This past May, I was watching now-former Russian oil giant YUKOS (PinkSheets: YUKOY) in what, at the time, 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 Depository Receipts (ADRs), at the time, traded 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. But back in May, the tax bill was $4 billion, not its eventual $26 billion. 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 produces 1% of the world's daily oil output, to operate unmolested. In bankruptcy the government would have taken a few non-core assets, such as YUKOS' stake in Sibneft, slapped its wrists, and let it re-emerge.
The risks of being a foreign investor
When analyzing international firms, you have to consider the political stability and condition of property rights in the countries in which they are domiciled. It may not be appropriate to assume that there are mechanisms in place that effectively protect your rights as a shareholder, especially given that you will be, by definition, a foreign shareholder. In the U.S. there is 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 Japanese were "buying up the country." This tendency, if anything, might be magnified elsewhere around the world. As a foreign investor, you are not likely to be high on the list of sympathetic characters in the event of malfeasance by a corporation or, more ominously, a government.
The tale of what took place in the past year at YUKOS is a worst-case scenario of what can happen in countries where property rights, or other political rights, are somewhat more tenuous than in developed capitalist countries such as the U.S. Shares of more and more companies from less-free countries are available for sale on the U.S. exchanges, so questions about property rights and the potential for expropriation or nationalization in foreign countries are much more relevant to individual investors in the U.S. than they were even five years ago. YUKOS may be a worst-case scenario, where the Russian government was more than happy to allow tens of billions in shareholder value to go up in smoke in its pursuit of the company, but it wasn't the first instance, and it won't be the last.
The bankruptcy scenario I painted above - and hoped for -- never came to pass. When bankruptcy came to YUKOS this past week, it didn't happen in Moscow, St. Petersburg, or anywhere in Russia. YUKOS filed in Houston, Texas, as part of a desperate attempt by the company to stop the Russian government from expropriating its key oil-producing subsidiary Yuganskneftegas ("Yugansk") in a sham auction, which took place undeterred this past weekend. YUKOS has called the Russian government's sale of Yugansk to the previously unknown entity Baikalfinansgrup ("Baikal") a "forcible and illegitimate removal" of its asset and has contended for more than a year that the original tax claim against it was "arbitrary, disproportionate, and invalid."
My colleague, Russian legal expert Rich Smith, has carried most of the water on coverage of the goings on at YUKOS over the past several months. The progression of events that caused YUKOS shareholders to lose virtually their entire investments might seem unbelievable to an American. I mean, whatever misgivings you might have about the U.S. market and whatever your memories of shareholder disasters like the one befalling Enron, you wouldn't expect the American government to steal from shareholders for political reasons.
Frankly, until the YUKOS situation (and one last year in Kazakhstan), I had figured that nationalization of businesses by governments was a thing of the past. After all, governments everywhere have been, if anything, selling off their operating company assets, and many of these, from Income Investor selection Telecom New Zealand (NYSE:TZT) to Deutsche Post (PinkSheets: DPSTF), are available to American shareholders. I was wrong, as recent events in Russia show in crystal clear fashion. And Russia, with the worst record of shareholder protection, is by no means the country of domicile for companies trading in the U.S. It just provides, at the moment, the most dramatic example for shareholders to consider.
Don't cross the mayor
Russia's claim that its actions aren't motivated by politics is not exactly convincing. In contributing to some of Vladimir Putin's rivals with financial and spoken support, Khodorkovsky, YUKOS' controlling shareholder, failed to live up to a widely rumored understanding between the Russian oligarchs and the regime that they could have free reign in business if they stayed away from politics. Russian tax collection is spotty at best; it strains credulity that the government claims its dogged pursuit of YUKOS isn't motivated by power politics rather than an unbiased application of the law.
So YUKOS is for all intents and purposes cored. Its main remaining asset is a call option lawsuit against Russia and any of the companies participating in the bid for Yugansk -- which leaves only Baikal. This is a public company, with public shareholders in Russia, the United States, and elsewhere. So where I had thought that the governmental tendency toward nationalization and expropriation might be a thing of the statist past, the reality is that investors who buy shares overseas really do need to consider this a risk.
Everywhere overseas?
Obviously, the risk 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. The trend toward internationalization is altogether healthy, and it is inexorable. On the U.S. exchanges, where the ADRs five years ago tended to be companies like Finland's Nokia (NYSE:NOK) and Japan's Sony (NYSE:SNE), which come from countries with strong commercial codes and property rights, the more recent ADRs have come largely from less-developed countries with less well defined limits on government power. Where in past years it would really have taken some effort for U.S.-based investors to buy shares in many foreign companies, the rapid rise in popularity in ADRs means that some most certainly buy and sell international firms without even recognizing that they are such, or at a minimum where they are located. Many people, if they are aware at all that Nokia is international, think that it is from Japan, rather than Finland. Petrokazakhstan (NYSE:PKZ), though most of its business is conducted in Central Asia, is a Canadian company.
I doubt that it's a coincidence that Russia undertook its grab at YUKOS in the same year that human rights and democracy watchdog Freedom House dropped its rating from "Partly Free" to "Not Free." The Russian government followed this action with a tax bill tossed at VimpelCom (NYSE:VIP), throwing a damper on that company's shares, as well. But it's not just the companies that are directly in the crosshairs of the Russian government: How much less likely would you be to run out and buy a Tatneft (NYSE:TNT) if you knew that the government whose laws it is incorporated under has shown a tendency to destroy companies, essentially by nationalizing them? What is the additional margin of safety in price you demand to hold any Russian security at this point?
Russia's not alone -- the big dog in listing on the American exchanges in the past two years is China (also listed "Not Free" at Freedom House), which has listed dozens of partially privatized government entities, including China Telecom (NYSE:CHA) and CNOOC (NYSE:CEO). China has shown a tendency to use its government ownership, multiple share classes, reciprocal holdings, and other confusing and tangled elements to diddle with the shareholder equity of Chinese companies' overseas owners.
Shareholder rights? Okaaaaaayyyy
International investing is something that is ascendant, and it is by and large extremely healthy. To address the widening tendency of cross-border security ownership, the International Accounting Standards Board has sought to harmonize the various accounting regulations from country to country, as well as to set an international standard that companies can provide investors, along with financial statements in their own domestic accounting principles. Most American investors, I suspect, when they buy internationally and view company financials, tend to look at the local standards and assume that they provide a "good enough" proxy to U.S. GAAP that they just accept these statements at face value for comparability's sake. Some companies -- though by no means all -- help American investors by also providing their financial statements in U.S. GAAP. Expect this harmonization to continue.
The chance that you are misinterpreting a foreign company's financial statements is an ongoing risk, though not necessarily a catastrophic one. As much as I had thought that nationalization of industries was a thing of the past, you have to assume that in countries that have unstable political situations, foreign ownership of domestic industries is an easy target for the opposition, as has taken place in Taiwan with Chunghwa Telecom (NYSE:CHT).
It is sufficient to say that your right of recovery in some places is nil. If this is something that does not sit well with you, a risk you do not wish to take, then investing in many developing countries is simply not for you. I waited for the sign that YUKOS had stabilized, and this sign never came. The Russian government was content with destroying the company. In a case like this one, there is precious little that foreign shareholders can do to recover their loss.
Bill Mann owns shares in Chunghwa Telecom and Petrokazakhstan. He is saddened because his passport with five additional inserts is about to expire. The Motley Fool has a disclosure policy.
