June 24 (Bloomberg) -- Turkish press mogul Aydin Dogan has counted many of the country’s movers and shakers as intimates -- among them 55-year-old incumbent Prime Minister Recep Tayyip Erdogan, who used to address Dogan, now 73, as ‘agabey,’ a term of respect that Turks use for older men.

Respect seemed nowhere apparent in February, however, as the prime minister paced a stage under heavy snow during an election rally for local candidates of his Justice and Development Party, or AKP, in the central Turkish town of Yozgat. “Mr. Dogan, come to your senses,” Erdogan shouted. “This prime minister is different. You’re used to prime ministers who bow and scrape before you.” He also whipped up the crowd with a fiery admonition: “Don’t buy newspapers that print lies.”

The row between a prime minister who has won the biggest share of the popular vote of any candidate since 1965 and a press baron who as chairman of Dogan Yayin Holding AS controls more than half of the country’s newspaper market isn’t a mere parochial falling out among powerful men. The fracas has spooked foreign investors at a time when the country, a U.S. ally and member of the North Atlantic Treaty Organization, can ill afford it.

The matter has also spilled beyond Turkey’s borders and onto the radar of the European Union in Brussels, where officials who will ultimately decide whether to admit Turkey to the EU have been weighing the implications of the Dogan-Erdogan dispute.

‘Investor Backlash’

Perceptions that the government is targeting a media company for political reasons mean “it could be harder to come by foreign direct investment in the future, and Turkey can’t afford that,” says Matthias Siller, who manages about $5 billion in emerging-market stocks at Baring Asset Management Ltd. in London. “The backlash of the international investor community could be very serious if Turkey went down this route.”

The nation is already struggling to maintain the inflow of investment that has helped its $700 billion economy post record growth under Erdogan. Foreign direct investment fell to $2.2 billion in the first quarter, about half the figure of a year earlier, according to the central bank.

The feud was set off almost a year ago after Dogan’s Istanbul-based newspaper Hurriyet published stories about the trial and September 2008 fraud convictions of three Turkish nationals in a Frankfurt court. The men worked for the German arm of Turkish charity Deniz Feneri, which means lighthouse in English. The charity mainly collects money from religious Turks living in Europe for distribution to the poor in Turkey and other Muslim countries.

Siphoned Cash

German prosecutors, in an indictment filed with the Frankfurt regional court, charged that the three had siphoned off about 17 million euros ($23.7 million) in Deniz Feneri donations, mostly for themselves or associates in Turkey. The indictment also cited computer records seized from one of the defendants that indicated that some of the siphoned money was to be sent to Erdogan’s office in Turkey -- a charge the defendant denied during trial.

Hurriyet, and most of the rest of the Turkish press, aggressively pursued the story. Another Dogan paper, the left- leaning Istanbul-based daily, Milliyet, published a piece on Sept. 5 based on an entry in the indictment that said there had been “attempts to exert political pressure on the inquiry,” including efforts by the Turkish government to get the accused men released from custody.

Lies, Reprisals

The indictment entry didn’t mention Erdogan or any other government official by name. Court officials later said they had received no such pressure. The Milliyet story stated that the indictment showed that Deniz Feneri was “intimately connected with the AKP.” A photograph of Erdogan accompanied the piece.

Collectively, the stories touched off Erdogan’s accusations at the election rally that Dogan was printing lies. Dogan says government reprisals soon followed, including draconian tax fines and sanctions against his various businesses that have knocked as much as $1 billion from the value of Dogan Yayin in the months since the feud began.

The story hasn’t gone away. In early June, Turkish prosecutors froze the bank accounts of 18 Turks with connections to Deniz Feneri, including a broadcast regulator appointed by the Erdogan government. That prompted Erdogan to give a June 7 speech in which he denied his party or government had links to or received money from the charity. “The opposition’s efforts to tar us with the scandal will fail,” he said.

‘Smear Campaign’

While the prime minister declined to be interviewed for this story, Erdogan’s AKP allies say Dogan, far from being a press martyr, tried to use his newspapers to discredit the prime minister because Erdogan declined Dogan’s request for favorable treatment in business deals. “This wasn’t news reporting; it was lies, slander, a smear campaign,” says Industry Minister Nihat Ergun, formerly the AKP’s parliamentary leader.

Dogan says he sought Erdogan’s approval in 2006 to build an oil refinery at Ceyhan on Turkey’s Mediterranean coast and was disappointed that permission went instead to Istanbul-based Calik Holding AS. The company has holdings that include media and energy companies and is run by Erdogan’s son-in-law Berat Albayrak. However, that setback had nothing to do with the reporting of the Deniz Feneri case, Dogan says. “We just reflected the proceedings in the Frankfurt court,” he says.

The European Union has taken notice. EU head Jose Manuel Barroso, when asked about the Dogan case at a press conference in Brussels on March 26, said the EU was concerned about the Turkish government penalizing Dogan in a way “that could put in question the necessary pluralism and complete freedom of the press.”

Free Press

At another event in Brussels a few days later, Olli Rehn, the EU official who has been helping to monitor Turkey’s EU application, said the EU would be watching for any perception that the government was imposing “a financial sanction which challenges the economic viability of an independent press group. This clearly touches upon press freedom, which is a cornerstone of any open society.”

Erdogan’s credentials as a business-friendly, pro-European reformer eager to continue luring foreign investment have taken a blow, as some in the global financial community have started to compare his actions to the treatment of tycoons by another leader: Russian Prime Minister Vladimir Putin.

“Some people were wondering whether Turkey was going to become Putin’s Russia,” says Wolfango Piccoli, an analyst at New York-based Eurasia Group, which measures the political risk of investing in emerging markets.

Yukos Precedent?

Weighing on investors’ minds is the case of Mikhail Khodorkovsky, former owner of the now nationalized Russian oil company, OAO Yukos Oil Co. Khodorkovsky, 46, has claimed he was railroaded into an eight-year Siberian prison sentence for tax evasion in 2005 because of his political opposition to Putin, a charge Putin, 56, has denied.

“Investors who are exposed in Turkey are generally also in Russia, so that was the example that sprang to mind,” Piccoli says. “Going after Dogan could have been a signal to other conglomerates too: Don’t cross the line and nothing will happen to you, but go over it and you’ll be punished.”

Dogan and his backers say the problem is Erdogan’s growing intolerance of critics and his willingness to use all the levers of power against them. “Turkey’s democracy is far less developed than the West, and the bureaucracy is totally subject to politics, so it’s extremely hard to be a media owner,” Dogan says. “There are various ways to censor the press. For a country’s prime minister to declare war on a media group, that can’t be right and it can’t be legal.”

Political Blood

Dogan was born in 1936 in Kelkit, a small mountain town in the lush, tea-growing hills of northeast Turkey. His father, a farmer, was the town’s mayor -- representing the Republican People’s Party, now the main opposition to Erdogan’s government -- and also owner of the Kelkit Cayi, a small party-affiliated newspaper.

That background still affects Dogan’s approach to the news business, says Tarhan Erdem, who managed Dogan’s Milliyet in the early 1980s and later helped Dogan set up his first bank, Istanbul-based Alternatifbank AS. “As a proprietor, you shouldn’t interfere with the editorial business,” Erdem says. “But he has political blood in his veins.”

Dogan entered Istanbul University in 1959 to study commerce; it was there that he joined the Republican youth movement. He left after two years without completing a degree and set up a goods transport business in Istanbul, buying a fleet of trucks with money from his father, according to “Aydin Dogan: Lord of the Plazas,” a 2003 biography by Emin Karaca.

Back Alley

His first office was near Sirkeci train station on the banks of Istanbul’s Golden Horn, in a back alley now filled with street vendors selling belts, cheap trousers and colorful headscarves.

“At high school, my dream was to expand our farm, to make it more modern,” Dogan says in an interview in his Ottoman- style wooden mansion on the hills overlooking Istanbul’s Bosporus. About 20 newspapers are piled on the table in front of him. Instead, he went into the auto business, selling locally produced cars and trucks, including Ford Transits.

Erdal Dumanli was a Ford salesman starting from the late 1960s. “There was just him, a helper and an accountant in a dark room with a wooden staircase up to the platform where they kept the books,” Dumanli, 67, says. The families became friends and used to go out together for evenings on the Bosporus, Dumanli says. “Aydin doesn’t drink much, but when he’s merry, he used to recite beautiful poems -- Ottoman court literature,” he says. “He has a very powerful memory.”

Editor Murdered

As Dogan’s car business was growing in the 1970s, Turkey’s politics and economy were sinking into turmoil. By decade’s end, the country was running out of foreign-currency reserves and vital commodities such as gasoline and sugar. Deadly street fighting between right- and left-wing groups resulted in daily assassinations. One of the highest-profile victims was Abdi Ipekci, editor of Milliyet, who was gunned down in Istanbul in February 1979. Shaken by that murder, Milliyet’s then-owner, Ercument Karacan, decided to sell the paper, according to Karaca in Lord of the Plazas. Dogan bought it.

“They said Milliyet was for sale, and I felt something stir inside me,” Dogan says. “I had the money. I’d been reading Milliyet since 1957. That’s why I got involved -- and I couldn’t get out again. If I hadn’t been a media owner, I would have been a lot richer.”

Mehmet Ali Birand, who now runs Dogan’s TV stations, Kanal D and CNN Turk, was a reporter at Milliyet in 1979 and recalls the arrival of his new boss. “He was very shy at first,” Birand says. “He was surrounded by all these giant egos, journalists who he’d seen from afar and admired or disliked.”

Branching Out

Within a year, Birand says, Dogan had asserted control over the newspaper. In the 1990s, he began branching out into banking and other industries. In 2000, Dogan won a government auction for a stake in Petrol Ofisi AS, Turkey’s biggest chain of gas stations. In 2005, he also bought the Hilton hotel in central Istanbul for $256 million in another of the privatization sales that have been part of the government’s policy since Erdogan took office in 2003.

Dogan’s media empire was also growing. He set up Kanal D, one of Turkey’s first non-government-owned television channels, in 1993. In 1994, he acquired Hurriyet, then the country’s best- selling news­paper, for $70 million, and in 2005 bought Star TV, a nationwide TV channel, in a government auction for $306.5 million. By the end of 2008, Dogan Yayin owned two of the three top-selling newspapers in Turkey and two of the four most- watched television stations.

‘Not Appropriate’

Dogan says his relations with Erdogan were cordial in the first few years. That’s why he says he was surprised when, in late 2006, he was rebuffed by Erdogan when he asked for approval for the Ceyhan refinery, the prime minister telling him instead that permission had been awarded to “our Calik” -- meaning Calik Holding, the firm whose chief executive officer is Erdogan’s son-in-law.

“I know it isn’t appropriate for me to ask the prime minister for permission to build a refinery,” Dogan says. “But I also know that in Turkey, if Erdogan doesn’t say yes, then no one else will either.” Erdogan declined to confirm that account of the meeting or offer a different version, his cabinet colleague Ergun says.

Erdogan was soon grappling with bigger problems than a business rivalry. In April 2007, Turkey’s army sought to block his party’s presidential candidate, Abdullah Gul, because of Gul’s Islamist background. The army views itself as the defender of Turkey’s secular system and is suspicious of Erdogan’s AKP because of its roots in conservative Islam.

Election Landslide

Erdogan responded by calling an early election in July 2007 -- and winning with 47 percent of the vote, the biggest share in more than four decades. The next year, national prosecutors filed a lawsuit to bar Erdogan and his party from politics on the grounds that they were seeking to impose Islamic law in secular Turkey. Erdogan escaped the ban by a single vote in Turkey’s 11-member Constitutional Court.

Part of Erdogan’s hostility toward Dogan and his companies may stem from a feeling that they are part of a secular establishment that has belittled the AKP, whose bedrock support comes from the nation’s poorer regions, says Akif Beki, a one- time press spokesman for Erdogan and now a columnist for another of Dogan’s newspapers, Radikal.

“The AKP’s political genes just aren’t accepted in some places,” Beki says. “The elite in Turkey either want to turn you into them, or if they can’t do that, then they take sides against you. But the prime minister and the AKP insisted on staying themselves.”

Short of Sympathy

Hakan Altinay, the director in Turkey for billionaire political activist George Soros’s Open Society Institute, says Dogan and his defenders might have earned more sympathy for their protests about curtailment of free speech had they sided with Erdogan’s government during its troubles with the army and the courts. “Still, nothing Dogan has done in the past legitimizes the way they’ve been treated,” Altinay says.

The verbal assaults on Dogan may be backfiring. The results of the March 29 local elections were disappointing to Erdogan’s AKP; its candidates won 38 percent of the vote, down from 47 percent two years ago. Coupled with Turkey’s economic problems, which have led to a surge in unemployment to 15.8 percent, Erdogan’s attacks on critics have dented his support, says Ozer Sencar, head of Ankara-based research company Metropoll Strategic & Social Research Center.

“The prime minister has a style problem, and that cost him votes,” Sencar says. “He has a harsh manner.” An October survey by Metropoll found that 42 percent of respondents backed Erdogan in his row with Dogan compared with 20 percent for Dogan -- yet almost two-thirds of respondents said the prime minister was wrong to call for a boycott of Dogan newspapers.

Possible Truce?

Dogan, speaking the day before the local elections in March, said he was hopeful tensions would ease after the vote. “We’re not completely innocent,” he said. “We’re ready to revise and correct our mistakes. I believe the prime minister will soften his stance.” And Erdogan’s aide Ergun also signaled a possible truce, saying that “probably, as time passes, everything will settle down and these disputes will get resolved somehow.”

Still, an April 21 ban that prevents Dogan companies from bidding on government contracts shows that hasn’t happened yet. The feud’s costs to Dogan and his companies continue to pile up.

On Feb. 18, Dogan Yayin said it received a bill for 914.8 million liras ($592 million) in back taxes and fines, stemming from the sale of a 25 percent stake in its television unit to Germany’s Axel Springer AG.

Tax Dispute

The Finance Ministry said Dogan’s company recorded the sale as taking place in 2007 when it actually happened in 2006. A company spokesman said that while the transaction was agreed to in November 2006, the money didn’t arrive until Jan. 2, 2007. The Finance Ministry’s press office said on April 16 that the penalty arose from a routine inspection unrelated to Dogan’s argument with the government.

“They started examining seven of my companies at the same time,” Dogan says. “If it’s an inspection of the whole industry, which other newspapers, TV stations, are under scrutiny? It’s not an industrywide assessment; it’s a targeted operation.”

The Finance Ministry rejected Dogan Yayin’s first two offers of collateral against the fine and froze the company’s bank accounts before accepting as surety some of the conglomerate’s real estate holdings and a stake in its television business. Dogan Yayin has appealed the fine in a lawsuit that may take several years to resolve. Its collateral remains frozen.

Fraud Lawsuit

The tax penalty isn’t the only sanction Dogan and his companies have been subjected to. On Oct. 16, the Capital Markets Board of Turkey said it asked prosecutors to press charges against Dogan and executives from his companies -- including one of his four daughters -- for defrauding shareholders in his listed publishing businesses by buying newsprint from companies privately held by the Dogan family at above-market prices. Dogan has denied the charges.

On April 21, Dogan’s Petrol Ofisi unit said the government banned it for one year from bidding on government fuel contracts because it had supplied the wrong kind of fuel oil to a state- owned power station, a charge the company denies and is challenging in court. That could deprive Petrol Ofisi of about $900 million of orders, based on its sales to the government in 2008.

Dogan says the dispute with the government is also causing him to miss out on the chance to expand his media empire outside Turkey, as the global crisis throws up bargains. “There are good opportunities to buy media companies in the U.S. and Germany,” he says. “If we can rescue ourselves from the government’s pressure, we may look into buying one.”

Published in the August issue of Bloomberg Markets Magazine.

To contact the reporters on this story: Ben Holland in Istanbul at bholland1@bloomberg.net; Firat Kayakiran in Istanbul at fkayakiran@bloomberg.net.

Last Updated: June 23, 2009 17:00 EDT