The crisis showed we have no capitalism
The government’s anti-crisis support measures came at a cost to business: officials are disappointed in Russian businesses and hold them in lower esteem, says Ruben Vardanyan.Ruben Vardanyan Troika Dialog Moscow School of Management SKOLKOVO Manager
Date: 30 September 2010
The government’s anti-crisis support measures came at a cost to business: officials are disappointed in Russian businesses and hold them in lower esteem, says Ruben Vardanyan.
The strengthening of the government’s role in the economy led to a regrettable result: some businessmen resemble Soviet factory directors, profiting off the government by shifting expenses to the latter while leaving the profits for themselves, with everyone else deprived of access to the officials’ offices and left searching for options, according to Vardanyan. He has headed Troika Dialog for nearly 20 years, but intends to leave and sell his stake in the company. Mr. Vardanyan spoke with Vedomosti about preparations for the eventual split.
A GAME WITH NO RULES
The situation is different in every country. On the outside, it would appear everything in Russia has stabilized – it looks beautiful and decorous. On the other hand, business is clearly at the stage where the footballer has been told: up until now we played football, but now, sorry, we have to return to playing without rules. Those who want to play can do so, those who don’t – won’t play.
We have an enormous amount of bureaucracy but our social institutions are weak, and are weakening still further, while personal relationships are now paramount. Furthermore, this is true not only for business, but for all professional spheres. We have returned to the pithy expression of one businessman: “I don’t buy shares. I buy situations.” In conditions when the majority of firms, even the most market-oriented ones, are controlled by a single shareholder and there’s no real corporate law, the system works very poorly and there’s no separation between manager, proprietor, management, board of directors and CEO. There’s no understanding of how decisions are made in business and the government. One and the same question can be answered in totally different ways. Basically there are a lot of interesting things happening. Deals depend to a greater extent upon individual considerations than market ones. As a result, company valuations and the rights and interests of all participants are so secondary that they have no meaning for the actual deal. Corruption is on the rise, and the reallocation of assets is proceeding in a nonmarket manner. The crisis showed there are very many people in our country who considered themselves businessmen and capitalists, yet they were very good at nationalizing losses and taking profits for themselves. I was surprised to realize that such people resemble the factory managers who during Soviet times manufactured goods in shadow facilities. These people also considered themselves genius capitalists and anticipated that as soon as the market economy started they would be ahead, because they already conducted market deals. Then the entire system collapsed and it was revealed that these people in fact were not capitalists, but the products of a very interesting system where all expenses and production costs rested with the government, while these people claimed the profit. Previously, there was a sense that we had achieved capitalism. The crisis, however, showed that we don’t have any capitalism at all, but a certain kind of pseudo-capitalism. The market is currently seeing the return of intermediaries who resemble the tutors from Soviet times who took money from all college applicants but didn’t do anything, and later returned the money to everyone who wasn’t accepted to college. Such intermediaries have appeared around Russia’s major state-owned banks. Also returning is the category of people who believe that businesses should be launched with borrowed funds, preferably the government’s, so that in the case of problems the business can be returned. Again there are many lobbyists and shuttles receiving rather than creating value. People have again started saying things like “Only a fool would spend his money” and “more money can be made from losses than from profits.” Finally, because of the credit and liquidity crisis, a surprising stage of liquidation took place – an enormous amount of assets turned out to be if not nationalized, then securitized under the government. Because of this officials have also changed their attitude toward business. More and more often they make comments like: what can you businessmen do without us? This situation primarily affects mid-sized business. Middle business suddenly awoke to find itself outside of the game. It lacks any personal access to the lawmakers’ and bank managers’ offices. It proved much harder for such businesses to survive in the present economic conditions.
A lack of a professional courts system and a strong atmosphere of uncertainty. Despite all the short-term prosperity – strong oil prices and macroeconomic indicators (lower inflation, high economic growth) – people are highly concerned. The planning horizon has changed sharply. Speaking with businessmen as an investment banker, you understand that they have stopped discussing plans for 5-10 years, which is fundamentally important for the country’s long-term development and the creation of effective businesses. The current planning horizon for practically any business is from one year to three at most. Overall, middle business is more at a loss, its activities and cash flows harder to forecast. Such businesses ended up in a situation where they could not take out loans. Banks are placing much stricter requirements on companies. In this regard middle business faces a much more difficult situation than major state-owned or private firms. Furthermore, it is unclear what will happen with specific industries and businesses: some areas are surging, like the auto industry, while others are falling short of expectations, like, for example, the anticipated growth in demand for residential real estate. State institutions began playing a very active role in allocating property – both state-owned and private. Given the extreme concentration of power in the hands of several key government officials, the decision making system is sclerotic. It is centralized, but to such an extent that certain decisions are not made or it is unclear how they are made. The government is seen to be taking a significant share of key industries – not because of the amount of debt in these sectors or because it’s more efficient this way, but because this way is far more convenient and understandable. Meanwhile, there is no organized public market that would work for everyone. For a normal public market it is typical to have companies in which major shareholders own stakes totaling 5%, but we don’t have any firms where the largest shareholder owns a stake less than 30%.
There should always be several different models in society. The important thing is for there to be a mechanism of restraints and counterbalances. But every model has its strengths and weaknesses. The 1990s was the time when the old system disintegrated. Back then there were different types and groups of people trying to do something: scam artists, idealists, pragmatists; former veterans of the Komsomol, students, members of the security forces, criminal bosses. All of them represented different spheres, but there weren’t any overpowering groups in the system who could take control of the market. Different people achieved success, representatives of various castes with different backgrounds. Sometimes for a brief period, sometimes for good. Now the community of successful people has become less diverse and more concentrated, and because of this – more complicated for work in market standards. As a result, individuals who do not belong to one of the groups now have a much harder time achieving success.
There are many reasons. One of which, of course, is that the government and state institutes had an exceptional amount of money. Another is that people lost confidence and therefore started making decisions for the short-term. Not everyone, of course, but many. The distinguishing feature of this crisis is that many businessmen, having understood they survived, came to realize they survived mostly by chance. When the crisis took hold, the majority of us experienced serious problems. And when the subsequent collapse failed to occur, even the smartest among us understood that this wasn’t their achievement, but that governments, Russia’s included, were able to stabilize the situation and prevent its undermining. But this didn’t make things better for many – everything remained just as unstable and dependent upon outside factors, absolutely unlike what it seemed to everyone, especially in sectors like real estate and finances. And people started to live by the principle “better here and now” than 3-5 years from now and who knows. But the laws of economics, like the laws of nature, cannot be cheated forever. Everything that is artificial will last only so long as it is sustained. There’s no evading the laws of the market, especially in conditions when Russia became part of the global economy. We are not North Korea and will always be part of global processes. More and more people are receiving an education – in Russia and elsewhere. More people are gong to join the stock market, more companies will go public. So sooner or later the principal laws of capitalism will work in our country as well. It’s a separate matter that the capitalist model has already shown its flaws and is also imperfect.
I don’t speak with our advisor very often, but I speak with our officials quite often. A change of the elite is under way, including among officials. More and more people are leaving business to join government structures. But unfortunately, the majority of officials still view us as thieves, just some people steal less than others. However paradoxically, the overall level of mistrust in Russian business has increased. When I said to one official that it would have been nice if the Rusal IPO had happened in Russia rather than Hong Kong, he answered: “You’re just upset that you weren’t in charge.” To which I said: “No, just for an issuer to sell shares in Russia.” And he: “Enough telling stories! We know what you want!” We’re in a situation where business cannot function without the government, which has increased the government’s disdain for business: “What would you do without us! Everyone is flocking to us, asking to spare a kopeck! You said you were so smart and rich, but we’re officials and we rescued you, so now quiet down about your intelligence.” At the same time, I don’t think any of the officials wants a monopolization of business by the government, because this is a surefire recipe for collapse. People want to preserve private ownership of their incomes and to have the opportunity to enjoy their wealth. Even those who speak out most ardently in favor for the government’s interests understand they can lose out if a system is built in which the government owns everything. Building a system for a limited number of people is impossible, especially given the size of our country and the degree of its integration into the world economy. Therefore Russia has one route – to create an effective competitive environment within the country. Our company has conducted operations for 20 years now. Over this time we have seen many things – both good and bad. I think the times are much better now than when we started the business. But at the same time there is a certain feeling of déjà-vu. We are seeing a lot of things that happened during the 1990s. Meanwhile, the level of incompetence remains very high in all spheres of our society – in private business as well as in the government. And everything can lead to regrettable results much faster than we can imagine. We have received a difficult legacy: a life according to understandings rather than rules and the law is seated in everyone’s conscience and strongly prevails over everything else. The fact is that we still haven’t developed a system of professional institutes and communities, and everything centers around individuals and understandings. Twenty years has elapsed since the start of market reforms, but the pervasive animosity, disrespect and disdain for private business and private property still remains. In a country where over the course of decades any forms of individualism were destroyed, vibrancy was discouraged, where Stalin was never condemned, where half the country served time while the other half stood guard and this was justified by one great purpose – "We flew to space" – in such a country it is very difficult to do the right things and in general to build something in the long-term horizon.
THE COST OF INDEPENDENCE
One of the shareholders’ key tasks is to understand how to make money on invested capital. You could emigrate and try to earn money in other countries, which isn’t very easy, especially in conditions of a world crisis, limited international managerial resources and experience. The second option is to join together. You could also sell your business to the government in order to wait out the difficult times. In our country right now this is an easier model than building an independent business.
I didn’t say that. This is difficult. Everything has its price. In this case you have to be ready for different things. For example, to receive an offer to sell your business or to be prepared that your license could be revoked or everyone will be ordered not to work with you anymore. In this regard you have to be ready for certain risks.
Russia is a big country with a surprising number of opportunities to make money and work outside of the mainstream. Second, there are quite a few companies, each working differently but in a market mode, and they do not like it when they are forced to work with one bank or another only because it took out a loan or through a different means of pressuring the company. They need a quality service. One more interesting trend is the idea to create in Moscow an international financial center (IFC) to attract foreign investments which Russia requires.
I believe in certain fundamental things that are impossible to ignore. I am convinced that Russia’s economy has no other option, and whether or not government officials, businessmen and quasi-patriots want this, the modernization of infrastructure will require billions of dollars from international investors – in the form of loans or capital investments. This is unavoidable because there is no money for the realization of such programs within the country.
That’s not enough. Although this is a good deal. The process of modernizing Russia’s infrastructure is unavoidable, regardless of whether it is implemented in 3-5 years or drawn out over a decade. Without this, our pseudo-capitalism, our strange, semi-market economy cannot function for long. Second, sooner or later it will become clear that performing management of a number of businesses is not that simple, and sometimes impossible, even provided the possibility to nationalize losses. After all, government resources are not infinite. Therefore, I am deeply convinced that the next stage will include another round of privatization and there inevitably will be work with a large number of strategic and portfolio investors and an attempt to find competent managers – Russians and foreigners alike. Yet there is also the risk of new conflict situations, when a highly respected international financial institute wants to buy an asset but they tell the seller he is selling at a very high cost. Previously, investment bankers were accused of cheaply selling assets, sold Russia for a pittance, but now the government officials can accuse that, on the contrary, it’s too expensive and therefore the wrong deal.
The model is clear. If the government has such a large order, it’s clear there also have to be government intermediates. But there will always be a certain number of major issuers, including state-owned ones, as well as investors who want to work with an independent professional company. For various reasons. Despite the apparent advantage of a commercial bank – size and the possibility of buying securities for your own position, for example, when placing corporate bonds – clients nevertheless prefer working with us, because we are leaders, we offer a high caliber of services, we have an extensive and high-quality base of clients-investors, while our analysts receive prestigious international awards like Thomson Extel and Institutional Investor. Our clients probably appreciate the cost of placement, the sale itself, and the liquidity. Clearly, given the current cycle of our economy’s development, state intermediaries will be highly visible on the marketplace. But there are always costs involved – they aren’t perfect at everything either.
The growth of state banks cannot continue forever. If Russia’s economy will continue to grow normally, while we, despite everything I have said, are optimists, the market will continue to grow and expand. Then there will always be opportunities for a professional financial house to work and provide professional services. When the auctions of securitized assets began in 1997, we, being a major investment bank, didn’t participate in them as intermediaries and disappeared from the radars of key media. This went on for 1.5-2 years and it seemed we had missed a market, but then everything fell back into place and we were again one of the key players on this market. This has to be viewed philosophically.
We have been through crises before. I have always said that our model allows us to survive more than 18 months without making a profit. We have traditionally had a large stock of stability, which allows us to work within our standards. Even now we are earning money off standard services. We rank among the largest Russian banks in terms of capital. We have around $1 bln of capital – real, live, not theoretical. A very small portion of this is invested in illiquid securities. Our expenses are such that we continue working without making a profit for several years. I think this is a good reserve. The question is what for and why.
Depending upon what is meant by Troika. The company is a legal entity: it has employees, shareholders and clients. The question is whether Troika would provide a better service to clients if it were part of a state bank. This could be positive for clients, because the sphere of products and possibilities the company could provide will increase. On the other hand, there are a number of things we wouldn’t be able to do as a state bank. Right now we are working successfully with Sberbank, VTB and foreign financial institutes. But if we became part of one of the state banks, we would lose the ability of selecting the optimal solution and the ability of offering several options to clients. If we’re talking about the company’s service, in conditions of a market where the government is the key player, we could earn more money and increase the scale of operations, meaning such a partnership would be more advantageous for employees. But as for the company’s shareholders who would have to sell their stakes at this point, that's the end of the story. At the same time, our market right now belongs to buyers more than sellers.
Negative-positive — these are just emotions. There’s a genius old phrase: “Nothing personal, it’s only business.” If I seriously consider myself the CEO, I bear responsibility for everything and I should say to the shareholders: here’s your choice – receive money now, receive money later, you can take a risk and earn money or lose everything. This isn’t negative-positive – this is a serious decision, whether we are ready for let’s say 2.5 years to be crossed out of all deals, earn nothing and devour our capital, or whether we are ready to assume the risk that we could have our licensing revoked for the reason that someone didn’t like us. The decision is up to the shareholders.
WHAT IS AN IFC
I think that having such a financial investor in the infrastructure on the right conditions is a good thing.
This sounds pretty. The question is who needs it and for what, and what the filling will be. This could be a good project in terms of real estate. This could be the desire to create a platform for Russian companies, companies from the CIS and for foreigners. The important thing is for there to be a leader and people who understand how this is done and what for. The current ratio of trading by residents and nonresidents on our market is 50:50. If we create convenient physical infrastructure, regulation, courts systems and everything else, then why would our companies sell securities in New York or London?
This is an aggregate sum of factors: regulation, stock exchange, depository, physical infrastructure providing the opportunity to conduct road shows. Company managers may want to travel to a road show and end up in a situation where one top manager of the company receives a visa, while another doesn’t. But this is a difficult project. Many changes are needed for its realization, including in people’s awareness.
This is a question for discussion. Having one stock exchange is better than having several, so long as it is a stock exchange with an efficient corporate management system accounting for the opinion of clients and shareholders, where all decision making mechanisms are understood and transparent. In my opinion, regulators are currently urging for this to happen on market conditions, rather than a merger “at the knee.” Many things are decided on our market not through the issuance of orders, but because it’s more convenient that way for participants; it’s hard to put it “under command.” Such attempts have happened in the past, in particular with the creation of the MFSE exchange. And we all know what that led to. If there’s only going to be one main shareholder while everyone else is confronted with the facts, this will end as the next 1998 (following devaluation of the ruble, the exchange that acted as intermediary on all deals enacted a compulsory closure of all currency futures on the upper border of the currency corridor of 7.15 rub/$. — Vedomosti). I have my own opinion, which occasionally coincides with that of my colleagues. The exchange doesn’t need to become a public company. It can make money for its development on its own. The model whereby exchanges raise money on the outside for development inevitably leads to a collapse across the world, as this creates a clear conflict of interest between shareholders, who require as much yield as possible on invested capital, and market participants, for whom it is important that the market be reliable and accessible. Therefore, I always spoke in favor of a noncommercial partnership in which those who trade the most have the most rights and votes in making decisions.
WHO WILL BUY TROIKA
We plan to receive a decent profit before payment of bonuses. They will be bigger than last year (in 2009 - $86 – Vedomosti).
Below 15% after payment of bonuses. A 15% result is very good for the industry, and many financial companies across the world will struggle to reach this level.
Global markets. Alternative investments haven’t worked for the last two years, Asset management is only beginning to recover, the same for private banking. You already see the number of investment banking deals on the market, although we participate in the majority of them. That leaves global markets, while it should be mentioned this isn’t only equities, but the debt market as well. Troika has introduced structured products that weren’t available before.
Yes, we succeeded. We may have even overfilled the plan.
We believe the industry will be in a comatose state for a long time. We don’t foresee any splashes or cataclysms. Soon there will be presidential elections, and, therefore, political uncertainty. In this regard there will be increased government spending on social projects, for which there could be a sale of certain government assets, as well as increased foreign borrowing. In addition, there will be less major projects and cross-border deals. Yet these could bring significant foreign investments. In the coming three years we plan to increase profits to $500 mln and AuM to $10 bln, while RoE will increase to 15% through growth in business by 15-18%. Staff headcount won’t change significantly but will increase 5-10%. Our main focus will be on Russia and CIS countries. We will also continue cooperation with Standard Bank and the ICBC in the China – Africa – Russia format on further emerging markets.
In my view, normal corporate culture stipulates that the clients of any major company have to be warned in advance that the CEO is leaving. At the end of 2007 I said that I may choose to leave in 2012. I will remain in my post for as long as it takes to make this go smoothly and painlessly. Ideally, in 2013 I would like to be able to tend to other matters.
Everything must be done to prevent causing a shock. First, it is necessary to settle upon a model of future growth. Second, a replacement must be found within or outside the company. Third, the situation in the company must be stable and free of problems. Fourth, all the connections have to be handed over: clients have to understand that I am not the only one with whom to do business, but also with Andrei Sharonov, Jacques Der Megreditchian, Igor Sagiryan, Anton Rakhmanov, Serguei Skvortsov and many others. The management team at Troika is quite strong and stable, unlike our competitors. Quite a few of my colleagues carry a lot of weight and command respect.
Like in any normal company, a committee will be formed that will recruit candidates and then the partners will decide who will head the company.
Certain topics remain, for example certain clients are litigating against us. However, these are isolated cases out of 90,000 clients. The company is squeaky clean and healthy. We have returned to profitability, don’t have any debts, a stable team, and the partnership system is functioning effectively. We are the leaders for brokerage services, we have the market’s best research team. We really don’t have any problems. Clients are gradually getting used to (the possible departure).
No, this isn’t the problem. We already conducted an LBO (leveraged buy-out) in 2001, when $60 mln was as large a sum as the current cost of my stake. The question is whether there is anyone who will take a risk and buy it. A lot can change before 2013.
I have always been proud that Troika has the freedom to choose. This was true in 1997 (several offers were submitted) and in 1998 (following the crisis). And in 2002 (when the MBO occurred), 2007 and 2008 – to sell or not, and in 2009 – to attract as a strategic partner Standard Bank, the EBRD or someone else. We have the freedom to choose now as well.
Yes. Maybe sooner. But there are several options. If the market is experiencing growth, it will be easier for the partners to find financing. After all, given that the company has almost no debts, it is possible to attract funds and buy out my share. There is also Standard Bank.
It depends upon who will buy the stake. One price will be for the partners, another – for an outside investor. For the past five years I have sold shares to my partners based on the 1 BV valuation, regardless of other prices on the market. The deal with Standard Bank took place close to 1.3 BV.
No. The deal with Standard Bank took place during the crisis in early 2009. Now Troika is worth more. The best players are currently trading with a coefficient around 2 BV. You have to look according to the situation.
I speak with everyone who is interested. We attentively listen to good offers.
We always regard what we do very seriously. All of this should be discussed together with the Standard Bank partners.
We did not take this initiative. What for? Given the size of our capital we could split the money between ourselves and part ways.
LIFE AFTER TROIKA
I would like to work on building the charity industry – not with my own funds, but creating a system of accumulating money for various projects in such a manner that the money is managed properly. People who receive, let’s say, a few thousand dollars a month right now could give a small amount for a one-time auction in the event something happens, for example Beslan or this summer with the fires, or to help a specific person whom they know, but they cannot, for example, donate $100 from their monthly salary to help children with cancer, because they don’t know how to do this. It’s a big problem in Russia that there aren’t any ways of providing money on a regular basis to those who would manage these funds appropriately and transparently. The idea is to create a family of such special purpose funds where the returns on investments would be sent to support various initiatives.
No. I think I would make a bad state official, because this is a separate culture and psychological type. I am not interested in this format. I also want Russia to have a bright future, but it would be better for me to do this through the things I am capable of – the business school and other projects. Actually, for the past twenty years I have been working for the country, exerting a tremendous amount of effort with my peers at Troika to make Russia competitive and integrated in the world system.
SKOLKOVO has existed for five years since the idea’s inception. This was a time of starting up and building the physical infrastructure, proving that our idea has a right to exist. The next five years will play a key role in terms of providing the school’s intellectual contents and establishing leadership in academic programs, research and student recruitment. I don’t think it will be necessary for me to play a more active role in SKOLKOVO’s operations. But I will continue to bear responsibility before my partners for the success of this project and therefore I will continue to work on this project for as long as required.
SCHOOL OR INNOVATIONS CITY
You have to clearly understand that SKOLKOVO business school is a private project where the government isn’t participating with money but renders a great deal of moral support. We have several paths of development, including living together. We have a lot of intersecting points and things in common, although there’s also a difference: one project is noncommercial with borrowed loans, the other – a state project involving private money. At some point this could become one big common business. If we are going to exist apart, probably it would be better to have different names in order to identify the business school. It is also possible to keep the same name for both projects and see what happens. We shouldn’t rush things. Among our school’s founders is Viktor Vekselberg (manager of the innovations city and managing director of TNK-BP) – although not directly, but through a company. In our country anything can happen. The government can think it will manage things better, although I don’t think this is the right decision – making business education a state affair – simply because the government poorly understands what business is about. Perhaps the government officials will get the urge to take over, this is one of Russia’s favorite exercises, so give them the flag.
Yes, the securitized assets include a building, land and several further assets. The ratio of borrowed and proprietary funds in the project is 1:1. When we took the loan there still wasn’t a building or a program. Now there are less risks and a different phase of realization: the building is finished, programs are launched, the cost of the project increased, and the shares have been withdrawn from security, although my own guarantee still remains. The loan is being serviced by schedule.
By July 1, 2015. This project turned out to be far more ambitious and complex than we had planned at first.
Overall, SKOLKOVO is a very successful project. We have launched practically everything that was planned, and some things even ahead of schedule. It should be noted that over the course of realization we set goals for ourselves that were more ambitious than planned. However, like with any startup, we haven’t yet seen everything through to the end. For example, it had been planned to raise a lot of money for the target financing fund. It’s probably a blessing that this didn’t happen, because then there was the crisis and everything would have failed. We haven’t yet completely united our research center, including in China, and the academic program. We haven’t entirely succeeded in attracting a large number of students from Asian countries. But this is an emotionally contagious project. The important thing is that, despite all the difficulties, we launched it in a brief amount of time. It will only be possible to tell whether the project was successful or not 20 years from now.
Usually, form the graduating class of the statistical average business school in the West, 40-50% go into consulting, 20-30% into investment banking, while the rest disperse among various corporations and only 3-5% try to start their own business. It should also be kept in mind that the majority of university graduates in Russia – nine of 10 – want to work for the government, because this is more prestigious, reliable and guaranteed. So we will see what happens. It is still very early for us to speak about results; the first Executive MBA graduates finished their studies this summer, while the first full-time MBA graduation will only take place in December 2010, and among them there are people who still haven’t decided upon their future. But it’s already obvious that our results will differ from the statistics. Among the pleasant surprises – many foreigners have decided to remain and continue working in Russia. Here it is very important to properly manage students' expectations and ensure they understand that the mere fact of receiving a diploma from a business school does not secure them a ticket to the millionaires’ club.
AVTOVAZ ROLLING TOWARD PROFIT
I always said we would base ourselves on the price. We did and continue to do consultation work on a number of questions regarding reorganization of AvtoVAZ’s property. Troika Dialog will be paid for this work – 436 mln rubles, and we decided to participate in the company’s additional issue for approximately an equivalent sum.
We will definitely participate this year. The question as to participation in 2012 is under discussion. The final decision will depend upon a number of factors: the company’s results, market value, investment potential and others.
20-21% by the end of 2011.
A block will be held by two strategic investors – Rostechnology and Renault. The remainder will eventually be placed on the public market to raise liquidity.
I don’t see any formal reasons to announce one.
I don’t know how the previous quarter will turn out. But in all likelihood after this year.
Troika Dialog is an independent Russian investment company and among the leaders of the investment banking business in Russia, Ukraine and Kazakhstan.