Legatum Capital continues the legacy of Sovereign Global which was de-merged in December 2006.
The story of Telebras, Brazil's national telephone monopoly, which had a 40% weighting in the Brazilian stock market index, encapsulated that of the nation. Despite its monopoly status and increasing consumer demand, in 1990 the company could not finance its capital expenditure. There was a two-year waiting list for a new phone line and a requirement to buy preference shares in the company to pay for the installation.
It was in the midst of a capital starved climate that Sovereign worked with leading equities houses to gain permission to invest in Brazil's publicly traded companies. Sovereign then invested in Telebras, acquiring 1.5% of the company in 1991.
Over the five years following Sovereign's investment, as reform gathered pace, Telebras was able to tap international capital markets to develop its fixed line and cellular services. The company expanded dramatically and prior to its eventual break-up into many 'Baby Bras' in 1998, Telebras was one of the world's largest telecommunications companies, serving 21 million customers and generating more than $14 billion in annual revenues.
In the final phase of its privatisation in 1998 the government sold its remaining 21.4% stake in the company for $19 billion - valuing South America's biggest telecom firm at almost $90 billion - 45 times its valuation of 1990.
From 1994 to 1998, Sovereign focused primarily on the Russian electricity sector. There had been a long term shortage of investment and infrastructure had become antiquated. Generation capacities were being renewed slower than electric power consumption increased. Sub station failures in Siberia were commonplace and the need for capital to replace equipment had reached a dire point.
In 1994 Sovereign acquired over 4% of Unified Energy Systems ('UES'), the state-controlled holding company for the power sector. The giant Russian power utility held varying ownership stakes in a large number of regional generation and distribution companies, as well as the national grid operator. With total generating capacity of over 100,000 MW, it was one of the world's largest electricity companies.
The company is the largest electricity company in Russia, generating 69% of general electricity output and 32% of general heat production in the country, and owning 96% of the high voltage grids and 77% of the distribution network in Russia. It employs 577,000 people.
Sovereign also acquired 11% of Mosenergo, the Moscow-focused power utility. Comprising both generation and distribution assets. Mosenergo was the financially strongest power utility in Russia, with revenues exceeding $3 billion.
With 15,000 MW of installed generation capacity, representing 6% of Russia's total heat and 8% of Russia's total electricity supply, the company today provides light and heat to the homes of 15 million citizens in the Moscow region.
During this period, Sovereign also accumulated a 10% shareholding of the Siberian hydroelectric utility Irkutskenergo, strategically situated on the shores of Lake Baikal, the world's largest freshwater lake.
Early in 1994, Sovereign accumulated a strategic shareholding of 15% in Novolipetsk Metallurgical Kombinat ('NLMK') - a holding which increased to 25% with subsequent purchases.
NLMK is widely regarded as Russia's leading modern steel mill. In 1994, NLMK had a 41,000 strong workforce, revenues of $2 billion and steel production of 7 million tons per annum. Situated 400 km south of Moscow, the plant is next to the enormous Kursk magnetic anomaly, which supplies the mill with generous quantities of low cost iron ore. NLMK has a diverse range of products including hot and cold-rolled steel and a variety of value added products, such as cold-rolled steel sheet, electrical steel and other speciality flat products.
Whilst NLMK was one of Russia's leading exporters and its specialisation in high-end product was recognised, the achievements of the company were undermined by corruption in the mid 1990s. NLMK's $2 billion revenues came overwhelmingly from exports, leaving it vulnerable to transfer-pricing or 'tolling'. It became clear that this was a real risk at NLMK, when profits collapsed between 1995 and 1996 from $480 million to just $40 million. No plausible explanation was given for this 90% evaporation of profits - especially against the backdrop of strengthening steel prices. There was an urgent need for international standards of best practice to be adopted if the capital invested in NLMK's infrastructure was to create prosperity for its shareholders, employees and the community.
Sovereign led a group of shareholders in a protracted legal battle against the management of NLMK for the enforcement of shareholder property rights, transparency of its operations and accountability for its disappearing profits. Sovereign's actions broadened domestic and international awareness of the need for sweeping corporate governance reform in Russia.
Once NLMK was completely owned by its management, profits miraculously appeared and the company was listed on the London Stock Exchange in December 2005 for $8.69 billion. In 2005, exports accounted for 65% of sales revenue as NLMK's products were exported to 65 countries in Europe, North America, Asia, Africa and the Middle East, as well as to a range of industrial sectors in Russia.
Between 1994 and 1997, Sovereign acquired a 3% shareholding in Surgutneftgas, at the time the third largest oil company in Russia and the tenth largest in the world. But it was between 1998 and 2004 that Sovereign really concentrated its portfolio on the oil and gas sector, including investments in Lukoil and in particular Gazprom.
By the time the curtain fell on communism and the capital markets started functioning in Russia in 1994, the oil and gas industry was in serious decline. Production had halved from 600 million tonnes in 1987 to just 300 million tonnes in 1994, due to a lack of investment and outdated extraction methods. Significant investment was needed, as well as the adoption of industry best practices if this trend was to be reversed and production of the wells maximised.
Gazprom is the world's largest hydrocarbon company supplying approximately 20% of Western Europe's gas requirements annually. Recognising the long-term potential of Gazprom, and identifying the opportunity to help establish Russia's largest company as a role model for all Russian companies, Sovereign became a significant minority investor with a 5% holding.
This investment led to a sustained corporate governance campaign which saw Sovereign highlight management abuses and lobby for reform at the Russian energy giant. Notable victories included the appointment of former Finance Minister, Boris Federov, as an independent director to the board, and the replacement of the incumbent CEO with Alexei Miller. Marshall Goldman, a Harvard professor has commented "Until [Alexei] Miller was brought in, Gazprom was being run as a private gift bag.It was a black hole of graft for his predecessor and their families."
Under Miller's leadership Gazprom made progress towards better corporate governance, recovering misappropriated assets and pushing for the introduction of rational tariff policies. Since he became chief executive profitability has increased from $361 million in 2001 to $7.1 billion in December 2005 and the company's market capitalisation has exploded from $14 billion to over $250 billion as of May 2006, ranking Gazprom as one of the world's three most valuable companies.
In 2002, the Japanese banking system was facing nationalisation due to non-performing loans undermining bank balance sheets. There was no available research, no price-earnings ratios, basically no standard road map for investors with which to analyse the banking sector. However, Sovereign identified that the Japanese banking sector comprised less than 5% of Japanese market capitalisation, compared to between 25% and 30% normally.
In 2002 and 2003, with balance sheets being rebuilt to support bad debt write-offs, Sovereign made significant investments to support the recapitalisation of the Japanese banking sector. Sovereign held positions in all of the four Japanese megabanks: Mizuho, MTFG, SMFG and UFJ. UFJ was subsequently merged with MTFG to form MUFG in October 2005.
The announcement of Sovereign's 5% stake in Japanese megabank UFJ on 29 July 2003 coincided with the turning point in the Japanese stock market and reflected Sovereign's confidence in the nascent economic recovery. Starting in 2003, the Japanese banking system staged a remarkable recovery. Non-performing loans, which peaked at 9.1% in March 2002, had been reduced to just 4% by March 2005. Public funds, which had been used to bail out the banks when they faced insolvency, were largely repaid by 2006. Finally, bank loan growth, which had been in decline for over a decade, turned positive in 2005 as Japan's deflationary period drew to an end.
The transformation of Mizuho perhaps best exemplifies the turnaround of the Japanese banking sector. In early 2003, the viability of Mizuho was in doubt. A deeply discounted preference share issue was sold to bank customers to maintain its capital adequacy requirements. From those dark days, Mizuho has emerged as one of the world's most valuable financial institutions with a market value exceeding $100 billion in 2006, over ten times its value just three years earlier.
Much credit for this turnaround must go to President and CEO Terunobu Maeda who integrated the three institutions that merged on 12 March 2003 to form Mizuho - Dai-Ichi Kangyo Bank, Fuji Bank and Industrial Bank of Japan. In Japan's conservative culture, Mizuho stands out for its determination to change traditional relationship-based lending practices to a focus on return on capital and shareholder value.
In 2003 Sovereign became the largest shareholder in SK Corporation by acquiring 14.9% of the company.
SK Corp is the holding company for the SK Group which comprises Korea's largest oil refinery, supplying 35% of the Korean petroleum market, as well as a controlling 20% interest in the country's largest telecommunications company, SK Telecom.
In early 2003, SK Corp Chief Executive, Chey Tae-won was convicted, along with nine other executives, for his part in a $1.2 billion fraud at SK Global. Sovereign acquired its holding with the intention of assisting SK Corp's management in transforming SK Corp into Asia's leading energy company.
However, Chey was released from prison after a few months and returned to run the same group he was convicted of defrauding. Sovereign worked unsuccessfully for almost three years to communicate the benefits of corporate governance. This included leading a campaign to bar convicted criminals from serving as directors as well as seeking to introduce an independent Board to SK Corp.
After losing almost $2 billion in 2002 as a result of the SK Global fraud, SK Corp recorded a net profit of almost $1.2 billion in 2003 and $1.5 billion in 2004. This resulted in a dramatic increase in the price of SK Corp's stock.
However, the failure of SK Corp's Board to implement effective corporate governance change during this time, combined with the continued leadership of a Chief Executive who had been convicted of fraud against the company, left Sovereign with no assurance that past abuses would not be repeated again. Accordingly, Sovereign was left with no alternative but to divest its holding, which it did in July 2005.
