Baring Vostok: From Russia With Love –

The idea of proprietary deal flow in the U.S. is quickly becoming just a fleeting memory for the older buyout players, and for the new guns, the concept seems more of a myth of the industry. With that said, though, if investors are willing to travel-and rough it’ in the deal-making sense-to regions without the financial framework of the U.S. or Western Europe, then proprietary deals can still be found.

Baring Vostok Capital Partners, an outgrowth of Baring Private Equity Partners, has been targeting Russia for over a decade now, and while critics will point to the financial crisis of 1998 as evidence of the risk involved, Baring can simply point to its returns as confirmation of the strategy; an approach that is centered around finding deals no other private equity firms have looked at.

“In five years we haven’t done a single deal that was part of a competitive auction,” Baring Vostok Co-Managing Director Michael Calvey says. “There have been massive changes over the time that we’ve invested in Russia. There’s been two financial crises, two Chechen wars and a currency default in 98, but despite all of that, we’ve managed to make money in every year. In the mid 1990s we were buying cheap industrial assets of rapidly growing companies. We could clean those up and sell them to a strategic buyer without much risk. We were essentially buying assets for five cents on the dollar and selling them back to strategic buyers for fifteen cents.”

The Launch

Baring Vostok raised its first fund, NIS Regional Fund I, in 1994, taking in a haul of $160 million. Of the 22 direct investments the fund made, 18 have been either realized or liquidated at an average return of roughly 2.7x cost, with a gross IRR of 49% per annum. In all, the NIS Fund has paid dividends to shareholders of $304.2 million and the four remaining companies in the portfolio are currently valued at $160 million.

While the bursting of the tech bubble still causes investors in the U.S. to grimace, the fallout of that crisis pales in comparison to what the Russian economy saw in 1998, when a spiraling GDP, soaring inflation and an out of control Federal deficit led to an economic disaster that in some ways is still being felt by the country’s economy.

For the private equity houses that viewed the fall of communism as an opportunity in the early 1990s, the fall of the Russian economy at the end of the decade meant it was time to reassess the investment thesis, and for most, that meant it was time to flee.

Baring Vostok, meanwhile, looked at the collapse as an opportunity, and while others were running for the exits, Baring was doubling down on its investment strategy.

“The financial crisis actually had a more positive impact than negative,” Calvey says. “And most companies in Russia became profitable almost immediately afterward, as product pricing became linked to the dollar.” Perhaps most important, though, at least for Baring Vostok, was the dilution of competition, and Calvey cites that after the crisis, “The private equity industry became much less competitive.”

Amid the retreat of other investors, Baring Vostok raised its second fund, a 2000-vintage $205 million vehicle. The fund, which is currently 67% invested, was the first and is currently the only fund that was raised after the crisis, according to Calvey.

The lack of competition even extends beyond private equity, and the absence of a financing market has assisted Baring Vostok as well, even though the very idea of leverage in its buyouts has been nonexistent. “For a long time, there has not been any financing, which means we have been able to invest in the country’s primary industries at reasonable valuations. Private equity capital in Russia is one of the only sources of financing, and it makes our bargaining power greater than it would be otherwise.”

The Road Ahead

In the four years since the collapse, the Russian economy has been steadily growing, and with Vladimir Putin’s rise to presidency in 2000, the country has achieved a comfort level not seen in a long time.

“There has been a steady increase in political stability since Putin became president, and for businesses, that’s led to an increase in capital investment.”

But with the stability, comes competition, as foreign investors are no longer spooked by the perceived perils. The Carlyle Group, for one, announced last month that it would reopen its office in Russia. Additionally, with the economic improvement, financing options are also slowly developing, giving businesses an option outside of private equity.

However, for Baring Vostok, which has been quick to adjust during its entire stay in Russia, the firm is not worried about the entry of any new corrivals. “In the next few years I think we’ll start to see the first few leveraged buyouts in Russia,” Calvey says. “Even if it’s 50%/50%, debt to equity, being able to find leverage will represent a great opportunity that hasn’t been there.”

As far as the increased private equity competition, Baring does not expect to see its deal flow diminish any time soon. “When others were leaving the country, we decided to reinforce both our business and our commitment to the market. And that we did so at its darkest moment is certainly a factor that we’re benefiting from today.”

Baring Vostok is currently finalizing the PPM for its next fund, which will have a target of $300 million and is expected to launch in May of this year. Despite the changes in Russia, Baring does not expect its thesis to change drastically. The firm will continue to focus on the same industries, concentrating on oil and energy, branded consumer products, telecom, media, financial services and technology, and will pursue both later-stage growth situations and buyouts.

“The main difference was that in the mid 1990s we were focused on buying cheap assets. Now that’s shifted to concentrating on assets that are growing rapidly,” says Calvey.