As the consolidation of Russian industry gathers momentum, many companies have already borrowed as much as they can. Yet rising competition and booming sales have kept the pressure on to continue consolidation. Russia’s managers are turning now to structured financial products to raise more money without increasing their debt.
M&A is driving the trend, with most of the deals remaining between Russian companies. The oligarchs that took up assets in 1999 are selling them to concentrate on core competences. Meanwhile, companies that have enjoyed high growth are looking for more capacity or want to move into new regions.
Corporate entities are the main users of structured products but, more recently, management buyouts (MBOs) have been picking up steam.
“There has been a spate of MBOs as the management of companies are more confident about the future,” says Alexei Panferov of MDM Bank. “In the past they would bring in investors so they could spread the risks.”
Structured products
However, M&A is running into a funding bottleneck and so structured products are becoming an attractive alternative for raising money without increasing leverage.
MDM Bank organised one of the first leveraged buyouts (LBO) three and half years ago of MTS’s purchase of mobile phone operator BM Telecom, which opened the gate to more deals. “We are now working in a more sophisticated environment,” says Mr Panferov, who organised the BM Telecom deal. “Owners are looking for ways of financing that fit their needs and keeping their debts at a manageable level.”
There have only been a handful of LBOs but companies are increasingly turning to their equity – or the equity of the companies that are behind the dealmaker – as a way of raising capital.
Foreign influence
“The awareness of using equity derivative products is rising,” says Oleg Zhulievskov, in charge of creating market leader Renaissance Capital’s derivative products. “As liquidity rises, companies are using them to raise capital but traders are also turning to things like options to manage volatility and they also provide access to shares otherwise restricted to foreign investors.”
Russian companies are quickly becoming familiar with the range of financial tools their western counterparts are already using. One approach is to use options to reduce the cost of borrowing. Loans are backed by equity pledges, but if the borrowing company signs an option agreement fixing the price of its shares in the future at a discount to expectations and hands over the difference, then the lender is willing to issue credits at lower rates. This is a form of convertible bond. So far, only blue chips Yukos and Lukoil have issued convertible bonds, but more are expected.
Another popular product among foreign private banks is capital guarantee notes. “The principle capital is fully protected but the buyer [of the note] agrees to take only a percentage of the upward movement of the shares. It means if the market tanks, investors are at least guaranteed to get all their initial investment back,” says Mr Zhulievskov. “Investors are used to being offered these in other markets.”
Increased options
Many Russian investors who are looking for ways to structure investment ideas, increase their leverage or alternatively hedge against risk favour options.
“Increasing volumes on the futures market make all these products possible. And traders are looking ahead to 2006 when they expect volatility to increase as the political uncertainties of the 2008 presidential elections loom,” says Mr Zhulievskov. “Also, options open a new way to short stocks to take advantage of this volatility.”
Western investors are also getting into the game, although they tend to be concentrated in the debt products where they make use of exchange products when buying bonds and things like credit linked notes, which are currently in vogue.
Looking to the future
Another product often used by foreign investors are exchange tradeable funds that allow access to otherwise restricted shares.
The most popular are funds that mirror Gazprom’s locally traded shares. A “ring fence” of special rules precludes foreigners from buying these shares. However, there are funds such as Renaissance Capital’s Rengaz, which is a Russian-registered fund that buys only Gazprom local shares. These shares are listed in London and are effectively a dollar-denominated proxy for Gazprom’s local shares traded abroad.
“For foreigners, many of the products are still more about giving access to restricted or semi-restricted shares, like those of Sberbank, than hedging,” says Mr Zhulievskov.
While the derivatives market is still only just stepping off square one – and has been driven by corporates looking for cash – the rapidly increasing liquidity this year is attracting more and more investors into the game.
