Despite the first listing of a company on the Hong Kong stock exchange, Russia continues to bear the brunt of the financial crisis as international investors reveal their cautious side. Fiona Rintoul reports
There was a time when any initial public offering (IPO) coming out of Russia was snapped up by international investors. But since the financial crisis, the realisation has dawned on investors that everything Russian that glitters is not necessarily gold.
The flows of IPOs from Russia and the Commonwealth of Independent States (CIS) countries had dried up in the aftermath of the crisis. When flows started up again with the listings in Hong Kong and Paris in January 2010 of the metals and mining company, Rusal, investors – unsurprisingly – proved more cautious than previously.
“Investors have become much more selective,” says Tom Mundy, chief strategist at Otkritie, one of Russia’s largest financial groups. This manifests itself in a keener eye both on valuations and on companies’ structure and the intended use of the capital.
“Basically, investors want to know that the capital is going to be reinvested in the company and that it won’t go on a villa in the south of France for one of the directors,” he says.
The result was that some companies were not able to achieve the valuations they had hoped for, and some listings were pulled. These included Monochrystal, Rusagro, SUEK (Siberian Coal Energy Company) and UralChem from Russia, and Geo Alliance and Olimp from the Ukraine.
The current position, according to PBN Company, a financial communications consultancy, is that there have been 173 reports of potential IPOs out of Russia, the Ukraine, Kazakhstan and other CIS countries since 1 January, 2010. Of these, 146 are pending, 23 have been completed and nine were cancelled.
In the central and eastern European (CEE) markets, the drivers have been somewhat different.
“There’s not much going on in Prague and, in Warsaw, IPOs are mostly the state selling to balance the budget,” says Jacob Grapengiesser, a partner at East Capital. “In Turkey, there have been a large number of IPOs and the pricing has been much more reasonable, though some were also cancelled.”
For the future, Russian and CIS issues should certainly be supported from the demand side.
“There have been sustained flows into emerging market funds, particularly Russia and CIS,” says Mickael Gibault, deputy head of investment banking at Troika Dialog. “That creates demand on the buyer side. Another driver is the good performance overall of the stock market and the fact that the Russian market in particular is supported by high commodity prices.”
There is also the question of the relative unattractiveness of other markets. “With GDP growth of 4 to 5%, Russia is one of the few markets that will post decent growth this year,” says Gibault.
However, they will perhaps be supported in a more thoughtful and demanding way than before – and not just in terms of valuations.
For one thing, “investors won’t buy unless they see there is some upside left”, says Graham Marshall of BNY Mellon’s depositary receipts team.
For another, “investors are looking for clean balance sheets, and companies with a reasonable amount of leverage and strong management teams”, says Gibault. “They want to see examples of the management handling crises and, on the technical side, they want to have trading liquidity after the transaction so they can trade in and out of the stock.”
In that respect, the fact that some Russian IPOs have failed may be seen as a good sign, according to Grapengiesser. “It means investors are getting more disciplined, more critical,” he says. “Investors are much less tolerant. We would certainly spend a lot of time understanding why someone is doing an IPO. We want to know that they will invest in the business and not just cash out.”
What’s not so good, says Grapengiesser, is that companies come to market at too-high valuations in the first place. “Why are the bankers not getting it?” he asks. “These questions should be asked upfront by them.”
More discipline in terms of valuations would benefit everyone, he suggests. Companies that come to market at a too-high valuation will only disappoint investors, and it will then be harder for them to raise further capital from the markets in future.
Chasing high valuations is also one possible explanation for experimenting with listings on new exchanges, suggests David Reid, analyst for the Eastern European Trust. And it is, of course, the wrong reason.
“Sometimes companies choose to list on a new exchange because they think it will be a magic bullet to improve valuations, but it’s not so easy,” says Reid. “There has to be some kind of valid logic for listing in a particular place.”
The logic behind Rusal’s ground-breaking listing in Hong Kong was the intertwined relations between Russia and China. Some, such as Otkritie’s Mundy, expect more Russian listings in Hong Kong, particularly in the energy sector where the greatest economic synchronicity exists: China needs energy and Russia has energy to sell. Others, however, are less convinced.
By listing away from the existing big global centres of London and New York, companies can open up pools of capital that are not accessible outside certain markets. For example, institutional investors that do not have a global reach, such as pension funds, which are often obliged to invest a certain portion of their assets domestically. But the price may be that they cut off other sources of capital.
“It’s a choice that has to be made carefully,” says Reid. “It’s very much a case by case thing.”
In that context, listing companies may do well to remember that a listing isn’t just about the IPO. More important in many ways is the ongoing trading environment. Or, as Ronald Kent, executive vice president and head of international listings at NYSE Euronext, puts it: “The focus should not just be on the wedding day but on the marriage.”
A critical choice for Russian and CIS companies is between a local listing on one of the two Moscow exchanges or an international listing – or a combination of the two. For BNY Mellon’s Marshall, the key criterion here is size. “The general rule of thumb in Russia is that if you are raising $300m (€208.5m) or less, stick to the local exchange,” he says. “For that amount it’s not worth the extra expense and work of an international listing. However, the development and depth of the local market mean that if you are raising more than $300m, you will struggle.”
And for most, the international exchange of choice for Russian and CIS companies remains the London Stock Exchange (LSE). Russian issuers have led the way in London IPOs in 2011, raising nearly $2bn in the first four months of the year, surpassing the total of $1.73bn raised throughout 2010
“It’s seen as prestige to list abroad, and London is the place to be,” says Grapengiesser, though he emphasises that the transparency investors perhaps hope to find by trading on the LSE rather than in Moscow is often absent.
Russian law stipulates that businesses can only sell 35% of their shares outside Russia. Companies circumvent this by having a Cyprus-based company that owns a Jersey-based company. Transparent it is not, though the law is expected to change in a year or so.
And there are exceptions to London’s dominance. Nasdaq makes sense for technology companies, as is proven by the recent successful IPO there of Yandex, the Russian search engine, while for historical reasons, Toronto makes sense for certain mining companies. A challenger to London is now also coming through in the shape of NYSE Euronext.
Kent sees London’s dominance not as an eternal given, but as a function of Sarbanes Oxley Act in the US, which turned investors off New York. “People have come to regard London as the natural default home for Russian companies, but it is not so at all,” he says.
“London has had the field of battle to itself for a few short years and it has had a field day. Now there are a lot more players on the field.”
One of these is the NYSE Euronext London, which, says Kent, was “set up specifically to offer an alternative to the LSE international order book for international companies seeking a London listing”. With its London operation, NYSE Euronext hopes to capitalise on the established attractions of the city as a financial centre, while offering integrated access to investors across Europe and in the US – a combination of Euronext’s pan-European reach and New York’s depth and experience.
As Kent says, “the US is still the deepest capital market”.
It is an argument that has yet to be won. There are no listings to date, and a glance at planned IPOs shows companies favouring London, Moscow, Hong Kong in some cases (EuroSibEnergo, Lukoil, Kamchatka Gold), and, interestingly, Warsaw, which has captured planned IPOs from a number of Ukrainian companies in particular.
“Poland has managed to create a good pool of capital through a very successful domestic pension fund system, and that has led to a lively exchange,” says Reid.
As a result, Poland has become a hub for regional capital and, he adds, provides a model of what Moscow may aspire to in terms of international appeal for listings in due course.
It is some way off – the Russian pensions system remains a perennial disappointment, says Mundy, and may not be sorted any time soon as there are so many other problems to address – but initiatives such as the proposed merger of the Micex and Russian Trading System exchanges provide an initial building block.
©2011 funds europe