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14.07.2011   General news

We Call Large-Scale Projects “Elephants”. Mikhail Khabarov, President of A1, about how not to pay too much for assets.

Источник: Kommersant

The A1 Company is the investment division of Alfa Group specializing in investments in risky projects undervalued by the market, for example, because of shareholders’ conflicts. It is from A1 investments that TNK-BP, Alfa-Bank, VimpelCom, and the X5 Retail Group have grown. MIKHAIL KHABAROV, president of the company, told Kommersant in this interview about the projects in which A1 is engaged now.

-Who owns A1?
-We have three main founders: Mikhail Fridman, German Khan and Alexei Kuzmichev, and this is no secret. They created the Group, they were the first to invest capital in Alfa-Eko, which became A1 – this company was and remains the central investment division of the whole Alfa Group. But we have partners in practically all our projects. Overall, the principle of A1 is to build a sufficiently wide platform as soon as possible in order to find more points for growth. The partners are necessary to accelerate this process; they help us to grow faster.

-Was it like that with Avianova?
-Yes. In Avianova (A1 owns 51%. – Kommersant) there is an active partner – the US Fund Indigo Partners (49%. – Kommersant), which is an expert in this field. We are not specialists in any specific industry from the standpoint of enterprise management at the micro-level. We know how to work with investments, finance, and management, with settling corporate and other disputes. And the partner provides us with expertise in a specific field of business.
If we’re talking about the latest events which have occurred at Avianova (Andrew Pine, who represents the interests of Indigo Partners, was removed from managing the company. – Kommersant), A1 doesn’t have any fundamental disagreements with Indigo about running the business. The company is developing, and opening up new areas of business. But in spite of this, the company’s shareholders are interested in strengthening the Avianova team.

-Information has appeared in the market to the effect that you are negotiating your withdrawal from the Avianova shareholders. And you are said to have supposedly received an offer from interested investors to sell your share (51%). Even an amount was mentioned – $35 million.
-We are not negotiating the sale of our share in the company for $35 million. We intend to keep our interest and to continue developing the carrier.

-So the issue of changing the owner won’t be discussed by Avianova’s Board of Directors when it meets in London on July 15?
-No, the agenda includes strengthening the airline’s top management and its further business strategies.

-What is the difference between A1 and Alfa Group’s other investment company – Alfa Capital Partners (ACP)?
-A1 specializes in the search for undervalued non-public assets. They are often undervalued because these assets are associated with many, diverse risks – corporate, financial, legal, and administrative. We're able to quickly make decisions and quickly invest, with the knowledge that there are rather high risks. And by doing this, we receive a high return on our investments. It doesn’t match the model of the clients’ funds with which ACP operates, as a classical private equity structure. There are three funds under its management, and the company has the task of investing clients’ money, basically the western ones, for quite a long period and to provide acceptable growth.

-And you and ACP do not compete for projects at all?
-Not really, though competition for resources at Alfa in one form or another always exists. Firstly, we often work with debt instruments, much more often than with shares. Secondly, the return which ACP is willing to obtain – from 8% per year, – doesn’t suit us at all. Our funding is expensive. We’re interested in more than 30%. From the point of view of successful projects we have very high standards: there was one asset which was purchased in 1992 for $1 million, and in 2003 we sold it for $100 million. And one of the shareholders said: “Not a very successful deal.” That was a good while ago, there were a lot of risks, we had to hold the asset for a long time, but a deal like that sets the level which shareholders expect from A1.

-It seems that an option was discussed in which some companies, including ACP and Alfa Capital, could merge on the basis of A1, that is, under your management?
-These are very different businesses, and their merger in the classical sense is hardly possible in principle. Today, I’m chairman of the Board of Directors at ACP and Alfa Capital. However, each business has its own strategy, and is directly managed by its CEO. I'm only responsible for the operational management of A1. Synergy, implementation of joint projects on the principle of complementarity of capabilities is another question. I'm familiar with the capability of Alfa Capital to attract large private and corporate investors and manage funds. Today we’re working on some joint projects with Alfa Capital, but it is too early to talk about them.

-OK, tell me about A1’s strategy
-Actually, my arrival in A1 meant a “reboot” of the company, first of all, its strategy, which now correlates directly with the Group’s strategy. The primary objective is that every five years A1 should create a new business area for the Group. Now there’re five of them: financial services (Alfa-Bank, Alfa-Insurance and others. – Kommerant), oil and gas production (TNK-BP. – Kommersant), telecommunications (VimpelCom, Kievstar, Italian WindTelecomunicazioni, Turkish Turkcell and others – Kommersant), retail (the Pyaterochka, Perekryostok, Karusel chains, and others. – Kommersant) and water supply (Rosvodokanal. – Kommersant). So, I’ll repeat, the bar is very high. Capitalization of a new area should reach several billion dollars. Of course, this is a challenge for the A1 team.

-Taking into account the completed and current projects of A1 and ACP, a lot of markets have already been tested. Could you tell me any industries which you might have a stake in next?
-For example, agricultural business and foodstuff production. As a whole, we see an upward trend in food products, and we might be interested in working further in this area. I think that the increase in prices in this sector will be rather long-term. Both in grain, in milk, and in meat... Retail is interesting in all senses. I don’t just mean retail grocery. Russia has a population of 140 million, and their living standards are obviously behind those of the population of Eastern Europe in terms of basic indicators. Here we can bank on an increase in consumption, and we already have some portfolio companies – Kronverk cinema network, Independence auto dealer, Avianova, which operate, basically, as retailers, and there will be others. In order to understand it better, where any business line is created, in the future it can be either sold or transferred to the Group because A1 itself doesn’t develop large businesses. An example is Rosvodokanal. The project was created by A1, but last year the Group decided that it wouldn’t sell Rosvodokanal and would develop it independently as a separate line. Possibly, it will be a broader line – housing and utilities services.

-Can one of the Group’s companies transfer any projects to you? For example, recently X5 RetailGroup sold its Internet shops, although they are a promising area…
-It’s possible that A1’s interests will also include the area of Internet trading. Actually, it is also a rather interesting market. But in truth, from our point of view, currently it has been a little overheated by successful IPOs and big money which can create a new bubble in terms of assets prices. There are the same figures that we saw in 2000 and in 2008, and it’s not really possible to miss the boat here. We simply have to search for the correct entry points.

-Are there any other industries still to be mentioned?
-So, the four I have listed – agricultural business, foodstuff production, retail, and the Internet. Perhaps another is pharmaceuticals. As of today the industry is in a difficult situation. Because of limits for price rises the majority of drugstores have a negative margin. Only a small number of factories have been certified in Russia. But the government shows that it is interested in the development of the industry. And this is the feature of A1’s investments: we are ready to come to the rescue when companies and industries have challenging times, and to share their risks.

-And what about real estate development?
-In this field, A1 has no long-term plans to create a major player. Once again, there isn’t any international consolidator in this sector with which we could work in partnership. And the figures show that not all the developers have sufficiently long-term funds to complete their projects. The crisis cycles in the developing countries, including Russia, are shorter than building industry cycles. We have already had crises in 2000, 2004, and 2008. It is quite possible that there will be crises in 2012, 2016, and 2020. And the construction of a skyscraper from scratch, its commissioning and bringing in residents take more than four years. There is a high probability that with your unfinished project and short-term finance you’ll end up in a financial crisis again. And in this case you’ll find yourself in such a vulnerable position that control will pass to the companies which are financing you.

-You’re referring now to MIAN, MiraxGroup and MosCityGroup, whose owners had to share their assets with Alfa?
-We have normal relations with them. Loans have not been paid back – so mortgages have been taken. The issue is not completely closed for the present, because the mortgages have not been sold yet and we have not received the money. That is the majority of them still owe the Bank. But we shouldn’t mix personal and business relationships. You can maintain good personal relations with someone in spite of the fact that there are corporate conflicts.

-Alfa-Bank doesn’t deal with non-core assets received after restructuring problem loans. Firstly, the AlfaDistressedAssets project (ADA) was created to manage them, and then this project was transferred to A1...
-The bank business is operational, with very strict business processes, oriented on issue of loans and repayment of loans. If instead of a loan and money a bank has some real estate, this is an emergency event! The number of problems with each property is enormous. Legal problems, sometimes even criminal problems, are a job for people who resolve such problems on a day-to-day basis.

-Which other industries, besides development, are on your blacklist?
-We don’t have a blacklist as such, but we are not interested in industries where there are long investment cycles and which are rigidly regulated by laws. That is, such matters as creation of large enterprises, for example, in heavy engineering, shipbuilding, are unlikely to interest us in the foreseeable future.

-What is the value of the assets which A1 controls now?
-About $700 million in our own projects and about $1 billion from ADA. But the crisis has almost ended, and so we’re going to close ADA completely by the year end. Almost weekly there are transactions with retiring assets.

-What are the approximate volumes of investments in each project, and period?
-Two-five years. As a whole, we aren’t interested in investments below $50 million. Because there are a lot of projects. Now we have more than 50 projects. We consider it is a lot...

-Your website mentions a smaller number.
-We don’t actually list all our projects on the website.

-Only the ones of which you’re proud?
-No, it includes the projects which have been announced publicly. It is also a feature of A1 – it is more advantageous for us to give information about completed projects, rather than about those which are just being started.

-Tell us about those projects which were completed last year.
-There was a sale of accounts payable of the Amtel tire holding to divisions of SIBUR. This was a typical project for A1. There was an almost bankrupt company, there was a group of various creditors which didn’t know how they could jointly come to an agreement. The financial and operational management was seriously run-down, it was in a situation of great stress. A1 acted as a consolidator for the creditors, built an operational management system, and then it sold Amtel for more than $100 million. It is efficient now, and now SIBUR, as I know from private sources, is going to sell it on to a strategic investor.
Another project, a similar one, is Donetsk Electrometallurgical Plant. The situation was the same: bankrupt condition, heavy debts, problems with trade unions, the tax authorities, creditors, and bad management. The A1 team worked with it for almost a year, and then it sold it to division of Mechel as a strategic investor. We earned our commission on it.
Part of our deals are completed with investment of our capital, and some are agency deals, where we are hired as people having expertise, ready to take risks. For clarity: our agency commission income for the last year was $120 million.

-And what about direct investment income?
-We didn’t have sales of any assets because there was a transition period from the management standpoint...

-So the $120 million were your entire earnings?
-Yes, they were. There will be sales this year, but last year there weren’t.

-On what does the remuneration of the A1 team depend?
-In some aspects our motivation system is unique. It is focused on our people who, as a matter of fact, are businessmen – people who are results-driven in their work in conditions of uncertainty. At A1 there are about 150 staff in total, 9 of whom are managing directors. Management is paid 30% of project profits. Successful well-to-do people cooperate with us – it is possible for them to implement independent projects, using the Alfa Group infrastructure, its financial and administrative resources, knowledge, experience, and legal assistance.

-Do managers receive one third of the income from their personal projects, or is the total remuneration shared?
-It is shared. Managing directors can receive about 10% of the income from a project which they have supervised, and the rest is from the total bonus pool. So, they are all interested in the final positive results for the company.

-How does A1 work – is the budget approved for a year or do you find projects and offer them to Alfa Group for approval?
-The budget which is approved on a yearly basis has little to say about the company’s work, because it reflects expenses to maintain its ability to operate. For example, bonuses for the managing directors and their teams, which can exceed the budget many times, are not planned in it. They are determined by results of implementing specific projects. As to investments in projects, we ourselves can approve deals which cost up to $10 million, and for this purpose we have an investment committee consisting of managing directors, and I head it. More substantial investments are discussed at the consulting committee, whose chairman is Alexei Kuzmichev. And another source of our strength: we can take a decision ourselves within the hour, and where shareholders are concerned – within the day. It’s a very rapid process.

-That is funds for projects are collected.
-There is no sense in meeting once a year and approving five $100 million projects. This is for Alfa-Bank or X5 – they can make forecasts. We can unexpectedly have the need to collect $100 million within a week for a purchase. This is the so-called Special Situation Market – an international term. Warren Buffett, for example, whom many think of as “the old man from Omaha,” in reality deals with, and very successfully, special situations. For example, in 2008, he bought a block of preference shares in GoldmanSachs Bank which was in a difficult financial situation and nobody was ready to give it money; he structured it and purchased it. In my opinion, profitability was about 40%. His approach is: businesses should be bought in difficult situations. But only the ones you understand very well from the point of view of their financial investment model.

-If there is no budget, the rates of investment are not so clear. How many projects do you have tolaunch each year?
-You can’t apply a schedule in this case. We already have too many projects, so we consider it is prudent to exit from some of them, and not to dissipate our resources. Because the strategic objective consists in the creation of a new business line. The existence of just two projects, such as VimpelCom, will in itself make any investment company unique.
We call such large-scale projects “elephants.” And such an “elephant” has to be reared for a long time, resources have to be put into it. And it is rather hard to determine immediately which business will reach such dimensions, and we have to try different areas. You can see this in the story of Alfa, it successfully exited from a lot of businesses, did not start to develop them further. The most interesting area is one where there are global consolidators of the industry, where you can build a Russian business and then promote it for a merger with a global business. It is necessary to have 12-15 projects in a portfolio, and to manage each of these projects so as to understand at which stage it is, what needs to be done – to merge it, to develop it systematically, or to sell it.

-How much do you interfere in management of separate projects?
-We choose the management. For example, recently we changed the Kronverk team (Andrei Tereshok, ex-head of Movie Formula, became the new CEO; Vitaly Podolsky, former top-manager of X5 RetailGroup, Euroset, Mosmart and Hediard, became  chairman of the Board of Directors. – Kommersant). We consider we should have approximately 15% of the market. Today we see that this can be achieved. And the new team is engaged in forming a new strategy. Independence Company also has new management: Oscar Akhmedov has been added (former member of the Board of Directors at the automobile division of Mercury Holding. – Kommersant), also a very strong person, on whom we can rely. We consider that the management’s task is to be completely involved in the operational management without the direct participation of A1. The managing directors of A1 and I are on some Boards of Directors, if necessary.

-I suppose A1 has a lot of offers...
-Frankly speaking, there are a lot requests for the so-called White Knight in Russia. That, by the way, is another international term meaning an investor, a strong partner who helps you to get out of a difficult corporate situation. Personal relations with people are imperfect, and corporate relations – even more so. Almost every day someone comes with an offer...

-In spite of the fact that Alfa Group has a reputation as a rather aggressive partner?
-We’ve got a good reputation.

-A developer joked: Alfa is dissatisfied – we worked together for six years, but I still have some money left...”
-We clearly defend our interests, and the interests of our projects. We are well-known, we can be trusted. If there were a choice between having a reputation as a strict and successful professional, or not, then naturally, it is better to have it.

-And how do you yourself search for projects?
-We try to use a systematic approach for this purpose. For the last half year we’ve developed a special analytical service, which has some unique aspects. We have a screening of all special situations which occur within Russia and Ukraine. A report is prepared every week, and we see a very interesting picture, it is even possible to say that we work with statistics. And it is hard to find an outstanding business in Russia, whose owners or top managers are not known to one of the A1 managing directors. That is, personal communications have huge importance in finding projects.

-You came to A1 in October of last year...
-I’ve been working for Alfa for five years, I had a contract with Alfa Capital till September 2011. I own about 10% of this company, and I consider it is a very good asset. The invitation to become president of A1 was an invitation to play on a much bigger field, and it was impossible to turn it down.