Michael Calvey became a venture capitalist 10 years ago, having headed a private equity firm in Russia. He does not seem to regret that he moved from London to Moscow then. Under his management, the funds of Baring Vostok Capital Partners have increased their assets several times, and one of these days Mr. Calvey is launching the third $400 million private equity fund - the largest one after the 1998 default.
- In February you are closing your third fund and it is twice as large as the previous two. Where are you planning to invest such a considerable amount?
- The $400 million raised for the new fund will be invested in companies with the annual turnover over $10 million in Russia and other CIS countries.
- Are the investors the same or have there appeared new ones?
- There are about 25 investors in the new fund - almost twice as many as in the second one. These are mostly large pension funds, insurance and investment companies from the U.S., Europe and Asia.
- What is the Russian share in the portfolio?
- Approximately 85-90%. Though we are looking with great interest at Ukraine and Kazakhstan.
- Will your investment strategy change?
- When we established our first fund, Russia was going through mass privatization; there were almost no fast-growing middle-sized private companies here. Therefore, about two thirds of the fund's resources were invested in companies which had been state-owned not long before. When we launched our second fund (in 2000 - Vedomosti), the situation was different. So, that time two thirds of the funds were invested in new companies and only one third - in formerly state-owned ones.
I expect this proportion to be preserved, but changes are inevitable. After all, those opportunities which looked attractive 10 years ago are of no interest to us now. For example, today it is hardly reasonable to try to invest in a company laying claims to the leadership in the wireless communication market, as the market is already divided among three large players.
- What is the new fund’s lifetime?
- 10 years. The investment period takes up 4 to 5 years. This time is spent on searching and acquiring promising companies, and then we add value to these companies and prepare for sale. If after 10 years we consider it necessary to hold over the exit from any projects, the period will be extended.
- U.S. pension funds are the most conservative investors avoiding risk investments. How did you manage to attract them to your new fund?
- Their primary markets are Europe and the U.S., where 95% of global private capital is concentrated. The opportunities to earn are decreasing, and it is practically impossible to generate 10-15% annual profits. That is why many investors enter the markets where the risk and, correspondingly, the expected return are higher. This does not necessarily mean that Russia will bring them vast sums of money. But even if investments in Russian assets will yield a negative result, this will have almost no effect on the overall performance - their share in the portfolio is too small.
- How do you and your clients evaluate political risks in Russia which, in the opinion of most experts, have dramatically grown recently?
- Of course, the YUKOS affair has scared some investors off. But those who have invested in our fund are confident that YUKOS is an absolutely specific case which does not bespeak the intention of authorities to reconsider the privatization results. Furthermore, the authorities are focusing on corporate giants, while our portfolio comprises middle-sized businesses and the political risk in such investments is considerably lower.
- You have been living in Russia for 10 years. What advice would you give to a good friend of yours who is thinking of starting business in Russia?
- I would say that now in Russia it is easier to lose money than to gain. And if you come here for a short period of time, your business will hardly be a success. Besides, it is very important to build the infrastructure which allows minimizing risks. I have 10 partners here and five of them are Russians. If foreigners just come to Russia, without any experience or contacts, they will hardly manage to achieve anything. I have a good example - Napoleon and his intervention in Russia. (He takes the scheme of Napoleon's campaign down from the wall.) When he crossed the Russian border, there were 422 000 soldiers in his army, he brought 100 000 to Moscow and retreated with only 4000. The same happened to some investment funds which had great plans in Russia, but were forced to concede defeat.
- Russia is considered a very corrupted country. Did you have to gratify to settle matters?
- No. We have come here to stay and reputation is not just an empty word to us. That is why we are ready to earn less, but do our business only by lawful means.
- What do you do, if the procedure of entering a project is protracted? For example, an official would not register the transfer of ownership and you cannot start participating in the company's development.
- If you have a good lawyer and a good team, such a problem can always be solved within the law. All in all, we had about 15 legal proceedings and we always managed to protect our interests. We have never violated the law and, probably, that is why we have very few enemies.
- But competitors are wide awake, aren't they?
- You are right; this is a highly competitive market. Especially in the last 4 to 5 years. And now our main competitors are local investors. In the private equity market in Russia the share of foreign investments makes up only 5%, the remaining 95% is Russian money most of which belongs to 10 largest financial and industrial groups.
- What groups do you mean?
- They are Millhouse, MDM, Alpha, Renova, Interros. However, the number of foreign investors is also growing - Russia Partners, Delta Capital, Carlyle, etc.
- Have you ever had to struggle with other private equity investors for any attractive asset?
- Over the last five years we have made 17 acquisitions, and none of them was a result of a severe corporate war. Generally, we work through the managers of the acquired companies and do not employ brokerage services. This is our advantage: together with entering the capital we ensure the company's financing, share our experience and so forth.
- Have you ever faced unfair competition?
- Two or three times we purchased a business, and when we were going to sell it and were negotiating with potential buyers, others wishing to acquire this asset tried to destabilize the company and knock down the price. We had to protect our rights in court. But now such cases become fewer.
- In Russia it is difficult to do business without the support of power structures, relations with government agencies, etc., in short, without an umbrella of protection. Do you have it?
- I would not say so. We have perfect relations with the authorities of the regions where we work, with governors, presidential administration, various security services. In the past it helped us to avoid certain problems. We do not have the administrative resource, as the Russian financial and industrial groups do, but the contacts we have are quite enough to protect our business.
- Do investors whose money is under your management participate in structuring of investment portfolio?
- They simply invest in our fund, and we make the decision where to invest the capital entrusted to us. Our investors enter the fund for 10 years and cannot reverse their decision and take the money back.
- In Russia, shareholders of closed-end funds or investment funds can influence the managers' decision. What about your clients, can they dispute your choice?
- Private equity funds are closed funds by definition. An investor makes an investment into such a fund and the manager controls the fund's assets. Investors may replace the manager, but only in case of emergency. For example, in 1999 Baring Vostok was appointed a new manager for a small $30 million fund. That was an emergency situation: after the default, the majority of investors and employees of the former management company simply left Russia.
- How much did Baring lose here during the crisis?
- The price of our portfolio dropped by approximately 50 %, but we still had some cash and we used it to buy out shares in the best companies from our portfolio. It helped us to generate a considerable profit when the market started to recover. Especially since our business is less vulnerable to the stock market behavior. Therefore, after the crisis we were able to restore the estimated value of our investments rather quickly.
- Your website says that the first fund has increased its assets three times over 10 years. But some portfolio funds which have survived the crisis managed to show more impressing results. Do your results suit your investors?
- This comparison is unequal as we enter and exit projects not according to a predetermined schedule, but at the most favorable, in our opinion, moment. That is to say our clients may receive nothing within several years and then earn very much at once.
As a matter of fact, portfolio investors purchase an index and revalue their investments almost daily. Last year, for example, our fund showed a 174% growth, and the growth of the Moscow Times index was only 30%. And a year earlier everything was vice versa: our fund generated 20%, and the Moscow Times returned 100%. It is different every year. The only right way to compare our performance is to calculate average annual return. Our average annual return makes up about 25%. This is a net profit - after all commissions, taxes, etc. The average annual return at the Moscow Times index would be only 16%.
- How do you report to investors?
- Consulting firms in the U.S. and UK range all private equity funds in emerging markets depending on their average return for 10 years. This is the main criterion. Such calculations cannot be made annually, because the value of most funds may not even change within a year. This happens only when a fund sells something. Over the last 10 years, according to Cambridge Research analysis, our first fund has been one of the best in terms of return out of approximately 200 private equity funds in Russia, China, South America, India, etc.
- How much have private equity investors earned in emerging markets on average?
- They have not been very much successful over the past 10 years. There was a crisis in Asia in 1997, and then in Russia in 1998, South America was also shaking with fever. Therefore, on average, the profit was below 10% a year. Besides, there are not so many western private equity investors in Russia, though many western managers have tried to work here over the past 10 years. Most of them did not pass through the crisis and had to leave.
I think that in the next 10 years there will appear new names in our ranks and comparisons will become fairer. Russia’s results are among the best in developing countries.
- Is your first fund still working?
- Yes, it has two more years to go.
- Will you close all its projects within this period?
- We will do this, if we see that the time is opportune for selling assets. Otherwise we will extend the period [of the fund's operations].
- The second fund cannot buy projects from the first one, can it?
- No, it cannot. This is a conflict of interest. The participants of one fund will think that they have sold too cheap, and the participants of the other will believe that they have overbought. It is impossible to satisfy all parties.
- What projects are left in the first fund?
- There are four of them. The main one is an oil company, Burren Energy, established in 1994. The company started its operations by transporting oil across the Caspian Sea from Turkmenistan to Russia. Now Burren Energy has turned from an unknown company into an important investor for Turkmenia. Apart from oil production in the Burunskoye field in the coastal zone of western Turkmenistan, the company is carrying out oil exploration and production activities in Congo and Western Africa and operates a cargo fleet of 11 tankers. In December, 2003 it listed its shares on the London Stock Exchange (LSE), and now it ranks among Top 200 companies in Great Britain in terms of market capitalization.
- What else?
- Golden Telecom. When we invested money in it, it was a private company the shares of which were not quoted. Then there was IPO on NASDAQ, and we are still shareholders and have not sold our shares yet. I am sitting on the board of directors together with other largest shareholders (Rostelecom, Alpha, Telenor, and Capital International).
- You have invested the greatest part of funds (18% of the portfolio) in telecommunications. Does this field remain your business priority?
- I think that in the next 10 years we will reduce the share of telecommunications. When we invested in VimpelCom and Golden Telecom, these companies were much smaller than they are now and there were no strong players in the market. It is hardly possible to find [equally promising] projects in the telecommunication industry.
- What industries will take up the decreased share of telecoms?
- This is not our view of the issue. When we find a good interesting project, we shall buy it.
- But you are looking closely into some industries, aren't you?
- They are consumer goods and financial services. We are interested in independent non-integrated oil companies which could be managed effectively, i.e. unlike YUKOS or Sibneft. We can also invest in those companies whose shares are already listed on the stock exchange, but only in case we have the controlling or at least blocking stake.
- Does transport seem a worthy industry for investments?
- Transport is developing rapidly, but for such long-term investors as we are it is difficult to earn good profit on it. The competition is very strong in this industry: there are no entry barriers, and as soon as the profit starts growing, 10 more competitors appear at once and the margin instantly drops. It is different, for example, with consumer goods, when a company has a brand, a distribution network, i.e. a strong position making its business more predictable. It is clear how to build this business to make a good profit and exit it successfully.
- You are looking closely into the financial sector. What are you interested in - a bank, a depositary?
- We have two financial projects already. They are a leasing company Europlan and Rusfinance (established together with the French Bank Societe Generale. – “Vedomosti”) which provides consumer loans to individuals for the purchase of durable goods and loans for urgent needs. We are quite satisfied with the work of them both and are ready to consider other projects connected with rendering financial services to small business and consumers.
- So, telecommunications, consumer goods, finance, oil and gas. What else?
- Timber industry. In this case, it is better to have an integrated structure, i.e. a company having a license for timber and a plant processing this timber.
- They say in the market that you are negotiating the sale of the Ozon online store with Amazon (the largest online bookshop in the world).
- Generally, we do not make comments on our plans concerning sales, but if someone wished to make a purchase, I would know this. Furthermore, there should be solid grounds for exiting from such a successful project now.
- Does this mean that our online shops manage to earn something?
- They certainly do. And the potential is very high.
- Which one of your 20-odd projects was the most successful?
- Burren Energy, I believe. We set up this company together with its management from scratch, having invested $26-27 million in it. And now its capitalization exceeds $1 billion.
- This project has not been closed yet, has it?. Besides, it is not entirely Russian.
- Syktyvkar Forestry was a very successful project. A group of investors, including us, restructured the company, after which it became the most efficient timber industry business in Russia.
- How much did you make on it?
- I cannot give you an exact figure as we have signed a confidentiality agreement.
- Could you give the rate of return at least?
- The average rate of return in 23 projects which we have already realized is 40% [per annum]. Syktyvkar Forestry brought us 44%.
- What about the most unsuccessful project?
- In this business, there are projects where you can lose everything. We had several such projects. One of them was a forestry business in Arkhangelsk - several timber industry enterprises and woodworking mills. After the crisis of 1998, the company failed to get out of losses and we decided to make no more investments in it. We had one more failure just at the beginning of our work with the Sadovoye Koltso chain of supermarkets. One of them, for example, was near the Udarnik cinema, at the present location of the Sedmoy Kontinent store. The plans were grand like in all similar projects - to become the largest chain in Russia. We were minority shareholders and the management had the controlling stake. A number of local and foreign investors held small stakes too. Our stake was too small to control the situation. And when it turned out that the company incurred huge losses, we decided to exit from this project.
These failures have taught us a good lesson. Now we either purchase the controlling stake or combine our efforts with
co-investors. However, nobody can hedge against errors. That is why we should pile up the rocks on successful transactions – then they will be able to compensate losses from unsuccessful projects. In principle, out of our 40 projects we have already closed 23 and written off only three of them.
- How do you usually exit from a project? In the West an investor can sell its share through IPO.
- A real IPO is very profitable, if you are a venture investor. But the company's capitalization must be at least $500 million to ensure successful share placement and liquidity,. Most Russian IPOs were much smaller in volumes. Such transactions are profitable to minority shareholders, and not to principal shareholders like us. Besides, the number of IPOs is not so large. How many IPOs can take place in Russia? One, two, four a year? More is just unrealistic. Thus, this exit tool is impractical for the time being.
- So, how do you solve this problem?
- In different ways. We have sold half of our companies to Russian buyers, a quarter - to western strategic investors and only the rest have been realized through IPO. I think that 25% is a limit [for an exit via IPO] for the future as well; all the rest will be sold in the over-the-counter market, mainly to foreigners.
-Where do you invest your personal money?
- I make most investments in Russia through our funds, even though the risks here are much higher than in the majority of other places. I have investments in China and India because these markets have very good prospects for the next 10 years; but in Russia our funds are holding a real business and I know how much our companies produce, I know their turnover and profit.
There are risks. We shall lose money sometimes. But we can control most risks ourselves. It is better than funds in Asia or America which I have a very little perception of already.
ABOUT THE COMPANY
Management company Baring Vostok Capital Partners (BVCP) is a member of Baring Private Equity International. BVCP manages private equity funds in Russia and other CIS countries with the total capital value of $800 million.
Over 10 years BVCP has invested $336 million in 40 projects in Russia and the CIS countries through its two funds. These projects include VimpelCom, Golden Telecom, Europlan, СТС Media, SladCo, Syktyvkar Forestry, Borjomi. As of January 31, 2005, 23 out of 40 projects were fully or partially realized generating the internal rate of return (IRR) of 44% per annum.
In 2005 there was raised a third fund under BVCP management - Baring Vostok Private Equity Fund (BVPE Fund III) - with the capital of $400 million.
BIOGRAPHY
Michael Calvey was born on October 3, 1967 in Wisconsin, USA. He got his master's degree in finance at the London School of Economics and the bachelor's business degree at the University of Oklahoma. Up to 1994 he worked at Salomon Brothers investment company and the European Bank for Reconstruction and Development (London). At EBRD he was responsible for investments in the energy sector of the Central and Eastern Europe.
In 1994 he became one of the managers of the First NIS Regional Fund and Baring Vostok Private Equity fund.
Mr. Calvey is the Chairman of the Investment Committees for all the three funds under the management of Baring Vostok.
Source: Vedomosti, 24.02.2005, No.32 (1314) Back to Projects List 
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