By John Helmer, Moscow
Sovcomflot, Russia’s dominant shipping company and (next to the Chinese) the world’s most valuable energy tanker fleet, announced yesterday that in 2020 its earnings had risen almost 10%, and its profit jumped by over 18%.
However, the stock market is decidedly unimpressed. On the Moscow Stock Exchange, where Sovcomflot shares have been listed since last October, the share price moved up by less than half of one percent on a tiny volume of transactions .
At its new price of Rb91.12 ($1.24), the market is telling the shipping company it is worth 13% less than the company claimed six months ago, when it issued its share prospectus at Rb105.
Worse yet may materialise in April, when the lock-up period expires for the anchor shareholders; they committed themselves to buying at Rb105 on October 7 and to waiting six months before selling out. At least one of them won’t do that, though. That’s OOO SCF Arctic, a Sovcomflot subsidiary holding part of the tanker fleet. In order to support the planned privatisation of Sovcomflot shares at the target share price, SCF Arctic promised to buy a block of shares from the share-sale bankers if they didn’t want them; that cost the shipping company $47.2 million.
In other words, Sovcomflot was an anchor investor in itself. The state sovereign investor, Russian Direct Investment Fund (RDIF), was the biggest of the other anchors. With state support like this, Moscow market analysts say they aren’t surprised at the lack of commercial investor demand. “The privatisation was a propaganda exercise”, comments a London shipping expert. “There is a problem in the reporting of Russian companies – the truthful part disguises lots of faking.”
The initial public offering (IPO) last October failed, says Pavel Gavrilov, a stock analyst with BCS Express in Moscow. “Technical difficulties, lack of information, the speculative component, and other factors” were to blame.
Yesterday, Sovcomflot’s chief executive Igor Tonkovidov said that “with swings in global oil demand causing extreme volatility across energy markets, SCF [Sovcomflot] Group has demonstrated resilience to such turbulence and has produced further increase in its key operational and financial metrics.”
Sovcomflot was a 100% state owned company until last October.
Plans to privatise part of this shareholding have been publicly announced for almost twenty years, although the government reason and the management motive behind these plans have changed. Sergei Frank, chief executive of Sovcomflot from 2004 until he was replaced by Tonkovidov in 2019, had aimed at an IPO on the London, New York or Frankfurt exchanges to multiply the capitalisation of the company by several magnitudes. The state property agency and the Finance Ministry had hoped to raise a substantial sum out of the share sale to add to the state budget, reducing the annual deficit. Several oligarchs with interests in oil, gas and transportation have had the ambition of taking the tanker fleet into their profit-making empires offshore.
The US and NATO war against Russia, especially capital sanctions, have ruled out the option of a US exchange listing. A 13-year long London court case which judged Frank to be vindictive and dishonest, cast a shadow over a London listing; read that story archive here .
Following Tonkovidov’s takeover of the management, Frank’s removal to board chairman, and a break with loss-making in the company’s balance-sheet led to last year’s share sale.
THE FALL OF SOVCOMFLOT’S SHARE PRICE SINCE PRIVATISATION
Market capitalisation, Rb214.4 billion ($2.9 billion); free float, 408.3 million of 2,370 million shares issued (17%). Source: https://www.moex.com/ 
However, the market capitalisation has fallen with the share price to just under $2.9 billion; that is less than half the value of the company’s fleet assets — $6.2 billion . This market valuation is also several hundred million dollars less than Sovcomflot’s loan debt of $3.2 billion. There is no market profit in these numbers.
On Monday, Nikolai Kolesnikov, chief financial officer of the company, claimed the IPO had “resulted in a strengthening the balance sheet and the financial position of the Group, with net debt to EBITDA [earnings before interest, taxes, depreciation and amortisation] ratio falling to 2.6 times [2.6x]. The Company has sufficient investment capacity to undertake large scale projects and to pursue further growth in its core strategic segments.” This ratio is a number on paper; its significance is to Sovcomflot’s bankers who have imposed covenants including this ratio for loan terms; and to the ship finance market which has seen the total indebtedness of the company and the debt-to-earnings ratio blow out to a peak of 6.0x in 2017-2018.
According to the IPO prospectus drafted for Sovcomflot by a combination of Russian state banks, US banks, and two international law firms, the company claimed it “intends to use net proceeds from the placement of the Offer Shares for general corporate purposes, including, without limitation, investments in new assets, with a focus on industrial projects, decarbonisation and further deleveraging.” Read the prospectus here .
The release of the 2020 financial accounts this week indicates that this isn’t quite what happened to the $550 million in gross share sale proceeds announced at the IPO, or to the net proceeds of $481 million, after the company bought its own shares back from the banks and paid them their fees. Overall loan debt at September 30, just before the IPO, was $3.45 billion. The number announced at year’s end – published on March 15 – was $3.23 billion, The reduction in debt appears to be $220 million.
However, according to the latest financial report, Sovcomflot signed a fresh contract this past January for one new liquefied natural gas (LNG) tanker at a cost of $182.8 million, with an option to build two more. In November it has borrowed $155 million from two Japanese banks to pay for the vessels.
There is no sign in the new financial report, audited by Ernst & Young, that Sovcomflot has paid the state budget any part of the share sale proceeds. Instead, in the small print it is revealed that there has been a large increase in the number on the “cash and cash equivalents” line – from $374.8 million in 2019 to $849.5 million now. This is an extra cash pile of $474.7 million the company is now sitting on. Kolesnikov’s calculation of the debt-to-earnings ratio counts this money for reduction of the gross debt figure to the net debt figure.
Source: http://sovcomflot.ru/en/investors/  – page 47.
There is no explanation for the decision to do this instead of doing what the IPO prospectus promised.
In years past, the added cash on the asset side of the balance-sheet might have helped boost the bonuses of the senior management of the company. In 2006, for example, the Moscow financial press reported that the formula for chief executive Frank’s bonus was one-quarter of the management bonus pool, while the pool was filled with company cash calculated from 5% of the dividend declared for the treasury, plus 2.5% of the asset value added to the balance-sheet during the year.
The company’s annual report for 2019 doesn’t say what the management bonus formula is except to claim it depends on “the attainment of number of key performance indicators”. (page 93). As chairman of the board of directors, Frank is now on fixed pay of just under $100,000 per annum. Tonkovidov, Kolesnikov and other senior executives received more in bonuses than in salary – Rb310 million versus Rb208 million – for 2019. Their benefit in 2020, and from the IPO, won’t be revealed until the new annual report appears – in July or August.
Left to right: Igor Tonkovidov, 57; Nikolai Kolesnikov, 58; Sergei Frank, 61.
In 2020 Sovcomflot’s fortunes depended, as they always did, on the price of crude oil; the rise and fall of tanker rates to transport it; and the cost of servicing the company’s heavy loan debt. In 2018 the Brent crude oil price had risen well above its 2017 level, rising from $67 per barrel to $84 in October and down again to $50 at the end of December. Over the same period the Baltic Dirty Tanker Index – a market measure of the voyage charge for crude oil tankers — rose from 680 at the start of the year to a peak of 1,256 on December Sovcomflot’s tanker revenues barely budged, however, at $1.1 billion. Vessel operating costs fell modestly by 6%. The bottom line was loss-making. At $46 million for 2018, however, this was two-thirds less than the $113 million lost the year before .
In 2019, the oil market was less volatile; the Brent marker commenced at $55 and ended at $66. The tanker index started sharply downward, hitting lows from 620 to 650 between April and July, then picking up again to reach between 1,500 and 2,000 in the last quarter of the year. Sovcomflot’s financial condition improved markedly. Revenues grew to $1.3 billion, up 18%; costs went down by 6%. The difference turned into a net profit of $225 million.
In 2020, the company managed to keep its tanker earnings stable even as the demand for oil collapsed with the onset of the pandemic, followed by the introduction of OPEC output limits. The tanker index plummeted from a high of 1,500 in January – when tankers were hired to store surplus oil afloat and at anchor in harbours around the world until market demand recovered — to between 400 and 550 in the second half of the year; that was as low as the index had fallen since 2009.
The bottom line for 2020 announced this week was a profit of $266.9 million; this was up by 18.4% on the year earlier.
Click to source for full-sized image: http://sovcomflot.ru/en/investors/ 
It was a decidedly better performance than a report of June 2020 from the Fitch ratings agency was forecasting. According to Fitch, falling tanker rates would press downwards on Sovcomflot’s revenue and profit lines. “SCF [Sovcomflot] has not yet been negatively affected by the coronavirus pandemic beyond small operational difficulties, which the management believes are manageable and negligible. However, we assume,” said Fitch , “that SCF’s earnings will fall in 2H20 despite a healthy 1Q20, resulting in annual EBITDA in 2020 that is about 19% lower than 2019.”
A month later, on July 17, 2020, the Standard & Poor’s (S&P) rating agency reported greater optimism. “The company will generate sufficient cash to absorb large, although diminishing, committed capex [capital expenditure] of $450 million-$500 million (including the dry-dock and special survey expense) and continue gradually reducing adjusted debt to about $3.3 billion in 2020 from about $3.6 billion in 2018.”
Moody’s, the third international rater, issued its assessment on June 9, 2020. Its analysts charted the blow-out of company debt – “credit metrics” and “leverage” were the terms they preferred — but they did not criticise Frank for it; nor did they report that his replacement by Tonkovidov pointed to a significant change of government policy for the company. Moody’s entirely missed the significance of the personnel change.
DEBT-TO-EARNINGS AND OTHER MEASURES OF SOVCOMFLOT’S LEVERAGE
KEY: FFO=funds from operations; LHS=left hand side (cost in base currency); EBITDA=earnings before interest, taxes, depreciation, and amortization; RCF=retained cash flow; RHS=right hand side. Source: http://sovcomflot.ru/ 
Sovcomflot’s “credit metrics deteriorated significantly in 2017, driven by the market downturn, which coincided [sic] with an extensive programme of debt-funded vessel construction and asset acquisitions (the company added more than $1.0 billion worth of assets to its balance sheet in 2016-17). As a result, the company’s leverage, measured as adjusted debt/EBITDA, rose to 6.2x in 2017 from 4.5x in 2016. In 2018-19, SCF reduced its investment activity, which, coupled with gradually improving EBITDA generation, resulted in its adjusted leverage declining to 5.6x and 4.2x, respectively.” There was a fresh warning of the risk of not being able to earn enough to cope with debt. “Despite the sound recovery in SCF’s financial metrics, with its adjusted debt/EBITDA likely trending below 4.0x in 2020, its credit profile has historically been fairly volatile and the company still needs to demonstrate its ability to maintain leverage at a comfortable level through the market and investment cycles.”
The plan, the company had assured Fitch in mid-June, was to privatise a block of 25% minus one. Standard & Poor’s report of mid-July warned against privatising a larger stake than that. “The rating may come under pressure if we revised down our assessment of the likelihood of government support. This could occur if, for example, the government decreased its stake in the company to less than 75%.” In other words, so long as Sovcomflot was carrying a heavy loan debt, the company’s shareholders were protected from the risk of default by the Russian state. Reduce the state stake, and the risk of the debt Frank had left behind at his departure would grow.
The Moody’s report said the same thing : “The government has named SCF a candidate for privatisation and plans to sell 25% less one share of SCF by 2022. We do not expect the privatisation of a non-blocking stake to have any significant effect on the company’s operations or reduce the degree of control of the state over SCF.” – page 7. An extra caution was added – Moody’s advised the company to use the cash from the share sales to pay down its debt balance. “Privatisation could improve SCF’s credit profile if proceeds are applied to recapitalise the company as initially planned.” Once the financial details became available this week, it is clear this isn’t what happened.
Tonkovidov had been promoted against Frank by the national security faction of government officials. Frank, they believed, was too friendly towards the British and Americans. His strategic mistake, in their eyes, had not only been to increase the company’s debt to a record level, increasing its dependence on international banks, especially American ones; but he had also built a fleet too big to serve Russian oil and gas exports, thereby increasing its vulnerability towards foreign energy customers, especially the Anglo-American group, such as ExxonMobil and Royal Dutch Shell.
The company has traditionally been coy in disclosing how much of its debt is under foreign bank control, as well as the proportion of its oil and gas cargo chartering customers who are not Russian. The start of the US sanctions war against Russia in 2014 has made both points sensitive ones in Moscow, and so more or less secret.
However, as early as October 2010, when Frank hired JP Morgan and Deutsche Bank to join the Russian VTB Capital to sell $750 million worth of debt securities, the company was obliged to warn : “the Group derives a significant portion of its revenues from Russian and international oil and gas companies. During 2009, the Group’s largest customer accounted for approximately 9% of the Group’s gross revenues, and the Group’s 10 largest customers accounted for approximately 52% of the Group’s gross revenues over the same period. If one or more of the Group’s key customers breach or terminate their charter contracts or renegotiate or renew them on terms less favorable than those currently in effect, or if any such customer decreases the amount of business it transacts with the Group, it could have a material adverse effect on the Group’s business, financial condition, prospects and results of operations.”
“Terrorist attacks and war or other events beyond the Group’s control that have an adverse effect on the production, transportation or distribution of oil and oil products could entitle the Group’s customers to terminate the Group’s charter contracts, which would have an adverse effect on the Group’s business, financial condition, prospects and results of operations.” The likelihood of US and NATO war against Russia seemed as remote in mid-2010 as it was certain a decade later, in mid-2020.
Sovcomflot’s prospectus of 2010 identified a list of US and NATO-allied oil company shippers, including ExxonMobil (US), Chevron (US), ConocoPhillips (US), British Petroleum (UK), Shell (Anglo-Dutch), Total (France), Repsol (Spain), and Statoil (Norway). It also listed as customers the international oil traders Glencore (Switzerland), Trafigura (Singapore), and Vitol (Switzerland), together with Gennady Timchenko’s Gunvor. But it avoided revealing what proportion of Sovcomflot’s revenues was earned transporting their cargoes.
A decade later, in June 2020, the company had become significantly more Russia-centered and less dependent on the US and NATO for clients:
SOVCOMFLOT’S TOP-9 CUSTOMERS
Source: Sovcomflot, share sale prospectus, October 7, 2020 – page 3. The figures for Trafigura and Vitol indicate crude oil produced by the state oil company Rosneft. Compared to a set of client figures reported by Moody’s for 2019, Total was up significantly, Exxon is up slightly, Shell down significantly, while the balance for others has dwindled by 7 percentage points.
The company has also reoriented its vessels to what it calls its “industrial” business. This includes gas transportation and the operation of LNG and liquefied petroleum gas (LPG) tankers. It also includes running shuttle tankers between offshore wells and larger vessels bound for export ports, as well as onshore terminals and refineries; operating vessels for seismic research of the deep seabed; and delivering workers, supplies and other logistic services to offshore rigs and platforms, most of them in the heavy ice conditions of the Arctic region. In 2005, Frank’s first year as chief executive, this line of business was non-existent; in 2010 it accounted for 18% of the time-charter equivalent revenues of the company; in 2019-2020 this has grown to just over 50%.
From 2014 US sanctions have been attacking the main Russian oil and gas producers, and targeting their foreign partners and sources of capital for the development of the Arctic offshore fields from which the oil, gas and industrial lines of Sovcomflot’s business have flowed. War risk, especially US sanctions threats, made a share listing in the US or UK impossible; it also made a discount for Sovcomflot’s share price inevitable.
Last September Reuters was told by “two sources familiar with the [share sale] plans” that “there was strong Russian interest, some of which could act as anchor investors.” The aim was “to raise at least $500 million in an initial public offering (IPO) on the Moscow Exchange…in a deal that could value it at roughly $10 billion.”
This valuation was calculated by comparison with Sovcomflot’s international shipping company peers. “A banker involved in the deal pointed out its peers trade at 7-12 times their expected core earnings (EBITDA). Sovcomflot posted EBITDA of $1.03 billion in the 12 months ended June 30 .” Thus, the target valuation to which Reuters and its Sovcomflot sources were pointing was between $7.2 billion and $12.4 billion – or $9.8 billion down the middle. The estimates by VTB and Bank of America (BoA) were more realistic: VTB put the company between $4 billion and $5 billion; BoA between $2.7 billion and $4.8 billion.
Most of these numbers were a fantasy. The list of international peers cited by Reuters revealed none with a market capitalisation above $1.5 billion: Reuters listed Scorpio Tankers, currently at $916.4 million; Frontline, $1.4 billion; Golar LNG Partners, $1.2 billion; Hoegh LNG Partners, $525.3 million; GasLog, $545.5 million; and Cosco Shipping Energy Transport, $476.7 million. The one exception on the list was the Chinese state shipping company, China Merchants Energy Shipping, whose market cap is currently $5.4 billion. China Merchants Energy Shipping has a smaller tanker fleet than Sovcomflot; at its initial public offering on the Shanghai exchange in 2011, its market capitalisation was priced at almost ten times earnings; the cap then came to $566 million . Today the China Merchants Energy Shipping’s market cap is ten times the initial value.
Two weeks after Sovcomflot’s IPO announcement, Reuters was told by the company’s bankers not to exaggerate. There were simply no buyers for wishful thinking. Bankers involved in the deal claimed “investors should expect the IPO to price at 105 rubles ($1.34) per share, with books oversubscribed. That compares to an initial marketing range of 105-117 rubles per share.”
By the time the order book closed and share trading started on October 7, instead of selling the target of 25% of the company’s shares, just 17.3% had been placed. The opening share price was at the bottom of the range, Rb105 ($1.34); market cap, $3.2 billion. The share price and market cap then nose-dived.
According to a briefing from those involved, reported by Reuters , the anchor investors took 85% of the share offering; just 15% of the shares went to retail investors in Russia and abroad. The state wealth institution Russian Direct Investment Fund (RDIF) acknowledged it was one of the anchor investors “along with leading wealth funds from the Middle East and Asia”.
This too was an exaggeration. Almost all of the Sovcomflot share sale had been paid up by Russian state funds, either committed directly or loaned to intermediary buyers with promises to secure against losses. They began selling immediately, according to stock brokers at the exchange. “According to Vasily Karpunin, head of the BCS World of Investments information and analytical department, rather ‘large volumes for sale were visible, which indicates a desire to exit the securities by a large participant.’ It is unlikely that these can be private investors, ‘because they for the most part implement a long-term investment strategy,’ he notes. Evgeny Shilenkov, Deputy General Director for Active Operations of Veles Capital IC, believes that investors who ‘expected the book to be re-signed’ without ‘seeing the upside’ began to sell the paper, but did not find demand ‘near the placement price.’ Buyers appeared at a price 10% lower – they were those who did not want to participate in the IPO the day before, he adds.”
After twenty-four hours the Moscow business press called Sovcomflot’s share sale a failure. Gavrilov of BCS Express tried to sound hopeful. “The short-term potential disappears very quickly due to the failed IPO. But the long-term view of the ‘sea wolf’ remains moderately positive. We can assume that the accumulated negative in the stock price will eventually go away. This is supported by strong financial results, new projects and contracts. From a psychological point of view, we need to return to the level of the IPO price — 105 rubles. Perhaps this will restore confidence to investors, and an uptrend will begin, which will be fundamentally fully justified. It will take several months to implement such a scenario.”
For the time being, Gavrilov said , “we can conclude that rapid growth of capitalisation will not happen. First of all, the shares need to return to the IPO level of 105 rubles, which is a certain psychological point for investors. This is possible with a stable external background, as well as a positive news background.”
Two charts show that as far as the buyers and sellers on the Moscow exchange are concerned, Sovcomflot has only itself to blame, as the tanker market news helped propel the share prices of its international rivals in the opposite direction; that is upwards.
HOW SOVCOMFLOT COMPARES WITH ITS US-LISTED TANKER RIVALS
October 2020-March 2021
Source: https://markets.ft.com/ 
KEY: Dark grey=Sovcomflot (market cap $2.9 billion; orange=Frontline ($1.4 billion); light grey=SFL ($911.6 million); yellow=DHT ($953.1 million ); green=Teekay ($321.5 million). Sovcomflot’s market cap remains larger than its international peers, but all of them perform better and above the Sovcomflot share-price line.; this indicates market rigging by Russia’s state banks. In market competitive terms, the best performers are DHT and Teekay whose share prices have gained significantly over the six-month period. Compared to mid-2019, DHT’s market cap has risen from $749.8 million to $953.1 million (up 27%); Frontline’s market cap has grown from $1.2 billion to $1.4 billion (+17%). By contrast, SFL has dropped from $1.5 billion to $911.6 million (down 39%); Teekay has fallen from $340.3 million to $321.5 million (down 6%).
HOW SOVCOMFLOT COMPARES WITH ITS BIGGEST INTERNATIONAL RIVAL, CHINA MERCHANTS ENERGY SHIPPING
Source: Sovkomflot PAO, FLOT:MCX interactive chart - FT.com 
What was really happening inside the company, and inside the Moscow market, which the outsiders didn’t know, and the insiders had no intention of letting on?
“The sale of newly issued shares has had nothing to do with open market activity or economic efficiency for the state as shareholder or for the company itself,” a Sovcomflot insider says. “The proceeds were not used to pay substantially increased dividends to the state or even to direct sale proceeds into the state budget. The company has not announced any new Russian project in partnership with the state. They are sitting on the money.”
“The privatisation operation – operation is the only term that’s appropriate – was carried out to convert piles of rubles from an oligarch group into shares of a company whose assets are valued in hard currency. Ths operation was camouflaged by side investors who have lost their money. As for Frank’s scheme for promoting the merger of Novoship and Sovcomflot and listing the shares at a premium price, the sharp, sustained drop in the price of the company’s shares since last October on such a protected and controlled stock exchange like Moscow’s has demonstrated his final failure.”
“Tanker companies have never been a good investment,” says Alexei Bezborodov, a leading Russian maritime industry expert. What oligarch group has moved into the shipping company? He doesn’t know, he says.
NOTE: Sovcomflot's chief executive officer was asked by telephone and email to identify points of fact or interpretation he wished to comment on or correct. No reply has been received.