Insulated Russia offers warmth in global freeze

Insulated Russia offers warmth in global freeze

By Andrew Hayes

Published: March 26 2008 02:00 | Last updated: March 26 2008 02:00

There is a strong chance that Moscow will become one of the world's top financial centres in the next 10 to 15 years.

This would see it overtake both Frankfurt and Paris, and see the Russian capital as second only to London in Europe.

In order to achieve this remarkable transition, Russia will need to ensure that capital flows freely to those most able to use it effectively, and assets are placed in the hands of owners and managers who are capable of improving their performance.

So what does this mean for mergers and acquisitions in Russia? The level of M&A in the country is certainly increasing. For example, we at Renaissance Capital advised on more than 25 M&A deals last year - more than double the number in the previous year.

Many of these were not publicly disclosed, so you will not see them in the published league tables. But this level of growth is clearly indicative of the market as a whole.

We expect the volume of M&A to grow further - certainly in the near term - before it settles and returns to the current level.

The reason being that M&A deals in Russia represented around 2 per cent of global M&A in the first half of 2007. This compares with Russia's GDP currently representing around 2 per cent of global GDP.

Whilst one could argue over the figures, we do consider GDP to be a very rough indication of long-term M&A trends in stable economies.

In the short term, however, Russia is undergoing an amazing transition. Companies are advised to become involved in the likely wave of M&A sooner rather than later as industries are restructured along more efficient lines.

The changes are already evident in the capital markets where Russian companies represented a staggering 20 per cent of global IPOs in the first half of 2007.

Many of these IPOs will trigger M&A deals as they provide Russian companies with the currency to consolidate their sectors.

About half of the transactions last year were domestic-to-domestic deals. The consumer sector has been particularly active, with one or two big entities seeking to act as its main consolidators - and eventual leaders.

High fragmentation within the sector means that deals, often driven by regional build-out strategies, tend not to cause concern with anti-trust regulators. They build scale, generate synergies and combine best operating practices across expanding groups.

What is surprising about Russia's cross-border M&A is that outbound deals represent a growing proportion of the sector, as Russian entities seek to secure their global leadership. These transactions tend to be focused on international industries where scale and reach is important, such as oil, gas, metals or mining.

Inbound M&A has been representing a decreasing proportion of Russian M&A activity over the past couple of years. International corporations are sometimes concerned - often unnecessarily - about the local risks, not least political ones.

In the event that the perceived political risk declines, the volume of inward M&A is likely to grow rapidly.

This is important because these deals, which help transfer international best practices to the Russian market, are critical in developing the nation's economy.

The big question we all face in 2008, of course, is what will be the impact of the credit squeeze, and in this case how it may affect Russian M&A.

The country is fully integrated with global financial markets, so there will definitely be an impact. However, the impact on the M&A market is likely to be relatively modest. The reason for this is that while the credit squeeze has influenced the equity markets, it has primarily affected highly-leveraged M&A deals, particularly leveraged buy-outs.

There have been few of these deals in the Russia market, as most M&A deals in Russia are driven by the need for fundamental restructuring of specific industries rather than by financial re-engineering.

The fact that Russia has to some degree been insulated from the credit squeeze is another indication of its journey towards becoming a robust financial market.

In the past, when there was a financial crisis in the west, it resulted in a "flight to quality" and therefore a withdrawal of credit from emerging markets: when the west sneezed, emerging markets caught a cold.

We have not seen such a withdrawal of funding this time - in part because markets such as Russia are seen as discrete financial centres that are more sophisticated and better understood by the global markets. Consequently, they deserve to be judged on their respective merits rather than under a blanket "emerging market" label, as was the case a few years ago. Andrew Hayes is head of M&A at Renaissance Capital