IMF World Bank 2006: Red Europ
Emerging European ECM continues to explode, with volumes exceeding US$15bn by mid-August. But the dependency on Russia for volume is growing. Only two years ago the majority of ECM volume was coming from other countries, such as Poland and Turkey. Factors specific to those countries have significantly diminished activity, but ECM teams are still growing thanks to the realisable potential of Russia, writes Owen Wild.
The switch to focus a greater number of European ECM originators on emerging markets has been rapid, reflecting the speed with which the market dynamic has changed. In 2004 only a handful of banks were active in bringing ECM deals from emerging Europe on a regular basis, but growing opportunities led to new entries, including some of the largest banks. Their prior absence reflected the wide geographical area to be covered with relatively few deal candidates, and then low fees on any deals that did appear.
In 2005 the picture changed, with volumes reaching US$11.7bn, with Russia accounting for US$7bn. Credit Suisse and Morgan Stanley gained first mover advantage to have a strangle hold on the Russian market, with Renaissance Capital winning some business as the local bank. Mandates have been more spread in 2006, reflecting the entry of other firms and the conversion of lending relationships into IPO mandates.
Despite the growing dominance of Russia, other Emerging European companies are also providing opportunities, but bringing these to market continues to be a struggle that is often highly political. The Polish government recently conceded that it would have a Z4bn (US$1.3bn) budget deficit for the financial year 2006-07 due to slow progress in privatisation, attributable to political debates over every sale.
The pipeline includes significant deals such as insurance company PZU, which has been on hold since Q1 2005, and the IPO of Polish airline Polskie Linie Lotnice (LOT), which was mandated to JPMorgan in July 2005. One banker close to that deal said that while it remains a live mandate it would not take place in 2006 and fees are not currently allocated to any budget – indicating a long delay before completion.
This is supported by the Polish treasury minister who declared that while the budget deficit was mostly due to privatisation revenues Z4.5bn below target there would not be any acceleration in privatisation activity. Bond issuance is expected to fill the void.
Delays and debate
The IPO of mobile phone company Polkomtel also looks likely to sit in the pipeline for many more months as legal action takes place between the various shareholders. The three Polish shareholder groups have previously issued RFPs for an IPO, with each looking to mandate their own bank for the sale of their holding, leading to appointments for Credit Suisse and Merrill Lynch.
But movement towards an IPO has been hindered by foreign shareholders TDC and Vodafone. The latest chapter has seen TDC abandon efforts to increase its shareholding and instead sell out of the company, offering a quarter of its shares to each shareholder at the same price. The sale was agreed with the Polish shareholders but Vodafone objected to the sale price so elected to take TDC to the International Court of Arbitration.
Turkish activity also remains light though this is because the equity market continues to be one of the most volatile in Europe. Market swings can be so dramatic that a deal can progress smoothly only to be pulled due to market falls irrelevant to the company. Despite an uncertain environment two deals completed in the second quarter of this year having been in the pipeline for years.
Vestel White Goods and Coca-Cola Icecek both found sufficient demand to price their IPOs successfully but completed at a time when the market was sensitive and fell in the aftermarket. VWG had a particularly dramatic fall and was down over 40% by August. As a result future Turkish deals are likely to gain little benefit from seeing the two previous high-profile, competitively priced IPOs complete.
Large deals are also in the pipeline from INA in Croatia and Ceska Pojistovna in the Czech Republic, but neither is expected until 2007. It is therefore no surprise that many houses are focusing their emerging market resources in Russia.
Russia is the home of many multi-billion dollar companies that are prize mandates. The surrounding Commonwealth of Independent States also is rich with banks and resources companies, and are beginning to show fruit for the houses that have pursued mandates here.
Kazakhmys entered the FTSE 100 following its IPO last year and it is now likely to be followed by a series of government and banking deals. September 2006 will see the long-awaited IPO from state-owned gas giant KazMunayGas that will involve a London listing and total approximately US$1bn.
That deal suggests a renewed momentum to the government's extensive privatisation plans. The government has already mandated ABN AMRO Rothschild to lead the IPO of rail firm Kazakhstan Temir Zholy and has plans to list a vehicle consolidating several assets into a holding company. Private sector activity is also scheduled before year-end through Alliance Bank and Halyk Bank.
Several other banks are also keen to tap the equity markets for capital to help them grow, but some bankers suggest their may not be sufficient appetite for all these deals. Kazakh banks are small compared to peers in other emerging European nations and all of the top three banks have expressed an interest in listing, with Alliance falling outside this group.
Bankers suggested that due to their small size it might be difficult to gain investor interest in several names. Alliance is likely to be first to market, which would be positive as it would be the smallest deal and could be followed. However if one of the top three comes first it could squeeze out others.
Other members of the CIS are also developing, with Ukraine the most prominent, but there are fewer opportunities here. However chicken producer Myronivsky Khlboprodukt is expected to revive its IPO later this year after postponing in Q2. The difficulty is that covering Russia and Kazakhstan is already resource-intensive, and so to cover Ukraine and Kyrgyzstan is not a priority for most houses.
Of all the larger listings from both Russia and Kazakhstan, there is one common component: the use of London as a listing venue. For deals of below US$400m a purely local listing is practical as there will be a sufficient specialised investor base, but for deals in excess of US$1bn London is critical.
Bankers argue that the audience needed for a deal of this size is not willing to deal with the difficulties of the Russian market. Issues abound in settlement both after an IPO and after any subsequent trades. The time for delivery of shares after an IPO can exceed a week and settlement after trading is more complex as there is no system of delivery versus payment. Many investors will therefore only invest in IPOs where GDRs are available ensuring a steady flow of business for the London Stock Exchange.
The deal where this was crucial was the US$10.4bn IPO of Rosneft. The IPO was much criticised at the time as it was felt the deal relied on the support of other oil companies and oligarchs. Oil companies were said to be buying future partnerships and contracts, while oligarchs were seen to be protecting their interests as the deal was so important to the Kremlin.
But leads on the deal said that a large number of institutions had also supported the deal, with 339 funds involved from pre-marketing, and it was only the high price set by the Kremlin that limited institutional allocations in the deal. Allocations were deliberately unclear after the deal due to the impact of pricing.
Yet bankers involved in the IPO suggest that it has had a beneficial impact on Russian ECM due to the large investor interest. Though they did not participate in this deal the process also introduced Russia to many accounts. One banker involved said the deal was successful "as a road-widening process for the path of money into Russia", which will translate into other deals out of Russia.
Russian companies are however also required to have a local listing, and this has ensured Russian banks' continuing presence on IPO mandates. Over half of Russian IPOs include a local house, as internationals are not always viewed as able to place domestically – though this is not necessarily the case. Internationals are increasing their local footprint with offices adding sales staff and product specific bankers, rather than those covering all investment banking.
Nevertheless, the perception that a local bank is a requirement for a successful listing is already being translated to other markets. For example, despite only recently being formed, Visor Capital holds a bookrunner position on the IPO of KazMunayGas. The bank is establishing itself as a full service investment bank in Kazakhstan and is therefore strongly placed to pick up further IPOs, though there is no requirement for companies to have a local listing.
Interest in much of emerging Europe remains limited to the same small club that covered the region three years ago, but every bank now has an interest in Russia – including many outside the top 10 by volume.
The economics of deals continues to be poor, with fees often low considering the amount of preparatory work that is required, but the frequency of deals and size ensures the emerging ECM is a much more profitable business than it has been for many years.
In addition to a plentiful supply of mandates that should keep every bank happy there is also support for local banks which are becoming increasingly professional in their approach. The only danger for volume is if a company plays fast and loose. Part of the progress to IPO is a maturing of the company in its management, governance and accounting. If this is not upheld or maintained then it could have a serious impact on future flows.