Telecoms holding company Sistema completed Russia’s biggest ever initial public offering (IPO) on the London Stock Exchange in mid-February. Demand for investment capital and improvements in corporate governance mean that, for the first time, Russian companies are turning to equity markets as a source of financing. Sistema’s IPO is only the first in what is expected to become a flood of IPOs, both on the Russian markets and abroad, over the next year.
Portfolio investors are as hungry for exposure to Russia’s flourishing retail sector as they are desperate to diversify away from increasingly risky energy stocks that make up at least 60% of the capitalisation of the Russian Trading System (RTS).
The issue was also the largest on the London Stock Exchange since mobile phone operator Orange’s float in 2001 and raised $1.35bn for majority shareholder Vladimir Yevtushenkov who sold 16.5% of the company, diluting his own stake to 65%.
Success story
Sistema has come a long way since the scientific committee attached to the Moscow city government was established in Soviet times. It gave birth to a sprawling telecoms and retail empire that built VimpelCom up into a leading mobile phone operator before selling out and repeating the trick with Moscow TeleSystems (MTS).
The group also owns stakes in Detski Mir (Children’s World), the legendary Soviet-era toy store, as well as operating a fixed line digital overlay network and a consumer electronics producer, among other assets.
However, the most exciting prospect is that Sistema is a leading contender to win the privatisation of a majority stake in Svyazinvest, the state-owned telecoms holding company that itself has majority stakes in all of Russia’s regional telecoms operators, slated for later this year.
Sistema’s flotation provided an insight into international investors’ attitude to Russia after the battering sentiment has taken in the past year following the fate of oil major, Yukos.
The IPO has been deemed a success, but, at two-and-half times oversubscribed, it has not generated as much excitement as other emerging market IPOs that command 10-times oversubscription rates. And the $17.45 which investors paid for the shares was mid-asking range.
“The issue was just about covered in emerging market terms,” says Chris Weafer, head of strategy at Alfa Bank, one of Russia’s largest privately owned banks. “And the price shows that while investors are interested, they won’t pay over the odds because of the significant risks. It was a decent result for Sistema, but not a spectacular one.”
Mixed bag
Russian IPOs abroad have had a mixed history, with about one-third of the dozen issues in 2004 outperforming the broader RTS index. But while the volatility of Russian equity performance has been decreasing steadily over the past few years, it took a drubbing last year with new uncertainties introduced by the Yukos affair.
Floating on the domestic RTS has not been popular. Costs are high, valuations have been low and the red tape thick. However, this is all changing as the RTS comes of age and the demand for investment capital starts to outweigh the disadvantages.
The market index has climbed from an all time low of 38.5 in October 1998 to top 700 last November before the destruction of Yukos took the froth off the top of investors’ optimism.
So far most of the biggest companies have chosen to list abroad (and London’s Alternative Investment Market is becoming an increasingly popular alternative for medium-sized Russian companies).
Government action
The popularity of foreign floats has spurred the government into improving conditions for floating on the RTS. It has begun simplifying the rules and getting rid of unpopular restrictions such as fixing the price range 45 days before listing and a subsequent three-week freeze on trading, but there is still much to do. For example, the badly needed law on insider trading was delayed again in January and is unlikely to appear this year.
The Director of Russia’s Federal Service for Financial Markets (FSFM) Oleg Vyugin warned in February that Russia may “lose its national capital market” if the government fails to make the nation’s financial institutions more competitive.
Still, valuations have risen close to the point where IPOs appeal to principle issuers. While several banks like Rosbank and MDM have plans to float they are waiting for valuations to rise a little more. However, in the retail sector, owners are prepared to forego some of the obvious gains to be made by waiting, preferring instead to raise capital that will buy them more market share at a crucial stage in the development of their market.
In November leading retailer Seventh Continent raised $81m in a landmark IPO as the first Russian supermarket to float. With revenues of $500m growing by about one-half a year – and retail sales in general rising 14% a year – the stock is clearly going to be worth a lot more in a few years, but as the retail market is growing exponentially, grabbing market share is overriding all other considerations.
The leading supermarket and hypermarket chains between them command a mere 5% of food sales.
Leading the way
RosBusinessConsulting, a leading media group, broke the ice with the first IPO on the RTS in April 2002 and was followed by 36.6, a leading pharmacy in January 2003. Both issues were small, but since then, issues have been getting progressively larger. The first sizeable IPO came last March when fighter jet maker Irkut raised $127m by selling 23% of the company to investors.
Since then, a lot more companies have lined up to float; more Russian companies have announced plans to come to market this year than all the IPOs of the last 14 years put together.
The lists of successful floats already includes Amtel, Russia’s third-largest automotive tyre-maker, which raised $34.2m from selling 10% of its stock; and the Mechel Steel Group, one of Russia’s seven big metallurgical firms, which raised $291m from floating 10% of the company in October. In another first, real estate holding company Open Investments belonging to oligarch Vladimir Potanin raised $68.8m through an IPO of 28.5% in November. Mr Potanin says he wants to bring one of his companies to market every year from now on.
Short supply
Despite the flurry of listings, the supply of stocks is still tiny. Some 240 companies are publicly traded in Russia, compared with 8000 in America, and the average free float of 27% has been falling as more and more strategic Russian investors snap up the best shares. Portfolio investment was dominated by foreigners before the 1998 financial crisis but, since the economy took off in 1999, Russian banks have been putting excess liquidity into the RTS. Bankers welcome the filling of the IPO pipeline.
“We are finally starting to see the equity market play its core function – providing a means for companies to raise capital,” says Charles Ryan, chairman and CEO of Russian investment bank United Financial Group, which arranged the Seventh Continent float.