Sunday, November 28, 2010



Russian Gas giant Gazprom is more than just an interesting firm. With a market value of almost USD 250 billion it is one of the largest firms in the world. It is also - in terms of assets and liquidity - one of the richest firms in the world. Taking into account its more or less monopolistic position in the Russian market and the fact that it holds about 17 percent of global proven gas reserves: what can be wrong with investing in this firm at a time when stock market prices are depressed?

Gazprom's problem is that notwithstanding being awarded the price for the international firm with the nicest corporate anthem (see below), its charm offensives did not really help it to get rid of its reputation as obscure behemoth directly linked to the direct sphere of control of the Russian state in general and Putin and Medvyedev in particular. First the song then the story:

Nice isn't it? Add to this the firm's positive involvement with top sports (via Schalke 04 in the German football competition, via Red Star Belgrade in Serbia and via Zenith St Peterburg in Russia itself, and added to that sponsorships for top sporters in dozens of other sports), and the PR machine seems to work at full power. On the firm's website we also see lots of actions to create a positive impression (environmental, social responsibility etc). But skepticism is larger than for any other major firm in the world.

If we take into account reasonable valuation levels for a firm that alone is responsible for about 10 percent of Russian GDP; that is not just a one trick pony (next to its dominance in gas it does also have own substantial oil field interests - including the acquisition of Sibneft back in 2005 -, interests in media (including its ownership of NTV and finance) and that it has a huge international set of clients and good government level relationships, what is the real drawback of the story? The firm's history gives us a clue.

Gazprom's history: the ties with the Russian government

Gazprom is the direct result of the transformation of the Russian Ministry of the Gas Industry into a state corporation back in 1989 in an effort led by former Russian PM Victor Chernomyrdin who at that time was still minister and later Chairman of Gazprom. When Yeltsin appointed him PM his influence grew. When the Soviet Union was dismantled back in 1991 Gazprom become the sole owner of the gas interests on the soil of the Russian federation with close ties with those interests that did now belong to some of the former Soviet states. For instance: even today there are strong ties with the gaz producers in Kazakhstan, Uzbekistan and Turkmenistan who export substantial amounts of their gas to Gazprom for below world market prices and then via Gazprom into the rest of the world using one of the company's biggest assets, its huge almost 160,000km still expanding international pipeline network.

During the period 1993-1997 Gazprom was privatized into a joint-stock company via the so-called voucher system that enabled employees and the Russian public at large to get a stake in the firm. Some 750,000 people gained an interest (combined) of one-third in Gazprom's share capital. The Russian state did always ensure that it had sufficient power to maintain a controlling stake, either directly or indirectly via the bylaws. Foreigners for instance were for many years not allowed to hold more than 9 percent of shares. Later this was increased to 20 percent with further liberatalizations now enabling foreigners to buy more. However, special rights to the Russian state do make this not your 'standard firm next door'.

When Putin took over in 2000 he started his attack against the oligarchs. One of the problems in Gazprom during its first 10 years was that Chernomyrdin and other seniors - often together with oligarchs - enabled asset strippings that basically left the Russian state with far too low a return on equity for its privatization (don't forget we are still talking a financially very healthy former Ministry turned into a firm here!). So basically: instead of starting with Putin's authoritarian actions in which he replaced Chernomyrdin and Viakhyrev (then CEO) with Medvyevev (yep, the current Russian president) and Alexei Miller (loyal allies from Putin's St Peterburg days) and the standard skepticism about this kind of actions, it is much better to analyze things from the start (1989) and looking at the Russian state as big shareholder. Would we have done anything different if we were shareholders in this firm? How would we judge the Putin post-2000 repair period vis-a-vis the previous 10-year robbery period, if this would have happened to our own governments? But as so often: when it comes to PR the Russian government does always have a big problem. And this PR problem did always translate into risk premiums that were higher than for other firms.

Earlier this month Chernomyrdin died at the age of 72, with Putin and Medvedev attending in one of those other opaque, obscure ceremonies where political and economic powers meet. Click here for a little article about the ceremony.

Gazprom's strong fundamentals

Strange, because if you join the firm as shareholder you are not investing in a low-valued country of sharks against the sharks but side-by-side with them! So if anything, we believe that Gazprom is a relatively safe bet for buying Russia exposure. Not just safe in terms of playing with the sharks side-by-side. But also safe when looking at fundamentals. The firm is one of the richest multinational corporations in the world with a current ratio (current assets/current liabilities) far above 2. It is actually closer to 3, levels that are in corporate finance handbooks treated as too high which could sooner or later translate into increased dividends or acquisitions.

The debt ratio is also relatively low, making the firm one of the best funded large corporate entities in the world. And that is definitely an asset as well during a period in which a lot of firms across the globe are struggling with their financials. This could enable the firm to acquire stakes in other firms at interesting prices.

And we are talking about a firm here that has gained solid experience in conglomerate style acquisitions. Interests in media (NTV), Finance (Gazprombank) and several other industries are all reasonably profitable. This is not the type of behemoth that acquired other firms for the sake of providing its leaders with a broader power base. I.e. the hubris hypothesis was not the main driver. Logical: if your leaders are more or less directly involved with running a country considered a global power already, why worry about a bit more or less power base via acquisitions of stakes in other firms? So no: these other activities are often either a) profitable in and of themselves; b) diversifying risk, making the firm less cyclical and dependent on global gas prices and demand-supply conditions and/or c) driven by other motives related to supporting its position in its main business lines (gas and oil).

We are convinced that investors who want to expand their interest in Global Emerging Markets, while at the same time not taking too much risk in terms of financial solidity of the entity they invest in cannot let the opportunity Gazprom pass by unnoticed, This 'state within the Russian state' is transforming itself into a global economic powerhouse. The political and economic risk situation at the moment is of course there, but for the aforementioned reasons it is definitely acceptable.

What to expect? We are not so sure if the Russian state will increase Gazprom's dividends a lot, but we do not exclude some increase which will make it a reasonable stock. But don't buy it for yield purposes alone. The firm is definitely not following some dividend stabilization strategy. But with its enormous financial resources and linkage to the Russian government machinery, it is the type of giant that can afford having a long-term agenda, waiting for the best possible deals at the right moment. That is why we believe it is a relatively cheap way of exposure to the Russian economy and via Gazprom's international agenda also to other countries across the globe. Taking into account the political and strategic issues that Gazprom will encounter when trying to make progress within Western Europe and/or the USA, we predict that the country will expand its influence rapidly in other Emerging markets. With these markets being growth regions in-and-of-itself we are not so afraid that Gazprom's investments and M&A activities will be mainly political. They can afford to go for the best dails using a matrix with BOTH a political AND economic axis. Only those that do well on both counts will be interesting enough for Gazprom. Taking into account the activities of another Russian firm, investment bank/hedge fund Renaissance Capital, in Africa we do for instance see tremendous opportunities for Gazprom Finance and Gazprombank. And with the joint networks of Putin, Medvyedev and German former chancellor Gerhard Schroeder, aka the German Czar, who is also involved with the firm, be sure that they do have sufficient political savviness on board so as to avoid silly mistakes in the international arena.

So it might sound contradictory when comparing things with international customs, but we consider Gazprom not a high risk, but more of a value component within an Emerging Markets investment strategy. One that might very soon translate into such an internationally diversified conglomerate that we cannot even call it a pure Emerging Markets play anymore. It is certainly too narrowly-minded to avoid it because of Russia fears.

Since August 2010 the stock is moving within a trading range of RUB 160-180 in Moscow. We believe that the stock can be classified as a great buy in the range 150-170 and wouldn't even be reluctant - as long term investor - to step in as long as prices are below RUB 200 (or - when buying in London or Franfurt - their Euro or USD equivalents).

Gazprom shares can be aquired in Moscow, Frankfurt and London.


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