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Analytical review “IPO of Russian companies” 2008

18.09.2008
The first Russian companies came to the stock market by holding initial public offerings (hereinafter – IPO) back in 1996. We have been witnessing considerable growth of numbers of IPO companies from countries with emerging economies since 2005.

If we want to see the pluses and minuses of IPO better, we must compare it with alternative capital attraction sources. Today funds can be raised from the following sources:
Firstly, undistributed profits. This is one of the most common sources of funding for investment projects. We need to take into account however that its availability greatly depends on the prevailing economic conditions and the financial and production status of the company. It is very risky to rely on this funding source in case of a long-term project where return is expected after several years.
Secondly, budget funds and governmental loans. This source has rather high capacity, even though getting access to it is quite problematic. Obtaining budget funds is always a time-consuming affair due to multiple delays caused by bureaucratic procedures. Only large-scale companies that receive partial support from the state can give serious consideration to this investment source.
Thirdly, bank loans that are becoming a very popular source of capital formation due to the rapid expansion of the banking system. However bank loans are not a miracle cure in that on the one hand they create undesirable dependency on one creditor and on the other hand the attracted funds have to be repaid at rather high interest rates.
 
And finally bonded debts floated by companies on the open market. For bonded debts, the required payment flow for coupon payments needs to be ensured, which can become a burden in case of a long-term project. In addition, quotation is often required from companies that want to obtain bonded debts in Russia, which also impedes their application for funding capital-intensive projects.
Thus IPO allows companies to attract large volumes of financial resources that almost can be treated as non-repayable and can potentially be used for business development.

Speaking of the indisputable advantages of IPO, we  cannot but mention that in addition to generating capital, the IPO mechanism offers a whole range of other unique business development opportunities to the issuing company, and in particular:
1. it enhances considerably the financial standing of the company;
2. it creates conditions for more profitable listing of the debt instruments and attract loans on the security of shares;
3. it creates of an efficient instrument of evaluation of the current market value of the company and an efficient process for merger/take-over transactions;
4. it allows the company to enhance its lobbying potential due to the fact that influential financial institutions become its shareholders;
5. it enhances the company’s prestige as a partner and counteragent in contacts with domestic and foreign companies.

No doubt, the owner-shareholder may refuse to hold an IPO both for objective and subjective reasons, but in this case his company risks losing the most promising development opportunity. 
The first IPO of a Russian company was carries out in 1996 when Vympelcom Company raised $110,8 million at NYSE. During the period from 1996 to 2003, 13 companies listed their shares, while in 2004 IPO was held by 7 companies. In 2005 and later, the situation in Russia enabled companies to turn to IPO as a source of funding, and the number of companies listed at stock exchanges reached 15.

In 2006, Russian companies raised about $60 billion by floating their shares and bonds, while in 2005 the raised amount was $33 billion. Capitalization of the Russian stock market grew almost twofold and amounted to over $1 trillion. This was caused both by the growth of quotations of many Russian companies and a large number of IPOs.
Initial public offering of shares became one of the most popular trends at the Russian stock market in 2006. As President of Russia Vladimir Putin noted at his press-conference in February, 2006 “can without reservation be called the year of IPO”.

In 2006, for the first time in the history of IPOs on the Russian stock market, individuals got the opportunity to submit requests to buy securities freely. The listing of Rosneft was the first “popular” IPO in Russia. It resulted in the fact that  115 000 of Russian citizens became shareholders of Rosneft, investing 20,2 billion roubles. In March 2007, 30 055 individual investors bought stock issued by Sberbank (the Savings Bank of Russia) to the total amount of 13,7 billion roubles.

Recently we have observed three emerging trends on the Russian IPO market. Firstly, it was the “popular” IPOs undertaken by Russian state-funded companies that were held on the largest scale.  Secondly, the sector structure of IPOs has changed drastically. Leaving alone the “popular” IPOs, developers and metallurgical companies are at the top of the list of industries where issuers operate in terms of amounts they raised by listing their shares at the stock exchange.  The growing share of the Russian trading sites in the total value of IPOs can be seen as the third trend. While in 2005 the Russian sites accounted only for 6% of the total amount of raised funds, in 2006 their share reached 36% and in the first six months of 2007  it was as high as 43% of the total value. Such dynamics can obviously be accounted for by the new regulations of the Federal Service for Financial Markets that took effect in January, 2006. They require that Russian companies float 30% or more of their equities at Russian stock exchanges if they decide to go public. In addition, going to domestic sites, such as RTS and MICEX, costs a company less and takes less time than listing on foreign exchanges, and due to the developing infrastructure companies get the opportunity to hold goal-oriented listings.

Experts of AksionBKG (CiG Business Consulting) Company specify six key methods of initial public offering that Russian companies use at present.

The first method consists in a public offer to sell the issuer’s shares made by the existing shareholders without involvement of the issuer. Shareholders use this method to ensure full or partial exit from the business on the best possible conditions. In the situation when the reserves for rapid growth of the current market value of most Russian companies have been exhausted, many stockholders make up their mind to part with their shares.  During the past 12 months, quasi-listings of this kind were undertaken, for instance, by stockholders of OAO Raspadskaya.
The second method is to list equities among a restricted number of investors. IPOs of this kind can also be viewed as quasi-listings as the offer is made to a previously determined number of potential investors or takes the form of a competition between portfolio investors. Such listings were held by Integra and the International Trade Centre.

The third method that was quite widely used until recently is when majority shareholders sell part of their shares to the general community of investors with subsequent purchase by such shareholders of the same number of shares in the process of closed subscription to a new issue of shares. Such scheme of listing has recently been used by Severstal and OAO Magnitogorsk Metallurgical Works. The wide use of this method was possible due to the imperfection of the laws that do not permit to proceed to secondary bidding immediately after the listing of shares. With the introduction of the new regulations of the Federal Service for Financial Markets (FSFM) , many companies will probably be able to stop using this method.
The fourth method is public listing of shares of companies incorporated in foreign countries whose business and assets are located in Russia. By holding such listings, companies do not have to comply with the regulations of the FSFM requiring to sell at least 30% of shares in the process of IPO on Russian exchanges. We can cite as examples listings held by RGI International ? Mirland Development.

The fifth method consists in public offering of stock issued by Russian companies on Russian exchanges. In this case both the issuer and the underwriter can act as the seller, while the existing shareholders may be provided with the opportunity to participate in the aggregate bidding of shares together with the issuer. It is obvious that the percentage of stockholders willing to sell their shares in the total volume of the bid should not be too high. The listing of Sberbank was held only on Russian exchanges – RTS and MICEX.

The sixth method is to float equities on the domestic and foreign market at the same time. The persons or entities that prepare the floatation keep a single request log where requests filed both by Russian and foreign investors are registered. The IPO held by Rosneft is the best known example of such listing. 63% of the total funds raised by the IPO were generated at the foreign market, and the company shareholders were the sellers of the vast majority of stock on the foreign market.

The forecast of BrokerCreditService Investment Company describes 3 possible IPO market development scenarios in Russia: the pessimistic, the optimistic and the most probable one.
If the pessimistic forecast is true, the volume of the Russian IPO market may reach $1,23 billion by 2010.

By optimistic estimates, we can expect the growth of the IPO market to $7,30 billion.

If the IPO market develops in accordance with the most probable scenario, by 2010 its volume will reach $3,95 billion.

Thus the study shows that by 2010 the volume of the Russian IPO market can be 4 to 25 times higher than it is today.

The high variation of values for the Russian primary stock market obtained by analysts can be accounted for by the market development situation and the high growth potential.
In conclusion it should be noted that the Russian primary stock market possesses a high growth potential that greatly depends on how shareholders of Russian companies will  change their attitude to the funding of their businesses through securities market instruments and on the governmental regulation and support of the market.
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