Business Week - March 27, 2000
Dot-Com Deals Come to the Steppes (int'l edition) Net stakes are dirt-cheap now, but prices are rising fast
By Sabrina Tavernise in Moscow
Pavel Cherkashin, a pony-tailed, 27-year-old Internet entrepreneur, is feeling cocky. His Moscow-based Web-development company, Actis Systems, brought in $1.2 million last year. Sounds puny. But it's triple 1998 revenues. This year he's spending most of his time taking calls from foreign investors who are clamoring to buy a stake in his 150-employee company. ``We're in the final stages. It's only a matter of weeks,'' says Cherkashin.
Global Net fever is getting so intense it's hitting even Net laggards like Russia. Foreign investors and deep-pocketed locals are competing to discover the Russian Amazon.com Inc. or Yahoo! Inc., even though only 1.5% of the 147 million population is hooked up. Lured by world-class computing talent, venture capitalists are looking beyond Russia's decayed infrastructure and regulatory minefields. They're acquiring stakes in Net businesses from online bookstores and financial services to search engines and newspapers. Russian Net companies could see as much as $30 million in investment this year.
The deals are small by American and Western European standards. For example, a 51% stake in St. Petersburg-based online bookstore Ozone.ru was snapped up for $1.8 million by a new investment company owned by United Financial Group, a Moscow-based investment bank, and Baring Vostok Capital Partners Ltd., ING Group's direct-equity investment company in Russia. All the money is foreign.
The country's strongest suit is its homegrown talent. Russians are known worldwide for their prowess in design and programming. Its hackers are infamous for their ability to break codes. And even though Russia's best brains have been draining to Palo Alto and Tel Aviv, now some are staying--or returning--home. Actis employs three Russians with U.S. passports.
NO HELP. Despite such enthusiasm, the obstacles to the growth of the Russian Net are immense. Phone lines are notoriously unreliable. Cable is virtually non-existent. Fast-developing mobile technology could help Russia leapfrog these limitations by allowing Russians to surf the Web on mobile phones. But in a country where the average wage hovers around $50 a month, most consumers can't afford to hook up now, much less pay mobile phone charges that run about 50 cents a minute. Just 7 million Russians own computers, and only one-third of those are hooked up to the Internet. And few have credit cards, which limits the growth of e-commerce.
Government policies don't help. New regulations require Internet service providers to install technology giving the Federal Security Service direct links to e-mail and give other law enforcement bodies, such as the Tax Police, access as well. ``The greatest threat to the future development of e-commerce is too much state involvement,'' says William E. Pomeranz, an attorney at Baker & McKenzie in Moscow.
Although deals are cheap now, Russian Net companies have high hopes of fetching U.S.-style valuations, say venture capitalists. But some Net investors think that's wildly unrealistic, given Russia's perilous business environment or the possibility that a foreign competitor will enter the market and crush local companies. ``It's hyped,'' says Boris Jordan, CEO of Sputnik Group, which is forming a company to make investments in high tech.
``People are asking for valuations of $50 million for a company that has $1 million in revenue and no idea what it's going to do tomorrow.''
Still, Russia's tiny Web is in the early stages of a growth spurt. The number of Internet users is projected to rise by an average of 25% a year until 2003, when between 5% and 7% of the population will use the Net, says Peter Kirkow, senior economist at ICE Securities Ltd. in London. A wave of Internet deals will close in the next few weeks, as companies such as search engine Yandex and online newspapers Lenta.ru and Polit.ru sell stakes to venture capitalists. Russia's Internet race is on.
Snapshot of the Russian Net COMPUTER OWNERSHIP 7 million INTERNET USERS 2.3 million, 1.5% of population GROWTH PROSPECTS 10 million users expected by 2004 NET STARTUPS 2,000 DATA: ICE SECURITIES LTD.