Research Notes

Tatneft: in Search of Growth Factors

Current price - $ 1.85
Target price - $ under review
Current recommendation - Hold

Maria Radina
(095) 204-8275
radina@finam.ru

Breakdown of Tatneft’s shareholders’ equity

Source: Tatneft’s 2Q 2004 financial report

Hostile takeover fears

This summer Tatneft amended its charter by adding a poison pill provision to guard against hostile takeover bids. According to these amendments, a shareholder intending to sell off more than a 5% stake in the company will be required to notify the company about such an intention 30 days in advance of the deal. Moreover, if the controlling stake in Tatneft changes hands, its creditors may demand premature repayment of borrowed funds. As the oil entity’s charter reads, borrowed funds (including bonds) should be repaid upfront in the event of a change in the company’s equity ownership, i.e. in cases where a single shareholder’s equity position in the company’s charter capital exceeds 50%.

Thus, in the event that some strategic investor becomes interested in buying up more than a 5% stake in Tatneft, certain hurdles may arise. A bid to purchase even a minor stake (5-10%) directly from current minority shareholders will immediately be transferred to the oil producer’s managers, who could pool their efforts to disrupt such a deal. Purchasing shares from the company’s employees could also be problematic, as top executives can exercise their administrative leverage. As a result, acquiring Tatneft shares on the open market turns out to be an alluring way to pick up shares in the oil major.

No growth fundamentals

We maintain that presently there are no fundamentals for growth in Tatneft’s market value. The company’s activities are marked by low opacity and a soft corporate governance track record. In recent years the oil producer has barely managed to stem a decline in its production of crude oil, which is characterized by high sulfur content and is classifiable as heavy crude. What’s more, some 80% of the company’s hydrocarbon reserves are hard to extract.

We view the acquisition of the company’s shares by an interested party as an upside factor for its market cap.

Option 1. (High probability).

Management strives to tighten its control over Tatneft by strengthening its grip on charter capital. If Tatneft’s state-owned stake is auctioned off, management would be able to vie for the controlling interest in the oil producer. Top managers most likely already hold a stake in its capital and are currently snapping up stocks on the open market to consolidate their holdings.

This option is underscored by Tatneft’s measures to guard itself against hostile takeover bids.

Option 2. (Medium probability).

The possibility exists that pre-sales preparations are already under way. In this case, events could evolve under the following scenarios:

1. news about the upcoming sale has been disclosed to a certain group of investors who have decided to take advantage of the opportunity.

2. a potential buyer has decided to snap up additional stakes in the company on the open market.

3. the company itself or some of its minority shareholders are artificially inflating prices in order to divest their holdings at higher prices at a later time.

The market has been abuzz with these rumors for some time now, leading investors to believe that French oil major Total is a potential buyer of a block of shares in Tatneft. While this is most unlikely, the oil firm’s shares could be picked up by investors who in turn would then offer them to a new major shareholder of the company.

Option 3. (Low probability).

Since a medium or large stake in Tatneft is difficult to buy, some outside investor may have decided to accumulate the oil company’s shares by acquiring them on the stock exchange. If this stake reaches 10% or in the event an agreement is struck with other minority shareholders, this part could install its nominee on the company’s board. However, the purchase of such a major equity position on the open market could cost such investor an arm and a leg.

Unexpected dividends

Tatneft’s announcement about paying out 9m 2004 interim dividends came like a bolt from the blue for the market. In the first place, it is surprising that the oil company adopted such a decision at all, and what’s more, the amount of these dividend payouts overshoots those paid for 2003. This looks at the more odd as the company is mulling foreign acquisitions (a 67% stake in Turkish state-owned refiner Tupras), while its debts, according to Tatneft’s 1H 2003 US GAAP financial statement, the latest data available, are in excess of $1 bln.

The company’s common and preferred dividend payouts in 1997-2004, Rub/share

Source: company data

The decision adopted by the oil entity’s management to make dividend payouts may be considered from three standpoints. Dividend payouts are a good way to siphon cash out of the company. Firstly, in this case Sibneft is an excellent example. Before announcing its sale, the company had earmarked up to 90% of its net profit for dividend payouts. According to our calculations, Tatneft will likely allocate about 10% of its net earnings to 9m 2004 interim dividend payouts. Secondly, if Tatneft executives already hold stakes in the company, dividend payouts will give them the funds needed to continue buying up the oil entity’s shares on the open market. Thirdly, if pre-sale preparations are being made, this move could raise the company’s market value and, consequently, allow the seller to strike a deal on more favorable terms.

Summing up

In our view, Tatneft shares are currently a high-risk investment vehicle. There are no fundamentals for upside in the oil company’s stock quotes, while it is highly probable that we are witnessing a large-scale acquisition of Tatneft stocks. And while such a strategy can unquestionably spell mega profits, investors must first decide whether they are willing to shoulder the heightened risks associated with this oil play.

We are currently revising our forecast for the fair value of Tatneft’s shares and will make it public shortly after the release of the oil firm’s 2003 US GAAP financial statement.

Maria Radina

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