Press Clippings

06 February 2008Russian investment banks are bidding aggressively for talent just as the booming markets show signs of cooling. — Edward Kaufman, Russian  Banking — Ruble High-Rollers

Whether providing financial counsel to former Yukos chief Mikhail Khodorkovsky earlier this decade, before his imprisonment, or advising on IPOs for steelmakers Severstal and Mechel, Edward Kaufman can often be found at the heart of the action in Russia’s financial markets. This was never more true than on Kaufman’s latest, and arguably greatest, deal, which involved none other than himself.

In March the 42-year-old American left UBS, where he had been the Swiss firm’s investment banking chief in Moscow, to run the fledgling investment banking business of Alfa Bank, the domestic lender owned by billionaire Mikhail Friedman. Kaufman’s guaranteed compensation in the new job has been reported to be as high as $20 million, a figure he merely says is «exaggerated.»

«A headhunter told me I was in a perfect storm,» Kaufman tells Institutional Investor during an interview at Alfa’s dowdy headquarters on the site of a former Soviet research institute just off the Garden Ring, the gridlocked boulevard that encircles central Moscow. «There are a lot of banks trying to expand across various products and disciplines and fewer experienced people than the market demands.»

Kaufman is hardly alone in benefiting from this frenzy. Banks in Russia have been on a hiring spree for the past year, one that is continuing in spite of the global credit crunch, as firms seek to take advantage of a surge in stock and bond issuance in the country. The arrival of new entrants, such as Alfa and Lehman Brothers, combined with a relative paucity of seasoned bankers has prompted a wave of high-profile poachings, pushing salaries through the roof. «I know a few people who have gotten $10 million plus options guaranteed for two or three years,» says Igor Shekhterman, managing partner of RosExpert, a Moscow-based executive search firm that represents global headhunter Korn/Ferry International in Russia.

Bankers believed to be in that lofty bracket include Nicholas Jordan (brother of the pioneering Moscow financier Boris Jordan), who left his post as co-head of Russian banking at Deutsche Bank in April to jump-start Lehman Brothers’ Moscow office, and Ruben Aganbegyan, who was promoted in December to CEO for Russia from head of investment banking at Moscow-based Renaissance Capital. Jordan, like Kaufman, is among a handful of senior Western bankers who have spent most of the post-Soviet period working in the Russian market; he is known for his close relationship with Gazprom, the giant state energy firm, which he advised on its $13.1 billion acquisition of oil company Sibneft.

Aganbegyan is a westernized Russian. Son of one of Mikhail Gorbachev’s top economic advisers, he worked at PricewaterhouseCoopers, law firm Clifford Chance and Credit Suisse before landing at Renaissance in 2002. His 2007 credits include managing a $1 billion initial public offering by chemical giant Uralkali in October and a $670 million IPO by oil services group Integra in February. He declines to comment on his pay package but says, «I think really top people all over the world are well taken care of.»

That is certainly the case in Russia. While financiers in New York and London are fearing pink slips and slashed bonuses because of losses from the worldwide credit crisis, Moscow has become a bastion of the good life. Bankers at the managing director level earned $2 million to $4 million in 2007, while mere mortals on the sales and trading desks pulled down an average $1 million, says Nicholas Rees, president for Russia of London-based search firm ExecuZen. That puts most Moscow bankers comfortably ahead of their counterparts in London and New York, once Russia’s flat 13 percent income tax is taken into account.

Even at those pay scales, banks are hungry to sign up more talent. «All the good people I have, I’ve got four or five houses bidding for them,» claims Rees. Although some major international houses have slowed hiring because of the global credit crunch, local banks and European firms are picking up the slack, says Fiona Porter, president of executive recruitment firm Whirlwind Search in London. Germany’s Dresdner Kleinwort announced in December that it would hire 60 new bankers in Moscow, for instance.

A new investment banking hierarchy is emerging out of this competitive ferment, with local houses like Renaissance and Troika Dialog going head to head against such heavyweights as Deutsche, Citigroup, Credit Suisse, JPMorgan Chase & Co. and Morgan Stanley, whose global networks are helping to satisfy the increasingly international ambitions of Russia’s biggest companies.

Meanwhile, the fruits of prosperity are pouring into trendy Eurasian fusion restaurants such as Moscow’s Cafe Pushkin and Turandot, where dinner starts at $200, and lounges like Shatush and Postscriptum, which offer Turkish coffee and a hookah, the latest fad in conspicuous consumption, for $100. Even normally modest bankers like Ruben Vardanyan, chief executive of Moscow-based Troika, have caught Gatsbyesque fever. Troika threw a late-summer lawn party for a thousand-odd guests at the historic Kolomenskoye Estate in Eastern Moscow, with pop star Prince headlining the entertainment. Vardanyan arrived by parachute, and distributed $10 million in early bonuses to Troika’s 900 employees.

As ever in the volatile investment banking business, the risk of the big splurge is that banks are shelling out far more in compensation than they can ever hope to earn back in fees. Already there are signs that Russia’s financial market is topping out, or at least pausing for breath, after three years of explosive growth. The benchmark Russian trading system share index was up a modest 28 percent in late December from the start of the year, compared with gains of 62 percent in 2006 and 85 percent in 2005. That 2007 performance trailed far behind those of other emerging markets like Brazil and China. One reason: a tax policy that hands the Kremlin 85 cents out of every dollar rise in petroleum sales, limiting profit growth in the sector that still accounts for 70 percent of Russia’s market capitalization. Profits at Lukoil, Russia’s largest privately owned oil company, fell 2.2 percent from a year earlier, to $6.23 billion in the first nine months of 2007, even as revenues rose by 11 percent.

Growth in equity offerings, a big driver of the investment banking buildup, has slowed considerably in recent months. Equity issuance rose to $34.8 billion last year, from $20.5 billion in 2006 and $6.7 billion in 2005, according to data provider Dealogic. But nearly half that total came from two massive offerings early in the year: Sberbank’s $8.8 billion rights issue in February and an $8 billion IPO by Vneshtorgbank, the country’s second-largest lender, in April. VTB shares, which were marketed aggressively to small investors in an operation dubbed the «people’s IPO,» were trading in late December at 9 percent below their offering price.

In September, Rusal, the world’s biggest aluminum producer, controlled by oligarch Oleg Deripaska, indefinitely postponed its plan for a blockbuster IPO that analysts had expected to total about $7.5 billion. That leaves the global banking elite to fight over half a dozen humbler new issues, like the $996 million that utility OGK-2 raised in October, or electronics retailer M.Video’s $365 million IPO in November.

Banks are thought to have earned little, if anything, even on many of the bigger Russian deals because they extended preferential loans or slashed commissions to obtain a seat at the table. For advising on Sberbank’s rights issue, for instance, Credit Suisse and JPMorgan reportedly shared a $10 million fee, or 0.1 percent of the transaction. That compares with an average equity issue fee of more than 2 percent in Europe and 6 to 7 percent in the U.S.

Russian corporate borrowing has also slowed significantly as a result of the global credit crunch. Debt issuance rose to $48.7 billion last year, from $43.2 billion in 2006 and $23.7 billion in 2005, but nearly 90 percent of the year’s issuance took place in the first three quarters, before the full force of the credit crisis hit.

«The debt markets are pretty much closed now, whether for eurobonds or domestic,» says RenCap’s Aganbegyan.

Despite those warning signs, banks are sticking with their expansion plans. Most regard Russia as a secular growth story that reflects the country’s emergence as a major economy after the post-Communist chaos in the 1990s. Economists predict that strong oil prices will keep growth humming at a rate of 6 to 7 percent a year. And financiers expect continued political stability following President Vladimir Putin’s selection of his first deputy prime minister, Dmitry Medvedev, as presidential candidate for his ruling Our Russia Party in the March election. Two days later, Medvedev announced that he would, in turn, tap Putin as his premier. Medvedev, a 42-year-old St. Petersburg lawyer, is viewed as a pragmatic, liberal-leaning choice compared with rivals such as Sergei Ivanov, another deputy prime minister who began his career in the Soviet security services.

«Russia is no longer an opportunistic market,» explains Steven Hellman, co-head of investment banking client coverage at Credit Suisse in Moscow. «We need to cover clients here the same way as in the U.K., which means dedicated sector and product specialists on the ground in Russia.» He says he needs seven or eight senior bankers supervising core sectors.

Alfa’s Kaufman also sees the Russian market becoming institutionalized, like other fast-growing emerging markets. «The craziest thing in this market is that the crazy stuff doesn’t happen anymore,» he says. «It’s all just business as usual.»

For most of the country’s post-Communist history, Russia’s securities markets have been dominated by four firms that started up in the early-to-mid-’90s: Troika, which Vardanyan, a 39-year-old Moscow entrepreneur, has run since 1992, one year after its founding; Renaissance, which was launched in 1995 by Boris Jordan and is now headed by New Zealand native Stephen Jennings; United Financial Group, which was started by American banker Charles Ryan and Russian economist and politician Boris Fyodorov; and Brunswick, which was founded by Martin Andersson, a Swedish banker who came to Russia to advise former privatization czar Anatoly Chubais. Warburg Dillon Read, the investment banking arm of the former Swiss Bank Corp., acquired half of Brunswick in 1997, shortly before SBC was bought out by UBS.

Credit Suisse was the biggest foreign player in the ’90s, but it withdrew for several years after losing almost $1 billion on loans to Russian banks and on government bonds, known as GKOs, after the state defaulted on its debts in 1998. That financial crisis also sent most other foreign bankers packing.

Global banks began reentering the market early in this decade as Russia’s economy and markets recovered. The trend gathered momentum in 2004, when Deutsche Bank paid $70 million for 40 percent of UFG; it acquired the remainder in 2006 for a reported $600 million. Also in 2004, UBS bought out the 50 percent of Brunswick it didn’t own for $165 million.

Citigroup, Morgan Stanley, JPMorgan, Merrill Lynch & Co. and Goldman, Sachs & Co. are among the foreign banks that have been aggressively looking to bulk up in Russia lately.

Both Troika and RenCap reportedly dallied with numerous suitors recently. Troika is widely believed to have come close to agreeing to a sale to JPMorgan early last year, but local players speculate that the Kremlin vetoed a deal because of its desire to have at least one leading investment bank under Russian ownership. Vardanyan does not go into detail when asked about the speculation. He tells II, «We refused to sell in February to one of the big banks, and made a strategic decision to remain independent for the next three to five years.» JPMorgan declined to comment on the reports.

Domestic players are also getting into the game, including VTB, the state-owned No. 2 bank that is hiring investment bankers in both Moscow and London. Commercial banks backed by Russian oligarchs, such as Alfa, Uralsib Financial Corporation and MDM Bank — Russia’s fifth-, seventh- and tenth- biggest lenders, respectively — are following suit, hoping to cull advisory and underwriting fees out of their existing lending relationships. «We want to be the go-to bank for Russian corporates,» says Alfa’s Kaufman. «We have 51,000 corporate banking clients. It’s logical to move into giving them M&A advice and IPO advice.»

Investment banking employment in Moscow has roughly doubled in the past three years, to 5,000 from 2,500, ExecuZen’s Rees estimates. Still, the local talent pool is far too shallow to support the ambitions of so many banks, a fact that makes the poaching fierce even by the cutthroat standards of investment banking. «Where do you get people?» RenCap’s Aganbegyan asks rhetorically. «From the competition.»

Bankers grumble that everyone’s salary but their own is too high. «The intensity of recruiting has created a bubble for resources, with talented bankers able to earn multiples of what they are getting in other parts of the world,» says Credit Suisse’s Hellman. Still, he sees little choice but to join in the bidding. Hellman, who worked in Moscow for Credit Suisse in 1997–’98, moved to the U.S.  after the default and then returned in late 2006, believes the country’s economy and markets are on a sustainable growth track.

Merrill Lynch staked its claim by recruiting veteran banker Bernard Sucher in February to head up its Moscow office. An American who co-founded Troika with Vardanyan, Sucher ran Alfa Bank’s $1 billion asset management business before joining Merrill.

JPMorgan managed to lure away more than a dozen professionals from MDM in June, led by the bank’s equities chief, Vladimir Bril, and research head, Alexander Kantarovich. For the most part, however, global banks hoping to cherry-pick staff from Russian houses have been disappointed. Goldman is still hunting for a Russian CEO, RosExpert’s Shekhterman reports, and Lehman has struggled to make senior hires to complement Jordan. Renaissance and Troika have proved particularly adept at hanging on to their talent. «Goldman tried to hire 180 people in Moscow and failed,» Vardanyan claims. «They saw it’s not so easy.» Spokesmen for Goldman and Lehman declined to comment.

Jennings has opened RenCap’s wallet to poach multinational talent from its rivals. He lured his investment banking head, Andrew Cornthwaite, from Credit Suisse in London in 2006, and took Gordon McCulloch from Goldman Sachs’ Moscow office, putting him in charge of derivatives last year. The talent is producing results. Renaissance jumped to second place in Russian equity underwriting in 2007 from sixth in 2006, according to Dealogic, participating in 16 deals worth a total of $4.7 billion. On a pan-European basis, RenCap ranked ninth in arranging IPOs last year, just behind Merrill Lynch. The firm is also a dominant trader of Russian equities.

But the cost of the expansion could leave the house of Jennings vulnerable to a slowdown in the market. «Stephen is a genius, but he is losing control of his payroll,» says one former employee.

The most heavily raided of the early banking powers has been UBS. Most of the senior Brunswick talent took flight after their posttakeover lockups expired, starting with Andersson himself, who joined MDM as chief of strategy in 2006 and later bought 10 percent of the bank. Kaufman took five banking colleagues with him to Alfa, including Gene Moldavsky, who had been instrumental in helping UBS arrange a $4.3 billion equity placement for Russian cellular telephone operator Mobile TeleSystems OJSC. Head trader Peter Kizenko defected to Goldman’s Moscow office. Research chief Alasdair Breach left for a sabbatical last year, and his team scattered. The bank’s performance reflects the turmoil. It ranked ninth in Russian equity underwriting in 2006 and 2007 and fell to fifth in debt underwriting last year from first in 2006.

Deutsche has also sustained losses. The April departure of Jordan, who worked out of Deutsche’s London office, was followed in August by the loss of Ilya Sherbovich, who had helped the bank win the underwriting mandate for VTB’s massive IPO. Sherbovich is reported to be preparing to launch his own investment fund.

But the Deutsche franchise has proved more durable, competitors say, thanks in large part to the continued presence of UFG’s Ryan, who has stayed on as the bank’s CEO for Russia. Deutsche topped the equity league table for Russia last year, up from fifth in 2006, by handling 11 deals worth a total of $5.3 billion, according to Dealogic. New investment banking co-heads Andrei Chulak, a Ukrainian-born merger specialist who joined Deutsche from Merrill Lynch’s London office, and Dmitry Snesar, a UFG veteran, have helped the bank win such recent deals as utility OGK-2’s IPO in October and the Bank of St. Petersburg’s $274 million offering in November. The German bank ranked second in debt underwriting in 2007, unchanged from a year earlier, but it fell to seventh place in mergers and acquisitions from first in 2006.

Other international banks also dominate the league tables. Morgan Stanley ranked third in equities, sixth in debt and fourth in M&A in 2007; Citigroup was fourth in equities, third in debt and sixth in M&A;  Credit Suisse came in sixth in equities, fourth in debt and fifth in M&A;  and JPMorgan placed fifth in equities, eighth in debt and second in M&A,  according to Dealogic. Among other firms, ABN Amro, now part of Royal Bank of Scotland, leveraged lending relationships dating back to the Soviet period into a first-place ranking in debt underwriting last year; it wasn’t among the top ten in 2006. And Merrill Lynch topped the list of M&A advisers, up from sixth place in 2006, by working on 29 deals totaling $63.3 billion. The bank won an advisory role to state power monopolist RAO UES of Russia, which is in the midst of spinning off and privatizing dozens of regional utilities, Sucher explains.

Renaissance boasts the strongest league-table presence among Russian firms. In addition to its second-place equity ranking, it came in ninth in M&A,  advising on 11 deals worth $14.9 billion. Among other Russian players, Troika ranked eighth in equities underwriting, unchanged from 2006, and VTB came in seventh in debt, up from ninth in 2006. IFC Metropol took third place in M&A,  also on the strength of power-sector transactions.

The ambition of Russian firms is greater than their league-table presence suggests. At Troika, Vardanyan wants to build a diversified securities firm that concentrates on midsize Russian companies, where his firm has an edge over big foreign players. Troika led a $408 million IPO in July for Novosibirsk-based URSA Bank. He also is looking to expand the firm’s asset management business, which is Russia’s leader, managing $4.5 billion of mostly small investors’ money. «We want to build on the model of Merrill Lynch or Nomura, build the biggest retail brokerage,» the CEO explains.

Renaissance is seeking to leverage its strong position at home to build a broader emerging-markets business. It aims to double its head count in Africa and Asia this year to 260 bankers. «Do we consider Morgan Stanley or Credit Suisse direct competitors? Absolutely,» Aganbegyan says.

Confident words. But the broader question remains: Can the Russian market support the ambitions — and paychecks — of so many millionaire bankers? Some bankers have their doubts. Alfa’s Kaufman estimates that Russia will generate only about ten major IPOs a year for the next few years.

Still, one encouraging sign is the growing diversity of the deal flow. The past 12 months have seen successful offerings in several sectors that previously generated few deals. Uralkali led the way for chemical producers (advised by Citigroup, RenCap and UBS). Two property developers generated major IPOS: Moscow-based PIK Group raised $1.8 billion in July, underwritten by Deutsche, Morgan Stanley, Merrill and Nomura. LSR Group of St. Petersburg followed in November with $772 million, lead-managed by Deutsche and Credit Suisse. The flotation of Bank of St. Petersburg, Russia’s 27th-largest lender, is likely to be the first of many from private banks. «Companies that were not even on the radar screen are all of a sudden going public with capitalizations of $8 billion or so,» says Diana Gindin, president of Credit Suisse in Russia.

Mergers and acquisitions are also likely to accelerate as pressure for consolidation builds and as Russian companies increasingly seek to flex their muscles abroad, predicts Deutsche’s Chulak. M&A volume jumped to $204 billion last year from $116 billion in 2006. «Capital raising will remain the main source of banking revenue here, as in most emerging markets,» says Chulak. «But some of the assets are coming of age for M&A too.»

Given such visions of growth and the hot competition from rivals, bankers are sparing little expense to stake their claims to the Russian market — and hoping for the best. «Right now the aim in this market is to grow as fast as you can,» says headhunter Rees. «A few years from now, they’ll step back and look at costs.»

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