catalyst russia country report 2012

“Many people seem unawarethat Russia is the world’ssixth largest economy andthat unlike some BRICcountries, Russia is an openmarket in which both largeand small foreigncorporations have madea lot of money in thelast 20 years”Mark Bond, Managing partner,NorthStar Corporate Finance

Russia is now a strategically important market for foreigncompanies. As the world’s sixth largest economy withgrowth amongst the fastest globally and now accessionto the WTO, opportunities across a range of sectors aresignificant. This will lead to rising levels of M&A.

The key observations from our research:

The Government is introducing a range of legislative and regulatoryreforms to build on its position as the sixth largest economy. These areaimed at attracting foreign companies, increasing economic growth anddiversifying the economy away from natural resources.

The opportunities in Russia are broader than just oil. Over US$1 trillionis being invested in upgrading infrastructure and US$24 billion invested inpreparation for the 2014 Winter Olympics and 2018 Football World Cup.

Russian consumers have the highest disposable income and fastestgrowth in consumer spending of all the BRIC economies. With almostthree-quarters of the population living in urban areas, foreign companieshave been investing in Russia both through acquisitions and directly tobenefit from rising demand for domestic and foreign-branded goods.

The most successful foreign companies are those who are locatingproduction and distribution in Russia, often using M&A and joint ventures.We believe this strategy will be used by more companies looking to takeadvantage of Russia’s economic growth.

M&A to increase as companies capitalise onRussia’s growth

Country Report - RussiaM&A update

Autumn 2012

CatalystCorporateFinanceLLP2012

President Putinencouraging foreignprivate investmentOver the past ten years the Russianeconomy has undergone a significanttransformation to become the sixthlargest economy globally (purchasingpower parity basis).

Real GDP grew by 4.2% in 2011compared to global and EuropeanGDP growth rates of 2.7% and 1.5%respectively. Figure 1 illustrates Russia’srapid move up the GDP rankings.

Russia has almost no sovereign debt,large foreign exchange reserves,moderating inflation rates (currently5%-6%), a strong labour market(unemployment is currently around6%), consumption growth and apositive balance of trade. An increase inthe oil price has benefited the balanceof trade which has been positive sincethe early 2000s.

The size of Russia’s economy, itsgeographical scale, high level of GDP anddisposable income per capita relative to itslargely undeveloped manufacturing andservice sectors means there is a focus on

investment-led growth. President Putin hasstated publicly that he wants investment inRussia to increase from 20% to 27% ofGDP by 2018. The initiatives designed toachieve this goal represent opportunitiesfor foreign companies.

Four-year privatisation plan whichmay include strategic sectors of theeconomy. Large foreign strategicinvestors will be allowed to participatein these privatisations.

Raising Russia’s ranking from 120th(of 183 countries) to 20th by 2020 in theWorld Bank’s “Ease of Doing Business”index. Roadmaps for three problematicareas – access to power grids,construction regulation and customsprocedures – have already beencreated.

US$1 trillion investment in infrastructureuntil 2020. Public and privatepartnerships (PPP) are regarded asone of the most efficient instrumentsprospectively in funding projects. Thegovernment is actively looking to bringforeign investment to Russianinfrastructure to develop roads,rail, airports and utilities.

Full membership of the WTO (ratifiedin August 2012) which will dismantleforeign trade barriers and reduce tariffs.This will help attract more foreign capitalto Russia, boost trade and investment,promote industrial reform andaccelerate the formation of atransparent and open marketenvironment (see page 4).

Low debt and healthytrade surpluses

supporting financialstability

US$1 trillioninfrastructure

investment by 2020

£4

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$12

$14

$10

$8

$6

$16

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3.0%4.2% 2.7% 0.7% 1.7% 0.4%

-0.7%6.9%

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2011 GDP growth amongst highestof leading economies

Figure 1: Russia is now the world'ssixth largest economy by GDP (PPP)

Source: World Bank

“It is imperative that weincrease investment by2018 to 27% of GDP.By 2020, Russia must beamong the top 20 nationswith the most comfortablebusiness climate”President Vladimir Putin,

St. Petersburg International Economic Forum, June 2012

2

Country Report - Russia M&A update


Russia set to becomeEurope’s largest auto

market in 2012

German companiesvery successful in

Russia

Distinguishingopportunities frommythsThere are several myths associatedwith doing business in Russia whichwe examine below.

Myth 1: The opportunities in Russiarest on oil

As the world’s largest oil producer,much attention has been focused on theopportunities for foreign companies to gainaccess to Russia’s exploration andproduction supply chain. However, there aremany other sectors which are developingquickly and have attractive growthopportunities.

Russia’s automotive market is thesecond largest in Europe after Germanywith over 2.6 million new cars sold in2011. With light vehicle density at just250 cars per 1,000 people compared to643 in the US, the potential for growthis significant. As shown in Figure 2, arange of foreign manufacturers havemeaningful market share. In 2011,locally-produced foreign brandsincluding Ford, Renault and VWdominated car sales (40%).

Upgrading infrastructure is a top priorityand Russia is actively encouraginginvolvement from foreign companies.For example, BombardierTransportation has signed co-operationagreements with Russian railmanufacturer Uralvagonzavod to jointlydevelop and sell metros and trams,establish local production facilitiesand transfer Bombardier technology.

Russia is hosting the 2014 WinterOlympics and 2018 Football World Cup.Some US$24 billion is being invested ininfrastructure including the constructionof new motorways, railways and touristfacilities, and the construction andreconstruction of football stadia in13 Russian cities.

Three-quarters of aircraft in Russia arecurrently foreign-made. While Russia isbuilding its own fleet of aircraft, strongair passenger growth (13% 2010-2011)means that partnerships with leadingforeign companies continue to be vital.Boeing for example, has a productionjoint venture with Russian Technologies,Ural Boeing Manufacturing, throughwhich it procures titanium parts forthe 787 Dreamliner.

Myth 2: Foreign companies can’tmake money in Russia

The performance record of foreigncompanies in Russia is evidence thatsuccess is achievable and meaningful.For example, E.ON Russia, the electricityproducing arm of the German utilityprovider, reported 2011 profits ofUS$495 million.

German companies have been particularlysuccessful (see figure 3). They view Russiaas a strategic market and have investedprogressively over a number of years.Companies typically invest in phases,building on proven demand for theirproducts and then combining plantinvestment with strong commitments totraining staff and developing sophisticatedlogistics systems to support componentimports and local distribution.

5%

20%

15%

10%

25%

0%

Lada

Chev

rolet

Hyun

dai

Rena

ult KIA

Niss

anTo

yota

Ford

Daew

oo Gaz

VW

Figure 2: Foreign brands accountedfor 72% of passenger car sales in2011

Source: Ernst & Young, AEB,Otkritie Capital Research 3



Automobiles,manufactured goods

and telecoms tobenefit from WTO

membership

Myth 3: The Russian economy istoo volatile

The government has established two fundsto reduce the impact of volatile oil and gasexport earnings on the economy. TheUS$60.5 billion Reserve Fund, built on oiland natural gas revenues, ensures thefinancing of federal budget expenses inthe case that oil and gas budget revenuesdecline. The US$85.6 billion NationalWelfare Fund, used to support the pensionsystem, has the ability to lend money toRussian banks and can be used to absorbexcessive liquidity.

Membership of the WTO should help tocreate a diversified economy. This bindsRussia to a series of trade rules andcommitments which should create a moretransparent and predictable environment forbusiness. Sectors that will benefit fromWTO membership include:

Automobiles. WTO membership willhalve car import duties to 15% by 2019.Import duties for trucks will fall from

25% to 5% by 2018. This will increasedemand for foreign cars which thegovernment will attempt to control viarecycling fees and by supporting thelocalisation of production for foreignbrands and the creation of joint ventureswith foreign producers. For example,the Russian automotive group Sollers’partnerships with Ford, Mazda andSsangYong.

Manufactured goods. A generalreduction in tariffs with the averagefalling from 10% to 7.8%. Russia hascommitted to join the informationtechnology agreement which providesfor duty free treatment of relevant goods(e.g. computers) within three years.

Telecoms. Increased market accessto the telecoms sector with a currentforeign equity ownership limitation of49% being phased out over four yearsfrom accession. Russia has agreedto abide by the WTO’s basictelecommunications agreement aimedat promoting fairness and competition.

Sector Company Approach

Automobiles Volkswagen Locally-based manufacturing in Kaluga.

Significant investment training mechanical and auto-mechanical engineers partly by apprenticeshipsat its Kaluga plant.

Currently 4% market share in Russia.

Consumer goods BSH Bosch and Siemenshousehold appliances

Locally-based manufacturing capability for washing machines, freezers, refrigerators near St. Petersburg.

Established logistics center.

Acquired 25% stake in Power Machines in 2006.

Industrials HeidelbergCement €600 million investment in a state-of-the art cement factory in Tula region, TulaCement.

The company will be the only local cement producer supplying high-strength cement types to thelocal Moscow regional market, which represents 85% of TulaCement sales. TulaCement willbenefit from the upcoming expansion of greater Moscow.

Industrials Schott Two manufacturing sites based near Nizhny Novgorod, a centre for the pharmaceutical industry in Russia,producing 590 million ampules and bottles annually for the country’s pharmaceutical industry.

Figure 3: German companies are making a significantcommitment to Russia

4



The rise of theRussian consumerSubstantially increased earnings andlow income tax have boosted spendingpower in Russia’s underpenetratedconsumer market. Russian consumershave the highest disposable incomeand fastest spending growth of allBRIC markets (see figure 4).

Unbranded goods dominate totalconsumption at low levels of householdincome and for essential goods andservices. However, as income starts torise, the preference for branded goodsincreases and at affluent levels,premium brands attract greatermarket share (see figure 5).

Foreign brands and companiesincluding BMW, Nivea, Adidas, andSony are taking advantage of thegrowth potential for internationalbrands in the discretionary space.

Global consumercompanies using

M&A to tap growth inconsumer spending

“We believe in Russia’s hugelong-term potential, that’swhy we continue with Nestléinvestments into thedevelopment of localproduction facilities.”Stefan De Loecker, Chief executive officer ofNestlé Rossiya.

Source: “Nestlé to Create a Greenfield Factory inVladimir Region,” Nestle press release, 15 June, 2010,www.nestle.com

Russia China India Brazil

% of households earning >$2,000 per month

Average growth in consumer spending 2000-2010

25%

21%19%

13%12%

10%

19%

10%

Figure 4: Russia has the highest proportion of high income households and fastest rate ofconsumer spending in the BRICs

5Source: World Bank and Credit Suisse Emerging Consumer Survey 2012



Foreign companiesattracted to

well-positionedlocal brands

Stable demand for locally-brandedessential goods and services across theincome curve is driving acquisitionactivity by foreign companies. PepsiCo’s2010 acquisition of Wimm-Bill-Danngave the company ownership of twoleading dairy brands. PepsiCo’sproducts are now sold in 98% of retailoutlets across Russia. Nestle has beenlinked to the potential acquisition ofRussian baby-food and juice producerProgress, having already madeacquisitions in Russia (for example,Ruzskaya Confectionary Factory).

Foreign companies are looking forlocal brands with a strong marketposition, growth potential andpositioned to take advantage of the shiftfrom unbranded to branded products.For example, Russia accounts forabout 40 per cent of Carlsberg’ssales. The brewer is close to finishinga US$1.2 billion purchase of minoritystakes in its local subsidiary, Baltika,

with total investment in the countryadding up to more than US$12 billionin the past two decades.

10%

40%

50%

30%

20%

60%

0%Dairy:

Domik vDerevne(PepsiCo)

Autos:Lada

(Renault)

Cosmetics:Nivea

(Beiersdorf)

Sportswear:adidas

TV:Sony

Fashion:Zara

(Industria deDiseno Textil

% penetration at lower income% penetration at higher income

Figure 5: Brand market penetrationaccording to income group

Source: Credit Suisse Emerging ConsumerSurvey 2012

Sporting success for AdidasAdidas, the world’s second largestsporting goods manufacturer,expects the Russia/CIS region tobecome its third largest marketglobally behind the United Statesand China with annual sales ofover US$1.3 billion by 2013. Salesare expected to increase by adouble-digit average growthrate annually to 2015.

Adidas is the market leader for sportinggoods in Russia/CIS with over 700

corporately owned stores and 13,000employees (Nike currently has around100 stores in Russia). The company hasits head office and distribution center inMoscow, and regional offices in sevenRussian cities. Adidas brands Reebok andRockport also have their own chain ofstores in Ukraine and Kazakhstan. Adidasaims to have 1,200 stores by 2015.

Source: “Adidas Group sales in Russia/CIS toexceed €1 billion by 2013 and grow double-digityearly till 2015,” Adidas press release, 10 October,2011, www.adidas-group.com

6



A perspective onM&A trends in RussiaNorthStar is Catalyst’s partner inRussia. Mark Bond, NorthStar’sChairman and Managing Partner, andNick van den Brul, Partner, have over 50years’ combined experience working inRussia. They discuss M&A trends andshare their insights about how foreigncompanies should approach Russia.

How would you describe theM&A market in Russia?

Nick van den Brul: There hasbeen a significant increase ininbound and outbound M&Aenquiries this year. As Russianbusinesses mature we are

seeing a shift away from new greenfieldinvestments to acquisitions of fully-fledgedbusinesses, such as PepsiCo’s purchase ofthe Wimm-Bill-Dann food producers andUnilever’s acquisition of Concern Kalina.

Mark Bond: Interest inRussia’s large consumermarket is driving a lot of theactivity. We expect continuedinterest in acquiring businesses

serving Russian consumers and generaladd-on acquisitions by companies whichalready have a local presence. It issurprising that there is not more interest inthe mining sector given the recent positivechanges in legislation regarding the biddingfor licences.

How should foreigncompanies approach Russia?

Nick van den Brul: Working with a goodpartner is vital. High profile corporate activitysuch as TNK-BP, an example of a 2003 jointventure that has resulted in widely reportedshareholder conflict, can put off foreigncompanies who do not yet have a footholdin Russia.

A suitable partner will ensure the investorretains control of investment and operatingdecisions. The many German companiesinvesting in Russia are good at this as theytake a long view, even if they are eventuallysurprised by the size and quickness of thereturns. The recent Carlsberg bid for theminority stakes in its Baltika beer business,which has a 38% market share in Russiaand accounts for 40% of Carlsberg’sglobal sales, shows how this can pay off.All successful investments have beenstructured this way whether by purchaseof the operating company or by acquisitionof the assets.

Interest in Russia’slarge consumermarket is driving

activity

Working with asuitable partner

is vital

10%

40%

60%

50%

70%

30%

20%

80%

0%

Domestic Inbound Outbound

2010 2011

Figure 6: Domestic activity currentlydominates M&A but inbound andoutbound activity is increasing

Source: Catalyst Corporate Finance

7



What should companies beaware of when transactinga deal with a Russiancompany?

Nick van den Brul: Rigorous duediligence to check whether a potentialpartner has a disreputable background isvital. Fundamental due diligence on criticalareas such as asset title, potential taxexposure or outstanding or potentiallitigation should also be conducted. Theabsence of GAAP or IFRS accountingstandards (apart from in the financial sector)means that a proper view of the operatingsituation can only be achieved through adetailed review of the managementaccounts. This can mean longer transactiontimetables. It is helpful that Russian sellersare open to the use of English law in M&Atransactions and to the use of offshoreacquisition vehicles.

Mark Bond: Strong personal relationshipsare important. As with other emergingeconomies, it’s important to buildrelationships with local administrative

officials and politicians. Also, the increasingnumber of Russians who go to Europeanand American business schools means thatmany managers are now willing to look atWestern corporate incentive arrangements,including share option schemes.

What are the typical marketentry strategies used bycompanies?

Nick van den Brul: The auto market is agood example of how companies can worksuccessfully in Russia – imports initially, thencomponent manufacture followed by thedevelopment of sophisticated logisticalsystems. German companies have beenpresent in this sector and logisticscompanies such as DHL and Rhenushave followed them. The infrastructure forsuccessful business operations is gettingbetter every year.

Rigorous duediligence is critical

Case study: GRUMA’s acquisition of Solntse MexicoIn July 2011, NorthStar advised Solntse Mexico,Russia’s leading tortilla manufacturer, on its saleto Mexican tortilla producer GRUMA. Founded in1949, GRUMA is one of the world's leading tortillaand corn flour producers and owner of the brandMission Foods. The company has operations in theUS, Mexico, Venezuela, Central America, Europe,Asia and Australia and exports to 105 countries.GRUMA has approximately 20,000 employeesand 96 plants.

Reason for acquisition

Over two thirds of GRUMA’s sales come from its non-Mexican operations. Solntse Mexico introduced tortillasand corn chips to the Russian market and grew tobecome the market leader with net sales in 2010 of

US$9 million. The acquisition gave GRUMA entry intoRussia. GRUMA had a presence only through exportsprior to the acquisition.

How the deal was transacted

The deal involved multiple jurisdictions, cultural and timedifferences. The Mexican management of GRUMA dealtthrough their American subsidiary based in Texas,USA, the legal jurisdiction was the law of Englandand Wales with the legal firm based in London, whileSolntse had its holding structure in the British VirginIslands andon-the-groundoperations inRussia.

8



What types of companies areRussian investors acquiring?

Mark Bond: There is a strong interest inbuying companies in natural resources andmanufacturing. This is being driven by thedesire to increase market access andgain operating synergies, acquire tradingoperations, and to acquire newtechnologies. For example, the Russiangroup Digital Sky Technologies acquiredstakes in a number of high-profile UStechnology companies (Facebook, Zynga).TNK-BP made a hinterland acquisitionbuying Vik Oil in Ukraine and has madeother acquisitions internationally. Sberbankacquired Troika Dialog in Russia and hasalso acquired a bank in Turkey, Deniz Bank.

How is private equityapproaching Russia?

Mark Bond: Private equity firms operatingin Russia add a useful dimension since, likethe Russian partners and entrepreneurs,they are interested at the outset in a clearroute to potential exit. Many Russiancompanies lack financial sophistication andthis means that constructing exit strategiesin order to avoid a potentially costly disputeis a key part of any investment.

There is now around US$5 billion of foreignprivate equity funds dedicated toinvestment in Russia, as well as the largeamount of investment by Russian-ownedfunds. For large deals involving a foreigninvestor where the investment is greaterthan US$100 million, the Russian DirectInvestment Fund (RDIF), established bythe Government in 2011, is a very helpfuldevelopment. We have already seen a jointventure announced between the RDIF,BlackRock, Goldman Sachs and Templetonto invest in leading Russian companiespreparing for IPOs in Moscow.

Russian companieslooking overseas to

acquire newtechnology

US$5 billion offoreign private equityfunds are invested

in Russia

“80% of our business growthis going to come from high-growth areas identified asBRICs. Our footprint willcorrelate with the ring ofgrowth in various placesaround the world, providingthey have good openmarkets.”Lloyd Blankfein, Goldman Sachs chief executive

St. Petersburg International Economic Forum, June 2012

9



Figure 7: Selected recent M&A transactionsDate Target Company Country Target Activities Acquirer Country Deal Value

(US$m)Deal Type

Jun-12 Stream LLC Russia Digital contentdelivery services

Sistema JSFC Russia 15 Domestic

May-12 DenizbankAnonim Sirketi

Turkey Turkish bank owned by Franca-Belgian Dexia

Sberbank Russia 3,542 Outbound

Apr-12 OOO BAW-RusMotor Corporation

Russia Manufactures SUVs,minivans

Beijing AutomobileWorks

China ND Inbound

Mar-12 Open Joint-StockCompany EnelOGK-5

Russia Engages in thegeneration and wholesaleof electricpower and heat

Rusenergo Fund/Russian DirectInvestment Fund

Russia 750 FinancialAcquisition

Mar-12 Natur ProduktInternational,JSC

Russia Over-the-counterdrugs, generics,and food supplements

Valent Pharmaceuticals Canada 185 Inbound

Feb-12 JSC Tascom Russia Wireless broadband service

Moscow City TelephoneNetwork

Russia 55 Domestic

Jan-12 Facebook,Twitter,Zynga

USA Various US basedleading onlinecompanies

Digital Sky Technologies Russia N/A Outbound

Dec-11 Concern Kalina Russia Russia's largestpersonalcare company

Unilever UK/Netherlands

694 Inbound

Nov-11 RTS Russia Merger of two Russianstock exchanges

Micex Russia N/A Domestic

Oct-11 Plastic Logic UK Develops andcommercialises plastic electronics

RUSNANO Russia 150 Outbound

Aug-11 Lenta Russia Chain of supermarkets TPG Capital USA 1,100 FinancialAcquisition

Mar-11 Novatek Russia 12% stake in Russia’ssecond-biggestnatural-gas producer

Total SA France 4,000 Inbound

Feb-11 Wimm-Bill-DannFoods OJSC.

Russia Produces dairyproducts, juices,mineral water andbaby food

PepsiCo Inc USA 1,356 Inbound

Oct-10 SevenTV Russia General entertainmenttelevision channel

Walt Disney Co. USA 300 Inbound

Jan-10 Vik Oil Ukraine Fuel stations and oildepots in the Ukraine

TNK-BP Russia/UK 302 Outbound

Source: Catalyst Corporate Finance

10



Positive outlookfor M&A

Prospects for M&AGiven the long-term drivers discussedabove, we expect to see a rise in M&Aover the next 18 months.

While the State retains overall controlof strategic sectors including oil andgas (above a certain size), thedefence industry and certain areas ininfrastructure such as railways, thereare many opportunities to invest inconsumer industries, manufacturing,infrastructure and many areas ofnatural resources, such as coal,gold and other metals.

Given the strong outlook for localbrands in essential goods and services,foreign companies will acquire localbrands.

Legislative reform such as the ThirdAnti-Monopoly Package and generalchanges to civil legislation should allimprove deal making conditions andencourage inbound M&A.

WTO membership will prompt domesticconsolidation in certain sectors,especially in telecommunications,insurance and other financial services,while legislative and regulatory initiativesshould encourage inbound M&A.

Further investment and acquisitionactivity by private equity, especiallyby those companies already activein Russia.

Catalyst and our partner firm NorthStar work with companies, ownersand entrepreneurs looking to access the fast-growing Russian market.In particular, we offer:

Acquisition search assignmentsAdvice on structuring and completing dealsInformation on sector trends and valuationsAccess to corporate decision-makers and owners

NorthStar’s senior advisers have dedicated their careers to Russia and Central Europeand have significant experience in completing deals.

Find out more

11


CatalystCorporateFinanceLLP2012Contact Mark Wilson,Partner, Catalyst Corporate Finance +44 (0) 20 7881 2960

Award-winning international corporate finance advice

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www.catalystcf.co.uk

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catalyst russia country report 2012

Documents

trillionthat russia

successful foreign companies

foreign companiesmarket

open growth

consumption growth

european gdp growth

foreignbranded goods

sixthlargest economy