On a warm June evening in southern Siberia, the sun still shines brightly above the horizon at 9:00 p.m.; it wont set for another two hours. The Trans-Siberian Railway snakes its way at a leisurely pace through seemingly endless expanses of pine and spruce forests near the shores of Lake Baikal. In a first-class wagon the usual pandemonium reigns. In one open compartment a couple and their two children watch a Russian soap opera at high volume, while in the corridor outside, two vodka-filled young men stagger along bare-chested, singing loudly off-key. The conductor shrugs at a passengers complaints about the cacophony and offers to sell snacks from his private stash.
In the adjoining restaurant car, a group of Swedish investors tire of waiting for service and commandeer the kitchen to prepare themselves a grilled salmon dinner. Their resourcefulness is a product of experience. The Swedes are on a four-day foray to inspect their investments in RusForest, one of the largest foreign-owned forestry companies in Russia. The logistics involved in reaching the companys remote Siberian properties and operating there are daunting, but RusForest and its youthful chief executive, Martin Hermansson, relish the challenge.
It is easier to take initiatives in forestry here than in Sweden or the rest of Europe, says the 28-year-old CEO. You try to be a first mover and take the best areas early and consolidate them into strongholds.
The Swedish investors are far from alone in the region. A number of the worlds leading paper products companies, including Finlands UPM-Kymmene Corp. and Stora Enso, Swedens Svenska Cellulosa and U.S. heavyweight International Paper Co., are forging ahead with investments in the taiga, as the Siberian forest is known, convinced that its lucrative potential outweighs the risks and challenges. Russias woodlands most of them in the taiga harbor half of the worlds evergreen, or softwood, trees, according to the Trade & Environment Database, an online journal published by American University in Washington. Yet Russias forests, which are entirely state-owned, account for only 3 percent of the worlds annual softwood harvest. Forestry is the last great Russian natural resource that hasnt been privatized, says Per Brilioth, chief executive of Vostok Nafta Investment, the Bermuda-registered, Stockholm-based outfit that controls RusForest.
Anticipating eventual privatization, RusForest has snapped up 49-year leases on 2.4 million hectares of woodlands roughly the size of New Hampshire, or slightly smaller than Belgium for a mere $75 million over the past five years. In Sweden, where it is difficult to buy more than 1,000 hectares of forest, such an enormous expanse would cost $25 billion if it could be obtained. Russian forestry reminds me of 15 or 16 years ago, when you could buy Russian oil in the ground for 10 to 15 cents a barrel, compared with valuations elsewhere in the world of $5 a barrel, says Ranjan Tandon, head of New Yorkbased Libra Advisors, a $2.5 billion hedge fund that owns 8.3 percent of RusForest.
The pitfalls of forestry investment in Russia can rival the returns, however. The forests are remote, with few well-maintained roads, railways and ports for getting timber to market. Skilled labor and effective management are also in short supply. A bureaucratic maze of regulations makes it difficult for companies to adopt modern forestry practices and import critical foreign machinery. Even Russian companies complain that the operational environment isnt predictable or stable, says Jukka Halonen, a Helsinki-based expert on Russian forestry for the Finnish Forest Industries Federation, a research and lobbying group for Finlands forestry companies.
Yet with global demand for wood products rising steadily, investment in Russia is large and growing. Despite predictions of a paperless, online world, there remains a strong correlation between population growth and timber demand, especially in emerging markets such as China and India. According to a 2010 study financed by the United Nations Economic Commission for Europe, the European Unions annual demand for timber, which last year reached 1 billion cubic meters, is estimated to exceed the EUs supply by 400 million cubic meters in 2030. Russias vast forests could meet that demand, but it will take a major effort. The countrys annual timber harvest peaked at 300 million cubic meters in the 1980s, then plunged to 100 million cubic meters in the early 90s, during the chaos of the post-Soviet era. Output has recovered some but still was just 155 million cubic meters in 2009, according to the most-recent government data.
That number should increase significantly in coming years, though. Forestry concerns have committed to invest about 30 billion ($43 billion) in some 30 large timber and wood-processing projects, according to a 2008 report by Pöyry Forest Industry Consulting, a Helsinki-based global firm. Russian companies account for the bulk of the investment, but foreigners are playing a growing role. Finlands Big Three forestry companies Stora Enso, UPM and Metsä Botnia have invested more than 1 billion already and plan to spend an additional 2 billion in the next few years. Svenska Cellulosa, Swedish furniture maker IKEA and Norwegian-Estonian joint venture Estonian Pulp have announced sizable investments as well.
One of the largest forestry projects, with more than 5 million hectares under lease, is Ilim Group, a 50-50 joint venture between St. Petersburgbased Ilim Holding and International Paper. The U.S. company has invested about $2 billion in the venture. A big plus for IP and other foreign investors is the fact that President Dmitry Medvedev was Ilims legal director between 1993 and 1999. Its a good thing that the president has roots in the forest industry, says the Finnish Forest Industries Federations Halonen. He understands the problems and language of forestry investors when he meets with them.
RusForest aims to become the third-largest foreign forestry company in Russia by 2014, after International Paper and UPM. The company is backed by veteran investors in Russias volatile economy. This group is led by Vostok Nafta Investment, whose largest shareholder, with a 27.7 percent stake, is the family of the late Swedish mining and oil entrepreneur Adolf Lundin. Vostok Nafta has invested in Russia since the early 1990s, when the country began the helter-skelter privatization of large chunks of the post-Soviet economy. Over the years we learned the hard way how to measure risks in Russia, says CEO Brilioth. You have to look closely at assets that seem cheap at face value and then stack up the risks against the potential rewards.
Thats easier said than done. Vostok Naftas first big Russian coup was its purchase in the mid-1990s of a 1.5 percent stake in giant gas producer Gazprom for about $450 million. The value of that holding rose to a peak of $3.4 billion in 2006 but then plummeted to about $500 million as business considerations took a backseat to politics at the state-controlled behemoth. Frustrated by its inability to push Gazprom to cut costs and raise productivity, Vostok Nafta spun off the stake to its shareholders in 2009. Gazproms stock has risen more than 11 percent since the end of 2009, to trade at 202.1 rubles ($7.36) on July 28.update in mid-august As a small investor, there is only so much you can do to influence a company the size of Gazprom, Brilioth says. Thats why we decided to invest in assets where we could be active ourselves in the corporate structure.
But even a hands-on approach is no guarantee for success in Russia. The country began privatizing farmland a decade ago, and Vostok Nafta plunged into agriculture in 2005, becoming the largest investor with a 24.9 percent stake in Black Earth Farming, a 330,000-hectare expanse of wheat, corn and barley fields in southern Russia (Institutional Investor, January 2009). The company has been plagued by mismanagement, large-scale pilferage of harvests and a drought that led the Kremlin to impose a ban on grain exports for 2010. Black Earth Farming failed to make a profit last year and has had four chief executives since 2008. In Russia there is a dearth of managerial talent to begin with, so it has been difficult to find the right person to run it, says Brilioth.
Now, Brilioth is hoping the lessons learned at Black Earth Farming will benefit RusForest. Vostok Nafta created RusForest in 2006 by teaming with another Swedish investment company to acquire three Russian forestry companies for $22 million. It subsequently bought out the Swedish partner, then raised 441 million Swedish kronor ($70 million) by floating a 57 percent stake in the business on First North, the Nordic stock exchange operated by Nasdaq OMX Group. Over the next four years, Vostok Nafta sold off coal interests on the properties, built up RusForests reserves under lease from an initial 724,000 hectares to todays 2.4 million and acquired five sawmills. But the financial crisis hammered RusForests share price along with much of the Russian market. The companys stock fell from a January 2007 high of Skr50.97 to a March 2009 low of Skr9.67. (It was trading last montheds: update in mid-August; quote is from July 28 at Skr 10.65.) RusForest has been able to attract money to finance its expansion, though. The company raised Skr437 million with a rights issue last year and sold Skr500 million of three-year, 11 percent bonds in May.
Vostok Nafta has reduced its holding in RusForest to 29.7 percent, mainly by bringing on board other investors with which it has done business in Russia. East Capital Asset Management, a Swedish investment company that participated in Black Earth Farming and has $5 billion in Russian assets, took 9.8 percent of RusForest for Skr116 million in May 2011. According to Jacob Grapengiesser, East Capitals Moscow-based partner, forestry is a simpler business than agriculture. You basically cut the timber, take it to the sawmill and sell the finished product, so the risk of things going wrong or getting stolen is much lower, he says. Besides, he adds, with RusForests stock price having fallen more than 80 percent, we were buying assets at a really steep discount.
Alecta, Swedens largest pension fund, with Skr500 billion in assets under management, is another principal owner in RusForest, with a 9.5 percent stake. It previously invested with Vostok Nafta in Black Earth Farming and Gazprom, among other Russian ventures. Those investments have experienced ups and downs, concedes Leif ?Törnvall, a Stockholm-based portfolio manager who runs Skr50 billion in midcap investments, including Russian businesses, for the pension fund. But forestry is an asset that has been around Sweden for a long time, and every investor here is familiar with it. Most of the Skr100 million that Alecta sank into RusForest was invested in October 2010, after the company began shedding noncore businesses to focus on forest products. The pension fund is willing to be patient with its holding. I would like to see continuous improvement at RusForest, says Törnvall. But we are not a quarterly focused fund. We have a long-term horizon.
The pension fund needs to take a long view. Investments in sawmill machinery and road improvements pushed RusForest into the red last year. The company posted a net loss of Skr130 million on sales of Skr301 million, compared with a net profit of Skr118 million on sales of Skr208 million in 2009. But RusForest expects its investments to help it ramp up production dramatically. The company aims to nearly triple production, to 930,000 cubic meters in 2014 from 320,000 cubic meters last year. RusForests three Siberian mills are projected to produce 500,000 cubic meters of logs and boards a year for markets in China, Japan, South Korea and the Middle East, while two mills in the Arkhangelsk region of Russias far north are expected to turn out 430,000 cubic meters of pulp, chips and boards, mostly for European clients. As output climbs, Brilioth says, the company should return to the black by the fourth quarter of this year and gain earnings momentum in 2012.
Much of the pressure for profits rests on the shoulders of Hermansson, RusForests chief executive. A boyish Swede with a thick mop of black hair, Hermansson was born in a forestry area of southwestern Sweden near Göteborg, where his family has been operating sawmills since the 19th century and owns some 3,500 hectares of woodlands. Hermanssons father bought him his first chain saw before he was 12. I briefly considered doing something else, says the CEO, who graduated from the London School of Economics and Political Science with a political science degree and fluency in Russian. That landed him a job in Russia with Stena, a Swedish oil shipping company, in 2005.
Excited by Russias woodland potential, he quit a year later to become an independent forest industry consultant. It gave me a chance to see a lot of forestry operations, Hermansson says. One of the best assets he came across was in the Arkhangelsk region: The million-hectare expanse had exceptional reserves of spruce and pine and fairly good access roads, and it sat in close proximity to the White Sea port at the city of Arkhangelsk, 600 miles (965 kilometers) northeast of Moscow. The forests 49-year lease and two sawmills were available for the rock-bottom price of $20 million. Hermansson took extensive photos, drew up a business plan and raised money from Danish and German private equity funds to buy the operation in 2007. At age 24 he became CEO of ?Nord Timber Group, and the future looked promising until the global crisis sent wood prices tumbling to 40-year lows.
At the markets nadir in 2009, Vostok Nafta approached Hermansson with the proposal that he run RusForest along with Nord Timber until the two companies could be merged. RusForest paid $50 million for Nord Timber in an all-share transaction that led to a 31 percent dilution for RusForest shareholders. The merger took place in May 2010, and Hermansson was named chief executive. He and his father, Lennart, who had invested in Nord Timber, together received a 4.2 percent stake in the expanded RusForest.
Vostok Nafta and the other investors were impressed with the way Hermansson had resolved the kinds of problems at Nord Timber that plague RusForest on a larger scale. Nord Timber was a Soviet-type organization with a lot of idle equipment and bottlenecks that he turned around into an efficient, Western-style operation, says Brilioth. At Nord Timber, Hermansson was credited with repairing access roads, increasing the harvest and installing best business practices. East Capital partner Grapengiesser liked the fact that Hermansson was willing to spend up to 80 percent of his time visiting operations around the country. Before Martin, RusForest was being run out of Moscow, and I dont think it is possible for a manager to be respected out in the regions if he does that, Grapengiesser says.
Hermansson lacks experience running a business as big as the RusForestNord Timber merger. To advise him on operational and financial decisions at RusForest, Vostok Nafta has built up an active board of directors with strong forestry backgrounds. They include three veteran Swedish forestry entrepreneurs: Jerker Karlsson, whose more than 40 years in the business include a stint as chief executive of Svenska Cellulosa; Kenneth Eriksson, former COO of Svenska Cellulosa; and Franz Bergstrand, who worked 35 years as a forestry engineer and is currently chairman of Swedish Timber Group. Martins youth is a plus because he needs tons of energy for the long, bumpy ride ahead, says Brilioth.
The Siberian tour has been arranged to give Swedish investors and analysts a glimpse of the demands involved in running RusForest and evidence of the progress being made. After an overnight flight across six time zones, from Moscow to Irkutsk, the groggy group boards a boat to cross a stretch of Lake Baikal. The largest lake in the world by depth and water volume, Baikal has just shed its winter ice in early June. While Irkutsk and the Siberian land mass seethe in record 90-degree (32 degrees Celsius) heat, the lake is so cold that boat passengers wrap themselves in wool blankets. Scores of gray seals doze on rocky outcrops. Pristine nature gives way to tackiness closer to shore, with plastic bottles bobbing in the waters and theme-park-design hotels on land.
After disembarking, the Swedes board another plane for a 90-minute flight north to the river transportation hub of Ust-Kut. From there they take a five-hour bus ride southeast to their ultimate destination, the town of Magistralny (population 12,000), where RusForest will inaugurate a sawmill the following day on one of its largest leased properties. The bus has no air-conditioning, but the windows remain closed because of the dust stirred up by log-bearing trucks rumbling along the gravel road. Adding to the discomfort, the driver refuses requests to stop smoking and to turn off the overhead screen showing Russian porno-rap videos.
The taigas birches, pines and larches stretch from both sides of the road to the distant, hilly horizons. This forbidding forest, with its gnarled underbrush and mosquito-ridden swamps, has none of the magical charm of the Finnish woods that inspired the tone poems of composer Jean Sibelius. A thickening carpet of plastic debris on the roadside announces the proximity of human settlements, mostly villages of dull wooden slat houses relieved by brightly painted window shutters.
The Swedes dont seem at all dispirited by the surroundings, however. One of them, Mikael Lönn, 62, is a retail investor in RusForest who has previously traveled to other company installations in Siberia and Arkhangelsk. A physician who earned a fortune by founding and then selling a company that helps manage private hospitals in Sweden, Lönn likes to engage in financial tourism, visiting the sites of ?his investments abroad. Financial figures and forecasts are important, but you have to come out here to get a gut feeling about how a project is doing and what the people managing it are like, he says.
Lönn limits his investments to medical start-ups and forestry; he considers the latter a secure alternative. There is very little downside because the trees will always be there and growing, even if prices drop for a while, he says. It is the same reasoning followed by U.S. and European public pension funds, which have become the leading investors in timberland around the world.
Near midnight, with the summer sun finally setting, the bus disgorges its drowsy passengers at the only hotel in Magistralny. After breakfast the Swedes are driven to the towns northern outskirts for the inauguration of the sawmill. Magistralny is one of three RusForest operations in eastern Siberia, and the new mill, with an annual capacity of 150,000 cubic meters of wood, is critical to the companys attempt to ramp up production.
Considering its isolated setting, the Magistralny sawmill is impressively large and high-tech. Its Italian-made machinery is housed in a structure about the size of a square city block. Outside, huge stacks of logs, which arrived by a rail spur and gravel roads, are being moved by cranes and forklifts in preparation for the mills start-up. Swarms of mosquitoes attack a throng of workers, Swedes and local dignitaries gathered to hear speeches by Magistralnys mayor; the local RusForest manager; CEO Hermansson; and Sven Hirdman, the former Swedish ambassador to Russia who is RusForests chairman. Then the quartet presses down simultaneously on a ceremonial button that starts the sawmill.
Logs roll one after another into the saws, where they are stripped and sliced into plywood boards in 15 seconds. The boards are conveyed and stacked in piles that are moved to kilns and dried for three days. The first shipment will go to Lebanon. Two young financial analysts clamber up stairwells to get a close-up look at the operation, then climb down to interview managers, board members and technicians.
The No. 1 priority for me is demonstrating that the harvesting operation is working smoothly enough to make the mill self-sufficient, says Edvard Lenner, an analyst for Öhman Equities, an investment bank headquartered in Stockholm. At the moment, they havent accomplished that. They are stuck with stacks of logs in the forest, which they havent been able to access because not enough roads exist. Susanna Helgesen, an analyst with Remium, a Stockholm-based fund that specializes in small and midsize companies, has uncovered delays in imports of equipment. Helgesen, who visited another RusForest-owned Siberian operation, further west in Boguchany, also has doubts about the facilities Russian middle managers. When I asked at Boguchany what happens when the foreign boss is away in Magistralny or elsewhere, I wasnt satisfied with the answer, she says. They have to make more-qualified hires.
Hermansson acknowledges the difficulties. For one thing, the company needs to build more access roads to extend the winter timber harvesting season into the spring, when the frozen ground that supports log-laden trucks turns swampy. Turning harvesting into a full-year operation is one of the main challenges moving forward, he says.
Further ahead, the biggest issue confronting RusForest and other forestry companies is land ownership. Although long-term leases have lured an initial wave of investment, outright ownership would attract more capital, allow companies to raise bank loans, spur much-needed infrastructure spending and create incentives for reforestation. But privatizing the taiga, a cultural icon that features in everything from medieval folktales to modern Russian novels, remains controversial.
It would be politically very unpopular to sell any forest land, says Andrey Romanov, the mayor of Magistralny, just after hailing RusForests new sawmill as the beginning of a new era for his community. Forestry has been the main livelihood here for more than 200 years, so it is very important for the local people to feel that the taiga will never be sold.
RusForest investors believe that forest privatization will come within a decade. We expect it to happen in five years or at least to have a political commitment by then, says Vostok Nafta CEO Brilioth. Public resistance has softened in the wake of recent forest fires that many experts have attributed to inadequate state management of timberlands. Last year, after Moscow was enveloped during the summer by smoke from burning woodlands hundreds of miles away, President Medvedev pushed through the partial privatization of Russias forest fire protection service, dismissed many government fire rangers and made leaseholders of forest properties responsible for detecting and fighting conflagrations. Only private companies have the resources to build access roads needed to reach fires at an early stage, Brilioth says. Almost on cue, a forest fire near Magistralny shortly before the inauguration of the sawmill forced RusForest to dispatch trucks and bulldozers to help contain it.
But for now the forestry industry has yet to build up a lobby in the Kremlin or Parliament to match the clout of bankers and oil magnates. RusForest must depend on the advice of its executive in charge of government relations, Vladimir Gaidamakin. He worked in the forestry area going back to Soviet times and knows how the bureaucracy works from the inside, says Hermansson.
Gaidamakin proved his worth in a celebrated episode in 2009 with Hermanssons predecessor as CEO, Alexander Williams. The start-up of RusForests sawmill at Boguchany was in limbo because regional officials were denying the plant access to electricity. Gaidamakin urged Williams to attend a Russo-Finnish forestry forum in London at which Prime Minister Vladimir Putin was the keynote speaker. After Putin had exhorted the attendees to increase their investments and opened the floor to questions, Williams complained that RusForest had already made all the necessary investments, bought the machinery and hired the employees, but its sawmill was stalled by a lack of electricity. Thats unacceptable, said Putin. He ordered his Energy minister up to the podium and demanded that he find out who was to blame. Within days the problem was resolved, and the sawmill began operating, says Hermansson.
But most bureaucratic problems are smaller and require constant interaction between the company and local politicians. They have to be brought into the process and kept informed, Hermansson says.
And fêted as well. At the celebratory lunch following the inauguration of the Magistralny sawmill, Mayor Romanov is clearly the star attraction. He leads several vodka toasts to Hermansson, to the board chairman, to the sawmill manager, to the 250 workers employed by the local RusForest operation, to the governor of the region all dutifully translated into English.
At meals end the investor group heads for the train station. Some members will head west on the Trans-Siberian for 23 hours to visit the sawmill at Boguchany, while others will get off at Bratsk, after a mere 13-hour trip, to catch a flight back to Moscow.
Hermansson, who calls a two-room rental apartment in Moscow home, will stay there only a day before his next business trip. He is on the road 280 days a year. I dont have a family or any personal commitments, which is an advantage for this job, he says. I have to consolidate operations, introduce new processes and build from scratch the relationships between the local managers and myself. The main challenge is finding good managers and keeping them. If I lose a manager, I often risk losing his entire team as well. Thats what really keeps me on the road.