Silovye Mashiny (Power Machinery) has gotten rid of its blocking stake in the Kaluga Turbine Factory, which among other things also produces military hardware. The company has thus rid itself of the last obstacle preventing SM from being taken over by Siemens

Andrei Vinkov and Irik Imamutdinov

Last week, Russia’s largest producer of equipment for the energy industry, Silovye Mashiny (SM), released its quarterly report according to international accounting standards. According to the report, the company has gotten rid of its stake in the charter capital of the Kaluga Turbine Factory (KTZ), an enterprise it struggled to gain control over for several years. Its stake, 25.5% of voting shares, was sold for a mere $4.87 million. The purchaser remains unknown, as are all the other details of the deal. Yet unofficial versions of the deal abound: the KTZ shares went to organizations belonging to the Interros Holding, SM’s main owner, in order to separate the military contractor from SM, soon to be taken over by Siemens.
SM holds stakes in other companies connected to the defense industry. The KTZ case may be setting a precedent, and the other military contractors may also be removed from the SM balance sheet. Then there will be no formal obstacles in the way of the Siemens deal, the general outline of which was approved by high-level Russian and German officials this summer.

A tough deal

This summer, Interros began its negotiations with German machine builder Siemens to sell SM. Siemens announced plans to directly purchase 71% of SM’s shares from Interros this June, and the German company already owns 5%. Siemens sent a request to this effect to the Federal Antimonopoly Service (FAS) on July 6. Interros even began to actively consult the Russian government regarding the sale of a controlling stake in SM to foreigners. However, though Russian officials welcomed the arrival of the trendsetter in world electronic instruments to the Russian market, they protested the transfer of SM’s assets to its control. In particular, Prime Minister Fradkov stated that the government would need to “study this deal in detail in order not to lose our market position,” noting that the deal involved “the interests of the Ministry of Defense.”
In fact, at least two of the companies controlled by SM are the only suppliers of electronic equipment for nuclear submarines in Russia. The Kaluga Turbine Factory produces steam turbines for atomic subs and Elektrosila builds their electric generators. The problem of how to separate civil and military production at these factories remains unsolved.
The parties participating in the deal began to seek a compromise. Interros announced that it would found a joint venture with Siemens. This company would hold 71% of SM’s stock, yet Interros would retain control. The Germans will pay for their 49% share in cash, around $100-150 million. In late September, antimonopoly authorities in Germany, the Bundeskartellamt, approved the Siemens-Interros joint venture. However, Russian antimonopoly authorities suspended its review of the Siemens request and demanded additional information. The deal seems to have stalled because of KTZ. According to the plan proposed by Siemens, it would be possible for the German company to gain a majority on the board of directors of KTZ, which remains on the list of strategically important Russian companies. Siemens would directly control around 24.8% of the factory’s shares (with SM and the state holding the 25.5% and 32.8% stakes respectively).

A legal fence

KTZ’s main products are small and medium-sized steam and gas turbines for power stations, as well as equipment for the submarine fleet. Siemens was most likely not interested in military hardware when it increased its stake in KTZ’s charter capital. Defense contracting is not an area where foreigners can make money in Russia. The General Director of the AST Center, Ruslan Pukhov, is convinced that KTZ’s defense orders are insignificant and if they will increase in coming years, then only by a little.
More likely, the Germans were drawn to the huge potential of the Russian market for equipment related to the energy industry. According to specialists’ estimates, after UES Rossiya is restructured, the market could expand to $20 billion dollars. A significant portion of this market will be for inexpensive energy conservation programs and small power stations. Here, KTZ could become one of Russia’s main manufacturers. According to Irina Lozhkina, a machinery and metals analyst at Prospekt Investment Company, “KTZ is without a doubt a strategic company for Siemens because the factory is operating in the promising small-scale energy segment.”
The Kaluga Turbine Factory was built in the mid-1950s as part of the Soviet program to develop small-scale power plants. Thanks to the mobile power plants equipped with 500-1000-kWt steam and diesel generators built by KTZ, almost 10,000 settlements gained electricity. In the 1960s the factory became the USSR’s biggest producer of generators for seafaring vessels, including nuclear submarines. Sub turbines, which require more scientific know how than their ordinary counterparts, allowed KTZ to become a constant source of original technological ideas for commercial innovation projects related to energy. For example, KTZ’s sub turbines use low-temperature steam (around 300°C), which requires a range of technological modifications that make them different from the classical high-temperature turbine. Material science, turbine construction, and hydrodynamic research all make KTZ of great interest to Siemens.
According to Vladimir Lunkov, Director of the Analytic Department at Atlanta Capital, the state is simply afraid it will lose day-to-day control over the military hardware produced by KTZ. Defense production, however, was separated from civil manufacturing long ago. A special fence runs across the factory’s campus dividing classified from non-classified production. The company only needs to throw up a legal fence around KTZ’s military section. Around a year ago, Ilya Khlebanov, at the time Minister of Industry, Science, and Technology, announced that sale of the state-owned stake in KTZ would precede the company’s restructuring. “The part of production connected to defense manufacturing will remain state property,” Klebanov specified at the time. However, this legal fence has yet to be completed.

Waiting for a patriot investor

SM currently has no KTZ stock on its balance sheet. This means that Interros has removed the assets that so irritated officials from the Antimonopoly Service and the Defense Ministry. But is KTZ really the final obstacle in the way of Siemen’s purchase of SM? The Russian machine builder still has stock in several companies with military pasts. What, for instance, should the company do with Elektrosila, which produces special electricity generators for nuclear subs? It seems the KTZ phenomenon will continue to haunt the parties involved in the Siemens deal. On one hand, Russian officials could legally separate civil and defense divisions and solve this problem, as well as others that may arise in the future. However, it is likely that the sluggishness of bureaucrats responsible for declassifying military secrets is based on the hope that some patriotic Russian investor will arrive on the scene.
Purely Russian capital or dynamic Russian strategic investors have yet to take hold of the energy industry. The great achievements and potential of the Soviet era are still there, which is clear from the example of KTZ, and yet Russians are abandoning the industry. The charismatic Kakha Bednukidze left OMZ, Energomash Corporation has disappeared from the corporate news, and now Interros is trying to sell SM. Russian entrepreneurs do not have enough ambition and decisiveness to create competitive, world-class technology giants on the basis of existing potential. They are more than willing to sell their businesses to foreigners. As one expert in machine building noted quite emotionally and very cynically, “only stupid rhetoric and hot air is preventing SM from merging with Siemens.” The state, for its part, is dawdling. It lacks the will and the desire to make strategic decisions and take responsibility for them.

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