It was expected that 2011 would be a very difficult year for equity capital markets (ECM). However, nobody could have predicted the depth of market uncertainty and extreme levels of volatility that global markets have faced. Russia was no exception. We saw many deals postponed or pulled due to market turbulence and a general aversion to risk among investors. However, notwithstanding this uncertainty, Russian equity capital markets demonstrated significant levels of activity until late summer in 2011, reaching a new high for the total equity capital raised since the 2008 financial crisis. <…> VTB Capital as a leading ECM advisory and distribution franchise in the Russian and CIS markets. The business pursues primary and secondary listings in local and international markets, and since 2009 has successfully raised a total of $13.4bn for companies in Russia and the CIS. According to leading international agencies, including Dealogic and Bloomberg, VTB Capital was ranked #1 Bookrunner in Russia and the CIS in 2010 and 2011 YTD.
by Elena Khisamova, VTB Capital
It was expected that 2011 would be a very difficult year for equity capital markets (ECM). However, nobody could have predicted the depth of market uncertainty and extreme levels of volatility that global markets have faced.
Russia was no exception. We saw many deals postponed or pulled due to market turbulence and a general aversion to risk among investors. However, notwithstanding this uncertainty, Russian equity capital markets demonstrated significant levels of activity until late summer in 2011, reaching a new high for the total equity capital raised since the 2008 financial crisis.
Russian ECM snap-shot
In 2011, Russian ECM has seen record results following historic lows after the 2008 financial crisis. There have been sixteen equity offerings completed over the past eight months, raising some US$10.4bn of equity capital. Importantly, seven out of the sixteen were successful attempts by Russian issuers to conduct IPOs.
Meanwhile, however, 2011 was a record year in terms of the deals that were withdrawn. Seven issuers pulled their IPOs (amounting to US$5.2bn), blaming unfavorable market conditions, which was not always the decisive factor. In many cases, the shelving of IPOs can be explained by fundamental weaknesses of equity story, uncertainties over sustainability of growth and profitability, a lack of implied liquidity after the offering, high leverage, and unrealistic valuation expectations.
This case is further reinforced by the successful IPOs this year totaling US$4.7bn. Despite adverse market conditions, these were placed due to combination of unique equity story with substantial growth prospects, high standards of corporate governance, correct tactical decision-making and management of valuation expectations. Throughout the year we have seen the highest levels of selectivity and price sensitivity among the investment community with regards to the equity stories they buy.
Despite a number of success stories in 2011, the Russian equity capital market is still lagging behind in terms of activity when compared to the peak years of 2006-2007. Back then the annual volume of equity funds raised reached close to US$20bn, with over 25 deals completed each year.
VTB Capital as a leading ECM advisory and distribution franchise in the Russian and CIS markets. The business pursues primary and secondary listings in local and international markets, and since 2009 has successfully raised a total of $13.4bn for companies in Russia and the CIS. According to leading international agencies, including Dealogic and Bloomberg, VTB Capital was ranked #1 Bookrunner in Russia and the CIS in 2010 and 2011 YTD.
Russia provides appealing investment opportunities
Russia’s economy has matured and offers a solid and appealing investment opportunity in the post 2008 crisis world.
At a time when the value of nominal money is falling in relation to real assets, the commodities price is developing in a positive way. Russia, with its large natural resource base of real assets, therefore looks more attractive than other countries. In addition, healthy levels of government debt with large central bank reserves tied in with a sensible policy for maintaining moderate inflation while using currency flexibility to stabilise local interest rates, gives us confidence that macroeconomic stability in Russia can be sustained.
The Russian market remains one of the cheapest in the emerging markets universe, trading at 40% discount to other EMs on 12M FWD P/E multiple. This therefore provides a certain confidence in downside protection for the investment community.
Over the past few years, the quantity of active work performed by Russian companies in capital markets has increased significantly. Russia’s goal to be seen as an attractive destination for international investment now gets widespread support at the highest levels of the country’s business community and government. Both of which are committed to enhancing the efficiency of business, providing the necessary infrastructure and developing business culture.
Key themes of the financial infrastructure development
Today, financial regulation is improving in Russia. This country is in the process of joining the Memorandum of the International Organisation of Securities Commissions, which allows market regulators to share the information.
Two major Russian stock exchanges, RTS and MICEX, are merging in order to create a leading trading platform in the CIS region. The two exchanges’ platforms are highly complementary in terms of business mix and will allow for the joint entity to become the exchange of choice for Russian issuers and investors both domestic and international by gaining market share from its closest competitors. The combined exchange will also employ industry best practices in terms of post-trading infrastructure. This will include enhanced depositary and clearing services (CCP, T+ settlement, etc.) which will fully meet investors’ requirements.
The merged exchange is expected to provide additional quality control while adhering to Russian issuers’ listing requirements, including best corporate governance practices, information disclosure and transparency (most importantly, that all Russian issuers with publicly traded stock will have to report under IFRS) which will give additional comfort to investors.
Moreover, the Federal Financial Markets Service (FFMS) initiative to release of a 25% limit on the circulation of shares outside of Russia will significantly raise the number of follow-on offerings as well as the willingness of investors to buy ordinary shares in the IPOs without concerns of a Depository Receipts (DRs) shortage. The changes are expected to be introduced in a year’s time.
One product not yet widely used by the Russian corporates as a fund raising mechanism is convertible bonds. To date, only five issuances have been successfully completed and only two of these were by companies incorporated in Russia: TMK and Lukoil. FFMS initiatives to reduce the restrictions on the DRs programme size will also boost issuance of convertible instruments by Russian companies as DRs are a preferable security used as underlying stock for convertible bonds.
The grand privatisation
This year we saw a pilot privatisation deal successfully executed via equity capital markets. The government raised US$3.3bn from the Secondary Public Offering (SPO) of VTB Bank in February 2011, in turn reducing its stake in Russia’s second largest bank from 85.5% to 75.5%. This was the first public ECM transaction made by the government since 2006. Notably, the government boosted VTB Bank’s share capital in September 2009 to bolster the bank’s liquidity and, more widely, the Russian economy. As a result of privatisation the government made US$1.7bn profit from the partial sale of VTB Bank shares bought in 2009.
The new wave of the government privatisation programme is aimed at attracting private capital, promoting economic development, fostering a favorable investment climate and creating transparency - not just for the equity market, but also for the Russian economy as a whole. The programme will run until 2017, and includes more than 20 public and private Russian corporates, including companies operating in strategic sectors of the Russian economy.
Although the total size of the privatisation deals announced by the government may reach over US$200bn, it is anticipated that the volume of deals executed via the equity capital markets may be closer to US$100bn. This is still quite a challenge when you consider that the total volume of all Russian ECM deals over last 3 years was just US$20bn.
The government’s privatisation plan is also creating a highly competitive environment for private issuers. These issuers use equity capital markets as a source of funding for their growing business and value monetisation for the founders. For the investment community, greater competition means more choice of investment opportunities and better returns.
Russian Depository Receipts
Following the successful establishment of the debut Russian Depositary Receipts (RDR) programme by UC RUSAL in December 2010, the market expected a queue of foreign issuers wanting to list their equity via RDRs in Russia. The launch of the first ever RDR program was an important milestone for the development of the Russian equity market, creating the infrastructure for companies incorporated outside of the Russian Federation to offer equity, obtain listings and be traded on the Russian stock exchanges. For UC RUSAL it was a necessary step towards eligibility for inclusion into the MSCI Russia index, as well as diversification of its investor base and facilitating investment into company’s equity from Russian and Russia dedicated investors.
Since then, MSCI has been analysing the new instrument to assess its comparability with ordinary shares, such as shareholders rights protection, trading and liquidity, and other characteristics. MSCI has been consulting with market participants and has been soliciting feedback to form a decision on its eligibility.
Although a few issuers have declared their desire to get an RDR listing in Russia to date and some have already launched a thorough preparation process, no one is yet at the final stage, pending the MSCI confirmation of the eligibility of the RDRs for MSCI Russia index inclusion. As soon as the decision is made and the market finds consensus in favor of a positive outcome we should expect new RDR listings.
Looking into next years
The long term outlook for the Russian equity market remains strong. However, the market, in many instances, will be driven by global trends. The key driver will be to getting market participants to form a consensus over the pace of global economic growth and stability within the Eurozone.
On a local front, the merit of the success will be implementation of the new financial infrastructure as well as improving the investment climate and investors’ perceptions risks when investing in Russia. A combination of these should allow the Russian market to be rerated in the emerging market universe which, in turn, should support the successful execution of an ambitious privatization plan while attracting considerable investments into the Russian economy.
Elena Khisamova, Head of Equity Capital Markets, VTB Capital