CIS CORPORATE FINANCE: Terms of endearment

15/05/2010 | Jake Rudnitsky

Companies across Russia and the CIS are gearing up for an explosion in capital raising this year. As fears over a eurozone break-up recede for now, markets may once again throw open their doors to the region’s funding efforts

During the global financial crisis, just about the only place Russian companies could raise money was in the Kremlin. With liquidity frozen and commodities prices down in the dumps, the government used a large chunk of its massive reserves to prop up Russia’s overleveraged businesses. Even so, 122 of the local market’s roughly 425 issuers defaulted.

A year on, companies across Russia and the former Soviet Union have been enjoying historically low interest rates and, through April, experienced little difficulty raising money from a variety of sources.

Since the start of the year, the whole of the CIS (Commonwealth of Independent States), of which Russia is the largest member, looked set to benefit from increased access to international debt markets. Commerzbank, for example, forecast between $20 billion to $30 billion in new Eurobond issuance for the entire CIS region in 2010, including sovereign, bank and corporate bonds, of which Russia would account for $15–25 billion.

But the picture changed dramatically last month, as market volatility surged on fears over Greece’s debt woes – hammering home the point that the region’s fundraising capacity is not immune to fallout from eurozone turbulence, especially if it worsens sharply.

Market turmoil has already hit Russia – specifically its much anticipated April 22 dual-tranche, $5.5 billion sovereign bond issue. The sovereign returned to the market after a decade without selling a bond to issue liquid five- and 10-year benchmarks.

The transaction was broadly welcomed immediately after pricing when it appeared to have met the sovereign’s goal of resetting its curve – and by extension, that of quasi-sovereign and corporate borrowers – by establishing a liquid benchmark.

But both tranches sank on secondary markets in the days after pricing, leading bankers to question what went wrong with the deal. Global markets turned sour as the deal was pricing, with heavy selling of Greek debt infecting other sovereign credits.

“We thought that the existing spread was not fully reflective of Russia’s fundamental strengths,” Russia’s deputy finance minister Dmitry Pankin told Emerging Markets’ sister newspaper EuroWeek. “We wanted to see what the demand was from the market, what kind of issue the bond market would like to have.”

Russia had hoped for even tighter pricing than that which it achieved in the $5.5 billion issue, he said. “The market was not so good at the time when we priced the bond. Our previous expectation was that we could get a better result.”

The five-year tranche was priced at 125bp over US Treasuries and the 10-year at 135bp over – pricing calculated to be as much as 35bp through the sovereign’s existing curve.

Many analysts believe the real purpose of the sovereign issue was to reduce borrowing costs for Russian companies and improve access to capital markets, rather than fill a hole in the state budget.

“These issues were purely a marketing exercise, as this year’s deficit will be negligible,” says Boris Ginzburg, head of fixed income at the investment bank UralSib. “The Russian government used them as a way to meet investors and draw attention to Russia’s re-emergence.”

But in light of poor secondary performance, some emerging markets bankers speculate the strategy might not bring down borrowing costs for other issuers.

Pankin noted that the Greek fiscal crisis and its fallout across Europe could have significant knock on effects in Russia and beyond. “It’s a serious question for us in terms of macroeconomic stability,” Pankin said. “It’s very difficult to make any projections, to make budget projections, if we have such an unstable market with huge volatility in the exchange rate and in the bond markets.”

Back in business?

Nevertheless, bankers are mostly downplaying the likely near-term impact of eurozone tremors on the region. “The CIS is driven by different factors than Europe,” says Andrei Arofikin, managing director for investment banking at Bank of America Merrill Lynch Russia, although he notes that “Russia is part of the global market, and thus is not immune to global challenges.”

Until recently, bond business was booming – both volumes and terms of the debt. Starting last June, Russian companies began returning to the debt market in droves, after the central bank expanded the list of securities accepted as collateral for loans to include ones rated as low as B-. Since then, the rouble debt market has thrived, with more rouble-denominated debt issued in the last six months of 2009 (R659 billion) than during the whole of pre-crisis 2007 (R470 billion).

Marina Vlasenko, Commerzbank’s lead emerging markets credit analyst in London, claims that bonds are the favourite instruments of CIS companies and banks for raising money. “Equity valuations and demand have improved significantly after the crisis, but they haven’t approached pre-crisis levels yet,” she says. “At the same time, the cost of debt is really affordable.”

First-tier companies are enjoying extremely low rates on domestic markets. An April three-year issue by MMK for R8 billion was priced at 7.65%, while Aeroflot placed two three-year issues for a total of R12 billion at 7.75%.

Second-tier companies are also joining the party, placing bonds at rates just under 10%. By now, many companies have already refinanced their existing debt and are considering issues to expand operations. “Second-tier companies are in the first stages of accessing the market,” says Ginzburg. “Lots of issues have been registered, but companies are not rushing to place them due to continued concerns about the economy.”

Russian blue chips are seeking foreign debt in the Eurobond markets, raising $13.7 billion last year. According to bankers, businesses are expected to issue between $10 billion and $13 billion this year, with some $6 billion already sold. In doing so, they hope to take advantage of current rates of 5.5–6.5%.

Even at low rates of interest, the popularity of Russian issues remains high. In late March Russian Railways issued a $1.5 billion, seven-year Eurobond at 5.739% – 245bp over swaps – that was 10 times oversubscribed.

According to Vlasenko, borrowers are still largely focused on deleveraging, with only a few sectors such as telecoms and oil and gas spending on investment programmes. “CIS corporates are concerned with two main problems: refinancing short-term debt and reducing funding costs,” she says.

Analysts say the corporate sector has learned a lesson from the crisis and now tries to match the currency of their revenues and debt. This helps explain why local bond markets are doing brisk business, while exporters prefer Eurobonds. “There’s a more conservative approach to debt than before the crisis,” says Bank of America Merrill’s Arofikin. “The leveraged finance that we used to see on all levels is a thing of the past.”

Banks are also borrowing again, albeit at slightly higher rates. In March, Bank VTB, Russia’s second-largest bank, issued $1.25 billion in five-year Eurobonds paying 6.465%. It plans to raise another $1.25 billion abroad before the end of the year, equal to half of its $5 billion in new debt planned for 2010.

VTB chief financial officer Herbert Moos says the bank plans to borrow the money through more exotic products, exploring options ranging from sovereign wealth fund deals to syndicated loans or even Islamic Sukuk.

State controlled Sberbank, Russia’s largest bank, is considering a Eurobond of its own. The bank says it may try to redeem R500 billion of subordinated loans it received from the central bank in 2008 during the crisis. The subordinated loan is due in 2018 at an annualized interest rate of 8%, which Sberbank believes is too expensive given current conditions.

International public offerings, which virtually disappeared in 2009, have been surging in 2010. Russian equity was bolstered by the announcement that GDP grew 4.5% year-on-year in the first quarter.

Peter Westin, head of research at Aton Capital, notes that Russia’s total external debt/GDP ratio of 39% and its government external debt/GDP ratio of just 3% “may offer some protection from any overflow from Europe’s sovereign default issues”.

Nonetheless, “Russian markets [are] highly correlated with global indices, and in particular with emerging markets, [and] in recent years Russia has tended to correct more than other bourses,” he acknowledges.

Analysts anticipate some $10–12 billion in IPOs (initial public offerings) during the year. The biggest blockbuster to date is Rusal’s $2.24 billion IPO in Hong Kong in January. Even though the world’s largest aluminium producer’s shares are trading 20% down from their January offering price, more Russian companies will follow.

SOURCES OF CAPITAL

But there is a perception among some Russian shareholders that Russian equities are undervalued compared to other emerging markets. Russian companies have the highest earnings per share but the lowest price/earnings ratio among Bric (Brazil, Russia, India and China) economies. This fact, coupled with low interest rates, has kept bonds popular, according to Natalia Orlova, chief economist at Russia’s Alfa Bank.

“The bond market is more important, given that valuations are still quite good for the price level,” says Orlova. “Shareholders are happy. However, the window of opportunity may be closing for IPOs, and we may see an uptick before the end of the year.”

At least one planned IPO has been shelved. Prof Media, the subsidiary of oligarch Vladimir Potanin’s holding Interros, abandoned plans for a $1 billion offering in April after receiving a credit line worth R7 billion from state-controlled bank Sberbank.

Media reports suggest Metalloinvest, the Russian iron ore mine and metallurgical company, is reconsidering an IPO after deciding that more attractive financing options existed.

Plenty of other IPOs are still on tap. “Companies generally do an IPO if they can, otherwise they go for bonds,” says Mattias Westman, chief executive of Prosperity Capital Management, the largest Russia and CIS-focused portfolio investor in the world. “They want to be listed as a stamp of approval.”

In late April, Russian pharmaceutical company Protek raised $400 million in the largest IPO on local exchanges since property developer LSR Group raised $772 million in 2007. “The successful completion of our IPO is a major milestone in the development of Protek. We are confident that as a public company we can continue to build on our track record of achievements across the Russian pharmaceutical sector,” says company president Vadim Muzyaev.

IPOs planned for this year include seafood producer Russian Sea Group, which is looking to raise $90 million with a free-float of 18.9% on Russian exchanges, and rail-freight operator TransContainer, which may sell up to 35% of its shares on Moscow and international exchanges this year. TransContainer is owned by state-owned Russian Railways, which may also float a stake of its freight operator Freight One later this year. SUEK, a leading coal producer, is considering a 10% flotation valued at up to $1.5 billion in London in the second quarter.

“We’ll continue to see international and domestic listings across all sectors,” says Arofikin. “There’s certainly going to be more to come in Hong Kong. If we’re lucky, there could be up to $20 billion in listings this year.”

Low inflation, a strong rouble and economic growth keep Russian bonds attractive. This year, inflation looks to be the lowest in post-Soviet history. It was running at an annual rate of 6.3% over the first four months of 2010, according to the central bank. Its chairman Sergei Ignatiev predicts that it will be 6.5–7.5% for the year.

The state has offered conservative growth estimates this year, with prime minister Vladimir Putin recently predicting that the economy will grow 3.1%. However, investment banks are predicting that growth could reach as high as 7–8%.

FURTHER AFIELD

Elsewhere in the CIS, companies are also returning – for now –to the bond markets after a tough 2009.

In Kazakhstan, where leading banks defaulted and were nationalized during the financial crisis, there has been limited interest in Eurobonds. State oil company Kazmunaigaz defied the bumpy market to sell a $1.5 billion, 10-year bond at the end of last month – the first Kazakh Eurobond since the crisis. Although guidance had been set at 275bp over US Treasuries, as markets deteriorated the deal finally priced at 347.7bp. State nuclear company Kazatomprom is also planning an issue.

Few IPOs are on tap, either, perhaps because the oil-rich central Asian country has the luxury of being able to look elsewhere for funding. “The Kazakhs always have the alternative of raising money from the Chinese,” says Westman of Prosperity Capital Management.

Ukrainian companies are starting to wade back into capital markets. Investors have reacted favourably to the recent gas deal with Russia and the prospect of renewed IMF funding. If a degree of political stability can be maintained, analysts estimate total possible Eurobond issues of $3 – $3.5 billion in 2010, including $1–1.5 billion of sovereign borrowing, and several IPOs.

Among the companies looking to raise funds are DTEK, Ferrexpo and Metinvest. In April, state bank Ukreximbank issued a $500 million Eurobond at 8.375%, which was the first by a Ukrainian entity since state energy company Naftogaz defaulted last year.

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