| Big private equity firms such as the Carlyle Group, advised by George Bush senior, are turning to Russia |
GEORGE BUSH SENIOR’S tenure as US president certainly divided opinion, but one thing is beyond doubt – he knows how to do business. Whenever he flies into a country, even for a few days, it usually means a billion-dollar, government-approved deal is on the cards for one of the companies he advises. So when Bush flew into Moscow last month, most market observers interpreted it as a sign that Russian foreign direct investment was about to receive a boost.
The main item on Bush’s agenda was Chevron-Texaco’s interest in a 25% stake in Yukos-Sibneft. If it goes through, it will be the biggest single FDI deal in Russia yet. But in between that and meeting his old sparring partner Mikhail Gorbachev, Bush also had time to speak at a conference organized by the Carlyle Group, the US-based private-equity firm that he advises. Carlyle is in talks with Alfa Capital, the private-equity arm of Alfa Group, to establish a $500 million Russian fund.
The deal has yet to be finalized, and Mark Bond, managing director of Alfa Capital, says: “Alfa has been talking to a lot of different companies. There are quite a few potential foreign partners, including Carlyle.” Carlyle declines to comment on the proposed fund. Bond is raising money for three prospective funds in Russia – a general fund, possibly with Carlyle; a real-estate fund; and a natural resources fund. “The level of interest is extremely encouraging,” he says. “People are waking up to private equity in Russia, despite negative experiences in the past.”
Activity in the past three months has provided abundant evidence of that. In July, AIG and Interros announced that they were raising a $300 million general fund. Interros is also planning to launch a real-estate fund, again possibly with AIG. US private-equity company Warburg Pincus has begun business in Russia, and made its first investment, buying a controlling stake in three Russian radio stations, in late September, for an undisclosed amount. The company’s European head of investment, Joseph Schull, declined to comment. GE Capital and Apax Partners are also said to be looking to invest in Russia. General Electric’s president, Jeffrey Immelt, visited Russia in July and met prime minister Mikhail Kasyanov to discuss investment opportunities for General Electric. GE declined to comment.
Delta Capital, one of the foreign private-equity houses with most experience of Russia, is also changing gear. Established in 1992 with money from the US Congress and a mandate to encourage the growth of private equity in Russia, it is now going private itself, and is raising funds, according to Patricia Cloherty, its new CEO.
Cloherty, who was previously president of Apax Partners and has about 30 years’ experience in private equity, replaced David Jones as Delta’s CEO this summer. Jones is staying with the firm as an adviser and says he intends to continue in the Russian private-equity market for the rest of his career.
Russian banks and holding companies are also looking to get into the private-equity market. Besides Alfa Capital and Interros, Sistema is said to be looking to set up a fund, as are brokers United Financial Group, Nikoil and Troika Dialog.
It is difficult to say how many private-equity companies already operate in Russia. As Delta’s Jones says: “There’s so much Russian money that just isn’t on the radar. Russian funds are much less visible, though they’re becoming more visible.” Russian magazine Russky Focus estimates that there are 1,000 funds with more than $1 billion, though any estimate is complicated by the fact that many Russian holding companies, such as Oleg Deripaska’s Basic Element, are structured like closed private-equity companies.
A young market There is, therefore, unprecedented activity in Russian private equity. As Andrei Bougrov, managing director of Interros, says: “A few years ago, this market did not exist, and it’s still fairly young.” The market, like all Russian FDI, has had its teething problems. Alfa Capital’s Bond says: “In the 1990s, very few private-equity firms were successful, mainly because there was total lawlessness.” US private-equity house Kohlberg Kravis Roberts was one of the companies to suffer from that. It ran into protracted legal battles over its stake in a porcelain factory in St Petersburg in 1999 after the government ordered that it be renationalized.
Besides the lack of a strong legal structure, the market was hampered by a scarcity of good local managers and large, multi-million dollar investment opportunities. Russia’s financial crisis of 1998 and the devaluation of the rouble also wiped out many funds.
Recently, foreign investors have regained their confidence in investing in Russia. That is partly because of the legal stability provided by president Vladimir Putin’s government, though private-equity investors are concerned by the Kremlin’s recent attack on Yukos. They are also attracted by the high GDP growth the government is aiming for. And, as Bougrov at Interros says: “There are still undervalued assets. There aren’t many blue-chip companies in Russia, only 30 or so, mostly in oil and gas. The rest are smaller private companies. Many need better management, cost-cutting and other increased efficiencies.”
The quality of management is improving, according to Delta’s Jones. He says: “I’m seeing more and more qualified managers, and more and more good business plans. Now, all you hear about is people development, market plans, exit routes. You didn’t hear anything about exit routes five years ago.”
Corporate governance has also improved, says Bougrov: “Good corporate governance, international accounting standards and so on is becoming more widely spread in big business, and we believe there’s some trickle down to SMEs as well.”
Alfa Capital’s Bond says: “Things are becoming more civilized. There are fewer contract killings, less outrageous behaviour from local government, better court systems.” He says deal size has also improved: “We’ve moved beyond the Mickey Mouse deal stage. Our general fund is looking for deals as big as $1.8 billion.”
And foreign private-equity companies have been attracted to Russia because of the moribund state of the sector elsewhere. Bond says: “We’ve seen stunted growth in the west for so long now. Private equity has had a really bad time of it for the last two or three years. Now there’s a beacon of light coming from Russia.”
But the general optimism is tempered by caution. As Bond says: “You always have the feeling in Russia of sitting on an earthquake, and never knowing when the next eruption might come, though it’s never been so stable as now.”
Michael Calvey, managing director of Barings Vostok Capital Management, one of the oldest and most active funds in Russia, with around $400 million under management, says: “The growth potential and potential profits in Russia are higher, while the entry costs are lower. But if foreigners come then they will find it difficult to organize.”
That is one reason why companies such as Carlyle and AIG have considered teaming up with a local partner. Yevgeniy Khata, head of private equity at KPMG in Russia, which helps funds set themselves up, says: “The Carlyle model is a very good one, and hopefully is the future of Russian private equity.” Delta’s Jones agrees. “Broadly speaking, it’s a good idea for foreign firms to get a local partner,” he says. “But you can get the wrong partner, and it’s better to have no partner than a bad one. Carlyle has picked a good one.”
But even the partner model is vulnerable to complications. Khata at KPMG says: “A problem could be that international managers have to be accustomed to the Russian working climate. I hope Carlyle and Warburg Pincus don’t underestimate the differences.” Carlyle and Alfa Capital haven’t finalized their partnership yet, sources say, because of just these differences. Because of the slow legal system in Russia, most successful business partnerships are based on trust rather than contracts, but Carlyle wants the terms of the partnership clearly defined by contract.
Demand for deals creates supply Another potential problem is the lack of deals relative to demand. Delta’s Jones says: “People have been asking me, ‘if all these foreign funds come, will there be enough deals?’ It’s particularly problematic because most private-equity companies don’t invest much in the oil sector. But it reminds me of Silicon Valley in the 1970s, where people also said ‘where on Earth will we find new deals for all this new capital?’ What happened there was the wave of capital created new deals.”
Bougrov of Interros agrees: “It’s a big country with a big economy. There’ll be lots of deals.” Sectors of particular interest for new deals, according to the market participants Euromoney spoke to, are raw materials such as timber and services, including financial services such as consumer lending, in which Delta Capital for one has already made successful investments. Others include real estate; retail, particularly breweries; the media, in which Alfa Capital, Delta Capital and Warburg Pincus have all invested; and technology companies, particularly companies that used to be part of the defence sector. Most of these sectors, such as media and retail, are driven by the growth of the urban middle class.
The growth of private equity will thus help Russia achieve what the IMF says it needs to do – diversify its economy away from overdependence on oil and gas. It will also help the growth of the capital markets. As Interros’s Bougrov, formerly head of the World Bank’s Russia office, says: “The growth of the private-equity market will lead to an increase in IPOs or strategic sales. We’ll see a robust expansion of the capital markets, which is precisely what the Russian economy needs.”
