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. Last Updated: 07/27/2016

THE ANALYST: Past Privatization Misdeeds Surface to Haunt Russia




The ghosts of privatization continue to haunt the graveyard of Russian industry. The latest specter has been conjured by the State Property Ministry, which conducts the sales of federally owned property. Officials at the ministry are reportedly filing suit to reverse the result of a 1994 sale of a majority interest in Avisma, Russia's largest and only producer of titanium sponge. The defendant: a company by the name of Mayak, which is a subsidiary of the Bank Menatep group.


At stake is control over a company that boasts one-fourth of worldwide production of the precious raw material used to manufacture airplane engines and golf clubs. Located in the Perm region, Avisma is a company anyone would want to get their hands on. It is one of the scant six producers of titanium sponge in the world, and in 1997 it produced 25 percent of global production, a market share the plant was able to improve last year. Used primarily in aircraft production, the titanium sponge is exported to a select list of buyers in the United States, Europe and Japan.


Two years ago, Mikhail Khodorkovsky, founder of Bank Menatep and one of Russia's self-professed oligarchs, had a change of heart. Instead of becoming a "mega-magnate" simultaneously involved in multiple industries, he wanted to concentrate his financial resources on oil. In order to create his dream company that would extract 100 million tons of crude annually, he started to jettison some of his finest non-oil holdings, including a 52 percent interest in Avisma.


For VSMPO, Russia's largest producer of titanium mill products (such as ingot), this was a golden opportunity. Since the break-up of the Soviet Union, VSMPO, located in the nearby Yekaterinburg region, was forced to source its raw materials (titanium sponge) from strategic stockpiles and other producers. Like so many other natural economic links, the Avisma-VSMPO connection was severed with the advent of a "market economy." Nonetheless, VSMPO managers managed to retain a 10 percent worldwide market share in titanium products, and never ceased hoping that one day they would take control over their core supplier of raw materials.


This was when the Moscow branch of Creditanstalt stepped into the picture. Representing a group of foreign investors, Creditanstalt convinced VSMPO management to conduct a share acquisition. After issuing foreign investors new stock, VSMPO would turn around and use the capital to buy a controlling stake in Avisma. Months in the making, the deal eventually succeeded in October and is now a landmark in that it became the prototype of a domestic acquisition financed with foreign capital. The VSMPO-Avisma alliance became the fifth integrated titanium producer in the world and possesses enormous unused capacity. In 1997 the group exported almost 80 percent of its output.


And now this litigation. According to the State Property Ministry, the Menatep subsidiary, Mayak, failed to invest in Avisma $17.3 million in 1994 and $18.3 million more over the following two years in accordance with the conditions spelled out in the tender. Sources close to Avisma say that it is no secret that Menatep never invested any significant capital in the company, although as soon as they took over operations Moscow bankers were keen to increase production and ensure that salaries were paid on time.


Certainly the most intriguing part of this escapade (which is exactly what any legal affair is in Russia when it involves an oligarch and/or the State Property Ministry) is the sudden legal action. Why, four years down the line, are privatization officials suddenly interested in whether Bank Menatep's subsidiary met its investment obligations? If there were violations, what took bureaucrats so long to act?


That is why the underlying reason for the suit is purely political. Someone in government is either jealous of VSMPO-Avisma's fortunate marriage or has a bone to pick with Menatep, which Khodorkovsky appears ready to toss to the vultures. The most probable theory is regional indignation. There are reports that since taking over Avisma, VSMPO has been forcing its supplier to sell titanium sponge at below-cost. Profits are transferred to Yekaterinburg, home of VSMPO, and Avisma's balance sheets end up with the losses. Once one of the top five taxpayers in the Perm region, Avisma is now a dud, and regional leaders are certainly miffed.


Alas, the ghosts of privatization are still arising. And since these spirits are more often than not summoned by a political medium, chances are we will see a lot of these hauntings over the next few years. And though the riddle of the Avisma tale is in bureaucrats' ulterior motive, its moral is the same as always: Privatization in Russia is nothing but neglect and abuse. It has been one of the most massive displays of incompetence in contemporary economic history. The bottom line is that Russians should give up trying to privatize their country and let a group of reliable foreigners do it for them.