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. Last Updated: 07/27/2016

Surgut Puzzle Has Banks Baffled

Investors took a dim view of unclear share machinations at Surgutneftegaz on Friday as the secretive, Kremlin-friendly oil firm's stock slid again to lose 8 percent in two days.

Since news broke Thursday that Surgut no longer owned a company holding 37 percent of its stock, banks have been baffled as to the status of the shares, with some viewing the move effectively as a share dilution, while others reserving judgment pending further explanation.

With little information available from Surgut, however, investors appeared inclined to believe the pessimists, marking the stock down about $0.11 to $1.23 at Friday's close.

Surgut has announced that, as of Dec. 31, it no longer owned Leasing Production, a limited liability company, Vedomosti reported Thursday. The status of the 37 percent of Surgut stock that this company held was a mystery, however, though market watchers agreed that it had been transferred to Surgut's own pension fund.

The move appears to be the latest blow to investment funds that have sought protection for shareholders' rights at Surgut through a long-running legal battle.

Alfa Bank rushed out a note late Thursday in which it lowered its Surgut target price by 19 percent to $1.13 and downgraded the stock to "sell." Among the country's big-league banks, this was the most negative reaction.

Deutsche UFG, on the other hand, maintained its target price of $1.73, as did Renaissance Capital for its $2.13 target price on the RTS exchange. Both advised investors to buy.

The differing assessments came down to the multibillion-dollar question: What, if anything, did the pension fund pay to have the reported $20.22 billion of Surgut shares transferred onto its books?

If it paid something, then banks must count the transferred shares as full-fledged Surgut stock, whereas before they were only treasury shares, which get no vote, make no dividends and tend to go uncounted.

In such a case, there would be some 7 billion more Surgut shares than previously thought, so the value of each existing share would go down by as much as 30 percent, Alfa Bank said.

If the pension fund paid nothing for the shares, however, then Surgut has simply moved them "from one pocket to another," and their value is unaffected, said Deutsche UFG analyst Pavel Kushnir.

When asked to settle the matter Friday, Surgut spokesman Igor Zakharko said, "I don't know. ... I heard [the shares] were moved into the pension fund," and declined to comment further.

Ronald Smith, author of the Alfa Bank note, said that because the fund was officially independent of Surgut, it would be illegal for the oil firm simply to hand over its stock for free. The fund most likely exchanged some of its debt in the transaction, Smith said, "but really it's a stab in the dark."

The market seems to be agreeing with Alfa Bank so far, while some analysts attribute the drop to frustration over Surgut's dogged silence.

"Sooner or later, they must start behaving like a market group," said Vadim Kleiner, head of research at Hermitage Capital Management, one of the country's biggest portfolio investors. Kleiner called for transparency and respect for shareholders' rights at Surgut.

The Supreme Arbitration Court and the Constitutional Court have rejected appeals from Hermitage, Prosperity Capital Management, Firebird Management and the Russian Investor Protection Association for Surgut's treasury shares to be canceled.

Hermitage CEO William Browder has been denied a Russian visa since November 2005, in what some have seen as possible retaliation for Hermitage's campaigns for shareholder rights, including at Surgut.

When questioned about Browder's case at the Group of Eight summit in St. Petersburg last July, President Vladimir Putin said he did not know why he had been barred from the country.

In early 2004, Putin praised Surgut as a good corporate citizen, compared to its neighbor in western Siberia, the town of Nefteyugansk, where Mikhail Khodorkovsky's Yukos then ruled the roost.

"Surgut and Nefteyugansk are as different as day and night," Putin said. "Here is an example of the businesses' attitudes toward the areas where they work."

Deutsche UFG's Kushnir said transparency and investor relations remained low on Surgut's agenda -- much lower than friendly ties with the Kremlin.

Rosneft, the state's flagship oil firm, is still likely to buy out Surgut, Kushnir said, reiterating an opinion Deutsche UFG voiced in December. But if the takeover takes place, it will be a friendly transfer "blessed by the highest levels of government," he said.

Surgut general director Vladimir Bogdanov, who ran President Vladimir Putin's 2000 election campaign in western Siberia, "will never go against the Kremlin," he added.

And in the case of a takeover, analysts expect the firm's accounts to grow murkier still.

The last accounting report Surgut released was in 2002, when it announced its ownership of Leasing Production.

But this rare bit of disclosure did not stop the Moscow-based Institute of Corporate Law and Corporate Governance from ranking the firm in last place for both transparency and management that year.

In a letter to the institute, Alexander Sinenko, then an aide to Bogdanov, pointed out an "interesting contradiction" between the company's low rankings and its high investor appeal. "Certainly, unless the market starts paying attention to these corporate governance ratings, nothing will happen in this country, at least not at our company," he wrote.