Russia: Still the Wild West for Private Equity

TPG Capital, the only global private equity firm with a presence in Russia, is finding out just how difficult it can be to do business there. From its base in Fort Worth, TPG manages about $48 billion in assets and counts among its investments Energy Future Holdings, the Texas power producer whose $43.2 billion leveraged buyout in 2007 was the largest in history. Since setting up a Moscow office in early 2007, it has made only one Russian private equity deal: the September 2009 purchase of a 31 percent stake in superstore chain Lenta, and that deal has led to lawsuits and a violent brawl. "There are pros and cons to every emerging market," says Stephen Peel, the TPG partner who oversees the firm's Russian operations. "None of them is perfect."

Russia has attracted less private equity money than other emerging markets—$1.4 billion over the past three years, compared with $28.6 billion for China, $15 billion for India, and $5 billion for Brazil, according to the Emerging Markets Private Equity Assn. "Russia is still perceived as the wild, wild West, and the issues TPG is facing there aren't helping," says Jérémie Le Febvre, a partner at Triago, which helps buyout firms raise money. "Investors much prefer Asia and Latin America right now."

Carlyle, the Washington-based buyout firm, shut its Moscow office in 2005, saying the returns weren't worth the risks. It doesn't plan to try again. "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 in March.

The Russian government hopes to change investor perceptions. In March, President Dmitry Medvedev announced a $10 billion private equity fund, partly funded by the government, that will make investments in conjunction with international firms. He also created a working group to turn Moscow into a global financial center. It includes Stephen A. Schwarzman, chief executive officer of Blackstone Group (BX), one of the world's largest private equity firms, Goldman Sachs's (GS) Lloyd C. Blankfein, and JPMorgan Chase's (JPM) Jamie Dimon. Separately, state-owned OAO Sberbank, Russia's largest bank, said it planned to work with Credit Suisse (CS) to raise a $1 billion private equity fund.

Michael Calvey, an American who launched Moscow-based private equity firm Baring Vostok Capital Partners in 1994, says foreigners have to adapt to Russia's peculiar business environment. "International firms aren't equipped for Russia," says Calvey. "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 supposedly unpaid taxes or a regulator announcing that a key license your business needs is going to be reviewed three years before it expires. "You just learn not to panic," he says. "It's routine."

Foreign investors are also deterred by widespread corruption. Russia ranked 154th out of 178 countries—worse than Libya, the Ivory Coast, and Haiti—in the 2010 corruption perceptions index published by Transparency International.

Calvey, a former Salomon Brothers banker, says his funds have returned four times their investors' money. He intensively researches companies and monitors them closely. Calvey's 10 Baring Vostok partners are Russian. In all, the firm has 20 investment professionals, plus four full-time lawyers, three government relations managers, and eight accountants and human resources managers dedicated to the companies in which it has stakes.

TPG, by contrast, has only three investment professionals in Russia. While two are Russian, none are partners. Their boss, Peel, moved from Moscow to Hong Kong in 2008. John Oliver, the operating partner in charge of Lenta, is in London.

Lenta, begun in 1993 as a cash-and-carry warehouse serving small retailers and restaurants, had two stores in 2002. It now owns 39 warehouse-size 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.

In September 2009, TPG and state-owned Russian bank VTB Group agreed to invest about $100 million in Lenta for 31 percent of the shares, which they bought from Lenta founder Oleg Zherebtsov. TPG and VTB signed a shareholders' agreement to operate Lenta jointly with Svoboda, an investment firm that owns 41 percent of Lenta. Svoboda is controlled by August Meyer, an American-born lawyer.

Zherebtsov and Meyer had quarreled over company strategy, according to Meyer. It didn't take long for the relationship between Meyer and TPG to sour. Within three months of the deal, Meyer said he intended to exercise his right under the shareholders' agreement to replace Dutch-born CEO Jan Dunning with Sergei Yuschenko, a Russian and former top Lenta executive. "I didn't want a CEO in there not speaking Russian," said Meyer during an interview in St. Petersburg.

In May of last year, Meyer and his longtime business partner Dmitry Kostygin, also a Lenta shareholder, convened a board meeting to bring back Yuschenko. TPG representatives left the meeting, and TPG sued to block the management change. Under the terms of the shareholders' agreement, the dispute was taken to arbitration in the U.K. In July an arbitration panel supported Yuschenko's appointment as interim CEO and asked the two sides to begin a joint search for a permanent CEO. Meyer and Kostygin haven't attended board meetings since.

Despite the arbitrators' ruling, TPG and VTB got Russian tax authorities to recognize Dunning as CEO. When Dunning arrived at Lenta's St. Petersburg headquarters in September to reclaim his post, a fight erupted. Dunning barged past Yuschenko and his colleagues and took control of the office. Clips shown on national television showed windows smashed and punches thrown. A TPG spokesman says the firm had no direct role in the fracas. Dunning and Tim Demschenko, head of VTB Capital and a Lenta board member, declined to comment.

The dustup didn't resolve Lenta's management issues. Today, 14 men in black stand guard outside its headquarters. Dunning, whose CEO contract expired in October, continues to work for Lenta as a consultant. Officially, the company has no CEO, according to TPG.

Meanwhile, Yuschenko is being investigated by police after Lenta's deputy CEO gave evidence that Yuschenko misappropriated 4.2 million rubles of company funds, according to three people with knowledge of the case. Yuschenko, also a Lenta shareholder, confirms the probe and denies wrongdoing.

Meyer has offered to buy the stake owned by TPG and VTB for $806 million, or about eight times their investment in 2009. TPG rejected the bid, proposing the two parties hold an auction with a starting valuation of $2 billion for all the shares. Meyer's latest offer was to sell his 41 percent stake to TPG and VTB for $1.17 billion.

"Lenta was acquired at an attractive price and at the right time," says TPG partner Peel. "The economy and the business have performed exceptionally well since then, and it is likely to be a very good investment."

The bottom line: Private equity is wary of Russia because of corruption and the violent experiences of firms such as TPG.

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