The recent sale of a significant minority equity stake in Rosneft caught the markets and analysts by surprise. The available information to date is limited only to a couple of announcements revealing few details. The deal is indeed of great complexity and the available details are not sufficient to decipher it. An initial analysis however leaves the impression that the announced buying consortium of Qatar’s sovereign wealth fund and Glencore might be not the only beneficial owner of the privatized 19.5% stake in Rosneft.
On December 5, Rosneft issued 600 billion Rubles locally placed bonds maturing in 10 years. The Russian market is clearly not deep enough for an issue of that magnitude and such a long tenor. Most probably, the money ultimately came from the Russian central bank, via repo deals rather than directly. It is unclear if the bond issue had anything to do with the privatization, but the striking match in both timing and amount begs questions. Rosneft unofficially floated the explanation that it will use the proceeds to make large tax payments in Rubles while conserving foreign currency. That, if true, boils down to borrowing from the Russian central bank to short the Ruble.
On December 8, President Putin and Rosneft CEO, and Putin’s chum, Igor Sechin announced the privatization of 19.5% of Rosneft’s existing shares (pictured). The seller was reportedly Rosneftegaz, an intermediate holding company owned by the Russian government. The buying consortium of Glencore and Qatar Investment Authority (QIA) with equal shares was said to have paid 10.5 billion Euro in cash. This price represents a 5% discount from Rosneft’s market quotations on December 6, but it’s still the “best price that could have been achieved”.
It is unusual that such a high profile sale was prepared in absolute secrecy instead of a more public competitive process. Chinese as well as other emerging market (Central Asian, Indian) buyers have both appetite and wherewithal for such a deal but were suspiciously missing. The sale price is 5% lower than the market, i.e. it looks similar to a block-trade where a broker takes a stake off investor’s hands with the aim to sell it down gradually without causing market disturbances. When an investor seeks actively to acquire a large stake, especially conveying some sort of control and other benefits, including increased dividend, the purchase price would typically be at a premium from the market.
The deal terms were not fully disclosed yet but a couple of announcements from Glencore and one from Rosneft have shed some light. A special purpose company owned by QIA and Glencore will pay 10.2 billion Euro to Rosneftegaz for 19.5% stake of the shares. Rosneftegaz will apparently add 0.3 billion Euro of its own funds and pay the total to the government. While Glencore and QIA have equal shares in the consortium, their contributions are very different. QIA invests 2.5 billion Euro in cash equity, while Glencore only puts 0.3 billion. Glencore also provides to the lenders 1.4 billion Euro of “margin guarantees”, supposedly some form of collateral protection, in case Rosneft share price materially declines. It looks like the “margin guarantees” are akin to out-of-the-money put options, which pay out when the price declines to certain level. Glencore on its turn hedges these “guarantees” with full indemnities from Russian banks and probably deems that resultant risk position is zero.
Glencore’s announcements regarding the deal are somewhat curious. Starting with minor details, e.g. the title of the first one, which refers not to the deal but to Russian government’s announcement of it. Glencore’s exposure is only limited to 0.3 billion Euro, which corresponds to 0.54% indirect equity interest in Rosneft. The wording is carefully chosen so it makes it perfectly clear that Glencore’s economic exposure to the shares is strictly limited to this, and this only. It assures that Glencore will have no other economic exposure, and that it has employed a limited liability structure, fully ring-fenced and non-recourse to Glencore. A bit wordy, but delivers the message. Now a public company, Glencore must make sure its statements are legally correct so it avoids legal risks.
Reading through, there is a seeming contradiction: gross deal assets attributable to Glencore are valued at 5.1 billion Euro, half of deal total. This makes the distinction between gross exposure of 5.1 billion Euro (9.75% of shares) and net exposure of 0.3 billion Euro (0.54% of shares) quite obvious. Therefore, assets worth 4.8 billion Euro (9.21% of shares) are “attributable” to Glencore, which however has no economic interest in them. In other words, someone else bears the risk and receives the benefits from these shares, i.e. Glencore is merely nominal rather than beneficial owner of the shares. The beneficial ownership may have been transferred via some sort of derivative instrument. It may have been baked in the debt arrangements, e.g. an equity call option, especially with the Russian banks, or as a separate “hedging” transaction, like a total return swap. QIA has not made any announcement as to its involvement, which would permit similar analysis of its gross and net position.
The debt side is also not fully devoid of wrinkles. The disclosed debt funding is 7.4 billion Euro (74% of assets value), the bulk of it provided by Intesa Sanpaolo, an Italian bank primarily specializing in retail market. Intesa is also serving as Russian government’s adviser for this transaction; it is a bit odd though not unheard of the sell-side adviser also to provide funding to the buyers. The balance of the debt was provided by Russian banks, probably the country’s largest. Glencore’s “margin guarantees” are of help here, so the non-recourse part is only 6 billion Euro, or c. 60% of assets value, which is high but not impossible. And Glencore must be good for 1.4 billion Euro risk, with the back-to-back indemnities from Russian banks providing additional comfort. This transaction is of course unsuitable for margin financing, where the lenders manage risk via topping up collateral, or failing that, liquidate shares on the market. Neither the market can absorb such a massive stake, nor the Russian government’s approval for such a “strategic” shareholding changing hands can be taken for granted. Lending in the vicinity of 4 billion Euro at such terms looks difficult for an Italian bank, even if it is not the most stretched one. European banks, and Italian ones in particular are harassed by capital calls and Basel III, and are wary of not breaching EU or US sanctions against Rosneft. Breaching sanctions is a dangerous affair as BNP Paribas recently found out, after being fined 9 billion dollars by the U.S.
Let’s glance at who the buyers are. Glencore is a secretive commodity trader, whose core competence is dealing with counterparts with some sort of difficulties: financial strain, embargo, etc. Its ownership structure is also a bit of a mystery. The management has likely sub-20% combined stake, 9% are owned by QIA, but it remains unknown who are the owners of an 60%+ stake. At the time of its 2012 IPO some exiting investors were revealed, including the “concierge” of Kazakhstan’s strongman Narsultan Nazarbaev. Rumors of Russian nexus in Glencore ownership persist but have not been substantiated so far. Glencore has been deeply involved with Russia already via several known interests: approximately 6 billion dollars oil prepayment financing to Rosneft, a 8.8% equity stake in UC Rusal, and 25% (down from 46%) stake in Russneft.
It looks like Glencore is set to gain most from the deal. The exceptionally good terms it receives left the impression that it is the leading consortium member, despite its small investment and net exposure. It also receives significant side business, including a crude offtake contract for 220,000 barrels per day for five years, i.e. about 20 billion US dollars at $50/bbl. In addition, Glencore will enter into a strategic partnership with Rosneft in global trading, logistics and infrastructure.
Qatar itself (via QIA) is a very unlikely buyer of a major Rosneft stake. Qatar’s political relations with Russia have been strained and volatile for years, at least since the murder by Russian intelligence of a Chechen exile in Qatar, and were tested in addition during the war in Syria. Its liquefied natural gas export is a major competitor for Russian pipeline gas exported to Europe as well as increasingly to the Far East. Also, QIA’s stated aim to diversify from hydrocarbons, where Qatar obviously has a great concentration, directly contravenes with the essence of this acquisition. Yet, against all odds Qatar has invested in Russia and in Rosneft.
There are different ways to interpret the rather limited public information on the deal, but let’s outline two distinctly different hypothetical versions, neither of which contradicts with what is known so far.
The White Deal
The Russian government seeks to sell another large chunk of Rosneft with three goals in mind: to fund its budget deficit, to improve Rosneft corporate governance, and to finish off the notion of its international isolation. Via its adviser Intesa, it organizes a discrete competitive process where it addresses in good faith many potentially interested investors, primarily in the emerging markets. The highest bid of Glencore and QIA wins by price alone. Not only are the investors upbeat about Rosneft value, but they perceive the strategic aspect of the deal as opening the door for broader cooperation in the hydrocarbon industry, and in QIA’s case, pursuing certain political agenda. On the banks side, Intesa is also interested to book some yielding assets and willingly provides the loan secured with the shares and just a bit of recourse to Glencore. Anticipating a soon relaxation of sanctions against Russia, it plans to sell down the debt at a profit. The Russian banks have similar considerations and follow suit.
The Black Deal
While President Putin seeks to raise funds to finance its government deficit and not less importantly to defy Western sanctions, he does not intend to let outsiders control an additional fifth of Rosneft shares, which he perceives as national treasure. Despite declining oil prices, Rosneft has been going strong, amassing new upstream and downstream assets such as Bashneft in Russia and Essar in India. There is genuine interest from foreign players, especially Chinese, to buy into Rosneft. Putin however is reluctant letting them in, taking into account how dependent is Rosneft on Chinese money already. A privatization scheme whereby Rosneft (via subsidiaries) acquires its own shares is conceived, and even discussed in public. In essence, a deal like that amounts to selective share buyback, which may be contested by Rosneft’s existing shareholders. Also, it would give the concept of privatization a whiff of absurdity as well as desperation.
Instead, Rosneft and its advisers (not necessarily Intesa) come up with a structure to the same effect but concealed by the participation of international investors. This new scheme has the added benefit that it removes a lot of the transparency and certain other Russian beneficiaries, possibly related not only to Rosneft but to Putin and Sechin to take part in it. It goes like this:
Rosneft (via a bond issue) borrows from the central bank an amount commensurate with the deal consideration. This amount is distributed among several of Rosneft’s subsidiaries, which would fund the transaction. Any Rosneft transaction above 1.5 billion Euro equivalent must be approved by Rosneft’s board of directors. However, if several subsidiaries make sub-1.5 billion Euro transactions each, such approval is not required, despite their combined size may be above the threshold. The subsidiaries distribute the funds to lending banks via a back-to-back arrangement similar to lending with cash collateral. Therefore, the banks appear to be principal lenders, but the risk is ultimately borne by Rosneft subsidiaries. Accordingly, the banks cannot liquidate the Rosneft shares serving as collateral.
The Russian beneficiaries (not the strongmen themselves but placeholder “oligarchs”) also fund part of the deal, whether on their own or with borrowed money. Their position is the riskiest but is also super-powered by beneficial interest in Rosneft shares. This interest probably also goes through the Russian banks and is woven in the loan agreements, “margin guarantees” and indemnities. It is likely that the Russian beneficiaries’ equity exposure is levered, i.e. disproportionately larger than the funds they invest. This allows Glencore to report gross assets of 5.1 billion Euro but net exposure of only 0.3 billion. It is not impossible that the Russian beneficiaries have similar arrangements with QIA, which is not a public company and does not need to make disclosures. Exactly the opacity of the financial transactions in Qatar make it a desired investing domicile for those who have a lot to hide.
Let’s take stock of the description of this second, “black” version of the deal. First, the Russian central bank prints 600 billion Rubles. Second, through Rosneft, the banks and the buying consortium, the money is used to purchase Rosneft shares from the government, which has a fiscal deficit to finance. Third, in the course of the deal the Russian sponsors acquire economic interest in at least 9.2% and perhaps 18.4% of Rosneft.
So which one is it: the white deal or the black deal? It’s hard to say, but the reality is probably some combination of both. For some time, it will remain gray.