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. Last Updated: 07/27/2016

Gazprom: What Is It Really Worth?

In theory, Gazprom is a stock that international investors should be delighted to finally have the chance to buy.


Gazprom is, indeed, a company of superlatives: It is Russia's largest company, it owns one-fourth of the world's gas reserves, its arena of operations is one of the world's largest territories, and it operates a pipeline network that could circle the world three times -- and then some.


But with its stock due to go on sale for the first time internationally on the London Stock Exchange in late October, interest in Gazprom shares is not as great as Gazprom management might have wished.


A company brochure -- "Dialogue with Gazprom" -- issued this year confidently promised, "In view of our control of a significant percentage of the market and the opportunities for further increases in production, we believe we are justified in valuing the company at $5 a share at the initial stage."


Yet for the public sale of 1 percent of the company's stock sometime later this month -- out of a total of 9 percent the company eventually plans to issue on foreign markets -- managing brokers Morgan Stanley and Kleinwort Benson established a price of $1.40 to $1.60 per share.


That price would mean Gazprom was worth, in total, about $38 billion -- well within the range of conservative Western valuations of between $30 billion and $50 billion, but not much for a company that sells about $8 billion worth of natural gas to the West each year and has even bigger revenues at home. The company's own figures claim a profit of $3.5 billion in 1995.


Part of the problem is the complicated trading restrictions on Gazprom stock within Russia which mean that it can be bought in three places at three different prices.


But the market's skepticism goes deeper: No Russian company has attracted as much attention and publicity as Gazprom, but given the dearth of real information, it is hard to distinguish fact from rumor. Investment analysts and bankers usually prefer to speak off the record when commenting about Gazprom.


In assessing Gazprom, the key fact is that the company has incredible political influence in Russia, far more influence than even the strong banking lobby. Three senior cabinet ministers -- Prime Minister Viktor Chernomyrdin, Deputy Prime Minister Vladimir Babichev and Energy Minister Pyotr Rodionov -- have all worked at Gazprom. Or, as they say at the head office, they've "gone along the pipeline."


"The government -- not just the big energy money issues -- is now run by Gazprom," said one recent report by a Western accounting firm.


Indeed, it was Chernomyrdin himself who in 1989 transformed the Soviet Gas Industry Ministry into the company Gazprom, which he then ran until he became deputy prime minister responsible for the gas industry in May 1992.


Though over four years have passed since Chernomyrdin left Gazprom, the 40 percent state-owned energy empire remains his power base.


Rumors were abundant last year, for instance, that Gazprom bribed key State Duma deputies to ensure that Chernomyrdin survived a dangerous vote of no confidence. And when President Boris Yeltsin was struggling to win a second term, representatives of Gazprom's closest Western partners -- their biggest Western client, Ruhrgas and the billion-Deutsche-mark German gas supply joint venture Wintershall -- had a hard time arranging meetings with top Gazprom management because they were all too busy campaigning.


The close relationship between Gazprom and the government is, in fact, one of finely balanced give-and-take.


For instance, thanks to Chernomyrdin's influence, Gazprom has remained a monopolistic behemoth; this is in marked contrast to the oil industry, which has been split up into scores of enterprises. The company is a conglomerate of 40 subsidiary enterprises, which handle everything from drilling wells to piping gas into homes.


The jury is still out on whether this is a "natural" monopoly or whether it would make more sense to introduce some competition into the market. In its defense, the company points out that while production in every other industry has slumped over the past five years, Gazprom has been one of the few stable companies and has continued to supply almost 50 percent of energy to both domestic and industrial consumers.


Even the International Monetary Fund does not have a strong opinion on whether Gazprom is too monopolistic.


"Until it is known how profitable Gazprom and its different subsidiaries really are, it is premature to argue whether to demonopolize it," said Moscow's IMF representative, Thomas Wolf.


The IMF has been more concerned about other aspects of the symbiotic relationship between the government and Gazprom -- in particular, the billions of dollars in tax concessions the government has granted it.


After years of dispute, the government finally managed in April to abolish a tax-free "stabilization fund" into which the gas monopoly had been allowed to transfer parts of its $8 billion export earnings.


As a result of this and other tax privileges, Gazprom's contribution to the government's budget revenues was far lower than its 8 percent contribution to gross domestic product. Harvard economist Jeffrey Sachs has charged that Gazprom was "stolen" from the Russian people.





But Gazprom can make a case that economic reality is far more complicated than these examples of government favors suggest. Gazprom does give something back to the government.


While in its huge exports to the West Gazprom is working more and more like a profit-maximizing company, it still functions in Russia in the tradition of the old Soviet Gas Ministry, which operated under political rather than profit-oriented guidelines.


For years, the gas giant has been subsidizing whole regions, huge sectors of industry and private households. It supplies at well below cost and keeps supplying even when consumers refuse to pay.


This was probably why Gazprom Chairman Rem Vyakhirev chose to enter the public spotlight a few weeks ago and complain publicly that local tax officers had seized Gazprom bank accounts and property over tax arrears.


At a press conference, Vyakhirev gave Gazprom's classic argument. On the one hand, the energy tycoon admitted, Gazprom owed the government some 15 trillion rubles ($2.8 billion). But on the other, he emphasized that, according to Gazprom figures, consumers owed it almost 50 trillion rubles.


Awkwardly, among Gazprom's debtors are about 60 republics, regions and cities -- including the big apple of Moscow itself. Vyakhirev noted all this ominously in a letter to the Federation Council. "Financially, the company has come to a critical limit," he warned.


For many, these financial difficulties are a sign of mismanagement and nepotism. "If Gazprom management cannot pay the company's bills in spite of export incomes worth billions of dollars a year, then it should step down," said one Russian investment banker.


Yet this is only one of the aspects of Gazprom's business strategy that is hard for outsiders to understand. On one hand, Gazprom workers go without wages for three or four months. On the other, the company has built a monumental headquarters in southern Moscow that cost at least $150 million.


And while important investments in core gas projects are put on hold for lack of funds, Gazprom is investing in media assets including the daily newspaper Komsomolskaya Pravda and NTV television.


Take another contradiction: Most international companies are committed to cutting fat and out-sourcing as a strategy for getting rid of loss-making business divisions, but Gazprom is still doing everything for itself and still wants to do more. Gazprom subsidiaries produce everything from fruit and vegetables to mineral water, and are involved in businesses from meat packing to door manufacturing. It recently bought into a new bank, National Reserve, which with Gazprom's help jumped from obscurity onto the list of Russia's top 10 financial institutions in a little over a year.


Many analysts are highly critical of this strategy of expansion: Gazprom is moving well outside its core business.


This is particularly important for the numerous companies and joint ventures that Gazprom is setting up abroad. Some of them, such as Germany's Wintershall gas supply joint venture, reflect a strategy of winning independence from major clients such as Ruhrgas, the major German gas distributor. Gazprom is trying to skim off the cream by selling gas directly to consumers abroad.


But Gazprom watchers also note the growth of vague "trading joint ventures" that are apparently little more than a pretext for international travel for Gazprom management.





The question of whether Gazprom is either efficient or potentially profitable is an enigma for many investment bankers, who must make their calculations without reliable profit-loss information.


"Gazprom's valuation presents significant challenges," the U.S. brokerage Salomon Brothers wrote in a study.


One of these challenges is Gazprom's management itself. Vyakhirev, 62, is a typical product of the old system. In his four decades in the gas and oil business, he ascended the ladder from simple mechanic to deputy gas minister of the Soviet Union, and in 1992 he finally followed in Chernomyrdin's footsteps as chairman of the company. In old Soviet tradition, Vyakhirev behaves more like a fatherly general director than as a Western-style top manager.


Many experts doubt that Vyakhirev is the right man to transform Gazprom into an efficient joint-stock company. A comparison with Western competitors shows that under Vyakhirev's management, the Russian giant still behaves much like a Soviet-era employer: The workers of the U.S. oil major Exxon, according to 1995 figures, have been almost 12 times as productive as their Gazprom colleagues.


One key issue is the lack of information about the company. Though investment bankers admit that Gazprom is working toward becoming more transparent, they still stress how much more needs to be done, especially if the company is to sell in London


"To date, foreign interest [in Gazprom's international issue] has been lukewarm," U.S. investment bank Morgan Stanley analysts wrote in a May report.


But Gazprom's closed books may gradually be opening. In 1995, for the first time in the company's history, Gazprom's records were checked by an international auditor. A team of some 70 full-time auditors from the international accounting firm Price Waterhouse spent more than a year going through Gazprom's books and produced a balance sheet audited and presented to international-standards. For 1996, profit-loss accounts, prepared to Russian standards, will be re-audited according to international standards.


But it is economic, not political expediency that has this once-closed and secretive company going public: They need billions of foreign dollars to finance their ambitious investment projects.


"To have gas reserves is one thing, to exploit them is another," said James Bunch of Renaissance Capital.


According to the study by Morgan Stanley, the company's capital requirements could exceed $15 billion over the next five years. The first two stages of the Yamal project -- pipelines from the Russia's Far North through Belarus and Poland and on to Western Europe -- are estimated by Morgan Stanley to have a price tag of up to $6 billion. With 95 percent of Russia's gas exports to Europe now crossing through Ukraine, making Russia and Gazprom singularly politically dependent on Kiev, the Yamal pipeline is at the top of Gazprom's -- and Russia's -- to-do list.


But the first two stages of the Yamal project -- which are scheduled, in the longer term, to be followed by a $32 billion to $34 billion exploration of huge gas reserves on the Arctic Yamal peninsula -- are just one part of huge investment requirements. Another major item on the balance sheet will be the replacement of old pipelines and compressor stations, estimated to demand another $5 billion over the next 10 years.


Analysts dispute to what extent Gazprom will be able to finance its slated multibillion-dollar investments out of its own pocket. In its preliminiary memorandum to the London stock offering, Gazprom estimated its investment needs at $40 billion over 10 years. This includes $16 billion for production, commissioning new fields, upgrading pipes and compressors stations and general maintenance. Another $12 billion will go to the two Yamal Europe pipelines.


While Morgan Stanley is quite optimistic that Gazprom can find in-house funding, Salomon Brothers paints a more conservative picture, estimating that Gazprom will need much more than $40 billion and may need to raise billions on international markets.


The first 1 percent slice of the total 9 percent of shares scheduled to be sold to foreigners will bring, at the most, $500 million.


The decisive factor for Gazprom will be the development of the domestic market. So far, Gazprom is practically strangled by low domestic gas prices and the non-payments crisis on its own market.


How will Gazprom extricate itself from its home-market woes? According to IMF and World Bank economists, the scenario is simple: Russia's energy giant must finally pay its taxes and at the same time collect trillions of rubles in payment arrears. The result would be massive bankruptcy among Russian companies and cuts in gas supplies to entire cities and regions.


This might be reasonable in terms of economic theory, but it is unthinkable in Russia's social and political landscape. A second scenario is more likely: For another couple of years, Gazprom will continue to supply huge sectors of the Russian economy with cheap gas. It will take a long time for Gazprom to start bringing domestic revenues in line with costs, and politics will likely take precedence over economic reason.


But this will create a conflict for Gazprom if it is to meet its investment plans. Unless the domestic market becomes more profitable, Gazprom will have to finance a huge part of its capital investment by credits and stock issues rather than out of profits.


"Unless domestic prices are raised, Gazprom will face serious difficulties in paying for essential investments on its own," said one Moscow investment analyst, who asked not to be identified.


This means a serious risk for foreign investors who take the plunge and decide to buy Gazprom shares. Either the shares might be watered down by new issues or debt repayments will take up a bigger and bigger share of the company's profits.


Further risks arise from the arbitrage between the two or even three markets for Gazprom shares that will soon exist.


The domestic market is highly illiquid because Gazprom management itself restricts the trade in its shares. Gazprom's written permission is required to acquire more than 3 percent of its shares, and Russian citizens holding Gazprom shares must offer them first to Gazprom before selling to anyone else. These regulations effectively kill the domestic market which is reflected in the low price of Gazprom shares in Russia.


While international investors will have to pay up to $1.60 for shares which they will be able to trade freely, on the domestic market Gazprom shares are priced currently at 49 cents in over-the-counter trade and at 54 cents on weekly auctions to institutional investors. But once the restrictions are lifted, the prices will equalize and the markets will merge.


While foreign investors in Gazprom shares might place their money at risk because of these problems, for Russia it is a question of greater import: Only if Gazprom is able to transform itself into a transparent and efficient joint-stock company will it be able to finance its huge share of the government's budget.


Only then can Gazprom begin to invest trillions of rubles back into Russia's economy and become an engine for economic growth. And only then will Gazprom chairman Vyakhirev be right in saying, as he is wont: "What's good for Gazprom is good for Russia."





Joerg Eigendorf works as an economic correspondent in Moscow. He writes for "Die Zeit."