Red notice

10. Preferred shares

I finally finished writing Sandy’s operating procedures manual six weeks after Davos. Now Sandy either would have to send the money that Safra had committed to the fund or renege on the deal.

If Yeltsin’s approval rating had stayed at 5.6 percent, Sandy would surely have reneged. But the oligarchs’ plan appeared to be working. By early March, Yeltsin’s approval rating had risen to 14 percent and this put Sandy in a quandary. A clause in the contract said that if Safra pulled out, then he would have to pay a multimillion-dollar penalty. However, if Sandy released the money and Yeltsin wasn’t reelected, Safra stood to lose even more than that. To buy a little more time, Sandy released $100,000 of working capital, which allowed me at least to set up the office in Moscow.

I was in a quandary too. I didn’t like the idea of moving to Moscow without any real business, but it didn’t make sense for me to force the issue. If Safra decided to pull out now, I wouldn’t be able to find another $25 million investor in the three months before the Russian elections.

I went about my work and continued to prepare for the move to Moscow with Sabrina, but things had become more complicated between us. She had become pregnant almost the moment I proposed and was hit with severe morning sickness. She was in such bad shape that several times I had to take her to the hospital to be rehydrated.

As we were packing our bags in our bedroom on the eve of our trip to Moscow, she finally said what I was dreading she might say.

«Bill, I’ve been up all night thinking, and I’m…»

«What is it?»

«I’m sorry, but I just can’t go to Russia».

«Because of the morning sickness?»

«Yes, and…»

«What? You’re going to come when the morning sickness passes, right?»

She turned away, looking confused. «Yes. I mean, I think so. I don’t know, Bill. I just don’t know».

While I wanted her to be with me in Moscow, I couldn’t fault her. She was going to be my wife and she was carrying our child. Whatever our previous arrangements were, she had to be comfortable and happy. That was what mattered most.

I accepted that she would stay in London, and the next morning Sabrina drove me to Heathrow. We said our good-byes on the curb and I promised to call her twice a day, every day. I kissed her and went through the airport, hoping that she would be able to join me soon.

I thought about all of this as I flew east. But then I landed at Sheremetyevo and was confronted with the crowds and the chaos, and I didn’t have the capacity to think about anything other than dealing with real life on the ground in Moscow.

I had a two-page-long to-do list, and the first item was to find an office. After checking into the National Hotel, I called Marc Holtzman, who had recently set up his own office in Moscow. He told me about an empty room just down the hall from his and I made an appointment to see it right away.

The next morning, I left the hotel to hail a cab. As soon as I stuck out my hand, an ambulance swerved dangerously from the middle lane and came to an abrupt stop in front of me. The driver leaned across, rolled down the window, and said, «Kuda vy edete?» He wanted to know where I was headed.

«Parus Business Center», I told him without a hint of a Russian accent. «Tverskaya Yamskaya dvacet tre» — the street address in Russian. That was about the extent of my fluency. Unlike many other Westerners in Moscow, I had never studied Russian literature, trained as a spy, or done anything useful to prepare for life in Russia.

«Piat teesich rublei», he said. Five thousand rubles — roughly one dollar — to go about two miles. As he spoke, four other random cars also stopped, queuing in case I decided to reject the ambulance. I was in a hurry so I jumped in. I looked over my shoulder as I slid into the passenger seat, praying that no bodies or injured people were in the back. Thankfully there weren’t. I shut the door and we pulled into traffic, heading up Tverskaya.

I soon learned that an ambulance stopping to pick up a fare in Moscow wasn’t unusual. Every vehicle was a potential taxi. Private cars, dump trucks, police cruisers — everyone was so desperate for money that any and all would take fares.

Ten minutes later we stopped in front of the Parus Business Center. I gave the driver his money, got out, and walked through the underpass to the other side of the street. I entered the building, passing a Chevy dealership on the ground floor, and met the building’s manager, a fast-talking Austrian.

He took me up to the empty office on the fourth floor. It was only two hundred square feet, about the size of an average master bedroom. The plate-glass windows, which opened only a few inches, looked over the parking lot to the west and a decrepit set of Soviet apartment blocks beyond that. The space wasn’t pretty but it was functional, had multiple phone jacks, and was just down the hall from Marc. The Austrian wanted $4,000 a month, making this one of the most expensive office spaces in Moscow per square foot. I tried to negotiate, but the Austrian just laughed at me. After a bit more bickering, I gave in and signed the lease.

Once I had the office, I needed people to help me run it. While tens of millions of Russians were desperate to make a living, hiring a good English-speaking employee in Moscow was almost impossible. Seventy years of communism had destroyed the work ethic of an entire nation. Millions of Russians had been sent to the gulags for showing the slightest hint of personal initiative. The Soviets severely penalized independent thinkers, so the natural self-preservation reaction was to do as little as possible and hope that nobody would notice you. This had been fed into the psyches of ordinary Russians from the moment they were on their mothers’ breasts. To run a Western-style business, therefore, you either had to completely brainwash a fresh young Russian about the virtues of efficiency and clear thinking or find some miraculous person whose natural psychology had somehow defied the pressures of communism.

Fortunately, I got lucky. A local brokerage firm with a number of Western-trained employees had recently gone bankrupt, and less than a week after arriving in Moscow I was able to hire three good people: Clive, a British junior trader and researcher; Svetlana, a secretary who spoke perfect English; and Alexei, an experienced driver who spoke only Russian.

After getting them in the office, I sent Svetlana to find some furniture. She was a short, pretty, twenty-two-year-old Lithuanian with dark hair and a sunny disposition, who enthusiastically went about her mission. When she got to the furniture store, she called to tell me about some nice Italian chairs and desks she thought would be perfect for the office.

«How much?» I asked.

«Around fifteen thousand dollars».

«Fifteen thousand bucks? You’ve got to be kidding. What else have they got?»

«Not much. Just some ugly picnic tables and folding chairs».

«How much for those?»

«About six hundred dollars».

«We’ll take them».

By the end of that day we had four picnic tables and eight folding chairs — plus a houseplant Svetlana bought on her own initiative. We then purchased some computers and set them up, and by the end of the week my fledgling operation was ready to go.

As I got set up, Yeltsin’s poll numbers continued to move in the right direction, but the election was still more than ten weeks away and Sandy was still not releasing any more of the funds. In the interim, I started researching companies for the fund on the assumption that eventually Safra was going to honor his $25 million commitment.

The first company I targeted was the Moscow Oil Refinery, known as MNPZ. At Salomon we had made a lot of money on oil-related companies in Russia, so a big Moscow refinery seemed like a promising place to start looking.

Svetlana made an appointment with MNPZ’s chief accountant and in early April we went to meet her at the company’s headquarters. Plump, blond, and in her fifties, she wore an unfashionable maroon pantsuit. She met us at the entrance of an ugly, old building and led us inside. The place had clearly seen better days. Lights flickered on and off, tiles were missing from the floor, and the walls were filthy.

In her office I asked a series of basic questions: «What were your revenues last year?» «What were your profits?» «Can you tell me how many shares are outstanding?» These questions may sound mundane, but in Russia there was no public information on companies and the only way of getting any was by going to the company and asking.

Svetlana translated as the accountant answered the revenue and profits questions, but when we got to the question about shares outstanding, she asked, «Do you mean common shares or preferred shares?»

I’d heard the term preferred shares before, but I didn’t know what she was talking about. «What are those?»

«Preferred shares were given to the workers during the privatization process».

«How are they different from the ordinary shares?»

«They pay out forty percent of profits in dividends».

«How much do the ordinary shares pay out?»

«Let me see». The accountant grabbed a large binder off her desk, inspected several stained sheets of paper, and said, «It says here that they paid nothing last year».

«So the preferred shares paid out dividends equal to forty percent of the profits and the ordinary shares paid out nothing», I offered, not quite understanding this discrepancy.

«Yes, exactly».

As soon as I was done with the meeting, Svetlana and I jumped into Alexei’s beat-up Zhiguli — a type of small, boxy Soviet car that was ubiquitous in Moscow — and puttered back to the office. As we inched through the midday traffic, I called Yuri Lopatinski, one of my favorite local brokers. Yuri was a Russian émigré from New York who’d recently moved back to Moscow to work for the brokerage firm Creditanstalt-Grant. He was not like the other brokers who trafficked in what I called tourist stocks, the banking equivalent of hawking $10 coconuts on a beach in Fiji when the locals bought them in town for twenty cents.

Yuri was in his early twenties and had a hushed way of speaking, as if he were always telling secrets. It was often difficult to understand anything he said, but when I did understand him, his information was usually interesting.

«Hey, Yuri, do you have a price on preferred shares of MNPZ?» I asked.

«Dunno. Probably. Let me see». He cupped the receiver and mumbled to his trader. I heard some garbled shouting in the background and Yuri came back on the line. «Yeah, I can get you a hundred thousand at fifty cents». He said this so inaudibly that I had to ask him to repeat it.

«How much for the ordinary shares?»

He mumbled something again and got another response. «A hundred thousand at seven bucks».

«You sure about that?»

«Yep. Those are the prices».

I didn’t want to tip my hand, but my heart started beating fast. «Let me get back to you on this».

I hung up and wondered: These preferred shares seem much more attractive than the ordinary shares. Is there something wrong with them? Why are they trading at a 95 percent discount to the ordinary shares?

When we finally made it back to the office, I sent Svetlana back to MNPZ to get a copy of the corporate charter, which would contain the details of the rights of different classes of shares. She came back two hours later and we pored over it. The only substantive difference between preferred shares and ordinary shares was that preferred shares didn’t have voting rights. That didn’t seem to be a problem because foreign investors such as ourselves never voted our shares at annual general meetings in Russia, anyway.

I was convinced that there must be some other explanation for the deep discount and spent the next several days searching for it. Did the preferred shares have different par values? No. Was the ownership restricted to workers? No. Could the higher dividends be arbitrarily changed or canceled by the company? No. Did they represent only some minuscule part of the share capital? No. There was no explanation. The only reason I could fathom for why they were so cheap was that no one had showed up to ask about them — until I had.

Amazingly, I found that this anomaly wasn’t restricted to MNPZ. Nearly every company in Russia had preferred shares and most of them traded at a huge discount to the ordinary shares. These things were a potential gold mine.

I intended to leave Sandy alone until after the election, but this situation was too compelling. These preferred shares were trading at a 95 percent discount to the ordinary shares, and the ordinary shares were trading between a 90 and 99 percent discount to the shares of comparable Western companies. Whatever Sandy’s concerns about Zyuganov, valuation anomalies like these were too rare to ignore. You’re lucky if you find something at a 30 percent discount, maybe even a 50 percent discount, but to find something this cheap was unheard of. I had to tell Sandy about them right away.

When I told him the numbers, he immediately perked up and started grilling me for more information. We finished the conversation and I could practically hear the wheels turning in his head about how he was going to justify this investment to Safra.

Two days later, the Levada polling agency[10] published Yeltsin’s latest approval ratings. They had jumped from 14 to 22 percent. About three minutes after this announcement hit the wires, my phone rang. «Bill», Sandy said excitedly, «have you seen the polls?»

«Yes. Amazing, isn’t it?»

«Listen, Bill, I think we should start buying some of those preferred shares. I’m wiring two million for tomorrow».

I told Clive and Svetlana the good news and we high-fived each other. I even walked over to Alexei, who hadn’t learned about high-fiving in his previous job in the Moscow Traffic Police. I awkwardly grabbed his arm, raised it in the air, and slapped his hand. He gave me a polite, toothy smile. Clearly he enjoyed being a part of this strange American ritual.

We were now in business, and by the end of the next day the fund had invested all of this new money in Russian preferred shares.

Over the next three weeks Yeltsin’s approval ratings jumped from 22 to 28 percent. For the first time since his campaign began, people started to factor in a real possibility that Yeltsin would win. New buyers entered the stock market, pushing my fund up 15 percent.

Unlike other decisions in life, with investing you know if you’re right or wrong, based on the market price. There is no ambiguity. That Sandy could see a $300,000 profit on his first $2 million gave him more confidence than any words or analysis. He called me that Saturday afternoon on my mobile phone to let me know he was wiring an additional $3 million into the fund for Monday morning.

With the probability of an apocalypse now fading, and the market starting to rise in reaction, other investors didn’t want to miss out, and more and more started to enter this small, illiquid stock market at once. Panic buying ensued. The week after Safra put in his additional $3 million, the fund was up a further 21 percent. Since we’d started investing a few weeks before, the fund was up a total of 40 percent, which in the world of hedge fund investing would have been an amazing year — only we had made it in three weeks!

The following Monday, Sandy wired an additional $5 million without even telling me.

In the midst of this excitement, I had a wedding to attend — my own. Sabrina and I were going to be married on May 26, 1996, only three weeks before the Russian presidential election. I rushed back to London on the Wednesday before the ceremony to prepare.

We’d invited 250 guests from all over the world, and when Sabrina and I stood on the bimah of the Marble Arch Synagogue and she vowed to love and cherish me as long as we might live, I was moved. The words felt as real as any I’d ever heard. As I made my vows, I stared through tears at my beautiful, vulnerable wife. After the ceremony we had a raucous party with an Israeli band, which started off by playing «Hava Nagila». We were lifted into the air on chairs and then danced all night. It was an amazing wedding with friends and family, and it felt as if all the planets had lined up for both of us.

I’d promised Sabrina a honeymoon, but I could do it only after the election, and I flew back to Moscow the following Monday exhausted but happy. When I got to the office, Clive told me that we had another $5 million in the account from Safra. Over the next two weeks, two more tranches of $5 million arrived. By the second week of June, only a week before the presidential election, Safra had invested the entire $25 million he had committed, and the Hermitage Fund was up 65 percent from inception.

The first round of the Russian presidential elections took place on June 16. Clive, Svetlana, Alexei, and I got to the office at 6:00 a.m. to track the results from Russia’s Far East, which was seven hours ahead of Moscow. The results were good for Yeltsin. In Sakhalin, he had 29.9 percent versus 26.9 percent for Zyuganov. The results moved west, and in Krasnoyarsk, Yeltsin got 34 percent. Finally, results came in from Moscow, where he won 61.7 percent of the votes. In all, Yeltsin had beaten Zyuganov 35.3 percent to 32 percent, the rest of the votes going to other marginal candidates. He had won, but since the Russian constitution requires a candidate to get 51 percent of the vote, there would be a second round on July 3.

Over the next two weeks, anyone with a vested interest in getting Yeltsin reelected went all in. I was a bit worried that the race would be too close to call, but I needn’t have been. By midday on July 3 it was clear that Yeltsin would retain the presidency. When the final votes were tallied, he had beaten Zyuganov by nearly 14 percentage points.

The markets went wild, and the fund was up 125 percent since we launched. That was it. I was well and truly in business.