Ukraine cities given extra time for Euro 2012

Graham Stack in Kyiv for business new europe (www.businessneweurope.eu)

European football’s governing body UEFA decided May 13 to confirm only Ukraine’s capital Kyiv as a host city for the Euro 2012 football championships, with three other cities being given a deadline of November 30 to prove their suitability. A face-saving, two-venue solution is looking increasingly likely for Ukraine come the final deadline in November.

Newswires have been quoting French sports journalist Eric Champel, confidante and biographer of UEFA President Michel Platini, saying that Platini felt let down by Ukraine, and was ready in Bucharest to slash to a minimum the number of Ukrainian venues hosting Euro 2012.

Champel had reported before the UEFA decision that the organisation would name four Polish cities and only two Ukrainian – Kyiv and Lviv. Champel proved to be spot on about the Polish cities, and is now sticking to his guns about Ukraine, despite UEFA giving three candidate cities – Donetsk, Kharkiv and Lviv – until November before a final decision on their suitability is made.

UEFA in fact only confirmed capital city Kyiv as a host city – and did so grudgingly at that, mentioning a number of significant shortcomings that need to be rectified. Before the decision, Platini had made clear that if the capital city failed to qualify as a venue, the country as a whole would lose its right to host the prestigious championships.

Backing up Champel’s version of events, Ukraine’s business daily Delo quoted a source from Ukraine’s delegation to UEFA alleging that UEFA was originally intending to make a final decision naming Kyiv as only Ukrainian venue. According to Delo, only a letter personally addressed to Platini, signed by Ukrainian President Viktor Yushchenko, Prime Minister Yulia Tymoshenko and Parliamentary Speaker Volodomyr Lytvin, giving a guarantee of improvements to Ukraine’s preparation staved this off, saving Ukraine’s four-four parity status for now. However, the “4+2″ outcome is looking most likely. Platini pointedly stated in the run-up to the decision that Euro 2012 could take place in as few as six host cities.

Lviving it up

Champel’s naming of Lviv as potentially the only Ukrainian host city besides the capital Kyiv sounded initially strange. Picturesque but poor, Lviv has been widely criticized for its backwardness in preparations, connected with its inability to find investors for a stadium and airport. There were expectations that reserve city Kharkiv would burst through to knock Lviv off the list

However, if UEFA were to scale down Ukraine’s participation to only two cities, as Champel suggests, Lviv would for purely logistical reasons be the natural second Ukrainian venue. The formerly Polish city is located close to the Polish border, with close transport connections to Polish venues. A single eastern Ukrainian venue, on the other hand, whether Kharkyv or Donetsk, would be logistically isolated from the main body of the event.

Opting for Lviv according to this logic would, however, be tough justice for eastern Ukraine, the heartland of Ukrainian football, and arguably way ahead of Lviv in terms of preparation for Euro 2012. Kharkyv and Donetsk are having their stadia and airport infrastructure modernised by the image-challenged oligarchs who also own the local football teams and have bankrolled their clubs’ impressive run of European victories this year.

In UEFA’s decision, Kharkiv even made the jump from reserve city to candidate host city, not least thanks to backing of oligarch Aleksandr Yaroslavskii, owner of DSN holding and of Kharkiv’s Metallist team, who reached the UEFA cup quarter finals this year. “It would be hurting if Kharkiv were not to be chosen,” Elena Derevyanko, adviser to Yaroslavskii, tells bne. “Michel Platini promised that the cities would host Euro 2012 that were best prepared to do so. Kharkiv is better prepared than all the others, because no other Ukrainian city has made so much progress in all respects. In some cities there is a stadium, but it needs improvement, and there’s no financial guarantees for airport reconstruction. In some, there are hotels, but neither a stadium nor an airport, and no investors willing to build them. Only in Kharkiv are all ingredients present.”

Kharkiv and Donetsk, however, are roughly as near to Moscow as to Kyiv, let alone Lviv, let alone the Polish venues, and, in the event of Euro 2012’s centre of gravity shifting west to Poland, this will inevitably count strongly against them. But preference shown by UEFA to western Ukraine on geographical grounds is unlikely to go down well in Ukrainian football’s Eastern heartland.

Ukraine hopes for economic stimulus from gas transit system overhaul

Graham Stack in Kyiv  for business new europe (www.businessneweurope.eu)

The Russian-Ukraine gas dispute in January set alarm bells ringing about the condition of the Ukrainian gas transit system (GTS) that transports 80% of Russia’s gas to Europe. Its organizational and technological backwardness meant it wasn’t possible to verify the conflicting Russian and Ukrainian claims about gas flows through the system. Another point of contention was the amount of “technical gas” that Ukraine needed to pump gas through the system, due to outdated compressor stations.

And as if the January dispute wasn’t enough, in April a major Ukraine-Bulgaria gas pipeline exploded in Moldova, causing supplies to Bulgaria to fall by 70%. The pipeline, it transpired, was over 40 years old. One week later, on April 9, the same thing happened to a Soviet-era pipeline in Turkmenistan. This confirmed dire warnings by Ukrainian experts in 2008 that the former Soviet Union’s over 40-year-old GTS was already living on borrowed time. And that Ukraine, at the heart of the system, was most threatened.

So the EU-Ukraine declaration of March 23 that committed Ukraine to revamp its GTS in return for billions of EU and international investment was long overdue. “We have been aware of the potential need for investments to modernize the GTS and of its importance as an economic asset for Ukraine for some time,” Martin Raiser, head of the World Bank mission to Belarus, Ukraine and Moldova, and one of the signatories to the EU-Ukraine Declaration tells bne. “With rising gas import prices and the move to more transparent gas trading relations between Russia and Ukraine, there is now an opportunity to realize this potential.”

Engineering a boost

Soviet Ukraine was not only at the heart of the gas transport system. The main engineering companies building and equipping this system were also located in Ukraine, which is why Gazprom still sources approximately 75% of its engineering needs from Ukraine. This means that any investment in the modernization of the GTS could have knock-on effects for Ukraine’s crisis-stricken engineering industry.

“Ukrainian companies are standing ready to participate in the GTS modernization, including Sumy Machinery Plant, Motor Sich, Khartzysk Pipe Plant, and Novomoskovsk Pipe Plants,” says Alfa Capital Ukraine analyst Denis Shauruk. “If Ukrainian producers will supply the modernization project with domestic equipment, the economic impact from such modernisation may range from 0.5% to 3% of GDP contribution annually, depending on the amount of investment in any particular year.”

Ukraine’s master plan for the modernization of the GTS, incorporated in the EU-Ukraine declaration, envisages a first phase of modernizing the existing transport and storage infrastructure, requiring $3.5bn over seven years, before a second phase sees new pipelines being built. Half of the sum for the first phase would to go to new compressor stations, with the rest divided between improvement of pipelines, underground storage facilities, and gas measuring stations at entry and exit points. This first phase holds most promise for machinery producers such as Sumy Machinery Plant, Gazprom’s supplier of choice, and turbine manufacturer Motor Sich, which can supply high quality gas compressor stations and gas pumping aggregates.

Ukraine’s authorities have apparently been quick to seize on the beckoning opportunities for local manufacturers. Ukrainian media reported in early April that Ukraine’s Fuel and Energy Ministry had taken steps to prioritise local companies in awarding contracts. According to Kommersant Ukraine, immediately following the EU-Ukraine declaration, a memorandum was signed by the Fuel and Energy Ministry, Ukraine’s pipeline operator Ukrtransgaz, state gas planners Urkgazproect, the Ukrainian Oil and Gas Institute, and engineering companies Zorya-Mashproect and Sumy Machinery Plant. The memorandum ascertains that the Ukrainian companies are “capable of satisfying all the needs of Ukraine’s GTS,” says the newspaper, and that pipeline operator Ukrtransgaz has named them as its “most likely suppliers” due to their positive collaborative history to date.

However, Ukraine’s authorities might not find it that easy to channel GTS modernization orders to Ukrainian companies. The memorandum in fact contradicts the sixth point of the EU-Ukraine declaration, which specifies the observation by Ukrtransgas of “best practice international procurement rules,” ie. competitive international tenders. Raiser emphasizes that the World Bank, as well as the European Bank of Reconstruction and Development (EBRD) and the European Investment Bank (EIB), prescribe procurement rules ensuring competitive and open tendering of goods and services. But this need not be to the detriment of Ukrainian companies. “Our rules do allow for some preferences for domestic manufacturers, and our experience shows that Ukrainian suppliers can often win under competitive tenders, particularly in civil works,” says Raiser.

However, funds provided directly by the EU or national governments are likely to be tied to procurement sourced in those countries. “Ukrainian manufacturers can supply both high-quality pipe and compressor equipment, but the major share of any EU loan is likely to be spent on imports of goods and services from the EU. This is a normal condition of governmental loans,” believes Mikhail Korchemkin, director of East European Gas Analysis.

Germany and Japan, both of which have shown interest in financing the GTS modernisation, have advanced engineering companies specialized in the natural gas sector, namely Man Turbo and Mitsubishi respectively.

Moreover, Prime Minister Yulia Tymoshenko agreed on April 29 with her Russian counterpart Vladimir Putin that Russian companies will also be involved in the work, possibly in exchange for Russian funding. This means that Ukrainian engineering companies could find that their slice of the action is less than they initially hoped. “The impact of the GTS modernisation plan on the Ukrainian economy may differ, depending on the degree of participation of Ukrainian companies, in the modernization contracts,” says Alfa’s Shauruk. “If a consortium of international banks will provide financing for modernisation of GTS and these funds will be channelled to purchasing imported equipment, the impact on the Ukrainian economy will be short term and negligible.”

But World Bank’s Raiser points out that Ukraine’s GTS is a priceless asset in and of itself. “The benefit is not just the linkages that investment spending has on domestic producers, but also the maintenance of a critical asset, earning several billions of dollars in revenues a year,” he says.

Russia and China sign US$25bn loans-for-crude deal

Graham Stack for business new europe (www.businessneweurope.eu)

Rosneft, Transneft, China National Petroleum Corporation (CNPC) and China Development Bank have signed off on a deal for $25bn in loans for the Russian state-owned companies in return for Russian crude oil supplies to China, according to newswires

The agreements were signed in Beijing on Tuesday February 17 at a meeting between Russian Deputy Prime Minister Igor Sechin and Chinese Vice Premier for Energy Wang Qishan.

Following the meeting, Sechin, who is also chairman of the board of Rosneft, said that Russia is expected to export 15 million tonnes per year (301,000 barrels a day) to China over a period of 20 years in exchange for the loans.

“We agreed on supplies of 15 million tonnes of oil every year over a period of 20 years,” Russian Deputy Prime Minister Igor Sechin told state news channel Vesti 24.

The China Development Bank signed the loan agreements with Rosneft and Transneft. Rosneft and CNPC signed documents on Russian oil deliveries to China for a 20-year period.

Transneft Vice-President Mikhail Barkov told Reuters his company would receive $10bn of the loan and Rosneft the other $15 billion.

“The maturity is around 20 years and this credit is linked to supplies,” Barkov told Reuters. “It is a historic event and the start of a big journey.”

China agreed to reduce the annual interest rate by one percentage point to 6 percent, RIA reported. Vedomosti speculates that the interest rate for the loan is 5.5-6% annually.

The deputy premier also signed a second deal on construction of a branch of the Eastern Siberia-Pacific Ocean pipeline (ESPO) to the Chinese border. CNPC and Transneft signed a corresponding contract on construction and operation of the ESPO branch, according to Prime Tass.
Russia will supply 30 million tonnes through the pipeline link to China when it reaches full capacity, a Transneft spokesman told Prime Tass.

VTB Capital’s Lev Snyvkov writes, “Rosneft could resolve its debt repayment issues without the Chinese loan, but it could be more expensive and problematic given the current tight liquidity conditions. We estimate Rosneft’s net debt at the end of 2008 at about USD 24bn, with USD 8.5bn to be repaid in 2009. The company’s 1Q09 repayments (USD 0.9bn) were covered by operating cash flow, while the 2Q09 repayments (USD 4.1bn) have already been agreed with banks (refinancing). In 2H09, Rosneft needs to repay USD 3.5bn.

The pricing parameters of crude supplies (as yet unknown) are important for assessing the true cost of the loan. The news is in line with what was announced earlier but is still marginally positive for Rosneft and Transneft as the agreement is an additional source of liquidity in the tight liquidity conditions on the market.”

UralSib’s Viktor Mishnyakov writes, “we believe the loans received might provide an impetus to massive development of Eastern Siberia. Assuming the government will exempt the East Siberian fields from export duty, the biggest winners will be Rosneft (which has the most projects in Eastern Siberia), TNKBP, Surgutneftegas, Slavneft and Gazprom Neft. Regional development would also likely trigger the extensive use of independent oil field services in the region, with Integra benefiting the most.” We think China might receive certain benefits in return. We believe that two options are possible: greater access to the East Siberian fields (currently two upstream projects via a JV with Rosneft) and the potential transformation of ESPO into a joint stock company, with China getting 49% or 50% control in it.”

Belarus Investment Agency to attract foreign investors

Graham Stack for business new europe (www.businessneweurope.eu)

The offices of the Belarus Investment Agency are small and on the outskirts of the Minsk, and a role call of 7 staff points to its embryonic status – but according to its head Oleg Zinoviev, it has a big future ahead of it.

And the first step will be its promotion to ministerial status and direct subordination to the prime minister as of January 2009.

“This status will allow us to become a fully-fledged single window for foreign investor, with powers to resolve any issues arising between foreign investors and government authorities where at national or local level,” says Zinoviev.

“Alone the fact that we will be awarded such a status and answer directly to the prime minister is testimony to the importance the government now places on attracting foreign direct investment.”

According to Zinoviev, the Belarus Investment Agency is modeled on ISPAT, the famous Investment Support and Promotion Agency of Turkey, likewise directly subordinated to the Turkish prime minister.

And if the offices are still modest, it is compensated for by a hectic itinerary through Europe and the former Soviet Union establishing contacts and putting the Belarus investment case.

Opening gambit

For many years Belarus and foreign investments entertained a mutual aversion. However, as of last year, all this has changed. In connection with Russia demanding a gradual shift to European gas prices, and also stopping duty-free oil exports to Belarus refineries, the risk of Belarus running a current account deficit suddenly emerged.

And in addition, rocketing domestic growth was outgrowing domestic, as well as new technologies and managerial capacities, to move on to the next level.

Zinoviev emphasizes the latter. “It is foreign technologies we need, and above all foreign managerial technologies. Too many of our directors still cling to the old ways.”

Zinoviev denies Belarus had ever been actively anti-FDI.

“Everyone knows we had a course aimed at primarily harnessing our internal resources, but there was never any different treatment for foreign investors than for domestic investors. And there isn’t now.”

The only really preferential treatment for foreign investors, he says, is a guarantee that existing regulations will continue to apply for five years to the investors.

FDI growing

It is undeniable that the volume of foreign investment is growing rapidly, albeit from a very low base.

FDI totaled $1.23bn in the first six months of 2008, approximately the same amount as for all 2007. FDI increased from 1.8bn dollars in 2005 to almost 4bn in 2006 and to 5.4bn in 2007, with 7bn dollars expected for this year. However, this sum is only 3.5% of fixed capital investment.

Russia accounts for 33.2% of all foreign investment, Switzerland for 20.2 %, the UK for 14.2% and Austria for 10.7%.

Zinoviev reels off happily what should make Belarus attractive for foreign investors.

Firstly, he says, Belarus combines rapid economic growth, averaging over 8% in recent years, with a high level of political stability and significantly lower corruption than in Ukraine or Russia. So investors can count on both profitability and sustainability of investment.

Secondly, Belarus geographical position at the watershed between the Black and the Baltic Seas and between Russian and Western Europe, and its cluster of road and railway connections, make it a strategic location for investors.

Thirdly, Belarus, which had one of the highest living standards in the USSR, with considerable investment in electronic and light industry made in the 1980s, has a plethora of technical universities and research institutes.

It is Zinoviev’s job to match up investment opportunities in Belarus with potental investors abroad, and to this effect a good deal of the time he is traveling.

The Belarus Investment Agency is tasked with turnkey provision of investment projects, from drawing up investment proposals and finding an investor to facilitating all bureaucratic and infrastructural measures in Belarus on behalf of the investor.

Zinoviev and his colleagues say their work was recently made a whole lot easier by the publication of the World Bank’s ‘Ease of Doing Business’ survey.

Belarus officials had been actively collaborating with World Bank staff to implement measures to boost Belarus’ lowly ranking. Those efforts paid off – with Belarus leaping from place 110 in the world ranking to place 85, leapfrogging Russia and Ukraine, the fourth highest climber of the year.

One point that World Bank officials says Belarus still has to work on is tax legislation.

“It is by far the most complicated I have ever seen, with 42 taxes meaning that huge administrative efforts are needed for compliance,” agrees Helmut Duhs, CEO of Telekom Austria-owned Velcom, Belarus’ second largest mobile operator told bne. “And it’s not just the number of taxes: taken together, Belarus has the highest tax rates in region,” he added.

However Zinoviev points out that the tax burden is being decreased from year to year, and many ‘taxes’ are in fact merely local dues. “It’s not much different from what you find anywhere else,” he argues.

The ‘Ease of Doing Business Ranking’ World Bank ranking serves Belarus as a target – with the goal being to enter the top 25 in the within the next three years. And the president’s office has set government officials targets for attracting FDI.

Opposition figures decry President Aleksandr Lukashenko’s swerve towards foreign investment as mere opportunism and unlikely to last. Zinoviev, however, points out that all the main normative acts improving the investment climate come direct from the president’s office.

“These are not government resolutions or local administrative acts,” says Zinoviev. “They are presidential decrees. So they won’t change. All the main decisions to open up for foreign investors have been presidential decisions, signed by the president. This is simply the strategic course he has chosen.”

Raiffeisen plays pioneering role with Priorbank

Graham Stack for business new europe

Austria’s Raiffeisen International is the Indiana Jones of the banking world. Even after Eastern Europe became fashionable amongst international financiers in about 2004, the idea of buying into Belarus crossed few people’s minds. Now that Belarus has thrown open its doors and is quickly becoming the hottest bank market in the region, banks arriving in the country will arrive to find Raiffeisen has already been there for five years.

Priorbank was founded as an innovation in 1989 during the first wave of private bank start-ups by a group of the county’s largest manufacturing concerns, including truck makers MAZ. Oil paintings of the banks’ industrial founders still adorn the walls of Priorbank’s headquarters, but the bank was never reduced to a pocket bank: at the same time as serving large corporate clients, as early as 1995 Prior was a partner of the European Bank for Reconstruction and Development’s Small and Medium Enterprise (SME) programme, and in 1997 the EBRD took a 27% stake.

Vladimir Dedioul, member of the Priorbank board responsible for investment banking, says Priorbank was then the country’s third-largest bank, and its largest private bank. A greenfield development in Belarus would have been difficult, but Priorbank was looking for a buyer. “So Priorbank followed the typical East European pattern of taking on first a financial investor, then a strategic investor,” explains Dedioul, who has worked in the bank since it’s founding.

The strategic investor came in the shape of Raiffeisen in 2003, which too first took a 50% stake and subsequently increased it to 63.1%. “Our purpose was to find a source of long-term money for the clients we knew well. Raiffeisen gave us know-how, technologies, finance,” says Dedioul.

Austrian Bernd Rosenberg, originally from Raiffeisen International, now a member of the Priorbank board responsible for risk management, jokes that “White Russia” was literally a blank on the map. But precisely this fact attracted Raiffeisen: “It’s always better to be first in the market and here as well we saw considerable potential for the future. We wanted to cover the whole region.”

All about timing

Raiffeisen chose the perfect moment to enter the market. From 2002-2007, Priorbank grew explosively along with the Belarusian banking sector. Priorbank’s loans to customers grew more than eightfold, assets more than five times, equity trebled, and retail deposits rocketed four and half times.

It’s testament to the strength of Priorbank’s position that, unusually for Raiffeisen, the bank still uses the Prior brand, with the Raiffeisen emblem adjoined. “We were also lucky in that Priorbank has always used yellow for it logo, like Raiffeisen,” jokes Dedioul.

The Priorbank deal was pioneering for Belarus – and is seen as having kick-started a process. “The Priorbank deal showed the government that foreign investors would act perfectly normally, on the one hand, pay taxes, pay their employees, and also introduce much needed technologies and improvement,” a source at a competitor bank tells bne. “But Prior and Raiffeisen have had to adapt a bit to realities. There was an initial euphoria in terms of public relations and openness, but recently they have become more closed. They serve a number of state-owned companies.”

Dedioul admits it has not been all plain sailing. However, he points out that the government has been so convinced of the benefits from foreign investors, that it has moved from tolerating them to actively seeking them – with a far-reaching privatization of the bank sector in the pipeline for 2008.

Dedioul claims the banking sector could go private “virtually overnight.” The share of foreign capital is currently just under 10% and there is a 25% cap on foreign bank ownership, but it is widely believed that this will be changed. “People often imagine the Belarusian banking system totally belongs to the government. However, that’s simply not the case: 23 of the 27 banks in Belarus are already private.” Admittedly, of the six largest banks, with about 80% of the total assets, only Priorbank, the third largest, is currently private. “But the fourth, fifth and sixth largest are all about to be privatised in the immediate future, and the two largest, Belarusbank and Belagrobank, will hold IPOs.”

Rosenberg says Priorbank is not worried about competition heating up. “We have first-comer’s advantages,” he says. “And we have done a lot of work over the past five years. Since we arrived, we have changed structures and approaches, switched from a three-tier to a one-tier structure, made large investments in IT and personnel. These are changes that the banks that are going to be privatised still have ahead of them. That will take time, and so we are far ahead of the field.”

Rosenberg explains Priorbank strategy as being Raiffeisen’s general approach tailored to suit local conditions. “The Raiffeisen strategy is to be a universal bank strong in corporative banking, where we are traditionally good, and to build up the retail area for private individuals and micro-crediting. We have a very clear focus on SMEs and retail.”

As an example of Raiffeisen’s approach, Rosenberg points to the introduction of standardized products for SMEs as being a general tendency – but “standardized products tailored to the Belarusian market, not imported from Vienna.”

IPOs postponed?

Priorbank recently qualified as an IPO partner for the Warsaw stock exchange – again, the first bank in Belarus to do so. With the government announcing upwards of 75 IPOs of state-owned companies to take place in the immediate future, this looks like a wise move to get a slice of the action.

Dedioul says, however, it is unclear how fast this can be achieved, giving the current international market conditions.

Rosenberg agrees: “It is very difficult to jump from isolation to integration in one go, in one year,” he argues. “There’s a whole science of how to do it: building up a credit history, working with international institutions, with private placements, sovereign borrowings, country ratings. To do it in one year is basically impossible.”

The private sector in Belarus, Dedioul and Rosenberg agree, appreciate the recent moves towards liberalisation, while emphasizing the importance of correct timing and consistency in implementation.

Global food retail leaders leave it late to set up shop in Russia

Graham Stack for business new europe
With a downturn in the West but the big emerging market countries still booming, Wal-mart et al want desperately to get into Russia, but are finding they have left it late.

At the World Retail Conference in Barcelona on April 9-11, the global retail sector’s biggest annual bash, there was not much of a party atmosphere. Carrefour CEO Jose Luis Duran summed up the prevailing mood by saying, “we are facing the most significant challenge in a generation.”

The only light on the horizon, most participants agreed, were the emerging markets, particularly Brazil, Russia, India and China. Russia is the last of the BRIC countries still lacking one of the big three supermarkets – Tesco, Carrefour and Wal-mart – but participants agreed this wouldn’t likely be for long.

Speculation that one of the big three will set up shop soon in Russia has reached fever pitch in 2008. In January, Carrefour was reported to be looking for a site in Russia’s oil rich Tyumen region – and subsequently the company officially announced plans to open up two hypermarkets by the end of the year. Then in March it was reported that Tesco had been holding talks with Petersburg-based hypermarket chain Lenta. Finally, on April 14, in the immediate aftermath of the Barcelona conference, Wal-mart announced it had appointed the hypermarket-experienced Stefan Fanderl as president of Wal-Mart Emerging Markets-East to “explore retail business opportunities in Russia and neighbouring markets.”

A piece of it

In its recent Global Retail Development Index report, AT Kearney ranked the Russian food retail market as the second most attractive emerging market for investment (after India) for three consecutive years. According to UniCredit research, the Russian food retail market is currently the fifth largest in Europe with a turnover of $193m in 2007 after the UK, France, Germany, and Italy. UniCredit expects the Russian retail market to become the second largest in Europe after the UK as soon as 2011, and to pass the $1-trillion mark in 2013.

So, in view of the current downturn on developed markets, the question for potential foreign investors is not when, but how? And whether through green-field development or acquisition? This is where the head-scratching starts.

Traditionally, the Russian listed retailer segment has been regarded as an M&A play, but Russian analysts are saying – think again. With growth rates of 40-50% per year set to continue in the medium term at least, none of the leading local names are in any hurry to sell out. And with major Russian brands established and growing, and some foreign majors such as Metro and Auchan also in the top 10 and doing very well, for even a global giant such as Wal-mart starting from scratch won’t be easy. As one participant of the Barcelona congress was heard to say: “Is now the time for us to move into Russia? No. The time was five years ago.”

In the words of Andrei Nikitin of investment bank UralSib: “Foreign retailers – Carrefour, Tesco, Wal-Mart – missed the opportunity of large-scale, unobstructed entry into Russia’s retail in the 90s, and now face an uphill struggle to gain entry in a market where domestic players have a strong foothold at national and regional levels. This, coupled with Russia’s inadequate infrastructure, real-estate related challenges, and administrative red tape, makes multinational retailers hesitant of building their own networks from scratch.”

“It’s difficult now to set up on your own,” agrees Alfa Bank’s Vitaly Kupeev. “The market is hot and competition is tough. Magnit, Auchan, X5 – all operate upwards of 20 hypermarkets currently, and the number grows every year.”

The major bottleneck is simply getting the land to build hypermarkets on. And this is means a global giant like Wal-mart will have difficulties setting up large-scale operations straight off. “It’s basically a land grab, with chains trying to acquire as much real estate as possible, trying to grow as fast as they can manage,” says Brady Martin of Alfa Bank.

“Real estate is the major challenge in cities, especially Moscow and Petersburg,” confirms agrees Nikitin. “There’s a deficiency in every class of real estate. You’re not just competing with other retailers, you’re also competing with residential development and office space and hotels.”

Russian bureaucracy, corruption and lack of infrastructure also slow down store openings. Moreover, labour is becoming an increasingly scarce resource as well.

Metro and Auchan, the two global names present in Russia, have done very well, says Brady, but Ikea and Germany’s MediaMarket have had problems related to local conditions. Moreover, according to Alfa Bank research, although French retailer Auchan has exhibited the highest growth of the top -10 retailers at 80%, jumping to the fourth-largest player as of end-2007, many Russian players have demonstrated similar growth rates, and in absolute terms Russian players continue to dominate the growth of the market. Despite being the largest player in the market, X5 Retail Group had the highest growth rate of all the top-10 players 2007.

So Russian retailers are no walkover. Bu but neither are they are a sellout either. The gist of a slew of recent report is that, with cricket score growth rates set to continue, none of the Russian leaders are interested in selling in the immediate future. “Why would anyone sell when they are growing at 50% per year?” asks Alfa’s Kupeleev. An Alfa Bank report published April 16 found that, “in our view, sale to a strategic investor is probably top of the list on the long-term exit strategy for owners of Russia’s largest retail chains. However, as long as the companies are able to sustain growth in excess of 40%, we do not feel that the majority shareholders of these assets will be in a hurry to sell.”

The other drawback to acquisition is that the Russian food retail sector is still hugely under-consolidated – both in terms of traditional formats such a small shops, markets and kiosks still counting for 70-80% of the total market, as well as within the 20-30% supermarket segment, where even major chains do not have market shares of more than 1.5%. “High market fragmentation undermines the validity of acquisition for the sake of market share,” according to UralSib’s Nikitin. Basically, you don’t get much market share for your money.

The two companies most often touted as potential Wal-mart targets are market leader and listed company X5, and St Petersburg-based non-listed Lenta, According to Uralsib’s Maria Startseva, however, X5’s management stated recently that the company, owned by Alfa Bank, might indeed be sold to Wal-mart, “but at the earliest within 20 years.” Wal-mart have said they might take a minority stake in a Russian company, and in February the owners of a 21% stake in X5 said they were interested in selling it. But Kupeev argues the stake is too small to make much sense for Wal-mart, and the deal would need to be approved by majority shareholder Alfa Bank, “and that will never happen.”

Analysts, therefore, regard non-listed companies, especially Russia’s fifth largest Lenta, as being the most likely candidates for acquisition. Lenta is known to have held talks with both Wal-mart and Tesco.

However, the problem with such companies is lack of transparency, according to Kupeleev. “Lenta don’t even publish their IFRS figures.” Such lack of transparency deters potential investors. Even in the case of Lenta, which counts the European Bank of Reconstruction and Develolpment among its shareholders with an 11% stake, everything is far from sweetness and light. The company’s major shareholders, among whom bizarrely is a US deputy prosecutor from San Diego called August Meyer, are currently at each others’ throats about who has the right to appoint the CEO. A court in the British Virgin Island made a ruling April 15 that confirmed the present CEO, but the dispute looks set to continue – and to hinder any takeover deal.

It can get worse than that. In 2007, UK electronics retailer DSG International, formerly Dixons, called off at the last moment a $1.9m investment into Russia’ leading electronics chain, Eldorado, due to concerns about “political, economic and corporative risks.” They obviously did their due diligence well, because on March 4 Eldorado was raided by Russian police, and two days later presented with a $327m back tax claim. This episode followed a tax raid of leading cosmetics purveyor Arbat Prestige in January that led to the arrest of its owner, together with a notorious international mafia boss, Semyon Mogilevich, whose wife turned out to be a major shareholder in the company.

This succession of raids is no coincidence: Russia’s tax service have publicly stated they are launching a crackdown on the retail sector, which they see to be a major transgressor of tax and customs laws. Further such developments are expected – and potential investors are hardly amused. So that could mean another option gone for global retailers looking to move into Russia big-time.

The most likely remaining option for the big names is that which Carrefour is pursuing: patiently put together an extensive land bank, open hypermarkets one by one as you can, and play a long-term game. But such a long-term strategy is too late coming to counteract the downturn on developed markets.

Russians gobble up European companies

Graham Stack for business new europe

It is hard to get alarmed by investors buying into tour companies, however big, but Germany’s influential Der Spiegel nonetheless rang the alarm bells when Russian steel oligarch Alexey Mordashov recently bought 10% of tourism giant TUI. But while a spate of acquisitions in Germany and Switzerland by Russian oligarchs is triggering paranoia about attempted political influence, Russian firms are more focused on conquering their domestic market – by buying up Western expertise and technology.

“What do the Russians want? Profits or political influence?” screamed Der Spiegel, before going on to accuse Russian investors of running a “simple plundering scam.” Describing in lurid tones the “fairytale riches” of Mordashov and his colleagues, the magazine concluded that, “they cannot find any profitable investment opportunities in Russia, so they are coming to Germany. The ruble is rolling towards the West.”

Fears that the Kremlin might gain control over German summer holidays were reminiscent of the quip in 2007 that the Russians were claiming the North Pole to control Christmas. A sense of realism returned days later when TUI and Mordashov’s investment vehicle declared they were founding a joint venture in order to tap into the potentially vast and booming Russian and CIS tourist market. Russian firms, it seems, are interested in acquiring technology and expertise to conquer the booming Russian domestic market by importing best practices on a large scale, they’re not looking to create a fifth column in the West, despite what the headline writers say. So far from reflecting a lack of investment opportunity in Russia, as Der Spiegel alleges, the exact opposite is true: such acquisitions directly reflect the massive investment opportunities opening up in Russia, ranging from an underdeveloped service sector benefiting from booming consumption, to upgrading scanty and crumbling infrastructure through generously sponsored public-private partnerships.

Mordashov’s interest in tourism is a reflection of the potential size of the Russian tourism market, and its current fragmentation. While Western Europe’s tourism market is saturated, Russian outbound tourism is the fastest growing in the world. According to the Russian Federal Agency for Tourism, between January and June 2007 a staggering 13.7m Russians went abroad for their holidays, with destinations such as Croatia, Egypt, and Greece growing 130-150% in 2007. Moreover, Russians, with their two-week compulsory break in January when the rest of Europe is back to work, are a tour operator’s dream – and one that Mordashov’s investment in TUI hopes to turn into reality.

Only a few days before Mordashov became TUI’s largest single shareholder, fellow oligarch Len Blavatnik, valued at $7.2bn by Forbes magazine, snapped up a 19% stake in Air Berlin, Europe’s third-largest discount airline with a market capitalization of €506m. Air Berlin is the only one of Europe’s big three budget airlines currently present on the booming Russian aviation market, with flights from Germany to Moscow and St Petersburg. Budget airlines are in their infancy in Russia, but this is another market ripe for growth.

Retooling Russia with European tech

Outside the tourism sector, on March 26 the Russian holding company FLC West, linked to Russia’s state-owned United Aircraft-building Corporation, bought 70% of the Aker shipyards in the German Baltic town of Rostock for €292m. Again, there was nothing coincidental about this purchase. The Kremlin launched a programme to revive Russia’s moribund ship-construction industry in 2007 by uniting state-owned naval shipyards in a holding – the United Aircraft-building Corporation, sister of the United Shipbuilding Corporation. The declared aim of the United Shipbuilding is to refocus state-owned shipyards from naval to commercial shipbuilding. Hopes are pinned on the niche of ice-class shipping – to serve the Russian energy sector’s growing demand for oil tankers, LNG tankers, pipeline-laying ships and supply ships capable of plying the icebound waters of the Arctic.

The Kremlin wants Russian shipyards to corner this market and win what Putin called in his 2007 parliamentary address, “a decent niche on the global market.” And in February 2008, the then-presidential candidate Dmitry Medvedev called on Russian companies “to acquire foreign enterprises both directly and through participation in joint stock capital [and] help re-equip Russian enterprises, enhance their production, diversify investment and gain new markets.”

This is where the Aker shipyards come in: Russian shipyards lag far behind in commercial-use technologies. The Aker shipyards are already producing ice-class dry-bulk carriers for Russian corporations such as Norilsk Nickel, the world’s largest nickel producer. The shipyards produce double-acting cargo vessels, the sterns of which are designed to double up as ice-breaking bows. A pioneering technology specially developed for Arctic shipping – and one now in Russian hands.

The equation is the same when it comes to uber-oligarch Oleg Deripaska’s investment in German-Austrian construction giants Strabag and Hochtief. In 2007, Deripaska acquired 10% of Germany’s Hochtief and 30% of Austria’s Strabag, both construction and infrastructure giants, in anticipation of Russia transforming “into a gigantic building site,” in the words of Deutsche Bank. A state-sponsored infrastructure building programme will, according to First Deputy Prime Minister Sergei Ivanov, be worth a staggering $1 trillion over 10 years. “This country needs everything: roads, hospitals, schools, airports, cars, trains, airplanes,” Deripaska said in a November 10 interview about his European construction industry acquisitions. “There is huge demand, and supply is not coping.”

Russians not welcome – yet

On April 4, the same day Blavatnik announced his acquisition of a stake in Air Berlin, an old friend from his student days, billionaire Viktor Vekselberg, announced he was increasing his year-old stake in Swiss technology concern Oerlikon, in which he first invested in 2007. That year, Renova also bought into Sulzer, the major Swiss engineering company producing, among other things, state-of the-art equipment for the oil industry. Renova is an energy-focused conglomerate with stakes in oil major TNK-BP as well as power generation assets. In a January interview with Russian business daily Vedomosti, Vekselberg put the total investment in Switzerland at $3bn-4bn.

The unexpected double acquisition raised hackles in Switzerland and was challenged in court. When asked by Vedomosti what his motive for investing in Oerlikon was, Vekselberg answered: “to get access to technology that we don’t have in Russia,” especially in the sphere of alternative energies – wind, solar and biofuels. Vekselberg patiently talked down the hostile response to his investment. “No one anticipated the appearance of major Russian investors in one of the historic leaders of the Swiss economy. They asked: ‘and what do these Russians want?’ You have to laugh, but they saw the Kremlin’s hand behind it all. They’re just not used to us – but given time that will change.”

Hardly had the news of Russian oligarchs’ new business operations in Germany subsided, than a new rumour was doing the rounds on April 11: that Russia’s largest bank, Sberbank was poised to acquire Dresdner Bank’s investment banking arm, Dresdner Kleinwort. However, in this case there was hope rather than suspicion in the German reports: Dresdner Kleinwort has been badly hit by the global financial crisis, is wearing a “save me” sign, but has nevertheless been turned down by potential investors such as the Chinese Investment Corp. sovereign wealth fund.

The Russian side, however, was quick to dismiss the rumours. Renaissance Capital’s banking analyst David Nangle says that while it’s obvious that Dresdner Kleinwort is being touted for a sale and there may have been some contacts in this connection with Sberbank, “I’ve been talking with the Sberbank people and there’s simply nothing behind it.”

“Sberbank are looking to add on an investment-banking wing, that much is true, but it’s going to be in Russia where their corporate clients are, of course. Either they’ll buy into a Russian investment bank, or most likely they’ll do it organically,” he says. “Dresdner Kleinwort might be going cheap, but Sberbank is far from going on a European shopping spree without rationale or strategy.”

A Renault u-turn urgently needed as Russia outgrows Avtovaz

Graham Stack for business new europe

Four months after the sensational announcement that turnaround experts Renault would become strategic investors in Russia’s Soviet-era car giant Avtovaz, analysts are hoping the company will now unlock a new class of low-income car owner.

It had been a long time since the producer of Lada cars, traditionally associated with gangland slayings and financial manipulation, made positive headlines, but December’s news that Carlos Ghosn’s Renault would take a 25% stake in Avtovaz caused a stir. The match between Russia’s ailing un-restructured car giant and Renault’s legendary turnaround star Ghosn, the man who single-handedly rescued Japan’s Nissan from the verge of bankruptcy, seemed perfect. Could he do the same this time, or had he bitten off more than he could chew?

“I was absolutely astonished. I refused to believe the reports, thinking the story was just groundless rumours, until it was confirmed officially,” is how Trust investment bank’s automotive analyst Aleksandr Yakubov recalls his surprise.

The surprise was all the greater because Avtovaz had been effectively renationalized in 2005, in a quite bizarre form: Russia’s state-owned arms exporting monopoly Rosoboronexport (ROE) had taken control, dislodging the previous management who controlled the company through an opaque system of cross-ownership by subsidiaries, and sending in whole battalions of riot police to expel criminal gangs from the premises.

Since ROE favours a policy of consolidating companies in sectoral holdings under state ownership, there were suspicions that moves were afoot to set up some national automotive corporation together with truck producer Kamaz and other Russian producers – and call on state funding to re-launch the Russian car industry. So it was a welcome surprise when ROE saw the light and called in Renault – banking $1bn for a 25% stake that had cost them a fraction of that.

While the ROE decision was surprisingly enlightened, analysts wondered about whether the same was true of Renault’s involvement in the troubled car giant. With only a 25% stake, how could they hope to turn the company around? Renault simply referred to the fact that they had bought into the biggest brand on what will very soon be Europe’s biggest market. And that it was very much the “people’s car” brand they were interested in.

Europe’s largest car market

With the value of Russia’s car market growing 57% in 2007 to $53.5bn, making it set to overtake Germany to become Europe’s largest in 2008, Avtovaz, Russia’s dominant car producer with 24% of the market, should be looking up.

Purely in volume terms, the market increased 36% on year to 2.75m cars, according to European Intelligence Unit. And growth is set to continue, driven by surging disposable incomes, which have increased twofold since 2000, and are currently growing at 10% on year. And a new wave is already breaking, with a surge in auto loans facilitating car purchases. Over 2002-2006, the proportion of new cars purchased on credit exploded from 7% to 42%. According to Autostat estimates, in 2007 new car credit grew 89% on year to $17bn. “Already in the near future,” says Renaissance Capital’s transport analyst Eduard Faritov, “this proportion could reach the European level of 60-80%.”

But this will still be just the tip of the iceberg: car penetration in Russia, despite a two-fold increase since 1993, is still astonishingly low. Even after a decade of strong growth, there are only about 185 cars per thousand people in Russia, compared with 205 per thousand in Central Europe, and dwarfed by the 450-600 per thousand level common in Western countries. And, according to Faritov, half of that car fleet is older than 10 years and in urgent needing of replacement.

All this of course looks like great news for Avtovaz – only it isn’t. While Avtovaz initially capitalized on Russia’s rebound after 1998, boosting production substantially through 2001, subsequently its sales stagnated. Why?

The Russian market is simply outgrowing Avtovaz, say analysts. “The market structure has changed dramatically, and is continuing to change dramatically,” says Faritov. “The structure of demand has shifted away from cheap cars. The average car price is now $20,000 – twice that of 2002. Lada cannot capture this demand.”

Yakubov agrees. “Avtovaz is looking very vulnerable. Higher incomes in Russia combined with retail credit and car loans are paradoxically translating into lower sales for Russian-made passenger cars – and Avtovaz, in contrast to the other Russian automotive producers, is completely exposed to the passenger car market.”

According to Renaissance Capital, the largest price segment in value terms is now the premium car segment (over $40,000), amounting to $10.9bn, or 20%, of the total passenger car market. The value of the $20,000-plus market is now larger than that of the sub-$20,000 segment. The shift in market structure is exemplified by the shift from used-car imports to new imports as the main alternative to Russian production. The new imports segment has grown at almost 70% per year over the past five years, increasing to more than 61% of the total market in 2007, from 17% in 2001. In 2002, used-car imports formed the largest segment in value terms ($4.8bn), followed by Russian cars ($3.6bn) and new imports ($2.3bn). By 2007, the situation had reversed: new imports segment ($32.8bn) had become the leader, followed by Russian-made foreign brands ($7.62) and used imports ($4.9bn).

If this was not alarming enough for Avtovaz, a government programme to boost foreign-branded car production took off in 2002, causing foreign-branded production in Russia to rocket 24 times. By the end of 2007, there were nine plants either running or planned in Russia, with total investment at more than $3.7bn. Total foreign-brand production is slated to reach about 1.46m units per year by 2010.

In response to this flood, Avtovaz has taken its finger out – but only to stick it in the dyke: previous Soviet-era management under Vladimir Kadannikov mostly limited itself to upgrading existing models, laying a Western veneer over the Soviet soul. “Avtovaz basically has not produced a new model since the 1970s,” says CentreInvest’s Natalia Sorokina. “And if things go on like this, it’s future might well be just assembling components.”

Renault’s revolutionary sLogan: “cheap but not crap”

In the face of these changes that threaten to shunt Avtovaz’s “cheap and crap” cars to the scrapheap, what does Renault think it can change?

True, managerial guru Carlos Ghosn turned Nissan around spectacularly, but as he himself admits, Nissan was the complete opposite case to Avtovaz, being a company with solid engineering traditions whose costs had spiralled out of control during a domestic recession. The key to understanding Renault’s interest in Avtovaz is not Nissan, but Romania’s Dacia plant that Renault acquired in 1999 – and the Logan model launched there in 2004, of which 600,000 have already been sold. The new business model behind the Logan could be the lifeline Renault throws to Avtovaz.

The Boston Consulting Group highlighted the Logan in a report named, “Tapping into Central and Eastern Europe’s 200m Neglected Consumers.” Boston calculates that 200m of the region’s 350m people live on incomes above the poverty line and below median household income. Together they account for half the region’s disposable income, and conscientiously by multinationals – until Renault’s Logan came along.

Promoted as the €5,000 car, the Logan made car buyers of income groups that producers had not previously considered potential customers. In a region characterized by low levels of car penetration, the Logan significantly dropped the market entry level, creating a new class of low-earning car owners.

The secret of the Logan’s success is that, in contrast to Lada cars, it’s cheap, but not crap. The design has economized on electronics and soundproofing, making the ride and driving experience less comfortable, but not compromising reliability. Cutting out much of the electronics even boosts reliability and ease of servicing. The Logan is also better adapted to Eastern European roads, thanks to a high chassis, and its engine is adapted for poor quality fuel. Basically, the Logan cuts costs by cutting elements that are anyway dubious in the Eastern European context.

Costs are also kept down by low-tech assembly lines that demand little initial investment. The Romanian Dacia plant hardly uses robots, as the cars are pieced together largely by hand. Wages are low, but the workers of the former obsolete state-owned giant are happy that their jobs have been saved. This strategy is tailor-made for such obsolete socialist giants: because the margin on such a cheap model is so small, and investment to be kept minimal, the strategy demands pre-existing large production capacities, a pre-existing dense dealership network, and a pre-existing established “people’s car” brand. Dacia had all three of these – and Avtovaz all the more, boasting production capacity of 1m vehicles per year, a dealership chain stretching from Lvov to Vladivostok, and a brand that is folklore in Russia.

So what Renault offered Avtovaz was the managerial knowledge of how to create a Russian Logan at Avtovaz – and with it a whole new class of low-income car owners.
And in March 2008, the two sides agreed the appointment of four influential Renault top managers to Avtovaz: Yann Vincent, as managing director; Kristian Muller, as senior vice president and procurement manager; Hugh Demarchez, as vice president; and an unnamed financial control manager.

However, Renault will not just be providing philosophy lessons, but also supplying technology for implementation. As CEO Ghosn said in an interview with business daily Vedomosti in March: “Costs are not the main problem. Avtovaz’s main problem today is the medium-term and long-term attractiveness of its production line. The plant needs a new platform, engine and transmission. This is where we are ready to help. Our main task is to support the Lada brand and help it retain its leading role in Russia.”

The big secret is what Lada’s new budget car, planned to replace its Classic model in 2009 and the lynchpin of the strategy, is going to look like. Avtovaz CEO Boris Alyoshin let slip that it will have a Lada platform, but the power-train will probably be supplied by Renault. As such, the car will be distinguished from the Logan, of which a Moscow-based joint venture produces 70,000 a year, but have enough of Renault’s engineering to constitute a new word in quality for a Lada car. Alyoshin has said the details of Avtovaz’s new Renault-supported strategy will be finalized and made public in May or June. Only then will it become clear just how much influence Renault is going to exercise.

Analysts were mystified as to why Renault was ready to get involved when only a blocking stake was on offer. “I just don’t know why Renault bought a blocking stake that gives them so little influence,” says Faritov.

“Control was never an issue,” explains Sorokina. “It was always clear that Avtovaz would retain control; the issue was which European partner would be chosen.”

The answer may be that ROE’s crisis management at Avtovaz, which had taken the first long overdue steps towards controlling costs and initiated reshaping the ownership structure, was able to assure Renault of its commitment to reform. Immediately prior to the deal’s announcement in December, the ROE management’s political weight was upped a notch, with CEO Vladimir Artyakov being appointed governor of Samara region, and government heavyweight Boris Alyoshin, formerly head of the Federal Industry Agency, taking over himself as the new CEO at Avtovaz. This means that Avtovaz management has the authority to implement whatever strategy is decided upon – and if they buy into Renault’s strategy wholeheartedly, the chances of its successful implementation are good, even if Renault only has a minority stake.

However, one measure that Renault used to good effect at Dacia is unlikely to be replicated at Avtovaz – job shedding. “Avtovaz has a workforce of 104,000,” says Faritov, “and produces only twice the number of cars as Toyota does with a tenth of that number.” However, analysts are certain that no sweeping job cuts are on the cards. “Avtovaz basically employs all of Toliatti,” says Trusts’ Yakubov, “and now as a state-run company, the political costs of laying off large numbers of workers would be enormous.”

But there is a workaround solution that seems to be on Renault’s mind, and would leave everyone happy. “Sooner or later,” Ghosn told Vedomosti, “we will start using some of Avtovaz capacities for our own production.”

A risky undertaking? European insurers begin assault on Russia

Graham Stack for business new europe
With their advanced actuarial techniques enjoying huge demand in Russia as rapid growth leaves companies exposed to bigger and bigger risks, European insurance companies closed four major deals in 2007 in Russia – and opened up one bitter corporate dispute.

The shopping spree started in February, when globally-active Zurich Financial Services Group spent $260m to buy 66% in Russian retail leader NASTA. Only days later, German giant Allianz consolidated 97% of ROSNO by acquiring AFK Sistema’s 46.2% stake for $750m. In May, Allianz acquired 100% in Progres Garant for around $100m. The year ended on a high note with French major Axa buying 36.7% of RESO Garantia for around $1.2bn, a record evaluation for a Russian insurance company.

“I think there’s always been interest in the Russian market,” explains Alex Bertolotti of Standard & Poor’s about the breakthrough in 2007, “but once there was a big deal, which was between Zurich and Nasta, that opened the floodgates.”

Anastasia Voronkova of Fitch Ratings says the firms chose this year to move into Russia because of improved transparency in the sector as a result of efforts by the regulatory and supervisory bodies. “Then they saw high growth rates and also potential for future growth especially in the retail lines,” she says.

There is no mistaking the surge in the insurance sector. Against a backdrop of Russian GDP growth in 2007 of 8.1%, the highest figure since the turnaround year of 2000, the Russian insurance sector grew a whole lot faster than the economy: gross premiums written soared by 27% in the first nine months.

This growth has featured a major expansion of retail insurance, kick-started by the introduction of compulsory motor insurance in 2003, and by regulatory changes that put an end to the use of life insurance as a tax avoidance scheme, which cleared the way for life to start as a market segment with enormous untapped potential.

It is precisely the massive growth and potential of retail insurance that is attracting the attention of European majors. “They’re basically interested in retail, you can see in the companies they acquire they are focusing on retail lines, and in particularly motor insurance,” says Voronkova. “Foreign investors also demonstrate interest in the establishing of fully owned life insurance start-up subsidiaries, although this segment remains at a very early stage of development.”

“I think people are most interested in life, because there’s such huge untapped potential, with 144m people, relatively high incomes and very low penetration,” confirms Bertolotti.

Opinions differ as to whether 2008 will see similar deals. Voronkova believes “everyone is here who wants to be here,” but according to Bertolotti, “the trend will continue into 2008.”

Much-needed expertise

Foreign companies are not only attracted by growth, but by the problems that growth is causing for Russian companies – and to which they have the solutions.

The Russian insurance sector is young: only a few years ago did the sector begin to eradicate dodgy schemes and start to grow through real business. With the introduction of compulsory motor insurance in 2003, the companies had to establish new internal underwriting, claims handling, data processing and analytical procedures to cope with the sharply increased volume of contracts, information and staff, according to Fitch. Having established the infrastructure, the insurers are now challenged as to whether they understand the trends in underwriting performance and can forecast them.

This is where foreign companies have an advantage. “Russian companies need to improve everything, especially internal business procedures and loss ratios: they must use results of actuarial work more efficiently, detect sectors which drive loss ratios up, select risks more carefully using the results of actuarial reviews, which are more efficient in motor insurance,” says Voronkova.

“Foreign companies will deploy their marketing technologies, and also claims handling and analysis of loss trends with advanced actuarial techniques,” she says. “All these advanced techniques applied on western markets can be deployed on the Russian market to create a competitive advantage.”

S&P’s Bertolutti agrees. “The foreign companies will bring improved business practice, focusing on efficiency of claims processing, better underwriting techniques, and better use of actuarial techniques, because in Russian the actuarial profession is practically non-existent.”

Contemporary actuarial technologies are seen as the key to Russian companies coping with the risks of rapid growth, and in this area foreign companies are a universe ahead of even their biggest Russian rivals. “The workload of actuaries in Russian insurance companies is particularly intensive,” Fitch’s Voronkova says. “However, the role of actuaries seems to be generally underestimated.”

Voronkova argues that Russian companies tend not to employ actuaries in senior technical positions and thus fail to derive full benefit from actuarial skills.

Nevertheless, the sudden appearance of major European companies in the sector and the competitive threat they pose is causing Russian companies to step up their modernization. The clearest sign of this was the appointment on January 16 of top Dutch actuary Jacob Westerlaken as CEO of Rosgosstrakh, another of Russia’s largest insurance companies. “Rosgosstrakh hired Westerlaken because they did not wish to lag behind in terms of international technologies,” says Voronkova. “Of course Russian companies are trying to improve their business procedures, because with market growing and loss rations worsening, there’s no other way to manage underwriting profitability.”

Deripaska’s body-Czech

Against the rash of successful big deals, only an attempt by Italy’s Generali to acquire a stake in market leader Ingosstrakh via Czech private equity group PPF went badly awry. Majority shareholder, uber-oligarch Oleg Deripaska, appeared to resent the fact that his former partner Alexander Mamut sold his approximately 38.5% stake to the Czechs without asking him. In October, an EGM to which PPF was apparently not invited, unceremoniously diluted the stake to around 10% by a fourfold increase in equity.

The dispute remains unresolved. After a court decision in December ruled against the dilutions, the company charter was altered in January to restrict membership of the board to persons with Russian citizenship, experience in the insurance sector and with financial or economic training. The EGM scheduled now for March 3 will see if PPF will succeed in asserting their claim to three places out of nine on the board.

After a year of revolutionary changes in the insurance sector, it is perhaps reassuring that some risks remain the same.

Overtaking on the inside track: Israeli developers facelift Moscow – with a little help from their friend

One of Moscow’s best kept secrets is that Israeli developers are doing their bit to facelift the Russian capital and bring it into the 21st century. They benefit from their international experience, expertise and reputation, and from their Russian connections.

Israeli newspaper headlines erupted December 2007 with the news that high-profile tycoon and religious benefactor, Israel’s richest man Lev Leviev, was leaving Israel to set up house in London. Where upon the London headlines erupted with the news that another “Russian-Israeli” oligarch was on his way, and had just snapped up London’s most expensive house for $70m – and an Bombadier 5000 luxury executive jet for just a little less.

Speculation was rife as to the reasons for relocation – running from his distate of Ehud Olmert’s ‘appeasement’ of Palestinians to the popularity of London as tax haven.

However, the official reason given by Leviev’s real estate holding Africa Israel was that as of December 2007 Leviev had become chairman of the board of directors of AFI Development, Africa Israel’s Russian subsidiary, listed in London, and that he intended to focus his entrepreneurial efforts on the Russian market.

With some of Moscow’s most grandiose projects under way, and a total of $10bn in investment pledged, this argument was not only official, but also the most plausible: Lev Leviev deemed the potential of the Russian market so great, and his personal influence so vital to execution – that it demanded his hands-on attention.

‘Mr. Leviev regards Russia as being one of the main growth engines for Africa Israel,” confirms AFI corporate director Igor Solomon.

Building the 21st Century in Moscow

Russia is undergoing a real-estate revolution, with prices spiraling at double, and occasionally triple digit, figures per year. In 2006, Moscow residential real estate famously grew by over 100%. In commercial real estate, prices in 2007 leapt by over 50%, and in 2008 should grow at only slightly lower rates for all the global credit squeeze. Construction is booming everywhere you turn, but it is still decades away from meeting demand.

This is the backdrop to Israeli companies’ taking Moscow by storm.

Pride of place among their projects goes to AFI’s Moscow City Central Core, the space-ship like heart of Moscow’s futuristic “City”. This is Russia’s answer to London’s City: the country’s financial centre, where office space will accommodate around 144,000 work places. To get an idea of the scale, add an on-site metro station, high-speed rail links to two of Moscow’s three major airports, direct access to major traffic arteries, 300 retail outlets, a 6,000-seat concert hall, and an ice rink,. AFI’s stake in the project is valued at $1.2bn.

A close second is AFI’s Tverskaya Zastava development, at the top of prestigious Tverskaya Ulitsa, 3 km from the Kremlin, where AFI is basically redesigning an entire district in the heart of Moscow. The combined projects will incorporate both a built-from-scratch interchange at Moscow’s busiest intersection, Moscow’s largest underground shopping center and over 224,000 sq m of office, retail, hotel and residential space, with total value over $2.1bn.

Impressive as this is, AFI Development is only of four major Israeli developers at work in Moscow. Mirland, affiliate of Israel’s massive Fishman group, showed it can hold its own with AFI by securing the rights to built the aptly named ‘Skyscraper’, a 48-storey premium class office and retail tower in downtown Moscow, to be completed in 2011. The company’s 100% stake in the project is valued at $141m.

Israeli-run RGI International implement exclusive ultra high-end projects, such as the recently-completed Butikovsky office complex in the exclusive Ostozhenka district adjacent to the Kremlin, valued at $55m. They have just broken ground on a a similarly high-end retail development on Moscow’s famous Tsvetnoy Boulevard, with six floors of retail space valued at $141m.

RGI is also creating an ultra high-end residential development two kilometers from the Kremlin, aptly named Chelsea. Moscow’s Chelsea will be worth $528m – double the price Roman Abramovich payed for his.

Big boys in a small country

For a small country, Israel breeds big industrial groups. According to Ben-Gurion University professor Daniel Maman, around 12 business groups dominate the economy, among them Leviav’s group, Fishman and Gaidamak’s Ocif. Such big groups have in recent years being looking further afield – with great success.

“Israel is a very small place, and at some stage if you want to keep growing you need to get out,” agrees AFI Development’s corporate director Igor Solomon. “The other thing is that business in Israel is so competitive, so the big guys are simply very good at it. In Israel you’re playing for several basis points spread, so when you have the opportunity to enter a market with great returns, you certainly take it.”

According to Maman, the move by Israeli concerns to invest abroad is “a new phenomena, which started at the end of the 1990s and accelerated in the early 2000s. This development is the result of Israeli state policies – which by deregulation (changing the law, tax policy etc.) open the way for the big business and business groups to invest in other countries. Russia is only one example.”

Moreover, according to Maman, “most of the big Israeli business groups have real estate development components. Until the late 90s their real estate operation was mainly in Israel. Now its all over: US, Europe, East Europe, Asia etc.”

“It’s not just Russia and not just real estate,” says Solomon. “Israelis are very present in East European insurance, for example.”

And Russia, he says, is short of the world class development quality the Israelis bring, leveraging their parent company’s expertise.

The Israelis offer world-class quality and international experience: Africa Israel, AFI Development parent company, has over 70 years of multinational experience in development, construction and management of large real estate projects. The Mirland parent company Fishman group boasts over 20 years of experience in international real estate development, and a current portfolio of over 4 mln sq m, an estimated 80% of which is outside of Israel.

Aviv Ocif, acquired by Arkady Gaidamak for $200m in April 2007, which he intends to enter the top five Russian developers, is one of Israel’s oldest and largest development companies, specialized in advanced complex construction technologies and internationally active.

So, while these companies are newcomers in Russia, their backers are considerably more established than any Russian company. In comparison to them, as Brady Martin notes, many of Russia’s newly-floated development companies are “young” and “have limited operating histories overall and even less experience as public companies,” and are consequently facing “steep learning curves”.

The Russian connection

But it’s not just the need to grow outside Israel, and the booming Russian economy offering huge opportunities, that has induced Israeli developers to take the plunge. It’s hardly a coincidence that three of the four Israeli developers active in Russia today are Soviet émigrés.

“It’s the Russian connection,” explains AFI Development’s Igor Solomon.

The most high profile of these Russian Israelis is Lev Leviev.

“He’s easily the biggest benefactor of Jewish communities in the CIS,” says Solomon. “Two of our key success factors are AFI’s backing from the Israeli parent company – and Mr. Leviev’s contacts in Russia.”

Legends surround Lev Leviev, reputedly Israel’s richest man with a fortune of around $5bn. He emigrated from Soviet Uzbekistan to Israel as a 15 year old in 1971, went into the diamond business in the 1980s, and became a billionaire by breaking De Beers monopoly on marketing diamonds by sourcing raw gems in Africa.

A deeply religious man, Leviev perceived the collapse of the Soviet Union not so much as a chance to do business, as primarily to finance and support a large-scale revival of Jewish religious belief and culture on the territory of the CIS. He founded the Federation of Jewish Councils (FJC), an umbrella organization both providing financial support and Orthodox education to Jewish communities across the CIS, and lobbying on behalf of Russia’s Jews in the corridors of power.

The Moscow authorities in the 1990s were closer to another Jewish organization,  the Russian Jewish Congress, headed by media mogul NTV owner Vladimir Gusinsky, an ally of Moscow mayor Yury Luzhkov. N.B: Vladimir Resin, Moscow’s long-serving vice mayor who oversees Moscow’s entire real estate construction and development sector, was and is a member of the RJC’s presidium.

Lev Leviev seems to have initially had better links to the Kremlin, with Putin attending the opening of the FJC’s Moscow Community Centre in 2000. When Vladimir Gusinsky was imprisoned and exappropriated in 2001, subsequently fleeing to Israel, Leviev’s candidate Rabbi Berel Lazar replaced the RJC man Adolf Shaevich as Russia’s Chief Rabbi, apparently with the Kremlin’s backing.

However, to the extent that Moscow Mayor Yury Luzhkov became increasingly reconciled with the Putin administration, Leviev has seemingly managed to retain the favour of both the Kremlin and Moscow City Hall.

Arkady Gaidamak, owner of Israeli real estate giant Aviv Ocif, regarded as a controversial maverick and populist in Israel, has long been a prominent benefactor of Russian Jews. Gaidamak emigrated to Israel from the Soviet Union in the 1972 as a twenty year old for Israel, and then lived twenty years in France, with a variety of business interests, including partnership with Leviev in Angolan diamond dealing.

After the collapse of the Soviet Union, Gaidamak backed the Congress of Jewish Religious Organisations and Associations of Russia, a successor to the Soviet-era Jewish organization. Now he is its president.

In addition, since announcing his move into Russian real estate in August 2007, Gaidamak has publicly backed the Kremlin in Israel, facilitating in December 2007 the return of two Orthodox churches to Russian ownership, and discussing funding the construction of a new Russian Embassy in Tel Aviv.

Compared to Leviev and Gaidamak, Boris Kuzinets, owner and CEO of RGI International, keeps a low public profile, and focuses instead on personal contacts. Kuzinets emigrated for Israel from Latvia in 1971, but relocated to Russia in 1990, building up his development business from scratch as one of the first developers to build contemporary architecture in Moscow, according to Alfa’s Brady Martin.

Despite Kuzinets’ Moscow location, RGI Development, registered in Guernsey, is a recognizably Israeli company, with five of seven board members Israeli citizens, and the remaining two Americans.

Kuzinets now has a string of successfully completed high end residential development projects to his name. For all the Israeli background, his long experience in Russia makes him the ultimate insider, considered be “extremely well-connected,” in the words of Iskyan. Indeed, according to Alfa bank, the main risk connected with RGI International is the company’s overweening “reliance on a single person for sourcing projects”.

Playing Moscow Monopoly

Such connections are a vital resource when it comes to playing the game of “Moscow monopoly’. Moscow real estate, agrees AFI Development’s director Igor Solomon, is a “pretty much a closed shop,” and largely out of bounds to foreign companies – with the Israelis the exception that proves the rule.

“Nothing in the real estate market in Moscow happens without the mayor playing some role, so you can make the obvious logical jump,” says UralSib’s Kim Iskyan. “Any real estate deal in Moscow has the city as a partner. Either they have about a 30% stake or they get in on the deal in some other way.”

“Put it this way,” says Iskyan, “You and I can’t just tomorrow decide to go into high end residential development in Moscow and get anywhere at all.” According to UralSib research, “lack of transaction transparency is a defining characteristic of the Russian real estate market.”

Such opacity restricts competition, meaning returns to those operating on the market are higher. As Renaissance Capital’s Alexei Yazykov says, this is hardly a great surprise when one of Moscow’s major construction companies, Inteko, is owned by the mayor’s billionaire wife, enjoying 20% Moscow market share, and another major player, Sistema Hals, also has, according to Alfa bank “strong connections with Moscow government both at the parent company level and through multiple infrastructure projects completed for the City of Moscow.”

The city government’s pervasive involvement in real estate is institutionally secured by the refusal to privatize land – a political victory won by Moscow mayor Yury Luzhkov over Kremlin reformers in the mid-1990s that has shaped the Moscow political economy ever since. The city makes land available only on long-term lease – meaning that every real estate deal is dependent on the goodwill of the authorities, and the city uses its bargaining power to the full

“They’ve had connections that have served them well,” says Iskyan of the Israeli companies. “It takes time to build these up. There’s certainly links to city hall, I wouldn’t want to speculate on their exact nature. These things you only see in the results. You and I can’t just tomorrow decide to go into high end development in Moscow and get anywhere at all. So the fact that these guys have, says something about their connections.”

AFI Development’s public relations manager Vladimir Rosin, says simply of Lev Leviev that “he’ s quite influentional in Russia and familiar with the Russian president, and has good relations to the Mayor of Moscow. Indeed, the Mayor of Moscow is very aware of Mr Leviev, and they met this year, several times throughout the year.”

Leviev’s personality seem important enough to the company for a sharp drop in AFI post-IPO share price to prompt him to take over in London.

“He wanted to pay more attention and participate in terms of more control more closely,” says Rosin. “Externally I think it’s a very positive and strong sign for the investment community and real estate players,” says Solomon. “But it won’t of course be a change for us internally because Mr Leviev was very closely involved in the activities of company since its inception.”

Surviving the credit crunch

If good connections in Moscow help Israeli companies get a foot in the door where other foreign companies stay outside, then the Israeli connection provides an advantage over Russian companies in times of financial turbulence.

“It should be an advantage for them having access to the Israeli market, since the yield will be more attractive. Where the parent companies are Israeli, it opens up other channels in terms of financing,” says Alfa’s Brady Martin.
This argument seemed to be borne out in November, when, with markets reeling under subprime fall out, and debt financing tightening in Russia, RGI International still successfully placed an approx 128m shekel bond ($32m) in Israel.

Renaissance Capital’s Alexei Yazykov points out, that, in the case of AFI Development, should things turn really nasty, the Israeli connection will provide “the potential to tap emergency financing should unforeseen events prevent AFI Development from funding its projects through more traditional sources of capital. We feel the financing potential is a real benefit.”

AFI’s Igor Solomon agrees that the company is relatively secure in terms of funding: “of course the market has become quite tight, but we have negotiated and secured a major project finance for our Tverskaya scheme in August and we are negotiating further funding for our biggest schemes on a project basis, and it seems quite promising that we will get the financing at reasonable terms. Being a globally diversified company helps in terms of access and experience.”

“We’re just normal people”

The larger than life Russian-Israeli trio of AFI Development, RGI International and Arkady Gaidamak’s Ocif are focused almost exclusively on the giant Moscow market – and thus dependent on good relations with City Hall.

The odd one out among Israeli developers in Russia is Mirland, subsidiary of the Fishman holding, one of the largest Israeli business groups. The Fishman family have no sort of “family connections” to Russia.

As a result, their strategy in Russia differs significantly from the Russian-Israeli developers. 49% of portfolio value comes from projects outside Moscow, and the company aims in the future as well to keep the Moscow / regions balance at 50 / 50. Moreover, their business in Moscow is dominated by one single massive project – the Skyscraper – mentioned above, compared with dozens of projects spread through the regions.

Mirland also stand out among Russian developers in five of the nine directors being independent, ‘a rare exception’ according to Alfa’s Brady Martin.

“If at one end of the spectrum there’s insiders like Sistema Hals,” says Kim Iskyan, “who basically can say we know everyone, then at the other end of the spectrum, if there’s no one who says we don’t know anyone, but a company might say ‘we’re just normal people trying to get the job done’, then Mirland are closer to that end of the spectrum.”

“Of course,” he continues, “they’re not going to say we don’t know people, because you can’t get anywhere without knowing people, but they are not flashy about it and they don’t brag about it. They say ‘there are the rules, and we try to play by the rules.’”

“This explains their regional approach,” says Iskyan. “It’s much easier to do this in the regions, where you are dealing with regional administrations who are not spoiled for choice, they don’t have lines at their door wanting to invest, and therefore they facilitate investment, rather than repelling it by demanding 30% stakes and whatever else.”

Mirland has successfully pioneered this approach in Russian real estate development. However, when the Fishman Group tried to replicate their “we’re normal people” approach in another business direction, they very quickly and very publicly found themselves in major difficulties.

In 2007, Tamir Fishman Venture Capital in partnership with the European Bank of Reconstruction and Development submitted a bid for venture financing from Russia’s new state-backed venture investment fund. Their minority Russian partner was a certain Oleg Shvartsman, head of Finantsgroup, who had originally proposed the idea to Fishman.

The whole world now knows that, in early December 2007, Shvartsman proved to have been a poor choice as business partner, and Mirland were exposed as looking very foolish in the Russian context.

Shvartsman, a hitherto unknown financiere and amateur poet, became famous overnight when Russian business daily Kommersant published an interview he had given on the sidelines of a technology conference in Paolo Alto.

In the interview he claimed to act on behalf of the Kremlin in employing a whole arsenal of extra-legal means to pressure companies into “voluntary deprivatisation”. In this capacity, according to Shvartsman’s detailed and plausible account, he answered directly to Igor Sechin, presidential aide and the alleged leader of the much-feared ‘silovilki’, the Kremlin hardline faction. A collective shiver ran down the backs of Russia watchers and company directors, as his account chimed true with what many had long suspected.

On the scandal breaking, Tamir Fishman and EBRD pulled out of the venture capital deal with egg on their faces.

Elmad Fishman, who runs the venture capital side of the business, could only comment ruefully afterwards to the press that: “Russia is complicated – and it’s very important to choose the right people.”

Lev Leviev no doubt agrees.