Sanctions unleash a tsunami of Russian M&A deals

Sanctions unleash a tsunami of Russian M&A deals
Sanctions have forced a massive restructuring of Russian business and also have resulted in a lot of bargains as leading Russian entrepreneurs snap up cheap assets as departing foreign firms try to rescue something from the debacle. / bne IntelliNews
By bne IntelliNews November 1, 2022

The extreme sanctions imposed on Russia after the invasion of Ukraine have thrown Russian business into chaos. In the space of a week products and inputs that are essential for production simply stopped arriving even if they were not on one of the sanctions lists. Western suppliers of all sorts just cut ties with Russia. 

Within a month over a 1,000 Western companies suspended operations in Russia, with many threatening to pull out of what had become Europe’s largest consumer market altogether. Eight months on and that process is ongoing, but it is proving much harder to do in practice. Western companies have invested hundreds of millions of dollars in building up their presence and, according to a report from Yale, have a turnover equivalent to 40% of Russia’s GDP.

Departing companies don’t want to abandon their investments entirely, and some have no intention of quitting the market completely. But Russia has become so toxic that simply ignoring the war in Ukraine is not an option either. That has driven a tsunami of M&A deals as Western investors try to rescue something from the Russian debacle.

A Russian official estimated in August that three-quarters of Western companies are still working in Russia, but the picture is muddled. According to a study by the Kyiv School of Economics (KSE), only about 50 companies have genuinely left the market completely, while others are in some sort of limbo. Other have moved their legal domiciles to “friendly countries.” Many have suspended their operations, but have kept the option to restart them in a few years’ time when the storm blows over. And many of them are selling their businesses to their Russian management, distribution partners or opportunistic entrepreneurs taking advantage of the fire-sale that is underway.

The picture is further muddied by parallel imports. While some companies like Apple and Nike have nominally pulled out of Russia they have done so by selling their distribution chains to their Russian management, which will continue to import their products via intermediate countries like Turkey, which has seen its trade with Russia grow by 50% this year compared to what it was a year ago before the war started.

Russians were buying 30mn smartphones in 2021 and Apple was at the top of the list, but this year the brand has completely fallen out of the top ten brand sales list, to be replaced by Chinese brands. Former president Dmitri Medvedev said this month that it is still possible to buy the new Apple 14 in Moscow – it has been released since the war started – just it costs 20% more, is imported via Turkey and doesn’t have any of the service agreements or company guarantees Apple offers in its legitimate markets.

Like most Western brands that have started to reappear in Russia, Apple has no control over the parallel imports. They are organised by traders who do not have the capacity to handle a million unit orders but are sending smaller orders, so volumes of sales have collapsed.

With other products like high-end suitcases the total volumes are of a manageable size for traders and the distributors that are taking over from the brand-owners will be able to continue their business more or less as normal. And often these sellers will continue to offer the same customer service and guarantees as the original producer, except taking those costs onto their own book rather than passing them to the parent company as in the past.

Apple hasn’t pulled out completely as it returned the apps of Russian internet major VK (former to the App Store at the start of October after the Russian company provided proof that it’s not “majority-owned or controlled by a sanctioned entity,” The Verge reported, thus further muddying the waters.

On top of that there are currently 400 oligarchs and mini-grachs in Dubai that are scrambling to break their companies into a Russian part and an international part that can continue business, according to bne IntelliNews reporters in the Arab city, the favoured and largest financial centre still open to Russian businessmen.

Some of these are taking their know-how, resources and money to launch new international versions of their existing businesses and are just building up mirror-image of businesses they have already pioneered in Russia.

Russia Inc. is going through a massive corporate restructuring as business responds to the sanctions earthquake that has toppled structures that have taken three decades to create.

The deals can be broken into three main types: super-large multinational players trying to exit or being forced out of the market; FMCG (fast moving consumer goods) and discretionary consumer goods purveyors that rely on large retail networks selling to partners or management; and opportunistic bargain hunting by big Russian companies or businesspeople.

Mega deals

The biggest companies have had the most problems, as they are simply too big to sell easily. At the same time, the Kremlin has banned some really big oil companies in strategic industries from leaving or has forced them into restructuring deals where they must decide to commit to Russia or exit completely.

In June Putin issued a decree that sets up a new holding company to control Russia’s LNG production on the Far East island of Sakhalin. Foreign stake holders – including Shell (27.5% minus one share), Japan's Mitsubishi (10%) and Mitsui (12.5%), Gazprom (50%) – were told to apply for shares in the new company or lose their stakes. Japan has sided with the West in sanctions on Russia, but it is also heavily reliant on Russian LNG for energy.

The Japanese companies have decide whether to remain shareholders but Shell expects the sale of its 27.5% in the new operator of the Sakhalin-2 project, the Sakhalinskaya Energiya company, to be completed in the first quarter of next year, the oil and gas company said in its quarterly financial report at the end of October, without saying who will buy it.

"On September 1, 2022, Shell formally advised the Russian Federation (RFG) that it would not apply for shares in the [newly-created Russian company] LLC, that it objected to the purported transfers from SEIC [Sakhalin Energy Investment Company] to the LLC and that it reserved all rights and remedies. The RFG is now expected to begin the process to sell Shell’s 27.5% (minus one share) share. This process is expected to be completed in the first quarter 2023," the report said.

Russian Deputy Prime Minister Alexander Novak said earlier the new shareholder of the Sakhalin-2 project replacing Shell would be defined by the end of the year, without giving more details. Novatek showed interest in the project earlier, reports BCS GM.

Much more tricky will be British multinational BP's 19.75% stake in Russian oil major Rosneft. BP has also said it will pull out of Russia, but it has not commented on how or who could buy its stake.

At the end of October Rosneft's Igor Sechin emphasised at the 15th Verona Eurasian Economic Forum in Baku that BP remains Rosneft’s shareholder and had collected $700mn worth of dividends from the second half of last year, which had been transferred to the company’s account.

"Despite the high-profile declarations made on February 27 by BP’s board of directors about the decision to divest from Rosneft, the company has not complied with that resolution. And despite all the rhetoric, it still remains a ‘shadow’ shareholder, not participating in the work of the company’s management bodies, maintaining all rights and corresponding dividends. I would like to take the opportunity to notify our friends from BP that their dividends for [the] second half of 2021 [amounting to] $700mn have been transferred to accounts that have been opened for them," Sechin said.

"Let me mention that BP’s revenues from participating in the share capital and joint ventures with Rosneft have already reached $37bn, with the total investment of around $10bn. I believe this is excellent compensation for the capital invested," Sechin added.

Other US oil firms have been pushed out and have taken large losses in the process. American oil giant ExxonMobil completed its exit from the Russian market after Putin ordered the expropriation of its assets, the company said on October 18.

ExxonMobil had been in negotiations with the Russian authorities to sell its more than $4bn in assets including its largest Russian investment, a 30% stake in the Sakhalin-1 oilfield in the Russian Far East since March. Sakhalin-1’s foreign investors were given one month to apply for shares in the new entity operated by state-run oil giant Rosneft.

The Exxon spokesperson did not say whether the company had received compensation for its assets, nor did he comment on whether the company would seek to challenge the seizure through the international courts. ExxonMobil had reduced its output on Sakhalin-1 by July, limiting volumes to the amount needed to sustain Khabarovsk and Vladivostok, the two largest cities in Russia’s Far East.

The sanctions regime has also thrown up problems for Russia’s leading privately owned oil company Lukoil, which is considering dividing itself into two companies, Swiss and Emirati, in order to allow European refining operations to continue after the European oil embargo begins on December 5. While the state-owned oil majors simply follow Kremlin orders, Lukoil has always endeavoured to maintain a tricky balance of retaining its independence and serving the interests of its shareholders, without stepping on the Kremlin’s toes. While the changes in Lukoil’s trading arm are not strictly speaking M&A, they are indicative of the corporate restructuring forced on everyone due to the extreme sanctions regime.

“Lukoil will face a more significant challenge in marketing Urals crude after the embargo begins in a few weeks. So far, its exports of Russian crude have been relatively lightly touched by Western sanctions thanks to the company being able to load its Sicilian refinery completely with its own Urals crude, and thus largely fully realising the value for that crude in the form of refined products sold on the Italian market rather than having to accept a significant discount to Brent crude,” BCS GM said in a note. “From December 5, however, the company will have to source non-Russian crude for the plant and find alternative outlets for perhaps 20% of its Urals exports that have been going to Sicily… The Swiss successor to Litasco will handle the sourcing of non-Russian crude for European refining, while the new Middle East trading arm will market Urals to that region and elsewhere.” One option is to export more Lukoil crude to the Middle East, where the Saudis have been refining it to increase the amount of their own crude exports, which in turn could be sent to Sicily.

There have also been big changes in the utilities sector. The Italian company Enel has pulled out of Russia after years of pioneering work that created the country’s greenest energy company.

Italian utility and gas major Enel has finalised the sale of its 56.43% stake in Enel Russia utility major to Russia’s second-largest oil producer Lukoil and investment fund Gazprombank-Frezia for €137mn, the company announced on October 14.

Another leading Russian utilities company Inter RAO was also opportunistically picking up attractive assets from departing foreigners, acquiring two Russia-based Siemens Energy assets – Siemens Energy share in the JV with Power Machines and power transformer producer – in deals worth €25mn, according to Interfax.

And the few big foreign players in Russia’s agricultural sector are headed for the door. French dairy products producer Danone is looking to sell its dairy and yoghurt business in Russia that it has built up over almost three decades, in a transaction that could result in a write-off of up to €1bn for one of the world’s biggest makers of consumer goods.

The FMCG companies were very early entrants to the Russian market, attracted by its very large population and the fact their products, like soap power and chocolate bars, were affordable to Russians even during the chaos of the early 90s. Mars, for example, is responsible for training an entire generation of Russian retail business managers. The FMCG products are the least likely to disappear from the Russian markets, as the traders will simply take over the business again, and buy out the local production that has been developed in the meantime. For example, Coca-Cola has five Russian factories that will all almost certainly go under the gavel now.

The French group said at the end of October that it would “initiate a process to transfer the effective control” of the business, which includes 13 factories, 7,200 employees and accounts for 5% of its annual sales of about €24bn.

“It remains unclear who will take over the business whose most popular brand is a local one called Prostokvashino, or if there would be proceeds from a sale. The move would not represent a complete exit from Russia, though, since Danone will continue to sell baby formula in the country,” BCS GM said in a note.

Car crash

Other than the energy and FMCG companies, Russia has attracted very little foreign direct investment (FDI), but the one other exception is in the automotive sector. With by far the largest population in Europe and a long engineering tradition – Lenin opened the GAZ plant that was a joint venture with Ford and the Soviets did another deal with Fiat to found the Avtovaz plant – the top six major carmakers are in the Russian market, and they are all leaving now.

The biggest departure is that the Renault-Nissan joint venture that took control of Russia’s biggest car maker Avtovaz, the maker of the Lada, and after years of work and investment had finally got it back into profit in 2021. This summer the JV was sold to the Kremlin for one ruble – but with an option to re-enter Russia if relations improve.

For the government the departure of carmakers is very political, as they are such large employers. The cities of Kaluga, Nizhny Novgorod and especially Tolyatti are almost entirely dependent on their local car plants. Consequently the Russian government has been heavily involved in many of the automotive car plant deals.

Car producer Nissan will sell its Russian assets to Central Scientific Research Automobile and Automotive Engines Institute (NAMI) of the Industry and Trade Ministry, with a buyback option within six years, the ministry said in a statement on Tuesday. “Nissan's executive committee has approved the sale of its Russian assets of Nissan Manufacturing Rus to Russia represented by NAMI subordinate to the Industry and Trade Ministry.”

Germany’s automotive manufacturing giant Mercedes-Benz has gone down a different route, planning to sell its shares in its Russian subsidiaries to one of its distributors, the Avtodom dealer, according to a statement released on the Russian Industry and Trade Ministry’s Telegram channel.

"Avtodom, the new owner of Mercedes-Benz’s Russian subsidiaries, will be able to attract other companies as partners to organise joint production on the basis of the facility in the Yesipovo industrial park," the statement said. After the deal is done, the new owner will be able to service the brand’s cars sold in Russia, Deputy Minister Albert Karimov said. This is also a return to the 90s, as originally all foreign cars were imported by dealers and it was only later that the manufacturers entered the market and worked directly with Russian consumers.

Truck producer Volvo Group has not decided whether it will leave Russia and is in negotiations with the Industry and Trade Ministry, a ministry spokesperson said when business daily Vedomosti reported that Volvo Group, which stopped producing trucks in Russia at the end of February, was considering selling the business fully or partially. "The company keeps in touch with the Industry and Trade Ministry but it is too early to speak of decisions," the official said.

Retail & CFA

Of all the FDI into Russia, retail is the most advanced. During the wild 90s of the Yeltsin-era Russia’s exports of oil and gas meant the ruble was overvalued as it suffered from a mild case of the Dutch disease.

That meant it was profitable to export to Russia and it skipped over the first phase of emerging markets FDI when manufacturers set up light manufacturing to capitalise on cheap wages. Russia has been running behind technologically ever since as a result. It was only recently that wages fell below those in China, where light manufacturing investment started to appear in earnest catering to the burgeoning consumer market that was growing thanks to e-commerce.

During the first decade of the Putin-era, the government increased public sector salaries by about 10% a year to close the income gap with the private sector, leading to a consumption-driven boom. Foreign retailers poured into this 140mn strong consumer market and made money hand over fist.

The most iconic retail investment was the opening of Swedish furniture flagship store in 2000 in the same month as Putin was elected president for the first time as the crown jewel in IKEA’s eastern European empire. And it is telling that while the network of 11 IKEA megastores has suspended trading, the company says it intends to re-enter the Russian market in two years and is not looking for a buyer for its Russian business.

Finding a buyer for foreign-owned Russian assets is one option, but in many cases the local management have simply taken over in an MBO and in these deals often the foreign owner includes a clause to buy back the assets in several years' time in case things improve.

The US luxury luggage purveyor Samsonite sold its Russian business to the “suitcase king” CEO Andrey Yazykov, who started life as a trader, importing Samsonite luggage in the early 90s before going on to be the brand’s biggest distributor.

Samsonite will not leave the Russian market, as Yazykov will continue to import the luggage via parallel import schemes and his new company Chemodan Pro (“Suitcase Pro” in Russian) will offer the same guarantees and customer service that Samsonite used to offer its customers.

The story is similar with Russian clothes distributor Jamilco, which plans to buy the Russian business of British children's clothing and goods chain Mothercare, which is pulling out after decades of successful trading.

Turnover in the clothes, fashion and accessories (CFA) sector has probably been the heaviest out of all the sectors. Multinational clothing firms are heavily invested in Russia, but they are also amongst the most sensitive to “reputational risk”, as a political boycott by sensitive consumers can be debilitating for their global sales.

Jamilco was founded by the son of a Damascus perfume trader that imported perfumes into Soviet Russia. His son went up-market and after making his first fortune importing Levi jeans in the first years following the Soviet Union’s collapse, he moved on to franchises of leading Western fashion brands including Christian Dior, Cerruti and Naf Naf, among others.

Mothercare is a household name, as Russians don't skimp when it comes to spending on their children and the brand has become a by-word in Russia for quality products. Like the suitcase king, Jamilco’s decision to buy out Mothercare is another opportunistic investment by a leading distributor of international goods on the Russian market.

According to local reports, the distributor is in talks with the Kuwaiti company Alshaya Group, which owns the master franchise brand Mothercare in Russia. According to one of the daily's interlocutors, as a part of the deal Jamilco will receive the lease rights for the stores of the Mothercare brand, as well as unsold goods, but the stores will be rebranded with a new name.

Spain's Inditex, the owner of the international fashion Zara brand, has reached an initial agreement to sell the Russian division to Daher Group, the company said in a statement at the end of October. "Inditex has reached an initial agreement to sell its business in the Russian Federation to Daher group," the company said. After fulfilment of the deal, Inditex will discontinue operations in Russia.

Russia’s leading multi-sector conglomerate, Sistema, announced it had agreed to buy 47.7% Melon Fashion Group in another opportunistic deal. According to the agreement, Sistema will buy the stake in the company from Swedish Eastnine and private equity investment fund East Capital Holding, as well as a group of individual investors, for RUB15.8bn. Sistema will finance the deal with its own and borrowed funds.

The deal is expected to close by the end of 2022 subject to further regulatory approvals and satisfaction of certain conditions. Melon Fashion Group is one of the largest and fastest-growing fashion retailers in Russia, according to Sistema’s press release. Its brands include Zarina, befree, Love Republic and Sela. It is engaged in the full cycle of fashion production, from modelling to sales distribution and promotion. Melon Fashion Group operated 845 stores in Russia and the CIS (Kazakhstan, Armenia and Belarus) as of the end of 2021. Online sales accounted for 32% revenue in 2021. Melon Fashion Group’s revenue in 2021 was at RUB37.5bn (+49% y/y), EBITDA was at RUB8.6bn (+38% y/y), net profit was RUB3.5bn. The company had no debt and cash and cash equivalents of RUB5.2bn at end 2021, reports BSC GM.

And Russia’s leading retail chain X5 group has made some opportunistic acquisitions to expand its coverage. It was given permission by the Federal Antimonopoly Services (FAS) to acquire 70% stakes in two Siberian chains, but with some restrictions.

Back in August, X5 Group announced that it would form a "strategic alliance" with the Krasny Yar and Slata groups, which are among the leading food retailers in Eastern Siberia. X5 intended to take a 70% stake in both businesses, but FAS is worried by X5's already significant market power.

First, there will be limits to mark-ups (5-10%) for some socially important food items for both Krasny Yar and Slata. Thus both chains will join X5 Group's voluntary price caps. Second, the FAS has demanded that X5 and the two chains reduce their combined market share in one particular area of the Krasnoyarsk Region to 35%. Their combined share in most regions would probably be below the thresholds set by the FAS, as X5 Group is not widely represented in the Siberian Federal District. This means that X5 should have some room to expand. In 2021, the group generated just 3.5% of its total revenues there (RUB77bn), which was only 5% of food retail turnover in the district. In contrast, almost half of X5's revenues in 2021 came from the Central Federal District, in which the group accounted for 16% of food retail turnover.

According to BCS GM estimates, the combined revenues of Krasny Yar and Slata exceeded RUB67bn in 2021, while X5 Group generated a total of RUB2.2 trillion in revenues last year. BCS GM estimates that for the full year 2022, both chains will generate around 3% of X5 Group's revenues.


Fast food     

Fast food has gone through similar huge changes like the other FMCG companies, and is another sector where the famous international brands were heavily invested but are now all rushing for the door.

The most dramatic departure is McDonald’s, which has given up its long-standing presence and handed over of its iconic flagship store on Pushkin’s Square that opened in the twilight years of the USSR. The new owner of the chain is a Russian operator Vekusna I Tochka (Russian for “Delicious and that’s it”) that re-launched the chain with identical products and almost identical branding for the presentation of the food. By all accounts, the burgers, fries and deserts taste identical to those produced by the American firm.

Russia's own KFC chain of 70 restaurants, owned by the American Yum! Brands, has also sold to a large franchisee from Izhevsk "Smart Service" that operates under the “Rostic’s” brand – another opportunistic investment by a large distributor.

KFC was slow to enter Russia. It had a single outlet on Kutuzovsky Prospect in central Moscow for years, while Rostic’s developed a nationwide network, clearly following the KFC model. In the midst of the 2008 crisis Yum! finally took the plunge and went into a joint venture with Rostic’s, which rebranded its outlets as KFC, including the flagship store on Tversakaya in the heart of Moscow. Now that process is being reversed, as the KFC outlets are rebranded back to Rostic’s stores.

Smart Service promised to rebrand all franchise establishments (not only its own) as Rostic’s, although the KFC brand will continue to operate for a while. According to Kommersant, part of the transaction will be financed by borrowed funds, but no figures were given. Experts estimate the value of the deal at RUB1.3bn, although the value of network alone is estimated to be RUB10bn and pre-war it was worth RUB30bn, according to Kommersant. The revenue of Yum! Restaurants Russia last year reached RUB18bn and net profit was RUB2.4bn.

The new owner of the KFC fast food chain in Russia plans to stay as true to the legacy menu of the restaurant as possible, a source close to the Food Service company told TASS. "The legacy menu will remain as much as possible, recipes will not change. Nothing will disappear among favourites."