After the success of the recent FIFA Football World Cup in Russia, the nation can breathe a sigh of relief. For several glorious weeks, a more balanced picture of Russia was beamed around the world: one of a rapidly modernising economy with engaged consumers and a friendly welcome. This picture, which is often distorted by recurrent geopolitical tensions, is welcome and shines a light on one of the world’s most overlooked and attractive private equity markets.
This is a very significant market; Russia is the world’s largest country, containing one eighth of world’s total landmass and home to 146 million people, making it by far the biggest European country in terms of population and area. The commensurate opportunities for development and growth are considerable: which other emerging market can offer gross domestic product of $1.3 trillion in 2016, extremely low public debt at 16 percent of GDP and inflation of 2.5 percent in 2017?
Many investors that take the trouble to look closely at Russia like what they see. In the public markets, the country is proving as popular with emerging markets fund managers as it did with football fans. Russia makes up just 3.5 percent of the MSCI Emerging Market index, yet many of the larger EM funds such as Lazard, Templeton and Fidelity have much larger allocations of up to 10 percent to the market.
The corporate sector also sees Russia as one of its best-kept secrets, particularly in the consumer sector. Russian foreign direct investment doubled in 2017 compared with 2016, reaching $23 billion, according to Bank of America Merrill Lynch. This ranks Russia seventh in the European league table, according to EY.
According to CEEMEA, a business consulting group with membership of more than 400 multinational corporations operating in the broader region, Russia is consistently reported by its members as their most important market, ahead of Poland and Turkey, delivering consistent double-digit revenue growth, and some of the best profit margins globally.
The irony is that this attitude is not repeated in the private markets. In Russia, there are fewer than six western-style institutional private equity investors. Between 2012-16, EMPEA reports Russia at the bottom of the global table for private capital allocations as a percentage of GDP, with four times less raised than for Nigeria and Poland, and seven times less than for Brazil. In the same period EMPEA reports that PE investments in Russia totalled $2 billion, versus more than $15 billion for Brazil.
The other side of the coin to these numbers is the outperformance of Russian PE against its global peers. Both European Bank for Reconstruction and Development and EMPEA have historically cited Russia as delivering the best returns over a 10-year basis, not just within EM, but also compared with developed markets. In particular, it is in the mid-cap sector where really spectacular growth can be found, in entrepreneurial companies run by outstanding entrepreneurs with a focus outside the traditional strategic oil and gas sectors, such as consumer, healthcare, pharmaceuticals, technology and telecommunications. Looking at our own portfolio, we see annual revenue growth across our investee companies in excess of 30 percent a year.
Finally, unlike other emerging markets, Russia’s exit environment has remained healthy through the cycles. KPMG statistics show that M&A deal values averaged over $75 billion annually from 2013-16 and in 2017 there were 546 deals worth a total of $67 billion.
In summary, the structural transition that Russia is going through is creating outstanding growth opportunities, but the private equity market is still very small relative to other emerging markets, let alone developed markets. We expect that to change as the attractive returns, combined with the long-term strategic nature of private equity, opens up opportunities that cannot easily be replicated elsewhere.