April 21 (Bloomberg) -- A dozen men in black guard the St. Petersburg offices of hypermarket operator Lenta LLC. They’re a reminder of how much muscle it is taking TPG Capital, which owns a stake in the company, to establish a beachhead in Russia.
The firm’s $100 million investment in Lenta in 2009, in partnership with state-controlled VTB Group, sparked a brawl in September. Jan Dunning, backed by TPG and surrounded by bodyguards, barged past Sergei Yuschenko, who had been installed as chief executive officer by rival investors, to reclaim his job running the company. Windows were smashed and punches thrown -- all of it broadcast on national television.
Russia’s government, seeking to diversify its economy away from energy, is finding it difficult to lure international private-equity firms, even as investors look to emerging markets. TPG co-founder David Bonderman is betting that with the right connections he’ll overcome a complex legal system, widespread corruption and competition from local oligarchs for assets. Doubters like the Carlyle Group aren’t buying.
“Russia is still perceived as the ‘wild, wild West,’ and the issues TPG is facing there aren’t helping,” said Jeremie Le Febvre, a partner at Triago SA, which helps firms raise funds. “Investors much prefer Asia and Latin America right now.”
After raising $1.4 billion over the last three years, Russian private-equity managers are seeking more than $4 billion this year and next as deal making is picking up. China, by contrast, attracted $28.6 billion from limited partners since 2008, India $15 billion and Brazil $5 billion as Western pension funds are turning to fast-growing economies to meet increasing obligations, according to the Washington-based Emerging Markets Private Equity Association. About 20 percent of limited partners are planning to invest more or start investing in Russia in the next two years, an EMPEA survey found in April.
“There will be intense fundraising activity in the next 12 months, and limited partners will take a fresh look at Russia,” said Mounir Guen, head of MVision Private Equity Advisers, which helps firms raise money. “There are some fantastic opportunities in Russia, and the contrarians are starting to show up.”
In March, Russian President Dmitry Medvedev announced a $10 billion private-equity fund, partly funded by the government and aimed at investing alongside international firms. He also created a working group to turn Moscow into a global financial center. It includes Stephen Schwarzman, CEO of Blackstone Group LP, one of the world’s largest private-equity firms, along with Goldman Sachs Group Inc.’s Lloyd Blankfein and JPMorgan Chase & Co.’s Jamie Dimon. Separately, state-owned OAO Sberbank, Russia’s largest bank, said it planned a $1 billion private-equity fund with Credit Suisse Group AG. The two firms will each contribute about $100 million to the project.
Russia ranked as less attractive for private-equity deals than Brazil, India and China -- the other members of the so-called BRIC nations -- as well as Africa and the Middle East in the EMPEA survey. Almost two-thirds of those questioned cited “political risk” as the main reason for avoiding the country.
Corruption within the local authorities and a small and volatile universe of fund managers that have survived crises are other deterrents, said Steven Cowan, a partner at 57 Stars, a Washington-based fund of funds investing in emerging markets for pension plans including the California Public Employees’ Retirement System.
Carlyle Pulls Out
“Russia is tough,” said Alexander Savin, a former investment executive at billionaire Mikhail Fridman’s Alfa Group who co-founded Moscow-based buyout firm Elbrus Capital last year. “Those who have cracked it can generate superior returns, but it has been difficult for international firms to do good deals over the long term.”
Elbrus is to seek $750 million this year, two people with knowledge of the matter said. Savin declined to comment.
Carlyle, the Washington-based buyout firm, attempted to set up a team in Russia twice since the late 1990s, only to withdraw. It shut its Moscow office in 2005, saying the returns weren’t worth the risks, after hiring a team the year before and failing to get enough investor support for a dedicated fund.
The firm has no plans for a third try.
“Russia has not proven to be a place where Western private-equity investors can have the returns and realize the profits commensurate with the risks they’ve had to take,” Carlyle co-founder David Rubenstein said in Berlin last month. The country doesn’t lack capital, especially among oligarchs, he said previously. The firm, which operates in China, India and the Middle East, said last month it hired a team to invest in Sub-Saharan Africa.
Anne Fossemalle, director at the European Bank for Reconstruction & Development, the London-based international financial institution created after the Soviet Union collapsed, disagrees. Returns from EBRD-backed private-equity funds in Russia and the former Soviet Union have exceeded those in emerging markets as a whole over five and 10 years, and have averaged 14 percent annually after fees since the mid-1990s, she said.
The EBRD helped start most of the country’s few success stories, mainly firms targeting mid-size companies.
Baring Vostok Capital Partners is one of them. The firm, started in 1994 by former Salomon Brothers oil banker Michael Calvey, has made about four times its money for investors on average, Calvey said in his office on Ulitsa Gasheka, a dusty street two metro stops from the Kremlin where Goldman Sachs and the EBRD have also settled. Baring Vostok, whose backers include Calpers and the Pennsylvania State Employees’ Retirement System, may start raising a $1.4 billion fund this year, according to three people briefed on the plans. Calvey, 44, declined to comment.
Of Baring Vostok’s 55 investments in entertainment, oil exploration, banking and confectionary, a quarter delivered more than four times the initial investment, including six “breakout winners” that returned more than 10 times, offsetting six money-losing deals, he said.
A future winner may be Yandex, in which Baring Vostok bought a minority stake in 2000. The Russian equivalent of Google is planning an initial public offering on the Nasdaq Stock Exchange this year. Baring Vostok’s $1.1 billion fund raised in 2007 is recovering from the financial crisis, posting a 20 percent gain as of December, said a person with knowledge of the matter who declined to be identified because the information is private.
While Russia is “much more civilized than 15 years ago,” the barriers to entry are high and the learning curve long for foreign firms, Calvey said. Epic fights against oligarchs in the 1990s provided some training, he recalled. Disputes are much less frequent now, he said.
“It’s a do-it-yourself market,” Calvey said. “You can’t rely on outside service providers.”
Besides 20 investment professionals, he employs four full-time lawyers, three government-relations managers, and eight accountants and human-resource managers dedicated to the portfolio companies. All of Oklahoma-raised Calvey’s other 10 partners are Russians.
“It looks like a venture-capital firm,” he said. “International firms aren’t equipped for Russia. And they usually have a low tolerance threshold for uncertainty and no sense of humor for Russian surprises.”
Such surprises may include a tax inspector showing up to seize assets because of unpaid value-added tax, a regulator announcing that a license for your business is under review three years before it expires, or a competitor raiding one of your companies, Calvey said.
TPG in Russia
“You just learn not to panic,” he said. “It’s routine.”
TPG, the only global buyout firm with a presence in Russia, manages about $48 billion in assets and counts among its investments Energy Future Holdings Corp., the Texas power producer whose $43.2 billion leveraged buyout in 2007 was the largest in history. The firm is finding out just how difficult a market Russia can be.
The Fort Worth, Texas-based firm, currently investing a $19.8 billion fund, set up a Moscow office in 2007 and has three investment professionals there, none of whom are partners. Stephen Peel, the partner overseeing the firm’s Russian operations, is based in Hong Kong and John Oliver, the operating partner in charge of Lenta, is in London. TPG’s Bonderman met with Prime Minister Vladimir Putin in 2009 and joined the board of VTB after buying a $100 million stake in Russia’s second-biggest lender in February.
Lawsuits and Violence
TPG dropped its bid to buy Moscow-based drug distributor SIA International Ltd. in September 2008 and abandoned a plan to raise a joint fund with VTB in the wake of the credit crisis, according to two people with knowledge of the matter. The Lenta deal has spawned lawsuits on three continents and claims of forgery, fraud and violence.
“There are pros and cons to every emerging market,” said Peel, who left Moscow for Hong Kong in 2008. “None of them is perfect and ultimately, we have to balance the risks with rewards of the specifics of the deal, the institutional investment framework of the country and the medium-term macro-economic outlook. Lenta was acquired at an attractive price and at the right time. The economy and the business have performed exceptionally well since then and it is likely to be a very good investment.”
TPG’s “Russian surprises” have mostly come from an unexpected direction: a fellow American-born investor.
In September 2009, TPG and VTB agreed to buy a 31 percent stake in Lenta and operate it jointly with Svoboda, the grocer’s largest shareholder. It didn’t take long for the relationship to sour.
Svoboda is controlled by August Meyer, an American-born lawyer-turned-businessman. Within three months of the deal, Meyer said he intended to exercise his right under the shareholders’ agreement to replace Dutch-born Dunning as CEO with Yuschenko, a Russian and former top Lenta executive.
“I didn’t want a CEO in there not speaking Russian and answering to only one shareholder,” Meyer said in an interview in St. Petersburg.
Meyer, 48, came to St. Petersburg in 1999 after being a prosecutor in San Diego for about 10 years. He fell in love with the Baltic Sea city built in baroque style by Peter the Great and decided to stay, he said, sitting in the Mozzarella Bar on Kanal Griboedova, close to the city’s Winter Palace and Hermitage Museum. He bought apartment buildings and started a hotel business.
Ayn Rand Fans
Speaking little Russian, he met Dmitry Kostygin, a fellow fan of St. Petersburg-born Russian-American author Ayn Rand, a champion of laissez-faire capitalism. Kostygin, 38, put him in touch with Lenta’s founder, Oleg Zherebtsov, and in 2002 Meyer bought a stake of about 36 percent for less than $20 million, using family money. Kostygin also invested in Lenta.
“I wanted something scalable,” Meyer said.
Lenta, started in 1993 as a cash-and-carry warehouse serving small retailers and restaurants, had two stores when Meyer got involved. It now owns 39 warehouse-sized hypermarkets in 20 cities, selling everything from food and cigarettes to toys and television sets. Sales grew 27 percent to 70.6 billion rubles ($2.5 billion) last year.
Its flagship store is next to the company’s headquarters in the city’s northern district of Staraya Derevnya, surrounded by low-rent housing. The format, combining retail, wholesale and discounter, appeals to Marina Valentina, a brown-haired chef in her 50s who got a 20 percent discount on a bulk purchase of pots, pans and plates.
“Lenta was the first supermarket in St. Petersburg to offer discounts if you buy in bulk,” she said. “The loyalty card is great value and it’s a well-run store.”
Partners at Odds
Zherebtsov and Meyer started to quarrel over strategy in 2008, Meyer said. Zherebtsov sacked Yuschenko, then the company’s CEO, and Meyer opposed the move. The EBRD, which bought an 11 percent stake in 2007, backed Meyer, resulting in the sale of most of Zherebtsov’s stake to TPG and VTB. Meyer bought another 5 percent for $15 million in January 2010, he said. Dunning was hired just weeks before the TPG deal.
By last May, Meyer and Kostygin wanted Dunning out and convened a board meeting to bring back Yuschenko. TPG walked out of the meeting before the vote and sued to block the change. EBRD has since sided with TPG and VTB.
A U.K. arbitration court in July confirmed Yuschenko’s appointment as interim CEO and requested the two sides hold a board meeting and look for a new CEO together to succeed him. Meyer and Kostygin haven’t attended board meetings since, and a search for a successor never started.
Opposed to Yuschenko staying on permanently, TPG and VTB convinced the tax authorities to recognize Dunning as the CEO, saying the board meeting dismissing him wasn’t valid. He took over again on Sept. 14 after the melee at Lenta’s headquarters.
A TPG spokesman said the firm had no direct role in the September scuffle. Tim Demchenko, head of VTB Capital and a Lenta board member, declined to comment.
Yuschenko is being investigated by police after Lenta’s deputy CEO provided evidence of misappropriation of 4.2 million rubles of company funds, according to three people with knowledge of the case. Yuschenko, also a shareholder in Lenta, confirmed the probe and denied wrongdoing in a phone interview.
“It’s been months now and I still haven’t seen the documents against me,” he said. “I want this investigation to go to term. My reputation is on the line. Lenta is a big part of my life and wealth.”
Calls to the office of the head of the St. Petersburg police department’s investigative committee, Alexander Romanov, were disconnected every time Bloomberg News called. Five calls to other numbers for the committee weren’t answered. The police department’s head of press relations, Vyacheslav Stepchenko, and other members of the press office didn’t pick up repeated calls.
Dunning, whose CEO contract expired in October, declined to comment. He continues to be employed by Lenta as a consultant. Officially, the company has no CEO, according to TPG.
“Dunning is now irrelevant,” Meyer said. “We’re far beyond that. The trust cannot be rebuilt.”
Meyer last month offered to buy TPG and VTB’s stake for $806 million, or about eight times their investment in 2009. TPG rejected the bid, proposing the two sides hold an auction with a starting valuation of $2 billion for the company. Meyer’s latest offer is to sell his 41 percent for $1.17 billion.
Baring Vostok’s Calvey said all the drama misses the lesson of Russian private equity.
“The real story is that TPG is going to make a big profit,” he said. “I bet it will be one of the best-performing investments of TPG’s latest fund.”
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