Page 116 - IFR Opportunities in Russian capital markets

CHAPTER MERGERSANDACQUISITIONS 07 Background
Russia's 1998 financial crisis turned into the biggest buying opportunity that Russia's leading businessmen have ever enjoyed. While foreign investors had fled the country en masse, it only took a year for Russia's richest businessmen to see that assets were massively undervalued and they ventured back into the market.
There are tales of businessmen picking up entire factories for as little as US$60,000, but oligarch Roman Abramovich got the ball rolling following his purchase of the PAZ bus factory in 1999. What was unusual about this deal was not the low price he paid for one of the biggest producers of buses in the country, but that rather than pulling government strings to fix a privatisation auction, the preferred method of privatisation in the 1990s, he simply bought the shares on
the open market.
Over the next two years, businessmen started snapping up companies in what turned into a wave of acquisitions. By 2002, fuelled by recovering oil prices, it was clear that Russia's economy was rebounding strongly from its nadir and the nature of these deals began to change as businessmen started building up integrated nationwide companies to compete in the various sectors.
By around 2004, these emerging conglomerates were starting to compete head-to-head as the leading rivals in each sector started to do battle for market share. At the same time, valuations had risen so high that oligarchs started weeding out their non-core assets and cashing in on the huge gains they had made over the previous five years. There were plenty of willing buyers, as other firms looked to add production facilities to their growing businesses.
At the start of this decade Russia's economy could be described as a ‘Soviet sandwich’ – the two bread and butter sectors earning most of the money were oil and gas at the top of the economy and food processing at the bottom. The middle was characterised as a pink greasy sausage of unreformed Soviet-era industry.
Russia’s privatisation turned every single factory, shop and warehouse into an individual company like so many pieces of Lego. After six years of strong growth, sectors are beginning to consolidate as the strongest companies buy out their less ambitious peers. Sectors such as meat- packing are still at the beginning of this process; others, such as steel, are already almost completely in the hands of half-a-dozen rival conglomerates.
Today, this process of consolidation is still going on. The bread and butter sectors have expanded in size and range, but the big change is that throughout the sausage in the middle there are seeds of growth as the leading companies have become profitable. In some sectors several companies have emerged as leaders and are starting to battle for customers. In others, the sector is dominated by a single company that is snapping up all the smaller ones. And in a very few sectors, such as steel, the sector has progressed to the point where the conglomerates are beginning to merge as they move out to compete on the global markets as true multinationals.
Sector changes in M&A
All in all, the Soviet sandwich has become a lot more appetising and this change is being driven by the frenetic pace of mergers and acquisitions (M&A). Below are some sketches of a few representative sectors.
Steel
Around six companies emerged from the chaos of the 1990s to lead the steel sector and built up vertically integrated companies, producing everything from coal through ore to specialist steels. The steel sector has been one of the first in Russia to move overseas, as the leading companies began to buy assets abroad (see Table 7.1). In 2006, the steel sector attempted to become the first Russian industry to integrate into the global economy with a merger between Alexei Mordashov's Severstal Steel and the European producer Arcelor, which ultimately failed.
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