IPNos in Russia

Russia’s 2007 IPO boom came to a shuddering halt in the first half of 2008, and nothing looks likely to change that in the second half.

The list is long of companies with plans to IPO this year that have now put them on ice: banking names such as UralSib, Gazprombank, KIT-Finans, AK BARS Bank and ZENIT Bank; and industrials such as AvtoVAZ and Sibur, Nitol Group, Acron and Mail.ru. In fact it’s easier to name the ones that actually happened in second quarter of this year; there was only one, rail operator GlobalTrans that IPO’d on April 30 raising $449m.

According to PBN Company, this translates into one second-quarter IPO compared to 10 in 2007, with a total value of second quarter IPOs in 2007 was $14.7bn, compared to GlobalTrans half billion. PNO vice president Artyom Dovlatov notes that the 2007 IPO result was exceptional partly due to two massive bank IPOs by VTB and Sberbank, the former the world’s largest in 2007, raising $8bn in May 2007.

However, it’s clearly not just the size of the offerings, but their number that has slumped, and there is a whole list of reasons for this.

Reasons to be cheerless

Alfa Bank’s Angelikia Henkel lists a dozen reasons why companies are postponing IPOs. First, according to Henkel, the tightening of international and domestic liquidity has made the global market for IPOs and secondary offerings less attractive.

Then come worsening conditions on international stock markets, with emerging markets dropping by 45% in some cases. Third, a sharp decline in M&A deals has made valuation of shares difficult for investors. Fourth, says Henkel, market structure has shifted in favour of private placements, with other forms of raising capital, such as pre-IPOs and private sales gaining in popularity ahead of IPOs.

Fifth and sixth, investor confidence in the banking sector has fallen sharply, and investors are also getting cold feet about investing in relatively small and unknown companies. Seventh, shares of companies IPOing in 2007 have mostly tanked, and, additionally, reason number eight, “People’s IPOs” of state-owned companies like Sberbank or VTB have temporarily been abandoned.

According to Henkel, higher bond yields have triggered an outflow to bond markets, while funds have preferred the secondary market to IPOs as soaring commodity prices boost the extraction sector. Eleventh, funds available on the IPO market have been absorbed by $6.1bn worth of power generation share placements of Russian power sector companies in first quarter 2008.

Twelfth and finally, according to Henkel, the sectorial distribution of offerings has changed: there is a shift towards relatively exotic sectors in the Russian context such as agriculture and Internet companies looking to raise funds, and investors feel less at ease with them.

This latter is a view shared by Ernst and Young Russia’s IPO department head Marchello Gelashvili, who expects “further diversification” to take place in the IPO market, “with diverse mid-sized IPOs’ showing” a rise in public offerings from companies in the technology, agriculture, infrastructure and engineering sectors.” And Deutsche Bank’s Yaroslav Lissovili also sees infrastructure and IT as the future IPO stars.

However, according to Troiika’s Mikhail Stiskin, with market conditions worsening, the next round of IPO activity is not likely to happen before 2009. Next up, and theoretically still on the cards, is the much anticipated IPO of Alisher Usmanov’s metals giant Metalloinvest, expected to float 25% in autumn 2008. “They are preparing for it, but it’s not going to happen in 2008,” says Stiskin. “Market sentiment is just too bad.”

As for the $4bn IPO of Mechel Mining, slated for second half of 2008, due to the handbagging Mechel received from Prime Minister Vladimir Putin for alleged transfer pricing, “this is obviously now not going to happen for another year or 18 months,” says Stiskin.

United Russia – a conservative party?

Graham Stack for Russia Profile
Putin’s party United Russia is increasingly referring to itself as a ‘ ‘conservative’ party. But is it anything like a conservative party in the Western sense?

One of the surprises following the death of Alexander Solzhenitsyn has been the reaction of Putin’s party United Russia. While the laments and praise of liberal figures, and the silence of the Communists were predictable, the leadership of United Russia was unexpectedly vocal in claiming Solzhenitsyn as one of its own – as a conservative.

Andrei Isaev, head of the Duma committee on labour and social policy, and leader of United Russia’s Centre for social-conservative policy, called Solzhenitsyn August 14th ‘the founder of conservative ideology in Russia,’ according to polit.ru

And with Solzhenitsyn’s death closely followed by the 100th day of Dmitry Medvedev’s presidency, United Russia figures were quick to claim the new president as one of their own as well – as a conservative. Isaev claimed that Medvedev was no liberal but “just as much a conservative as Putin.”

There are even rumours afoot that United Russia is about to adopt ‘conservatism’ as the sole definition of its ideology at its party conference in November.

‘Conservatism’ would then replace the current master concept of ’sovereign democracy’, dubbed by critics ’sovereign disregard for democracy’. Medvedev himself has publicly criticized the ’sovereign democracy’ concept, and Putin, now United Russia’s honory chairman, himself has repeatedly savaged for its lack of any clear ideology.

Political conservatism in Russia is paradoxical – the very word had to be imported from English, and is unfortunately consonant with the Russian for condom. Russia’s conservatives in the literal sense would seem to be the Communists and nationalist parties, harking back to Soviet and imperial greatness – and propogating the very opposite of Western conservative values.

So is United Russia really going conservative, or is the label just a Potemkin village?

“There isn’t, in my view, a Russian equivalent to the conservatism of European Christian Democrats or of either the free-market trend or the one-nation trend in British conservatism,” says Phillip Hanson, emeritus professor at Britain’s foreign policy institute Chatham House. “Russian conservatism as the Russian political mainstream is dogmatically nationalist and its connections with business are close and corrupt, but Russian political conservatism is not business-friendly in the sense of either dancing to the tune of big business, or seeking to promote a good business environment for all comers.”

However, politics professor Nikolai Petro of Rhode Island University, disagrees:

“I believe that United Russia is what political scientists like to call a “catch all party;” i.e., one that defines itself not in partisan terms, but as THE party of law, order, and prosperity, an agenda that transcends political divisions. They model themselves on the French Gaullists, whose purpose is to preserve a politically viable elite in power, not to promote any particular ideology. (…) Also, as the country as a whole is becoming more aware of its pre-Soviet historical identity, it is becoming more comfortable with an identity that is truly “conservative,” in the traditional sense. Such an identity was severely repressed in Soviet times, and is just now beginning to become politically significant, with the political rise of young people”

Private property and political rights are key to conservatism

Conservative parties the world over indulge in nationalist rhetoric, especially when it comes to foreign interference in domestic affairs, and also talk tough about law and order. The key to conservatism, however, is that all the “strong state” talk stops as soon it comes to private property and political rights. Because basically, conservatism is all about political rights protecting private property from state intervention.

This is the million dollar question about Russian conservatism.

“Russian society views conservatism as the idea of strong state protection. Conservatism has stronger traditions in Russian politics than socialism. At the same time, elements of the socialist past are regarded as part of the idea of conservatism as well,” says Alexander Rahr of Germany’s foreign policy think tank German Society for Foreign Policy.

So in Russian conservatism with a small c, the protection of private property plays a small role – because historically private property has played a small role in Russia.

Now, however, with 80% of Russians homeowners, after the privatization of the 1990s, conservatism theoretically has a natural constituency – a vast one at that.

However, United Russia are clearly reluctant to harp on about private property. The reason is that the population de facto owned their apartments in late Soviet times, although they could not buy and sell them. “Private property”, on the other hand, is still widely associated with the injustice of the 1990s’ privatizations that saw a class of ‘oligarchs’ emerge. And, although Vladimir Putin’s election in 2000 arguably saved the 1990s privatization from reversal, the Putin administration resorted on occasion to anti-oligarch rhetoric, and in the notorious Yukos case, to very real deeds.

So the jury is out on whether Russia’s self-named conservatives really understand that the key to conservatism is the self-restricting state.

Critics point to media control, violence in Chechnya, nationalization of key companies and appointment of regional governors as indicating otherwise.

Putin supporters, on the other hand, argue that it was Putin who saved privatization from reversal, unified the legal space, introduced private ownership of land, brought in jury trials, slashed the draft, retained the death penalty moratorium and, finally, stepped down after two terms.

With this ambivalence at the heart of Russia conservatism, it is telling that the homage paid to Solzhenitsyn was also ambivalent.

For all that Solzhenitsyn loathed communism, Isaev finds in him support for a gradual move from communism instead of the ‘ultraliberal course’ embarked on in the 1990s by Boris Yeltsin, i.e. as a critique of privatization.

“I remember that Solzhenitsyn’s article ‘How to rebuild Russia’ of 1990 seemed to many in the country to be too moderate, conservative and even out of touch,” says Isaev. “But now, with hindsight, if we had listened to him then, we would have been able to avoid many disasters.”

Russian’s wannabe conservatives might better heed Solzhenitsyn’s more recent words – in his last interview – on the importance to conservatism of property rights and entrepreneurship.

“Although many fortunes were amassed in Yeltsin’s times by ransacking, the only reasonable way to correct the situation is not to go after big businesses but to give breathing room to medium and small businesses. That means protecting citizens and small entrepreneurs from arbitrary rule and corruption,” Solzhenitsyn told Germany’s Der Spiegel in 2007.

Conservatives prefer evolution to revolution – and Russia’s conservatives, like Russia itself, are themselves still only evolving.

On 10th anniversary of 1998 financial crisis, history repeats for Kerimov

Graham Stack in Berlin

Russian tycoon Suleiman Kerimov has a chameleon-like capacity for adapting instantly to new conditions. Ten years ago, he seized opportunities arising from the Russian financial meltdown of August 1998 to move into big league business. Ten years later, he is seizing chances presented by the current global financial crisis to buy into the global league of financial institutions- just as his position in Russia becomes precarious.

A Wall Street Journal report June 30 that troubled Dutch-Belgian bank Fortis NV had turned to Russian oligarch Suleiman Kerimov, no. 36 on Forbes world’s richest people list, for a 400m euro cash injection, confirmed a slew of media reports that Kerimov was using the global financial crisis to snap up shares in Western banks on the cheap – and selling his Russian assets to do so.

Today, Alfa bank analyst Natalia Orlova writes that since former economy minister German Gref took over at Sberbank from Andrei Kazmin in late 2007, the three largest Russia corporate investor, companies representing Elena Baturina, Sulejman Kerimov and Filaret Galchev, have slashed their combined stake from 9.2% to 4.2%.

And today’s Vedomosti writes that most of this drop was due to Kerimov selling out: from a 5.5% stake one year ago to 1.5% today, according to German Gref.

Kerimov’s rise started ten years ago

Excactly ten years ago, the Russian August 1998 financial meltdown opened door to the business big time in Russia for Kerimov.

In a striking parallel to his moves in 2008, within months of Russia’s default of August 17, 1998, Kerimov had divested his main assets – midsize Federal Industrial Bank and the ailing Vnukovo Airlines – to buy into major oil trader Nafta Moskva, as shareholders stung by the crisis rushed to sell up.

“In the aftermath of the crisis, oil was the only business that looked sure to generate money, and Kerimov thought Nafta Moskba was his entry ticket,” remembers Dmitry Mossienko, head of oil consultancy UPECO, who covered Kerimov’s shadowy rise for Petroleum Argus.

“We knew Kerimov was involved in Nafta Moskva, but it was much later, not until 2000, that people started saying he was the owner,” remembers oil sector analyst Maria Zabralova. “He kept it secret for as long as he could, and often denied his ownership. But by 1999 he was in control.”

From oil trader to corporate raider

Kerimov then tried to use Nafta Moskva as a basis to establish a vertically-integrated oil company, with moves to acquire upstream facilities in 2000-2001. But here he failed – in contrast to his friend and business partner Mikhail Gusteriev.

“Gutseriev achieved something everyone regarded as a miracle – he put together a vertically integrated oil company – Russneft,” says Mossienko. “Kerimov, on the other hand, has never managed to build up that sort of business. He never got into the proper oil business at all. In fact Nafta Moskva as an oil trader soon turned out to be a dead end. It was the M&A experience that paid off for him. The means became an end.”

Not only had Kerimov failed to put together a vertically integrated company. In 2001, Nafta Moskva’s core business of oil trading went down the tube in 2001. Oil majors had long been establishing their own trading structures, and dispensing of Nafta Moskva’s services. Only weeks after 9/11, Nafta Moskva’s last remaining major customer, Surgutneftegaz, announced it would do likewise.

So chameleon-like, Kerimov simply again switched his core business to match the new circumstances. And not for the last time.

He transformed Nafta Moskva into an M&A operation, similar to Alfa Bank’s arm Alfa-Ekho, to profit from the ongoing redistribution of property in the wake of 1998.

Almost immediately following Surgutneftegaz’s desertion, in autumn 2001, Kerimov made headlines with a huge and highly controversial deal buying Avtovazbank owner Andrei Andreev’s business empire, which he then resold within a year to a number of parties at a huge mark-up.

Andreev subsequently went to court claiming he had been expropriated by Krasnoyarsk mafia boss Rodion Gamzaev. He claimed Gamzaev had practically taken Avtobank CEO Natalia Razaevskaya hostage, and forced her to sign off on the sale of his assets.

No one, not even Kerimov, disputes that it was Gamzaev and Razaevskaya who signed away Andreev’s empire. Andreev has said that Gamzaev was paid $60m for assets he claims were worth a total of over $700m. Kerimov, however, asserts that Gamzaev and Razaevskaya were valid business partners of Andreev.

Razaevskaya later told business daily Vedomosti that when signing the deal, she stated repeatedly that she was not the owner and had no rights to sell. Kerimov, according to Razaevskaya’s account, which he refutes, replied with the now legendary phrase: “It doesn’t matter. I am buying the situation.”

Kerimov the financial investor

Reaping such enormous profits with a string of similar M&A deals, Kerimov then sought the most lucrative investment opportunity for his money, and found it in the form of Gazprom and Sberbank. Gazprom shares promised monster profits when the ring fence was removed between domestic and foreign held shares, and a political insider like Kerimov was excellently informed about the government’s plans.

In the case of Sberbank, according to investigations carried out by Forbes, Kerimov went further: creating a feedback loop between his shareholding and credit facilities.

According to Forbes researcher Ilya Khrennikov, Kerimov developed a cosy relationship with Sberbank management. Kerimov bought Sberbank shares using Sberbank loans, and then used the shares as collateral for new loans, with which he bought Sberbank and Gazprom shares at a steep margin.

By 2005, Kerimov owed Sberbank more thgan $3bn, one and a half times more than total lending permitted to any one client – because Kerimov worked through two separate companies GNK and construction company “New Project”, according to Forbes.

From 2004 through to today the price of Gazprom shares has risen 6 fold, and those of Sberbank 10 fold.

In all these spectacularly profitable activities, Kerimov, protected by his status as parliamentary deputy, and operating a network of nominal beneficiaries, has been extraordinarily skilful in sailing close to the law.

In autumn 2007, however, the wind changed.

First of all, Sberbank management was replaced by German Gref, Putin’s trusted economy minister of many years standing. Gref had previously blasted Kerimov for ‘greenmailing’, and now declared it his intention to provide loans to industrialists and the population, “but not to speculators.”

Then Putin added insult to injury by demanding that Edinaya Rossiya rid itself of business tycoons, commenting that “as a rule various crooks try to join such institutions [governing parties] and they partly succeed. For such people not what’s best for the nation but personal wealth is the objective.”

As a result, Kerimov, who had switched from the LDPR to Edinaya Rossiya earlier in the year, was removed from the party’s list of candidates for the December 2007 elections. This exposed Kerimov for the first time since 1999 to the possibility of criminal prosecution.

Kerimov quickly took a place in the Federal Council, representing Dagestan. But promptly in July 2008, influential officials such as Petersburg’s mayor Valentina Matvienko and Federation Council Sergei Mironov publicly voiced concerns about the presence ‘of tycoons pursuing their own interests’ in the Federation Council, and proposed measures to prevent this.

Light in the West

While the skies seemed to darken in Russia for Kerimov in 2008, light came from the west. The global credit crunch causing a steep fall in share prices for major global banks. And Kerimov has been very quick to exploit this – and to make his exit from Russia.

In the period since autumn 2007, he has divested a large part of his Russian assets, and through his Millenium fund he has bought into Western banks that have lost 30-40% of their share price since 2007.

Kerimov has sold a controlling stake in silver producer Polimetal for around $1.8m, in the Rublyovo-Arkhangelsk construction project for $3.5bn, and NTK cable TV operator for another $1.5bn.

Moreover, July 15 2008, German Gref told Reuters that Kerimov’s stake had fallen from 6% to a ‘healthier’ 1.5% over the previous six months.

Kerimov invested the proceeds, according to a flurry of media reports, in Deutsche Bank, Royal Bank of Scotland, Credit Suisse, and Morgan Stanley.

The Wall Street Journal then revealed June 30th that Dutch bank Fortis had appealed directly to Kerimov’s Millenium Fund, already holder of a 2% stake, to provide a 400m euro cash injection in the context of a share issue.

There has been much talk in the investment community of Russia as being a safe haven from global financial turmoil. For Kerimov, however, the global financial turmoil that has provided a safe haven from Russia.

South Ossetia – The Prequel

Graham Stack for Russia Profile

The South Ossetian conflict flaring up in late 1989 started the break up of Georgia. The conflict of 2008 might well seal it.

Four months after Slobodan Milosevic’s speech on the Kosovo Field June 1989 symbolised the start of the Yugloslavia conflict, Georgia’s nationalist leader Zviad Gamsakhurdia, backed by over 20,000 supporters including paramilitaries, rolled towards the South Ossetian capital Tskhinvali, to assert ethnic Georgian rule over the entire territory of the republic. Ossetian groups duly blocked Gamsakhurdia’s entry to the town, and violence broke out. Andrei Sakharov, not long before his death, commented gloomily on the creation of “minor empires” in the former Soviet republics.

The standoff escalated through 1990. In April 1990, the Supreme Soviet in Moscow ruled that the ethnic autonomous territories of any republic seceding from the Soviet Union retained the right to remain in the Soviet Union. Then it was Tbilisi’s turn to pour fuel on the fire. In August 1990, the Georgian Soviet adopted a law prohibiting regional parties from participating in Georgian elections. Excluded from the political process in Georgia, South Ossetia boycotted parliamentary elections in October 1990, instead holding elections to their parliament in December 1990.

In response to the South Ossetian elections, the newly-elected Georgian parliament abolished the autonomy status of South Ossetia, declared a state of emergency in the region and in late December, imposed an economic blockade on the region that was to last to July 1992.

The conflict finally escalated into war the following month. In the first days of 1991, the Supreme Council of Georgia passed a law on the formation of the National Guard of Georgia. Then on January 5th, at the time of the Orthodox Christmas festivities, several thousand Georgian troops, police and paramilitaries entered Tskhinvali and carried out violent reprisals and atrocities against the population, ostensibly in search of arms.

The weekend war

The initial fighting took place mainly in and around Tskhinvali, around the Georgian villages, and north along the road to North Ossetia, the lifeline of the South Ossetians in the face of the Georgian blockade.

According to Nikola Cvetkovski of Caucasus Links, who has written a history of the South Ossetia conflict, the fighting in Tskhinvali initially divided the town into an Ossetian-controlled western sections and a Georgian-controlled east. But fierce resistance from Ossetian irregulars meant that already by the end of January, 1990, Georgian forces withdrew to take up positions on the heights around the city. From there they enforced a blockade that lasted almost one and a half years, and aimed at cutting the town off from heat, electricity, water and food.

Actual fighting was low intensity, deploying mostly light arms. Fighting however peaked regularly at weekends, as the so-called ‘weekend warriors’ of paramilitary formations arrived from Georgia proper. The ‘weekend warriors’ were themselves more interested in looting than fighting. As a result, military fatalities stayed low, but of the roughly 1000 Ossetians killed in the conflict, only around 100 are regarded to have been militia members: the remaining 900 were civilians. In addition, according to Alexei Zverev, ethnic conflict expert at Vrije University of Brussels, 93 villages (mostly Ossetian) were completely burned down.

Even the newly-formed Georgian national guard, intended to become the core of a new Georgian army, was recruited and financed “almost exclusively by private individuals, especially successful black-market entrepreneurs,” according to Swiss security expert Christoph Zuercher, who has written the classic account of the Georgian crisis in “The Post-Soviet Wars”.

Georgia’s second main (para)military formation prosecuting the war, the Mkhedrioni (Georgian for medieval knights), was, according to Zuercher, “created in 1989 by Jaba Ioseliani, a former patron of the Soviet underworld, and funded its activities from criminal dealings, including extortion and racketeering,” and constituted “a private army at the service of the state when it was waging war against secessionist minorities.”

“The Georgian militias—the Mkhedrioni and the National Guard—were to a very significant extent driven by the presence of private entrepreneurs of violence, undisciplined weekend warriors, who conducted frequent attacks on the civilian population and took hostages,” Zuercher continues. “But in the case of the Ossetian and Abkhazian fighters, the use of military force was not mainly motivated by private profit, but by the perceived threat to the status quo posed by an independent and nationalistic Georgia. (…). Once the Georgian militias entered their territories, Ossetians and Abkhazians saw their fears confirmed, and organized violence ceased to be an option and became a necessity,” adds Zuercher in his seminal study.

Russia appears on the scene

Until then, the Soviet Centre, in its death throes, had remained largely on the sidelines in the conflict. The Soviet leadership had apparently latterly struck a deal with Tbilisi, allowing Gamsakhurdia a free hand in South Ossetia in return for accepting Soviet supremacy. This deal was shown up during the Moscow Putsch in August 1991, when supposedly nationalist Gamsakhurdia – in sharp contrast to events in Moscow and Leningrad – meekly accepted the authority of the Provisional Committee established by the putsch, and subordinated his armed units to the Soviet Interior Ministry.

The failure of the putsch, however, destroyed Gamsakhurdia’s authority: On December 22, 1991, in the last days of the Soviet Union, approximately 500 National Guard soldiers entered Tbilisi and drove Gamsakhurdia out, marking the start of the Georgian civil war. The new interim authorities—Ioseliani (leader of the Mkhedrioni) and Kitovani (head of the National Guard), then called Eduard Shevardnadze, former Soviet foreign minister, back from Moscow to head Georgia.

The struggle for power in Tiblisi now hugely exacerbated the ongoing ethnic conflicts, as the deposed president mounted military resistance from his home region in western Georgia against the new authorities in Tbilisi – and thus triggered the Abkhasian conflict, flaring up in spring 1992 and turning to war by the summer.

The conflict constellation now also changed due to the appearance of an entirely new actor: Boris Yeltsin’s Russia. Yeltsin’s new Russia, born of the idealism of the Perestroika liberal movement, and riding high on the wave of enthusiasm following the defeat of the Putsch, was more concerned about the rights of minorities in neighbouring states than the Soviet leadership had been. Russia was also sensitive to the concerns of the North Ossetian leadership, who were inundated with refugees from the South Ossetian conflict and feared further destabilisation.

According to Alexei Zverev, this new conflict constellation made Russian intervention on the side of the South Ossetians look increasingly probable. In mid-April 1992, Georgian artillery resumed daily missile attacks on the residential quarters of Tskhinvali. Then, in 20 May 1992, unidentified gunmen, whom the Ossetians claimed were Georgians, massacred a busload of Ossetian refugees fleeing Tskhinvali.

The massacre prompted North Ossetia to cut the gas pipeline to Georgia, and elicited furious statements from Russian politicians, including chief reformer Yegor Gaidar. By June 1992, Boris Yeltsin’s administration seemed to be on the brink of intervening to protect South Ossetia.

The situation was ironically saved only by a further escalation of Georgia’s own civil war between Shevardnadze and Gamsakhurdia in Western Georgia, which was simultaneously making conflict between Tbilisi and separatist Abkhazia look imminent. In the face of this extraordinarily dangerous situation, Shevardnadze could not possibly afford to fall out with the Russians.

On 22 June 1992, Yeltsin and Shevardnadze duly met with North and South Ossetian representatives in Sochi and signed a ceasefire agreement. The agreement envisaged the deployment of joint Russian, Georgian and Ossetian peacekeeping forces. The peacekeepers moved into the region on 14 July, 1992.

In view of the civil war raging at the time in Georgia and the start of the Abkhazian conflict, no one initially gave the South Ossetian ceasefire much chance. But it held 16 years.

Russia’s second tier investment banks are in a league of their own

Graham Stack for business new europe

While Russia’s top tier investment banks are making headlines with Chelski-esque recruitment and multi-million salaries, second tier setups quietly play their own game.

Moscow’s investment banks have separated into two very different leagues that however peacefully coexist. There is an upper bracket comprising global brands such as UBS, Deutsche Bank and Unicredit, alongside their Russian competitors such as Renaissance Capital and Troika.

Then there are the rest: investment banks often run by their founder-owners, such as Veles Capital, IFK Metropol, Brokerkreditservis, Otkrytie, Trust Investment, that are growing rapidly, but not sufficiently to narrow the gap.

“They’re definitely not catching up with the big guys,” says Evgenny Tarzimanov of Standard & Poor’s, “and the gap is probably widening.”

Investment banks’ business is often difficult to compare, but the clearest indication of the gulf between first and second class is on the labour market.

Russian and Western media have recently been full of stories about the soaring salaries paid by Moscow’s investment banks, numerated in millions of dollars.

“Young people under 30 are arriving without any real experience and starting on $2m a year,” a VTB insider commented to business daily Vedomosti in July.

VTB’s own recruitment policy made headlines in April when the newly launched investment bank division of Russia’s second biggest bank wielded a blank chequebook to ’steal’ a large part of Deutsche Bank’s staff.

This is where the second tier banks opt out.

Small is beautiful

“There are two different leagues on the labour market,” says Troika Bank’s Olga Veselova. “Top tier investment banks pay at least twofold compared to second tier.”

Top tier banks are either owned by globally-active banks such as Deutsche Bank or UBS, or, in the case of Russia’s homebred Renaissance Capital and Troika, they compete directly with them – and recruit internationally. The top tier is part of the global banking market.

“Top tier banks recruit from other top tier banks or from abroad, not from second and third tier banks,” says Veselova.

Renaissance Capital and Troika are currently extremely aggressive on the labour market, “paying crazy dollars for the people they want,” says Tarzimanov. “The second tier banks are far more cost conscious.”

“We are not trying to recruit ‘stars’,” admits Marina Mironova, human resources head of second tier Veles Capital. “Our priority is not the publicity a candidate brings, but real experience, willingness to take responsibility, his achievements.”

While the stars stick firmly to the first tier firmament, questions are already being asked about whether their mouthwatering wage deals are justified: both in the case of the Russian banks trying to compete with global giants such as UBS and Deutsche Bank despite limited resources, and the global names exposed to the credit crisis.

The other drawback to the big investment banks’ Chelski-esque recruitment is high personnel turnover creating instability, such as in the case of Deutsche Bank.

Second tier banks, on the other hand, says Tarzimanov, “boast stable teams, often with owner management, low personnel turnover and long track records.”

Renaissance Capital head Aleksandr Pertsovsky explained to Vedomosti July 10 the chasm opening between first and second tiers as a result of the rapid growth of the Russian market was combined with its inefficiency.

“It doesn’t necessarily mean that number one automatically takes ten times more than number two, but an inefficient market means that distribution of revenue is skewed,” said Pertsovsky. “I don’t want to assess the competition, but look at the top ten according to Thomson, Bloomberg or Dealogic – only the global banks and Renaissance.”

In this context, it is not surprising that the second tier banks pursue very different business models.

For a start, according to Tarzimanov, much of their trading is proprietary trading with their own positions. Three quarters of Renaissance Capital business, on the other hand, is client-driven.

In addition, says Troika’s Veselova, 2nd tier investment banks serve predominantly Russian clients, whereas around 50% of clients of first tier banks are foreign.”

Second tier banks make a virtue out of being small by offering customised services. “They are more flexible: can go for smaller deals that big banks wont do, for a fee, for instance, of $1m,” says Tarzimanov.

“When the client enters our company,” says Veles Capital’s CEO Alexey Gnedovsky, “he will be met by a top manager, not the client manager. And this is not only a psychological advantage. A top manager can offer products or special conditions tailored for each client. We are in a position to develop and offer individual investment strategies.”

Flexibility means that smaller setups explore second and third tier stocks and even non-listed stocks. “There are many successful companies in Russia with sales over than $15m that are not traded yet. It is possible to buy these shares with 50-90% discount to fair value,” says Andrey Lee, head of Veles strategic investment department. Tarzimanov names real estate as a particularly attractive sector to smaller investment banks.

Seeking niches

And second tier banks also seek out niches. Mikhail Slipenchuk’s IFK Metropol, for instance, burst through to lead the M&A market by a number of deals in 2007, as a result of working closely with the new companies spinning off from electricity monopoly RAO EES. Veles, on the other hand, has never conducted an IPO, but is a leader on the Russian promissory note market.

However, such specialization brings with it increased risk. “Second tier banks are threatened by weak risk management, lack of diversification, coupled with low shareholder equity,” argues Tarzimanov. The larger the share of proprietary trading, the greater the exposure to the volatility of the Russian stock market.

Troika’s Veselova also points to increased competition within the second tier, as banks such as Bank of Moscow, Nomos and Gazprombank spin off their treasury arms as brokerage and investment operations, often with bank customers as client base. KIT Finance is thought to be planning the same move.

Despite increased competition, no one expects much of a wave of M&A in the second tier soon, in contrast to the entry of global majors to Russia’s first tier. Merril Lynch’s acquisition of 10% of Trust Investment Bank in November 2007 “was an exception rather than a rule,” says Veselova. Rumours, however, are swirling that Mikhail Slipenchuk, 100% owner and head of IFK Metropol, is looking to sell a stake, but the bank has said nothing official.

According to Tarzimanov, the majority of owner-managers still characteristic of second tier setups are simply not interested in selling: “They see huge growth potential ahead in Russia, and they love their businesses.”

Russian outbound tourist market heats up in summer

Graham Stack for business new europe

With an increasing number of Russians splashing out on foreign vacations, the leading homegrown operators are moving to acquire their own charter airlines, while oligarchs are buying into Europe’s largest operators.

Russians are increasingly popping up in places the West does not expect to see them: on the seabed of the North Pole, in the semifinals of Euro 2008, and on sundrenched beaches from Turkey to Thailand. Russia is now the world’s fastest growing outbound tourist market. In the first quarter of 2008, the number of outbound tourists reached a staggering 1,869,511, up 29% year on year from 2007, according to Federal Tourist Agency figures. According to the Russian Tourist Industry Association, 9.36m Russians went on holiday abroad in 2007, 20.8% more than in 2006, with 1.9m going to Turkey, and 1.2m to Egypt.

The Russian market remains largely under-consolidated, with surveys showing that Russians rarely use the same operator twice. However, the largest operators are reaching a size when they are starting not just to charter flights and book hotels in Egypt and Spain, but to own, run or build hotels in destination countries. The biggest step is to acquire their own air carrier companies to reduce dependency on third party suppliers during peak holiday seasons.

Three of the largest operators – VAO Inturist, successor of the Soviet tourism monopoly, Pegas Turistik and Tez Tours have declared their intention to acquire their own carriers.

But to date, only Pegas Turistik, which handled just over 50,000 guests in 2007 according to media reports, has taken the plunge. The company acquired Nordwind Airlines earlier this year. Nordwind will start flying for Pegas in September with leased Boeing 757s, according to director of marketing Ali Dirik.

But it is not all sunshine for tour operators. Along with the global aviation sector, Russian carriers are sweating due to soaring fuel prices. The issue has even gone to government level, with Prime Minister Vladimir Putin urging in July that the Federal Anti-Monopoly Service get involved.

“We are not worried about the fuel price in the medium term, since we are certain it will fall. And without our own charter division we would be even more exposed to it,” Pegas marketing director Dirik told bne.

But the soaring fuel prices mean that Pegas’ competitors are getting cold feet on their airline projects. Tez Tours director of marketing Roman Rybakov says that Tez Tour plans have been shelved. “With the current price of fuel, there’s no way we’re going to take in the risk of running a charter line,” he said.

Oligarchs to increase competition

The surge in fuel price is also putting pressure on European operators, just as global financial turmoil has depressed valuations. This is opening doors for Russian oligarchs to buy into West European tour operators and airlines, targeting synergies with the booming Russian tourist market.

First to do so was steel baron Alexei Mordashov, who 2007-2008 accumulated 15% in Germany’s TUI to become the largest shareholder in Europe’s largest tour operator.

Then in April 2008, Len Blavatnik, one of the TNK-BP shareholders in dispute with BP, snapped up a 19% stake in Air Berlin, Europe’s third largest budget airline, and the only one flying to Russia.

Now in July 2008, oligarch Aleksandr Lebedev of National Reserve Bank, owner of a slew of airline assets, announced the purchase of a controlling stake in Oger Reisen, Germany’s sixth largest tour operator for an estimated $125m.

“We want to be one of the major players on the Russian outbound tourism market,” Lebedev told Germany’s Der Spiegel in July. According to Lebedev, Oger can book a huge number of hotel rooms in Turkey and Egypt, while Lebedev’s airlines will fly Russian customers to their destinations. “We won’t even need to buy a tour operator in Russia,” he argued, “instead we can offer customers prices 20% or 30% lower.”

Lebedev’s German-based Blue Wings airline currently has only ten planes, but 20 Airbuses have been ordered from EADS for delivery 2009-2011. Lebedev plans to launch a new brand on the Russian market – Oger-NRK – and to start flying Russians and Ukrainians to Turkey and Egypt starting next year, and earn €100m in turnover, the first year’s target.

Pegas Turistik and Tez Tours both claim they are not afraid of the competition from oligarchs in conjunction with large European businesses due to the specifics of the Russian tourism business: they argue that Russians behave very differently from Europeans, frequently booking only days ahead of their departure date. A further difference is the structure of the holiday season. Russians enjoy two weeks of national holidays straight after New Year. When the rest of the world is back at work, Russians in their masses escape the winter for warmer climes.

But since outbound tourism is by definition an international business, with flights and hotel rooms the key factors, international set-ups like Oger and TUI in conjunction with local oligarchs could be a hard team to beat. Of the Russian market leaders, only Inturist VAO, successor to the Soviet tourism monopoly, now owned by oligarch Vladimir Yevtushenkov, has both the brand and the financial clout to compete on similar terms.

However, the Inturist PR team were unavailable for comment to bne, since they are all abroad on vacation.