Falling oil prices finally saw the brakes applied to Russian M&A in Q4 2014. We expect M&A to further decline in 2015, both in terms of the average value and the number of deals
2014 saw Russian M&A fall by 38% to USD71.1 billion driven by the impact of falling oil prices and restricted access to capital as a result of sanctions.
Inbound investment declined from March onwards as political tension over Ukraine escalated and Russia was subjected to a range of sanctions. As a result, the value of inbound M&A fell by 53% during 2014 to USD8.0 billion. Oil prices went into free-fall during the second-half of 2014 amid slowing demand and rising global production – Russian production hit a post-Soviet record of 10.67 million barrels per day in December. The fall in oil prices and Russia’s economic dependence on the energy sector led to a sharp devaluation of the ruble with the CBR swiftly increasing the base rate to 17%. This coupled with constrained access to foreign capital as a result of the economic sanctions saw the brakes firmly applied to domestic M&A during Q4, as the value of deals crashed by 85% to a five-year low of USD6.6 billion.
Weakening confidence amongst Russian corporates regarding the economic outlook also took its toll on domestic activity, as investment in both organic and inorganic growth initiatives was put on hold. We expect to see this trend accelerate during 2015 as the economy heads into recession.
Russian M&A was in stark contrast to the global picture in 2014.
Global deal making surged by 44% to a staggering USD3.26 trillion during 2014; only 11% below the 2007 peak of USD3.67 trillion – with the value of deals in the second half of the year actually 4% higher than the same period in 2007. By comparison, Russian M&A in 2014 was 45% below its 2007 level, while Russia’s share of global M&A also fell from 5.1% in 2013 to 2.2%.
Much of the decline in Russian M&A was concentrated in the energy and natural resources industry, and communications and media sector, which experienced a combined USD39.3 billion (52%) decline in the value of deals during 2014 to USD36.7 billion, equal to 52% of total value (2013: 66%):
Despite significant levels of uninvested capital, the private equity industry adopted an increasingly cautious approach during 2014 as economic conditions worsened, resulting in the value of M&A falling by more than half to USD8.4 billion. Much of this decline was driven by the value of acquisitions, which despite a 67% increase in the number of deals, fell by 64% to USD4.3 billion. The largest acquisitions seeing RDIF and Gazprom bank acquire the Ust-Luga marine terminal from Sibur for USD700 million, and Millhouse and Pharmstandart pay the same amount for a 70% stake in the pharmaceutical company Biocad. A total of 18 private equity exists worth USD4.1 billion were announced in 2014, compared to USD5.2 billion in 2013. The largest deals saw United Capital Partners sell its 48% stake in the social network Vkontakte for USD1.47 billion, a year after acquiring the stake for USD720 million, and TPG Capital, EBRD and VTB Capital partially exit the supermarket chain Lenta in a USD1.0 billion IPO.
No Russian mega-deals were announced during 2014 – the first time since 2011. The largest deal of 2014 saw Alliance Oil and the Independent Petroleum Company (IPC) form the USD6 billion NNK-Aktiv joint venture in April, only for Alliance Oil to subsequently sell its 60% stake in the joint venture to IPC in September for USD4.2 billion. The second largest deal of 2014 saw businessman Ruslan Baysarov acquire a further 44.1% stake in Stroygazconsulting for USD5.0 billion. The deal increased his holding in the infrastructure construction group to 74.1%, having acquired an initial 30% stake in the company less than six months earlier for USD4.8 billion.
Average deal value fell by two-thirds in 2014 to USD169 million, as the number of transactions valued at less than USD250 million surged by more than two-and-a-half times to 362 deals while the value of deals worth over USD500 million fell by 57% to USD42.1 billion.
M&A activity increased almost two-fold in 2014 – despite the decline in deal value – with 595 deals announced during the year, up from 316 a year-earlier. Deal volumes peaked in Q2 2014 (189 deals), following six-straight quarters of growth, before slowing in the second half of 2014, as activity fell to the 2013 level by Q4 (115 deals). Transparency also improved during 2014, with transaction values disclosed for 71% of all announced deals (2013: 67%).
Real estate and construction remained the most active sector during 2014 with 153 announced deals (2013: 63), accounting for 26% of total volume (2013: 20%). Transactions involving state controlled enterprises were the key driver of activity, accounting for 42% of total deal volume in the real estate and construction sector during 2014. Elsewhere, consumer markets, communications and media, banking and insurance, and innovation and technology each contributed 10-12% of the growth in the number of deals.
So what can we expect 2015 to hold for Russian M&A?
As a result of the economic outlook, we expect M&A to decline in 2015, both in terms of the value and number of deals. While it is difficult to predict with any degree of certainty just how far the market will fall, recent history shows us that the impact could be significant. The value of Russian M&A declined by 43% during the last recession in 2009, although at that time GDP fell by 7.8% – considerably more than the current 2015 forecasts.
Many of our Asian and Middle Eastern clients are telling us that whilst they are keen to invest in Russia, they are holding off at present until the macro-economic outlook becomes clearer. Nevertheless, recession is likely to see a number of opportunistic transactions during 2015 as corporates with strong balance sheets and private equity houses with uninvested funds take advantage of distressed asset sales.
Automotive and non-food consumer segments will suffer as the economy weakens; the AEB Automotive Manufacturers Committee expects a 24% decline in new car registrations during 2015. Dislocation in these sectors may well lead to deals as stronger players take advantage of consolidation opportunities.
With access to foreign capital restricted and Russia’s sovereign credit rating cut by the world’s largest rating agencies – Standard & Poor, Fitch and Moody – the government has shifted its focused to the East, as China’s leading rating agency, Dagong, maintained Russia’s rating at A, with a stable outlook.
However, anticipated gold-rush of M&A investment from the East has not arrived in recent years. Since 2010, Asia-Pacific investment into Russia has totalled USD5.1 billion, or just 8% of inbound M&A over this period. And although China has been by far the largest investor from the region, accounting for USD3.5 billion (69%) of investment, only two transactions were announced in 2014 – no deal value was disclosed for either. Chinese investors have been renowned for driving hard bargains, with the value expectation gap between buyer and seller contributing to the lack of completed deals during 2014.
Trading fundamentals for the Russian agriculture sector have improved as a consequence of the ban on Western food imports, creating new opportunities for some players. We expect investment into what is an under invested sector to increase in 2015, with Asian players leading the charge.
Divestments, particularly of assets which were underperforming before the current crisis, by non-Russian owners increased during 2014. We expect to see the number of Foreign investors exiting the market accelerate in 2015 as economic conditions deteriorate, although those with a long track record in the country may view this as simply another cycle in the longer term investment horizon of Russia.
Overall, we expect to see a decline in 2015 Russian M&A – domestic activity will suffer from the economic headwinds and low oil price, while Western investors are likely to remain cautious for as long as sanctions remain in place. Weakness of the ruble combined with Russian players focusing on disposals of foreign assets to raise capital to service debt repayments will depress outbound M&A.