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13 April 2015

Green shoots of recovery in Russian equity capital markets

Large international investors continue to closely monitor Russian issuers and are ready to invest if their requirements are met, as demonstrated by two recent deals successfully brought to the market.

Activity in Russian equity capital markets (ECM) has been put on hold for almost a year after a severe fall of the stock exchange market initiated in Q1 2014, when it became clear the Russian economy had run out of steam and was entering into recession.

Russian GDP added 0.6% in 2014 and is expected to drop to 4% in 2015. This is in stark contrast to the anticipated growth of 2.4% and 2.65% respectively at the beginning of 2014.

In addition, the stock exchange was hit by massive portfolio capital outflows after the economic sanctions, falling oil prices and consequent Russian rouble devaluation.

All in all, the Moscow Exchange (MOEX) RUB-denominated stock exchange index decreased by 7.2%, while the USD-denominated RTS Index fell by 45% in 2014.

The Russian stock exchange’s counter performance is quite remarkable, given it occurred during a relatively auspicious period in global ECM that witnessed a steady rally in North America and Europe.

Signs of convalescence

However, to put it in perspective, the Russian market’s downturn echoes increased volatility and similar trends in net-oil-exporting emerging countries.

Since the beginning of 2015, the Russian ECM has shown signs of convalescence due to a mix of positive economic news: trends towards the stabilisation of global oil prices and the relative strengthening of the Russian currency exchange rate.

As a result, Russian MOEX and RTS indexes rose by 16% and 11% respectively in Q1 2015. During this period, despite continuous macroeconomic weakness, two Russian companies, Magnit and Lenta, seized the opportunity and successfully conducted their secondary public offerings on the Moscow and London Stock Exchanges in Q1 2015.

Both transactions attracted large investors from Europe, the US and UK. VTB Capital acted as a joint global coordinator on both deals.

In the current circumstances, international investors tend to select companies that show more resilience and creditable performance despite domestic financial turbulence.

Both Magnit and Lenta are best performers in the Russian retail sector, which remains highly attractive to investors. Magnit is also an almost decade-long 'veteran’ public company in the relatively young Russian stock market and is very well-known by the investor community with five successful public deals, including the most recent one.

Attractive return

Despite gloomy consumer sentiment, both companies managed to increase sales in real terms, open new stores and demonstrate continuous efficiency and profitability. It is worth mentioning that Lenta’s $225 million offering was a sizeable one compared with its free-float, representing more than a quarter of the latter’s amount pre-money.

The entire offering amount was anchored before the deal’s launch, which allowed to price the deal with a tight discount of 3.8% to the previous market close. Post-pricing, both companies’ stocks showed great performance, rising more than 15% – an immediate, attractive return that may increase investors’ appetite for future transactions.

Remarkably, the composition of investors subscribing to recent Russian offerings has not changed dramatically over the last year, despite the changing market. The main investors remain the same: large investment funds from the UK and US dedicated to global emerging markets.

Investors from these countries remain the largest source of equity capital for Russian public companies. However, there has been a clear decline in demand from Continental Europe, compensated by stronger interest from Russian domestic funds, the share of which grew from about 5-10% to a 20-25% share in the book.

Arguably, domestic investors seem more confident in Russian economic prospects. The emergence of a strong Russian demand pool has long been awaited, but it is still to be determined if this will be a long-term trend.

All the same, global investors’ interest for Russia has to be supported by additional quality offers and a general improvement of macroeconomic indicators, as well as a stronger government push for structural reforms.

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