It took decades for American fund managers to assert their stock ownership rights in public companies. But in the Czech Republic, where nearly 70 per cent of stock is owned by investment funds, the power of fund managers has been crystal clear since the launch of the privatisation process. Indeed, the Czech market is left wondering whether those running investment funds want to be fund managers or industrial barons.
In fact no market has been more open to developing a modern capital market than the Czech Republic. The voucher privatisation scheme attracted some 8 mn Czechs – population:10.4 mn – most of whom have placed their vouchers into the hands of a select group of investment funds. Today some 15 funds own two-thirds of all shares on the Prague Stock Exchange.
‘Funds acquired a greater stake in Czech corporations than anyone expected,’ notes Petra Wendelova, senior vice president of investment banking at CS First Boston, and one-time head of Harvard Brokerage Services. ‘At first there were fears that too much power had been given to a small number of people. Many companies expected a tough brand of corporate governance.
‘Surprisingly,’ Wendelova says, ‘the investment funds have done relatively little in terms of governance. Until recently, ownership has been too widely dispersed for the fund shareholders to have a major influence over company management.’
Lately, the power of the funds has come to a head as ownership of Czech industry narrows. The sale of the fund management business of Austria’s Creditanstalt to Agrobanka, the largest privately-owned bank in the Republic, has brought serious questions on concentration of ownership. Meanwhile, the close collaboration between Viktor Kozeny’s Harvard funds and financier Michael Dingman’s Stratton Investments has set corporate management on edge.
Before the sale, Creditanstalt and Harvard were both part of an exclusive club made up of the few major non-Czech bank-owned funds in the Republic. Currently, the Czech banks hold controlling stakes in all major companies through funds, and rumour has it that many receive inside information because of their prominent position.
‘Bank dominated funds are ridden with conflicts of interest because the same banks are often lending to companies in their portfolio,’ says George Collins, managing director of Patria Asset Management based in Prague. ‘Moreover, they often lack industry expertise for effective corporate governance.
Still, the current spate of restructuring, which is concentrating ownership and giving more board power to funds, could have benefits. ‘Czech corporate governance is improving, but at a slow pace,’ Collins says. ‘Some investment funds are evolving from mutual funds to industrial holding companies, which could bring benefits for companies and shareholders if done properly.
Alexander Angell, director of sales and trading at Wood & Co, a leading Prague broker, has mixed feelings about the banks’ role. ‘Companies benefit from competition at the board level to provide cheaper and more efficient financial services,’ he says. ‘The disadvantage is that companies are under pressure to use bank financing instead of raising new capital on the stock market.’
While the agenda of the Czech banks is not totally clear, the movements of Harvard and Stratton are far more transparent. Harvard, now the only large fund outside the Bank Club, has led the way in terms of corporate governance and proxy battles. And one point must be made about Kozeny’s tactics: they have not wavered.
In 1991, with Czech privatisation floundering, Kozeny entered the market with a massive advertising campaign, promising a 1,000 per cent return to shareholders willing to give him vouchers. Over 800,000 Czechs did, and today Kozeny controls some 15 per cent of the Prague Exchange. He now lives in the Bahamas and has never made any secret of his belief in the need for Czech industrial restructuring, involving fundamental change at the management level.
Recently, Kozeny teamed up with Dingman, former chairman of Allied Signal, who created wholly-owned Stratton Investments on the advice of Kozeny, and will invest over $240 mn into the Czech Republic. Together Stratton and Harvard have controlling positions in around eight companies, and are doing their best to exercise control of the boards at target companies. The partnership makes sense on other levels too. Funds are restricted from owning over 20 per cent of a Czech company, but individuals can hold unlimited stakes.
In November, Stratton and Kozeny teamed up to complete eastern Europe’s first corporate proxy fight since the fall of communism. The battle against AssiDoman, a Swedish paper company, was for control of Sepap, a $300 mn crown jewel paper producer. AssiDoman held a 34 per cent position in Sepap, and launched numerous projects with the Czech firm. After winning 57 per cent of the vote, and stacking the board with allies, Stratton removed Sepap’s top five executives. This was a clear slap in the face for AssiDoman, and the media quickly accused Dingman of trying to make a name as the first Czech greenmailer.
However in an about-face, Stratton and AssiDoman announced in February that they would work together to build Sepap, and expand their alliance to business outside the Republic. Stratton has already made forays into the Russian paper industry, and AssiDoman has interests in the region. Stratton’s aim is to take over companies, inject western know-how and then roll it all into a vehicle to be listed in New York.
In late February, Harvard launched an attack on the board of chemical company Fatra SA. Since October, Harvard funds and the brokerage arm have gone on similar forays in eight companies. In the case of Fatra, Harvard was acting for Stratton, which claimed that it would soon own Harvard’s 52 per cent stake in Fatra. Five new board members, all Harvard employees, were added. Stratton sent in two US executives to look over the company.
To focus more on corporate control and governance issues, Harvard seems to be unloading prime assets, provoking irritation among some of its investors. Harvard claims its link to Dingman will pay off in time, but analysts say The Harvard Dividend Fund, the company’s largest, has performed below expectations. Had the fund left its portfolio unchanged, it would have risen by over 28 per cent compared to a 19 per cent rise in the PSE index. Instead, it fell by over 2 per cent during that period, according to Creditanstalt. Harvard notes that this does not include the sale of shares to Dingman.
This state of affairs has drawn a strong reaction from the global and domestic markets. Some traders have openly accused Harvard of giving the Czech market a ‘black eye’; others say the Harvard move ‘brings into question the entire viability of the market’ and fair distribution of information. While other bank-owned funds are doing the same, the Dingman alliance is now in the spotlight.
‘The market is in a wait-and-see pattern,’ says Angell. ‘Everyone is looking for evidence of good faith on the part of Harvard and Stratton that premiums will be paid back to shareholders. Harvard and Stratton are hiring industry specialists for the companies they have targeted, which is a good sign. But their interests coincide with those of minority shareholders only to the extent shareholders will be able to participate in the same bid when the fund sells off stock.’
Angell looks to new securities legislation for reassurance. Amendments to the law, expected to be cleared by parliament in May and implemented in July, will introduce strict disclosure requirements for funds and call for protection for minority investors.
‘Investors have been confused by non-cash settlements and stock swaps between funds,’ says Angell. ‘The recent frenzy of activity witnessed deals made at undisclosed prices and forward settlement dates. With so much happening off-market, the real value of the securities is hidden. There is broad suspicion, particularly among foreign portfolio investors, that stock price is not accurately reflecting true company valuation as’
The new law would give minority shareholders a chance to participate in the strategic bids now taking place. Besides having to publicly disclose holdings, funds making bids for companies would have to declare them openly and offer all investors a price determined by the average of the stock price over the previous six months.
At Patria, which is not large enough to seek controlling stakes, fund manager Collins is concerned for the rights of minority shareholders and portfolio investors. He applauds the impending legislation which promises to protect their rights. Collins welcomes the consolidation of ownership and the increased corporate governance it brings but says: ‘It’s too soon to tell whether new portfolio structures will benefit either companies or shareholders.’
CSFB’s Wendelova says the new rules remain uncertain. Some lobbyists are demanding that funds should not be allowed board seats, or only under government licence; while some investment funds are vying to eliminate the 20 per cent cap on fund investment in a company. Certain funds are considering changing their statutes to shed their identity as investment funds, in order to be free from disclosure obligations and rules governing the type of investments they enter into.
Potential loopholes apart, Wendelova believes shareholder value will be well-served by the legislation. ‘Consolidation of assets has been driven more by the need to monitor and value investments than a desire to manage companies,’ she says.’Funds could not value stakes solely on the basis of public information, so they sought board seats. The new rules should bring transparency to the market.’ But Wendelova warns that efficiency will still be limited by available capital and the strength of portfolio companies.
As thousands of Czech citizens look to a new era of investment, and foreigners speculate about what has so far had the appearance of an insiders’ market, the Czech government is under pressure to steer home effective legislation. At stake is the third wave of Central Europe’s most exciting privatisation experiment.
