GROWTH FUNDS
IN RUSSIA
Alexander Aivazov
Managing Partner
Head of IB Department
Nord Capital
The Frozen Financial Markets (1)
• The credit markets’ meltdown during 2008-2009 has left many small
and middle market companies searching for finance to fund their
growth as well as day-to-day operations
• Collaterals are assessed with deep discount, many companies
cannot apply for standard banking products
• Russian credit facilities are not well-developed: loans to small and
middle-sized entities account for only 13.8% of banking lending
portfolio
• Bank loan growth has slowed – for the last 18 months lending
portfolio has grown by 0.4%
2
The Frozen Financial Markets (2)
• M&A market volume in Russia has dramatically declined by 65%
during the last two years
• Current domestic bond market is highly risk-averse: huge demand
for top-quality securities comes along with low bond offerings activity
in second and third tier
• Barriers to Russian bond market entry for small businesses: the
issuance amount should exceed $30m to meet the demand and
liquidity
3
Notional Amount Breakdown
• Bonds with notional amount of the issue less than $50m account for
3.9% of market offerings in 2010
Russian Domestic Bond Offerings in 2010
Notional Amount Breakdown
<$50m;
3,9%
$50m-$100m;
10,1%
>$500m; 30,5%
$100m-$200m;
17,7%
$200m-$500m;
37,9%
Source: MICEX
4
Growth Funds – Perhaps the Only Game in Town
• Russian Small&MidCap companies are looking for new capital
sources while clear corporate strategy and growth potential are not
sufficient criteria to access debt financing
• Currently Growth Funds are not wide-spread in Russia, but,
probably, this is the most appropriate option for those companies,
which provide strong demand for:
 Growth Equity capital
 Mezzanine financing
 Debt/Equity capital combination
5
The Hidden Peak Investment Strategy
Top-down analysis
• Fast-evolving industries
• Pre-IPO stage – transparent corporate structure and management
strategy
• Moderate total leverage
• Lacking access to capital markets
• Growth potential
• Participation in industry cluster is strong advantage
6
Industry Focus. Consumer Lending & Microfinance (1)
Industry Average
(Consumer lending)
• High growth potential
•
In Eastern Europe “Consumer lending/GDP” ratio varies
within the range 13%-22%, while in Russia it equals only
to 6,1%
•
Increasing personal incomes (+6,2% from the beginning
of 2010)
ROA
1,9%
ROE
10,5%
Net Interest
Margin
5,7%
• Establishment of legal environment of microfinancing activity:
•
Increasing market efficiency
•
Access to debt capital markets for microfinance organizations
•
Ministry of Finance expects microfinancial market to grow by 5-6 times in 3 years
due to the law impact, therefore consumer microcredit segment will increase to
$1,5-$2,5bn
7
Industry Focus. Consumer lending & microfinance (2)
• Low market penetration in provinces (compared to Moscow and SaintPetersburg): from the beginning of 2009 consumer lending amount in
Russia declined by 10%-15%
Consumer lending regional slowdown by 1H2010
(Dec-08 Volume as 100%)
94%
92%
90%
88%
94%
93%
92%
90%
86%
84%
82%
85%
83%
80%
Source: Central Bank of Russia
8
Industry Focus. Pharmaceutical Manufacturing
• Fast-growing industry, which has performed 2%
growth especially during financial crisis (Russian
GDP fell for 7.9% in 2009)
• Government support to domestic manufacturers
• Large amount of potential targets: profitable
stand-alone businesses with revenue of $10m or
much
• Legislative initiatives on certification according
to GMP standards
• 9 emerging pharmaceutical clusters
Industry Average
(pharmaceutical
manufacturers with
revenue ≥ $10m)
EBITDA
Margin
16,8%
Net Profit
Margin
8,8%
Net Debt /
EBITDA
1,5
• Strong demand and high multiples for SmallCap
Pharmaceutical and Life Science shares during
and after IPOs
9
Industry Focus.TMT (1)
Triple-Play services, Broadband Internet &
Wi-Max technologies
• High growth momentum in Triple-Play
services and broadband Internet access
segments:
•
•
Triple-Play market more than +40% gain YoY in
2009
Russian broadband Internet access segment
amounts to $2bn and increased by 36% in previous
year
Industry Average
(telecommunication
companies with
revenue ≥ $5m)
EBITDA
Margin
16,3%
Net Profit
Margin
9,0%
Net Debt /
EBITDA
2,9
• Industry consolidation on the basis of
government-owned Rostelecom – probable
exit opportunity in 2-4 years
10
Industry Focus.TMT (2)
Mobile Virtual Network Operators (MVNO)
• Strong competitive position against standard mobile operators due
to low tariffs and flexible strategy development
• High growth potential: in developed countries virtual operators
provide services for 3.2% of total subscriber base, while in Russia
MVNOs market share amounts only to 0.5%
• Government support: Ministry of Communication legitimized virtual
operators’ activity in 2009
• Russian virtual mobile market grew 2.6 times in 2009. Expected
annual growth in 2010 equals to 65%
11
Other Industries
• IT and Internet projects
•
Software, social networks, online games development
• Energy-saving technologies
• Alternative energy
• Advanced materials and substances
12
Business Clusters
• Modernization of Russian economy by industry clusters development
• Government support:
•
$700m of government transfers to clusters are expected in 2010
•
Low administrative, infrastructure and transaction costs
•
Tax remissions (property tax, custom duties, zero equipment VAT)
• Skolkovo Innovation cluster
•
Largest and most ambitious Russian public-private partnership, financed by
government and venture investors
•
Investment program till 2013-2015 amounts to $6-7bn
• Pharmaceuticals
• Hi-Tech
• Engineering, new materials development, tourism, etc.
13
Investment Preferences for Growth Funds
• Acquisition of between “25%+1” to “50%-1” shares of target
company
• Cash-in type of investments in priority
• Tailored approach to each company: combination of debt/
mezzanine/ equity capital
• Active co-operation with top-management and participation in BoD
of the company
• Management strategy is based on significant market share
capturing and rapid revenue multiplication
• The invested money should be give a trigger for the sales
acceleration and margin growth
14
Planning and Decision-Making (1)
• Industry and company selection with top-down analysis
•
Industries outlook
•
Diversification of investments
•
Company market share and growth ability (for existing entities: segment share
should vary from 5% to 25%
•
Corporate structure and management strategy
•
Financial analysis and modeling (“Net Debt/EBITDA” ≤ 3, breakeven point: 12-30
months)
•
Investment duration: 3 to 5 years
•
IRR>65%
15
Planning and Decision-Making (2)
• Investment facility selection depends on company’s financial ratios
and stage of development
•
Growth stage + high funding requirement → Equity investments for growth and
CapEx, debt capital for operational costs
•
Financing is provided with 3-5 years tenor
•
Each investment has precise financial and structural covenants
•
The Fund obtains the put option with 15% annual yield at the end of negotiated
investment period
16
Planning and Decision-Making (3)
• Exit opportunities
•
Strategic investors: many industries have not consolidated yet (financial services,
pharmaceuticals, IT, Alternative Energy, etc)
•
Financial investors
•
IPO
• In 1H2010 Russian companies raised more than $700m on domestic stock
exchanges during initial offerings
• Increasing activity in Small&MidCap IPO market segment, because private
investors are interested in portfolios’ diversification
•
MBO
17
Case Study (1)
• Pharmaceutical manufacturer ABC
•
Owned by management
•
The company has stable industry position, but with strong government contracts
and limited capacities to emerge
•
Revenue totals to $40m, EBITDA equals to $7m
•
Leverage is moderate, but ABC lacks tangible asset to provide them as a
collateral
•
Corporate strategy is based on facility expansion, production diversification, R&D
innovations and aggressive marketing
•
Participation in industry cluster
•
Capital requirements - $35m
18
Case Study (2)
ABC Investment program
Uses
Amount
Facility
Term
Description
Management
Option
Covenants
Exit
Opportunities
Production facilities
$17
Equity
R&D
Marketing
$12m
$6m
Mezzanine
Mezzanine or Debt
4 years
15% annual yield;
25% of equity;
Mezzanine - the same
Equity kicker - conversion:
Put option after 4th year
with R&D;
$1debt = $0,95equity (price
with 35% annual yield;
Debt - 18% annual yield
determined by current PV)
Management receives a call option for funds stake at 45% annual return; call
option may be executed anytime, but management has to payoff mezzanine and
debt
Liabilities secured by management shares;
Precise financial covenants: breach leads to possible debt to shares conversion at
par value and execution of put-option
MBO by execution of put-option;
IPO of rapidly growing innovative company;
Strategic investors
19
THANKS FOR ATTENTION
20