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Inside Perspectives: An Interview with Michael Calvey of Baring Vostok

Posted on: 27 Mar 2013

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Michael Calvey, Founder and Senior Partner of Baring Vostok, shares his perspectives on the private equity landscape in Russia and the Commonwealth of Independent States (CIS), and discusses some memorable transactions throughout his career in the region. Baring Vostok is one of the oldest and largest private equity firms focusing on Russia and the CIS; it recently closed its fifth fund with US$1.5 billion in aggregate capital commitments, constituting the largest fund raised for the region to date.

You have been investing in Russia with Baring Vostok for nearly 20 years, during which time Russia and the CIS have undergone a tremendous amount of change. From your perspective, how has the market evolved since you began investing in it?

When we first started investing in 1994, the Russian economy was still contracting sharply after the end of the Soviet Union. During the first four years of our firm’s existence, Russia’s GDP fell by about 40–50% as the elimination of subsidies and state orders led to a collapse in unsustainable Soviet economic activity. At the same time, the private sector was growing rapidly, but from a small base, so there were not many private companies of size in which to invest.

So we invested about two-thirds of our first fund in former Soviet businesses that had been privatized, and about one-third in new private companies. Some of the private companies were big successes—companies like VimpelCom, for example, which became Russia’s biggest mobile player. However, we also made a lot of money from investing in privatized businesses, which was a different type of opportunity requiring different skill sets. For most of these formerly state-owned businesses, there were huge assets that could be acquired very cheaply, but they needed to be restructured, cleaned up and repositioned to be profitable over the long term. This opportunity existed only briefly, but we took advantage of it, and the profits we generated helped us both to survive the Russian financial crisis of 1998 and to keep investing afterwards.

This was one of the big lessons over the last 20 years: periodic crises are inevitable in rapidly evolving emerging markets, and while most investors develop a “bunker mentality” afterwards— getting depressed and being reactive—these periods often present the best opportunities both to buy great companies and to transform existing businesses. From 1999 onwards, Russia has been an excellent growth market, with GDP growing by more than 8x in U.S. dollar terms and some truly outstanding businesses being created. The “survivor” private equity firms of 1998 benefitted from this enormously, and generated returns mainly from growth.

For years, LPs have viewed Russia as one of the least attractive markets for private equity investment—it ranked last in EMPEA’s Annual LP Survey both in 2010 and 2011. Yet Baring Vostok had success raising US$1.5 billion for its fifth fund—the largest raised for the region to date. Are LP perceptions toward Russia changing?

Russia is irrationally unpopular with mainstream investors since the returns on investing in private equity in Russia have been better than those in most other emerging markets over the last 18 years. Obviously, there have been individual funds in Russia that were disasters and some funds in other markets that have been highly successful, but if you look at the industry overall, IRRs and cash multiples in Russian PE have been higher on average than those in other regions. Russia’s macroeconomic fundamentals are also relatively good, with low debt, budget surpluses and gradually declining inflation. Clearly, investor perceptions today are based on variables besides investment results or economic realities.

To illustrate this point, we recently asked a number of investors to participate in an exercise where we disguised countries as planets. Then we put up 10 statistics on each planet that were relevant when making investment decisions, such as GDP, growth, budget deficit/surplus, net debt position and the price-earnings ratio of the stock market. We even let the audience pick the parameters. When the audience ranked the planets in order of which was most attractive for investment, Russia came out number one, China was number two, Germany was number three and Brazil was number four.

That is anecdotal evidence, but it demonstrates that there is an irrational bias about Russia. It’s not a paradise, of course, but there isn’t an investment paradise anywhere in the world. I think people’s perceptions about Russia are based mainly on a lot of other variables, especially external politics, which is probably important and certainly intellectually intriguing, but doesn’t reflect the real economic situation or affect the types of businesses in which we invest. And whenever a country’s or a company’s image becomes disconnected with economic and business reality, it usually presents an opportunity for investors to profit from it.

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