Privatization in Eastern Europe and Russia

My awareness of what was happening in regard to privatization in Eastern Europe came through the strangest of conversations and relationships. When I was twenty-three, I opened a musical instrument shop in Morecambe – which I still have today – and I had a wonderful guy running it for me called Keith Harris who taught me so much about the retail business to the point I definitely class him as a mentor.

Keith worked for me for nearly twenty-five years until his retirement, and he knew every trick in the book when it came to retailing. He’s smart, quick, well read, and was always up for a deal. Keith forged relationships with all the UK companies we needed to be dealing with and discovered a guy in Los Angeles called George who could possibly help us be more profitable.

As a fledgling business, Keith worked hard to buy right, and here was a chance to buy exactly the same goods that we were buying from the UK distributors, at a better price from this man George. Although based in the US, George was the Eastern European musical instrument and accessory distributor for many of the brands we were selling and he often talked about supplying the likes of Hungary, Poland, Bulgaria, Romania and his family homeland, now the Czech Republic.

Around the early 90’s, I called George one day and he wasn’t in the office. I used to call him in the evening from my home because of the time difference; and evenings were a great time to chat because I had plenty of spare time. On the particular day George was out, I ended up speaking to another guy.

The guy turned out to be Jaromir Strizka, who was the founder and owner of the music distribution company European Crafts. We got on famously, and as anyone who knows me, I can talk! Jaromir and I spent the evening talking about everything from how we could do more business together; to our childhoods and him having a love for athletics; to how he moved to the US when he was in his mid-30’s because of the political problems with the Communist Party in Czechoslovakia.

Jaromir clearly loved business, he loved people, and he was clearly very kind with his time. Jaromir mentioned that George was over in Eastern Europe on European Crafts’ usual business, but was also looking in to the “privatization programme” that had started to effect businesses there. He told me what he knew about what was happening and it sounded fascinating.

Over the next twenty or so years, Jaromir and I spoke on and off and to this day, I’m still not actually sure if George was Jaromir’s son, nephew or a colleague.

Privatization in Eastern Europe
What happened after that original conversation with Jaromir was some of the best performing emerging market funds in the world were created out of former state owned enterprises in Eastern Europe; and the post-soviet Russia privatization went on to give some of the best investment returns in the history of investing.

The early smart money – like Jaromir knew would happen – moved in to investments in Eastern Europe shortly after the Berlin Wall came down and the Velvet Revolution happened in Czechoslovakia [as it was known as then]. What we didn’t know at the time was most of Eastern Europe would follow quite quickly. Many of the workers in these Eastern European companies were living in decaying concrete soviet style block buildings and were now facing a period of high inflation and food shortages. Life wasn’t good for them at work either and they were more insecure than ever before.

Compared to Western companies, most of these Eastern European enterprises were massively behind the times in terms of product design, production methods, business structure, and many didn’t understand how to do business like the west did because they had never had to in the same way. Rather than former state money and the subsidies that went with the territory of running a state owned enterprise; the World Bank was now involved in helping former state owned enterprises find a new direction and bringing in new investors.

For some of these Eastern European enterprises after privatization, their town / local government carried on buying from them just as before, but the profits were leaving the company, and often the country. What some of these newly privatised companies had was valuable land, plant, machinery, highly skilled workforce and a very low price to earnings ratio and debt to equity ratio.

Some companies were selling at £1 of share price, to 50p of profit of the previous year; and some companies were even selling at £1 of share price, to £2 of profit of the previous year!

In the latter, if you bought a share of these companies – with all of their assets – you would have your original investment back in just six months. Nowadays, that would sound too good to be true, but that’s how crazy it was! People simply chose which business they wanted to invest in from the newspaper, exchanged their currency, went to the post office to fill in the privatization form, and everything was done and you were an owner.

Privatization in Russia
By 1993, many investors had turned their interest to the former Soviet Union where the companies there were either as cheap as Eastern European ones, or even cheaper because of the way privatization was being conducted. Former Soviet companies seem to have had much better quality assets [plant, machinery, etc.] and the condition of those assets was exemplary in some cases.

The Russian privatization programme was quite bizarre because the government gave almost one-third of its companies and their assets to its 150 million citizens in a voucher privatization system where everyone got a voucher. The vouchers exchanged hands for various amounts but if you said the average was around £11 per voucher you wouldn’t be far wrong.

Therefore, if you had 150 million [citizens] x £11 [per voucher], that valued 30% of all Russian companies at £1.65 billion. What needs to be remembered here, is this is a country that had around 25% of the World’s gas, and 10% of the World’s oil, and the whole lot was therefore being valued at around £5.5 billion. Once the vouchers had been released, anyone from anywhere could buy them.

There wasn’t a stock exchange in Moscow as such at that time. To buy shares in Russian companies, all you needed to do was, change your £ in to US $ – because that’s the currency they wanted – and turn up at the old voucher exchange hall in Moscow which was close to the former State Department Store called GUM that faces Red Square [it’s like the Harrods of Russia].

Once you were in the hall – which was like a smoky British working men’s club in the 1970’s – you waited for voucher traders who sat at tables to declare that they had vouchers to sell. They said how many they had and the price they wanted. You then decided whether to buy or not.

It was all cash, and the place was either packed or empty depending on the supply, demand and prices being charged. Although vouchers were around £11 on average, they were often sold for less or more. The most important thing for westerners to do, was to have a Russian speaker; and if buying vast amounts of vouchers, have an armed guard too because there wasn’t any security in the exchange hall, or outside for that matter.

Now the bizarre bit about the privatization is the process of investing them in Russian companies. It was done through a kind of auction sale with a difference. These auction sales were widely advertised and anyone – in theory – could turn up to them. Although you knew which companies were coming up at the auction sale, you had absolutely no idea how much of the company you would be buying until the auction was over.

So here’s the bizarre bit, and how some people got rich beyond belief; if there was only ten of you at the auction sale, with one voucher each, those ten vouchers – around £110 in all (10 vouchers x £11 each) – got the whole company!

On the flip side, if a thousand people turned up with a thousand vouchers each, the company would be divided between all the vouchers in the auction sale. You can probably see, if you were the only person who ‘knew about the auction sale’, you could end up a billionaire. (I’m sure you can read between the lines of what I’m saying). I ‘believe’ that some people were even prevented from going to auction sales through various tactics to stop them.

Finally, whatever people say, Russia in the past has been a dangerous place to do business. For any students out there reading this, all you have to do is put the names Michael Calvey and Philippe Delpal in to google and have a read.

Written March 2010

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