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Time to redress the equity balance

15 Apr 2004

Ukraine's equity markets have remained underdeveloped as the government and the country's companies have focused on developing domestic and international bond markets in recent years. As a result, any funds to reach Ukraine's companies have taken the form of private equity investments. Kathryn Wells asks whether this situation is about to change.

"Our first priority is to develop our stock market. This is a field that neither the government nor Ukrainian companies have paid enough attention to in the past." So says Ukraine's minister of finance and deputy prime minister Mykola Azarov, acknowledging that while progress has been made on the international and domestic debt markets in recent years, huge efforts are needed before the country's equity market can take on a healthy hue.

"Ukrainian enterprises have very low capitalisations," Azarov continues. "Most companies do not have international accounts, so there is a paradoxical situation in which companies might in practice have huge assets, and carry out projects worth hundreds of millions of dollars, but theoretically they continue to have low capitalisations.

"Because of this, Ukrainian companies have low liquidity on the stock market. They are not known or trusted on the international markets, while on the domestic market they do not offer a high enough yield to be interesting to domestic investors."

Capitalisation of Ukraine's principal stock exchange, the PFTS (First Stock Trading System), reached $4.8bn in 2003, substantially down on levels of $7.7bn in 1998, but nonetheless an improvement from 1999's level of $1.3bn immediately after the Russian crisis of August 1998.

In 2003, trading of corporate bonds represented the largest portion of the exchange's activity, at around 63%, with equity trading making up around 17%.

Of the equity segment, power utility companies represent 20% of the sector, chemicals 15%, recreation and tourism 11.5% and construction nearly 11%. Closely behind are fuel companies on 9%, and machine-building and metal work on 7%.

Metallurgy companies make up three of the top five largest companies by capitalisation on the equity market. According to Irina Zarya, president of the PFTS stock exchange in Kiev, the top five are: Ukrtelecom, with a market cap of $1.2bn, metallurgy company Nikopol Ferroalloys on $394m, oil and gas firm Ukrnafta at $346m, metallurgy firm Mariupol Illych Steelworks at $261m and metallurgy company Zaporizhstal at $169m.

While some of these levels look attractive on paper, the biggest problem for investors is the lack of liquidity - according to figures from investment bank Dragon Capital in Kiev, the free float of Ukrtelecom stands at a mere 2%, while Ukrnafta's is not much better at only 8%. The largest free float of any of Ukraine's blue chips is for energy generator Zakhidenergo. The company has a market cap of $123m, and a free float of 30%, Dragon analysts say.

"Positive progress in the equity market will depend more on political factors, privatisation policy and corporate governance levels than on the economic situation or companies' attractiveness," says the PFTS's Zarya. "Pension reform will be one of the key factors for the development of all segments of the market."

Private equity leads the way
Because of the lack of liquid stocks to invest in, and the lack of any genuine pipeline of IPOs to look forward to, activity has focused instead on private equity.

The EBRD is the most active investor in Ukraine - injecting the biggest funds across a range of markets and structures.

As of the beginning of March, the EBRD's commitments to Ukraine stood at Eu1.3bn, spread across 58 projects. This represented nearly one quarter of the total cumulative foreign direct investment in Ukraine at the beginning of January 2004.

The EBRD's 29 equity investments to date have been mostly focused on investments of up to Eu1m, with Eu15.9m having been disbursed in these micro projects.

One such project was a Eu8.4m investment in Kredit Bank Ukraine. In return for the investment, the EBRD received a 28.25% stake, and helped to restructure what was a de facto bankrupt bank.

The bank has also made a $12m loan, convertible into equity, to Gostomel glass factory, Ukraine's largest and oldest glass container producer.

"So far the investment climate has not been conducive to large scale private equity and venture capital investments due to the low standards of corporate governance, weak minority shareholder protection and the undeveloped public equity markets," explains Kamen Zahariev, the EBRD's director for Ukraine in Kiev.

Zakariev believes that over the next three to seven years the appetite for long term funding will increase once ownership battles have been resolved, and that consolidation will lead to increased M&A activity. Furthermore, the EU enlargement process is expected to fuel foreign direct investment inflows into the country. 

15 Apr 2004