Russia’s thirst for overseas power repels InterRao investors

The Russian government’s pursuit of power generation assets abroad is frustrating investors who believe their interests would be better served by the state developing its own under-funded electricity sector.

InterRao, an $11 billion holding company for a myriad of state power assets, has said it is eyeing acquisitions in Germany, Italy and other markets in a bid to have 25 percent of what it owns outside Russia by 2015, bringing new technologies to Russia and boosting its international profile along the way.

A director’s comments that it is in talks with indebted German utility RWE about buying some of its units were received badly by the market, which has since spurned the stock in protest at its lack of domestic focus.

Its shares are down 11.7 percent in the year to date, while the MICEX power industry index is up 13.5 percent amid a strong run for Russian equities.

“I understand that InterRao management has been tasked (by the government) to proceed with global expansion. I think some of the share price underperformance could be attributed to this,” said Dmitry Mikhailov, manager of Renaissance Asset Managers’ Russian Power Utilities Fund.

“An expansion policy is not always regarded well by minority shareholders ... it is not clear how a Russian company can improve the efficiency of assets such as, for example, windmills in Finland,” he added.

The push overseas has been led by Russia’s deputy prime minister and energy tsar, Igor Sechin, who chaired InterRao until ministers were forced out of state company boardrooms by President Dmitry Medvedev last year.

A second Russian power investor said Sechin’s hands-on involvement had put off investors who believed he would put political ambitions above the generation of shareholder value and Western corporate governance.

“InterRao has been very aggressive in its growth strategy ... The way it achieved that (growth) is not necessarily in full compliance with best corporate governance standards,” said Sergey Ezimov, portfolio manager of Wermuth Asset Management’s Go East For Value utilities fund.

“It has a close relationship with the government ─ it is one of Sechin’s pet companies ─ and therefore at times enjoys preferential treatment,” he added.

Sechin’s role in any future government after Vladimir Putin resumes his presidential duties in May is one of the burning issues for foreign investors looking for signs that Russia will pursue a reformist agenda.

Sparkle in their profit

A spokesman for InterRao confirmed the group is seeking generation assets and joint ventures in mainland Europe, and also has its eye on Asia and South America.

The strategy may have failed to strike a chord with minority shareholders, but is in line with government ambitions to modernize Russia’s economy and cut dependence on oil and gas.

“There are two benefits for the state - one, that InterRao will act as an importer of foreign technologies in the sector, helping to modernize the Russian economy, and two, that it will build closer economic ties with neighboring countries,” said Renaissance Asset Managers’ Mikhailov.

InterRao was effectively created last May when, as a power trading group chaired by Sechin, it was selected to become the home of state electricity assets that had not been sold during the first wave of privatization last decade.

The group controls two major Russian power companies, OGK-1 and OGK-3, but the duo lag foreign-owned industry leaders Enel OGK-5 and E.ON Russia in terms of both profitability and the fulfillment of capital expenditure obligations.

Russian generators must contribute to the $500 billion cost of renewing the country’s Soviet-era power sector, troubled by power cuts and fatal accidents, before they can let shareholders benefit from expected rising domestic demand and electricity tariffs by hiking dividends.

Russian electricity demand is anticipated to rise with economic growth, and household electricity tariffs are widely expected to be hiked after Putin secured a return to the presidency in a March 4 election.

“If they carry on looking overseas they cannot expect analysts to come out with raging buys, as that is not going to raise the share price. Profits and dividend will. It’s very simple ... developing its Russian assets is the key to ramping up the share price,” said Derek Weaving, utilities analyst at Renaissance Capital.

“E.ON and Enel see Russia as the sparkle in their profit and loss line. International expansion (for InterRao) only makes sense in terms of prestige,” Weaving said.

Too aggressive

Investors’ low opinion of InterRao has been highlighted by a plan to absorb its own majority-owned power firms OGK-1 and OGK-3, offering minor shareholders InterRao stock or cash in return.

The move has caused a dilemma for some OGK investors, who are unsure whether they want to own InterRao shares, even though the conversion rate has been received positively by the market.

“The management team are pretty aggressive and we don’t always agree with what they are doing with their daughter companies,” said Wermuth’s Ezimov, a holder of OGK-1 stock.

“It’s difficult for me to believe that these guys can successfully manage assets in countries like Germany,” he added. “I don’t think foreign expansion is a good strategy.”

($1 = 29.2075 Russian roubles)