Fundamental Faults

Alexander Voronin

Golden rain has fallen on Russian builders. But the industry is ill-prepared for large-scale investments — it can boast neither proper modern technologies and reliable resources, nor good level of corporate management.

Dramatic growth of industrial and housing construction in the recent years has notably strengthened the industry stand in our annual rating. According to the previous Expert-400, the share of construction companies in total revenues of the rating participants amounted to 1.7%, in the current rating it was already 2.2%. The list of 400 largest companies contains 13 construction companies engaged in industrial and infrastructural construction and 9 development and housing companies.

Infrastructural and industrial construction

Leading infrastructural and industrial construction companies entered the modern market, safely stemming from their Soviet industrial roots. It is them who develop growing investment programs of the natural monopolies. Thus, the largest share of construction contracts of Gazprom, annually spending 20% of its revenues for investments, goes to Stroitransgaz and Welding-Erection Trust (operate on such big projects as Nord Stream and Sakhalin-2). Similar is the case with construction investment programs by Transneft (in 2006 infrastructural investments by the company itself exceeded 70% of its revenues; the largest project deals with VSTO pipe-laying and costs 12.5 bln dollars) and by the Russian Railways (infrastructural costs in 2008–2010 would constitute 13.5 bln rubles, the main contractor being Roszheldorstroi).

Construction companies started actively obtaining funds in the bond market

Infrastructural component of implemented and planned housing objects is also very impressive — within the framework of the national project the government selected 22 complexes, offered by private business, whose engineering and transportation nets would be financed by the state. 256 bln rubles would be allocated for this purpose in 2008–2010. Another large-scale infrastructural project is the preparation for the Olympic Games in Sochi in 2014, demanding about 330 bln rubles. 110 bln out of the sum is to be spent for the construction of new regional transportation net.

Industrial construction is also far from standing idle. Among its leading representatives in the rating is Group E4, responsible for design, construction and commissioning of energy units, and Globalstroi-Engineering, engaged in construction and modernization of oil and gas processing plants. In many ways their further development depends on industrial investment programs. RAO UES of Russia introduced corrections to the approved investment program for the current year: the new version provides for 3.1 trillion rubles to be spent for construction and modernization of the energy sector in 2008–2010 (true, the sum includes expenditures for new equipment). Within the last several years oilmen have shown their readiness to spend up to 20% of their revenues for investments annually. For instance, LUKoil plans to spend in 2006–2016 78 to 112 bln dollars — depending on the price of oil.

Infrastructural contracts in Russia would come primarily from private business — the state, having plans to spend money for development of communal nets and pre-Olympic modernization of Sochi, would not control more than one third of 300 bln rubles — the annual sum planned for construction development.

One of the key problems for the industry to deal with while realizing the growing financial flow relates to personnel. In the turbulent 90-ies specialized trusts more or less managed to retain construction specialists and partly even educational institutions to train such specialists — but this is not the case with the industrial construction. The Soviet school of mass-scale industrial construction simply passed away — for the long ten post-Soviet years domestic industry laid no foundations of green field sites altogether. As a result, the country at present has no companies capable of offering complex services to build metallurgical and chemical enterprises; what is more or less developed is installation of electrical and mechanical equipment. The case recently mentioned by Expert (see №34 this year) is quite noteworthy: construction of new capacities for ОМК-Steel in Novgorod region is done by a Turkish construction company.

Housing construction

To catch up with developed countries in the area of housing, we need to build 140-150 mln sq. meters (three times more than at present) of new houses within 20 years. That means serious and long-termed potential demand for the industry. But how about real demand and real capacities? Unfortunately, the situation is not that bright. While launching the national project in 2004, the government and housing complex representatives declared: only 9% of households at the moment were capable of improving their living conditions on their own (and even them need mortgage). Somehow, the alternative way of financing housing construction — through budget allocations at different levels — took roots only in Moscow, St.-Petersburg and in the Ministry of Defense (by the way, currently budget allocations for housing construction for the military personnel dropped down to 11.45 bln rubles against 19.6 bln rubles a year before).

Thus, mortgage has remained the main source of financing housing construction. But for the majority of potential borrowers it is still out of reach. Within the first year of implementation of the national project (2006) real monetary revenues of the population went up by mere 12.5%, but the cost of housing increased by 47.5%.

According to the authorities, active budget injections into engineering infrastructure may turn the situation for the better — to take the burden off the developer’s shoulders. As was already mentioned, the state budgetary expenses in 2008–2010 for this component should constitute 256 bln rubles. But it is hard to assess the effectiveness of these investments now, since the project only passes its initial stages.

Visible increase of housing commissioning (2006 — 50.5 mln sq. meters, a bit more than the all-time Soviet record — 49.4 mln, see diagram 2) should hardly be explained by the state targeted efforts. About 40% of these enchanting millions have been realized through individual construction, or, rather, self-construction — something built by citizens themselves or uncontrolled brigades of guest workers. This is rather a manufacturing and not industrial way of production.

The industry soon will encounter another limitation — resources. Despite ongoing discussions about the future of mass Russian housing (individual with limited number of stores or mass panel-monolithic), time-tested multi-stored housing takes the upper hand. Increased construction rates in the regions usually follow the same scheme: large companies from Moscow purchase local enterprises manufacturing reinforced concrete structures and fixtures. But to revive the net of integrated house-building factories all over the country would require, following certain assessments, serious investments — about 50–55 bln rubles. Besides, our industry of construction materials is presently incapable of providing materials in required amounts. Thus, cement people have almost reached the limits of their capacities, their load of 82% implies: the resource to increase production is practically exhausted. To develop housing and corresponding infrastructure in desired volumes require over 80 mln tons of cement, which is more than the industry can produce — even considering announced factories’ capacities about 10 mln tons a year (55 mln tons in 2006).

Resource-saving technologies, which might help surpassing the limitation, can not be properly utilized due to absence of reliable amount of specialists and weak corporate management in the industry — the level of transparency still remains in the 90-ies. Managing financial and operational risks of certain projects is based on their localization inside a special one project company. A holding or a corporation may have scores of such companies with cross ownership and, consequently, chaotic financial flows. Current corporate development of the Russian construction business means its enlargement, or rather transformation of non-obvious ties between companies into structured holdings or corporations. More advanced transformation of corporate management happens very rarely. Thus, before making IPO PIK group of companies spent several months to shape a comprehensible organization structure. The award was 1.85 bln dollars for 15% of shares sold following IPO last May.

But such a way of financing expanding construction business is not a rule, but an exception. After the law №214 "On equity participation…" became effective, developers lost access to money of the housing future owners. The way out was the scheme announced at the beginning of 2006 to provide targeted crediting through Sberbank — as a result most market players turned from wallets of purchasers to a classical banking financing by direct crediting and issuing bonds. The third echelon of bonds turned out to be the market driving force.

In 2002–2003 nobody ever considered corporate bonds as a reliable source of funding, and there were only several pioneering borrowers at the market: PIK group, Severny Gorod and Stroimetresurs. But in 2004 the situation drastically changed — the bond market started growing speedily. Excessive liquidity of banks only favored the development. In 2007 (by mid-September) developers placed 24.6 bln rubles in bonds with another 25.3 bln planned for the future. Developers are interested in developing and refinancing — three companies placed credit notes for 603 mln dollars. But the real obstacle is the dystrophic Russian financial system. The US mortgage crisis reminded to the world: sources of banking funds are highly dependent on the capital markets’ external conjuncture. Pretty often organizing banks themselves bought out their emissions through repo deals to guarantee the placement. But the flow went dry, and on September 17 newspapers informed the world that VTB bank stopped giving repo credits guaranteed by the third echelon securities due to necessity to pay for their own borrowings.

Debt financing as the growth strategy (sometimes called European) has its limits. With increased load the ratio between one’s own and borrowed sources becomes non-optimal — credit servicing significantly affects profits. Under such circumstances a developer makes the only proper decision — he changes the type of development into an American one and attracts a new strategic shareholder or declares IPO. But due to above-mentioned corporate management risks the mechanism of attracting capital proves to be too exotic, therefore IPO boom of the Russian developers can hardly be expected in the near future.

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