HERMITAGE CAPITAL MANAGEMENT The Re-Rating of Russia

1

HERMITAGE CAPITAL MANAGEMENT

The Re-Rating of Russia

by William F. BrowderManaging Director,

Hermitage Capital Management

February 2002

2

HERMITAGE CAPITAL MANAGEMENTAgenda

1. Catalysts for Re-rating

2. Macroeconomics

3. Fixed Income vs. Equity

4. Microeconomics

5. Risks to Re-rating

6. Hermitage’s Investment Approach

7. Case Studies

8. Hermitage Performance

3

HERMITAGE CAPITAL MANAGEMENTRe-rating of Russia

Catalysts for

Re-rating

Economic Reforms

Solid Macro-Economics

Improved Corporate Governance

Good fundamentals + Cheap valuations + Trigger = Re-rating

Political Stability

Cheap Valuations relative to GEM*

September 11

Good Fundamentals

Crackdown on Corruption

Re-rating

4

HERMITAGE CAPITAL MANAGEMENTSeptember 11th as a Trigger

• Official end of “Cold War”

• Key non-Middle East oil supplier

• Russian WTO entry

• Better terms at the Paris Club

• Better terms with the IMF

• No more condemnation on Chechnya Lower global interest rates

• Emerging markets’ bailout “across the board” (Turkey and Pakistan)

• Lower oil prices V

Russia is a clear winner of world’s re-shaping after Sept.11th

Positive Effects Negative Effects

5

HERMITAGE CAPITAL MANAGEMENTEconomic Reforms

Tax Reform

Banking Reform

Business De-regulation

Judicial Reform

Pension Reform

Natural Monopolies

Bankruptcy Reform

Labor Code

Land Code

For the first time in the history of modern Russia, significant reforms are being implemented

2000 2001 2002

6


17.3

19.9

10

12

14

16

18

20

2001E 2002E

US$ Billion

+15%

US$17.3 Bln.

US$19.9 Bln.

15%

20%

25%

30%

35%

40%

2001 2002

%

35%

24%

0%

5%

10%

15%

20%

25%

30%

35%

40%

2000 2001

%

35%

13%

Tax Reform

Tax rates are coming down and tax collection is going up

Source: ING Barings, Alfa-Bank, Russian Ministry of Tax Collections, December 2001

Tax RateCollection

Tax Rate Collection

Ind

ivid

ual

sC

orp

orat

ion

s

5.8

8.6

3

5

7

9

2000 2001E

US$ billion

+49%

US$ 5.8 Bln.

US$ 8.6 Bln.

7

HERMITAGE CAPITAL MANAGEMENTLabor CodeTremendous improvement of Labor Code should stimulate more flexible and efficient relationships between businesses and employees

Old Labor Code(primary goal is

to protect an employee*) Number of working hours can not

exceed 40 hours per week Virtual impossibility to fire an

employee without a prior consent from a trade union

A person may take three year maternity leave and have salary and position sustained upon return

New Labor Code(more realistic in the current

economic environment) Number of working hours is not limited

to 40 hours per week and is subject to agreement between a firm and an employee

No consent from a trade union is needed to fire an employee

Launching a strike requires approval from 2/3 of employees (vs. minority)

* Under the old Labor Code 78% of all layoff cases considered by Russian courts were won by employees

8

HERMITAGE CAPITAL MANAGEMENTEconomic Reforms

The other reforms in progress are:

Pension Reform Introduction of fully funded individual

pension accounts instead of unsustainable pay-as-you-go system

Transparent and open asset management process instead of existing “shadow” allocation among local banks

Banking Reform Opening a banking market to foreign

financial institutions Introduction of government deposit

insurance scheme in 2004 Government to sell its stakes in a number

of banks International accounting and reporting

standards are to be adopted in 2004

Bankruptcy Reform The main goal is to create a simplified

bankruptcy procedure Elimination of loopholes, which currently

allow to use a bankruptcy procedure as a tool in hostile takeovers

Judicial Reform Judges can be fired or imprisoned for

accepting bribes Local courts to be more independent from

local authorities Introduction of jury trials in criminal

cases and improved pay for judges Increased pay for judges

9

HERMITAGE CAPITAL MANAGEMENTCrackdown on Corruption

Organization Name Accusations Consequences Date

Aeroflot

Gazprom

Railway Ministry

Berezovsky

Goldovsky, Koshits

Aksenenko

Diversion of cash via offshore firms

Massive asset stripping via Sibur

Mis-spending of US$70 million of Ministry’s cash

Currently in exile, former associates are in prison

Both are arrested, charged and currently in prison

Resignation from government. On-going investigation

2000-2001

January 2002

December 2001

Presidential Administration

Voloshin No formal accusations

Currently under investigation launched at request of Duma

January 2002

10


Organization Name Accusations Consequences Date

Duma

Defense Ministry

Ministry of Justice

Golovlev

Oleinik

Kovalev

Stealing of US$600 million while running a regional property fund

Stealing of US$200 million and accepting bribes

Currently under investigation, immunity stripped

Faces imprisonment for 10 years

Sentence of 9 years in prison

2000-2001

2000-2001

1999-2001

Ministry of Finance

Vavilov Stealing of S$330 million

Currently under investigation; can’t leave the country

June 2001

Mis-spending of US$440 million

11


Ministry of Emergency Situations

Ministry of Finance

Ministry of Railways

Committee of StatisticsDefense Ministry

Ministry of Justice

Committee of Fishing

Customs Committee

Ministries State Committees

Under investigation by General

Prosecutor’s Office (2001-2002)

In addition, 5 Ministries and 3 Government Committees are under investigation by the General Prosecutor’s Office

Source: General Prosecutor’s Office, January 2002

12

HERMITAGE CAPITAL MANAGEMENTImproved Corporate Governance

Government Actions

Owners Self-Interest

Shareholder Activism

+ Firing Gazprom CEO Vyakhirev

+ Throwing out Chubais’ UES asset stripping plan

+ Challenging Norilsk Nickel in court

+ A new law on joint stock companies

+ Corporate Governance Code

+ Minority shareholders have appointed representatives to more than 20 corporate boards

+ Minority shareholder revolt at UES

+ More than 15 lawsuits filed against issuers by minority shareholders

+ Elimination of transfer pricing

+ Payment of significant dividends

+ Introduction of corporate governance charters

Corporate Governance has also significantly improved on many fronts

13

HERMITAGE CAPITAL MANAGEMENTSolid Macroeconomics

0.2%

-2.3%

-9.0%-9.2%

-14.8%

-4.8%-5.0%

-3.2%-2.8%-2.5%-1.3%-1.0%

-1.1%

0.7%

-16%

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

Ru

ssia

Sou

th A

fric

a

Kor

ea

Arg

enti

na

Mex

ico

Per

u

Ch

ina

Th

aila

nd

Ind

ones

ia

Bra

zil

Pol

and

Cze

ch R

.

Ind

ia

Tu

rkey

10.9%

4.3%3.0%2.3%

1.4%1.1%0.7%

-5.6%-6.5%

-7.3%

-2.4%-1.5%

3.3%

11.0%

-10%

-5%

0%

5%

10%

15%

Ru

ssia

Ind

ones

ia

Sou

th A

fric

a

Arg

enti

na

Th

aila

nd

Kor

ea

Ch

ina

Bra

zil

Per

u

Mex

ico

Ind

ia

Cze

ch R

.

Tu

rkey

Pol

and

5.0%

3.8%3.0% 3.0% 2.8%

2.4% 2.3% 2.0% 1.7%1.2%

-2.3%

3.0%

7.0%

-4%

-2%

0%

2%

4%

6%

8%

Ch

ina

Ind

ia

Ru

ssia

Per

u

Kor

ea

Ind

ones

ia

Tu

rkey

Pol

and

Bra

zil

Th

aila

nd

Sou

th A

fric

a

Mex

ico

Arg

enti

na

3.2%

1.8% 1.7% 1.5% 1.3%0.4%-0.1%

-2.2%

-3.8%

-5.3%-5.7%

-0.6%

6.5%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

Ru

ssia

Th

aila

nd

Ind

ones

ia

Kor

ea

Tu

rkey

Ch

ina

Arg

enti

na

Sou

th A

fric

a

Ind

ia

Per

u

Bra

zil

Pol

and

Cze

ch R

.

GDP Growth (%), 2002E Current Balance (% of GDP), 2002E

Trade Balance (% of GDP), 2002E

Fiscal Budget (%), 2002E

Russian macroeconomic indicators remain very attractive relative to other economies (in spite of lower prices)

Source: Deutsche Bank, Alfa-Bank, Morgan Stanley, JP Morgan, Merrill Lynch, December 2001

14


10

15

20

25

30

35

40

45

50

55

January-00 May-00 September-00 January-01 May-01 September-01 January-02

%Inflation (18.5%)

Current YTM (16.8%)

-1.7%

Fixed Income vs. Equity

Low domestic interest rates and relatively high inflation mean Russia now has negative real interest rates

Source: Renaissance Capital. Interest rate is given for a benchmark GKO26003 maturing in March 15, 2003

Domestic Interest Rate vs. Inflation

Real Interest

Rate

15


0

500

1000

1500

2000

2500

3000

3500

4000

Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02

EMBI Global Emerging Markets Spread

EMBI Russian Bonds Spread

BasisPoints


Russian sovereign debt is already trading at lower yields than Global Emerging Markets

Source: Bloomberg

Russia vs. Global Emerging Markets, Spread (in basis points)

16


B+ / Positive

B / Stable

B- / Stable

CCC / Negative

CCC- / Negative

SD SD SD

Aug-98 Sep-98 Jan-99 May-99 Feb-00 Jul-00 Dec-00 Jun-01 Dec-01


The fixed income re-rating is being closely matched by the Credit rating agencies

Sources: JP Morgan, Standard & Poor’s, January 2002

Changes in S&P Rating on Russia

B+

B

B-

BB

BB-

BB+ Non

Investment Grade

Lower Non-

Investment Grade

S&P’s Rating Scale

Current S&P’s Rating for Russia

17

HERMITAGE CAPITAL MANAGEMENTFixed Income vs. Equity

Despite the recent rally, Russia remains the cheapest emerging equity market in the world

Source: Merrill Lynch. Data as of January 9, 2002.

Price/Earnings Ratios of Emerging Markets, 2002E

27.2 26.8

22.9 22.321.5

16.7 16.014.7

12.6

9.2 8.5 8.3

5.7

0.0

4.0

8.0

12.0

16.0

20.0

24.0

28.0

Tu

rkey

MS

CI

Wo

rld

Ma

lay

sia

Ta

iwa

n

Ph

ilip

pin

es

So

uth

Kor

ea

Arg

enti

na

Em

erg

ing

Ma

rket

s

Ch

ina

Cze

ch R

.

Bra

zil

Ind

on

esia

Ru

ssia

P/ERatio

18

HERMITAGE CAPITAL MANAGEMENTMicroeconomics

Even with a decline in world oil prices, Russian companies will continue to have strong earnings

Source: Troika Dialog, Brunswick Warburg, Renaissance Capital, Aton, January 2002

Net Income (US$ million)

(900)

100

1,100

2,100

3,100

4,100L

uk

oil

Su

rgu

tNG

Yu

ko

s

Sib

nef

t

Ta

tnef

t

Ga

zpro

m

UE

S

Sb

erb

an

k

1999

2000

2001E

2002E

US$million

19


5.1%

22.6%

1.8%1.9% 1.3%2.3% 1.5%1.9%0.4%

1.8%3.3%

0.5% 3.0%1.2%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

Lu

koi

l

Su

rgu

tNG

Yu

kos

Sib

nef

t

Tat

nef

t

Gaz

pro

m

Sb

erb

ank

2000

2001

Dividend Yield (%)

Microeconomics

Dividend yield has been reaching Western standards

Source: Alfa-Bank,Troika Dialog, Brunswick Warburg, Renaissance Capital, Aton, Bloomberg. Data as of January 18, 2002.

Dividend Yield, 2000-2001E

Dividend Yield (1.4%), S&P 500 Index

20


8.4%7.0%

78.0%

12.0%6.4%

3.0%2.0%0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%L

uk

oil

Su

rgu

tNG

Yu

kos

Sib

nef

t

Tatn

eft

Gazp

rom

Sb

erb

an

k

Dividend Payout Ratio

Microeconomics

But the dividend payout ratio is still lagging Western benchmarks and leaves much room for higher dividends in the future

Source: Renaissance Capital, Federal Reserve Bank of Cleveland, December 2001

Dividend Payout Ratios, 2001 Dividend Payout Ratio (34%),

S&P 500 Index

21


At the same time Russian oil companies keep a huge amount of cash to finance their investment programs. Why?

Source: Alfa-Bank, January 23, 2002; Based on financial statements as of 1H2001

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Yukos SurgutNG LUKoil

US$ Billion

Cash on a balance sheet for selected Russian companies

(US$ Billion)

1.7

3.83.8

22


Among the three sources of financing generally available, Russian companies only had an access to retained earnings in the past

Global debt markets closed 1998-2001

Russian companies X

Retained Earnings

Equity Markets at 5x PE too expensive for Companies

X

23


47%

23%

60%

42%

10%

12%5%

95%

33%

29%

1%

4%

4%34%

Microeconomics

Therefore, Russian companies are extremely underleveraged compared to their Western peers

* Cash includes Cash and Marketable Securities, Debt includes Short- and Long-term Debt

Common-size balance sheet* as of January 1, 2001

Assets (%)

Equity & Liabilities

(%) Equity

Debt

Cash

Equity

Fixed Assets

Other Assets

Fixed Assets Other Assets

A/P

DebtA/R

A/P

A/R

CashSurgutneftegas Exxon Mobil

24


Access to capital markets means that there will no more need for Russian companies to hold such piles of cash

Upcoming debt issue issues in 2002

Sibneft, Debt, US$250 m

Gazprom, Debt, US$700 m

Magnitogorsk Steel, Debt, US$150 m

Alrosa, Debt, US$500 m

TNK, Debt, US$500 m

Russian Federation, Debt, US$2,000 m

Lukoil, Convertible, US$300 m

Tatneft, Debt, US$200 m

Debt issues in 2001

Yukos, Convertible, US$250 m

MTS, Debt, US$250 m

Rosneft, Debt, US$150 m

Sibneft, Debt, US$175 m

Tatneft, Debt, US$325 m

Source: Brunswick Warburg, January 2002

Total = US$1.2 Billion

Total = US$4.7 Billion

Greater dividends in future

25


Source: Troika Dialog, Brunswick Warburg, Renaissance Capital, Aton, January 20, 2002

Price/Earnings Ratio, 2002E (as of January 20, 2002)

5.86.6

4.9

2.9

4.8

2.0

18.9

5.4

0

5

10

15

20

25

Lu

koi

l

Su

rgu

tNG

Yu

kos

Sib

nef

t

Tat

nef

t

Gaz

pro

m

Sb

erb

ank

Un

ifie

dE

ner

gy

P/E

MicroeconomicsIn spite of growing dividends in future, Russian stocks are still cheap

26

HERMITAGE CAPITAL MANAGEMENTRisks to Russia’s Re-rating

Global Financial Markets Meltdown

Collapse of Oil Price

Loss of Putin / Government Crisis

Refinancing Crisis in 2003

What are the major risks to Russia’s re-rating?

Re-rating of Russia

27


1.50%

2.50%3.50%

4.50%

5.50%

0.0%

2.0%

4.0%

6.0%

30 25 20 15 10Oil Price (US$ per barrel)

-0.7%

0.0%

1.2%

2.3%

4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

30 25 20 15 10

Oil Price (US$ per barrel)

Risks: Collapse of Oil Price

Fiscal Surplus (% of GDP)

Source: Goldman Sachs, October 2001

Although oil generates important tax revenues for the government, the budget will only go into deficit at below US$15 per barrel

And economy will grow in almost any oil price scenario

GDP Growth (%)

Break-even

28


13.6

11.610.8

9.6 9.7

11.1

7.2

5.4

7.86.9

5.6

10.29.4

8.7

7.3 6.9

8.8

11.6

-

2

4

6

8

10

12

14

16

Tatneft LUKoil SurgutNG Yukos Sibneft Average

Break-even (domestic) Break-even (export) Average Break-even

US$ per

Barrel

Source: Alfa Bank, January 2002

Russian companies should be profitable even if oil price is US$15 per barrel

Break-even for Russian Oil Companies (US$ per Barrel)


29


Over the last 10 years oil price has never traded below US$15 per barrel for more than 14 months

0

5

10

15

20

25

30

35

April-91 April-93 April-95 April-97 April-99 April-01

US$ per

barrel

Source: Reuters, Morgan Stanley, December 2001

Oil Price (Brent, US$ per barrel)

Break-even for Russian

budget

Median Price (US$ 19

per barrel)

Break-even for Russian oil companies


30


73%

0%

20%

40%

60%

80%

100%

Approveactionsof Putin

% of Respondents

Public Support for Putin

Latest rating by ROMIR, December 2001

Risks: Loss of Putin

Source: ROMIR, December 2001

Putin is the most likely winner of the next presidential election in 2004

48 49

5557

60

69

75

30

40

50

60

70

80

Blair Putin Bush Schroeder Koizumi Chirac Zemin

Years

Age of World Leaders

UK Russia USA Germany Japan France China

31

HERMITAGE CAPITAL MANAGEMENTRisks: Refinancing Crisis in 2003Russia reduced the outstanding sovereign debt due in 2003 by US$5 Billion

12.014.2

12.114.0

36.7

3.2

19.0

0

5

10

15

20

25

30

35

40

2001 2002 2003 2004 2005 2007 2008

US$ Billion

Debt Repayment (US$ Billion)

Reserves of Russia (US$ Billion)

vs.

Central Bank

Reserves

Reserves of Russian

Government

Buyback and early repayment to IMF

14.0

X

Sources: Alfa-Bank, Troika Dialogue, January 2002

32

HERMITAGE CAPITAL MANAGEMENTRisks: Global Markets MeltdownRussian equities correlate strongly with global markets only in time of extreme volatility (long-term correlation* over last 6 months is 45%)

60

80

100

120

140

160

180

August-01 September-01 September-01 October-01 November-01 December-01 December-01 January-02

%

Source: Reuters, Bloomberg January 23, 2001

* Correlation between RTS Index and Dow Jones Industrial

** Correlation between RTS Index and Dow Jones Industrial is calculated for the following periods - Sept. 3 - Oct. 1, 2001 and Dec. 23 - Jan. 23, 2001

Russia vs. Global Markets

RTS Index

Nasdaq

Dow Jones

DAX

Correlation =83%** Correlation = -50%

“September 11”Value of indices is rebased

to 100 on August 15, 2001

33

HERMITAGE CAPITAL MANAGEMENTRisks: Summary

Global Financial Markets Meltdown

Long-term Collapse of Oil Price

Loss of Putin / Government Crisis

Refinancing Crisis in 2003

Only dramatic and long-term fall of oil price (for more than a year) presents a major danger to Russia’s fundamentals. Russia has enough momentum and reserves to survive a short-term fall in price of oil

Risk Probability of event

LOW

?

VERY LOW

VERY LOW

The only real risks are

global

34

HERMITAGE CAPITAL MANAGEMENTHermitage’s Investment Approach

• In-house data-driven research

• Small number of large positions

• Regular and frequent visits to portfolio companies

• Shareholder activism (Board representation, Russian courts, publicity)

• Work with the government, Russian SEC and other shareholders to fight corruption

• Long-term investments vs. short term-trading

• No use of leverage

• Ignoring advice from sell-side analysts and stockbrokers

35

HERMITAGE CAPITAL MANAGEMENTCase Studies

GazpromSberbank Unified Energy

Hermitage

36

HERMITAGE CAPITAL MANAGEMENTCase Study: Sberbank

Very Cheap Valuations

Very Negative Market Perception New Law as a Trigger

P/E of 1.5 P/BV of 0.5

Bad management

History of dilutions

On-going threat of a new dilution

Preemptive rights on shares issue in new Law on January 1, 2002

Shareholders Activism

• EGM to fire CEO

• Lawsuit

• Publicity

• Board appointment

SBERBANK

What do you need for a share price to triple?

37


P/E (2001)20.0 19.5 19.3 18.4 17.3 16.9

13.6 12.911.1 10.9

9.6 8.4 7.65.3

1.5

26.5

0

5

10

15

20

25

30

Cesk

aS

po

rit

eln

a

(Czech

)

UB

S A

G

JP

Mo

rg

an

Ch

aS

E

Isb

an

k

(Tu

rk

ey

)

Ro

ya

l B

an

k

of

Sco

tla

nd

Cit

igro

up

HS

BC

Ho

ldin

gs

Deu

tch

e B

an

k

Ba

rcla

ys

Plc

So

cie

te

Gen

era

le

Fir

stR

an

d

(S.A

frik

a)

Pek

ao

(Po

lan

d)

OT

P

(Hu

ng

ary

)

Ko

mercn

iBa

nk

a

(Czech

)

CIB

(E

gy

pt)

Sb

erb

an

k

P/BV (2001)2.7 2.62.4 2.3 2.3

2.0 1.9 1.8 1.8 1.7 1.6 1.5 1.4 1.4

0.5

3.2

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Cit

igro

up

Ba

rcla

ys

Plc

HS

BC

Ho

ldin

gs

UB

S A

G

Ro

ya

l B

an

k

of

Sco

tla

nd

Fir

stR

an

d

(S.A

frik

a)

OT

P

(Hu

ng

ary

)

So

cie

te

Gen

era

le

Isb

an

k

(Tu

rk

ey

)

JP

Mo

rg

an

Ch

aS

E

Cesk

aS

po

rit

eln

a

(Czech

)

Deu

tch

e B

an

k

Pek

ao

(Po

lan

d)

Ko

mercn

iBa

nk

a

(Czech

)

CIB

(E

gy

pt)

Sb

erb

an

k

Very Cheap Valuations at the time of dilution

of Major World Banks

of Major World Banks

Source:: Morgan Stanley, Troika Dialogue, December 2000

38


In December 2000, Sberbank announced it wanted to sell 68% discount to book value in a new issue without granting rights to existing investors

Source: Central Bank web-site, January 2001

Case Study: Sberbank

-

5

10

15

20

Number of shares,

million

Central Bank 61.8%

26.3%to be sold

Others 4.9%

Investment companies 21.4%

Central Bank45.5%

Investment companies 15.8%

226,000individuals 11.9%

226,000individuals 8.8%

Others 3.6%

36% capital increase

14,002,000

19,000,0004,998,000 New shares will be sold for approx. $173 mln

Before New Issue

Proposed New Issue

39


The equity analysts hated the stock:

• “The issuance underscores the management’s short-sightedness and illustrates its total disregard for shareholder value. We recommend that investors who do not hold Sberbank look elsewhere in the Russian equity market for more attractive opportunities ”, Kim Iskyan, Renaissance Capital, January 30, 2001

• “While the bank is fundamentally undervalued, we believe that negative perceptions about unfair treatment of minority shareholders and the possible dilution of their stake should keep the share price depressed. We have downgraded our recommendation to Neutral”, Andrei Ivanov, Troika Dialog, January 24, 2001

40


Organized Shareholders• Combined efforts with minority shareholders owning 10% of share capital to call EGM to oust CEO

Kazmin and change charter of the company

Legal actions• Filed a lawsuit to uphold EGM• Filed a lawsuit against Central Bank to annul registration of new issue and against Sberbank to cancel

Supervisory Board decision on the new issue• Filed appeals with the Moscow Arbitration Court

Public Relations Campaign• Organized a PR campaign against new issue in Russian and Western media: more than 70 articles

appeared during 2001 in Financial Times, Wall Street Journal, Bloomberg, Reuters, Moscow Times, Kommersant, Economist

Board of Directors• Gained support from minority shareholders and became a member of the Board of Directors after an

election fight

What Hermitage did to stop the dilutive issue:

41

HERMITAGE CAPITAL MANAGEMENTCase Study: SberbankThe Sberbank fight highlighted dilution problems, which helped create a new law guaranteeing proportional rights in all new share issues

As of January 1, 2001 any new issue now has to be sold pro-rata to existing shareholders

Distribution of ownership

New Issue

Central Bank Central Bank

Sources: Alfa-Bank, Troika Dialogue, January 2002

Foreign Investors Foreign

Investors

Local InvestorsLocal Investors

42


10

20

30

40

50

60

70

80

90

100

May-9

9

July-9

9

Septe

mber

-99

November

-99

January-0

0

Marc

h-00

May-0

0

July-0

0

Septe

mber

-00

November

-00

January-0

1

Marc

h-01

May-0

1

July-0

1

Septe

mber

-01

November

-01

January-0

2

US$ per

share

Case Study: Sberbank

Source: RTS

- Medium-term downtrend - The stock gets “very boring”

Sberbank dilutes minority shareholders

Since Sept. 25th Sberbank’s share price tripled (!)

Market starts to realize that Sberbank can not issue new shares without granting pre-emptive rights to shareholders

Hermitage fights Sberbank and puts member on board to block future issues

Sberbank’s share price (US$)

2 equity analysts issue BUY recommendations for the first time

+350% return (%) since May 1999

43

HERMITAGE CAPITAL MANAGEMENTCase Study: Unified Energy

Bad Restructuring Plan

Very Negative Market Sentiment New Restructuring Plan as a Trigger

Management wanted to give away company

assets to local oligarchs

Share prices loses 66% of its value after announcement of its restructuring plan

No asset sales

Shareholders Activism

Lobbying Government to stop asset sale

UNIFIED ENERGY

What do you need for a share price to rise by 145%?

Proportional distribution of assets

Board oversight

A major PR campaign

Formulation of a new restructuring plan

44


Bad restructuring plan

Unified Energy Systems

72 Regional

Power Company

24 Thermal

Power Stations

11 Hydro Power

Stations

Oligarchs Management of UES

Local Governors

Friends

Liquidation sale of all assets via

non-transparent Regional Auctions

Electricity Grid

45

HERMITAGE CAPITAL MANAGEMENTCase Study: Unified EnergyNegative market sentiment: Share price drops by 66% after UES announced its restructuring plan

0.00

0.04

0.08

0.12

0.16

0.20

0.24

November-99 February-00 May-00 August-00 November-00

US$ per

share

- 66%

UES’ announcement

Share Price of UES (US$)

46


Shareholder Activism

• Call for EGM to fire Chubais and change charter of UES

• Investor letter to Putin and PR campaign with all international media

• Alternative restructuring plan by Hermitage and Government Officials

New Restructuring Plan

• Convinced the Presidential Administration to change the charter

• The new restructuring plan fixed a bad management plan and eventually was approved by Putin on July 11, 2001

C

Shareholder activism to improve the restructuring plan

Outsiders Shareholders

Old Plan New Plan

Sales Pro-rata distribution

C

C

47


Market changes its sentiment towards UES a result of new restructuring plan

Share Price of UES (US$)

0.06

0.08

0.10

0.12

0.14

0.16

0.18

January-01 April-01 July-01 October-01 January-02

US$ per

share+ 146%

"September 11"

Government signs a revised restructuring plan

Kress Group issues alternative plan

Putin sets up a Group on Restructuring of Energy Sector ("Kress"Group) for alternative plan

Source: RTS

48

HERMITAGE CAPITAL MANAGEMENTCase Study: Gazprom

Very Cheap Valuation

Huge Difference between Perception and Reality

Resolution of Situation

Market assumes 99% theft

TRIGGER

Disclosure of asset theft

Gazprom

Call for external fraud Audit

Analysis suggest 9% theft

25% of world’s natural gas reserves for US$13.8 Billion

Government reclaimes lost assets

What do you need for a share price to go up tenfold?

US$0.12 per barrel of reserve

Government fires CEO

2001E P/E

49


Market Capitalization on reserves (US$/boe)

12.2

10.79.8

8.8 8.5 8.4 8.2 7.9 7.6

4.53.6

2.3 1.9 1.71.1 1.1 0.8 0.8

0.2 0.10

2

4

6

8

10

12

14

Market Capitalization on production (US$/boe)

164

138 137

124 122 119 114109

93

5243 39 38 37 35

29 2819

7 4

0

20

40

60

80

100

120

140

160

180

Gazprom is the cheapest oil and gas company in the world because market believes that 99% of its assets are stolen

Case Study: Gazprom

50


What exactly was stolen from Gazprom?

Case Study: Gazprom

G a z p ro m

C om p an y D ate % los tR es erv es ,tr illion cf

R es erv es ,b oe

% o f to ta lG a zp ro mre se rve s

P u rga s 1 9 9 8 -1 9 9 9 8 1 % 1 3 .4 2 .4 1 .2 5 %

R o s p a n 1 9 9 7 -2 0 0 1 5 1 % 1 7 .4 3 .1 1 .6 2 %

Ta rko s a le n e fte gas 1 9 9 7 -2 0 0 1 3 8 % 1 4 .2 2 .5 1 .3 3 %

S ib n e ftegas 1 9 9 9 3 5 % 11 .1 2 .0 1 .0 4 %

A c h im n e ftega s 2 0 0 0 4 9 % 1 2 .5 2 .2 1 .1 6 %

V o s to kga s 1 9 9 9 4 9 % 1 0 .6 1 .9 0 .9 8 %

S e ve rn e ftega s p ro m2 0 0 0 -2 0 0 1 8 9 % 2 4 .3 4 .3 2 .2 6 %

T otal 1 9 9 7 -2 0 0 1 103 .5 18 .4 9 .65%

51


0%

20%

40%

60%

80%

100%

_______Perception versus Reality_______

Case Study: Gazprom

Market Perception Hermitage’s Analysis

99% Stolen Assets

9.65% Stolen Assets

90.35% Assets in place

vs.

1% Assets in place

52


What Hermitage did to unlock the value of Gazprom:

Case Study: Gazprom

Research• Hermitage was the first financial institution to research and make public numerous examples of

asset stripping at Zapsibgasprom, Purgas, Rospan, Sibneftegas, Tarkosaleneftegas, Sibur and Vostokgas

Public Relations• Organized a PR campaign with all international media: more than 200 articles appeared from

October 15, 2000 to August 30, 2001 in Financial Times, Wall Street Journal, New York Times, Business Week, Vedomosti, Reuters, Kommersant, Washington Post, Business Week and Bloomberg, exposing all the asset stripping

EBRD• Presented finding of research to Jean Lemierre at the EBRD, who then declined to lend US$250

million to Gazrpom unless it disclosed relationship with Itera and Stroytransgaz

Appealed to Market Regulators• Together with other minority shareholders filed complaints with the Russian Federal Securities

Market Commission

Organized Shareholders to demand independent audit of the asset strippingtransactions• Combined efforts with UFG and other minority shareholders with a total stake of 10% and

demanded an independent audit of Gazprom by Deloitte & Touche.

53

HERMITAGE CAPITAL MANAGEMENTCase Study: Gazprom

+140%

Gazprom has started its way to US$6 per share

Gazprom Share Price

0.05

0.15

0.25

0.35

0.45

0.55

0.65

Oct-00 Nov-00 Jan-01 Mar-01 Apr-01 Jun-01 Aug-01 Sep-01 Nov-01 Jan-02

US $ per share

"The FT has learned of one case in which Gazprom has been awarding large contracts to a company which is majority owned by the relatives of Gazprom's … management" Financial Times

"Gazprom has sold shares at below market prices, ... to Stroytransgaz, … a company, majority owned by Gazprom managers and their relatives" Business Week

"In the past two years, Gazprom has quietly shuffled roughly two trillion cubic meters of gas reserves into ventures … owned by Itera" Wall Street Journal

“Gazprom … has transferred hundreds of millions of dollars in assets while signing … deals with a firm largely owned by Gazprom’s directors …” Washington Post

Resignation of Gazprom CEOVyakhirev

10% shareholders of Gazprom demand independent Audit of Gazprom

New CEO Miller succeeds in getting back Purgaz

54

HERMITAGE CAPITAL MANAGEMENTHermitage Performance

Since inception

1 Year 2 Years 3 Years 4 Years 5 Years

Hermitage Fund

CSFB ROS Index

80% 57% 502% -28% 62%

57% 17% 350% -14% 13%

355%

161%

-200%

-100%

0%

100%

200%

300%

400%

500%

600%

700%

800%

900%

April-96 April-97 April-98 April-99 April-00 April-01

%

Performance of Hermitage Fund vs. CSFB ROS Index

Hermitage

CSFB ROS Index

Total Return*

* Total returns for each period are calculated using the last bid as of January 18, 2001

55


* Since inception

2001 80.55% 61.13%

December 11.60% 11.44%November 13.16% 14.11%October 7.09% 9.85%September -9.90% -14.68%August 0.02% 1.63%July -3.86% -7.12%June 11.80% 5.41%May 7.11% 11.04%April 10.71% 7.38%March 5.79% 4.96%February -8.39% -13.54%January 19.94% 24.50%

2000 -4.87% -25.89%1999 195.95% 212.85%1998 -88.63% -82.64%1997 228.21% 103.77%1996 119.19% 78.94

Total Return

*

56


Source: Nelson’s Investment Management Database

43.3%

31.8%

20.9%

15.3% 14.5% 14.2%11.7%

9.6% 9.6% 9.5% 8.7%5.8% 5.0% 4.4% 3.7% 2.8% 2.5% 2.5% 2.2% 1.9%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Hermitage Fund has outperformed all other emerging market funds in the world over the last 5 years ending March 31, 2001

% Annualized

Return

Annualized performance of emerging markets funds

57

HERMITAGE CAPITAL MANAGEMENTHermitage

Cash1%

ADRs58%

2nd & 3rd Tier9%

Other "Blue Chips"

5%

Local Shares27%

Financials10%

Electric Utilities

18%

Misc.1%

Telecom1%

Gas17%

Oil53%

Composition of Portfolio*

Fund Strategy Sector Allocation

* As of December 31, 2001

58


Disclaimer

This material is for information purposes only and is not an invitation to subscribe for units or shares in the Hermitage Fund. Subscriptions will only be received and units or shares issued on the basis of the current prospectus for the Fund, and prospective investors should carefully consider the risk warnings and disclosures for the Fund set out therein. Investors should also consider any other factors that may be relevant to their circumstances, including tax considerations, before making an investment.

The information is based on data obtained from publicly available sources, which have not been verified by Hermitage Capital Management Limited, or any of its respective associates or affiliates. As a result of the difficulty in obtaining reliable data in Russia, we do not represent this information to be accurate and complete and we do not accept any responsibility for the reasonableness of any conclusions based upon such information.

Past performance is not necessarily indicative of the likely future performance of an investment. The price of units or shares can go down as well as up and may be affected by changes in rates of exchange.

The Hermitage Fund has been authorised by the Guernsey Financial Services Commission as a Class B Collective Investment Scheme under the Protection of Investors (Bailiwick of Guernsey) Law 1987 and the Collective Investment Schemes (Class B) Rules 1990. It must be understood that in giving this authorisation the Commission does not vouch for the financial soundness or correctness of any of the statements made or opinions expressed with regard to The Hermitage Fund. Investors in The Hermitage Fund are not eligible for the payment of any compensation under the Collective Investment Schemes (Compensation of Investors) Rules 1998 made under the Law.

HERMITAGE CAPITAL MANAGEMENT The Re-Rating of Russia

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