When in 1995 the first company I established, Skate Inc (www.skatefn.com) published the first ever company handbook for Russian stocks (Skate Blue Chips), it was a smash hit. After selling over 100 subscriptions in just a few weeks and earning in one month more than Skate earned in the previous year, I started to think 'Well, how can we expand the product?'
At that time Skate Blue Chips was covering 100 Russian companies, mostly recently privatised ventures plus some banks. Within a year my team at Skate managed to double the coverage, but that was it -- between 1996 and 1998 there was no growth in the traded universe, and we were stuck covering all the same oil and gas, energos and telcos.
In 1997 I sold Skate. After that I established and sold a few more companies, and in summer 2001 I moved back to Moscow and now run a private equity firm called IndexAtlas. When the editors asked me to contribute to this handbook, I gladly accepted the offer. I think my message is very simple -- Russia needs more traded companies, and once Russian IPO deals start to come through, this will be the sign that capital markets have finally arrived in Russia and would make it a great moment for global investors to reconsider their allocations of Russian stocks.
In early 2002 the Russian traded universe is not much different from the one five years before -- meaningful trading is limited to only 20 stocks, over 80% of market capitalisation is in oil and gas, utilities and telecommunications, and the landscape for portfolio investors is as boring as it always was.
However, a change is coming. There are three reasons why I believe the Russian stock market is bound for a fundamental and positive change. This would not necessarily translate into yet another huge stock market rally (Russia has seen quite a few in the last 18 months) but would be seen as a qualitative expansion of the market, with more issuers entering the market spotlight and complying with the world's best disclosure and corporate governance standards from day one of their flotation.
The first reason is the emergence of a sophisticated and very aggressive Russian private equity industry. With a few notable exceptions, Russia saw no professional private equity investors until recently. Most Russian capital, whilst plentiful, is still shying away from blank pool investment vehicles and is not that professionally managed. This is now changing: according to IndexAtlas own estimates, no less than USD0.6bn in fund-structured private equity money will flow into Russia in the first half of 2002 alone, no less than 30% of it coming from Russian investors repatriating their funds in yet another way. Not a big deal for the developed markets but about equal to the whole of Russian IPO deals in the last 24 months. This flow of private equity money that plays by the book and wants to see exits for its investments, combined with a strong return on equity (expectations for Russian funds are normally in the high thirties before expenses), will become a powerful engine behind capital markets activity, feeding more IPO candidates to the market once the IPO window becomes more visible to entrepreneurs and venture capitalists.
The fact that this window of IPO opportunities is becoming visible is my second reason to support the case for an interesting time ahead for the Russian stock market. On February 8, 2002 Wimm Bill Dann, the Russian food and drinks conglomerate, successfully priced its IPO at the New York Stock Exchange (ticker WBD). This was the fourth true Russian IPO in the US and the first one brought to the international market by die hard Russian entrepreneurs with no Western background, questionalbe business practices in the past and no strategic Western shareholders before IPO to support the story. In spite of the awkward name, designed by the founders to make Wimm Bill Dann juices appear to be a quality imported product (while being manufactured locally), WBD is as Russian a company as one can possibly get, with the company's offering memorandum making for great reading as a story of Russian wild capitalism and its leaders. This deal would have been a non-starter in early 2001, and it was postponed from the original IPO date set for October 2001. On February 8, 2002 it was heavily oversubscribed: French food conglomerate Danone jumped to buy 4% of the total stock, hinting it wanted more, and the stock closed almost 16% up after the first day of trading. What is even more important, Russian entrepreneurs and business owners watched WBD's debut with great attention and obviously thought to themselves -- if WBD with its controversial business development history and notoriously complex corporate structure could make it to the New York Stock Exchange, then many more companies could list on NYSE or smaller stock exchanges as well.
Now, with the inflow of venture capital and establishment of an IPO precedent, there are strong reasons to believe more companies might be willing to consider opening up and eventually listing, thus making the Russian stock market larger, more balanced and in general more interesting to participate in. This however is not enough -- if business owners are happy to own their private companies and take home their profits without forcing themselves into a painful pre-IPO transformation of the way they conduct business, they are not going to fill the IPO pipeline with quality product. Fortunately, there seem to be plenty of signs that owners of many Russian businesses are interested, if not to exit, then definitely to increase their personal liquidity and, more importantly, to create new currency in the form of their company's stock to use for acquisitions at home and abroad as their businesses keep expanding.
And this is my third reason to believe that Russia is going to be a good place to be for stock market professionals in a few years to come. Only time will tell, but there is no shortage of reasons for Russian private companies to open up. One is closely tied to human nature -- most Russian solid private ventures, with annual sales in excess of USD100m, are 10 years old or more, and few of them have an acceptable credit history, growing mostly from cash flow, 'funny' transactions such as Russian privatisations and mergers, and domestic bank loans. Owners of such companies are getting older, think a lot about delegation and continuity, and would not mind achieving a milestone of partial exit through a public flotation, which is not only good for the bank account, but helps credibility (the source of wealth/origin of funds) as well. Another reason -- particularly seen in industries most exposed to foreign competition such as FMCG, food and beverages, financial services, engineering and retailing -- is that Russian private business owners are starting to face competition challenges on their home turf and developing access to the capital markets is seen as a vital element of their survival strategy. There are plenty of other reasons to go public of course, and one may soon become even more compelling for Russian entrepreneurs, most of them in their late 30s or early 40s -- it would be just cool to go public.
In the light of the three factors mentioned above -- private equity and original business founders building sell-side, and WBD setting IPO precedent for a genuinely Russian company, -- Russia might indeed turn into an exciting place to be for global investors. As Central European convergence runs out of steam with even fewer IPO-able companies available in the region, and with Latin America still feeling the contagious effect of a continuous Argentina meltdown, Russia might well find a place on the global capital markets map and see a good market for its IPOs, at least this seems to be a safe assumption for the year 2002.
Those reading this essay up until now, might raise a very legitimate question --this Russian story seems to be good, the investing strategy of 'buy IPOs' seems to make sense, but where is the catch? Well, yes, there is a catch and the name of it is the inherent Russian risk, which has not really gone away -- with all those credit rating notch-by-notch upgrades, Russia still has not made it out of the speculative grade and is fundamentally a high risk emerging market economy. The Russian government put out a lot of propaganda recently promoting its flat 13% income tax reform and newly adopted corporate governance code. Without going into a detailed discussion of Russian so-called tax reforms and initiatives in protection of minority shareholder rights, I would just dare to say that these efforts are making very little impact, and do not fundamentally change the way corporate Russia conducts its business.
Since August 2001 IndexAtlas has acted as business development adviser and later as 'go public partner' of Micex, Russia's largest stock exchange. Our major goal was to identify possible IPO candidates in Russia and market Micex services to them. Micex, being a Central Bank-controlled institution and enjoying strongly pro-market and savvy leadership, managed to build a major domestic rouble corporate bond market in Russia after the crisis of 1998; over 50 corporate issuers raised about USD2bn worth of funds through corporate bonds at the Micex exchange. The premise of the Micex/IndexAtlas IPO initiative was to propose that those and other issuers consider making new issues and IPOs at the Exchange. After six months of trying, we are yet to find the first candidate for a domestic on-shore IPO. As one can guess, the reason is not the lack of companies willing to float or lack of capital at Micex. It is Russian tax and securities market legislation that makes for a major stumbling block, forcing the likes of Vympelcom, Golden Telecom, Moscow Cellular and Wimm Bill Dann (the four last and only Russian IPOs) to float internationally while not being able to float domestically. Most successful Russian private businesses consolidate their ownership and books offshore, and foreign domiciled companies, even if they have over 95% of their assets and cash flow in Russia, still cannot list in Russia, full stop.
As a result, even the best Russian public companies that adhere to the best disclosure standards, such as those imposed on the recently floated companies by the US Securities and Exchange Commission, tell two different truths: one for their international shareholders, and another one for their domestic regulators. This is wrong and will not be sustainable in the long run, imposing unnecessary risks on investors; and this is where the catch is.
