Business of the Patient
- How does BVCP work in the investment market: does it buy 100% of businesses or confine itself to acquiring a small stake?
- The fund makes an investment in a company and gets its shares (at least the blocking stake) in return. Sometimes we would buy out 100% of the shares. We may also spend a part of the money on buying out shares and allocate the rest for the company’s development. In any case, this is done with the view to a considerable increase in the project’s capitalization and its further selling to the benefit of the fund.
- In what situations is it more profitable for company owners to turn to a private equity fund for money than to place shares on a stock market or to get a bank loan?
- Companies turn to private equity funds (PEFs), when their owners and the investor have the same goal: to increase the company’s capitalization and sell it. That is, to sell it after it has become a successful and attractive business - otherwise nobody will buy it.
Many companies do not raise loans. Why? Nowadays it has become common to believe that there are few credit resources in Russia. On the one hand, it is true. However, if you look at strong companies, it will become clear that they do not feel the lack of loans: banks compete with each other for the most attractive customers. Yet, sooner or later such a business may face the problem of rational balance between debt and equity, and at a certain point banks may just stop financing you. Then you’ll need the infusion of money into the share capital, and the owners will start looking for partners, including private equity funds.
- Two years ago Michael Calvey, the head of BVCP, said that the volume of direct investments which could come into Russia did not exceed half a billion dollars. Not long ago he mentioned an amount of one billion. So, can we draw the conclusion that the capacity of the Russian private equity market has seen an explosion?
- Certainly. During the period from 1994 to 2004 capital investments into Russian enterprises made up about $56 billion a year. Out of this, foreign investments accounted for approximately four billion. And our annual investments - about 35 million. This means there is still much space in the market for private equity funds. Moreover, if a fund raises a billion, this does not mean it must immediately invest it – it has three to five years to screen suitable projects.
- What is the financial performance of BVCP?
- In February we launched here our third fund already, with the capital of $400 million. The first one, which was set up 11 years ago is almost entirely closed (20 projects out of 22 have been sold out). The capital of the first fund made up $160 million, the amount of resources raised for the second one was $205 million. All in all, the funds have paid out $577 million in dividends during 11 years. - How many projects did you have to write off and what were the reasons for the failures?
- We have written off four companies: a retail company, a timber cutting company and two timber processing projects. This rejection rate is quite normal, there aren't any private equity funds having no unsuccessful investments. The predominance of successful projects is what’s important.
- BVCP manages capital invested by Western pension and insurance funds. What is the mechanism of profit distribution between the “source of capital” and those who managed it upon expiration of a portfolio and its closure?
- That is true, pension funds are the most common investors for the funds like ours. As for the profit – each fund has its own schemes. This is not public information. I can only say that the distribution, as a rule, is arranged in the following way: first, the initial capital is repaid, plus the predetermined interest, and then the profit remaining above this amount is distributed in a certain proportion.
- Are there many western private equity funds operating in this country?
- Once a year the International Financial Corporation holds a conference for representatives of private equity funds operating in emerging markets. The audience of this conference is about 200 people. Of course, this is not much. And there are just about a dozen funds trying to make money in Russia. All in all, they have brought in this country approximately a billion ready for investment, and 400 million out of this amount are ours. I am referring to the money which will be invested in the nearest future and not to the funds which are already in portfolios.
- How intense is the competition between such funds in Russia?
- We certainly see each other in the market and some projects become a target for a competitive struggle for several funds. There exist more developed areas – telecommunications, oil, foodstuff projects – and here one can have a keen sense of competition. But once you step a bit aside (say, to take a closer look at financial services) – there you find a vast unexplored space. It is likely that the competition between funds will increase, but I do not see a problem here.
- If you take a look at the portfolio of BVCP, it turns out quite diversified: from mass media, confectionery, beer and timber processing to oil and telecommunication companies. What industries, in your opinion, are of particular interest?
- The main idea of private equity funds is to penetrate into such industries which are not available through the stock market. Compare the structures of the Russian GDP and the RTS market. The differences are striking. But this does not mean that the industries which are not represented on the exchange do not grow; that they do not have large players or that they are not interesting for investment. It is not so.
- Can we say that in terms of direct investment profitability Russia ranks one of the first in the world?
- From the perspective of attractiveness, potential investors are guided by forecasts about the countries which will become the “drivers of the world economy” in the next 20 years. Russia is among them. Apart from us these countries include China, India and Brazil. But this, of course, does not mean that attractive projects cannot be found in other countries. For example, although the project return in the U.S. changes from year to year, it can be as high as 30 or 40 percent.
- Why, then, invest in the markets with lower performance predictability?
- It is important from the perspective of investment diversification. Our investors include not only U.S. funds. There are both European and Asian investors as well. On the whole, it is wrong to assert that the Russian market is more attractive than the Asian, Latin-American or European ones. There is no sense in comparing our performance with investments into highly liquid assets. The life of the fund is 10 years; the investment period is 4 to 5 years. At that, having invested money you won’t be able to sell the assets “with a snap of your fingers”. So, if something catastrophic happens, for example, in Asia, you won’t be able to liquidate your portfolio immediately. You’ll stay with it and you’ll have to pass through this crisis. So, if now indices are rising in one place of the globe and falling in another, this does not at all mean that private equity funds behave in the same way.
For example, after the Russian crisis of 1998 we managed to restore the capitalization of our portfolios quickly, and the years of 1999 and 2000 were the most successful for investment – we were lucky to have money and we invested it, in particular, buying out shares in Burren Energy (it is our most successful project) and SladCo…
- Is the life of funds before portfolio closing similar around the world? And why is it precisely ten years?
- Time periods do not have any local peculiarities. Such intervals exist everywhere, they have been derived empirically. Do not force managers so that their money burns a hole in their pockets. By reducing timelines you increase chances of having low quality projects in your portfolio.
You should invest only if you really believe in the project, approaching it very carefully, as if it were the last project in your life. All the more so we deal with piece-goods.
The private equity business is the business of the patient. This applies not only to Russia, but to all parts of the world. Starting your business you should be prepared that at first everything will not be so smooth and won’t develop according to a conceived plan. You should know how to come out of a crisis, including by means of reserving certain financial resources for this purpose. Our path was not strewn with roses either, and there were moments when we thought that we had made a miscalculation and something had gone wrong. In such cases our ability to add investments through expanding the company’s capital or buying out the “hopeless” was of much help. Often this proved to be the most profitable investment.
- Does this mean that your projects do not have strictly fixed budgets and, if necessary, additional investments can be made?
- Certainly. Moreover, in most cases it was just the case – additional investments were required and we made them.
- How does BVCP evaluate Russian companies when buying them, in view of the fact that the shares of the overwhelming majority of them are not traded in open markets?
- In the long run, only one measure – profit – is of importance to us. It is the most reliable indicator. If you analyze any statistical information about transactions, you’ll see that the scope of estimates is very wide – and not only in Russia. That is why the only fair estimate, in essence, lies in the amount someone is ready to pay in cash for your company today. Everything else is an attempt to round off rough corners and start the subject of this fair estimate… - And what selling procedures are used most often to exit a business? How rare are IPOs? Is the management buy-out wide-spread?
- IPO is not so very rare. We have already had four such exits. Of course, in comparison with other countries here it is a less common instrument for the time being, but its development is merely a matter of time. Also, there were four instances of management buy-outs, in the financial sector and in the field of construction materials in particular.
- When acquiring a new business, what changes do you make to it in the first place?
- Our main task is to create certain corporate culture in a company and to whittle down contradictions between the owners and the hired management. The next step is to strengthen the management team. For example, if no appropriate people can be found in the country, we’ll bring them from abroad.
- Do you use services of external consultants when adjusting business processes?
- Yes, we do, for example, when we enter a new sector. As for specific projects, in some cases it is the company that hires consultants. But I do not strongly believe that it is possible to find a consultant who will say what to do. If he really knew this, he would be an investor, and not a consultant. I only believe in consultants, when they are assigned an absolutely specific task, rather than a global one.
- Michael Calvey once mentioned that BVCP considered applications for about one thousand projects and only 38 of them worked out. This means that your admission is more competitive than the one in a most prestigious university. How does your “admission committee” work?
- Approximately 60% of the projects which have received our investments are those from the fields of our already operating businesses. And only 40% represent new contacts and relations. But in both cases it is a result of a goal-oriented search. Of course, the proportion is changing. For example, at the very beginning, 11 years ago, we had no portfolio yet which would generate “spin-off” projects becoming their source. By the way, I consider this very mechanism one of our main competitive advantages.
- Among the thousands of proposals you received, there surely were absurd ones. Which one was the pick of the basket?
- There were plenty of them. I have a big collection of such proposals. The favorite months are March and September.
There was a project of a paid pet cemetery in one of the Russian towns with the population of less than half a million. There was a proposal to build a nuclear-powered trimaran (three submarines with a nuclear reactor welded together) for taking tourists to the North Pole and breaking the polar ice. There were projects for obtaining sugar from rye and gasification of small Russian villages by means of producing gas from poultry manure.
And the most global project was as follows: The author of the business plan on eight pages without any punctuation marks offered to us to finance measures aimed at a drastic reduction of the world’s population which, in his opinion, was “absolutely uncultured, and at the same time reproducing itself promiscuously…”
The interview conducted by Konstantin GURDIN
REFERENCE INFORMATION
Andrey Anatolievich Costyashkin
A Partner and the Head of Research at Baring Vostok Capital Partners. He has been working with the company since February 1999.
From 1993 to 1996, he was the Head of Research at Alfa Capital, an investment bank.
Mr. Costyashkin holds a Ph.D. in Economics from the Institute of Transportation Engineering, where he also worked as a researcher and lecturer for six years.
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