Two steps forward, one step back

  • 22 Oct 2004
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Russian equity issuance has been muted this year, with the Yukos saga and the summer banking crisis taking their toll on stock market valuations and investor confidence. However, bankers are confident that this year's pipeline will lead to more deals in 2005. Harry Wilson reports.

How do you make a small fortune? Answer: start with a large one. The old investors' joke applies well to anyone unfortunate enough to have held large amounts of Yukos shares this year.

The Russian government's long legal campaign against Russia's largest oil producer has taken its toll on Yukos stock, which has fallen 59.8% in value so far this year, and 72.6% over the last 12 months.

But, for every loser there is a winner, and for those who bought shares in majority state owned energy company Gazprom, the scale of their gains have been the reverse of Yukos investors' losses. Gazprom stock has soared 92.9% this year, and increased 70.7% over the past 12 months.

The government's suggestion in September that it would remove the ring-fence prohibiting foreign investors from buying Gazprom's Moscow-listed shares was a major factor in the share price increase. But another more subtle cause is the perceived security offered by Gazprom, in which the government has a 38.4% stake.

The difference in sentiment towards the two companies is best seen by comparing their forecast PE ratios for 2004. Gazprom's PE of 8.5 is over three times higher than that of Yukos at 2.4. That compares to last October when Yukos was trading at 6.9 versus Gazprom at 4.

The Russian ministry of justice's reported refusal to accept a Dresdner Kleinwort Wasserstein valuation of Yuganskneftegaz, Yukos's main oil producing subsidiary, of $15.7bn-$18.3bn, means there is no end in sight for the company's legal problems.

In contrast, Gazprom continues to go from strength to strength, with the news that it is near to completing negotiations on a liquid natural gas project with energy company Royal Dutch Shell, which will give it access to the latest Western technology.

But for investors swapping their stock out of Yukos into Gazprom, the move will have in part seemed like a step back, for while Yukos has become one of the most transparent and efficiently managed companies in Russia, Gazprom is a more opaque and less efficiently run business.

This situation is unlikely to change. Gazprom's takeover of wholly state owned oil company Rosneft will make the government its majority shareholder, with a 50% plus one share stake. Ironically, as analysts at brokerage house Troika Dialog pointed out in a report published in September, this makes the structural reform of Gazprom, the original motive for the government takeover, less likely as the company becomes a national energy champion.

Aiming for London
Fortunately for investors, a growing number of Russian companies are preparing to list their stock internationally. In September alone, six Russian businesses announced plans to list or sell further tranches of shares. Among those were some of Russia's largest companies, including Sual, its second largest aluminium producer, and RusPromAvto, an automotive holding company with a majority stake in Gaz, Russia's largest car manufacturer.

For these companies, as for wealthy Russians, London is the international stock exchange of choice, in particular London's junior market AIM.

Why Yuganskneftegaz may not be sold
Dresdner Kleinwort Wasserstein's publication on October 14 of its valuation report for Yuganskneftegaz (YNG), Yukos' main oil producing subsidiary, brought a new twist to a saga which started when the government arrested the company's major shareholder Mikhail Khodorkovsky in October last year.

DrKW estimated YNG's equity value as $15.7bn-$18.3bn, while the Russian ministry of justice reportedly said it would start bids for the company at $4bn.

But, while most of the market has focused on the supposed valuation discrepancy between DrKW and the government, few have stopped to ask how likely a sale really is. Russian equity market veteran William Browder, chief executive of Moscow-based specialist Russian investment fund Hermitage Capital, believes that is an oversight.

Browder argues that the sale of YNG, whatever the price, would not fulfil the government's aims in its struggle with Khodorkovsky.

?If the government sells Yuganskneftegaz for $4bn then it will discredit itself with the international investment community,? says Browder. ?But, if they sell it for $17bn or more, then they will enrich Khodorkovsky, which negates the point of this whole exercise.?

In Browder's argument, the sale of YNG is just another threat levelled by the government in its attempt to wrest control of Yukos away from Khodorkovsky.

Indeed, as analysts at Russian brokerage United Financial Group pointed out in an October 18 report, there are five problems that will have to be resolved if a sale is to be successful.

* YNG's lack of its own marketing organisation. Though YNG exports the majority of its oil, Yukos holds the export quota.

* $2.04bn of Yukos' long term loans are guaranteed by YNG exports. As DrKW pointed out, that means that the sale of YNG would result in technical default of those loans, with YNG liable.

* The Russian tax authorities are poised to present claims of about $600m for 1999-2001, as well as additional claims for 2002-2003.

* YNG's accounts are frozen, so it is unable to pay its current tax liabilities, which could lead to its licences being revoked, reducing the company's technical value to zero.

* Yukos' shareholders could dispute any valuation of YNG as well as other claims. This means any lack of transparency during the auction will have a negative impact on the international investment community's view of Russia.

Browder asserts that even without these problems, there are few companies that would be prepared to buy YNG, since few international oil companies will judge it an acceptable risk, and apart from Surgutneftegaz, no Russian oil company has the money to be able to pay anything close to DrKW's valuation figures for the company.


?Russian natural resource companies have found a strong peer group, with the London market already home to many Australian and Canadian natural resource companies,? says Jon Edwards, head of business development for Russia at the London Stock Exchange. ?Whenever you have a peer group it helps to attract other companies in the sector to the market, and it becomes a focus for investors.?

However, Edwards points out that while natural resource companies are still one of the largest constituents of AIM, the diversity of sectors and the size of the companies on the exchange are both expanding, and that is reflected in the size of Russian businesses coming to the market.

Despite the image of AIM as the home of small businesses, all the companies with Russian assets to list on the exchange this year had market capitalisations of over £100m. Edwards argues that while these businesses would hardly register on the radar screen of New York investors, they attract a lot of attention in London.

Aside from that level of investor focus and the obvious geographic proximity compared to New York, one of the main advantages of London, and in particular AIM, is its regulatory regime. The regulatory requirements for an AIM listing mean that companies with shorter dated trading and accounting records, common issues for Russian firms, have fewer problems getting approval for a flotation.

?For companies that don't have three years of IAS, but are mature enough to list, AIM gives them a way to raise money now,? says Edwards. ?This is not to say that getting a listing is a cheap or easy process, as the due diligence process is substantial and not cheap ? though cheaper than any other European or US exchange.?

Not all companies have taken the London route. Steel and coal holding company Mechel is pursuing a placement of its ADRs on the New York Stock Exchange. However, it is the exception, and equity bankers say that London is likely to remain the favourite destination for Russian companies.

?Most Russian companies are contemplating listing in London, since that is where a significant portion of the emerging markets investors are located,? says George Pavey, a director of ECM focusing on emerging markets at Credit Suisse First Boston in New York. ?London offers good corporate governance standards, but with a listing regime that is slightly more amenable to Russian companies, who can find the SEC's requirements difficult to meet.?

Deals brewing
This October, Efes Breweries International's $178m IPO answered the prayers of many investors in Russia by providing an opportunity to buy exposure to its booming consumer sector.

Efes, the Netherlands-based unit of Turkey's Anadolu Efes, is the third largest brewer in the country with an 8% market share, though it is the leading brewer in Moscow, the most sophisticated of Russia's drinks markets.

"Efes is one of the best opportunities to get exposure to the Russian consumer sector,? says Pavey at CSFB, who worked on the deal. ?Investors want to diversify away from the natural resources sector, and this is one of the best plays to do that. We saw broad cross-over interest in the offering with pan-European and sector investors also participating in the offering.?

The March Skr5.13bn ($673m) flotation of Swedish cosmetics company Oriflame is the best example this year of how strong investor demand is for companies that offer exposure to the Russian consumer sector. The company direct markets cosmetics to eastern Europe, in particular Russia. Such was demand for the stock that the IPO's lead managers, Merrill Lynch and Carnegie, were able to increase the deal size by 15% and cover the book 10 times, pricing the offer close to the top of its range.

However, natural resources companies continue to dominate the Russian domestic stock markets, as well as international equity issues from the country. The $127m IPO of aircraft manufacturer Irkut in March should have been an opportunity for international investors to diversify their portfolio, yet, surprisingly, the company chose not to place any of its shares internationally, meaning many international investors were unable to participate.

The lawyer's view
Tim Jeveons, a partner focusing on emerging markets at law firm White & Case, the largest international law firm in Russia, examines the issues for Russian companies looking at an international listing.

What are the main issues when preparing Russian companies that want to list? What corporate governance issues have to be resolved?
The issues will depend on whether the company wants a domestic or international listing, and if restructuring is required. Generically, the company needs to consider if it is really ready to be fully transparent. Furthermore, are the directors fully aware of the responsibilities of running a listed entity? That is to say, being fully transparent, having proper accounting mechanisms, having correct procedures in place for the treatment of minority shareholders, and so on.

What do Russian companies find particularly attractive about AIM, and do other markets, such as the NYSE or Euronext, offer a similarly attractive regulatory regime?
AIM is an attractive market for businesses all around the world, not just Russia, which is why it's had more than 90 international companies list on it since its inception in 1995. Its light touch regulatory regime and the lower costs associated with it, coupled with the market's liquidity, mean that it is compelling for smaller businesses looking to access public equity and at the moment no other market can really match that. We're expecting an increasing number of Russian businesses, particularly natural resource companies, to list on AIM in the next 12-18 months.

Are Russian companies easier to prepare for an international listing than other companies from emerging markets?
Companies from emerging markets each have to be treated as individual cases ? it would be wrong to say that in general businesses from one emerging market are easier to prepare for a listing than those from another. The key issue is to examine each on its own merits.


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?We had a lot of emerging funds interested in the company, but a lot of them did not have the systems and custodial relationships in place to own a Moscow-listed stock,? says Pavey, who also worked on Irkut's IPO.

At the time of the deal, the company said it might list its shares in London, and bankers working on the deal told EuroWeek that a GDR placement would attract a lot of interest from funds that had stayed out of the IPO.

Many bankers remain confident that a spate of Russian companies will list over the next year or so. Pavey at CSFB estimates that as many as 12 companies might list by the first half of next year. That is a view supported by Edwards who says that over 40 Russian companies attended a London Stock Exchange conference in Moscow in June that was aimed at attracting Russian companies to consider listing in London.

In a sign that investors are not prepared to sit and wait for a vague pipeline of deals to appear, many are taking direct action to increase the dealflow. Peter Westin, chief economist at Russian brokerage Aton Capital, says that many investors are using private equity-like investments to do this.

?Investors are pushing for issues ? some funds are even creating direct equity funds to accelerate businesses towards the stock market,? he says.

Bonds still attractive
Many bankers and investors have been expecting a rush of equity issuance from Russia since the last few months of 2003 and are increasingly frustrated by the lack of activity. However, the same issues that kept volumes down last year, have continued to afflict the market this year.

The big factor holding back issuance is the strength of the Russian corporate bond market, which has doubled in size over the past two years. Low interest rates mean debt issuance is still the most attractive way for Russian companies to finance themselves, and that has dissuaded many from considering a domestic or international share listing.

On top of this, Russian stock market valuations have been hard hit over the course of this year. The most obvious source of trouble has been the Yukos saga, but its importance can be overstated. The company's valuation has fallen so sharply that it has gone from comprising 25% of the RTS index to about 4%, thereby reducing its influence on market values.

More significant were the summer events surrounding the Russian banking sector, when some smaller Russian retail and business banks had their licenses revoked, leading to widespread deposit withdrawals and increased capital flight (see box), further denting investor confidence in Russia.

Russian market analysts say that the Yukos debacle and the banking crisis are factored into current stock market valuations, which are well below those of the first half of the year, making equity issuance unattractive once again.

All these factors mean investors might be sitting on their small fortunes for a while longer.

Capital flight returns
Capital flight has been a perennial feature of the Russian economy, though it has been falling over the past four years. However, this year total capital flight is projected by Aton Capital to total $12bn, over five times the volume of 2003, and approaching the 2001 figure of $15.3bn.

Like the Yukos saga, the importance of this outflow of capital on equity market valuations can be overstated. When measured as a percentage of GDP, capital flight this year will be only 2.1%, just four times higher than the figure for last year, and less than half the proportion of 2001.

However, it was the large inflows of Russian money into the economy earlier this year which underpinned the high stock market valuations (for correlation see graph of private net flows versus the RTS index), and led to an increase in the number of companies looking to float. The reversal of these flows will be important for the return of attractive stock market valuations, but Peter Westin, chief economist at Aton Capital in Moscow, argues that it is not certain that capital flight will fall in the near future.

?From the point of view of Yukos and the mini banking crisis we had this year, the demand for dollars has increased, which you could argue increases the incentive for capital flight,? he says. ?Also, the high oil price has led some oil companies to keep some of their earnings abroad, which is partly an insurance policy for them, especially in the light of Yukos.?

Indeed, as Westin points out, the government is mildly supportive of the outflows, since in a macro-economic environment where there is a fiscal surplus and increasing export revenues, they can help to prevent the rouble from appreciating too much. All of which means capital flight is unlikely to fall sharply any time soon.


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  • 22 Oct 2004

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 242,385.66 930 8.17%
2 JPMorgan 224,331.47 1001 7.56%
3 Bank of America Merrill Lynch 216,781.07 727 7.31%
4 Barclays 185,859.78 675 6.27%
5 Goldman Sachs 160,296.83 522 5.40%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 JPMorgan 32,522.19 61 6.53%
2 BNP Paribas 32,284.10 130 6.48%
3 UniCredit 26,992.47 123 5.42%
4 SG Corporate & Investment Banking 26,569.73 97 5.33%
5 Credit Agricole CIB 23,807.36 111 4.78%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Goldman Sachs 10,167.68 46 8.81%
2 JPMorgan 9,894.90 42 8.58%
3 Citi 8,202.25 45 7.11%
4 UBS 6,098.17 23 5.29%
5 Credit Suisse 5,236.02 28 4.54%