Taking stock of Russian equities
VimpelCom comes to the Big Apple
Even the signing ceremony was unusual in this most unusual of deals. Elated by having successfully achieved the largest-ever debut Eurobond for a sovereign credit a $1 billion five-year issue Russian officials in their enthusiam insisted on organizing and paying for the celebrations. This was a thank you, they said, to the international banks, which could hardly be said to have done badly out of the deal and which might normally have been expected to foot the bill for the pleasantries.
Along with representatives from the lead banks that had worked closest on the deal there were senior bankers from many of the syndicate firms. They arrived from around the world, including a nonplussed representative from a Japanese house who spoke neither English nor Russian. For good measure the Russians also threw open the festivities at the Kremlin to most of the foreign bankers they knew in Moscow.
Not quite the average signing ceremony. Then again, given that the November 1996 celebrations marked Russia’s return to the international capital markets for the first time since the October 1917 revolution, the hosts could perhaps be excused for not knowing the form for these occasions.
The deal gave the Russians everything they wanted from the market and more. Joint-lead managers JP Morgan and SBC Warburg generated $2.6 billion of demand and priced the bond at 345 basis points over US treasuries whereas the deal had first been mooted as being for a two- or three-year maturity and no more than $500 million. Having thus completed a larger, longer-dated deal, Russia has set a benchmark for future borrowing that may save it billions of dollars in debt service costs.
Narrowing the spread
The spread represents a huge improvement on similar-maturity dollar-denominated Russian internal MinFin (ministry of finance) bonds which at launch were yielding more than 500bp over treasuries. Within a week of the Eurobond launch, there were signs of the domestic debt market repricing. Yields on short-dated GKOs (rouble-denominated government bonds), which had hovered above 45%, declined to 38%.
In some ways the Russians were lucky. Last year international bond investors became desperate for assets offering a decent yield. Spreads tightened on all manner of emerging-market debt, none more dramatically than on Russian assets. With president Boris Yeltsin safely re-elected, foreign investors began to pay attention to the country’s impressive economic stabilization programme.
The annualized inflation rate, which in August 1995 was running at 225%, had come down to 31.5% by last September and was heading for 20% this year. Although the cost of this has been high, with real interest rates of 50% and GDP falling about 6% last year, investors nevertheless piled into Russian debt, including MinFin bonds and Vnesh (Vnesheconombank) loans. At the start of 1996, MinFin bonds had yielded 1500bp over treasuries.
The Eurobond took nearly a year to complete from mandate to launch. It was, at times, a tortuous and confused process. Constitutional issues were raised: the deal required Russia to borrow under English law for the first time. Russian proponents of the deal had to force that through a hostile Duma (parliament), overcoming the criticism of nationalists inclined to attack all foreign borrowing as a sign of weakness.
The task of obtaining ratings and making presentations to foreign investors stretched Russian officials to the limit. Unused to being interrogated by foreigners, they hated the process. They found it bewildering but it went well: the agencies produced higher-than-expected ratings and the roadshows were crowded with fund managers.
Success was vital. The Eurobond raised much-needed budget finance for Russia at a time when the IMF had begun to withhold $330 million monthly disbursements from its $10 billion extended facility. Even more important is the potential the bond has unleashed to bring down Russia’s high domestic borrowing costs. Real rates on domestic treasury bills last year were close to 50%. Although domestic debt is a modest 15% of GDP, were high interest costs to continue, that debt might double and double again over the next two to three years. As execution of the deal approached, Russian officials became ever more determined for it to work. It may even be that the deal’s timetable influenced the timing of Yeltsin’s heart by-pass operation.
Yet late in the day the deal was threatened by misunderstandings between Russian officials who misread the market and investment bankers who had devoted much of last year to the transaction. There were also the little practical difficulties, such as obtaining visas for the large number of high-ranking Russians some with backgrounds of potential interest to foreign intelligence agencies who were required to enter previously hostile countries. Just a handful of deputy ministers and senior officials bore the brunt of all this organization in what spare time they had, when not dealing with the IMF and other groups of creditors including angry French holders of pre-revolutionary Tsarist bonds.
Banks had been talking to the Russian ministry of finance about a sovereign financing since early 1995. But first Russia had to reach agreement with its official and bank creditors to reschedule the debts of the former Soviet Union which had defaulted on $105 billion of external debt in December 1991. Russia accepted sole responsibility for the debt in April 1993 then in November 1995 struck a provisional deal with bank creditors to spread principal repayments over 25 years starting from 2002. Negotiations with the Paris Club dragged on until April 1996 when Russia agreed to a similar deal for official creditors.
Busy with these negotiations and in other talks with the IMF on a crucial $10.2 billion extended finance facility were first deputy finance minister Andrey Vavilov, deputy minister Mikhail Kasyanov, director of the department of foreign credits and external borrowing Alexei SmirnoV and his deputy director Vladimir Dmitriev. Their hands were all but full. However, long before such high-profile and intense official negotiations were anywhere near complete, eager investment bankers had planted the idea of a Eurobond in the minds of this same small group.
So the Russians were toying with the notion of a Eurobond deal as early as the first half of 1995. They would have to play two games simultaneously: to official creditors they would plead hardship, point out the dangers of saddling the economy with a huge debt burden then illustrate the wisdom for creditors of settling on a lenient repayment schedule; to potential bond investors, the story would be one of improving economic fundamentals and heroic Russian commitment to debt service.
It was not until September 1995 that it became clear that the Russian team was determined to conclude a rescheduling and return to the bond market. The finance ministry invited a handful of banks to Moscow to make presentations in September, November and December of that year.
Mandate mix-up
From the start, there was confusion. The finance ministry invited proposals on two separate occasions. News screens flashed that Merrill Lynch had a mandate for the deal. Perhaps so, but not from the right group of Russian officials. SBC Warburg, with only a modest presence in Russia, had one advantage: it was advising the Russian government on debt rescheduling. Although a Chinese wall separated SBC Warburg’s sovereign advisers from the capital-markets team, the bank won the deal. It was a source of some frustration to members of the capital-markets team that over the next few months they should spend many anxious days pitching ideas to the Russians who then passed them across the Chinese wall for their own colleagues to criticize.
Initially banks had pitched individually for the mandate but the Russians decided to team SBC Warburg with JP Morgan, knowing the two had worked well on a successful deal for South Africa. It was to be the start of a beautiful friendship for capital-markets staff at the two banks, which also worked together on deals for Mexico and Argentina in 1995.
Both banks had made presentations on what they believed they could deliver in size, maturity and pricing. Formal notification of the mandate came in February 1996. The Russians wanted to push through a deal before the presidential elections scheduled for that summer. Such a deal was just possible a huge rally in emerging-market debt was under way and the IMF came in with a timely boost in February when it agreed a key $10 billion facility. But the London and Paris Club deals still were not signed. Worse still, Boris Yeltsin was trailing the Communist candidate in the polls.
“At that stage, with no credit rating, all that would have been possible was a $200 million to $300 million deal for two or three years,” says Patrick O’Brien, executive director of debt capital markets at SBC Warburg. “It would have been the first-ever public sovereign deal launched before Paris and London Club agreements.”
Wisely, the Russians attended first to those negotiations. That was in April and May. Meanwhile, technical issues had surfaced. The official obligor for rescheduled debt is Vnesheconombank, with a declaration of support from the Russian government. The Eurobond, by contrast, had to be an obligation of the Russian government and subject to English law. The matter was a potential deal-breaker. Without English law, the deal would be a MinFin issue and neither JP Morgan nor SBC Warburg would underwrite it.
By now the Russian election campaign was in full swing. As MinFin yields rose on concerns for Yeltsin’s prospects, the deal was put on hold. Then, Yeltsin having been safely reconfirmed as president at the start of July, work resumed in earnest. The main task now, one which took three months well into September was to obtain ratings from the main agencies. The lead managers sent teams to comb official Russian sources for the statistics the rating agencies would require. They ignored all pre-1994 numbers, deciding they were hopelessly unrepresentative. Russian officials were drilled on the questions the agency teams probably would ask during official presentations and how they should respond.
Western bankers were surprised at the freedom of the press in Moscow to print almost anything about the deal and by the extraordinary stories that began to appear. JP Morgan’s head of emerging market debt syndicate Richard Luddington most relished a pronouncement from one Russian government source “saying that Russia was set to get a credit rating similar either to Spain, Greece or Portugal an interesting span from AA to BBB”. Bond market expectations generally were for weak BB ratings.
Practice runs for the rating agency presentations revealed that the Russians had little experience of smooth talking. O’Brien recalls: “They were repeatedly asked about future privatization proceeds and didn’t answer. They seemed evasive. But the truth was that no budget had been passed nor any privatization schedule agreed. They didn’t want to say enterprises would be privatized and then find the relevant government ministries disowning their claims.”
If the ratings came in below BB the lead banks were prepared to appeal. Another worry was that the ratings might come out days apart and be widely different. Pleasingly, all three ratings were announced within 90 minutes of each other on October 7 as middle-to-strong BBs: BB+ from IBCA, BB from S&P and BA2 from Moody’s. They made a strong impression on the bond markets. Restructured Vnesh loans rallied by three percentage points.
In September the bankers became confident that a deal of some sort was doable. They began to move quickly as they did not want to launch in December: emerging-market deals, such as that for Pakistan in December 1994, struggle in that month as key market participants slope off early for the Christmas and New Year holidays. So while working on their investor presentations the bankers pushed the Russians to address the remaining technical issues, including that being left until last the tax treatment of the bond. It was time for the lead banks to start booking dates with senior Russian ministers for worldwide roadshows.
From the beginning, bankers had trouble convincing the Russians of the need for senior ministers to participate in roadshows. All were good at talking about the Russian economy but their intellectual appreciation of a Eurobond appeared less impressive. In the end, almost every Russian official involved in dealing with external creditors was lined up to join the shows. The heavyweights included finance minister Alexander Livshits (who subsequently presented in London and Frankfurt), first deputy prime minister Vladimir Potanin (New York) and first deputy finance minister Oleg Viugin, the key contact between Russia and the IMF.
Obtaining visas for certain officials was to be a constant difficulty, especially for countries with which Russia historically had experienced strained relations, such as Japan and the US. The capital-markets team members had on occasion to ask senior officials of their own banks to lobby governments to let in the Russians. The bankers turned this occasionally fraught aspect of the deal into something of a joke in an attempt to build team spirit: they offered a prize to the Russian team member who had most visa applications turned down. The official documentation does not record who won and with what total.
Three possible roadshow schedules were drawn up by the bankers, who then found the Russians distracted by arguments with the IMF over the government’s poor record of tax collection and concern about Yeltsin’s health. But eventually the Russians committed themselves to a timetable. An hour after the lead banks received notification of this, news appeared on Reuter screens that Yeltsin’s heart surgery had been set for Tuesday, November 5, a week before the roadshows were to begin and close to the US presidential election.
The Thursday and Friday of the week of Yeltsin’s scheduled operation were holidays in Russia. It occurred to some bankers that the Russians were building in a buffer to protect themselves against an unfortunate outcome in the operating theatre. The US election would provide a distraction, attracting huge media attention. If Yeltsin died, the closure of Russian financial markets would forestall any immediate panic selling.
Launch of the bond was set for November 21 and at this stage talk was of a three-to-five-year deal of up to $500 million. That amount was the maximum for which the Russian team had Duma authorization but still the Russians had not committed to any aspect of the deal size, maturity or spread. They stuck to the line that the roadshows were being undertaken to spread the message of recent economic successes and to gauge demand among potential foreign investors.
Bankers were worried about the reception that might be accorded to the Russians in certain locations as the shows opened on Monday, November 11, with an Asian team in Tokyo and a European team in Luxembourg. Immediately there were glitches. A senior Russian official was delayed on his way to Asia but later commandeered a Gazprom jet to catch up with the team in Seoul. One hostile questioner in Hong Kong harangued the delegation about MinFin bonds which had been frozen after the theft of bonds from banks in Chechnya. And the Russians proved stilted in some of their presentations. The natural instinct of the older, Soviet-schooled officials, was to avoid saying anything very much to westerners and certainly never to exceed their own brief. The Soviet style is to answer around a question and rely on the questioner not to make you lose face by ever pressing the point.”
Appetite from the east
At most roadshows the same questions came up about the outlook for GDP growth, for reducing tax arrears, for the stability of the banking system, for unfreezing MinFin bonds. Mercifully, politics was not a topic. Investors realized that the visiting Russians could not say much on Kremlin infighting. They also tended not to say much during the rare press briefings, clamming up when such questions as the terms for the proposed bond arose.
“The smaller gatherings were better,” recalls Eva Lindholm, coverage officer at JP Morgan. “In Los Angeles it was 20 very sophisticated fund managers seated within touching distance of the Russians. There was a lot of back-and-forth and I don’t imagine any of those investors left feeling their questions had not been answered.”
The same could not be said of the Russians’ performance at the larger roadshow gatherings, such as that in London which attracted 450 people to an overstretched Chiswell Street Brewery. These produced the least impressive performances. Livshits, the top man in London, walked out after the formal presentations to catch a plane to Frankfurt for a press briefing. That left the more junior officials to face the inquisitors but at least they generally were better equipped to answer technical points and were able to do so free from the intimidating presence of their boss.
Worryingly for the bankers, the Russians at times also seemed to be following their own parallel agenda. In Paris on November 13 they made time to negotiate with the French government on a series of bilateral claims, including those of France on Tsarist bonds. A day earlier, Viugin suddenly had returned to Moscow from Switzerland in what proved to be a significant moment. The IMF had withheld two monthly disbursements of $330 million. Viugin secured approval to raise the cap on the Eurobond by a further $680 million.
Despite the hitches and the bankers’ concerns, it nevertheless was clear almost from the outset that the deal would go well. On the second day of the Asian roadshow, the team landed in Seoul and realized it had found a big group of takers for the bond. All year, Korean investors had been buyers of short-dated emerging-market debt from Romania, Slovenia and Colombia and their strong bid for the Russian deal underpinned the transaction. News of the strong Asian reception filtered through to Europe where if attendances were anything to go by, the deal was in the bag: 60 people for breakfast on a wet Tuesday morning in Geneva and 150 that afternoon in Zürich.
The bankers pressed home a simple message: Russia is such a big, important country that emerging-market portfolios need some Russian assets. And given uncertainties over MinFins, Eurobonds should be the investment of choice, they suggested. Investors looking for a pricing guide thought of recent five-year dollar globals for Argentina and Mexico yielding respectively some 360bp and 315bp over treasuries. Even before the roadshow moved on to its second week in the US, it was clear that a large deal was possible at 350-375bp over treasuries.
Yet still the Russians refused to commit to anything. Then on Friday, November 15, following the huge attendance at the London roadshow, they presented a surprising proposal to the lead banks: a small deal, but a tight spread, below 300bp over treasuries. “Their expectations on price seemed to have been raised to unrealistic levels by the massive investor turnout at the roadshows,” says O’Brien. The lead banks met to discuss their response, a meeting which went on through the night.
It seemed that the Russians had not fully grasped what the market was telling them. The lead banks had to hope that the trust and friendship they had built up through months of working together would help them find a solution. People had grown close. Just the previous day, one of the younger Russian female assistants had pleaded special leave to fly back to Moscow from Frankfurt for her wedding what should have been her hen party had been spent in the company of the roadshow team.
The lead banks rolled up their sleeves and prepared to take the Russians through the book of orders. The price demand curve was quite steep at 335bp over treasuries; they would be lucky to raise $100 million, at 340bp maybe $500 million. Thereafter demand took off. At 350bp they could theoretically sell $2.5 billion or more. But as for any attempt to issue at a spread below 300bp, there was simply no deal.
On Monday, November 18, the first presentations in the US went well but audiences were smaller: 20 for breakfast in Minneapolis, 40 for lunch in Chicago. On Tuesday in Boston, to the immense relief of all involved, the Russians finally agreed to a deal of at least $750 million at a spread of around 350bp and allowed the lead managers to announce that plan. After almost a year’s work and with less than two days to launch, it was the first official discussion of deal terms. The following day at 5.15pm New York time, in a very smoky room at the Pierre Hotel, the Russians agreed to the final structure of the deal: $1 billion at 345bp over treasuries. The deal was launched at 8.30am London time the next day. In a final piece of good news, the rallying treasury market allowed the coupon on the deal to be lowered from 9.5% to 9.25%.
The lead managers had done their jobs almost. Quality of distribution remained a nagging concern. Tickets to the syndicate were small: $19 million each to six co-leads, $9 million each to 10 co-managers and the bookrunners controlling $398 million each. The lead banks wanted syndicate members with very strong demand to go to the brokers to fill their orders. For all its momentum, the deal was a natural for smart proprietary traders to sell short. The obvious spread trade would be to sell the Eurobond and buy MinFin bonds in the expectation that MinFin yields would fall after its launch. More than that, the leads did not want investors simply buying small amounts of the Eurobond in the hope of producing capital appreciation on larger MinFin positions.
Shorters held at bay
The deal had a short payment date of four days to discourage speculative outright short-selling. But professional spread traders set up short positions of $200 million within two days and $500 million within two weeks. The bond immediately became eligible for the repo market at an expensive Libor-less-2.75% to borrow.
Overall trading volume was heavy in the weeks immediately after launch, reaching $1.5 billion by early December. However, the spread held. The professional short positions were balanced as investors who had been underallocated in the primary market now sought to top up their positions. The impact on MinFin bonds was immediate. Yields on MinFin IIIs (see chart on next page) tightened in two weeks to 480bp from 528bp at launch.
Following this first sovereign issue, the gateway to the international bond markets now stands open for other Russian issuers. The danger is that a wild herd of borrowers will try to stampede through it. “In fixed income, the busiest and fastest-growing activity we have is our ratings advisory service,” says Alex Knaster, head of CS First Boston in Moscow. He predicts a calendar of over $2 billion-worth of Eurobond deals this year, most around $100 million but several larger ones. Credit Suisse First Boston already has a mandate from the municipal authorities in Moscow and Salomon Brothers for St Petersburg. These deals could be $250 million each.
Salomon Brothers’ director for Russia and CIS James Dannis agrees with Knaster’s estimate, foreseeing 10 deals of around $150 million each. “You could double that if the ministry of finance resolved various technical questions and the very large companies tried to do large deals.” In addition, bankers expect the Russian government itself to return to the bond markets for up to $2 billion, perhaps in new currencies such as Deutschmarks and yen and with more dollar-denominated deals.
Russian companies which had been working towards equity deals are considering whether they can do Eurobonds instead, to raise cheaper finance without giving up voting control to foreign investors. Suddenly debt is an option and politically it is easier to justify than selling equity abroad. The Moscow Telephone Company MGTS has mandated Salomon Brothers. Gazprom and LukOil have invited proposals from international underwriters. Most blue chips are considering the idea. Some could borrow at close to the sovereign benchmark. Banks also may issue and on-lend the proceeds to smaller Russian companies unable to borrow internationally in their own right.
Beware a debt binge
To date, most companies have financed themselves by not paying their taxes and extending their payables. Such tactics carry obvious penalties: tough action from the government which is now threatening non-payers of tax with bankruptcy proceedings, and stopped credit from important suppliers. Replacing such finance with conventional long-term debt is an attractive idea. Many Russian companies were privatized with little debt on their balance sheets. Demand from international investors, ever eager for yield, should remain strong this year. The availability of Eurobond debt might even boost Russian companies’ share prices. One obstacle, however, is that public issues will have to be of a minimum $100 million.
As Russian companies reveal more about their cashflows through International Accounting Standard reports, it may emerge that some large companies are unable to sustain such borrowings this year. Balance sheets and low gearing should make $500 million deals theoretically possible for larger companies but the inter-company payment crisis in Russia may be a constraint.
“My sense is that inter-company debt is a bigger, more complex and more political problem than is widely realized,” says Andrew Bulgarnie, head of Morgan Stanley’s Moscow office. “It is an arrears problem that has got out of hand and will probably need some kind of netting arrangements to resolve.” He might add that Eurobond proceeds are not usually devoted to providing short-term working capital. Classic western corporate finance theory holds that long-term debt should fund long-term assets.
The danger is obvious: an investment bank eager to make an impression in Russia, striving to do a quick deal for a weak corporate credit, taking on too much debt, leading to a failed issue, or, worse, a default. That might close the gate again to Russian issuers. O’Brien says: “A lot of investors’ credit lines for Russia have just been opened. The ministry of finance realizes that future issuing has to be controlled. With an economy of this size, with such need for dollar funding, supply of issues might quickly outstrip demand. If borrowing is not orderly, there could be some big spread dislocations.”
If Russian issuers avoid such mistakes and their bankers claim that the more enlightened companies will do the right things by obtaining credit ratings and developing proper strategies for regular borrowing the potential for business is considerable. “Our view is that Russia will be an investment-grade country within two years,” says Eric Fine, emerging-market debt analyst for Morgan Stanley. “Many of its credit statistics are better than its ratings imply. Debt relative to exports is 147% for Russia compared to 165% for Mexico and 109% for Poland, which is investment grade. Russia’s debt-to-GDP ratio is 23% compared to 34% for Poland and debt service-to-hard-currency earnings is just 12%.” One effect of the Eurobond is that analysts such as Fine have been talking to investors in Japan and the US who previously have not shown interest in Russia.
Fine’s main recommendation is still to buy the longer-duration Vnesh loans. These appreciated by 200% last year, and, he predicts, might provide an annualized rate of return of 60% in the first quarter of this. He sees some Vnesh loans trading at spreads of 700bp which might tighten to 500bp. These are highly liquid. But many institutions cannot buy restructured debt, which is complicated to value. Their attention should shift to Eurobonds.
It is by no means certain that the widely expected flood of Russian Eurobond issues will come this year. The federal government has made it clear that it will not stand behind municipal borrowers whose precise tax-gathering powers would have to be well understood by international investors. At least two years of credible published budget data would be required. Moscow, as a politically influential municipality, might be able to borrow quickly and without a credit rating but other municipal borrowers eyeing the market, such as Nizhny Novgorod, would be a tougher sell.
Various technical issues also will have to be resolved by the central bank, the ministry of finance and the securities commission before Eurobond issuance commences on a large scale. Will interest payments be tax-deductible? Will Russian borrowers need off-shore financing vehicles? Will withholding tax apply to coupon payments? Issues such as these, of vital importance to the success of a programme, are not yet clear.
MinFin III and IV spread to US treasuries during 1996
Taking stock of Russian equities
The Russian equity market came of age in 1996. Prices doubled and the range of investors broadened to include some of the world’s largest institutional investors. Will the boom continue in 1997? Peter Lee reports
Last November, a week after completing a $110 million international stock offering for Russian cellular phone company Vimpelcom, Michael Anderson at Donaldson Lufkin & Jenrette fielded a call from an anxious executive at VimpelCom’s Moscow headquarters. The Berlin and Düsseldorf stock exchanges had just informed the company that they had listed its shares even though neither the company nor its international financial advisers had ever solicited such an honour. There was talk of the much larger Deutsche Börse in Frankfurt making a similar move.
“While it is unusual, the request of the two exchanges underscores the wide-reaching interest generated by the company’s offering,” says Anderson, a senior vice-president of equity capital markets at the US firm. Quickly shrugging off his surprise, he counselled Vimpelcom to discourage Frankfurt from listing the stock because of the potential threat to the liquidity of its just-distributed American depositary shares (ADSs) — which were the first Russian shares to be listed on the New York Stock Exchange (NYSE). A minor incident, perhaps, but indicative of the tremendous appetite for all things Russian now prevailing in the international capital markets.
That Russian equities should exert such an allure is not surprising: Russia is a superpower and an emerging market at the same time. When its oil and other natural resource companies start generating earnings commensurate with the scale of their reserves, they will be giants. Moreover, Russian stock prices more than doubled last year, propelling Russian country funds to the top of the performance rankings for emerging market funds. The only class of investments that provided a better return were Russian debt funds: some dollar-denominated Russian debt securities appreciated 200% last year.
As 1996 drew to a close, it became clear that more and more international investors were seeking exposure to the country for the first time. Put simply, says Andrew Bulgarnie, head of the Moscow office of Morgan Stanley, “there is now more money that wants to come to Russia than there are places to put it”. That has led to a run-up in prices for a range of instruments: all debt securities, American depositary receipts (ADRs), local stocks of Russian blue-chip companies and even some second-tier names.
But after a strong performance in 1996, Russian equity market bulls are still hungry for more. “Nineteen ninety-seven has the potential to be a terrific year for Russian equity markets,” says Charles Harman, chief executive of MC Securities. “Valuations should be much higher than present levels.” Alex Knaster, country head for Credit Suisse First Boston’s investment banking business in Russia, agrees. He cites the case of LukOil, for which CSFB led a $320 million convertible in 1995 in the first international equity deal out of Russia. “LukOil has a market capitalization of just $7 billion, yet it has reserves greater than any other oil company in the world. It has a credible expansion strategy, a $5 billion joint venture with Atlantic Richfield (Arco) and transparent financial statements. Yet it still trades on an 80% discount to western companies when it should be a lot closer. The risks in Russia are lower now.”
Sentiment towards the country has improved dramatically since the start of 1995 when monthly inflation was 17%, the rouble was in free fall, the economy was contracting at an annualized rate of 15% to 20%, war was raging in Chechnya and president Boris Yeltsin’s chances of re-election looked remote. Even last year, when the stock market doubled between April and November, was messy and volatile. The market took two months at the beginning of the year to absorb the results of the Duma election. Then came a four-month run-up to the presidential election which was soon followed by alarm at Yeltsin’s illness and hospitalization and infighting among his deputies back in the Kremlin. All that gave international investors plenty of excuses for staying away. “Even those who liked the improving economic and business story regularly told us they would not enter the market until the latest worry had been resolved,” Harman recalls.
There are still worries over low rates of tax collection, strikes, inter-company debts, the government’s inability to pass a budget, and its inclination to borrow to meet wage arrears. But Harman hopes that a calmer political climate will allow investors to focus on the brighter aspects of the economic scene. Inflation this year should be under 20% with a stable rouble and short-term interest rates coming down below 40% from recent highs of 200%. Investors are now looking for signs of a return to economic growth.
Russia gained more credibility last month when it received a Ba2 rating from Moody’s and BB from Standard & Poor’s, paving the way for the launch of its debut Eurobond, a $1 billion, five-year issue at just 345bp over US treasuries. “Fund managers don’t get sacked for investing in countries like that,” Harman says. “It’s not blackjack any more. Conservative long-term investors such as pension funds, which have rightly stayed away until now, can begin to take Russia seriously.”
The first foreign portfolio investors into Russia in 1994 were hedge funds, some of which have taken an uncharacteristically long-term outlook. In 1995, specialist country funds came to the fore. And in 1996 new wider-ranging emerging market funds entered, as Russia was included for the first time in the IFC index. “My guess is that the average global emerging market fund managed out of London now has 2% of its investments in Russia,” says John-Paul Smith, Russian equity strategist at Morgan Stanley. “Some may have as much as 6% or 7%. Some still have zero.”
Taste of corporate Russia
Although there are no accurate figures for trading volumes in Russian ADRs or local stocks, the strength of international demand was evident in the enthusiastic reception for two international new issues from Russia last year. VimpelCom, a small start-up company which offers mobile-phone services in Moscow under the Bee-line brand name, broke new ground with the first Russian level-three capital-raising ADR and first NYSE listing. But the most important deal was the sale of $400 million of stock in Russian gas giant Gazprom, for which joint global coordinators were Morgan Stanley and Dresdner Kleinwort Benson. Both deals gave investors something unique. VimpelCom was a modern, hi-tech company unencumbered by old liabilities but with an existing western management influence. Gazprom, the country’s largest export earner and taxpayer, was corporate Russia writ large. Although it did not supply income statements audited to international accounting standards (IAS), Gazprom at least produced consolidated balance-sheet figures on an IAS basis. Just as significantly, this was the first equity deal from Russia large enough to satisfy the requirement for liquidity of the larger, non-specialist investment funds. The transaction won respect from rival investment banks. “Gazprom is a real watershed,” says Henry Anstey, head of Russian equity sales at ING Barings. “It was immensely successful and has broadened the investor base for Russia beyond just emerging market specialists,” judges James Dannis, head of Salomon Brothers’ Russian investment banking team.
Into the global portfolio
One of the goals of the transaction was to promote Gazprom as a major global energy stock suitable for sector portfolios on a three- to-five-year view. “A lot of the stock went into European general portfolios searching for some spice. But the deal was really driven by energy funds searching for value in an emerging market,” says David Rogers, director of equity capital markets at Dresdner Kleinwort Benson. It’s a significant development. If Russian stocks become acceptable fodder for global equity funds and sector specialists, that opens up a huge new pool of capital that might drive Russian stock prices higher this year. Harman says: “There are signs at the margin of more new buyers looking at Gazprom, LukOil, UES, Rostelecom. And if they compare Rostelecom to Matáv in Hungary or to telecom stocks in Greece, Portugal, Brazil, Malaysia, it is clearly the cheapest around.”
ADRs offer the more cautious and strictly regulated international investors a way of gaining exposure to Russia. By late 1995, only two Russian companies, LukOil and Mosenergo, had set up ADR programmes of any significance. Now 13 Russian issuers have ADR programmes. Some of them have separate programmes for ordinary and preference shares or for level 1 trading and rule 144A trading. Newcomers include Bank Vozrozhdeniye, Chernogorneft, Inkombank, Menatep, Gazprom, Soversky Tube Works, Sun Brewery, Gum, Tatneft, VimpelCom and Irkutzenergo. So far, only VimpelCom’s is a level-three programme, meeting the strictest reporting requirements of the American SEC.
This year, LukOil will establish a programme for its preference shares and, even more significantly, a level-three capital-raising programme through which it intends to sell up to 15% of its share capital. At prevailing market prices that implies a $1 billion equity deal , the largest ever out of Russia. One or two other large deals are possible. Every investment bank doing business in Russia is pitching proposals to Gazprom for second and third tranche deals to distribute the remaining 8.85% of its shares that are available for international sale. Boris Jordan, chief executive of Renaissance, the Russian investment bank, predicts up to $2 billion of public equity deals out of Russia this year.
In theory, ADRs should become a less important vehicle for trading in Russian equity as the local market develops more robust infrastructure, better regulation and larger domestic investors. But progress has not been as rapid as many hoped 18 months ago when the local market last hit its peak, and ADRs remain an important conduit for foreign portfolio investment into the country. For some Russian companies, ADRs now account for a considerable proportion of issued shares: 24% for Mosenergo, 20% for LukOil, 17% for Chernogorneft, 15% for Seversky Tube Works, 21% for VimpelCom. “We could see 20 Russian equity ADR programmes by the end of 1997,” predicts Christopher Kearns, assistant vice-president at Bank of New York, who has set up many of the Russian programmes. There are obvious examples of major Russian companies that don’t yet have programmes and really ought to, such as Rostelecom, the national grid company UES, and oil company Surgutneftegas. “We will see some more capital raisings, as Russian companies progress with US and international accounting standards,” says Kearns. “And some of the existing programmes will be upgraded for capital raising.” Likely candidates for this are Chernogorneft, Gazprom, Gum and Mosenergo.
A tiering is emerging in the Russian securities markets between different classes of investors and different types of investment. The custodians and trustees of many global emerging market funds still do not recognize the Russian Trading System as an approved stock exchange. That caps the amount of money those funds can put directly into Russian stocks. There has not yet been much investment in the country by pension funds. Only a handful of banks Chase Manhattan, Credit Suisse, Uneximbank, ING Eurasia have custody operations in Russia that meet the rule 17f5 requirements of the American SEC that permits mutual funds to use them. So the gateway for mutual fund investment into Russia remains narrow. Clearing and settlement are labour-intensive at best and at times nightmarish. Foreign investors may be less worried than three years ago about company-owned registrars simply wiping out their names and disqualifying them for owning shares: Russian companies now realize that such drastic action might prevent their ever returning to the international equity market. But there are still problems. Russian registrars have been known to close for up to three weeks in order to clear backlogs of paper-work, leaving Moscow-based brokers funding positions at penal interest rates of over 40%.
Large foreign investors have the option of using local brokers, buying shares through them as beneficial owners but allowing the local shares to remain held in the broker’s name on the company’s share register. That exposes investors to the risk of the broker collapsing. To their intense frustration, many Russian brokers find that, for all their specialist knowledge, they are too thinly capitalized to be acceptable counterparties for international investors. The brokers and investment banks, are also falling into tiers. The large international investment banks still tend to research and follow closely only a few stocks. Why should they cover more? Only six or seven move the market indices and only a handful will be ready for international issues in the next two years. The Russian local brokers are searching for new candidates to join this group. This is true of CentreInvest, which used to be the largest broker in Tatarstan oil company Tatneft but was usurped by Dresdner Kleinwort Benson after the oil company’s $90 million international ADS offer. James Fenkner, head of research at CentreInvest, says: “Say there are 14,000 companies in Russia. Even if only 10% are viable that’s 1,400. Our job is to discover them and bring them to the market. We are the foot soldiers for the big international investment banks.”
ADR premium
Meanwhile the larger, more conventional institutional investors, the ultimate audience for these enticing Russian stories, deal mainly in ADRs, while only the smaller specialist funds deal in local stocks. That drives prices. ADRs tend to be more expensive than local stocks. Gazprom is the most glaring example. It strictly controls the market in its local shares, reserving the right to repurchase them at regular intervals at any price to ensure control of the company does not pass into foreign hands at cheap prices. Only 1.15% of the company’s stock is held by foreign institutions as ADRs, following the recent issue which was priced at $1.575 per share ($15.75 per ADR) at a time when Gazprom local shares traded at $0.40.
“There are 50 foreign accounts from around the world which buy Gazprom local stock and they would never touch the Gazprom ADRs because they are so expensive,” says a salesmen at a large Russian broker. Even for other Russian companies, which do not impose the same restrictions on local shares as Gazprom, ADRs still tend to trade at a premium. Some traders are tempted to buy local shares, when a company issues ADRs, reasoning that the price between the two should narrow over time. Russian brokerages are devising funds to hold Gazprom local shares, intending to sell holdings in those funds to international investors. The reasoning is that the gap between local share prices and ADRs should narrow.
The pricing differential makes it even more attractive for Russian companies to sell equity abroad. Gazprom’s ADR price values the company at $40 billion, its local share price at less than $10 billion. VimpelCom’s international share offer implies a market value of $800 million, just under half the $1.8 billion valuation that the local market puts on the far larger Rostelecom. Values for companies locked into the domestic market are incredibly low. Sberbank made $1 billion last year but its shares trade on a price to earnings ratio of just over 1/3, giving it a market capitalization of $400 million. It’s clear where Russian companies should look to sell shares, if they want to raise large amounts of capital.
“What this amounts to is a substantial premium for custody,” explains Dominic Bokor-Ingram, director at Regent Fund Management, which manages $350 million worth of Russian equity funds. The group’s investment strategy for Russia is evolving as a result. Bokor-Ingram says: “So far, the key decision for investors looking at Russia has been simply whether to be in or not. At any time over the past two or three years you could come up with 100 reasons not to invest in Russia: settlement and custody risk, registration, politics. It’s a market that it’s easy to talk yourself out of. But you would be wrong on each count. The decision to go in is the one that has made people money.”
Increasingly selective
Because valuations were so low, Western fund managers could afford not to be too concerned about poor disclosure. One fund manager says: “Say you are buying an oil stock on one times earnings and it turns out to have made half as much profit as you thought, you are still getting it at two times earnings. It’s not a worry. You are probably more interested in an independent audit of its oil reserves.”
Some fund managers are still making that simple decision, buying Russia from the top down and stock-picking only to the extent of trying to avoid the more expensive ADRs. But from now on, the more experienced fund managers are going to be increasingly selective about which stocks and sectors to buy. The Regent funds have recently gone from being fully invested to being 25% in cash, giving them the liquidity to implement a new strategy. Regent still holds the big ADR stocks, such as LukOil and Mosenergo, but has recently looked to switch out of these into stocks of companies that are likely to set up ADR programmes. Bokor-Ingram believes the cheapest of all is UES, whose shares were to be issued in the form of an international convertible bond. This plan was scrapped and the Russian government is now hoping to place an 8% block of shares with a strategic investor.
If the Russian stock market is in a transition from being driven purely by liquidity to being driven by company fundamentals, accounting standards will become an ever more important issue for Russian companies that want to raise new equity capital. Last year saw a rerating of stock as pent-up foreign demand was satisfied by new ADR programmes. The next big move may depend on how impressed investors are by the individual stories of Russian companies. That will require greater transparency.
Valuing Russian companies requires investors to explore basic liquidity ratios, such as the balance of payables and receivables, which may be overlooked at western companies of the same size. Morgan Stanley’s Smith argues: “Even for companies with unqualified IAS accounts, it is still wise to ask questions: what are their criteria for establishing bad debts? How do they value fixed assets, adjust for inflation and how do they value barter arrangements?”
Barter arrangements are increasingly important to Russian companies as they struggle with a shortage of cash and high inter-company debts. As Tatneft completed roadshows late last year for its equity offering, readers of its IAS cashflow statement discovered that a remarkable 47% of its 1995 sales were in barter form. Oil companies have been supplying governments and regional authorities with oil and instead of receiving payment in cash have had their unpaid tax liabilities reduced an arrangement that may soon come to an end.
The worry for investors is the extent to which barter is distorting companies’ underlying businesses. Are companies selling to certain customers just because they have barter goods to offer and do companies then use those barter goods themselves or sell them on? Russian car companies have paid their suppliers in cars to such an extent that those suppliers are now setting up parallel distribution networks, preventing manufacturers from controlling the markets and prices for their own products.
For the moment, the warning voices on Russia are few and not much listened to. But they are there. Per Mellstrom, head of research at Brunswick, says: “You could say this is the time to buy Russia, and it may be risky for global funds to stay out of Russia, if it gains weightings in benchmark indices. But there is no great hurry to get in. There could be some volatility before the next big move up.
“The big problem has been lack of growth in the economy and to achieve growth politically difficult decisions will need to be taken, including reform of the tax system in a way that brings the shadow economy into the real economy. It may require forcing a wave of bankruptcies, lowering the tax burden on large industrial companies and increasing it on individuals, none of which is likely to win the government any friends.”
One danger for the Russian market is that global emerging market funds may grow disillusioned by delayed economic growth and by the difficult microeconomic climate for businesses. They may simply move on to markets that performed less well in 1996, such as Thailand, Korea and India.
Many western investors suspect that the Russian market is a huge inside game from which they are excluded. Often they are right. At the end of 1996, the loans-for-shares scheme was playing itself out. Russian banks had acquired blocks of shares in return for loans to the cash-strapped Russian government at the end of 1995. The banks had to sell these stakes after 12 months and return two-thirds of any capital gain to the government. All along the banks intended simply to sell the stakes to their affiliates so as to retain control of potentially valuable resource companies. Menatep Bank acquired a huge stake in the country’s second-largest oil company, Yukos. Uneximbank obtained an interest in Norilsk Nickel, the world’s largest nickel producer.
Uneximbank has been trying to improve the management and performance of Norilsk Nickel. It is a vast enterprise whose restructuring raises difficult questions of what operations the company should continue to own and what social assets can be passed on to municipal and regional budgets. Menatep too has recruited a team of western-trained managers from Amoco and put them into Yukos. But the banks had no interest in raising share prices, as they would have to return such a high proportion of the gains on the sales to the government. Only when questions of ownership have been fully resolved will the interests of majority shareholders and foreign portfolio investors be more closely aligned.
Until very recently, controlling shareholders have had a greater interest in talking prices down. Aside from the loans-for-shares scheme, ownership is still being resolved among many of the major oil companies. Often major oil groups have separate shares trading for holding companies and various operating companies. Chernogorneft is one of the better-run Russian oil companies with a coherent strategy to improve production which, as at all Russian oil companies, has fallen in recent years. It has begun to provide investors with financial reports compiled to US GAAP standard. While the investment plans of some oil companies have stalled through lack of cash, Chernogorneft has financed capital expenditure with oil, paying the subcontractors that drill and repair its wells with what those wells produce. Its shares ran up from $5.5 in March to over $11 last November.
It is a true Russian blue chip which might well attract eager foreign equity investment. But Chernogorneft is likely to be folded into Sidanco, the holding company that last year secured majority control through an investment tender a vague promise to put in new money and now owns 51% of the shares. The terms and timetable on which the full conversion of Chernogorneft into Sidanco will take place are not clear. The prospect of this conversion and others for many Russian oil companies leaves foreign investors unsure where to put their money: in the operating companies, which they often like and understand, or higher up the chain of ownership, into the more opaque holding companies, or even the financial and industrial groups with stakes in the holding companies.
Such operations have not always been kind to minority investors. Last October Surgut Holding announced that it had diluted existing shareholders in its oil operating subsidiary Surgutneftegas a company planning an ADR programme by entirely taking up a surprise new issue of 500 million ordinary shares. These were priced at $0.18 each against a market price of $0.40 per Surgutneftegas share. In the process, the holding company raised its own stake in the company to 43.5% from 38%. It was a deal that prompted an investigation by the Russian SEC and had foreign investors bailing out of Surgutneftegas stock, which fell 17% on the day after the announcement. It’s the kind of operation that gives the Russian market a bad name. One Russian banker explains: “The operating company is a very good asset and Surgut Holding’s own financing needs and tax liabilities are not as great as many other Russian companies. Maybe it thinks that if it waits for two years or more before coming to the international equity market, investors will have forgotten about what it did to them.”
Questions of control
There is almost nothing to prevent insider trading in Russia. Prices can move dramatically on thin volumes. Take Tatneft. From the end of 1995 to March 1996, its shares were flat around $8.00. In June they hit $19.50 and then surged from September, eventually hitting $45.75 in mid-November. All this was on volumes of no more than 10,000 shares a day and all in the run-up to its international offer of American depositary shares (ADSs).
Some bankers detect a hardening of attitudes in Russia against Western investors. ING Barings’ Anstey says: “When you regularly visit Russian companies you understand that they prefer to retain voting control. Foreigners need to build the trust of management before they will cede control.” Questions of control remain foremost in the minds of many Russians. “They know they are dealing with very undervalued assets,” says CentreInvest’s Fenkner. “The question is do they sell them now, or do they wait?” Russian companies are torn between their desire to raise new money and their fear of ceding control. Many are now hoping to follow the federal government and issue Eurobonds. But even some very large companies may be unable to convince fixed-income credit analysts of their suitability to do this.
International bond investors require sizeable deals $200 million or more to provide some scope of liquidity. That will leave many companies with equity financing as their best option. So far, there has not been a failed capital markets transaction out of Russia. But, given the number of investment banks pitching for business, the apparent eagerness of investors to take a positive view on Russia, and the condition of Russian companies, some questionable deals may ensue. For instance, some Russian companies and international investment banks have been discussing issuing non-voting shares internationally an unattractive idea given Russian companies’ record on respecting shareholder rights. “What investors want is normal common stock,” says Harman at MC Securities. “Russian issuers should keep it simple.”
At least a portfolio investor with under 1% of the shares of a Russian company can liquidate his holdings if it believes company management is ignoring shareholder rights. Though the market even for so-called local Russian stock is concentrated offshore with cash settlement often in Cyprus and Dublin and shares being moved among brokerage accounts in Russia liquidity is usually reasonable. Investors can deal $3 million to $4 million blocks on a 1.25% turn. But in fast-moving markets, that can dry up. Foreign multinationals have not been eager to take large strategic stakes in Russian companies and expose themselves to the risk of being cheated by Russian management. Arco’s 7% stake in LukOil, acquired by taking up $250 million of the convertible bond in 1995, is a rare example.
A jump ahead
But another route for foreign money to flow into Russia is through private equity. This is the speciality of Renaissance Capital which Jordan hopes to expand as a Russian investment bank by developing ties with the growth Russian companies that may be giants in 10 years’ time. Jordan says: “VimpelCom showed that Russia has an industrial corporate base not just of privatized companies but of businesses run by entrepreneurs who have jumped far ahead in business strategy, management style and transparency.” His firm’s strategy is to develop ties to such companies early in their life. It may bring in outside management and outside equity finance through private placements and injections of seed capital from the private equity funds that Renaissance Capital itself manages and distributes as the Sputnik funds.
It did a private placement for VimpelCom in 1995 and deals for Saint Spring, the country’s dominant mineral water company, and RIG Restaurants, owner of the Rostik chain of fried-chicken fast-food outlets.
“There are 10 major investment banks pitching for UES. Let them,” says Jordan. “It’s a highly political situation. Our business will be with the mid-caps. You can take these companies from obscurity to being significant businesses in 18 months and do debt and equity deals for them.”
Jordan rejects the idea that Russia is closed to foreigners, even though he himself was shut out of the country for two months early last year. Renaissance Capital can be hostile to existing company management and one threatened group used its political influence to withhold Jordan’s visa during the run-up to the election.
A key in direct investment is getting control over the assets, Jordan points out. He recounts one early success in buying Segezhabumprom, a pulp and paper company that was virtually bankrupt, replacing the board and management, bringing in new people and eventually selling off a 51% stake to a foreign industrial buyer.
But to Jordan: “Access to capital in Russia is not the big deal. It’s fixing the companies, both the front end and the back end of the manufacturing processes: finance, distribution, marketing. I’ve not found managers from the old Russian privatized companies that can do that as well as the new generation of industry experts or those that we have brought in from the outside.” *
VimpelCom comes to the Big Apple
For 30 years, scientist Dimitri Zimin beavered away at the Mintz Radio Technical Institute, developing advanced radio electronics and related defence equipment. It was secret work, the institute being a key part of the Soviet military establishment. By the eve of the collapse of communism, Zimin had been promoted to a senior managerial position and was working on anti-missile defence systems.
All this makes him an unlikely candidate to emerge from his bunker and lead the first Russian company to list on the New York Stock Exchange. But he did exactly that in a $110 million American depositary share (ADS) offer last November with joint global coordinators Donaldson, Lufkin & Jenrette and Renaissance Capital. Despite his poor command of English, crumpled suits and modest demeanour, Zimin convinced investors that VimpelCom was a unique investment: it was a fast-growing start-up Russian company that had been profitable from day one and whose managers understood the importance of brand awareness and how good customer service could keep it ahead of local competition.
Help from Chicago
By the early 1990s, Zimin could see that the changes sweeping Russia would mean the end of unlimited budgets for military-industrial researchers such as he. He also guessed that the dreadful fixed-line Russian telephone system might create demand for a good cellular phone service.
In early 1992, Zimin and a group of younger Russian colleagues from related defence institutes set up VimpelCom. Almost from the start they had outside help in the form of a US partner and investor in the project, Fabela Groupe Internacional. A father-and-son business from Chicago, Fabela Group had been an operator and supplier of equipment to cellular telephone businesses in Latin America and Asia. The Americans brought marketing, financial and other management skills. The Russians supplied technical expertise, vision and perhaps most important of all the right political connections to secure valuable licences to operate both a cellular network, aimed at wealthier business subscribers, and a personal communication services network for ordinary customers.
VimpelCom began full-scale commercial operations in 1994 using Ericsson equipment. It was innovative from the outset, selling its service under the brand name Bee-line, setting up a large distribution network of licensed dealers and maintaining a customer service department manned 24 hours a day. Subscribers and revenues grew rapidly. Net income was $9.5 million in 1994 on revenues of $30 million and in 1995 net income rose to $27.6 million on revenues of $101 million. By last November, the company had attracted 45,000 subscribers and carved out a 59% share of the valuable Moscow market.
From the start, the founding partners had envisaged a public share sale, probably using FGI Wireless, the American vehicle for the Fabela group’s investment, to obtain a higher valuation. Late in 1995, Renaissance Capital forged a relationship with Augie Fabela, chairman of the VimpelCom board and raised private equity for FGI Wireless. Renaissance suggested that VimpelCom should consider selling equity directly to western investors who would prefer more direct ownership of the Russian assets and might be excited by the novelty of a Russian stock listed in New York.
From late 1995, that became the goal. The company and its advisers had to work through a mass of red tape in Russia, obtaining approvals from the ministry of finance, the ministry of communications, the Russian central bank and the Russian SEC. Dealing with the US authorities was reasonably straightforward by comparison, since VimpelCom had used US GAAP accounting from its foundation. The only sticking point was the normal requirement for three years of financial statements. As a recent start-up, the VimpelCom had only two. A waiver was obtained.
In preparation for its listing, the company was restructured into a combined holding and operating company. Its most valuable licences were transferred to two subsidiaries, each working to develop their systems, the idea being to create internal competition.
Succession question
Proceeds from the share offer were needed to buy equipment and expand networks and to refinance debt taken on to purchase KBI, a company that owns the only personal communication services licence for Moscow and which will be the operating company for that network. KBI had previously been indirectly controlled by Zimin himself. He, in turn, owned 52.1% of VimpelCom’s shares before the offer, with FGI Wireless holding 31.2%. As part of the offer, FGI Wireless sold shares worth $37 million, with VimpelCom itself raising $66 million. After the deal, Zimin owns 45.1% of the company and FGI Wireless 20.1%, with 20.4% belonging to the new public shareholders.
Were investors worried that the deal was designed to enrich Zimin, obviously a key figure for the company, perhaps as a prelude to retirement? Zimin had wanted to sell some of his own shares but was persuaded that this might send the wrong signal if a key financial investor were selling at the same time. But that issue barely surfaced during discussions at the roadshows, according to Alan Apter, an investment banker at Renaissance: “From the start, Zimin has been aware of the succession question but this is not a one-man show. His management team has been with him since the start and is extremely capable.”
In the first half of last year, the company made a stock grant to key managers to cement their loyalty. Augie Fabela of FGI Wireless remains VimpelCom chairman, a symbol of the influence of minority shareholders.
The global coordinators waited until after the Russian presidential elections to launch the deal. By late November, Gazprom had already completed the first large share sale from Russia and potential investors were becoming accustomed to analyzing Russia risk. What concerned them much more in the case of the VimpelCom were the “laws governing and procedures for renewing the company’s operating licences and the sustainability of its market share lead over its rivals,” says DLJ’s Michael Anderson.
Some general emerging market funds which could not buy local stock were tempted into VimpelCom as a Russian asset. But the lead banks strove to lure more price-sensitive specialist telecom and growth investors into the deal. They employed a discounted cashflow method to value the company with a discount for Russian risk priced in.
This discount declined as momentum built during the roadshow and investors focused on the business of VimpelCom rather than the Russian economy. As the roadshow progressed, the leads became concerned that orders were being inflated by potential stock flippers. George Soros, an early investor in FGI Wireless, had talked up VimpelCom in a speech to a telecoms conference held in the US during that period.
The initial price range was quite wide at $15.75 to $18.75. By the end of the roadshow, the leads knew they could push for $20. Finally, the deal was priced at $20.50 after a three-hour discussion over the final $0.50 rise.
The deal was 10 times oversubscribed and many investors requesting stock received none. In immediate trading the shares shot up to $32, before settling back to $26.125.
