Moscow - In August, Russian President Vladimir Putin flew to the Black Sea resort of Sochi, where his country is spending a record $48 billion (R480bn) on the 2014 Winter Olympics. A regular visitor with an official residence in town, Putin watched mixed martial arts contests at a nightclub.
After the first fight, the venue was suddenly plunged into darkness for almost three minutes – a taste of the blackouts that have plagued Sochi for years. Putin, poker faced when the power returned, strode into the ring to congratulate the fighters as the tournament concluded.
“Here in Russia, we have always valued and respected men who know how to stand firm to the last,” he said.
Putin is bracing for a fight of his own in the mad rush to the February 7 opening ceremony. With concerns about terrorist attacks, lack of snow and anti-gay laws dominating headlines, Sochi has endured its share of pre-Olympics tension.
Yet another, potentially longer-lasting, battle is playing out behind the scenes involving Putin’s government, some of Russia’s wealthiest industrialists and a state-owned bank. The government is demanding that the country’s biggest companies stand firm on commitments to bankroll the games.
To finance venues and accommodation in the Caucasus mountains and along Sochi’s coast, state-owned Vnesheconombank, known as VEB, lent $7.4bn to the who’s who of Russia’s elite.
Among the biggest loan recipients were companies controlled by Vladimir Potanin, the chief executive of Norilsk Nickel, the world’s largest nickel producer. Other chief executives to receive loans were Oleg Deripaska of United Company Rusal, the world’s largest aluminium company; Alexey Miller of state-controlled gas provider Gazprom; and German Gref of Sberbank, Russia’s largest bank.
The moguls say sky-rocketing costs and restrictions on commercial activities mean they risk losses on their investments unless the government helps. They want extended tax breaks and subsidies on the interest payments they owe VEB for Sochi assets.
Putin is staking Russia’s image – and his legacy – on his pet Olympics project. He was scheduled to fly to Sochi yesterday for three days to check on construction projects.
Sochi 2014 might as well be renamed Putin 2014, says Scott Antel, a partner at DLA Piper in Moscow, who has worked on hotel projects in the region. Antel says Putin twisted billionaires’ arms to get the Olympics off the ground in return for letting their companies continue to run as quasi-monopolies.
“This was a deal with the devil,” Antel says.
He expressed the deal as: “You will do your civic duty and build facilities in Sochi so we can have this coming-out party for the new Russian state. This is your indirect taxation to be allowed to continue with your main business activity.”
Deputy Prime Minister Dmitry Kozak, the country’s top Olympics official, dismisses suggestions of coercion. Kozak, who has worked with Putin for two decades, dating back to the St Petersburg city administration, says investors got good deals – from favourable rates to government-built roads.
“All investors were invited to the project voluntarily,” Kozak says.
Investors will have to forfeit Sochi projects if they cannot repay their loans.
“If they default, then they will lose their equity and lose their [Olympic] business,” Kozak says. “The shares will be sold at auction.”
The Winter Games have already proved a gamble for Putin. Russia’s economic growth is set to slow to 1.5 percent this year, just as Sochi soaks up the single biggest infrastructure investment since the Soviet Union collapsed in 1991.
“It’s the single most important event for Putin’s presidency,” says Chris Weafer, a partner at Moscow-based consultancy Macro Advisory. “If it is deemed to be a failure, there will be a focus on the cost.”
The reason Sochi’s price tag has quadrupled from Putin’s original $12bn estimate depends on whom you ask. Boris Nemtsov, who ran unsuccessfully for mayor of Sochi in 2009, says as much as $30bn has disappeared through corruption, a charge Kozak denies.
Locals blame inflated prices for labour and materials.
Putin has unleashed the unparalleled spending to try to transform Sochi, a fading resort city 1 610km south of Moscow with pebble beaches and mountain views, into a year-round destination.
The spa region favoured by Soviet-era leaders now has about 12 000 new hotel rooms. Near the Olympic stadium, apartment blocks dot the seashore. In the mountains, white-knuckle chairlifts have been replaced with modern equipment to lure Russian skiers from their beloved French resort of Courchevel.
Backers are betting that nightclubs and malls will turn sleepy Caucasus villages into hot spots. The priciest project: government-owned Russian Railways built an $8.7bn rail line and highway to provide a 48km, 30-minute link between ski sites around Krasnaya Polyana and Adler on the coast.
Russian Railways chief executive Vladimir Yakunin, a close associate of Putin, says the government ordered him to construct the road even after the transport ministry concluded the project was too difficult. “I was very reluctant,” Yakunin says. “They decided we were a sacrificial goat.”
If the hoped-for influx of post-Olympics tourists does not materialise, Putin’s government may end up with heavily indebted ghost towns around Adler and Krasnaya Polyana.
“There’s massive infrastructure, and there’s no plan to attract business,” Weafer says.
Basic Element, the holding company of Rusal chief Deripaska, has made one of the biggest private investments. It oversees Sochi projects worth $2.4bn, using about $1bn of loans from VEB. Among them are a $778 million Olympic athletes village on the coast; a $186m cargo port that Deripaska wants to turn into a yacht marina; and a $440m overhaul of Sochi International Airport – with a VIP terminal just for Putin.
Deripaska’s Olympics headaches mounted in October 2012, when his Port Sochi Imeretensky defaulted on a VEB loan of about $118m. In one of a flurry of Olympics-related lawsuits, the port company sued Olympstroy, the state firm building most venues, in April and VEB in May.
Deripaska’s company claimed that just 20 percent of the planned 14 million tons of Olympic cargo had been shipped via sea since 2010. Without sufficient cargo, the port has been unable to keep up with loan payments. In October, VEB countersued the port company and Olympstroy for about $150m.
Andrey Elinson, the deputy chief executive of Basic Element, says the government invited the company to build a port to get Olympics-related goods into Sochi. Basic Element would never have pursued it without Olympstroy’s outlining minimum expectations.
“We’re in a bit of a disagreement with the government,” he says. “They have pushed more cargo through railways and invested in extending railway cargo capacity while the port was underloaded.”
The government made no promises, Kozak says.
“No one guaranteed a flow of goods,” he says. “Neither Olympstroy nor anyone else forced Oleg Deripaska to build the port.”
For his part, Russian Railways’ Yakunin says the port was not up to the Olympics task, hence the doubling in the cargo shipped via rail.
Other projects are burdened with debt and scant cash flow after delays in turning them into commercial businesses. Basic Element in 2011 counted on pre-selling some of the 1 500 apartments it built in the coastal Olympic Village, where palm trees from Italy adorn courtyards with pools. The company plans to turn the complex into a resort and market it as a Russian Cote d’Azur.
VEB wouldn’t allow apartments to be sold early, Elinson says. Deripaska’s companies must start repaying the principal of a $687m loan next year and are trying to renegotiate, he says.
“The government has to forgive the interest payments for a certain amount of the loan lifetime,” Elinson says. “We’re also discussing the cancellation of property taxes.”
VEB is caught in the middle. After Putin’s government tapped the bank to lend billions to finance the Olympics and rescue companies amid the financial crisis, VEB’s capital adequacy ratio approached 10 percent in July, nearing the minimum allowed under the bank’s internal requirements.
If investors default and VEB can’t quickly sell the assets to cover the loan, its capital could take a further hit.
“In the case of default, the Olympic projects will form a big hole in the balance sheet,” VEB deputy chairman Sergey Vasiliev says.
Potanin, Russia’s ninth-richest man, is bleeding money in Rosa Khutor, which will host skiing and snowboarding events. Potanin and Putin hatched the idea for Rosa Khutor in 2002, when they were skiing in Austria.
Potanin originally planned to spend about $300m. After Russia’s successful games bid in 2007, his costs soared to $2.6bn, including interest, as he made the resort Olympic class. He financed the upgrades with a $1.7bn loan from VEB, which has grown to $2.2bn with interest. Repayments on the principal must begin next June.
Rosa Khutor assumed about $500m of non-commercial expenses for facilities and equipment that Potanin says he wouldn’t have added without the games. He has erected apartments for 2 600 athletes in the mountains and stockpiled snow.
He says the government indicated last year it would be willing to reimburse about $245m, or half of the costs required by the games, but he hasn’t received anything yet. He’s negotiating for tax breaks and restructured debt payments. VEB rates, currently at about 9 percent, have dented cash flow.
“Nowhere in the world are green field projects like this one financed at such high interest rates,” he says.
Deripaska and Potanin are just two investors seeking government relief. Gazprom is spending about $3bn on projects, including a power station in Adler, a gas pipeline and a cross-country and biathlon complex, according to Olympstroy.
Sberbank took over construction of the $2.4bn Gornaya Karusel mountain resort in Krasnaya Polyana.
Gazprom’s Miller and Sberbank’s Gref joined Potanin and Deripaska in writing a letter in March to the deputy prime minister. They demanded subsidies for interest payments on loans and asked that Sochi become a special economic zone with lower property tax rates.
“Our companies agreed to participate in investing in Olympic venues, taking into consideration the social nature of the project,” they wrote. “At the same time, Sberbank, Gazprom, Rusal and Norilsk Nickel are public commercial companies, the aim of which is to increase returns for their shareholders.”
The standoff continues.
In an indication of how pinched they are feeling, Potanin and Deripaska transferred some Sochi debts to Norilsk in April. Norilsk lent $140m to a company controlled by Deripaska, who leads Rusal, which owns a stake in the nickel producer. The loan can be repaid with stakes in Olympic Village assets. The company also took an undisclosed share of Rosa Khutor in exchange for about $140m of debt.
Kozak says investors must be prepared to repay. On most loans VEB charged just 0.4 percentage point above the Russian central bank rate, currently at 8.25 percent. Plus, the government had built infrastructure.
Kozak dismisses the notion of tax breaks: “We cannot give tax preferences to those we already supported and leave others on their own to face their debts.”
Elinson says Russian companies delivered venues on an accelerated time scale and need to recoup their investments.
“It’s not fair to treat us in a way that we should just leave the sites because we’re not able to repay the loans,” he says. “It was never intended to be a sponsorship idea.”
Whatever the original intent, Putin’s government and the ultrarich Olympic backers are likely to be contesting who’s on the hook for the most expensive Winter Games long after the final gold medal has been awarded. – Bloomberg