Russia debate: Crisis presents opportunity for Russia

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Euromoney The IMF has cut its growth forecast for Russia and foreign capital has been leaving the country. But despite this, the mood is still upbeat in the Russian capital markets. Companies are still reporting strong numbers and everyone I speak to is very positive about the future. But even still in the short term there are clearly problems. Where are we with the markets?

EK, VTB Capital Despite global uncertainty and volatility, the Russian ECM market has had a record year. Sixteen deals were completed in the first half and more than $10 billion was raised. Of course it was not just a record year in terms of completed deals, it was also a record year for deals that were pulled: more than six IPOs, worth about $5 billion, were pulled from the market. If every deal had happened we would have raised $15 billion, and that is very close to pre-crisis levels.

Investors in the market are displaying a high level of selectivity and price sensitivity, especially now that the market is not stable on a global level. So not all the companies were well prepared to do deals.

AS, VTB Capital On the DCM side, in the first half of the year all issuers and investment banks were expecting high volatility in the second half. But in the first half $17 billion was raised in the international debt markets by Russian issuers, while only $6 billion matured. So you can argue that $11 billion of new money came into Russia. In the CIS, overall issuance was around $26 billion, which is 40% growth for the six months year on year. A lot of companies have pre-funded themselves. Quite a few Russian issuers also became innovative. For instance, the sovereign’s Russian rouble Eurobond issuance and Russian Railways, which went to the sterling market and placed an unheard of 20-year transaction.

Euromoney Igor, given that Alrosa is planning an IPO, from a CFO’s point of view how do you view your ability to access the capital markets?

IK, Alrosa There is a backdrop of volatility and tension in the market, but for first-class issuers the markets are still open. We see no need for extra liquidity domestically or internationally. We see certain volatility in interest rates but liquidity is sufficient. This is true of issuers of our calibre. Our smaller counterparties have been complaining and are in a more stressful situation.

Euromoney From an investor’s point of view what are the challenges facing the Russian IPO market? Are they to do with the internal culture of the market players or to do with vulnerabilities to the external crises happening in the world, or is it more to do with the structural issues facing the Russian domestic capital markets?

JG, East Capital If we start with the mentality and culture in Russia, the aim is to maximize the price in the IPO, which doesn’t make sense from an entrepreneur’s point of view. If you are too greedy, you might end up selling 20% but keep 80%. If the IPO ends a failure, the rest of your holding – the 80% – could not do well. We need to change the attitude of Russian entrepreneurs. Also for a company doing an IPO, it needs to look at peers in the market and take a certain discount. It is realistic to expect to do an IPO at a slight discount to the listed peers as the market does not know them.

OM, Rusal We are in a provocative discussion here. I actually agree that in many cases the owners want to maximize the value of their own assets. When you do a deal, it means there is a market price. The question is, what is going to happen further. If you are to sell your stock in a growing market, investors are happy, but if it is in a volatile market, investors could be disappointed. Since 2008 we have been in a volatile world so I think it is a bit unfair to blame Russian companies for trying to raise as much capital as possible. If you look at Rusal’s IPO for example, the price of our share at IPO was HK$10.80. In the past 12 months it has gone from HK$7 to HK$14 so investors could have made – and lost – a lot of money. But it is important that Russian companies are getting more experience. Even if the public market is closed we are seeing private transactions. We will see lots of interesting public deals when the markets come back.

Euromoney Jean-Pascal, Nomos recently successfully completed its IPO, and is now seen as one of the premier Russian bank stocks. What lessons did you take from the process and do you think maximizing proceeds is sensible?

J-PD, Nomos I took some lessons from the process of doing our IPO, and although it is difficult to draw conclusions I will try. First, you need to have the right price expectations. Secondly you need the right management team in front of investors. Investors are buying the reputation of the future management team and past performance. You also have to talk to investors very early on – even six or nine months before the IPO. And then regarding bankers, I would hire many investment bankers as you do not want to rely on just one. It is a very tricky process and many things can go wrong, so you are better having a consortium and managing them directly. Finally you need to be very lucky with market timing.

Euromoney How can companies make their stocks as attractive as possible for foreign investors? Maxim, you recently undertook a conversion of preferred shares into common stock. What was the thinking behind that?

MV, PhosAgro We just follow the advice of the banks even though preferred shares used to be unpopular but are now becoming more popular. We converted our preferred shares into ordinary shares because the formula on the dividend distribution on the preferred shares was not really transparent to the market. We think it has been beneficial, even though it was a technical process, which did not add to our valuation. But it is more attractive as our dividend policy is declared at 30% of net income for the next year and it is straightforward.

OM, Rusal Investors have six or seven meetings a day and the amount of prospectuses and marketing materials they are getting is enormous. So you need to make sure you are not getting lost in all these names coming to these investors. You need to develop your own approach to the investor community. This means doing your own roadshows, participating in investment conferences, distributing information packages. It is important and investment bankers can help but companies need to do their own work.

EK, VTB Capital Investors want a direct dialogue with the company. Banks are happy to support companies in building up and maintaining that dialogue. But it has to be a primary function of internal IR.

PI, Russian Railways In 2010, our company Transcontainer launched an IPO and it is probably the only example of the valuation of the company being above issue price. It has remained fairly stable. But following up from what my colleague at Nomos Bank said, it is luck. The timing was right and the window of opportunity was there. It is the job of the management team to ensure that investors’ expectations are met. Also, outreach should be maximized and communication with investors should be well organized. Dividends should be paid transparently as well.

IK, Alrosa We are at the beginning of the road [to our IPO]. We are talking to our major shareholders and discussing our IPO prospects. It is likely to take place at the end of 2012 or the beginning of 2013 and will likely be a mix of IPO and SPO. The Russian Federation will decide how much of the company will be privatized and depending on how much cash the company will need we will determine the amount of the deal. In the run-up to that we are doing as much as possible to maximize the value of the company. For instance, earlier this year we converted the company from a private company to a public one. Then we decided to split the stock. And then in parallel we are working with our consultants and auditors to improve the transparency of the company. We are also bringing the corporate governance standards of the company closer to the standards that investors are used to. We have already changed the composition of the board of directors. We are taking our time and trying not to repeat someone else’s mistakes. Euromoney Russian companies have a unique ability to list in many different venues around the world. Leading tech companies such as Yandex are listed on Nasdaq, many others are listed in London and now UC Rusal is listed in Hong Kong. Some are even listed in Russia! James, from your point of view how do the listing venues of Russian companies affect your investment advice?

JB, Société Générale It doesn’t change things too much. Mostly we are dealing with western-based investors and I believe there is a premium they will pay to own shares in a company that is listed in the UK or US because they better trust the regulation of those markets.

OM, Rusal It was a good decision for us to list in Hong Kong, although it is not very obvious. We have not had much Asian demand since the IPO and we did not expect many investors to come on the first day. So our decision was long term. If you look at the development of [the Hong Kong] capital market, the amount of capital raised has increased dramatically in the past 10 years. It was $8 billion 10 years ago versus $110 billion last year. There were 113 IPOs in Hong Kong last year versus 95 in London. Hong Kong has already become an international financial centre that is comparable to New York and London. Hong Kong is now seen as a gate for Chinese domestic capital going abroad, the inverse to what it was 10 years ago when it was a tool for getting foreign money into China.

In a few years the Hong Kong market will be the main way for domestic Chinese money to invest in foreign-listed companies. That is why it is important to list in Hong Kong. But you need to be in the market for longer before Chinese investors start buying your stock. It was a strategic decision, not a short-term one. For international institutional investors, it does not really matter if you are listed in London, New York or Hong Kong. They can buy your stock in any of those markets. We also listed in Russia in the first-ever Russian depositary receipts deal.

Euromoney Elena, how do you approach the issue of listing venue when it comes to prospective deal sizes, company sector and deal type? Do you recommend different venues for different types of deals or companies?

EK, VTB Capital There are a number of factors in choosing a listing platform. Listing determines the success of your deal. It is true that for quality stories investors will go everywhere and it doesn’t matter where you list. But to get a successful deal, the company should go to the market that provides the highest liquidity, presence of the peer group, and the widest investor base. The US is still the most liquid market in the world. And for the technology sector, Nasdaq remains the platform of choice and it is where such deals should happen. Yandex IPO is a good example.

London is still the most popular listing location because it is the easiest and most straightforward route to get an international listing. The investors are well educated, and there are already many companies from Russia listed there. Hong Kong is strategically an important market. When you go to Hong Kong you keep all your existing investors plus you get access to the most promising Asian investor base. The results will probably be seen from a long-term perspective. Overall, listing choice should be assessed on a case-by-case basis.

OM, Rusal There is also a fundamental industrial element to the decision. If you look at the foreign companies recently listed in Hong Kong, you have commodity producers like us, like Glencore and Vale, because the key consumer of most commodities is China. It consumes 45% of all the aluminium produced, 47% of all the nickel produced and over 50% of all the iron ore. This trend will continue and so the main commodity companies must be listed in China as this is the main market for their product.

Euromoney One of the ironies at the heart of this debate about internationalizing Russia’s capital markets is that before international investors embrace a new market, they want to see that its local market functions effectively and in particular that local investors are active. How important is it that the local capital markets in Russia are developed before international investors come in and invest in Russian companies?

JG, East Capital It is important to develop a local investor base. The Russian government needs to prioritize developing the pension fund industry both in terms of savings and also how the pension funds can invest, basically allowing them to invest in the equity markets. We have seen other places in Eastern Europe where this has been a great success, most notably Poland. Then little by little you can get the general population investing in mutual funds. The second step is that, over time, Russia should be a natural place for Russian companies to list. But there are technical problems at the moment that are an obstacle. If you are a large Russian company, most probably you would like to list in both London and Moscow, or Hong Kong and Moscow. But if you are a Russian incorporated entity you can only list 25% of your shares outside Russia. This leads to a lot of Russian companies being set up offshore in Jersey or Cyprus and they would list that entity abroad. Then there is little point in listing in Moscow as well. Once that technicality is changed, it will change the incentive for listing in Russia.

Euromoney Do you the think the RDR [Russian depositary receipt] structure will bring some of those foreign incorporated but Russian companies back to Russia and would you invest in those RDRs?

JG, East Capital Yes, the RDR is a partial solution. But I would rather see the law changing. With the RDR you are essentially going around in a big circle to get back to Russia. For a big company it may make sense but for a small company it is too complicated.

Euromoney This brings us to the privatization process. Much has been made of the government’s list of major companies that it is looking to sell over the next two to three years. Moving away from the actual companies involved, do you think the process of privatization can be used to further the development of the Russian capital markets or do you think companies should just focus on maximizing proceeds? Igor, as a representative of a privatizing company, what is your perspective?

IK, Alrosa We believe that the statements made by the government about the creation of an international financial centre in Russia and Moscow will not be possible without creating the right trading venue where Russian issuers can do IPOs. There are some technical requirements and the exchanges are not ready for this. For instance, there is no national depositary that will allow investors to operate their stocks. There are several other technical and legal issues. Some laws and decrees stand in the way of moving capital and securities. We are just at the beginning of this path.

When we at Alrosa started our IPO process we spoke with Micex and VTB and a number of other banks about changing this situation and we understand that this is something that companies with a big government stake can do. They are a big bulldozer that can push through these changes. They can work with the government on this. If our IPO and SPO are to take place in 2012 or 2013, we want it to take place on Micex in Moscow. If this works for us, we want to act as a locomotive that can push through this barrier that stands in the way for big and small companies looking to list in Moscow. The choice of venue is very important for us.

As for privatization, as a government-owned company we know about the debates that are going on in the government. This is quite a complicated debate: who will be on the list, how will privatization be carried out, how the government should exit the companies and whether the government should keep a block of stocks. It is not decided yet and there are many different opinions. Some want the full privatization of big companies such as Alrosa, others believe a partial privatization should be done so the government would have blocking rights. I think the decision will be made in the next weeks and months on the list of the companies to be privatized in 2012 and 2013.

If we are to follow this strategy we should not act in a hurry but should first do all the preparation work and then select the best windows to go public. The goal of privatization is not just to turn companies into public companies but also to get the best price that can contribute to the budget of the Russian Federation.

PI, Russian Railways At this time, our company is on the list of potential state-owned assets to be privatized after 2013. The final decision has not been made yet. There are some important fundamental factors that will influence the final decision. There are important decisions around the regulation of the industry that are yet to be made. Tariff regulation is still done on a short-term basis and in this situation it would be difficult to come up with a transparent business model that is understood by investors. We are working to improve our reporting transparency both on the debt and equity markets. We want to make sure the company is as ready as possible.

Euromoney It is clearly a very difficult time in the markets right now, but Andrey, although the debt markets might be closed at the moment, in general how are Russian companies accessing the international debt markets?

AS, VTB Capital I definitely think the market is growing for Russian companies accessing the international debt markets. Before 2008 we saw quite a few second-tier financial institutions come to the market. But after 2008 we have seen more highly rated companies coming to the market. Another important trend is that companies have been looking at issuing in alternative currencies, trying to diversify their investor bases and finding some arbitrage opportunities. Russian companies have come into the Swiss market and the Asian markets: VTB has issued in Singapore dollars and in renminbis and this opened the market for other Russian companies. They were public deals fully bookbuilt. For VTB it helped that our name was well known and Asian investors had purchased our bonds in US dollars. There has also been more active participation of Russian investors in international deals. It is not rare now to see 20% or 25% of the orders in the book coming from Russian investors. It helps Russian companies get better terms, as Russian investors know the names and credits much better than foreign investors. Foreign investors are more comfortable if they can see Russian investors putting in the orders.

J-PG, Nomos We are avoiding issuing any debt right now as it is impossible to do anything. But over the summer we had a 10 non-call five bond and it is usually common practice to call the bond. Since our reputation in the market is very important to us, we decided to call the bond and at the same time, one of our two strategic shareholders issued us with a long-term subordinated debt so that we would end up net-net with more capital than we had before. That’s the benefit of having strong financial strategic shareholders in the company: when the financial markets are not there they can provide some help.

Otherwise Nomos has a diversified funding base and a calendar of repayment of our issues that is well distributed over time. Our strategy is never to be the prisoner of the capital markets. In good times they are there and in bad times they are shut down.

PI, Russian Railways Traditionally Russian Railways has been a benchmark in the local bond market. We have about R200 billion [$6.25 billion] outstanding and up to six-and-a-half years is our horizon. It is our main source of funding. But after the 2008 crisis and the lessons we have learnt, we have decided to take advantage of favourable markets and diversify our funding sources. We decided to change the structure of the portfolio and refinance the debt with more comfortable maturities and terms. In 2010 we had a debut with dollar-denominated Eurobonds and that was a big success. We planned to place $1 billion for seven years but demand was for $9.5 billion. So we decided to increase the volume. We focused deliberately on US dollars to reach out to the broadest possible investor base and so to maximize our proceeds.

After that we began thinking about the next instrument that we would offer to investors. So we went to the sterling Eurobond market, which is unique in that you can issue up to 50 or 70 years. We saw it as an opportunity to prove to ourselves, to the regulators and to the ministries what we can do. The company proved that we are able to borrow from the debt markets on a very long-term basis. The first deal was done in March this year when the markets were in turmoil due to hostilities in Libya and the disaster in Japan. We managed to place £350 million [$542 million] at 20 years. We came back to market in June and nearly doubled the issuance to £650 million. It’s a unique transaction for Russian issuers, the Russian market and for Russian risk. In the future we plan to use the same practice to change our borrowing profile and diversify our sources of funding.

OM, Rusal We have 10 years’ experience in the debt market. And the key to borrowing is that your repayment profile matches your long-term financial model. It will help you go through the crises, especially for companies working in cyclical industries. Secondly it is important to match the currency of your debt with your revenue to avoid currency risks.

This year we raised about R30 billion in two tranches and immediately hedged it in the dollar swap market – our product, aluminium, is priced in US dollars. We got an attractive price for this four-year and five-year financing, about 5% in US dollars, which is less than it would have cost in the dollar Eurobond market.

I think it is also important to control your lender base because when you face any necessity to discuss and renegotiate the terms of your financing, you find the lender base is quite diversified and it is not easy to negotiate with. We completed our global debt refinancing and we decreased the number of our lenders from about 70 to 15 or 20. It is now much more comfortable to negotiate and discuss financing with the key relationship lenders rather than with a complicated market.

We never issued Eurobonds as we have targeted the lower-cost syndicated loan market. We recently raised $4.75 billion to refinance our debt. And the cost of our financing is about 4.5% at the moment, which is a relatively good benchmark for the Russian borrower.

Euromoney So is it still easier to go to the international syndicated loan market than the Eurobond market and is the access available for Russian companies in the loan market hindering the development of the international bond market?

OM, Rusal There is no conflict here. You should diversify your debt portfolio. But the syndicated loan market is limited in terms of maturity. It is five or seven years maximum. You can also not borrow too much as the number of banks is quite limited. The Eurobond market is wider and you can get longer maturity. But it depends on your strategy.

JB, Société Générale There is a very wide dichotomy in the debt market compared with the equity market. Unfortunately Russia has a hard-earned poor reputation in the equity market but when you look at the bond market it is quite different. Investors can see that in the Russian culture it is important to try to honour bonds as much as possible. Perhaps it has something to do with 1998. A lot of our global investors have a lot of interest in Russian bonds. From a diversification perspective it is very good to hear from these companies about their interest in issuing in foreign currencies. From a high-net-worth perspective, our clients also maintain a diversified exposure to currencies for their own asset allocation and so they will happily buy bonds in other currencies.

In the equity market you might see more regionalization of interest depending on which market you are listed on, but in the bond markets there is global interest to have exposure to a wide variety of currencies. It works for both the issuer and the investors.

OM, Rusal The renminbi market is very interesting as there is a huge supply of renminbi available in Hong Kong. The market is relatively young as it opened up to international borrowers only 12 months ago. We looked at this opportunity and continue to monitor it. The market is getting bigger and bigger and I think in a few years it will be a good alternative to the Eurobond market. However at the moment the liquidity is very low and this is the real obstacle. Investors buy your bonds and sit on them. The trading is very small at the moment. The market needs some time for development but it is good to try to enter the market and get some experience. More Russian companies have to try, especially those that export to China.

AS, VTB Capital When you raise the money in renminbis you probably want to swap it back into a more conventional currency like the US dollar. But the swap market is very thin. So when we did our issue the book was seven times oversubscribed but we were unable to increase the eventual size due to the swap market.

Euromoney I know it is a very difficult time to be making any predictions, but what is your outlook for Russian activity in the international capital market over the next year?

EK, VTB Capital We are quite confident in the future of the Russian capital markets but right now markets are driven by global economic problems. Our experience tells us that the market will remain closed for a while but starting from April/May we hope to see more positive developments. Fundamentally, Russia is very strong, but unfortunately our market depends to a large extent on international investments. We need to develop the local investor base to sustain our growth. At the moment 90% of investments in Russian IPOs are international and until the global picture becomes clearer, there is no certainty in Russian capital markets either.

PI, Russian Railways This year we have a new policy from the finance ministry that shows that the minister sees the need for the development of infrastructure and the need to provide easier access for international investors to Russian debt markets. This is very important as it will make it easier to use international experience locally. We will be able to make the Russian debt markets more profound and allow Russian companies to borrow domestically and so reduce their FX risks.

The situation developing in the market actually offers good opportunities. While the international markets are closed we can use the time to develop the local markets so that when the situation improves globally Russian markets could become one of the priority markets for global investors. Fundamentally Russian companies look quite good. They are ready for hard periods in the economy so that when growth recovers we can be among the leaders and the first to go out and borrow from global investors.

AS, VTB Capital We saw after 2008 that the bond market opens before the equity market and we think it might happen again. Investors from real-money accounts and private accounts have liquidity but they are not prepared to invest when the market is moving so much. There will be a time when investors decide we have hit the bottom.

JG, East Capital I think we are near the bottom but we have different views on that within our company. I think it is different from 2008 as the financial sector in the US and Europe is better prepared. But we will see substantially lower growth in the US and Europe. In terms of equities I would be relatively positive.

JB, Société Générale The way I would look at it from a Russian perspective is that there is now an enormous opportunity. As we go through this crisis it is quite clear that the Russian market is functioning and that is a big difference from 2008. Of course there are some differences in the nature of this crisis. But when you can move from such a negative environment in 2008 and see it survive a shock like this and continue to function, it is a big shift in sentiment and mentality. It is really improving the reputation of the Russian financial infrastructure. It’s a very good thing. It is important to capture that shift and move it forward. With that in mind the next step that needs to happen is that corporate governance needs to follow suit. That is where the reputational issues will continue to linger. While the momentum is there it is important to seize the initiative and move things forward.