Goldman Finds Perseverance Pays at Kremlin

May 23, 2011, 7:23 PM EDT By Jason Corcoran and Denis Maternovsky

May 24 (Bloomberg) -- Goldman Sachs Group Inc. is making a third attempt in 17 years to crack the Russian market, this time by leveraging a $1 billion private-equity bet to win deals and wooing the Kremlin for roles in asset sales.

The effort is paying off. The firm has jumped to second place in advising on Russian mergers and acquisitions this year, behind Morgan Stanley, after failing to make the top three for more than a decade, data compiled by Bloomberg show. It has also secured pledges from companies including Mail.ru Group Ltd. and Tinkoff Credit Systems to arrange equity and Eurobond deals in return for investing more than $1 billion of its own money.

The bank, led by Chief Executive Officer Lloyd Blankfein, who visited Russia twice in the past year, struggled after opening its first office in Moscow in 1994. It scaled back soon after as part of a worldwide retrenchment, returned in 1998 weeks before Russia defaulted, withdrew almost entirely after the crisis and ramped up again in 2006. Since then, the firm has more than tripled its workforce in Moscow to 150.

“The old perception of Goldman Sachs in Russia is that we haven’t been consistent in our efforts in this country,” said Christopher Barter, co-head of Goldman Sachs in Russia, in an interview in Moscow May 12. “This is not the reality today.”

Advising Medvedev

Goldman Sachs, the fifth-largest U.S. bank by assets, jumped to fourth place in handling equity sales for Russian companies last year, its highest position ever, behind VTB Capital and Renaissance Capital, both based in Moscow, and Morgan Stanley. The company has underwritten the third-largest amount of foreign debt this year, up from 13th place in 2010.

While Goldman Sachs has been slower to expand in Russia than rivals such as Deutsche Bank AG and Credit Suisse Group AG because of concerns about the integrity of financial markets, it may become a co-investor alongside a new $10 billion state-owned private-equity fund, according to two sources familiar with the matter. Blankfein, 56, who along with other bank executives is advising Russian President Dmitry Medvedev on transforming Moscow into a global financial center, is also pushing to win mandates for the Kremlin’s $30 billion privatization program.

The key to success has been private equity, according to Barter, who called it “a major differentiator.”

Goldman Sachs, based in New York, has made more direct investments in privately held Russian businesses than any foreign bank, buying stakes in 15 companies totaling more than $1 billion since 2007, Barter said. The firm’s four private- equity bankers in Moscow made the purchases on the condition that Goldman Sachs get mandates later, according to a person familiar with the deals who asked not to be identified because he wasn’t authorized to speak about them.

Mail.ru Stake

“That has been a magnet for companies wanting pre-IPO financing,” said Barter, who has worked for Goldman Sachs since 1993 and became co-head of the Moscow office in 2007. A Russian speaker, he shares the job with Jean Raby, a French-Canadian who relocated to Moscow in January from Paris, where he headed operations, and is just learning the language.

Goldman Sachs’s investment in Moscow-based Mail.ru helped the bank score a role in the Russian internet company’s $912 million initial public offering in London in November. The stock surged as much as 41 percent on its first day of trading as the IPO was more than 20 times oversubscribed. Goldman Sachs has since helped Mail.ru founder Yuri Milner, CEO of Russian venture-capital firm Digital Sky Technologies, and his partner, Alisher Usmanov, raise $1 billion to finance future investments.

‘Global Behemoth’

“DST is an amazing case study,” said Barter, whose first client in Russia was Milner, 49. “Something really small and unknown in Russia that develops into something truly entrepreneurial, and then grows into a global behemoth by focusing on the Internet and not the commodity space.”

DST Global, Milner’s first fund, owns about 10 percent of social-networking company Facebook Inc., based in Palo Alto, California. He and Usmanov have backed some of Silicon Valley’s fastest-growing businesses. They led a $135 million investment last year in Groupon Inc., the largest provider of online daily deal coupons, and were part of a group that put $180 million into Zynga Game Network Inc., a social-gaming service, in 2009.

Goldman Sachs raised $1.5 billion for Facebook in January in a round of financing that valued the firm at $50 billion.

Along with Deutsche Bank and Morgan Stanley, Goldman Sachs is also managing this week’s IPO on the Nasdaq Stock Market for Yandex NV, the owner of Russia’s most popular search engine.

Private-Equity Fund

“Goldman is a credible player in Russia, and now it has individual success stories like Mail.ru to showcase,” said Kirill Dmitriev, a former Goldman Sachs banker appointed May 18 to run the government’s $10 billion private-equity fund.

The bank also acquired a stake in Tinkoff, a Moscow-based credit-card issuer, in 2007, according to two people familiar with the matter. Goldman Sachs and Citigroup Inc. managed the sale of $175 million of Tinkoff bonds in April. Barter declined to discuss the firm’s clients, and Oleg Tinkov, the owner of the company, couldn’t be reached for comment.

The same month Goldman Sachs also managed the sale of $1 billion of 10-year bonds for Alfa Bank, Russia’s biggest private lender, and $850 million of Eurobonds for Evraz Group SA, the country’s second-largest steelmaker.

Foreign private-equity companies, except Forth Worth, Texas-based TPG Capital, have avoided Russia, which remains a difficult place to do business. The country is the world’s most corrupt major economy, according to Berlin-based Transparency International’s 2010 Corruption Perceptions Index. It ranked 154th among 178 countries, tied with Tajikistan and Kenya.

Investor ‘Uncertainty’

“There’s political uncertainty for investors ahead of next year’s presidential elections, but also uncertainty about reasonable investor interests being upheld in many cases,” said Richard Hainsworth, CEO of RusRating, an independent credit- ratings firm in Moscow.

David A. Viniar, Goldman Sachs’s chief financial officer, expressed similar concerns to investors in February 2006, four months before Blankfein was appointed chairman and CEO, saying it isn’t “clear to us that the Russian authorities are as set on turning the financial markets into modern financial markets with the rule of law as the Chinese authorities are.”

Goldman Sachs first did business in Russia in 1926, when Western banks, including many from the U.S., helped the Communist government raise cash for rural electrification and other projects. The window closed in 1929 when Josef Stalin consolidated power and the U.S. stock market crashed.

1994 Opening

The 142-year-old firm didn’t open an office in Russia until 1994, after the collapse of the Soviet Union, only to pull back in a global retrenchment. The bank returned in June 1998, weeks before the Russian government defaulted on ruble debt, causing hundreds of millions of dollars in trading losses for securities firms worldwide. While the company maintained a representative office in Moscow after the default, it significantly scaled back operations, according to a person familiar with the matter.

“They didn’t see how they could make money then,” said Chris Weafer, chief strategist at UralSib Financial Corp. in Moscow. “Goldman has been accused of many things, but it has never been confused with a charity. It’s always all about making money, and Russia is no different.”

Not long after Blankfein took over in June 2006, he sent David Schwimmer, his Russian-speaking former chief of staff, to Moscow to help run investment banking. The firm won approval that year to become a stand-alone broker-dealer and opened an office in 2007 to accommodate securities sales and trading. In 2008, it got permission to set up a bank.

Letter to Putin

Blankfein has been courting the Kremlin since at least April 2007, when he wrote to then-President Vladimir Putin seeking a meeting to discuss expanding operations. He told investors in New York in June 2007 that the firm couldn’t afford to miss opportunities in Russia and other developing economies.

“If you forgo the opportunities in emerging markets, you’re putting your global franchise at risk,” Blankfein said at the time, acknowledging that he had built his career “in part on not being seduced by certain fads of people investing in emerging markets.”

The bank’s board of directors travelled to Russia in June 2008 for a four-day meeting split between St. Petersburg and Moscow. The trip included a tour of the State Hermitage Museum, a private session with Putin and a speech by former Russian leader Mikhail Gorbachev, according to an account in Andrew Ross Sorkin’s book about the 2008 global financial crisis.

BRIC Capital

Today, deploying capital to the so-called BRIC countries -- Brazil, Russia, India and China -- is a priority for Goldman Sachs’s securities division, Barclays analysts wrote in a research note on May 11 after meeting with Viniar and David B. Heller and Harvey M. Schwartz, two of four co-heads at the bank’s securities unit.

Part of the allure for foreign investment banks is advisory work on the government’s plan to sell $30 billion of assets by 2015 to replenish state coffers and improve corporate governance. The Kremlin is auctioning companies including OAO Sovcomflot, Russia’s biggest shipper, and OAO Russian Railways, the rail monopoly, to help cover a budget shortfall it sees at about 1 percent of gross domestic product this year. It expects privatizations to generate about 1 trillion rubles ($32 billion) in the next three years.

Russia’s last major IPO of a state-owned company was in 2007, when VTB Group, the country’s second-biggest lender, raised $8 billion. Goldman Sachs, which worked alongside Deutsche Bank and New York-based Citigroup on the offering, was selected with 22 other lenders to be an adviser on the new round of asset sales.

‘Greater Opportunity’

“Banks, such as Goldman, will have a considerably greater opportunity to earn fees from deals and advisory work than was the case over the past 10 years,” said UralSib’s Weafer. “The next government will have to accelerate efforts to make the economy more efficient and to raise investment spending to create new industries and to improve infrastructure. Otherwise the country faces a much slower growth outlook and, potentially, a risk of social instability.”

Russia will emerge from the global financial crisis by 2012 and must double productivity over the next decade to achieve its goal of becoming one of the top five economies, Putin, now prime minister, said on April 20. The economy expanded 4 percent last year, rebounding from the worst recession since the Soviet era. It contracted 7.8 percent in 2009, in the wake of the global credit crunch, after posting an average annual growth rate of almost 7 percent from 1999 to 2008.

Deutsche Bank Falters

While investment-banking competition has stiffened with the emergence of domestic players such as VTB, Goldman Sachs is doing better than Deutsche Bank, which has regressed since 2007, when it was the top manager of equity sales in Russia, second in M&A and third in Eurobonds. VTB, which created a brokerage in 2008, has hired more than 100 people from its German rival. Last year, Frankfurt-based Deutsche Bank was sixth in equities and M&A and seventh in Eurobonds.

Andrew Chulack, head of global banking at Deutsche Bank in Russia, said his company is “well-positioned” and had regained momentum following the financial crisis. Deutsche Bank is the second-biggest manager of equity deals this year, having worked on a $640 million IPO for Nomos Bank and VTB’s $3 billion share sale. In the Eurobond market, its bankers are in seventh place.

VTB’s emergence hurt domestic banks more than foreign ones, Chulack said.

‘Good Niche’

“VTB has a good niche, is very well-positioned locally, but is not a direct competitor to us or other foreign investment banks on deals,” he said.

Renaissance Capital, a Moscow-based investment bank half owned by billionaire Mikhail Prokhorov, declined to comment, as did Troika Dialog, Moscow’s oldest brokerage, which is being acquired by OAO Sberbank, Russia’s largest lender.

“The independent banks were under pressure because they didn’t have big balance sheets,” said Rustam Botashev, deputy head of research at UniCredit SpA in Moscow.

Morgan Stanley and Zurich-based Credit Suisse have both profited in Russia because of consistent commitment and strong leadership, RusRating’s Hainsworth said.

“A great deal of work here is down to relationship with the company or the oligarch,” he said.

Last year was the biggest for Russian M&A since 2007, helped by 96 deals worth $50.9 billion in the fourth quarter alone, according to Bloomberg data. Goldman Sachs, second to New York-based Morgan Stanley last year, advised on 21 deals worth $36 billion, including Wind Telecomunicazioni SpA’s $6.5 billion merger in April with VimpelCom Ltd., Russia’s third-largest mobile phone operator.

The bank is currently advising Russian potash producer OAO Uralkali on its $7.8 billion acquisition of rival OAO Silvinit.

Bond-Sale Fees

Managing bond sales helps banks to increase their role in other revenue-generating businesses, including trading the debt and providing borrowers with hedging instruments and loans. Fees from debt origination account at most for about 2 percent of banks’ revenue, according to Mark Rubinstein, deputy head of research at IFC Metropol in Moscow.

Banks get lower fees for underwriting ruble bonds compared with sales in the U.S. Underwriters charge between 0.05 percent of the issue and 0.15 percent for the most creditworthy issuers, and as much as 0.2 percent for “second-tier” companies, said Evgeny Vorobyev, a fixed-income analyst at Otkritie Financial Corp., a brokerage in Moscow partly owned by VTB. The rates compare with average fees of 0.593 percent for U.S. corporate bonds sold this year, data compiled by Bloomberg show.

Goldman Sachs, which has an offshore Russian wealth- management unit in London, plans to hire more personnel in the Russian capital, according to Raby, co-head of the office there.

Hainsworth, a former Renaissance Capital banker who has worked in Russia since 1981, remains skeptical about the bank’s prospects, notwithstanding its recent advances.

“Each time, Goldman has come with a big fanfare and said they were committed before turning on their tails and running,” he said.

--With assistance from Brad Cook in Moscow, Anne-Sylvaine Chassany in London and Christine Harper in New York. Editors: Robert Friedman, Peter Eichenbaum

To contact the reporters on this story: Jason Corcoran at jcorcoran13@bloomberg.net; Denis Maternovsky in Moscow at dmaternovsky@bloomberg.net

To contact the editor responsible for this story: Gavin Serkin at gserkin@bloomberg.net

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