Cold-Shouldered

Every other weekend for the past decade, William Browder, founder of Moscow-based Hermitage Capital Management, has flown from Russia to London — where he has a second home — and back again to Russia. He estimates that he has made the trip more than 250 times since launching the hedge fund firm in 1996, and he has never had a problem with his visa — until recently.

On November 13, 2005, Browder was awaiting clearance in the VIP lounge of Sheremetyevo International Airport in Moscow, when he realized that the process was taking too long. Usually, he says, he gets through immigration in five to ten minutes. This time he sat waiting for nearly an hour until his driver went to make an inquiry. Finally, an immigration officer told Browder that his visa had been revoked.

The hedge fund manager, who had to sit in the airport on a plastic bench for 14 hours until he was shipped back to London the next day, was stunned. Browder, 42, is the biggest foreign portfolio manager in Russia. His $4.3 billion in assets, of which $3.3 billion is in the flagship Hermitage Fund, are invested entirely in publicly traded Russian companies, primarily in the energy sector. Having spent a decade working in Russia, Browder is also a staunch supporter of President Vladimir Putin’s reform efforts and has long been a vocal proponent of greater transparency and accountability in the Russian markets.

But Browder, who doesn’t know who is behind his visa woes and refuses to speculate, has also earned a reputation as one of Russia’s most outspoken and litigious shareholder activists. The only official communiquŽ he has received is a letter, dated November 27, 2005, citing Article 27 of Russian federal law, stating that government agents have the right to refuse entry to anyone, based on national security, public order or public health concerns.

For Browder, a U.S.-born, naturalized U.K. citizen who calls Russia “my adopted country,” the revocation of his visa has been a personal, as well as a professional, blow. Browder’s ties to Russia run deep. His grandfather, Earl Browder, was head of the American Communist Party and spent the 1920s in Russia, where he met his wife, Raissa. As an MBA student at the Stanford Graduate School of Business in Palo Alto, California, the younger Browder became enamored of the idea of retracing his grandfather’s footsteps to Russia. His firm has been headquartered there since Browder founded it in 1996 with $25 million in seed capital from financier Edmond Safra.

Now Browder wonders when he will be able to go back. He has received public support from Jack Straw, until recently U.K. foreign secretary; Oleg Vyugin, the Russian financial markets regulator; Jean Lemierre, head of the European Bank for Reconstruction and Development; and Clara Furse, chief executive of the London Stock Exchange. On April 25, Furse wrote directly to Putin, expressing her concern that Browder’s situation could negatively affect Russia’s public image: “Left unresolved, I am concerned that this situation may do significant damage to Russia’s reputation as a country that welcomes foreign investors.”

During the past decade Browder has been a tireless champion of investing in Russia. He has challenged the management of Gazprom, Russia’s biggest natural-gas company; Lukoil, the country’s biggest oil producer; and Unified Energy Systems, which controls virtually the entire Russian electrical grid. He has filed dozens of lawsuits challenging Russian companies’ corporate dealings and off-balance-sheet maneuvers.

“We have never been victimized by something like this,” says Mattias Westman, founding partner of London-based investment firm Prosperity Capital Management and co-founder of the Investor Protection Association of Russia. “It’s just another example of the way in which Russia has not matured yet as a state. I’m sure the right hand didn’t know what the left was doing.”

In an interview with Alpha Senior Editor Loch Adamson at the end of April, Browder discussed the challenges of being an activist investor in a hostile climate and explained why he and his team at Hermitage are still so proudly bullish on the Russian bear.

Alpha: Your team is based in Moscow. Has it been difficult to run the business at a distance?

Browder: No. I’ve opened up a London office and keep about a third of the team with me at any point in time. I’ve got 15 people, and all but two of them are Russian citizens. Thankfully, none of them have had any trouble. Even though I haven’t been able to get back to Moscow, I can rotate my analysts through London, so I still have the ability to brainstorm and work with them.

How is the Hermitage Fund portfolio doing?

It’s doing great. The portfolio is up 60 percent net since this happened in November. Last year we were up 81.5 percent net. This year, we’re already up more than 40 percent through the first four months.

How would you describe the evolution of your investing style over the past decade?

When I first got to Russia in 1996, I considered myself a value investor. The approach worked very well at that time, mostly because the vast majority of investors in Russia had to rely on brokerage firms for information. I had a big advantage over anyone sitting in New York or London because I could do my own research. I found that there was a big discrepancy between those companies that had been researched and those that hadn’t, in terms of valuation. And that strategy worked beautifully at the beginning. Through the first 18 months, my fund was up about 800 percent. But then the Asian currency crisis led to contagion, which eventually infected Russia. Russian bonds defaulted, the currency devalued, and the stock market went down 88 percent. I found myself in a much different world.

What aspect of that experience turned you into a shareholder activist?

Well, on the one hand, I found myself in a much better world as an investor, because I was mostly investing in oil companies, whose revenues were in dollars. Those revenues hadn’t changed, but their costs were in rubles, which had dropped by 75 percent. In theory, the value of these companies should have skyrocketed; the problem was that the people who owned these companies were mostly Russian oligarchs who quickly discovered that they had no incentives to behave well because Wall Street was closed for business. There were no disincentives for misbehaving, either, because the laws that were in existence were not enforced. So it created this set of economic circumstances where these people embarked on an orgy of stealing that has been unprecedented in the history of business. I soon realized that I was going to have to develop new skills to protect my investments. That’s when I became a shareholder activist.

When did you first become embroiled in a corporate battle?

The first instance was in 1998 with an investment in an oil company called Sidanco, in which the Hermitage Fund had a 2 percent stake. We found ourselves in a situation where the majority shareholder was trying to issue nearly three times as many new shares at a 97.5 percent discount to the market price in a closed subscription. As a minority shareholder, we would have been excluded, so it forced us to go head-to-head with the majority shareholder in a public relations and regulatory war, which we, surprisingly, ended up winning. That experience gave me a sense of how to defend myself, and since then, when we’ve found ourselves in bad situations, we haven’t hesitated to act.

Does the Russian legal system provide adequate recourse?

Well, no. The legal system hasn’t worked — and in most cases, still doesn’t work. We’ve been to court 52 times and lost 43 cases. And it’s not because we hire bad lawyers, but because there are all sorts of extraneous factors that influence the way decisions are made in the courts. Sometimes it’s due to outright corruption, but sometimes — when an important person is standing on the other side of the table — judges just rule in favor of the important person. It is a real problem, because if you don’t have enforceable laws, it’s very hard to have a governable country.

You’ve long supported President Putin. What do you make of his government’s redistribution of industrial assets to state-owned companies?

The main reason I have been so enthusiastic about Putin is that when he came to power, he took action. Whenever we had corporate governance problems, he or one of his deputies would step in to solve them. In 2002 we discovered that the managers of Unified Energy System of Russia were trying to embark on a big asset-stripping program. We called for an extraordinary general meeting to fire the CEO and change the charter of the company, and as soon as we did, the government got in touch with us. We talked to the head of the presidential administration, who agreed to join us in rewriting the charter of the company if we dropped our demands to fire the CEO. So every Wednesday night, my head of research went to the Kremlin to rewrite the charter of Unified Energy System and prevent the asset stripping.

Did Putin overreach in dismantling oil producer Yukos? Its key refinery has been given to a new, state-owned company called Rosneft, which is going to be taken public shortly.

The one big misconception about Yukos is that it wasn’t a fair fight. In other words, everyone says, “Oh, evil Putin and poor [former Yukos CEO Mikhail] Khodorkovsky.” People don’t quite grasp that it was a battle of two heavyweights — one of them happened to be stronger than the other, but they were still two heavyweights, and they were fighting dirty. The big misconception about this in the press was that somehow Khodorkovsky was an innocent in this thing. He wasn’t. The innocents in the mess were all of the minority shareholders who got stuck in the crossfire.

So what is your opinion of the Rosneft IPO?

As a concept it’s interesting, but it depends on how they price all the different assets and risks. I don’t think it’s possible to make a judgment on it until we read the prospectus and see how it’s priced. But I’m very happy to see another oil company available for investment. I like oil. My portfolio is 93 percent oil.

Do you think the Russian economy will ever become less reliant on oil and gas?

Not for a long time. Make no mistake, Russia is just a colder-climate version of Saudi Arabia. Some 72 percent of its export earnings comes from oil and gas. While I think Russia has the capacity to diversify away from energy because it has an educated workforce, I wouldn’t want to see the government waste money in an attempt to diversify the economy right now and just see the money get stolen. That is the likely outcome in today’s Russia.”

What is the biggest challenge facing Russia?

The single greatest challenge that Russia faces is creating institutions that abide by the rule of law. Russia is still extremely undervalued on an asset basis, but the question of whether it gets to fair value or not will depend on whether there is an effective implementation of a real court system, with checks and balances so that bureaucrats can’t abuse their power. And it’s hard to say whether that will happen. That’s the big challenge, and that’s the thing to watch. And if it does happen, then we will have a predictable country with high and boring valuations. But if it doesn’t, then Russia will be under a black cloud of discounted assets for a long time.

Should your experience make other managers think twice before investing in Russia?

Well, people are motivated by money, so I doubt this has slowed anyone down because everyone is making so much money right now. But I’m sure that my situation makes every foreign businessperson’s heart beat a little faster as they’re passing through passport control in Moscow. I think I’ve been a friend to Russia, and this is no way to treat a friend.

Do you want to go back to Russia?

Yes, as soon as they let me. I’ve adopted Russia as my own country. It’s the place where I’ve built my business, and I love it there. This problem will be resolved, and as soon as it is, I’ll be back.