Russia’s RDIF Courts Sovereign Funds

August 16, 2013 by Craig Mellow

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MAURICE TAYLOR JR., chairman and CEO of Illinois-based industrial wheel and tire manufacturer Titan International, had been eyeing the Russian market without making a move for about four years. An entrepreneur so hard-charging that he calls himself "the Grizz," as in grizzly bear, Taylor has expanded Titan around the world over the past two decades, opening subsidiaries everywhere from Brazil to India.

But the Grizz always thought better of attacking Russia, despite the allure of its vast farmlands and bountiful mines, full of big machines needing tires. Like other investors, Taylor feared the country’s reputation for lawlessness and behind-the-scenes intrigue. "When you put in money over there, you never know whether you really own something or some guy in a BMW is going to drive up one day and announce that he is your new partner," he says.

Taylor’s reluctance began to fade one day in New York last year when he met Konstantin Ryzhkov, a director at the Russian Direct Investment Fund (RDIF), a $10 billion, state-owned vehicle founded in 2011. On closer acquaintance, Taylor found Ryzhkov and his colleagues to be "a pretty sharp bunch of boys and ladies."

His admiration culminated in a June announcement that Titan, RDIF and New York–based One Equity Partners, the private equity arm of JPMorgan Chase & Co., would team up to buy a controlling stake in Voltyre-Prom, Russia’s top agricultural tire maker, headquartered near Volgograd, in the country’s southern breadbasket.

Although the purchase price will remain secret until the deal closes later this year, Taylor is eager to crow about the structure of the purchase, which allows Titan to run and revamp Voltyre-Prom while sharing financial risk with partners and having the strong arm of the Kremlin at the ready to swat aside any pests in BMWs. "We are the general partners right out of the box, with the option to buy out the other partners in three to five years," he explains.

Chalk up another small milestone for Kirill Dmitriev, CEO of RDIF, which is a sort of sovereign wealth fund in reverse. The fund’s rules allow it to invest as much as 20 percent of its cash outside Russia, but its raison d’être is to lure money in as a partner with other sovereign wealth funds and private direct investors. RDIF is limited to a 49 percent stake in any single investment. So its $10 billion war chest should, in theory, leverage to at least $20 billion that can be poured into Russia’s dilapidated infrastructure and health care system or spurring growth sectors like information technology and entertainment.

Most of RDIF’s powder remains dry. But Dmitriev and his colleagues have generated an interesting array of ice-breaking deals with marquee private partners like U.S. technology giant General Electric Co. and asset management colossus BlackRock.

The challenge ahead is to engage sovereign wealth funds in China, Abu Dhabi and elsewhere on much bigger transactions. "These relationships could produce billion-dollar investments rather than ten $100 million deals," Dmitriev observes. But he will have to find Russian capital projects that look safe and solid enough to satisfy the stringent investment criteria of funds like China Investment Corp. (CIC) and Abu Dhabi’s Mubadala Development Co. That will not be easy.

Dmitriev says RDIF has so far committed $620 million, while co-investors have supplied $2 billion. Most of its projects were announced this year.

In June RDIF unveiled a joint venture with GE to build power co-generation facilities at industrial plants throughout Russia; Dmitriev expects his fund’s side of the deal to reach $100 million. It invested $200 million in Russia’s premier stock exchange, the Moscow Interbank Currency Exchange (Micex), joining New York–based BlackRock and the European Bank for Reconstruction and Development. Micex went public in late 2012. The RDIF sank $50 million into the October 2012 London IPO of Moscow-based MD Medical Group, a budding chain of private maternity hospitals (again bringing BlackRock along with it), and $100 million into Moscow IT outsourcing firm Maykor.

Cooperation with fellow state-owned investors is developing more cautiously. CIC, Mubadala and State Bank of India have all signed memoranda of understanding with RDIF establishing multibillion-dollar joint investment vehicles.

Some cash has already been committed. In May the Russia-China Investment Fund, the RDIF-CIC collaborative structure, put nearly $200 million into Russian Forest Products Group, the country’s largest wood-processing company, based in the far eastern city of Khabarovsk. The Kuwait Investment Authority, the sovereign vehicle for the Arabian Gulf oil producer, has a standing agreement to take a minority stake in any RDIF investment, up to a total of $500 million.

It’s not a bad start considering the miserable national backdrop. Russian leader Vladimir Putin effectively kicked off RDIF in April 2011, organizing a Kremlin summit that brought grandees from the sovereign wealth world together with kingpins of Western private equity like Blackstone Group’s Stephen Schwarzman and David Bonderman of TPG Capital.

But Russia’s dollar-denominated RTS Index has lost one third of its value since then, and Putin’s reassumption of the presidency in May 2012 for an additional six years stamped out any flickering hopes for the "modernization" policy rhetorically championed by his placeholder, Dmitry Medvedev. Clampdowns on protest leaders, alliances with gruesome dictators like Libya’s late Muammar Qaddafi and Bashar al-Assad of Syria, and a general sense of rot as oil-driven growth decelerates have convinced most investors that Russia is a place to avoid.

All these adverse circumstances make it "a great time to be in private equity," RDIF’s Dmitriev insists. "The average P/E of the Russian stock market should be 8 or 9 instead of 5 like it is," he says. "But we can take advantage of the low valuations."

Dmitriev, a lanky 38-year-old whose style tends to the rumpled and informal, epitomizes the class of globally skilled smart guys whom post-Soviet Russia has bred in abundance despite an often-glowering official stance. His favorite story about himself describes his first meeting with an American tourist as a teenager in Kiev during the heady days of perestroika. The traveler proffered a T-shirt from Stanford University, and young Kirill decided on the spot — so he says now — that he would attend that far-off temple of learning.

A few years later he did, adding a Harvard University MBA and a stint at Goldman Sachs Group before returning to Moscow in the 1990s to work for a U.S.-founded fund, Delta Private Equity Partners, where he rose to the rank of managing partner.

Dmitriev has amassed a team of a dozen like-minded financial pros. Sean Glodek, his No. 2 at RDIF, is an American of Eastern European background and a veteran of M&A at Deutsche Bank and Lehman Brothers Holdings. Ryzhkov, a U.S. college graduate and the man responsible for bringing Titan International to Russia, joined RDIF from VTB Capital, the once-sleepy state organization that has become the nation’s top investment bank, where he headed merchant banking. Maxim Arefyev, another director, previously worked as an investment banker at privately owned Renaissance Capital in Moscow and before that with ING Barings and Deutsche. Chief risk officer Kishan Pandey is a newcomer to Russia; his last job was heading international private equity for GE Capital out of Hong Kong.

"We felt very comfortable with the RDIF guys because we already knew them from the industry," says Konstantin Povstyanoy, a partner at Moscow’s Baring Vostok Capital Partners, which is considered the foremost private equity house focusing on Russia. Late last year Baring Vostok recruited RDIF as a co-investor on its $100 million buyout of Moscow-based cinema chain Karo Film. "We gave them two weeks to review the documents, and they did absolutely great work," Povstyanoy says. "All their suggestions were constructive."

There’s a contradiction at the heart of RDIF’s mission. The Russian state wouldn’t need an investment vehicle if its own oppressive dysfunction didn’t scare so much private investment away. The country runs huge perennial foreign trade surpluses thanks to its sales of oil, gas and other commodities; the 2012 figure was about $186 billion. That has made Moscow the world’s leading city for resident billionaires, who numbered 131 at last count.

But money leaves Russia nearly as fast as it comes in, as oligarchs hedge their bets against the risk of becoming the next Mikhail Khodorkovsky — the celebrated Yukos Oil Co. CEO who is approaching his 11th year in prison — and entrepreneurs tire of negotiating the swamps of red tape and corruption.

"Russia is a place with tons of money but no capital," says Bernard Sucher, a seasoned expatriate financial player who sits on the board of Moscow investment bank Aton Capital. Net outflows from the country totaled a prodigious $782.5 billion between 1994 and 2011, according to Washington-based watchdog group Global Financial Integrity.

From this perspective, the RDIF strikes some people as a Band-Aid placed hopefully, or cynically, over an artillery shell wound. "The government can’t solve any of the real problems that are keeping investment away, so they create this new show project instead," grumbles one veteran Moscow financier, who prefers to remain anonymous.

Dmitriev keeps smiling in the face of such criticism and trotting the globe pushing the Russian growth story, which persists despite all the negatives. It might not be obvious from reading the papers, but Russia is by far the richest of the BRIC countries, with per capita income of $18,000 at purchasing power parity, and the most educated, with an average of 14 years’ schooling. The middle class, defined as families with annual disposable income above $10,000, tripled between 2005 and 2010 and now includes 30 percent of the population, according to the RDIF website. And so on. The message is seeping through to skeptics like Titan boss Taylor and other onetime naysayers across the world. "Kirill and his team have done a pretty good marketing job," says Baring Vostok’s Povstyanoy.

Comrades in the private financial markets are not the only, or the most important, audience for Dmitriev’s marketing blitz, though. The RDIF crew is also engaged in high-stakes financial diplomacy with sovereign wealth funds from an array of nations that would like closer ties to Russia for its mineral riches or as a geopolitical balance to the U.S. and other powers. But they need investments whose bottom lines and risk-reward scenarios add up.

The key relationship to watch is with CIC. The economic ties between Russia and China are burgeoning. Bilateral trade jumped 11 percent last year, to $88 billion, the Chinese General Administration of Customs reports, and the two governments are aiming for $100 billion by 2015. On a May visit to Beijing with Igor Shuvalov, the deputy prime minister who oversees Russian economic policy, Dmitriev told China Daily that he would like to double the Russia-China Investment Fund, to $4 billion. The fund’s brief is to invest 70 percent in Russia and 30 percent in China.

But Beijing and Moscow can find it tough to agree. Negotiations on a multidecade deal for state monopoly Gazprom to provide Russian natural gas to China — a seeming synergistic slam-dunk — have dragged on since 2004. In June the two countries missed their latest deadline for agreeing on a price. Dmitriev is vague about how RDIF and CIC will spend $4 billion together, other than to say that "the Far East is a very interesting place."

Dmitriev seems to be forging an easier friendship looking West, to France’s two-century-old national investment fund, Caisse des Dépôts et Consignations. Laurent Vigier, Caisse des Dépôts’ director of international affairs, sits on RDIF’s supervisory board and often appears by Dmitriev’s side at fund events. An inveterate Russophile, Vigier has even involved himself in a somewhat quixotic Franco-Russian alliance to transform the violence-torn North Caucasus into an international skiing playground.

RDIF isn’t backing that particular development. Rather, Dmitriev is keen to leverage his friendship with Vigier into his fund’s first investments outside Russia, capitalizing on even-more-dismal investor sentiment in Western Europe. "We are seeing some very interesting opportunities in Europe among companies in France or Italy that can benefit tremendously by selling into the Russian market," he says. He predicts "one or two deals outside Russia this year," one of them probably a French target in tandem with Caisse des Dépôts.

The Russian state is employing a growing army of financiers, and Dmitriev is far from the only one with an impressive global CV. VTB, which leaped to dominance in Russian investment banking by buying most of the team at Deutsche Bank’s Moscow office in early 2008, is now challenged by fellow state banking behemoth Sberbank, which last year swallowed respected private investment bank Troika Dialog.

In the private equity–venture capital world, RDIF is joined by Rusnano, a $5 billion fund launched in 2007 to spur high-tech investment, and Skolkovo, a would-be Russian Silicon Valley outside Moscow that has generous grant money to provide to anchor tenants. But the RDIF appears to be the most promising entity so far.

Rusnano was raked over the coals earlier this year by the Accounts Chamber of the Russian Federation, a relatively reliable monitor of government spending, for various acts of waste, fraud and abuse, including some $450 million poured into a failing solar-battery producer in Siberia. Putin poured on ridicule shortly afterward during a TV appearance to answer questions from the public. "It’s dark when you get up and dark when you go to bed" during the Russian winter, the president observed. "When would these [solar] batteries charge?"

The Skolkovo Foundation is grappling with a scandal of its own: Management was recently overhauled amid allegations of a rogue $750 million payment to an opposition Duma deputy for public relations and marketing services.

Wherever the truth lies — and in Russia it’s usually impossible to know — these blowups at similar institutions are one more indicator of how tough Dmitriev’s job really is. But he’s earned some benefit of the doubt. "People in the market are willing to give these guys a chance," says a longtime Moscow financial professional who’s been negotiating a possible deal with RDIF. "They’re not just a joke like Skolkovo."

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