UKRAINE: PRIVATIZATION UNLIKELY TO HELP CLOSE BUDGET GAP

UNCLAS SECTION 01 OF 02 KYIV 000785

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SUBJECT: UKRAINE: PRIVATIZATION UNLIKELY TO HELP CLOSE BUDGET GAP

REF: 08 KYIV 447


1. (SBU) Summary: Ukraine's 2009 budget foresees $1.1 billion of
budget revenues this year, but the GOU is unlikely to earn anything
near that amount from privatization of state-owned enterprises. The
IMF, in its most recent review of its Stand-By Agreement, now
estimates that Ukraine will generate about $390 million from
privatization. The unfavorable market environment will make the
sale of even well-prepared state companies difficult. Two flagship
state companies - fixed-line telecommunications giant Ukrtelekom and
chemical giant Odesa Portside Plant (OPP) -- lead the GOU's
privatization list. While the State Property Fund (SPF) has made
progress in preparing OPP for sale, Ukrtelekom looks to be less
ready, and leading GOU and company officials continue to announce
unrealistic timelines for the company's privatization. In addition,
the ongoing political squabbling between PM Tymoshenko and President
Yushchenko over the legal basis for privatization, and over
leadership of the SPF, continues to lame the privatization agency.
End summary.

Privatization Revenue To Fall Short of GOU Target
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2. (SBU) The Ministry of Finance foresees $1.1 billion of budget
revenues this year, but the GOU is unlikely to earn anything near
that amount as it attempts to finance a ballooning deficit, which
the IMF now expects to be about $4 billion (excluding costs of bank
recapitalization.) The IMF now estimates privatization revenues to
be about $390 million, or 0.3 percent of GDP. The ability to
generate significant revenue from privatization will depend on
whether Ukraine will be able to ensure the sale of two flagship
companies still in state ownership -- Ukrtelekom and the Odessa
Portside Plant -- which in turn will be contingent on reaching a
political consensus on privatizations and the ability to find
respective buyers in the current economic climate.


3. (SBU) Ukraine has had a dismal record of privatization in recent
years. In 2008, privatization revenues were only $95 million
against planned revenues of $1.7 billion. Privatization has been
effectively blocked since the $4.8 billion sale of Ukraine's largest
steel mill, Krivorizhstal, in 2005. The political rivalry between
President Yushchenko and Prime Minister has hit privatization hard.
The two have waged an ongoing battle over the leadership of the
State Property Fund (SPF) practically from the moment that
Tymoshenko assumed office in late 2007 (reftel),a dispute that
shows no signs of abating. On May 6, Yushchenko suspended a recent
CabMin resolution naming a new SPF deputy head and announced
intentions to challenge in the Constitutional Court.


4. (SBU) The Prime Minister and President disagree on the legal
basis for privatization as well. Last December Yushchenko issued a
decree instructing the GOU to suspend the privatization of strategic
assets until the adoption of laws on both the SPF and the
privatization program itself. In February the law on the
privatization program failed in the second reading. The Rada later
did pass a law on the SPF, but Yushchenko vetoed it, arguing that it
included some contradictory provisions.


5. (SBU) However, as the situation with the 2009 budget gets worse,
there appears to be a change in the view of the President with
regard to at least the sale of Ukrtelekom. On March 25, First
Deputy Head of the Presidential Secretariat Oleksandr Shlapak
announced that the President would support the privatization of
Ukrtelekom provided that the Cabmin coordinates the tender
conditions with the President. Shlapak also emphasized the
importance of adhering to transparency requirements during the
privatization.

Ukrtelekom Revenue Later This Year?
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6. (SBU) Even if the political will emerges to move forward with
Ukrtelekom's sale, it is not clear whether the privatization can be
conducted quickly enough to generate meaningful funding for the 2009
budget deficit. Ukraine has tried to sell the land-line monopoly
since 1997, and has routinely announced unrealistic timelines.
Earlier this year, for example, Transportation Minister Yosyp
Vinskiy expected that a tender would be conducted in the first half
of this year. Media reports have quoted officials as saying that
the tender could take place in October. However, by all accounts,
little progress has been made to prepare the company for
privatization. The need to restructure Ukrtelekom, to separate it
from the government's communication service, and the requirement to
conduct an international audit of the company will all influence the
timeline. Ukrtelekom is Ukraine's largest fixed-line operator and

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has 70 percent market share, or 9.7 million subscribers. It also is
a leader in providing internet broadband connections, serving more
than 10 million households. However, given the tough competition in
the sector Ukrtelekom risks loosing large part of its market share,
justifying the need for fast privatization of the plant.

Companies Purportedly Voice Interest in Ukrtelekom
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7. (SBU) On February 11 the GOU passed a resolution aimed at
selling a 67.8 percent stake in Ukrtelekom this year. On March 18,
acting head of the SPF Dmytro Parfenenko announced that 10 companies
were interested in participating in the privatization. He mentioned
Deutsche Telekom and its Hungarian subsidiary Magyar Telekom,
Turkish Turkcell, Russian RosTelecom as well as Systema Group (owner
of MTS and Komstar Ukraine). Some commercial and investment banks,
including Bank of New York, UBS, Nomura, Russian Alfa Capital,
Austrian Raiffeisenbank, Credit Suisse, and Merrill Lynch have
reportedly expressed interest. To our knowledge, however, none of
the companies mentioned by the GOU have independently and openly
expressed interest. Some of the conditions announced in tender
plans in 2008 were viewed as a deterrent for investors. A ban on
cutting Ukrtelekom's bloated workforce, for example, was seen as the
primary obstacle to modernizing the company.

Ukrtelekom's Price Probably Lower This Year
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8. (SBU) Estimate of Ukrtelekom's worth vary widely.
Transportation Minister Vinskiy said the GOU could fetch $3.25
billion, while the SPF estimates that Ukrtelekom is worth only $970
million. The company's market capitalization is about $630 million
(seven percent owned by management and employees is listed on
Ukraine's stock market) reflecting the recent abrupt decline in
share prices, as last year's capitalization was $2.35 billion.
Concorde Capital analyst Oleksandr Parashchiy estimated the starting
price to be $936 million, and thought the company could eventually
be sold for $1 to $1.9 billion. Roman Zhukovskiy, a social and
economic policy advisor to the President, estimated that the GOU
will most likely get about $1 billion as compared with $3 billion
last year if it had sold the Ukrtelekom stake last year.

Odessa Portside Plant Could be Privatized More Quickly
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9. (SBU) The privatization of the Odessa Portside Plant (OPP),
Ukraine's largest ammonium producer, could be swifter, since the
company underwent significant privatization preparations in 2008.
Commentators put the price for OPP at about $1 billion, far lower
than the price expected for 2008. Higher prices for Russian gas
made the plant less attractive, as gas accounts for about 45 percent
of the plant's costs. Media reports have said that companies that
are interested in the privatization may include those that have
access to their own sources of gas, such as Russian Sibur, Eurochim,
or Ukrainian company IBE Trade, which is the owner of Stirol plant.
Local press have speculated that Dmitriy Firtash, owner of other
chemical plants in Ukraine, such as RivneAzot, no longer has access
to cheap gas and would not be interested in OPP.


10. (SBU) Other companies scheduled for privatization include
stakes in five oblenergos and controlling stakes in plants like
Makeyev coking chemistry plant and Horlovka machine-building plant.
However, the SPF had to recently cancel the tender for a 25 percent
stake in one oblenergo due to a lack of bidders. The plan also
includes privatization of 22.39 percent of aviation company
Aerosvit. The interest in these privatizations is likely to be
limited to existing shareholders of the companies and the cumulative
value of the packages is not expected to exceed $500 million.


11. (SBU) Comment: The sale of Ukrtelekom or the Odessa Portside
Plant will require political consensus and at least medium term
planning. The latter is not common in Ukraine's political world,
with its short horizons, and it remains to be seen if the former
will be possible as the presidential election campaign intensifies
later this year.
In any case it appears increasingly unlikely that privatization will
contribute more that a modicum to the financing of Ukraine's budget
deficit this year. End comment.

TAYLOR