No happy endings for Croatia's privatisation story

By bne IntelliNews March 18, 2014

Guy Norton in Zagreb -

According to the epigram of Roman poet Marcus Valerius Martialis: Fortuna multis dat nimbus, satis nulli (Fortune gives too much to many, enough to none). Almost two millennia after those lines were penned, the Croatian government is no doubt ruing its own particular lack of fortune after the country's latest failed privatisation sale - one of a depressingly long and still growing list.

On March 12 the deadline for binding offers to buy a controlling stake in Croatian fertiliser firm Petrokemija passed without any concrete bids from the troika of preferred bidders - Borealis from Austria, Nitrogenmuvek from Hungary and Agrofert from the Czech Republic. As a result, the authorities in Zagreb are still saddled with a loss-making firm whose Yugoslav-era industrial facilities are in desperate need of investment to be competitive and meet the exacting environmental standards laid down by the EU, which Croatia joined on July 1 last year.

The much-heralded sale of Petrokemija - attempts at full-scale privatisation date back all the way to 1998 - was supposed to show that Croatia was fully committed to restructuring what remains of its devastated Yugoslav-era manufacturing base, some 80% of which has collapsed since the country declared independence in 1991. It was also an important element of the current centre-left coalition government's plan to boost budget revenues so that it can avoid having to make damaging job and welfare cuts. Last year the general government deficit is estimated to have been around 6% of GDP. Consequently, Croatia has been forced to join the EU's excessive deficit procedure mechanism, whereby it will have to cut the country's fiscal gap to 3% of GDP by 2016. But slashing public spending is no easy task in a country with a rising unemployment rate that is fast approaching the 20% mark, and with an estimated 25% of the 4.3m population living in poverty according to internationally accepted criteria.

No surprise then that the government's proposal to sell Petrokemija to a strategic investor was broadly welcomed. "There's really no case to make for the state owning a fertiliser firm, especially a loss-making one," says Michael Glazer, a Zagreb-based consultant for business advisory firm Wyn River.

When the idea of selling Petrokemija was revived in March 2012 it was enthusiastically received by stock market investors, whose optimism a strategic investor could help to restore Petrokemija's fortunes lifted the Zagreb Stock Exchange-listed shares to an all-time high of HRK272 (€35.50). But confidence in the Petrokemija restructuring and privatisation story has since evaporated into thin air, with the shares slumping over 41% in the year to March 12 and were languishing at a price of HRK97 when it was announced that none of the three bidders for a controlling stake in Petrokemija had actually made an official offer. The shares have since fallen another 22% and by the close of trading on March 13 were languishing at just HRK78.

The sharp fall in the company's share price - down from a 12-month high of HRK249 as recently as September 2013 - has not only affected dedicated equity investors, but has also hit ordinary Croatians in their pockets, as Croatian pension funds were the main participants in a HRK186m recapitalisation of Petrokemija last November, which investors bought into a price of HRK170 a share. The issue of new shares saw the government's stake in Petrokemija diluted below 50% for the first time in history, with CERP, the state-run centre for enterprise restructuring and privatisation that is responsible for managing the state's corporate holdings, currently controlling a 43.83% share of the firm's capital.

Though the recapitalisation, overseen by a new management team that was brought in last September to oversee the restructuring and sale of the firm, was deemed a success at the time and seen as an important stopping stone on the path to Petrokemija's privatisation, tough market conditions hammered Petrokemija's bottom line. Indeed, in mid-February with the company's privatisation in full swing, Petrokemija felt that speculation over the deterioration in the company's financial performance was so serious as to warrant the publication of the business results for 2013 earlier than the legally prescribed mid-March deadline.

The results made for grim reading. As a result of what the management described as "serious disruptions" to its business operations, Petrokemija reported a pre-tax loss of HRK329m (€43.4m). As the management dolefully noted, the fact that Petrokemija ended last year in the red was far from being an exceptional result. "For quite a long period now Petrokemija has been operating at a loss - in the last 10 years, the company has only reported a profit in three of them."

Commenting on the reasons for the loss, the company blamed it on the global downward trend in fertiliser prices as a result of increasing competition from low-cost producers from Russia and the US where manufacturers benefit from lower gas prices than in Europe.

Despite the poor trading results for 2013, Petrokemija's president Dragan Marcinko issued a statement asserting that the company still remained an attractive takeover target. "In Central and Eastern Europe there is great potential for growth in sales of our products and with the recovery of prices in the market, we expect a profitable business," he said. "Petrokemija has numerous advantages and the potential that can, with good investment in a medium- and long-term period, realize a significant market success."

Foot on the gas

Going forward, a key determining factor for Petrokemija's future business results will be the price its pays for gas supplies, which account for around 50% of its overall business costs.

Despite being one of the largest consumers of gas in Croatia, Petrokemija has historically failed to secure favourable pricing for the gas it uses from its traditional supplier, Croatian oil and gas company INA. Ironically, Petrokemija was originally founded in 1968 as a subsidiary of then state-owned INA. However, since INA was privatised over a decade ago, Petrokemija has failed to achieve any sizeable discount on the price it pays for gas from INA, whose current main shareholder is Hungarian oil and gas enterprise MOL.

Although the company has recently started to diversify its gas suppliers - last year it signed a contract with Germany's E.ON Ruhrgas, for example - critics of the company say that its previous management should have been much more aggressive in their pursuit of lower gas prices and argue that historically INA has been allowed to profit at Petrokemija's expense.

There's been similar criticism of the company in the past with regard to its purchase of supplies from petrochemical firm Dioki, owned by controversial Croatian tycoon Robert Jezic, with Petrokemija accused of purchasing feedstock for its operations from Dioki at inflated prices.

Indeed, more market-savvy procurement policies were flagged up as one of the pre-conditions for Petrokemija to return to profitability in a report by consultancy firm AT Kearney, commissioned by the government last year. According to the report, if properly restructured, Petrokemija by 2016 could reasonably be expected to generate a profit of HRK300m a year rather than generating an average annual loss of HRK200m as it has in recent years.

For that to happen though, the current 2,300 strong workforce would likely need to be reduced by around a third. At the same time, AT Kearney estimated the modernisation of the current plant, built in the 1970s and the last major industrial facility to be completed in Croatia during the Yugoslav era, would require at least HRK1bn in investment, while a planned standalone power plant for Petrokemija would cost at least an additional HRK1.5bn. It's likely that the headline figure of roughly HRK3bn in total restructuring and investment costs over the medium term is what finally persuaded the government to seek a strategic partner for Petrokemija.

Part of a unhappy trend

The conundrum now facing the Croatian government is what to do with a company that for much of the recent past has been a drain on the state's finances, but which requires billions in investment for it ever to be profitable. Worse, Petrokemija is far from being the only financial headache the government is suffering.

In recent months the authorities have failed to secure new strategic partners for a number of often loss-making businesses. "Privatisations have not moved along anywhere near as smartly - in every sense of the word - as the government had hoped and that's really beginning to hurt on the budgetary side," says Wyn River's Glazer.

An attempt to privatise Croatia Airlines in November last year failed after foreign carriers showed zero interest in bidding for the government's 49.5% stake in the flag carrier, which in 2012 recorded a loss of €62.6m, its worst result on record. However, the government is looking to resume the privatisation process in the second half of this year on the back of the publication of Croatia Airlines' 2013 financial results.

Given the obvious politico-economic rivalry between Croatia and Serbia, Zagreb is under pressure to find as an attractive a strategic partner for Croatia Airlines as the government in Belgrade did last August when it secured Ethihad Airways as a strategic partner for its flag carrier, Jat Airways. This has since been rebranded as Air Serbia complete with new planes and routes, while Serbia is receiving a huge boost as it becomes a European hub for Etihad.

Meanwhile, in December last year the sale of the government's 99.13% stake in Hrvatske Postanska Banka failed after Croatia rejected the only binding bid, filed by Erste Bank. The Austrian lender offered HRK789m or HRK905.71 per share, which was HRK232.29 a share lower than the non-binding offer it lodged in October. "The offered price is below what we expected for a bank which has been successful in recovering from losses it made in 2009 and 2010," Finance Minister Slavko Linic told a cabinet session. "I assume that, after due diligence, they [Erste Bank] concluded that there are too many lawsuits present as well as placements [loans] that require reservations [provisions]."

Linic's reasoning received partial confirmation last month when HPB reported financial results for 2013 that showed a near 30% increase in provisioning costs totalling HRK262m, which resulted in net profit slumping by 58% to HRK43M. Critics have thus questioned the wisdom of putting HPB up for sale in the first place when there are still many unresolved legal issues surrounding the actions of its former management. A number of former HPB officials, including its one-time chairman Josip Protega, face criminal charges in the so-called "ATM trial", which alleges that between 2004-2009 they damaged HPB to the tune of HRK667m by granting risky loans to favoured clients who failed to pay them back and of illegally boosting management bonus payouts based on false reporting of profit levels at the bank.

Another state disposal that fell through involved freight train operator HZ Cargo. Talks between the Croatian transport ministry and Romanian company Grampet over the sale of a 75% stake in HZ Cargo for a total of around HRK1.3bn broke down irrevocably at the end of January amid recriminations that each side had negotiated in bad faith. Shortly after the talks failed, Gruia Stoica, owner of Grampet, was arrested by the anti-graft office in Romania on charges that he had bribed a lawyer to gain access to confidential data that enabled his firm to secure a coal transportation contract for Romanian energy company Complexul Energetic Oltenia.

Though the failure of the HZ Cargo sale may be a blessing in disguise - "It certainly looks as if the government may have had a lucky escape," says Wyn River's Glazer - HZ Cargo is a loss-making firm burdened with over HRK1bn of debt that faces the unwelcome prospect of its monopoly position in the Croatian rail freight transpiration market being abolished on July 1 this year, when, under EU competition rules, the market has to be opened up to foreign operators.

One gets through the gate

Finally, the sole successful privatisation in recent times, the sale of the country's leading insurer Croatia Osiguranje (CO) to local tobacco-to-tourism Adris Grupa, has attracted its own fair share of criticism.

On December 18, the Croatian government said it had accepted Adris' offer of €970.45 per share for a 39.05% stake of CO and a capital boost of €110m that will raise its stake to 60%. But one local banker, speaking on condition of anonymity, described this as a "sweetheart" deal. He cited the example of Austrian insurer Uniqa, which last October was prepared to pay roughly €71m to acquire a 100% interest in the Croatian business of Switzerland's Basler Insurance, which had a market share of just 4.5%. Given that CO has a market share of just over 30%, the banker argued that on an admittedly simplistic like-for-like comparison, the value of the total CO business was in the region of €500m. Under the terms of the deal, Adris has agreed to pay the equivalent of €230m for a 60% stake in CO - roughly €70m less than the €300m valuation implied by the terms of the Uniqa/Basler insurance deal.

The still-to-be determined details of the recapitalisation have provoked some controversy as well. According to reports by Croatian business daily Poslovni Dnevnik, speculation that Adris may bring in outside investors to help fund the recapitalisation - both the European Bank for Reconstruction and local pension funds have been mooted as possible business partners - has apparently prompted indignation among CO management and workers who supposedly feel that they should be offered the chance to participate in the recapitalisation. Adris itself has previously allowed its employees to buy into the firm under the auspices of an employees share ownership plan (Esop) and Poslovni Dnevnikhas claimed that CO staff feel that they should be offered an Esop option as well.

On a separate issue, Ozren Matijasevic, leader of the Croatian Association of Trade Unions, whose members include CO staff, has expressed concerns over provisions in the privatisation contract that could allow Adris to claim up to a 15% discount on the contracted purchase price for CO if there are any financial skeletons in the insurance company's closet. According to Poslovni Dnevnik, Matijasevic believes that cash-rich Adris has effectively been granted a low-cost, low-risk option on buying a prime government asset.

So even when the Croatian authorities actually manage to successfully close a sale, it seems that fortune still fails to smile on them.

No happy endings for Croatia's privatisation story

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