enjoys Putinesque levels of popularity, as the economy surges ahead.

On the other hand, such a move would require Belarus’ ‘Batka’ to at least allow public questioning of his infallibility – and there has been little sign that he is psychologically ready for this.

Belarus’ surprise opening gambit

Graham Stack for business new europe

For a country long regarded as a regional backwater, Belarus has been full of surprises since 2007.

First came the “gas war” with Russia in January 2007, where Russia hiked prices for gas and slapped export duties on oil – contradicting preconceptions about Russia using energy prices to punish enemies, such as Ukraine, and reward friends like Belarus. Then came a bigger surprise from the Belarusian side. After a decade of anti-Western rhetoric, the government announced a whole raft of measures to open up the economy to foreign investment and liberalise the economy. But doesn’t take much to link the two.

“For a whole decade, nothing was done to support the private sector, and no one expected these measures. Now we are hearing at a frequency of once a week cardinal measures decided on from the president or government. And all these measures are extremely positive for entrepreneurs and the private sector,” says Sergei Shaban, deputy chairman of the board of Belgazprombank.

Belgazprombank, the country’s seventh largest bank in terms of assets and third largest in terms of share capital, owned jointly by Gazprom and Gazprombank, handles the Belarus gas trade accounting for the Russian giant, while lending to Belarusian small and medium-sized enterprises. As such, it enjoys a unique insight into both state and private sectors. “Our opinion is that the measures taken by the government and president are conditioned by the need to adapt to new prices for energy,” Shaban says. “Before the price hike, there were enough resources – internal and also subsidized energy prices from Russia. This has ended, and companies need to become more competitive, to upgrade their facilities, and this requires extra capital,” says Viktar Strachuk, senior partner in the Minsk branch of Deloitte & Touche.

Dmitry Kruk of the Institute of Privatization and Management, a think-tank that drew up privatisation plans in the 1990s only to see them mothballed when Lukashenko came to power, explains that the price hike for gas and the imposition of export duties on oil shipped to Belarus threatened a lurch into the red for the trade balance, jeopardizing macroeconomic stability. The hike in energy prices also looked certain to hit enterprise profitability, making investment in upgrading facilities and making it more imperative to raise energy efficiency. But soaring world oil prices in 2008 have removed any immediate necessity to liberalise. Belarus still enjoys a “political” gas price of $128 per 1,000 cubic meters, and Belarus oil refining is still very profitable. “So it’s a paradox,” says Kruk. “This year, the trade balance will be much more favourable than last year, but the government efforts to attract investment are much more concerted that ever before.”

“It seems to be a strategic decision,” he concludes. “Everybody actually expected a slowing of reforms this year due to favourable external circumstances.”

Between Europe and a hard place

Opening up the Belarusian economy seems both a concession to Russian demands, as well as an attempt to limit Russian influence. “There is pressure from the Kremlin to open the economy. Russia understood that it’s more useful to use economic influence than political,” argues Shaban.

According to Shaban, the move to privatization was sealed by the sale to Gazprom of Belarus gas pipelines operator Beltransgaz as part of the gas deal reached in 2007. “Beltransgaz had important symbolic value in terms of privatisation. We reckoned if this deal goes ahead, privatization will continue. The Belarus government saw that nothing had changed, nothing terrible happened.”

But analysts also argue that this year’s wooing of foreign direct investment (FDI) is aimed at western investors to prevent Russian economic domination. “The priority is investment from western Europe, not Russian investment,” says Kryuk. “There’s a specific policy of restricting Russian investment proportionally, it is evident at investment forums. Russian investment is too political.”

Deloitte’s Strachuk agrees that the government is looking to balance sources of investment, because there’s already a lot of Russian capital, especially in the banking sphere. “Western countries are still wary, but Belarus’ neighbours such as Poland, Latvia and Ukraine are interested. Also Persian Gulf countries are quite active here in real estate, and there are some contacts with China and Korea. Basically, they want a mix,” he says.

Not only has juggling east and west given liberalization a momentum of its own. The very success to date of the “Belarusian economic miracle” – with regular 8%-plus GDP growth rates – means that fixed capital investment is urgently required to renew and expand capacities. This was illustrated on June 25, when the Lukomi power station, the country’s largest, suddenly packed up, causing outages across the country for both industrial and residential consumers.

Moreover, while the economy has benefited hugely from the export of goods to the booming Russian market, competitiveness in terms of market share has been falling, as Soviet-era technologies become obsolete. And with the government still the owner of most large companies, it could cash out to harvest a bonanza to finance infrastructural measures, such as constructing a nuclear power plant to reduce its energy dependence on Russia.

Belarus simply has everything to gain from opening up, as Shaban argues: it is slap in the heart of Europe, with an educated workforce, social stability, and good production capacities. And, despite the conflict in 2007, “Belarus still has a huge price advantage in energy relative to other European countries, and the government can exploit this to attract extra capital,” according to Shaban.

Targets for investment

“Every ministry and every authority now has a major priority to attract foreign investments, having all been assigned certain targets in terms of millions of dollars of FDI to be attracted. Now a major part of their day is spent meeting with foreign investors to achieve these targets,” says Strachuk.

As evidence of the government’s reform efforts, it has publicly committed itself to leapfrogging up the World Bank’s ease-of-doing-business ranking from its current 110th position to a top-25 place by 2011. The most telling proof is that the privatisation of major companies is back on the agenda. That includes the imminent privatization of the two remaining state-owned mobile operators to Russia’s MTS and Turkey’s Turkcell; of fourth-largest Belinvest bank to Germany’s Commerzbank; and of giant truck builder MAZ to Oleg Deripaska’s Russian Machines. Michelin is also known to be interested in tyre producer Belshina. “There is an ambiguous logic about privatization,” says Kruk. “Enterprises that are currently profitable but facing an uncertain future will be sold, as companies in a tight situation will also be sold.” According to Kruk, companies with stable profits such as Minsk Tractor Factory, potash giant Belaruskali, and the largest oil refineries will remain in state ownership.

Crucial to stimulating investor interest in privatisation was the abolition in February of the notorious golden share rule, which gave the government the right to intervene in the running of a privatised company in the event of layoffs or losses.

Parallel to case-by-case privatization, as part of an institutional shift towards an investment-friendly economy, government unitary enterprises are to be transformed en masse into joint stock companies (JSC): 30% this year, and the remaining 70%, around 500 companies, through 2010. Government plans then envisage IPOs for the new JSCs, but current market conditions, and also the need to establish credit histories and introduce international accounting standards, make such ambitious claims seem unrealistic for the immediate future, according to most analysts

Besides attracting strategic investors, the privatization of majority and minority stakes is intended to stimulate the development of a stock market. To support this, earlier this year the tax on securities trading was slashed from a prohibitive 40% to a profit tax level of 24%. A moratorium imposed in the 1990s on trading shares in privatized companies was also lifted, and the government passed an umbrella programme on “corporate securities market expansion program for 2008-2010″ in January, envisaging 25% free float of total shares by 2010. However, considering the current embryonic state of the Belarus stock market, in conjunction with the disarray on the global capital markets, most analysts agree it will be a long time before things really start to take off here.

More significant in the short term are moves to streamline the tortuous tax system. With 42 different taxes, compliance is currently a nightmare, and the overall take high in comparison to neighbouring countries. But in 2009, the government will introduce a flat rate income tax of 12%, and reduce turnover tax, a major burden, by 2% to 1%, and possible phase it out entirely in 2010.

And it’s not just taxes. “Worse than taxes themselves are the many mandatory payments that are not taxes, but contributions to sector support funds not covered by tax law, but only by the budget law,” Deloitte’s Strachuk says.

Too much bureaucracy, not enough democracy

Nevertheless, a poll taken of foreign investors at the recent Minsk Investment Forum showed that taxes were not the main obstacle to investment. “More serious was a general lack of transparency, difficulties with regulations regarding pricing, and regulations regarding accounting in general, which is very formalistic,” Strachuk says. “The basic problem is bureaucracy and slow decision-making.”

Belgazprombank’s Shaban agrees: “In Belarus, corruption, for example, is significantly lower than in Ukraine and Russia. The problem lies in the speed of taking decisions.”

The government has a number of programmes that provide tax incentives for investors, such as a development programme for small and midsize towns, for “agricultural cities,” and for technology parks. However, some of these programmes also include administrative measures compelling companies to contribute. There is still a mix of policies being applied.

An excess of bureaucracy is twinned with a dearth of democracy. It’s still too early to say whether the Belarusian economic liberalization could prompt political liberalization. To secure the foreign investment from Western Europe needed to balance Russian money, President Alexander Lukashenko has to do something about his image – and he promptly took first steps in this direction in 2007, hiring Tim Bell, legendary British spin doctor for late Chilean dictator Augusto Pinochet, Russian oligarch Boris Berezovsky and the McCanns, among others. The upcoming parliamentary elections in September will be a litmus test of how far the administration is prepared to put substance behind spin.

Minsk cabbies

Moving from the “Batka” of Belarus, as Lukashenko is referred to, to the Minsk cabby for a view from the grassroots, Svetlana, one of Mink’s few female taxi drivers, told bne that government regulations forced her to change jobs. “Previously, I had a stall trading textiles,” she says, but new government regulations now forbid the self-employed from hiring additional workers, demanding they re-register as firms, with all the accompanying costs and hassle. “There were demonstrations against the regulations on the part of small-scale entrepreneurs in the centre of Minsk, but nothing appeared about them on TV, it was all hushed up and then they were dispersed by force.”

Another Minsk cabby, Grigory, a Hare Krishna acolyte, says he earns enough as a taxi driver, without a family to support, to have visited India for six weeks this spring. Freedom to travel is one thing. “But Hare Krishna are not allowed to celebrate on the streets in Minsk – in Moscow, yes, but not in Minsk,” he complains.

However, as a taxi driver in Moscow, he could hardly afford a six-week trip to India. This is one of the paradoxes of Belarus. In Moscow, “official” cabs are rare; instead there are myriad of gypsy cabs driven by migrant workers. In Minsk, the iron grip of Lukashenko means there is an organized, competitive and efficient taxi market. Late night revellers debate which taxi service is cheaper, much as they might discuss which mobile operator gives the best deal.

Under Lukashenko, Belarus identity is openly Soviet-rooted. Independence Day is no longer July 27, the declaration of sovereignty from the Soviet Union in 1991, but July 3, the liberation of Minsk by Soviet troops in 1944.

But this is not the same as subservience to modern Russia. In some ways it’s the opposite. Belarus is proud of the “Soviet virtues” abandoned by Russia for “corruption and low morals.” Ordinary people often echo Lukashenko’s boasts that he has prevented the appearance of oligarchs, bandits, graft and ethnic strife – the plagues of modern Russia. As a visitor to Minsk watches diners in Macdonald’s actually clear their tables after eating, something unheard of in Moscow, there’s a possibility that this proud Soviet vestige might yet take on a European tinge.

Belarus takes big step with Velcom privatization

Graham Stack for business new europe

Velcom’s new Austrian CEO Helmut Duhs does not hesitate to call the privatization of Belarus’ second-largest mobile operator by Telecom Austria, “the biggest step in privatisation for Belarus.” The 37-year-old Duhs hardly anticipated Minsk as a future posting, but since he took over in November, Velcom has become a flagship for Belarus’ new economic policy of openness.

The privatization has been a feather in the cap for President Alexander Lukashenko’s privatization programme, but the deal was mired in scandal to start with. Only a year ago, the Belarusian government suddenly announced that its second-largest mobile telecom asset, then called Mobile Digital Communications (MDC), had been clandestinely privatized for an undisclosed sum to a shadowy Syrian investor called Ead Samawi, bringing with it accusations of insider dealing.

Samawi’s business interests in Belarus allegedly originated with arms trading, and he was one of the few foreigners in the country said to be close to the president. Ead Samawi also surfaced in public shortly after the Syrian foreign minister visited Minsk on a state visit about two years ago. Analysts point out that the state arms exporter Beltekhexport held 20% of the government’s total 51% in MDC. Relationships between the Belarus administration and Samawi have had their ups and downs since MDC was founded in 1998: Samawi even spent a night in a KGB detention cell in 2003. But 2008 saw a number of televised love-ins between Samawi and Lukashenko, which seemed to pave the way for the behind-the-scenes privatization. With a decade’s delay, Belarus seemed to be making the same transition from state-ownership to crony capitalism that Russia and Ukraine had done in the 1990s.

This initial apprehension made the cheer greeting the Telekom Austria deal weeks later all the louder: the Austria firm bought 70% of Samawi’s holding company SB Telecom for €730m, with a call option agreement for the remaining 30% exercisable in the fourth quarter 2010, valued at approximately €320m. Suddenly a new optimism was in the air: Belarus seemed to be skipping over the crony capitalism stage and looking instead to attract foreign investors – from the West.

The shift was a big surprise apparently for Telekom Austria itself, which first made contact with the Belarusian government in 2007. The sum Telekom Austria paid SB Telecom, Duhs told bne, was only a slightly higher valuation than the €550m the government belatedly this year said it had received from SB Telekom for its 51% stake.

And now the government has said it intends to privatize the other two mobile phone companies as soon as possible. The Belarusian market leader, MTS, a joint venture between Russian mobile giant MTS (49%) and Belarus fixed-line monopolist Beltelecom (51%), looks set to see the Russian company acquire an extra 2% for around $27m, according to the telecommunications ministry. The third-placed BeST is likely to be acquired by Turkey’s Turkcell when a price has been agreed upon.

So what only a year ago would have seemed fantasy, is now nearing reality: the complete privatization of a key sector to foreign investors.

Duhs himself disputes that there has been any u-turn in government policy, arguing the development is entirely logical. “Velcom was the first GSM operator in Belarus and Samawi was always the driving force behind the company. The digital mobile industry was from day one, competitive and liberalized. It simply made sense for the state to sell its stake when the market had matured and the entrepreneurial stage completed. It made sense that the existing partner make a deal, and then negotiate with an international investor.”

President Lukashenko himself boasted to students at Belarus State University in February about how profitable this strategy had been for the state: “We invested nothing at all [in Velcom] and got around $600m for our stake,” he said, adding that “billions” were being offered the state for MTS, and for BeST even “with all its debts.”

Growth potential

From the point of view of Telekom Austria, the attraction of the Belarus market lies in its great potential for growth. “It is the only market we have with less than 100% penetration, in fact around 70%, and currently our tariffs are 70% lower than in the next lowest market,” explains Duhs.

Velcom’s monthly ARPU in the first quarter was €6.5, compared with Telekom Austria’s ARPU of €28.7 in Austria for the same period. In the Belarusian context, however, Velcom boasts the country’s highest ARPU due to its traditional focus on better-off users: market leader MTS reported only €6.25 of ARPU in 2007.

Part of the reason for such low tariffs, besides competition, has been government involvement in the branch, admits Duhs, and the ideology of a “socially-oriented economy.”

“This is a country-specific approach,” shrugs Duhs, “which requires a commitment from large companies. You have to know and accept it before you enter the market.”

One such commitment is for mobile operators to provide equal quality to all inhabitants, ie. to ensure coverage of unprofitable rural areas. The rural population is an important government constituency, and because Belarus is sparsely populated, operators have to invest a lot in their networks relative to subscribers. In addition, the fixed-line operator Beltelekom is a state monopoly offering the lowest call tariffs in Europe. “Mobile phone operators subsidise the fixed-line operators,” says Duhs.

So Velcom has no worries about a price war breaking out between the newly privatized operators as happened in Ukraine 2006: “Prices are simply as low as they can get.” Instead, Duhs welcomes increased competition as stimulating market growth.

He also notes that Belarus is committed to WTO entry, which requires the liberalization of fixed-line communications. “Positive signs by the government on such issues were a condition for us entering the market.”

But for all the low ARPU and social strings attached, the 3.2m Velcom subscribers now comprise 20% of Telekom Austria’s mobile subscribers in a country with GDP growth averaging 8% per year, with the first tenders for 3G licenses likely to take place this year. And Duhs is aiming higher: for Velcom to be market leaders within five years, by providing more value-added services while diversifying its subscriber base away from business users.

Improving investment climate

Regarding the investment climate as a whole, Duhs points to the Belarusian tax system as the biggest obstacle. “It is by far the most complicated I have ever seen, with 42 taxes meaning that huge administrative efforts are needed for compliance.” And it’s not just the number of taxes: taken together, Belarus has the highest tax rates in region, says Duhs.

Duhs points out that Velcom enjoys a privileged position when it comes to dealing with government, “because the privatization is perceived by all parties as a pioneer action and supported as such.” In general, he says, since foreign investors are still a novelty, government works with them on a case-to-case basis, not yet having developed routinised procedures.

Duhs sees Velcom acting both as an “ambassador” for Belarus abroad, promoting the country as an investment location, as well as for Austrian business investing into Eastern Europe. “The Austrian approach regarding [foreign direct investment] is more flexible than in larger countries, and Austria has always been a pioneer in entering East European markets. So it’s not a coincidence that the biggest sectors in Belarus are privatized first with the help of Austrian companies.”

Duhs points to Austria’s historical links to Central and Eastern Europe. Metternich once quipped that the Balkans start on the outskirts of Vienna, and it’s no coincidence that the Austrian pioneers in Belarus, Telekom Austria and Raiffeisen International, are both headed by men with roots in the former Yugloslavia – Boris Nemsic and Herbert Stepic, respectively. Looking east comes easy to them.

That is not all the two pioneering investors share: Belarusians might well imagine that yellow and black are the Austrian national colours. Following rebranding, Velcom’s new black on yellow logo now perfectly matches the Raiffeisen emblem displayed by Priorbank. The new Velcom brand aesthetics are also pioneering: The eye candy previously smiling from billboards has now been replaced by sombre, even harsh, images of “real people,” about which even Velcom’s own sales staff openly express their puzzlement.

But this, argues Duhs, is what foreign investment can bring – new approaches, new ideas, new technologies. And thus, to explain the rebranding to staff, Duhs and his team did what few Belarusian managers do – they launched a roadshow through Belarus to convince workforce on the rebranding, explaining the concepts and answering questions openly. “There were a lot of questions,” smiles Duhs.

Chubais has left the building

Graham Stack for business new europe

On July 1, Russia’s electricity sectoral holding RAO UES will cease to exist, replaced by a host of privatised power generation companies and state-owned grid operators – thanks to the efforts of ‘the great privatisator’ CEO Anatoly Chubais. Although the unbundling and privatization of RAO UES has been hailed as a huge success, concerns remain – not least because Chubais will no longer be there to look after his baby.

In the RAO UES offices, the last post was sounded for the former blue chip company, and CEO Anatoly Chubais lowered the company flag. In its place, a battery of new flags was hoisted: those of the 24 successor companies: 6 wholesale generation companies, 14 territorial generation companies, the hydroelectric giant RusHydro, and assorted grid and distribution operators.

This was the culmination of a turbulent 10 years work for Anatoly Chubais. When Chubais moved from the government to UES in January 1998, his legion of enemies predicted it would be the death of the company. Ten years later, he has proved them right.

In 1998, RAO UES was in dire straits, caught at the centre of the Kafkaesque nightmare of arrears and barter payments that passed for an economy at the time. Chubais’ reputation had taken a battering due to the scandals associated with privatisation, and suffered what seemed a terminal blow during the financial meltdown of August 1998. The ensuing economic rebound and the Putin presidency gave him a new lease of life as reformer – but made him no less controversial a public figure.

Flak from all sides

Chubais’ reform proposals for the electricity sector attracted flak from all sides: from the Communists as a matter of principle, but also from Western analysts and investors who feared a repeat of the sweetheart privatization deals, and by fundamentalist liberals. His most committed opponents didn’t stop at verbal attacks – Chubais was the target of an all-out mortar and machine-gun assassination attempt in 2005.

The protracted saga of RAO UES reform repeatedly seemed bogged down in parliamentary hearings and cabinet meetings – and yet it moved. Chubais has attributed this to direct support from President Vladimir Putin, “without whom none of this would have been possible.”

The story then exploded in 2007, as the first wave of privatizations to strategic investors took place – for unexpectedly large sums and attracting major European energy concerns.

“The result of ten years of reform is a new structure based on private property and market principles,” Chubais wrote in business daily Vedomosti, June 30th. “In the place of the RAO UES holding, new dynamically developing companies gave emerged – in generation and distribution, sales and service. A competitive market in electric power has been created in the country, and many billions of dollars in investment attracted giving a powerful boost to our country’s economy.”

“In the course of one and a half years,” Chubais continued, “Russian and foreign private investors have invested almost RUB1 trillion in our power generation companies… The detailed investment plan 2008-2012 envisages RUB4.3 trillion to be invested, with 43,000MW of new capacity alone costing RUB1,798 trillion.”

But, far from being dizzy with success, Chubais is aware of the considerable risks still facing the implementation of the reform.

Until only recently, one of the most serious threats to the reform came from Gazprom buying massively into power generation capacity, and looking set to dominate the market. Especially worrying were plans for Gazprom’s power generation assets to merge with coal concern SUEK’s, giving the joint venture a 15% share of total power generation, around 40% of fossil-fuel power generation, and almost a monopoly on supplies of gas and coal. Chubais himself referred to such plans as “the rebirth of state capitalism.” Most analysts agreed with him, but viewed the development as inevitable: what Gazprom wants it gets.

Sensational

It was thus a sensation when on June 10th Gazprom recalled the deal from consideration by the Federal Anti-Monopoly Service (FAS) with woolly justification. Abstaining from the SUEK merger plan seems to show that new President Dmitry Medvedev is on the side of the liberals, and reinforces Chubais’ reputation for beating apparently impossible odds – a reputation earned masterminding Yeltsin’s reelection in 1996.

The most serious remaining risk, in Chubais’ view, is solving the problem of cross-subsidisation of household tariffs by industrial customers, which he says totals RUB120bn per year. “Not one government resolution directed at ending this practice has been implemented over the last ten years,” he complains in his article. “As a result, the structure of the retail market is inadequate. Because of artificially low rates for households, and inflated rates for industry, we had to create the institution of guaranteed supplier, which then restricts free competition… [and thus] lead to structural conflicts between distribution companies and sales companies.”

The second serious risk, according to Chubais, is that of capex inflation pushing up prices. The huge capex programme in Russian power generation, has coincided with a doubling of costs for generation capacity on the global market over the last three years, and also with the current credit crisis increasing financing costs.

“All this will lead to a significant increase in the cost of investment programs, and… in the end prices charged to consumers,” warns Chubais, who calls on the government to rely on the market and competition to keep prices as low as possible.

Both these factors highlighted by Chubais could lead to a sharp increase in prices for electricity at a time when inflation is already surging. Moreover, today’s prime minister is a holy cow rather than a potential scapegoat, meaning that there will be political pressure to delay unpopular decisions.

Chubais nonetheless argues that price liberalisation is unlikely to be postponed. Standard and Poor’s electricity analysts are less optimistic about this. “Reforms have been beset with delays and revisions that erode the nature of the ultimate plan’s clarity,” Elena Dubovitsjaya and Ekaterina Marushkevich warn in a report. “Tariff regulation, particularly in heat generation, remains opaque and politicised despite legal changes that were designed to create a more transparent regulatory framework. In this environment we consider power generation companies to be highly exposed to the risk of political interference, including implicit price controls.”

The Standard and Poor’s team, who focus on corporate governance risks, points to politically motivated decisions, inefficient government regulation and control, limited control of new owners over strategy and investment programs, and new state monopolisation in the form of Gazprom, as risks facing the new owners.

The recent departure of top management from generation companies due to generous golden parachutes has also raised questions about future managerial capacities.

Paradoxically, according to Standard and Poor’s, one of the main threats to the reform results from another departure: “the liquidation of the fundamental ideologist behind the reform – RAO UES.”

But RAO UES head Chubais feels his work has now been done – and says his future plans involve only “to sleep for six months.”

Before going home for some well-earned kip, he left a farewell note on the RAO UES website:

“Thanks to all of you who accompanied us along the way – whatever side of the barricade you were on. We are leaving now. But the lights will stay on – because the building called the Russian power sector now has new owners.”