My awareness of what was happening in regard to privatization in Eastern Europe came through the strangest of conversations and relationships. When I was 23 years old, I opened a musical instrument shop in Morecambe (which I still have today) and I had a wonderful guy running it for me called Keith Harris.
Keith taught me so much about the retail business and I class him as a mentor. He worked for me for nearly twenty-five years [until his retirement] and knew every trick in the book when it came to musical instrument retailing. He’s smart, quick, well read, and was always up for a deal. As a fledgling business, Keith worked hard to buy right and here was our chance to buy – exactly the same goods as we were buying from the UK distributors – but at a better price.
Keith forged relationships with UK companies and discovered a guy in Los Angeles called George, who could help us become more profitable. Although based in the USA, George was the Eastern European musical instrument and accessory distributor for many of the brands we were selling and often talked about supplying to Hungary, Poland, Bulgaria, Romania, and – his family homeland – the Czech Republic.
Around the very early 90’s, I called George one day (he wasn’t in the office) and I ended up speaking to guy called Jaromir Strizka, the founder and owner of the music distribution company European Crafts. I got on famously with Jaromir and spent many evenings talking about business, our families, his love for athletics, and how he moved to the US when he was in his mid-30’s, because of the political problems with the Communist Party in Czechoslovakia.
Jaromir loved business, loved people, and was very kind with his time. One day he mentioned that George was over in Eastern Europe on European Crafts business but also looking in to the “privatization programme” that had started to effect businesses there. He told me what he knew about what was happening with the privatization programme and it sounded fascinating. Over the next ten or so years, I spoke with Jaromir regularly, and to this day, I’m still not sure if George was his son, a nephew, or a colleague.
Privatization in Eastern Europe
What happened after that original conversation with Jaromir was I saw some of the best performing emerging market funds in the world, which were created out of former state owned enterprises in Eastern Europe. Shortly after the Berlin Wall came down and the Velvet Revolution had happened in Czechoslovakia [now known as the countries of the Czech Republic and Slovakia], the early smart money – like Jaromir predicted – moved into investments in Eastern Europe.
What we didn’t know at the time was that most of Eastern Europe would follow quite quickly. Many of the workers in these Eastern European companies were living in decaying concrete soviet style block buildings and were facing high inflation and food shortages. Life wasn’t good for them at work either and they were more insecure than ever before.
Compared to Western companies, most Eastern European enterprises were massively behind the times in terms of product design, production methods, and business structure. Many didn’t understand how to do business – like the west did – because they had never had to in the same way.
Rather than former state money and subsidies that went with the territory of running a state owned enterprise, the World Bank was now involved in helping former state owned enterprises to find a new direction and bring in new investors. For some Eastern European enterprises after privatization, their local government carried on buying from them just as before, but the profits were now leaving the company, and often leaving the country.
What some newly privatised companies had was: valuable land, plant, great machinery, highly skilled workforce, low price to earnings ratio, and a low debt to equity ratio. Some companies were being sold for £1 of share price to 50p of yearly profit, and some were sold at £1 of share price to £2 of yearly profit. Therefore, if you bought a share in one of these companies – with all of their assets – you would get your original investment back in six months… which is crazy!.
Nowadays, that would sound too good to be true, but that’s how it was! People simply chose which business they wanted to invest in from the newspaper, exchanged their currency, went to the post office to fill in the privatization form, and everything was done and you were an owner.
Privatization in Russia
By 1993, many investors were turning their interest to the former Soviet Union where the companies there were either as cheap as Eastern European ones, or even cheaper because of the way privatization was being conducted. Former Soviet companies seem to have had much better quality assets [plant, machinery, etc.] than many eastern European countries and the condition of those assets was exemplary in some cases.
The Russian privatization programme was quite bizarre because the government gave almost one-third of its companies (and their assets) to its 150 million citizens, through a voucher privatization system where everyone got one voucher. The voucher exchanged hands for various amounts, but the average was around £11 per voucher.
Therefore, 30% of all Russian companies and their assets were only valued at £1.65 billion. That’s 150 million vouchers x £11 [the average value of each voucher]. I think what needs to be remembered is for 30% of a country that had around 25% of the World’s gas and 10% of the World’s oil. The whole lot was therefore being valued – or should I say, undervalued – at around £5.5 billion.
There wasn’t a stock exchange as such in Moscow at the time. Once the vouchers had been released, anyone from anywhere could buy them. To buy shares in Russian companies, all you needed to do was, exchange your £ sterling in to US $ (because that’s the currency they wanted). Turn up in Moscow and go to the old voucher exchange hall, which was close to the former State Department Store called GUM – the building that faces Red Square – that is like the Harrods of Russia.
Once in the hall – which was like a smoky British working men’s club in the 1970’s – you waited for voucher traders, who sat at tables, to declare that they had vouchers to sell. They said how many vouchers they had, the price they wanted, and you then decided whether to buy or not. It was all cash and the place was either packed, or empty, depending on supply, demand, and the price being charged.
Although vouchers were around £11 on average, they were often sold for less, or more. The most important thing for a westerner was to have a Russian translator… and if buying vast amounts of vouchers, they also needed an armed guard because there wasn’t any security in the exchange hall, or outside for that matter.
Now the bizarre bit about the privatization voucher scheme was the process of investing them in Russian companies. It was done through a kind of auction sale with a difference. These auction sales were widely advertised and anyone – in theory – could turn up to them. Although you knew which companies were coming up at the auction sale, you had absolutely no idea how much of the company you would be buying until the auction was over.
So here’s the bizarre bit and how some people got rich beyond belief. If there were only 10 people at the auction sale, with 1 voucher each (valued at £11 per voucher), the whole company was valued and sold for £110 [10 people x 1 voucher each x £11 per voucher = £110]. On the flip side, if there were 1,000 people at the auction sale, with 1,000 vouchers each (valued at £11 per voucher), the whole company was valued and sold for £11 million [1,000 people x 1,000 vouchers x £11 each = £11 million]
As you can probably see, if you were the only person who ‘knew about the auction sale’, you could end up a billionaire. [I’m sure you can read between the lines of what I’m saying]. I ‘believe’ that some people were even prevented from going to auction sales through various tactics to stop them.
Finally, whatever people say, Russia in the past has been a dangerous place to do business. For any students out there reading this, all you have to do is put the names Michael Calvey and Philippe Delpal in to google and have a read.
Written March 2010