Russia's State Sell Off: `It's Sink Or Swim Time'

Ludmilla Shikulina, 28, has worked at Moscow's Red October Chocolate Factory for half her life. As a company veteran, she received 38 shares worth 1,000 rubles each when the 125-year-old candy factory was privatized in a voucher auction in 1992. The offering was part of a national voucher program that transferred 70% of Russia's state-run businesses into private hands. After two stock splits, Shikulina's stake has grown to 700 shares. But she isn't selling. "Their value will go up and up," she says, plucking imperfectly shaped chocolate pieces from the assembly line.

It won't take long to find out if she is right. On July 1, Russia's privatization program moves into a new and critical stage. That's when the government will begin to sell controlling stakes in two-thirds of the remaining state-owned companies through tenders aimed at professional investors. Many of the newly privatized companies themselves will raise money from foreign buyers through share offerings or private placements. Even Shikulina's company is jumping on the equity bandwagon: Red October will float 7.72 million new shares for $5 per share.

BLAMING YELTSIN. The rush of equity issues, coupled with a tough new bankruptcy law and cuts in state subsidies, is likely to spark a dramatic restructuring of Russia's economy. It marks the beginning of a new capitalist discipline that is certain to stir up Russia's old ways more than ever. As companies try to jazz up their performance to attract investors, layoffs and management shakeups will be inevitable. Says Drew Guff, manager of PaineWebber Inc.'s $105 million Russia Partners Fund: "It's sink-or-swim time."

In more ways than one. The expected surge in layoffs from privatization and increased bankruptcies as subsidies are slashed will put pressure on the limping economy, which has seen industrial production fall 26% so far this year. That can only add to the growing problems of President Boris Yeltsin, who is blamed for high prices and rampant crime. Already, Yeltsin's opponents are preparing campaigns to take advantage of public discontent if there are massive layoffs.

But if Russia's nascent capital markets can inspire the trust of foreign investors, they could be the engine the country needs to get its economy moving. And they could help lure back the millions that Russians have stashed in Swiss banks. "Equity markets in Russia will grow very rapidly," says Charles Blitzer, an economist in the World Bank's Moscow office.

While the first round of privatization, started 18 months ago, was primarily a cashless transfer of ownership from the government to the Russian people, this time is different. Before, some 150 million Russians each received a free voucher that could be invested in an individual enterprise or an investment fund. Foreigners could buy only the few shares offered in voucher-privatization auctions through Russian intermediaries. Now, foreigners will be allowed to buy Russian equities directly--in fact, they will be encouraged to jump into the fray. "The State Property Committee wants to aggressively use these sales to attract foreign investors," says James Dannis, a partner at Cleary, Gottlieb, Steen & Hamilton's London office.

HOT STOCKS. There's plenty for Westerners to choose from among the 12,000 companies that have gone through voucher privatization. Foreign portfolio investors already are active in the Russian secondary market, buying shares from voucher investment funds or workers. The Moscow office of CS First Boston has bought stakes ranging from 2% to 5% in five oil companies. "I estimate that foreigners are buying Russian stocks at the rate of $100 million to $300 million per month," says Oleg Tsarkov, head of stock trading at Grant Financial Group, one of Russia's most active investment funds. Like Alfa Capital and First Voucher Fund, Russia's two biggest voucher funds, Grant bought controlling stakes in Russian companies that it hopes to resell to foreign investors.

The risks, of course, are high. Up to now, Russia's securities markets have been largely unregulated. Thousands of Russians placed their vouchers in unlicensed investment funds that collapsed when directors skipped town with the proceeds. Other funds promised sky-high dividends that never materialized. So Yeltsin is cracking down on unscrupulous brokers. Issuers of stock and bonds will now have to register with the government and provide quarterly balance sheets. But it will take several years before markets are well regulated.

What's more, he market is so new that it's highly regional and highly illiquid. Few of the newly privatized companies will trade on Russia's stock exchanges, which list mostly newly formed companies. There are also physical impediments to heavy-volume trading, since there aren't any large clearinghouses. For now, foreign investors will have to buy through brokers and Western investment funds. But there are already some hot stocks: Rostelekom, Russia's national phone company, and Unified Energy System, the world's largest power-generation company.

If the first six months of 1994 are any indication, Russia could soon become a popular emerging market. Bankers say that more than $600 million in portfolio investment has moved into Russia so far this year, and government officials predict that the figure will top $4 billion by the end of the year. If any of these investors put their money in Red October, Shikulina will be sitting pretty.



Ends on June 30, after 18 months of trading vouchers for shares in state-owned companies. The results:

-- Assets of 12,000 state companies transferred to 40 million Russian citizens

-- 650 mutual funds formed to acquire shares

-- Door opened for foreign investors to buy controlling stakes in food,

tobacco, and metals industries

-- Shareholders start voting out some ineffective managers


Starting July 1, blocks of shares in privatized and remaining state com-

panies will be sold for cash. The goals:

-- Encourage foreign investors to buy shares directly in privatized or

bankrupt enterprises

-- Spark development of new-issues market

-- Provide badly needed investment capital

-- Eliminate state subsidies to privatized firms

-- Increase managers' accountability


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