M&A starts as Russia's economy stabilises

By bne IntelliNews March 25, 2009

Ben Aris in Berlin -

Crises hurt, but for those that come out the other side with money in the bank, they also represent massive opportunities. As the Russian economy begins to stabilise, there has been a small, but perceptible, up tick in merger and acquisition activity at the end of February.

Russian M&A has been booming in recent years. Both the volumes and the size of the deals were more or less doubling every year since 2000. That is until the current crisis floored everyone.

Ernst & Young reported that in 2008, thanks to a very strong first half of the year, the volume of M&A deals in Russia reached $120bn, only $11bn less than the volume in 2007. "The financial crisis which developed in the fall of 2008 brought drastic change to the M&A market. However, thanks to a very active market in the first six months of the year, total transactions did not fall significantly," says Hakob Sarkissian, partner at Ernst & Young and head of M&A advisory.

The number of deals has remained more or less constant over the last two years, but what changed was more and more small- and medium-sized enterprises were getting into the M&A game; small business grew bigger by tying up with, or buying, their competition. Moreover, the number of foreign firms entering the Russian market through an acquisition jumped by 42% on year in 2008 with $28.6bn worth of purchases.

But as the crisis hit Eastern Europe, business came to an abrupt halt and M&A volumes fell to almost nothing. A rough guide to the change can be seen in bne's weekly M&A newsletter, "bne:Deal", which reported on 77 deals in the mid-September issue worth a total of $10.9bn. By end of February, there were only 13 stories about deals worth a total of $1.3bn - and several of these deals were distressed asset sales.

Crises always lead to a shuffling of the pack. Oligarchs like Basic Element's Oleg Deripaska, who built up an energy and metal empire largely using debt, has been crushed in the sell-off. Others like Onexim's Mikhail Prokhorov, who are sitting on large cash piles (he had just completed the sale of his 25% stake in Norilsk Nickel worth billions of dollars), have gone shopping for bargains.

But by the start of March, the ruble devaluation process seems to be coming to an end, opening the door to a resumption of business. Investment banks report that capital flight slowed from $30bn in January to about $4bn in February and the Central Bank of Russia (CBR) has stopped intervening in the foreign exchange market. As the future becomes a little more predictable, businessmen are starting to look about to see what is on offer, and the banking and retail sectors have seen the most action so far.

Banks on offer

Prokhorov picked up a 49% stake in leading investment bank Renaissance Capital for $500m in September, a stake that was valued at about $2bn only a year earlier. More recently, South Africa's Standard Bank bought a 33% in Russia's other leading investment bank Troika Dialog for a reported $200m, which was likewise worth almost 10-times as much only a year previously.

The banking sector's high-water mark was probably the purchase of Expobank in March 2008 by the UK's Barclays Bank. The British bank paid the highest sum ever for the bank owned by Peter Hambro, shelling out $745m against its $186m in capital as of the end of 2007. The price implied a ratio of 4-times capital, which topped the previous record of 3.8-times capital.

But a study by Uralsib shows that the prices for banks have been falling steadily since the start of the US sub-prime debacle. Ratios had fallen from a high of 6-times capital to about 3.6-times in 2007 and was down to 2.9-times by the first half of 2008. And if banks' equity prices are anything to go by, then the ratios have now fallen below 1-times capital.

Even at these reduced prices, more bank acquisitions are on the cards. With capital growing by at least a quarter a year, few bank owners were willing to sell. But now banks are struggling to just keep their heads above water, let alone grow, most owners of smaller banks are desperate to sell. On top of this, the central bank is widely expected to use this crisis to force a rapid consolidation of the bank sector. The CBR is already providing liquidity to the buyers of small banks to help the process along and at the start of February introduced new rules that make buying a bank much easier. "Despite the black clouds hanging over the sector, smaller banks can find willing buyers," says Richard Hainsworth, CEO of RusRating, a Russian bank-rating agency. "Many international banks are still interested in entering the market, but not at the 2007 prices. Smaller banks are particularly attractive, as they are a shortcut to getting a Russian banking license."

Retail shopping spree

The other sector with a vibrant M&A scene is retail. Arguably the most competitive sector in the Russian economy, half a dozen large retail chains have been battling it out for market share. As western-style shops are a relatively new innovation in Russia, whoever can win the loyalty of customers now can look forward to constant sales growth for decades to come: in 2000, only 8% of goods were sold through shops and outdoor markets took the lion's share of the rest; by 2008, organised retail had doubled its share, but clearly still has a long way to go.

And with retail turnover already counted in the billions of dollars, supermarket chains were amongst the most active issuers of bonds and equity as they raced to open as many stores as they could. The crisis caught many players with their trousers down and several have been forced to sell assets at knockdown prices to cover debts.

The crisis will lead to a consolidation of the supermarket business. The market leader, Alfa Group's X5 Retail Group, looks well placed to be one of the big winners. Backed by the powerful Alfa financial-industrial group, the company has already added a couple of chains to its cart and hasn't been through checkout yet.

X5 CEO Lev Khasis said at an economic conference in February: "I think there will be many mergers and acquisitions, and we are going to have an active role in these deals." X5's sister company Alfa Bank took over children's goods retailer Banana-mama after it defaulted on its loans and is reported to also be in takeover talks with Russia's third-biggest supermarket chain Kopeika, a discount food retailer.

Ironically, the crisis is good for supermarkets, as Russian shoppers trade down to domestic goods. Prior to the crisis, some 40% of Russian foodstuffs were imported (60% in the Moscow market), but post-crash, shoppers are going for the cheaper domestic produce. X5 says it's expecting sales volumes to rise by a quarter in 2009, while market number two, regional supermarket chain Magnit, says its sales should rise by almost 40% this year. In a sign of the times, Magnit says it will roll out 400 new discount stores this year investing $650m, but has slashed the number of hypermarkets it was planning to open.

However, the Russian companies will also face stiffer competition from foreign outfits. After two attempts to enter the Russian market, US retail giant Wal-Mart looks like it may finally take the plunge. The company has twice commissioned studies on the Russian retail market, but each time decided the cost of entry was too high. However, in January the discounter hired Credit Suisse to hunt for an acquisition target and is reportedly already in talks with St Petersburg retailer Lenta. "Russia remains a market of interest for Wal-Mart," said Richard J. Coyle, Wal-Mart senior director for international corporate affairs.

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