The Mighty Red Army’s IPO

Irkut is the first Russian defense firm to go public. Does its stock offering signal a bright new phase in Russian capitalism?

Until a dozen years ago, Irkutsk Aviation Plant was a massive cog in the Soviet military machine. Its aircraft factory churned out the supersonic fighter jets, heavy combat planes, and elephantine transport aircraft that were the stuff of American school kids’ nightmares. But following privatization in 1992, the company—wisely re-christened Irkut Corp.—slowly dug itself out of the hole of the post-Soviet economic collapse to become the second-largest producer of military aircraft in Russia. Foreign governments, including China, India, and Malaysia, line up to buy Irkut’s Su-30MKI supersonic heavy fighter, the Su-27UB heavy combat trainer, the Be-200 multipurpose amphibious plane—an aircraft designed for firefighting that can drop 12 tons of water at a time—and an alphabet soup of other military and civilian aircraft.

Later this month, Irkut—in a capitalist-bull-eats-Soviet-bear turnabout—will try to raise around $150 million from European, American, Russian, and other investors in an initial public offering on Russian stock exchanges. This will be the first-ever IPO of a Russian defense company.

The Irkut IPO is an interesting counterpoint to Russia’s very Potemkin presidential election last week. As President Vladimir Putin’s re-election showed, the Soviet obsession with secrecy, silence, and control still characterizes Russian politics, society, and culture. But many of the country’s businesses are pushing hard and fast in the opposite direction. Irkut—a Cold War crown jewel—even went on a road show to drum up international investor interest in its IPO.

Opening up to investors hasn’t come easily to Russian companies. Until just a few years ago, investing in Russia was a back-alley mugging. Share dilutions, asset stripping, transfer pricing, cash flow diversion, dodgy accounting practices, and other thinly disguised methods of stealing—these were standard practices. Only the most nimble—or naive—investors braved the market.

Many Russian companies began to change their ways after the country’s second-largest oil producer, Yukos Oil Co., showed in late 1998 the upside of getting stock market religion. Abetted by a savvy PR program, Yukos underwent a two-year conversion from a poster child for corporate thievery and bad corporate governance to one of Russia’s most transparent and open companies. Its shares rocketed from a nickel to $16 over the course of five years as investors piled into one of the few Russian companies that was straight with them. As a result, Yukos’ then-CEO Mikhail Khodorkovsky, the company’s largest shareholder, became Russia’s richest man, with a net worth north of $15 billion. 

The lesson that transparency and openness could lead to enormous wealth and allow access to external sources of funding wasn’t lost on Khodorkovsky’s corporate colleagues. Russian corporate managers have subsequently tripped over themselves to “do a Yukos” by publishing accounting statements audited to U.S. GAAP (generally accepted accounting principles) standards, inviting activist foreign investors onto their boards, communicating with shareholders via fancy Web sites, publicly naming major shareholders (even the ones hiding behind shell corporations), holding quarterly analyst and investor meetings, and visiting London and New York to chat up investors. Increasingly, Russian companies have begun to treat minority shareholders like they’re partners, not pests—which has long been standard practice in the world’s more evolved markets. Irkut is just the latest Russian company to learn the lesson that playing nice with investors can pay off handsomely.

That said, it’s easy to overstate corporate Russia’s transparency transformation. For the vast majority of Russia’s corporations—all except the largest 100 or so—the notion of willingly revealing even the most basic financial or operational information to an outsider is as foreign and bewildering as a party without vodka. Fear of the tax man, or of so-called commercial secrets being revealed to competitors, stifles the flow of information throughout most of corporate Russia. Nikoil, a local bank, recently flew into a tizzy when Vedomosti, a Russian business newspaper, reported the bank’s ownership structure on its front page. Irkut is a trend-setter in Russia’s still-secretive defense industry, with a formal corporate governance code and a plan to have five independent board members, but the State Secrets Law still imposes information disclosure restrictions on Irkut, and management watches its words carefully. (With many Russian managers, scratch the surface of the Armani suit, and there’s Homo Sovieticus dying to keep his secrets.)

Despite continued problems—it will take at least a generation or two before the Soviet mentality is exorcised from corporate Russia—investment in Russia is booming. The country’s stock market has increased nearly 18-fold since 1999. Foreign direct investment jumped 69 percent last year, and volumes of foreign loans soared. According to Forbes magazine, Russia is home to 25 billionaires (including six big Yukos shareholders)—behind only the United States, with 279, and Germany, with 52. Russia’s impressive rates of economic growth are largely thanks to strong commodities prices but have certainly been aided by transparency.

Fortunately for Russia’s businessmen (and for investors in their companies), Putin seems to understand that trying to apply his vision of opaque authoritarianism to commerce would spell disaster. That even Irkut, a charter member of the Soviet military-industrial complex, understands transparency and its benefits underscores just how far the country’s business environment has diverged from its political one.

But it seems vain to hope that the transparency, openness, and accountability of commerce can spill over into the rest of Russian society, especially politics. One of the hallmarks of Putin’s regime is the dramatic increase in the power of former KGB and law-enforcement officials—for whom information is a weapon and distrust a way of life—throughout the government bureaucracy. Putin seems to be generally following the Chinese model of allowing economic freedoms while keeping a firm grip on the levers of political power.

Whenever a businessman has questioned Putin, the government has shut him down. Putin had Yukos’ Khodorkovsky tossed in a Moscow jail when the billionaire challenged the regime. Irkut, whose bosses still remember the Soviet Union very well, won’t forget this lesson. After its IPO, Irkut will listen to its shareholders, but it will still answer to the state.