ZAO KREMLIN: The Chemezov Code

By bne IntelliNews September 5, 2007

Graham Stack in Berlin -

Sergei Chemezov, head of the state-controlled arms export agency Rosoboronexport and chief of the shadowy Siloviki Kremlin securities clan, carries a copy of Dan Brown's conspiracy thriller "The Da Vinci Code" whenever he flies.

"A very useful book," says maybe the most powerful man in Russia after President Vladimir Putin. But then adds, in case anyone gets the wrong impression, "sends me to sleep in two minutes."

Over the last two years, Rosoboronexport has transformed itself from a government office handling Russia's trade in weapons into a state-owned corporate raider that has launched a string of hostile takeover bids.

Rosoboronexport is now considered to be the key holding in ZAO Kremlin, the financial-industrial-military conglomerate that the Kremlin is building. It owns carmaker AvtoVAZ, helicopter plants, steel mills, engine builders, investment funds and metallurgical plants, among other things. Altogether, Rosoboronexport is represented on the board of directors of more than 20 export-oriented concerns, including Sukhoi, Almaz-Antei, Tactical Rocket Weapons, Ulan Ude Aviation Plant, OAO Moscow Helicopter Plant Milya and others.

The man in the shadows

Sergei Chemezov was born in 1952 in Irkutsk, and with training in the special services, arrived in Dresden, East Germany in 1983 as representative of an industrial association. Shortly afterwards, a young KGB agent from Leningrad moved into the same house. That young man's name was Vladimir Putin, and over a period of four years they were neighbours and friends as well as colleagues.

When Putin was hired by the late-president Boris Yeltsin to work in the presidential administration in 1996, Putin got a job for his Dresden-days buddy in the same department.

Chemezov's career in arms exports started with Putin's appointment as prime minister in 1999 and a year later the now President Putin appointed Chemezov deputy head of Rosoboronexport. One of Putin's very first actions as president was to take control of the state arms export agency, a nest of corruption and influence peddling. By April 2004, a month after Putin began his second term as president, Chemezov was promoted to head of the agency. It was as if the last four years were a preparation for this point and Chemezov's appointment marked the start of a new direction for Russia and a changing of the guard, as Yeltsin's team was eased out of the Kremlin and replaced by loyal Putin-ites.

Immediately Rosoboronexport subsidiaries started snapping up shares of lucrative enterprises - and not only in the defence sector, but right across the industrial spectrum. Chemezov claims there is nothing sinister going on. He quips that, "one man's de-privatisation conspiracy is another's quest for diversification."

Worth its weight in gold

For Chemezov the defence sector is the key to Russia's quest to diversify from oil and gas exports. "Our mineral deposits are finite," says Chemezov, "There are few remaining undiscovered gas and oil deposits in Russia, and they are non-renewable. But high technology, including for military use, can be refined without end, and its price is stable and predictable, whereas oil has fluctuated from $8-60 a barrel over only the last 10 years."

Simply put the defence sector is worth more than gold, Chemezov says. "A state-of-the-art fighter jet costs around $50m. This is the price of two and half tonnes of gold. Russia produces 166-180 tonnes of gold per year, enough for 65 fighters. Our Irkutsk plant alone will turn out 32 Su-30s in 2007 - worth half of the gold mined in the country in the course of the year!"

Chemezov points out that the defence sector directly involves around 1,300 companies throughout Russia, and indirectly around 70% of all Russian industry. "Everyone knows that we have to get away from our country's dependency on commodity exports. We have to diversify our industrial production. Reforming Russian industry is simply a question of national security," he says.

But it is going to take a bit of alchemy to turn Russia's leaden defence sector into gold. Privatisation all but destroyed the sector after the Soviet military-industrial economy collapsed in 1991. Today, a third of Russian defence sector enterprises are in effect bankrupt, while innovation and investment has virtually ceased.

"Defence enterprises were privatised, robbed, stripped down, sold and resold for pennies. New owners bankrupted and sold for nothing the famous Chelyabinsk factory of measuring appliances - now it simply no longer exists," says an obviously irritated Chemezov. "Western investors also did their bit. The unique Stupino plant for producing blades for aviation turbines was sold to a Swiss company, who now use it to produce chocolate. And now we have to purchase these blades for military and civil aviation abroad at a high price… All this directly threatens the country's national security."

Russian Knights Templar

Anyone watching Chemezov in action will soon start to feel like Robert Langdon, Brown's hero of "The Da Vinci Code", who believed he was surrounded by an intricate and powerful cabal that wields enormous unseen power. Clearly the leading state enterprises are closely interwoven. Take for example the appointment of Sergei Makarov as Rosneft's chief financial officer in June. Makarov was the CEO of helicopter-maker Oboronprom in 2003, but moved to state-owned VTB Bank in 2005 before landing at Rosneft - all these firms are closely associated with the Siloviki and represent their main interests in defence, finance and energy.

The Oboronprom holding has proven to be highly successful hybrid that marries both the state and commercial aspects of Chemezov's vision for how Russia's economy should be developed. Also in June, Rosoboronexport said it was considering a move into yet another sector with a new huge electronics holding using the same template.

"We are going to found holdings similar with Oboronprom in structure. For instance, we are developing a concept of a large electronics producing holding jointly with the Russian Agency for Industry now," Chemezov said on the sidelines of the Paris Airshow earlier this year.

Chemezov denies that Rosoboronexport is just looking to pile up property. "We set up Oboronprom to restructure the defence sector in a civilised manner, within the framework of the law and under state control. Our aim is not to exercise control over the capital of defence enterprises. We don't even have a controlling share packet in Oboronprom. In order to exert influence, it is often enough for us to manage the state's share packets." But he adds that Rosoboronexport invests its profits in acquiring additional shares.

Chemezov believes the state should supervise key branches of the economy and the role of foreigners should be limited, but this does not mean Chemezov is against foreign participation. The opposite is true: Chemezov believes it to be, "absolutely obvious" that international collaboration is vital for the defence sector, pointing out, for instance that Sukhoi and the Italian Finmeccanica subsidiary Alenia Aeronautica have signed an agreement on strategic partnership in creating the Russian Regional Jet, with Alenia gaining a 25% share in the project.

But the Russian state will take the lead in all these projects. Rosoboronexport and Oboronprom have been successful in handing control to the state and at the same time making money. Rosoboronexport's exports have grown from about $3bn a year in 2000 when Putin took over to the $6bn the agency is expect to earn for the Treasury this year.

Rosoboronexport has intervened in non-defence sectors to effectively de-privatise key enterprises. The case of the troubled car-maker AvtoVAZ, of which Rosoboronexport now aims to own 75%-plus-1 share on completing its takeover, attracted hostile international attention. This is Chemezov's version of events: "In December 2005, we started an operation to rescue AvtoVAZ. In one year we achieved a lot. Most of all, we eliminated criminality, which was sucking the plant dry like a cancer, and threatening to bring about its complete collapse. Remember that only recently full-scale criminal wars were being waged in Tolyatti, costing hundreds of lives. I don't want to dwell on this topic. I believe that organised crime has been driven from the factory for good."

"However outlandish it might seem, the significant growth in profits we achieved was mostly just a result of eradicating crime and theft at the plant. We cut costs by almost a third in one year, and growth in profit was up 40% year on year."

Rosoboronexport's acquisition of 66% of Russian titanium producer VSMPO-Avisma in 2006 was a similar story. The plant provides a third of Boeing's titanium needs and half of Airbus requirements, and demand for titanium is due to double in the coming years. "Sooner or later," argues Chemezov, "VSMPO-Avisma would have ended up dependent on foreign investors. And together with it, the entire Russia aerospace sector. If the state had not intervened, then Russian companies, and not Boeing or Airbus, would have been queuing up for Russian titanium."

A joint venture has been set up with Boeing to manufacture titanium components in Russia rather than exporting it as raw material.

Restructuring the restructurer

Chemezov is lobbying hard for a special law to be passed giving Rosoboronexport the status of state corporation, thereby "disposing of the full legal rights of an integrated economic subject, plus the rights of state procurement for certain types of military exports - something between a unitary enterprise and a joint stock company."

He surprisingly names the now forgotten Agency for Restructuring Credit Organisations (ARKO), responsible for restructuring the financial sector after the 1998 crisis, as being the model for such an organisation. "The president has received my proposal and it is being examined by the government. I am already sure of approval from the Federal Assembly."

The advantage of such a set-up is obvious: Rosoboronexport would gain wide-ranging freedom from government supervision, while the export monopolist would gain a powerful additional lever of influence over defence sector producers.

Despite its soporific effect, Chemezov got to the end of "The Da Vinci Code" after one and a half years of reading, so he says. Next on his reading list, however, is Dan Brown's "Angels and Demons" – about an invincible new weapon based on antimatter, developed in the state of the art CERN laboratories in Geneva. Now that would be a good a good addition to Rosoboronexport's products.

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ZAO KREMLIN: The Chemezov Code

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