United Capital Partners – Russian rainmakers trying to change their spots

United Capital Partners – Russian rainmakers trying to change their spots
/ Photo by UCP
By Jason Corcoran in Moscow October 20, 2016

United Capital Partners (UCP) has an image problem. The Russian finance firm, headed by legendary rainmaker Ilya Sherbovich, wants to be seen as an independent activist investor, but can’t shake the impression it has friends in high places.

Its senior partners recently sat down with this journalist to try to convince him that UCP doesn’t have any especially close ties with Kremlin structures. A week later, it transpired that UCP was in bed with Russia’ state-controlled oil producer Rosneft and commodity trader Trafigura to buy India’s Essar Oil for a mouth-watering $13bn.

Analysts at Sberbank CIB in Moscow suggested that the deal was political payback after Rosneft allowed Indian counterparties to acquire several stakes in its best producing assets. “They are returning the favour,” analyst Ilya Lyapustin wrote in an October 18 report. “We do not see the rationale behind exchanging core greenfields for foreign downstream assets.”

UCP’s claim to be involved in activist investment has some merit, but Sherbovich’s background and certain complex deals make it hard for some buysiders to believe that the firm is on the same side as them. Sherbovich, who has sat on the boards of Kremlin-controlled Rosneft, Transneft, Sberbank and FSK, was the key dealmaker at investment bank UFG until its sale to Deutsche Bank in 2006. A Bloomberg News profile in 2013 claimed Sherbovich has “helped craft deals for people close to Vladimir Putin throughout his career” and had gotten rich by serving their interests. UCP dismisses the claims, but never pursued corrections or retractions from the US newswire.

“UCP is an activist investor,” Mikhail Trofimov, a partner at UCP, insists to bne IntelliNews in an interview. “So whenever we feel like our investment can grow in value, we participate in corporate governance initiatives.”

A veteran Russian equity investor said he was tickled pink that UCP and Sherbovich were now fighting in the activist trenches. “This is very funny,” the investor tells bne IntelliNews. “We can only hope they came over from the dark side to the light side.”

The dark side, as most movie buffs know, is a veiled reference to Star Wars. Igor Sechin, the chief executive of Rosneft, Putin’s energy czar and a key figure in the Kremlin, is popularly known in the Russian media as Darth Vader and the “scariest man on earth”.

UCP and Sherbovich have tried to distance themselves from being seen as brokers for Kremlin-controlled entities, but not everyone is convinced. A leading Russian energy analyst quipped that UCP’s involvement in the India deal is reminiscent of a famous line uttered by Michael Corleone in Godfather III: “Just when I thought I was out... they pull me back in.”

Don’t Vkontakte us...

So far, UCP has been involved in four investments that they perceive to be shareholder activist disputes.

The firm’s most prominent entanglement has been with Pavel Durov and oligarch Alisher Usmanov over control of the popular social network Vkontakte. Durov, who was the brains behind the Facebook clone, or VK, as it’s known, claimed he was fired as chief executive for political reasons and later fled Russia. In response, UCP claimed he was fired for mismanaging the company, which he denies.

The dispute raised concerns over freedom of speech when it comes to social media and sharing information online in Russia. Durov also claimed Russian intelligence had demanded information about users suspected of participating in Kyiv’s Euromaidan protests, while UCP say that those arguments were a distraction from what Durov was really up to.

“In our view, all political issues surrounding VK were grossly exaggerated,” Victoria Lazareva, partner and managing director of UCP, tells bne IntelliNews. “At the board level, we’ve been made aware of the discussions that took place between management of VK and government agencies and regulators with regards to VK content, but the board members have never gotten involved in changing direction or strategy of VK, which was always under control of the CEO. The majority of the content-related discussions were focused on the illegal content and copyrights infringement issues.”

Lazareva said reports about pressure on Durov to block a VK account run by opposition leader Alexey Navalny was “a made-up story” and that his account is still running two years after Durov’s departure.

UCP insists they didn’t get involved in VK at the behest of the government or to try to help restrict internet freedom in Russia; they saw VK as a company with a potential valuation of $8bn and as an IPO opportunity within three to five years. However, Lazareva says Durov and Usmanov’s Mail.ru blocked their IPO plans because Mail.ru owned 100% of a social network called Odnoklassniki (classmates), which was a rival to VK.

Durov ultimately left the company to develop his own messenger service, which UCP claim he had developed using VK resources and engineers. UCP had a number of claims to that effect, but they were settled after they sold their shares to Mail.ru for about $1.5bn. “Despite the fact that we didn’t achieve an IPO of the business as per our originally contemplated strategy, this investment was very successful for UCP,” says Lazareva.

Now in the pipeline

UCP’s latest investor spat is with the pipeline monopoly operator Transneft, which has long been considered as Russia’s worst corporate governance practitioner. Transneft has had a rocky relationship with Rosneft over the years, but UCP denied it is fighting a proxy battle for Sechin’s company.

Transneft’s tight-fisted approach to paying dividends to preference shareholders has been a flashpoint for portfolio investors for years. However, this is the first time that the company has been taken to court for what UCP claims is “illegal and unfair” differential treatment of preferred shareholders over ordinary shareholders.  

UCP, which is believed to own a 6% stake in the monopoly, argues that Transneft purposely consolidates its profits in a subsidiary to avoid paying higher dividends and is ducking a government command for state companies to pay dividends worth 50% of earnings under International Financial Reporting Standards (IFRS).

UCP is leading a group of minority shareholders suing Eurasia Drilling Company, Russia's largest oilfield services company, in the Cayman Islands over the price of a share buyback. Cancelling buybacks and squeezing minorities was typical of the corporate behaviour in the last economic crisis in 2008-2009 and most minorities got little change in the court.

Chelyabinsk zinc plant (CZP) was a also target for UCP, which built up a 27% stake in the company by 2014 after taking the view that it was fundamentally undervalued. Through analysis of CZP’s financials, they discovered the firm had corporate governance issues, including a tolling scheme which helped the controlling shareholder to milk some of the profits. UCP exited the investment in 2015 after corporate governance standards improved and the share price rallied.

Curious model

UCP’s partners would admit that the business model is somewhat curious. They started out doing private equity and advisory work, but the latter has taken back seat in recent years. Initially, the firm had sought third-party money and even had a commitment worth $50mn from the European Bank of Reconstruction and Development (EBRD) in 2011. As risk appetite for Russia evaporated, the efforts to raise $250mn collapsed and the firm turned to its own personnel and unspecified partners to seed its investments.  

Headcount at the firm stands at about 55, while assets under management have surged to about $3.5bn. “Majority of the funds are UCP partners’ money. We also have bank financing and co-investors funds in our projects,” notes Lazareva.

UCP is a significant investor in the Russian stock market and also holds shares in Sberbank, Gazprom, Rosneft and Alrosa, amongst others. Not all of these represent activist targets for the firm’s portfolio managers – even though gas export monopoly Gazprom is wildly undervalued and is seen by many as a weapon in the Kremlin’s foreign affairs strategies.

However, Sherbovich and his clients did once take on the Gazprom behemoth in the early 2000s while he was at UFG. Boris Fedorov, a co-founder of UFG, was even elected to Gazprom’s board after minorities rounded up the legally required 10% of shareholders to call for an audit of Gazprom’s accounts. Rem Vyakhirev, who had ruled Gazprom as his fiefdom, resisted, but was ousted by President Vladimir Putin and replaced with his aide, Alexei Miller.

UFG’s taste for activism seemed to wane as Russia’s capital markets roared, as did fees from investment banking. In 2005 Sherbovich helped advise Gazprom on its acquisition of Roman Abramovich’s oil firm Sibneft for $13bn in the largest takeover at the time.

Bill Browder, who once managed about $5bn in assets in Russia but was expelled from the country in 2005 for his shareholder activism, says looking back he doesn’t believe that UFG were on the same side of the fight as Hermitage Capital and other minority shareholders. “I have no idea what’s going on now, but back in the UFG days I would hardly call our work collaborative with UFG,” Browder tells bne IntelliNews.

“In one instance we voted our large position in Sberbank to get Boris Fedorov on the board. As soon as he got elected, he voted together with corrupt management in favour of a highly dilutive share issue to insiders in a closed subscription against our wishes. UFG was paid an investment banking fee on that transaction,” Browder recalls.

In subsequent years, Hermitage put forward a candidate for the Gazprom board against Fedorov, a former finance minister who had set up UFG with American Charlie Ryan after serving under Boris Yeltsin. Sherbovich joined UFG in 1995 and was one of the largest shareholders. Fedorov, who died in 2008, had been elected as an independent director to Gazprom’s board,  but Browder opposed him because he “was regularly rubber-stamping asset-stripping transactions by the management”.