The Russian Bear awakes
-The following was published in the March 1, 2010 edition of Acquisitions Monthly-
(Acquisitions Monthly) Last year, Russia was in the midst of its worst economic crisis for a decade, but with the return of growth and the successful debt restructuring of aluminium giant UC Rusal, recovery is just around the corner. M&A activity will, however, start slow.
Russia’s GDP plummeted by 7.9% in 2009, according to the government’s own statistics, mainly thanks to the global financial crisis that brought a crash in commodity prices – the current mainstay of Russia’s economy. It was the first time since 1998 that the Russian Bear had experienced a bear economy. The fact that Russian M&A was down almost 80% by value of deals came as no surprise.
It seemed that suddenly, when it came to the matter of diversifying Russia’s economy away from oil and gas, all those advocates for doing so – from Anatoly Chubais, who had overseen the privatisation of state assets in the 1990s, to German Gref, the former economy minister and head of Sberbank, the country’s biggest lender – had been proven right.
They had realised rightly that one of Russia’s greatest strengths was also one of her greatest weaknesses – her over-dependence on oil and gas revenues. (Commodity prices are determined by how well the global economy is doing, what geopolitical situation is unfolding in which part of the world, and speculative trading.) The years 2008 and 2009 saw dramatic volatility in wholesale prices, and Russia found herself spending significant amounts of her forex reserves as a result to prop up the rouble.
Because of the global financial crisis, it became more pressing than ever for Russia to speed up the diversification of her economy into a more post-modern, entrepreneurial one, the liberals pointed out. Both Prime Minister Vladimir Putin and President Dmitry Medvedev were acutely aware of this. Indeed, Medvedev has been pushing for more diversification.
However, with a stabilisation of commodity prices and a price increase in global crude during the latter part of last year, plus a massive governmental fiscal stimulus totalling about US$120bn, Russia’s economy is growing again.
According to preliminary figures released by Russia’s Ministry of Economic Development and Trade, Russia’s GDP grew by more than 3% in the fourth quarter of last year. It could even reach 6.4% by year-end if oil reaches US$79 a barrel, Moscow-based brokerage Aton predicts. Already, the price of crude is approaching US$80.
If growth had not returned in the US (at 5.7% between October and December 2009) and if there had not been a significant pick-up in Chinese exports, Russian and Western M&A bankers would have found themselves back at their desks after their long Christmas breaks twiddling their restructuring thumbs and wondering which major company would go under next.
Russian corporates had found themselves in the unenviable position of having to figure out how to refinance about US$500bn of international bank debt (not in default).
The situation had not looked particularly promising – not for Russia Inc in terms of its growth prospects and not for the big Western banks, which had seen their balance sheets decimated and exposed to Russia.
Hearts were racing; cardiac arrests were just around the corner. So too were more restructurings and distressed asset sales. Restructuring some US$16.8bn of debt held by UC Rusal, the world’s largest aluminium company, hung in the balance.
On entering the fourth quarter of 2009, it looked as though international capital was about to take flight from Russia, which would have seen Western banks having to unwillingly accept massive write-downs on their depleted balance sheets.
Fortunately, that Armageddon moment did not occur. Some bankers consider the prospect of it happening to have largely passed, with the multi-billion debt restructurings of Mechel and UC Rusal so far successful.
Mechel and UC Rusal get away
Mechel, the Moscow-based steelmaker run by billionaire Igor Zyuzin, had managed by July last year to agree with its international creditors a US$2.6bn refinancing. This was Russia’s first largest restructuring of corporate foreign debt since the start of the financial crisis (that date being July 31 2007, when two off-balance sheet subprime hedge funds belonging to Bear Stearns collapsed).
By December 2009, Mechel had secured a three-year extension to a Rbs15bn loan made to it by state bank VTB in 2008.
The same month, and in the run-up to Christmas, Rusal’s main owner and chief executive, oligarch Oleg Deripaska, had finally managed to negotiate the restructuring of US$16.8bn worth of debt in preparation for a main listing in Hong Kong.
That included the conversion of US$1.82bn of a total US$2.7bn owed to Russian oligarch Mikhail Prokhorov, in exchange for 6% of Rusal’s equity, bringing his total shareholding in Rusal to 20.4% in the run-up to the company’s IPO and, thereby reducing Rusal’s debt at that time to US$14.9bn.
By January, with the cornerstone support of Russian state bank VEB agreeing to take a 3.15% slice in Rusal as part of its IPO, the aluminium group successfully listed a 10.81% stake on the Hong Kong stock exchange for US$2.2bn at HK$10.80 per share, with a secondary listing in Paris.
As a result, the public offering diluted Deripaska’s stake to 47.59% from 54%, while Prokhorov now had a 17.09% stake, down from 20.4%.
Possibly because of his exposure to UC Rusal, Prokhorov had been knocked off his perch as Russia’s richest man. That accolade now goes to steel oligarch Vladimir Lisin, who owns most of NLMK.
Once Rusal’s shares started trading on January 27, they immediately tanked over concerns of a market slump in Asia; a US$1bn compensation claim made by the new government of Guinea against Rusal over the ownership of the latter’s bauxite and alumina assets in the West African country; a looming US$4bn litigation suit in London against Derispaska by his former business partner Mikhail Chernoy, who believes he still owns part of what is now UC Rusal; and the company’s debt position, although now much reduced to US$12.9bn thanks to US$2.14bn in proceeds from its IPO.
In effect, the Rusal restructuring has given the company a four-year breathing space to repay its debt and figure out its future. In the meantime, creditors will prevent the company from making acquisitions, although disposals are a strong probability.
There may be IPOs ahead
With the bond markets now wide open, some bankers do not see a spate of major Russian corporate distressed sales or restructurings for the year ahead. Finding liquidity is not as pressing as it was last year.
However, the bank loans market, including bridge loans, for acquisition finance, remains tight for all except the best Russian investment-grade corporates such as Lukoil.
Instead, it is likely that Russian companies will raise capital through IPOs, following Rusal’s example, or through private placements and secondary offerings, to make bolt-on acquisitions, or to reduce debt, or as opportune exits for their owners.
While certain other Russian corporates are keen to follow the Rusal IPO road, the London Stock Exchange remains their preferred route – and not Hong Kong. According to some bankers, there is no incremental demand if you list in China and, therefore the general trend will continue to be London.
But there is still much uncertainty in the global economy, with the eurozone in trouble and a tightening of lending among Chinese banks, plus the depressing fact that some economies are either still in recession, have flat growth, or face a double-dip.
It seems the small window of opportunity to IPO has for the time being closed, with several major London offerings, including those for New Look, Travelport and Merlin Entertainments, withdrawn or postponed in February. International fund managers want to invest in an organic growth story; they are not interested in deleveraging a company’s balance sheet.
Nevertheless, there remain plenty of Russian companies keen to list in London. Russian fertiliser maker Uralchem, run by majority-owner and oligarch Dmitry Mazepin, wants to raise up to US$600m for a 30% listing in order to help it pay down some US$867.5m worth of debt.
Coal producer Suek is also aiming to float a 10% stake worth US$1bn in London in the second quarter, after its tie-up with Gazprom failed in 2008. Steel firm Metalloinvest, which is half-owned by oligarch Alisher Usmanov, is seeking to raise as much as US$2bn through an IPO to help it to refinance debt.
Even Russian media group ProfMedia, controlled by Russian oligarch Vladimir Potanin, wants to list as much as 40% on the LSE in what could turn out to be a US$500m listing come April. That would release liquidity in the company for opportunistic acquisitions, specifically targeting those Russian media businesses under financial pressure.
In short, domestic consolidation is inevitable as companies seek to strengthen their financial positions through cost-saving synergies and opportunities to scale up the business. Media is one sector already mentioned; banking is another.
Now, Russian state development bank VEB is trying to find a strategic partner to take up to 50% for US$1bn-plus in a planned federal postal bank, which will combine subsidiary Svyazbank with Russian Post, to compete against Sberbank’s network of branches. VEB has set a March 18 deadline for bid proposals.
Meanwhile, Mikhail Prokhorov has invited other oligarchs to pool resources and use his MFK Bank as a platform to buy distressed banking assets.
That leaves open the question of what Western banks are going to do with their retail networks.
“A lot of the foreign banks – in part because they have their own liquidity problems back home – are losing their taste for Russian retail risk, so they’ve got to figure out what to do with their networks,” says Matthew Roazen, a partner with law firm Akin Gump in Moscow, “and I think you’re seeing them looking at each other hoping somebody else is going to buy them, but I don’t know if you are going to have buyers or a whole bunch of sellers.”
Belgian bank KBC, which received a €7bn state bailout, has put its Russian bank Absolut on the market, although no sale process will begin until after 2011, it says. Back in 2007, KBC trumpeted its US$1.01bn acquisition of Absolut just as the market was about to crash.
“KBC is quite keen to get out [of Russia],” as one FIG adviser based in London succinctly describes the situation.
“What we will see is that some foreign banks will have made the decision to offload over the coming quarters of 2010 some parts of their portfolios here,” continues Roazen, “so I think you will see M&A between foreign banks regarding the transfer of Russian banking assets from one of them to the other”.
Another sector is airliners. The Kremlin has abandoned its plan to set up a competing national airline to Aeroflot and, instead will privatise and merge six flagging regional airlines into Aeroflot itself. The move comes after aspiring media tycoon Alexander Lebedev agreed to sell his 25.8% stake in Aeroflot to the state for about US$400m at an 18% market discount.
Lebedev, who has always been critical about the way Aeroflot has been run, seems these days to be much more interested in beefing up his UK newspapers empire and is keen to buy the Independent titles.
The telecoms sector is also heating up, this time to create a more competitive environment against the dominance of oligarch Mikhail Fridman. With the closure of the merger imminent between Ukraine’s Kyivstar and Russia’s Vimpelcom, the number two mobile operator, and with the proposed JV between Fridman and TeliaSonera to combine their Russian and Turkish mobile assets, Fridman would effectively control even more of the Russian mobile communications market.
The Russian government does not want that. It wants state-controlled Svyazinvest to merge with MegaFon, and for TeliaSonera, Fridman, and Alisher Usmanov to sell their equity in Russia’s number three mobile operator to, or merge it with Svyazinvest in what could be a US$19bn deal. Talks are understood to be ongoing.
When it comes to the energy sector, Bashneft, which groups together Sistema’s oil assets, has applied to Russia’s regulatory authority, the Anti-Monopoly service, to buy 49% of mid-sized oil producer Russneft. The latter had been under the stewardship of Oleg Deripaska, until he reportedly sold back control of the business to its controversial founder Mikhail Gutseriyev.
Russia Inc abroad
While many Russian companies will stay at home to digest previous acquisitions, or sell assets (because of their financial predicaments), those with reasonably healthy balance sheets will look abroad to do deals.
To this effect, Sistema has signed a memorandum of understanding with India’s state-owned ONGC Videsh Limited (OVL) “to explore the possibilities of jointly studying, and if mutually agreed, to participate in attractive oil and gas assets in Russia and third countries”. OVL already owns 20% of Sakhalin 1 – the huge oil and gas project in Russia’s far east.
“My view is that the downstream part of Bashneft is pretty good and I think from a strategic perspective it makes sense for the company to beef up its upstream portfolio, so I think all its strategy will be driven by that,” says Stanislav Song, the head of M&A for JP Morgan in Russia/ CIS.
Meanwhile, Lukoil, Russia’s second largest oil producer, may have seen its net income for 2009 dive by 23% to US$7bn, in line with a drop in oil prices, but that will not stop it making acquisitions abroad both at the downstream and upstream level. Its next move could be in Uganda as it seeks to strengthen its oil reserves.
And, despite the contested presidential election in Ukraine, there is no doubt that president-elect Viktor Yanukovych will court major Russian investment into his country, which is dogged by a crippling economy and a massive IMF bailout.
When it comes to foreign investment into Russia, the situation is fairly sluggish. With the near-resolution of the five-year spat between Fridman’s Alfa and Telenor over the control and strategy of Vimpelcom and Kyivstar, in addition to the restructuring of UC Rusal, it is hoped that Western capital flows will be attracted back into Russia.
The international bank lending market is only now beginning to open up, after a lot of major bulge-bracket banks got burnt with Russian restructurings and bad loans. Because overall the European loans market remains quite tight, Western banks will only start lending to Russian investment-grade borrowers.
So far this year, the biggest Western potential deal into Russia could be Coca-Cola acquiring Russia’s fourth-largest juice maker Nidan Soki from US private-equity group Lion Capital for US$500m-plus. The days of the mega deal are not yet back.
“Certainly, there is an interest from outside investors to invest in Russia, but the interest is fairly selective, I would say. Those people who are interested, they are really targeting the best companies and they’re not just buying because it’s Russia – they want to see strong fundamentals behind the business they’re buying,” says Song.
John Goodwin, managing partner for Linklaters in Moscow, agrees. He says: “The real buyers from abroad coming into Russia are those who have been looking at it for a while and want to take an opportunity . . . they’ll be strategic buyers, buying in the same industry as themselves and buying for effectively a bolt-on or a strategic reason.”
But with moves afoot to strip TNK-BP, Russia’s third largest oil company, of its licence to exploit the huge Kovykta gas field on China’s border, all that good PR – which the Russian government has been trying of late to disseminate to the Western investment community – could be put on a back foot.
The dispute is linked to a 2007 agreement for TNK-BP to sell its stake in Kovykta to Gazprom, but the two parties have continued to haggle over the sale price. The showdown comes at exactly the same time that TNK-BP has announced that it will invest US$1.7bn in two oil and gas greenfield sites in Siberia.
The oil and gas sector in Russia has always been strategic to the Russian state, but other areas are not so risky for foreign investors. Even then, they are mitigating risk through joint ventures.
Italy’s Fiat and Russian automaker Sollers are establishing a €2.4bn 50/50 joint venture to make 500,000 Fiat cars annually. Durex maker SSL is forking out no more than £140m to increase its stake in Russian condom distributor BLBV from 50.6% to 75%. In 2011, SSL can exercise an option to take 100% control of BLBV, which it is likely to do since it sees Russia as its biggest single market going forward. Even eBay’s chief executive John Donahoe would consider JVs to gain a foothold in Russia’s estimated US$5bn online retail market.
Healthcare will also continue to be an important area for foreign investment. In October last year, France’s Sanofi-Aventis bought a 74% stake in Russian pharmaceutical products manufacturer Bioton Wostok. Then in January this year at Davos, the chairman of Novartis, Daniel Vasella, said he saw Russia as one of his strategic goals over the next two to three years, because of the country’s strong R&D and its 140m people population.
As for sovereign wealth funds from Singapore, China, and Libya, they are scouting for deals in Russia and the wider CIS, but none of them have so far worked out.
“I think there will be modest growth compared with 2009, I think there will be foreign investment into Russia, but they will be strategic acquisitions of mid-size,” says John Goodwin. “I think we will not see very much by way of external investment by Russian corporates, with the exception of the energy sector, and I think liquidity will remain tight.”