… and get ready for more bonds?
Until the end of October, 1997 had been a good year for equity in central and eastern Europe. Although new issues were fairly light on the ground, some of the largest companies in the region were privatized or floated. The second tranche of the Hungarian oil and gas company MOL was put on the market in May, followed by shares in Poland’s Bank Handlowy and Hungary’s pharmaceuticals com-pany Gedeon Richter in June. The Polish copper producer KGHM had an IPO in July, which turned out to be one of the few unsuccessful privatizations of the year. This flurry of market activity culminated in November with the largest-ever equity deal from eastern Europe, again in Hungary: the IPO of telecommunications operator Matav, which has so far raised over $1 billion.
“Matav set an important precedent for privatizations in the region,” says Rory Scott, director of equity capital markets at ING Barings. A combination of strategic sale (to Ameritech and Deutsche Telekom in 1993, which led to an exhaustive restructuring programme) and public offering, the sale process has been likened to telecoms sell-offs in France, Spain and Italy. The Matav deal succeeded despite difficult market conditions. The Hungarian stock exchange fell 21% in the three days leading up to the issue on November 13, and comparable telecoms firms (OTE in Greece and SPT in the Czech Republic) were underperforming at the time.
Joint global coordinators on the deal, Merrill Lynch and CSFB, were pleased with the issue’s reception. “There was a market environment challenge and a valuation challenge,” says Julian Summer, managing director of equity capital markets at Merrill Lynch. “Yet Matav was three times oversubscribed.” The company’s share price has risen around 25% since the IPO. With the issue representing 20% of the entire Hungarian stock market, Summer says that for many investors the stock “was a must-have”.
Although Matav was a success, other equity issues in the region were badly hit by the Asia crisis. The sale of the second tranche of Croatian pharmaceuticals firm Pliva was postponed in November because of the company’s plunging market price. Another victim of the market turbulence was Bonton, the Czech music group, which had planned an equity offering.
With political uncertainty set to continue in some central and eastern European countries including the Czech Republic, investors are looking more cautiously at the region’s equity markets in 1998.
Radhika Ajmera, head of emerging markets excluding Asia at Aberdeen Asset Managers, is pessimistic about the region this year. She cites disappointing earnings growth in Poland, the volatile coalition government in the Czech Republic and fears for the rouble in Russia as reasons for fund managers to be careful. Stability and growth can only come through political reform and restructuring, says Ajmera. “But with the upset in emerging markets worldwide the whole process will be delayed.”
Some major bank equity analysts are also gloomy about the coming year. “Many big plans for 1998 have now been put on ice,” says Michael Boardman, director of equity capital markets at Nomura, blaming a shift in economic climate which will worsen if interest rates go up in the US and Germany. An analyst at a leading American investment bank feels that the region’s progress was slow last year anyway: “There has been no real leap forward and people have been turned off emerging markets.”
He predicts that this is a temporary low, however, and recovery will be swift in 1998. Mixed feelings seem to be widespread at investment banks. Analysts at HSBC expect little equity activity in the first half of the year, but are confident that volumes will pick up substantially after June. But one thing on which most analysts are agreed is that each country in eastern Europe has its own problems and prospects and there can be no single prediction for the region as a whole this year.
The equity divisions at Salomon Smith Barney, Merrill Lynch, Robert Fleming and Creditanstalt Investmentbank Austria (CA IB) are among those who are feeling relatively bullish. For many analysts optimism stems from a few specific deals expected this year, particularly the privatization of TPSA, the Polish telecoms company. TPSA promises to equal or even exceed the value of the Matav deal. (Given Poland’s much larger population than Hungary, TPSA’s potential customer base is more than double that of Matav.)
Nearly all the major banks are clamouring to be involved at some level with the privatization, which is still at pitching stage. The successful banks are likely to be announced by the end of January, and estimates of the timing of the issue range from June to some time in the last quarter.
The Polish government is likely to hold on to the majority of shares and retain management control. It is also likely to encourage domestic buying by reserving some shares for Polish investors. Some analysts feel that as a result of political preferences the Polish government will probably choose an American investment house as global co-ordinator for the deal, probably working with a local bank. Salomon Smith Barney has been in consortium with two local banks for over a year, and Merrill Lynch has been working with Pekao bank in Warsaw.
Interesting opportunities
Other Polish equity offerings this year won’t cause quite as much excitement as TPSA but there will be some interesting opportunities. In general, the country’s economic outlook is good, which should encourage further foreign investment. While growth may start to slow in 1998, GDP is still forecast to increase by a solid 5%. As Mike Anderson, senior vice-president of equity capital markets at Donaldson, Lufkin & Jenrette, says: “Poland has great potential.” Boardman at Nomura predicts that within three years Poland will be in the EU and will soon be seen as essentially a west European country. He likens the country’s progress to the rise of Portugal in recent years.
But as in many countries in the region, what happens to equity is reliant on political factors. The country’s new centre-right government is keen to press ahead with economic reforms; a privatization plan is to be published at the end of January. The Warsaw stock exchange is also keen to encourage new companies to float on the market by making entry to the exchange more straightforward. In addition to the high-profile privatizations, Bogumila Cebelinski of Wood & Co in Warsaw expects IPOs from at least 10 small private companies this year and HSBC predicts nearer to 80 new issues.
Pekao, the largest retail bank in Poland, is to be sold by the government in the first quarter. Todd Berman, head of central and east European investment banking at Salomon Smith Barney, calls Pekao “a very well-run bank and an attractive story”. In December 1997 the bank was granted an IBCA credit rating of BBB. However, earnings growth, which has been low generally in Poland, has been particularly poor in the banking sector which makes up 35% of the stock market and further structural reforms are needed. Other companies tipped to privatize this year include Lot, the Polish airline, and PZV insurance.
Political upsets
The Czech Republic has suffered much publicized problems in the past few months. The resignation of prime minister Vaclav Klaus in early December led to the formation of a volatile coalition government, the country’s credit rating was downgraded by IBCA in November and interest rates have risen to support a weakening currency. Scott at ING Barings thinks “conditions will worsen before they get better; the coalition government will fall apart”. But Berman at Salomon Smith Barney is not particularly concerned about these political upsets. “People are focusing on the headlines when they should be looking at a company’s horizon,” he says.
The future of Czech equity rests largely on what happens to the four main government-owned banks: Ceska Sporitelna (CS), Komerc-ni banka (KB), Investicni a Postovni Banka (IPB) and Ceskoslovenska Obchodni (CSOB). Before the fall of the Klaus government, a plan had been drawn up to restructure and privatize the banking sector, which in turn would speed up the sale of industrial companies.
For Boardman at Nomura, bank privatization is an urgent priority: “A fully functioning banking sector is crucial for a successful private sector.” But because of the political volatility and probable shift to the left by the government, the privatization programme is currently on hold.
Analysts now expect bank privatization through strategic sales, with a possible partial public offering for CS. Justina Stewart, head of central and east European capital markets at Dresdner Kleinwort Benson, thinks that much needs to be done. “Further equity offerings of the three main banks can only occur after strategic investors come in,” she says. “Additionally, international investors need to receive sufficient comfort that issues relating to stock-market regulation and corporate governance have been addressed.”
Ajmera of Aberdeen Asset Managers is also cautious about Czech equity and at the moment would only consider investing in the telecoms company SPT. But Wood & Co analyst Christopher Fitzwilliam-Lay is more optimistic. “There is a sense of urgency in the country to get it back on track,” he says. “It often takes a calamity for things to change as in Japan.” The only strong source of new Czech equity in 1998 is from the privatization of the breweries, for which Nomura is currently advising the government.
Hungarian success story
The clearest success story of central and eastern Europe in 1997 has been Hungary, and most banks see the country’s strong economic performance continuing in 1998 despite a high level of inflation.
The austerity programme of recent years is now paying off with GDP growth accelerating, and the country looks set not only to attract investment from dedicated east European funds but also from many previously involved in Asia. Political and economic uncertainty is low even though an election is expected this year.
“Hungary is most advanced and resilient regionally in the medium term,” says Nigel à Brassard chairman of equity capital markets at Dresdner Kleinwort Benson. This is not just because of last year’s Matav deal; the sale of the second tranche of oil and gas company MOL helped set the scene for the healthy Hungarian market. Salomon Smith Barney was joint global co-ordinator on the deal and Berman gives glowing reports of “the strength of Hungarian management”.
The Hungarian government’s privatization programme is more or less completed, and the only major offering on the horizon is the eagerly awaited third and final tranche of MOL. “Hungary shows how the privatization process in the region can and should work,” says Markus Rezny, assistant director of equity capital markets at CA IB Securities, citing high levels of strategic investment, a willingness to make use of outside skills and good management as reasons for the success of the process. The government is keen to encourage domestic participation in the MOL sale as part of its concerted effort to steer the population towards an entrepreneurial culture. It is hoped that up to 70% of the third-tranche offering will be bought by the domestic market.
Market observers also expect a growing number of small private companies to list on the stock market. Several listed companies, including retailer Csopak, are likely to make secondary offerings. At present there are just over 40 companies listed on the stock exchange. “There is not much choice,” points out Ajmera of Aberdeen Asset Managers. “But the quality of firms is very high.”
Several other countries in central and eastern Europe are expected to begin or expand the process of privatization this year. Ukraine will begin to privatize its utilities, starting with the electricity company Donbasenergo, an offering due in the first quarter of 1998. Privatization has been pushed forward by the IMF, which has made major restructuring of the economy a condition of its loan to the country. However Ukraine’s outlook is complicated by serious political problems and the risk of a currency devaluation. Kazakhstan is another ex-soviet republic embarking on privatization this year with a telecoms sell-off worth between $3 million and $4 million.
Many countries beginning the privatization process have chosen to start by selling telecoms companies, since this is seen as a sure-fire way to raise capital and attract foreign investment. This is a sector with rapidly growing profits and, after Matav, the region has a good telecoms record. In 1998, as well as TPSA in Poland, telecoms equity issues can be expected from Romania, Slovakia and all three Baltic states. The privatization of the Lithuanian telecoms company is currently being handled by UBS with a view to a partial strategic sale and an IPO in 1999. Estonia’s telecom operator, due to be sold in early 1998, will be particularly attractive, giving investors a chance to buy into a country which has been one of eastern Europe’s economic success stories. The economy is stable and well managed. Berman at Salomon Smith Barney notes: “The sophistication of government management of the telecoms deal is extraordinary.” Shares in the country’s Hansa Bank may also be issued this year.
Elsewhere in the Baltics, Latvia aims to privatize its telecoms company, its oil and gas utilities and the majority of state-owned enterprises by the end of the year, although many expect the process to take considerably longer. Throughout the Baltics, many small to medium-sized firms have already been privatized (especially in Estonia) signalling a level of market maturity, but many investors still see the area as marginal.
Don’t overlook the Balkans
Romania, Bulgaria and Croatia can’t be ignored in terms of equity this year. Croatia has a very sophisticated economy and a long tradition of capitalism. David Mathew, a director at Robert Fleming, praises the advanced state of the economic transition process in Croatia and the entrepreneurial spirit reflected in the development of many small businesses over the past five or six years. “There is no detritus from the old management,” says Mathew, “no worrying background, as these companies were set up since the wall came down.” He expects offerings from the oil company, Ina, food producer, Podrazkha, and the delayed second tranche of pharmaceuticals manufacturer, Pliva.
The Bulgarian stock exchange closed in 1996 in the wake of the country’s financial crisis and reopened in November 1997 with an improved system of regulation. A total of 66 companies aim to begin the process of issuing equity in 1998, and the biggest privatizations will probably involve the country’s electricity generators.
Romania has high hopes for privatization this year, led by the sell-off of telecoms operator Romtel that could earn the state up to $1 billion. “There has been a complete renaissance in Romania,” says ING Barings’ Scott. “More has happened in the last six months than has happened in the previous five years.” He credits a “strong-willed government determined to create market opportunities” for the change. “Romtel is the final frontier in terms of foreign direct investment,” he says. Other forthcoming equity issues may include the cement company Romcim, tyremaker Tofan, the Romanian development bank and the oil and gas utilities.
However, a government reshuffle at the end of 1997 has brought the privatization process under review and Rezny at CA IB feels that the small size of many companies and the lack of meaningful liquidity could slow down privatization down.
Central and eastern Europe is clearly a region with great potential for new equity issues, but the pace of market growth is dependent on several factors, some of which are outside the control of those in the region. Investors’ appetite for equity issues is reliant on economic performance in the rest of the world. Following the Asian crisis, investors retreated to more established markets, even though the fundamentals of central and eastern Europe are very different from those of any Asian country.
Domestic political changes also have an impact on the course of privatizations. In Poland, for example, partners in the new coalition government differ in their attitudes to privatization. Solidarity favours a voucher-based mass privatization scheme, while the Freedom Union wants either strategic cash sales or market offerings. The situation in Russia a country seen by many analysts as a region in its own right has a great influence on other markets in central and eastern Europe. Meanwhile enthusiasm for entry into the EU has led some governments to modernize and open up their economies, a process encouraged in other countries by conditions attached to IMF loans.
Most analysts see the economies of Poland, Hungary, Estonia and Croatia maturing in 1998 with new private companies increasingly entering the capital market. There are hopes for economic recovery in the Czech Republic, and expansion of market activity in Romania, Bulgaria, Ukraine, Kazakhstan, Latvia and Lithuania. Two trends that some predict for central and eastern Europe in 1998 are a focus on reasonable pricing and a flight to quality. From an investor’s point of view, this could signal a good year for bargains. Ajmera at Aberdeen Asset Managers believes that realistic pricing of equity issues is needed to restore health to the markets. She thinks that some of the big deals of 1997 were overvalued, citing the Polish copper producer KGHM as the most obvious example. The company is currently trading at 36% below its July 1997 issue price.
Ajmera also feels that this year investors will be far more discerning about which stocks they buy, looking at the dynamics of each company before committing money to central and eastern Europe in 1998. But Summer at Merrill Lynch is bullish about the next 12 months and puts the problems of the last quarter of 1997 down to a “year-end effect” that started early in response to the Asia crisis.
He defends the KGHM deal, believing that it was the copper market that was overvalued, not the company. Others, like Berman at Salomon Smith Barney, put the deal’s failure down to bad structuring, bad timing and bad management but stand by the quality of the company.
Will central and eastern Europe take over from Asia as the emerging market of choice with investors in the wake of the Asia crisis? In the short term some investors may be switching between the two regions, but as Rezny at CA IB Securities points out, Asia and eastern Europe have little in common in terms of the size of their economies and their stage of economic development.
However, in the past few months eastern Europe’s stock markets have outperformed those in Asia, and Rezny predicts that they will continue to do so. As central and eastern Europe has little history of market capitalism, Rezny hopes that these countries can “start from scratch and do it the right way, avoiding the mistakes made by the Pacific Rim”.
