Was Henry Kravis Outfoxed In Russia?

KKR claims it deserves a payout in Tatarstan. The government says "no deal"

In the U.S., they're Masters of the Universe. In Russia, they could be just another piece of roadkill. Three years ago, Kohlberg Kravis Roberts & Co. struck a deal with truckmaker Kamaz on the steppes of Tatarstan in central Russia. KKR agreed to raise money to pull the newly privatized company out of a deep financial ditch. In exchange, KKR got an option to buy a big stake in Kamaz. Since 1993, KKR partners logged hundreds of hours, spent millions out of pocket, lined up more than $750 million in loans and refinancing, and dispatched consultants and lawyers to help Kamaz restructure.

With Russia's economy showing signs of recovery and its stock market surging, Kamaz may be on the brink of a turnaround. But Kamaz' management changed in June, and KKR's big payoff--control of a 16.5% stake currently worth $50 million--may be snatched away. The government of Tatarstan, an autonomous republic within Russia, has taken control of Kamaz, and all bets are off as to whether KKR will receive its promised equity. Ravil Muratov, who is both Tatarstan's Deputy Prime Minister and Kamaz' new chairman, claims that KKR was required to raise equity capital, not bank loans. KKR declined public comment.

TOO OPTIMISTIC. Muratov contends that KKR took advantage of Kamaz when it was desperate. "I said to KKR: `Can you show me where in your experience in Europe and America you can find idiots in a government who will give you something for nothing,"' he recalls. Unless the leveraged buyout firm immediately raises $300 million in new equity, Muratov says, "KKR is not going to get hold of those shares."

Upon receiving Muratov's ultimatum, KKR executives immediately hopped on a plane to Moscow to meet with him. The chairman refused to budge. KKR clearly will fight to protect its stake. And no wonder. KKR partners are among the world's savviest dealmakers, and they negotiated terms on a high-risk deal that could give them a huge potential payoff with only a $50,000 up-front investment. If Kamaz gets back on track--and if KKR ever collects its equity--it will have paid a song to make a $34 million profit on its stake.

Still, sources familiar with the deal note that Kamaz hasn't paid KKR a promised $10 million a year in management fees since 1993. It's clear that KKR considers Kamaz' about-face a violation of Russian and international law. "This is a major international incident. They are thumbing their nose at the entire Western financial Establishment," says a key source.

For its part, KKR may have misjudged the difficulty of turning around a Soviet-style industrial behemoth. And it may have been overly optimistic for Kravis and partners to expect to squeeze American-style fees out of a destitute truck factory. What is certain, though, is that the LBO firm underestimated the power of Tatarstan, one of Russia's richest and most fiercely independent regions.

Tatarstan may well get away with its move against KKR even though the firm has a strong claim to the equity. A lawyer who represented Kamaz in drafting the agreement says it clearly specified that bank loans would satisfy KKR's fund-raising obligations. The agreement permits KKR to seek arbitration outside Russia to settle the dispute. But an arbitrator's decision would have to be enforced by the Russian government. And Moscow may not want to pick a fight with Tatarstan, one of the few Russian regions not in debt to the federal treasury. "KKR is probably sorry they ever heard of Kamaz," says a Western banker who watched the drama unfold.

At least KKR has only the firm's--and not their investors'--money at stake. Still, KKR invested large amounts of management time, including the personal involvement of the firm's two founders, Henry R. Kravis and George R. Roberts. Partner Michael T. Tokarz, KKR's point man on the project, averages an hour a day on Kamaz and is a frequent visitor to the factory. Time is a valuable commodity at a firm where just 11 partners manage a portfolio of 21 companies with combined revenues of $47 billion.

The KKR dispute may scare away potential foreign investment in Russia. For instance, it could affect Tatneft, a big oil company based in Tatarstan that is poised to become the first privatized Russian company to get a full American depositary receipt listing on the New York Stock Exchange. The Tatarstan government hopes to issue Eurobonds by the end of 1997.

In hindsight, KKR's investment may appear rash for a firm without international experience. But in 1993, Russia's investment potential seemed limitless. Industries were being privatized with the stroke of a pen, Western aid was pouring in, and Boris Yeltsin's government was wooing foreign investors. And Kamaz' management was eager for help. When it opened in 1975, Kamaz was the world's largest truck factory with 117,000 employees. In 1990, the company was privatized and the Tatarstan government retained an 8.3% stake.

But even after privatization, the company's problems were massive. Its trucks were outmoded and its market dried up. Kamaz even served as the municipal government of Naberezhnye Chelny and had to provide services for a city of 500,000. Then, in 1993, a fire destroyed the engine plant where Kamaz and Cummins Engine Corp. had a joint venture. Desperate Kamaz managers called American Re-Insurance Corp., then owned by KKR, to assess the damage. AmRe suggested calling KKR.

Soon after, when a delegation of Kamaz managers showed up at their Manhattan offices, Kravis and his colleagues listened politely and sent them away. "We told them: `You don't qualify for investments like we make,"' says a source who attended the meeting. Twice more Kamaz persisted, before offering KKR an option to acquire shares in the company in exchange for fund-raising and management assistance.

Bolstered by expensive legal advice--and the possibility of a huge payoff--KKR took the plunge. "Henry and George didn't put up any real money. And if it did work, there would be enormous upside," says one U.S. banker. In 1993, KKR paid $50,000 for a 1% stake in Kamaz and signed a consulting agreement. Soon after, KKR agreed to the complex arrangement under which it could acquire Kamaz stock.

KKR quickly lined up a $100 million loan from the European Bank for Reconstruction & Development and $150 million from Vneshtorgbank, a Russian bank. It also secured refinancing of more than $500 million in bank debt, saving Kamaz millions in interest payments. With help from consultants--recruited by KKR but paid for by Kamaz--the truck company made considerable progress, shedding most of its social responsibilities and stepping up production of a popular 3.5-horsepower micro-car called the Oka.

But Kamaz slid deeper into debt. In June, Kamaz' board agreed to give Tatarstan a 43% stake in Kamaz in exchange for loan guarantees and restructuring Kamaz' bank debts. KKR supported the transaction. The board also ousted longtime Chairman Nikolai I. Bekh, who had wooed KKR, and replaced him with Muratov, a leading power in the autocratic regime of Tatarstan's Prime Minister Shaimiev. The Shaimiev government had grown impatient with Kamaz' slow progress under Bekh and felt he had let KKR take advantage of the company.

WHITE KNIGHT? Today, things are looking up. Kamaz, which plans to spin off its Oka division, has watched its stock soar 175% this year. "Kamaz is at a turning point," says Igor S. Antonov, deputy chairman of Oneximbank, a major Russian bank considering a loan to the company.

Muratov depicts Tatarstan as a white knight that is helping Kamaz much as the U.S. government bailed out Chrysler Corp. He pledges to pursue the restructuring plan recommended by KKR, while shoring up the truckmaker with tax breaks, subsidies, and loan guarantees. But just as KKR underestimated the difficulties of rescuing Kamaz, Tatarstan may not realize the damage it could cause itself by reneging on the KKR deal. "It will piss off a hell of a lot of people," says a key source. If KKR gets run off the road, Tatarstan and Kamaz could be the real victims.