Strapped for cash and increasingly desperate, the Russian government has put privatisation back on the agenda. The trouble is it is the same privatisation programme that flopped after being launched by Russian Prime Minister Dmitry Medvedev in the good times at the start of 2008. With the economy shrinking and the Kremlin 'shirt-fronting' the West, what chances are there for the Kremlin to sell anything this time round?

The government has long since admitted that it needs to get out of business, but talk has recently turned from generalities to specifics again.

"We're considering a more ambitious privatisation plan," First Deputy Prime Minister Igor Shuvalov told delegates to the Gaidar Forum on January 12, when answering a question about whether the Russian government is considering privatisation of the country's biggest lenders in 2016. "Negotiations are constantly underway and investors' attention hasn't gone down. Privatisation at whatever the cost is not a professionally set question. Market environment and general quality of sales is taken into consideration during negotiations," he added.

Russia has a ill-fated history of privatisations, although while the first round in the 1990s was not exactly fair – most of the country's attractive assets ended up in the hands of their managers – it did have the benefit of ending the centrally planned economy and transforming Russia into a capitalist state.

The voucher privatisation was the brain child of the much-hated by the Russians, but much-loved by the West "young reformer" Anatoly Chubais. Vouchers were issued that could be turned into shares in 1995 when the Russian Trading System stock market was launched. In theory, everyone was going to benefit, with workers owning a slice of the company that employed them. In practise managers conned or cajoled workers to swap their vouchers for a few dollars or even a bottle of vodka and built up controlling stakes. Several famous bankers like Boris Jordan, the founder of investment bank Renaissance Capital, made their fortunes playing the same game.

The second round of privatisation, or prikhvatizatsia as Russians like to joke, fusing the Russian word  privatizatsia and the verb "to snatch", also didn't go well. This was actually a deal cut between the then-president Boris Yeltsin and the oligarchs who had become rich speculating against hyperinflation in the mid-1990s. Desperate for cash, the state borrowed hundreds of millions from the oligarchs using shares in its industrial jewels as collateral. If the state failed to pay, these shares would be sold at auction. Of course, the state didn't even try to pay back its debts and in the now infamous "loans-for-shares" auctions in 1995 and 1996 the only bidders for the stakes were the oligarchs who held them as collateral; the oligarchs met in secret and agreed to carve up the economy between them.

In this way, today's bastions of anti-government sentiment like Mikhail Khordorkovsky and Vladimir Potanin walked off with the assets that became the Yukos oil company and nickel mining giant Norilsk Nickel, paying a few hundred million dollars for assets that are today worth billions.

After that experience the government more or less gave up on privatisation as a bad idea. Indeed, when President Vladimir Putin took office in 2000 he began reversing many of these privatisations: at the time, Russia was unusual in that the bulk of oil was produced by privately-owned companies; today, the vast majority of oil is produced by state-owned companies. The same story has played out in the banking sector.

The notable exception is telecommunications, Putin's first reform effort, where the regional svyaz  holdings were broken up, reorganised and sold off. Today, the telecom sector is almost entirely privately owned and probably the only fully modernised and mature sector of the economy.

Under the brief liberalisation policy at the end of the boom years, a third attempt was made at privatisation. Academic Sergei Guriev, rector of the New Economic School and columnist for bne IntelliNews, took intellectual control of Russia's policymaking. Friends with oligarchs and lawmakers alike, he told this correspondent that he wrote then-president Dmitry Medvedev's keynote speech for the annual St Petersburg Economic Forum and the president read it verbatim.

 

 

That speech re-launched the privatisation programme and set an extremely ambitious RUB1 trillion ($31bn at the exchange rate of the time) target with some of Russia's best-known companies on the list.

Investors got very excited. Offices were redecorated, investor relations managers were hired, and international funds commissioned research, scouring the list of thousands of companies for bargains.

Then the 2008 financial crisis hit. The economy went from 8% growth to an 8% contraction. Asset prices crashed with the RTS Index falling from over 2000 to around 500 in a matter of months. No one was going to buy anything in that climate. Even as the economy began to recover in 2011 and 2012, uncertainties continued to plague the market and soon the political temperature was rising as the EU tried to persuade Ukraine's then-president Viktor Yanukovych to sign off on the free trade and association deal with the EU at the Vilnius summit in November 2013.

Cash for clunkers

Since then, the investment climate in Russia has gotten even worse. Oil was back under $30 per barrel as of January 15 and even the modest budget plan agreed only in December already needs revising down, Russian Finance Minister Anton Siluanov said at the recent Gaidar Forum. A revised budget will be proposed at the end of the first quarter that assumes an average oil price of not $50 but one of $40 or maybe even $30, Siluanov said.

Most importantly, that means the government's 3% budget deficit target has already been blown out of the water. Siluanov warned delegates to the forum, Russia's first prestigious get-together of the calendar, that the deficit could reach 7.5% of GDP unless at least 10% of cuts could be found. The state is going to be short somewhere between RUB1.7 trillion and RUB4 trillion this year.

Going beyond 3% is anathema to Putin, so to help plug the hole the state has re-launched Guriev's RUB1 trillion (currently worth $13.5bn) sell-off plan. Just how serious the government is could be apparent in the January decision to sack Olga Dergunova, head of the Federal Agency for State Property Management (Rosimushchestvo), who is nominally in charge of the privatisation process. Under Dergunova, sales were stalled by institutional opposition at the regional government and ministry level, Russian daily Kommersant reports. The property agency prepared a list of 42 assets to sell in March 2015 worth a total of RUB12bn ($156mn), but only managed to sell less than half in 2015, or RUB5.3bn.

Of the total of 204 share packages on the privatisation list, 40 were suspended last year by the agency due to various disputes. This year another 150 packages have been put on the roster for sale collectively worth RUB20bn ($260mn), many of them medium-sized companies that will mainly be interesting to local oligarchs.

And the plan is to significant ramp up the process. Probably top of the list is shipping giant Sovkomflot, one of the biggest logistics companies in the world. And at the Gaidar Forum some senior participants were even calling for the full privatisation of the state's two banking giants, Sberbank and VTB Bank, which the government often use as slush funds to finance "strategically important" projects, as well as its oil behemoth Rosneft.

Companies on the list

If the Kremlin sticks to the original plan, then there will several thousand companies on the list, but the vast majority of these will only appeal to local oligarchs. For foreign investors it is only the blue chips that should be of interest. Below is a list of prominent names that have already been mentioned in connection with possible privatisation this year.

1) Aeroflot

"Aeroflot is ready for privatisation," its board chairman Kirill Androsov said at the Gaidar Forum, but adding that he would rather it not be sold, expressing what must be a typical attitude amongst the bosses of the best companies. Androsov argued that the company's stock is already traded on the Moscow Exchange, which showed it could be sold, but because it was already listed it doesn't need to be. What he means is with the state owning 51.2% of the shares, he is in charge; but if the state goes into the minority, he will have to answer to shareholders.

 

	2015E
Financials, $mln
Revenues	6,359
EBITDA	168
EBITDA margin	3%
Net income	-512
Market cap	$884mn

 

Main Shareholders
Russian Federation	51.20%
Rostec	3.60%
Treasury shares	5.10%
Free float	40.20%

 

2) Alrosa

Alrosa is Russia's diamond producing monopoly and was reorganizsed to give its local regions a larger share in the company a few years ago, otherwise it is effectively 100% in the government's hands. Located in Siberia's vast and remote Yakutia region, the mine works on several massive concentrations of diamonds, known as kimberlite pipes, and has the world's largest rough diamond reserves, sufficient for at least another 18–20 years of production.

 

	2015E
Financials, $ mln
Revenues	3,474
EBITDA 2,528 2,063	1,728
EBITDA margin	50%
Net income	587
Market cap	$6,098 mln

 

Main Shareholders
Russian Federal Property Management Agency	43.90%
Republic of Sakha	25.00%
Municipal districts of Republic of Sakha	8.00%
Free float	23.10%

 

3) Sberbank

The former Soviet People's Saving bank, Sberbank is the biggest lender in the country, with the largest branch network and about half of all retail savings. Under the stewardship of former economy minister German Gref the bank was transformed and is now considered to be one of the most attractive assets in the country. Its expansion into the Central European markets has also made it one of the biggest banks in Europe and it has the potential to be a world beater.

 

Sberbank 3Q15E income statement, IFRS, RUB mln
	3Q14	9M14	2Q15	3Q15E	QoQ, %	9M15E	YoY,
Net interest income	255,200	745,100	227,100	264,000	16	691,400	-7
Net F&C income	69,600	192,300	77,300	83,500	8	230,300	20
Trading income/(loss)	600	3,200	6,500	2,400	-63	14,500	353
FX gain/(loss)	9,100	17,600	17,400	9,500	-45	54,000	207
Other income	-1,700	2,400	10,500	2,000	-81	14,900	521
Total operating income	332,800	960,600	338,800	361,400	7	1,005,100	5
Operating expenses	-137,500	-399,000	-146,600	-148,200	1	-434,500	9
Operating profit before provision	195,300	561,600	192,200	213,200	11	570,600	2
Provision charge	-104,500	-255,400	-117,100	-146,000	25	-378,400	48
Profit before taxes	90,800	306,200	75,100	67,200	-11	192,200	-37
Taxes	-19,900.00	-64,900	-20,500	-13,400	-35	-53,200	-18
Net profit	70,900	241,300	54,600	53,800	-1	139,000	-42
Source: Company data, URALSIB estimates

 

4) Sovkomflot

Sovkomflot is the St Petersburg-based Russian maritime shipping company specializing in petroleum and LNG shipping and is 100% owned by the state. In 2007-2008 Sovkomflot absorbed the assets of the state-owned, Novorossiysk-based Novoship and became the largest shipping company in Russia. It is 50% owned by the state, while the rest of its shares are publicly traded. Deputy Finance Minister Alexei Moisseev told investors at the end of last year the company would be sold "come what may" in 2016. 

5) Sukhoi Log

Located in the Siberian region of Irkutsk, the Sukhoi Log mine holds one of the largest deposits of gold in the world, estimated to be between 2,000 and 3,000 tonnes. That is about double Russia's current state gold reserves. The privatisation of the mine has been on and off the agenda for two decades, but new plans to sell the license were announced in September and industry insiders think it might actually happen this time. However, thanks to its remote location and almost total absence of infrastructure, the development is expected to take at least a decade and cost $1.5bn.

6) Rosen

A smaller state-owned oil company that was renationalised last year, Rosen is being prepared for privatisation, according to Finance Minister Siluanov. Plans to sell a 19.5% stake from the state's holding of 69.5% in Rosen were first announced in 2013 and approved by the government a year ago, but little has happened since then.

7) Rosneft

Russia's largest oil company, its most attractive subsidiaries are based on the former oil assets of the Yukos oil company, which was renationalized after its owner Khodorkovsky was arrested and jailed in 2003 on tax fraud charges.

Rosneft raised $10.6bn from a troubled IPO on the London Stock Exchange in 2006 where foreign oil majors and Russian 'oligarchs' stepped in to cover the book after other investors baulked at the price of the shares. The floation gave the company a market cap of $79.8bn with an initial trading value of $7.55. But the value of the company has been cut in half by the crisis and the shares were trading at $3.07 as of January 15.

Finance Minister Siluanov announced that Rosneft would be on the sell list at the end of last year, but the company's powerful CEO Igor Sechin quickly countered by saying the company could only be sold after it had been "prepared" for sale. He also implied that it makes no sense to sell the company at current market valuations, as its share price is currently undervalued due to sanctions and the problems on oil markets.

 

	2015E
Financials, $ mln
Revenues	86,726
EBITDA	18,034
EBITDA margin	21%
Net income 9,238 8,299	6,780
Market cap	$43,860 mln

 

Main Shareholders
Russian government (Rosneftegaz)	69.50%
BP	19.80%
Strategic investors (Petronas, CNPC)	2.00%
Other (free float)	8.70%

 

8) Russian Helicopters

The government also suggested that a 25% stake in Russian Helicopters could be sold under the new plan, which is currently 100% owned by the state. This is the highly successful maker of civilian helicopters. It is a well-run and highly profitable business, with at least half of its production going towards exports.

9) VTB Bank

The former Soviet Foreign Economic Relations Bank, VTB is the second largest bank in the country. Unlike Sberbank, it focuses more on the corporate end of the business, as well as through its investment banking subsidiary VTB Capital. However, the bank's retail arm, VTB24, is a significant player in the retail segment. The bank is 71.4% owned by the government. In May 2007 it raised $8bn from the "People’s IPO" by placing a 22.5% stake, which was sold at 13.6 kopeks for the local shares and $10.56 for its GDRs.

But the bank has been one of the biggest victims of the crisis and is currently worth a tenth of its market cap at the time of the IPO. Its GDRs were trading at $1.83 as of January 15.

 

VTB 11m15 IFRS results, R bln
	Nov Õ15	Nov Õ14	y-o-y	10/15/2016	m-o-m	11m15	11m14	y-o-y
Income statement
Net interest income	28	29	-3%	33	-15%	263	330.1	-20%
Provisions	-1	-26	-95%	-18	-93%	-157	-218	-28%
Fee income	7	7	8%	7	-4%	69	56.9	20%
Total operating income	33	11	Ð	21	61%	223	214.5	4%
Operating costs	-18.8	-20.8	-10%	-19.1	-2%	-210.8	-199.4	6%
Profit before tax	14.6	-9.8	Ð	1.7	Ð	11.8	15.1	-22%
Net income (pre-minorities)	10.9	-8.9	Ð	3	Ð	3	-4.9	Ð
Ratios
ROAE	9.10%	-9.30%	Ð	2.50%	Ð	0.30%	-0.50%	Ð
NIM	2.90%	3.60%	Ð	3.40%	Ð	2.60%	4.20%	Ð
Cost/income	54%	56.60%	Ð	47%	Ð	55%	46.30%	Ð
NPLs/gross loans	6.30%	Ð	Ð	6.70%	Ð	6.30%	Ð	Ð
Cost of risk	0.20%	3.00%	Ð	2.30%	Ð	1.80%	3.00%	Ð
Tier 1	13.00%	Ð	Ð	13.10%	Ð	13.00%	Ð	Ð
	Nov Õ15	2,014	YTD	Oct Õ15	m-o-m	11m15	9m15	QTD
Balance sheet
Assets	12,887	12,191	6%	12,616	2.10%	12,887	12,792	1%
Net loans	9,042	8,537	6%	8,816	2.60%	9,042	8,842	2%
Retail deposits	2,634	2,149	23%	2,571	2.40%	2,634	2,594	2%
Corporate accounts	4,754	3,520	35%	4,745	0.20%	4,754	4,551	4.50%
Source: Company, Sberbank CIB Investment Research