Value of the Russian IPOs

Financial markets have been extremely volatile, while many newly-listed companies have performed badly. Events including Japan’s tsunami, unrest in the Middle East, and the eurozone debt crisis have made investors jittery and held back appetite for new issues.

This year has fallen well short of the bonanza that had been expected from Russian companies floating on international stock markets. Analysts originally forecast private companies could raise more than $25bn in 2011 from so-called initial public offerings of their shares, up from only $5.5bn last year. In fact, only $3.9bn was raised in the first half of the year from a mere six deals.

Seven other planned issues by Russian companies, seeking to raise some $7bn, were postponed in the same period. Even if some still manage to float in the second half of the year, total 2011 issuance now looks unlikely to exceed $15bn at best.

That is prompting yet more soul-searching about Russia’s lack of attractiveness to international investors, even as president Dmitry Medvedev has announced measures to try to improve the investment environment. It comes as domestic investors also seem reluctant to invest in Russia ahead of parliamentary elections in December and next March’s presidential poll - leading to billions of dollars of net capital outflows in recent months.

Russia’s IPO experience is, in fairness, not unique. Globally, IPOs raised $102bn in the first six months of this year, up 8 per cent from the first half of 2010. But bankers say that headline figure masks what a difficult time it has been for flotations.

Financial markets have been extremely volatile, while many newly-listed companies have performed badly. Events including Japan’s tsunami, unrest in the Middle East, and the eurozone debt crisis have made investors jittery and held back appetite for new issues.

According to Credit Suisse, 17 deals together worth $15.5bn have been postponed in Europe, Africa and the Middle East this year. Of those deals that have completed, only 17 per cent were priced in the top half of the initial price ranges announced by the companies.

Russia, however, has fared particularly poorly – accounting for a large proportion of the offerings that have been pulled. There are several reasons why.

One is that investors had their fingers burned by some past Russian IPOs. According to UralSib, a Moscow brokerage, only 12 out of 34 IPOs or secondary offerings (when a company already quoted on a market issues more stock) up to the end of last year outperformed Russia’s RTS index in the first 12 months after the issue.

That makes investors look very carefully at how Russian companies are being priced in IPOs compared with their international counterparts. Following on from that, experience this year suggests investors are wary of paying the kind of prices owners are seeking for companies in the “extractive” industries that already dominate the Russian market – oil and gas, metals and mining. They are more willing to pay for businesses that give access to new areas, especially high-growth sectors such as technology.

That seems clear simply from looking at which IPOs have been postponed, and which went ahead. Among the former are Suek (a steam coal producer), KOKS (pig iron and coking coal), ChelPipe (steel pipes) and Nord Gold (gold mining). Those that have succeeded, on the other hand, include Nomos bank, Etalon (real estate), Rusagro (agri-industry), and, most successful of all, the $1.43bn New York issue of Yandex, the Russian search engine. That was the biggest internet IPO in the US since Google.

Investors also favour offers where the proceeds are going to be invested back in the business over those where owners are simply cashing out part of their stake. Once again, several of this year’s pulled Russian IPOs fell into the latter category.

But an issue that never lurks far away in Russian offerings is political risk. That was starkly illustrated by the postponement at the end of May of the planned $700m-$1bn listing of Domodedovo, Moscow’s busiest airport. Denis Nuzhdin, Domodedovo’s chief executive, used a similar formula to other companies that postponed issues, saying it was “not satisfied that a fair valuation could be achieved in the current market valuations”.

But analysts had other explanations. They suggested investors might have been spooked by apparent tensions between the company and Russian authorities. Russia’s prosecutor-general – later echoed by president Medvedev himself – criticised the company’s complex offshore ownership structure. The ultimate ownership was, in fact, revealed only during the IPO process itself.

Some market participants believe Domodedovo’s owners may have come under pressure to pull the float because Russian authorities favour a different plan: to merge the airport with Moscow’s other hubs of Sheremetyevo and Vnukovo. Indeed, some saw the IPO itself as an attempt by management to avoid that fate. In what may have been another sign of political pressure, Russian media reports during the IPO process suggested the company’s management might be forced to sell a stake to a state-connected private investor.

Where an offer seems compelling enough, of course, investors will sometimes look beyond political risk. Even Yandex, Russia’s most successful IPO of recent years, warned in its prospectus that “high-profile businesses in Russia, such as ours, can be particularly vulnerable to politically motivated actions”.

Yet it is difficult to achieve top valuations for Russian IPOs when its whole market remains undervalued – largely because of the political “discount” investors apply to the country. Even stripping out lowly-valued oil and gas stocks, the Moscow stock market is at its biggest discount, on a price/earnings basis, to the MSCI Emerging Markets index for three years. On top of perennial concerns over corruption and weak rule of law, that seems to reflect uncertainty over the outcome of the presidential election, and whether Russia will be able to conduct reforms needed to boost its flagging economic growth.

Views expressed are of individual Members and Contributors, rather than the Club's, unless explicitly stated otherwise.