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Like most big western companies, the British home-electronics retailer Dixons Group has closely tracked the rise of Russia’s consumer market over the past few years, agonizing over when and how to jump in. This month, the company finally took the plunge, announcing a $1.9 billion deal to acquire Eldorado, Russia’s leading specialist retailer of consumer electronics and domestic appliances, with more than 600 stores. But Dixons is still nervous about the Russian investment climate, and its worries haven’t been helped by recent problems at high-profile Western firms, including BP. So the firm agreed to start paying for Eldorado only in 2008. In essence, Dixons has given itself a three-year trial period to determine if it really wants to be in Russia. “It’s a no-risk option,” says Dixons spokesman Hamish Thompson.

Few executives would describe Russia as “no risk,” and the mixture of apprehension and opportunism with which Dixons is entering the market perfectly captures Western investors’ feelings about the country’s business climate. The Russian economy is powering ahead, propelled by the high price of oil, its key export. Growth exceeded 7% in each of the past two years and is expected to be about 6% this year, more than triple the euro-zone average. Many Russians are still poor and live in wretched conditions, but on the whole, household income is up and, especially in big cities like Moscow and St. Petersburg, people are ready to splurge. The spending boom is creating a merger wave in sectors as varied as banking, brewing and confectionery. In just the past month, alongside the Dixons deal, the huge Belgian beer company InBev has been finalizing the last pieces of a $730 million acquisition of Russian beer giant Sun Interbrew, and Coca-Cola agreed to buy Multon, Russia’s second largest juice company, for an estimated $600 million. Excluding the energy sector, mergers and acquisitions of Russian firms soared to more than $8 billion last year from $4.8 billion in 2003, according to Thomson Financial, which tracks worldwide M&A trends (see chart). Yet even as Western firms rush to buy Russian, at the back of everyone’s mind is the nagging question: Just how big is the risk, and is it really worth taking?

Since President Vladimir Putin came to power, the Russian economy has staged a dramatic comeback after its near collapse in 1998. But along with red tape and corruption, companies face political and government meddling, primarily in the form of a highly unpredictable tax-enforcement policy. The most battered victim to date is Yukos, the former Russian oil giant that is currently in its death throes after being hit with multibillion-dollar back-tax claims that its erstwhile owners say were part of a Kremlin campaign against them. A Moscow court is expected to deliver its verdict this week on Mikhail Khodorkovsky, the former Yukos chief executive and a major shareholder, who has stood trial on multiple charges of fraud and tax evasion and could face up to 10 years in jail if convicted.

Foreign firms, too, are vulnerable. Russian tax authorities recently slapped BP’s oil joint venture in Russia, TNK-BP, with a $1 billion back-tax bill for 2001. The move has caused dismay at BP in London and prompted Chief Executive John Browne to schedule a trip to Moscow last week, where he met personally with Putin. Meanwhile, the Japanese tobacco company JTI, which makes Winston and Camel brands at a $400 million state-of-the-art factory it built in St. Petersburg, is embroiled in a furious court battle with authorities over a more than $80 million tax demand from 2000 that has prompted complaints from the Japanese government. And tax isn’t the only weapon; this month, the German electronics manufacturer Siemens was officially told it couldn’t acquire a majority stake in a Russian company that manufactures some defense-related equipment. Siemens had offered between $200 million and $300 million for a 73% stake in the firm, Power Machines, but the deal was blocked by Russia’s antitrust authority, reportedly for national security reasons. “Success automatically makes you a target,” says Mikhail Kozhokin, vice president of KROS, a major Russian consulting and promotional firm. “Once your business becomes a success, you’ll have to spend 70% of your time defending rather than developing it.”

Hence the caution of Western businesses like Dixons. “The politics do concern us,” says Grant Winterton, Coca-Cola’s regional manager for Russia, Ukraine and Belarus. The beverage titan knows the risks firsthand. Coca-Cola invested $800 million in the 1990s to build 11 plants in Russia and an extensive distribution system. The company’s fortunes took a severe knock in 1998, when Russia was hit by a debt crisis and massive devaluation of its currency. But since then Coca-Cola’s Russian operations have grown back to profitability, Winterton says, and it currently has half of Russia’s $1.9 billion carbonated soft-drink market. And thus, concludes Winterton, “the opportunity far outweighs the risk.”

Indeed, Coke’s acquisition of Multon marks a deeper commitment to the Russian market, linked to the emergence of viable Russian consumer brands. Winterton says Coca-Cola thought about introducing its own juices in Russia, but decided to acquire Multon because the Russian firm was already well established, with strong local brands. “It’s a very good business that would be hard to compete against,” he says.The story is the same at Orkla, a $5 billion Norwegian consumer goods and chemicals conglomerate that last December bought a Russian confectionery company called SladCo for an undisclosed amount. SladCo’s revenues were estimated at $160 million last year. “Our experience is that acquiring an established company often gives a better and more viable entry into a local market than starting up from scratch,” says Hkon Christian Andersen, who heads the firm’s Russian operations.

Is there a way to predict which outside firms will prevail in Russia? Christopher Weafer, chief strategist at Alfa Bank in Moscow, talks about Russia as a “triple-layer” economy: on the top is the nation’s fiscal strength, on the bottom the roiling consumer sector (mobile-phone subscriptions notched up another record in March, and Ford sold one-third more cars in the first quarter of this year than it did a year ago). But Weafer cautions about the middle layer: energy and other areas that could be construed by the Kremlin as being of strategic value. There, investment risk is greatest due to the lack of legal enforcement of ownership rights and increased meddling by the state. “Putin will have to follow through on his promise to end some of the unsettling actions that are driving capital flight and blocking investment,” says Weafer. According to Russia’s Central Bank, capital flight quadrupled last year as worried investors moved their assets offshore. Net capital outflow jumped from $1.9 billion in 2003 to $9.4 billion. If that trend continues, economic confidence in Russia could drastically erode.

But for now, Western companies seem eager to keep on buying, and it’s not hard to see why. Eldorado, which was founded a decade ago by two brothers, Igor and Oleg Yakovlev, has been growing at a phenomenal rate. The company says its sales jumped by 83% last year alone, to $2.5 billion. With numbers like that unreachable in any other emerging market outside of China, Russia may well be a risk worth taking.

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