Why it might pay to keep the faith

In the last couple of years, Russia has made its way on to many LPs' ‘bad lists’. Toby Mitchenall asks if the reputation is justified

In Russia, there seems to be a glimmer of light at the end of the tunnel. A global crisis that hit both commodities and banks was always going to be tough on Russia, but optimists might say that tentative steps are being made to start reversing the damage. The economy returned to modest growth in October 2009 according to official figures, Vladimir Putin has announced that state funding for the banks is becoming less of a necessity, and the price of oil – at the time of writing – is on the rise.

“With some of the highest reserves in the world, Russia should be able to recover from the global economic crisis faster than other countries in Europe,” says James Cook, a director of Aurora Russia, a London-listed private equity firm investing from its Moscow base. Cook adds that while the Russian economy is enjoying uplift from a rising oil price, the real growth story will take place in the services sector in the mid- to long-term. This growth, he says, will be driven by factors such as a growing middle class – which is expected to double over the next five years – a favourable tax regime and low levels of corporate and consumer debt.

But while faith in Russia's fundamental growth story remains strong among GPs in the country, expectations of economic recovery are still muted. “We do not rely on a quick recovery when evaluating potential investee companies,” says Alexander Vlasov, an investment director at CapMan Russia, who adds that his firm assumes another two years of poor economic conditions when assessing a target company's viability.

“There seem to be green shoots all over the planet,” says Fredrik Ekman, co-founder and managing partner of lower mid-market firm Mint Capital, “but not that many in Russia yet. We are distinctly outside of the mainstream Russia investment body of raw materials and natural resources.”

“There seem to be green shoots all over the planet, but not that many in Russia yet”


Only four fnancial sponsor-backed acquisitions have broken the $5m barrier in 2009 to date, according to Dealogic data
Deal type Deal size Target Buyer Seller Month
Entry $111m Lenta Group TPG, VTB Capital Private investor september
(Oleg Zherebtsov)
Bolt-on $58m Freevale Vimpelcom not specifed september
Enterprises (Alfa Capital Partners
portfolio company)
Entry $19m RusForest Varyag Resources Vostok nafta May
Entry $9m stolichnoye Mint Capital not specifed May

With just $97 million invested in the first half of the year, the execution of new investments has slipped down many GPs' agendas for most of 2009 to be replaced by portfolio company management priorities. In a country where many private equity strategies are based on consumer-led theses, consumers have been having a difficult time. Wage arrears, which had improved over the last five months, were once again on the rise in October. Falling consumption and the associated economic malaise has led to attention being necessarily diverted to maintaining portfolio company health.

One firm that acknowledges the need to invest time in nursing portfolio companies is Mint Capital. Mint is at the tail end of the investment period for its $130 million second fund and, during the course of the financial crisis, experienced a tough chapter of its 10-year history. “We have had a few situations in the portfolio,” says co-founder and managing partner Fredrik Ekman. “If you had asked us how we stood back in March or April it would probably have been a very gloomy account.”

Since then, says Ekman, the firm has managed to pull its investments through and keep hold of all the equity stakes in its portfolio. Turnover numbers are down, he adds, and doubledigit growth is no longer on the cards, but “we think we landed on our feet”. Furthermore the firm achieved an exit at the end of October from its first fund, selling mobile communications firm jNetX to US trade buyer Amdocs, which Ekman describes as a “symbolic” exit. He admits, however, that the exit would have counted for little if the second fund – the bulk of the firm's AUM – had not pulled through safely.

In asking market participants which firms are “alive and kicking” in the Russian private equity market, the name Russia Partners is – along with another longstanding player Baring Vostok Capital Partners – ubiquitous. Russia Partners closed a $626 million fund in November 2007, while Baring is investing from a $1 billion vehicle – Russia's largest ever – that closed in the same year and was followed shortly afterwards by a $450 million supplementary fund.

The overall lack of investment activity during 2009 has made completed deals all the more notable. Mint's acquisition of debt collection business Capital Collection Agency in June received a lot of media attention even thought it was a deal worth less than $10 million.

In early November Russia Partners acquired a 3.3 percent stake in MDM Bank in what was billed as the first investment by a foreign entity – Russia Partners is owned by New York-based private equity firm Siguler Guff – in a Russian bank.

The deal does not, however, portend an impending rush of foreign private equity investment into the Russian banking system, according to Max Atanassov, chief executive officer of boutique M&A firm Brunel, which advised on the deal. He says that MDM represented a “special case” among Russian banks: “It stood out because of the quality of management – especially the merged bank, which also has a very strong shareholder group supporting it.”

Russia Partners beat off competition from a number of other international private equity players, says Atanassov. International firms have long eyed the Russian opportunity, often making significant – if sporadic – sorties into country. And as Atanassov's comment suggests, they have not, as one might expect, been dissuaded by the events of the last two years.

In October VTB Capital, the private equity affiliate of Russian statebacked bank VTB, partnered with global private equity giant TPG to buy a 35.4 percent stake in hypermarket chain Lenta. Financial details of the transaction were not disclosed, but data provider Dealogic pegs the deal value at $111 million.

“Russia should be able to recover from the global economic crisis faster than other countries in Europe”

Lenta was TPG's second foray into the Russian market since setting up in Moscow in 2006. Its first was in April 2008 when it wrote an $800 million equity cheque – the country's largest private equity investment ever – for a 50 percent stake in pharmaceutical distributor SIA International.

“Foreign players have been looking at the market and continue to do so throughout the crisis. They have not retreated, and just because they have not done any deals recently does not mean they are not looking,” says VTB's Demchenko.

He goes on to underline the importance for international players of having a presence or reliable partner in the country. “Those players who have not invested in their local team or partnered with someone locally will continue to struggle – and it is no secret that we are offering our partnership to those looking to do bigger-ticket deals in the country,” he says.

While LPs are often deterred by the perceived risks – a combination of geopolitical events and corporate governance horror stories – those who can look past these see a compelling investment opportunity. Koenraad Foulon is a private equity senior managing partner at Capital International, an organisation that has a long experience Russia, and he believes it has some positive surprises in store for investors. “Russia is currently on LP's bad list but that's because they understandably are looking at it through the rear view mirror,” he says.

As one prominent local GP once wryly put it: “Russia has always enjoyed a bad reputation,” meaning that those with the connections, knowhow and inclination to make private equity investments in the country have enjoyed the ability to do so in an environment of limited competition. This may be truer now than ever.