Art of investments


Comment of Aidar Kaliev, Head of Venture Investment at VTB Capital, for Euromoney magazine (UK)

Tags: venture capital

Sep 15, 2011
Russian state capital leads growth in tech sector

by Dominiс O’Neill (Euromoney)

Anna Chapman, a former spy, started this summer as editor of Venture Business News, a print and internet newsletter for Russian tech finance. After the US expelled Chapman and others last year for being part of a Russian spy ring, prime minister Vladimir Putin said: "I have no doubts they will have interesting, bright lives."
But Chapman's new job is in some ways just another patriotic mission. And participation in this mission – to grow Russia's high-tech industry – is becoming more widespread.
Putin himself launched a so-called Agency for Strategic Initiatives in June, providing backing to medium-sized businesses in sectors where technological innovation is important. He mentioned pharmaceuticals in particular.
According to Putin, this is complementary – not a rival – to Russian president Dmitry Medvedev's project to turn the Moscow suburb of Skolkovo into a hub for the development and commercialisation of new technologies.
State development bank VEB will invest in Putin's project, with VEB potentially providing funding to companies selected by the agency. Last year, VEB approved plans to deploy 20% of its lending in the high-tech sector.
Up to now, Russia's larger industrial companies have often been ill at ease deploying new technology. High commodity prices have not been incentives to make the oil and gas industry more efficient by modernising the technology used.

Political drive
Thanks to the new political drive, many of the big state corporations have appointed technical innovation officers.
If these officers have influence, they could boost demand in Russia's domestic tech market. The electricity sector is one in need of high-tech upgrades, for example.
Sceptics say Russia's oil-induced Dutch disease, its economy dominated by a relatively small number of big corporations and its risky legal and regulatory environment will all prevent the emergence of a truly innovative, profitable and exporting technology industry.
Venture capital funds in Russia have proliferated in recent years as the government has tried to kick-start the industry. According to one study, there are now more than 60 venture capital funds (covering all sectors), with more than $2 billion under management.
But more than half of these funds include at least some government funding. The entire venture capital industry in Russia sometimes seems like a public-private partnership – and it might well remain so, at least in the short term.
US private equity firm Siguler Guff plans to invest $250 million in IT projects in Skolkovo. But so far, none of the best-known international venture capital funds have set up offices in Russia.
As a result, and out of the need for know-how and access to foreign financial and product markets, tie-ups with the government in Russia's tech sector are taking an increasingly international character.
For example, US venture capital firm Draper Fisher Jurvetson (DFJ) is launching a $100 million fund to invest in Russian and Commonwealth of Independent States tech start-ups, alongside the investment-banking arm of Russian state lender VTB. Rusnano, a $10 billion state investment vehicle for the Russian nanotech sector set up in 2007, and VTB Capital are each backing the fund to the tune of $50 million.
"DFJ will be a vital source of advice on investing in the technology industry," says Aidar Kaliev, head of venture investment at VTB Capital. Indeed, DFJ has around $7 billion in assets under management and its history includes backing firms such as Hotmail and Skype.

State investment
Funds managed for Rusnano are set to more than double VTB Capital's venture assets under management, to $375 million, meaning that its headcount in venture capital will also double. Yet aside from backing outsourced funds, Rusnano – whose chief executive is politician and billionaire Anatoly Chubais – invests far more money directly, often in larger companies.
"Rusnano is trying to establish itself as an investor in global nanotech companies, to show that Russia is a place where these firms can do business," Georgy Kolpachev, managing director at Rusnano, tells Euromoney.
In total, since its inception in 2007, Rusnano has approved more than 120 deals in more than 60 companies, deploying more than $2.5 billion. Kolpachev says Rusnano's growing portfolio in foreign entities already amounts to around $300 million, with around $500 million committed.
Most recently, this summer, Rusnano agreed to provide debt and equity financing to Nesscap, a South Korean manufacturer of ultracapacitors. Ultracapacitors are batteries that give short bursts of power, allowing electric cars to accelerate, or allowing conventional vehicle engines to start in extremely cold temperatures. So it is technology of growing importance, and also one eminently suited to the Russian market.
Perhaps the most helpful aspect to Russia's tech industry is that the agreement between Rusnano and Nesscap anticipates Nesscap establishing manufacturing and research-and-development facilities in Russia (through a wholly owned subsidiary).
"When we invest, it should be a mutual understanding that the company sees logic in coming to Russia," says Rusnano's Kolpachev. "If the company can do nothing in Russia, the answer is 'no'."
The Rusnano-Nesscap deal partly grew out of an earlier investment in Nesscap by London-based (but globally focused) clean-tech venture fund I2BF. One of Nesscap's directors is Russian-born Stamford University engineering graduate Ilya Golbovich.
Golbovich founded I2BF five years ago after assisting a Russian private-sector investment in a Canadian clean-tech firm. I2BF is managing a new nanotech start-up fund alongside VTB Capital, with $50 million in cash from Rusnano and a subsidiary of the Kazakh sovereign wealth fund Samruk-Kazyna.
The contact between Rusnano and Nesscap was therefore easily facilitated – and hopefully schemes like the one with DFJ will provide similar contacts for Russia's tech sector.
One of Rusnano's most important international deals before this was struck last year with Plastic Logic, a California plastic electronics firm set up by researchers from the UK's Cambridge University. Plastic Logic's technology includes screens that can be used for electronic books, screens that are made from plastic instead of silicon, and therefore far more flexible, less easy to crack and potentially more energy-efficient. In an era of iPads and Amazon Kindles, it could be an extremely successful product.
Plastic Logic will establish a $700 million factory in Russia, using capital from Rusnano, as well as from Plastic Logic's existing lead investor, US venture capital firm Oak Investment Partners. The Russian factory will add to Plastic Logic's existing production facility in Dresden, Germany. Rusnano will provide an initial $150 million equity investment and $100 million in bank guarantees. Oak will inject an additional $50 million.
"After the Plastic Logic deal, other US companies have started to pay more attention to Rusnano as an investor," says Kolpachev.
Proudly showing a front-page article on the Plastic Logic deal from the Financial Times, he says some US companies have even asked to go to Plastic Logic for a reference as to Rusnano's suitability as an investor.
"More and more companies are willing to work with us now," says Kolpachev.
Cheap brains
While sceptics remain, Rusnano has its antecedents. Indeed, it has another agreement with two highly experienced agencies that have successful industrial policies: the Korea Advanced Institute of Science and Technology and the Singapore Economic Development Board. The three parties will set up a joint investment fund of between $100 million and $200 million for Asian tech funds, partly with the aim of attracting these companies to Russia.
During the Soviet era, one of the few ways of rising socially was to become a scientist or an engineer. Much of the technology was for military use. Interestingly, the Plastic Logic factory will be in Zelenograd – a town near Moscow built in the 1960s, purposefully for electronics research and production.
Today, Zelenograd is a special economic zone with tax benefits, but during the Soviet era scientific clusters such as Zelenograd were common.
Although they now work in England, the two most recent Nobel laureates in nanotechnology, Andre Geim and Konstantin Novoselovare, are both Soviet-born graduates of Moscow Institute of Physics and Technology, a university founded under Stalin.
Rusnano's Kolpachev is also a graduate of MIPT. At one time, he was accepted to do a PhD in theoretical physics in Uppsala, Sweden. He later moved to finance, performing analytical modelling in derivatives for a US firm – something he says he found very easy.
After the 1960s, Russia's lead in science and technology waned as America's star rose. Applicants to the leading technical schools declined rapidly during the 1990s after the fall of the Soviet Union. But applications have since begun to grow again. Russia is still one of the few countries to have a space programme.
Sure, revenues from oil have produced hikes in labour prices, meaning that the manufacturing sector in Russia has grown relatively slowly. But Russia's technical workforce is still much cheaper than in some other countries with similar educational standards in science and technology.
There have been examples of highly successful start-ups. This year, Yandex, a Russian search engine, became the biggest internet IPO in the US since Google seven years ago, raising $1.3 billion on Nasdaq (involving Deutsche Bank, Goldman Sachs and Morgan Stanley). Moscow-based Baring Vostok Capital Partners bought into Yandex more than 10 years ago, when it was valued at only $15 million.
Outside the online sector, Russian Navigation Technologies is often given as an example of a successful Russian high-tech start-up. The company was started by MIPT graduates and its flagship product (AutoTracker) uses US and Russian satellite navigation technology to allow trucking firms to monitor their fleets more effectively. This is extremely useful in a country as big as Russia.
Russian Navigation Technologies' revenues are roughly doubling every year and it is growing internationally. Last year its IPO raised $10 million on Moscow's Market for Innovations and Investments, a newly launched equity platform sponsored by Rusnano as part of Micex, Russia's biggest stock exchange.
Perhaps predictably, the main capital behind Russian Navigation Technologies was state-linked, in the form of VTB Capital Venture Fund and money ultimately from Russian Venture Company, a $1 billion government fund of funds and development institution established in 2006. Many of AutoTracker's biggest buyers are state-owned too.
However, outside the less capital-intensive online sector, successful tech start-ups are almost unheard of in Russia. Even in the online sector, firms such as Yandex have little possibility of sales outside Russian and the CIS. Much of their success has been about developing products suited to the particular needs of Russian society.
Kolpachev describes how one of Rusnano's invested companies is a scanning microscope firm, now exporting to the US, and set up by a physics professor at Moscow State University. This professor, Igor Yaminksy, is old enough to have worked during the Soviet era.
But more frequently, the more senior scientists in Russia are unfamiliar and uncomfortable with commercializing their research. Rather than setting up their own firms, even Russian graduates of US business schools tend to aim at jobs in state companies when they return to Russia.
Long-term goals
Like VTB Capital, Russian investment bank Troika Dialog is expanding its venture capital business. It is in talks with state-owned Sberbank, Russia's biggest lender, on setting up a new venture capital fund partly with cash from Sberbank. In March Sberbank agreed to buy a majority stake in Troika.
In addition, Sberbank is in talks with a foreign partner about setting up a bank dedicated to venture capital, according to a report by Russian news agency Prime-Tass. Sberbank also announced in July plans to invest $800 million in a new IT and data centre in Skolkovo. While Sberbank's Skolkovo project will initially be for the bank's own needs, the aim is eventually to export indigenously developed banking technology.
Firms such as Rusnano and Russian Venture Company are trying to build a venture-capital ecosystem in Russia, through training and other programmes. Russian Venture Company is trying to change international perceptions of Russia as a place to do business in high-tech, and to encourage links with global markets.
Russian Venture Company already has offices in New England and Silicon Valley – the main centres of the US venture capital and high-tech industries. According to CEO Igor Agamirzyan, the firm is starting up operations in the UK and Israel – both homes to successful technology and venture-capital industries.
However, Russian lawyers, financiers and other specialists still lack experience in venture capital. Luring staff to Moscow from the balmy climes of California or elsewhere is an expensive business. In any case, professionals who don't speak Russian are of limited use.
Business angels are few and far between in Russia. Those with more ideas than money have to rely on "friends, family and fools", as one banker puts it.
In the US, tech corporations such as Microsoft and Cisco frequently end up buying successful start-ups. Many of these firms have agreed to open offices in Skolkovo. Cisco has said it will invest up to $1 billion in Skolkovo in the next couple of years, a boon for employment in the tech sector. But these firms will take some time to establish themselves in the new environment, especially as investors in Russian start-ups.
Overall, Russia's economy is notorious for being dominated by state firms and oligarchies. Even leaving aside the legal and regulatory difficulties, it means that smaller firms stand little chance of success. From a venture capital perspective, it means a lack of available exit options too.
Russia's state-led venture capital sector, then, might not immediately spawn globally marketable technical and commercial innovation. And Skolkovo might not succeed in becoming the next Silicon Valley any time soon. It will be a long-term project.
But that doesn't necessarily mean that Russia's tech sector won't grow, potentially laying the groundwork for highly profitable Russian technology corporates, even if this is decades away. Rusnano's approach – tie-ups with companies outside Russia, encouraging outsourced manufacturing and R&D facilities in Russia – is one way of getting round barriers to the initial growth of the industry. Whether or not Rusnano is profitable in the short term is another question (although an IPO of the firm has been suggested).
As Russian Venture Company's Agamirzyan says: "Venture capital is just a tool. The goal is to create an economy where a significant part of GDP is based on innovative technology."
With the Russian government's backing, international involvement and the state's considerable financial resources, there might still be some achievement in diversifying the economy away from hydrocarbon exports and towards technology. This is especially true when one counts Russia's cheap, highly educated workforce and its potential as a market for technology products.
Perhaps the most important element will be making sure that the will to support the sector is widely shared, at all levels of government, as well as in the private sector. To succeed, support for a profitable and globally integrated tech sector in Russia must be a long-term commitment, rather than a public-relations fad.

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