This plethora of deals in Russia represent a rise of 11 percent in the volume and 57 percent in the value of deals from the previous year, which saw $75bn transacted across some 759 deals.
Looking at these deals in a little more detail, it is clear that just as Russian businesses are becoming increasingly acquisitive on the international stage, so too are foreign companies taking more of an interest in Russian assets. Of the deals in 2007, 300 were domestic transactions, 56 saw Russian companies embarking upon international expansion and 489 were deals led by non-Russian firms.
Driving factors
In terms of outbound investment, Russia is home to a number of large corporations that have developed as a result of the abundance of Russia’s large reserves of natural resources, principally gas and mining. In recent years Gazprom has made some significant international acquisitions, including including Natural Gas Shipping Services Ltd in the UK and WINGAS GmbH in Germany.
So far in 2008 Gazprom has concluded two deals outside Russia, acquiring Serbian investment company Naftna Industrija Srbije for $730m and Austria-based Central European Gas Hub GmbH for a undisclosed figure.
But it is not just these traditional sectors that are enjoying popularity. Russia as a nation is rapidly coming up to speed with its Western counterparts, and as such there is considerable investment in sectors that contribute to this development.
Infrastructure-related industries such as real estate, telecommunications, technology and public services have received a boost from private investors, and in the near future government initiatives look set to spur further development.
Western countries have launched a number of Public Private Partnerships (PPPs), designed to revitalise weary public services. And although in Russia, investment in infrastructure is hotly debated, as in other fields, Russia is likely to develop its own unique approach and solution.
Interest in infrastructure development is expected to be big. Investment bank Merrill Lynch estimates that investment in the infrastructure sector could reach as much as £90bn over the next three years. Add to this the downward pressure on the $US, and Russian assets are looking increasingly attractive price-wise.
The fact that international private equity firms are taking a keen interest confirms this. Big names including Texas Pacific, Lion Capital, Mid-Europa, Morgan Stanley, Barclays and Deutsche Bank have all taken significant shareholdings in Russian companies. In 2007 alone there were 60 private equity-backed transactions in Russia, totalling more than £11.3bn in value.
Business framework
With investors queuing at the door, it is just as well that Russia’s business framework is conducive to doing deals. Russian businesses are served by a strong network of advisors, well-equipped to handle the needs of the acquisitive business.
PwC has 2400 professionals on the ground in Russia, offering a range of services including pre and post transaction services.
With 450 employees, one of the largest departments – reflective of the size and importance of the task – is the tax and legal practice. PwC’s tax and legal services provide assistance to businesses involved n M & A, helping them structure the transaction to ensure it is built in the most efficient way, put together as quickly as possible, is focused on value creation and the strategic priorities of the business.
Tax planning at an early stage can add significant value to a transaction, and is essential to reduce both the actual transaction tax costs and the long-term sustainable effective tax rate following the transaction.
Common issues faced on M & A deals in Russia include the tax philosophy or tax culture of the target, which by western standards may be considered either overly aggressive or overly conservative. Tax savings opportunities and strategies employed by the target may not be acceptable to a western buyer. Other tax issues include the complexity of the group structure, underlying transaction flow, related party transactions, transfer pricing practices, unrecorded transactions, and transparency of the target including ownership and control.
Overcoming issues
Russia is a vast country with many different tax jurisdictions, and as such the way certain aspects of tax is handled by one tax authority may differ from that of a neighbouring tax authority.
Bill Henry is a partner and tax specialist, based at PwC’s Moscow office. ‘The authorities are still developing and they are having to adapt quickly to a rapidly-growing business environment. Tax authority risk includes resource constraints, lack of experience and sophistication relative to market developments, harsh and indiscriminate actions of some tax authorities. In some cases, authorities have been viewed as biased against taxpayers and have said to serve as an instrument of pressure.
But it is heading in the right direction. ‘The tax legislation is actually in pretty good shape, and it is possible to get some good letters of clarity. However, the problem is one of scale – the ministry of finance is working hard to bring about better organisation and consistency, but this can’t happen overnight. It is a huge logistical challenge.’
Since the judicial system does not have the expertise to handle the modern business climate, with particular reference to M & A transactions, more time is spent by the advisors in managing tax risks. This provides lots of work for the advisors, but it is such great news if you want to get your deal done quickly and efficiently.
Aside from administration, there are other issues facing a high-growth business community.
Indigenous talent
The main issue is that there is a shortage of people with the correct level of experience and expertise to manage within the business community. This is a result of the speed at which the country has developed – there is just not enough indigenous talent to cope with the amount of work.
Furthermore, the businesses that do employ good Russian staff are finding it increasingly hard to retain them. It is all too common for internationally-trained professionals to quickly change employers for increasing opportunity and reward afforded by the booming economy.
But these problems are just teething troubles – the sign and the stigma of a developing market – and there is no doubt that they will soon be addressed. On balance, the pros of investing in Russia easily outweigh the cons.
One of the biggest attractions of doing business in the Russian market is the way it has fared in the wake of the credit crisis. At a time when billions of dollars has been wiped off the balance sheets of some of the world largest businesses and large corporate acquisitions due to the lack of availability of debt to fund the transactions, Russia has remained relatively unscathed by the turmoil that has hit the West.
Bill Henry comments, ‘The credit crunch has not yet had an impact on Russian transactions – in fact I can only think of one enterprise that has collapsed, and that was more down to the quality of the balance sheet, not the availability of funding.’
One reason for Russia’s near unique position amidst all the credit issues is simple: until recently the country was isolated from the trends of Western banking. As such there is no great levels of consumer debt as is found in the US and the UK, for instance. So when the crisis came, there was much less of a credit crunch in Russia. However, Russian companies will have to refinance short term borrowings. While the expect volume of refinancing is not expected to bring about a crisis, defaults are possible among those who lack credit worthiness in the tighter credit environment.
On the public markets, too, the issues in the credit market are not as pronounced as in some Western markets. Whereas, as expected, there has been a slight slowdown in IPO activity, it does not mirror the near total shutdown in institutional interest for listings.
In 2007, 55 Russian companies achieved a listing, just four fewer than the previous year. Putting this into perspective, in the UK the total number of IPOs fell from 433 to 339 over the same period. What is most interesting is the amounts of money achieved by such listings. The total value of listings by UK companies in 2007 was $16.3bn, as compared with $15bn by Russian companies.
Business landscape
From the huge difference in the number of listings it is clear that many more large cap Russian businesses made it to market that year. Indeed the Russian business landscape is largely characterised by a small number of very large companies.
And there are other plusses that Russia has on its side. There is an affluent middle class in Russia with strong spending power, and this is likely to appeal to retail investors.
Furthermore, although some catching-up is needed, especially in terms of the tax administration, certain aspects of Russia’s business legislation has been more flexible than in many Western nations. One of the most significant is connected with anti-avoidance laws.
Most countries have in place legislation that dictates that if a company enters into a domestic or cross border arrangement primarily for the purpose of reducing their tax burden, the resulting tax advantage can be removed. Therefore, any arrangement that confers a tax advantage should also have a commercial purpose, and should be set up, at least in part, for reasons other than tax planning.
The historical absence of any real anti-avoidance restrictions has been a real advantage for Russian businesses. However, recently there has been an emergence of anti-avoidance practices on a substantive approach including guidance issued by the Supreme Arbitration Court and proposed tax policy instruments including controlled foreign corporation legislation, tax residency based upon the place of management and control, and proposed amendment to transfer pricing rules.
Looking to 2008, it seems that the Russian market is in for another prosperous year. In the first two months alone the total value of M & A deals involving Russian companies tipped 100, with a combined deal value of just over $8bn.
But figures only tell half the tale. It is those on the ground involved in business that count. What does Bill Henry think the future will hold for Russian business? ‘Simply put, the opportunities are unlimited.’
For further information:
Tel: +7 (495) 967 6023
Email: bill.henry@ru.pwc.com
Website: www.ru.pwc.com
