The Russian Equity Market:
Raising the Bar in 2003:
Strong Foundations; Heading Forward?
April 23, 2003 Boston, Mass
Timothy Seymour, Managing Director, Troika Dialog Group
/President, Troika Dialog USA
Overview:
• Where are we? Recent events as evidence of change
• Troika Dialog
• Corporate Governance/Market infrastructure
– A look back;
– Key events to watch
• Economic viability for growth
– Can the economy broaden on weak financial system?
– Sectors for growth
• Market Valuations
• Investment thoughts
Bar Has Been Raised Last 2 weeks:
• Yukos/Sibneft
• Dividend pmts soar( LUK, Rostel, Yukos)
• MTS deal fair and transparent; controlling stake
• Transneft capitulates
• Market forces lead change (Surgut?)
– EXOGENOUS FACTORS KEY…BUT RUSSIA GROWS INTERNALLY
Practicing what we Preach • 1991 Among the first in the market Troika gets the license,
to operate as a broker
• 1992 Among first in the market Troika converts to GAAPPWC is our auditor since 1998 until now
• 1993 - 1997 Troika actively participates and leads in the building of Russia's financial market infrastructure
• 1998 Troika honored all of its commercial obligations
Troika helped launch the Coordination Center for Investor Protection
Troika began publishing weekly CG updates
Troika is among the founding members of 2015 Club
• 1999 The 1st CG overview report in Russia
Troika is among the founding members of the Investor Protection Association
Building a Business on Good Governance
• 2000 Troika is among the founding members of the WEF’s task force “Changing Corporate Governance in Russia”
• 2001 The Perception and Cost of Corporate Governance Risk survey for WEF, presented
at the annual meeting in Davos
• 2002 Troika’s president becomes a chair of the RSPP Corporate governance Committee Management buyout
• 2003 Troika’s president recently elected a member of the National Council for Corporate Governance
Role of Troika Dialog as a “Market Participant”
• Key contributor in creation of NAUFOR
• Co-founder RTS (Russian Trading System)
• Market infrastructure support: DCC
– helped set up exchanges
– helped set up rules of trade
– helped set up settlement and safekeeping systems
– worked with international assistance organizations
– advised government and regulators
These structures and standards survived intact the Banking Crisis of 1998
Troika Dialog USA, Inc.
• Est. 1999, 1st Russian Broker to receive license after crisis
• NASD Broker/Dealer
• SEC governed
• Leading market share in listed and OTC Equity/Debt Securities in US to institutional investors among “local brokers”
• 2-way flow of capital between US-Russia; distribution for key Investment Banking Projects and Asset Management (Private Equity, US Mutual fund, VC)
Corporate Governance…changing
• Recent Milestones
• Hurdles
Market infrastructure: 1991-2003
2003 milestones
• FCSM to regulate price manipulation in the market
• The FCSM together with the RSPP launched the National Council for Corporate Governance
• Consolidation in the telecommunication industry
• The natural monopoly reorganization:
– The electricity reform program is enacted on the legal level
– Government to proceed to reorganization of the gas sector
2003 milestones:
• State tightens control over largest domestic companies
• Domestic investor base to grow
• FCSM delegates some supervisory functions to exchanges
• FCSM to tackle the price manipulation in the stock market
• Reforms of natural monopolies:
– Telecommunication sector consolidates
– Electricity Law adopted
CalPERS’ current Permissible Country List (Equity).
“Prohibited for investment” List
China
Colombia
Egypt
India
Indonesia
Jordan
Kenya
Malaysia
Morocco
Pakistan
Philippines
Russia
Slovakia
Sri Lanka
Venezuela
Zimbabwe
Source: Patient Pension Capital by William Dale Crist, Ph.D and Kayla J. Gillan, J.D.http://www.calpers-governance.org/viewpoint/speeches/crist.asp
CalPERS' Permissible Country Program
Source: Patient Pension Capital by William Dale Crist, Ph.D and Kayla J. Gillan, J.D.http://www.calpers-governance.org/viewpoint/speeches/crist.asp
Category Assigned Weight, %
1 Political Risk 10
2 Market Liquidity/Volatility 15
3 Country Development 10
4 Market Regulation/Legal System/Investor Protection 20
5 Investment Restrictions 15
6 Settlement Proficiency 15
7 Transaction Costs 5
8 Technological Growth 10
9 Social Issues N/a
Challenges that remain
• Dividend legislation is stalled in its track
• Voting treasury stock
– Affiliated party regulation
– M&A regulation
Accounting and audit reform in Russia
• The government to discuss the accounting reform program within the next six months
• Accounting dodges: RUSSIA and US
“Accounting” dangers to shareholders Russia US Poor accounting standards YES NO Stock option plans NO YES Loans to directors and top executives NO YES Auditors provide additional non-audit service YES YES Off-balance liabilities
YES YES
Next steps to watch
• UES reform is underway
– UES to discuss 5+5 strategy program
– Deregulation postponed?
• Gazprom is next in line
– Economics Ministry to submit third draft of gas industry reform program
– No real changes until post-presidential election
– Capex transparency?
– Liberalization of shares?
Russian Economy in 2003:-on the brink of an intense structural transformation?
20031999
20022001
2000
1997
19961995
1998
1994
-15
-10
-5
0
5
10
15
0 2 4 6 8 10 12 14 16 18 20
Current Account (% of GDP)
Gro
wth
(%
)
Moving into this area?
Diversified economy and developed financial system should remove dependence on current account (i.e. oil price)
• Incomes rose rapidly and, with them, domestic demand. However, Russian companies were unable to increase production accordingly.
• Demand shifted toward more expensive and higher-quality products, resulting in higher imports.
• However, consumer services (which cannot be imported) are likely to have grown much faster than the 0.4% growth officially reported for 2002.
• An expansion in small businesses was recorded in 2002, mostly in the service sector. To some extent, the economy became healthier and government efforts to de-regulate did bring results. However, a great deal still needs to be done.
• Financial sector reform is still on the agenda.
Themes:
Growth rates (y-o-y) slowed on back of continued strength in oil price…
100
101
102
103
104
105
106
107
1Q01 2Q01 3Q01 4Q01 1Q02 2Q02 3Q02 4Q02
GDP Five basic sectors Industrial output
75
80
85
90
95
100
Jan-01 Jul-01 Jan-02 Jul-02
2
3
4
5
6
7
$ bln
Import, $ bln Real effective exchange rate (Jan-01=100%)
Effective real exchange rate even depreciated slightly (by 1.7%) in 2002, while imports grew 12.7%
100
110
120
130
140
150
1999 2000 2001 2002 2003e
Investments Real effective exchange rate
Ruble appreciates substantially: harmful for “old” economy, but may stimulate economic restructuring
80
90
100
110
120
130
140
150
160
170
180
1998 1999 2000 2001 2002 2003
Non-interest federal expenditures GDP
In real terms non-interest spending grew much faster than GDP, contributing to inefficient allocation of resources...
100
102
104
106
108
110
112
114
01/01/02 04/01/02 07/01/02 10/01/02 01/01/03
37
39
41
43
45
47
49
51
Public debt Private debt
Domestic borrowing limited by low monetization of economy
0
5
10
15
20
25
30
2001 2002 2003
1-day MIACR Deposit rate Credit rate Refinancing rate
Due to oil windfalls, money market interest rates are well below refinancing rate
Russian Market:
• Oils have re-rated
• What sectors lag
• Where is growth to come from?
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 20060
100
200
300
400
500
600
Russian Oils Re-rate
Rest of Russia Re-rates
Source: DATASTREAM
RTS: From Oils and Beyond
Non-Oil Sectors Are at Discount to Their Global Peers
Ratio of Russian sector EV/EBITDA ‘03 to its GEM average
Source: Troika Dialog, Bloomberg
44%
–24% –25% –26%
–35%
–46%
–61%
–36%
–0.8
–0.6
–0.4
–0.2
0
0.2
0.4
0.6O
il a
nd
Gas
Tel
ecom
s
Con
sum
er
Man
ufa
ctu
rin
g
Ban
kin
g
Met
als
Tra
nsp
ort
Ele
ctri
city
Domestic consumption – key growth driver for economy• Industries targeting domestic
consumption lead economic growth
• Growth drivers:
• Change in consumption patterns toward branded products
• 6-7% growth in private incomes over next three years
• Consolidation and new quality standards
• FDI growth
Food industry remains a growth leader
Source: State Statistics Committee, Troika Dialog
-15%
-10%
-5%
0%
5%
10%
15%
20%
1996 1997 1998 1999 2000 2001 2002 2003E 2004F
Food industry GDP growth
Consumer Sector: Trending beyond 2003• Consumer Sector unlikely to total
more than 10% of total Russian market cap.
• 2003-2005 remain industrial export oriented
• Growth financed by external debt and export revenue, not banking sector loans
• Consumer Sector will see greater sophistication in brand awareness,; consumers will demand improved products and better packaging
70.0
80.0
90.0
100.0
110.0
120.0
130.0
140.0
1996 1997 1998 1999 2000 2001 2002
Real disposable income Retail turnover Food production
Retail and food industries have got most benefits from economy growth
Investment opportunities in consumer and financial sectorsDriver
• Industry consolidation by global players
• Structural changes in economy
• Emerging of new domestic leaders
How to play
• Wimm-Bill-Dann.
– Upside to estimated acquisition price 50%
– Danone is potential acquirer
• Sberbank
– Liberalization of trading with banking stock
– Improved environment on reform of banking monitoring and implementation of retail deposit insurance
• Incoming IPOs
– Banks: MDM, Alfa-bank
– Retail: Pyaterochka Seventh Continent, Perekrestok
New consumer good stocks provide extensive growth of the market • Industry is on the earlier stage of
consolidation
• Current growth is financed by own profit and direct investors
• Several companies will reach critical size to go public in 2004
• Most IPO’s should be among retail companies
– Low penetration promises high growth potential
– Chains account 12% of total turnover in Russia vs. over 30% in eastern Europe
– Low attractiveness as targets for global players
Share of consumer good industries in 2002 FDI
23,0%
Share of consumer good companies in market capitalization
1,7%
Pyaterochka Retail Sales
$500 mln
Perekrestok Retail Sales
$320 mln
M-video Retail (electronics)
Sales
$365 mln
Kalina Cosmetics Sales
$130 млн
Expected IPO’s 2004 – 05
What to expect in next 2-3 years
• IPO calendar still light through 2004 as companies look to raise valuations in line with macro re-rating before selling out…
• …Companies will be leveraging up
• Gazprom is the bellwether and will prove best liquid performer in next 18months
• Russia will go investment grade late 2004
• Domestic flow of funds will remain driver of valuations and should provide technical out performance foundation.
• Watch out for “ Chaebolization” effect