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. Last Updated: 07/27/2016

UES: The Future Looks Bright

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Baron Nathan Rothschild, one of the best investors in history, said that the right time to invest is when blood is running in the streets. His point was that periods of turmoil, when investors are panicked and everyone assumes that only catastrophe awaits, offer the best opportunities. Russia is not undergoing a bloody revolution but, figuratively speaking, there is blood in the streets of the electricity sector. Share prices are less than 10 percent of similar companies in other countries. Influential investment banks forecast that most assets will be lost to shareholders over the course of restructuring. The market believes that any assets not lost will never be profitable due to inefficient regulation. This looks like an excellent time to invest.

Today all may look dark in the electricity sector, but not much really needs to happen for investment interest in the sector to pick up. In my role as minority shareholder representative on the board of directors of Unified Energy Systems, I spend a lot of time talking to portfolio investors who are minority shareholders of the company. These shareholders care about a small number of criteria:

A clear, consistent plan for reform;

Clear ownership rights maintained over the course of restructuring;

A market which allows efficient, well managed businesses to be profitable;

And, sufficient liquidity of company shares.

These criteria are all achievable. A clear, consistent plan for reform will emerge shortly after the State Duma passes the electricity sector reform laws.

Ownership rights have so far been respected, albeit with occasional threats, and ownership will remain respected so long as we remain vigilant. My key focus on the board is to remain vigilant.

The reform laws should allow efficient businesses to be profitable.

Sufficient liquidity of shares is one of my goals on the board, and I have proposed ADR facilities for all spun-off companies as well as company mergers to improve liquidity. At the end of the reform, most if not all of UES spin-offs will be large enough to be liquid.

One key concern of investors is that electricity sector reforms in Russia will not be carried through at all. This risk is minimized by the fact that over the long run prices will always be higher under a cost-plus system, such as the one Russia uses today, than under competition. The government is smart enough to realize that the only real way to reduce electricity tariffs is competition.

The other concern I often hear is that of the "Chubais Risk." Some analysts and investors believe that UES CEO Anatoly Chubais is necessary for reform and worry about his removal. Others believe that effective and fair reform cannot be carried out while he heads UES and worry that he will not be removed. Both beliefs are mistaken. Personalizing reform as a debate over Chubais is an easy way out for people who don't really understand the reform. It is easy to say "Chubais is evil so all the measures he proposes are evil" or "Chubais is good so all the measures he proposes are good."

Despite my strong opposition to many of his initiatives I would not say that I am anti-Chubais. I want reforms to happen, shareholders to retain ownership over assets and the market to function efficiently. I support any proposals that promote those goals.

I share with the market all of the information I receive on the board of UES and, in fact, by the time the board receives any information it has been seen by hundreds of people.

However, I do know one important thing that the market either doesn't know or doesn't believe. It is not all agreed beforehand. Market analysts seem to think that key decision makers sit around behind closed doors, smoke cigars and divide up Russia's electricity sector. Well, I'm sure that people sit around behind closed doors and talk about all sorts of things, but I know that a number of key decision makers in the Russian government are honestly trying to think through the issues and make the best decision for the country.

Investors today are too cynical and their cynicism causes them to miss this opportunity.

In 1999, after a series of corporate governance abuses, oil major Yukos cost only 18 cents per share but nobody wanted to buy. Yukos management claimed it was reformed and presented evidence of good intentions, but investors said, "We're too smart to be tricked this time." Today, those same investors are happy to buy shares in Yukos at $9.00 per share.

Similarly, the market does not believe the positive steps taken toward electricity sector reform. One potential investor said to me, "Well yes, the initial steps are good but that is just to lure you in. I'm too smart to be tricked."

I don't think that electricity company prices will rise 50 times, but UES is clearly worth 5 to 10 times its current share price.

Electricity sector reform is a tricky process and it is only smart to learn from the mistakes made in other countries. It makes sense to bring international expertise to Russian companies and thus improve the professionalism of the sector as well as make profitable investments.

In summary, although prospects for Russia's electricity sector today look dim when you read about them in the press or in market analysis, prospects look brighter when you examine key requirements for investment and the oft-cited risks. Cynicism and the market perception of blood running in the streets of the electricity sector scare investors from a good investment opportunity.

David Herne is a member of the board of directors of UES and managing director of Halcyon Advisers. This comment first appeared in Vedomosti.