OREANDA-NEWS. May 13, 2013. Venture investment in the Russian market totalled USD 910.6 million in 2012, according to the third review of Russia's venture capital market, prepared jointly by PwC's Centre for Technology and Innovation (CTI) and Russian Venture Company (RVC). The total figure represents 201 transactions, including those for which no value was disclosed.

As in our previous review covering the first three quarters of 2012, this publication focuses on the information technology (IT) sector, where we compare venture investment trends over a two-year period. Also, for the second time in a row, our analysis covers two additional sectors: biotechnology and industrial technology.

What sets this report apart is the change in the volume of analysed deals that we categorise as "major" transactions, and which we have excluded from the scope of our study because investor activity has grown at more mature stages, i.e. deals ranging between USD 50 million and USD 100 million. This edition of the MoneyTreeТМ: Russia report was prepared in direct cooperation with the RVC VentureDatabase, a partner project, as well as with other RVC and PwC partnership resources, in particular RusBase (Start-Up Afisha), a special service for start-ups and investors whose analysts closely monitor developments in the Russian venture market. We have used RusBase data to adjust our full-year 2012 findings and provide you with a more up-to-date picture of Russia's venture market.

In 2012, most deals (84%) took place in the IT sector, with biotech accounting for only 7% and industrial technology for 9%. Overall, this distribution is in line with the Russian market's current investor structure. Bear in mind, however, that corporate investment programmes account for the lion's share of investments in science-intensive projects. Similarly, grant programmes play a major role in powering biotechnology and industrial technology initiatives.

As previously, the IT sector accounts for the greatest amount of venture capital raised: in 2012, companies in the sector raised USD 792.1 million, or twice the amount raised in 2011.

Last year, we focused on three new IT sub-sectors: IT-enabled financial operations, medical care for healthy lifestyles, and educational services. Over 2012, we observed a gradual shift in investor focus from early-stage company development to more mature stages. The change in the structure of the venture investment market in favour of more mature stages of company growth represents a logical trend in the sector's development. Biotechnology and industrial technology still lag behind the market leader, IT, both in terms of the number of deals and the volume of investment raised. The 2012 results show 18 deals worth USD 108.4 million in the industrial technology sector and 15 transactions worth USD 10.2 million in biotech.

In addition, three major deals were closed, each in excess of USD 100 million, with the aggregate investment totalling USD 516 million. Based on or new methodology, this category covered four deals worth USD 1.8 billion in 2011. Major deals are the biggest driver of capitalisation growth in Russia's innovation-driven sector as well as for attracting major international players.

In 2012, a total of 702 grants with an aggregate worth of more than USD 145 million were allocated to companies in the IT, biotech and industrial technology sectors. It is noteworthy that we have not factored grant-related data into the total market volume, as we have categorised grants as non-market tools for financing innovation-driven companies.

Innovation infrastructure development accounted for eight deals closed in 2012 with an aggregate worth of USD 37.7 million, which, in fact, shows that the venture market continues to grow. We have not included these deals in the overall market volume as well.

Also, 2012 saw venture capital funds being more active in meeting the needs of more mature companies. This affirms the willingness of investors to allocate significant funds to promising companies. This year, we have noted 12 investor exits from projects with an aggregate worth of USD 372 million.

Anton Abashkin, Director of PwC's Centre for Technology and Innovation (CTI), says:

"The past year showed a higher level of maturity and transparency in the venture market, where the investment focus shifted from early to later stages of project maturity, marked by 12 successful investor exits. In my opinion, we will see more market growth next year. However, the sector must offer a sufficient pipeline of projects, which have passed the seed stage, so that the pace of development doesn't slow down. Looking at things from a sector perspective, we can expect more investor activity in science-intensive industries as a result of greater market transparency and availability of information on corporate investment programmes."

Andrei Vvedensky, Director of the Infrastructure and Regional Development Department at RVC, adds:

“According to expert assessments, 2012 saw an end to the wave of "overhyped" start-ups and unjustifiably inflated investment expectations. Last year, investors demonstrated a more careful approach to selecting portfolio projects, favouring those whose owners had managed to show a tangible record of business success and realistic prospects. On our estimates, given the gradual saturation and imbalancein the e-commerce market, in 2013 new investments will be more actively channeled into other segments of the IT market, and companies involved in industrial innovation, education, medicine and healthy lifestyles will gradually gain popularity among investors. In 2013 we also expect to see informationdisclosures on several venture investor exits, which will serve as a benchmark for the entire market.”

IT

Venture capital investment by quarter: Investment raised, number of deals, average deal value
IT companies alone accounted for 84% of investment deals closed in 2012. The data obtained shows overall that most venture investors still prefer to focus on IT companies exclusively.

Total venture transactions grew 19% last year, or 27% in absolute numbers. In 2011, the sector recorded 141 transactions (for only one of which no value was disclosed), whereas 2012 saw 168 deals (for 14 of which no value was disclosed). The aggregate venture investment in the IT sector doubled to reach USD 792 million in 2012, versus USD 392 million in 2011.

The larger average deal size accounted, by and large, for the substantial growth in aggregate investment in the IT sector. Specifically, if one deal accounted for USD 2.8 million in 2011, in 2012 this data point doubled to reach USD 5.1 million. In the first place, this appears to be the result of greater overall venture market maturity and a shift in investor priorities to focus more on later-stage start-ups and more mature projects. In addition, the IT sector showed a markedly higher level of competition in 2012.

Venture capital investment by project development stage

The year 2012 saw 22% less deals (60) struck at the seed stage versus 2011 (77), while, at the start-up stage the number of deals almost doubled, with 65 transactions in 2012 versus 34 in 2011. Considerably more deals were recorded at the "early growth" stage (16 transactions in 2011 versus 31 in 2012) and at the "expansion" stage (a total of 3 deals in 2011 versus 12 in 2012).

The findings of our investment volume analysis show a more notable refocusing of funding from early-stage to later-stage development of companies. In 2012, investors put up a total of USD 27.7 million at the "seed" stage, or nearly 10% less than in 2011 (USD 30.6  million). Specifically, investments made at the "start-up" stage almost doubled (USD 96.6 million versus USD 38.8 million in 2011). Investments grew nearly 2.5 times at both the "early growth" stage (USD 253.8 million compared to USD 94.1 million),  and the "expansion" stage (USD 414 million compared to USD 169.6 million).

Venture capital investment by sub-sector: investment volume and number of deals

The year 2012 showed the largest growth in total deals and volume of venture investment raised in mobile applications (13-fold increase in number terms), social media and reference information services (twofold increase in total deals). In part, this resulted from the saturation of e-commerce companies in investment portfolios and the need for greater industry diversification. In 2012, we also highlighted several new IT segments that are proving popular among investors, such as education and medical services as well as financial sector technologies.

Nevertheless, e-commerce remains the leading sub-sector in terms of volume of investment funds raised.  Overall, investors put USD 395.6 million into the sector in 2012. This represents a nearly twofold increase over the 2011 figure. Also, the e-commerce segment accounts for the largest deals in the venture market, with volumes often exceeding USD 20-25 million or in some cases even reaching USD 100 million.

The mobile application sub-sector led the market for growth in the number of deals concluded in 2012, with investors closing 13 transactions versus only 1 deal in 2011. Total investment reached USD 28.8 million, with the average deal value around USD 2.2 million.

Cloud-computing technology continues to see active growth:  we recorded 30 deals in 2012 worth USD 104.4 million.

However, the sharp growth in social media projects and reference information services came as a surprise, with 29 deals worth USD 25.1 million in 2012 versus 15 deals worth USD 21.9 million in 2011. Such sub-sectors as educational services, financial sector technologies and medical services have become increasingly more popular with 7 (USD 12.6 million), 6  (USD 7.8 million) and 6 (USD 11.6 million) deals, respectively,  closed in 2012.

Investors have also shown roughly the same level of interest as last year in online tourism. They completed 10 deals worth USD 47.2 million involving such companies in 2012.

Our overall observation is that the segmentation of the venture market's IT sub-sector is still ongoing. This trend is the result of market saturation in individual segments, which in turn has triggered the need to develop better infrastructure and related services.

Biotechnology and industrial technology
Total venture investment in Russia's biotechnology sector in 2012 came to USD 10.2  million. A total of 15 transactions were concluded, around a third of which were closed deals.  Total venture investment in Russia's industrial technology sector came to USD 108.4 million in 2012. A total of 18 transactions were carried out.

The bulk of deals in biotechnology and industrial technology now under way are at the early stage, and have a relatively low average value (around USD 1 million for biotech deals, and around USD 7.2 million for  deals in industrial  technology. The Russian market is still out of sync with global trends, however, where the sector is characterised by highly capital intensive and long-term investment projects.

Future development of venture investment in Russia
We are confident that the Russian venture market has great potential for further growth and could double over the medium to long term.  However, major changes are needed for the market to realise its potential, such as more avenues for doing major projects, attracting new players with critical experience (including experience with investment project failures), accelerating the role of major Russian and foreign companies as both users of innovations and a source of venture capital, and expanding venture activity outside of the IT sector.  Furthermore, the market's rapid development means dealing with such issues as human capital, protection of intellectual property, enhancing the role of universities and academic institutions in stimulating innovation-focused activities, reducing the regional imbalance in the development of the innovation-venture ecosystem, and boosting the overall quality of the investment climate and business culture in Russia.

Our estimates suggest that the Russian venture market could see slowing growth in 2013, while the overall market volume itself will see less substantial change compared to 2012. At the same time, we expect that investors will continue to shift their focus more toward companies that have already successfully raised the initial rounds of investment and now need additional capital to fuel further growth. In turn, this should substantially change the market's structure in favour of companies in later stages of development while also increasing the average size of venture deals. Bearing in mind the gradual saturation of the e-commerce market and its internal problems, new investment will be more actively concentrated in other IT sectors while investors will be more enamoured with companies engaged in industrial innovation, as well as pharmaceuticals and health care products.  Depending on the overall situation with the global market and the stability of the Russian market, we could also see a new wave of exits this year as companies that have grown over recent years go public, and larger Russian and foreign players start making acquisitions.