Cablegate: Ukraine: Dniproenergo - an Example of Intransparency

DE RUEHKV #2892/01 3301348
R 261348Z NOV 07





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Sensitive But Unclassified. Not for Internet Distribution.

1. (SBU) Summary. Rinat Akhmetov, Ukraine's richest man and a key
financial sponsor of the Party of Regions, recently acquired 40
percent ownership in financially troubled Dniproenergo, a large
power generation company, through a controversial share issuance.
Most observers believe that Akhmetov got the stake at far below its
true value. Both President Yushchenko and Yuliya Tymoshenko
criticized the handling of the privatization, with Tymoshenko
assuring voters prior to the recent elections that she would return
Dniproenergo to state ownership should she become prime minister.
Later, however, she said she would let the courts decide the fate of
the deal. Prime Minister Yanukovych has defended the deal. The
transaction is unfortunately yet another example of problems
besetting Ukraine's deeply flawed privatization policy, yet it may
have a silver lining. Widespread critical media coverage suggests
that more transparency might raise the risks of such transactions
and hence make them more unlikely in the future. Tymoshenko's
willingness to refer the deal to the courts might indicate that she
might have learned from the re-privatization mistakes committed
during her last stint as Prime Minister in 2005. End summary.

Dniproenergo's History of Financial Woes

2. (U) Dniproenergo, headquartered in the Zaporizhya Region, is
Ukraine's second largest thermal power generation company. Like
many companies in the energy sector, it has a history of financial
problems. In 2001, an economic court of the Zaporizhya region
initiated bankruptcy procedures against Dniproenergo. The same
court, in September 2003, recognized $275 million of debt to 65
companies and organizations. The court also appointed a financial
restructuring manager for Dniproenergo. According to the local
press, the present restructuring manager is a former board member of
a coal mine owned by Donbass Fuel Energy Company (DTEK), the energy
arm of Akhmetov's System Capital Management holding company.

Dniproenergo Share Issuance

3. (SBU) In late August 2007, representatives of the state's
interest in Dniproenergo agreed to issue a 52 percent increase in
share capital to avoid bankruptcy. According to Ukrainian press,
the only company effectively allowed to purchase these shares was
DTEK, one of Dniproenergo's largest creditors. Press reports
indicate that a debt-for-equity deal was reached in which DTEK
agreed to cover $200 million of debt to creditors, mostly state
enterprises, in exchange for additional equity that increased DTEK's
stake in the company from 9 to approximately 40 percent. In
addition, DTEK pledged to invest $200 million to upgrade capacity
over the next five years. However, the pledge does not appear to be
legally binding. The market value of the company is currently
estimated at between $1.5 and $2.2 billion. Analysts thus believe
that DTEK purchased its shares at a substantial discount to the
market price.

Deal Expands Akhmetov's Interests, Dilutes Others
--------------------------------------------- ----

4. (SBU) Akhmetov, by all accounts Ukraine's richest citizen, is a
member of parliament and the primary financial sponsor of the Party
of Regions. With his companies already managing VostokEnergo, a
thermal power generating company in Donetsk, the additional
investment in Dniproenergo gives Akhmetov strong influence over
almost half of the country's thermally generated power. The share
issuance reduced the state's stake in Dniproenergo from 76 to 50
percent plus one share. The remainder belongs to minority
shareholders whose stakes have been reduced from 15 to 10 percent.
According to press reports, foreign investors who saw their holdings
shrink are angry and claim that the transaction could damage
Ukraine's investment climate. However, while the minority
stakeholders could file suit, most reportedly are expected to take
advantage of a share buyback scheme on offer or hold onto their
reduced stakes in hopes that the share price will continue to

Yushchenko and Tymoshenko Criticize Deal

5. (U) Yushchenko criticized Yanukovych's handling of the
privatization and issued a decree in early August ordering the
government to prevent asset stripping of state-controlled energy
companies by imposing a ban on share capital dilutions. He also
took measures to prevent the planned privatizations of several other
companies. (Note: under Ukrainian law the President's decree was
not binding, as the authority to ban share capital dilutions belongs
to the Cabinet of Ministers. End note). Yuliya Tymoshenko took the

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issue a step further. As part of a broader attack on what she
described as the current government's policy of enriching its
allies, Tymoshenko sharply criticized Yanukovych and Akhmetov and
alleged that the deal had been fixed. In a letter to the
Korrespondent newspaper, she claimed the Dniproenergo sell-off
represented a classic scheme in which a company is forced into
bankruptcy and subsequently rescued by a kind creditor who, in
reality, facilitated the forced bankruptcy in order to gain control
of the company. She also asserted that the company had been
undervalued and that Akhmetov could now move to control the energy
sector and increase electricity prices significantly.

6. (SBU) Most commentators now believe that the reprivatization
policy during Tymoshenko's eight-month term as prime minister in
2005 was poorly managed and damaging to the investment climate,
despite her success in reprivatizing Kryvorizhstal. (Note:
Kryvorizhstal was sold to Akhmetov and fellow oligarch Viktor
Pynchuk for $800 million in 2004 just before then-President Kuchma
left office. Tymoshenko retook control of the company when she came
to power and subsequently sold it to steel magnate Lakshmi Mittal
for $4.8 billion in an open and transparent tender. End note.)
Prior to the pre-term September 2007 elections, Tymoshenko declared
that companies such as Dniproenergo that had been "stolen" through
shadowy privatizations would be returned to the state. She
subsequently clarified in a newspaper interview that such disputes
would be resolved in the courts and said that lawsuits had already
been filed to stop the Dniproenergo acquisition.

Yanukovych Defends Deal, Criticizes Tymoshenko
--------------------------------------------- -

7. (SBU) Yanukovych has defended the acquisition as a way of
improving Dniproenergo's financial position. Some analysts agree
that greater private ownership could improve management, eventually
raising share prices. In addition, Yanukovych's supporters
responded to the attacks by drawing attention to controversial deals
made by the government during Tymoshenko's term as prime minister,
and to her own alleged ties to big business.


8. (SBU) The Dniproenergo case is not an isolated one, as Ukraine's
history is marred with non-transparent privatizations that have
benefited a few well-connected insiders. The fate of Dniproenergo
will depend on whichever political constellation forms a government.
It seems fair to assume the deal is unlikely to be questioned as
long as PM Yanukovych remains in power. An Orange government might
question the privatization, yet it now appears that Tymoshenko,
should she become PM, will allow the courts to decide the legitimacy
of the deal.
The Dniproenergo deal may have a silver lining. Minutiae of the
deal have been widely reported and analyzed in the media, with
nearly all commentators arguing that Akhmetov got his share on the
cheap. Such vigorous reporting is an indication that it is becoming
more difficult to pull off shady deals without Ukrainian society
taking notice. More transparency could raise the costs and risks of
such transactions and hence reduce their likelihood in the future.
In addition, Tymoshenko's willingness to refer the deal to the
courts might indicate that her campaign threats were only rhetoric,
and that she might have learned from the re-privatization mistakes
committed during her last stint as Prime Minister. End comment.


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