By any measure, Russian equity capital markets are red hot. Despite the emerging market correction in February, confidence in the robustness of Russian business has kept the country highly visible on investors radars.But with issuers trying to cram so many equity issues into the market before the 2008 elections, they may have to temper their most optimistic pricing expectations. Ivan Castano reports.
IPOs and equity offerings of Russian companies are set to raise over $30bn this year, up from $16bn in 2006, as investors continue to buy into the countrys appealing growth prospects.
However, investors are becoming increasingly choosy about the companies they back and this coupled with expectations of a glut of IPOs before the 2008 elections will likely undermine private companies ability to fetch a top price for their business.
There are also fears that any slump in the international capital markets following Februarys correction, and a drop in oil prices, could prompt investors to shift their assets outside Russia.
The finance and utility sectors are expected to lead this years IPO and equity run, raising $16bn and $15bn each, according to research by Alfa Bank. The mining and retail sectors are also expected to raise capital this year, say market participants.
"Investors are still enthusiastic about Russian IPOs," says Andrei Burlinov, executive director of investment banking at Troika Dialog bank in Moscow. "However, they are becoming increasingly selective about what they buy and how much they pay for it and this is going to pressure deal pricing and economics."
Jeroen van de Crommenacker, vice president of equity capital markets at ING in London, agrees: "We dont see any IPO fatigue and theres enough liquidity out there for good companies. However, many companies want to get their IPOs out of the way before the elections and this is going to create a pile-up effect in which they will have to work harder to get a top price."
If oversupply kicks in, only the fittest companies will get the high prices they have come to expect in recent months, says Alfa Bank equities strategist Erik DePoy.
"There is still a lot of money out there for quality companies with solid business plans and these will do well if priced attractively," he says. "But if you are a weak firm with an average growth story, or your management is seen to want to exit the shareholding at greedy prices, you will probably have to compromise on price."
The equity markets nose-dive in late February, prompted by the sell-off on the Shanghai stock exchange which wiped billions off bourses worldwide, caused investors to swift their investments out of emerging markets.
This left first quarter Russian fund holdings down $117.3m, throwing the entire emerging market asset class into a $1.28bn loss. In the same 2006 period, Russian fund flows stood at $1.06bn, bolstering the emerging markets sector to $4.3bn, according to Alfa Bank research.
Negative fund flows have stoked concerns about whether investors will continue to back Russian equity placements. Despite this, and indications that investors are taking a cooler stance on Russia, DePoy insists the sectors outlook remains strong.
"Obviously, Russian IPOs wont go anywhere if these funds dont increase but we dont expect the current situation to worsen and we are not alarmed," he says, adding that investors are waiting for the right signal to jump back into Russian equities.
Last years correction was worse
DePoy points out that Russia fund outflows were smaller in the corrections worst week this year, than they were in the corresponding week in 2006. In the week to March 7, investors moved $225m from emerging market funds, compared with $583m in the week to June 7, 2006. Meanwhile, the primary share index, the RTS, fell 14% after this Februarys market turbulence, whereas it fell 31% in the corresponding 2006 event, DePoy adds.
During previous sell-offs, Russia has been the first emerging market country to recover its losses and has done so convincingly, as happened last year when the RTS swung to a 71% gain when the markets recovered.
"Investors are going to be more hesitant to take money out of Russian stocks in 2007," DePoy says. "They have learned their history lesson."
Market jitters aside, a sharp drop in the price of oil, the lifeblood of Russias economy, could also make investors wary.
"If oil prices fall to $30 a barrel [from $63 currently], this could be a dramatic scenario for Russia," says Vadim Kleiner, head of research at Hermitage Capital Management in London, an investment company managing $3bn of Russian and CIS equity.
Barring that possibility, investors should continue to back Russian equity offerings, he says. "Russias strong macroeconomic outlook and consumer boom continue to make it one of the best investment stories in the emerging markets."
However, bankers point out that many companies have done very well by going public (including technology firm Integra and steel group Evraz) and that Russian investors usually take a longer investment view on the country.
Despite this, many Russian IPOs have underperformed the RTS share index by 25% since listing, according to Alfa Bank.
Elections to go smoothly
Brightening the outlook is the market view that Russias presidential elections are poised to go smoothly. Parliamentary elections are being held this autumn and presidential elections in March 2008.
"We dont expect to see any market turmoil surrounding the elections," Kleiner says, echoing the markets predominant view that President Vladimir Putin will pick his successor and that the people will back that appointment.
"Russian salaries have risen five times during Putins term," Kleiner points out. "Russians will follow his choice."
Political observers say Putin has already narrowed the field to two candidates: defence minister Sergey Ivanov and deputy prime minister Alexander Zhukov.
Despite this, there are fears that Putin could try to change the Russian constitution to let him run for a third presidential term. Some investors are also concerned that Russia could develop its concept of strategic industries beyond oil and gas, precious metals and other natural resources, exerting state influence over other business sectors and deterring foreign investors.
Putin has denied he will run for a third term. However, were his successor to expand the category of strategic industries, that would also alarm investors.
"If he were to suddenly turn the food or clothing trades into strategic sectors and start squeezing out competitors to create national champions in those spaces, that wouldnt be in the interest of Russian consumers, nor would it create value for foreign shareholders and investors," says Scott Eversman, head of the Russian division at consulting firm Heidrick & Struggles.
Russian state-owned gas giant Gazprom recently cut gas supplies to Belarus as part of a price dispute with that country, following a similar row with Ukraine last year, threatening supply to much of eastern and western Europe. The move brought further admonishment from the international community, which has criticised Russia for using its energy monopoly to push its political agenda.
If Russia increases the frequency and scale of such actions, some foreign investors could reduce their presence in the country, Eversman says.
"Investors will continue to look for evidence that Russian corporations are answering to commercial interests rather than being a tool of Russian foreign policy," he says.
Better corporate governance
In 2007 more Russian companies seeking a foreign listing are improving their corporate governance, something investors are increasingly sensitive about.
Investors want 50% of Russian boards to be independent members, preferably from a foreign country. They are also looking for companies that can provide three years of audited financial accounts and firms that promote a Western-style corporate culture, catering to public shareholders instead of a single owner.
Most London and New York-listed Russian companies fulfil these requirements and many IPO hopefuls are putting in procedures to implement them.
However, most companies still have "a lot of work to do to get there", Eversman says.
Finance and power to the fore
The fast growing financial services and energy sectors are set to lead this years run of Russian equity issues.
In the financial sector, a string of banks are working on primary and secondary equity sales most notably VTB, Rosbank, Bank of Moscow and Vozrozhdenie that are expected to raise $7.2bn.
As this report went to press, VTB was set for a $6bn London and Moscow float via Citigroup, Deutsche Bank, Goldman Sachs in the middle of May. Meanwhile, Rosbank and Bank of Moscow are aiming for a $200m IPO and $700m secondary offer, both in Moscow, in the second half. Smaller bank Vozrozhdenie hopes to generate up to $250m in a domestic equity sale.
Industry champion and Russias largest bank Sberbank completed an $8.8bn rights sale in February. This was below the expected $11bn target but met the banks own financing objectives. The deals success is seen as paving the way for the upcoming bank sector floats, which analysts expect to go well.
"Investors are very interested in Russias financial sector, so these deals should succeed," says Rustam Botashev, a bank analyst at Aton Capital in Moscow. "The banking market is still largely underdeveloped and should grow 70% this year and 30% annually until 2010," he says.Russias mortgage and loans sector is booming and the government needs funds to carry out multi-billion rouble projects to expand and modernise national infrastructure, likely to further boost banks profits.
In the energy sector, utility group Unified Energy System is divesting a handful of listed regional power suppliers to raise $50bn and upgrade the countrys outmoded electricity network.
The sales, which will be mostly secondary offerings, are expected to raise $22bn at current market prices and $15.4bn at the steep discount analysts say the companies will have to offer to complete their deals.
Electricity supplier OGK-4 is set to launch a $2.3bn Moscow share offering in July, through Troika Dialog and UBS, while regional power firm TGK-5 plans a $220m Moscow equity sale soon afterwards.
Other regional electricity players TGK-2, TGK-8 and TGK-9 are scheduled for August, September and October, while
others are due later in the year.
X5 returns to market
Power and banking floats aside, Russias largest food retailer X5 Retail Group is mulling an $800m-$1bn Moscow secondary offer to buy hypermarket chain Karusel and trim its $1.1bn debt.
In Russias growing precious metals industry, small gold producer GV Gold has revived plans for a $200m London and Moscow float to finance growth. The company, based in the Irkutsk region of Siberia, abandoned the IPO in Feburary after investors chastised its over-zealous pricing expectations.
One company that has moved into investors radar screens is Magnitogorsk Iron And Steel Works (MMK). The company, which owns Russias largest steel works, is expected to raise over $1bn when it prices its London and Moscow listing in late April. So far, the companys $12.25-$15.50 GDR price range is generating a lot of interest, bankers say.
Russias swelling IPO pipeline shows companies are unfazed by the stockmarkets recent dip and are eager to play Russian roulette with foreign and local investors.
|Performance history of EQUITY issuance in 2006 and 2007|
|Total raised $m||IPO price ($)||Current share price ($)||Gain / loss|
|Issued in 2006|
|Trader Media East||650||13.00||9.25||-28.8%|
|Issued in 2007|