In From The Cold

By ANDREW MEIER/MOSCOW

At the edge of the Baltic Sea, just past the rusting hulks of the trawlers that crowd the port of Kaliningrad, sits a nondescript, seemingly abandoned factory. Inside, however, scores of mechanics are assembling classy sedans, while nearby, engineers in white lab coats huddle to discuss production levels with their Russian colleagues in German-inflected English. It's an incongruous setting for one of Europe's most prestigious automotive marques, the Bayerische Motorwerken, better known as BMW.

In a move that struck many in Moscow's downtrodden business circles as quixotic, BMW set up shop 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 Konigsberg, 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--is actually assembling cars 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." As it happens, BMW's latest plant is a former Soviet naval factory that was built by Germans before the war to make U-boats. "A good German foundation," 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 that lend new meaning to the term hostile takeover. From Vyborg to Vladivostok, court fights over shareholders' rights 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." For too many foreigners, investing in Russia has proved to be tortuous and hugely expensive. Just ask the folks at BP Amoco. Last fall the company 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 with 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). BP Amoco vehemently objected and in late December reached a tentative settlement with TNK. But the Sidanko affair is still cited in expatriate business circles as a symbol of the hurdles foreigners face in Russia.

Yet as BMW shows, hurdles are there to be leaped. Along with the German automaker last year, Ikea, Nestle, Caterpillar, Lucent Technologies, Ford Motor Co., Gillette and Philip Morris quietly added to their investments--nearly all built production plants with local partners, pouring more than half a billion dollars in direct foreign investment into Russia. In all cases, investors have developed a range of protection plans to help ensure that they prosper, even if that word is somewhat loosely defined.

BMW's strategy focuses on advance sales and tax breaks. Customs duties make up 60% of the price of imported BMWs in Russia, but Kaliningrad, a free-trade zone, grants importers immunity from imposts. Atop that, 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 can afford. The joint venture already has on its books a big order, however--from the Kremlin. The administration of new acting President Vladimir Putin has bought 130 of the luxury sedans and an unknown number of customized limousines 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 that gray-market importers have put on the market. An estimated 120,000 BMWs cruise Russian roads, but just 4,500 were sold through official dealers in the past five years. When the Kaliningrad plant hits full stride, it will produce as many as 10,000 luxury autos a year.

Companies like BMW that are willing to take a big plunge into Russia's uncertainties are still rare enough to win admiration from Moscow's financial experts, who have a good understanding of the tough local business climate. "Yeltsin's retirement is certainly good news, but Russia still lacks good corporate governance and a viable legal infrastructure," says Bill Browder, founder and head of the Hermitage Fund, which has been one of the leading players in the Russian market. Since August 1998, when the country suddenly devalued the ruble and defaulted on $40 billion in foreign debt, notes Browder, "Russia's been cut off from the capital markets, and thus there's been no incentive [for local businessmen] to behave"--hence ploys like the Sidanko caper. But those who have played Russia's market for years know it is ruled by a simple equation: high returns rarely come without equally high risks. "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 foreign companies now forging ahead, nearly all have joined forces with solid local firms with existing factories or other hard assets. 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, 30 miles south of Russia's second city, Caterpillar has just completed its biggest investment in 25 years in Russia--a $50 million factory to make component parts for its European assembly plants and also put together 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 with a local state-owned partner. The factory is expected to be finished this summer and will make as many as 100,000 cars annually. Philip Morris and Gillette are putting up factories in the region, joining Wrigley, which opened a plant nearby last June. Elsewhere, Nestle is pumping $30 million into six factories across Russia, while Lucent Technologies is spinning fiber-optic cables at a plant in Voronezh, in central Russia. This month Ikea, the Swedish furniture maker, will open a Moscow megastore as the first step in a national plan to outfit Russia's famously bleak apartments.

The best barometer of investors' hopes may be the push by Western carmakers 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 start up this year with a small initial volume. "If you start small," says Maria Tarulina, an analyst with the Moscow brokerage Troika Dialog, "you can delay your big investment until you see how the first step goes."

In the past, too many investors did not heed that advice. The big losers in the 1998 ruble debacle were portfolio investors who bought soon-to-be-worthless stocks and bonds. None of them did the basic homework necessary to ensure that their investments were reasonably secure. Many of those pioneers have justifiably thrown up their hands and headed for home. But now there are others who concur with Caterpillar's Levenick that "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." Just so long as you're careful.