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. Last Updated: 07/27/2016

Under Siege




Germany's Knauf is losing its battle for control of a building


materials factory in the Krasnodar Territory, but it has its own formula for winning the war in its other Russian enterprises.


Mark Whitehouse reports.


PSEBAI, Southern Russia -- As winter set in, the Germans were under siege, holed up with a gas generator, a satellite phone, sausage, bread and a sleeping mat. Local Cossacks were on the warpath, threatening to hang the "occupants."


The disputed territory? Kubansky Gips, a factory in the Krasnodar Territory of southern Russia that processes gypsum, a key ingredient in plasterboard.


"I believe in the future of the Russian market and Russian industry," said the Germans' leader, Bernd Hofmann, as he faxed yet another SOS to Moscow. "That's why we're sitting here like idiots."


On Nov. 24, five days after Hofmann pronounced the word "idiots," the director collected a mob of locals and physically ejected Knauf's representatives and guards from their own property.


Hofmann came to Russia to make money, not war. His employer, Knauf, one of Europe's biggest building materials firms, has invested some 250 million Deutsche marks ($150 million) in 12 Russian enterprises, most of which are working well. It took a controlling stake in the Kubansky Gips-Knauf gypsum factory in 1995, planning to turn it into the leading producer of plasterboard in the Krasnodar Territory and southern Russia.


But instead of building business plans, Knauf has been trying for nearly two years, using legal means, to wrest control of its factory from a renegade director, so far with no luck.


Knauf's plight has reached the agendas of top officials here and in Germany, becoming a key test of the Kremlin's influence over its far-flung regions and the sanctity of private property in Russia. German Chancellor Helmut Kohl mentioned the case as a sticking point in his meeting earlier this month with President Boris Yeltsin. In the meantime, Krasnodar Territory's Communist governor and his allies in the State Duma have been trying to renationalize the plant.


The Germans' experience proves that in Russia even smart investors can run into trouble, and that despite nearly six years of economic reforms, they still can't rely on the law or the government to come to their defense.


The Krasnodar authorities "want people to invest here and agree to get nothing out of it," said Valery Fomenko, the chairman of the Kubansky Gips-Knauf board-in-exile. "They've set the economic issues aside and started playing pure politics."


Time to pack up and leave? Not necessarily. Knauf has looked hard at what happened in Krasnodar and learned that even in a lawless land, there are ways to reduce the risk of getting fleeced. The key is to realize that you can count on nobody but yourself.


"Self-sufficiency is the motto," said Toby Latta, FSU consultant at Control Risks Group, a London-based firm that advises companies on risk management. "Getting out of a mess once you're in it is much more difficult in Russia than in other countries."


DEBACLE


Back in 1993, when Knauf first came to Russia, Kubansky Gips looked like a great investment. It was in some financial trouble, but it had its own easily mined reserves of high-quality gypsum and relatively modern equipment. Despite the plant's remote location in Psebai, a tiny town in the Mostovskoi district near the Georgian border, Knauf specialists believed it had the potential to win markets in southern Russia, Ukraine and Kazakhstan.


After meeting with the management and signing a framework agreement, Knauf bought a 37 percent stake in the factory in late 1993. At the end of 1994, Knauf and management came to a new agreement under which the Germans invested 1.2 million Deutsche marks ($680,000) in new equipment and promised to reinvest all profits for a period of at least eight years. In return, Knauf received a controlling stake in the factory, which was newly registered as Kubansky Gips-Knauf.


When the new enterprise was born, the retiring general director, with whom Knauf had built a good relationship, recommended Alim Sergienko as his successor. Since there were no other viable candidates, the shareholders elected Sergienko for a one-year term in early 1995.


Soon afterward, Knauf started to notice some irregularities. Sergienko unilaterally extended his term to three years and started dragging his feet when the majority shareholders asked for financial data. Even more worrying, gypsum was disappearing: According to an independent study conducted by the Moscow-based VNIIStrom institute, the amount of raw gypsum used for each ton of plasterboard was at least 25 percent higher than normal.


"It was theft -- today we know that's the case," said Hofmann, Knauf's director for Eastern Europe. He estimates that the director was making about $100,000 a year on the missing gypsum alone.


Sergienko avoids journalists. When The Moscow Times visited his offices in Psebai last month, his secretary said that he was out and would not agree to an interview. He was later seen leaving the factory in a white Volga sedan with two bodyguards.


Sergienko's deputy, technical director Anatoly Bondarenko, refused an offer to tell his side of the story. "It's our internal problem," he said. "Let us deal with it ourselves."


By the end of 1995, the Germans received more bad news: The factory had built up some $400,000 in tax debts. Knauf agreed to pay the debts, but demanded a closer look at the company's books.


Feeling the heat, Sergienko went to war. In January 1996, he kicked out two Knauf engineers and barred all other Knauf personnel from entering the factory.


"For one and a half years not one of us was allowed onto the territory of the factory," said Hofmann. "We received no information whatsoever."


Knauf, which holds a 50.1 percent stake in the factory, called an emergency shareholders' meeting in May 1996 and presented a list of 12 key violations committed by Sergienko, including theft, tax manipulations, closing out the majority shareholder and unilateral cancellation of the board of directors' decisions. The shareholders present suspended Sergienko and sent the charges to the local prosecutor.


The prosecutor did nothing, and Sergienko began to hold his own shareholders' meetings, making attendance obligatory for the factory's 400 workers.


"He runs them as he sees fit," said Alexei Veryovkin, 66, a pensioner who worked 24 years at the plant as an excavator operator and traded his family's vouchers for the company's shares during Russia's mass privatization drive in 1993. "If you go to the Knauf meeting, you can be sure that you don't have a job."


At two meetings in May and September of 1996, Sergienko removed Knauf from the company's name and issued new sharesto dilute the Germans' stake. According to Knauf lawyer Nikolai Piksin, the registration chamber in Moscow refused to approve the new share issue, so Sergienko went to the head of the Mostovskoi district administration, Igor Asmolov, who signed the issue in January 1997.


"The administration had no right to do that," Piksin said.


Asmolov was not troubled by the legality of his actions. "For the Germans to work they only need a blocking stake, or a little more than 25 percent," he said in an interview last month. "They don't want to compromise."


Hoping to appeal to reason, Hofmann arranged a meeting with the newly elected governor of Krasnodar Territory, Nikolai Kondratenko, a longtime Communist who has made his name playing on his constituency's nationalist leanings. Hofmann presented the governor with a business plan under which Knauf would pay off the company's debts and invest millions more in new lines to produce fireproof, waterproof plasterboard and other building materials.


Kondratenko was terse and polite, but soon flew his true colors: In April 1997, he signed a decree to renationalize the factory, issuing new government shares worth 64 percent of total capital.


"This is the Red Belt," said Knauf-backed chairman-in-exile Fomenko. "Communists have taken power -- the kind of Communists who only know how to divide and allot. ... But since here a concrete owner has appeared, you can't just allot his property. Therefore you have to take away some of that property so you can start dividing and allotting again."


Knauf had already taken its case to court, and after a long and arduous process it won two key decisions: In August 1997, the North Caucasus Federal Arbitration Court confirmed its controlling stake, and in October the same court ruled that AO Kubansky Gips, the company that Sergienko set up, does not exist and therefore cannot hold any shareholders' meetings.


IMPOTENCE


Encouraged by the court decisions, Knauf representatives returned to the factory Sept. 27 with the help of unarmed guards. But Sergienko would not be outdone: He turned off their heat, electricity and telephone lines, organized a picket of the administrative building where he and the Germans both worked on the third floor and hired local Cossacks to guard him and his offices.


"There are more security guards here than managers," said Fomenko.


The head of the Mostovskoi Cossacks, Viktor Savchenko, launched into the battle with gusto, publishing a threatening open letter in a leading regional newspaper, Kubanskiye Novosti.


"Brothers!" he wrote. "We see the invasion of armed mercenaries from Moscow at Kubansky Gips as a provocation designed to create a situation in Kuban like that in Chechnya. ... We warn that we will take all necessary measures to prevent the squandering of Kuban's wealth!"


The Germans lasted nearly two months, during which they came to understand the real value of court decisions in Russia. At one point, presented with a court order to allow Fomenko into the administrative building, Sergienko reportedly ripped the document onto shreds.


The Russian government's reaction to the flagrant undermining of its authority has been at best tepid.


In October, the Commission for the Protection of Investors' Rights, headed by Prime Minister Viktor Chernomyrdin, sent a group of officials to Krasnodar and Psebai to investigate Knauf's problems. More than a month later, they concluded in a report that Knauf's rights were being violated, and that "the administration of the Krasnodar territory is not taking any actions to protect the rights of the foreign investor."


"Everybody here laughs at the government and at Chernomyrdin," said Hofmann.


The commission's efforts have so far brought only one concrete result: On Dec. 1, the Federal Securities Commission, or FKTsB, issued an order to annul the dilution of Kubansky Gips-Knauf shares. But according to acting FKTsB press secretary Vadim Bely, neither Sergienko northe local authorities are obligated by law to fulfill the order.


"The FKTsB has done all it can to solve the problem," he said. "It's a distant region with its own peculiarities."


While the battle has raged, the gypsum factory's financial health has visibly deteriorated, though little real information is available. According to Hofmann, the plant produced and sold 550,000 square meters of plasterboard in 1995, and had contracts to sell more than 1 million square meters in 1996, but ultimately produced only 350,000 square meters. In September, he said, local tax police arrested 2.5 billion rubles' ($425,000) worth of the company's assets due to unpaid back taxes.


Asked how much money he estimated Knauf had lost in Psebai, attorney Gerd Lenga was philosophical: "It's no longer an economic question, it's a matter of principle."


HARD-WON LESSONS


Knauf cannot be dismissed as a naive investor, nor can Psebai be called an isolated incident. Across the country, similar property battles are unfolding: Owners of the Kosmos-TV cable company in Moscow have been trying for months to get rid of an unwanted director; foreign and Russian portfolio investors have had a protracted court battle to gain seats on the board of the Novolipetsk Metallurgical Factory; and the Orenburg-based steel plant Nosta shocked shareholders last month with a surprise share dilution that effectively annihilated their stakes.


To some extent, the key to avoiding such pitfalls is a blend of luck, the personalities of the partners and the politics of the local authorities. At TIGI-Knauf, for example, a factory similar to Kubansky Gips in the Moscow region town of Krasnogorsk, the Germans have achieved stellar results.


TIGI-Knauf produces and sells near its capacity of 10 million square meters of plasterboard a year, generates about 12 million Deutsche marks in annual profits, and has sprouted a separate marketing firm, several new product lines and a training center to teach builders how to use its products. Last month, the factory won an award from the Russian Union of Entrepreneurs as a model of Russian-foreign cooperation.


"I'm just differently educated than Sergienko," said TIGI-Knauf director Alexei Gorovoi. "If I'm told that I'm not needed, I'll just turn around and leave. ... The mayor of Krasnogorsk would never sign the documents that Asmolov signed, because he respects the law."


Still, Knauf has learned some lessons in Psebai that it plans to apply throughout the country, said J?rgen Weiss, head of planning, control and personnel for the CIS:


...Do background checks on top management before investing. This includes checking the managers' personal ties to local officials and the number of people they have actually involved in the production process. Weiss looks out for too many supervisors and too many secretaries. "If they have a lot of secretaries, that is a bad sign for us," he said. "When a lot of people have secretaries they don't work any more themselves."


...Improve financial reporting. Knauf is installing software at all its factories that will ultimately provide weekly financial reports. One of the problems at Kubansky Gips, said Weiss, was that they didn't know how bad the financial situation was until it was too late. "We can see which guy is selling at lower prices than he should," he said.


...Spread the power, so that if the director blows a fuse, somebody will be around to make independent decisions. "In Russia, the director decides everything," said Weiss. "We give more responsibility to the lower management."


...Invest in employees. Knauf says it pays Russian employees well above average, and is putting new emphasis on training that helps them feel like a part of the company.


Gorovoi pointed out that in Russia, investors must assert their control or risk losing it, no matter what how big their stake might be. Knauf, he believes, could have averted disaster in Psebai if it had fired Sergienko when the first problems appeared.


"You need to show a toughness of character," he said. "Knauf has a hard time deciding to get rid of directors. In the period of a year, Sergienko dug in so deep that they already couldn't get rid of him."


Latta of Control Risks agreed: "It's everything from posturing correctly, making it felt that you are a tough and determined investor, making it felt that you're bringing something positive to the party, to actually doing what you say you're going to do."


But while hindsight might help Knauf and other investors act more wisely in the future, it offers little consolation to Hofmann, who is still sending faxes to top officials and hoping that something will come of Kohl's meeting with Yeltsin.


"There is no higher authority," said Hofmann. "Only God can help us now."