It’s amazing how being in love changes things. When Elena and I returned to Moscow, I was totally reenergized. With Elena at my side, I felt as though I could take on any challenge.
At the time, my overriding concern was to stop the massive theft taking place in the companies in the fund’s portfolio. The Hermitage Fund had already lost 90 percent of its value from the Russian default, and now the oligarchs were in the process of stealing the remaining 10 percent. If I didn’t do something, the fund would be left with absolutely nothing.
These thefts were happening in every business sector, from banking to natural resources, but the company that truly distinguished itself was Russia’s largest—the oil and gas giant Gazprom.
In terms of output and strategic significance, Gazprom was one of the world’s most important companies. Yet the entire market value of the company—$12 billion—was smaller than your average midsize US oil and gas firm. In terms of hydrocarbon reserves, Gazprom was eight times the size of ExxonMobil and twelve times bigger than BP, the largest oil companies in the world—yet it traded at a 99.7 percent discount to those companies per barrel of reserves.
Why was it so cheap? The simple answer was that most investors thought that 99.7 percent of the company’s assets had been stolen. But how could virtually all of one of the world’s largest companies even be stolen? No one knew for sure, but everyone accepted it as fact.
Even though I knew how crooked the Russians could be, I couldn’t accept that Gazprom’s management had stolen the whole thing. If I could somehow prove that the market was wrong, then there was a lot of money to be made. I needed to study this company and figure out what was really going on. What I needed to do was a “stealing analysis.”
But how do you do a stealing analysis of a Russian company? This wasn’t something they taught at Stanford Business School. I obviously couldn’t confront Gazprom’s management directly. I also couldn’t ask the research analysts at any of the major international investment banks. All that mattered to them was fee-paying work, meaning their lips were so firmly planted on the asses of Gazprom’s management that they would never publicly acknowledge the egregious thefts going on under their noses.
As I thought about how to proceed, I realized that my experience at BCG was worth something in this situation. As a management consultant I’d learned that the best way to answer difficult questions was to find the people who knew the answers and interview them.
So I made a list of people who knew things about Gazprom: competitors, customers, suppliers, ex-employees, government regulators, and so on. I then invited each of them to a breakfast, lunch, dinner, tea, coffee, or dessert. I didn’t want to scare them off prematurely, so I didn’t tell them my whole agenda. I just said that I was a Western investor interested in talking to them. Surprisingly, about three-quarters of the roughly forty people I invited agreed to meet.
My first meeting was with the head of planning at one of Gazprom’s small domestic competitors. Bald and slightly overweight, he wore a Soviet watch and a rumpled gray suit. Vadim and I met him for lunch at an Italian restaurant called Dorian Gray, directly across the Moscow River from Bolotnaya Square.
After the usual introductory chitchat, I said bluntly, “We wanted to talk to you because we’re trying to figure out what’s been stolen from Gazprom. You’re one of the experts in the field, and I was wondering if you might be willing to share some of your knowledge with us?”
There was a moment of silence and I thought maybe I’d crossed a line. But then his face lit up. He placed his hands on the white tablecloth and leaned forward. “I am so glad you’ve asked. Gazprom management is the biggest bunch of crooks you could imagine. They’re stealing everything.”
“Such as?” Vadim asked.
“Take Tarkosaleneftegaz,” the man said, banging his spoon on the table. “They took it right out of Gazprom.”
Vadim asked, “What’s Tarko—”
“Tarko Saley,” the man said, cutting Vadim off. “It’s a gas field in the Yamalo-Nenets region. It has something like four hundred billion cubic meters of gas.”
Vadim got out his calculator and converted this number into barrels of oil equivalent.1 The number he got—2.7 billion barrels of oil—meant that Tarko Saley was bigger than the reserves of the US oil company Occidental Petroleum, a $9 billion company.
I have pretty thick skin, but taking a company worth $9 billion right out of Gazprom shocked me. As the man went through the details, he named names, gave dates, and told us about other major gas fields that were being stolen. We followed up with as many questions as we could think of and filled seven pages of a Black n’ Red notebook. We eventually had to end lunch after two hours, otherwise he would have gone on forever.
Without knowing it, I’d stumbled upon one of the most important cultural phenomena of post-Soviet Russia—the exploding wealth gap. In Soviet times, the richest person in Russia was about six times richer than the poorest. Members of the Politburo might have had a bigger apartment, a car, and a nice dacha, but not much more than that. However, by the year 2000 the richest person had become 250,000 times richer than the poorest person. This wealth disparity was created in such a short period of time that it poisoned the psychology of the nation. People were so angry that they were ready to spill their guts to anyone who wanted to talk about it.
Most of our other meetings went roughly the same way. We met a gas industry consultant who told us about another stolen gas field. We had a meeting with a gas pipeline executive who recounted how Gazprom had diverted all of its gas sales in the former Soviet Union to a murky intermediary. We met with an ex-employee who described how Gazprom had made large, below-market loans to friends of management. In all, we filled two notebooks with damning allegations of theft and fraud.
If you were to believe all the information we collected, this was probably the largest theft in the history of business. Only there was one big catch. We had no idea if any of these allegations were true. The things people were saying could easily have been sour grapes, exaggeration, or deliberate misinformation. We needed to find a way to verify what we had heard.
But how could we verify anything in Russia? Wasn’t that the essence of the problem we were facing with Gazprom in the first place? Wasn’t Russia a place that was so extremely opaque that you sometimes felt as though you couldn’t even see your hand in front of your face?
It appeared that way, but in reality, it wasn’t so opaque at all. All you needed to do was scratch the surface to find that Russia was strangely one of the most transparent places in the world. You just needed to know how to get the information, and we learned this almost by accident a few weeks after we’d finished the Gazprom interviews.
Vadim was driving his VW Golf to work when traffic ground to a halt where the Boulevard Ring meets Tverskaya at Pushkin Square. At that junction, every car has to turn either left or right, creating near-permanent gridlock at most times of the day. With motorists stuck in their cars for as long as an hour, a small army of enterprising street urchins had popped up to sell anything from pirated DVDs to newspapers to cigarette lighters.
While Vadim sat there that day, a boy approached the car brandishing his wares. Vadim wasn’t interested, but the boy persisted.
“All right, what are you selling?” Vadim asked warily.
The boy held open his dirty blue parka to reveal a collection of CD-ROMs in a plastic portfolio. “I’ve got databases.”
Vadim’s ears perked up. “What kind of databases?”
“All kinds. Mobile phone directories, tax return records, traffic violations, pension fund info, you name it.”
“Interesting. How much?”
“Depends. Anywhere from five to fifty dollars.”
Vadim squinted at the small print on the collection of discs in this kid’s portfolio and spotted one entitled “Moscow Registration Chamber Database.” Vadim did a double take. The Moscow Registration Chamber is the organization that tracks and collects information about who owns all Moscow-based companies.
Vadim pointed to the disc. “How much for that one?”
“That? Eh . . . five dollars.”
Vadim gave the boy a $5 bill and took the disc.
As soon as Vadim got to the office, he went to his computer to see if he’d just spent $5 on a blank disc. But just as the boy had promised, a menu appeared allowing Vadim to search for the beneficial ownership of every single company in Moscow.
It was at that moment that we discovered the second most interesting cultural phenomenon in Russia—that it was one of the most bureaucratic places in the world. Because of Soviet central planning, Moscow needed data on every single facet of life so its bureaucrats could decide on everything from how many eggs were needed in Krasnoyarsk to how much electricity was needed in Vladivostok. The fact that the Soviet regime had fallen hadn’t changed anything—Moscow’s ministries continued to exist, and their bureaucracies took great pains to account for everything for which they were responsible.
After Vadim’s chance run-in on Pushkin Square, we quickly became adept at finding all sorts of other data to help us cross-check the allegations we’d collected in the Gazprom interviews. Using these databases, we calculated that the management of Gazprom had sold seven major gas fields between 1996 and 1999 for next to nothing.
These asset transfers weren’t merely huge, they were brazen, and they were done without the slightest sense of shame. The new owners of the stolen property did nothing to even try to hide their ownership.
One of the more blatant examples was the story of Sibneftegaz, a subsidiary of Gazprom. Sibneftegaz, a Siberian gas producer, obtained licenses for a gas field containing 1.6 billion barrels of oil equivalent in 1998. Based on an extremely conservative estimate, we determined this subsidiary was worth about $530 million, yet a group of buyers was allowed to buy 53 percent of Sibneftegaz for a total of $1.3 million—a 99.5 percent discount to our calculation of its fair value!
Who were these fortunate buyers? One was Gennady Vyakhirev, the brother of Gazprom’s CEO, Rem Vyakhirev. Gennady, along with his son Andrey, used a company to buy 5 percent of Sibneftegaz for $87,600.
Another 18 percent block was bought for $158,000 by a company partially owned by a Victor Bryanskih, who was a manager in Gazprom’s strategic-development department. A further 10 percent of Sibneftegaz was bought by a company owned by Vyacheslav Kuznetsov and his wife, Natalie. Vyacheslav was the head of Gazprom’s internal audit department, the very department that was supposed to detect and stop this type of thing from happening in the first place.
We uncovered six other major asset transfers using similar techniques. When Vadim added up all the oil and gas reserves that had left Gazprom’s balance sheet, he found that Gazprom had effectively given away reserves equivalent to the size of Kuwait’s. Full-scale wars had been fought over far less.
What was most astonishing, though, was that while these oil and gas reserves were huge, Vadim determined they represented only 9.65 percent of Gazprom’s total reserves. In other words, more than 90 percent of Gazprom’s reserves had not been stolen. No other investors understood this. The markets had assumed that literally every last cubic meter of gas and every drop of oil had been pilfered from the company, which was why it traded at a 99.7 percent discount to its Western peers. But we had just proved that more than 90 percent was still there—and no one else knew it.
What should an investor do in a situation like this? I’ll tell you what: you buy the shit out of that stock.
In a world where people fight tooth and nail to make 20 percent, we’d just found something that might generate 1,000 percent, or even 5,000 percent. It was so obvious, that the fund increased its investment in Gazprom right up to the 20 percent limit, the largest percentage for a single stock that the fund allowed.
For most investment professionals, this is where you would stop. You do your analysis, make your investment, and then wait for others to discover what you’ve learned. But I couldn’t do that. Our discoveries about Gazprom were too great. I had to share them with the world.
I then did something very unusual in my profession. I divided the Gazprom dossier into six sections and gave each one to a major Western news outlet. The reporters and editors at these outlets immediately saw the impact this story would have, and our research was so exhaustive that they couldn’t resist. We’d saved them months of investigative work, and it didn’t take long for them to turn our research into a slew of staggering articles.
The first appeared in the Wall Street Journal on October 24, 2000, entitled “Gas Guzzler?” It described how the stolen gas fields had enough natural gas “to keep all of Europe going for five years.” The next day, the Financial Times came out with its story, “Gazprom Directors to Meet over Governance.” This article detailed all of the “friends and family” transactions at Gazprom. On October 28, the New York Times published “Directors Act on Asset Sales at Gazprom” in its international-business section. Less than a month later, on November 20, BusinessWeek published “Gazprom on the Grill.” And on December 24, the Washington Post published “Asset Transfers May Provide Challenge to Putin.”
The public in Russia and abroad was shocked by the level of corruption at Gazprom. Over the next six months, there were more than 500 articles in Russian and 275 in English, all reporting what we had exposed at Gazprom.
This coverage had a noticeable effect in Russia. Russians accepted the concept of corruption and graft in the abstract, but when they were given concrete examples of who was getting money and how much they were getting, they were furious. So furious, the Russian Parliament called for debates in January 2001 about the situation at Gazprom. These led to a recommendation for the Audit Chamber, Russia’s equivalent to the US General Accounting Office, to conduct its own investigation of Gazprom.
Responding to the Audit Chamber’s investigation, Gazprom’s board of directors commissioned PricewaterhouseCoopers, the big American accounting firm, to conduct an independent review.
After several weeks, the Audit Chamber announced the results of its investigation. Perhaps not too surprisingly, it said that they hadn’t found anything wrong with the conduct of Gazprom’s management. It justified the asset transfers by saying, “Gazprom was capital constrained and needed the outside capital.”
All that was left was the PwC report. This accounting firm was making millions of dollars off Gazprom as its auditor, so any indictment of Gazprom would have been an indictment of itself. Sure enough, it also exonerated Gazprom’s actions. It came up with obtuse and irrational arguments to explain why all the things that we’d exposed were reasonable and legal.
While these were not completely unexpected outcomes, I was so fed up with everything that I didn’t want to be anywhere near Moscow when Gazprom held its annual general meeting on June 30, 2001. I knew that in spite of all we’d exposed, the management would strut around like proud peacocks, telling the world how well managed the company was.
I wanted to avoid the whole spectacle, so I asked Elena if she wanted to get away from Moscow for a long weekend. She had just finished a big project at work and agreed, so I booked two tickets to Istanbul, one of the few desirable places we could go without Elena’s having to get a visa.
We flew on the day of Gazprom’s annual meeting, and after arriving at Atatürk Airport we took a taxi to the Ciragan Palace Hotel, a former sultan’s palace on the European side of the Bosporus. It was a beautiful summer day. We went to the veranda next to the pool and ate lunch under a huge white umbrella, with the sun beating down. Ships of all sizes slowly passed below as they made their way in and out of the Sea of Marmara. It had only been a three-hour flight, but the exotic sights and sounds of Turkey, combined with Elena’s soothing presence, made me feel a million miles away from the dirty dishonesty of Russia.
As we ordered mint tea and dessert, my mobile phone rang. I didn’t want to answer, but it was Vadim, so I did.
And he had the most amazing news.
Gazprom’s management wasn’t strutting around their annual general meeting at all. Rem Vyakhirev had just been fired as CEO by none other than President Vladimir Putin.
Putin replaced Vyakhirev with a virtually unknown man named Alexey Miller. No sooner had Miller taken office than he announced that he would secure the remaining assets on Gazprom’s balance sheet and recover what had been stolen. In response to that, the stock price went up 134 percent in one day.
In the following two years, it doubled again. Then, it doubled again . . . and again. By 2005, Gazprom was up a hundred times from the price at which the Hermitage Fund had purchased its first shares. Not 100 percent—one hundred times. Our little campaign had gotten rid of one of the country’s dirtiest oligarchs. It was, without question, the single best investment I have ever been involved with in my life.
1 Barrel of oil equivalent, or BOE, is a unit of energy used to compare cubic meters of gas to barrels of oil.