The recent spree of rushed and uncompetitive privatizations of Ukrainian energy assets, including some of the last blue-chip properties, has prompted a wave of criticism among Ukrainian and foreign experts.
Many of them note the low prices that the state assets fetched and the bad timing for the privatization, given declines in the Ukrainian stock exchange, a troublesome investment climate, and low investor confidence.
But, for most critics, the biggest problem with the sales of four energy companies – three that generate power and one that distributes it — was the tender process itself. The conditions appear to have been drawn to favor one bidder, Rinat Akhmetov, the country’s richest person and one of the strongest allies of President Viktor Yanukovych.
In early 2012, DTEK, the energy arm of Akhmetov’s System Capital Management holding, won four privatization auctions.
In two of them – for the blocking stakes in Dniproenergo and Zakhidenergo, the nation’s first and third largest power generators, respectively, DTEK was the sole bidder.
In the other two privatization auctions of stakes in Kyivenergo, the power producer and supplier in Ukraine’s capital, and Donetskoblenergo, an eastern Ukrainian distributor, Akhmetov encountered little competition.
When it comes to Akhmetov, his energy holdings reached a level of concentration that experts believe is unprecedented in Europe for a single individual. According to estimates, DTEK is now in control of 33 percent of the country’s total generation capacity. When it comes to thermal generation, the holding now controls 54 percent of existing capacity.
The controversy surrounding Akhmetov’s recent shopping spree appears to be a matter of great concern to Maxim Timchenko, DTEK’s CEO, as he spells out one of his main challenges in the upcoming years: the establishment of trust between large corporations, such as DTEK, and the society, considerably shaken down globally in the aftermath of the financial crisis. With this goal in mind, Timchenko offered his counter-arguments to the voiced criticism of DTEK’s recent energy acquisitions in an interview with the Kyiv Post.
Kyiv Post: All the experts we talked to last week criticized the privatization. Their main points ranged from obviously low prices and bad timing for the sale due to Ukraine’s stock exchange nearly 40-percent price fall, to very straightforward statements that the privatization was nothing else but “selling off the assets Akhmetov wanted to buy.”
Maxim Timchenko: That’s quite an assessment of Rinat Akhmetov’s powers… Here is my answer using specific examples. I think [during our September interview] I told you that “high or low price” is an abstract thing. And you can speculate about this as long as you want until the [international] stock market shows whether the asset price is high or low. Take Zakhidenergo and its 45 percent stake. The evaluation by Ernst & Young, done in the summer, equaled $207 million. The starting price was $241 million, and we bought it for $244 million. So, my question is whether or not Ernst & Young price is objective?
KP: It seems that it’s taking into account the overall drop of prices of Ukrainian assets, which in the last several months reached 40 percent. The general opinion is that today is not the best time to sell these assets.
MT: I, myself, used to work for an auditing company [PwC] and can tell you this: an asset evaluation is based on cash flows. There are revenues minus expenses and investments and you get a free cash flow, which is then discounted to form the current price. As for the revenues, tariffs in Ukraine are lower by manifold even comparing to its neighbors. So that’s a minus to the revenue component. As for the expenses, mainly it’s the coal price and state of the equipment at the coal mines.
Every year, the salaries of miners, which make up for 60 percent of the costs, inflate by 15-20 percent. Much of it is based on populism, without any economic basis, as far as salaries are concerned.
So, expenses would be another minus to the asset price, as salaries and inflation grow considerably faster than tariffs do.
As for the investment obligations that are imposed on us, in the nearest five years we have to invest around $900 million into Zakhidenergo alone to meet them.
And then you get the free cash flow, if it’s there at all, which is then discounted. The discount depends upon the risks associated with the country, political situation, regulatory environment, currency risks etc.
So, if you take it all into account, you get the price lower than the starting price. I am ready to prove it at any forum, but I don’t have to do it. As Ernst & Young has already done it.
KP: In this situation, when the tariffs are low, the risks associated with the country are high, so that major strategic investors are afraid to enter the market, which all works towards lowering the assets price, DTEK gets these assets. It’s safe to assume that Akhmetov has enough influence to lobby for the tariffs increase. This extra revenue will be invested into these companies, so that in a couple of years through selling a minority stake at an initial public offering DTEK gets back the money it’s paid for the assets well in excess. Sounds like you are just benefiting from the negative market situation and poor investment climate.
MT: First of all, I am deeply convinced that the amount of money we paid for these assets [was higher than the current market price], as we are betting on the economic situation in Ukraine to improve, and that things will change regarding the regulatory and tariffs policy.
Second, we’ve taken upon ourselves millions of dollars worth of investment obligations, and we are ready to fulfill them.
Third, we are strategic investors, and we privatize the companies that fit our development strategy. We are not speculators to buy assets cheaply for one-two years and sell them at a higher price.
And it takes around 10 years in order for these assets to reach at least the price levels of Poland. And we want to move forward with these assets over the next 10 years. Of course, we are looking to raise the value of these assets.
We are building a strong Ukrainian company, having a clear investment plan for the next five years, at least, and we think that we will be able to significantly increase the value of this company before making it public.
KP: In our previous interview, you said that one cannot build a successful and sustainable company if it cannot win in open competitive tenders. So, do you have a lingering feeling of dissatisfaction left after the privatizations then?
MT: There is a feeling of dissatisfaction left because of the starting prices set by the State Property Fund of Ukraine.
Probably, considering the market situation, both the fund and the [Energy] Ministry, which came up with the five-page long list of investment obligations, decided to solve their problems, by placing all the burden on our shoulders. So, I do have the feeling of dissatisfaction as to whether or not our calculations and economic forecasts have been right.
And I will also tell you about one more reason to be dissatisfied, a double one. This is about Dniproenergo, an example of managerial decisions that might not have always been right.
There have been numerous additional issues of shares. At that moment we had 20 percent of a bankrupt company.
Since we believed in our energy and thought about building a large company, we paid $200 million worth of its debts to the state and $200 million of investment obligations, raising our stake from 20 percent to 45 percent. So, we paid $400 million for a 25 percent stake. So, there was a lot of noise, negative information, but when [the authorities] looked into it, it all subsided. And all the governments recognized this deal.
KP: But on the other hand, it’s really hard to think about any European country where such a large share of the overall energy generation would be concentrated in the hands of one individual. Can you think of any examples of such market concentration anywhere in Europe, whose rules of play Ukraine claims it wants to assume?
MT: We have a Western-type system of corporate governance in our company, an independent board where members are making decisions, ensuring that the standards within the company are acceptable in the West. We also wouldn’t raise $500 million [from a recent issue of Eurobonds] if there was no assurance that the company is transparent and comprehensive enough for foreign investors.
Then, you’ve probably noticed that the company has been quite successful over the recent years. [In 2010, $360 million profit, representing a 60 percent growth year-on-year, and $3 billion revenue – a three-fold increase].
Then, our energy sector is regulated by the authorities to such an extent, that no matter what market share you have, a private investor is left with very little space for maneuver.
KP: Nobody doubts the efficiency of DTEK’s management. This is about the company’s beneficiary ownership and the fact that such market concentration in one’s hands leaves an opportunity for abuse.
As for the seemingly strict regulators, it’s hard to remember any instance when DTEK, as well as other businesses run by Akhmetov, have been subject to tough measures by the authorities like it happened with Arcelor Mittal [in 2010 the Prosecutor General’s Office probed whether the company, which in 2005 bought Ukraine’s largest steel mill for $4.8 billion, fulfilled its investment commitments. Some think that only the intervention of French President Nicolas Sarkozy during Viktor Yanukovych’s visit to France stopped the re-nationalization of the steel mill].
MT: Since we never experienced any tough measures on behalf of regulators, regardless of what government was in power, perhaps, this is an indication of how the company operates on the market and how we treat our competitors.
KP: So, was ArcelorMittal operating badly?
MT: I don’t know the story with ArcelorMittal.
KP: Perhaps, this is rather the indication that Akhmetov’s companies, to a certain extent, are enjoying “greenhouse conditions” in Ukraine in general?
MT: Had it not been for all this political turbulence since the moment DTEK was established, we would be able to say that. But the company has existed for more than seven years, and you know better than I do what has been going on in the country during these years.
So, given that several governments have changed in Ukraine, I don’t think it’s fair to talk about “greenhouse conditions.” Am I right?
Kyiv Post staff writer Vlad Lavrov can be reached at [email protected].
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