International Superstar Stocks: A Cautionary Tale

In May of 2004, I was watching former Russian oil giant YUKOS in what seemed like the later stages of its tax-bill problem with the Russian government. Oh, man, I was armed and loaded for bear. This was an opportunity to end all opportunities. The stock's American Depositary Receipts (ADRs) were trading at $31 per share here in the States, and I had the company's value pegged at some 60% higher than that, minimum.

Yep, all that needed to happen was for YUKOS to declare bankruptcy. That's right -- I was ready to buy shares of the company upon its filing for protection against its creditors. The theory at the time was that Russian officials wanted to nail billionaire Mikhail Khodorkovsky, take much of his wealth, and then allow YUKOS, which produced 1% of the world's daily oil output at that time, to operate unmolested. In bankruptcy, the government would have taken a few non-core assets such as YUKOS' stake in Sibneft, slapped the company's wrists, and let it re-emerge. But that May, the tax bill was $4 billion, not the eventual $26 billion it would turn out to be. And YUKOS would suffer a fate much different from what I'd imagined.

The risks of being a foreign investor
Before you invest in an international company, you need to consider the political stability and property rights in the country where it's domiciled. You can't always assume that every country has effective protections for shareholders' rights -- especially for foreign shareholders.

In the U.S., there's a tendency in some circles to vilify foreign capital. Consider the gnashing of teeth that took place in the early 1990s, when it seemed that the Japanese were "buying up the country." If anything, this tendency might be magnified elsewhere on Earth. As a foreign investor, you're not likely to rank high on the list of sympathetic characters in the event of malfeasance by a corporation or, more ominously, a government.

As shares of companies from less-free countries like Russia and China become more common on U.S. exchanges, questions about the risks of expropriation and nationalization of foreign companies have grown increasingly relevant to individual investors. In YUKOS' case, the Russian government was more than happy to send tens of billions in shareholder value up in smoke as it pursued ownership of the company. It wasn't the first instance, and it won't be the last.

When YUKOS filed for bankruptcy late last year, it happened not in Moscow, but in Houston. It was part of the company's desperate attempt to stop the Russian government from expropriating its key oil-producing subsidiary Yuganskneftegas ("Yugansk") in a sham auction, which ended up taking place undeterred. YUKOS called the Russian government's sale of Yugansk to the previously unknown entity Baikalfinansgrup ("Baikal") a "forcible and illegitimate removal" of its asset, and it contended for several years that the original tax claim against it was "arbitrary, disproportionate, and invalid."

My colleague, Russian legal expert Rich Smith, carried most of the water on coverage of the YUKOS goings-on. The progression of events that caused YUKOS shareholders to lose virtually their entire investments might seem unbelievable to an American. Whatever your misgivings about the U.S. market, and whatever your memories of shareholder disasters like Enron, you'd hardly expect the American government to steal from shareholders for political reasons.

Frankly, until the YUKOS situation (and one in 2003 in Kazakhstan), I'd assumed that government nationalization of businesses was a thing of the past. If anything, governments everywhere have been selling off formerly state-controlled assets. Many of these companies, from Motley Fool Income Investor selection Telecom New Zealand (NYSE: NZT) to Deutsche Post, are available to American shareholders. Last year's events in Russia showed all too clearly that I was wrong.

Don't cross the Kremlin
Russia claimed that its actions against YUKOS weren't politically motivated. It wasn't exactly convincing. Khodorkovsky, YUKOS' controlling shareholder, had lent his financial and public support to some of Russian President Vladimir Putin's rivals. In the process, he violated a widely rumored understanding between the Russian oligarchs and the regime that gave businesses free rein if they stayed away from politics. Russian tax collection is spotty at best; the government's claims that its dogged pursuit of YUKOS was motivated more by law than politics strains credulity.

In the end, the Russian government left YUKOS all but gutted. Its main remaining asset was a call-option lawsuit against Russia and any of the companies participating in the bid for Yugansk -- specifically Baikal, a publicly traded company with shareholders in Russia, the United States, and elsewhere.

Naturally, the risk of another YUKOS-like scenario varies from place to place. There's a better chance of government expropriation happening in California than there is in Canada or Singapore, for example. But as the inexorable -- and mostly healthy -- trend of international investing accelerates, so do its overall risks.

Everywhere overseas?
Five years ago, ADRs on the U.S. exchanges tended to be companies like Finland's Nokia and Japan's Sony, from countries with strong commercial codes and property rights. But the more recent ADRs have come largely from less-developed countries with murkier limits on government power. ADRs' rapid rise in popularity makes it easier than ever to buy and sell international firms without even recognizing their foreign status or country of origin. Most people think Nokia comes from Japan, if they're even aware it's an international company in the first place. And though it conducted most of its business in Central Asia, Petrokazakhstan, which has recently been acquired by China National Petroleum, was once a Canadian company.