Privatisations in Kazakhstan: Edition 2.0

‘You cannot step into the same river twice’.
Heraclitus (c. 535 – c. 475 BCE)

With all the geopolitical uncertainty surrounding Russia’s interference in Ukraine since 2014 and, since September 2015, its military action in Syria, many Western observers tend to overlook what has been going on at Russia’s periphery. Although it basks in the media spotlight more often than the other four Central Asian ‘stans’ (Kyrgyzstan, Uzbekistan, Tajikistan and Turkmenistan), Kazakhstan is one such example. The country is five times the size of France, but has a population of only 17.6 million people. Yet it is the second-largest producer and exporter of oil within the former Soviet Union – just behind Russia, and far ahead of Azerbaijan.

According to the State Statistics Committee,1 Kazakhstan produced 67.9 million tonnes of crude and 12.9 million tonnes of gas condensate last year, in addition to 42.9 billion cubic metres of natural gas. This year, the country’s strategic energy sector intends to yield approximately 80.5 million tonnes of liquid hydrocarbons, which is roughly in line with 2014 output. However, as the price of oil has collapsed by more than 60% since the middle of 2014, next year’s aggregate production is expected to be just shy of 77 million tonnes.

Crude oil accounts for about a quarter of Kazakhstan’s GDP and some 60% of both exports and total government revenue on a yearly basis. The precipitous decline in the price of the key export commodity, alongside comparably sharp decreases in the price of other raw materials – such as steel, copper and uranium – has been a powerful drag on economic growth. National Economy Minister, Yerbolat Dossayev, announced on November 18 that GDP growth from January-October 2015 was a meagre 1%.2 Since the normal business cycle is characterised by sluggish, if any, growth in Q4, it is likely that the annualised rate will be in a range of decimals.

The current slowdown – which increasingly resembles a protracted crisis, especially if the price of oil is to dip as low as USD 20/barrel, as some experts predict – stands in stark contrast to the earlier halcyon years of rapid growth and care-free prosperity. Following the discovery of new major oil and gas deposits in the 1990s, the Kazakh economy grew the fastest in 2002, at 13.5% a year, boosted by high energy prices. Later growth averaged 9.7% between 2003 and 2007. While the 2008-2009 global financial crisis suddenly put the brakes on the economy’s steady expansion, Kazakhstan’s GDP again grew by more than 7% in 2010 and 2011, respectively by 7.3% and 7.5%.3 From 2012 onwards, however, the long-term trend has been a downward reality.

Back in April 2013, Kazakh President, Nursultan Nazarbayev, who has ruled the country since its independence in 1991, proclaimed the start of a “second wave of privatisations”.4 He was referring to the first wave of the 1990s which, akin to simultaneous developments in Russia, had given rise to a cohort of home-grown oligarchs (even if, for the majority of them, the newly-founded riches rarely exceeded USD 0.5 billion). In autumn 2012, the president’s political advisor, Yermukhamet Yertysbayev, had prophesied that the key task of a new government led by Serik Akhmetov would be further separation of the state from business in order to ensure a gradual transition from “state-oligarchic capitalism” towards “people’s capitalism”.

That year, the government launched the so-called ‘People’s IPO’, although the credit belongs to Akhmetov’s predecessor, Karim Massimov (2007-2012), who has been prime minister for a second time since April 2014. This programme was initially aimed at enabling small investors heretofore unfamiliar with the stock market to become minority shareholders in flagship domestic companies.

In December 2012, KazTransOil – a transport company responsible for inland pipeline transportation of crude oil – sold 10% of newly issued ordinary shares (minus one share) on the Kazakhstan Stock Exchange (KASE).5 At the time, 7.91% of these shares were bought by thousands of individuals, whereas 2.04% were acquired by a group of institutional investors (private pension funds) and the remaining 0.05% went to the market maker. The 90% majority stake has since been owned by the state-owned oil and gas company KazMunaiGas (KMG), itself 90% owned by the Samruk-Kazyna sovereign wealth fund.

The only other company that has gone public via the People’s IPO, in 2014, is Kazakhstan Electricity Grid Operating Company (KEGOC). Minority interests currently account for 10% minus one ordinary share of KEGOC’s share capital, with the rest being directly owned by Samruk-Kazyna. In a similar vein, a Samruk subsidiary called Samruk-Energo, which manages power plants throughout Kazakhstan, was until recently slated to sell a minority stake on the KASE by the end of 2015. However, the government’s plans have changed of late so that it will likely go public under a standard IPO scheme by 2019.

On balance, the People’s IPO has largely failed to deliver on its primary goal. In fact, not only have a very small group of people been able to invest in just two firms, but the ROI of their holdings has done little to impress. If expressed in USD terms, KazTransOil shares have depreciated by a whopping 43% since 2013,6 with KEGOC shares losing 16% of their dollar value since the grid operator obtained a stock exchange listing last year.7 A similarly frustrating fate has fallen to a government programme of auction-based privatisations approved in April 2014, whereby Samruk-Kazyna planned to sell stakes in 106 subsidiaries by 2016. Only 21 assets were privatised in 2014, and further sales were halted shortly thereafter.

In response to the worsening economic situation and previous setbacks, Deputy Prime Minister Bakytzshan Sagintaev unveiled on September 22 a revamped plan to privatise 60 major companies, including 38 subsidiaries of Samruk-Kazyna, four subsidiaries of the Baterek (financial services) and Kazagro (agriculture) holdings each, and 14 assets directly owned by the government.8 The authorities want to conduct ‘normal’ IPOs and auctions, allowing the state to disengage for up to 50% plus one ordinary share (limited to 25% for entities deemed to be of ‘strategic interest’ to the country). The preliminary list9 comprises, for instance; all three oil refineries, Astana International Airport, Kazatomprom, Eurasian Resources Group, Kazakhtelecom, Air Astana, and so on. Whatever the inherent limitations of the above privatisation agenda, it still represents a rare opportunity for domestic and (especially) foreign investors to partake in the benefits of owning shares in top-tier Kazakh companies. Thanks to the 40% depreciation of the tenge since August 2015,10 Kazakhstan has been following, albeit with a delay, Russia’s lead in letting market forces do a better job than government regulation. Its assets have therefore become considerably cheaper and have more potential for a rally next year and in 2017 than in those emerging market peers where local currencies are consistently overvalued. Another of Kazakhstan’s advantages over Russia is in its deliberate strategy of avoiding diplomatic controversies, which more often than not scare away even the least risk-averse investors.

Another interesting fact is that the Nazarbayev administration has significantly improved Kazakhstan’s ranking in the World Bank Doing Business Index 2016, especially with regards to ‘protecting minority interests’.11 In comparison with the 2015 assessment, the country has jumped from 64th to 25th, an unprecedented improvement of 39 positions. The move follows the introduction of new legislation that requires enhanced disclosures of related-party transactions and directors’ secondary appointments; prohibits subsidiaries from acquiring stakes in parent companies; and enshrines an elevated degree of protection of rights associated with the possession of shares. Kazakhstan has advanced from 53rd to 41st on all counts combined.

While it will definitely open up as yet unseen opportunities, the forthcoming privatisation campaign also has risks attached to it. The biggest challenge lies in the realm of corporate governance, as current state-owned enterprises, which will have successfully switched to private ownership, will need to adjust to significantly different management realities. These will include, inter alia, a qualitatively higher standard of transparency vis-à-vis minority shareholders, specifically as far as directors’ remuneration and senior managers’ recruitment are concerned, as well as a more responsible focus on the optimisation of costs and the maximisation of profits and intrinsic value. It is likely that, in cases where privatisation will be limited to not more than 25% of share capital, the transition will prove much harder to implement.

A recent statement by Fitch Ratings highlights an additional difficulty. On November 17, the agency said it might downgrade some Kazakh companies’ corporate ratings if they ceased to be state-owned.12 This is because they would be less likely to receive government aid in moments of need. With that in mind, post-privatisation managers may find themselves hard-pressed to carry out in-depth reorganisations with a view to limiting debt exposure while seeking to improve the ROA- and ROE-measured performance.

In lieu of a conclusion, any savvy investor keen to take advantage of Kazakhstan’s renewed privatisation drive must have access to strong due diligence and political risk capabilities in order to make well-informed investment decisions. On the one hand, the 75-year-old president will sooner or later relinquish the reins, raising legitimate concerns about his much-awaited succession. On the other, Kazakhstan is still one of those countries where, to be successful, one has to skilfully navigate the murky waters of local politics, mingling with oligarchs, shadowy intermediaries, and members of the presidential family – while trying at all times to stay clear of scandal-prone individuals and deals.