Restructuring of Unified Energy Systems

1
Restructuring of
Unified Energy Systems
By Vadim Kleiner,

Director of Research,
Hermitage Capital Management June 2003
2
Original Structure of Unified Energy
One of the major issues plaguing the Russian
economy is artificially low electricity tariffs
which are regulated by the government
Electricity prices for industrial
consumers Russia vs other countries (cents per 1
kWh)
Original Structure of Unified Energy
Discount to EU tariffs 60.5
Source Eurostat, Electricity prices for EU
industry on 1 January 2002, RAO UES, Power in
East Europe 27-05-2002
3
Original Structure of Unified Energy
The overall value of these subsidies to oligarchs
is between US3.5 and US5.8
billion annually
Lost annual profits in major privatized
industries, US mln. (in the event of
electricity tariff increase to Ukrainian and
Average European level)
Value Chain of Russian
Export-Oriented Businesses
Unified Energy Systems
Commodity Producers
Export Markets
Supply of Electricity at Cheap Domestic Prices
Selling Commodities at International Prices
Annual Subsidies of US3.5-5.8 bln.
US mln.
- at Ukrainian tariffs
- at average European tariffs
Source Goskomstat, Hermitage estimates
4
UES Managements Restructuring Plan
In May 2000 Unified Energy announced a plan to
sell assets and launched five pilot projects
Pilot Projects of Unified Energy, May 2000
Unified Energy Systems Assets
73 AO- energos and 33 Power Plants
Orenburgenergo
Sayano-Shushenskaya HPP
Samaraenergo
Sverdlovskenergo
Omskenergo
Source AKM
5
UES Managements Restructuring Plan
Assets sales would have yielded almost no value
to the shareholders of UES at the time of its
announcement in 2000
Market Cap per MW of Capacity in May 2000
UES Share Price
Average 1,154
Average 64
Discount 94.5
Source Brunswick
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Minorities Response
In response, Hermitage and Prosperity, together
with other minority shareholders, called for an
EGM to fire Chubais
August 2, 2000
September 2000
April 28, 2001
75
86
Shareholders
Ownership Structure of UES ()
Ownership Structure of UES ()
Ownership Structure of UES ()
53
Government
and Minority Shareholders
Minority Shareholders
10
10
Minority shareholders called for an EGM to fire
Chubais and restrict asset sales
Government agreed to change the charter
At the AGM 86 of UES shareholders voted to
restrict asset sales in UES charter
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Minorities Response
Putin also invited Hermitage, Prosperity and
other shareholders to join the government in
drafting a new restructuring plan
Restructuring Commission appointed by Putin in
December 2000
Chubais Zavadnikov
Sinyugin Gref
Illarionov Vasiliev
Golovka Danilov-Danilyan
Kudryavy Melyukhin
Prozorov
Skorospelov Trunov
Sharonov Kleiner - Hermitage
Branis - Prosperity Kress Androsov
Fedorov Kusharev
Lebedev Kutovoi
Nekipelpov Kuznetsov Chernavsky
UES Management
Members of Government
and Officials
Minority Shareholders
Regional Governor
Other Members of Kress Group
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Minorities Response
On July 11, 2001 the Russian government signed
decree 526, which was based on a Hermitage and
Prosperitys proposal for a pro-rata distribution
of UES assets instead of asset sales
Break up of Unified Energy,
Government Plan (June 2001)
Break up of ATT (1984)
Shareholders
Shareholders
Unified Energy Systems
ATT
Shareholders
Shareholders
.
NYNEX
Generation 1
ATT
Generation 73
Pacific Telesis
Distribution 1
Ameritech
Pro-rata distribution of shares
Pro-rata distribution of shares
Distribution 73
SBC
.
Bell Atlantic
Grid
US West
.
Bell South
Source www.fcc.gov, Government Decree 526
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UES Managements Restructuring Plan
In 2002 UES presented five asset sales proposals
to the board (which complied with the charter
changes, and did not directly contradicted decree
526)
Pilot Projects of Unified Energy, 2002
Unified Energy Systems Assets
73 AO- energos and 33 Power Plants
Tomskenergo
Shakhtinsk PP
Insiders
Mosenergo
Moscow Government
Boguchansk HPP
Kuzbassenergo
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Example Shakhtinsk Power Plant Sale
Transaction Structure
100
UES
Rostovenergo
14
27
Combined Operations
100
Shakhtinsk CC Plant

• Payment
• US0 today

• Payment
• US0 today

Shakhtinsk Power Plant

• US2 mln. from future earnings

• US1.9 mln. from future earnings

Sale of
Sale of
100
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ZAO Energo perspectiva
Source Documents for BoD meeting at Unified
Energy, August 2002
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Example Shakhtinsk Power Plant Sale
Who is the buyer? The same person as the seller.
UES
Same Person !?
Mr. Evgeny Sitnikov, Head of Southern Regional
District of UES
Rostovenergo

ZAO Energoperspectiva
Shakhstinsk Power Plant
Mr. Evgeny Sitnikov, Chairman of the BoD
approved by UES
Mr. Evgeny Sitnikov, Chairman of the Board
Shakhstinsk Combd Cycle Plant
Source FCSM
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Market Reaction
The immediate reaction of investors was very
negative
Unified Energy Share Price (US per share)
RTS Index
Prices are rebased to
100 as of January 1, 2002
-82
Unified Energy
Source Bloomberg
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Market Over-Reaction
Perception versus Reality
Assets in place
Total Assets of
Unified Energy
(100)
Assets in
place
Assets to be stolen
Assets to be stolen
Hermitages Analysis
Market Perception
Source Hermitage Estimates
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Minorities Response - II
Hermitage called again for the EGM to fire
Chubais and revealed his plans to the Government
Electricity Laws
signed by Putin on March
26, 2003
Minority shareholders called again
for an EGM to fire Chubais (October 2002)
Ownership Structure of UES ()
10
Minority Shareholders
- No sale of assets
- Pro-rata distribution of assets
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Oligarchs Choice
As soon as oligarchs realized that they cant
buy assets of Unified Energy, their only choice
was to buy shares of UES
Oligarchs
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Oligarchs Choice
As soon as oligarchs realized that they cant
buy assets of Unified Energy, their only choice
was to buy shares of UES
UES Share Price (US per share)
Structure of UES Equity ()
ADRs
ADRs
193
Local Shares
Local Shares
December 2001
May 2003
Source Bloomberg, UES
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New Restructuring Plan
Basic principle of de-monopolization of UES
stated by the law is pro-rata distribution
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UES Strategy 55

• The new strategy of UES 55 Plan consists of
  three stages
• Independent valuation
• Voluntary pro-rata swap of UES shares for shares
  in its subsidiary
• Auction open to any UES shareholder to bid for
  stake in the subsidiary still owned by UES after
  pro-rata swap

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UES Strategy 55
Valuation implies that UES should be valued as
sum of pieces therefore, the first step is
valuation of UES subsidiaries prepared for spin
off
Values determined by independent appraiser
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UES Strategy 55
Pro-rata swap Assuming there are only two UES
shareholders - state with 51 and private
shareholder with 49, the private investor can
pro-rata swap part of its UES stake for 49 in
Generator 1
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UES Strategy 55
The Auction for remaining 51 of Generator 1 will
take place in order to entirely spin it out of
UES only UES shareholders can bid for it with
starting price determined by valuation ratio
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UES Strategy 55
The proposed formula to pay for the stakes in UES
subsidiaries by UES shares turns UES shares into
bidding currency Subject to shareholders belief
in appreciation of various assets after the
unbundling of UES, they can either obtain the
pro-rata share in the UES assets or use their UES
shares to bid for the most attractive assets
during the auctions, which will take place after
the pro-rata swap
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Conclusion

• The new plan creates numerous opportunities for
• manipulation, especially in the following areas
• Valuation process
• Winning bid awards
• Bidder collusion
• Sequence of asset spin off

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Hermitage Performance
Since inception
2003 to date
2002 to date
2001 to date
2000 to date
1999 to date
Total Return
1998 to date
1997 to date
Hermitage Fund
74.0
214.1
198.8
784.3
0.5
623.2
229.9
29.7
CSFB ROS Index
38.0
93.1
4.9
113.7
61.7
160.6
504.1
282.4
Performance of Hermitage Fund vs. CSFB ROS Index
Hermitage Fund
CSFB ROS Index
623.2
Return ()
282.4
Total returns for each period are calculated
using the last bid as of June 20, 2003 The
Hermitage Fund was launched on April 27, 1996
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Disclaimer
This material is for information purposes only
and is not an invitation to subscribe for units
or shares in the Hermitage Fund. Subscriptions
will only be received and units or shares issued
on the basis of the current prospectus for the
Fund, and prospective investors should carefully
consider the risk warnings and disclosures for
the Fund set out therein. Investors should also
consider any other factors that may be relevant
to their circumstances, including tax
considerations, before making an investment. 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. Past performance is not
necessarily indicative of the likely future
performance of an investment. The price of units
or shares can go down as well as up and may be
affected by changes in rates of exchange. The
Hermitage Fund has been authorised by the
Guernsey Financial Services Commission as a Class
B Collective Investment Scheme under the
Protection of Investors (Bailiwick of Guernsey)
Law 1987 and the Collective Investment Schemes
(Class B) Rules 1990. It must be understood that
in giving this authorisation the Commission does
not vouch for the financial soundness or
correctness of any of the statements made or
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Fund. Investors in The Hermitage Fund are not
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under the Collective Investment Schemes
(Compensation of Investors) Rules 1998 made under
the Law.