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Morgan Stanley's Misadventure
- 2. !Morgan Stanley’s Ukrainian Misadventure November 2011 bloombergmarkets 73 TheNewYorkbank envisionedgold intheblacksoilof theformerSoviet republic’sgrain farms.Itsforayinto agriculturecame upfallow. By Alan Katz and Peter Robison ILLUSTRATION BY ALEXI NABAUM
- 3. simoncrofts IowanativeJustinBruch marveledattheopportunitywhenMor- ganStanleycalledinlate2007torecruit him for anunusual assignment. The NewYorkbank,flushwith$7.5billionin fiscal 2006 profit—the biggest in its his- tory—was going to be farming 11 parcels on the steppes of Ukraine. The com- moditiesteamwantedBruch,aredhead with meaty hands who’d been farming all his life, to manage one of them. Bruch saw a chance to dig into some famousdirt.TheformerSovietrepublic has 30 percent of the world’s black soil, earth so fertile Adolf Hitler had troops cart some back to Germany during World War II. Wheat, corn, rapeseed and sunflowers thrive there. “It’s like the prairie land that was broken in the Midwest 100 years ago,” says Bruch, 34, who grew up on his family’s 2,500-acre (1,012-hectare) corn and soybean farm. “The soil and potential for crops that Ukraine has is the best in the world.” Morgan Stanley was primed for the investment. It was then the second- largest U.S. securities firm by market value, after Goldman Sachs Group Inc. Chief Executive Officer John Mack was pushing managers to take more risks. The year Morgan Stanley called Bruch about running a farm in the Mykolayiv region near Odessa on the Black Sea, the bank spent $6.5 billion for Crescent Real Estate Equities Co., which had 54 officebuildingsinDallas,LasVegas,Mi- ami and elsewhere. The bank also fi- nanced an Atlantic City casino resort after buying the land for it in 2006. The commodities division, which had ac- quired operators of fuel terminals and oil tankers, recruited for its European agriculture desk, anticipating rising food prices. The increases would spark riots in several countries in 2008. Enselco Ltd., the company Morgan Stanley funded that owned the Ukrai- nian farms, bought satellite-guided John Deere tractors to plow its weed- strewn Ukrainian acres and imported mold-preventing grain bags as long as football fields. Bruch picked up enough Russian to joke with his tractor drivers and order a meal in his adopted home. Things began to fall apart within months. The locals stole fertilizer and insecticide, Bruch says, and he sus- pected that harvested wheat was dis- appearing too. He wound up fighting with tax, immigration, fire and police inspectorsandtryingtosatisfyofficials who wanted him to build roads, not just till fields. He left the farm, called Golden Fields, in June 2009 to man- ageaUkrainianfarmownedbyanother foreign investor. “I worked my tail off for a year on that, trying to do a good job, produce a good crop,” Bruch says in a Lviv beer garden over a meal of spit-roasted pig. “It was pretty stressful and pretty much a headache, so I’m really happy not ever to deal with any of it again.” Morgan Stanley gave up on farming in Ukraine in July 2009, abandoning the initiative in the middle of a harvest. It bought out its local partner, Alek- sandr Mamontenko, then sold Enselco toaninvestmentfirmbasedinJerseyin 74 bloomberg markets November 2011 Aleksandr Mamontenko served as Morgan Stanley’s local partner in Ukraine. ‘thesoilandpotentialforcropsthatukraine hasisthebestintheworld,’saysbruch,who farmedthereformorganStanley.
- 4. alankatz the Channel Islands,at what people familiar with the situation say was a loss. All told, Morgan Stanley put about $30 million into Enselco through loans, according to Igor Bobrov, who was hired in 2008 to be Enselco’s chief financial officer and later became its CEO. Hugh Fraser, a London–based Morgan Stanley spokesman, says bank officials de- clined to comment for this story. Morgan Stanley’s failed gamble in Ukraine shows how Wall Street firms, in the last gasp of a debt-fueled bull market, strayed further from their tra- ditional business of advising compa- nies and underwriting stock sales to embracediverseprojectswithunfamil- iar risks. By 2007, banks were investing ineverythingfromcasinodevelopment to mortgage lending in Russia. That year, the five major U.S. investment banks had only $1 in capital for every $40 of assets, meaning a 3 percent drop in asset value could wipe out a firm, ac- cording to a January report by a con- gressionally appointed panel probing the 2008 credit crisis. “You don’t buy farms if you’re a bro- kerage,” says Richard Bove, an ana- lyst who follows Morgan Stanley for Stamford, Connecticut–based Roch- dale Securities LLC and has covered Wall Street for 30 years. “It’s an ex- ample of stretching too hard to make a killing without thinking about the core responsibility.” After credit and equity markets col- lapsed in the wake of Lehman Brothers Holdings Inc.’s failure in September 2008, Morgan Stanley borrowed $107.3 billion from the Federal Reserve to survive, according to a Bloomberg News compilation of data obtained throughFreedomofInformationActre- quests, litigation and an act of Congress. It also got a $10 billion capital infusion in October as part of a $700 billion governmentbailoutoftheindustry. Morgan Stanley’s misadventure in Ukraine points up risks for current- day investors lured by statistics that may seem to paint agriculture as a no- brainer. Rising wealth is changing the diets of 2.5 billion people in China and India, requiring more grain to feed cattle and pigs just as soil erosion and urbanization are limiting available farmland. To keep food inflation under control,atleast185millionnewacres— twicetheareaofGermany—willhaveto be cultivated by 2015, says Philippe de Laperouse, the St. Louis–based direc- tor of the agribusiness practice at con- sulting firm HighQuest Partners LLC. Less than 60 million acres were added during the 10 years through 2005, he says. Global food prices spiked to records in 2008 and again this year, according to a United Nations food in- dex. Prices in August were 26 percent higher than a year earlier, after having peaked in February. Hedge funds, mutual funds, univer- sity endowments and others with little experience in agriculture are buying farms at an unprecedented pace, pour- ing at least $13 billion since the end of 2007 into land or funds that involve ag- riculture, according to London-based Hardman & Co. “These investments are driven by people who put invest- ments together; they aren’t farmers,” says Howard Buffett, the son of Berk- shire Hathaway Inc. Chairman Warren Buffett. The younger Buffett runs a farm in Illinois and is a former director of agricultural behemoths ConAgra FoodsInc.andArcherDanielsMidland Co. in addition to sitting on Berkshire’s board. “It’s a very difficult business, and people really underestimate that.” Some foreign investors have had a tough time in Ukraine, even with the humus-laced black earth—called cher- nozem in Russian—that once made the 76 bloomberg markets November 2011 ‘it’saverydifficultbusiness,andpeoplereally underestimatethat,’sayswarrenbuffett’sson Howard,whofarmsinillinois. Justin Bruch, who ran Golden Fields, says he’s happy to be working in Ukraine for new employer Alpcot Agro.
- 5. region Europe’s breadbasket.Outsid- ers often struggle to appreciate the mind-set of Ukrainian workers, says Yuriy Kosyuk, CEO of Myronivsky Hliboproduct SA, a Kiev poultry and grain producer. “We still have Soviet brains,” the shirt-sleeved Kosyuk says in a room adorned with porcelain chickens at company headquarters. “A lot of people here don’t want a job for the salary. They want it to be able to steal something, or for some prefer- ence or way to get ahead.” Landkom International Plc, based on the Isle of Man, leases 74,000 hec tares, mainly in western Ukraine. It raised 54 million pounds ($111 million) in a 2007 U.K. public offering and has since lost a similar amount, according to its financial reports. Richard Spinks, thecompany’sformerCEO,recallsput- ting 96 people on his payroll for secu- rity. They caught workers with plastic bottles of diesel fuel stuffed in their boots, he says. Landkom said on Sept. 7 that it doesn’t expect to report a pre- tax profit this fiscal year because of a poor rapeseed harvest. Ukraine—which ties with Nigeria, Sierra Leone and Azerbaijan for 134th place in Transparency International’s 2010 corruption perceptions index— wasn’tMorganStanley’sfirsttryatpro- ducing food. The bank also invested in U.S. pig farms, says Brad Hintz, a for- mer Morgan Stanley treasurer who left the company in 1996 and is now an an- alyst at Sanford C. Bernstein & Co. in New York. Morgan Stanley’s merchant banking funds had a controlling stake inPrinceton,Missouri–basedPremium Standard Farms Inc., founded in 1988, according to a filing with the U.S. Se- curities and Exchange Commission. The pork producer ran up $461 million in debt as it in- vested in new hog barns and packing plants while hog prices fell to the lowest levels since the mid-1970s, the fil- ing says. Premium Standard sought bankruptcy protection in 1996. “Itwassoclearthatthiswasa troubledinvestmentthatwhen you would sit in the merchant bankingreviewcommittees,in the back of the room there would always be an associate who would do ‘snort, snort, snort,’” Hintz says, making a noise like a pig. With Ukraine, Morgan Stanley saw a first step into a poten- tial multibillion-dollar crop-growing business, according to people with knowledge of the discussions. Rec ord profits from advising on mergers, underwriting stock offers and selling mortgage-backed securities tied to U.S. housing prices had transformed Wall Street. Banks were opening the throttle on risk taking. Mack, hired in 2005 after execu- tive defections and lagging profits weakened predecessor Philip Purcell, wantedmanagerstoemulateNewYork rivalGoldmanSachsandwagermoreof thefirm’sowncapital,Hintzsays.Mack set aside $2.5 billion for principal investments and encouraged em ployees to come to him with ideas. Mikhail Chernyy, who worked in the bank’s Moscow office, helped propose the investment in Ukraine, according totwopeoplefamiliarwiththecreation of Enselco. Mamontenko, a member of the supervisory board of AKB Finbank in Odessa, says Chernyy called him to suggest a partnership. The company was registered in Kiev on Jan. 11, 2007, amid a two-year surge in food prices thatpeakedinmid-2008.Chernyy,now deputy director of strategy and energy markets at OAO Bashkirenergo, a util- ity in Russia’s Bashkortostan region, declined to comment. Mamontenko led a search for suit- able property for Enselco, of which he was CEO. After the Soviet Union was dismantled in 1991, most of Ukraine’s landwasgiventoitspeopleinplotsthat average 3 hectares and that can’t be sold or used as collateral. Enselco ac- quired 11 operating farms that leased land from thousands of peasants in the Mykolayiv region, where Bruch was a manager, and in the Khmelnytsky re- gion of western Ukraine. The farms produced wheat, rapeseed and other grains and oilseed. “I can imagine the visions of sugar- plums,” says Bove, the Rochdale ana- lyst. He says the bank may have wanted to grow grain to give its traders in fu- turesmarketsanedge,asithasincrude oil by chartering tankers. Bruch, the farmer from Iowa, was finishing a Master of Business Ad ministration at California State Uni- versityinFresnoin2007whenMorgan 78 bloomberg markets November 2011 Goldengrain An index of wheat, corn and rice prices approached its 2008 high this year. 300 250 200 150 100 2006 2007 2008 2009 2010 2011* *ThroughAug.31. Source: United Nations Food and Agriculture Organization FAO Cereal Index ‘Alotofpeopleheredon’twantajobforthe salary,’theceoofakievgrainproducersays. ‘theywanttobeabletostealsomething.’
- 6. simoncrofts;MapSbyDavidFoster Stanley called. He’dgotten a taste for international farming in Brazil, where he worked with his brother running a 1,250-acrefarminthestateofBahia.In Ukraine, Bruch says, he was struck by the timelessness of a place where on some plots women still drop seeds by hand behind horse-drawn plows. “When you come from Iowa, you’re naive,” Bruch says on a rainy afternoon by a wheat field owned by his current employer, Stockholm-based farm in- vestment company Alpcot Agro AB. He soon learned that the ancient land- scape hid a bureaucracy little changed from Soviet days. The red tape begins with bringing equipment into Ukraine. Most coun- tries require one piece of paper for im- ports, says Joseph Gooch, an Indiana farm equipment broker. He loaded five containers for Morgan Stanley’s Ukraine operations in 2008. Included were a 500-horsepower John Deere 9620 tractor, a 300-hp John Deere 8430, a self-propelled sprayer and two grain-bagging systems. He says that in Ukraine, importers need a “certificate of quality,” a “certificate of origin,” a packing list and a “pro forma” invoice. “The Communist mentality just hasn’t died,” Gooch says. On the farm, Bruch was facing a rash of thefts. “It’s mind-boggling what peo- ple will steal from you,” he says. “The chemicals don’t go in the sprayer, they go in the back of someone’s Lada and are sold to a neighbor down the road.” Bruch says he didn’t mind losing a few gallons of insecticide; what con- cerned him was the wheat that might notgrowbecausehedidn’thaveenough to cover the last few acres. After the 2008 harvest, his doubts increased. Bruch wondered whether whole truck- loads of wheat had been pilfered. “I would look at a wheat field and know that it was about a 4½-ton field, that I had a good crop,” he says, point- ing to a steel grate where trucks pour in grain after it has been weighed. “Then it comes across the scale at 3¼ tons, and I would lie awake at night and wonder was I way off or did that wheat get stolen? I’ll never know.” Still, yields weren’t bad; some wheat fields came in at 5.2 tons a hectare and somerapeseedat3tonsahectare,above the average in Ukraine, Bruch says. The larger concern was the bank’s dispute with its partner, he says. “I didn’t have the brains to see what a problem that 80 bloomberg markets November 2011 Golden Fields in the Mykolayiv region was one of 11 parcels in Morgan Stanley’s farm venture. Sea of Azov RUSSIA ROMANIA POLAND BELARUS MOLDOVA UKRAINE Mykolayiv Khmelnytsky Black Sea unhappyharvest Golden Fields farm was part of Morgan Stanley’s failed plan to cultivate agricultural profits in two Ukrainian regions, where the soil is among the richest on Earth. Golden Fields farm Kiev Odessa
- 7. would be,” saysBruch, declining to be more specific. By 2008, Morgan Stanley was spar- ring with Mamontenko, according to two people familiar with the situation. Enselco was owned by Venusaur Hold- ings Ltd., a Cyprus–based firm whose sole shareholder was Mamontenko, ac- cording to documents in the Depart- ment of the Registrar of Companies in Nicosia. Venusaur pledged 100 percent of the equity in Enselco as collateral to Morgan Stanley, the documents show. The bank questioned Mamontenko’s decisions, people familiar with the matter say. Enselco bought chemicals from intermediary companies that charged markups and sold crops to middlemen at prices below market lev- els, according to three of these people, who declined to be quoted by name be- cause they don’t have documents to prove the markups. Mamontenkosayshewasn’taffiliated with intermediaries and coordinated priceswithMorganStanleyofficials.He says he had a good relationship with the bank.Leaningoveradark-woodtablein hisFinbankofficeinOdessa,hesaysthe market panic following Lehman’s Sep- tember 2008 collapse caused the bank to bow out. “The biggest problem was the financial crisis,” says Mamontenko, his white shirt open to reveal a tanned chestwithathickchainandagoldcross. “That spoiled everything. Without that, we’d be farming 200,000 hectares now.” By the end of the 2008 harvest, Mor- gan Stanley was cutting its far-flung in- vestments as fast as it had been making them. Mack reduced leverage—a mea- sure of how extensively a firm is using borrowed money to enhance returns on shareholders’ capital—to 11 times by the endofMarch2009fromalmost28times a year earlier, according to bank figures. The Ukrainian farms went out the door in July 2009 when Enselco was sold to JadenFinch Ltd., a firm that invests on behalf of oil trader Robert Finch and his family. Kernel Holding SA, Ukraine’s largestsunfloweroilproducer,agreedon Sept. 9 to an option to buy Enselco for $52.3million. The bank’s shares haven’t recovered. So far this year, the stock has dropped 45 percent through Sept. 12, closing at $15.05 that day—or one-fifth of its $74.13 peak in June 2007. James Gorman took over as Mor- gan Stanley’s chief executive in Jan- uary 2010. Mack, who’d stayed on as chairman, will end that role on Jan. 1, making Gorman both chairman and CEO. The bank wrote down all but $40 million of its $1.2 billion invest- mentinahalf-builtAtlanticCitycasino last year—another sign it’s getting back to the business of banking. Bruch is in his element too. Fishtail- ing up a muddy track in a red Lada, he points to the wheat and rapeseed fields he’s cultivating for Alpcot. After losing money for three years, the com- pany, which specializes in the black- earth belt of Russia and Ukraine, said on Aug. 31 that it had turned its first operating profit in Ukraine. “I just want to raise the best crops I can for the best value,” Bruch says. “Now I just focus on raising crops.” The bankers at Morgan Stanley, who once fancied themselves farmers, learned how hard that can be. Alan Katz is a projects and investigations reporter in Paris. akatz5@bloomberg.net Peter Robison is a projects and investigations reporter in Seattle. robison@bloomberg.net With assistance from Seth Lubove in Los Angeles, Bradley Keoun, Beth Jinks and Michael J. Moore in New York, William Davison in Addis Ababa, Daryna Krasnolutska and Kateryna Choursina in Kiev and Stelios Orphanides in Nicosia. To write a letter to the editor, send an e-mail to bloombergmag@bloomberg.net or type MAG <Go>. 82 bloomberg markets November 2011 You can use the Global Agriculture Pricing (AGGP) function to compare prices for crops in Ukraine with prices around the world. Type AGGP <Go>. Click on the arrow to the right of the field in the upper-left corner and select Sample if it’s not already selected. Next, click on the arrow to the right of the second field and select Global Wheat Prices, for example. Scroll down to Ukraine in the table. Click on Milling Wheat (11.5%) and select Chart Histor- ical Spot. To chart additional prices such as the futures contract that trades in Chicago, click on the box to the left of its name. JON ASMUNDSSON Ukrainian Wheat Prices BloombergTıps ‘Thebiggestproblemwasthefinancialcrisis,’ saysaleksandrmamontenko,morganstanley’s ukrainepartner.‘thatspoiledeverything.’