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Local knowledge goes a long way

Government intervention in the Russian energy sector is providing an unexpected fillip to local investment banks offering mergers and acquisitions advisory services. 
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When Minister for Natural Resources Yuri Trutnev announced last month that foreign-owned entities would be banned from developing key energy and mineral deposits – in some cases removing rights it had already awarded – it was yet another example of how Russia can be more a political free-for-all than a free market.

Judging by the growing level of foreign direct investment, the government’s seizure and sale of assets belonging to oil giant Yukos failed to raise too many concerns about the inherent risks of operating in Russia. But the cancellation of tenders won by ExxonMobil and ChevronTexaco has underscored the dangers facing companies that are eager to access the market.

Enter Russia’s homegrown investment banks. Already benefiting from a rise in brokering purely Russian deals, these relative tiddlers see an opportunity to punch above their weight in a booming market for cross-border mergers and acquisitions (M&A).

Russian expertise

By offering local expertise, experience and a range of contacts that few of their Western-owned competitors can match, they are increasingly being included in larger deals. Some have even become takeover targets for Western banks that are seeking to increase their Russian presence.

“Western investment banks need local expertise on the ground,” says Roland Nash, head of research at Moscow-based Renaissance Capital. “As Yukos showed, the complications of dealing with local companies becomes clear when things go wrong.”

According to Richard Ogdon, head of investment banking at Troika Dialog in Moscow, the same holds true for their foreign clients: “In the post-Yukos world, overseas investors need a helping hand when investing into Russia. Rather than a one-way move upward, the situation today is vastly different from what it was a couple of years ago.”

 M&A heats up

 Three trends are bolstering the fortunes of local investment banks and the universal banks offering advisory services, but none more so than the continued heady pace of M&A activity in rapidly restructuring Russia. Although precise figures are difficult to come by in the country’s opaque reporting environment, the general consensus is that M&A activity in 2004 soared well above the $20bn mark of a year earlier. The December merger of state-owned natural gas giant Gazprom with Rosneft contributed more than $9bn alone to the total.

“Despite the bad publicity engendered by Yukos, the rising level of deal flow shows that Russia still holds great attractiveness for foreign investors,” says Vladimir Tatarchuk, a board member and head of corporate finance at Alfa Bank. “It’s also indicative of the fact that many Russian and Commonwealth of Independent States companies have matured to the point where an aggressive acquisition strategy is the next step in their development.”

As the values of their businesses have risen, the owners of Russian companies are displaying a willingness to include investment bankers in deals that at one time would have been the product of handshake agreements conducted behind closed doors. And although fees – from simple retainers to commissions of 5%-10% – may not always be lucrative, local bankers say that they are seeing a larger volume of deals and in a range of sectors and sizes.

Third party priority

“Once a deal gets into the $50m-$100m range, then the greed-and-fear factor starts to kick in and having a third party seal of approval becomes a bigger priority,” says Guerman Aliev, deputy chairman of the executive board responsible for investment banking and capital markets at privately-owned Rosbank. “It provides a good foothold for the investment banking business at Russian banks because these deals are too small for Western banks.”

Russia’s economic revival, which is now entering its sixth year, is the third factor that is driving the deal flow to local banks. The upward progression of incomes has meant that energy and commodity deals no longer dominate the M&A landscape, although they are still significant. From supermarkets to cement production, restructuring and consolidation are taking place across a diverse array of sectors and industries.

Even the banks themselves have not been spared. In January, Deutsche Bank announced that it would purchase the remaining 60% in United Financial Group that it did not already own, giving the German giant a full-blown presence on the Russian investment banking market. The move follows UBS’s acquisition in August of the remaining 50% stake in Moscow-based Brunswick brokerage, which also offers investment banking services.

Consolidation drive

The country’s ongoing banking sector reforms promise to whittle down drastically the 1300 or so banks that operate in the local market. “In addition to waves of consolidation in the banking sector, we are likely to see the state sell off a portion of its holding in [foreign trade giant] Vneshtorgbank some time this year,” says Mr Tatarchuk. “And as the growth in consumer lending – which increased 65% last year – continues, more deals like GE Capital’s $150m purchase of Delta Credit will come through the pipeline.”

With more than $3bn in new deals announced in the first five weeks of this year, the pace of M&A activity shows no signs of abating. Because the mix includes foreign companies seeking stakes in Russian firms, as well as blue chip Russian companies investing internationally, Western banks look as though they will remain at the top of the (albeit non-existent) league tables.

Yet, as long as political risk remains a concern, the country’s homegrown investment banks have good reason to believe that they will be included in headline deals, as well as brokering their own. “The value we can add comes from the local knowledge and local contacts that the Western banks don’t have,” says Mr Ogdon. “And because we operate regional offices in key industrial areas across the country, we are able to offer our M&A advisory services to a greater range of Russian corporates.”

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Read more about:  Central & Eastern Europe , Russia