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Special Report: Sanctioned weapons mogul who supplied Russia’s troops has ties to Philip Morris

Stock Markets Apr 21, 2022 08:29AM ET
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11/11 © Reuters. FILE PHOTO: Russian billionaire Igor Kesaev delivers a speech during a ceremony to present The Mercury City Tower as Europe's tallest skyscraper in Moscow, November 1, 2012. REUTERS/Sergei Karpukhin/File Photo 2/11

By Chris Kirkham, Richa Naidu, Sergiy Karazy and David Gauthier-Villars

(Reuters) - A longtime Russian business associate of American tobacco giant Philip Morris International Inc (NYSE:PM) - a billionaire whose holdings have included a major stake in a weapons plant supplying Russia’s military - has been sanctioned in Europe for aiding Russia’s invasion of Ukraine, according to a Reuters review of business registries and sanctions lists.

Igor Kesaev, 55, listed by Forbes as Russia’s 35th-richest person last year, was sanctioned April 13 by the United Kingdom and on April 8 by the European Union. The EU noted in its sanctions document that Kesaev’s holdings in tobacco distribution and weapons production are funneling “substantial” revenue to the Russian Federation to fund its “destabilisation of Ukraine.”

Kesaev owned a 49% share in the V.A. Degtyarev plant, located 165 miles northeast of Moscow, which makes machine guns, anti-tank and anti-aircraft weapons that are sold to the Russian military and countries in the Middle East, North Africa and Latin America, according to Russian business records as of Dec. 31 and the plant’s website. The plant is known for producing Kalashnikov PKM and PKTM machine guns, as well as Kord rifles and machine guns, some of which are mounted on armored vehicles. Kesaev’s interest in the weapons business dates back to at least 2012, Degtyarev’s corporate filings show.

Kesaev spokesperson Anatoly Shiryaev told Reuters in an emailed statement Wednesday that Kesaev “currently is not a shareholder” in Degtyarev and “isn’t part of its management.” Shiryaev didn’t respond to follow-up questions or requests to provide documentation of Kesaev’s exit from the arms business.

The Degtyarev plant’s 2021 annual report - released April 14 - listed Kesaev as holding a 49% stake in the factory. Alexander Tmenov, the plant’s general director, referred to Kesaev as “our main shareholder” in an in-house publication dated March 16 and posted on the Degtyarev facility’s website. In its April 8 sanctions document, the EU referred to Kesaev as “the major shareholder of Degtyarev Plant.”

Until recently, Kesaev was also the board chairman of a sprawling Russian tobacco distribution company, TC Megapolis JSC. And he was a board member of that firm's Dutch holding company, in which Philip Morris, maker of Marlboro cigarettes, has a 23% stake. Kesaev resigned both posts April 11, according to Philip Morris and a TC Megapolis JSC press release.

He retains ultimate control of Megapolis, however, according to the EU. In its sanctions statement, the EU said Kesaev is the president and owner of Mercury Group, which owns Megapolis, “the leading tobacco distributor in Russia.”

In his emailed statement, Kesaev spokesperson Shiryaev said the businessman “isn’t part of the Megapolis Group’s management and therefore doesn’t comment on Megapolis' relations with (Philip Morris).”

Reuters couldn’t determine the size of Kesaev’s stake in the holding company, Megapolis Distribution BV. A December report from Russia-focused business news service Interfax said Kesaev and a longtime business associate, Sergei Katsiev, together owned 52.8%. The April 11 Megapolis press release said Kesaev is not a controlling or majority shareholder in the distribution company or any of its subsidiaries, and that he doesn’t influence or make decisions about the business.

Philip Morris’ ties with Kesaev date to the early 1990s, when the entrepreneur helped the American firm navigate post-Soviet Russia and tap its coveted market of heavy smokers, according to news reports. That relationship could now prove a public-relations nightmare for the company. Images of Russian armaments pounding Ukraine have horrified much of the world, putting pressure on Western brands to cut ties to Russia and the oligarchs who dominate its economy - much less one with a track record of supplying arms to Russia’s military.

There’s “a reputational risk. Like, 'what the hell is Philip Morris doing dealing with this guy?'" said Daniel Fried, a former U.S. diplomat who coordinated sanctions policy for the Obama administration following Russia’s 2014 annexation of Crimea.

The Degtyarev weapons factory has referred to standing contracts to supply Russia’s navy, air force and ground forces in press releases on its website.

Reuters was unable to confirm definitively whether weapons made at the plant are being used in Russia’s invasion of Ukraine, though evidence pieced together by the news agency supports that conclusion.

Philip Morris in an emailed statement said the company and its subsidiaries “comply with all applicable sanctions.” The multinational said it has already taken steps to scale down its operations in Russia and was working on options to exit in an “orderly” fashion. It provided no timeline or additional details on how such an exit would work. Philip Morris said last month it had suspended all marketing activities in Russia, was canceling all new product launches there, and that it had discontinued some products, though it did not specify which ones.

In a March statement about the situation in Ukraine, Philip Morris International Chief Executive Jacek Olczak said of his company: “We stand in solidarity with the innocent men, women and children who are suffering.”

Over the past three decades, Kesaev’s distribution muscle has helped Philip Morris, the world’s largest tobacco company by market capitalization, win more than a quarter of Russia’s cigarette market. Russia generated revenue of more than $1.8 billion last year for Philip Morris, around 6% of the New York-based company’s global sales, the firm’s financial and press statements show. Philip Morris’ factory outside St. Petersburg is the largest in its global empire, according to the company website.

Russian President Vladimir Putin has repeatedly decried Western sanctions on his country and some of its business titans. Last month he called these penalties an attempt “to deliver a blow to our entire economy, our social and cultural sphere, every family and every Russian citizen.”

Russia has portrayed its invasion of Ukraine as a “special operation” to demilitarize and “denazify” its much smaller, democratic neighbor.

While Reuters couldn’t substantiate conclusively that Russian fighters in that conflict are using weapons from the Degtyarev arms factory, evidence from Ukraine appears to support that determination. The news agency examined part of a Kord machine gun this week at a Kyiv auto mechanic shop that repairs Russian weapons recovered from the battlefield for re-use by Ukrainian fighters. The part was likely manufactured at the Degtyarev plant, according to independent weapons expert Damien Spleeters of the London-based research group Conflict Armament Research, which traces weapons in war zones.

Spleeters examined photos of the Kord machine gun provided by Reuters. He said that particular Kord weapon is a type found mounted on tanks, armored personnel carriers and other fighting vehicles. It bore identifying numbers, etched into the metal. The shapes and style of those numbers matched those of etchings found on a high-caliber rifle that Conflict Armament Research examined in Ukraine in 2018. The research group determined at the time that the rifle - an ASVK typically used to destroy military equipment - was produced at the Degtyarev plant.

"It’s pretty striking, the similarity between the characters there," Spleeters said.

He added it was “very likely” that other machine guns from the Degtyarev plant are being used on Russian fighting vehicles in Ukraine.

One of the Kyiv mechanics, Oleksandr Fedchenko, told Reuters in March that he and a team of welders and engineers conferred with Ukrainian soldiers on the front lines, who removed weapons from disabled Russian tanks and brought them back to his auto repair shop.

It’s unclear how recently the Kord machine gun was manufactured, and Reuters could not independently corroborate the mechanics’ accounts that the weapons were recovered from invading Russian forces.

‘DIRTY MONEY’

For Ukrainians, Kesaev’s tobacco and arms businesses have been inextricably linked.

In 2014, Ukraine’s pro-Russian president, Viktor Yanukovych, was toppled in a popular uprising, leading to Russia’s annexation of Crimea later that year. Ukrainian officials, meanwhile, began scrutinizing the role of Russian companies in various sectors of its economy.

At the time, the firm Trading Company Megapolis-Ukraine was by far the country's largest tobacco distributor, controlling 99% of the market, according to research from the Anti-Monopoly Committee of Ukraine, the nation’s top competition regulator. Ukrainian authorities started drawing attention to Megapolis’ ties to Kesaev and Russian weapons production.

Kyiv sanctioned Kesaev in 2016 for unspecified actions it said threatened Ukraine’s national security. A top Ukrainian prosecutor later accused Kesaev of supporting “terrorist organizations” by supplying arms to Russian-backed separatist groups that have been fighting for nearly a decade to carve out two independent states - Donetsk and Luhansk - in resource-rich eastern Ukraine.

Representatives of the self-proclaimed Donetsk People's Republic did not respond to requests for comment, while representatives of the self-proclaimed Luhansk People's Republic could not be reached for comment.

Yaroslav Yurchyshyn, a member of the Ukrainian Parliament and former head of the Ukrainian branch of the anti-corruption nonprofit Transparency International, said multinational companies that continue to do business with Kesaev are helping to fuel Moscow’s war machine.

“These are the people who are responsible for the…aggression, for more deaths of Ukrainian people,” Yurchyshyn told Reuters. “It’s dirty money.”

Philip Morris did not respond to a request for comment on Yurchyshyn’s assertions.

Other investors in the Degtyarev weapons factory as of Dec. 31, company records show, include Rostec, a Russian state defense company that has been on the U.S. Treasury Department’s sanctions list since 2014; and NPO High-Precision Systems, another state weapons company that was named in a round of Treasury Department sanctions in late March.

Rostec and NPO High-Precision Systems did not respond to requests for comment.

Kesaev and the Degtyarev plant have not been sanctioned by the United States. The Treasury Department, which enforces economic sanctions, declined to comment. The U.S. State Department said it “cannot preview future sanctions actions,” but said it has targeted Russian oligarchs financing the war and “will continue to act with our allies and partners around the world in imposing costs on the Kremlin” if the conflict continues.

The entanglement with Kesaev is another sticky public-relations challenge in the history of the tobacco leviathan, whose parent company once was known as Philip Morris Companies Inc. Philip Morris Inc, the U.S. unit, was one of four major tobacco firms that in 1998 agreed to pay an estimated $206 billion, the largest civil settlement in U.S. history, to compensate states for the costs of smokers whose health was wrecked by their products.

Philip Morris Companies renamed itself Altria Group (NYSE:MO) Inc in 2003, and in 2008 spun off Philip Morris International into a separate company that sells outside of the United States. Philip Morris International posted revenue of $31.4 billion last year, with operating profit of nearly $13 billion.

‘EMBEDDED’ IN RUSSIA

Russia is a dream market for international tobacco companies, with its large population of around 145 million people and one of the highest smoking rates in the world. More than 40% of men there light up, according to the World Health Organization. The number of cigarettes sold annually in Russia is about the same as the United States, though Russia’s population is less than half the size.

In 2020, Philip Morris, Japan Tobacco (OTC:JAPAF) Inc, and England-based British American Tobacco (NYSE:BTI) Plc and Imperial Brands (OTC:IMBBY) Plc together comprised more than 97% of cigarette sales in Russia, according to data from Bernstein Research, an investment research firm. Philip Morris alone had a 26% share, with its top sellers including Parliament and Bond Street, according to Bernstein Research.

U.S. anti-tobacco activist Matthew Myers worked to reduce smoking in Russia as president of the Campaign for Tobacco-Free Kids, an American nonprofit that has expanded its work globally. He said the success of foreign cigarette companies in Russia is virtually unmatched by other well-known consumer products firms.

“Western tobacco companies literally took over the industry,” Myers said. “They are embedded.”

Putin in 2020 honored Philip Morris for donating food to the elderly and providing personal protective equipment to volunteers participating in a Russian COVID-19 aid program. The company touted the “commemorative medal and a letter of thanks” it received from the president in a report about its sustainability efforts published last year on the website of its Russia operation.

Philip Morris said it was one of many local and international businesses recognized in Russia for aid efforts during the pandemic.

It was the Communists who first opened the door for the firm. In the 1970s, Philip Morris struck a licensing deal for its Marlboro brand to be manufactured in the USSR, according to Philip Morris’ website. It had no corporate presence or factories there, but it persevered. That arrangement birthed a new brand of cigarettes commemorating the Apollo-Soyuz joint space mission between the United States and the Soviet Union, which is credited for raising Philip Morris’ profile with young smokers, tobacco researchers say.

Opportunity knocked again in 1990, the twilight of Communist rule, when tobacco shortages triggered widespread protests. Answering the call from Soviet President Mikhail Gorbachev, Philip Morris, along with its U.S. competitor R.J. Reynolds Tobacco Company, agreed to deliver 34 billion cigarettes, according to news accounts and statements by the companies at the time.

The 1991 collapse of the Soviet Union threw the gates wide open. Philip Morris by 1993 had committed $1 billion to expansion in the region, enabling it to snap up existing factories and build others, company statements and news accounts show. It brought manufacturing know-how and superior tobacco blends. It also unleashed slick marketing that celebrated freedom and consumerism, with ads from the period showing the Marlboro Man cowboy in the wide-open spaces of the American West and young newlyweds leaving their ceremony on a motorcycle.

Today, Russia is Philip Morris’ second-largest market for tobacco sales, behind Indonesia, according to the company’s most recent annual report. Excluding banks, insurance firms and investment companies, Philip Morris in 2021 was the largest foreign company by revenue operating in Russia, according to a Forbes Russia ranking.

Russian consumers are also major buyers of so-called reduced-risk products that Philip Morris is banking on to stave off declining global cigarette sales. Its signature technology is IQOS, a device that heats tobacco without burning it to create a nicotine-filled aerosol for smokers to inhale. Russia last year accounted for 17% of Philip Morris’ global IQOS product sales, a share exceeded only by Japan, according to its most recent annual report.

Retail space is essential for reaching customers. Which is why distributor Kesaev, born near Russia’s border with Georgia, has been so instrumental to Philip Morris’ success in Russia.

In the early 1990s, Kesaev started an importing business that worked with international tobacco companies eager to get their products onto store shelves, according to a 2014 profile of the magnate in Forbes magazine’s Russian website. It said Kesaev spoke excellent English, having graduated from MGIMO University, a prestigious international relations school. He moved to Switzerland for a time in the 1990s, the website said, where he developed a personal connection with Philip Morris executives at the company’s regional headquarters in Lausanne.

Over time, Kesaev built the largest tobacco distributor in Russia through acquisitions of regional competitors, according to Forbes’ Russian website. That company, Megapolis, delivers to 160,000 retailers spanning 7,000 miles, according to the firm's website. Kesaev is also one of three majority shareholders of Mercury Retail Group, which operates two large convenience store chains, according to a December press release from Mercury Retail Group.

In 2013, Philip Morris and rival Japan Tobacco Inc both purchased 20% stakes in Megapolis' holding company for $750 million each, according to the companies.

CLEAN EXIT?

Philip Morris’ long-standing ties to Kesaev and the Russian market, including its now-23% stake in Megapolis, could make the country hard to quit.

“If you spend a quarter of a century building up a brand portfolio and presence, you’ll be very reluctant to give that up,” said Andy Rowell, a research fellow studying the tobacco industry at England’s University of Bath, which is part of a global anti-tobacco consortium called STOP.

The company’s connections to Russia are made stickier by the fact that the country is one of only two markets worldwide – along with Algeria – where Philip Morris holds an ownership stake in a company tied to a distributor, according to its most recent annual report. Up until last week, the 12-member board of Megapolis’ Dutch holding company included Kesaev, three of his business associates and four executives from Philip Morris and Japan Tobacco, according to a Netherlands business registry.

Of the remaining 11 directors now listed there, seven did not respond to requests for comment and the others could not be located.

To sever all ties with Russia, Philip Morris would need to sell its Megapolis stake. The company has not mentioned Megapolis in any of its recent statements about exiting the Russian market and did not answer Reuters’ questions about plans for its Megapolis investment.

Megapolis said in its April 11 press release that the EU’s sanctions “in no way affect” the distribution company and its subsidiaries.

The United States and the EU do not ban companies outright from doing business in Russia, but their sanctions prohibit a wide range of dealings with entities such as Russia’s central bank, some of its largest financial institutions and other sanctioned individuals or companies. U.S. rules also prohibit new investment in Russia by U.S. citizens or entities, while the EU bans investment in Russia's energy sector and has blocked a wide range of exports to Moscow worth billions of euros a year.

Many multinational companies have decided that the optics of doing business in Russia, along with the difficulties in navigating the financial system, aren’t worth it.

Fried, the former U.S. diplomat, says he’s been advising American companies since the 2014 round of Crimea-related sanctions that Russia had become a riskier place for them to do business. Add in the latest sanctions emanating from its invasion of Ukraine and he said the potential peril has soared.

"Now it’s sky-high. It’s through the roof,” said Fried, now a fellow at the Atlantic Council, an international affairs think tank in Washington.

Philip Morris isn’t the only multinational tobacco company grappling with its future in Russia.

Japan Tobacco, now the biggest player in Russia with more than a third of the market, on March 10 said it was suspending new investments and marketing activities in Russia but stopped short of committing to an exit. The Japanese government owns a third of Japan Tobacco.

Japan Tobacco said it is “committed to complying with all applicable national and international sanctions imposed on Russia,” adding that Kesaev is no longer on the board of Megapolis or involved in managing the company as of April 11. In a statement, Japan’s Ministry of Finance said it believed Japan Tobacco’s management “will take appropriate and timely action with the situation in accordance with relevant laws and regulations.”

British American Tobacco Plc said it would leave Russia and told Reuters in March it would likely sell to its longtime distributor. That firm, Russia-based SNS Group of Companies, last month told the news agency that the process of transferring BAT’s business to SNS was “well under way.” BAT (LON:BATS) said it had no further comment.

Imperial Brands Plc, with less than 10% of the Russian market, said last month it would cease sales and operations there. The company told Reuters it is in talks with a “local third party” to sell its business, but declined to elaborate.

With foreign companies dominating Russia’s tobacco market, there is no major domestic operator that could make up the supply if all four companies stopped selling. Western sanctions could complicate efforts by Russian importers to buy the products abroad.

Callum Elliott, an analyst at Bernstein Research, said it’s possible Philip Morris could license its brands to a Russian company. After all, that’s how it got started in Soviet times. But Elliott said such a strategy carries potential risks for Philip Morris after so many decades operating there because a licensee might “impair the value of the brand.”

Philip Morris declined to comment.

As for Kesaev, his purported exit from the arms business comes amid sanctions that may also cloud the prospects for his tobacco empire.

But at the Degtyarev weapons plant, business has been booming.

A November statement from Tmenov, the plant’s general director, said “2021 has been a busier year than ever."

Special Report: Sanctioned weapons mogul who supplied Russia’s troops has ties to Philip Morris
 

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