VZCZCXYZ0005
RR RUEHWEB

DE RUEHBW #1257/01 2211108
ZNR UUUUU ZZH
R 091108Z AUG 06
FM AMEMBASSY BELGRADE
TO RUEHC/SECSTATE WASHDC 9118
INFO RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS BELGRADE 001257 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: PREL ENRG ECON EINV SR
SUBJECT: GOS ADOPTS PRIVATIZATION STRATEGY FOR NIS 
 
Ref: Belgrade 1013 
 
SUMMARY 
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¶1. (U) On July 20, the Government of Serbia (GOS) approved the 
privatization strategy of state-owned oil company "Naftna Industrija 
Srbije" (NIS).  The approved strategy was not the preferred option 
proposed by the privatization advisor consortium Merrill Lynch and 
Raiffeisen Investment.  The approved strategy calls for 
privatization of the minority stake in NIS (up to 49 percent) 
instead of the recommended option of 51 percent majority stake 
(reftel).  This decision sends a negative message to investors and 
the international community, about GOS readiness to undertake 
certain key structural reforms in the economy.  The move also 
undercuts previous obligations to the IMF about its intention to 
sell a majority stake in the refineries.  The various interests of 
stakeholders in NIS and the political interest of preserving the 
weak political coalition and majority in the Parliament are all 
factors in the GOS decision to pursue the alternate strategy. 
 
NIS PRIVATIZATION STRATEGY APPROVED 
----------------------------------- 
¶2. (U) On July 25, the Strategy for NIS privatization was publicly 
presented at the press conference in the Ministry of Energy and 
Mining by Radomir Naumov, Minister of Energy; Slobodan Sokolovic, 
Assistant Minister; Rados Ilincic, Managing Director of Raiffeisen 
Investment and Scott Lewis, Director of European Energy and Power 
Investment Banking from Merrill Lynch. 
 
¶3. (U) Minister Naumov repeated the goals of the GOS which are the 
terms of reference (TOR) for the privatization advisor: to privatize 
NIS in such a manner as to create a competitive and liberal oil 
market; to attract strategic partners that will invest and develop 
programs, introduce new technologies and management methods while 
respecting environmental standards; and to implement the 
privatization in reasonable time.  Minister Naumov stressed that the 
GOS approved the strategy proposed by the privatization advisor and 
reviewed by the GOS steering committee that will oblige the GOS to 
enable strategic partner to obtain up to 49 percent of NIS through 
recapitalization without the influence of the GOS. 
 
TWO PHASES PRIVATIZATION 
------------------------ 
¶4. (U) Rados Ilincic from Raiffeisen Investment presented the 
strategy in detail starting with four cornerstones of the strategy: 
the configuration of NIS, the program of capital investments, the 
social program and changes to the regulatory framework.  Ilincic 
said that strategy envisaged preservation of the 
vertically-integrated company and the process of privatization in 
phases.  The capital investments are expected to reach some USD 500 
million in two phases with the focus on environmental protection, 
fuel quality and working conditions.  The social program will be 
defined later but will not be different from any other.  Redundant 
workers will get approximately EUR 200 per year of employment, and 
the shares will be at their disposal immediately with a guaranteed 
minimum selling price.  The regulatory framework will be gradually 
changed during two to four years to give the company time to prepare 
for competition.  Sokolovic explained that changes to the Customs 
Law will introduce custom taxes that will be phased-out to EU levels 
by 2012. 
 
¶5. (U)  The first phase of privatization consists of two steps that 
will flow continuously.  In the first step, the GOS will sell 25 
percent of shares to the strategic partner with the money going to 
the budget, and in the second step the strategic partner will 
increase the capital of NIS by 20 percent through recapitalization 
of USD 250 to 300 million, which will enable it to obtain 37.5 
percent of NIS.  The GOS will have the same stake with around 6.7 
percent belonging to NIS employees and around 18.3 percent belonging 
to the Privatization Register for distribution to other citizens 
after the entire privatization process in Serbia is finished.   The 
strategic partner most likely will acquire all the shares from NIS 
employees between the two phases. 
 
¶6. (U) The GOS hopes that through investments and good management 
the value of the company will increase after three years.  At that 
time it will offer its shares through an initial public offer at the 
Belgrade Stock Exchange or some foreign stock exchange to the 
strategic partner.  Through another recapitalization of some USD 300 
million and possible buying of shares at the secondary market, the 
strategic investor should obtain up to 49 percent of NIS.  The state 
will have 21 percent of shares, the Privatization Register some 15 
percent and the remaining 15 percent will be freely traded on the 
market.  In the third phase, the GOS will have the discretionary 
right to decide how and when it sells the rest of its shares. 
 
MANAGEMENT CONTROL "GUARANTEED" 
------------------------------- 
¶7. (U) The strategy emphasizes the importance of giving the 
strategic partner, as a future minority owner, management control 
from the beginning.  The strategic partner will have the majority in 
the Managing and Executive Board of Directors, but the GOS will have 
certain negative or vto rights, in effect maintaining ultimate 
manageent control.  The specific rights and obligations f boh 
sides will be defined later in the sales greement.  In addition, 
the strategic partner wil have the option of buying the 
petrchemical complex "Petrohemija" Pancevo, which is an independent 
company complementary to NIS.  The tender for this company will be 
issued at the same time as NIS. 
 
¶8. (U) Rados Ilincic from Raiffeisen stated at the press conference 
that the decision of whether to sell the minority or majority share 
of NIS was difficult and the most time-consuming for the GOS. 
However, he believes that the goals set forth in the TOR of the 
privatization advisor justify the decision to sell a minority share. 
 Ilincic said that three years would be an optimal period for 
acquaintance between the GOS and the strategic partner.  The 
minority strategy may bring a lower price for NIS, but he believes 
that it will be justified in the middle term.  Sokolovic explained 
that the GOS would rather see NIS as a strong regional player that 
spurs growth in other Serbian companies than to merely increase 
revenues for the budget from the sale. 
 
¶9. (SBU) Mladen Levanic from Merrill Lynch told Econoff that 
although two options were presented to the GOS for consideration, 
the advisor recommended privatization of the majority stake.  The 
Steering Committee agreed with this recommendation (see reftel) and 
presented it to the GOS.  However, after final consultations with 
members of the GOS, the Steering Committee revised its 
recommendation and the GOS adopted the minority stake option for the 
strategic partner. 
 
LEGAL AND POLITICAL REASONS FOR ADOPTING MINORITY STRATEGY 
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - 
¶10. (SBU) There are different explanations as to why the GOS changed 
its strategy to sell a minority stake to the strategic partner. 
Sokolovic told Econ FSN that the official explanation for the change 
in the strategy is that the GOS could not guarantee the majority in 
NIS to the strategic partner in the second phase of privatization 
since it is against the competitiveness principle in Article Two of 
the Privatization Law.  Dimitrije Boarov, a local journalist, 
unofficially said that the GOS could not announce the tender for NIS 
to sell firstly the minority stake in NIS because it is against the 
Privatization Law. (Note: According to the current Privatization 
Law, only 70 percent of the capital or property is subject to sale. 
However, the current law refers only to socially-owned capital, and 
does not apply to a state-owned company like NIS.  The GOS announced 
earlier that state-owned companies would be privatized under special 
legislation). 
 
¶11. (SBU) The better solution would have been to change the current 
law, but the politically-weak ruling coalition did not have 
sufficient votes in Parliament without the support of former 
Milosevic's Socialist Party of Serbia (SPS), said Boarov.  The 
ruling coalition is heavily dependant on SPS which is against 
privatization in the energy sector and of state-owned land. 
Moreover, Boarov said that they are using these assets for private 
interests (private pockets) and for financing the party.  Therefore 
the GOS adopted the Decree on privatization of state-owned companies 
in the energy sector on the same day that the privatization strategy 
was adopted.  The Decree enables privatization of the minority share 
in state-owned companies in the energy sector.  Boarov thinks that 
the GOS is just buying time to persuade SPS to accept changes in the 
Privatization Law, because avoidance of the law through the Decree 
is not constitutional.  The Decree in general only serves to 
implement the law but is not the law itself.  Boarov believes that 
there is a majority in the GOS for the privatization of NIS and 
particularly for the model prescribed by IMF.  However, the GOS 
argues it was constrained in pursuing this strategy due to current 
political realities. 
 
UNCLEAR MODEL OF PRIVATIZATION BAD SIGNAL TO INVESTORS 
- - - - - - - - - - - - - - - - - - - - - - - - - - - 
¶12. (SBU) Zorana Mihajlovic Milanovic, former energy advisor to 
former Deputy Prime Minister Miroljub Labus, told Econ FSN that the 
proposed strategy actually means delaying and slowing down of the 
privatization.  She expressed doubts that an investor will invest 
huge amounts of money for a little more than 30 percent of shares in 
the first phase without any guarantee of the majority ownership 
later.  She believes that the GOS has privately already made a deal 
with either Russian Lukoil or Hungarian MOL to become a majority 
owner in the future.  The deal would be to share the profit but the 
question is where the money would go. 
 
¶13. (SBU) Harold Hirschofer, International Monetary Fund (IMF) 
resident in Serbia, told Econoff that the deviations from the 
strategic advisor's recommendations will adversely impact the sale. 
The GOS deviated in two important areas: selling a minority stake in 
the company and not giving the strategic partner full management 
control immediately by ceding negative or veto rights to the GOS. 
Hirschofer believes that these deviations reduce the attractiveness 
of the investment and will bring a lower price. 
 
¶14. (SBU) Hirschofer said that GOS is breaching commitments made in 
the last IMF agreement.  The GOS agreed to include in the terms of 
reference for the strategic advisor achieving the highest sales 
price which it did not include in the TOR with Merrill Lynch.  The 
GOS agreed to sell majority stake in the two oil refineries which is 
not included in the adopted strategy.  Hirschofer said that Serbia 
is also breaching its fiscal commitments with the recently-announced 
National Investment Plan of EUR 1.1 billion.  The Paris Club wrote 
off debt based on these commitments, and Hirschoffer sees GOS 
actions as a bad signal. 
 
¶15. (U) Other experts also consider the proposed strategy as 
unclear.  Danijel Cvjeticanin, professor at the Belgrade School of 
Economics, thinks that the strategy is complicated, unusual and 
contradictory.  He thinks that it is not clear why the GOS does not 
want to sell the majority in NIS but is giving the management 
control to the strategic partner and why it is doing in phases. 
 
Privatization Timeline 
---------------------- 
¶16. (U) The privatization advisor will prepare the tender 
documentation by August 2006 in order to issue a tender by October 
2006 and finish the transaction at the beginning of 2007.  Thus far, 
all of the interested companies are regional players: Hellenic 
Petroleum from Greece, OMV from Austria, MOL from Hungary, PKN 
Orlean from Poland, Lukoil from Russia and Israeli Corporation. 
 
 
Comment 
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¶17. (SBU) This move signals GOS unwillingness to undertake certain 
politically key structural changes -- especially when state-owned 
dinosaur companies are used as financial tools of political parties 
and serve the private interests of the managing board members 
themselves.  It is clear that the strategy enabling the guaranteed 
majority ownership in three phases was proposed as the first choice 
of the privatization advisor (reftel), but the GOS lacked the 
ability and potentially the will to pursue such a course. 
 
POLT