Saturday, February 7, 2015

The Browder Affair and the Death of Russian Economic Reform 2/3

 by Nomad

Part One of this series

In Part two, we pick up the story of the crusader investor, William Browder. As an activist shareholder whose business model was based on exposing corruption, Browder was about to meet his Waterloo with the Russian global energy giant, Gazprom.

The Payoff and the Payout

William Browder's mission to expose and clean up corruption within Russian corporations was not based on any altruistic motives. On the contrary, it was an application of basic capitalist principles. simply a way of increasing the value of the companies in which he owned stock.
A corporation cleared of corruption was bound to be more efficient and in practical terms, more accountable to its shareholders. Furthermore, it was bound to be more profitable.

However when it came to Gazprom, Russia's oil giant, that practical idea was to hit a snag. When Browder's investment fund  Hermitage Capital Management (along with other minority shareholders) launched its anti-corruption campaign, it would turn out to be, in fact, an indictment against the whole Russian way of doing business.

A Washington Post article in December 2000 reports the growing concern by foreign shareholders. Accountability was, they discovered, an illusion.
The huge natural gas monopoly Gazprom, one of Russia's largest enterprises, has transferred hundreds of millions of dollars in assets outside the company in recent years while signing lucrative deals with a firm largely owned by Gazprom's current and former directors, executives and their relatives, documents show.
(The article- though predictably complex- lays out a pretty good case for widespread corporate abuse that would have made Enron executives blush.)

In early 2001, shareholders hired the international accounting firm of Deloitte & Touche to conduct an independent audit. Hermitage lodged "a series of legal actions" with the Moscow Arbitration Court.
Browder, the most outspoken of the shareholders, charged  that earlier audits of the company were "deliberately false." He claimed the audits were designed to cover up fraud at high levels.

It was just one of many steps taken by Hermitage. Browder's company also organized a PR campaign to put pressure on the gas and oil giant. That campaign ran over 200 articles which appeared from October 2000 to August 2001 in such investor news sources as Financial Times, Wall Street Journal, New York Times, Business Week, Vedomosti, Reuters, Kommersant, Washington Post, Bloomberg and others. Browder was, at least in terms of publicity, playing hardball. At first it seemed to be successful.

In May 2001, Rem Vyakhirev, the head of the gas monopoly, was replaced by a chairman loyal to President Putin, Alexei Miller. Ties between the two went back to Putin's St. Petersburg days, in the 1990s before Putin's swift rise to power.

In 2002, Browder bluntly told reporters,
"We've met with a number of senior government officials and they share our concerns."
Who was Browder speaking about? None other than Dmitry Medvedev, who at the time was the deputy head of the presidential administration. He would later play a crucial role in Putin's hold on power.

By sticking close to Putin (and by that, I mean, being a hand puppet)  Medvedev became the third president of Russia and the tenth Prime Minister. (Bowing to Putin, Medvedev tends to make every position he holds largely ceremonial.)

A total house-cleaning- the removal of all corruption from the Gazprom- was realistically a far-fetched idea. The problem was that the largest shareholder of  Gazprom was Russian government.

The Serious Questions

In a very real sense, Gazprom was the Russian government in corporate form. Corruption in the corporation equaled government corruption. Thus, to cross the oil giant and the people who had ran and profited from committing fraud was a challenge to the entire Russian government.
For savvy investors in the West, it was a litmus test for New Russia.
The questions about Gazprom, which is partly state owned, represent a challenge for President Vladimir Putin's pledges of economic reform. They go to the heart of a long-running but still unsettled debate: Will Russia's economy become an open, transparent market in which property and shareholder rights are protected, as Putin has promised, or will it be dominated by suspicious deals and political risk, as it is today?
Not only were Putin's assurances of ending corruption not serious, critics charged, the attempts to expose fraud and criminality were seen by officials as a challenge to Putin's authority.
The real face of Vladimir Putin, the former KGB officer, was about to be revealed.

The saddest irony of all was that Hermitage's efforts were paying off. After Hermitage's attempt at house cleaning. Miller was able to take credit for the company's value increase.
The company recorded steady growth in the first five years of his tutelage, but it was between 2007 and 2008 that Gazprom grew quicker than at any point in its history. The total market cost of all listed Gazprom shares had reached $341.8bn, $8.3bn more than in 2007, and the company leaped from the seventh to the third biggest company in the world.
“We have witnessed how Gazprom developed from a Russian company with limited foreign equity into a global transnational corporation with Russian roots. In the coming years, Gazprom will be not just a major company in the world, but the most influential company in the energy business and its target is to reach a market capitalisation of $1trn.”
Instead of re-investment in the company, Miller instead used the profits on showy construction projects in St. Petersburg, largely aimed at re-making the exterior of the company.

It was a classic case of poor management decisions. First proposed in 2005, the business center project, initially called Gazprom City, is still unfinished. Residents of St. Petersburg hated the idea and the project was relocated to another area. 
The plans were to include the tallest building in Europe, a scientific and educational complex, sports and leisure facilities, and an outdoor amphitheater.
In September of 2014, the final cost of the design and construction of Lakhta Center was reportedly around $200 billion. The complex is scheduled to be finished in 2018. Since the crash of oil prices and the Western sanctions, many have doubts that even that goal will be reached.

A Case of Economic Dependence

By 2008, Gazprom’s activities accounted for 10 percent of Russia’s GDP. Taxes from the company accounted for a jaw-dropping 25 percent of all Russian tax revenues.
This presented a problem nobody seemed to understand at the time. Such a heavy dependence on one source of revenue entailed high risk for a government but especially for one as fragile as Russia.

As head of Gazprom, Alexei Miller also helped himself to the good times. According to the Russian newspaper Vedomosti, Miller earned about  $5.3 million in total from his various Gazprom-related interests, and another $2.8m from his chairmanship of the gas producer’s oil unit, OAO Gazprom Neft.
And there was more. He raked in more than $500,000 for being deputy chairman of Gazprom and at least $2m for holding the position of CEO.

When the 2008 economic meltdown occurred- followed by the recession- the Gazprom party was over. In the space of 12 months, Gazprom's value reportedly dropped by 65 percent.
Another problem was Ukraine's debts, a sore point between the two countries since about 2005. (Ten years later, the dispute has turned into an international crisis.)

The ongoing dispute between Russia and the Ukraine began over unpaid gas bills (and the price at which Ukraine purchased Russian gas). The way Russian handled the problem was a warning siren to all of Europe which suddenly woke up to the immense bargaining power held by Russia in the European energy sector. 

By that time Browder was long gone and Hermitage had been airbrushed out of the Gazprom family photos.