Ukraine crisis: fight or flight for private equity?

As the world holds its breath to see if the shaky ceasefire between Ukraine and pro-Russian rebel forces will hold, the EU and US economic sanctions still loom large. While the full extent of the trade restrictions is still unclear, there has already been a tangible impact on companies with import- or export-driven business models.

Is it time for firms exposed to Russia to cut and run, or stand their ground as the Russian bear faces off against the west?

Finnish GP CapMan has chosen the latter option. Hans Christian Dall Nygård, a partner at the GP's Moscow office, says his firm is committed to its presence in Russia. The GP has faced a Russian crisis before in 1998, when it weathered the economic crisis brought on by Russia's sovereign debt default.

The Russian economy returned to growth almost immediately after the 1998 crisis, and with the country's current economy much stronger than 16 years ago, a quick and substantial rebound is not unlikely if the Ukraine conflict is resolved.

"We were one of the only fund managers that did not pull out of the country following the crisis in 1998," says Nygård. "I think that made us very strong, because it taught us how to do crisis management of portfolio companies, where we had some very tough turnaround cases."

Nygård says CapMan is using some of the knowledge gained in the previous crisis to position itself now: "We might find that we have opportunities that others might not get, and the businesses will know that it's easier to work with us because the other GPs might leave the next time there is a troublesome situation."

Buyer's market
While a continuation or escalation of the conflict will see GPs face significant uncertainty, there may be a reward for the firms that brave the storm. An exodus among private equity managers would lead to a more favourable market for buyers thanks to improved supply/demand dynamics.

GPs in the Russian small and mid-market are already seeing less competition than just six months ago, and new players are highly unlikely to enter the market any time soon. Indeed, the European Bank for Reconstruction and Development (EBRD), a key central and eastern European LP, has already halted its investment programme in the country because of the conflict. And as an LP it has side letters allowing it to restrict call-downs on existing investments in the event of further sanctions.

Healthy returns for Russian private equity in the past have not enticed investors, which have instead flocked to emerging markets in Asia and Latin America. The result could be a potential goldmine for GPs with patience and steady hands.

"It's all very bad, but if you have ice in your stomach, now is a good time to invest, as you find a lot of good Russian companies with good entrepreneurs. Firms will have a window of between one and three years where it will be a buyer's market," says CapMan's Nygård.

"Very few – if any – other private equity groups are investing in Russian small and mid-cap, and it's even more difficult for these target companies to find any financing with Russian banks," notes Nygård.

Nygård says CapMan's plan is to invest the money they have over the next two to three years and not rush into investments. The firm will continue its current strategy, looking in particular at companies serving Russia's growing middle class.

The GP will continue to invest in companies and sectors that are highly unlikely to be affected by current or future sanctions or, indeed, internal politics, according to Nygård. He also notes the crisis is likely to influence the length of investments, with a five to seven-year timeline instead of the typical three to four.

Fundraising frustrations
With uncertainty surrounding the impact of the crisis and sanctions on the Russian economy and foreign investors, fundraising has come to a screeching halt in Russia.

In early September, DMC Partners reportedly abandoned a $2bn fund targeting, among others, Russian companies. Despite a management team of three former high-profile Goldman Sachs bankers, LPs apparently lost confidence in the vehicle.

CapMan has also seen the effect on the fundraising for its Russia II fund. The fund held its first close on €97m in March 2013, and Nygård says it will likely be the final close. "We were planning to increase the fund size with a final close this September, but we see now that it's quite obvious there won't be a queue of investors to the fund coming in at the final close.

"There might be one or two, or maybe three investors that we might still be able to get on board, but full-fledged fundraising activity for a Russian fund in today's market doesn't make sense," says Nygård. "It's quite clear that in today's market you're not able to raise any money for a Russia-focused fund."

Sticking it out
According to unquote" data, the fund was originally targeting €175m. Nygård says the first close is more than sufficient for CapMan to continue its strategy and maintain a team in Russia. He adds that the GP is happy to have a fund that is only slightly lower than its previous fund, given today's market.

Though the conflict is currently threatening to derail Russian private equity's plans, Russia remains a market with 140 million inhabitants with close to 60% classified as middle class. Nygård points out there is enormous purchasing power in the country, with very few firms competing, and a lot of potential for investments.

"Even though you have political differences between the authorities in Russia and in Europe, the law of economics still work here," says Nygård. "I hope LPs will find a way back to investors in Russia when this is over."

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