Mr. Ryan, Red Herring
is known for its investments tips, telling its readers
where new investment opportunities are to be found.
So what would you recommend to the readers of Red
Herring who have an interest in the Russian economy?
Charles Ryan: I imagine that the readers of
RED HERRING are mostly focused on equity, and there
has been a very large re-rating of Russian risk
and yields on Russian sovereign bonds have fallen
from almost as high as 20% about 18 months ago,
to well under 10% today, (currently around 8%) and
falling ¼ % down further. What usually happens
in a capital market when you have that kind of re-rating
in the debt market is that you see a similar re-rating
in the equity market. Some of this has already happened,
so in that same period of time, the Russian stock
market index has doubled from 200 to almost 400
(on the index that we look at as the RTS index).
Yet we have to put this all into a historical context.
When the Russian market was at its all-time high,
back in late 1997, this figure was around 575 before
the crisis of 1998. Today the oil price is at about
$27.5 per barrel, while back in 1997 the oil price
was actually about $15 per barrel.
Arguably today there is still some upside left in
the Russian stock market, most of which is in the
natural resources sector, such as oil and gas, power
generation and telecom. Yet the most interesting
segment is in the segment of the Russian economy
that was not privatised, because it did not exist
during the Soviet Union. That is being reflected
today in IPOs [Initial Public Offerings] of companies
like the juice maker Wimm Bill Dann, which is certain
to be followed by other IPOs in other companies
offering some services and products that did not
exist previously, but are increasingly in demand.
These are companies like RU-NET and systems integrators,
for example.
If we look at the RTS right now, it is growing
substantially, yet a lot of people are saying that
it is overvalued and it is going to bottom out.
What is your prognosis?
Ryan: I think that everything is relative; arguably
it has probably risen quicker than any of us expected.
But when people are looking for new markets for
investments opportunities, it is partly a function
of what other opportunities exist elsewhere.
Following the dog days of the Russian market after
1998, when Russian companies were not valued at
all, equities have come to a point today where they
are valued at about half their global peers. Our
view is that they still have upsides, and they could
still prove to be interesting investments for people
who consider what the potential upside is. It is
much more likely that Russian companies will go
from an enterprise value of 4 to 5.5 or 6. At the
same time, I think that it is likely that a global
company will go from around 8 to 12.
IPO potential is growing in Russia, from small
start-ups like RU-NET to major companies like MTS
[Mobile TeleSystems] spinning off parts of their
operations. What does this growth represent for
UFG in financial terms?
Ryan: What it basically means is that there
are two ways sources of capital today for Russian
companies; one of them is by attracting financial
investors through public and private markets; the
other is through strategic financial investors.
So a great deal of UFG's business comes from merger
and acquisition advisory work for western strategic
investors looking to acquire assets here, or in
advising Russian companies during negotiations with
western acquisitors. There are also many of mergers
and acquisitions going on today that involve Russian
companies and acquiring companies from Eastern and
Western Europe. It is a combination of us intermediating
more capital flows to financial investors and Russian
companies, playing a role as advisors in merger
and acquisition transactions as well.
Where did the inspiration to start the New Technology
Group (NTG) come from, and did you not feel it was
a little bit risky, bearing in mind the post-Internet
boom?
Ryan: The roots of it were in a private equity
fund that we created in 1997 with Columbia Capital,
which is a Virginia-based private equity fund. We
went through the whole process of raising a private
equity fund to invest in Russian telecom and information
technology companies, but then we effectively decided
to give our money back and not to proceed because
of all turbulence created by the financial crisis
of 1998. Nonetheless, the interest that we had in
Russian telecommunication and technology investments
was still there, even if the capital was no longer
available in the amounts we wanted, so we started
to talk with one of the founders of Columbia about
their willingness to commit their resources, irrespective
of the fact that we had not followed through in
closing the fund, and to make some investments here.
One of the things we quickly realised was that,
on one hand, there was not a lot to invest in and
we would have to find someone who could create something
here, yet on the other hand we realised that Russia
is at a very different point of the technology cycle.
For example, US investment in IT [Information Technology]
is completely saturated, but you cannot import that
trend to Russia, because the economy is at an entirely
different point in the investment cycle. Today numerous
Russian companies are making investments in IT similar
to those that we did in the US 10 years ago. This
means that even if today it would not be such a
great time to invest money into US system integrators,
it is exactly the right time to do it here. It was
the right time in the US in 1989, and it is the
right time in Russia now.
Mr. Boguslavsky, you started with the concept
of RU-NET, which is an example for many Russian
entrepreneurs looking to start the same business.
What was the path that led you to the door of Charles
Ryan?
Leonid Boguslavsky: When I first started business
in Russia in 1990, my business idea to build up
a system integration company. For several years,
a number of technology vendors entered the Russian
market through my company - LBS. We were working
with vendors like CISCO as business partners for
the Russian market. I then sold my company to Price
Waterhouse Coppers (PWC), which was the first transaction
in Russia of a traditional service system integration
business.
Then after being for over 4 years a senior Partner
in PWC, I started to think about becoming a venture
capitalist. The most important issue was the market
situation. IT is a brand new post-Soviet industry,
and the IT and computer market really started growing
in 1990 and it became one of the most well organised
industries in Russia. It is also one of the most
transparent industries; people are learning corporate
governance rules and implementing them in their
companies.
The IT market is very fragmented - it grown into
a pyramid, represented by a few leaders on top,
dozens of mid-sized companies and numerous small
companies below. Yet what is happening now is the
whole pyramid is lifting up. There are a number
of mature businesses which have been built during
these ten years, but there are not a many mergers
and acquisitions in the market.
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Since I was not an active
player in the IT market, and I was also well-connected,
I was in a position to develop partnerships as an
experienced and neutral person. I knew that there
was enough room to grow the market further, so I
was keeping an open eye for financial investors
and partners who would be experienced both in investment
banking and in the equity market.
So I was looking to start a mergers and acquisitions
game in Russia, and I accidentally met Charles Ryan.
In total we are four major partners, and I think
we are an excellent team because we have a business
development side, an entrepreneurial side, along
with investment experience.
You have already made some Internet investments
already… What characterises your major investments
so far?
Boguslavsky: We have made three major investments,
which includes system integration and IT services.
We invested in one of the leaders in system integration
and merged this company with three other properties
in order to diversify its operations. By merging
this company into a regional system integrator,
it became one of the largest Russian IT enterprises.
We then merged it with a web development software
outsourcing team and added to this an IT training
centre. So this how we formed our IT services "basket",
under just one company. This merging of four entities,
with different cultures, client bases, and activities
was a very interesting experience.
With this foundation and experience, we were looking
to add other services initiatives, technology and
business lines to the same basket. Another investment
was two years ago when we invested in YANDEX, a
Russian search engine which was positioned as the
number 4 web page search engine in Russia. Today,
two years later, it is the no. 1 search engine in
Russia and hold a 36 % share in the company.
Our third investment involved OZONE, the Russian
"Amazon". It started as an e-commerce
project (probably the oldest e-commerce in Russia),
and grew from being an Internet project to a retail
project. We have used the Ozone brand to build up
other sales channels and we are now selling over
350 000 books, CDs and videos monthly, which equates
to almost USD 5 million and growing. We have also
just added a catalogue of the same brand offering
the same products for people without a computer.
Although it might be true that today many Russians
might not have computers, tomorrow they will, so
we are building the brand name and preparing for
an additional future client base.
The IT sector suffers from a lack of liquidity,
yet you have succeeded by finding the right partners
and concentrating on a specific market niche. What
are your strategic goals for the short term regarding
this niche?
Boguslavsky: This is a profitable business
and we are growing quickly. To do this we treat
all three of our properties differently in terms
of strategy. With regard to the biggest one, which
is the IT service business integrator, we have built
a clean, transparent, well-capitalised client base,
and in three to five years as we may decide to announce
a public offering.
Another possible business strategy might derive
from eventual mergers and acquisitions from such
companies IBM and Hewlett Packard (HP). Well-established
Russian companies would be a huge resource for foreign
companies since they already hold a strong client
base. The price for the ticket to enter the Russian
market is very high. Companies like IBM, Oracle
and HP are selling their products rather than services.
Yet there are many IT services companies who do
not have their own products, but are selling services…
so there is still much to be done.
In light of the success of this partnership with
RU-NET, what other sectors is UFG looking to jump
into?
Ryan: The IT sector was something new and
exciting, and there are many other areas that we
are looking at, especially in the goods and services
sector where you can find Russian entrepreneurs.
There are major opportunities in retail, consumer
goods and high tech. The other area where we see
some opportunities is in the large, slow moving,
complicated restructurings of the natural monopolies,
such as gas. There are already many opportunities
in the utilities sector, and new business opportunities
in the gas sector are also promising.
Generally speaking, at UFG we tend to look at major
opportunities where there is a way to analyse what
the future will bring in an industry that is going
through structural changes. I personally believe
that the real growth for Russia will come from the
untapped potential of intellectual capital.
What is the strategy right now to get people
think about Russia, and to invest with UFG?
Ryan: For a long time it was a challenge
to convince people that the mafia did not run Russia,
and that Russia was actually a European country.
These days investors are more confident about the
Russian market, yet what is more difficult is the
recognition of Russian country risk and charting
a path for the client to invest in. So even though
it might be easy to sell Russia, it is not always
clear what you are selling. There are some people
that are happy to make long-term investments, knowing
that the story will be continuous and that it is
the time to buy today. Yet other investors are not
sure that public markets are right for them, preferring
private placements and equity instead. Our job is
to explain why public markets still represent good
value, relative to other markets and investment
opportunities, and help them broaden their investment
portfolio.
You studied government at Harvard, then worked
for the European Bank for reconstruction and development
(EBRD) in London before coming to Moscow. How does
this experience help you bring innovation to UFG?
Ryan: Studying government sparked my interest
in Russia, and the topic of my senior thesis was
Soviet Foreign policy. I later started to work for
EBRD in June 1991, and concentrated on private equity
investments in various countries. The first projects
that I worked on for EBRD was in Poland, then I
was sent to Saint Petersburg to work on the reform
and privatisation of Saint Petersburg's assets.
Two things happened there: I met my partner Dr.
Boris Fedorov, who was my boss, and we became friends;
then I was given the chance to live and work with
the Saint Petersburg team, who were people like
President Putin and Anatoly Chubais. The main lesson
I learnt was that international western financial
models and principles could not be applied directly
here. You have to apply them creatively, and that
is the key lesson to keep in mind when investing
in Russia.
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