From roulette to reward

Linklaters’ Hugo Stolkin, partner, and Kim Latypov, managing associate, track Russia's progress in from the cold.

TPG Capital’s recent purchase of an $800 million stake in SIA International, a pharmaceuticals company, Russia's biggest private equity investment to date, is a sure sign that western private equity appetite for the market is increasing.

Hugo Stolkin

Buyout firm interest in Russia is nothing new – several firms have been tip-toeing in the market for a while and there has been active smaller-scale portfolio investment by a number of funds for several years. But what is significant is that mid-market players are now leapfrogging the more established central and eastern Europe region and going straight for the less mature Moscow. This is exactly what TPG, which has an office in Moscow but no base in Central and Eastern Europe, has done.

Russia is still perceived to have a higher degree of economic and political risk than the recent accession EU member states but attitudes are changing and the potential rewards are greater. Where investors are buying less than 100 percent of a target, shareholder protections are critical. In this regard, extensive private M&A experience in Russia is invaluable.

As with all the CIS markets, leverage is rarely used in deals, meaning that current Russian deals are similar to those being done in CEE a few years ago. Russia is growing much faster than the west, so buyouts are less reliant on debt to generate healthy returns. TPG’s deal marks a shift into so-called ‘growth-equity’ investments, which buyout firms believe will bring returns through the growth of the underlying business as opposed to making profit from loading the target with cheap debt.

According to the Emerging Markets Private Equity Association, funds raised in CEE and Russia soared to $14.6 billion in 2007, up from just $3.3 billion the previous year, and we expect to see Russia driving further growth this year. The signs are good, as established specialists such as Mid Europa and Advent have also raised record funds. Moscow-based Renaissance Group’s $660 million fundraising for its maiden private equity fund shows that local players will also play a significant role in deal activity.

Kim Latypov

The rapidly increasing level of personal consumption is the underlying driver for private equity activity. The retail, consumer services and pharmaceuticals sectors are hotly tipped. With the huge amount of investment required in roads, railways and airports in the CIS, infrastructure investment is bound to be another hot topic. Investors are also looking at business services as the market opens up in similar fashion to what we’ve seen in the EU accession states.

Another driver for growth is the knock on effect of the global credit squeeze: mid-sized Russian companies are finding it tougher now to raise financing from banks following the tightening of credit, prompting some to look to private equity for cash for the first time.

Western private equity groups are right to view markets such as Russia with a degree of caution, fearing the risks of political intervention and fraud, but confidence is growing; there is a feeling that continued stability under Dmitry Medvedev, the newly elected President, will encourage foreign investment.

Some buyout firms have worked hard to establish themselves in Moscow already. Starved of deals in their current operating markets, others are starting to see that it is well worth the trip east: what was once seen to be a game of Russian roulette is fast becoming a rewarding investment.