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By John Helmer, Moscow

Until today, milk, fruit pulp, and flavoured water (aka juice) have not been known to be strategic resources in the Russian Federation. But clever lobbying, or incredible stupidity, has arranged to make them seem so, and thereby create the appearance of compliance with Russia’s competition and anti-monopoly laws – without the reality.

In June at a speech in St. Petersburg, President Dmitry Medvedev claimed: “The state’s job is to ensure a good business climate for Russian and foreign entrepreneurs, and a fair and honest competitive environment.”

Not long after he said that, there was a ceremonial signing of an agreement between Danone, the French milk product, baby food and water company, and the Russian dairy company Unimilk, to merge their operations and assets in Russia. Before the transaction signing, three dairy producers dominated the Russian market – Wimm Bill Dann (WBD), with a 28.3% market share; Unimilk with a 16.5% market share, and Danone with 14.3%. After Medvedev’s modernization, there are now two, with a combined market shares of almost 60%. Danone is the dominant one of the two with more than 30%.

The weekend before last in Berlin, Prime Minister Vladimir Putin declared: “the economy should not be burdened with unnecessary obligations; on the contrary, it needs incentives and a favourable environment to become competitive…Investing in sectors that are not classified as strategic does not require any permits.”

A week later, there was another ceremonial signing in Moscow, this time to confirm that WBD is selling out to the US beverage and snack-food company, PepsiCo. The full transaction value is estimated at $5.4 billion, with $3.8 billion paid down for a 66% shareholding. This represents a premium to WBD’s pre-takeover share price of 32%. PepsiCo called the deal “its largest-ever international acquisition.” It also observed that “the transaction makes Pepsico the largest food and beverage business in Russia.” With Lebedyansky, another Russian juice producer acquired in 2008, PepsiCo will have an 80% share of the flavoured water market in Russia.

PepsiCo, it also seems, is having to pay much more for WBD than Danone for Unimilk, which was priced at €1.3 billion for the initial acquisition, with full transaction value of €3 billion realizable only in 12 years’ time. Industry analysts put the Unimilk takeover at a 20% discount to the value of WBD before the PepsiCo transaction.

The Federal Antimonopoly Service (FAS) announced today that it has arranged a fast-track review of the PepsiCo deal, putting it on the agenda of this month’s meeting of the Government Commission for Control of Foreign Investment in the Russian Federation, aka the Control Commission. The brief announcement was signed by FAS head, Igor Artemyev.

But wait just a minute – the statute and regulations which created the Control Commission, seating Prime Minister Putin as chairman, and designating the 42 sectors of strategic importance to the economic, physical and military security of the country don’t say anything about milk or water on the control list. Unusually secretive though the Control Commission is, and exceptionally slow in its approvals process, what reason can there be for the PepsiCo takeover of WBD to go before it – and at such a speed the FAS secretariat will hardly have time to pin the application papers together, let alone analyze the deal implications for food and beverage production, distribution, and sale to consumers across Russia?

Can the Control Commission Chairman be unaware that PepsiCo’s non-strategic investment, however big and rewarding it obviously is for WBD’s shareholders, is being compelled to obtain a permit which Putin has declared to be unnecessary?

Responding to this question, a spokesman for PepsiCo in Moscow said that PepsiCo understands that Russian law requires the FAS to check transactions which affect large or dominant market shares, in order to determine the competitive effect on prices and regulate it, according to the existing statutory standards. According to announcements from PepsiCo at last week’s deal signing, the company is hopeful “the required government approvals” will take no more than two to four months.

But PepsiCo and also WBD decline to say why the Control Commission is undertaking the transaction review, not the FAS.

It has happened before — when Danone acquired Unimilk in June: The Control Commission examined the deal, and issued its approval two months later in August. The FAS also issued its own regulatory permit, but only after the Control Commission had acted first.

According to Unimilk spokesman, Yevgenia Lampadova, “the FAS checks companies if the service believes a transaction could threaten normal market competition. There are two succeeding checks, one by the Control Commission ,and then another by FAS. Together they took about two months.” Among the conditions imposed on Danone for the takeover, the company is required to file quarterly reports to the FAS detailing the prices it pays for raw and dry milk, as well as the sale prices of its products, so that the agency can monitor price trends and profit margins. Danone was also obligated not to apply pricing pressure or discriminate against sellers of raw milk, nor close or convert milk-processing dairies without advance permission from the FAS.

One of WBD’s selling shareholders, David Yakobashvili, appears to be impatient for his cash. The day after the deal announcement he said he hopes the FAS will not impose such conditions on PepsiCo in return for its approval. Yakobashvili claimed that he had consulted lawyers, and had been assured there are no anti-trust violations in the deal itself, and no need for regulatory controls to prevent abuse of PepsiCo’s newly dominant market position.

Perhaps it was Yakobashvili’s idea to have the Control Commission rush its approval of the takeover through as a way of saving PepsiCo from taking fright, and walking away from the deal. Did WBD engage lobbyists to try to persuade the ministers on the Control Commission to limit the amount of regulatory supervision they will allow to the price watchdogs at the FAS?

In mid-year, Danone had employed a Moscow lobbyist, Dmitry Afanasiev, to advise on how to put the Unimilk takeover through the Kremlin. In that case, the deal went first to the Control Commission and then to the FAS. According to Afanasiev’s spokesman, this time round, “unfortunately we do not represent any of the parties in the transaction.”

But if everyone agrees milk and water aren’t strategic resources, is the submission of the deal to the Control Commission a way of lobbying for light, rather than heavy pricing and competition regulation? Putin’s spokesman, Dmitry Peskov, is reported to have told the press after the deal announcement that he thought there is no need for the Control Commission to be involved. According to Peskov, that’s because WBD is not “among the companies of strategic importance”.

So the FAS was asked to explain why the deal is going to the Control Commission after all.

Spokesman Maria Chernova said that for the time being, the FAS has not received an application from PepsiCo, but that when it is received, it will go to the Control Commission. The reason, she said, is this: “The transaction falls under the Federal Law 57-FZ because one of the companies [WBD] has laboratories which can be a source of infectious agents. Our amendments to 57-FZ reducing the number of strategic sectors (including the potential sources of infectious agents) have not been approved yet, so the deal should be examined by the Control Commission, and it should make a decision at the next meeting in December 2010.”

And so it’s bugs that are obliging the Prime Minister to break his word, not clever lobbying. It is also bugs in the deal, which are worrying the Consumer Rights Protection Society (OZPP) in Moscow. Mikhail Anshakov, the chairman, said he is not concerned about the competition impact of the takeover. “I don’t see any big problem with takeovers or share swaps with foreign companies. It’s normal international practice. We have the antimonopoly service [FAS], and if they think the transactions are normal, then they probably are. What really raises concern is the quality of production. The Soviet GOST [state technical and quality standards] system which included over 75, 000 items, has been eliminated. It was planned to replace it with the set of new technical regulations. But to date only 17 out of 400 have been adopted. Everything has been destroyed. We are a country of the Third World now, with a nineteenth-century level of consumer protection.

Rospotrebnadzor is absolutely helpless with its right to perform checks only once in three years with advance notice, and the sanctions they apply are pathetic.”

OZPP’s primary concern is that, with the market of Russian dairy foods shared between just two international giants, price regulation by FAS will fail to detect adulteration and deterioration of production, so that profit margins are increased by the diminution of product quality. OZPP, says spokesman Yulia Sharapova, has “an overall concern for the quality of dairy products on the Russian market. Recently, we conducted our own study, and after the [PepsiCo] takeover we will closely monitor the quality of dairy products. Currently, we are in several court cases over milk quality — poor-quality dairy products, including the companies mentioned – so we can also point out violations of the technical regulations and lack of control in this sphere.”

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