CROATIAN PRIVATIZATION: 14 STEPS FORWARD, UNKNOWN

1. (SBU) The Croatian Privatization Fund -- under energetic
leadership and with the help of U.S.-funded advisors -- has
fought an uphill battle the past seven months, and can take
some pride in the privatization of 14 majority
government-owned firms over that period. Privatization of
subsidy-sucking large agricultural conglomerates has almost
been completed. On the other hand, the government has
effectively "re-nationalized" several private companies
rather than accept layoffs, and one privatization is in
danger because the workers refuse to allow the new owner to
take possession. The government has largely failed to move
on privatization of industrial properties, and in some cases
is moving in the wrong direction, with ill-conceived schemes
to merge industrial dinosaurs. The international community
is working together with new urgency to help the government
make the tough decision to move forward on the more difficult
privatizations. So far, we do not see much evidence that the
government will quicken the pace of reform before the May
local elections. If the IMF and World Bank hold the line, it
will help the government stiffen its resolve. The USG is
prepared to extend its assistance to the privatization
process if the government decides to move forward with
industrial privatizations.

Success, Especially in Agricultural Companies


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2. (U) Over the past year, the Fund has been able to sell 14
majority state-owned enterprises. They consisted of five
agricultural companies, eight hotels, and one medium-sized
metal working company. These were mainly small-to-medium
sized firms, with the exception of Belje and PIK Vrbovec.
These two together employ 3600 permanent employees, and have
over a billion kuna (USD 175 million) in known debt. The
sale of these companies represents a major victory, both in
terms of the number of employees and debts cleared from the
government ledger. However, the path to the sales was far
from smooth, and similar successes will be hard to duplicate.
Both were sold to Agrokor, one of the largest companies in
Croatia. Agrokor was able to agree to conditions not easily
met by other (especially foreign) bidders -- such as buying
the sprawling companies in their entireties, and promising to
retain all the employees for three years. If these "social
clauses" come to be considered the norm, future sales will be
more difficult.

Hotels "Flying Out" the Portfolio


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3. (SBU) Hotel sales are brisk -- as they should be. The
Fund even managed to easily sell a hotel with a lovely view
of the Rijeka oil refinery. Even the Suncani Hvar saga
appears to be entering its final chapters. After the sale of
this diverse resort almost caused a rupture in the former
coalition government and was halted, the hotel sank deeper
into debt. The Quaestus Fund, a local group headed by a
former HDZ (Croatian Democratic Union) finance minister,
offered to "help out" the government by entering into a
public-private partnership for the resort, with no tender.
Quaestus would have made minimal investment, held onto the
property for five years, and then sold its share. The
government would have retained a majority. The Privatization
Fund pushed for doing it right, and worked feverishly to
craft a credible public-private partnership model (something
new for Croatia). The model developed provides for eventual
sale of the government share. Now there are a number of
international and national bidders interested in the
property, and the bids are higher than the original Quaestus
offer.



4. (U) The government has also been able to sell off
minority shares in over 250 companies via the stock
exchanges. Tenders have been prepared for 10 additional
majority state-owned companies.

Who's in Charge Here?


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5. (U) Another near-success was the tender of sugar company,
Sladorana. The Fund staff identified the best bid as that of
another Croatian sugar company with good marketing channels
in Western Europe. However, the workers -- whose ESOP bid
came in third -- have refused to let the winner take over the


company, and the completion of the sale is in jeopardy.



6. (U) The workers at Sladorana publicly invoked the example
of the agricultural company Valpovo. Valpovo was privatized
in the early '90s. When a minority shareholder launched a
successful takeover bid in 2003, the workers refused to let
the new management enter the plant. Rather than risk
violence by upholding the court order to turn over the plant
to the owner, in early 2004 the government bought the owner's
shares at a good price, and put them on the stock exchange,
where they have sat untouched since. A call by the workers
for new subsidies is reportedly being given favorable
consideration by the government.



7. (SBU) Sladorana and Valpovo are part of a larger pattern
of the government finding it politically impossible to accept
job losses or social strife, even in already privatized
firms. As reported earlier, the government took over Sisak
Steel and its 1600 workers. Sisak had been sold in a
bankruptcy in the late '90s. Most experts agree that Sisak
is a "dead company." Two successive companies have been
unable to make a go of it. (As part of a vicious cycle, the
last two owners have made unrealistic investment and
employment promises in order to get access to Croatia's
export quota for steel to Europe. After the quota is
exhausted, they walked away from the plant, which is
uncompetitive under normal market conditions. The reputation
of the privatization and bankruptcy procedures has been
blackened in the process).



8. (U) The press is now reporting that the government has
stepped in to buy Goricanka, a textile firm that had been
sold to a successful Croatian bakery chain, Pan Pek, in a
bankruptcy procedure. Pan Pek was accused of planning to lay
off workers and convert the plant to its main line of
business. If the sale to the government is finalized, the
Privatization Fund will add another 250 workers to its
portfolio. And the fact that the government stepped in after
workers had threatened to blockade the company (ala Valpovo,
and possibly Sladorana) will not be much of a selling point
if the firm is finally put up for sale.

Industrial Firms Proving Difficult


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9. (SBU) Earlier, the government had committed to working
quickly on two industrial firms -- Split Steel and TLM (an
aluminum plant in Sibenik). Split Steel had a number of
interested bidders, but the government would not commit to
write off the debt necessary to make any sale feasible.
Meanwhile, the director of Sisak Steel, desperate to keep his
company afloat, has promoted the idea of merging Sisak Steel
and Split Steel to create CroSteel. Most experts believe the
plan ill-conceived (the two plants are geographically far
apart and produce completely different products) but the
press reports rumors that the German consultant hired by the
government to consider its scheme will give the plan a
positive evaluation.



10. (SBU) The government has not shown the will to move
forward on TLM, which is rumored to be mired in over a
billion kuna (USD 175 million) of debt. For 2005, the
management has asked the government for over an over 400
million kuna (USD 70 million) subsidy, and still projects a
loss of over 60 million kuna (USD 10.5 million). The subsidy
package would include an odd mixture of reduced price energy
from the state electric company, HEP, and reduced or free
aluminum from an aluminum plant in Mostar -- of which TLM
owns a 15 percent share.

Shipyard Privatization Stuck in Port


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11. (SBU) Another bad idea promoted by the Minister of
Economy and his deputy (a former shipyard head) is to combine
the six large state-owned shipyards into one mega-company.
The ministry has declared a need for a "restructuring plan"
that would effectively pull the shipyards out of the
privatization process until well into the next decade.
Meanwhile, the management of best of the lot, the Uljanik
yard in Pula, is urging that its shipyard be privatized.

International Community Standing Shoulder to Shoulder


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12. (SBU) In December, representatives of USAID, the EU

Commission, the World Bank and the IMF met in Zagreb to
discuss how to support the government's efforts to clear out
the privatization portfolio. The Ambassador co-signed a
letter with the IMF Resident Representative and the World
Bank Regional Director urging the restarting of the
privatization process of Split Steel and TLM, and the
inclusion of Uljanik Shipyard into the list of companies to
be privatized this year. The IMF and World Bank are making
privatization of these three companies hard conditions of
their programs. USAID has offered to extend its assistance
(due to end later this year) to the Fund to assist with these
privatizations.
FRANK


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