Ben Aris in Berlin -

Michael Calvey, the managing director of Barings Vostok Capital Partners, will be speaking at the Adam Smith conference on Russian alternative investments in London on February 21-22.

Michael Calvey is the managing director of Barings Vostok Capital Partners (BVCP) and one of the pioneers of Russia's private equity market. BVCP set up one of the very first funds buying into Russian companies in 1994, when it was still not clear if Russia was going to stick to the road of democracy and market economics.

BVCP has stakes in about 25 companies from across the industrial spectrum, including independent oil producers, retailers, financial services and media. It has raised and invested some $800m, and is in the process of closing a fourth fund.

Private equity in Russia is growing fast, but remains largely a domestic game. Calvey estimates the total amount of private equity investment made to date in Russia at $40bn, of which foreign investors account for only $2bn, or 5%.

With a flood of IPOs coming to market, foreign interest in Russian private equity has taken off in the last two years as exits from investments become increasingly straightforward. But domestic private equity investments are growing just as fast and it's unlikely that the foreign share will get over 10% of the total in the next five years, believes Calvey.

"The increasing share prices and asset values have encouraged more and more owners to take their companies public," says Calvey. "And we will see more and more companies from the second tier listing; those companies with market capitalisation on the order of $500m that also give investors exposures to new sectors like consumer consumption."

Analysts say that despite the triple digit gains in the last three years that have sent the value of Russia's listed companies over the $1-trillion mark, Russian companies are still trading at a 20% discount to similar companies in other emerging markets.

"The whole world has been awash in liquidity and Russian companies still look reasonably priced, whether you judge them in terms of price/earnings ratios or in terms of book/value multiples - they don't look expensive compared to their global emerging market peers," says Calvey.

Minigarchs to the fore

Most of the investment so far has come from the first generation of entrepreneurs: the oligarchs that made their fortunes in the 1990s and were looking for new opportunities beyond their core businesses. However, the growth of the economy and, more recently, the after-effects of the so-called Yukos affair – the politically motivated crushing of oil company Yukos by the Kremlin – have changed the nature of the game.

"In the last three years the rate at which the oligarchs are making private equity investments slowed after the Yukos affair and they have become more subdued," says Calvey. "This has created an opportunity for the 50-100 smaller industrial groups. They see this as their time to become serious players and they are growing aggressively."

This second tier of so-called "minigarchs" is made up of entrepreneurs who have built up a strong business that contains 5-10 companies with cash flows on the order of $50m. With the bank sector's capital growing by over 40% a year, these minigarchs now have access to substantial credit, which allows them to finance deals of $20m-40m - enough to buy a factory or successful publishing company.

There are few Russian institutional investors and what there are consists almost entirely of the likes of state-owned banks, such as Sberbank, VTB and Gazprombank, which are also making proprietary private equity investments. But these banks are also the main source of funds for minigarch investors.

Despite all the progress, making private equity investments still involves cutting deals with individuals and Calvey says that corporate governance is still a concern; BVCP likes to maintain a controlling stake in their companies.

"In a raging bull market corporate governance is usually pretty good," says Calvey. "The problems appear once the market turns, then the incentives for founding owners deteriorates and you can expect more serious problems for minority shareholders. If you have a controlling stake, you can control the cash flow and so if sentiment turns sour it is still possible to make money."

And at some point the Russian "raging bull" will run into a wall. Calvey says that after six straight years of extraordinary growth investors into Russia are bound to get ahead of themselves.

"It will not happen in the near future, but at some point we are expecting the market to overshoot and there will be a correction - probably a very serious one," says Calvey.

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