It’s a measure of the growing sophistication of central and eastern Europe’s stock markets that some of the region’s largest companies are shunning western markets in favour of listing closer to home.
Russia is at the vanguard of the region’s equity market dealflow, but Poland and Turkey, the other members of the big three European growth markets, are in hot pursuit.
But listing companies aren’t having it all their own way yet: concerns over the likely impact and success of government privatization drives, and sluggish reform of the region’s business models have raised a number of questions about the sustainability of the region’s equity market boom. The next few years will be crucial in the attempts of the region’s largest exchanges to attract both large- and small-cap listings from across central and eastern Europe.
RUSSIA'S CAUTIOUS OPTIMISM
This hasn’t deterred Russian issuers, for whom equity capital market prospects are finally looking good, with a slew of successful deals outweighing a handful of failures. It’s a patchy performance but a big improvement on the crisis years, which took a disproportionate toll on the country’s equity markets and left investors ruing the anything-goes IPO (initial public offering) attitude of 2007.
But memories of losses, the enduring bugbears of governance opacity and market illiquidity, and a volatile global macroeconomic environment are making every deal difficult. So, with western Europe IPO issuers struggling to make headway with an investor base uninterested in new listings – certainly without discounts so large as to make all but the most committed sellers blanch – the success of some Russian companies to come to market is all the more striking.
What’s needed to make this a sustained trend is a confidence-builder, say bankers – a deal, or deals, that perform strongly. “Russia is a market that hasn’t made any significant money for investors since 2007 – and a lot of people are still hurting from some of those deals,” says Christian Steffens, co-head of capital markets at UniCredit in London. “Now, the market needs a few sensible issuers with reasonable price expectations. We also need a couple of deals to trade well.”
Three IPO windows for Russian borrowers have now come and gone since global markets switched back to a risk-on setting in September 2010 – and two of those, late 2010 and March/April 2011, have proved positive.
In March/April, four borrowers launched IPOs: Nomos Bank, Etalon, a residential property developer, Euroset, a mobile phone retailer, and Ros Agro, a sugar producer. Only Euroset failed to make it to completion; Nomos and Ros Agro even put in positive early trading performances, a rare thing in Europe this year.
Only the February window counts as a negative. Nord Gold, a spin-out from Severstal, Chelyabinsk Tube Rolling Plant (ChelPipe) and Koks, a coking coal and pig iron firm, all postponed IPOs at the end of their book building periods in February. Hydraulic Machines & Systems, a pump manufacturer, was the sole success among the IPO candidates – and it printed a cut-price deal that subsequently traded for a sustained period below its offer price.
While macro conditions were far from perfect and valuations controversial, the deals were hindered by the government’s decision, mid-roadshows, to sell a $3.5 billion stake in state-owned VTB Bank. The success of that deal only served to show the dichotomy between investors’ enthusiasm for large-cap, liquid stocks and their caution over buying mid-cap new issuers.
It’s a problem that has bedevilled the wider European IPO market in 2011 – but with Russian issuers always viewed with suspicion, it made it even harder for deals from the country.
The toughness of the market, though, is welcomed by some bankers. “The mixed reception of investors to the Russian IPOs so far this year shows that investors have learnt their lessons from the 2007 cycle and are being very disciplined on price and story,” says Richard Cormack, EMEA head of emerging markets ECM at Goldman Sachs in London. “So although there have been some disappointments, it actually makes for a far healthier IPO market than at the top of the previous cycle.”
The lesson that ECM syndicate bankers point to is that the companies that completed deals were the ones that listened to market feedback. Credit Suisse was one of the bookrunners on all four of the March/April IPOs, and Nick Koemtzopoulos, managing director of equity capital markets in emerging markets at the firm, says that pricing was important. “We’ve seen a very broad engagement from investors,” he says. “Investors remain relatively sensitive to valuations of transactions in Russia, particularly IPOs.
DON'T DISCOUNT RUSSIA
Koemtzopoulos is hoping – along with rivals – that the deals perform well, which could allow the next batch of IPO candidates to offer shares at a slimmer discount to their listed peers than was evident this time around.
“If these deals trade well, and the companies perform and deliver, we hope it will foster more trust between investors and future Russian IPOs, and over time you could see the discount that investors require narrowing,” he says.
The question of discount remains a difficult one for vendors. By some bankers’ reckoning, Etalon, for instance, was offering shares as much as 40% cheaper than its peers, while Nomos Bank, according to some measures of book value, was sold at close to half that of retail market leader Sberbank.
And in Russia, vendors also have to get comfortable with the notion that many listed stocks already exhibit large discounts to their peers elsewhere in the world. “Investors tend to apply a discount associated with risks including corporate governance and lack of transparency of accounts and internal reporting, but all on a case-by-case basis. Being an emerging market carries certain risks,” says Darius Daubaras, head of Russia, CIS and CEE equity capital markets at BNP Paribas in London.
“But then again, if you look across the sectors, some of the companies are trading at premiums to their peers, and the discount disappears for high-profile growth companies.”
REFORMING THROUGH SALES
Some market observers hope that economic and financial reforms championed by president Dmitry Medvedev will help narrow the Russia discount. The financial reforms are important to Russian equity investors – if only because the government’s privatization programme is expected to make up such a high proportion of new issuance in 2011 and the following years.
The VTB stake was just the first on the block – a sale of Sberbank shares is widely expected in the autumn that could be worth $6 billion. Other sell-downs will follow in companies including oil major Rosneft, while a slew of IPOs are also planned.
“The government is very clear that they are doing the privatization programme to commercialize industries and to develop the capital markets locally, as well as to have broader international investment coming into Russia,” says Daubaras.
“The privatizations help to develop local markets because local tranches go to local investors, and it’s also important to develop the retail investor base – and that will increase with rising disposable incomes. It’s happening a little bit but it starts with policy, and that policy has been clearly stated.”
WHERE IN THE WORLD?
Developing the local investor base is a big aim of the Russian government, but the local markets, RTS and Micex, even if they merge as now planned, are unlikely to provide enough liquidity on their own for many companies. As a result, many Russian companies continue to court overseas listings.
While London has traditionally been the bourse of choice for both large- and small-cap Russian corporates looking to list overseas, an increasing number are now looking to Hong Kong, in a bid to tie their future growth trajectories to emerging Asia. This is especially true for natural resource firms keen to follow in the footsteps of United Company Rusal, which chose Hong Kong over London for a primary listing in its $2.2 billion IPO in January 2010.
Other exchanges are also in the game. Deutsche Borse is courting emerging market listings, including Russia, and Euronext is also seen as a contender. Meanwhile, the New York Stock Exchange and Nasdaq are still attractive to some, with the latter due to host a $1 billion deal for internet search engine Yandex.
WARSAW CALLING
For smaller firms from Russia and across central and eastern Europe, though, there is a ready-made alternative.
The Warsaw Stock Exchange (WSE) is fast becoming a regional hub and has already attracted Russian companies. The attraction is ample liquidity – helped by the country’s well-developed pension fund industry – and the cluster-effect of similar firms listed in the same place.
The listing framework, meanwhile, strikes the right balance, says Richad Soundardjee, head of Ceemea equity and debt capital markets at Société Générale in Paris. “It has the speed and efficiency that is required by issuers, but it also has the demands that make it strongly reliable for international investors through the level of transparency and disclosure requirement,” he says.
A smart privatization strategy – with the October IPO of the exchange itself as the centrepiece – is credited as crucial in making the leap from aspirant to incumbent. In what has been a difficult past 12 months for equity capital markets, Poland’s state treasury has been able to IPO energy firm Tauron, insurer PZU and the WSE itself, and then conduct secondary sell-downs in PGE and Tauron.
“In the context of a disciplined IPO market, to do some of Europe’s biggest transactions since the crisis and to do them as successfully as they have shows that they have got many things right in terms of structuring and pricing,” says Goldman Sachs’ Cormack.
But some – generally those banks not mandated – gripe about the process. The criticisms are inter-related. First, the treasury has been adamant that it will only mandate bookrunners that can show that they, as institutions, are committed to the Polish market for the long term. Second, it has typically mandated a large number of banks for each deal, relative to the size of the transaction. For instance, a E1 billion follow-on sale of stock in energy company PGE in October 2010 saw eight lead managers involved. And third, the fees it pays, and those of other issuers from the country, are typically lower than in western Europe’s core markets.
Putting significant numbers of bankers on the ground and then sharing out a small fee pool among many mouths is a tough proposition for many. But so far, the allure of Warsaw’s vibrant market for the banks is undimmed – and the treasury, criticism or not, has had a clean run of successful deals.
This strategy was on display in October for the IPO of the Warsaw Stock Exchange itself. Though it was only a $420 million deal, the treasury went through an exhaustive marketing process, while final allocations were made with an eye on the investment managers that would buy future listings on the hub.
“It was a comprehensive IPO marketing process not because the deal was huge but more because it was part of positioning the Warsaw Stock Exchange as a regional hub,” says SocGen’s Soundardjee, one of the eight bookrunners on the deal. “Having gone through the pre-marketing and marketing of the IPO, that was very much part of the discussions we had with investors. Buying the equity story of the Warsaw Stock Exchange was also buying the story that it will become a prominent hub and attract listings from all kinds of different companies from the region.”
This is already happening – Warsaw has become almost a domestic exchange for Ukrainian agriculture firms – indeed, the WSE at the beginning of May launched its WIG Ukraine index to benchmark, initially five firms listed there.
“I’m impressed by the way that the Warsaw Stock Exchange has positioned itself as a regional hub by attracting a number of Ukrainian companies already and becoming a tangible proposition for Czech, Romanian and even Russian companies,” Soundardjee adds. “It still has potential to grow with companies from more countries in central and eastern Europe listing there.”
POLAND'S PENSIONS PICKLE
The country’s equity-hungry pension funds have also played a big role in the growth of the country’s equity capital markets. “There haven’t been big falls in the market because the pension funds are buy and hold and provide a natural support,” says UniCredit’s Steffens.
But ongoing reform of Poland’s pensions system threatens to undermine this advantage.
The country was an early reformer of its pension fund system in 1999. The system rests on three pillars: state and private pensions funded through mandatory pay-roll contributions, and a discretionary private pension. But reform of the first two pillars is creating controversy – and questions over the future of Polish-listed equities.
The government, motivated in part by a need to close its budget deficit, has proposed that some of the mandatory contributions going to the private portion are transferred instead to the state portion. Instead of 7.3% of payroll going to pillar two, only 5% will.
And with the pension funds required to buy mostly domestically listed equities, there is some fear that a key support for new listings will be removed.
Steffens shares the concerns of many at the effects of the reform on deals too small to get international investors’ attention. “We’ve seen that with smaller deals it is difficult to get international investors’ attention, so if locals cut back it could have an impact on that sector,” he says.
But even though overall private pension inflows will fall, the institutions are likely to up their asset allocation to equities over bonds as a cap is removed. Most ECM bankers think that the effect will be marginal – and that the system up to now has allowed Poland’s equity market to develop to a point at which it can stand on its own two feet.
“The growing maturity of the investor base in Poland has allowed small IPOs to get done,” says Soundardjee. “The pensions policy is being reformed but it allowed the local capital markets to develop in a very short space of time and to create a liquid stock exchange, something which is very good for Poland.”
With the new pension law imminent at the time of writing, bankers are yet to discern much effect. The $155 million IPO of independent financial advisory firm Open Finance went well, with investors attracted by the track record of Leszek Czarnecki, the billionaire owner of Getin Noble. But the listing of Ukraine’s Industrial Milk – one of a number of agriculture plays listed in Warsaw – was scaled back, and closed as a $25 million deal instead of the up-to $55 million expected.
As for privatizations, the next test will be the government’s sale of a 37% stake in Banku Gospodarki Zywnosciowej (BGZ) on May 27, for which roadshows are already underway. That will be followed by the IPO of coal miner JSW – which, with trades unions gearing up for a fight, could be the most difficult deal yet for Poland’s all-conquering state treasury.
TURKEY: SLOW AND STEADY
Turkey represents the third, and last, of the key CEE equity capital market hubs with a vibrant domestic market, though one that still requires international participation to meet the liquidity needs of mid- and large-cap companies.
As with Poland and Russia, a continuing privatization programme helps – though the government has adopted a piecemeal approach. Bankers, though, expect a steady stream of deals from the country. Already this year, cash-and-carry wholesaler Bizim Toptan made a $250 million debut, while property developer Ronesans is in the process at the time of writing of seeking a $300 million listing.
Steffens at UniCredit says that the strong performance of Turkey’s economy has been a boon to its capital markets. “Turkey is politically stable and growing fast economically,” he says.
He points to the experience of UniCredit in Turkey, where in November 2010 it took government-backed property developer Emlak Konut public after a year of deals that had largely disappointed the market. “It has traded well and that has given the market a lot of confidence,” he notes.
But the development of capital markets continues to be hindered by the country’s business structure. “Equity capital markets haven’t developed faster because there are a lot of family-run businesses, conglomerates, which have been well and cheaply financed through the banks,” Steffens says.
“That’s changing, although slowly. Conglomerates are increasingly looking at what to do with their assets, and increasingly looking to finance growth through the equity markets. They don’t want to finance everything through the banks.”
REGION-WIDE DEVELOPMENT
That’s a dynamic seen across the region’s markets – and one that is slowly changing. And that in itself will provide more opportunities in the form of secondary sales, say bankers.
“An increasing number of companies in the broad region have gone public so the potential for secondary sell-downs has gone up,” says Cormack. “Across the growth markets, companies tend to be family owned and it’s not as natural for them to be sellers as for sponsor-owned companies in developed markets. It’s a slower unwind process.”
Elsewhere in the region, there are few countries likely to provide anything but a handful of deals each year.
However, in central Europe, Romania looks set to take at least a portion of investors’ attention as the country’s government starts privatizing assets. Fondul Proprietatea, the country’s restitution fund, which owns many listed and unlisted industrial stakes, is now run by EM specialist fund manager Franklin Templeton, and bankers think that professional management will lead to it becoming an active ECM participant.
Straight sales of equity will also enhance the country’s ECM standing. “The privatization programme is going to boost the Romanian equity market,” says Soundardjee. “But the current size of this programme would not be big enough to make Bucharest look like another Warsaw Stock Exchange to which non-domestic companies will want to come and capture the liquidity.”
For now, then, the growth of equity capital markets in the region will continue to be dominated by Russia, Poland and Turkey. And while all three face significant challenges, the momentum appears to be in place to fuel their continued growth.