Kommersant, no. 196 as of October 25, 2019
State-owned holding ROSSETI has made another step in the struggle for complete consolidation of its subsidiaries, which may eventually lead to their total absorption, also referred to as conversion to a single share. According to Kommersant, the holding is already in negotiations with investors on a scheme to convert the securities owned by the minority shareholders of the subsidiary inter-regional distribution grid companies into ROSSETI shares in a major follow-on offering. The holding’s management is even considering the takeover of the key asset, Federal Grid Company, but the deal has not been settled so far for fear of triggering a severe conflict in the power grid sector. The public authorities have not greenlighted the plans either as Russia’s Federal Antimonopoly Service (FAS Russia) and the Ministry of Economy feel like continuing privatization of the IDGCs, as envisaged by the power industry reform.
Rosseti is set to fully consolidate the shares of its subsidiaries, several sources in the industry told Kommersant. Far from the interregional distribution grid companies (IDGCs), the consolidation plans include Federal Grid Company of Unified Energy System (FGC UES), the owner of the trunk power lines, the most profitable and independent asset of the holding.
According to Kommersant informants, the holding embarked on negotiations with the minority shareholders of the IDGCs late last year. According to several sources familiar with the offer, ROSSETI negotiated for deeper power grid consolidation and centralization of managerial functions, which assumes the restructuring of the IDGCs – and, probably, FGC UES – as branches.
The main working option was to offer minority shareholders of the IDGCs to voluntarily convert their shares into ROSSETI securities in the course of a large-scale follow-on offering intended to be conducted within several years. The scheme was confirmed by ROSSETI’s acting Deputy General Director for Strategy Egor Prokhorov in an interview with Interfax on October 23. “Among other things, it offers a potential tool for consolidating the shares of our subsidiaries,” he noted.
It is the rumors of planned consolidation that drove the growth of the stock price of ROSSETI securities last November and in the following months, sources in the investment banking community believe. Its securities soared in price by a whopping 116% reaching a peak in June 2019 (this was followed by a correction mitigating the growth to 52%). “Investors realized that ROSSETI would make an offer or propose another consolidation scheme sooner or later and massively flocked to its securities which traded below par at that time," one of the paper’s informants emphasized. According to Kommersant’s sources, the following stock price setback was an effect of correction combined with “some disappointment of investors.”
ROSSETI currently has 15 subsidiary companies, including FGC (see the infographics). The largest minority shareholders include EOS Russia which holds a 11.47% stake in IDGC of Volga, 14.41% in IDGC of North-West, 6.28% in IDGC of Center and Volga Region, 6.69% in IDGC of Urals. Funds managed by Prosperity Capital Management own a 15.87% stake in IDGC of Center and Volga Region, 15% in IDGC of Centre and 7.7% in IDGC of South through Genhold and Protsvetaniye Holdings Limited. Prosperity also has the largest minority position in FGC (3.4%). The largest minority stake across the holding (40% in IDGC of Siberia) belongs to entities of SUEK beneficially owned by Andrey Melnichenko.
What is at stake
The minority shareholdings in the IDGCs are valued at 84 billion rubles, the minority interests in FGC at 43 billion rubles. The total price of these stakes is just above the amount earned by the company in net profit in 2018, and ROSSETI has no free funds to buy back the shares from the minority shareholders without an additional offering. If all minority shareholdings are converted at current market price, the Government’s interest in ROSSETI may shrink from today’s level of 88% to 63% in a merged company absorbing the IDGCs, to 55% in case the consolidation also includes FGC.
So far, the minority shareholders surveyed by Kommersant are unenthusiastic about ROSSETI’s initiative, expressly prioritizing privatization of the state-owned holding’s assets and unwilling to see their influence disappear in a purely operating company (see the interview). Some of them, however, note they may accept the conversion if offered an adequate price.
ROSSETI’s draft strategy for the period until 2030 submitted to the Ministry of Energy in late September (a copy of which is available to Kommersant) does not present clear-cut consolidation plans. The document only sets general objectives to optimize the management structure, improve manageability of subsidiaries, and eliminate the discount to the holding’s fair value through higher stock liquidity and tighter corporate control.
The detailed grid asset consolidation program is expected to take shape as a separate roadmap in the first quarter of 2020. If the scheme is supported by the Government and the company reaches an agreement with the shareholders, ROSSETI may continue as an operating company rather than a holding company.
The key challenge for the team of ROSSETI’s General Director Pavel Livinsky may be consolidation of Federal Grid Company headed by Andrey Murov as this ambition will inevitably spark a new conflict just as in 2015 when the possible merger of treasuries was discussed at the initiative of ex-CEO Oleg Budargin. The idea was not then supported by Vladimir Putin. Last year, Pavel Livinsky already made the first attempt to put ROSSETI in charge of corporate governance of FGC by terminating the practice of direct management instructions given to FGC by the Government. The attempt, however, was no success.
ROSSETI has been struggling against FGC’s autonomy since the holding was set up in 2013. After protracted discussions, FGC became subordinate to the power grid monopoly based on JSC IDGC Holding, but retained certain independence.
Of special note is that FGC is the most expensive and profitable asset of ROSSETI. In 2018, it earned 92.8 billion rubles in 12-month IFRS net profit out of the whole holding’s profit of 124 billion rubles. The market capitalization of the two companies is almost equal: 236.6 billion rubles for ROSSETI, 234 billion rubles for FGC. According to Kommersant’s sources in the energy market, Mr. Livinsky’s initiative to consolidate FGC, if publicly announced, will bring back the “who-will-be-the-boss” question. According to Kommersant’s insiders, no final decision has so far been made inside ROSSETI as to FGC consolidation, but no other part of the overall consolidation plan can produce such powerful effect as far as market cap growth is concerned: “If they do not consolidate FGC, it’s not quite clear whether the whole business worth starting it at all.”
Energy reform reversed
Another stumbling point for the management of ROSSETI will be the contradiction between consolidation plans and the very logic of the RAO UES reform. It was initially assumed that private investors would be gradually given the reins of control over the distribution networks but privatization is now de facto under a moratorium extended every year. ROSSETI’s draft strategy actually acknowledges the digression from the reform logic as a fait accompli. In particular, it is noted that the low capitalization of the holding “leaves no opportunities to effectively use the stock market as an instrument of financing and to effectively conduct partial privatization.” The company, among other things, recalls the unsuccessful experimental management of TDC by France-based EdF in 2012-2015. The French company was expected to bring in modern management techniques and advanced technologies, to boost the efficiency of TDC. But the contract was terminated prematurely as EdF claimed generous bonuses “which their work was not worth,” one of Kommersant sources says. Another one voices a different opinion: the experiment was considered a success but had to be discontinued as the ruble exchange rate collapsed in 2014. EdF did not comment on that case.
As a result, as follows from the draft strategy, ROSSETI has no “reliable proof of proper quality of management at independent grid companies,” while “the investor attraction plans did not work out,” and the state-owned holding itself has been stuck “halfway towards restructuring, with a transition management model,” for the past six years. Besides, SUEK entities have been seeking access to management of IDGC of Siberia for a long time: the company approached the Government with this initiative, but ROSSETI parried this move saying it would acquire the private stake.
Meanwhile, Moscow’s White House is not ready to scrap the plans of further IDGC privatization. In a letter to the Government dated September 13 (its copy being available to Kommersant), Russia’s Deputy Minister of Economy Mikhail Rasstrigin notes that selling ROSSETI’s shareholdings in the IDGCs could be the main source of private investment in the power grid, “with proceeds to be used for grid infrastructure modernization and development.” In his opinion, the Government should end up having partial control over the IDGCs, while private investors should be guaranteed “fixed regulatory provisions and preservation of the cost savings achieved through grid optimization and modernization.”
On October 18, Igor Artemyev, head of FAS Russia, gave Interfax an interview saying that he believes in the possibility of starting power grid privatization from individual IDGCs. “Why not have a go at individual IDGCs? Launch a smart pilot project, attract investment, build a top-notch grid infrastructure and show that’s a perfect way to go,” the head of the Russian competition watchdog said.
According to the Ministry of Energy’s comment for Kommersant, ROSSETI’s strategy is under consideration “and will remain confidential” until it is submitted to the Board of Directors of the holding. The Ministry of Economy noted it was not aware of the parameters of the proposed stock conversion and therefore unable to draw conclusions. FAS Russia, ROSSETI and FGC did not respond to Kommersant’s request for comment.
Vladimir Sklyar (VTB Capital) estimates the current discount to the market value of Rosset due to the company’s holding structure at up to 20%. The discount arises from two reasons: poor translation of dividends from subsidiaries into dividends paid by the holding and a substantial percentage of minority shareholders, which complicates management. “Both issues will be solved if ROSSETI increases its position in the IDGCs and, ideally, absorbs the subsidiaries,” the analyst notes. According to Vladimir Sklyar, the fewer ROSSETI subsidiaries on the stock exchange, the more ROSSETI will resemble a full-featured operating company. Investors will then look at the financial condition of ROSSETI as such, not its ability to distribute the earned dividends, the analyst explains.