Investing in Russia

During my groups debate on which project to take on for our M&A pitch book, we all prepared ideas which ended up leading to an excellent conversation when it came time to choose. While we did not end up choosing my proposed topic, I felt that it was a reasonable enough topic to write on for my supplemental analysis. In reviewing world markets, it seemed that most are well valued and some are even inflated (see US) due to accommodative monetary policy. Bottom line being that it was difficult to find huge value in the markets in current times.

After reviewing price to earnings ratios for indices worldwide, I was able to find a region which still has good value. Of course, this excellent value comes accompanied with extensive political risk that scares many investors off. The country of Russia currently has a very attractively valued stock market. Many companies are trading at less than 5x earnings and less than 5x free cash flow as well. While I have heard many horror stories related to investing in Russia, after a bit of research I was not surprised to find that many successful deals occur as well.

While Russia was a member of the original BRIC emerging markets countries, their growth as measured by GDP and ROI has lagged that of the other 3 countries in this classification[1]. In this sense, investments in Russia have been a relative disappointment. However, I feel that Russia still has long term potential for those that are patient and this is evident through their seriously low valuation when compared to other regions of the world. In addition, earlier in 2013 Putin made commitments to welcome international investment into Russia[2]. He realizes that many are weary of the political risk of such investments; however the country is going to great lengths to evade this poor reputation.

Where to invest/potential M&A deals

Oil & Gas

I have highlighted two sectors which I feel offer good potential investment opportunities for an international company looking for expansion options in Russia. The first is obvious, Oil and Gas. As an international leader in Oil and Gas production, this is by far the strongest business segment in Russia. Gazprom would be the first option, although it may be difficult to make an acquisition of Gazprom due to extensive political and government ties into the company. Per the company website, the Russian government owns a slight majority in the company with a stake of 50.02%[3].

Lukoil would be the other Oil giant in Russia, and this company is primarily owned by insiders which lessen the political risk. However, this does not mean a takeover would be easy. Russian government has been known to cause a ruckus in large foreign investment deals, even if they are not a majority shareholder. Lukoil is currently trading at P/E ratio of 4.42. This is an excellent value for any company looking to expand into Russia.

As far as potential suitors go, I would claim that a Chinese CNOOC, a British BP, or maybe even a Chevron or Exxon Mobile would have good incentive to look into a takeover of one of the Russian giants. Chinese CNOOC would probably be the most likely fit, as they are known for their takeovers and acquisitions of other regional Oil and Gas firms (see Nexen). In addition, they are a powerful regional neighbor of Russia’s and geographically a Russian acquisition would seem to make sense. If the acquirer were to be a North American firm, it may be a good idea to consider a stock deal or part stock part cash deal due to the inflated US markets. A CNOOC deal would more likely be a cash deal.

Airlines

Another sector which may hold some potential for a takeover would be the airline industry. Investors have been warming up to this sector in the last year or so, as growth numbers for fliers are finally outpacing the extensive concerns of profitability in the often troubled sector. As international airlines continue to consolidate, the low valuations in Russia could cause some of the bigger airlines to look into this region. Once again though, the Russian government owns 51% of this airline, so this may complicate things.[4] Seeing is it is one of the oldest airlines in the world, the Russian government may not want to divest.

Conclusion

While Russian companies are currently available at extremely attractive valuations, the political control of the nation may cause some to look other places for investment. However, for the right team, with the right skills and connections, they are some very lucrative deals waiting to happen. In my opinion it is only a matter of time before this Russia hones investment and investment hones Russia.

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