The Russian stock market has come of age. For the first time, companies are turning to their equity to raise capital. More companies floated on the Russian Trading System (RTS) last year than all the initial public offerings (IPOs) since the market was set up in the early 1990s and this year an explosive rise in IPOs is expected from across the industrial spectrum.
Companies have been talking about IPOs for years but, until recently, few took the plunge. A dozen Russian companies debuted on the RTS in 2004, raising €241m. In the first three months of this year, another nine have sold shares to investors raising €119m. RTS president Oleg Safonov says that more than 50 companies plan to float this year and analysts estimate there is more than $5bn in the IPO pipeline during the next couple of years.
Despite the RTS’s extreme fluctuations, valuations have risen to the point at which the cost of floating is small enough for IPOs to compete with other sources of capital. Charles Ryan, chairman and CEO of United Financial Group, estimates that the cost of raising equity capital has fallen to less than 13% – on a par with bank loans and bonds – as company owners become increasingly desperate for investment cash to fight for market share in the most competitive sectors of the economy.
“Finally the equity capital markets are playing their core role as a source of capital. For years there was exclusively secondary market trading. Now there has been a radical change and more IPOs are slated for the next six months than we have seen in the past eight years,” says Mr Ryan.
Domestic IPOs
Media company RosBusinessConsulting made history with the first ever domestic IPO on April 16, 2002. Pharmaceutical retailer 36.6 followed nine months later. But both flotations were small, raising $13m and $14m respectively. The first major IPO on the domestic market was made in March 2004 when fighter jet maker Irkut floated, raising $127m for its investment needs.
Issues have started to come thick and fast since then, with retail and consumer-orientated companies leading the charge. “Retail is growing so fast that the opportunity cost of not having capital to grow is very high, pushing companies towards flotation as one of the ways of raising investment funds,” says Mr Ryan.
Popular shares
Investors, desperate to diversify their portfolios, are snapping up these shares. The top three Russian stocks, LUKoil, Surgutneftegaz and Norilsk Nickel, all natural resource producers, together make up 70% of the RTS’s capitalisation. UralSI, a regional telecoms company, is the biggest company on the RTS that gives direct exposure to booming consumer spending, but it accounts for only 1% of the RTS index.
Sedmoi Kontinent broke the ice in November with Russia’s first ever supermarket float, raising $80m by selling 13% of the company on the RTS. Then Lebedyansky Experimental Canning Plant, which seemed to come from nowhere, became Russia’s largest juice producer and raised $151m in February with an IPO of just under 20% of the company on the RTS. The offer was three and half times oversubscribed and the final price of $37.23 was at the top of the asking range. International investors bought three quarters of the offered stock.
Such is the demand for retail-orientated stocks that Lebedyansky’s capital almost immediately rose to $800m, overtaking the long-standing poster boy of Russian retailing, juice and dairy producer Wimm Bill Dann, despite the latter having bigger sales.
The latest little-known company to appear from left field and persuade portfolio investors to take a punt is Khelb Altaya, Russia’s leading grain processor from the south of the country, which raised $4m at the end of March by floating 10% of its shares on the RTS.
“To float a company you need to be able to offer several hundreds of millions of dollars of value and now there are lots of companies that have reached this level,” says Mikhail Leshenko, director of corporate finances at MDM Bank. “Valuations have risen to the point where the market has critical mass.”
Flotation wave broadens
Retailers are floating because they need the money to continue building outlets and capturing market share but the wave is broadening into other sectors. One thing that all this year’s prospective IPOs have in common is they are geared to the Russian economy, most of them are consumer-orientated businesses and many only appeared after the 1998 financial crisis.
Among the companies with definite plans to float on the local exchanges in the next 18 months are: regional mobile phone operator SMARTS, Perm-based steel product manufacturer Motovilikhinskiye Plants and Russia’s leading internet search engine Rambler.
These companies are relatively small and although Russia is on course to overtake Warsaw as the hottest issuance market in central and eastern Europe in terms of the number of issues, it is lagging behind in terms of value. There were 36 IPOs on the Warsaw Stock Exchange last year from companies that raised a total of €3bn, making it the third most active market among Europe’s 13 major exchanges.
IPOs are getting progressively bigger and could tap the equity capital markets for billions of dollars. The question that companies are asking themselves is: should they float at home or abroad?
Home or away?
On January 25, Russian telecoms conglomerate Sistema raised a record-breaking $1.56bn on the London Stock Exchange (LSE) in Russia’s biggest ever IPO, five times bigger than steel company Mechel’s float on the New York Stock Exchange (NYSE) in October and the biggest London float since 2001.
Set up in 1993 by Russian billionaire Vladimir Yevtushenkov, Sistema’s main asset is leading mobile company Moscow TeleSystems (MTS) but it also has investments in retail, insurance and consumer electronics, among other things.
Next up will be leading independent gas producer Novatek, which has hired advisers and expects to sell 10%-20% of the company on the LSE in May or June. Novatek agreed to sell 25% to French oil company TotalFinaElf for $900m last year but switched to an IPO after the Kremlin quashed the deal earlier this year.
Likewise, Russia’s second largest bank, Vneshtorgbank (VTB), seems to have abandoned plans to sell a 10%-20% stake to a strategic buyer – the European Bank for Reconstruction and Development, International Finance Corporation and Deutsche Bank have all been mentioned as possible brides – after its chairman Andrei Kostin said in March that the bank was also considering an IPO.
Too big for Russia
There is wide agreement that the Sistema IPO was too big for the Russian equity markets and that it is natural that the company goes overseas to raise that amount of money. However, the case with Mechel’s $331m IPO is less clear because Russian investors could afford a float of that size.
“Crudely speaking, size does matter,” says Anastasia Bloom, director equity capital markets at independent investment bank United Financial Group (UFG). “Sistema couldn’t raise $1.5bn on the Russian domestic market, while, on the other hand, the cost of listing abroad is prohibitive for all but the biggest flotations, and smaller Russian companies get more bang for their buck on the domestic markets.”
Domestic IPOs are only just beginning to take off. But half a dozen Russian blue chips have been raising money in New York and more recently in London, since MTS’s main rival VimpelCom raised $127m on the NYSE in November 1996 – Russia’s first ever IPO. Since then another four Russian companies joined VimpelCom on US exchanges and more recently Efes Breweries and Sistema chose to go to the LSE instead.
Losing business
The RTS was a natural choice for both Lebedyansky and Sedmoi Kontinent but Russia’s equity market regulators are worried about losing the IPO business to the likes of London’s Alternative Investment Market (AIM), the UK’s answer to Nasdaq, which is proving to be an increasingly popular exchange for smaller Russian companies. Several of Russia’s gold mines, including Peter Hambro Mines and Highland Gold, are already listed on AIM and its representatives were in Moscow in March to meet companies. A leading Russian marketing company has already decided to go ahead with a $15m AIM float later this year and several other companies are likely to follow.
Oleg Vyugin, chairman of the Federal Service on Financial Markets (FSFM), Russia’s stock market watchdog, says that 70% of the trade in Russian listed companies is conducted on foreign exchanges (although over-the-counter trading still makes up the bulk of shares turnover) and he is considering introducing regulations to force companies to list at home before they go overseas. He concedes that companies like Sistema could not find $1.5bn-worth of investors in Russia but wants to impose a cut-off of about $500m of company capitalisation for foreign IPOs.
“The idea is to stimulate the Russian system. We are thinking of fixing regulations so that a company contemplating a global IPO will first list in Russia with a very limited amount [of shares] before going onto other markets,” says Mr Vyugin. “It won’t be restrictive.”
Listing laws
Currently, companies registered in Russia are forced to list in the country before they can float overseas and their foreign listings are capped at 40% of the companies stock. However, companies registered offshore – Cyprus is the domicile of choice – are under no restrictions and can list as much as they want wherever they like.
Since the Yukos affair, many Russian companies have been moving their legal address back to Russia. But a huge number of companies, especially in the raw materials sector, are technically foreign businesses. “From the ethical point of view, we disapprove of registering offshore,” says Mr Vyugin. “It is legal but we believe it is inappropriate behaviour for a company.”
These are still only ideas and in the meantime the FSFM is getting on with the job of improving the market’s infrastructure. A draft action plan to reform the Russian exchanges, which should make it significantly easier for Russian companies to float, was sent to the Duma at the start of April. Mr Vyugin says he is confident that it will receive at least one of three readings by the end of the spring session.
“Everyone is interested in getting this bill through; there is no objection from government or from market players,” says Mr Vyugin. “Everyone wants to see it happen.”
Brokers complain that existing regulations are onerous. For example, companies have to set their offer price 45 days before the IPO, and the gap between placing the shares and the start of trading on the secondary market, once all the documents are registered, can be as long as a month.
“Under the new rules, the offer price will be set by an auction process and the responsibility for registering the prospectus will become that of the exchanges. With these changes, prices will be set just before the placement and secondary market trading will be able to start almost immediately,” says Mr Vyugin.
The goal is to increase the share of Russian companies traded on domestic exchanges to 70% of total world trading in Russian stocks by 2008 and to raise the market capitalisation from 40% to 50% of gross domestic product (GDP). Mr Vyugin also wants to boost the value of corporate bonds from 1.5% to 3% of GDP and the value of shares of the share investment funds from 1% to 5% of the GDP.
