Russia's Giants Are Getting Bigger Fast

The country's industrial combines are on a buying binge

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 companies 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 a graduate business degree from the University of Northumbria in Britain: "We believe conglomerates work very well in our country right now."

With foreign capital scarce, conglomerates are some of the only players investing in low-priced Russian companies and forcing their bloated and ill-managed operations to restructure. 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 execs at both companies to slash staff and cut costs.

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 gain--and get away with it. Such wholesale plundering plagued the Russian economy in the '90s. Today minority investors are protesting a share swap that's diluting their stake in Norilsk Nickel, Interros' key property, even though Norilsk managers swear the move will boost share prices and dividends.

Yet 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 export revenues expected for the 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, fell 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 was Cyprus--a haven for Russian business lords.

The business combines are investing more at home partly because Putin's effort to consolidate political power is creating a more orderly environment. Barons like Fridman of Alfa Group, Vladimir Potanin of Interros, and Oleg Deripaska of Siberian Aluminum also enjoy tight political connections.

Despite the advantages of bulking up, some Russian companies 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 mining 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

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