Article by Aleksei Nikolskiy, Elena Mukhametshina, Olga Churakova, Svetlana Bocharova for Vedomosti. Translated by Claire Haffner.
On 6 March Vladimir Putin is scheduled to visit Uralvagonzavod (UVZ), where he will take part in a forum for young workers. UVZ – the only tank manufacturer in the country – became a symbol of support for Putin during his 2011-2012 election campaign, which was met by mass protests. During Putin’s annual “Direct Line” live Q&A, Igor Kholmanskikh, head of assembly of military hardware, suggested that if the police couldn’t keep the protests in check, they should take to the streets “with their muscle” and “defend stability, but, of course, within the limits of the law”. After the May 2012 elections, Kholmanskikh was appointed presidential envoy of the Ural Federal District. However, it wasn’t the president who was most in need of help, but UVZ. The symbol of the Russian defense industry was mired in debt and found itself on the brink of collapse. In order to save the company, it had to be transferred to Rostec and have its leadership overhauled. But most importantly, transport operators had to be made to buy the company’s main civilian products: railroad cars.
From T-34 to T-72
UVZ was built in the 1930s in Nizhny Tagil to manufacture railroad cars, becoming one of the country’s first machine-building enterprises with a steady flow of production. During World War II, UVZ took on a tank factory evacuated from Kharkov along with about 10 other enterprises. As a result, the factory was forced to cut production in all areas one after the other, freeing up space for the enterprises that had been evacuated to Nizhny Tagil from the new Ural tank factory No. 183. The factory became the largest manufacturer of T-34 tanks, producing 25,266 units before the end of the war.
After the war, the design bureau created several models of tanks, including the T-72, the largest tank in the world since the 1970s. Simultaneously, UVZ was developing railroad cars, tractors, and road equipment. But a severe crisis awaited the business in the 1990s: railroad car production dropped, and the Russian army stopped buying tanks. Furthermore, the only major export contract for T-72 tanks to Iran was unable to be fulfilled due to Russia’s 1995 agreement with the US, in which Russia agreed to stop selling conventional weapons to Iran under the so-called Gore-Chernomyrdin protocol.
Today, however, UVZ is the only tank manufacturer in the country, as the other remaining Russian tank factories in Omsk and St. Petersburg have closed. In 2007 UVZ was reincorporated as a joint-stock company, and in 2008-2009 state-owned stocks in Factory No. 9 (a manufacturer of artillery systems) were transferred to UVZ along with the Ural Design Bureau of Transportation Engineering (UKBTM, the head design bureau for tank development), Electromashina (manufacturer of control systems and driving), Omsktransmash (the former manufacturer of T-80 tanks), and a number of other design bureaus and enterprises. This decision was explained by the “difficult financial and economic situation of the enterprise”. What, then, was the cause of the crisis? What kind of production – military or civilian – dragged it down?
In the early 2000s, UVZ’s military production was saved by an Indian contract signed in 2001 for 310 model T-90S tanks – the future upgrade of the T-72. Another contract with India was signed in 2004 for approximately 350 tanks, and in 2006 an agreement was reached to license their production in India. However, the company didn’t receive enough orders for armed vehicles in the second half of the 2000s, and in 2011 the Russian army refused to buy the new T-90 tanks, deeming them not up to current standards.
In the crisis of 2008-2009, UVZ also saw a sharp drop in demand for railroad cars. Yet the President came to their rescue, giving the company a 25 billion ruble subsidy.
But in 2012, a new crisis began for UVZ. The main cause was “the barbaric extension of the operating life of railcars without manufacturer consent”. According to a source close to former top management at UVZ, the railcars’ operating lifetime was extended by 5-7 years. This extension took place “on paper” despite the fact that their technical certificates indicated a service period of 22 years. This led to a drop in demand for new railcars produced by UVZ. In order to salvage the situation and prevent railcar production from being shut down, UVZ created its own operating company, UVZ Logistics, and became a loan guarantor for the purchase of the railcar company from itself. This led to a rapid increase in the company’s debts, though it allowed UVZ to continue production.
The second factor in the crisis was the spike in the exchange rate in 2014-2015 and the growth of interest rates on loans; the company’s total debt at that moment amounted to 182.6 billion rubles. But the surplus of railcars on the market led to a drop in daily railcar rents from 1,500 to 300 rubles. The company again found itself on the verge of collapse. In 2016 following presidential orders, the Ministry of Industry and Trade forbade railway operators from extending the service life of railcars – they had to phase out the old cars and begin buying new ones. This gave the factory new orders to fulfill, and interest rates on loans had already started to decline.
Why Rostec appeared on the scene
In September 2016, Deputy Prime Minister Dmitry Rogozin, who oversees the military industrial complex, wrote a letter to President Putin expressing his dissatisfaction with UVZ’s work and its CEO, Oleg Sienko. He explained the need for personnel changes in the company’s difficult financial and economic situation, and the threat this posed to fulfilling state defense orders. The company’s net debt by midyear 2016 amounted to 276 billion rubles, with 43.1 billion rubles of revenue for that period. Rogozin proposed transferring 100% of UVZ’s shares to the state corporation Rostec.
In December 2016, Putin signed an order authorizing the transfer of 100% of UVZ’s design bureau to Rostec. “We need to conduct financial rehabilitation since there are fairly sizeable debts. They’re mostly due to the creation of UVZ Logistics, which bought cars for itself, since RZhD hadn’t bought them for two or three years in a row. This was done in order to keep production going,” Sergei Chemezov, CEO of Rostec said at the time. In March of the following year, Aleksandr Potapov, the former Deputy Minister of Industry and Trade, became the new CEO of UVZ.
Sienko’s successor from Rostec has not changed the company’s previous development program which runs through 2025 and has made no fundamental changes to the plans adopted under Sienko, according to a manager of one of UVZ’s contractors. However, new management did “reduce overhead costs” in its work with contractors, and many entrepreneurs, fearing that they wouldn’t be paid again, now only work for UVZ on the condition of advance payment. Workers’ wages – for example in Department 563, where the case was taken to court – are actually dropping. A Vedomosti correspondent says that it seems no coincidence that the Rostec team arrived just as UVZ’s financial situation began to improve overall, though a UVZ representative countered that prices in that department dropped because production was modernized. The company won all its court cases, and in April there will be а 5.76% indexation of salaries to compensate workers in full for their previous losses.
How UVZ was ruined
You could say that UVZ was ruined by railroad cars and trucks, and its hopes for state support in the form of stricter market regulations over several years were not realized, as suggested by Viktor Murakhovsky, editor of the journal Arsenal of the Fatherland. According to Murakhovsky, most of UVZ’s debts are due to investments in the manufacture of civilian products, primarily railroad cars, as well as road and construction equipment. As for military production, loans for its development (including the construction of new workshops and the purchase of machinery) were taken under state guarantees and were mostly repaid by the state in 2016, Murakhovsky continues.
UVZ’s problems were due to a strategic error. According to Mikhail Burmistrov, CEO of the Infoline Analytics agency, the company was late in transitioning to production of innovative railcars and developing service capacities for their maintenance. UVZ had the opportunity to become not only the first, but also the largest manufacturer of innovative cars (the models appeared in 2009), but during periods of high demand in 2012-2014 the company didn’t make a full transition, instead continuing to issue standard cars that were simpler to produce in terms of manufacturing technology.
According to a source close to UVZ, Sienko had made mistakes in the beginning when his team “sped up production” and met a glut in the market. The “railcar crisis” of 2014-2016 coincided with sanctions as well as the need to modify production for the new T-14 Armata tank, on which a number of contracts depended and which required a switch from Czech to Russian and Chinese equipment. However, Sienko and his team were gradually able to sort out this mess, our correspondent reports.
Nevertheless, UVZ’s biggest challenges in 2015-2017 were its high level of debt and the unprofitability of its transport business division, UVZ Logistics, in addition to its failure to fully utilize the devaluation of the ruble to increase revenues from export sales in 2015-2017, Burmistrov summarizes.
Potapov and Sienko declined to comment.
Since 2012, there have been no new purchases of T-90 tanks for the Russian Armed Forces, says Mikhail Barabanov, an expert at the Center for Analysis of Strategies and Technologies. Barabanov believes that UVZ’s main tank production profits come from exporting T-90S tanks to Azerbaijan and Algeria, and more recently, to Iraq and Vietnam. According to a source close to Rosoboronexport leadership, since 2011, more than 300 new T-90S tanks have been contracted for export to Algeria, 44 to Uganda, 200 to Azerbaijan, and in 2016-2017 alone, about 60 were slated for Vietnam and 200 for Iraq. In 2017, UVZ produced approximately 100 tanks for export.
The situation is different for other military manufacturing corporations (such as Uraltransmash, manufacturer of Msta-S and Koalitsiya-SV artillery systems, Omsktransmash, and the Burevestnik artillery design bureau in Nizhny Novgorod oblast), although the enterprise’s head design bureau – UKBTM in Nizhny Tagil – will most likely receive state funding to develop Armata tanks, Barabanov believes.
Military production has been breaking even for years, continues Murakhovsky, even though it’s a non-market sector. It’s necessary to keep in mind that the principle of “cost recovery” in price setting for military products makes it possible to break even by putting out 10 tanks a year if the Ministry of Defense accepts and reimburses all of the company’s costs, Murkahovsky points out.
According to a Vedomosti source close to former top managers, UVZ’s military production has always been cost effective. The question was rather about the norm of profitability – management considered a level of at least 10-20% to be necessary, while in reality profits were at 0.5-2%. At that time, this was enough to fulfill state defense orders, and export orders were especially profitable.
UVZ’s military production prospects are tied to a new unifying platform on the basis of which T-14 Armata tanks, heavy infantry fighting vehicle (IFV) T-15, and armored recovery vehicle (BREM) T-16 are being created. There are plans for about 100 of these machines to undergo field tests in 2018-2019, with serial production set to begin in 2020, but it is possible that these dates could shift depending on trial outcomes, Murakhovsky says. This is a complex and revolutionary project, with the Russian army’s total needs amounting to approximately 3,000 T-14s, 200-250 BREMs, and up to 1,000 T-15 IFVs, according to Murakhovsky’s estimates. Prior to launching production of a new generation of machines, UVZ is busy upgrading its existing tanks, which allows it to maintain its core operations as well as subcontractors. This includes a contract for the delivery of upgraded T-80 BVM and T-90M tanks as well as tank support combat vehicles (BMPT). The delivery of T-90M and BMPT to the Russian army could stimulate exports, Murakhovsky concludes.
It was a mistake for the Ministry of Industry and Trade to cancel the 2016 Russia Arms Expo in Nizhny Tagil, relocating it to Patriot Park outside of Moscow, believes a source close to top management at UVZ. It was the only exhibition in the world permitting live-fire demonstrations of weapons in motion and, despite sanctions, was still very important for marketing UVZ’s products. Officially, the expo was closed in an effort to save money, but this was not something worth skimping on, a Vedomosti correspondent points out.
As for the railroad cars, the new UVZ management is implementing a set of measures aimed at increasing the efficiency of the business, Burmistrov says. A number of unprofitable licensing contracts have been closed, the company has begun concentrating its efforts on developing upgraded cars for service, and it cancelled without penalty a gondola lease contract with the joint-stock company Federal Freight (FGK), thus increasing the attractiveness of UVZ Logistics. These measures, combined with the growth in demand for rolling stock, make it possible to forecast that the company will be profitable by the end of 2018, Burmistrov says.
After its transfer to Rostec, the corporation has seen steady growth in production, with the share of non-military production reaching 43%. Revenues are expected to grow by 13% to 69 billion rubles, and the company is on track to turn its first profit in 2018, a UVZ representative says. The company began to rid itself of non-essential assets and found a buyer for UVZ Logistics, though the representative declined to give the buyer’s name. In February 2018, Chemezov promised that UVZ would attract private investors in the future, but this won’t happen for at least another three years. Rostec declined to comment.