Developer Contests Outlook Report

MTSistema-Hals wants to renegotiate its contract for the Leningradsky Towers office center because of rising costs.
Fitch Ratings knocked its outlook for real estate developer Sistema-Hals from stable to negative last week because of problems with liquidity and the construction of Siemens' Moscow offices, raising concerns in the press that the construction bubble could burst.

The change in outlook, Fitch wrote in the rating report release, was mainly spurred by "heightened concerns over Sistema-Hals' liquidity position, which has worsened in recent months and is now significantly weaker than previously expected."

The decision comes after another of the city's top construction firms, Mirax Group, saw its ratings docked by Fitch in March, a more significant measure, which also came after what the agency called increasing liquidity problems.

But analysts say media speculation that the real estate market is shaky and likely to worsen is premature, as demand continues to outstrip supply in all sectors. The problems of individual companies, they say, do not represent a danger for Moscow's ongoing building boom.

"My view is that this is a one-off, company-specific issue and not related to an overall market decline," said Barry Schumaker, an equity research analyst at UralSib. "I suspect that Fitch initiated this on a negative news flow about the dispute over the Siemens building project," he said.

Fitch, too, has predicted that the residential and commercial sectors are relatively safe.

Julian Crush, a senior director at Fitch Ratings, wrote in an e-mailed response to questions that in Moscow, the sectors would be "generally positive for the next three years."

Sistema-Halls, the construction arm of billionaire Vladimir Yevtushenkov's Sistema holding, announced in April that it was experiencing significant cost overruns on a fixed-price contract to develop the twin-tower, 110,000-square-meter Leningradsky Towers office center, which will house the headquarters of Siemens Russia, as well as Sistema-Hals.

The 27-story complex, which was supposed to be completed sometime next year, is currently only nine stories high.

The developer, run by Yevtushenkov's son, Felix Yevtushenkov, is now "trying to renegotiate the contract price to pass some of these increased costs onto Siemens and/or the subcontractor," Fitch wrote in its report.

Vedomosti reported late last month that the firm had raised its price to $305 million, up from the original $187 million, citing Sistema-Hals financial director Andrei Solovyov. The company's press office could not confirm the higher cost in its e-mailed response.

A Siemens spokeswoman in Moscow said she was unable to comment Monday evening.

The problems with the project could compound Sistema-Hals' cash difficulties, because if negotiations with Siemens prove unsuccessful, either side could cancel the contract. That would force the developer to return all advanced payments -- totaling some 64 million euros ($100 million), according Sistema-Hals -- back to Siemens on short notice.

The company, however, is confident that its liquidity situation is under control.

"We don't see a temporary fall in the liquidity ratio vs. the projected Fitch amount as a potential long-term concern for us," Sistema-Hals wrote. "At the moment, we are strengthening out liquidity policy, which we plan to introduce to the board of directors on [Thursday]."

To deal with the situation, the company said, it will "create a 'liquidity cushion' [and] anticipatory reserves for all contract-bound cash outflows."

And while there was a change in the company's outlook, its ratings remained the same. The long-term rating remained at B+, short-term at B and the national long-term at A-. Fitch said a downgrade of the firm's rating would occur if Sistema-Hals is not successful in implementing a new liquidity policy.

Mirax, for its part, undertook a restructuring shortly after the downgrade, saying the move was in preparation for a possible share offer abroad and to increase the company's transparency.

Mirax deputy CEO Alexander Paperno said in a statement in March that because of the restructuring, all assets belonging to Mirax Group had been consolidated in a new company, Mirax Group Holding.

"The decision by Fitch to place our ratings in the negative watch list is linked to this fact," Paperno said, adding that Mirax Group liabilities were fully backed by the new holding company.

Sistema-Hals, while acknowledging Fitch's concerns, was adamant that it was "not experiencing difficulties," saying that despite problems in the credit market, it was confident that it could raise funds as needed.

"Although we realize the situation in the credit market is a tough one at the moment and fully understand the concern of the rating agency in this regard, we feel very confident that we will be able both to generate cash flow from operations, from the sale of apartments and land plots and to attract necessary additional funding to finance both immediate short-term cash needs and long-term project financing," the statement said.

Analysts cautioned, however, that the construction sector could still face problems down the road if demand drops.

"We see the sector still booming led by demand far outpacing supply. The real market concern is if demand falls, which doesn't seem too likely in the near term," said Schumaker, of UralSib.

"The conditions are tighter now," said Vladimir Pantyushin, head of the economic and strategic research group at Jones Lang LaSalle. "But for developers, the market is still quite lucrative."

"In my opinion, the key risk really for any real estate developer is whether they can keep a promise," Pantyushin said.

Alexei Yazykov, a real estate analyst at Renaissance Capital, said "the general debt capital environment" was facing difficulties at the moment. "As a result of the so-called credit crunch, the banks are much more risk averse," he said.

"It's not only the credit crunch, it's also the balance sheet. It doesn't mean the company is in dire straits, but if the liquidity situation with the balance continues, it could prove to be dangerous," Yazykov said.