After Russia's unfinished revolution

Global Finance, Apr 2003 by Johnson, Mark

Unprecedented political stability and surging hydrocarbon exports have provided a platform for a remarkable recovery from the depths of Russia's 1998 crisis, but structural problems linger.

On February 11, UK oil giant BP announced it was investing $6.75 billion in a joint venture with Tyumen Oil Co. (TNK) in Russia's largest-ever equity deal-and a move that matched the amount FDI in the whole Of the Country over the preceding three years.

Russia's RTS stock index jumped 2.7% On the news, as participants and observers alike predicted a flood of copycat deals that would cement Russia's return from the pariah status that dogged it since its 1998 financial crisis.

"There's been a change in Western attitudes," says Mikhail Fridman chairman of Alfa Group, one of two major shareholders in TNK. "We are now regarded as not just oligarchs but just normal big businessmen with our own interests." The BP moNe was widely dubbed all the more significant as the company had become entangled in a highly publicized spat with Fridman and allies over a 2001 joint venture with TNK's fellow oil company Sidanco.

"Who better to paint a big story of support than someone who has been burnt in the past?"says William Browder, the CEO of fund manager Hermitage Capital Management in Moscow and a seasoned jouster with entrenched interests in post-Soviet Russia.

BP's hunger for new oil reserves dovetailed neatly with TNK's desire to realize some of its investment in the oil industry-and inject some much-needed Western expertise. But that's a story that can be played out across much of Russian industry. A small group of hard-headed businessmen have wrested control of large parts of the country's economy-ranging from oil and gas through metals and energy-and have plugged the leaks and cleaned the companies up to international standards.

The oligarchs effectively have come to terms with Russian Federation president Vladimir Putin, rendering unto Caesar what is Caesar's: They'll run their companies efficiently, stop the most egregious asset-stripping and pay their taxes. In exchange, Putin will let bygones be bygones and not pry into how post-Soviet assets were so ruthlessly corralled into so few hands. And by re-establishing the rule of law-cleaning tip the courts, reining in wayward provincial governors-Putin's made Russia a safer place to do business.

That's good news for a group of businessmen making the transition from hunter-gatherer to farmer. Like it or not, it's been good for Russia, too, aligning these key owners' interest with those of their companies and their shareholders. "The attitudes of management are changing faster than the legal landscape itself," says Anya Goldin, a partner in the Moscow office of Latham & Watkins. "Breaking the rules doesn't pay as much any more."

Across large swaths of the Russian economy, that's made leading businessmen agents of change. In doing so, this process has finally begun to deliver some of the promise of an economy so long snowed under by mismanagement, corruption and unenforceable laws. And that has finally made large sections of the Russian economy attractive enough for foreign investment. "This is a huge consolidation and restructuring play," says Steve Jennings, CEO of Renaissance Capital, a Moscow investment bank.

But headline deals like the TNK/BP link-up are few and far between. There are other clear signs that investors have woken up to the attractions of the New Russia. International buyers have long dominated trading volumes in stocks such as oil giants Yukos and Lukoil; between 70% and 80% of trades in those shares are between overseas buyers, say analysts.

Re-rating of the oil sector has finally shifted a stock market mired for much of last year by wider emerging market woes, says Al Breach, chief economist at broker UBS Brunswick Warburg.The RTS index has risen by 8% this year, against a dismal background for emerging-markets stocks.

The country's top-flight companies have found overseas investors ever more ready to buy their IOUs. In February the world's largest gas company, Gazprom, issued a $1.5 billion eurobond, the largest yet in emerging markets.

And private equity firms are again circling the country, with new money lining up along some players who have been in Russia during previous ups-and downs. "There is an enormous change in the investment climate today compared to before 1998," says Michael Calvey, joint CEO of Barings Vostok Capital Partners, a private equity firm that has been investing in Russia since 1994.

For many, these are tangible signs that Russia's post-1998 rebirth is real."The optimists are right this time," says James Fenkner, chief equity strategist at Troika Dialog, a Russian investment bank.That may be, but as with any boom, it's crucial to untangle the structural from the cyclical.

Rocketing oil prices have flooded state coffers with cash, making the process of reform far less painful. Russia has paid down $60 billion of debt since 1998, has foreign currency reserves of over $50 billion and had a debt-to-GDP ratio of just 30% at the end of 2002.