Russia’s largest privatisation in a decade will be an insider Kremlin deal

Russia’s largest privatisation in a decade will be an insider Kremlin deal
Rosneft CEO Igor Sechin (l) beat Russia's government in tussle over Bashneft.
By bne IntelliNews October 7, 2016

Russia’s largest oil company Rosneft and its influential head Igor Sechin have won the battle for one of the country’s most attractive domestic hydrocarbon assets, and will acquire 50.8% of Bashneft by year’s end, despite both being state-controlled companies.

The deal is expected to be closed in a matter of weeks, helping the cash-strapped government to finance the widening hole in the 2016 federal budget, while consolidating Rosneft’s control of more than 50% of Russia’s entire production of crude.

According to a newly signed government decree that was reported on October 6 by Interfax, Reuters, and Bloomberg, Rosneft will pay RUB330bn ($5.3bn) in the largest privatisation deal since 2006, when the $10.7bn IPO of Rosneft was held.

“The sum of RUB330bn is above the valuation range of Bashneft of RUB297-RUB315bn and corresponds to RUB3,709 per share,” BCS Equity commented on October 7, adding that there is an upside potential of 18.7% for share price in case of a minority buyback. 

However, governance concerns likely contributed to Bashneft’s preferred shares sinking by 7.4% after the confirmation of Rosneft’s acquisition eligibility, while the common shares reversed their previous gain with a 2.7% decline.

Rosneft previously argued to the government that by allowing two state companies to merge, the subsequently planned privatisation of 19.5% in Rosneft would yield as much as $11bn, generating a total of over $16bn for the budget.

Rosneft got the green light to bid following “very strong pressure from Igor Sechin”, an unnamed source in the government told Vedomosti daily. And while the approval confirms Sechin’s extensive influence in both the government and Kremlin, it remains unclear how easily the privatisation proceeds will trickle down to the budget.

“In reality this is a way to extract badly needed money to cover the budget deficit from Rosneft,” another unnamed official told the newspaper. He noted that previously Rosneft did not comply with a requirement to pay 50% of IFRS net profit in dividends due to a complicated ownership scheme implemented through the Rosneftegaz holding.

A major risk for shareholders is that instead of  the privatisation of 19.5% of Rosneft for $11bn the company will buy back the shares from the state on its own, as some unconfirmed reports already suggested, BCS Equity warns.

Othee than that BCS Equity recommends buying Rosneft against the shares of Bashneft, seeing high potential upside from synergy effects for the former, together with expectations of recovering oil prices and high perceived risk/yield ratio.

Meanwhile, shareholders are likely to be agitated at the rapid manoeuvring around the Bashneft sale. The last time the Sechin-led Rosneft expanded through acquiring major domestic competitor TNK-BP in 2013, minority shareholders ended up getting a buyout proposal that was about a half less valuable than that of the original deal.

The acquisition of TNK-BP for $44.4bn in cash and 12.84% of its own shares enabled Rosneft to consolidate 40% in Russia’s crude output, making it the world’s largest traded oil company. The Bashneft deal is now set to push Rosneft’s market share yet further, according to previous estimates.

While back in 2013 TNK-BP acqusition resulted in alarming leverage for Rosneft, this time it seems the major can afford to finance Bashneft acqusition. 

“At the end of 2Q16, Rosneft’s cash and bank deposits totalled RUB1.1 trillion ($17bn) and securities as part of short-term assets made up RUB220bn ($3.4bn),” UralSib Capital commented on October 7.

The bank also reminds that in addition to getting prepayments on future oil deliveries to China, Rosneft’s cash position will be boosted by at least another $4bn in cash from sales of Vankorneft and Taas-Yuriakh oil fields to Indian companies. 

But many questions remain about the form the corporate structure of Bashneft, based in Russia’s republic of Bashkortostan, will take after the sale.

“It is possible, due to the 25% stake Bashkortostan owns in Bashneft, that the company will keep operating as a separate business, distributing profits to shareholders via dividends,” UralSib Capital suggested on October 3.

Another possibility is that minority shareholders will be bought out at a premium of about 20% to the current price. But the analysts are concerned with the risks of a management change and “a less generous dividend policy” carrying risks for minorities.        

Rosneft’s shadow was already hanging over Bashneft in 2011 when the state behemoth was reportedly competing for the major Trebs and Titov oil fields, auctioned to a joint venture of Bashneft and Lukoil. Private oil major Lukoil was also the only serious contender competing for Bashneft's privatisation in 2016.

Bashneft was privatised in the early 2000s by AFK Sistema by consolidating oil and gas assets in Bashkortostan, and was effectively renationalised in 2014 by court order after Sistema chief Vladimir Yevtushenkov was placed under house arrest.

As the controversial case of re-nationalisation was unfolding, many commentators feared that extracting Bashneft from Sistema was the new “Yukos case”, referring to the jailing of oligarch Mikhail Khodorkovsky and the ensuing firesale of the company’s assets, said to have been orchestrated by Sechin and marking the rise of Rosneft's domination of the sector.