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Notes on Foreign Investment in Armenia since 1997 [February 5, 2007] The main goals of this article are identification of big investors in Armenia and assessment of return on their investment since 1997. Analyses are based on reliable data available on internet and related to investments that fall under Article 39 of “Law on Corporate Income Tax” of the Republic of Armenia (hereafter Article 39). Article 39 is perceived to be one of the major incentives for FDI in Armenia which allows invested companies to exercise corporate income tax exemption for two fiscal years and 50% discount for another two. To be entitled to this tax vacation the investment must be foreign and consist at least 500 million Armenian Dram (about $1 million). The major results derived are follows: • All investments since 1997 consisting more than $1 million were done by foreign incorporated investors (no local). • 40% of foreign investors were incorporated in tax heavens and shortly before privatization of target company, even thought they were officially mentioned differently in all cases (e.g. British company for British Virgin Icelands). • The companies invested are all registered as closed joint stock company (private company) which allows operating under total secrecy. • Investors had impressive annualized return on investments assessed from 30% to 100% (sometimes even more) compared to average 23% in emerging markets during the same period (1998-2006) [1]. • The officially announced amounts of those investors' investments are highly misleading/exaggerated and based on unreliable data and wrong methodology. InvestorsAs, I could not receive requested data from State Statistics Service of Armenia (data of State Revenue Service is confidential), I used data of World Bank regarding privatization[2] to create the list of companies with investment more than $1M, as most of investments (local and foreign) in Armenia are done via privatization. The data supplemented with other known facts and is not so far to real list if the official data were been provided. The list analyzed consists 15 companies privatized since 1997. It is not surprising, that without any exception all these companies were sold to foreign investors. Even thought a few of them are well known foreign companies, others are hard to believe to be so. It would be naïve to buy the company as a local, when you can incorporate foreign company (the quickness, cheapness and easiness of incorporating foreign company especially in offshore zone is well known) and buy it via this incorporated company. The list of offshore zones/countries is issued[3]. Especially, as most of those “foreign” companies are incorporated in tax heavens (such as British Virgin Islands, which seems to be very popular in Armenia) and shortly before the purchase. In addition, those newly incorporated companies privatize the strategic companies of Armenia, where some experience of investor are expected and even declared by the Government level. The analysis of every investor is presented bellow. Return on InvestmentBy term investor we usually mean the owner (or owners) of the company. In case of privatization it is the company(s) or person purchasing the company. Investor and company must be differentiated and not mixed up, they are different entities. In Armenian official disclosures they are combined together which makes absurd and exaggerated announcement of investment. For example, lets consider a simple but widespread practice. An investor buys state company for the amount of $1 million, and gives promise to invest another $20 million for coming two years. During this time, the company takes $5 million loan from the investor, takes another $9 million from EBRD and earns $5 million from its operations. Then the company invests $20 million for a major project. As a result, the company and the Armenian Government would announce that the Investor invested $20 million in the project as promised. In reality, the investor invested only $1 million (the amount that is under risk). $20 million investment is done by the company and not by investor. There is another sad reality that even official announcements are made, nobody checks reliability and reasonableness of disclosed $20 million, as it is based on announcement of the private company, whose financial statements are confidential and not accessible. It is mutually beneficial for the investor and Armenian Government to announce highly exaggerated invested amounts for better statistical figures. In addition, by declaring huge investment, the investor latter can sell its stake at much higher price (e.g. Armentel). Therefore, in my analysis I ignored all these kind of misleading announcements and statistical data available publicly and tried to find the true amount of Investors investment in the company. That is the amount that I used to assess return on investment and is in line with financial sound practices. The cash flows to investor include dividends, disposable value of ownership, management fee, royalties. If there was sale of ownership (e.g. Armentel), then that amount is taken as disposable amount. Otherwise, I looked other reliable methods to valuing the company (such as recent sale of similar asset). Because of inaccessibility of financial statements and limitation of my time and resources, I could not find adequate data for assessments for all investments. The huge privileges of entitling as FDI is not limited by above mentioned profit tax vacation (see KPMG publication: Investment in Armenia[4]). There are other tax, political and secrecy advantages. Without any exception, all this companies are incorporated as closed joint stock companies (similar to that of Private Company) which allow them to work under total secrecy without any requirement to disclose any financial or other important information. Returns on investments are calculated by using cash flows from or to investor, and disposable (or current) value of the company invested. As those data are not accessible, I used indirect methods to make assessments. On of data source is corporate income tax payments published by State Revenue Service[5] as a basis to derive net profit to investors. The simple arithmetic is that Net Income is equal to four times of Corporate Income Tax (according to Article 33.1 of “Law on Corporate Income Tax” of Republic of Armenia, the Corporate Income Tax rate is 20%). In case, the company exercised 50% waiver, then Net Income is equal 9 times to tax amount. As the published amount is aggregate of corporate income tax and personal income tax, I applied State Tax Service data which shows percentage of each tax in total tax to split them[6]. So, the corporate income tax is assessed as 70% of aggregate of profit and income tax number disclosed. In reality, there is difference between Accounting Income and Taxable Income (latter is used to calculate corporate income tax) due to adjustments for taxability, deductibility, waivers, limits and many other special tax privilege decrees. Also, those companies that are the biggest companies in Armenia are paying the lowest tax amounts possible due to their high level contacts, many special tax privileges and capability to employ the highest quality tax, accounting and legal professionals. Thus, the investment returns calculated would been higher if truthful Financial Statement were available. As return on investments is calculated using net cash flows instead of accounting profits, I made rough assumption that net income derived is approximately equal to net cash flows. The assumption, especially for Armenian business reality of mostly cash transactions and short credit terms, would not result to materially misleading results. Conclusions and suggestions• There certainly should not be discrepancy between foreign investment and local investment. Any kind of difference will lead to manipulations by investors to get favorable treatment. Nobody is stupid to invest as local, when foreign investment could lead to sizable tax vacation. • All kinds of special tax privileges given to foreign investors (or any other special investors) should be eliminated: all business entities must operate in the same competitive environment. The current monopolistic business environment of Armenia is partially due to these discrepancies, too. • There are more important and applicable strategies to boost foreign investment than giving unreasonable tax privileges. The well known major obstacle for investment in Armenia is corruption. • There should never been privatization without proper conducted bidding process. • Most investors made outstanding return on investment; in contrast, the State budget (people) lost huge money as a result of above mentioned practices. • There must be strict distinction between the Investor and the Company invested amounts, and Government official announcement must be made after an adequate due diligence is done to check the truthful amount of the investment project. Short data for each company included in the listArmenian Telephone Company (Armentel) First in 1995[7], 49% of Armentel was given (via establishing Joint Venture) to Transworld Telecommunications Inc (TTI) (declared to be company in United State)[8]. There are some Transworld Telecommunications companies in the world. Transworld Telecommunications, Inc. (US) is a private equity financed firm engaged in acquiring telecommunications companies in the United States[9] and 1999 was acquired by Sprint for only $30m. I could not find any disclosure by this public company or other US source regarding to purchase of Armentel. There are another TTI incorporated in Bermuda (tax heaven), UK, British Virgin Icelands (tax heaven). Then, at December 9 1997, OTE (Hellenic Telecommunications Organizations SA) purchased 90% by paying $142.7 million, from which $62 million was paid to TTI for 49%. Thus Armenia received $80.7 million for selling 41%. Both the split of amount (it should been opposite) and the fact that TTI had no objection to sell its whole stake in highly valuable company when Armenian government decided to sell its part of share are very strange and lack sound business logic. Thus, I am highly assuming the TTI was not US incorporated one but one of those tax heaven incorporated. In November 16 2006, OTE sold its stake in Armentel (90%) to Russian company VimPelCom for $487.8 million[10]. I could not find the price (if any) paid by TTI for Armentel. So in every case, TTI profited at least $60 million in two years for nothing (about 33% of Armenia budget for 1997)[11]. Performing internal rate of return analysis on available data (sale to Vimpelcom and State Revenue tax report) and reasonable assumption, I have calculated that OTE had 31% average annual return for nine years of 1998-2006. Yerevan Brandy Company cjsc In 1998, it was sold to French company Pernod Ricard for $30 million. I could not find enough reliable data to assess return on investment. Aragats-Perlite cjsc In June 1998, it was purchased by Dicalite Europe NV, part of US firm Grefeo Minerals Inc., for $1.42 million[12]. I could not find reliable data to assess return on equity. Hotel Yerevan cjsc In 1999, it was sold to Renco spa (Italy) for $1 million. I could not find enough reliable data to assess return on investment. Diamond Company of Armenia cjsc In 1998[13], Diamond Company of Armenia bought by Furfano Corporation (UK, according to official version) for $5.5 million. In reality, Furfano LTD is incorporated in Shannon offshore zone of Ireland[14]. I could not find enough reliable data to assess return on investment. Shoghakn Diamond Cutting Plant cjsc In 1999, it was sold to Leviev International DiamondsLtd. of Israel. I could not find enough reliable data to assess return on investment. Prometey-Qimprom (Vanadzor Chemical Company) cjsc In May 1999[15], it was sold to Russia's Zakneftgazstroi Prometei (owned by an Armenian businessman, Senik Gevorkian) for $1.5 million. After 13 years of standing idle the Vanadzor complex in November 2001 resumed production. But high prices for gas and changes in market trends forced the company to suspend production in 2002. This investment seams to be exceptional in efforts to reestablish and develop the company in trouble. In July 2002, Britain's Ransat (established in 1995) buys 50% of Armenian chemical company[16]. Ransat earlier purchased Nairit-1 but was unable to adequately operate it, and shortly after disposed its ownership in Nairit-1. I could not find enough reliable data to assess return on investment. Alaverdi Copper Smelter cjsc Manes & Vallex (an Armenian-Liechtenstein joint venture) is managing Alaverdi Copper Smelter located in the North of Armenia[17]. Liechtenstein is offshore zone, too. I could not find enough reliable data to assess return on investment. “Armenia” International Airports (Zvartnots International Airport) cjsc In June 2002, Zvartnots airport was give to American International Airports (AIA)[19] (officially declared as American company) via concession agreement. Even thought its impressive name, the company has no airports in US and only an office in NY Madison Avenue[20]. But, there are a few mentioning of the company, together with Argentinean Edwardo Eurnekian (in according to government disclosures, too). So, I am not sure of incorporation of the company or its experience in Airport operations. There was no payment to state budget (it seems to be gift) but in order to exercise Article 39 (tax holydays), the owner, AIA, must been invested around $1 million, which is considered as initial investment for assessing investment on return. Tax revenue service reports and sale of Carrasco airport[21] are used to derive return on investment which is equal to 106% annually for years 2002-2006. Armenian Electricity Grid cjsc In 2002, it was sold to Midland Resources Holding for $37 million. The owner was officially disclosed as British company, while in reality it is incorporated in offshore zone Guernsey (The Bailiwick of Guernsey is a British crown dependency in the English Channel of the cost of Normandy)[22]. In January 2005, it was purchase by offshore company Interenergo BV which is subsidiary of Russian company Unified Energy Systems for $73M[23]. Therefore, the return on investment would be 97% annually for years 2002 to 2004 . General Transworld Manufacturing Company (Yerevan Tire Plant) cjsc[24] American company TS Investment Corp bought 75% of Shinnik (the company's nickname) in April 2002 for $1.287 million and the company renamed in December of that year to General Transworld Manufacturing Company (GTMC). I could not find any source of identifying true incorporation of the company. Production was suspended in January 2004 due to financial problems and 75% of the employees were placed on leave without pay. I could not find enough reliable data to assess return on investment. Armenian Airlines (Armavia) cjsc In 2003, Armenian Airlines was liquidated having $19 million debt[25] (debt stayed liability of Armenian Airlines and was not transferred to buyers of routes!). Companies 17 routes were sold to Armavia and 7 routes to Armenian International Airlines. Armavia was 68% owned by Russian S7 Airlines (also known as Siberia Airlines) and 32% by Mika Armenia Limited[26]. I do find the amount (if any) paid by S7 Airlines for 17 routes. On 2005, Mika Armenia Limited purchased 68% from S7 Airlines, so becoming 100% owner of the company. The price paid is controversial, as Russian announced $50 million while Head of Mika Armenia Trading told that rather big sum has been spent for 68% of the shares, but by far not $50 million[27]. I prudently assume that $50 million announced by aviation experts referred to valuation of Armavia, so paid price was around $34 million. Deno Gold Mining Company (Kapan) cjsc Deno Gold Mining Company (“Deno Gold”), with its principal asset, the Kapan Mining Project, located in Southern Armenia, is owned 100% by Vatrin Investment Ltd (British Virgin Icelands)[28]. In August 2006, Dundee Precious Metals Inc. (DPM – TSX) (“Dundee Precious”, “DPM” or “the Company acquired 80% of Vatrin Investment Limited (“Vatrin”), a private entity, for $22million[29]. I could not find enough reliable data to assess return on investment. Zangezour Copper Molybdenum combine, cjsc In December 2004, it was privatized to consortium of companies for $132 million. The major one is Cronimet (German[30]) which purchased 75% controlling skate. By using data of State Tax Service of paid taxes for year 2005 and I semi-annual period of 2006, internal rate of return is about 84% annually. 1. Northern Trust. “Emerging Markets Investing”. <http://www-ac.northerntrust.com/content/media/ attachment/data/white_paper/0701/document/emergingmarkets_0107.pdf> 2. World Bank. <www.worldbank.org> 3. Decree on offshore duty. <http://www.a-r-t-group.com/eng/tema2.html> 4. KPMG Armenia. “Investment in Armenia”. <http://www.kpmg.am/index.thtml/en/library/InvestmentInArmenia/index.html > 5. TaxInfo. .The largest tax payers. <http://www.taxinfo.am/> 6. State Tax Service. Statistics. <http://www.taxservice.am/> 7. History. Armenian Telephone Company. <http://www.armentel.com/eng/about/history1.htm> 8. “Armenia Hails Greek Ote's 90 Pct Buy of Armentel”. Hasmik Mkrtchyan. <http://www.cilicia.com/armo3d8.html> 9. <http://www.globalstar.com/en/company/management/> 10. “Armentel was restricted”. Tatyana Zolotova. <http://www.comnews.ru/index.cfm?id=26433> 11. IMF. Statistics. <http://www.imfstatistics.org/imf/output/1D2817DA-E5D6-41F1-8BFB-0E1F26BE8C38/IFS_Table_61768.7779373.xls> 12. Richard M. Levine and Glenn J. Wallace. “Mineral Industries of CIS”. <http://minerals.usgs.gov/minerals/pubs/country/2001/cismyb01.pdf> 13.Armenian Development Agency. <http://www.ada.am/html/jewelry___diamonds.html> 14. Richard M. Levine and Glenn J. Wallace. “Mineral Industries of CIS”. <http://minerals.usgs.gov/minerals/pubs/country/2001/cismyb01.pdf> 15. Prometay-Qimprom. <http://www.armeniandiaspora.com/archive/8490.html> 16. CIS and Baltic states news. <http://www.accessmylibrary.com/coms2/summary_0286-25746167_ITM> 17. Armenian Development Agancy. <http://www.ada.am/html/mining.html> 19. EBRD. <http://www.ebrd.com/projects/psd/psd2006/36013.htm> 20. < http://www.allpages.com/listings/a/a-6346.html> 21. < http://www.findarticles.com/p/articles/mi_qn4174/is_20030828/ai_n12920248 > 22. Wikipedia. “Midland Group”. <http://en.wikipedia.org/wiki/Midland_Group> 23. Atom Makarian. ‘Russians Announce Purchase of Armenian Power Grids”. <http://forum.armenianclub.com/archive/index.php/t-5813.html> 24. General Transworld Manufacturing Company. <http://www.armeniandiaspora.com/archive/8490.html> 25. U .S. & FOREIGN COMMERCIAL SERVICE AND U.S. DEPARTMENT OF STATE, 2005 . “Aviation Serivice.” <http://strategis.ic.gc.ca/epic/site/imr-ri.nsf/en/gr123070e.html> 26. Wikipedia. “Armavia”. <http://en.wikipedia.org/wiki/Armavia> 27. Arminfo. “Mika head clains to have paid much less than $50 million for Armavia.” <http://www.armeniandiaspora.com/archive/32388.html> 28. EBRD. Project Summary document. http://www.ebrd.com/projects/psd/psd2006/37490.htm 29. <http://www.armembassycanada.ca/Docs/DUNDEE_release.pdf> 30. Cronimet. Company website. http://www.cronimet.de/en/information/about.php
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