TNKabuki: Sechin And Medvedev Propose Potemkin Shareholder Protections

 |  Includes: BP
by: Craig Pirrong

Sechin and Prime Minister Dmitri Medvedev discussed buying out minority shareholders in TNK-BP. Medvedev expressed concerns about Russian corporate governance, and the nation's bad reputation among international investors, and suggested to Sechin that a gesture by a state corporation could help improve this image:

Warning that Russia faced an economic "abyss" if it did not push through serious market reforms, Mr Medvedev urged Rosneft to improve corporate governance. "A state company can give an example of the right way to treat minorities. This will improve the investment climate," he said

Sechin responded by saying that the company would consider voluntarily buying out minority shareholders in the TNK-BP holding company, despite the fact that it was under legal obligation to do so. My first reaction was one of surprise, and positive. Then I saw the details. Medvedev and Sechin agreed that the minority holders would be paid a 20 to 30 percent premium over the average price over the last several months. A premium? Great, right?

Not really. Sechin's previous refusal to buy out the minority shareholders had crushed the share price. He said they'd get squat, and the stock price fell to squat. Now he's generously offering to pay squat plus 20 percent. Yes, this is better than nothing, but doesn't really represent reasonable compensation. In other words, the stock price was predicated on an estimate of what pittance Sechin might be persuaded to part with, rather than an objective appraisal of the value of the shares. Offering to pay a small premium over the pittance price is hardly a great boon to the minority holders.

In terms of precedent, it also creates uncertainty due to the circularity of the process. Think about a future episode. The price of minority shares will depend on what shareholders and potential buyers think the acquirer can be persuaded to give up in compensation. This compensation is not based on an independent appraisal of the value of the assets but the previous price, which is based on an estimate of the compensation; this is an infinite loop with no linkage to the value of the assets which the shares give a claim to. This makes the price indeterminate.

The only thing that likely connects the price to value is the knowledge that someone in Sechin's position would refuse to go along with the deal if the compensation paid represented a large fraction of value. That is, in the present instance, Sechin may be willing to act all cooperative because the stock price has been so far below value that he's not really giving up that much. Here the fraction of value believed acceptable to the acquirer can anchor the stock price to value-or, more accurately, some fraction of value.

For instance, say the fair value of the shares is 100 Rubles, and that it is widely believed that an acquirer like Sechin will be willing to pay 15 percent of this value to make the minority shareholders go away, or to get political pressure off his back, or to make it look like he's being all magnanimous. So the shares sell for 15 Rubles. If the conjecture is correct, in the future Sechin will be able to get the shares for 15 Rubles, which he's willing to pay, but which is far below value. So again, it's what the acquirer is willing to pay-or believes he can get away with paying to avoid political flack-rather than value that determines price. That doesn't provide any real protection to minority shareholders.

This means that this apparent concession really doesn't fix the fundamental problem that vexes Medvedev. Only some independent appraisal mechanism and a legal obligation to treat minority shareholders fairly will do that. Tying the buyout price to the previous market price doesn't.

Speaking of Medvedev, this Kabuki play seems to be a part of a political campaign on his part. In addition to the colloquy with Igor, he published a long article in Vedemosti raising an alarm that Russia faced a serious risk of prolonged economic stagnation. The central part of his diagnosis is Russia's institutional rot, the natural state that I've written about since the very early days of this blog:

I believe that the protection of private property and competition remains our unconditional political priority. The Russian economy still posts low investment levels, and this is not only caused by specific arithmetic calculations of potential capital-efficiency volumes. Investors still harbour irrational fears of working in an incomprehensible and sometimes unpredictable Russia. Add to this the absolutely explainable distrust of public institutions, including the judicial system and law-enforcement agencies. This is something which is very sad. As Fyodor Dostoyevsky wrote, capital likes external and domestic stability, otherwise it hides.

Among other things, this situation is caused by the fact that many officials, judges and police officers (although, of course, not all of them) still believe that state property, and therefore state companies, have the right to better protection, and that these rights are infinitely greater than those of individuals. They also believe that the latter pursue exclusively personal interests and are therefore suspicious and must be rigidly controlled.

The most frequently quoted phrase in this ("the irrational fears") actually doesn't make sense: in context, it is clear that Medvedev believes the fears are very rational. Read that way, the diagnosis makes perfect sense: it's not all that different from what I've written here for years.

But when it comes to recommending reforms, Medvedev shrinks from his diagnosis and advances technocratic proposals that will do nothing to correct the very real evils he identifies in the paragraphs quoted above. The proposal that companies like Rosneft and Gazprom create and operate their own universities is particularly risible. Russia's problem is not a shortage of institutions of higher education, and the idea that corrupt and hidebound entities like Gazprom or Rosneft would be able to become world class educators is so bizarre that one wonders what Medvedev was thinking.

In other words, Medvedev is playing his by now familiar role of being one of the few in the elite that speaks frankly about Russia's serious institutional weaknesses (Kudrin being another), but being completely unable to do anything about it. The buyout of the minority shareholders in TNK-BP is just another one of those token efforts that betray an understanding of the Russia's fundamental problems, and the complete lack of will to do anything serious about it.