UPDATE ON THE (STALLED) PRIVATIZATION PROGRAM

UNCLAS SECTION 01 OF 03 ANKARA 003257

SIPDIS


SENSITIVE


STATE FOR E, EUR/SE, AND EUR/IFD
TREASURY FOR OASIA - MMILLS, RADKINS
NSC FOR BRYZA AND MCKIBBEN


E.O. 12958: N/A
TAGS: EFIN EIND ECON TU
SUBJECT: UPDATE ON THE (STALLED) PRIVATIZATION PROGRAM

1.(Sbu) Summary. The travails of the Tupras privatization and
recent meetings with Privatization Authority (PA) officials
and other contacts confirm that Turkey,s privatization
program continues to be plagued by PA mistakes, which opens
the way for vested interests to use the courts to block
privatizations and an excessive focus on the proceeds of the
sale rather than the efficiency gains to the economy. The
bottom line is that only one significant privatization has
taken place since the current government came to power, and
all the major privatizations seem to be moving at a snail's
pace. On June 10, Finance Minister Unakitan optimistically
claimed the GOT would realize deals worth $2.3 billion in
2004, of which $468 million would be in cash. End Summary.


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Overview
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2. (Sbu) Although the current Government is widely considered
to support privatization more than previous governments, its
track record continues to underwhelm. In 2003 (AKP,s first
full year in power),the GOT projected privatization proceeds
for the year of USD four billion, and for the period 2003-06
of 12.4 billion. 2003 was marked, however, by high-profile
debacles--the failures of Tekel tobacco and Petkim--and slow
motion on the other large privatizations. Finalized deals
totaled only some USD 900 million, most of which were small
transactions. For 2004, GOT reduced its target for total
sales to only USD 1.2 billion. Trying to put the best
possible face on the situation, at a press conference June
10, just after the courts blocked the $1.3 billion Tupras
privatization, Finance Minister Unakitan claimed the GOT
would realize sales in 2004 worth $2.3 billion of which only
$468 million would be in cash. These estimates seem highly
optimistic, even if the Tupras deal goes through. Just in the
past year, the GOT 's inability to conclude three large
privatizations has cost it $3 billion in revenues and, more
importantly, an opportunity to accelerate the reform process
and enhance market confidence.

3. (Sbu) In separate meetings with econoffs, Privatization
Authority President Metin Kilci and Vice President Osman
Ilter claimed they were proceeding as quickly as possible,
but the subtext of the discussions was that any particular
privatization will occur only if the sale price is
politically palatable.
4.(Sbu) Post has previously reported the PA,s problems with
excessively high internal valuations, and officials, fears
of being criticized or even prosecuted for selling below the
internal valuation. Moreover, senior GOT officials tend to
focus only on the fiscal benefit to the state from the
proceeds of the privatization, rather than on the efficiency
gains to the economy. PA President Kilci told us that senior
GOT officials measure the PA's success purely in terms of
revenue raised.
5.(Sbu) In recent weeks, as the Tupras privatization has
become ensnarled in the courts (see below),two post contacts
from outside the government have privately accused the PA of
technical and legal incompetence that leaves it open to court
challenges from the many vested interests opposed to
privatization. Faik Oztrak, the former Treasury
Undersecretary, told econcouns that the PA is required to
accept only unconditional bids, but accepted a conditional
bid on the Tupras deal. Likewise, Ergun Okur, EVP of Oyak
Group, said the PA had made mistakes in conducting the Tupras
privatization process.
6.(Sbu) If the privatization process seems slow now, it may
get worse: Kilci acknowledged that the PA has about a year to
finalize its most contentious divestitures, before political
considerations render tough choices impossible. As set forth
below, the PA faces a huge challenge in meeting this deadline.
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Tupras (Refinery)
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7. (Sbu) Tupras has been in the PA portfolio since 1990. A
tender last fall produced a high bid of USD 1.3 billion to a
consortium of the Russian oil company Tatneft and the Turkish
conglomerate, Zorlu group. The sale was originally expected
to be concluded by the end of 2003, but the sale has been
delayed by difficult contract negotiations and by lawsuits
brought by Tatneft,s minority shareholders and by Tupras
unions. Shortly after Kilci opined to us that the sale would
be finalized by the end of June, an appeals court reinstated
a lower court restraining order blocking the sale. While the
PA may well be successful in its appeal to the Council of
State, this sell-off is already being compared to the 2003
Petkim and Tekel debacles. As Tupras is the only possible
near-term &win8 for the PA, if the appeal is lost the PA,s
credibility, such as it is, will be badly damaged.
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Petkim (Petrochemicals)
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8. (Sbu) Petkim also has been in the PA portfolio since 1990.
Though the PA had accepted the bid by the Uzan group,s
Standart Kimya in 2003, once the Uzan group companies were
seized over the Imar Bank collapse, Standart Kimya was unable
to come up with the funds to make the initial payment, and
the PA had to cancel the tender. It then re-tendered the
company, only to cancel the tender in January for lack of
interest. Kilci said he hopes to announce a tender this year
or early next year, but first he &wants to see some good
financial statements.8 (For 2004 Q1, Petkim reported a USD
40 million loss.) At his press conference, Unakitan said the
PA would re-tender by the end of the year. Comment: The
problem with waiting for &good financial statements8 is
two-fold: First, the wait could be long. Second, in its
valuations PA seems to apply to earnings a much higher
multiple than do investors. As such, as a company,s
performance improves, it perversely becomes more difficult to
sell, because the discrepancy between the PA,s valuation and
those of potential purchasers is magnified. End Comment.


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Erdemir (Iron and Steel)
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9. (Sbu) Erdemir has been in the PA portfolio since 1987.
Ilter explained that the PA wants to delay the block sale of
the state,s 50% interest in Erdemir until (a) its
publicly-traded stock recovers the value it recently lost
(because of what Ilter considers an overreaction by the
market to a fall in Chinese steel purchases),(b) the Tupras
sale is concluded (thus demonstrating the &credibility8 of
Turkey,s privatization program),and (c) additional
investors show interest (two have shown interest so far, but
Ilter very much wants to see other investor interest).
Comment: The PA will be waiting a very long time for all
three of Ilter,s conditions to come into alignment.
Ilter,s caution is unfortunate: Erdemir has been profitable
in 2003 and likely in 2004, benefiting from surging local
demand from the booming Turkish auto and white goods sectors,
and probably could be sold relatively quickly. Econoff
recently visited Erdemir,s headquarters in the Black Sea
town of Eregli and will report septel. End Comment.
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Turkish Airlines (THY)
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10. (Sbu) THY has been in the PA portfolio since 1990. Ilter
explained that the PA is considering a limited public
offering of 20-30 percent with a subsequent block sale.
Kilci thought the IPO could be concluded before the year end.
Ilter revealed that the Transport Minister has held up
approval to prepare for the IPO. According to Ilter, this is
probably because of the Transport Minister,s irritation that
the PA, under the authority of Finance Minister Unakitan, has
the lead on the THY privatization.
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Tekel (Tobacco)
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11. (Sbu) Tekel has been in the PA portfolio since 2001.
The GOT,s rejection last fall of the high ($1.3 billion) bid
for Tekel,s tobacco operations has left the PA frantically
-- and to date unsuccessfully -- searching for options. Kilci
said that the PA is trying to develop a &more attractive
model.8 However, the only meaningful alternative that has
been suggested ) separate sales of individual brands -- is
not under consideration. The privatization of Tekel,s
smaller alcohol operations was successfully completed earlier
in 2004, the only significant company privatized by the GOT
in the past year.
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Turk Telekom
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12.(Sbu) Turk Telekom (TT) has been slated for sale since
1998, though consideration of TT,s privatization began in
the 1980s. TT is perhaps the most politically controversial
of the potential privatizations, and the TT privatization
process comes under its own special legislative framework.
Although technically not part of the PA,s portfolio, the PA
is involved in the TT sell-off. The GOT seems to be
proceeding diligently to address the many problems that must
be resolved before this sale can proceed, such as amending
the public procurement law to allow the PA to retain a
financial advisor for the sale. Kilci agreed that labor is
TT,s biggest problem, and said that a bill has been
submitted to Parliament that will aid TT,s downsizing. Kilci
also stated, however, that the PA can best handle the labor
problem by finding a &good customer8 for TT.



13. (Sbu) The U.S. Trade and Development agency has financed
a U.S. consultant doing a study of TT,s information
technology upgrade needs. Econoffs recently met with the
consultant, who described a company with serious systems
problems. The consultant said TT desperately needed
investment in new systems, and he wondered about the
company,s ability to manage IT projects. The consultant
said TT had clearly underinvested for years, lacked a
customer service mindset, and badly needs strengthened
management, marketing and systems.
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Electricity Distribution
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14.(Sbu) Under the GOT,s recently-agreed energy sector
strategy, elaborated with the help of the World Bank, the GOT
plans to privatize some government-owned generation
facilities and divide the country's distribution network into
21 regions, creating a joint stock company for each region,
and establishing regional tariffs. The difficulty is that, in
the Eastern part of Turkey, up to 80 percent of all
electricity is stolen. The total loss nationwide is
estimated at $1.75 billion annually. Thus, at present, with a
national tariff system, the Western part of Turkey, in which
leakage is much smaller, is subsidizing the Eastern part of
Turkey. Kilci advised that the World Bank has now agreed with
GOT to maintain national tariffs for five years, during which
time the GOT expects private distribution companies to
significantly reduce losses.


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State Bank Privatization:
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15. (Sbu) The privatizations of state-owned Ziraat and Halk
Banks, and of state-controlled Vakif Bank are central
elements in IMF and World Bank programs in Turkey. In the
course of the negotiations over the IMF,s Seventh Review, in
March and April, the GOT agreed with the IFI,s on a state
bank privatization strategy for Halk and Ziraat, and
continues to try to resolve ownership structure issues that
prevent the privatization of Vakif. As reported earlier, the
strategy is to shrink Ziraat and Halk*especially their
outsized government securities portfolios*to prepare for
eventual privatization. Though Halk and Ziraat management
initially behaved contrary to the strategy, by aggressively
competing for consumer lending business, several contacts
have confirmed that these banks have finally been reined in
by Treasury, and are no longer undercutting private banks,
lending rates. Rodrigo Chavez, the World Bank economist who
has the lead on the state bank issue, told econoff the plan
is for the GOT to pull $5 billion in capital out of Ziraat
and Halk in the coming months. He said the GOT moved rather
quickly to select an advisor, McKinsey, who is already
working on the process. Comment: Despite the progress, and
Chavez, optimism, the privatization of these banks, with
their gigantic branch networks and payrolls, is likely to be
a very long process. End Comment.
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Comment:
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16. (Sbu) Though the privatization program is seriously
undermined by widespread anti-privatization attitudes,
litigious labor unions, and unsympathetic and capricious
courts, the GOT itself has yet to demonstrate that it
understands the efficiency gains that could be obtained from
faster privatization, or has the will and competence to speed
up the process. The GOT has proven adept at convincing the
IFI,s that it is working towards privatization, while, by
and large, only the small companies are actually transferred
to the private sector.


EDELMAN