Saturday, 22 September 2018

Make acquisitions, not war

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The few televisions across America and Europe that were not showing the Olympics in Beijing were hijacked by scenes of Georgian civilians fleeing their homes in South Ossetia, and Russian armour rolling into Gori. The scenes have given foreigners pause, but inside Russia it is business as usual. Benjamin Seeder reports.

Russia's brief war in August generated reams of bad publicity for the former Soviet country, and sent its markets tumbling. Investors, already skittish from falling oil prices and a Yukos-like attack on a major steel firm, headed for the exits. Even more importantly for Russian investment bankers, however, was the impact the scenes had on the M&A market: until mid-year, Russian markets seemed to defy the gravitation pull of financial malaise in the outside world. But the picture started to change in May-June, before August, when the war in the Caucuses put the final nail in the coffin of the "decoupling" theory. Russia's economy was no longer immune to the ongoing woes of the outside world.

Russian bankers say the M&A market has all but evaporated in the past two months. Things seem unlikely to change until the markets settle down. Russia has firmly "coupled" with the outside world.

"I'd say, right up until the Georgian war, both fields of M&A [inwards and outwards] were firing on all cylinders," said Peter Vanhecke, a banker with Renaissance Capital in Moscow. Already, several deals involving foreign investors have disappeared or been put on hold. Most bankers agree they've seen little activity in recent weeks.

The question is whether this is temporary or something longer-lasting. Despite the credit crisis and the global financial worries, Russian M&A transactions in the first half held their own against 2007, according to figures from, a website that tracks Russian M&A activity. The site reports there were 635 M&A transactions in the first half of 2008, against 623 in the same period of 2007. Transaction volume totalled US$72.1bn, or 25% more than in the first six months of 2007.

Chief among the 2008 deals including Russian companies acquiring outside the country included Evraz's purchase of 16% of Australian miner Cape Lambert; Severstal's acquisition of Ohio-based WCI Steel and its US$1.3bn acquisition of US-based PBS Coal; and TMK's US$1.25bn deal to buy the tube assets of US-based IPSCO.

Foreign companies acquiring in Russia included Pepsi Co., which bought Lebedyansky, Russia's biggest juice maker; and France's Renault purchasing a percentage of Avtovaz, the country’s biggest carmaker. Overall, foreign investor deals in the first half doubled to US$11bn, according to

The biggest deal overall was alumina company UC Rusal's purchase of 25% of Norilsk Nickel, Russia's biggest miner. Meanwhile, UES' electricity market reorganisation continued, generating billions of dollars worth of deals for bankers.

But despite all the activity in the first half, analysts expect total M&A volumes and numbers in 2008 to drop well below the level seen in 2007. "I think it started even earlier than with the trouble in the Caucuses," said Sergei Grechishkin, head of investment banking at local bank KIT Finance. KIT vaulted to the top five of the Russian M&A league table in 2007 by securing several of the mandates to advise the old electricity monopoly, RAO UES, in its US$70bn breakup into 23 different generating, transmission and distribution companies.

Private equity squeeze

According to Vanhecke, the dearth of deals is linked to both investors' reduced appetite for Russian risk, and their reduced access to funds to pay for acquisitions. This liquidity issue is especially acute for private equity funds, which once made up as much as 50% of the Russian M&A market. The ratio of private equity versus strategic investors in M&A deals has now changed considerably: "It was almost 50-50, but after credit crunch hit, private equity was most affected by that ... and I think it would be 70-30 now," he said. "I've seen the activity of private equity decline. They might still be there, but they are less aggressive, more nervous, and they have less money at their disposal." Strategic investors, who are much less dependent on leverage than portfolio investors, are still standing.

Russia's economy is still growing by 6-8% per annum; it is already one of the top consumer markets in Europe, making it a very attractive destination for strategic investors. For strategic buyers, therefore, little has changed.

"For them, Russia is a very attractive proposition, and the war in Georgia hasn't changed the fundamentals,” said Venhecke. “People in Moscow are still going to buy BMWs and Fords regardless of whether Russian tanks are in Gori."

With economic growth continuing, sector consolidation will continue - which means Russian companies will continue to merge and acquire into the future. "I personally feel there is a bit of negativity at the moment on Russia. I think its markets have been irrationally punished," said Venhecke.

Russia's market began its slide in May, after Prime Minister, Vladimir Putin, launched a public assault on steel company Mechel, accusing it of dodging taxes and colluding to fix domestic commodity prices. The event evoked memories of Yukos, and Russian markets turned bearish, a phase from which it is yet to emerge. As of mid-September, the benchmark RTS Index had fallen almost 50% since the beginning of 2008.

Vanhecke said the attack on Mechel was overblown by the Western financial media: "It's been settled for US$32m." Similarly, the much-publicised struggle for TNK-BP - 50%-owned by BP plc – was resolved amicably, he said.

The drop in the oil price is, of course, unsettling for Russian bankers, but Vanhecke remains convinced a floor will be found. Besides, Russia has its oil stabilisation fund and one of the world's largest foreign exchange coffers to ride out this turbulence.

Yet even if the present fall in M&A volumes does prove temporary, the fact buyers are putting deals on hold to see how much further valuations slide remains a problem. Several large, foreign, strategic investors have frozen acquisition deals in recent weeks, Vanhecke said. "Buyers agreed on a price three months ago, and valuations have halved since then, so they're seeking to re-negotiate."

It implies the Russian M&A market could bounce back towards the end of the year, if Russian valuations bottom out, he predicted. Other bankers expect the trend of large Russian companies buying assets abroad will continue. "I don't see the present situation affecting that," said Kit Finance's Grechishkin.

Sectors to watch

"Everything at the moment depends on whether this war crisis will blow over, who the president of the US will be, how the peace settlement goes down," said Vanhecke. But Russia's vodka and water industries are growing quickly and beginning to consolidate, which could stoke the Russian M&A furnace somewhat.

The trend has already begun. In January, Russian company Synergy bought out Tomsk-based Russian Vodka Company; in July, private equity firm Lion Capital and Polish firm Central European Distribution Company bought Russian Alcohol, one of the country's largest premium vodka makers. Yet despite the deals the top three market players in Russian vodka production account for little more than 10% of the market, leaving room for plenty of deals in the future. The bottled water market is even more fragmented.

Vanhecke doesn't expect a deluge of deals in the sectors seemed "strategic" by the Russian government. Foreign players in the mining, steel, defence and oil and gas sectors have mostly been scared off. But the chemicals sector could potentially become a hotbed of activity.

"It is unconsolidated, and there are large players there that want to get bigger," said Vanhecke. Take Uralchem, the fertilizer holding being built by former Gazprom executive Dmitry Mazepin: this year it acquired a 7.5% stake in Tolyattiazot, the country's biggest ammonia producer, and 72% of Voskresensk Mineral Fertilizers, a plant located just outside of Moscow. The company is planning an IPO in London, and is intent on further acquisitions in Russia and abroad.

With the exception of the industries included in the government's strategic list, Russia has a relatively liberal M&A regime. As in most jurisdictions, mergers are subject to approval by the competition authority, the Federal Anti-monopoly Service. Yet this does not pose an insurmountable obstacle: "I've done so many consumer deals now, and I've never felt any kind of competition barriers any different from other countries," said one Russian banker.

But some sectors have consolidated to the point where competition is now, or soon will be, a problem. "There's a legal framework which is largely applied. Up until now, there have been very few deals pulled for competition reasons. Now, if two of the biggest brewers in Russia, for example, wanted to merge, there'd be a problem," the banker added. "It's something that will become increasingly relevant in the next few years as industries consolidate."

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