HEAD OF UCP ILYA SHERBOVICH: CRISIS IS THE RIGHT TIME TO BUY ASSETS
Established in 2006, United Capital Partners investment group has invested in major Russian assets ranging from agriculture to Internet technologies. UCP owns shares of the largest enterprises, including those with state ownership.
The principal beneficiary of UCP is Ilya Sherbovich, a former executive of Deutsche Bank who owns a share of 77.7%.
In an interview to RIA Novosti, he discusses the specifics of doing business in a depressed market, the benefits of investing in start-ups, is it a good time for privatization and also talks about why his company sold its stake in Mail.ru and why many Russian companies remain based offshore.
How do you assess the current situation in the Russian economy, do you see signs of recovery, stabilization of inflation, decreasing ruble volatility?
The overall macroeconomic situation is not easy but also is not critical. Indeed, macroeconomic indicators have somewhat stabilised helped by a rebound in oil prices and, paradoxically, by low economic activity. However, some internal and external factors continue to severely hamper the country’s return to normal growth. As for the internal factors, I think, the main negative factor is a lack of understanding of global capital markets drivers, and as a consequence, poor investment climate in our country. Among external factors putting pressure on economy are the current economic sanctions.
In your opinion, is it possible for businesses in Russia to operate profitably in the current high interest rates environment? What is the adequate level of the Central Bank of Russia (CBR) benchmark interest rate for Russian companies?
Current high interest rates make it difficult for many companies to generate returns. Availability of cheap credit is the main prerequisite for economic growth. With interest rates in excess of 14% it is extremely difficult for companies to deliver profitable performance for shareholders. Only high margin traders and monopoly companies with artificially high margins can operate profitably in high rates environment. It is indeed difficult to expect an investment boom until the lending rates decline to at least half of the current level of the CBR rate which is 10.5%. The Central Bank retains rates at a high level to prevent inflation and rouble volatility. The government officials seem to be acting on the basis of the following misconception: “with lower interest rate it will be cheaper to borrow funds in rubles and use them for speculations in FX market”. For some reason, there is a lack of analysis behind this concept. And here again the factor of investment climate comes to play. If local and global investors were comfortable to invest their capital into the Russian market, then the investment flows into Russian assets and local currency would significantly exceed speculative flows.
What is your investment strategy today: do you prefer high risk or low risk assets? Which companies/sectors look most attractive in terms of return on capital today?
UCP is a financial investor. Typically we do not seek control or pursue a management role in our portfolio companies. So far we have managed to find interesting investment opportunities in many different sectors. And we are confident that we will continue to see new opportunities. The key challenge is the ability to identify attractive targets and select the right timing for investment.
Russian assets are still trading at a phenomenal discount compared to assets on other markets. There is a wide choice of names among Russian public companies across different sectors. I would be cautious, however, with companies overburdened with debt as their survival is in question. We are one of the few players in the market who still believe in better times for shareholders of public companies with state control, such as Rosneft, Gazprom, Transneft and others. Sooner or later, reasonable priorities for governing such entities will be established.
What are the reasonable priorities for governing state-owned companies?
Instead of management via directives and micromanagement by different state bodies, the focus should be made on the essence of mechanisms of joint-stock company governance. Shareholders want to see capitalisation growing. Once this factor becomes vitally important for the CEO of a company, then efficiency will inevitably improve, profits will grow, dividends will increase for the shareholders, and investment programs will be rationalised. Should value of a company grow significantly, its managers will get sizeable bonuses. Or, if a manager fails running the company effectively he needs to give way for others. High capitalization of Russian companies does not contradict but, on the contrary, serves to our national interests. If companies are appreciated and respected by investors, they will have no problems operating all over the world and securing financing anytime. This understanding is lacking yet. It is often that you get to hear: “Why are you bothering us with your capitalization! There are more important priorities right now”. Can you imagine shareholders of Apple or Exxon hearing something like that from the management? This is completely unimaginable. That is why there is a strong demand for shares of these companies, while Russian stocks are not doing very well. Again, this may change.
Is crisis a good time to buy or sell assets?
Of course, crisis is a time to buy. But investors who bought cheap Russian assets after 2008 have had to wait for their recovery for too long. Many of them don’t have enough patience. Global stock indices in leading economies are close to historical highs, while Russian RTS index needs to grow three times to return to its historical levels. But we are optimistic. We believe in the future and have patience to wait. But we also are ready to contribute to maximisation of shareholder value of companies in our portfolio in the capacity of an activist investor.
Does UCP have plans to enter new projects? In which sectors?
Yes, we are looking at investment opportunities in various sectors of Russian economy. Our model envisages that, first of all, we invest in companies with strong management teams and with a proven business model. With current assets valuation and lack of capital in the market sometimes interesting projects appear that are worth considering. At the same time, most of our Russian investments in recent years are investments not in rapidly growing companies but in companies with relatively stable but undervalued business.
We do not invest with an idea of “buy in May, sell in July”. There are long-term investments in our portfolio, with a horizon of five to seven years. For example, recent years are characterised by a rather bad commodity price cycle. However, it does not mean that such a situation will last forever. Today, for example, you can buy shares in Rosneft, Lukoil, Gazprom, and they even can go down for a while after you buy them, but they can grow significantly over a horizon of ten years or so.
Are you interested in investing in the banking sector?
We used to consider investing in commercial banks. However, today we are confused by the situation both in the global banking sector and in Russia. Often these are entities with bad loans and non-transparent balance sheets. Shareholders of banks constantly suffer because of restructuring, new share issues and bankruptcies. Look at the fate of Lehman Brothers. Almost every week some banking licenses are being revoked in Russia. In general, I am under the impression that most Russian banks in the middle and lower segments use criminal schemes: they raise funds under a guarantee system and then syphon them for the benefit of their management companies and founders.
Yes, there are good exceptions, most often they are the largest banks, for example, Sberbank. Shareholders appreciate the high quality of its corporate governance. Recently, Sberbank shares were at historic maximum in rubles. Sberbank securities are perhaps one of the few, if not the only, suitable public instruments for investing in the banking industry in Russia now. But overall, banking sector is not interesting enough for us.
Is this a right time to invest in start-ups? Do you consider this possibility in Russia or abroad?
Venture capital investing is not our main focus. But we are sure that the development of technologies and innovative business models are the main drivers of creating value and increasing efficiency. Several years ago we decided to start investing in early stage technology companies and reserved a small amount of capital for such projects. We invested in several companies with strong growth potential and continue looking for investment opportunities in this sector.
What is the potential for investments in technology sector? Can such projects as Hyper Loop replace traditional logistics in the near future, will there be a demand for it from clients and is it economically unviable?
Definition of technology sector is quite broad. We live in an era when technologies, including Internet technologies, biotechnology, robotics, the development of renewable energy sources and so on change consumer preferences, lifestyle, companies and states very quickly. Therefore, it is worth investing in technologies, but the key thing is to make correct assessment of project potential and keep in mind the cyclical nature of the industry. Fashion for everything new and technological has already led to a market bubble. When a company trades on a PE ratio of more than 150 and advertises challenging projects, we are more inclined to take advantage of this trend and short-sell such shares. For instance, we have a significant portfolio of short positions in the US market. As for the Hyperloop, this project is interesting but is very capital intensive. It is quite possible that as a result of its implementation it will become a niche logistics solution for some regions with high density of rich population.
You exited VKontakte, does this mean that you are no longer interested in IT companies, Internet companies? Do you consider the possibility of buying assets in these industries? Perhaps in the telecom industry?
We are interested in IT companies and are ready to consider investing in both publicly traded and private IT companies. Traditional telecom is a mature industry, in our view, there is practically no growth left there, so investment opportunities are limited. However, we have a good expertise in telecommunications infrastructure sector, e.g. in the business of renting mobile operator towers. We continue to study this sector and communicate with market players.
After the sale of our stake in VKontakte, we retained a team with a competence in this industry, we made a number of investments, but nothing large, nothing major.
Now we have sold almost the entire stake in Mail.ru Group which was purchased after we exited from VK. Our decision was motivated by the ruble depreciation. We sold at no loss and earned only a little. Now we retained a very small stake worth of about 25 million dollars, while previously our position was bigger by an order of magnitude.
Has ruble devaluation significantly affected your business?
All investors in Russian assets have been affected by the ruble devaluation because most of our companies have ruble denominated revenues. I would not say that we had material negative consequences but over the past two years we had to revalue some of our positions downwards. At the same time, we continued to buy local assets, especially when the RTS index fell below 750.
Despite the weak market, the Ministry of Finance of the Russian Federation placed sovereign bonds in May. Minister of Finance Anton Siluanov stated that this placement will serve as a trigger for corporate borrowers. Do you agree with this view? Is it a good time for shares and bonds placements? Does UCP have plans to take companies to the market?
Of course, successful placement of sovereign bonds helps corporate borrowers. I guess that the Ministry of Finance and the underwriters/consultants have done everything that could be done in the current situation. Without sanctions, of course, the demand would be many times higher and yields lower. But I am personally impressed by the performance of the organisers who did not complain or looked for whom to blame but did everything possible in given circumstances. We sometimes buy fixed income securities but we do not take issuers to the market. This is the scope of work for investment banks.
In your opinion, is it necessary to raise taxes in Russia? Is business ready for this? Can it be avoided, if not, should it be done now or after the 2018 elections? Will this lead to a return to grey practices?
I am not an expert on this issue but it is obvious that, like in any other country, any increase in taxes will not be welcomed by the business community. And this is ok. There will never be time when businessmen say: “And now you can raise taxes on us, let’s do it!” So here we need good analysis and thorough calculations by relevant state bodies regarding the timing and approach to changing the tax legislation.
In your opinion, was amnesty of capital justified, should it be extended? What is your opinion on Panamagate, is it really true that all the major Russian officials are moving their assets abroad and why?
I do not consider the use of offshore companies as something wrong. The rationale for using this instrument is not tax related only. Now, when foreign controlled companies (FCC) need to declare and pay taxes on their profits, the purpose of offshore companies is often reduced to structuring of complex transactions based on foreign law.
As for Russian officials: I would not generalise this in such way. In the end, this is a matter for everyone to decide for their own. If someone uses offshore structures illegally then that person or entity is exposed to significant tax and legal risks. The amnesty was not worked out enough, and there was more discussions around it than any real result. At the same time, the concept of FCCs has been worked out quite well. As a result, the state will definitely collect more taxes from offshore companies. But the issue is that this capital will remain in offshore banks and not in the Russian banking system.
The Russian industry is currently in a difficult conditions amid a decline in demand and commodity prices. Do we need additional measures of state support for metallurgy and other sectors of economy?
Yes, state support is always needed but within reasonable frame. On one hand, it is important to provide a set of stimulus for increasing production. On another hand, someone has to take on losses of inefficient, poorly managed companies. This problem is typical not only for Russia. Any support has its downside. But it is still necessary to provide help selectively.
The Russian government plans to sell a number of state assets this year. Do you plan to participate in privatisation? In general, do you think now is a good time for privatisation?
We will look at everything that will be sold publicly. It is impossible to decide in advance as the timing of sale and the valuation are very important. If companies are sold at a premium to market then portfolio investors will hardly have an appetite for such assets. If there is an interesting discount, as it usually happens in such transactions, then demand will be there.
From the point of view of the state as a seller, of course, you can only sell assets now for cheap. Usually you would have to admit that the current timing for selling assets is wrong, but if there is no other way to fill the budget then this becomes a compelling necessity.
Do you currently conduct negotiations with Transneft on the sale of UCP’s stake? Does your fund negotiate with other potential buyers? Are you interested in selling the entire shareholding or only a part of it? What could be the price for Transneft preferred shares?
The situation around Transneft has attracted a lot of speculations. I can only say that it wasn’t us who initiated a conversation about the sale. We have been contacted by our counterparty. Negotiations on such transactions are confidential, so our policy is not to comment on them. We, as a financial investor, of course have no plans to keep the asset indefinitely. Therefore, when we get approached with offers, we consider them.
What are the reasons behind your confrontation with Transneft?
We are not against Transneft, we are not against the government. As shareholders, we only want fair dividends. This is a matter of principle. The Board of Directors recommended that shareholders are paid dividends for 2015 at a rate of only 9% of the consolidated profit. This is several times lower than other companies with state control pay.
At the same time, owners of Transneft preferred shares may receive less than a half of the dividend paid for ordinary shares. Such a situation is not acceptable to us as we are the largest owners of preferred shares of Transneft. It is surprising that those who are responsible for the decision making on this matter do not see the consequences of such discrimination for the attractiveness of the Russian stock market as a whole. Look at the register of the largest Transneft shareholders. How are we going to sell shares of other state-controlled companies to the same international investment funds during privatisation?
In early June Inter RAO received from Eurosibenergo a first tranche of 45 billion rubles for the sale of its stake in Irkutskenergo. Will UCP raise the issue of special dividend payment or at least the payment of interim dividends for 2016? In what amount?
Shareholders always welcome dividends if there are no other economically rational uses of funds by the company. Take Transneft, for example. It pays peanuts to shareholders while losing huge amounts of shareholders’ money on dubious derivatives transactions and on deposits in troubled banks. Shareholders obviously are not happy with it. In case of Inter RAO, I do not think that there is an urgent need for an interim dividend, although theoretically this is possible. This year, Inter RAO is completing a cycle of large capital investments. Given the high profitability and stable financial position of the company, we believe that it will be in a position to proceed with higher dividend payout. But this matter is to be decided by the simple majority of shareholders together with the management.
Would UCP be interested in buying a stake in Inter RAO owned by RusHydro (4.92%)? Has RusHydro come up with such an offer? If the transaction was discussed then what was the price of the stake? Market based?
We were not approached with such an offer.
In April last year, Gazprombank and UCP on a parity basis bought Stroygazkonsulting (SGK). What are your plans regarding the road construction business of the SGK – have you tried or will you try to bring to the market? Is there an interest for it on the market? What could be an approximate valuation?
SGK is an interesting project, a unique company with leading market positions. The macroeconomic situation is not easy which affects the industry as a whole. In recent months, the company has restored its customer relationships and is working intensely. Today, we have no intention of exiting this investment. But if we see an interesting proposal, we will consider it.
Original article: RIA Novosti