ENTERPRISES AND GROUPINGS OF ENTERPRISES¹

Text by: Vladimir Gorelov
Solid Invest Group
September 2001

Integration patterns

Industrial production in Russia is characterized by high concentration. According to the Russian analytical journal "Expert", the two hundred largest Russian companies had a 77% share in the total industrial production of the country in 2000. Among them the top 15 companies had about a 52% share. At present these enterprises are the core or subsidiaries of large Russian holdings that often have both financial and industrial components. They are called financial-and-industrial groups (FIGs).

Since the early 90s there have been mainly three alternatives for the development of large integrated companies (holdings) that have played the key role in the Russian economy up to now. These alternatives are the following:

• With the participation of the state
  In certain industrial branches connected with special state interests (in general the military complex, power generation and transmission etc.), the governmental bodies have created financial-and-industrial groups as state owned enterprises in order to be able to exercise control over the assets.
• Around large banks
  In this group integration was initiated by financial institutions, which possessed at a certain time a considerable amount of capital that was spent on the purchasing of shareholdings in industrial enterprises. After the August -98 crisis a large number of these groups either stopped their operations or were re-organized.
• Around large enterprises
  Large companies (mainly formed on the basis of the largest branch enterprises of the former USSR), which were capable of accumulating considerable financial flows, created or acquired specialized banking, investment, insurance and other institutions to satisfy their own needs and exploit their publicity for financial businesses. Many groups were formed in the oil and gas sector and in the metal industry. These groups are still the most powerful in the Russian economy.

Problems of transition

In 1990-1997, due to the well-known problems of transition in Russia (offering of substantially undervalued corporate stocks for sale through privatisation in a very short period of time, lack of any business strategy in many large companies, limited availability of managerial personnel with skills appropriate for the changing environment, low adaptability of technologies and processes and high geographical concentration of industrial production, long distances between producers and markets, major shifts in demand and price regulations etc.), the majority of financial and industrial groups became barely manageable conglomerates. At that time, the acquisition of corporate governance was often based on:

• Personal connections with regional and state PR bodies responsible for the privatisation, and their patronage in receiving control over the enterprises put up for auction;
• The use of loopholes in the Russian legislation and, in particular, in the laws "On Joint Stock Companies" and "On Insolvency (Bankruptcy) of Enterprises";
• Connections with law-enforcement and criminal structures for the purpose of solving corporate conflicts.

The assets acquired at that period were often not based on elaborate strategies but were regarded either as bargains or important sources of current assets (cash from sales primarily). This resulted in the "pumping" of working capital out of these companies, which led to further deterioration of their assets.

The crisis of 1998 brought most of these companies to the edge of, or even, into bankruptcy. The crisis also necessitated a substantial restructuring in those large Russian integrated companies that survived the crisis. The restructuring still continues in Russian FIGs.

Current developments and trends

In 1999, the active process of redistribution of assets in the Russian economy practically stopped. During the last two years, the tendency of transition from comparatively amorphous formations² of conglomeration towards vertically integrated structures of a more homogeneous nature with more or less clear organizational and legal forms has been identified. The re-organization of the Russian holdings follows three main courses:

• Assets consolidation in the core businesses and divestments of non-core assets processes are mostly implemented by the companies in the oil (Surgutneftgaz, LUKoil, YUKOS) and metal (Norilsk Nickel, Russian Aluminium (RUSAL)) sectors.
• Holding restructuring - RAO UES of Russia (the programme aimed at splitting-off, generating a transport and sales companies in a separate corporate structure), GAZPROM (transformation of 17 subsidiary transport companies into joint stock companies with independent accounting).
• Amicable mergers and acquisitions - some deals were carried out in the IT and telecommunication market (acquisition by the cellular operators MTS and Megafon of regional cellular operators) and in the food industry (acquiring of regional breweries by St. Petersburg Brewery Baltika, formation of the confectionery holding Krasny Oktjabr etc).

Corporate governance has recently obtained more civilized forms. Many companies have announced the introduction of "independent directors" and a corporate code of fair practice etc. At the same time company acquisitions are becoming more strategy oriented. The following aspects have become the key criteria for mergers and acquisitions:

• technological, financial and economic advisability of absorbing new assets;
• high level of corporate control over affiliated structures (75% or more);
• organizational and legal transformation (including full-scaled merger, consolidation within the framework and between holdings, transfer to a single share etc.).

Major evidence of more efficient corporate governance is the change in ownership from insider control to outside shareholders' domination, which is illustrated in the Table below.

Changes in the ownership structure of medium-sized and large Russian joint stock companies, % of authorized capital*

* The Table does not take into account the largest companies and holdings, enterprises of strategic importance (with blocks of shares assigned as the state property) and branch differences. The real share of insiders (managers) is normally higher, taking into consideration affiliated structures regarded in this case as outside shareholders.

Source: Institute of Economy in Transition, Russia

However, the trend for decreasing insider control is much less observable in the larger holdings, where power is concentrated in narrow groups of owners, mostly the management of the companies. The main remaining problem is the lack of transparency with respect to the minority shareholders. In most cases the minority shareholders are either notified after a reorganization has taken place (Norilsk Nickel, Surgutneftegaz etc.) or they are informed but not involved in the decision making on the alternatives (RAO UES of Russia). There is still a substantial gap between the word of the law and its implementation. Despite legislation, minority shareholders' declared rights are not always guaranteed. The Stock market as an efficient mechanism of control in such cases is yet to demonstrate its true influence in Russia.

Notes

¹ Based on the report "Economy of Russia in 2000", prepared by the Institute of Transitional Period.
² For a long time there has been a legislative basis in Russia, which regulates the questions connected with the organization and activity of financial-and-industrial groups. However, the process of securing the legal status of FIG was not widespread due to lack of practical incentives and economic reasons for that.