Kingmakers Dethroned Global Downturn Brings Russia's Oligarchs to Their Knees

The global financial crisis is wiping out the wealth and political influence of Russia's once-mighty oligarchs. Yesterday's kingmakers are now having to beg the Kremlin for loans.

Editor's Note: This feature is part of a SPIEGEL series that will continue all week on how the economic downturn is affecting people and companies around the world. No other downturn in history has hit as many of the world's economies. The current crisis  is hitting migrant laborers in China , automobile workers in Detroit  and even strong traditional German firms like the chemical giant BASF .

Judging by the furnishings, you would never guess that this office is where plans were made to launch Russia's economy into the modern age. The room is dominated by heavy furniture made of dark wood. Antique books are displayed in glass bookcases. Working from this office, Vladimir Yevtushenkov, intends to reduce his huge country's dependence on raw materials exports. To achieve this objective, his subsidiary Sitronics has built a cutting-edge semiconductor production plant on the outskirts of Moscow.

"That's the last thing that I would give up," says Yevtushenkov. He doesn't want his company to become an ominous symbol of the downturn in Russia's economy. After 10 euphoric years and a recent growth rate of 7 percent, the world's largest country is now in danger of economic collapse.

Yevtushenkov has just reshuffled his Sitronics debts and secured a €182 million ($248 million) loan for his showpiece company from the state development bank Vnesheconombank. The oligarch will use this money to service debts at Germany's Dresdner Bank. But right now that is the least of his problems.

A recent conference call had three times as many investors on the line as was normally the case before the financial crisis. And all of them were anxious, because Yevtushenkov's holding company Sistema, which includes a colorful hodgepodge of companies ranging from construction and telecommunications firms to children's fashions, is over €7 billion in debt.

Yevtushenkov is a member of a class of super-rich who are coming under pressure, and whose wealth has regularly made headlines at home and abroad. Their international reputation stems partly from their many spectacular takeover plans -- and Yevtushenkov is a man who has always done his best to come up with high-profile deals. Only two years ago, he tried to buy a major stake in German telecommunications giant Deutsche Telekom.

When it comes to throwing money around, the oligarchs have always had a knack for raising eyebrows. For instance, banker and art collector Pyotr Aven equipped his villa in England with a nuclear bunker. In late 2006, financial high-flyer Suleyman Kerimov, who was reportedly interested in a stake in Deutsche Bank, totaled his astronomically expensive Ferrari Enzo in a crash in Nice. The passenger was a beautiful Moscow female TV presenter -- who happened to be married to somebody else.

Finally, there is Roman Abramovich, who has been competing with Arabian princes to see who can build the longest yacht in the world. He has invested the incredible sum of €600 million in the English football club Chelsea -- enough cash to purchase the German retail giant Arcandor.

Such flamboyant personalities were the driving force behind the privatization of the Russian economy after the collapse of communism. The more unscrupulous oligarchs milked ailing companies for all they were worth, while the respectable ones restructured the old Soviet firms. They brought international management practices and cutting-edge technology to Russia. In addition to the state-owned energy giant Gazprom, it is the oligarchs who have spearheaded the expansion of Russian companies in the West over the past few years.

But the halcyon days now appear to be over. The US business magazine Forbes estimates that the 25 richest Russians alone have lost nearly €180 billion during the current global economic crisis. Abramovich, who invested his money primarily in the holding company Evraz, lost a staggering amount of money on the London Stock Exchange within just six months as Evraz's value plummeted from €28 billion to just €3.2 billion. Russian steel baron Alexei Mordashov, who has a stake in the German travel giant TUI, lost €18 billion.

The total amount of debt owed by large Russian companies and banks comes to an estimated €360 billion. That is almost as much money as the Russian state, which controls the third-largest gold and currency reserves in the world, still has set aside for a rainy day, after weeks of market interventions to shore up the faltering ruble and costly bailout packages for financial institutions and companies.

Times are tough for the Russian oligarchs, who are now dependent on the government for help. The yacht aficionado Abramovich has received €1.4 billion, and Yevtushenkov keeps a close eye on the Kremlin from his window on the third floor of an imposing Stalin-era building.

"I would be a lousy captain of industry if I didn't maintain relations with our government," he says. "Things are no different in America and Europe. I can only dream of the billions of euros that the German government spent to bailout a bank."

Yevtushenkov is currently negotiating the sale of his stake in the telecommunications company Svyazinvest. The buyer would be the Russian state. That would generate money to settle the firm's debts and bring in new investments. The banker Pyotr Aven recently had the pleasure of flying to Siberia with Prime Minister Vladimir Putin. Just a few days later, the government granted him a loan worth €1.5 billion.

All of this stands in stark contrast to the 1990s, when the oligarchs used their money to secure the re-election of then-President Boris Yeltsin. Four years after that, financial magnate Boris Berezovsky helped his erstwhile protégé Putin become Yeltsin's successor. Now it is no longer the oligarchs who are supporting the Kremlin -- it is the Kremlin that is bailing out the oligarchs.

Politics determines who can continue to play in this enormous game of Monopoly, and who will vanish from the board. The kingmakers of yesteryear, so it seems, are now forced to beg for favors.

Aluminum czar Oleg Deripaska, who was once the richest of them all with an estimated pre-crunch net worth of €23 billion, would be teetering on the brink of bankruptcy if the state had not granted him a €3.5 billion loan.

During the boom years, Deripaska purchased so many production plants and companies that his industrial holding Basic Element today includes everything from carmakers and insurance companies to banks and aviation firms. He operates plants from Nigeria to Tajikistan.

But the size of his burgeoning workforce, which had reached nearly 300,000 by late summer, didn't grow as fast as Deripaska's obligations. At his aluminum subsidiary Rusal alone, accounts payable have soared by 500 percent since 2004, while profits have only risen half as fast. Deripaska has built his entire empire on credit.

When the tycoon took over the world's largest nickel producer, Norilsk Nickel, in April, he pledged his shares as collateral to a consortium of 11 international big banks. During the financial crisis, the value of that stock plummeted, and the banks have started to press for new guarantees.

In order to prevent foreign financial institutions from becoming co-owners of this jewel of the Russian metal industry, the Kremlin loaned Deripaska billions of rubles and, in exchange, placed its own representative on the supervisory board. Now a number of experts are afraid that the state will become a kind of super-oligarch and roll back many of the privatizations carried out in the 1990s.

Waiting for the Upswing

Back then, the oligarchy supported the Yeltsin government with billions of rubles and, in return, received choice segments of the country's industry -- and ministerial appointments. Now the Kremlin has thrown this process into reverse. Most of the oil and gas industry had already reverted back to government control before the crisis. Last summer, Putin transformed a government defense export agency into a holding with a total of 423 companies. This new entity -- which receives subsidies and essentially acts as a huge state corporation -- is headed by Sergei Chemezov, a close ally of Putin and a former colleague from the days when they both worked as KGB intelligence agents in the former East Germany.

Yevtushenkov still believes, however, that the Kremlin will later re-privatize the companies that it is now taking over. "Our poor Prime Minister Putin has to constantly repeat this," says the magnate. "Everyone knows that bureaucrats make poor corporate managers."

Nevertheless, a fundamental policy dispute is raging between proponents of a liberal market economy, spearheaded by Finance Minister Alexei Kudrin, and supporters of greater state control, led by Deputy Prime Minister Igor Sechin. The outcome of this debate is just as open as the question of when gas and oil prices -- which are crucial to Russia's economy -- will rise again.

One thing is for certain, however: The expansion of Russian companies abroad has come to a standstill. Deripaska has already had to sell at a loss his stake in German construction company Hochtief and Canadian automotive supplier Magna. Steel tycoon Alexei Mordashov did admittedly purchase US coal mining firm PBS Coals last November for €1 billion, but he also announced that he was slashing an investment program worth billions.

Mordashov had become the fourth largest steel producer in the US. But now he's ordered his workers in the northern Russian city of Cherepovets and in Dearborn, Michigan to work reduced hours.

Mordashov's greatest competitor, steel magnate Vladimir Lisin, aborted at the last minute the $3.5 billion takeover of US steelmaker John Maneely. His company's share price had nose-dived by nearly 90 percent within just four months, meaning that the cost of the takeover would have suddenly exceeded his own company's current market capitalization.

Shutting Down the Furnaces

The heart of the Lisin conglomerate beats in Lipetsk, 400 km (250 miles) south of Moscow. The city was founded by Peter the Great, who had cast-iron cannons for his navy made there.

Lipetsk is well known in Russia because of a certain story which is told about the city. It's said that Hitler's air force, the Luftwaffe, spared the city because German airmen had their girlfriends there. During the Weimar Republic, when the German army cooperated with the Red Army, officers were trained in the city.

Vladimir Lisin's NLMK huge steel mill, where a total of 34,000 people work, is located close to the river that divides the city. During the summer, the furnaces are concealed behind pristine birch tree forests. The streets still bear the same Soviet names like "Avenue of the Energy Worker" and "Boulevard of the Rolling Mill Worker," except the air is better, now that modern filters have been installed.

Right now the pollution level is particularly low. The financial crisis has turned out to have an environmentally-friendly side effect: Three out of five furnaces have been shut down until further notice.

At the rolling mill, with its 1,000-meter-long production hall, shift manager Sergei Mazur, 43, monitors the processing of glowing pieces of steel, each weighing several tons. Before the crisis struck, the unit used to spit out a roll every 20 seconds. Now it produces one every two minutes.

Within two months, the NLMK steelworks saw demand plunge, with a 40 percent fall in pig iron sales and a 60 percent drop in steel sales. Deripaska and his car company GAZ, for instance, can no longer pay the bills for steel orders, so Lisin has canceled the deliveries. It's a similar story with thousands of companies across the country.

This has prompted most independent experts to lower their growth forecasts for Russia for 2009 from 7 to 3 percent -- and this is a "best-case scenario," many of them add with concern. In order to support domestic industries, the Russian government has raised import duties for cars, sparking protests in a number of cities.

People like Mazur, who have up till now belonged to the rapidly growing middle class, are afraid that they may soon no longer be able to afford their annual vacation trips to Turkey and Egypt. They can only hope for the next upswing.

Volkswagen buys some of its steel from NLMK. The steel mill's equipment comes from Japan, Italy, America, but primarily from Germany, where it is made by companies such as SMS-Demag and Sundwig. Over the past few years, Lisin has purchased over €200 million worth of equipment in Germany.

When business slows for the steelworkers in Lipetsk, and the Russians purchase fewer cars, this also has consequences for Germany. Over 70,000 German jobs depend on the export business with Russia.

Betting on Potatoes

The close trade relations between the two countries can also be observed in the small village of Popovka, located midway between Lipetsk and Moscow. Russian tycoon Alexander Lebedev has ordered €4 million worth of agricultural equipment from the Grimme company in Lower Saxony. "We are building the largest potato packaging plant in Europe," he says. He has already invested €40 million, and plans to spend an additional €40 million.

Lebedev's operation is a symbol of the risks as well as the opportunities that come with the crisis. On the one hand, he has to pay back foreign exchange loans, which are becoming increasingly expensive due to the creeping devaluation of the ruble. The modest prosperity in the village -- reflected in Western cars, satellite dishes and new houses -- is at stake. On the other hand, Lebedev is venturing into a huge growth market.

"During the crisis, we need ideas that will generate the profits of tomorrow more than ever," he says. And didn't the agricultural minister say that Russia was not only a raw materials superpower, but also a future farming world power? Back under the czars, the country was the world's largest producer of wheat. After agriculture was collectivized, harvests dropped and the Soviet Union eventually had to purchase grain from the West.

In the village of Popovka, population 1,600, Lebedev has purchased the old "Maxim Gorki" collective farm -- and already increased potato production to a level which is 10 times what it was during the final years of the Soviet period.

After all, if so many trendy industrial sectors are no longer making a profit, why not give an old-fashioned business model a try?

Translated from the German by Paul Cohen.
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