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31 March, 2017  ▪  Oleksandr Kramar

The big manger

Why public sector is the main source of corrupt wealth

As of October 2016, there were 3,447 state-owned companies of various sizes in Ukraine, with the total asset value of over UAH 1.5 trillion. They employed 862,000 people, or over 10% of all those officially employed in the commercial sector. By comparison, SCM group owned by oligarch Rinat Akhmetov, which remains Ukraine's largest private employer, has about 300,000 employees. A significant part of this workforce is located in the occupied parts of Donetsk and Luhansk oblasts.

A big problem is the ballast of enterprises that went out of business long ago. Out of the above mentioned 3,447 companies, only 1,789 were still operating as of the end of 2016. The rest are undergoing liquidation or bankruptcy procedures. For decades, they remain on the balances of dozens of different state bodies that have neither the resources nor the qualified personnel or expertise to carry out their liquidation effectively. However, state officials are often interested in using state property in the shadows (mainly, land plots or premises) to get considerable unaccounted income.

In the first nine months of 2016, public sector received UAH 38.2bn of net income. This means that the average annual profitability of public sector enterprises (ratio of net income to asset value) will not be higher than 3–3.5%. Only 1,112 companies (62% of all those still operating) generated profits in 2016. The rest are unprofitable, at least formally, and, therefore, depend on state subsidies.

Out of 89 active companies subordinate to the Ministry of Energy and Coal Industry of Ukraine and employing about 115,000 people, only 30 are profitable. Out of the hundred companies in Ukroboronprom, the association of Ukrainian defense industry enterprises that employ 78,200 people, only 58 are profitable. Out of 75 companies managed by the State Property Fund (SPF), only 30 are profitable.

Public sector anatomy

A series of reports prepared by the Economy Ministry in 2015–2016 gives an idea of ​​the extensive network of state-owned companies in Ukraine. Earlier data are more comprehensive, although mostly based on the already outdated materials dating to 2013–2014. More recent data are increasingly scanty. While earlier reports were an attempt to consolidate and thoroughly analyze at least a hundred out of several thousands of state-owned enterprises (these account for the lion's share of assets and turnovers of the public sector in general), the latest 2015 reports that are currently available to the public deal with only a few dozen companies.

As of the end of 2014, the largest amounts of assets in Ukraine were held by state-owned energy sector companies, Naftogaz (the oil and gas operator) and Energoatom (the nuclear power sector operator), which, taken together, accounted for nearly 50% of the entire public sector at the time. Together with Ukrazaliznistya, or Ukrainian Railways, their share exceeded 61% of all assets. In 2015, the value of assets increased, primarily due to a serious revaluation carried out by Ukrainian Railways, which reduced its lag behind Naftogaz and Energoatom.

RELATED ARTICLE: Nuclear power sector in Ukraine: prospects and challenges

As of 2015, 94 major state-owned enterprises with the total assets amounting at that time to UAH 1,386.5bn, sold UAH 352.6bn worth of products. Their EBIDTA (earnings before interest, tax, depreciation and amortization) amounted to UAH 40.33bn (EBIDTA margin of 11.44%). In major companies owned by Rinat Akhmetov's empire these figures were UAH 149.2bn revenues and 11.2bn EBITDA for Metinvest; UAH 95.4bn and UAH 7.51bn, respectively, for DTEK; and UAH 6.77bn and 1.86bn for Ukrtelecom.

In this way, average EBIDTA margin of public companies was even higher than that of Akhmetov's SCM. By total revenues and EBITDA, top 94 largest public companies outweighed the largest private conglomerate of the country. However, first of all, the structures owned by the oligarch were motivated to understate their official profitability in order to minimize taxes, and secondly, various state-owned enterprises largely differ. While some of them had high profitability even officially, others were on the verge of bankruptcy. In some cases, good EBIDTA performance was offset by huge amortization and artificial understatement of expenses through underinvenstment, which is especially characteristic of infrastructure and energy assets, the most profitable in terms of EBIDTA in the public sector.

Frontrunners and outsiders

In the recent years, Ukrainian state enterprises operating in the transportation sector showed the most profits. In particular, EBITDA margin of Ukrainian Sea Ports Authority (USPA), established in 2013 and managing 13 small seaports, was 69.2% in 2014 and 78.8% in 2015. In 2015, they accounted for 35.2% of all cargo handling. USPA's net profitability in 2015 was 56.5%, against 37.8% in 2014. The country's largest port, Yuzhnyi, which in 2015 handled 33.6% of all cargoes, is only slightly less profitable. Its EBITDA margin increased from 47.6% in 2014 to 52.6% in 2015, however, in absolute terms the figure is rather modest: UAH 1.14bn, or less than USD 50mn. The best EBITDA to total revenues ratio in 2015 was demonstrated by the Odesa port: 105.3%, against 84.7% in 2014. But its overall performance and transshipment volumes were almost twice lower than those of Yuzhnyi port. EBITDA understatement in the ports of Odesa and Yuzhny is especially noticeable when compared to the Chornomorsky (formerly Ilichevsky) and Mariupol seaports which, with transshipment volumes 2–2.5 times lower than in Odesa port and 4–5 lower than in Yuzhnyi port, had almost the same EBITDA figures: UAH 0.73 and 0.8bn, respectively (with profitability of 44.5% and 80.8%, respectively).

State enterprises in air transportation sector are only slightly less profitable. Borispol airport, which in 2015 handled 68% of all Ukrainian air passenger traffic, had EBITDA of nearly UAH 2bn and EBITDA margin of 79.0%. Despite its smaller size, Lviv International Airport, the largest in Western Ukraine, is also financially interesting. Its EBITDA in 2015 was only UAH 76mn, but its EBITDA margin grew to 42.4%, against 28.6% in 2014. State Air Traffic Service Enterprise (UkSATSE) had EBIDTA margin of 31.5% in 2015, with its net profit reaching UAH 342mn.

Ukrainian Railways, however, due to artificially low cargo transportation tariffs and flourishing corruption, as Infrastructure Minister Vladimir Omelyan publicly stated, is trailing far behind in the sector. With the highest EBITDA of UAH 12.82bn in 2015, its profit margin was only 21.3%. At the same time, this company with 308,000 employees is a major employer in the public sector and a treasure trove for the young oligarchic Dubnevych family. Its modest EBITDA is offset by high depreciation costs and the need for renovation of its outdated fixed assets. The situation in the third largest (after Ukroboronprom) state-owned company by the number of employees, Ukrainian Post Office, is even more critical. Its EBITDA margin was only 4.3%, with only UAH 0.17bn (USD 8mn) turnover. At the same time, the company's numerous employees have the lowest wages in the country and in the public sector.

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Electric energy sector companies in 2015 almost doubled their EBITDA, which amounted to UAH 19bn, compared to last year. This was mainly owing to Energoatom, which accounted for UAH 14bn out of this figure. This company, as well as Ukrenergo (high-voltage power grids operator) and Hidroenergo (HPPs operator), have high EBITDA margin (41.6%, 68.8% and 60.5%, respectively), which has recently increased. However, companies playing the key role in ensuring stable electricity supply in the country require significant depreciation costs and capital investments that offset high EBITDA rates and suffer from price discrimination through their obviously underestimated tariffs.

The situation with Regional Electric Networks (REN) and Tsentrenergo, the operator of the last three state-owned thermal power plants, two of which run on scarce anthracite coal, is much worse. The former in 2015 had negative EBITDA (of over 2 billion), one of the highest in the public sector, while the latter had the EBITDA of only UAH 0.25bn, with EBITDA margin of 3.7%. While in the first case this is largely due to the still low service tariffs (apart from the corruption component traditional in the entire public sector), Tsentrenergo keeps appearing in corruption scandals that suggest large-scale abuse with inflated prices for fuel, works and materials purchased by the company and its business units.

As for the other SOEs, only Turboatom can boast of some profitability. In the recent years, this enterprise was also featured in corruption scandals in the media. However, its unique potential and the demand for its products both in Ukraine and in the world market creates the conditions for highly profitable operations. With sale volumes in 2015 amounting to UAH 2.73bn, the cost of production was only UAH 1.24bn, and EBITDA was UAH 1.8bn, which means the growth from 36.6% in 2014 to 65.1% in 2015. The company produces turbine equipment for thermal, nuclear and hydroelectric power plants, catering for more than 10% of the world market demand for nuclear power plant turbines. In Ukraine, 40% of thermal, 85% of nuclear and 95% of hydroelectric power plants are equipped with its turbines. The company supplies its turbines to 45 countries and competes with giants such as General Electric, Siemens, Alstom, and Voith. The share of exports in total sales is 65%, and recently the company signed contracts for tens of millions of dollars with EU companies to supply equipment for the reconstruction of a number of European NPPs (in Hungary and Bulgaria).

Most other large state enterprises covered by the Ministry of Economy 2015 reporting and working in manufacturing and chemicals sector, in electricity supply and distribution, and even the agricultural State Food and Grain Corporation (EBITDA margin 12.0% in 2015) could not boast of high profit margins in the recent years. EBITDA margin of the key state-owned fertilizer producers, Odesa Port Plant and Sumykhimprom, due to the high prices for imported gas and the falling world market prices for finished product, was only 5.7–2.8%. Pivdenmash's EBITDA is negative, at –UAH 1.3bn. Electrotyazhmash's EBITDA margin fell from 6% in 2014 to -0.4% in 2015. Hartron Corporation's EBITDA was about only UAH 1.5mn.

Naftogaz National Joint Stock Company was unprofitable in 2015, when the analyzed report of the Ministry of Economy was compiled. In 2016, it finally reached a high level of profitability. However, this was mainly due to Ukrtransgaz's assets that are currently being divested from Naftogaz. In this way, the future and the very existence of one of the three largest state enterprises in terms of assets and sales depends on whether it will keep the assets of Ukrgazvydobuvannya and whether the government continues its policy of market liberalization and implementation of market rates for natural gas. The government, however, may choose, as it did recently, to return to the artificially controlled prices for gas produced by the state-owned company, which are increasingly at odds with the market prices at which it is sold by private companies.

The main prize of election campaigns

The control over state-owned companies and the financial and economic opportunities that come with it is the key motivator to run in elections for all existing party projects and, at the same time, the main means of monetizing the votes received during election campaigns. The votes, however expensive, pay back a hundredfold in the case of success. Parasitism on state and municipal enterprises, control over which is distributed by quotas, is the main source of corruption income.

Formally lossmaking or on the verge of profitability, the companies still remaining officially in state ownership actually bring hundreds of billions to those who controls them on behalf of the people of Ukraine. This explains the adamant opposition to any attempts of changing the system in the recent years. The change of management of the technically unprofitable or at least insufficiently profitable companies is often accompanied by lengthy appeals of competition results and the attempts to bring back the old management through court decisions.

The basic mechanisms for making money in state enterprises are paying overestimated prices for goods, works and services purchased for fully or partially state-owned companies (public procurement), as well as the sale at reduced prices of finished goods or services to intermediary firms, with their further resale at market prices. In both cases, the management of state enterprises either uses associated companies or receives a portion of excess profits obtained in this way as kickbacks. At the same time, the funds of large state-owned companies are stolen by their managers at various levels.

To understand the scale of proceeds from the purchase of goods, works and services, it's enough to have a look at the information on its total volume: according to the data of the State Statistics Committee for 2016, total amount of spending planned for procurement by state enterprises (and companies with the state share of 50% and more) was UAH 410.5bn. Corruption proceeds at state enterprises largely exceed the possibilities of earning by embezzling public funds. Companies with the state share of 50% or more or those fully owned by the state account for 75% of all public procurement in the country.

Recently, SBU jointly with the Prosecutor General's Office and the National Police revealed a mechanism that allowed officials of one of the regional branches of Ukrainian Railways for embezzling nearly UAH 20mn. The law enforcement found out that those officials during tenders held in 2015–2016 deliberately bought unsaleable and stolen goods from commercial structures controlled by them. To carry out those transactions, they provided forged documentation with fraudulent information. The malefactors converted funds into cash through fictitious companies.

RELATED ARTICLE: How Ukraine's power generation sector changed in 2015-2016

In 2016, officials of the State Audit Service of Ukraine revealed illegal spending and misapplication of funds at 1,900 companies. Audits of the State Administration of Railway Transport of Ukraine conducted from 2013 to May 2016 revealed financial irregularities that led to the loss of financial and material resources to the total amount of UAH 135.2mn, as well as purchase agreements not complying with legal requirements for the total amount of UAH 6.1bn and USD 30.9mn. Inspections of road services in Ivano-Frankivsk, Kyiv and Odessa regions in the first eight months of 2016 revealed the costs of works overstated by contractor organizations for the amount of UAH 22.5mn; purchase of material resources through a series of intermediaries, leading to cost increase by 38 million; and irregularities in procurement agreements for almost UAH 1.4bn. The use by contractor companies of schemes involving intermediaries increased the cost of repair works on the roads of Kyiv Oblast by UAH 10.3mn, and in Odesa Oblast by UAH 16mn.

Occasional cases of detecting abuse and even instituting criminal proceedings reveal only the tip of the iceberg or, in fact, the tails of the system of public funds embezzlement. The persons involved are those who either were not able to oil the wheels or had the misfortune to become a sacred sacrifice. Often this becomes an outright farce, when the response of regulators or law enforcement bodies is forced by the public reaction to a specific case of abuse, triggered by either civic activists or competitors.

Often in such situations, the investigations are conducted for show, to avoid accusations of inaction. Defendants enjoying protection and having significant funds accumulated as the result of embezzlement in most cases are lucky enough not only to escape punishment, but also to return to their previous activities.

Switching to ProZorro electronic procurement system was supposed to reduce corruption opportunities. Last year, the system became mandatory for all public procurement of goods and services for the amounts exceeding UAH 200,000, and of works for over UAH 1.5mn. Customers can also use Prozorro system voluntarily to participate in "subthreashold" tenders (for the amounts less than UAH 200,000). However, numerous methods of bypassing the system have already been invented. It is especially easy when sanctioned or covered from above and tolerated by law enforcement bodies.

Privatization: a solution?

Politicians strongly oppose the privatization of the public sector. Agreeing the transfer of assets into the right hands on favorable terms is becoming increasingly difficult. Hopes for a chance of taking part in the future distribution of quotas for profitable posts block any initiatives to sell those assets at transparent auctions. The public is being told that it is enough to replace corrupt managers for the state to be able to earn billions of hryvnias from state-owned enterprises. However, this is out of question, while those who should be solving management problems are not interested in doing so.

Recently, State Property Fund resolved on the order of priority of putting up for sale the shares in stated-owned companies in 2017. First of all, these are five controlling stakes in regional power companies (oblenergos) that will be offered for sale after the Electricity Market Law is enacted and incentive power tariffs are introduced. Then, the last state-owned TPPs (Tsentrenergo) will be sold. After that, Sumykhimprom, a monopolist in the market of complex fertilizers, and Zaporizhzhya Aluminum Plant will be put up for sale, along with the scandalous President Hotel, which is the area of serious business interests of structures close to state leadership. A separate government decision provides for the privatization of Turboatom. And, finally, another attempt will be made to sell the troubled Odessa Port Plant, entangled with debts (possibly fictitious) to Dmytro Firtash's Osthem Holding. On December 5, 2016, State Property Fund of Ukraine decided to privatize state-owned stakes in the Agrarian Fund and State Food and Grain Corporation.

But when it comes to privatization, it should be remembered that the state traditionally demonstrates not only often inefficient management of the companies under its control. It is also incapable of efficiently using its share in joint stock companies where it owns significant stakes of 25–50%. In many cases, private investors holding a minority stake actually control public assets (let's recall the recent story with Ukrnafta, 50% in which were held by the state, and 40.9% by the structures of the oligarch Ihor Kolomoisky). The situation with Azovmash PJSC, where the state's share is 50%, is similar. However, the company is controlled by the people associated with a well-known crime boss and an ally of fugitive President Viktor Yanukovych, Yuriy Ivanyuschenko, who owns the remaining shares.

RELATED ARTICLE: How the privatization campaign of the 1990s affected Ukraine's population and gave rise to its oligarchs

The situation is even worse in cases when the state retained a blocking stake, obtaining a ballast in return (neither serious dividends nor the possibility to influence the management of such companies). For example, the state owns 43% stake in Ukrtatnafta, the majority stake in which belongs to Kolomoisky. However, the government has no real impact on the company. The situation is similar with ORP Halychyna JSC and Naftokhimik Prykarpattya owned by the same oligarch, where the state still retains 25% and 26% of shares, respectively, but has neither the impact on the activities of these companies, nor significant dividends.

The state has 25% stake in most energy companies controlled by thermal energy production monopolist, Rinat Akhmetov's DTEK. These companies not only control the lion's share of power production by thermal power plants, but also its delivery to customers in three regions with its highest consumption in Ukraine. These are Kyivenergo (72.4% owned by DTEK), DTEK Zakhidenergo (72.2% owned by DTEK), DTEK Dniproenergo (68.8% owned by DTEK), DTEK Donetskoblenergo (71.5% owned by DTEK) and DTEK Dniprooblenergo (51.6% owned by DTEK).

Similarly, the state still owns 25% stake in the country's third largest coal power producer, Donbasenergo (with over 60% of its shares owned by Energoinvest Holding BV, registered in the Netherlands and controlled by the structures that media reports link to Oleksandr Yanukovych). However, the state's impact on decision-making in these companies is close to zero, as evidenced by their management’s sabotaging the transfer of their TPPs from scarce anthracitic coal to gas, available in sufficient quantities in the unoccupied territory.

All of this shows that corporization and sale of controlling or significant blocking stakes in state companies to private structures in the Ukrainian situation is meaningless. For the government, it results in the complete impossibility to use significant assets in owns in such companies, to define their policy, or even to receive substantial dividends. Therefore, companies should either remain under the full state control or be fully sold to private owners. Partial decisions in the situation of rampant corruption and political lobbying by oligarchic groups only results in the actual loss by the government of the possibility to control public property, without getting anything in return.

Translated by Anastasia Leonova

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