Private equity: Fund hopes pinned on expert names

Financial Times, By Courtney Weaver, 03.10.2011
It is mid-September and Kirill Dmitriev, the head of Russia’s newly created $10bn direct investment fund, is in the middle of a whirlwind stay in Moscow.

Within two days, the private equity veteran will be off to Sochi to hear Prime Minister Vladimir Putin announce that Leon Black of Apollo and the heads of the Korean Investment Corporation and CIC, a Chinese sovereign wealth fund, will be among the names leading the fund’s international advisory board.

One week later, he is heading to New York to meet 20 leading US fund managers, including Stephen Schwarzman of Blackstone Group. Mr Dmitriev is anxious to cement support from the international private equity community as the fund prepares to unveil a first raft of deals barely a year after its inception.

Within the next six months, the fund will finalise a $100m-plus deal to invest, with a leading UK fund, in the Russian healthcare sector. “The idea is to merge their expertise and understanding of how to manage hospitals with this opportunity in Russia where we can create a national leader in private healthcare,” Mr Dmitriev says. The fund will also be starting a strategic partnership with a leading European pharmaceuticals group, which wants to begin local production in Russia. Separately, it will be making a significant agreement with one of the leading sovereign wealth funds, Mr Dmitriev says, declining to give details.

“Our goal is to do two to three good transactions in the next six months, basically highlighting our investment approach which is to not invest so much in [natural] resources … but in market leaders, in growing industries, and infrastructure that allow us to generate good returns with a very limited downside,” Mr Dmitriev says. While western private equity groups have generally shied away from Russia, given the risks associated with the market, the Kremlin is hoping it can gradually coax them in with the help of the iPad-wielding, Harvard and Stanford-educated Mr Dmitriev, who provides a friendlier, English-speaking face to the fund.

One of the fund’s founding principles is that it can only invest in projects that receive at least equal support from investors. The minimum sized deal it is allowed to do would be $100m – with $50m from the fund and $50m from co-investors. The maximum amount the fund itself is allowed to invest is $500m, however co-investors could bring the deal to more than $1bn by putting up even more.

So far, the fund is focusing on under-developed markets such as healthcare – where the biggest operator has just a 3 per cent market share – and pharmaceuticals. The biofuel and forestry industries are two other sectors of interest, Mr Dmitriev says.

The fund’s strategy mirrors that of groups, such as VTB Capital which, since its inception in 2008, has completed 10 private equity deals, worth $2.5bn.

Tim Demchenko, VTB Capital’s head of private equity and special situations, says the investment bank hopes to co-invest with the direct investment fund in the larger-sized deals that Mr Dmitriev has been promising.

The fund will hopefully make the market more dynamic and transparent, Mr Demchenko says. But a lot of questions will be asked regarding how its strategy will be executed and where the fund will find so many sizeable deals, he adds.

“The fund is earmarked for a very high amount of capital … For this kind of capital to be attractively deployed in Russia, you have a very limited number of large deals. If you look at the PE deals closed in Russia historically, the deals exceeding $200m to $300m tend to be rare ones,” Mr Demchenko says.

Other market participants question whether the fund will be able to put returns first rather than the political interests of the government. “If the fund makes an investment in a certain company, and the time comes to close that company’s factory, that’s where the gist will be,” says one sceptical western investment banker.

Mr Dmitriev is the first to admit that not all international private equity groups and fund managers will sign up to co-invest with the fund. But he emphasises that having the likes of Mr Schwarzman and Mr Black give it serious consideration is an achievement in itself.

“Some [investors] are ready to invest, some are ready to hear about it. Others are basically saying ‘we’ll listen in one year but we’ll go to some of the meetings’. But the fact that people are willing to listen and willing to think about Russia as an investment destination is a fact,” he says.

“For a Russian sovereign wealth fund that has just been created, we’ve basically got a Who’s Who of the investment community and I think it’s going to generate a lot of attention and excitement.”