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3rd Eurasian Corporate Governance Roundtable

3rd Eurasian Corporate Governance Roundtable Shareholder Rights, Equitable Treatment and the Role of the State April 17-18, 2002 hosted by Securities and Stock Market State Commission of Ukraine State Property Fund of Ukraine PFTS with the support of The Government of Japan. The Global

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3rd Eurasian Corporate Governance Roundtable

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  1. 3rd Eurasian Corporate Governance Roundtable Shareholder Rights, Equitable Treatment and the Role of the State April 17-18, 2002 hosted by Securities and Stock Market State Commission of Ukraine State Property Fund of Ukraine PFTS with the support of The Government of Japan The Global Corporate Governance Forum

  2. Gazprom gifts to ITERA Review of PWC Audit of Itera By Mr. Vadim KleinerHermitage Capital Management

  3. Outline of Presentation • Introduction of the problem • Analysis of PWC conclusion • Recommendation

  4. Introduction to the Problem In October of 2000, Hermitage Capital Management investigated and discovered a number of dubious transactions that stripped value out of Gazprom: Source:Weighted estimates of PWC and reserve-based valuations.

  5. Hermitage Investigation The findings were exposed to a number of shareholders, board members and international and domestic media organizations: Media Date Key Facts Exposed

  6. Origination of Audit of those transactions As a result of public outrage, investors pushed for an explanation of those transactions Step 1Step 2 Step 3 Step 4Step 5 Analysis and Exposure of dubious transactions 10.11% shareholders of Gazprom called for independent audit of assets stripping using new auditor (Deloitte & Touche instead of PWC) Gazprom management rejected call for independent audit by Deloitte & Touche Board of Directors of Gazprom appointed PWC to audit alleged relationship with ITERA Audit undertaken by PWC Oct-Dec Dec Dec Jan Jan-Jun 2000 2000 2000 2001 2001

  7. PWC was asked to look at number of issues • The basis for business between Gazprom and Itera: • Did Itera pay a fair price for assets? • Analysis of Yamal-Nenetsk and Nadym tax payments • Justification of Gazprom - Itera business dealings • Analysis of alleged asset stripping for Itera benefit

  8. Highlights 1. Gazprom ‘gift’ of Purgas to Itera 2. Yamal-Nenetsk & Nadym tax scam 3. Vyakhirev negotiating with Turkmenistan on behalf of Itera 4. Gazprom ‘gift’ of Belorussian market to Itera 5. Gazprom ‘gift’ of Tarkosaleneftegaz to Itera 6. Summary of lost reserves

  9. 1. Gazprom ‘gift’ of Purgas to Itera • Background Itera purchase of Purgas: • In 1998 Gazprom put 381 bln. m3 of reserves into joint venture with Itera named Purgas (51% vs. 49%); • Itera received 49% without any meaningful consideration; • In 1999 Gazprom sold another 32% in Purgas to Itera for $1,200 only; • PWC valued Purgas at $1,768 mln. (PWC report: p.30), which implied a value of $566 mln. per 32%.

  10. 1. Gazprom ‘gift’ of Purgas to Itera • PWC conclusion on Itera purchase of Purgas : • It is difficult to evaluate those transaction from the commercial point of view due to the absence of comparative information regarding the acquisition of Russian gas fields (PWC report: p.32) • Significant cash shortages forced Gazprom to let Itera and other companies to obtain stakes in the companies which held licenses for gas reserves (PWC report: p.21)

  11. 1. Gazprom ‘gift’ of Purgas to Itera Economic Analysis: Cash shortages were caused by transfers from Gazprom to Itera Total amount of financing provided by Gazprom to Itera Source:PWC investigation of Gazprom - Itera relationship; PWC 2000 audit of Gazprom; Audit Chamber report on Itera, 2001.

  12. 2. Yamal-Nenetsk and Nadym tax scam Background: The tax “scam” Gazprom entered into with Itera drained even more cash from Gazprom Source:PWC investigation of Gazprom - Itera relationship; Audit Chamber report on Itera, 2001.

  13. 2. Yamal-Nenetsk and Nadym tax scam PWC conclusion: Gazprom benefited from this arrangement because they saved scare cash resources. Otherwise Gazprom should raise debt financing when the interest rate reached 50% (PWC report: p. 51, p. 2) Economic Analysis of PWC conclusions: Interest rate should have had to be 1600% to justify selling gas at $2-4/ thousands m3 vs. borrowing money

  14. 3. Vyakhirev negotiating with Turkmenistan on behalf of Itera • Background: • In December 1999 after tough negotiations of CEO of Gazprom Rem Vyakhirev with President of Turkmenistan S. Niyazov Turmenistan agreed to supply about 10 bln. m3 of gas at about $36 per 1,000 m3 • It turned out that Mr.Vyakhirev was negotiating on behalf Itera which bought Turkmenian gas at $35.4 per 1,000 m3 and further resold it to Gazprom at $45 per 1,000 m3

  15. 3. Vyakhirev negotiating with Turkmenistan on behalf of Itera PWC conclusion:The price is roughly based on the price paid by ITERA to the Turkmenistan government plus transportation costs (PWC report: p.14) • Economic Analysis of PWC conclusions: • Itera earned about $87 mln. on the transaction negotiated by Gazprom • Transportation costs were reimbursed by Gazprom by separate agreement

  16. 4.Gazprom ‘gift’ of Belarussian market to Itera Background: Belarus occupies the third place among CIS countries in terms of gas consumption • Belarus consumes about 16 bln. m3 of gas • ...valued at about $500 mln. per annum • Gazprom granted to Itera 35% of Belarus market without any compensation

  17. 4.Gazprom ‘gift’ of Belarussian market to Itera PWC conclusion: Profit margins of these operations were hardly of any significance (PWC report: p.61, p.4) • Economic Analysis of PWC conclusions: • According to information from reports of PWC and Audit Chamber gas was exported to Belarus at 57% margin $ 99.7 mln annual loss to Gazprom

  18. 5.Gazprom ‘gift’ of Tarkosaleneftegaz to Itera Background: Tarkosaleneftegaz intrinsic value is between $112 mln. and $896 mln.

  19. 5.Gazprom ‘gift’ of Tarkosaleneftegaz to Itera Background: Gazprom being one of two founders of Tarkosaleneftegaz decreased its stake in Tarkosaleneftegaz through a set of controversial new share issues. Source:FSCM website.

  20. 5.Gazprom ‘gift’ of Tarkosaleneftegaz to Itera Background: Gazprom is selling cheap and buying expensive Source:FSCM website.

  21. 5.Gazprom ‘gift’ of Tarkosaleneftegaz to Itera PWC conclusion: Gazprom allowed its share to be reduced by non-participation in new share issues and direct sale of 16.2% to Itera to avoid taking future obligations on financing this project (PWC report: p. 36, p. 2) • Economic Analysis of PWC conclusions: • Gazprom passed five rights issue required $7.9 mln. and participated in one rights issue where they contributed $65.5 mln. • The new owners lack financing and have been making roadshows to raise capital for last three months with no success

  22. 6. Summary of lost reserves Background: Gazprom gave up control over 2.9 trln. m3 of its reserves, which comprises 10% of Gazprom total reserves Yamal-Nenetzk region

  23. 6. Summary of lost reserves A $325 mln. compensation was paid for control over the total of 2.9 trln. m3 of gas reserves in 7 companies ($0.11 per 1,000 m3 of reserves) • Economic Analysis of PWC conclusions: • At the same time, PWC estimated the fair price for Purgas (381 bln. m3) at $1,768 mln. which implies $4.6 per 1,000 m3 (PWC report: p.30); • Based on this valuation, the total of 2.9 trln. m3 of gas reserves should have cost $13,340 mln., not $325 mln. Itera paid for it. ..the squirrel cannot overweigh the rhinoceros

  24. Conclusions • PWC confirmed assets diversion from Gazprom to Itera • PWC identified Itera compensation for former Gazprom assets, but did not find anything wrong with it, despite an enormous discount to the fair value of these assets • PWC did not make any conclusion on whether relations between Gazprom and Itera had commercial nature or resulted in the losses for Gazprom • PWC failed to address an involvement of Gazprom management and its family members in ownership of Itera • PWC investigated Gazprom tax payments in kind and did not find anything wrong with it • PWC report mislead the government

  25. Government Actions • 1. Reopen forensic audit of transactions immediately: • new auditor; • include non-Itera asset stripping. • 2. Sack PWC as official auditor at AGM and replace with a new auditor under a transparent tender procedure. • 3. Launch international lawsuit against PWC for malpractice. • 4. Improve audit legislation: • introduce rules and liabilities for auditors’ malpractice; • strengthen regulatory body overviewing auditors activity. • 5. Set up inter department government task force to: • retrieve lost assets; • fire responsible Gazprom managers; • prosecute responsible executives.

  26. Shareholders Actions Hermitage Capital Management has made the following proposals for Gazprom AGM to improve the value of the Company: 1. Adopt FSCM Corporate Governance Code of Gazprom 2. Various Charter amendments in order to implement Board of Directors oversight of assets transactions; 3. Charter amendments to allow Board of Directors instigate any audit of any transactions using any audit; 3. Boards oversight over financial activity of Gazprom (lending, borrowing, encumbrance); 4. Set up Audit sub-committee of Board of Directors to control all auditing process in Gazprom; 5. Sack PWC as official auditor at AGM and replace with a new auditor under a transparent tender procedure;

  27. Recommendations for FCSM • 1. Reopen forensic audit of transactions immediately: • new auditor; • include non-Itera asset stripping. • 2. Sack PWC as official auditor at AGM and replace with a new auditor under a transparent tender procedure. • 3. Launch international lawsuit against PWC for malpractice. • 4. Improve audit legislation: • introduce rules and liabilities for auditors’ malpractice; • strengthen regulatory body overviewing auditors activity. • 5. Set up inter department government task force to: • retrieve lost assets; • fire responsible Gazprom managers; • prosecute responsible executives.

  28. Disclaimer The information is based on data obtained from publicly available sources, which have not been verified by Hermitage Capital Management Limited, or any of its respective associates or affiliates. As a result of the difficulty in obtaining reliable data in Russia, we do not represent this information to be accurate and complete and we do not accept any responsibility for the reasonableness of any conclusions based upon such information.

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