IPO Trends in Russia

Marchello Gelashvili Partner Ernst & Young
Despite the global credit crunch, 2007 was still a record-breaking year for IPOs, with 30 listings by CIS and Russian domiciled companies generating $34 billion. Investors continued to focus on large deals, with a median deal size of $614.2 million.

The biggest global IPO was that of Russia's second largest state-owned bank, VTB, which raised $8 billion through a dual listing on a local Moscow exchange and issuance of a London GDR. In 2007, 36 percent of IPOs were dual listings of GDRs on the LSE and shares on MICEX and/or RTS.

In terms of business sector breakdown, deals by retail consumer products companies amounted to 26 percent of the total IPOs of CIS companies, while real estate companies had 23 percent; industrial products, 16 percent; energy, chemicals, and utilities, 13 percent; and financial services, 13 percent.

Galina Shilina Director, Transaction Support group Ernst & Young
The key value drivers in Russian IPOs are evolving. Russian companies are no longer an automatic buy, and new issuers from Russia and the CIS should be prepared to face a very tough competitive environment in which qualitative value drivers such as good corporate governance, transparency, and articulate and compelling management are increasingly important.

The local Russian market has enough liquidity to support small or mid-cap IPOs up to a value of $500 million, with many improvements to the listing process, market infrastructure, and trading system underway. For larger Russian IPOs, given limited local Russian liquidity, cross-border transactions such as a London GDR together with a Rule 144A offering in the US will remain the most effective form of listing.

Among the LSE's most attractive features are large and sophisticated institutional investor pools, regulatory flexibility for secondary listings and GDRs, and lower listing costs compared to the US exchanges. Russian companies are legally required to list at least 30percent of their equity locally in Russia, and they usually opt to issue GDRs in London, although GDRs bear certain implicit limitations to liquidity: GDR offerings are limited to institutional investors only and are not eligible for inclusion in major indices (except a specially designed Russian GDR index). For most Russian companies, the advantages of a full LSE listing, such as index inclusion and greater liquidity, do not outweigh the disadvantages of higher cost, stricter corporate governance, and other more demanding requirements.

In 2007, many Russian IPOs were sold at overvalued prices with several failing to deliver so far on promises of growth. Deals sold at aggressive forward multiples have often fared poorly in post-IPO trading. As of the end of 2007, almost one-third of Russian and CIS IPOs were trading below issue price.

Among IPOs in the CIS by the end of 2007, the best performance was shown by Russian Rosinter Restaurants (83 percent above IPO price) and Ukrainian Kernel Holding S.A. (42 percent above IPO price). The worst performance was shown by technology company Sitronics (down 50 percent) and property developer AFI Development (down 32 percent).

Private equity activity is also developing in Russia and the CIS with only smaller PE-backed IPOs going through so far. A key question in Russia is how to finance the growth of newly established high-growth companies of about $100 million. It is no longer easy for these companies to obtain cheap loans from Russian banks. Since many of these companies are well suited to tap into the private equity market, private financing- whether private equity, private debt, or any hybrid product between debt and equity- will be increasingly important in Russia.

Robust Russian M&A activity continues to be another driver for IPOs, as many strategic transactions not reliant on leverage are underway. An aggressively growing Russian company will grow by merging with its peers and then, when the merged companies reach a critical mass, will seek to go public.

According to our preliminary estimate, the Russian M&A market doubled in 2007, reaching $130.4 billion. The three largest transactions were completed by RusAl ($12.6 billion), E.ON ($5.7 billion), VimpelCom ($4.3 billion), and Nornikel ($6.4 billion).

In addition, the total value of acquisitions of foreign assets by Russian companies in 2007 exceeded the foreign acquisition of Russian assets ($22.3 billion vs. $20.0 billion, respectively).

Several regulatory initiatives introduced by the Federal Financial Markets Service in the past two years have given new opportunities to international issuers. In 2006, the regulatory framework for Russian depository receipts was developed, and in 2007 the initiative was complemented by a new regulation allowing for admission of foreign issuers to listings on Russian exchanges. Both initiatives primarily target CIS issuers and companies with a Russian operational domicile but registered in a foreign jurisdiction.

In March 2008, the Russian regulator issued the "RF Financial Market Development Strategy to 2020." This strategy demonstrates the strong intention of the Russian government to turn Russia into an international financial center.