Ukraine takes cautious steps down IPO road


Chloe Hayward
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There is a lot of talk in Kiev about companies undertaking IPOs. Every banker and company manager has contemplated the possibilities and many have attended conferences on the subject. Does Kiev need to brace itself for an onslaught of new IPOs as the market opens up or will the local legal infrastructure and stringent international standards stop all the talk in its tracks? Chloe Hayward reports from Kiev.

IPOs Announced by Ukrainian Companies
Year Company Stake Status
2007Mironov Khliboprod20%Announced
2007Finance and Credit25%Announced
2007Image Holdingn/aAnnounced
2007Velyka Kyshenyan/aAnnounced
Source: Concorde Capital

Problems and prospects for privatization

THIS YEAR A number of Ukrainian companies are expected to undertake IPOs in the local and international equity markets. "Two years ago, if you had asked a Ukrainian company if they were going to do an IPO they would have asked ‘Why, what’s the point?’ but now companies are finally realizing the necessity, and the potential gains, of the capital markets," says Andrei Bogdanov, head of Ukraine research at Troika Dialog, an independent Russian investment bank that opened an office in Kiev last year.

Up to now, Ukrainian companies have largely relied on the bank market to fund their expansion but as they become more and more leveraged, IPOs increasingly make sense. "The pre-IPO market is very strong in Ukraine and an IPO boom is going to happen. This year we will see a lot of companies get ready for fully fledged IPOs," says Lucas Romriell, equity sales associate of Concorde Capital, the second-biggest investment bank in Kiev.

At least eight Ukrainian companies have announced their intention of selling their shares on public markets over the next 18 months (see table). These include Finance and Credit, the country’s 10th-biggest bank, which plans to offer 25% of its equity. Milkiland, a dairy products manufacturer, is poised to offer 20% of its shares on the Frankfurt stock exchange in the second quarter of this year. Galnaftogaz, the country’s biggest independent operator of petrol stations, is also rumoured to be about to announce IPO intentions.

There are, however, challenges facing any prospective equity issuer. Although the main local stock exchange, the PFTS, is the world’s best performer this year, with 62% growth, it only trades privately placed shares and has never listed a public IPO. At the same time, the international markets pose a huge accounting and corporate governance test for Ukrainian companies.

Changing mentality

So far, Ukrainian companies have followed a standard pattern in their funding strategies. Initially, excess profits fuelled their growth but as companies expanded, so their financing needs increased. Businesses such as Milkiland and XXI Century Investments, a property company that is one of a handful of Ukrainian firms to have undertaken an IPO, often turned to the local banks for dollar-denominated loans.

But as corporate leverage levels have grown dramatically, in some instances above five times, banks have become less compliant. "Some companies that have announced IPO plans are [highly] leveraged and need to balance their capital structure. The release of new equity by such companies should expand their capacity for new borrowings and facilitate their further growth," says Valeria Gontareva, deputy chair of the board and head of financial markets, ING Bank Ukraine.

"Even when pension funds come in Ukraine, they will be extremely risk averse, and therefore will be bond investors at first"
David Lucterhand, USAID Access to Credit initiative

David Lucterhand, USAID Access to Credit initiative
Certainly, it’s a propitious time for Ukraine’s banks, despite the country’s political problems, which resulted in president Viktor Yushchenko dissolving parliament in April. The ensuing months have seen street protests and a break down of communication between Yushchenko and prime minister Viktor Yanukovich. Several dates have been set for re-elections, and an end to this crisis, and the last weekend of May marked an apparent breakthrough. As interior ministry troops closed in on Kiev on May 26 so talks between the two rivals made progress. On May 27 the two announced that elections would be held on September 30, assuming all other opposition parties agree also. Despite events, economically, Ukraine is flourishing, with a real GDP growth rate of 7.1% in 2006 and predictions of 4.5% in 2007, according to the IMF. Surging consumer demand is one of the main reasons for this growth. In addition, Ukraine’s accession to the World Trade Organization, which is expected to be finalized by the middle of this year, will increase economic competitiveness. The country’s companies will be under further pressure to raise capital to take advantage of the potential growth.

Some bankers, however, caution that although more Ukrainian IPOs will be evident over the next few months, no one should get too carried away. "I think it is premature to say that this is an IPO boom," says Gregory Gurtovoy, chief executive officer of the Ukraine office at Russian investment bank Renaissance Capital. "More IPOs are clearly necessary and likely to happen soon but it is a process, not an event. It is a process where the issuer has to be ready and understand the associated advantages and disadvantages of the capital markets."

So far, four Ukrainian companies have undertaken IPOs – all on international exchanges. These include XXI Century Investments, which raised $137 million in December 2005, and Ukrproduct Group, which raised $11 million in February 2005. Both were listed on the UK’s Alternative Investment Market (AIM). These first IPOs offer valuable lessons about the time and expense necessary for international listings but they also illustrate the huge differences between companies that have listed on international exchanges and those Ukrainian companies that have announced plans to go to the local markets.

"This is the first generation of capitalists and so they are not necessarily the best clients to do an IPO. Many business owners are still afraid to lose control over their businesses or disclose the amount of information international listings require," says Borys Tymonkin, chairman of the board of Ukrsotsbank, the sixth-largest bank in Ukraine by assets.

Andrei Bogdanov, Troika Dialog

"Paradoxically, in Ukraine it seems that the economy does better when politics are in a mess"
Andrei Bogdanov, Troika Dialog

Cultural shifts do not take place overnight. So far, companies that have announced IPO plans have offered only small stakes of 10% to 20%. Ukrainian law states that a 75% share of a company is needed to retain total control, so no owner wants to offer more than 24%. But issuances of small stakes will not do anything to deepen the already poor liquidity on the PFTS, which accounts for 96.4% of market share by volume of trade in Ukraine. The rest of the market is serviced by another seven exchanges that occupy specialist niches and by two trading information systems.

Problems with the PFTS

Liquidity is a big problem on the PFTS. Russia’s RTS equity market has a market capitalization of more than $1 trillion, with about 25% of that traded daily. In contrast, the market capitalization of the PFTS is about $5 billion. Only 7% of that volume is traded daily. Up to 60% of trades are done over the counter.

Attempts to improve the situation were implemented last year. The law now states that if a company has no, or limited, trading volumes for more than one month it can be delisted from the PFTS or dropped into a lower tier on the three-tier system.

Poor liquidity on the PFTS has sparked a debate on the privatization process in Ukraine, with some market observers saying that it should be used to help improve liquidity on the exchange, while others say this is a side concern. The government is yet to make a unified decision on it and so in the meantime the process is rather haphazard (see Problems and prospects for privatization, Euromoney, June 2007).

"The local stock exchanges will become more attractive to investors once minority rights are better protected and currency movements are easier"
Olexiy Volchkov, Calyon

Olexiy Volchkov, Calyon
A thin market isn’t the only problem that the PFTS faces. It also needs to improve its technology, especially as exchanges in Russia and Poland are trying to steal a share of the Ukrainian market. "If the PFTS does not improve rapidly then incoming stock exchanges, like Russia’s RTS, could take away some of their market share," says Bogdanov. On March 30, the shareholders of Inex, a Ukrainian stock exchange with a marginal market share of 0.2%, met to discuss a potential investment from the RTS, which hopes to increase its stake in the exchange from one share to 60%.

But Andrei Kolomiets, head of information at PFTS defends its progress. "We have a new auction system due to come live in the next two months," he says. "This will hopefully make the market more accessible and trading more efficient." It is also hoped that this will enable the first non-private placement IPO to take place.

Local investor void

One of the issues facing market players in Ukraine is what an IPO actually amounts to. "It depends on how people are defining IPOs," says Brian Best, director at Dragon Capital, Ukraine’s leading investment bank. "If we are comparing them to London, then what we have here is really very different. To date Ukraine has done only private placements with a technical listing on the local PFTS." The fact that there has been no local public IPO is partly a reflection of company owners wanting to deal directly with their investors, but also the result of a political and legislative environment that doesn’t support or encourage investors to buy Ukrainian stocks.

Roman Kachur, ITT

"Bank deposit rates are very appealing, but also those that do invest money are more inclined to put it in real estate than risk it in the markets"
Roman Kachur, ITT

Locally investors are sparse. Disposable incomes are low, so few people can access the markets even if they want too. But more influential are the high deposit rates that banks are still able to offer. "Some of the tier 2 banks offer deposit rates of 14%, while the average tier 1 rate is 6%," says Roman Kachur, director, ITT Consult, part of the four-branch ITT investment group. "These rates are clearly very appealing, but also those that do invest money are more inclined to put it in real estate than risk it in the markets at the moment."

Ukrsotsbank’s Tymonkin cites the country’s political problems. "At the moment there is an investor void in Ukraine – local and foreign institutional investors see many risks still in this market," he says.

However, despite Standard & Poor’s adjusting its BB– rating to a negative outlook from neutral and international investors becoming concerned about the political situation, analysts such as Troika Dialog’s Bogdanov reckon that it is less of a concern. "From my point of view political instability doesn’t make much difference to the economy at the moment," he says. "Right now is a perfect example of how the economy is booming while the political situation is in a mess. Paradoxically it seems that the economy does better when politics are in a mess." But, while the Rada (Ukraine’s legislature) is not assembled there will be a halt in passing much needed reforms, especially regarding its capital markets.

Legislative reform

"Ukraine is the second-biggest market beyond Russia in the CIS countries. However, its capital market infrastructure requires the establishment of more precise and clear shareholder laws," says Iryna Trygub, equity analyst at Troika Dialog. Ukraine is the last country in the CIS region still to update its joint stock company law, with companies still operating under the 1991 law, which does not establish the rights of minority shareholders in joint stock companies.

"This law would be an important signal to investors everywhere – it would be ‘welcome Ukraine’ after 15 years of foot-dragging," says Martin Raiser, economic adviser for Europe and central Asia at the World Bank. So far, the Rada has vetoed each attempt to pass this law as several businessmen who are influential in the political system are only too aware of how they could be affected if more transparency was required.

"Ukraine’s capital market infrastructure requires the establishment of more precise and clear shareholder laws"
Iryna Trygub, Troika

Iryna Trygub, Troika
But times are starting to change. This year the World Bank is making a new joint stock law one of the key conditions for the finalization of its next adjustment loan. A new, and, it is to be hoped, final draft of the law is due to be read in June. "There is a growing recognition that passing this law is important for Ukraine and so this time I believe that it will get the coherence of the political will behind it and it will go through," says Raiser. "I believe the government when they say they are eager to develop the domestic capital markets, and they realize that this isn’t going to happen unless this law is passed."

Another reform needed to encourage investors is an easing of restrictions on currency movements across borders. At the moment, Ukrainians are still unable to open bank accounts outside Ukraine and when foreign investors try to move money out of the country they are taxed. However, if this law is changed investors will be able to look to Ukraine for short-term investment and so more money could flow into the markets. There is hope that these law changes will help spur the growth of the capital markets.

"The local stock exchanges will become more attractive to investors once the minority rights of shareholders are better protected and currency movements are easier. With this more investors will look to Ukraine, which could also drive companies to raise the bar in terms of transparency and corporate governance," says Olexiy Volchkov, vice-president at Calyon corporate and investment bank, Ukraine.

London vs local

But these law changes will take time, and while some of the smaller companies will wait, the larger companies, which are planning IPOs for more than $100 million, such as Milkiland and Mironov Khliboprod, are looking to London or Frankfurt for their placements. Prospective issuers in the international markets will need to raise their levels of transparency and corporate governance.

"Many companies like the idea of doing an international IPO and the recognition that is associated with one, but once these companies look at the practical requirements many are changing their minds," says Vadym Mironyuk, head of international business at UkrSibbank, the country’s third-biggest bank by assets. Calyon’s Volchkov agrees. "There will be a massive difference between those companies that have announced IPO intentions and those that actually do make it to the markets in the next year," he says.

The managements of the larger companies that need funds are realizing the reputational gains that an international listing can offer: "A process has started where some businessmen are voluntarily moving towards better corporate governance and more transparency so they can reap the rewards of an international IPO," says Jeffrey Franks, senior resident representative of the IMF in Ukraine. Not only are the international IPOs able to apply the international stock exchange laws, they will also access new investors, gain more capital, as well as achieve the stamp of approval that will keep them competitive. But this is expensive and time-consuming for small companies that need money fast.

One of two routes forward

So which route should companies take to raise funds? Two distinct routes have emerged – one for companies looking to undertake IPOs seeking to raise more than $100 million and a different one for smaller companies with smaller issuances planned.

Borys Tymonkin, Ukrsotsbank

"The first generation of capitalists are not necessarily the best IPO clients. They are often still afraid to lose control over their businesses"
Borys Tymonkin, Ukrsotsbank

The small companies, argues Kolomiets of PFTS, should list in Ukraine. "Small companies wanting up to $100 million from an IPO are not big enough to go to London or Frankfurt," he says. "Listing here will be cheaper and more time effective then going abroad." Dragon Capital’s Best adds: "Dragon works with more than 1,000 institutional clients so we can easily find the investors needed for listings up to $150 million to $200 million." Once a certain amount of growth has been achieved then these companies could go to Frankfurt and then eventually London, suggests Trygub.

Unlike in Kazakhstan or Russia, Ukraine’s big companies are not being encouraged to undertake dual listings. Instead, several bankers and local advisers think that going to the international markets first is a good route. "Ukraine will introduce a second pillar to their pension scheme in 2009. Until then, domestic funds are not sufficiently large to meet the level of investment necessary to invest in large IPOs. And even when pension funds do come, they will be extremely risk averse, and therefore will be bond investors at first," says David Lucterhand, chief of party for USAID’s Access to Credit Initiative.

The few locals that are able to make investments are unlikely to divert their investment strategy from tangible assets until property market yields decrease and foreign investors have successfully shown that the stock market is a safe and profitable way to go. But at the moment the market is not safe to dabble in: "Foreign investors are buying the future when there will be better transparency, and huge growth in the process of getting there," says Bogdanov.

Whichever of these routes the companies follow, as long as some make it to the international exchanges the investment banks see a bright future. As Best of Dragon Capital says: "A self-fulfilling cycle will start as companies start to list abroad. Gradually new standards of transparency and governance will emerge and even now we are seeing local companies emerge from the shadows and start to report profitability accurately. This will filter throughout the market and help everybody."

IPOs made by Ukrainian companies, 2000-07 YTD
Pricing DateDeal typeIssuerIssuer nationalityDeal value $mlnExchangeBookrunner parent
Dec 13, 2005IPOXXI Century Investments Public LtdUkraine137AIM (Alternative Investment Market), LondonING
Aug 4, 2006IPOAstarta Holding NVUkraine30WarsawING
Apr 15, 2005IPOCardinal Resources plcUkraine20AIM (Alternative Investment Market), LondonFox-Davies Capital Ltd
Feb 11, 2005IPOUkrproduct Group LtdUkraine11AIM (Alternative Investment Market), LondonWH Ireland Ltd
Source: Dealogic