Monday, 26 February 2007

Foreign buyers flock to Russia

Private Equity News

The former Soviet Union is attracting big game hunters

By Jason Corcoran in Moscow

An estimated $2.5bn (€1.9bn) was raised in Russia last year by funds using mainly foreign institutional money, and the government announced plans for a $1bn venture capital fund to stimulate investment in technology start-ups.

The market is dominated by local investors who have been around for a decade or more but there are signs Russia is arousing the interest of international private equity firms.

London-listed 3i planted its marker last year, committing $20m to Quadriga Capital Russia, based in St Petersburg. The fund has taken five significant minority stakes in companies in Moscow and St Petersburg, including a plastic container producer and a computer console game manufacturer.

Ere Kariola, the head of 3i in Finland, said the group’s next step would be to make direct coinvestments with Quadriga in the Russian midmarket. He said: “In Russia, you can’t sell private equity from a hotel rooftop. You must have a local presence to understand what is going on because it is a complicated place.”

Kariola said 3i’s relationship with Quadriga was a strategic one to pave the way for a push into the country although he declined to say whether 3i would take a stake in the Finnish firm. “It’s very critical to watch what’s happening to the Russian markets in the run-up to the presidential elections,” he said.

Last year, Russian investment banks Troika Dialog and Renaissance Capital raised almost $300m and $200m for their respective private equity funds. Former Russian finance minister Boris Fyodorov closed UFG Asset Management’s private equity fund at $280m.

Swedish investment managemement firm raised €350m to acquire stakes in the region’s banking sector and Guernsey-based Aurora raised £75m (€114m) on the Alternative Investment Market to invest in Russian mid-market companies.

Overall, foreign investment has shot up to $2.5bn from about $500m five years ago, according to Mike Calvey, managing partner at Baring Vostok Capital Partners, Russia’s largest private equity fund.

Calvey said: “Investment is increasing but it only represents about 5% of total M&A activity. Investors are scared off by geopolitical issues and what they read in the newspapers. They still don’t regard Russia as part of the global economy like China and India.”

Although many investors remain nervous of Russia’s record on corporate governance, accounting standards and lack of minority shareholder rights, Aurora director John McRoberts said its economic fundamentals were difficult to ignore. He said: “Hedge funds are sniffing around at pre-IPO funds and the big private equity funds will come as well when acquisition targets become large enough.”

The established participants say returns have been extremely good in recent years, with firms making several times their money. Baring Vostok and Renaissance Capital claimed to have notched up average historical portfolio growth rates of 40%.

Renaissance fund manager Sergey Nazov said RenFin, the group’s third private equity fund, had attracted more than 30 private and institutional investors, both international and domestic.

He said: “The idea for this fund was triggered by the high growth rates in the financial sector and the interest by foreign investors who are prepared to pay high multiples for strategic investments."

The decision by Carlyle to close its Moscow office in 2005 after making one modest investment has not deterred other western private equity firms from heading eastwards. Chris Rowlands, head of group markets at 3i, said the investment gave the group a foothold in a fastgrowing market with 7% GDP and a population of 140 million people.

US firm Texas Pacific and UK buyout firms Permira and CVC are also rumoured to be the running the slide rule over Russian investment opportunities for their global funds.

Investors say the range of target companies is expanding, and valuations increasing. The hottest sectors are consumer services and banking and financial services. East Capital’s Financial Institutions fund last year acquired sizeable holdings in Russian banks Kedr and Probusinessbank and stakes in Kazak bank JSC and Ukrainian bank Nadra. Aurora last month acquired a blocking stake in Unistream, Russia’s leading money transfer bank.

The recent pick-up in M&A activity means private equity firms have more exit strategies than the traditional trade sale route. Russian IPOs had a bumper 2006 and the pipeline is busy again this year with many private companies keen to diversify and engineer an exit ahead of presidential elections next year.

The Russian government is to set up 10 venture capital funds with $50m of state money in each. The government will contribute 49% of the capital with the remaining 51% being raised from private investors. A shortlist of asset managers is being whittled down before the Kremlin decides who will run the funds.

A demand for investor exposure to central and eastern Europe has arisen partly due its closer integration with the European Union. Mid Europa Partners closed its second fund 30% above its target with €650m while Argus Capital Partners last month closed its second fund at €262.73m, exceeding its €200m target and its €250m hard cap.

Ali Artunkal, managing partner of Argus, said exits had improved with big European funds entering the market and a rise in secondary transactions. He said: “It’s a maturing private equity scene compared to the transactions we were doing six or seven years ago. We now have a buyout environment with a lot of entrepreneurs in the region looking to cash in their chips.”

Investors say the risk premium is declining and prices are starting to go up.
Bridgepoint, a UK private equity group, has two significant investments in the region. AKatsastus, a vehicle inspection group, has operations in Poland and Russia while Forstinger, an automotive spare parts firm, serves central Europe.

A spokesman for Bridgepoint denied a rumour it was opening an office in Warsaw. “We
have an eye on eastern Europe and we have a lot of investments with operations there but we have no imminent plans for a presence on the ground,” he said.

As the central and eastern European market has matured, more financing instruments such as leverage buyouts and dedicated mezzanine funds have become available.

Franz Hörhager, executive director of Mezzanine Management, an investment manager, said his firm had seen the market for mezzanine deals take off in Poland, the Czech Republic and Hungary. He said: “Mezzanine in central and eastern Europe has a better chance of being done than in western Europe which is stretched to snapping point.”

Hörhager said returns had come down from 19% a few years ago in Poland to the mid teens but returns of 22% were possible in undeveloped markets such as Ukraine. Mezzanine Management is launching a new fund in the coming weeks which could take up to 20% exposure to Ukraine and Russia.

Mid Europa Partners along with investment bank Lehman Brothers and Al Bateen Investment, an Abu Dhabi investment holding company, recently acquired 100% of Czech telecom provider Radiokomunikace and 40% of TMobile Czech Republic. The transaction is to be partly funded with senior and mezzanine debt financing of €750m, in addition to equity.

February 15, 2007

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