London still calling

IFR IMF Special Report 2011
12 min read
Abhinav Ramnarayan

Russian companies should offer an attractive investment profile given stable GDP growth and the largely positive outlook for commodities and oil prices, therefore key to the economy’s performance, but in 2011 failures litter the ECM landscape.

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This year has been a bleak period for Russian firms hoping to access equity capital markets. Half of the companies attempting to list have failed. Although firms have looked for a more welcoming listing venue, for most London remains the only option and deep discounts will have to be accepted.

A senior banker tells the story of travelling in the Russian wilderness, through a place he had never heard of and stumbling across an unknown company large enough to be in the FTSE 100. Such is the appeal of the largest country in the world – a behemoth that could churn out new issue after issue for investors around the world to feast on as it makes its transition into a developed, capitalist economy.

Yet, somewhere things have gone a bit awry, and Russian firms stepping into the international arena (primarily through London listings) are struggling to garner the sort of appeal they should.

One Russian banker working in equity capital markets claimed London has a “prejudice” against Russian issuers. While this is hyperbole, others agreed that investors are displaying an increased degree of hostility towards Russian firms. A lengthy list of failed London deals has led bankers and issuers to reconsider the best venues for listings, yet the UK remains favourite.

“London remains the most attractive destination for Russian companies, though there may be a few cases where New York may be more suitable,” said Marina Kraschenko, head of Russian ECM for Deutsche Bank. In some transactions, emerging market funds in the UK can be very demanding on the discount, she said, but Hong Kong and New York are only suitable for specific firms.

In the year to date, a dozen Russian IPOs have launched London IPOs, and only half have priced. The argument that macroeconomic conditions were to blame is not entirely true as three of those failures came in the first quarter of the year, when there were as yet no signs of the eurozone turmoil that has subsequently frozen markets across the continent.

The six that priced have fared indifferently, with container terminals operator Global Ports the only one trading above list price in late August. Market conditions have played a part, but HMS Hydraulic Machines and Systems and Rusagro both dipped in value well before broader markets slumped.

“It is true that investors have shown a high degree of discipline, but this does not mean London does not work as an IPO venue for Russian companies,” said Richard Cormack, head of ECM for the emerging EMEA region at Goldman Sachs. “If you look at the last two deals, Global Ports and Phosagro, they priced above the bottom of the range.”

As with any IPO, you need to bring the right offer at the right price, he added. Unfortunately, that has been part of the problem.The key reason why there was a high percentage of failures was the disconnect between issuer valuations and investor expectations on price.

Discounts required

“Some management teams and owners retain a mental image of a period of time that no longer applies, when valuations were substantially higher than today,” said Daniel Jacobowitz, co-head of investment banking for Deutsche Bank in Russia.

Controlling shareholders in Russian companies have been tough salesmen since the UK IPO market opened up for them in 2005, but with stock prices depressed they have become even less keen on accepting discounts.

“In their defence, they have to set themselves against a Russian peer group that is already trading at a 10%–15% discount to Asian peers, for example, and have to offer a hefty discount to those already discounted stocks,” an analyst at a Russian bank said. The IPO of Russian Helicopters collapsed earlier this year when investors demanded a 40% discount to some Western European peers.

Asset fund managers in the UK, ever wary of the Yukos precedent – the company taken over by the government in controversial circumstances in 2003 following the arrest of billionaire owner Mikhail Khodorkovsky – expect that discount to offset the risk of government intervention and the perceived lower corporate governance standards, the two main factors that funds worry about according to an RBS Russian investor survey. Fears over corporate governance have increased since the 2008 financial crisis – something that companies listing this year have not appreciated fully, one Russian ECM banker said.

Two incidents this year served to reinforce those fears. In January, the Russian Interior Ministry accused IPO candidate Suek of price collusion with other coal market participants. In July a Russian government body suggested criminal offences had been committed at Domodedovo airport, operated by DME.

Since then the task force, which was investigating operations at the airport following a terrorist attack, has said it aims to discover who the owners of the airport are and bring them to justice. DME had attempted a London listing two months earlier, and the fact that the authorities still do not know who the owners are has not gone down well in the market, said one Russian ECM banker who preferred to remain anonymous.

“If the chairman was arrested that could significantly affect Russian IPOs – especially from certain sectors such as resources,” he said. “Would it make investors go off Russia? No. But it will give them another bargaining chip when negotiating on price.”

Seeking greener pastures

The problem is finding alternatives. One of the first questions almost every Russian company looking for a listing now asks is: “What about Hong Kong?” Valuations in the Asian city are far higher and in tune with what the Russians believe they should achieve. Billionaire oligarch Oleg Deripaska tested this out by floating aluminum giant Rusal there in early 2010 which tanked spectacularly initially and took nearly a year to recover to its issue price. Unabashed, Deripaska went to Asia again with his energy firm EuroSibEnergo (EN+) last year – only to pull the deal.

The success of Italian luxury brand Prada reignited interest in heading east rather than west, but one Russian ECM banker said bluntly: “I think it is clear now that only companies with a strong Asian story should bother trying.”

“Hong Kong will remain an option for eastward-looking Russian companies with a strong Asia angle,” said Chris Marschall, head of foreign listings in Hong Kong for RBS, and previously head of ECM for emerging Europe for the bank in their London office.

“I wouldn’t say that Hong Kong investors have higher risk tolerance, although they perhaps are willing to take on risk in return for the prospect of higher returns. Asian investors have high return expectations,” he said.

He added that corporate governance standards are high in Hong Kong, but this is a potential deterrent for some owners of Russian companies.

“Hong Kong listings can involve a large retail component,” Jacobowitz of Deutsche Bank said. “The regulator looks to protect retail and institutional investors, and as a result, the governance and disclosure requirements are robust.”

The other problem is lack of interest. Chinese investors were keen to get a slice of a brand they bought like Prada, but bankers are far more negative on the prospects of Russian shoe maker Centrobuv and its planned US$800m listing in Hong Kong.

“There is no suggestion that Asian investors are keen to get exposure to the Russian middle class,” one banker said.

As for other exchanges, technology companies will find a natural home in New York. This view should be supported by the experience of Monocrystal late last year when US-based investors shunned its IPO because of the decision to list only domestically, while internet firm Yandex was embraced by US names at its Nasdaq IPO in May. Such was demand for the firm known as the Russian Google that the bookbuild was extended with upwardly revised pricing.

There were signs that agricultural firms in the Rostov and the Volgograd region could attempt to list in Warsaw, following the route of Ukrainian agricultural companies, but the first to do so, Valinor, pulled its Polish IPO earlier this year. Frankfurt remains a market for specific sectors such as automotives and machinery.

Domestic support

Ultimately, Russians would like to list in Moscow, Marschall of RBS believes. But for this to happen, the country has to build an investor community the way Poland has done over the last decade. This would also help international listings.

“Turkey and Poland both benefit from having strong local markets,” said Cormack of Goldman Sachs. “Around 60%–70% of the recent Polish privatisation deals have been placed with retail and local institutions. If you look at Turkey over the last year, a number of deals got done with strong local buying.”

As of now, the liquidity on the Moscow exchanges is poor. The RTS and the MICEX, Russia’s dollar and rouble exchanges, lack a spread of funds trading on a daily basis, with some Russian funds actually preferring to trade the London GDRs.

Acknowledging the issue, earlier this year, Vladimir Milovidov, then head of the country’s Federal Financial Markets Service, indicated that strict rules governing foreign listings could be eased. This could remove restrictive provisions over how much stock must be placed in Russia and caps on that to be sold abroad, which larger companies avoid by establishing foreign holding companies.

The Kremlin has shown intent to mature the domestic market with the proposed merger between RTS and MICEX, but it will still take a long time for the market to mature.

“It took a long time for Poland to get to where it is today,” one emerging markets banker pointed out. Russia needs to not only develop the local funds, but also provide the infrastructure to allow local and international funds to trade and settle trades more easily in the local market, he said.

Another banker said that the stage when a Russian company could complete a US$500m domestic float from only local investment is at least five years away, according to another banker operating in the region said. Until then London will dominate, with the only plan of action an idea that companies may look for full listings in the UK – matching the corporate governance standards of UK firms – rather than the less demanding GDR approach. This would also open up a new investor audience as the companies would then be eligible for index inclusion. However Nord Gold tried that approach earlier this year and failed, so it is no guarantee of success.