The flow of equity issuance from Russia and the CIS is relentless with the year’s volumes surpassed only by the UK in the EMEA region. Yet returns have been disappointing and the risk/reward profile has left many investors looking for new opportunities. Could sub-Saharan Africa really be like Russia five years ago as some suggest? Owen Wild reports.
Since 2005, Russian and CIS equity capital markets have developed beyond recognition. Bankers concede that while the pipeline has always been reasonably visible for the largest deals, none would have dreamed that activity could grow at the rate it has. More importantly none had expected buyside appetite to grow at a commensurate rate. Yet demand has supported the huge growth in activity with sectoral investors piling into Russian deals alongside emerging market specialists, to the point where banks find it difficult to identify which fund types are buyers of its deals.
This, however, creates a challenge in that while emerging market investors would never stop putting their money to work in Russia, they are being asked to ignore ‘Russian risk’ and are seeing pricing at bullish levels against Western European peers. Such a dramatic change in the risk/reward profile has forced some to seek out those markets where the rewards are more reflective of the ensuing risks.
“Over the past few years returns from investing in Russian IPOs have been terrific for many, but not all deals,” said Charles Lucas, head of CEEMEA ECM at ABN AMRO Rothschild. “Investing in the principal components of the indices has been a more reliable strategy particularly recently.”
A squeeze on pricing is not surprising when Russia has grown into such an important market in EMEA with an ever increasing audience of investors as well as increasing funds under management for emerging market funds.
“Some issuers have been aggressive on pricing, but as some deals have been crowded during bookbuilding so they can push pricing,” said an emerging market ECM head at one US house. “But in some cases the incremental buyer in the bookbuild has not been there in the aftermarket”
In the first half of 2007 Russian ECM volume totalled US$22.3bn through 17 issues. This put Russia into second place in Europe between the UK, which totalled US$37.8bn, and France, which had issuance of US$17bn. Russian volume represents more than 15% of total European issuance.
For IPOs, Russia has become the single most important market in EMEA, eclipsing all other countries, including the UK, by several percentage points. Russia has also been the source of the two largest deals of the first half with the US$8.9bn follow-on for Sberbank in February and the US$7.99bn IPO of Vneshtorgbank (VTB) in May. However, aftermarket performance has been no match for primary volume. At the end of the first half there was not a single Russian issue among the 10 top performing IPOs of the year, yet there were four from the UK.
A changing dynamic
Emerging market investors have for many years become accustomed to a ‘Russian risk’ discount, to reflect the impact of political interference in markets and companies. Over the past two years concerns, at least over ownership, have diminished and vendors have become more aggressive.
“Some issuers have argued that there should be a “Russian premium” as opposed to an emerging markets discount, due to the superior returns available in the Russian market compared to developed markets,” said Alasdair Warren at Goldman Sachs.
While it is logical that the greater potential for growth should encourage higher pricing, investors are well aware that companies can struggle to deliver the sensational growth they promise at IPO. In some cases it can be a very short period of time before those promises are shattered by grim realisation in the form of first results.
Sitronics, which completed its IPO in early February this year, is a case in point. The technology firm was floated by parent Sistema in a US$414m offering of GDRs in London by Credit Suisse, Goldman Sachs and Renaissance Capital. The deal came when there was some nervousness over heavy supply thanks to a pipeline that included Sberbank and VTB. Price was clearly an issue throughout, leading to the adoption of the decoupled bookbuild, despite a clear dislike of the process by some of the bankers involved.
The deal size was only set on the penultimate day of bookbuilding and that came below the target of US$500m–$550m. The deal finally priced at the bottom of US$12–$15 guidance as technology investors demanded a Russian discount.
The debut performance saw the stock slump to US$11, although it jumped back to US$11.80 within a week. By July 31, the stock fell to just US$6.88, making it Russia’s worst performing IPO this year.
The dismal performance came because of the company’s inability to deliver on its growth promises. The company is not the only one to provide very poor results this year (see table). An equal investment in each of this year’s Russian IPOs results in a gain of just 0.04% by July 31. In the same period, the RTS Index gained 3.7%. The MSCI EM EMEA index shows a gain of 10.5% for the same period.
Peace and progress
Progress in other new markets such as Kazakhstan and Ukraine has been slow with an initial flurry of the easier issues, followed by a lull as other companies are identified as candidates and then prepared for IPO. In some cases it is taking well over a year for a company to debut after mandating lead banks.
“Kazakhstan is still one of the top three markets, with Russia and Ukraine, but you have had the easy deals first,” said Charles Lucas. “Now you have the question of what is the next deal?”
The area that offers the greatest potential, according to many bankers, is sub-Saharan Africa. Not all banks are sold on the region, expecting there to be few suitable companies to float, but bankers already present suggest the pipeline is strong and most deals require only three to six months preparation.
So far this year there have been several equity issues from Nigeria, with the IPO of Kenyan mobile operator Safaricom set to follow in the second half. Guaranty Trust Bank, Access Bank and United Bank for Africa have all completed issues while First Bank Nigeria is in the process of getting SEC approval for its issue, which would take 2007 issuance to almost US$2.4bn from the banking sector. Banks are leading the moves into international markets as regulation is gradually becoming more stringent, requiring them to improve capital adequacy ratios.
JPMorgan also brought the US$450m IPO of Nigeria’s Dangote Sugar Refinery in January in a purely local offering.
Amid the positives, some bankers warn that the quality of some companies is doubtful.
“Investor demand for exposure to Nigeria is currently very strong for a variety of reasons including high oil prices, increased political stability and a large population that is expected to develop a significant middle class rapidly,” according to Lorcan O’Shea, an emerging markets banker at Merrill Lynch.
“However, as in any early stage high growth developing market, there are likely to be casualties in the new issue market. As investor choice increases with supply, high quality disclosure and corporate governance will become a key differentiating factor. To attract demand, companies may seek a full GDR listing on the London market, which brings liquidity and governance benefits. But for now, big EM funds are seeing the country as having similar growth characteristics to Russia four years ago,” he added.
The potential for Nigerian companies is clear but investors are selective when investing at such an early stage, as conglomerate Transcorp discovered to its disappointment. The company completed bookbuilding on its IPO in February but only concluded the issue in August as demand was sufficient to leave books just 36.2% covered. The conglomerate did not appeal to many accounts as it held a strange mix of assets including a hotel, a national telecoms company and oil and gas assets, all of which were bought from the government.
But those companies that do have a good story offer a good proposition. Banks are at the front of the queue due to the massive growth potential in a country in which less than 10% of the population has a bank account. In most emerging markets, investors are solely focused on growth, but in Nigeria, they are looking at a variety of parameters.
“Appetite for deals is good and locally retail dominates, though pension reform two years ago has also led to significant extra demand of US$3bn–$4bn per annum,” said Yvonne Ike, JPMorgan’s senior country officer for Nigeria. “The retail customer is usually more focused on dividend over growth.”
This focus from the main investor base means many companies pay out 40%–50% of profits, which could change as they tap an international investor base.
For the time being, Nigeria will remain a market for investors willing to take the risks required when looking at Russia several years ago. One particular issue is getting comfortable with the different style of running deals with forward-looking statements actually encouraged. The local regulator requires IPOs to be completed at a fixed price and ‘audited’ numbers provided for the following five years.
But with Russian returns languishing at such low levels, there is likely to be interest from the most aggressive emerging market accounts. As one emerging market ECM banker said:
“Sub-Saharan Africa does fill me with dread. Dread that those banks already there are right and I’m going to have to go and build yet another new business.”
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