Alfa Bank’s sale marks the end of one of Russia’s most successful private enterprises

According to sources of bne IntelliNews, Mikhail Fridman—one of Russia’s richest men—is on the verge of selling his most valuable asset to the Kremlin. Alfa Bank—Russia’s largest private lender by assets—is expected to be sold to a state-owned bank, with VTB Group and Gazprombank seen as frontrunners for the acquisition. Bne sources caution that Fridman has only agreed a sale in principle, and price negotiations could drag on for some time to come.

If true however, it will mark a significant withdrawal from Russia by one of the country’s most long-standing oligarchs, and a further consolidation of the banking sector in state hands. It will also raise new questions about the nexus between Russian business and politics, and the extent to which independent players can operate free of Kremlin interference.

Mikhail Fridman: from Moscow to Mayfair

One of seven oligarchs who towered over Russia’s fledgling market economy in the 1990s, Fridman owes his success to hard-nosed pragmatism in the business arena. Born to Jewish parents in Soviet Lviv, Western Ukraine, Fridman moved to Moscow in the 1980s to study physics. Due to unofficial anti-semitic quotas, he was barred from the city’s best universities, and had to continue his studies at the dreary Moscow Institute of Steel and Alloys.

Mikhail Fridman (Photo by promdevelop.ru)

During his university years, he was a member of Moscow’s nascent entrepreneurial class. Fridman ran a student disco and bartered theatre tickets for cash, before making a fortune buying up oil at subsidised Soviet prices and re-selling it on international markets. By December 1991, when the hammer and sickle was lowered for the final time, Fridman was already a multi-millionaire.

1991 was also the year that Fridman founded Alfa Bank, along with classmates and business partners German Khan and Alexei Kuzmichev. He racked up a large fortune by borrowing cheaply on international markets and lending out at higher domestic rates. Alfa was Russia’s only oligarch-owned bank to weather the storm of the 1998 financial crisis, and emerged from the wreckage as the undisputed leader of Russian finance.

Fridman’s partly owes his long-standing success in Russian business to an exceptional lobbying operation. By hiring Petr Aven—an economist and former Yeltsin minister of foreign economic relations—as Alfa Bank’s president in 1994, Fridman kept Alfa firmly in the Kremlin’s favor through the chaotic 1990s and state-cronyistic 2000s.

He was also a good businessman in his own right. In 1997, Fridman and his Alfa partners teamed up to purchase a 40% stake in Tyumen Oil Company (TNK).

Fridman with Petr Aven (Photo by newvz.ru)

Having paid $320 million for the aging and heavily-indebted asset, TNK turned into a cash cow in the 2000s, after Fridman restructured its debt and oil prices began to soar. He consolidated his grip on the oil sector through methods that were not always high-minded, like in 1997, when he cheated BP out of a $571 million stake in TNK by fixing a Siberian court.

The last of the oligarchic old-guard to remain in the oil business under Putin, Fridman eventually sold out to Rosneft in 2013, which netted him a cool $14 billion. Until now, Fridman has retained his hold over Alfa, which remains the country’s fifth largest bank, and accumulated substantial assets in Russian retail and telecommunications. Prized assets include his controlling stake in telecoms giant Veon and X5 Retail Group, a giant supermarket chain in Russia.

Putin: new rules of the game

The crowning of a new ‘tsar’ in 2000 ushered in a new set of rules for Russia’s business elite. In return for unequivocal loyalty and occasional favors to the regime, the oligarchs would be allowed to continue their business uninterrupted.

Rapidly however, things began to go wrong for the ancien régime. Boris Berezovsky—a former Yeltsin protégé who became a billionaire through car-making, airline and oil acquisitions, fell out with Putin and used his media holdings to undermine the new president. Vladimir Gusinsky—another media baron—had infuriated Putin in 1999, when his TV channel NTV heavily criticized Russian military operations in Chechnya. Both men soon found themselves facing fraud charges and were forced to divest from their Russian holdings. By 2002, they had fled the country.

Mikhail Khodorkovsky, whose Yukos Oil Company became a model of Western-style corporate governance in the early 2000s, fell foul of the Kremlin after criticizing state corruption in a televised debate with Putin. Having been arrested on fraud and tax evasion charges in October 2003, he spent ten years in some of Russia’s most punishing jails before being released.

In contrast to his former business associates, Fridman has always sought to remain loyal to the regime while retaining a respectful distance from power. As such, he had little trouble adapting to the new rules of the Putin regime. Although a close friend of opposition leader Boris Nemtsov, who was ultimately gunned down near Red Square in 2015, Fridman strategically broke off all contact, fearing it “would be interpreted as a kind of support” for Kremlin foes. While never close to Putin personally, Fridman steered clear of politics, which enabled him to not only survive, but also challenge some of the Kremlin’s most powerful business allies.

In 2011, Fridman surprised the world by taking on Rosneft boss and Putin henchman Igor Sechin, after the latter signed a secret deal with BP for arctic drilling rights. Fridman, who argued that the deal violated the exclusivity clause of his own BP partnership, took the company to court and won an injunction to block the agreement. In 2013, when Fridman finally consented to sell his oil assets to Rosneft, he received an eye-watering $14 billion in return.

This deal may have been the catalyst for the now-expected Alfa Bank sale. When congratulating Fridman and other oligarchs on their 2013 sales, Putin sternly warned “I would encourage them to invest it in Russia.”

Vladimir Potanin (Photograph by theins.ru)

This advice was lost on Fridman, who relocated to London and acquired British vitamins retailer Holland & Barrett for nearly $2 billion in 2017. The sale (if confirmed) will signal a partial exit from Russia by one of the last top-tier oligarchs who are not close to the Kremlin. Only Vladimir Potanin, a Soviet blue-blood turned metals tycoon and owner of Norilsk Nickel—remains untouched out of the original 1990s oligarchs. However, Fridman’s relationship with the Kremlin through Petr Aven should see him hold onto other assets like X5 Retail Group.

Deep in the red

Russia’s banking sector has been mired in turmoil for years. After the West imposed sanctions on Russia in 2014, financial institutions took a major hit. Russian banks lost an estimated $5 billion over the Ukrainian crisis in 2014-15 alone—partially due to a loss of investor confidence and partially due to the direct effects of sanctions on profits.

The Russian economy’s performance is also structurally linked to oil and gas prices. Russian banks were hammered by Brent crude’s sharp declines, which began in June 2014. After a brief recovery, 2017 also proved to be disastrous for Russian banking, after the Central Bank nationalized three top-10 lenders in four months to the tune of $24 billion. 2018 has been a volatile year for Russian financial markets, which have been negatively impacted by political risks, particularly the prospect of more punitive economic sanctions. This poor economic environment has significantly impacted every Russian bank’s operations and financial position.

Alfa Bank

Russia’s largest private bank and the fifth largest overall by assets, Alfa Bank has recently gained notoriety for its alleged role in Russia’s meddling in the 2016 presidential election.

Alfa currently operates in 7 countries. It has just under 400,000 corporate customers and 14.2 million retail clients. In contrast to most other Russian banks, Alfa has performed well in the last few years. Net profits grew 150% in 2017 y/y, amounting to $728 million. By the end of 2017, Alfa Bank had solidified its position as the largest private Russian bank by total assets, as well as by total equity, deposit, and loan portfolios.

For years, Alfa Bank’s achilles heel had been credit risk, and its overexposure to corporate credit. In 2018, management took steps to alleviate this weakness. As of July 2018, the bank had decreased its exposure to oil and gas—a sector with an abnormally high concentration of risk and volatility—by 6%.

For prospective buyers, acquiring Alfa Bank will extend their international footprint, and drive significant growth in retail, corporate, and investment banking. Last year, Alfa had $45.1 billion in total assets and just under $38 billion in liabilities for a net balance sheet position of over $7 billion. Additionally, it has a respectable credit rating. On November 29, 2018 Fitch gave Alfa-Bank’s long-term issuer default rating a BB+.

Alfa Bank’s ROA (The ROA ratio is considered an important profitability ratio, indicating the per-dollar profit a company earns on its assets.)

Given the auspicious picture painted by these numbers, and their contrast to the gloom that shrouds much of the Russian banking sector, it is little wonder that economist Anders Aslund describes Alfa “the biggest & best private bank in Russia.” The sale of Alfa (if confirmed) will call time on hopes the Russian banking sector could avoid succumbing to state re-capture and clientelism.

The new prospective owners

There are a number of Russian banks that could conceivably acquire Alfa, but three—Gazprombank, UniCredit, and VTB—are the most likely contenders.

The Long Shots: B&N/Otkirite and Sberbank

Founded by Russian power player Mikhail Gutsierev, B&N is an unlikely long-shot to acquire Alfa. The once-powerful bank has recently fallen on hard times. In 2017, B&N lost 2,118 bps y/y in deposits—the 6th worst loss of any bank worldwide. It will reportedly be merged with Otkirite, another failing Russian bank, by April 2019.

Otkirite had the largest pre-tax losses of any top 1000 bank in the world ($7.52 billion), per data provided by The Banker. Otkirite also had the fourth largest losses worldwide in y/y deposits last year, slightly edging out B&N and falling 2,401 bps. It was nationalized late in 2017 to stave off collapse. The government has been planning its merger with another bank subsequently.

The hobbled predicament of B&N-Otkritie make them unlikely buyers of the highly-profitable and westernized Alfa Bank.

At the opposite side of the Russian finance spectrum lies Sberbank. Despite a poor environment for banking overall, Sberbank has rocketed to become Russia’s most valuable company, ahead of Rosneft, Gazprom, and LUKoil. Currently valued at around $65 billion with a BBB- credit rating, Sberbank is not a likely landing spot for Alfa Bank. Currently the 66th largest bank in the world by assets, acquiring Alfa would place Sberbank in the top 60 globally, not enough to jolt it into the race for global domination but further increasing its disproportionate size compared to other Russian banks.

It is therefore likely that Alfa winds up in the arms of another bank, in order to counterbalance to Sberbank’s already-colossal economic and political might within Russia.

Gazprombank

Gazprombank is one of three highly likely destinations for Alfa Bank in the event of a sale. The third largest bank in Russia was founded in 1990 by natural gas producer Gazprom (GAZP) to provide banking services to other gas industry clients. It has since expanded into every industry, now serving over 45,000 corporate and about 5 million private customers.

Alexey Miller with Vladimir Putin (Photo by Kremlin.ru)

In the wake of the 2014 Ukraine crisis, Gazprombank was one of the first companies to be sanctioned by the West. Despite this, it has done a reasonable job staying afloat. It currently has $92.7 billion in assets. Alexey Miller, head of gas titan Gazprom, sits as Chairman of the Board.

If Gazprombank acquires Alfa Bank, it will consolidate its position as Russia’s third largest bank, clearly separating itself off from challengers further down the pecking order. It will also become a clear rival to Sberbank and VTB for years to come. Gazprombank would also bolster its investment banking prestige, quickly shooting up to be among the most powerful Russian investment banks, and in a league of its own with VTB and RenCap.

Politically, this move makes sense for a few reasons. Alexey Miller has been a loyal Putin acolyte for years, having successfully steered Gazprom through economic downturns time and again. Gifting Alfa Bank to Gazprombank would be a reasonable reward for Miller. Additionally, compared to VTB, Gazprombank has a much smaller global footprint, only operating in 6 countries outside of Russia. As Putin notoriously hates it when elites conspicuously move personal or company assets outside Russia, this may be a reward for keeping Gazprombank’s capital in Russia (VTB, as will later be noted, operates all over the world).

UniCredit

UniCredit is a major European retail bank, headquartered in Milan, Italy. It has a considerable presence in Eastern Europe and Russia. In 2017 it netted over $22 billion in revenue. UniCredit also controls the largest non-Russian bank in Russia. In 2016, coincidentally, it sold its Ukrainian holdings to Alfa. The deal gave UniCredit a 10% stake in Alfa Bank’s holding company, Alfa Group.

Although UniCredit is in talks to purchase Alfa Bank, it seems an unlikely proposition for a number a reasons. First, the Kremlin is unlikely to yield control of one of its best assets to a bank based in the EU. Second, over 5% of UniCredit is owned by the private American financial services company, Capital Group. Americans have recently been hesitant to expose themselves to Russian markets and Moscow is not keen to see Alfa Bank in the hands of Americans. Norwegian and UAE based companies also own significant stakes in UniCredit, although neither of those would be a major impediment to a deal. It is more likely that UniCredit’s role is more of a threatening one to prod VTB or Gazprombank into buying sooner or for more money.

VTB

Alfa Bank’s most probable next home will be VTB. Currently, the 113th largest bank in the world by total assets (with over 13 trillion RUB), VTB would catapult into the top 90 if Alfa Bank joins its ranks. The sanctioned bank currently has 38.9 million clients, 20 subsidiary banks and companies, and 10,000 branches in Russia. VTB operates in 19 countries and is constantly looking to expand its horizons. It currently has a BBB- credit rating from S&P, although its risk of credit failure is low. Andrei Kostin, VTB’s long time head, is a close ally of Putin’s and has managed to secure $18 billion in state subsidies over the last decade (Sberbank by comparison, has received none while remaining profitable).

Andrei Kostin (Photo by ok.ru)

VTB is currently Russia’s second largest retail and largest investment bank, boasting over 57% of all M&A deal flow in Russia. Furthermore, it accounts for a quarter of Russian investment banking fees. In 2017, VTB enjoyed a 120.1 RUB billion net profit, 2.3 times more than its 2016 year-end results. Part of its astounding success comes from its growing foothold in China, which is becoming a key strategic partner for the Kremlin. Putin will encourage VTB to continue strengthening its presence in the Chinese market. In 2017, VTB made 12.6CNY billion ($1.83 billion) in revenue in China. It is now among the top 20 M&A advisory services in China as measured by fees.

VTB’s takeover of Alfa Bank would make sense for two reasons. First, the Russian state owns 92.2% of VTB. That will give it full oversight over Alfa while still allowing part of its business to be owned by individuals and institutions and traded on public markets. This balance will give the Kremlin back seat control while also promoting the illusion of a well-functioning market economy. Second, VTB has proven its ‘worth’ in the past on similar deals. In February 2011, it acquired a majority stake in Bank of Moscow. In the course of the sale over $3 billion went “missing,” in a likely pre-orchestrated heist to reward figures within Putin’s inner circle. If the Kremlin has similar plans for Alfa Bank, Andrey Kostin may know what levers to pull.

VTB came into existence after Kostin convinced Putin that to be a great nation, Russia needed to have a great investment bank. It went public in 2007 in London, and was valued at $8 billion, that year’s largest IPO on the LSE. VTB has a similar churn to Goldman Sachs—many of its former employees occupy in important positions in the Russian government. The economy minister, two deputy finance ministers, and the head of the Central Bank’s monetary department all formerly worked for VTB. If the deal goes to VTB, this clear partnership between the government and VTB will undoubtedly have played a role.

The remains of the day: what’s left of Russian banking

If the Alfa sale to any of these banks goes ahead, Russia’s financial sector—with the exception of Sberbank—will have little left to boast of. The last little-known jewel of Russia’s financial sector is Renaissance Capital. With a stellar macroeconomic research team, a slew of investment banking solutions and a strong asset management division, RenCap is a diamond in the rough of the Russian finance world. Founded by Boris Jordan, a former CS First Boston investment banker (and brief character in Bill Browder’s Red Notice), RenCap is the most elite financial institution in Russia. But since its assets under management are negligible compared to those managed by larger players, it would appear as if Russia’s banking system is slowly descending into a long hibernation caused by state recapture, clientelism and corruption.

From Alfa to omega

Mikhail Fridman once described his relationship with the Kremlin as an exercise in ‘remaining in the second row.’ In exchange for loyalty to Putin and occasional contributions to government projects, he and a dwindling band of non-Kremlin aligned oligarchs could run their business as they pleased. But the expected sale of Alfa Bank to a state-owned entity suggests the space for independent business owners is receding, with oligarchs increasingly called upon to either invest their money as the government sees fit, or lose their assets altogether.

On the macro level, it also suggests the state re-capture of key Russian industries is now all but complete. The oil industry and the banking sector are all but dominated by government companies and run by allies in Putin’s inner circle. This exacerbates the conditions for state-sponsored corruption, in a country where active and passive bribery are already highly normative at boardroom level. It also reduces the scope for independent players to compete on an even footing with state-backed giants, while loosening competitive pressures on the Russia’s largest companies.

If Alfa Bank is eventually sold to VTB, then a few preconceptions of the inner workings of Russian power will need to be re-evaluated. Although Kostin is a close Putin ally, he is not currently in the top tier of Russian business elites. Alfa Bank’s sale to VTB would change that, making him one of the 10-15 most influential figures in the Russian economy. If he manages to snap up Alfa Bank, Kostin will be one to watch in the coming years.