Investor Prosperity attacks Russia’s Transneft over “creative accounting”

Investor Prosperity attacks Russia’s Transneft over “creative accounting”
By Jason Corcoran in London September 16, 2016

Prosperity Capital Management has written to senior members of the Russian government to complain about the dividend policy and what it believes is creative accounting employed by pipeline monopoly Transneft, bne IntelliNews can reveal.

Prosperity, one of the oldest and biggest Russia-focused investors, wrote to Prime Minister Dmitry Medvedev and First Deputy Prime Minister Igor Shuvalov in August to highlight how Transneft’s payouts were “undermining” the Kremlin’s efforts to raise dividends paid by state-controlled companies.

The letter, which was obtained by bne IntelliNews, was penned by Prosperity’s managing director Oliver Sinton and was also addressed to President Vladimir Putin’s economic assistant Andrei Belousov, as well as Dmitry Pristankov, head of the Federal Agency for State Property Management.

Prosperity, which has about $2.6bn in assets under management, is concerned about Transneft’s approach to its net profit calculations. The consolidated reports of the Transneft group of companies show that 95% of the group’s revenue is generated by the mother company. However, the net profit of the mother company Transneft at year-end 2014 is a small fraction (7-20%) of the group’s net profit, according to Prosperity.

“In circumstances where Transneft’s revenue is approximately the same as that of the group, this, in our view, may demonstrate that Transneft’s net profit has been artificially diminished by transferring it to subsidiaries whilst, at the same time, Transneft has, possibly, disallowed its subsidiaries from paying dividends to the public company,” wrote Prosperity.

The letter from Prosperity, which is headed by Swede Mattias Westman, said these actions, if proven, represent “a violation of the rights of shareholders of Transneft”.

The company currently pays out dividends worth about 1-5% of consolidated profits earned under International Financial Reporting Standards (IFRS) despite a government campaign for payouts to be lifted to 50% of earnings. Instead of paying out half of its RUB142.8bn (€1.76bn) in profit under IFRS, Transneft is prepared to pay out just RUB12.8bn.

Prosperity, which holds preference shares in Transneft, said it is concerned by the situation where investors in preference shares received dividends in 2013 and 2015 smaller than holders of ordinary stock. Typically, preferred shareholders have priority rights to dividends in exchange for diminished voting rights.

“We think that such questionable practises may reflect negatively on the Russian investment climate,” said Prosperity’s Sinton, who warned that Trasneft’s corporate governance transgressions could “likely undermine” any future capital raising.

New allies

Transneft’s mean-fisted dividend policy has been a flash point for minority investors over the past few years, but Prosperity has a new ally with strong connections in its bid to challenge the pipeline operator.

In March, Russian investor UCP stepped up its fight for higher dividends after Transneft said it would pay ordinary shareholders a dividend 2.5 times more than the payout earmarked for preferred shareholders.

UCP, which has a 6% stake in Transneft, said the differential treatment of preferred and ordinary shares is “illegal and unfair”, and filed a lawsuit over the company’s 2013 dividend. UCP is headed by Ilya Sherbovich, a former UFG investment banker who now works closely with Kremlin structures on murky M&A deals.

It is also understood that international law firm Berwin Leighton Paisner has been hired by minority shareholders and also appealed to the Russian government to do something about Transneft’s dividend policy.

In 2011, a Transneft spokesman told this journalist that paying more dividends would curtail aid to orphans and other charity work. Higher dividends would reduce money destined for “the sick, supporting sport, renovating churches and monasteries,” Moscow-based Transneft said in a document in 2011. Some of the company’s charitable largesse extended to an aquarium and an organisation that helps retired Russian spies.

Transneft made RUB3.2bn of charitable contributions in 2009, 7.8 times more than the dividends it paid to private investors, according to the company’s financial reports. That spurred preferred shareholders such as Prosperity and East Capital to demand more information as they seek a larger slice of profit.

At the time, Transneft CEO Nikolay Tokarev said he saw no reason to pay higher dividends to “feed three people” who held the company’s preferred shares.

Transneft cut dividends to private shareholders by 75% from 2003 to 2009 at a time when net income increased fourfold to RUB121.8bn, according to the company’s financial statements.

Transneft has one of the worst corporate governance reputations of any Russian blue-chip. Putin in 2012 called for an investigation into allegations that $4bn fraud was siphoned off by Transneft executives during the construction of an oil pipeline across eastern Siberia. The claims were published by anti-corruption campaigner Alexei Navalny, who had taken a small holding in the stock.

It is understood that Prosperity has yet to receive a formal reply to its letter to Medvedev, Shuvalov or anyone else in the government.

In April 2015, Maksim Grishanin, First Vice President of Transneft, said the company would adopt a new dividend policy that year, moving to a payout worth 25% of IFRS.

Transneft's press service didn't immediately respond to emailed requests for comment. 

Other state companies, including gas monopoly Gazprom, have also been dragging their heels on raising their dividend payouts to 50% of IFRS, or the equivalent under Russian Accounting Standards (RAS). In May, Gazprom’s shares plunged after the company said it was seeking an exemption to the ruling.

“Most of the state companies are trying to wriggle out of their obligations to pay minorities more,” a long-term Russian portfolio manager told bne IntelliNews. “But [Transneft] is the outlier and they still think they can get away with their old habits.”