Russia's Big Get Bigger
Moscow-based Alfa Group is snapping up stakes in telcos to diversify a portfolio dominated by oil holdings. Local rival Interros is adding a naval shipyard to its nickel-mining interests. And in Cheropovets, in the pine forests of northwestern Russia, the young managers of steelmaker Severstal are busy buying automotive, motor engine, and locomotive factories.
Flush with export revenues from oil and gas, aluminum, steel, and other metals, Russia's industrial titans are on a buying binge. They're consolidating core stakes in commodities and adding major new holdings in manufacturing, defense, and information services. Such acquisitions could boost these companies' control of the $260 billion nonfarm economy from about 30% now to 40% or even higher within two years, according to Eric Kraus, chief strategist of Moscow investment bank Nikoil Capital Markets. Only state-controlled monopolies such as Gazprom wield similar clout.
BLOATED. The creation of such sprawling operations has largely gone out of fashion in the West, where corporations tend to focus on a handful of core businesses. Not so in Russia. Says Vadim Makhov, Severstal's 29-year-old strategic planning director, who has an MBA from the University of Northumbria in Britain: "We believe conglomerates work very well in our country right now."
That's because conglomerates are some of the only players now investing in low-priced Russian companies and forcing their bloated and ill-managed operations to restructure. Foreign capital is scarce. But there are opportunities galore because "Russia is bankrupt," says Alfa Group Chairman Mikhail Fridman, 37. Alfa recently paid $330 million for its investments in Golden Telecom Inc. and cellular operator VimpelCom, and is pushing executives at both companies to slash staff and improve cost controls.
The growth of these hydra-headed operations also poses risks. One is that the CEOs in question will be powerful enough to strip assets from their companies for their own personal gain--and get away with it. Such wholesale plundering plagued the Russian economy in the 1990s. No wonder outside shareholders are nervously eyeing the latest corporate maneuverings for signs of self-dealing. Minority investors, for example, are loudly protesting a share swap that is diluting their stake in Norilsk Nickel, Interros' key nickel-mining property, even though Norilsk managers swear the move will boost share prices and dividends. The swap transaction is due to be completed on Aug. 21.
As they tighten their grip over key industries, these conglomerateurs are already pressuring the government to raise barriers to foreign competition. Prodded by domestic carmakers, Russian President Vladimir V. Putin recently declared his intention to raise custom duties on used-car imports. The move stands to benefit Severstal as well as Siberian Aluminum Group, another fast-growing conglomerate, which recently paid $300 million for a controlling stake in Gorky Automotive Factory, Russia's second-largest carmaker.
For better or worse, the consolidation wave keeps surging. With their big stakes in commodities, conglomerates such as Siberian Aluminum, Alfa Group, Interros, and Severstal are among the biggest beneficiaries of the $105 billion in total export revenues expected for the Russian economy this year. A growing share of the take from exports is getting plowed back into the Russian economy. Capital outflows from Russia, as a percentage of the country's gross domestic product, declined from 15% in the first quarter of 2000 to 10% in the first quarter of this year, estimates the Finance Ministry. The leading source of foreign investment into Russia for the first quarter of this year was Cyprus--a haven for Russian business lords.
The business combines are investing more heavily at home partly because Putin's effort to consolidate political power is creating a more orderly environment. Barons such as Fridman of Alfa Group, Vladimir Potanin of Interros, and Oleg Deripaska of Siberian Aluminum also enjoy tight political connections with top figures in Russian government. Back in April, after Alfa Group purchased its 44% stake in Golden Telecom from Virginia-based Global TeleSystems Inc., Golden's shares rose 20% as investors bet Alfa's political clout would secure its new holding valuable franchises in telephone and Internet services. "Alfa, I think, will make a tremendous difference," says Golden Telecom President and CEO Stewart P. Reich.
HIDDEN OWNERS. Some acquired companies are already prospering under their parent's tutelage--and becoming more open about their dealings. Net profits at Tyumen Oil Co., half owned by Alfa Group, have soared from $45 million in 1998 to an expected $1.12 billion this year, thanks to higher oil prices and the payoff from $2.1 billion in capital spending. The owners' goal is to sell Tyumen to a Western oil major within three to five years--and that gives them an incentive to make the company transparent to potential buyers. Alfa Group itself is owned by a Liechtenstein-based trust, Crown Finance Foundation, whose ownership structure the group won't reveal except to say Fridman is a shareholder.
Productivity can also improve when managers with a long-term horizon take full control. Severstal has sharply boosted investments and cut costs since an inside executive team, led by General Director Alexei Mordashov, a 35-year-old economist, gained more than 75% control in 1999.
Are there limits to the growth of conglomerates? Certainly not any imposed by Putin's government, whose Anti-Monopoly Ministry views the trend as a spur to efficiency. For example, it approved mergers that gave a group led by Deripaska control of more than 70% of Russia's huge aluminum resources. But an appreciating ruble could bite at the export revenues used to finance acquisitions and diminish the cost advantages enjoyed by local companies. Protectionist walls erected by the government at the combines' behest ultimately could also prove counterproductive by diminishing incentives for restructuring.
Even now, some Russian companies with the financial and political potential to become conglomerates are not taking that route because they foresee greater advantages in focusing on a few core businesses. "We don't like the idea of being a conglomerate," says Kakha A. Bendukidze, general director of Moscow-based Uralmash. The manufacturer, with annual sales of $385 million, is shedding holdings in such sectors as steel to concentrate on oil drilling rigs and min-ing equipment.
But at this primitive stage in Russia's development, the conglomerate phase may be just beginning. Indeed, at the right price, Bendukidze says he would be prepared to sell Uralmash to a conglomerate. "They will get bigger," he predicts. And better, if Russia's bosses learn to manage.
By Paul Starobin, with Catherine Belton, in Moscow