!Morgan Stanley’SUkrainian

MiSadventUre

N ov e m b e r 2 0 1 1 b lo o m b e r g m a r k e ts 73

The New York bank envisioned gold in the black soil of the former Soviet republic’s grain farms. Its foray into agriculture came up fallow.BY AlAn KAtz aNd Peter robisonI L LU ST R aT I O N BY AleXi nAbAUM

sim

on

cr

oft

s

iowa native JUStin BrUch marveled at the opportunity when Mor-gan Stanley called in late 2007 to recruit him for an unusual assignment. The New York bank, flush with $7.5 billion in fiscal 2006 profit—the biggest in its his-tory—was going to be farming 11 parcels on the steppes of Ukraine. The com-modities team wanted Bruch, a redhead with meaty hands who’d been farming all his life, to manage one of them.

Bruch saw a chance to dig into some famous dirt. The former Soviet republic 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 office buildings in Dallas, Las Vegas, 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 inspectors and trying to satisfy officials who wanted him to build roads, not just till fields. He left the farm, called Golden Fields, in June 2009 to man-age a Ukrainian farm owned by another 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 to an investment firm based in Jersey in

74 b lo o m b e r g m a r k e ts N ov e m b e r 2 0 1 1

aleksandr mamontenko served as morgan stanley’s local partner in Ukraine.

‘The SOIL aNd pOTeNTIaL fOR cROpS ThaT UkRaINe haS IS The BeST IN The wORLd,’ SaYS BRUch, whO faRmed TheRe fOR mORgaN STaNLeY.

ala

n k

atz

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 embrace diverse projects with unfamil-iar risks. By 2007, banks were investing in everything from casino development 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

through Freedom of Information Act re-quests, litigation and an act of Congress. It also got a $10 billion capital infusion in October as part of a $700  billion government bailout of the industry.

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, at least 185 million new acres—twice the area of Germany—will have to 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 Foods Inc. and Archer Daniels Midland 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 b lo o m b e r g m a r k e ts N ov e m b e r 2 0 1 1

‘IT’S a veRY dIffIcULT BUSINeSS, aNd peOpLe ReaLLY UNdeReSTImaTe ThaT,’ SaYS waRReN BUffeTT’S SON hOwaRd, whO faRmS IN ILLINOIS.

Justin bruch, who ran Golden fields, says he’s happy to be working in Ukraine for new employer alpcot agro.

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, the company’s former CEO, recalls put-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’t Morgan Stanley’s first try at pro-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 in Princeton, Missouri–based Premium 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.

“It was so clear that this was a troubled investment that when you would sit in the merchant banking review committees, 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, under writing 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, wanted managers to emulate New York rival Goldman Sachs and wager more of the firm’s own capital, Hintz says. 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 to two people familiar with the creation 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 that peaked in mid-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 land was given to its people in plots that 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-tures markets an edge, as it has in crude oil by chartering tankers.

Bruch, the farmer from Iowa, was finishing a Master of Business Ad-ministration at California State Uni-versity in Fresno in 2007 when Morgan

78 b lo o m b e r g m a r k e ts N ov e m b e r 2 0 1 1

Golden GrAinAn index of wheat, corn and rice prices approached its 2008 high this year.

300

250

200

150

1002006 2007 2008 2009 2010 2011*

*through aug. 31.

Source: United Nations Food and Agriculture Organization

Fao Cereal Index

‘a LOT Of peOpLe heRe dON’T waNT a jOB fOR The SaLaRY,’ The ceO Of a kIev gRaIN pROdUceR SaYS.

‘TheY waNT TO Be aBLe TO STeaL SOmeThINg.’

sim

on

cr

oft

s; m

aps

by

Dav

iD f

ost

er

Stanley called. He’d gotten a taste for international farming in Brazil, where he worked with his brother running a 1,250-acre farm in the state of Bahia. 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 not grow because he didn’t have enough 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 some rapeseed at 3 tons a hectare, 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

8 0 b lo o m b e r g m a r k e ts N ov e m b e r 2 0 1 1

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

UnhAPPy hArvestGolden 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

would be,” says Bruch, 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.

Mamontenko says he wasn’t affiliated with intermediaries and coordinated prices with Morgan Stanley officials. He says he had a good relationship with the bank. Leaning over a dark-wood table in his Finbank office in Odessa, he says the 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 chest with a thick chain and a gold cross. “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

end of March 2009 from almost 28 times 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 largest sunflower oil producer, agreed on Sept. 9 to an option to buy Enselco for $52.3 million.

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-ment in a half-built Atlantic City casino 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>.

8 2 b lo o m b e r g m a r k e ts N ov e m b e r 2 0 1 1

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

bloomberg tıps

‘The BIggeST pROBLem waS The fINaNcIaL cRISIS,’ SaYS aLekSaNdR mamONTeNkO, mORgaN STaNLeY’S UkRaINe paRTNeR. ‘ThaT SpOILed eveRYThINg.’