The Russian IPO Market in 2010

As the global economy shows signs of recovery, there has been much talk of a revival in the IPO market.

But is this just talk and nothing more? Investment banks and private equity houses seem keen to stoke the coals of the market, with many predicting an influx of new issuers this year.

The London Stock Exchange (LSE) is already showing signs of recovery. In the first quarter, there were 19 initial public offerings raising around GBP 1.87 billion, compared to 14 flotations raising under GBP 1 billion in the final three months of 2009.

Asian markets remain the strongest, as they were in 2009, when the Hong Kong Stock Exchange (HKEx) took the title of world’s largest IPO market, with companies raising a total of USD 32 billion.

The main trend on the global capital markets for 2010 will likely be a shift in the reasons for listing. Whereas last year companies were approaching the capital markets in desperate need of cash to rescue their balance sheets, 2010 will see more companies looking to raise capital for expansion, as well as to refinance their debts.

In 2010, the Russian economy, and to a certain extent, the Russian IPO market, will depend on the performance of the world’s leading economies and the recovery in the emerging markets, particularly the other BRIC countries. Brazil and India are already showing good signs of recovery and if China continues to demonstrate solid growth, demand for Russia’s natural resources will increase to pre-crisis levels. The current outlook for Russia’s economy is positive; we are now seeing the beginning of a slow recovery. Looking forward, if the Russian economy shows strength, or at least stability in the first half of 2010, then a large number of Russian IPOs planned for this year will go ahead.

The story so far

According to statistics from Uralsib, the Russian commercial and investment bank, the total amount raised by Russian companies through 79 IPOs and SPOs to date is USD 62.7 billion. Just over half of this (USD 32.9 billion) came in 2007, the biggest year so far for Russian IPOs. Looking at Russian listings over the last year, in the second half of 2009, several Russian companies made well-received additional share offerings on the world’s capital markets, demonstrating that international investors are turning their attention back to Russian issuers.

In July 2009, in the first placement since Acron’s IPO in late 2008, Russian steel maker Evraz raised USD 315 million in an additional share offering. Subsequently, in October 2009, Magnit, the budget Russian grocery chain, raised USD 527 million in London in a heavily oversubscribed SPO. In addition, a number of small- and medium-sized enterprises operating in the Russian oil and gas sector have made successful additional share offerings, including Alliance Oil, Volga Gas and PetroNeft.

Amidst positive responses to offerings by Russian issuers, two small companies went ahead with IPOs in December 2009. Exillon Energy, a Russia-focused oil producer, and the Human Stem Cell Institute, a Russian biotechnology company, raised USD 100 million on the LSE and USD 5 million on MICEX respectively. Although the size of these IPOs is a far cry from pre-crisis times, they are a positive indication of investor appetite for new Russian stock.

Going forward, the Russian IPO pipeline is looking well stocked; at least 18 companies are thought to be preparing to make initial public offerings, including large listings from SUEK, Sovcomflot, Kamchatka Gold, Metalloinvest and Transcontainer. One issue that could stand in their way is the introduction of new rules from the Federal Financial Markets Service, the Russian financial regulator, further limiting the percentage of shares that a Russian company may list on international exchanges. The full impact of these changes, which came into effect in January this year, is yet to be seen. However, to get round this issue, some companies are rumoured to be investigating the possibility of using holding companies in foreign jurisdictions through which they could list their shares.

Paving the way

The most noteworthy listing of the year so far was that of UC Rusal on HKEx. Rusal’s IPO is significant in many ways. Firstly, it was the first Russian IPO of size since 2007. Secondly, and more importantly, it was the first Russian company to list on HKEx, paving the way for what could be a whole host of new Russian issuers heading east. So why did Rusal choose HKEx? In many ways, Hong Kong was the logical venue for Rusal’s listing. Chinese investors have a lot of capital to invest, and commodities are an area they understand. Moreover, China is the world’s largest aluminium consumer and Chalco, the Chinese aluminium giant and Rusal’s global peer, is also listed in Hong Kong.

Since its January IPO, which raised USD 2.2 billion, Rusal’s shares have taken a tumble. However, there are a number of reasons why this should not deter Russian issuers from listing in Hong Kong. Firstly, aluminium prices have fallen; this has also been reflected in the performance of other aluminium companies listed in Hong Kong, including Chalco. Secondly, the pricing was a bit too aggressive for a company that had just gone through a major debt restructuring and creditors had to accept non-lucrative terms. Thirdly, the markets are still volatile and shares in any company, particularly from a growth market such as Russia, are vulnerable to a certain degree of fluctuation in the short term. How Rusal’s stocks perform over the coming year will be a more telling indicator.

¹Maxim Lubomudrov is the lead partner for Deloitte’s integrated IPO services offering in Russia and the CIS. Simon Molyneux is editor of The Deloitte Times, a quarterly publication about the CIS market with a focus on IPO. For more information about Deloitte’s integrated IPO services for companies in Russia and the CIS, please visit www.deloitte.ru or email ipo@deloitte.ru.

Page2

For Russian companies looking to list their shares on international markets, the LSE has always been the logical choice. London investors are relatively familiar with the Russian market, LSE requirements are well-known and new issuers can draw upon the past experience of other Russian companies when it comes to making a listing. But Rusal’s listing has changed all of that. A look at today’s IPO pipeline will reveal that Russian companies are now looking at HKEx as a viable option. The idea, although HKEx officials have been quick to deny this, that listing requirements are more lax in Hong Kong than in London has proved an attractive one for capital-hungry Russian firms.

Is Hong Kong really a viable alternative to London?

Judging by the number of Russian companies that have expressed an interest in listing there, it certainly is. In 2009, companies raised USD 32 billion through 73 listings on HKEx, making it the world’s biggest IPO market. This is largely thanks to China’s growth, which has left Chinese investors with cash to spend. However, Chinese investors are cautious, most interested in sectors they can understand, such as energy and commodities. They are looking for international, good quality investments with high exposure. If a Russian issuer operating in the energy or commodities sector can demonstrate that it has a good story and international presence, then demand and interest from investors will follow. Moreover, if the business of a Russian issuer is in some way linked with China, then its stocks will have even better chances of being in demand.

Judging by the number of Russian companies that have expressed an interest in listing there, it certainly is. In 2009, companies raised USD 32 billion through 73 listings on HKEx, making it the world’s biggest IPO market. This is largely thanks to China’s growth, which has left Chinese investors with cash to spend. However, Chinese investors are cautious, most interested in sectors they can understand, such as energy and commodities. They are looking for international, good quality investments with high exposure. If a Russian issuer operating in the energy or commodities sector can demonstrate that it has a good story and international presence, then demand and interest from investors will follow. Moreover, if the business of a Russian issuer is in some way linked with China, then its stocks will have even better chances of being in demand.

But what about London?

Rusal showed Russian companies that London has a serious contender. But the LSE still has the edge. The route to London is a well-trodden path. Best practice for listing on the LSE is already well established, with over 100 companies from the CIS having listed on the Main Market and AIM. Going public is a big step for any company, and for issuers to know that they are following in the footsteps of other successful CIS issuers makes that step a little easier.

Despite the relatively small number of listings on the LSE in 2009, the market is looking strong. Late last year Russiafocused Exillon Energy made a small but well-received offering in London, showing that investors are again interested in Russia. The liquidity is still there and the rise in commodity prices has led to some good performances from companies listed on the LSE and operating in the oil and gas, mining, steel and real estate sectors, from which most Russian issuers will come. This year, London is expecting to see a number of IPOs from UK companies, which will warm up investors.

New London listing rules

One issue that now confronts new issuers from Russia is the LSE’s new listing rules set down by the UK’s Financial Services Authority (FSA). The new listing rules restructure the listing regime of the LSE’s Main Market into two issuer segments – Premium (previously known as a Primary Listing) and Standard (previously known as a Secondary Listing). Under the new regime, issuers with a Premium Listing will be required to comply with ‘premium’ or ‘super-equivalent’ standards, while issuers with a Standard Listing need only comply with the less demanding EU minimum standards. The main change is that non-UK companies wishing to achieve a Premium Listing will now need to ‘comply or explain’ against the UK’s Combined Code on Corporate Governance, instead of simply meeting the corporate governance requirements of their own country.

The LSE explains this tightening of requirements as the codification of corporate governance best practice, but it could present a hurdle for Russian companies wishing to obtain a Premium Listing. However, requirements for a Standard Listing have been slightly relaxed, with sponsors no longer required. The market’s reaction to this change remains to be seen.

So who will be successful in 2010 and where will they list?

Investors are interested in Russian stocks. Risk appetite is increasing and so is confidence in Russia’s recovery. For many large Russian companies, 2010 is the year when they switch from survival to growth mode and they will need funds to drive this growth in the recovering consumer and commodities markets. IPO is once again a viable means to raise capital for companies from Russia. In 2010, there will likely be a small number of issuers who follow the Rusal path to Hong Kong, but, for the most part, Russian companies will continue to choose London for their IPOs.

Quality is key for Russian IPOs in 2010. The FSA’s new listing rules are demanding quality in London, as is the Securities and Futures Commission, Hong Kong’s market regulator. Investors are also looking for it, and if a Russian issuer is to be successful in 2010, then quality is what they will have to demonstrate; quality in all operational areas, quality corporate governance, quality information disclosure, quality risk management, quality internal controls and quality in all other aspects of their business.

With such a packed pipeline, when will these IPOs happen?

At present, it seems that both investors and issuers are waiting for further signs of recovery and better pricing before they make their offerings. Investors believe issuers are pricing too high, whereas, on the contrary, issuers are unwilling to come to market for the amount of money they could currently raise. This is particularly the case for Russian issuers, which, having seen the large amounts of money raised in precrisis times, are likely to wait for better pricing before listing their shares on international exchanges.

But is it wise to wait? Some analysts are arguing that while China’s economy is strong, and Russia is showing signs of stability, issuers should push forward with their listings. Investor interest in growth market stocks seems to be strong, as does risk appetite, but only if corporate governance is good. Only one point is certain; the Russian IPO market is picking up and companies need to act now and begin preparation for IPO.