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Interview of Tim Demchenko, Global Head of Private Equity and Special Situations at VTB Capital, for Private Equity International (UK)

9 January 2013

Insight 2013: A view fr om Russia

Successful firms will continue to build on their track record next year, says VTB Capital’s Tim Demchenko, provided they look out for the right opportunities.

2012 has been an active year for Russian private equity. Baring Vostok closed a record-breaking $1.15 billion fund, a consortium of firms led by Da Vinci Capital listed the first CIS company on the New York Stock Exchange in eight years, and VTB Capital sealed a partnership to roll out Burger King outlets across the country.

There’s no reason why next year shouldn’t follow the same route, according to Tim Demchenko, global head of private equity and special situations at VTB Capital.

The market remains rich in opportunities, he argued. “You basically have something close to a white space in terms of private equity activity in Russia. You can count by the fingers of one hand the number of players that are significant for the industry.”

In a country the size of Russia, that means everyone should be able to find a space – and that competition will remain relatively low. “In more developed private equity markets, you have to compete, go through tenders, auctions, etc. You also have to be much more creative about how you extract value fr om your investment.”

In Russia, capital is scarce, but deal flow is strong, he said. VTB, for example, has enjoyed a good pipeline of deals, across consumer driven industries, business services, and even resources.

Russia’s most obvious sectors will remain somewhat closed to private equity, he said. “Natural resources, energy, mining, are not exactly markets wh ere Russian private equity feels comfortable. They’re a bit like sandwiches for fund managers: the market is too consolidated at the top and there are a lot of start-ups at the bottom.” Private equity firms, who typically take medium sized companies to their next stage of growth, are squeezed in the middle.

But that doesn’t mean there aren’t opportunities hidden under the stones, he said. “Agriculture – especially wheat, corn, soy – is a legitimate part of commodities, wh ere resources are not massively consolidated. The key resource is land and it mostly involves small players. So the extent of operational efficiencies that can be achieved is virtually enormous: potentially 2-3x in a short period of time.”

That was the main rationale for the launch of VTB’s first agricultural private equity fund, which will seek to harvest $500 million, he explained. A winning strategy for firms next year could lie in marketing funds with specific themes or mandates, aside from their flagship vehicles.

Fundraising will remain difficult next year, he conceded. But given the relatively weak competition that exists in the Russian market, and provided firms have a strong track record, he is confident new opportunities will arise.

The way to grow was not to raise mega-funds, he said. Firms don’t have enough space to go much beyond $500 million – a good number by Russian standards, but still small compared to the biggest funds in developed markets.

In terms of transactions, he commented, it will probably be more of the same next year.

Deals will continue to be mainly equity-driven, due to the difficulty of accessing bank financing on good terms. “The domestic market remains dominated by five large banks, and the cost of credit is rarely attractive. And a lot of international banks have scaled down their activity in Russia, to focus on their core market. So I don’t expect this to change in the next 12 to 24 months.”

Exits will be mostly made through trade sales, though there might be the occasional IPO, he said. “It’s kind of available for good companies; it’s totally shut for average ones. If you have an exceptionally good company then I’m confident you will be able to list it.”

The recent $1.7 billion IPO of MegaFon, a big one by Russian standards, was a reason for optimism, he said. “It’s tremendously comforting to see that the market is still open to good companies.”

He expected London, for energy and resources IPOs, and New York, for media and telecom listings, to remain the most sought after exchanges for firms seeking to tap the public markets.?

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