2011 was a rather disappointing year for M&A both globally and in Russia. Compared to the 6% decline in the value of global M&A deals, Russia’s M&A market experienced an even stronger reduction in value, by almost 28%. This is a sign of its continuing higher volatility, but also the result of fewer mega deals taking place than in previous years.
The top of the league table, as well as overall activity, is dominated by domestic activity, reflecting the current low appetite of foreign investors in relation to acquiring Russian assets.
The large share of oil and gas and metals and mining deals among the high-value transactions mirrors the industrial landscape of Russia. The significant outbound investment in social media and e-commerce businesses was primarily driven by one player, which we do not believe is indicative of a future trend in the Russian communications and media sector more broadly.
During Q1 2012 deal volume continued in line with the run-rate during H2 2011 and M&A activity continued to follow the key trends, which shaped the industry in 2011.
Russian communications and media companies follow global technology trends, in line with the globalization of technology, products and processes. As recent KPMG research entitled the ‘Convergence Lifestyle’ determined, consumers are currently talking about how technology enables their lifestyle. From buying goods online to keeping up with friends on social networks, consumers seem to be more and more reliant on a range of technologies. Although Russian consumers may be behind many of their international peers, successful companies active in the Russian market are adapting their business models to reflect changing consumer preferences and to reap the benefits related to the increasing prevalence of tablet technology, social networking and e-commerce.
At 49%, internet penetration in Russia remains low compared to developed markets. However, it is increasing at a high rate (CAGR of 23%; 2003-2011), primarily as a result of the current under-penetration in areas outside major Russian cities, and both fixed and mobile internet are expected to continue to develop rapidly. Technology players are seeking to monetize consumer preference trends through the introduction of new value-added services, control of content and payment systems. A certain degree of integration is occurring between the financial services industry, online services and payment systems, although banks active in Russia, like those in other geographies, have been somewhat slow to adopt online payments and – as a result – lost their share of this growing market.
Changes in consumer preferences and companies’ efforts to identify opportunities to add value continue to drive M&A in the Russian communications and media sector. 2010 saw a peak in M&A activity in the sector, with the announced deal value totaling $33.5 billion, driven by the active consolidation of the telecoms market by the Big 4 operators. The acquisitions of Weather Investments by VimpelСom ($20.7 billion) and inter-regional communications companies (MRKs) by Rostelekom ($8.7 billion) accounted for 88% of total 2010 deal value. In comparison to 2010, when 52 deals were announced, a total of 46 deals were announced in 2011 with a combined value of $9.6 billion revealing a higher average deal value.
Excluding the VimpelCom acquisition of Weather Investments, the level of activity is consistent with the 2010 pattern, and highlights the fact that many smaller regional telecom companies (CATV, WiFi operators, etc.) tend to consolidate regional positions before being consolidated themselves by the Big 4 operators. Moreover, we are increasingly seeing a larger number of internet deals as the landscape of the Russian e-commerce sector evolves, providing new opportunities for companies to develop and consolidate more specialized niche positions within core focus markets or platforms. Finally, a number of strategic sales of media assets by international media groups to local companies have taken place over the last 2 years, with notable exits by News Corporation and Lagardere in radio broadcast media assets following recent changes in legislation.
At $4.6 billion the value of outbound transactions was almost 10% higher than the value of domestic transactions during 2011. Outbound activity was principally driven by Digital Sky Technologies (DST), which announced six investments which accounted for 97% of outbound deal value in the sector.
Social media and e-commerce
Digital Sky Technologies (DST), the international Internet-focused investment firm founded by Yuri Milner and majority owned by Alisher Usmanov, acquired minority stakes in six high profile global social media and e-commerce companies during 2011. DST was a co-investor in all but one of these transactions, which totaled $4.45 billion and accounted for 46% of the total 2011 deal value in the Russian communications and media sector. DST completed two acquisitions in January 2011; a 1% interest in Facebook for $500 million as a co-investor with Goldman Sachs and an undisclosed interest in Groupon Inc. for $950 million as part of a group of eight investors. This was followed in April by the acquisition of an undisclosed interest in 360buy.com, a Chinese eB2C commerce company, for $500 million. In June, DST acquired an undisclosed interest in Spotify Limited for $100 million as part of a five party investor group. In August, DST and JP Morgan acquired a 10% interest in the social media giant Twitter Inc. for $800 million, followed in November by the largest deal of the year in the Russian communications and media sector, the acquisition of a 5% interest in Alibaba Group, the Chinese eB2B commerce company, for $1.6 billion.
The Russian e-commerce market is experiencing rapid growth, as the fourth fastest growing market in the world. In 2011 the market grew by 35% and it is expected to continue to grow at 22% annually. Internet broadband and mobile handset penetration, together with the increasing popularity of online shopping, are driving the sector’s development.
Russian startups, in most cases emulating successful international companies, e.g. Ozon (Amazon), KupiVip (Vente-privee), Darberry (Groupon), have experienced significant growth over recent years. As in 2010, Russian online retailers continued to attract investment during 2011. KupiVip raised $55 million for development of its online shopping club in exchange for an undisclosed stake in April 2011. Ozon.ru then almost doubled this record in September 2011, raising $100 million from an investor consortium, led by ru-Net Ltd, an existing investor, and including Japanese online retailer Rakuten, Swiss equity fund manager Alpha Associates and Index Ventures, together with Baring Vostok Private Equity Fund, the controlling shareholder and investor since 2000. Ozon announced plans to use the funds to open logistics centers and purchase equipment, as well as expand its product offering.
Telecoms
The current high penetration rate of mobile services and broadband internet in the Moscow region and other large urban areas has resulted in Russia’s Big 4 telecoms companies (Rostelecom, Megafon, VimpelCom and MTS) continuing to look for opportunities for expansion through acquisitions of smaller regional operators. One of the most significant transactions in 2011 was completed by Megafon, which acquired NetByNet Holding (NBN) for $270 million. NBN is planned to be used as a platform for regional expansion and to improve Megafon’s position in Moscow, where competition among key players is expected to increase further. At the end of 2011 Megafon completed the acquisition of YugraTelecom for $78 million. VimpelCom also made progress in relation to its announced plan to improve its market presence in the Far East of Russia through its acquisition of OJSC New Telephone Company for $433 million.
Share of voice revenue continued to decline in 2011, while share of revenue from data services increased and is expected to continue to grow as a result of the anticipated deployment of LTE (4G) networks. The key players in this market are seeking opportunities to develop other non-voice services, including pay-TV, call centers, and cloud technologies and data storage. In 2011, Rostelecom acquired a 71.8% stake in National Telecommunications, a cable TV operator and provider of broadband Internet services, for $947 million. This acquisition enabled Rostelecom to strengthen its capabilities in the Russian pay-TV market and to increase its presence in the largest Russian cities.
Media
Advertising is the single largest revenue generator for media businesses. The Russian advertising market demonstrated a significant recovery in 2011 and is expected to continue growing at a CAGR of 15% over the next 4 years.
Traditional media channels (i.e. television, outdoor, radio, print) continue to account for the majority of advertising revenues in Russia (86%), with Internet advertising accounting for 13%. However, the share of the former is expected to decline, with radio and print forecast to show very modest growth dynamics below the market average over the next 4 years. Internet advertising is expected to grow rapidly and account for 17%-20% of the market by 2015, supported by the expected increase in the penetration of high speed Internet access.
The current market conditions and tightening of government regulation are having an impact on M&A in the sector, with international investors exiting their investments in Russian media assets. In July 2011, News Corporation disposed of NewsOutdoor Russia and NewsOutdoor Romania (outdoor advertising companies) to a consortium led by Alfa Capital through its investment vehicle Marathon Outdoor Cooperatief U.A., VTB Capital and the founder of CTC Media for $270 million.
There was a further wave of consolidation of media assets during 2011. The largest of the transactions was the acquisition of a 25.2% stake in CTC Media from Alfa Group in June for $1.1 billion by a consortium of companies associated with National Media Group and Bank Rossiya.
The number of professional content developers in Russia is currently low and as a result the industry is suffering from a lack of quality content. In response, media groups are taking steps to secure access through acquisitions of content producers. The acquisition of Comedy Club by TNT announced in Q1 2012 demonstrates such continued search for high-quality content. On the other hand, global media groups seek to secure a share of the local media market. Thus, in October Walt Disney Company acquired a 49% stake in Seven TV from United Television Holding Russia for $300 million. The deal will enable Walt Disney Company to establish a free-to air service in Russia and expand the Disney brand more broadly in the market.
Outlook
In 2012 we expect to see transactions driven by further consolidation of media assets and especially continued consolidation of regional telecom assets by Rostelecom, MTS, VimpelСom, and MegaFon. While we expect several regional operators to continue to expand their networks and acquire new subscribers, we believe that further opportunities for investment into the regional operators are becoming rather limited and, therefore, the Big 4 will concentrate on opportunities to retain subscribers and improve the quality of their subscriber base, as growth begins to either slow or plateau and smaller competitors begin to feel the effects of competition in the form of pricing pressure.
Q1 2012 also saw the government of the Russian Federation commented that the long-awaited introduction of a mandate for mobile number portability is closer to becoming a reality. The initiative is likely to boost competition in the sector as Mobile Network Operators (MNO’s) margins become further depressed, forcing them to identify new ways of retaining and even growing their subscriber bases.
Telecoms infrastructure assets (such as Russian Towers, which in Q1 2012 received a new round of financing) continue attracting investment, and we are seeing an increasing level of interest in the wider prospects for passive and active infrastructure sharing.
Further acquisitions of content producers are likely to occur, driven by the need to secure supply of quality content. As delivery channels mature, key Russian and international media groups will look to local content providers, though it is largely expected that domestic companies will continue to originate content deals with local companies or license international content for use in Russia.
We expect that in 2012 the Russian e-commerce market will attract investors into both existing and new projects. As success stories of recent fundraisings of Russian internet and e-commerce companies resonate against the backdrop of the success listing of Yandex and, presumably, Facebook, we expect further development and specialization of the Russian Internet space, including expansion and development of Russian-language social networks and development of e-fulfillment services and support infrastructure. Furthermore, we expect that key investors into social networking such as DST Global will continue, with their investment partners, to be at the forefront of investing into the further development of social networks in both developed and emerging markets.
Vyacheslav Jaravine is a director in Transactions & Restructuring KPMG in Russia and CIS.
