Heyday for private equity in Kazakhstan still lies ahead

FOR MOST OF the first decade of the century, private equity managers in Kazakhstan found themselves in a state of almost permanent frustration. Although the economic backdrop in the country seemed perfectly suited to private equity investment, with GDP expanding by roughly 10% a year from 1998 to 2007 on the back of fast-growing commodity exports and quickly rising domestic consumption levels, fund managers found themselves sitting on the sidelines, twiddling their thumbs as the majority of corporates opted to fund their expansion through cheap, plentiful loans provided by domestic banks, which indulged in an orgy of Eurobond issuance to fund their fast-expanding loan portfolios.

However, with the onset of the credit crunch, which hit Kazakhstan in September 2007, the Eurobond funding route for Kazakh banks disappeared entirely and with it went the availability of local debt funding for all but a chosen few corporates. The conventional wisdom seemed to suggest that private equity investors would be greeted with open arms by cash-strapped firms but the reality has proved otherwise. "The private equity industry in Kazakhstan has very good potential, but only if there is a cultural change," says Askar Yelemessov, chairman of Russia investment bank Troika Dialog in Kazakhstan. He adds that many business owners have yet to recognize the potential benefits of private equity capital compared with debt capital. "The heyday for the private equity industry in Kazakhstan still lies ahead of us," Yelemessov says. "The Kazakh banking system brought $100 billion of debt capital into the country, now it’s time to try equity capital." Eldar Abdrazakov, chief executive of investment banking boutique Centras Capital, agrees: "In Kazakhstan we need to have a have a real alternative source of funding to bank lending."

David Herbada, head of private equity at Almaty-based Compass Asset Management, says that although there is no shortage of funds available for private equity investment in Kazakhstan, there is still a lack of suitable investment opportunities. "There are a lot of zombie-type companies in Kazakhstan – they’re financially dead, but they just don’t know it yet." Michael Carter, chief executive of Kazakh investment bank Visor Capital, takes a similar view: "There are companies with, say, $70 million in revenues but with debts of $500 million, whose owners still think they’re worth billions." One of the key challenges for private equity investors, therefore, says Herbada, is finding owners who take a realistic view of the true worth of their businesses. "There are a lot of people who don’t understand the difference between the equity value versus the enterprise value of their companies," he says.

Nevertheless Herbada remains confident that the general outlook for private equity in Kazakhstan is improving, a view bolstered by the fact that in the past year Compass has been able to close two investments for the Tau Capital fund it manages on behalf of Spencer House Capital Management. Established in 2007, Tau Capital is a hybrid fund, comprising both public and private equity investments. It is notable for being listed on the Alternative Investment Market segment of the London Stock Exchange, which gives it a higher public profile than most private equity investment vehicles in Kazakhstan. Its recent transactions include a $21.5 million investment in drugs distributor Stopharm and a $4.5 million commitment in junior oil company Lucent Petroleum.

"KCM has made a big financial and educational push to help establish equity investment as a viable alternative source of funding to the bank lending that dominated before the credit crunch" Abay Alpamyssov, KCM

One of the main additions to private equity in Kazakhstan in the post-credit crunch period has been Kazyna Capital Management (KCM), the private equity arm of Kazakhstan’s sovereign wealth fund, Samruk-Kazyna, which was founded in 2008. KCM has made a big financial and educational push to help establish equity investment as a viable alternative source of funding to the bank lending that dominated before the credit crunch. Abay Alpamyssov, KCM’s chairman, says that KCM has so far supported the establishment of nine private equity funds with a total capitalization of about $2.5 billion. As a result, Alpamyssov expects KCM-backed funds to target investments of $1 billion to $1.2 billion in Kazakhstan in the next three to five years – a big advance given that in previous years private equity investments have been measured in the low tens of millions. Alpamyssov says that KCM has also been active in education, issuing guides on private equity investment to local corporates and encouraging municipal authorities to put forward potential investment projects to be considered by KCM-backed funds.

Although it’s still too early to judge if the KCM experiment will ultimately be successful, its achievements so far have won it widespread admiration. "The basic premise behind KCM of creating a fund of funds and bringing Kazakhstan to the attention of the global private equity community is a very sound one," says Abdrazakov at Centras. "The key point is how many mistakes KCM will make and whether it learns from them."

But although KCM has succeeded in attracting private equity investors and foreign fund managers to Kazakhstan, it still remains to be seen how quickly and productively the financing it has provided can be put to work. "There’s a lot of financial firepower out there with a shrinking investment time horizon," says Herbada at Compass. However, among the private equity funds backed by KCM there’s a cautious optimism about the investment outlook given the combination of an improving economic climate – GDP this year is expected to grow by 7% – and proposed changes to the country’s capital markets and taxation infrastructure.

Raj Morjaria, a partner at Aureos Capital in London, which manages the $70 million Aureos Central Asian Fund, says: "Kazakhstan has faced a few challenging years following the global financial crisis. Businesses have required not only growth capital but also basic working capital as debt markets have dried up. But things are starting to pick up slowly and we continue to see a steady stream of opportunities." This has enabled his fund to invest about $20 million of its committed capital to date, with deals in the leasing, cable TV/internet and paint industries, all of which are poised to benefit from higher domestic investment and spending levels. Morjaria says that although investment in Kazakhstan has been sluggish to date, it is set to accelerate.