Mergers & Acquisitions in Russia: A Rapidly Developing Industry

Michael Knoll
Partner, Head of M&A Lead Advisory
PricewaterhouseCoopers in Russia

While both the number of deals and the total deal volume decreased significantly in 2009 on the back of the financial crisis, deal activity across all sectors has picked up considerably since the beginning of the year.

Particularly active sectors are the FMCG (Fast Moving Consumer Goods), financial services, and general manufacturing sectors. As far as the financial services sector and in particular the banking industry are concerned, we expect to see an increased number of “mergers of equals” to bring about the long-awaited and required consolidation of the industry.

A decade ago, deal activity in Russia was limited, and transactions often were planned and executed without proper preparation. Most of the time, the involvement of financial advisors, if any, was very limited. In contrast, over the last five years, the market has become more sophisticated, and nowadays about 40 percent to 50 percent of all mid-market transactions — that is, in the enterprise value space of between $50 million and $250 million or higher — are prepared and executed with the involvement of a financial advisor on at least one side, either the sell side or the buy side.

Both sellers and buyers have become more sophisticated and understand the value that good-quality advisors can bring to a transaction, be it in terms of deal preparation or execution. Unfortunately, what is less understood at this stage is that proper planning for the integration of a deal, or the execution of the integration of the deal, is just as important as the deal preparation and execution itself. Various international studies have shown that about 50 percent of the value creation of a deal is attributable to proper deal preparation and execution, while the other 50 percent is harvested provided that the acquired business or the merged businesses are professionally integrated.

Given the much longer M&A history in the West, foreign buyers are in general still more diligent than Russian buyers as regards the depth of deal preparation and deal execution. Even in larger transactions, Russian parties might not have conducted a due diligence or might commission only a high-level due diligence. On the other hand, Western buyers are sometimes overly cautious and perhaps do not understand that agility and speed are of the essence if they wish to secure a high-quality business or asset which, usually, both well-established and professionally run Russian and Western groups bid for.

There is a lack of focus on core activities. The conglomerate or diversified group approach, particularly of some of the larger Russian groups, still prevails in Russia. As a result, investors often do not understand what a particular business stands for and what kind of “equity story” they would buy into, which reduces the number of potential investors. Moreover, investors typically would apply a price discount to a conglomerate.

In the last few months, we have seen exceptionally high interest from U.S. buyers in the Russian market and in Russian businesses, and we expect that to continue for some time. Most of these U.S. buyers are medium-size, internationally oriented players. To what extent this will lead to transaction closings remains to be seen.

There has been a revival of private equity (PE) interest after a difficult 2009 for the global PE industry. We are seeing strong interest both from the established Russian PE houses as well as from some of the global PE houses, which until recently were on the sidelines. However, most of the deals currently being worked on are financed on a pure equity basis given the still difficult credit markets.

Whereas the Russian M&A market has developed rapidly over the last few years —and while some of the current market trends will accelerate this development — a lot remains to be done to achieve a mature market environment. Areas to work on include: making sure that businesses are ready for sale in terms of financial reporting or having the business properly structured from a management, legal and tax point of view; securing more realistic views of owners in terms of price expectations; and having better discipline regarding how a buy-side, sell-side or merger process should be structured and run.

Other areas to work on include the following: the phasing-out of unqualified advisors, since too many deals are still advised by those who lack necessary skills and experience; documenting transactions properly so that legal matters, such as how a deadlock situation is resolved, and financial matters, such as the calculation of an exercise price in case of call and/or put options, are clearly regulated; and finally, ensuring that the anticipated value creation is at least largely secured on the back of a proper and professionally executed integration plan.