WHILE PRIVATE EQUITY firms in the US and western Europe are facing the twin perils of an economic recession and severely reduced access to capital, the opposite is true of the emerging markets universe in general and Russia in particular. Talk to private equity firms in Moscow and there is an unmistakeable air of optimism about the prospects for the asset class, given continuing strong economic output and a growing pool of investable companies and investors to back them.
However, a refreshingly pragmatic stance is being taken by many of the private equity players in Russia. The public equity markets have at times been a perfect example of hype outweighing reality but participants in private equity, which perforce has a longer-term investment viewpoint than listed equities, have a much more measured view of Russia’s investment potential. Although the overall climate for Russian private equity firms has arguably never been more favourable, nobody is in any doubt that delivering high returns for investors remains a challenge. "To a certain extent private equity has been able to capture the low-hanging fruit in the last few years," says Reinhard Kohleick, managing director at Quadriga Capital Russia in St Petersburg, adding that in future private equity players will have to work harder to produce high returns.
Patricia Cloherty, chief executive of Delta Private Equity Partners in Moscow, who started her private equity career when Apax Partners was formed in 1969 and worked in the US, Europe and Asia before moving to Russia in 2000, says that for all the growing sophistication in the market, "Russia is still very much a market where who you know and trust is very important".
One of the standout features of the past two years, though, is the extent to which experienced western private equity talent has migrated into the burgeoning Russian market. A prime example is Rory Cullinan, co-managing partner of Renaissance Partners, the merchant banking arm of Moscow-headquartered emerging market investment bank Renaissance Group. Cullinan joined Renaissance from Permira Partners, Europe’s largest private equity firm, at the start of 2007 with a view to transforming its private equity platform from an informal club to a formal fund basis. In the previous decade, Renaissance had made a number of successful private equity investments on either a standalone or an ad hoc co-operation basis with a select number of investors.
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"If you are looking for alpha, you should be looking at the emerging markets in general and Russia in particular"
Rory Cullinan, Renaissance Partners |
The combination of global expertise combined with in-depth local knowledge, which Cullinan says is Renaissance Partners’ key selling point, proved a winning formula earlier this year when it closed its first private equity fund in March at $660 million, just six months after launch, and well above its $500 million initial target. "It was a significant sum for a first fund," says Cullinan, adding that investors took comfort from the fact that Renaissance Group was willing to seed the fund to the tune of 40%, which he claims is a uniquely high level of commitment for a Russia-focused private equity fund to date. Furthermore Renaissance can point to several successful proprietary-type transactions. "Renaissance has a reputation for being able to fish beneath the net when it comes to Russia," says Cullinan.
He says that the firm attracted a mix of private, hedge fund and institutional money into the fund, which will have a predominant focus on the consumer and media sectors. Investors were attracted by the fact that of all the major emerging markets, Russia displays arguably the strongest macroeconomic fundamentals. "If you are looking for alpha, you should be looking at the emerging markets in general and Russia in particular," Cullinan says.
The overall focus of the fund, which is likely to make up to a dozen investments at an average equity investment of $50 million, will be firmly on domestic demand-driven rather than export-dependent stories. Although the consumption investment theme is faltering in the US and western Europe, it is still very much in place in Russia. In terms of the investment horizon, Cullinan expects the average holding period for the new fund to be between three and four years, compared with the 18-month average for Renaissance’s previous private equity investments. "We’re now more focused on a capital-driven rather than an arbitrage-driven approach," he says, adding that he expects the fund to be fully invested within three years.
Bigger and better
Renaissance is one of the latest firms to raise a new fund this year but it is by no means alone in persuading investors that Russia is a must-be-there destination for private equity. In early August, Troika Capital Partners (TCP), the private equity arm of Renaissance’s arch-rival in investment banking, Troika Dialog, made the first close on its latest fund. Although unwilling to be drawn on the exact amount raised, Giedrius Pukas, managing director, says that it was a "substantial proportion" of its $1 billion target, which it hopes to reach by final close in October. Founded in 1998, TCP has about $1 billion under management and so its latest fund, its third to date, is a significant advance on previous fundraisings.
Nevertheless, Pukas says that the private equity industry still has a long way to go to reach its full potential. "The private equity market in Russia is still very much in its infancy, but each and every way the market is getting bigger and better," he says, adding: "Fundraising in 2000 for example was very much more difficult than it is now."
Given the still nascent state of the market official figures are hard to come by, but a rough estimate suggests that to date about $40 billion of private equity-type capital has been raised. Of that, about $27 billion has come from oligarch-type sources such as Viktor Vekselberg’s Renova Capital and Roman Abramovich’s Millhouse Capital, which effectively play the role that insurance or pension funds take on in developed markets. Of the $13 billion balance, most has come from what could be termed classical private equity sources – supranational agencies such as the International Finance Corporation and the European Bank for Reconstruction and Development, allied with western pension and insurance fund money, supplemented by private banking and hedge fund cash. In terms of the investor universe for private equity in Russia, Pukas says that TCP is seeing increasing interest from investors from North America and the Middle East, which is helping to supplement the traditional participation from western Europe and southeast Asia.