AZERBAIJAN INVESTMENT COMPANY STARTS TO PURSUE ITS

C O N F I D E N T I A L SECTION 01 OF 03 BAKU 000474

SIPDIS

SIPDIS

DEPT FOR EEB SPECIAL REPRESENTATIVE FRANK MERMOUD
COMMERCE FOR A/S ISRAEL HERNANDEZ, DAS PAUL DYCK AND DAS
DANIEL HARRIS
ANKARA FOR FCS JAMES FLUCKER

E.O. 12958: DECL: 04/12/2017
TAGS: PREL PGOV ECON EAGR EPET KCOR AJ
SUBJECT: AZERBAIJAN INVESTMENT COMPANY STARTS TO PURSUE ITS
MISSION


Classified By: Ambassador Anne E. Derse, Reasons 1.4 (b,d)


1. (C) SUMMARY: Azerbaijan Investment Company (AIC),
established by the Government of Azerbaijan (GOAJ) in 2006 to
promote the development of Azerbaijan's non-oil sectors, is
beginning to identify specific multi-million-dollar domestic
and regional investment projects. After a slow start, AIC is
planning to invest up to USD 50 million of its USD 100
million capitalization in 2007 in non-energy sector projects.
Due to the lack of viable partners in the non-energy sector,
AIC is looking to invest with established international
companies already operating in Azerbaijan. Development of
Azerbaijan's non-energy sectors is vital to its development
and stability and it was established to attract and help
foreign investors penetrate Azerbaijan's market. AIC is a
step in the right direction but, like any other investor, it
faces serious challenges in Azerbaijan's difficult business
climate. END SUMMARY.

BACKGROUND
==========


2. (SBU) In March 2006, President Ilham Aliyev signed a
decree establishing the Azerbaijan Investment Company (AIC),
with the primary purpose of helping to attract foreign
investors to develop Azerbaijan's domestic non-energy
sectors. Since then, the joint-stock company has been engaged
in identifying and researching investment opportunities. The
GOAJ used USD 100 million from the State Oil Fund to create
AIC's statutory capital from the State Oil Fund. AIC
operations began in September 2006 but it did not invest in
any projects until March 2007.


3. (C) In a March conversation with Embassy Commercial
Officer and Commercial Assistant, AIC Executive Director Anar
Akhundov said that AIC's activities are supervised by the
Observation Council, which is headed by Economic Development
Minister Heydar Babayev and includes the Executive Director
of the State Oil Fund Shahmar Movsumov. The Ministry of
Economic Development (MED) also keeps and manages AIC's
state-owned shares. According to Akhundov, AIC's management
philosophy is similar to a private equity firm or fund. He
said that AIC only invests to become a minority equity
shareholder, but one with a blocking vote.


4. (C) Akhundov explained that AIC insists that companies in
which it invests implement best practices and best technology
for the most efficient operations. AIC also wants these
companies to apply best corporate governance standards and
have audits by one of the big four international audit
companies. AIC told EconOff that it had not been more active
in the non-energy sectors, such as agriculture, since it was
having trouble finding viable partners with which to invest.

COOPERATION WITH IFIs
=====================


5. (SBU) Akhundov said that in March the International
Finance Corporation (IFC) and AIC signed a memorandum of
understanding on mutual cooperation for corporate governance
in Azerbaijan. IFC will provide consulting and training
service in Azerbaijan through the Azerbaijan Corporate
Governance Project. A joint methodology will be developed to
help assess corporate governance in the companies of interest
to AIC. In January, AIC became a member of European Private
Equity and Venture Capital Association (EVCA) and of Emerging
Markets Private Equity Association (EMPEA). Akhundov said
that AIC membership in these organizations will promote
integration into the international investment network and
help disseminate information about investment opportunities
in Azerbaijan's non-energy sectors. AIC is also in contact
with Kuwait-based investment companies to research
establishing mutual funds.


6. (C) The European Bank for Reconstruction and Development
has also provided technical assistance to AIC at its
establishment in September 2006. Aygen Yayikoglu, current
EBRD Head of Office in Baku, told EconOff that EBRD provided
guidance and assistance with AIC's charter. Yayikoglu said

BAKU 00000474 002 OF 003


that EBRD likes the AIC concept of investing in the
non-energy sector but that AIC needs to build up a track
record. If AIC remains a transparent fund and if it works
properly, AIC can play a key role in the development of the
agricultural sector and other non-oil sectors. He added that
EBRD is ready to co-invest with AIC in appropriate on-energy
sector projects. Yayikoglu stressed tat AIC needs to stay
focused on investment opporunities in the non-energy sector.
Yayikoglu also said that AIC's Supervisory Board has
proposed to the Presidential Apparat an amendment to AIC's
original Presidential Decree revising AIC's veto clause.
This veto clause has hindered AIC's cooperation with
international companies.

CAPACITY-BUILDING
=================


7. (C) Akhundov said AIC's greatest need was
capacity-building, and as such he was very interested in
partnering with international industry leaders for just this
purpose. AIC is the first company of this nature in
Azerbaijan, and he said it would need help and support from
international partners to develop its managerial and
analytical talent.

SPECIFIC INVESTMENT PROJECTS
============================


8. (C) Akhundov said that AIC researched more than 50
investment projects in 2006, and is currently conducting
feasibility studies with international consulting companies
for 14 projects. In February, AIC announced its intention to
buy a 20 percent equity in the Garadagh Cement Factory from
Holcim (Garadagh's shares currently are 90 percent owned by
Holcim and 10 percent by EBRD). In a subsequent meeting with
EconOff, Akhundov and AIC Deputy Director Riad Gasimov said
that negotiations with Garadagh Cement are not complete.
Garadagh Cement and AIC are still discussing the AIC's veto
power.


9. (C) AIC is also conducting a feasibility study with
Lafarge to construct a second cement factory in support of
regional development. The proposed factory will use full dry
technology, which, although more expensive, is ecologically
friendlier. Based on current demand for cement in
Azerbaijan's real estate boom, there is enough domestic
demand to justify two cement factories in Azerbaijan. AIC
also announced its intention to obtain 20 percent ownership
in major dairy and juice manufacturer Milk-Pro (currently 25
percent EBRD ownership). Within the project, AIC will
co-finance a new dairy plant near Hovsan outside Baku. The
plant will produce cheese, butter, milk and yogurt for
domestic consumption. AIC also believes there may be export
potential to Georgia and Kazakhstan.


10. (SBU) Akhundov said that among other projects, AIC is
conducting feasibility studies for:

- petrochemical production worth USD 1 billion;
- insulin production for domestic consumption and potential
export to Georgia and Kazakhstan (a joint project with a
British company);
- greenhouses to export fruits and vegetables to Russia;
- vermicomposting farms (California worms);
- a shipping company to transport oil in the Mediterranean;
- a shipyard in Garadagh (together with South-Korean
manufacturers);
- an oil terminal in Garadagh (near Baku) to transport Kazakh
oil to the West (a project controlled by powerful Azersun
Holdings),and
- meat processing.


11. (C) Regarding AIC's proposed investment with AzerSun in
the Garadagh oil terminal project, EBRD Head of Office
Yayikoglu said that EBRD in general keeps its distance from
AzerSun and its operations, due to ownership and connections
to the GOAJ. Yayikoglu said that the oil terminal project
would appear to go against the mandate of the AIC. He agreed
that this investment most likely did not come from AIC

BAKU 00000474 003 OF 003


itself, but rather was proposed by Babayev and the
Supervisory Board. (COMMENT: AzerSun does not need AIC money
for any proposed investments. It has plenty of financing and
can attract other investment funds. AIC, on the other hand,
is eager to show positive results and return. Embassy will
monitor closely AIC to ensure that its efforts for a positive
return do not translate into poorly planned projects, wasting
GOAJ resources.)

COMMENT
=======


12. (C) Development of Azerbaijan's non-energy sectors is
vital to its long-term economic health and stability. AIC is
a step in the right direction, but the still relatively small
size and weakness of Azerbaijan's non-energy sectors already
are making it difficult for AIC to find viable projects. The
AIC - like any other investor in Azerbaijan - also faces
continuing, serious problems in the business climate,
including transparency and rule-of-law. Moreover, without a
strong and fully enforced Azerbaijani conflict of interest
law, there is a danger that senior Azerbaijani officials --
who control AIC's decision-making structure and themselves
hold significant business holdings -- could steer AIC funds
to their own projects.
DERSE