Rough Landing: What the Transaero Saga Tells Us About Russia’s Economy

The death of airline Transaero is an unfortunate microcosm of everything wrong with Russia’s business climate. 

May 18, 2015

By: Aaron Schwartzbaum                                  

On October 1, 2015 Russian Prime Minister Dmitri Medvedev announced that Transaero, Russia’s second largest airline, would go bankrupt. Though the story did not receive much play in Western media, it is both fascinating and highly indicative of the uncertain state of the Russian economy. Especially for investors mulling a return to the Russian market, the past year for local civil aviation has been a microcosm for much that has changed about Russia’s economy as a result of its ongoing crisis – and much that has not.

A Bird’s Eye View

From a business standpoint, Transaero’s downfall represented a perfect storm. The company, an early post-Soviet success story, had been built up from a single aircraft and 500,000 rubles, and is credited for having introduced Western customer service standards (and planes) to the Russian market. Between 2002 and 2010, its passenger load increased by more than 1000 percent, while its revenue exploded by more than 700 percent, and its fleet doubled in size between 2010 and 2013.

Unfortunately for the company, the timing of its recent expansion proved fateful. The ruble’s collapse and overall economic downturn in 2014 hit both the company’s revenue and cost lines. Regarding the former, Russians, facing a 10 percent contraction in real income in 2014 (one that has continued since), stopped spending on luxury goods such as air travel. And with the ruble losing almost half its value, the company found itself unable to pay aircraft leases, which are denominated primarily in dollars.

The most direct consequence of the bankruptcy for Russian civil aviation has been continued market consolidation, namely under state-owned Aeroflot, which now enjoys a market share of more than 50 percent. To be sure, this has been a mixed blessing for the airline, which took an $89 million loss for 2015, due in part to being forced to take on stranded Transaero passengers. And that is an improvement from 2014.

This episode ties into a broader trend: Russia’s economic crisis has seen state-owned companies thrive (or suffer less) while smaller, privately owned businesses – often the key innovators in any economy – have struggled. The net effect is a retrenchment of the role of the state in Russia’s economy. Indeed, when Transaero’s difficulties began, it immediately approached the government for relief, which was provided in the form of a $166 million loan from state-owned VTB bank.

Turbulent Rule of Law

Transaero’s descent into insolvency makes clear the profound vagueness of Russian bankruptcy law. Two attempts to save the company failed: the first, state-backed attempted takeover by Aeroflot – for the symbolic price of a ruble – was nixed by Transaero shareholders, while another attempt by S7 airlines met a similar fate. The latter attempt was not helped by the fact that the government revoked Transaero’s operating license prior to the deal falling through.

At one point, two separate groups of creditors rushed to file a bankruptcy suit (as opposed to Transaero filing for protection – such practice is common under Russian law), while Aeroflot retained operational control of the airline, despite not owning a stake in the company. Soon after, Aeroflot and the Pleshakovs, owners of Transaero, had named different CEOs of the company. The bankruptcy saga – one that remains ongoing as of this writing – also saw the involvement of oligarch Mikhail Prokhorov and a Rosneft daughter company, both creditors of Transaero, weigh in. The case ultimately lead to a number of Western airlines adopting second-hand aircraft from a Russian company, in stark contrast to the typical flow of equipment in the industry.

As the Kremlin aims to return life to an economy that faces long-term structural stagnation, boosting investment will be of paramount importance. Creating a clear procedure for bankruptcy, and one that offers entrepreneurs a greater degree of protection, would undoubtedly be a boon for investment. Unfortunately, though such a step is necessary, it is not sufficient to fix the problem.

Spiral of Corruption

The saga’s most bizarre chapter began on November 4, when the Interstate Aviation Committee (IAC), the post-Soviet equivalent of the U.S. National Transportation Safety Board (NTSB), released a letter temporarily revoking the certificates for all Boeing 737s in Russia, citing a vague safety concern being evaluated with the Federal Aviation Administration. The grounding would have had a colossal impact on Russian aviation: half of Transaero’s fleet, regardless of its operator, would have been grounded, and Pobeda (Victory), Aeroflot’s domestic low-cost carrier, would have been unable to fly its entire fleet. As the aviation community struggled to make sense of the letter, it emerged that the chair of the IAC, Tatyana Anodina, is the mother of Aleksandr Pleshakov, Transaero’s founder. According to the report, the two share a villa in France, and at least until recently, she was a Transaero shareholder. The request by the IAC was annulled the next day, which for unexplained reasons, was announced by Natalia Fileva, head of S7. A headline in Vedomosti on the topic effectively summarizes the episode: “Transaero Owners Strike Back.” Moreover, the discovery of accounting irregularities in the run-up to the airline’s appeal for state support does not do much to help the company’s image.

Needless to say, to have a major oversight agency chaired by the mother of the owner of a key market player raises an eyebrow and numerous questions. And unfortunately, more recent events have not suggested the emergence of a friendlier operating climate. In April, the owner of Domodedovo Airport, the second largest airport in Russia, was arrested five years after a terrorist attack there. The charges surround improper implementation of security protocols, although as is frequently the case, these guidelines were vague. Early reports suggest high-level interest in consolidating state control over Moscow’s air transit infrastructure. On an interesting note, the ownership structure of the airport remains largely a mystery.

Departing Thoughts

The death of Transaero was, and continues to be, an unfortunate microcosm of everything wrong with Russia’s business climate. The events surrounding the airline’s bankruptcy seem confusing, and that is exactly the point: both domestic and international investors have watched what ought to be a routine business procedure spiral out of control, and it is hard to imagine this inspires their confidence.

For Western policymakers, the case demonstrates that sanctions may ultimately exacerbate the impact of low oil prices on free enterprise. While sanctions are ultimately not what caused Transaero’s decline – although they most certainly cut off a potential line of credit – they boost Russia’s state capitalist system, which is arguably the exact opposite of their intended effect. And for Russian leadership, the case makes clear the immense challenges faced in improving the operating environment for businesses both foreign and domestic. There remains, in short, much to be done before Russia’s economy can take off.

 



Aaron Schwartzbaum
is a 2015-2016 Rising Expert at CGI and a researcher at Eurasia Group, on the Eurasia and Global Macro teams. Prior to joining Eurasia Group, he worked at International Investment Partners, a boutique investment banking firm in New York that operates in the mining and minerals sector and Ukraine. Follow him on Twitter at 
@aaron_schwa.

The views and opinions expressed in this article are those of the author alone and do not reflect the position of the affiliated organizations or the Center on Global Interests.

Comments Off