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The golden age of Russian IPOs

15 Oct 2006

By the end of this year, as much as $20bn will have been raised by Russian companies via IPOs since the first one was sold in 1996. It is a staggering amount and one that could be matched next year when as many as 50 IPOs are set to come to market. But there are plenty of warning signs that the good times cannot last forever. Julian Evans reports.

2005 was a breakthrough year for Russian IPOs, with 12 deals raising around $5bn. But 2006 has been even more of a bumper year, with eight deals so far raising $14.5bn. Analysts think another $5bn or so could be raised by year end.

And next year, the last year before presidential elections begin, as many as 50 IPOs are planned, looking to raise around $13bn. "Everyone is focusing on 2007 as the last year you can do IPOs for a while, because of political risk and dropping oil prices," says Natalia Orlova, chief economist at Alfa Bank.

That means total banking fees, from 2005 to 2007, of around $1bn. Not bad news for the market leaders — Morgan Stanley, Credit Suisse, UBS and ABN Amro Rothschild.

Banks are scrambling to increase their Moscow teams to capture more of the IPO market. ABN Amro Rothschild, for example, set up a Moscow office in October. Jan de Ruiter, joint chief executive of ABN Amro Rothschild, says: "Russian equity issuance has grown dramatically over the past year. 2006 volumes already stand at more than double 2005. Our Russian business will aim to capture a significant market share in this burgeoning region."

ABN was one of the lead managers on the biggest Russian IPO ever — the $10.6bn Rosneft IPO which was priced in July. Credit Suisse, Dresdner Kleinwort and Morgan Stanley were the other lead managers, with 10 other banks involved in the book.

The deal was obviously a benchmark for Russian deals. It accounts for half of the total volume of IPOs done since 1996. It is also the fifth biggest IPO in the history of the markets.

There was a lot of concern that the IPO, because it was such a benchmark deal for Russia, could go wrong, and bring much of the emerging markets' sector down with it. After all, global emerging markets were shaky in April and May, with the MSCI index falling 200 points.

The run-up to the IPO was rocky. Several high profile western investors, among them George Soros, said the deal was an attempt by the Russian government to legitimise its grab of Yukos assets and the arrest of several Yukos executives. Many foreign investors had lost money in that asset grab. As Angelika Millendorfer, emerging Europe fund manager for Raiffeisen Capital Management, put it some months ago: "Why should we buy back what the state has taken from us?".

Other investors had concerns that the new company would be subject to endless litigation from Yukos through the international courts.

In the end, the deal was priced successfully, at the top end of the price range. Charles Lucas, managing director of ABN Amro Rothschild and head of its new Moscow office, says: "The litigation question was clearly an issue for investors. But billions of dollars in bids still came in. People like the Rosneft story. It's the oil champion of Russia, and its access to new reserves means it's in a very good position."

But how much of the demand for the deal was actually from foreign portfolio investors? Chris Weafer, chief strategist for Alfa Bank, says: "The bulk of the issue was subscribed for by either strategic investors or domestic investors pursuing a political agenda. It was more a private placement than a genuine IPO. The main reason for such a large level of support was political".

Political timing?

This was a highly political deal, timed to coincide with the G8 Summit, which Russia hosted in St Petersburg in July. It was orchestrated, like a piece of theatre, to show Russia's new oil power, and its openness to foreign investors, to the visiting world leaders.

Rosneft has struggled since launch, as the market shows it has reservations. It sank below its market price for several months, and is now slightly above it. But in fact most oil company stocks have been down in recent weeks.

But Weafer is bearish on many other Russian IPOs as well. He says: "Of the 25 Russian IPOs placed since the beginning of 2004, only five have performed better than the RTS Index from the date of issue."

He goes on: "If an investor had invested $100,000 in each IPO since the start of 2004, and at the same time invested $100,000 in an index tracking fund (ie on the same date as each IPO), then today that investment in IPOs would be showing a gain of 48.3%, while the RTS index would have delivered a gain of 85.5%."

Weafer also notes that seven of the 25 IPOs issued since 2004 are trading below issue price, including Trader Media East, Amtel-Vredenstein, Comstar UTS, Veropharm and Cherkizovo Group. He says in large part, deals have done badly because the core shareholders have pressed for a high valuation, either to support their "lifestyle aspirations" or to protect them against Yukos-style attacks from the government.

One head of European equity capital markets in London agrees: "Banks have been pricing deals too expensively. We've been a bit greedy. Everyone is guilty of it."

But Charlie Ryan, CEO of Deutsche UFG, says: "It's a slightly unfair evaluation. The RTS has been down quite a lot since April, so some deals have suffered through that, in line with the rest of the market."

Some IPOs have certainly done well. The best performing IPO has been Open Investments, the real estate company. It capitalised on positive investor sentiment in September, when it raised a further $880m in a secondary offering. CEO Sergei Batchin says: "Western investors like us because we've performed so well since launch."

The company's shares are up 257% since it floated in November 2004. Weafer says this is because the company "occupies an exclusive niche in the stock market. [It] represents the only direct way for portfolio investors to get exposure to the real estate market." Another real estate IPO, from Sistema-Hals, is looking to raise funds in the next month, in a deal lead managed by Deutsche Bank, Nomura and UBS.

The next wave of deals

The Sistema-Hals deal is one of around 80 deals looking to come to market in the next 15 months, as Russian companies look to raise around $18bn in equity capital.

That includes around $2.3bn in electricity deals, as the first wave of RAO UES subsidiaries come to market. The electricity sector needs around $250bn in investment over the next 20 years, and the CEO of RAO UES CEO Anatoly Chubais wants to raise at least some of that in IPOs in London and Moscow, with a first spate of deals planned for the next few years. Alfa Bank and Merrill Lynch are UES's consultants for all the different deals.

The first of these to come to market is OGK-5, a regional generating company which hopes to do an IPO in November, in a deal lead managed by Credit Suisse, Deutsche Bank and Troika Dialog. Anatoly Bushin, general director of the company, says: "IPOs are a very important way for UES in general, and us in particular, to raise funds. It's an important time for us to invest, because we have a sharp electricity deficit, and we need capital to build new facilities."

It will be interesting to see how the UES IPOs do. Russian newspaper Kommersant reported that a number of big western investors had met with Chubais at a meeting in London in September, and expressed reservations about the deals, saying they needed clarification about the pace of reform at both UES and Gazprom, which provides gas to UES and is itself a big buyer of UES stocks.

Derek Weaving, an independent analyst who has advised UES, says: "In many ways it's an acid test for Russia. People buy shares in Gazprom, even though it has bad corporate governance, because it has so much gas. But electricity companies will really have to convince foreign shareholders that they will be treated well and will receive proper dividends. And utility prices will have to go up."

Other big deals in the pipeline include Severstal, the steel company, which is coming to the LSE having failed to merge with Arcelor of France. The company, which is looking to raise around $1.5bn, could do well, though it is noticeable that the stock of subsidiary Severstal-Auto has been one of the worst performers since it was launched in April 2005.

Vneshtorgbank, Russia's second biggest state bank, is also planning an IPO of a 25% stake in 2007, probably in the second or third quarter, which could raise $2bn-$3bn. It is one of eight financial companies looking to come to market, according to analysts. Many banks, including Vneshtorgbank, are facing capital constraints because of the lending boom in Russia.

IPOs not for everyone

Opinion is divided over how well banking IPOs might do. Artem Konstandian, managing director of Promsvyazbank, says: "I'm not convinced that IPOs are the answer for private banks. It makes more sense for state banks, which have no problem attracting equity capital. IPOs aren't just about raising capital — it's a whole new model. Sometimes the demands for exaggerated corporate governance can stand in the way of effectiveness, at least tactically."

In fact, all companies coming to market might find it tougher over the next 12 months than they have over the last 12. In the first six months of the year, $30bn in global funds flowed into emerging markets, and since then $20bn has flowed out. According to analysts, within emerging markets, a lot more capital is heading towards China and India than Russia. Some enormous deals are coming from China in the near future, including the IPO of Industrial and Commercial Bank of China (ICBC), which could raise as much as $21bn.

Chris Weafer says: "Sellers face a much tougher IPO environment and only those who have learned the lessons of the past will have successful placements. A lot of the planned Russian IPOs will either have to be delayed, or they will have to come at an attractive valuation. IPOs will fail or succeed based on valuation."

Stephane Gruffat, director of ECM syndicate at Credit Suisse, agrees: "If you didn't buy IPOs in the first quarter of 2006, you were nuts. Now, there is a fair number of IPOs around the world to choose from. So you can figure out what you want to invest in. Investors are becoming more selective and cautious."

It is notable that, at the time of writing, Uralkaly, the world's fifth largest producer of potash, has just pulled a planned IPO, because it was not able to sell its shares "within a price range that reflects the company's perception of its fair value", according to a company statement.

In other words, the Rosneft IPO might have marked the end of the golden age of Russian IPOs, and perhaps a more discriminating, and more demanding, age has begun.

15 Oct 2006