What's Behind the Glitch in the Yukos/Sibneft Merger?

A strange brew of politics and business boiled over during the Thanksgiving holiday, placing a widely watched Russian oil merger on hold.

Just when it looked as though the industry would dodge a November bullet this year, intriguing news erupted overseas. The largest corporate merger in Russian history broke apart when Sibneft unexpectedly announced that merger plans with Yukos had been put on hold.

This is a rapidly evolving story with urgent talks underway to salvage the arrangement among major shareholders in London, Tel Aviv, and Moscow. Meanwhile, management at Yukos announced plans to seek the $1 billion penalty both sides agreed to in the event either party pulled out of the deal before completion.

What makes this intriguing is that the deal was officially finalized in September. Sibneft shareholders had already received $3 billion in payment for their 25 percent stake in the new company and, through additional swaps, now control 26 percent of the combined entity.

Yukos had been holding press conferences over the last month--some with Sibneft personnel--indicating the deal, variously estimated at $11 to $13 billion and which would create the world's fourth largest oil company, was on track. In fact, last Friday's board meeting between the two companies was to have been routine and involved approving the name change to YukosSibneft, approving the new articles of incorporation, and electing a joint board of directors.

When Sibneft backed out, it issued what it called a joint statement in the name of both companies saying the merger had been postponed. The statement was a shock to Yukos executives who later insisted they were proceeding with the original shareholder agreement from last April when the merger was first announced.

The break up was major news in American media late last week. Over the last six months, news about Yukos has evolved from occasional blurbs in obscure foreign media to prominent play with bylined stories in the Financial Times, New York Times, Washington Post, Barrons, and the Wall Street Journal, to mention just a few.

The Kremlin's crackdown on Yukos management, including the October arrest of its CEO and president Mikhail Khodorkovsky for tax evasion and fraud, coupled with rumors that either ExxonMobil or ChevronTexaco planned to purchase a significant share of YukosSibneft catapulted the Russian merger into larger public view.

Friday's surprise announcement suggests that things are never what they seem in Russia. Here are some of the current theories that attempt to place the Yukos/Sibneft glitch in context:

Sibneft's main shareholder, Roman Abramovich, a close personal friend of Russian president Vladimir Putin, was attempting to gain control of the merged company in the wake of Mr. Khodorkovsky's legal problems. Apparently the Russian trade press has carried news about internal struggles involving whether Sibneft managers or Yukos executives would run the merged company's daily business. Mr. Abramovich pushed Eugene Shvidler as CEO of the new company. Mr. Shvidler is the head of Sibneft. When the Yukos executive faction won out, Sibneft backed away, citing "business concerns."

Or, Mr. Abramovich simply wanted to get away from the mushrooming legal problems at Yukos. The government has frozen 44 percent of Yukos shares, and the Russian agency responsible for overseeing licensing in the country's oilpatch had announced intentions to review terms of the nation's licenses with Yukos to see if all covenants had been met--the first step towards possible revocation.

Last Thursday, Russian prosecutors confiscated another set of documents from Yukos' Moscow corporate offices for additional investigation into tax evasion and fraud. The number of Yukos executives under investigation has now reached five dozen with the most prominent in jail--some since July. In this scenario, Mr. Abramovich was concerned about whether Yukos' continuing legal troubles would impact his investment, particularly since the value of the Yukos/Sibneft merger had declined from $45 billion following the merger announcement in April to $30 billion as of last week.

The Yukos/Sibneft merger was primarily a child of Mikhail Khodorkovsky who overreached in his attempts to create a major multinational oil company. This was complicated further by Mr. Khodorkovsky's brazen entry into opposition politics, which angered the Russian president and reportedly triggered the Yukos investigation.

But Mr. Khodorkovsky also angered conservative members of the Russian government when he offered to open the new company to foreign investment, providing Western multinationals entree into the Russian oil industry. For some members of the Russian government, the feelings against significant foreign investment in the Russian oilpatch are quite strong. It would be akin to the U.S. opening BLM lands in the west to Saudi Arabia to drill for natural gas.

Under this scenario, Mr. Abramovich was simply doing the Kremlin's bidding by putting the deal on ice, further damaging Yukos and its attempts to sell a significant portion of the company to non-Russian investors. Since Mr. Abramovich failed to gain control, the Kremlin will press forward now with further investigations, possibly breaking Yukos up and eliminating any potential value for Western investment.

Does Friday's surprise signal the end to the Yukos/Sibneft merger? Initial responses were pessimistic regarding whether the deal would go through. Basically, these follow a line of reasoning that asks the following: What does London-based Roman Abramovich know that would prompt him to pay the $1 billion penalty to forego the planned merger?

On the other hand, this could simply be what it seems at face value in which a significant minority shareholder attempts to increase influence while the larger partner is buffeted by problems. Eventually everyone comes to a new understanding and the deal goes through, according to this scenario.

Much of the attention over Yukos/Sibneft centers on the fact that the only way U.S. firms can obtain access to the Russian oilpatch is through purchasing stakes in individual Russian companies that hold licenses for oil or gas production. BP started the trend in February when it acquired a $7 billion stake in Tyumen Oil Co. (TNK).

But if Western firms are growing gun-shy, it is not evident in the press. Attempts by Western multinationals to gain equity shares in Russian oil firms have been much broader than heretofore noted. ChevronTexaco, ConocoPhillips, and Total are among companies listed as suitors for a 26 percent stake in Rusia Petroleum which, incidentally, is majority owned by the TNK-BP Russian joint venture. In all, more than 15 companies are involved in the bid, which holds an operating license for a 1.9 Tcf undeveloped gas field in eastern Siberia.

Other possible acquisitions include the 7.6 percent stake in Lukoil held by the Russian government, which intends to sell its share at a privatization auction in 2004. Additionally, rumors circulate in the trade press over whether ConocoPhillips and Lukoil were in discussion for an asset swap that would result in ConocoPhillips gaining a 10 to 15 percent stake in Lukoil.

As much as Western firms would love to gain an equity stake in the Russian oilpatch, the latest news has to be chilling. In Russia, a deal is never finished, even when it is done.


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