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. Last Updated: 07/27/2016

Surgut Says Share Dilution Was Legal, Safe

The head of securities for Surgut Holding on Friday defended the oil company's controversial share dilution, saying it was a legal move made to ensure that management retained control over the valuable enterprise.


"We knew what we were doing and are ready to face the music," Andrei Serebryakov, acting chief of Surgut Holding's securities department, said in a telephone interview.


The supplemental share issue, which came to light late last month, was made to protect against the possible dilution of management control in the holding if the company is unable to pay dividends on 25 percent of its preferred stock, he said.


Failure to pay such dividends would force the company to convert the preferred stock into common shares, which could result in management's stake falling below 50 percent.


"This was done to ensure the holding retains control under any circumstances," Serebryakov said. "We don't know what the taxes are going to be next year and whether we'll be able to pay dividends, so we want to be on the safe side."


Surgut Holding last month acquired the entire issue of 500 million common shares, and 34 million preferred shares in the main production unit, Surgutneftegaz -- effectively amounting to a 10 percent dilution. The nominal value of the shares was about $100 million against a market price of $210 million.


Following complaints by minority shareholders that the stock dilution infringed upon their rights, Russia's Federal Securities Commission has sent an investigative team to company headquarters in the western Siberian city of Surgut, commission spokeswoman Valentina Rasumnova said.


The commission has also asked the Finance Ministry to suspend the registration of the share issue, although the government has not yet done so, Rasumnova said.


Serebryakov said he expected a decision by the commission within two weeks.


Share dilutions are hardly uncommon in Russia's brief annals of corporate history, with oil company Komineft and Primorsky Shipping gaining notoriety last year for so-called stealth stock issues. But the share dilution by the parent of Surgutneftegaz -- one of Russia's most actively traded and attractive stocks among foreign and domestic investors -- surprised many in the market.


The essence of shareholder complaints is that the entire issue was bought by the holding company at a per share par value of $0.18, well below the average trading price of $0.46 prior to the issue. Brokers downgraded common shares of Surgutneftegaz, and the stock fell sharply on the news. It has largely recovered in heavy trading, though, closing Friday at $0.427.


"By not telling existing shareholders and selling it below market price to an insider [means] they are not really concerned about share value at the subsidiary level. They're concerned about control issues," said Renaissance Capital analyst James Bunch.


But Serebryakov said the company's intentions should have been clear. The timing of the issue was made, he said, because of Surgutneftegaz's expected issue by the end of the year of American Depository Receipts -- share look-alikes of Russian stock that allow easy trading in foreign markets.


"Competent analysts should have guessed that we were going to do this before the ADR issue because later it would be more difficult, and more trouble," Serebryakov said. "We couldn't have informed everyone about the issue beforehand, because that would mean a lot of headache."


Surgut Holding contends that the issue was made in accordance with the company's charter, approved last June, and was expected to increase its control over the subsidiary.


"The law does not define what the market value is. There are no clear legal guidelines as to how it could be established," Serebryakov said. "We tried to prove to the commission that in this case it was the par value."


Serebryakov declined to comment on whether the Federal Securities Commission was satisfied with the holding's explanation of the share issuance. But he said that, if regulators agreed, it "will set a precedent."


Even if the securities commission rules that the share issue was illegal, Surgutneftegaz management's reputation for being intent on keeping full control of its assets means "they'll just make sure they do it in a legal way so that it can't be challenged," Bunch said.


Serebryakov also said the holding company wanted to increase control because some of the shares belonging to employees of Surgutneftegaz had already been sold to Moscow brokerages, then "found their way abroad."


"Of course the company relied on employees' voting stock, so this is another reason for us to renew the lost control," said Serebryakov, adding that the new issue will not reach the secondary market


Investors raised questions, however, about management's argument that it needed to offset the growing leverage of Moscow brokers who had been buying the subsidiary's stocks throughout the region.


Before the issue and buy-out, Surgut holding owned a 51 percent stake in its production subsidiary. With the new shares added in, it now controls 56.3 percent of ordinary shares.


"There is no threat to their control from Moscow brokers buying up the shares," Bunch said.


Bunch said that management's control over the company could be at risk only if the holding was forced to convert the preferred stock into ordinary shares, or decided to consolidate the subsidiary into the holding company.


"By doing this share issuance [managers] increase their percentage ownership slightly," Bunch said, "which makes the control issue less of a concern."