Transcript KPMG Full Page Talkbook Template

Strategy Group
Private Equity in Russia
Discussion at the International Finance Faculty of the Finance Academy
24 March 2008
ADVISORY
Content
 PE in Russia – not significant yet but increasingly important
 Fundamentals drive Russian PE activity, not financial engineering
 The are significant challenges ahead, you can help overcoming them
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
1
Private Equity – a life cycle that make an economy moving
PE LIFE CYCLE
TARGET LIFE CYCLE
Fund raising
Start-Up / Venture
Target search
Growth
Investment
Value creation
Buy-Out
Restructuring
Exit
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
2
According to official numbers Private Equity houses have increased their activity significantly over the last two years
Total Value of investments
PE transaction in Russia, number and av. deal size
90
24
+ 21 deals
80
18
70
20
10
0
600
16
12
11
5.1
10.0
7.5
4
33
65
2004
2005
2006
Source: RVCA Report 2006
Exits
400
652
300
200
43
Investments
8
500
USD million
19
40
30
20
USD million
Number of deals
60
50
+ USD 431 m
700
0
100
221
247
0
2004
2005
2006
Average deal size USD m
Source: RVCA Report 2006
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
3
The longer term perspective shows a constant increase of the funds invested and active in Russia
Capitalization of active players
Number of active funds in Russia
+ 59 funds
+ USD 3,480 m
7
6
90
70
4
60
60
6.3
3
2
2.5
2.7
2.8
3.0
4.0
5.0
Number of funds
USD billion
79
80
5
1
98
100
50
40
39
37
1998
1999
36
37
39
2000
2001
2002
43
30
20
10
0
2000
2001
Source: RVCA Report 2006
2002
2003
2004
2005
2006
0
2003
2004
2005
2006
Source: RVCA Report 2006
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
4
There is consensus in the Russia PE market that the real market size is likely to be higher than official numbers suggested
Real Russian PE market 2006, estimation
 The publicly available market assessment of USD6.3bn is likely to underestimated
14
12
12
USD billion
10
8
 There seems to be consensus in the market that this number does not include
all PE investments and definitely not most of the larger investments of
“Oligarch” structures
10
Indicative range
 The likely number of PE structures (without Oligarch) is likely to be in the region
between USD8bn and USD11bn
6
 In addition, Oligarch structures might currently add further USD25bn to USD 30bn
to Russian PE investments
6

4
2
RVCA, lower
estimates
Source:
the actual size of the PE market in Russia
Medium
estimates
“I would argue RVCA estimates at USD 6.3 billion . I believe that market size
is significantly higher with USD 10 – 12 billion for institutional PE houses and
up to USD 28 billion for oligarchic entities” Managing Director, Russia PE
house
Higher
estimates
RVCA 2006 report
Interviews with 27 PE houses active in Russia
Even the larger market size estimates do not include pure “Oligarch” driven investments
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
5
Content
 PE in Russia – not significant yet but increasingly important
 Fundamentals drive Russian PE activity, not financial engineering
 The are significant challenges ahead, you can help overcoming them
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
6
The uptake of the Russian PE investments is driven by a combination of fundamental and financial developments
Key drivers behind the uptake of
Russian PE investments
Lifecycle of key industries in Russia
Financial performance of private vs. public
investments
Increasing availability of end-to-end deal
cycle and corresponding decrease of
transaction costs
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
Availability of funding support from the
state and EBRD
7
Investments into growth companies have dominated the market and account for at least 80% of the investments
Russian PE investments 2006 by investment type
 Investments of Russian PE players can be associated with three main stages
that correspond with definition in established markets
700
 The investment phase attracting the majority of PE investments is very clearly
the growth financing
600
 At least 80% of investments are allocated to the phase

500
493
USDm
400
653
 Investments into Start-Up financing have been very limited so far and market
participants see this as a functions of limited supply
300

200
limited leverage and not too many management teams had the quality to
proceed with an MBO / MBI
75
Seed and
start-up
Restructuring
“We do not have VC as there was no technology. People are not used to
market their ideas. But that is to change soon” Russian PE house
 Buyouts have also been limited as transactions have usually no or just a very
84
100
0
“In my opinion it is even more than 80%. But that is obviously also a
question of definition. What people call buyout here is often just growth”
Western PE house active in Russia
Growth
Total
(Buyout)
Source: RVCA 2006 report , Interviews with PE professionals
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
8
Targets have become available at valuations presenting attractive investment options for PE player
Entry valuation 2006
INDICATIVE
 Investment managers indicated that the number of targets available at attractive entry
valuation has increased recently. Drivers behind this trend appear to be
 improvement in transparency
 Targets achieving a reasonable size
European average
 education and qualification of management
 Still, all these areas remain weakness for the Russian economy and the PE industry
 Entry valuation are highly impacted by the PE house and the segment of the target
 Russian players are more on a “buy cheap, sell expensive” strategy and indicated to
have overall significantly lower entry valuation. However, in competitive situations
Russian players appear also willing to increase a bid significantly and fast
 Some of the segments, in particular retail and FS, are partly seen as already
overheated and entry valuations above 10xEBITDA (or >5 book) are common
 Furthermore, the majority of players interviewed by us are avoiding investments into
segments that are strongly regulated or considered to be potentially strategic
 e.g. out of 30 investment managers we spoke to only one considered telecom as
attractive
Retail
Construction
Telecoms
Food manufacturing
2
4
6
8
10
12
EBITDA MULTIPLE
Notes:
Sources:
Based on interviews with 27 PE houses active in Russia
KPMG Interviews
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
9
PE companies were usually brought in to help the targets mastering specific expansion related challenges
Importance
Rationale
Current
Description
Future
Earn a transparency or Corporate Governance Transparency of Russian companies is very low. A high number of companies still operate “black” value chains (not fully compliant with tax, labour
and other regulations). Both factors are hindering Russian companies to expand / acquire successfully abroad or to attract international investors.
premium
Transforming these business generates significant value and was a key investment rationale
“I would assume a lack of transparency is the bread of PE investor: we try to look for correctable inefficiencies, correct them and cash out”.
Representative of western institutional investor
Expanding into regions
It is one of the most widespread ways of adding value to the business (especially for popular sectors such as retail, media and telecom). Regional
expansion becoming more attractive due to lower competition and growing disposable income in regions. Furthermore, the expansion in the regions
pulls other investments: infrastructure, logistics, industrial services
Consolidate industry segments
Only a very limited number of (strategic) industries is already consolidated. Driving consolidation is therefore a key value creation strategy in Russia.
However, this strategy requires high investment that have not been taken on by the PE players so far. Hence, this area is dominated by Oligarch
structures and captive investment teams.
Restructure processes
So far, the focus of PE has not been to improve processes and profitability. However, the downstream move of a number of industries (oil, gas) is
likely to cause disposals of upstream activities (e.g. oil field services). Being exposed to market conditions will require them to rethink their operations
fundamentally
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
10
Example for value creation by PE “Transparency premium”
Pharma
Pharma
Pharma acquires the option to access the
Russian pharmaceutical market
Pharma executes the option if milestones
are achieved, sells option if not achieved
PRIVATE EQUITY PLAYER
PE acquires majority share of an
identified target
Russian pharmacy player
 Strong market position, high growth, strong local
PE house and management team transforms the target
to a white value chain, implements control and protects
Pharma against reputation damage
Russian pharmacy player
 Strong market position, high growth, strong
brands, access to distribution
local brands, access to distribution
 “Black” value chain, partly non-compliant, poor
 Transformed value chain, compliant, integration
governance, tax issues, partly doubtful ownership
plans in place, cooperation already started
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
11
The majority of Russian PE houses expects to generate IRRs of above 35%
IRR distribution, 2006
 PE players active in Russia appear to realize high IRRs on their investments
 32% of PE houses interviewed by us claim an IRR of above 40% for their near
exits and none of the active houses experienced exits blow 30%

36%
32%
“At the moment it is very difficult to get it wrong. Assuming you can accept
the risk” Russian PE house
 Russian houses find themselves more on the higher side of the IRR spectrum while
Western houses are closer to the medium
 Most players active for a longer period have observed a slight IRR erosion recently
 Western players tend to anticipate a decreasing IRR for the future (5-pt. over
18%
14%
the coming three years) while Russian players are more bullish and expect the
current rates around 40% to be sustainable
75% > 35% IRR
30 < 35
35<40
40 < 45
>45
Estimation of IRR, %
Notes:
Sources:
Based on interviews with 27 PE houses active in Russia
KPMG Interviews
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
12
Content
 PE in Russia – not significant yet but increasingly important
 Fundamentals drive Russian PE activity, not financial engineering
 The are significant challenges ahead, you can help overcoming them
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
13
The PE life cycle in Russia provides a number of country specific challenges
LIFE CYCLE
CHARACTER OF CHALLENGE
Fund raising
Pre deal evaluation
 Relationships and active search dominate target identification
 Quality of information is low, only 30% of targets prepare IMs
 Limited share of targets is attractive but the scan process can be intensive
 Difficult and lengthy negotiations (on average 5 months)
Deal execution
 Issues identified in due diligence often lead to deal abortion
 High number of PE professionals required to run the process
 Highly complex legal structures
Value creation
Exit
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
14
Challenges pre-deal evaluation
Challenge
Description
Relationships and active search dominate target
identification


Deal flow in Russia is generated actively by the PE teams

main source for exclusive deals are relationship of senior staff

PE houses often maintain own research teams, identifying attractive industries, regions and targets
Information asymmetry is a key feature of the Russian market. In particular access to governmental bodies still represents a significant advantage for investors

Quality of information is very low

Deal flow from intermediaries is very limited and is not seen as a source for attractive deals currently

Companies also approach PE houses directly, in particular for early stage or small investments

Introduction to an opportunity is often given verbally and based on a selection of financials and KPIs


Only a small share of opportunities are attractive
“Connections and network are extremely important. You need to know in advance where they (the government) will put their money or restructure. Russian PE houses (Oligarchs)
have such connections and they can make their money “work” very quickly”. Source: Representative of western PE house

Quality and reliability of IM received is very low, even when sell side support is involved

Quality of IMs without sell side support was ranked 1.8 out of 7; IM with sell side support only 4.6

main source for exclusive deals are relationship of senior staff
Although the time to be spend on pre-scanning is very high, only between 3% and 30% are regarded as attractive


70% of the opportunities come without IM and PE houses spend on average 1 month to develop their first own investment proposal
Quality of senior management relationships appears to be the main differentiator for this KPI
Out of opportunities regarded as attractive only 5% to 15% made it to closing

This number, however, is highly indicative and requires more testing for scaling the operations
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
15
Challenges deal execution
Challenge
Description
Difficult and lengthy negotiations

One of the key challenges in Russia seems to be approaching targets on a trustful base, in particular in the regions


Negotiation are also often relatively unstructured and “solved” issues need to be revisited several times

Due diligence findings leading to abortion
Higher number of professionals required for PE houses
operating in Russia
most PE therefore reported negotiation time between 2 and 12 months (average 5) with Russian PE on the lower end

Sellers are usually purely price focused and discussions of conditions are seen as not adding value

In particular Western style houses face difficulties as sellers often expect handshake deals and do not understand clauses like “subject to…”

Although time spent on pre-deal scan is high due diligence often identifies a number of common deal breakers:


targets operating black value chain and transformation would make the business loss making

value chain weakness do not allow the opportunity to implement management plans

the larger the target the larger the dependence on the state or regulations

often unrecorded cash transactions, tax optimization schemes exist

poor financial information gives too little comfort an the basis of evaluating the deal
Teams of professional required to manage investment much higher than in established countries



“Per dollar of investment you need three times more specialists in Russia than in western economies”
PE house professional need substantial operational experience

Complex legal structure
understanding of the PE concept is very weak and PEs are often seen as raiders, leading to hostile reactions based on negative experience in Russia’s recent history
High number of targets “designed for sale. Although strategy and appearance is in line with market development the substance is missing (experience, system, management)
Legal structure even of small targets is usually highly complex, leading to significant cost for tax and legal due diligence and restructuring
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
16
Participants in the Russian PE market suggest that a combination of Russian and Western PE capabilities delivers the strongest
competitive position
PE model performance on critical success factors
Performance of Russian PE models on critical success factors
(7=best performance, 1=very weak performance)
Theoretical best
Criteria / Model
Russian + Western PE
Western PE
Russian +
Western
PE
IB
strong
Russian PE
Relationships
very strong
strong
weak
strong
Investment team
weak
strong
very strong
very strong
strong
PE + investment bank
Flexibility, speed
strong
strong
moderate
moderate
moderate
Operational team
moderate
very strong
moderate
strong
strong
Availability of funds
very strong
strong
strong
strong
strong
Industry insights
Russian individually owned
Note:
Source:
Russian PE
CSF breakdown
Western PE
Low
Individ. owned
High
strong
strong
weak
strong
strong
Reputation
very weak
moderate
very strong
very strong
moderate
Track record
very weak
strong
moderate
strong
moderate
Total rated performance based on 8 criteria
Sum of ratings based on interviews with 27 PE houses active in Russia
KPMG Interviews
Note:
Source:
Average rating based on interviews with 27 PE houses active in Russia
KPMG Interviews
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
17
An expected increase of sell side support is likely to erode some merits of “buy cheap” strategies but increases source of deals for those
without networks
Sell side advice in Russian PE transactions
Sell side support
30%
Expected change in seller approach
More sell
side advice
Auctions < 10%
82
More
auctions
No
change
No sell side support
70%
-
Notes:
Sources:
In terms of number of transactions
Based on interviews with 27 PE houses active in Russia
KPMG Interviews
Notes:
Sources:
40
18
% of responds
20
40
60
80
100
Sum of ratings based on interviews with 27 PE houses active in Russia
More than one answer possible
KPMG Interviews
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
18
PE models having their strength in deal management, financial engineering and enjoying local access are likely to
improve their position
Change of position
INDICATIVE
FOR DISUSSION ONLY
 Trends in Russian PE market suggest some change of competitive advantages in
Russia
 Deals become larger
 Secondary and LBOs are approaching
Western + Russian
PE
 Sell side advice is increasing
 Auctions to take more share in the medium term
 More PE competing in the market
Future position
Western
PE
Russian
PE
PE
IB
 Capabilities required to succeed in competitive transaction will provide more of an
advantage than historically
 Strong process and deal management understanding
 Deal structuring and financial engineering experience
Oligarch
model
Current position
…
Strengthening position
…
Stable position
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with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
19
High competition for M&A professionals remains a key bottleneck
RUSSIAN M&A CAPABILITIES
 Experience M&A staff is currently highly demanded by both, Corporates and
Strategic
PEs
Russian M&A
beyond 2007
Core capability
 “Any asset” M&A teams of Russian corporates will become available while
competition for “right asset” teams will even increase
Opportunistic
Rational
 Salary premium not as high as in Europe
Russian M&A 2000
Momentum deals
Low
Frequency
High
© 2007 KPMG Limited, a company incorporated under the Guernsey Companies Act and a member firm of the KPMG network of independent member firms affiliated
with KPMG International, a Swiss cooperative. All rights reserved. Printed in Russia.
20