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Interview of Tim Demchenko, Global Head of Private Equity and Special Situations at VTB Capital, for Bloomberg

13 June 2013

VTB Capital Trumps Baring Vostok in Russia Buyouts Without Raising Funds

By Jason Corcoran

June 11 (Bloomberg) -- VTB Capital, a unit of Russia’s second-largest bank, overtook Baring Vostok Capital Partners as the country’s largest private-equity investor without ever raising money fr om a third party.

VTB Capital acquired Tele2 Russia, the fourth-largest wireless operator in Russia, for $3.6 billion this quarter, pushing its private-equity total to about $5 billion since VTB Group Chief Executive Officer Andrey Kostin created the unit five years ago. That surpasses the $1.8 billion that Baring Vostok has spent of the $3.7 billion raised for five funds since 1994, according to the company’s website.

“It’s not a standard business model in the marketplace and there’s no denying it’s not for everyone,” Tim Demchenko, head of private equity at Moscow-based VTB Capital, said in an interview on June 3. The Russian state owns a majority stake in VTB Group.

Regulations similar to the U.S.’s Volcker rule will eventually be applied in Russia, making VTB Capital’s current model unsustainable, according to Demchenko. The rule, named after former Federal Reserve Chairman Paul Volcker, would ban proprietary trading at banks and limit how much of their own money they can invest in private equity and hedge funds.

VTB Capital is considering moving away fr om its ‘captive’ model, under which most of the equity for buyouts comes fr om the firm itself, by raising as much as $1 billion fr om outside investors, according to Demchenko.

‘Captive Banking’

Captive private-equity firms can encounter conflicts of interest because they have to please their corporate parents as well as their lim ited partners, said Oleg Jelezko, managing partner and CEO of Da Vinci Capital in Moscow. The practice is prevalent in China and South Korea and becoming less so in India, wh ere banks have started selling their private-equity units, Jelezko said by phone.

VTB Capital may seek to raise a private-equity fund from some of the companies and institutions it has already worked with. Those include Fort Worth, Texas-based TPG Capital, the European Bank for Reconstruction and Development and the Chinese and Norwegian sovereign wealth funds, which bought shares in VTB Group’s $3 billion secondary share sale in April.

“The captive banking model for private equity has admittedly had a mixed track record,” Demchenko said. “Our intent is to start attracting more external capital into our activities through deal-by-deal and fund-like structures rather than trying to deploy more money from the balance sheet.”

The acquisition of Tele2 from Stockholm-based Tele2 AB would have set off alarm bells in other countries, Michael Calvey, founder and senior partner of Baring Vostok, said in an interview in Moscow.

‘Unusual’ Deal

Equity investments by lenders create competition with their own clients, which usually means regulators are forced to have a very high-risk weighting against such deals, according to Calvey. Baring Vostok earned a 500-fold return in 2011 on its investment a decade earlier in Yandex NV, Russia’s biggest search engine.

“It is highly unusual that a regulated bank would make a multibillion-plus acquisition like that,” Calvey said. “There aren’t many countries in the world wh ere regulators would allow this,” Calvey said. “There are also not many countries wh ere banks are involved in private equity from their own balance sheet as a long-term proposition.”

Goldman, Deutsche

Goldman Sachs Group Inc. and Deutsche Bank AG are among banks that have raised third-party capital for private-equity deals in Russia while also investing on behalf of the company, their clients and their employees.

So, too, has the Kremlin’s private-equity fund, the Russian Direct Investment Fund, which has acquired more than $2 billion of assets since it was set up in 2011, according to its website.

Each of those deals was done with co-investors, including China Investment Corp., the $480 billion sovereign wealth fund, and Blackrock Inc., the biggest asset manager.

“Tele2 is indeed a remarkable deal,” Yuri Soloviev, first deputy CEO of VTB Bank, said in e-mailed comments. Sweden’s Tele2 sold its entire Russian unit to VTB even as operators VimpelCom Ltd. and OAO Mobile TeleSystems were offering higher prices.

VTB Capital invests $50 million to $100 million on average in private equity and expects to make three- to four-and-a-half times its money, said DemchenkoVTB Capital has bought stakes in Burger King Corp.’s Russian franchisee, satellite television operator Tricolor TV, commercial real estate and agriculture projects.

Lenta IPO

The bank has sold just four of the stakes it’s acquired to date, including software developer EPAM, which raised $72 million in an IPO in New York last year.

“Our cost base is $400 million and our portfolio has been growing heavily,” Demchenko said.

VTB Capital’s most profitable investment may be Lenta LLC, a supermarket chain based in St. Petersburg. VTB Capital and TPG Capital bought a combined 31 percent stake in Lenta in 2009 for $100 million, leading to a conflict over strategy with August Meyer, the founder of the company.

After lawsuits and a violent brawl at Lenta’s offices, VTB and TPG agreed in 2011 to pay $1.1 billion for the 41 percent held by Meyer, a U.S.-born lawyer. TPG now has more than 50 percent of Lenta, the European Bank for Reconstruction and Development, or EBRD, has 21 percent and VTB Capital has 12 percent, according to Demchenko.

Lenta may hold an IPO in London this year that could value the company at as much as $5 billion, Marat Ibragimov, an analyst at UralSib Capital, a Moscow-based brokerage, said by e-mail on May 29. 

VTB Capital

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