In from the Cold

At the edge of the Baltic Sea, just past the rusting hulks of the trawlers that crowd the port of Kaliningrad, sits a nondescript factory that at first glance seems abandoned. Inside, however, scores of mechanics are assembling classy sedans, while nearby, engineers in white lab coats use German-inflected English to discuss production levels with their Russian colleagues. In a move that struck many in Moscow's downtrodden business circles as quixotic, the Bayerische Motorwerken, aka BMW, arrived in Russia last fall.

The arrival represents a return to an area closely linked with German history. Before World War II, the Russian region of Kaliningrad, separated from the Motherland by Poland and Lithuania, was Knigsberg, capital of East Prussia. From 1945 until the collapse of the Soviet Union it served as a major Soviet naval base and was off limits to Westerners. But now BMW's $25 million joint venture is up and running and--mirabile dictu--actually assembling cars, albeit from so-called knockdown kits. "The Russian market may be chaotic," says Klaus Liske, BMW's local production director, "but we're confident that we've found a good home." It is a home with an interesting history. BMW's latest outpost is a former Soviet naval factory that was first built by Germans before the war to make U-boats. "A good German foundation," as Liske notes, "for our move into Russia."

Good foundations for foreign investments are hard to come by in Russia these days, at least according to recent headlines featuring shareholder battles and lending new meaning to the term hostile takeover. From Vyborg to Vladivostok, court fights have even led to bloody clashes between riot troops and local workers. "If you want to empty a boardroom on Wall Street," quips an American investment banker in Moscow, "just say the word Russia."

Certainly the price paid by many investors has been high. In the wake of Boris Yeltsin's sudden departure, Russian stocks jumped 18%. But the good news was short-lived. For too many foreigners, investing in Russia has proved tortuous. Just ask the folks at BP Amoco. Last fall, BP Amoco nearly saw its $484 million investment in Russian oil giant Sidanko all but disappear in a maze of Russian corporate shenanigans. In a complex scheme that had a brutishly simple result, Sidanko's most prodigious subsidiary was declared bankrupt and sold for a song to a rival, the Tyumen Oil Co. (TNK). In late December, BP Amoco reached a tentative deal with TNK to settle the dispute. But the conflict lives on as an apt symbol of the troubles foreigners face in Russia.

That is just one of a series of unsettling serial setbacks for Western investors in Russia, but a number of Western multinationals of a more conservative bent have devised strategies for surviving--and even thriving. Last year, Ikea, Nestle, Caterpillar, Lucent Technologies, Ford Motor Co., Gillette and Philip Morris all quietly extended their investments. Not blind to tumult or afraid of short-term setbacks, these investors have developed a range of protection plans.

BMW's strategy focuses on advance sales and tax breaks. Duties comprise 60% of the price of imported BMWs in Russia. But Kaliningrad, a free-trade zone, grants importers immunity. Moreover, BMW's Russian partner is assembling the cars cheaply--the top pay for its workers is only about $200 a month. The Kaliningrad BMWs, deluxe Series 5 models, will sell at upwards of $40,000, a price only Russia's richest few could afford. But the joint venture already has on its books a big order--from the Kremlin. The presidential administration has bought 130 of the luxury sedans for a reported $7 million.

Another key to the deal is the development of a $37.5 million BMW dealership network in Russia, which the company hopes will end the stranglehold gray-market importers have on the market. An estimated 120,000 BMWs cruise Russian roads, but just 4,500 were sold through official dealers in the last five years. When the Kaliningrad plant hits full stride, it will produce as many as 10,000 BMWs a year. Moscow's financial mavens took BMW's advance into Russia as a portentous sign, but few harbor illusions about the long crawl ahead. "Yeltsin's retirement is certainly good news, but Russia still lacks good corporate governance and a viable legal infrastructure," says Bill Browder of the Hermitage Fund, a high-end Moscow investment fund. Since the August 1998 devaluation, notes Browder, "Russia's been cut off from the capital markets and thus there's been no incentive to behave." But those who have long played Russia's market know it is ruled by a simple equation: high returns rarely come without equally high risks. The trick is to minimize that risk. "One can't be blind to Russia's problems," says a British corporate security consultant who advises Western companies. "But one can certainly still do business here--without paying bribes and without loss of life."

Of the companies now forging ahead, nearly all have joined forces with solid local firms that have existing production facilities. And nearly all have chosen corners of Russia where the investment climate seems better protected from the political storms that buffet the country at large. Leningrad Oblast, the province surrounding St. Petersburg, is a favorite.

In the town of Tosno, 45 km south of Russia's second city, Caterpillar has just completed its biggest investment in 25 years in Russia--a $50 million factory that will make component parts for its European assembly plants and assemble tractors for the Russian market. Says Stu Levenick, Caterpillar's director in Russia, "You've got to take the long-term view and at the same time manage the uncertainty. That's why our strategy is to combine exports to Europe and a move to domestic assembly as the local market develops."

Caterpillar is in good company. In nearby Vsevolozhsk, Ford is investing $150 million in a joint venture plant, expected to be finished this summer, which will have an annual production capacity of 100,000 cars. Philip Morris, Gillette and the Wm. Wrigley Jr. Co., are also putting up factories in the region. Nestle is pumping $30 million into six factories across Russia, while Lucent Technologies is spinning fiber optic cables in central Russia. And in spring Ikea, the Swedish furniture maker, will open a Moscow megastore with plans to expand nationally to outfit Russia's famously bleak apartments.

The best barometer of investors' hopes, however, may be the push by Western carmakers eager to follow BMW and Ford into Russia. GM hopes to sign a deal this year with AvtoVAZ, Russia's largest automaker, on a $200 million Opel Astra assembly plant. Fiat's long-awaited venture with GAZ, Russia's second carmaker, is at last set to launch this year with a small initial volume. Fiat's strategy typifies the insurance policies Western companies often opt for in Russia. "If you start small," explains Maria Tarulina, an analyst with the Moscow brokerage Troika Dialog, "you can delay your big investment until you see how the first step goes."

Too many investors did not heed that advice. The big losers in the 1998 ruble debacle were the portfolio investors who bought soon-to-be-worthless stocks and bonds and the big multinationals who didn't do the basic homework necessary to insure their investments were reasonably secure. Many of those pioneers have justifiably thrown up their hands and headed for home. But others side with Caterpillar's Levenick: "For a global player today, 'To be in Russia or not to be,' isn't really a question. You look at the country's resources and consumer market and you know this is a market you have to be in." And Russia, ready or not, is more eager than ever to welcome the hardiest--and best-insured--investors.