Russia’s biggest companies – the likes of Gazprom, Rosneft, and Lukoil – feature regularly in the world media and their actions are watched closely by both business and political leaders around the globe. Recent years have seen these firms embark on an aggressive expansion binge, but behind the scenes they have also been active in trying to transform themselves from former state-held behemoths or cobbled-together holdings into more effective, efficient, and profitable companies.
A new report from the Economist Intelligence Unit and sponsored by Ernst & Young – Corporate transformation in Russia’s emerging multi-nationals – explains what these companies are doing and why. It paints a fascinating picture of what is going on inside corporate Russia, and one that is very different to the traditional representation of the Russian business scene.
“Many of Russia’s fastest-growing firms are beginning to bump up against capital constraints, meaning they need to tap global financial markets to continue growing. This means they are under heavy pressure from the investor community to become more transparent and tighten up management practices,” says Matthew Shinkman, the editor of the report. However, as Russia’s leading corporates expand into new markets, they are increasingly competing head-on against global leaders, providing another source of pressure to improve their competitiveness.
“Recent changes in corporate governance are being driven to a large extent by capital market requirements. Thus far in 2007 there have been 18 public offerings by CIS companies for a total of almost $26bn raised,” says Karl Johansson, Managing Partner of Ernst & Young in Russia and the CIS. “The process of Russian companies going public in international markets will continue and will help these companies become global players.”
Restructuring
The report’s examination of the internal reform efforts of Russia’s emerging multi-nationals reveals several key themes. Reform is indeed happening, if at a slow and uneven pace, it says; “The biggest Russian firms, with the most contact with the outside world, have been very active in corporate restructuring, implementing modern, best practice corporate governance systems, upgrading internal processes and procedures, and building environmental sustainability into their businesses. Firms that are closer to the state, not surprisingly, tend to move more slowly in this regard.”
The report also argues that change is being driven in part by funding requirements. To minimise their cost of capital on global markets, “Russian multi-nationals are being forced to introduce more transparency, improve reporting procedures, and get corporate governance right.” Acquisitions and establishment of operations in western markets have also forced these companies to play by western business rules.
However, it would be wrong to conclude that these reforms are being forced upon the Russian multi-nationals, the report says. “The senior executives with whom we spoke confirmed that corporate transformation efforts are not being made just as pre-IPO window dressing,” the authors write. “In most cases executives understand that the long-term competitiveness of their firms will depend upon meeting or beating global best practices in operations, governance, and finance.”
The report notes that while the behind-the-scenes corporate modernisation activities of the emerging Russian multi-nationals may not be well-documented, their increasingly confident forays into both emerging markets – including Russia’s backyard CIS countries – and even the more sophisticated markets of Europe and the US has made front-page news, and forced western rivals to take note.
It cites research by M&A Intelligence, a Moscow-based consultancy, which suggests that last year Russian companies completed almost 100 cross-border mergers and acquisitions worth some $15bn. The most well-known and controversial of the Russian firms venturing abroad is gas giant Gazprom, which has gained control over assets in the CIS and eastern Europe which allow it to exert major influence over the supply of gas to western Europe.
In contrast to the prevailing view in the global media, though, “aggressive corporate expansion abroad is not solely the purview of the biggest firms, nor those most closely-linked to the Kremlin, and in most cases is based on purely commercial motives,” the report says. Russian companies such as Lukoil, UC Rusal, and Severstal – all highly active in overseas M&A – are all several steps further removed from the state than Gazprom, while smaller Russian multi-nationals such as the telecommunications company MTS and food manufacturer Wimm-Bill-Dann are barely more than a decade old and are less central to the Kremlin’s economic strategy, it says.
The report argues that for the largest Russian energy and natural resources firms, years of high global oil and commodity prices, accompanied by exceptionally high demand from both emerging and developed markets, have produced a windfall of export earnings and left these firms cash-rich and in a buying mood. This rapid earnings growth, along with robust macro-economic growth, has also trickled down into rising incomes for a growing Russian middle class, which has in turn boosted the performance – and ability to invest – of financial services, consumer goods, and technology firms as well.
“Russian companies have for years been active in the CIS countries, leveraging common language, similar business practices, and trade and other links established in former Soviet Union times to build market share in and extract natural resources from Russia’s near-abroad,” it says. “Russian companies account for over a third of all foreign direct investment in the CIS countries. This investment is led by the oil and gas sectors, but telecommunications, financial services, and consumer companies are also heavily active in the region.”
Many Russian emerging multi-nationals are now looking further abroad, re-tracing the steps of Soviet state enterprises, which were active in the Soviet Union’s former spheres of influence, ranging from Asia to Latin America and Africa, the report says. “These firms are now using the skills built up in both the challenging domestic Russian market and the still-undeveloped CIS to venture into far choppier waters – including places few Western companies are willing to go.”
Expanded market
Currently, the international presence of Russian telecommunications companies, including MTS and VimpelCom, is largely limited to the former Soviet republics. As opportunities in this expanded home market become harder to come by, though, they suggest they are considering entering markets like North Korea and Afghanistan to sustain growth beyond 2009. The report refers to comments made this summer by Alexander Izosimov, chief executive of VimpelCom, who told journalists that, “We will be ready to look at markets that are riskier, the markets that, in the mind of western companies, are taboo.” Other reports have suggested that Altimo, the telecoms arm of billionaire Mikhail Fridman’s Alfa Group conglomerate, has been in talks to buy into Iranian mobile phone company Iraphone.
While Russian multi-nationals hold a commanding position in the CIS and operate comfortably across a range of emerging markets, their experiences entering the developed western markets have been more mixed, the report says. “This experience has been in large part driven by ongoing concerns over transparency and corporate practice, but the circumstances have been made more difficult for Russian firms by the rise in political tensions between the administration of Vladimir Putin and the US and Europe.”
The report cites research from M&A Intelligence on failed cross-border deals that highlights the troubles Russian firms have had accessing developed markets. Between January 2006 and January 2007, the consultancy reports that Russian companies failed to clinch 13 foreign deals with a total worth of $50.2bn (well ahead of the $15bn in closed deals). The thwarted deals included five by Gazprom, three by Lukoil and two by Severstal, with the biggest being Severstal’s $13bn bid to buy Luxembourg-based steelmaker Arcelor. During the same period, companies from the Middle East lost just $18bn worth of deals in Europe and North America.
“Political considerations have worked against Russian firms in recent cross-border bids,” the report says. In early 2006, for example, rumours that Gazprom was considering a bid for Centrica, the UK-based energy supplier, raised such concerns within the UK government that then-Prime Minister Tony Blair issued a statement officially confirming that the government would not actively block a bid. And Severstal’s bid to takeover Arcelor, the Luxembourg-based steelmaker, in 2005 drew a sharp response from European politicians and the company was eventually thwarted by a rival bid from Mittal Steel.
“Political sensitivities are even greater in the former communist countries of eastern Europe,” the report claims. Steel and mining company Evraz Group bought the ailing Vitkovice Steelworks in the Czech Republic in 2005. It was the group’s first international purchase and the memories of the two countries’ common communist past complicated the bid. “We faced serious challenges in this acquisition,” the report quotes Irina Kibina, vice-president for corporate affairs and investor relations at Evraz, saying. “All the memory, all the fears, they are still alive. Besides, it was our first international acquisition and we were just learning how to do it right.”
Studies
Inexperience is only half of the problem, according to the report. Russian firms – and Russia itself – currently suffer from a very poor image within the global business community, it says, citing numerous studies, including several from the Economist Intelligence Unit.
“The news for Russian multi-nationals trying to get into western markets has not been all bad, though,” it says. Evraz has since gone on to conclude a string of acquisitions, including the highly-publicised purchase of Portland, Oregon-based Oregon Steel Mills, which was completed in January, 2007 despite concerns that US anti-trust authorities might not approve the purchase due to Evraz co-owner Roman Abramovich’s ties to the Kremlin.
“While Russian firms’ efforts to transform themselves via acquisition have been met with some backlash, a more collaborative approach has reaped rewards for a number of big Russian firms in potentially sensitive industries,” the report says. The most successful of these firms are increasingly seen as credible business partners and important vehicles for access to the big Russian home market and the country’s vast natural resources.
While the report puts Russian enterprise in a new light, it notes that the country’s multi-nationals are still hampered by an image problem. “Many senior executives around the world are still either wary of or at least uninformed about the actions of Russia’s biggest firms,” it says. “These companies have a big image problem to solve, and it’s not just a case of prejudice: Russian executives need to become more open to communicating with the business world.”
It concludes that there is still a long way to go. “Impressive progress has been made, but the emerging Russian multi-nationals are still emerging. Substantial room for improvement still exists, which presents an opportunity for these firms to continue their vault into the upper echelons of the global business world, if they choose to take it.”
