Russian bull

The Deal Magazine, by Vyvyan Tenorio, 14.10.2011

In just a few months, Kirill Dmitriev has become the public face of Russia's most ambitious effort yet to lure foreign investors. Since being appointed CEO of the $10 billion Russia Direct Investment Fund earlier this year, the Western-educated former president of one of Russia's largest private equity firms, Icon Private Equity, has been meeting with key officials from sovereign wealth funds, private equity firms and other institutions.

But Dmitriev, 36, isn't just an emissary with a hefty checkbook; he wants to be a local partner and make money. He'd like the RDIF to be viewed as a PE fund co-investing alongside foreign investors, providing at least half of every dollar of the total equity investment. Its target internal rate of return is upwards of 20%. "That's why the fund was created," he says. "We welcome foreign investment, and we want investors to make good returns."

That Dmitriev, a highly regarded, Stanford University- and Harvard Business School-trained investor, was picked by President Dmitry Medvedev to lead it was seen as a big positive by many inside and outside Russia. Dmitriev cut his teeth at Delta Private Equity Partners LLC, a U.S. government-financed vehicle, a decade ago before moving on to manage $1 billion at Icon, which, he says happily, managed to make money during the crisis.

That counts for a lot in a country long viewed as an enormous, opportunity-rich but rugged frontier mired in politics, corruption and the absence of rule of law. In some ways the RDIF envisions redrawing the lines of engagement for investors who have to cope with the unpredictability of business in Russia. Cautionary tales abound; at one extreme is the saga of former Yukos Oil Co. head Mikhail Khodorkovsky, who has spent the past seven years in prison after incurring then-President Vladimir Putin's ire when he tried to strike his own deals with foreign partners. The police raid on BP plc's Moscow offices, stemming from its ill-fated joint venture agreement with state oil producer OAO Rosneft, is another reminder that there's more to be done in Russia by way of establishing a stable, long-term framework for foreign investment.

While the lofty goals espoused by the RDIF's patrons of promoting modernization often seem at odds with sobering realities on the ground, for the moment everyone would appear to give the RDIF the benefit of the doubt. They see it as a tantalizing way, at the very least, for Russia's economy to be less dependent on petrodollars.

"The good news with RDIF is that it's a measure that's partly designed to stimulate development of a more balanced and diversified economy," says Joseph Schull, Warburg Pincus' head of European operations.

Last month, the RDIF unveiled an advisory board comprising a star-studded lineup of buyout chiefs and heads of SWFs. Many have waxed optimistic: "We are all excited about the fund," gushed Apax Partners LLP's Michael Phillips in a video. Schull, who's on the RDIF board, believes Dmitriev's leadership offers a level of comfort to potential investors. "I can't think of a better CEO," he says.

The fund is moving quickly. Last week, it unveiled plans for a partnership fund with China Investment Corp., targeting $3 billion to $4 billion in capital. RDIF's game plan is to take controlling stakes in companies, along with co-investors. Capitalized at $10 billion over the next five years, it received the first $2 billion through parent Vnesheconombank, the state development bank. About 20 deals are in the pipeline, according to Dmitriev, targeting areas such as agriculture, healthcare, pharmaceuticals, logistics, high tech, production, consumer goods and retail.

Given that the RDIF's target equity size is between $50 million and $500 million, Dmitriev wants the fund to be a catalyst for large, chunky transactions. That might not be so easy to do. Russia has the least developed PE industry of most emerging markets. Only a third of some $24 billion of Russia-focused capital commitments raised since 2003 are solely geared toward Russia, according to London's Preqin Ltd. Dealogic tracked 21 announced deals, mostly small, in as many months.

The reasons may have far less to do with fiscal risks than market dynamics, observers say. Buoyant oil prices have resulted in great liquidity in the system, while valuations of public companies are very low, with Russia's index trading at a roughly 50% discount to most emerging markets. "Obviously, that's a great opportunity if you've got a willing vendor, but if a vendor can borrow cheaper money elsewhere, it's hard to get them to transact at those prices," says Andrew Cowley, CEO of Macquarie Group Ltd.'s Macquarie Renaissance Infrastructure Fund, the country's first infrastructure fund, which recently raised $630 million.

Finding good projects in Russia can also be a challenge. "Sometimes you're dealing with unreasonable, if unrealistic, expectations on company valuation, particularly in IT," says Laura Brank, head of Dechert LLP's Russia practice.

Mostly, the competition is daunting when Russia's oligarchs effectively exert a stranglehold over many sectors of the economy. That's a disincentive to foreign PE investors, practitioners say, but the RDIF's alignment of interest with foreign investors should help.

"There's quite a bit of interest in partnership," says Dmitriev. "It's really an opportunity to close the gap between a deal that's talked about but not closed and a deal that's actually closed."

But even having a powerful local partner won't shield investors from things like shareholder warfare. Battles over fractions of a percentage point can be intense. Recently, TPG Capital's partnership with Russian investment bank VTB Capital, in acquiring control of hypermarket chain Lenta LLC, was marred by a rancorous dispute with the largest selling shareholder, U.S. businessman August Meyer. TPG declined to be interviewed.

Still, the hope, Dmitriev says, is that the RDIF will help bridge the "perception gap between real issues and how people perceive them."