Deal making, privatisation, modernisation and investing in Russia
An interview of John Hammond with Modern Russia
Following the recent Deal Drivers Russia 2011 survey by mergermarket and CMS, the firm’s Senior Partner John Hammond talked with Modern Russia about the state of the Russian M&A market and what should be done to attract more investors and deal makers.
1. How would you describe the M&A market in Russia? How does it compare to other markets?
The M&A market in Russia is still a relatively young market which has only been one economic cycle: growth in the years from 2000 to 2008 followed by a sharp decline in 2009 with recovery starting in 2010. Although seen sometimes as one of the world’s most volatile markets, the decline between 2008 and 2009 was more or less in line with the decline in the global M&A market; for example in Russia there was a 52 percent decline in value and 40 percent decline in volume against a 55 percent decline in value and 35 percent decline in volume in Europe overall. Looking at the upturn between 2009 and 2010, global M&A has increased by about 24 percent by deal count, while in Russia the number of deals has increased by 29 percent. So we might say the Russian M&A market generally “outperforms” the global M&A market by a few percent whether it is increasing or decreasing.
It shouldn’t be overlooked that the Russian M&A market remains a very small market relative to the size of the Russian economy. In 2010 213 M&A deals were announced in Russia with an overall value of € 52 billion. If you compare this with Australia, which has a slightly smaller economy and which is also principally a supplier of natural recourses, the point is clearly illustrated: the Australian market saw 932 M&A deals in 2010. And if you look at the world’s largest M&A market, the United States of America, you will see that nearly 3500 deals were announced in 2010 with a combined valuation of more than € 530 billion. The good news from all of this is that with an undersized M&A market comparative to GDP, there is plenty of headroom for the market to grow rapidly in the near future.
2. What do you expect to be the drivers of M&A activity in Russia in 2011?
Everyone expects that one of the key-drivers will be federal and local governments’ widely talked about modernization programs. Opportunities to invest in major, successful Russian corporates such as VTB, Sberbank and Rosneft will attract significant interest from foreign investors and, as we are already seeing, may make it more challenging for other companies to attract interest. The state banks are also known to be sitting on substantial portfolios of assets which, as the economy picks up, they will need and want to dispose of. Our survey reflects this view with 23 percent of respondents listing this as a primary deal driver for the year ahead. Other factors which the market thinks will play a role are cash-rich acquirers and undervalued targets. Companies have been rebuilding their balance sheets over the last two years and keeping their powder dry. With optimism replacing fears of a double dip, we anticipate that some of these will look to accelerate their growth in the Russian market by acquisition. One example would be MegaFon whose head of M&A, Dmitriy Komarov, recently explained to mergermarket that they see possibilities for growth through M&A in the broadband internet and content spheres.
3. What effect will the government’s privatization plans have on M&A activity in Russia?
The government’s privatization plans will on the one hand boost the M&A market by bringing good quality assets to the market which will generate a great deal of interest. Assuming the assets are available to foreign players through, for example, professionally run fortune processes, this could act as a catalyst by generating confidence in the market and stimulating further growth. In the short term there may be a negative impact on the private M&A market as investment resources are diverted towards the government’s privatization targets from medium to long term greater engagement of the international community in Russia will support market growth.
4. Which sectors do you expect to show significant deal activity and growth opportunities for international investing in Russia?
The traditional sectors of the Russian economy will, in our view, continue to lead in M&A. These are, of course, energy, mining and utilities and TMT. Deal values in both sectors tend to be high and there is still room for some major consolidation plays. Interestingly, the heat chart published in our report shows the transportation sector as an unexpected hotspot for 2011. This no doubt reflects the anticipated sell-off of infrastructure assets such as airports, ports and railway infrastructure. The consumer sector is also expected to perform strongly as retail sails peak up and players jostle for market share. The energy, mining and utilities sector continues to be difficult for international investors whom we expect to look more to consumer, industrials and possibly pharma assets.
5. What factors impact the growth of M&A activity in Russia? Are the government’s modernization efforts moving in the right direction? What else should be done to attract more investors and deal makers?
The big issue in Russia for M&A deal makers continues to be inward investors’ perception of political risk. When asked what they believe would be the principle obstacle to M&A activity in Russia over the next twelve months, nearly 30 percent of our survey identified political risks as the number one issue. It is difficult to know quite what is meant by this but it clearly reflects continuing concern about the relationship between government and business in Russia. On the plus side, the price of oil is also relevant and the expectation of continuing high prices will, in our view, stimulate interest from foreigners investing in Russia. With low growth rates afflicting most of Europe and the US, Russia is one country with a relatively developed economy in which attractive returns are available.
The government’s modernization goals are undoubtedly laudable but simply developing a high-tech economy is not sufficient. All businessmen, Russian and foreign, will tell you that businesses are overregulated here and, for foreign investors, coping with these regulations and remaining compliant with US and European anti-corruption legislation is a challenge that drives up the cost of doing business. There is no doubt that the biggest challenges remain: streamlining the regulatory environment, professionalizing the civil service and driving out corruption. Without evidence both of political will and actual progress on these three issues, Russia will continue to underperform economically and as M&A market. Investors want an open playing field with clear rules that they can understand, comply with and if necessary, enforce.