Issuance from the EU accession countries has been relatively low compared to the explosion of activity from Russia and the CIS. A lower risk profile and lower growth forecasts than other emerging markets have played a part, but the pipeline of privatisations remains strong, reports Ian Forrest.
The accession of 10 eastern European countries into the EU in May 2004 was expected to lead to an increase in ECM activity as investors gained further confidence in the fast-growing economies from the Baltic to the Balkans.
The ten countries which joined were Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia. Romania and Bulgaria joined in January 2007.
But issuance in these countries has actually been slower than many predicted, and considerably slower than was seen in Russia and the CIS, despite economic growth reaching forecast levels and remaining well above the average of the developed economies of Western Europe. Expectations were also fuelled by ambitious forecasts from some analysts at the time of accession. Many of the expected ECM deals were privatisation IPOs, but the flow of these has remained as erratic as before accession.
Some bankers were always sceptical about the possibility of a big rise in ECM activity post-accession and believed it would be a much more gradual process.
"The deal volumes in the accession countries were never going to be large, it is more about the frequency of deals than the volume", said Anton Cherny, head of ECM at Renaissance Capital.
Neither did Francis Kucera, a Linklaters capital markets partner specialising in emerging markets, expect a rush of ECM activity post-accession: "Economies and businesses were much the same before as after accession and issues such as size or IPO-eligibilty of companies or availability of debt funding did not change overnight".
The ongoing change in corporate culture in many of the countries is also regarded as a factor by some analysts. Business owners are taking time to become comfortable with the idea of looking to the capital markets for funding, and accepting the ceding of some ownership to outside investors.
"There is a big sociological shift taking place in these countries,” said Alex Tarver, an emerging markets product specialist at HSBC's active fund management group Halbis. “Company managements took time to come to terms with the idea of moving away from state or private control and towards public shareholder control, but are now taking positive steps in that direction. Another issue for investors and issuers has been the regulatory system in these countries, which is also now evolving in a positive way.”
Corporate governance standards have improved since 2004 but remain a concern for some investors because some countries have taken longer than expected to get used to new rules in areas such as transparency. One notable improvement is the gradual adoption of the IFRS accounting rules which makes companies more appealing to emerging markets investors.
"I expect to see a continued improvement in levels of corporate governance because companies which want the higher public profile that goes with a listing want to be seen to be complying fully with all the necessary rules. Many companies have looked at the UK Combined Code because it is widely known and respected in Europe, but some have found it too constricting," said Kucera.
Within the accession countries mini-groups have emerged where countries trade largely with each other and whose economies are more closely aligned. The largest economy in the accession group, Poland, grew its GDP by a healthy 5.8% in 2006, but was easily beaten by Romania, with 7.7% and the Czech Republic with 6.1%.
The Baltic states, which are benefiting from economic growth in Sweden, Finland and Germany, all recorded higher growth levels – but are much smaller economies. The Balkan states, on the other hand, have developed at a slower pace since 2004, mainly due to local politics, though they have still recorded growth rates well above those of Western Europe.
Poland is the only country in the region to fulfill its expected level of ECM activity. The largest deal since accession was the US$2.3bn privatisation IPO of Poland's largest bank, PKO, in November 2004, which attracted huge demand among both local and international investors.
The recent election of a more liberal, free market-orientated government is expected to provide a further boost to ECM activity. It has already launched an extensive privatisation program and appears to favour public market offers rather than strategic sales for many of the deals. A US$1bn IPO of energy group ENEA is scheduled for later this year, to be closely followed by a US$1.5bn IPO of fellow energy group Polska Grupa Energetyczna (PGE). Bank Gospodarki Zywnosciowej (BGZ) is also preparing for an IPO later this year, with the government considering a sale of its entire 37% stake.
"We are expecting to see a lot of deals in Poland this year", predicted Cherny.
Privatisation deals have been a strong theme across the accession group and remain a large part of the current pipeline. The Hungarian government has recently outlined plans to offer a number of state-owned groups to the public via IPOs. Its main intention is to extend ownership to as many Hungarian citizens as possible, so retail tranches are likely to be large. Companies mentioned so far include motorway operator AAK, energy group MVM, lottery operator Szerencsejatek
The Czech government has a smaller privatisation program, which includes CSA, Prague Airport and the Budvar brewery, but it is expected to opt for strategic sales rather than IPOs. The Serbian and Romanian governments are also keen to get on with their privatisation programs because they are aware that smaller markets around them are developing fast.
But bankers believe that for countries that have little or no experience of privatisation IPOs it is worth taking extra time to prepare fully and wait for the right moment. That is especially true where governments are hoping to float a succession of companies and are aware of large, private groups which are also looking to float.
"The first big ECM deals can act as trailblazers and attract a huge amount of publicity,” said said Richard Stout, an ECM managing director at Citi, citing the €300m IPO of Nova Kreditna banka Maribor, the Slovenian banking group which floated last December, which might encourage more floatations on the Ljubljana exchange.
All roads lead to Warsaw
The Warsaw Stock Exchange has emerged as the pre-eminent market in the region since 2004, and has seen annual share trading turnover quadruple to Z480bn between then and 2007. The number of listed companies has risen by 53% to 351 over the same period.
Much of the growth has been due to the strength of the local investor base; large Polish pension funds are not allowed to invest more than 5% of their funds in foreign investments, though foreign companies listed in Poland are allowed. The exchange is therefore increasingly popular among small and medium-sized companies in Poland and the Czech Republic, while even CIS countries like Ukraine are looking increasingly at Warsaw instead of London, due to the possibility of getting on the index.
"The Warsaw exchange is now in a virtuous circle where the level of listings and trading activity has raised its international profile with issuers and investors which, in turn, has led more companies to consider a listing there", said Kucera.
All of this activity has led to speculation that the exchange might become a takeover target for one of the major global exchange groups, with NYSE-Euronext known to be interested. NYSE-Euronext is keen that, if companies do not see it as a first choice listing venue, then it should certainly be the second choice.
The decision by the Polish government to float the exchange later this year will instantly provide a valuation for a potential bidder to work from. The government owns 99% of the stock and has indicated its willingness to reduce its holding to below 50% after the IPO, either by public offers or sales to institutional investors.
The next big economic milestone for many of the accession countries is to join the eurozone, though this is not expected to have a major impact on ECM activity. "Most of the (accession) countries are expecting to join the eurozone before 2012. It is less likely to have a significant impact on levels of ECM activity because most investors are already increasingly flexible when it comes to handling different currencies", said Citi's Stout.
The ECM pipeline for the remainder of 2008 in the accession group is healthy, although it is still dominated by privatisation deals in the banking, energy and infrastructure sectors of a handful of countries.
The real estate sector is also expected to see continued activity driven by the need for capital to fund the expansion of property development groups. "There is still a considerable need for middle class housing and office space across many of the accession countries. In the Czech Rep and Hungary most of the deals are likely to come from the private sector, rather than privatisations", said Kucera.
With equity markets still volatile, and investors remaining cautious, the accession group may prove more attractive to some emerging markets investors. "Although none of the accession countries has a commodity-based economy, such as Kazakhstan, investors regard them as having a lower risk profile than many other emerging markets in Latin America and Asia" said Reinout Koopmans, co-head of CEEMEA ECM at Deutsche Bank.
But being lower risk does not mean having lower growth. While GDP growth in the accession countries may decline slightly over the short-term it should remain above the average for Western Europe.