Ripping the ‘Iron Heart’ out of Czechia

Ripping the ‘Iron Heart’ out of Czechia
How Zdenek Bakala brought Czech coal miner OKD to its knees.
By Robert Anderson in Ostrava and Prague June 1, 2016

When Zdenek Bakala revealed in 2004 that he had bought OKD, the Czech Republic’s only hard coal miner, it was seen not just as an audacious coup, but as another step forward in the new EU member’s transformation.

One of the country’s foremost old industrial companies – which had been grabbed in murky circumstances by its own managers during the “wild privatisation” of the mid 1990s – would now be run by a Western-educated banker who had long campaigned to clean up the country’s corporate governance.

But instead, after reportedly extracting up to CZK150bn (about €6bn) in dividends, share sales and disposals of non-core assets following the leveraged buyout, Bakala in February abandoned New World Resources (NWR), the London-listed holding that owns OKD, just before OKD declared insolvency at the start of May. The rough-and-ready post-communist corporate practices of OKD’s former owners have ended up looked rather quaint compared to Bakala’s ruthlessly efficient “financial engineering”.

Jan Mladek, the Czech industry minister, has accused Bakala of running from OKD “like a coward”, while President Milos Zeman compared him to the fugitive 1990s investment fund “tunneller” Viktor Kozeny. Bakala's representatives did not respond to a request for comment.

The insolvency of OKD is potentially one of the country’s most costly industrial collapses, and could have significant political repercussions, above all in north Moravia, the country’s industrial heartland.

End of the mine

During meetings on May 6 in the regional capital Ostrava, the country’s third largest city and its ‘zelezna srdce’ (iron heart), bne IntelliNews watched Czech Prime Minister Bohuslav Sobotka repeatedly reassure local mayors, unions and business people that the government was ready to help, in particular by funding requalification programmes for the 13,000 workers whose jobs are now at risk.

But for some miners the likely end of their way of life is hard to comprehend. “They are in denial,” one politician tells bne IntelliNews after the meetings. “They ask, ‘Why should we do something else? We want to mine coal’.”

“People are shaken,” Josef Stredula, president of the Czech-Moravian Confederation of Trade Unions, tells bne IntelliNews. “People want to believe in the future but are without information.”

OKD declared itself insolvent on May 3 – a filing approved by a court on May 9 – after the government refused to inject cash to tide the company over until coal prices recover. Coal prices, which have halved compared to 2011 levels and show no signs of recovering, have left several mines uneconomic, and had pushed the company into annual losses from 2012 onwards as it struggled to service its huge debts.

But this was a slow-motion train crash. The miner had been loaded up with debt and stripped of non-core assets, leaving it horribly exposed to the prolonged price downturn.

OKD’s collapse could knock 0.4 percentage point from the country’s GDP and cost the state budget CZK33bn (€1.2bn), according to Deloitte, the company’s advisers. In the Moravia-Silesia region, it estimates immediate closure would cut employment by 4% and GDP by almost 5%.

Adding insult to injury

OKD currently employs 9,800 permanent workers and 2,700 contract staff. Under the loss-making company’s proposal for a gradual restructuring, half the group’s mines would be closed over the next two years. Paskov mine would be shuttered in early 2017, and Lazy and Darkov mines’ underground operations would cease in early 2018. CSM North mine would be significantly downsized, but it would continue operations, together with CSM South and CSA.

Now, even if the company continues operating as a going concern, these closures will be accelerated. OKD could employ less than half of its permanent workers by the end of next year, government officials say. Adding insult to injury, redundant workers are also likely to only receive the statutory three-month severance pay, rather than the up to 12 months in their contracts, as there is no money for that.

The Deloitte report estimates that around one-quarter of the workers would be able to find new jobs. However, judging by other mining wind-downs, the deep miners themselves will struggle to find suitable jobs. Those that do face pay cuts of more than a third from their current monthly gross wage of CZK28,000 (€1,036). Instead the government is looking to enable miners to retire early or to get CZK8,000 a month in top-up pay for up to three years.

In the whole Moravia-Silesia region, a further 13,000 jobs at the company’s 1,200 suppliers are at risk, according to unions. This is at a time when the future of two of the region’s biggest industrial employers, steelmakers ArcelorMittal Ostrava and Vitkovice, are already in question. “Under pressure are more than 25,000 jobs,” says Stredula of the OKD collapse, in a region that had 46,000 jobless at the end of 2015, according to the Czech Statistics Office, and the highest concentration of structural unemployment in the country.

The consolation for the Czech Republic is that much of the coal industry’s downsizing has already been done, with OKD only employing 12% of the 105,000 workers it had in 1990. In neighbouring Polish Silesia, the hard coal mining industry still employs almost 100,000, around a quarter of the 400,000 workforce it had when communism collapsed. “Our situation is much more comfortable,” Industry Minister Mladek tells bne IntelliNews. “We are approaching the final stage.”

Moravia-Silesia has also begun to successfully diversify away from coal and steel. Since Hyundai started mass production at its plant at Nosovice in November 2008, an automotive cluster has grown up which now employs 20,000, Pavel Juricek, CEO of automotive group Brano, tells bne IntelliNews. He says the cluster has had long-term problems recruiting workers, and has had to bring in labour from Slovakia and Romania. They are now ready to take on 1,000 workers in the first phase of the government’s planned requalification programme.

Cents on the dollar

The prospects are bleaker for shareholders and creditors. According to its insolvency filing, OKD has trade and financial debts of CZK17.3bn (€728.6mn), some CZK13bn via New World Resources (NWR), OKD’s London-listed parent, but it only has assets of CZK6.7bn. In addition, the government estimates that if all the mines are closed, the company will have to pay CZK5.9bn in severance pay and wind-down expenses. Pity the company no longer has some of the up to €6bn that Bakala and his shadowy partner Peter Kadar are estimated to have taken out during their 11 years in charge.

In a note on May 9 withdrawing its ratings, Moody’s Investors Service said the insolvency of NWR itself was only a matter of time. “Moody’s expects that this administrative process will ultimately result in the liquidation of OKD and the entire NWR group,” it said.

NWR shareholders put £1.265bn into the company during its IPO in London, Warsaw and Prague in May 2008, £1.08bn of which went straight into the pockets of Bakala and Kadar. The shareholders are now certain to lose everything. “It is expected that there will be very minimal or no returns to the shareholders of NWR Plc,” NWR said in a statement on May 4 when it asked for trading to be suspended on the Prague Stock Exchange.

Even NWR bondholders look like being left just holding a handful of cents on the dollar, giving them total potential losses of upwards of half a billion euros.

The Ad Hoc Consortium (Ashmore Investment Management Limited, Gramercy Funds Management, and M&G Investment Management Limited) – which has been in control of the company since February, when Bakala’s group gave up their shares – holds an estimated 65% of the group’s more than €350mn of net debt and around 60% of the company’s voting shares. They already took part in a debt restructuring in 2014 in which bondholders wrote off €325mn of debt.

Looking for excuses

The bondholders have continually attacked the Czech government for refusing to negotiate, let alone help, but it is arguably a sign of the Czech Republic’s political and economic maturity that the state was firm in its refusal to throw money at a company left rudderless by its private owners. “We were very careful to show that we were not providing public support,” says Mladek. “They tried to use us as an excuse not to declare bankruptcy.”

A source close to the industry ministry puts it more bluntly: “They thought they could squeeze us, that the government was scared shitless of bankruptcy. It was a very wrong strategic assumption. If they had filed for bankruptcy four months ago, they would have been in a much better position.”

Now the company has run out of time and money. It had only €86mn in cash at the start of the year and is expected to run out of cash in June, which could require the state to step in immediately to provide operational financing. “What is crucial is that there is some kind of financing to maintain basic operations,” Mladek says. “The main priority is to ensure that the mining is not stopped immediately and that there is a gradual process of firing people”.

The insolvency court will have to decide whether to put OKD in reorganisation or liquidation. Either way, the industry ministry is preparing Diamo, the state-owned uranium miner, to acquire the uneconomic mines and close them down, leaving the healthy part of OKD to continue operating and eventually be sold.

Government officials argue that just without the Paskov mine, the rest of OKD could be positive at an operating level. Nevertheless, they admit that all of the mines will probably have to close within seven years.

For the ruling Social Democrats, who politically dominate in the region, achieving a smooth decline of the hard coal mining industry could eventually even be painted as a success at this autumn’s regional elections. An uncontrolled collapse of mining, however, could be very damaging, not least because Prime Minister Sobotka when finance minister privatised the remaining state shares in OKD to its managers in 2004 for a suspiciously low price.

“If we manage this process, there will be no damage,” says Mladek. “If it goes in an uncontrolled way, it will be difficult.” 


Zdenek Bakala: capitalist evangelist

Robert Anderson in Prague

“In this market, if you are a short-termer – a speculator – you can get rich very quickly. But in the process of getting rich you will have to perpetuate and cement the flaws of the system. That is the danger… But today it’s time to step back and start thinking about the long term.” Zdenek Bakala, interviewed in the Financial Times in December 1996.

Twenty years ago, Bakala, a US-educated and trained Czech investment banker, often spoke out against the way the first post-communist governments were trying to build capitalism without establishing the rules and institutions to regulate it, enabling factory managers and shady investment funds to fleece investors and steal state assets.

As head of Credit Suisse First Boston’s office in Prague, and then from 1994 as the founder of the country’s first homegrown investment bank Patria Finance, he acted as an evangelist of American-style capitalism. He regularly appeared on television to explain the basics of investment, while fretting in interviews that short-termist and criminal corporate behaviour was discrediting the nascent shareholder democracy.

While Bakala became part of the liberal circle around dissident-turned-president Vaclav Havel, Patria became the go-to investment bank for foreign investors seeking to win privatisations. Eventually, after reportedly playing a key behind-the-scenes role in the state’s forcible takeover of IPB bank and its quick sale to KBC-owned CSOB, he sold Patria to the Belgian bank for around CZK1.6bn (then €43mn) in 2000 and disappeared from view.

He resurfaced with Hungarian partner Peter Kadar in 2004 with the “deal of the century”, snapping up a controlling stake in OKD in a leveraged buyout for reportedly CZK9bn just as coal prices took off. He then floated the holding company New World Resources (NWR) at the top of the range price of £13.25 as coal prices peaked in 2008 – in an issue that was eight-times subscribed – just before the global financial crisis. He boasted that this was only the start and that he had a long-term plan to build an Eastern European coal empire, as if he could turn the dirty bulk commodity into pure gold.

Bakala, then the country’s second richest man, revelled in his new fame as a Czech Maecenas, splashing out on a range of local business ventures and philanthropic causes. He was regularly photographed with his new ex-model wife in designer clobber in fashionable bars, and magazines devoted spreads to the gargantuan mansion he constructed for himself in the Sumava mountains, his taste for expensive cigars and his South African vineyards.

He became a Czech political player too. He bought himself a media empire based around the country’s main business paper, Hospodarske noviny, and financed no less than three centre-right political parties in the 2010 elections.

The collapse of OKD has wrecked Bakala’s once lofty reputation and his former defenders have now all gone silent. To Czechs today he is almost a cartoon cigar-chomping robber baron, notorious for making a verbal promise to give OKD families first refusal on buying their modest flats and then instead flogging the 43,000-unit portfolio off for a reported CZK20bn (€740mn).

The insolvency has also hit Bakala hard financially. The loss of his NWR shares – together with the slump in the value of his 24% stake with Kadar in London-listed Ukrainian iron ore producer Ferrexpo – means that the 54-year-old financier is now no longer a billionaire according to Forbes Magazine.

But perhaps most telling is the way Bakala has forfeited his business credibility. Ironically, it is Bakala’s OKD investment that now looks like an old-fashioned short-term speculation, while many of the controversial tycoons of the early 1990s – such as Petr Kellner, now Central Europe’s richest man – have gone on to build well-respected and long-lasting business empires.